What's Next For Equity Markets? And What To Do?

[clifp]

Personally, my fear of the IRS has decreased dramatically after the latest scandal about administration officials

Here is a snippet from the WSJ article on Geithner.

In 2006, the IRS audited Mr. Geithner's 2003 and 2004 taxes and concluded he owed taxes and interest totaling $17,230, according to documents released by the Senate Finance Committee. The IRS waived the related penalties.
During the vetting of Mr. Geithner late last year, the Obama transition team discovered the nominee had failed to pay the same taxes for 2001 and 2002. "Upon learning of this error on Nov. 21, 2008, Mr. Geithner immediately submitted payment for tax that would have been due in those years, plus interest," a transition aide said. The sum totaled $25,970.
The Obama team said Mr. Geithner's taxes have been paid in full, and that he didn't intend to avoid payment, but made a mistake common for employees of international institutions. That characterization was contested by Senate Finance Republicans, who produced IMF documents showing that employees are repeatedly told they are responsible for paying their payroll taxes.
As to why Mr. Geithner didn't pay all his back taxes after the 2006 audit, an Obama aide said the nominee was advised by his accountant he had no further liability. Senate Finance aides said they were concerned either Mr. Geithner or his accountant used the IRS's statute of limitations to avoid further back-tax payments at the time of the audit.
Other tax issues also surfaced during the vetting, including the fact Mr. Geithner used his child's time at overnight camps in 2001, 2004 and 2005 to calculate dependent-care tax deductions. Sleepaway camps don't qualify.

Now this isn't a political statement, but just my observation, that unless you are deliberately attempting to defraud the government the IRS doesn't seem to be particularly nasty recently.
Two things stand out. First they IRS waived penalties. Second despite clear evidence that Geithner screwed up the IrS wasn't smart enough and audit previous year returns. So even if the IRS audits you one time and rules against your method, it seems unlikely that you'll owe more than interest on the taxes.

Finally what are these capital gains you are writing.

 

[Ed_The_Gypsy]

I just now saw Ha's post here.

My portfolio has performed about the same as Ha's and I have wondered what to do, too. Since I couldn't come up with any better ideas, I am sticking with my basic plan: 70/30 equity/bond funds & CDs, and the equity 50/50 US/foreign. Starting in the middle of last year, I began to build a CD ladder.

It would be real nice for my valuations to go back up. Theory says they will. I am guessing that this will take a few years, though. Time for strong stomachs.

I wonder how gummy is doing these days? There is a quant's quant! Does he ever get the willies in times like these, or is he a man of iron? Inquiring minds want to know!

Gypsy

 

[rjsciurus]

Distributions (mutual fund distributions include dividends or any short and long-term capital gains realized ) paid from a mutual fund increase the basis because you pay tax on the distributions. That's how taxes on mutual funds work. Then when you sell mutual fund shares later, any distributions paid out already increase the basis because you already paid tax, you only pay tax on any additional gains.
Audrey

Hello,
Delurking because this caught my attention. I'm trying to decide if I'm reading too much into this, or if there's some issue I've neglected. My understanding was that MFs adjust their NAV when they give dividend or CG distributions. If you reinvest, your total value doesn't see it-- changes in NAV are counteracted by increased shares. If you don't, you *may* see the NAV lurch slightly. The tax paid on distributions is reflected by the drop in NAV (thus basis).

In the end, it's quite simple if I track every purchase/redemption (including reinvestments) with something like Quicken. I can easily use FIFO tax basis for sales of x shares of the fund by simply having Quicken report my basis for all purchases from the oldest up to x shares. The distribution-based taxes paid yearly in the past are irrelevant. That's useful if you believe FIFO is to your advantage and wish to harvest tax liability now-- taxes will go up, or low current tax bracket. It's a permanent decision for that fund made at the first sale, of course.

Would you agree with this, Audrey?

 

[Grep]

Clifp, I wouldn't read too much into how Mr. Geithner's case was handled. It was, one might imagine, a "special" case. On the other hand, yes, the IRS is a pussycat compared to many state's tax boards (like mine).

As to capital gains, I increased my allocation to stocks at the lows and, mirable dictu, some things are up for the moment.

Back to the original question, I do not know what will happen in the future, but in broad strokes my strategy is to:

1) Tax loss harvest when appropriate and use the money to:
2) Increase diversity and/or rebalance into beaten-down funds.
3) Don't try to time the markets short term, yet watch valuations and:
4) Within reason, increase equity exposure at new lows.
5) Hang on for the long term, yet slowly ease back to normal levels as the situation improves.

During this crisis, I moved from a fairly basic total market approach to one somewhat more heavily weighted towards small / value, foreign, small-cap foreign, emerging markets, REIT's, etc.

We may not see a full recovery for many years, but things will improve.

 

[tuixiu]

We're just rounding the corner to where our non-retirement (as in not in a 401k, 457, Roth) savings are getting significant enough to really start considering the impact of taxes and strategies to best avoid.

It's daunting to say the least.

 

[charlie]

Is anyone but me concerned that the market will take a hit
when the bank stress test results come out? If I had any cash
to invest, I think I would hold it a little longer and wait for
a correction. After all, the runup from early November can't
keep going forever.

Cheers,

charlie

 

[Gotadimple]

The market has already priced these results into each bank's stock price. With the biggest banks reporting profits, I don't think the overall market's reaction will be driven by the specific results. That doesn't mean, though, that we won't see volatility -- as long as it isn't 20% a day, I'm relatively OK with that.

-- Rita

 

[NW-Bound]

Is anyone but me concerned that the market will take a hit
when the bank stress test results come out? If I had any cash
to invest, I think I would hold it a little longer and wait for
a correction. After all, the runup from early November can't
keep going forever.

Cheers,

charlie

I don't know much about these bank stress tests, but feel the same apprehension about the "impending correction". I don't know why you mentioned November low. The indices dipped lower in March 09 than in Nov 08.

Anyway, although my past attempts at market timing weren't that good, it did not keep me from trying again. Just sold some weaker stocks this morning to lower the stock AA from 60% to 50%. The market rose afterwards, and I would have a few more $K if I had left them alone. I will sit on my hands a while to avoid tweaking my AA too much.

On a positive note, I can brag that my portfolio value is back to the beginning of the year, while the Dow and S&P indices but not the Nasdaq are still a few percent down year-to-date.

 

[charlie]

I ment to say "runup from early March" but had an attack of senility.

Cheers,

charlie

 

[TromboneAl]

The lesson for me this past year was to have a wider band like you! I ended up rebalancing on the downswing too often last year (twice, but that was once too often!). I had set a narrower AA range band so that under "normal" swift market corrections (10 to 15%) there would be enough of an out-of-balance condition to cause me to rebalance.

After this past year I've decided to wait for more extreme market events/stronger divergences before rebalancing. The other little market correction "opportunities" aren't so important.

Audrey

I'm not so sure that that was a good lesson to learn. That is, your strategy resulted in a bad outcome last year (just as mine did -- I rebalanced on Jan 3, 09), but with slightly different timing of the ups and downs, your strategy might have been ideal.

Next year a downturn of 8% might be followed by a 30% uptick, and then your older strategy would have been better.

 

[NW-Bound]

Ah. So there are two types of investors: some are self-admitting market timers, and the remaining ones are hiding behind their "rebalance" personal strategies.

Actually, why are market timers called "dirty"? Is it because they most often fail in their Quixotic quest and lose their shirts?

However, the market timer, if successful, does a lot of good. He not only adds to his fortune, but also acts as a market stabilizing force. By selling high and buying low, he provides liquidity and reduces the market wild swings. His actions counter the madness of the crowd who flocks into the market en-masse in good years, and liquidates stocks in downturns. A very noble act indeed!

The successful ones are revered as heroic and wise contrarians, while the failing ones are called "dirty".

So, don't fail, damn it!

 

[audreyh1]

Hello,
Delurking because this caught my attention. I'm trying to decide if I'm reading too much into this, or if there's some issue I've neglected. My understanding was that MFs adjust their NAV when they give dividend or CG distributions. If you reinvest, your total value doesn't see it-- changes in NAV are counteracted by increased shares. If you don't, you *may* see the NAV lurch slightly. The tax paid on distributions is reflected by the drop in NAV (thus basis).

In the end, it's quite simple if I track every purchase/redemption (including reinvestments) with something like Quicken. I can easily use FIFO tax basis for sales of x shares of the fund by simply having Quicken report my basis for all purchases from the oldest up to x shares. The distribution-based taxes paid yearly in the past are irrelevant. That's useful if you believe FIFO is to your advantage and wish to harvest tax liability now-- taxes will go up, or low current tax bracket. It's a permanent decision for that fund made at the first sale, of course.

Would you agree with this, Audrey?

Yes, I think you are right. If you track individual lots and track any share lots bought via reinvested separately then the drop in the current NAV of the should take into account the distributions. That can be a whole lotta tracking though. The "basis raising" applies if the total $ amount originally invested is compared (for tax purposes) against the current total $ in the fund that includes reinvested dividends which bought more shares. That is what can be confusing.

Some folks never reinvest distributions so they can do the individual lot tracking more easily. Since I let the mutual fund company calculate my average share costs basis for me I don't worry about it. Average basis is usually better than FIFO for tax purposes, but with the roller coaster market for the past decade it probably is a wash nowadays.

I notice that my bond funds almost never show a capital gain but rather a capital loss in spite of my fund balances continually increasing over the years because almost all "gains" were due to reinvested dividends and I have already paid taxes on them. Rebalancing lately for me has meant realizing some capital gains losses helping my tax situation which takes a little of the sting out.

Audrey

 

[audreyh1]

I'm not so sure that that was a good lesson to learn. That is, your strategy resulted in a bad outcome last year (just as mine did -- I rebalanced on Jan 3, 09), but with slightly different timing of the ups and downs, your strategy might have been ideal.

Next year a downturn of 8% might be followed by a 30% uptick, and then your older strategy would have been better.

I recognize that it means there is a chase to miss an opportunity rebalance on a smaller drop in the market. That would be a deliberate choice. I like the idea of excuses to fiddle with the portfolio less often, and a wider band encourages this. I think in general, rebalancing less often has been shown to be more beneficial, especially for taxable accounts.

As far as I know there haven't been any studies that have shown a benefit to using an "out-of-balance" trigger for rebalancing, it's just an idea that intuitively appeals to some of us. I would probably be better off not even using such a thing but just go strictly by the 18 month to 2 year schedule that seems to be optimal for rebalancing in taxable accounts. Another big advantage of not using any out-of-balance trigger is that you can completely ignore what your portfolio is doing until the calendar says it's time to rebalance.

Audrey