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What Goes Up ...

Stock Market News

May 2001

What Goes Up ...

It’s funny how a timeworn phrase can sometimes hold such simple, practical wisdom for complicated times. The stock market has been leading investors around by the nose for some time now. While there are still some prognosticators still out there trying to direct traffic and investments, there are more and more reports of how to invest wisely, how to manage losses, the tax ramifications of stock market losses, how to hedge your investments, and so on. In this month’s article we are providing a little of the viewpoints of both the prognosticator and the manager.

I think it appropriate to start with a brief comment on the recent history of the stock market as way of guiding us to future investing. Let us take as our example, a biotech company, EntreMed. In March of 2000, EntreMed was selling at $100 per share, up from $33 just a few months before. Hitch you wagon to this star performer was what many investors did. In June of 2000, shares were selling again for about $30 per share. What goes up ... The people who bought at about $30, and held onto their investment, had nothing to worry about. However, those who were dazzled by the prospects of meteoric profits, found re-entry into the atmosphere a little toasty.

A close analysis of EntreMed will reveal a very complicated scenario, however, it is important here to step back and take a practical, if simplistic, view. Obviously investors want to make money. After all, that’s what investing is all about. But, we have seen this EntreMed scenario over and over again in recent months. Perhaps it’s the lure of the "home run" or the enthusiastic advice of a commission-based broker. But whatever the apparent cause, the motivation was impractical given the results. From this view, the stock market (including all the dot coms) have shown us this same pattern. If we can see what the stock market has be been telling us, we can adjust our investing habits and achieve a healthier, more sound investment strategy that will be more likely to withstand the ups and downs of heady trends.

There are two, polar opposite, responses to the above scenario: Conservative and adventurous. The conservative approach is to keep cash in money market accounts, savings, or stable, long-term assets. This strategy is to simply develop a "lowest risk" portfolio.

The opposite approach, of the adventurer, is to keep watch for the high risers and get out before they adjust (granted this may be an exaggeration). But, this path seeks to increase the potential for future earnings at the expense of increased risk. The insurance against loss is a host of investment aids, software, projections, research and so on, in short, to be well informed. Let us offer you some simple guidelines to help you determine your best approach and where you fit on the scale.

Keep Your Priorities Straight
Why did you invest in the first place, and are those purposes still valid for you today? Was it for retirement, income, or for your children? These priorities will be the standards by which you can set your compass. Rethink your goals. Here you have something of value to weigh your risks against. The market has always gone through corrections, and it will continue to do so. Where do you want to be in the next wave?

Be Patient
This may sound more like a kindergarten platitude rather than a mature investment strategy. But the history of the stock market shows an overall performance of 12% growth. Not bad. Thus, it would be wise to avoid fads and look at trends. Realize also that past performance is no guarantee of future results. Know the companies well that you are investing in. It helps if you believe in what they are doing knowing that your money is going to support something you can relate to.

This is not new advice. But we would suggest diversifying in a manner that best serves your long-term goals. If your primary interest is large, short-term capital gains and you are willing to bet on your investing acumen, then have a concomitantly large percentage of your portfolio in high risk, high yield investments. However, watch your back end and have something to fall back on if need be. Conversely, if your goals are more long-term and you are not comfortable risking 30 years of savings, have the major portion of your investments in low-risk, long-term investments. Your broker or financial planner can help you with these decisions.

Invest a Little at a Time
Simply put (another timeworn phrase), don’t put all your eggs in one basket. If you like a particular stock, don’t put all your reserve cash into it. Hold some back for the times when there is a downturn and you can pick up more shares at a lower cost thereby increasing your long-term potential. This is called dollar-cost averaging and while it doesn’t guarantee success (nothing in this world can do that), it can keep you alert to bargains that result from market fluctuations.

Manage Your Taxes Well
If you’ve lost money in the stock market, why lose more from poorly managed tax reporting? There are a few things that you can do to minimize your tax liabilities. Here are a few suggestions.

  • Losses on investments held for less than a year can be used to offset short-term gains. Long term losses can only be applied against long term gains. Keep in mind that long-term gains are taxed at the capital gains rate and the short-term gains are at your ordinary, higher, income rate.

  • If you are selling a stock that has not performed well, you can maximize your loss deductions by specifying which shares you sell. Let’s say you bought XYZ company at $50 per share and then some more stock at $75 per share only to find the company going to $25 per share. If you sell the block of shares you bought at the lowest price, this will give you the greatest loss and thus the greatest deduction. But you must specify which shares are to be sold at the time of sale. If you don’t, the IRS will use the first-in-first-out method on your return which means the share you bought first are the ones sold first.

  • If you were considering selling other things of value, such as anitques or rare coins, you can offset the gains you would be reporting on them with the losses you suffered in the stock market. Gains on collectibles, generally, are taxed at 28%.

  • About that 401(k). Sad to say, if you suffer losses here, you can’t do much about that since the money is tax deferred. Thus you can’t deduct losses until you actually withdraw the money.

In Closing
If you are working with a broker, we suggest you make sure that the temperament and goals of your broker are close to your own. You are more likely to get the advice best suited to your objectives. One thing is for certain, life is uncertain. Those that stay around, are those that keep their feet on the ground. What goes up ..., well, all of the fundamental principles of business (and of life) still apply.

If would like further information or would like to discuss your personal situation more in depth, we’re here to help. And to all the moms out there, happy Mother’s day.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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