Planning for an unpredictable future

All lawyers should assess what they have, what they should
have and what they should do with it to secure some peace

by Robert Berend

I firmly believe the stock market will collapse. Someday. It may last a week, or it may last two years. I don't know when it will come, but I definitely think it will.

What do you have now?

Hopefully, you have some sort of retirement plan, such as an IRA, profit sharing plan or 401(k). If you have been playing it safe, you have all that money in cash. You may have lost money -- buying power -- by barely earning interest at the rate of inflation, maybe 3 percent a year. Your fear has been a bad investment, since the stock market has done well these last 14 years.

Perhaps you have it all invested in aggressive growth small company stocks. You may have made a fortune in profit over these years.

Maybe you are in bonds, again hoping to avoid a stock market crash. What exactly is a bond? A bond is an IOU. You lend money to a company or government entity, it promises you a fixed percentage interest rate of return for all the years until that bond matures. In a mutual fund, there are always new bonds being bought, so there is no maturity date.

If you want cash flow (dividend checks), the time to buy bonds is when interest rates are high. As of mid-February, a 30-year U.S. government bond yields about 6.8 percent (federally taxable). As a California resident, for totally tax-free interest, you should own California municipal bonds. (It may still be subject to Alternative Minimum Tax [AMT].).

Lawyers should consider buying municipal bonds today. You should have been owning them all of your professional life, since tax-free income probably means more to you than taxable interest, such as what a bank CD or a corporate bond yields, after you finish paying the taxes. Munis offer federal tax-free, and sometimes state tax-free, income, and you can sell them at the going market price, which fluctuates, any business day.

If you hold it to maturity, you will get the face value and will have received the interest every six months between now and the maturity date.

If you want to make a profit in bonds (not really a lucrative goal unless you have millions invested), you know the rule: Buy low and sell high. Bond prices generally go up when interest rates go down. Interest rates, low today, will eventually rise, which means the price of your bonds, should you sell them before maturity, or the bond manager you invest with does, will have dropped. You'll have a loss, which, so long as it is not in a retirement plan, will be tax deductible.

What should you have?

You should probably have a mix of stocks, bonds and cash. You should also have insurance, including long-term care and disability, and own real estate. Need to pay off a big bill? The interest on your credit card is not deductible, but if you had a line of credit on your house, that interest payment is deductible.

Consider putting a little into collectibles (enhance your childhood comic book or Barbie collection), and maybe some money into utility, precious metal and natural resources mutual funds or stocks, if you feel that is prudent diversification.

If you have excess money, you could and probably should be investing into a tax-deferred variable annuity. You can put in all the money you want and it will be invested in stocks, bonds or cash and any earnings are tax-deferred. Most tax-deferred annuities also guarantee that, even if the investments collapse, the least your beneficiaries will collect upon your demise is the amount you put in. However, shop wisely because this guarantee is based on the claims paying ability of the issuing insurance company. If the investments profit, they collect the larger figure.

If you are fortunate enough to be making too much money and taxes are a problem, consider tax credit programs. These are usually in affordable housing (Section 42, not low-income Section 8), the tax credits are already approved for the life of the investment by Congress, and these are credits which go to the bottom line of your 1040. Unlike a tax deduction, a tax credit will reduce, dollar for dollar, your tax obligation. But keep in mind this does not reduce one's Alternative Minimum Tax and these programs are generally illiquid and are suitable only for qualified investors.

What should you do?

The simple answer is: diversify your portfolio. If you seek high reward and can tolerate the accompanying high level of risk, go aggressive. You could be in small company aggressive stocks, hi-tech, and located in developing countries. Overseas helps spread the risk of investing 100 percent in the U.S., but markets and currencies collapse, governments change and economies experience instability.

If you like to sleep better at night, spread the risk and diversify your assets. Diversification is best done between "asset classes," which means owning conservative and aggressive stocks and bonds in the U.S. and overseas, plus cash, land and natural resources. No one knows which group will win in any year, but over the long haul, all of these have the potential to rise in value and diversification should help lower your risk of having all your nest egg in one basket.

Historically, all declining (bear) market crashes and corrections have ended. The following upward (bull) market always went to newer highs. However, past performance is no guarantee of future results -- the risk is there.

But stay invested, buy wisely and when it is cheap and remember: You can't take it with you, but you can leave it for the next generation.

Robert Berend, a Berkeley-based attorney, stockbroker and registered investment advisor, can be reached at 510/845-2471.