Young tax payers in any tax bracket with small IRA balances may also want to convert this year.  That is because by converting now they will be able to shelter any future gains on their current IRA from taxes, and for a young person those gains could be substantial.  For example the future gain on $10,000 for a 30year old could be $310,000 by the time the person reaches 70.  In addition if your current IRA contributions were not tax deductible because your income was too high, most or all of your Roth conversion could be tax free.

One last benefit for converting in 2010 is that you are able to spread any taxes you do owe over a 3-year period vs. paying them all this year.

Does this mean that you should use active managers for poorly performing asset classes?   No.  The problem with this conclusion is not that actively managers are picking better stocks in their primary asset class but they are moving outside their designated asset class to try and improve performance.  When they do this they change your overall asset allocation and risk/return profile without telling you.  If you wanted to you could do the same thing with index funds but at least you would be aware of the changes you were making.

The article also did not address if they active managers’ performance was after all fees and expenses.  Actively managed funds have management fees that average 6x higher a low cost index funds.   In addition if you buy an actively managed fund through a broker you load fees in addition.  There is also the issue of taxes.    An actively managed fund turns its stock portofilio over about 3x/year which could generate signficiant short-term capital gains on which the mutual funds shareholders are taxed on lowering their overall retrun.  An index fund may only turn over 20% or less of its portfolio generating much lower taxable gains.

My advice:  Stick with low-cost index funds, for superior long-term performance.

The article has some great advice about raising your deductibles to save money, avoiding small claims which could raise your rates or get your dropped, and checking rates every few years.

You can read the article at www.consumerreports.org/ (online subscription required)

They would rather have the guaranteed lower cost of an index fund vs. the unfulfilled promise of better performance through an actively managed fund.

This is the strategy that I use with my clients.  Although some actively managed funds will out perform an index fund the percentage that do is actually less than chance would predict.  It is also difficult to predict which managers will outperform and index fund year after year.  This is especially true for bond funds.  According to Morningstar the Vanguard Total Bond Market Index Fund has outperformed 83% of its peers over the last 10-years.

Index funds charge substantially less than their actively managed peers.  A low cost index fund costs about 1% per year less than its actively managed peer.  That means that the actively managed fund would have to outperform the index fund by 1% per year just to be equal.  That is very difficult to do for almost all managers.

The Wall Street Journal says that asset allocation has “failed miserably” as an investment strategy.  That is like saying democracy is a failed political system because it allowed the severe recession to happen.  The problem with the WSJ analysis is that neither asset allocation nor democracy is a perfect system.  Far from it; but the real measure of success of either is evaluated over the long-term not on a single year.  In addition, no one has come up with an alternative strategy that has stood the test of time.

What I have seen from many new clients whose portfolios were managed by large brokers was no asset allocation strategy but just a random collection of stuff that the brokerage houses were trying to push on their clients.  For clients who did have a semblance of an asset allocation strategy their broker had not explicitly explained the downside risk of their investment portfolio.

Here are two questions that you should always ask your advisor:

* What is my potential percentage loss on this portfolio (1%) chance?
* What is my potential dollar loss on this portfolio (1%) chance?

If she can’t answer those questions then you should find another advisor.

I’d like to publicly thank these clients and the many others who have been willing to open up their financial lives so that others can learn from their experiences.

To Read about John and Mike:

To Read about Jody and Rob:

In the past I recommended the Utah plan to some clients due to its low fees. In some instances the lower fees overcame the IL state income tax deduction. Now with the lower fees in the Bright Start 529 plan I strongly recommend this plan to all clients. Clients who are in the Utah plan should transfer their assets to the Bright Start 529 Plan. This is something we will be working on during the first quarter of 2007.