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Happy New Year!  If, back in early March with the Dow Jones Industrial Average, hovering around 6,500, you were told that we would end the year with this index above 10,000 you would have thought that they were crazy.  However, we did and here we are now beginning a new year and, in fact, a new decade.  With this in mind, and in a similar fashion to our “Nine for 2009” column which appeared in The Record in early January, 2009 we pen our “Ten for 2010” which appears below.  Please note that these ideas are not in any particular order.

Theme number one – interest rates will go up.  Not through the roof but enough to impinge bond returns for investors with longer term portfolios.  It is never wise to go “all in” with a particular investment or investment outlook.  Fixed income investors should favor short to intermediate term bonds versus those with longer-dated maturities as well as corporate issues versus those issued by the U.S. Government.  We believe there is still value in the corporate sector and relative safety, in the sense that a rising interest rate environment is lethal to long bonds but dramatically less so to shorter term debt.

Theme number two – boring is back.  .  Calendar year 2009 was one filled with chaos, panic, rally, greed and finally solid gains for all of the major averages.  The place to be as 2009 wound down was in the more aggressive and economically sensitive areas. The large-cap, blue chip, conservative areas of the equity market, having more successfully “ridden out” 2008 lagged.  Companies like Pepsi, Johnson & Johnson, Proctor and Gamble and McDonalds endowed investors with dividends and a level of comfort but not the rock ‘em-sock ‘em returns of their smaller, more economically sensitive counterparts.  We believe that calendar year 2010 will be a better year for the more staid, conservative issues.

Theme number three – international equities keep rolling along.  It is easy to focus on the United States as, by any measure, it is by far, the world’s largest equity market as well as economy.  The majority of assets that we manage at Fagan Associates that are invested in equities are invested in U.S. Companies and mutual funds that invest in U.S. Companies.  That said, investors need to incorporate some international exposure into their asset allocation model as emerging markets are most likely to be the best performing as we move forward.  These markets are also likely to be the most volatile, unpredictable and vulnerable to geopolitical shocks as well.  Specifically, investors might consider BLDRs Emerging Markets 50 Index (symbol ADRE), the Harding Loevner Emerging Markets Fund (HLEMX) and our largest international holding, the William Blair International Growth Fund (WBIGX).

Theme number four – variety is the “spice of life” when it comes to bonds.  Despite our cautious posture outlined in our first investment theme, fixed income investors must understand the consequences of movements in interest rate and adjust their portfolios accordingly.  That said, on one hand, there is no guarantee that rates will go up in 2010 and that we will see inflation.  However, on the other hand, with short-term interest rates near zero and the slope of the yield curve very steep on an historical basic, from these levels, how much lower can rates really go.  Interest rates may linger in this area but lower really is not an option.  For this reason, we are using funds with short-intermediate maturities such as the Payden GNMA Fund (symbol PYGNX) and PIMCO Total Return Fund (symbol PTTDX) as cornerstone fixed-income investments.  Mixed in with these are the Loomis Sayles Bond Fund (symbol LSBDX), a strategic bond fund that delivered a 25%-plus return in 2009 after a dismal 2008.  Investors should also consider the Oppenheimer International Bond Fund (symbol OIBAX), a solid fund.  However, the U.S. dollar has recently shown some signs of strength, so keep this five-star star fund on a short leash.

Theme number five – opportunities will present themselves.  The stock market ended 2009 on a bull run, moving more than sixty percent off its early March lows, without even one ten percent correction.  For 2010, we envision some pullbacks that may offer buying opportunities.  Nobody knows the catalyst for such a move, but reasons include terrorism, a flare-up of hostilities in the Middle East or just some good old fashioned profit taking.

Theme number five – consider dividend paying stocks.  As noted above, many U.S. companies with solid balance sheets and attractive dividends were overlooked during 2009.  Six companies that merit a look include Intel (3.1% dividend), Honeywell (3.1%), Johnson & Johnson (3.0%), ConocoPhillips (3.9%), First Niagara Financial (4.0%) and Yum Brands (2.4%).  With CD rates hovering near one percent and with those investors experiencing “renewal sticker shock” as their CDs mature, these six could continue to be attractive alternatives to those investors seeking income.  Please note that stocks inherently contain more risk than fixed-income investments, but dividends tend to cushion that volatility.

Theme number six – maintain an even keel.  Historically it pays to sit back and take a deep breath when stocks are falling and to perhaps skim a little off the top when, like now, stocks are rallying.  It is at these inflection points that an investor is most likely to make a mistake.  Giddiness in the face of exuberant returns leads investors to take undue risk while pessimism and despair in the face of market turmoil leaves investors underinvested in equities.  Balance and control in life as well as investing keeps you on the right track.  Everything in moderation.

Theme number seven – cash is no longer king.  A looming bubble in cash, money markets and Certficates of Deposit looms.  We have started to see this bubble bursting with the maturation of CDs, U.S. Treasuries and with money market rates at historic lows.  This will continue through early 2010 as the Fed will be very reluctant to raise rates, fearful that by so doing might choke off this fledgling recovery.  These low rates will provide a floor of sorts to the stock market.  While we believe that the market is vulnerable to a geopolitical event, it also has a ready supply of investors who are disenchanted with the low rates.

Theme number eight – invest in Treasury Inflation Protected Securities (TIPS) as a hedge against inflation.  Despite the negative connotation, we believe that Inflation is like rain, some is good as it creates demand for goods and services.  However, too much is bad as prices of those goods and services tend to appreciate faster than our incomes, thereby destroying purchasing power.  We believe that 2010 will be accompanied by a little inflation and therefore recommend either the iShares Barclays TIPS Bond (symbol TIP), an ETF that invests primarily in inflation-protected bonds or the Vanguard Inflation Protected Securities Fund (symbol VIPSX).

Theme number nine – the stock market will outperform cash and bonds.  No, during 2010 investors most likely will not get the rip-roaring twenty-some percent that they garnered during 2009.  However, should, as we believe, interest trend up a bit pushing the value of bonds a bit lower, there should be enough good corporate and economic news to provide stocks with a bit of an advantage versus bonds.

Theme number ten – continue to “barbell” your stock investments.  As noted above, we like the more mature companies, but believe in moderation.  Therefore, we would suggest that investors invest in those companies on one side and complement or barbell them with some growth companies including Apple Computer, Cisco Systems, Oracle, Intel, Mosaic and some BioTech stocks.

Best wishes for a Happy, Healthy and Profitable 2010!

This article is the third of a four part series that pertains to year-end financial planning.  The articles will appear on consecutive Sundays during December in “The Record” and include, in order, “Year-End Tax Planning for Shareholders of Individual Stocks and Bonds” which appeared December 3^rd; “Year-End Tax Planning for Shareholders of Mutual Funds” which appeared last week; this article and finally “Investment Portfolio Re-Balancing for the New Year” which will appear next Sunday.  Following this series, we will immediately provide readers with a Review of 2009 and our Investment Outlook for 2010.

Given the nature of our business, in our opinion the most obvious and effective way to give to a charitable organization is through a gift of appreciated stock.  This is a win-win situation for both the taxpayer and the charity.  The taxpayer can deduct the market value of the stock on the date of the gift and the charity gets the donation.  Furthermore, by donating the appreciated stock rather than selling the stock and donating the cash proceeds, the taxpayer also avoids any capital gains tax.  Please note that this only will work with appreciated securities within taxable accounts.  Should you hold a stock that has depreciated in value, it is generally wise to sell the stock and donate the cash proceeds.  Utilizing this method, the taxpayer can write off the capital loss up to current IRS limitations.

Readers will note that the above paragraph does not pertain only to appreciated stock, but rather to all appreciated assets, including bonds, mutual funds and real estate.

The Pension Protection Act of 2006 allowed taxpayers age 70 ½ to exclude from adjusted gross income qualified charitable contributions up to $100,000 per year from either a traditional or Roth IRA and despite the fact that required mandatory distributions were suspended for calendar year 2009, this legislation was extended through 2009.  Prior to the passing of this legislation, a taxpayer would have to first withdraw the money from his IRA and then make the contribution.  Many times this withdrawal resulted in the taxation of the Social Security Benefits of the taxpayer, reductions in property tax assistance and reductions in other government sponsored programs.  This law allows the taxpayer to circumvent this step thereby eliminating the prior pitfalls noted in the preceding sentence.  Additional benefits to rolling over the IRA distribution directly to a qualifying charity is that this donation qualifies toward the owner’s minimum required distribution, but does not count toward the IRA owner’s maximum 50% cash contribution limit as a percentage of their adjusted gross income.

One final way to get into the charitable giving mood this holiday season is through gifts of life insurance policies.  To accomplish this transfer, the current owner must name the qualified charitable as either the new owner or the irrevocable beneficiary.  If the owner does one of these then he/she is able to obtain a tax deduction on the present value of the insurance contract or his/her accumulated premium payments, whichever is higher.

As always, please be sure to check with your tax advisor prior to making any sizable charitable contributions.

This article is the second of a four part series that pertains to year-end financial planning.  The articles will appear on consecutive Sundays over the next four weeks in “The Record” and include, in order, “Year-End Tax Planning for Shareholders of Individual Stocks and Bonds” which appeared last week, this article, “Year-End Charitable Bequest Planning; and “Investment Portfolio Re-Balancing for the New Year.”  Following this series, we will immediately provide readers with a Review of 2009 and our Investment Outlook for 2010.

Prior to identifying those areas that can help you reduce your taxes regarding your mutual fund holdings, it is prudent to briefly review the IRS rules surrounding capital gains and losses, in general.  If when comparing your realized (those securities sold or where the company has been purchased for cash by another company) gain with your realized loss, the net result is a loss, only up to $3,000 can be deducted from ordinary income.  The balance can be carried forward, indefinitely.  An additional component to consider prior to realizing a capital gain or loss in your portfolio is whether the transaction would trigger a long-term versus short-term capital gain/loss.  Long-term transactions are defined as those in which the underlying security has been held for one year or longer and are taxed at either zero percent for those taxpayers that are in the 10% to 15% marginal tax brackets or at 15% for those in the twenty-eight percent bracket.  Short-term transactions, those which the security has been held for less than one year are taxed as ordinary income and subject to the same tax rate as your wages or dividend income.  For most taxpayers, the rate is twenty-eight percent for the Federal Government.  In both instances, for taxpayers in New York State, long-term and short-term capital gains are taxed as ordinary income.

Number one, call your mutual fund and ask them if they are planning any year-end distributions.  Keep in mind that capital gains declared by mutual funds are taxable regardless of whether you receive them in cash or reinvest in additional shares.  Furthermore, there is no economic benefit to the distribution.  It is the same as getting four taxable quarters in return for your non-taxable one dollar bill.  Upon calling, should you learn that your mutual fund is intending to declare a capital gain, find out how much it will be on a per share basis and on what date it will be declared.  This information will help you determine what steps, if any, need to be taken in order to minimize the impact of this declared gain.

Second, swap the mutual fund in which you have a taxable loss for a similar fund.  Please note that your adjusted tax basis consists of your initial contribution to the fund plus any subsequent out-of-pocket contributions as well as any reinvested dividends or capital gains declared during prior calendar years less any withdrawals.  Regardless of what others might say to the contrary, given the fact that there are over eight thousand mutual funds to choose from, there is always an appropriate alternative to your current fund.  Do not think that your fund is “the best” or “one of a kind.”

Be certain to check with your tax advisor prior to making any year-end portfolio transactions.

Good luck, pruning your portfolio for tax savings makes dollars and cents!