I hope all of you are enjoying this holiday season. As usual, this period is proving to be quite slow for the financial markets. Wall Street traders and investors are preoccupied with families, friends and festivities so trading volumes tend to be low.Take a look at the chart below to see how the major indices are ending 2007. The Nasdaq (black line) and the Dow (gold line) are going to end the year with good but unspectacular gains. As of today, the S&P 500 (blue line) is up about 6%. If you are hoping for better gains in 2008, I suspect you should hope for a strong rally early in the year. With and uncertain presidential election in the fall, Wall Street with probably see a precautionary sell-off ahead of time.

Enjoy the weekend and the start of 2008. We hope next week is the start of a prosperous year for each of you.

F.S.

As late as Halloween, it appeared that 2007 had the potential to be a pretty good year for the stock market. The Nasdaq was up about 17%, the Dow was up 12% and the S&P 500 was still holding a 9% gain. With a week until Christmas, the picture was markedly different with the S&P 500 barely clinging to a 2% gain. The Nasdaq was leading with a 7% gain and the Dow was up just 6% for the year.

Barring some unforeseen rally the last week of the year, 2007 is going to go into the books as a very ho-hum year for investors.

There are plenty of reasons for the recent weakness in stocks. The sub-prime mortgage fiasco gets most of the press. But high energy costs and rising inflation are also to blame.

The chart below gives a good illustration of the condition of the equity market and it isn’t pretty. The black line is the daily closing price of the Nasdaq. The blue line is its 200-day moving average. It is currently below that line and showing a lot of weakness. The bottom portion of the chart is a moving average convergence divergence of the Nasdaq. Notice that after it bottomed and started moving up nicely in December, the past few days it turned downward again–not a good sign. Finally, the gold line is the S&P 500, included just for comparison purposes. Notice that it is showing even more weakness and is in danger of moving into negative territory before the end of the year.

A few weeks ago I explained my reasons for believing that we would have a rally in December that would carry stocks to their highest levels of the year. Obviously that seems very unlikely now. Probably the best we can hope for is that stocks will rally back to their highs reached earlier this month.

There is a lot of nervousness by investors and Wall Street traders right now. On a long-term basis the market remains in an uptrend, but the next three or four weeks will go a long ways to determining whether that will continue. Keep a close watch through the holiday season and be prepared to sell long positions if we see consecutive sharp down sessions.

Have a great Christmas Holiday with friends and loved ones.
F.S.

The end of the year brings one of the more confusing aspects of mutual funds for investors. Fund owners are given a distribution, usually sometime in December. The distribution comes from the dividends and yields paid to the fund from the stocks it holds. The fund is required by law to pass these gains onto its shareholders.

The term “distribution” is a little misleading, because instead of passing these dividends on to the mutual fund client, the fund keeps the cash and reduces the value of the fund shares. Then it issues additional share to fund investors to make up for the difference.For example, on Dec. 15 Fund ABC has an Net Asset Value (NAV) of $10 per share. Investor Bob owns 10 shares for a total account value of $100.

On Dec. 16, Fund ABC issues a 10% distribution. Investor Bob still has $100 in his account, but he now owns 11.11 shares valued at $9.

Investors who are not aware of how these distributions are handled can be shocked when they check the share price of a fund they own and find that it dropped dramatically for no apparent reason. Often they fail to see that the price decrease is offset by owning a greater number of shares.

The accompanying chart illustrates this problem. The red arrows mark two separate December distributions. In each instance, the price of the fund appears to plunge. In reality, anyone owning the fund would have the price decline offset by an increased number of lower-price shares. So the net effect on an account balance would be zero. But it can cause a panic for an investor who does not realize what has taken place.

Of course, there can also be tax implications with these phantom distributions. In qualified accounts like IRAs or 401Ks, the distribution is essentially a non-event. But in a taxable account, the distribution is counted as income. That means in the example above, as far as the IRS is concerned, Investor Bob received an extra $10 in income on which he must now pay taxes. It doesn’t matter than his account value did not change.

In this example, the amount is not significant. In real life, phantom distribution income can be major. In funds with high returns and high portfolio turnover, distributions can be 20% or even more. That can result in an unexpected hefty tax burden for someone caught unaware.

Some investors avoid the distribution problem by finding out when a fund historically makes its distributions and then selling ahead of that date. Of course the investor who takes this approach must then wait the required period before buying back into the fund or he faces the tax implications of a wash sale.

F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group. This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Flint, at 800-279-3377.

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Since bottoming on Nov. 26, major stock indices like the Nasdaq, Dow, and S&P 500 have gained from 4% to 7%. That leaves them 5% or 6% from their previous highs of the year and sets the stage for them to peak between now and the end of December. In case you’ve forgotten, that is the exact scenario I anticipated and wrote about in the Nov. 15 blog. Feel free to go back and check it out.

The stock markets are unpredictable, however, and there is still a need to watch our positions with cautious optimism over the next few weeks. But for now it certainly appears there is a good chance for stocks to follow their usual pattern of reaching their highest point of the year right around Christmas break.

More about managing your self-directed retirement account

If you have any sort of a self-directed retirement account, it is important that you have a strategy for managing those financial assets. Without some kind of a plan, there is a high likelihood that you will take too much risk or have a low return. Many plans try to help participants with this problem with offerings called lifestyle or lifecycle portfolios.

Lifecycle portfolios consist of an asset mix determined by a professional manager. This mix is adjusted depending on how many years remain before participants are going to retire. Sometimes these portfolios are given a name that corresponds to a future year. One might be called XYZ Insurance Lifecycle 2020. The next might be XYZ Insurance Lifecycle 2025, and so on. Participants merely choose the fund that corresponds most closely to the year they intend to retire. Other times the portfolios are less specific. For example, in my wife’s 401K the lifecycle selections are called Short Horizon, Medium Horizon and Long Horizon.

Usually the asset mix is an assortment of stock funds and bond funds. The lifecycle choices that are closer to maturity contain a higher percentage of bond funds as an attempt to reduce volatility and risk.

In contrast, lifestyle portfolios usually correspond to a risk category. These are usually defined as something like XYZ Insurance Lifecycle Aggressive, XYZ Insurance Lifecycle Moderate, XYZ Insurance Lifecycle Balanced, etc. While both lifecycle and lifestyle portfolios are professionally supervised, there can be huge disparities in performance within offerings in the same plan or among the offerings of different plans. So it is important to thoroughly investigate the management style and performance history of the plan offerings.

Buy and hold or asset allocation

Another option for managing your defined contribution pension plan is to follow a diversified buy and hold approach. This is also commonly referred to as asset allocation. With this type of strategy the account owner attempts to minimize risk by dividing the account assets among several of the plan’s investment alternatives.

For example, the plan participant might put 20% in a bond fund, 20% in a large cap fund, 20% in a small cap fund, 20% in an international fund, and 20% in an S&P 500 index fund. In reality, this type of strategy doesn’t do much to reduce overall market risk. There are many studies that show there is a fairly high correlation between international funds and an A&P 500 index fund, for example. So while a person taking an asset allocation approach believes he has diversified his risk, that might not be true.

An active management approach

Some plan participants want to take a more active role in the management of their retirement assets. While that can be a good thing, it can also increase the risk level.

Often the increased risk occurs because plan participants are unsure of how they should invest the assets of their account. So they seek out the advice of a co-worker who is perceived to have some knowledge about the investment markets. I know of one office where most of the participants in the company 401K plan invested all of their assets in an energy sector fund on the recommendation of a company supervisor.

It was a period of rising oil prices and the recommendation turned out well for most participants. Unfortunately for some, they neglected to sell when the price of oil dropped and their accounts suffered accordingly. The point is, even for those who got out in time, putting all of their assets in a single market sector was risky and inappropriate.

When properly practiced, an active management approach can actually decrease portfolio risk. Instead of a static allocation like the buy and hold investment style, active management involves moving assets to cash or to lower risk alternatives when market risk is high then reallocating to stronger sectors when market risk declines.

Obviously the difficulty is being able to identify those high risk periods and knowing when to move assets from one market sector to another.

To successfully follow an active management approach, an investor needs to have a fairly high level of market knowledge and sophistication. Like any other field, this usually comes through study and experience. Fortunately there are plenty of places an investor can go to acquire information, such as this web site.

The phrase “active management” can be a little misleading. Sometime investors get the incorrect impression that active management means constantly changing one’s portfolio allocation. In practice, changes are only made when absolutely needed. In a 401K or other retirement plan, those times might only occur once or twice a year.

At DentalDollars.net (Strategis Financial Group) our active management utilizes a combination of technical, cyclical and fundamental tools to help us make decisions about when to make changes in portfolio allocations. Throughout the course of a year, we include information about many of the tools and the decision-making process in this weekly advisory service. These include things like moving averages, various oscillators, breadth indicators, and momentum indicators.

Professional management

Some investors like the active management style, but lack the time or expertise to do it themselves. Some defined contribution plans allow for the possibility of professional management by an outside party. Usually the cost for this type of management is in the range of 1% to 2% a year.

If you are unhappy with the performance or cost of your company’s 401K or other defined contribution plan, please feel free to contact Strategis Financial Group for a review of the plan and a comparison proposal. (800-279-3377) In many cases we can actually offer a less expensive alternative that included much better features and investment options.
F.S.