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Year-End Reminders


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As I try to get back into shape for snowboarding, here are a few year-end investing reminders.

All Investors

  • If you expect your 2010 tax rate to be lower than usual (due to starting a business, unemployment, etc), converting IRAs and old 401k's into a Roth IRA could be a smart move. The deadline to convert is December 31.
  • An easy way to reduce taxes is to realize capital losses in your taxable accounts. You can sell investments that have dropped in price and replace them immediately with something similar (but not the same!) Your portfolio remains roughly the same, but now you have a tax deduction. The deadline to sell is December 31.
  • If you are looking to sell appreciated investments within the next few months, consider selling them this year instead of next, because the tax rate on capital gains may go up in 2011.

Parents

  • If you plan on paying for your child's college education, 529 plans are a great way to save for those expenses. The deadline to open accounts and make contributions for 2010 is December 31.
  • Already have a 529 account opened and funded? Remember to use your annual trade by December 31 if you are not using an age-based option.

Business Owners / Self Employed Workers

  • If you are self-employed or own a business without full-time employees, Individual 401k's are a great way to save for retirement.  The deadline to set one up is December 31.
  • Depending on how your business is taxed, the deadline for employee contributions to an Individual 401k can be as early as January 15, 2011.  Speak to your accountant for your specific limits and deadlines.

Philanthropists

  • Make your donations by December 31 to deduct them for 2010. You can even donate appreciated assets to avoid the capital gains tax. 
  • If you want the tax benefits of a charitable donation this year, but you are not ready to decide on a charity, you can open a donor-advised fund. You get the tax deduction when you contribute, and you can decide which charity gets the money later. 

The Mariposa Blog

In case you missed them, here are a few recent blog posts:

Online Investment Advisors: MarketRiders, Betterment, and Plantly
This post compares 3 new online investment services to investing in a target-date fund.

Stock Market Experts of the 1930s
How did market experts and institutional investors from the 1930s do in predicting the stock market?

Investment Options: US Real Estate
What are the best index funds and ETFs for exposure to US real estate?

Edwin's Market Commentary

As the year comes to a close, you will without a doubt see financial magazines and newspapers predicting what the markets will do in 2011 and suggesting what you should do about it.  Most will be supported by a good story, not necessarily evidence. If you do notice any that seem well-researched, send them my way. I will be pleasantly surprised.

We already know that successfully predicting stock market movements is extremely difficult--just ask mutual fund managers, Wall Street research analysts, or even your grandparents' market experts. So if you want to consider it, whether for fun or for profit, you need to be particularly skeptical and careful with your research.

To see what we're up against, let's try to estimate future stock market returns using a valuation metric we've discussed previously: the P/E ratio. First, take a look at the historical relationship between the P/E ratio using 20 years of earnings and the following returns over 1 and 20 years (annualized and adjusted for inflation.)

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The two sets of data look completely different. 1-year returns (in blue) are not only highly volatile, but the relationship with P/E ratios does not look very strong.  The 20-year annualized returns (in red) are more stable as expected, but they also show a stronger relationship with P/E ratios. It looks like P/E ratios--even when using 20 years of earnings--are not very helpful in predicting 1-year returns.  Keep this in mind as you read those 2011 forecasts, especially if they rely on P/E ratios.

So when are P/E ratios useful? Let's evaluate the benefit of using P/E ratios to predict returns for the next 1 to 20 years starting at current market levels (S&P index = 1219.)  The lines below show the range of predicted returns (plus/minus two standard deviations) with and without the use of the P/E ratio.

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The two blue lines show the typical range of returns calculated simply from historical returns. The two red lines show the range of returns predicted by the P/E ratio when using 20 years of earnings. The two ranges do not seem materially different until 10- and 20-year predictions, so we can only consider P/E ratios to be helpful when predicting returns over such long time periods.  For short-term predictions, our search for a useful metric continues.

And more bad news, based on historical relationships, it looks like we should expect returns in the lower part of the typical range, especially over the long term. 

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Mariposa Capital Management is an investment advisor to individuals looking for a different kind of advisor.  Our approach to investing is to use simple yet effective strategies that are based on research and empirical data.

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