Today the Dow Jones Industrial Average dropped 166.13 points or 1.39 percent. The Nasdaq was down 68.39 points or 2.48 percent. The S&P 500 was down 1.79 percent. The reported reason: the unrest in Egypt and concern about interruption in the oil markets.

Just when everyone thinks things are getting better, some unexpected event occurs to create more uncertainty. I’m sure there are some out there who predicted the turmoil in Tunisia but most people didn’t see it coming. And even if they did, would they have also predicted what is now happening in Egypt? And would they have been so confident of what the world reaction would be that they would have adjusted their portfolios accordingly, in order to take advantage of what was about to happen?

If you assume there were some who were able to see this all coming and profit from it, did they also see the recent rise in the market that took us to nearly 12000 on the Dow this last week? Let’s suppose you were able to anticipate all of the above events. Are you also confident about what’s going to happen next? We sure aren’t. Things could easily get worse in the Mideast or they could quiet down and we could see a return to a slowly rising Dow as our economy makes a steady but slow recovery. Or, our economy might take a double-dip as interest rates and inflation rise as a result of our mounting debt.

Just about the time you think you know what’s best to do in the market to make a killing, a Tunisia-Egypt crisis, a BP oil spill, an Exxon Valdez accident, a tech-stock bubble, a housing crisis, natural disaster or what have you occurs unexpectedly. You can’t time the market. Stay broadly diversified and rebalance your portfolio regularly. You can’t time the market!

Too often, investors spend all their time focusing on their gross investment returns and ignore the tax efficiency of their investments. If you reduce the taxes paid on your investments by even a small amount it can have a big impact on your net, after-tax return.

An example will help illustrate what we’re talking about. Suppose your taxable investment accounts amount to $100,000, currently, and earn 7% annually, on average, over the next thirty years. Let’s assume your after tax return is 6%. Let’s further assume that through prudent placement of income-producing assets and selection of tax-efficient investment vehicles that you can increase your after-tax return to 6.5%. At a net return of 6% after tax, your $100,000 would grow to $574,349 after 30 years. With an improved 6.5% after-tax return, your $100,000 would grow to $661,436, a difference of $87,087!

Clearly, it pays to spend some time focusing on the tax efficiency of your portfolio. How do you do this, you ask? First, you need to pay attention to the assets you place in your taxable accounts versus the assets you place in your retirement accounts. IRAs and 401(k) accounts grow tax free. Therefore, it makes sense to place income-producing assets (i.e., those that pay interest and dividends) in your retirement accounts and place assets that don’t generate much income, such as non-dividend-paying stocks and growth funds, in your taxable accounts.

When selecting mutual funds, it also helps to pay attention to their tax efficiency. On the Morningstar® website, you can click on the “Tax” tab for mutual funds to see the pre-tax return, tax-adjusted return and tax-cost ratio for mutual funds. Morningstar also provides the Potential Capital Gains Exposure (PCGE) of a fund. Potential capital gain exposure (PCGE) is an estimate of the percent of a fund’s assets that represent gains. PCGE measures how much the fund’s assets have appreciated, and it can be an indicator of possible future capital gain distributions.

Selecting good investments is more involved than many people realize. Focusing on the tax characteristics of your investments can have a big impact on how much your portfolio grows.

Investors generally spend most of their time trying to figure out what stock to buy and at what price to buy, and then pay little or no attention to when to sell. An old Wall Street adage is good advice for investors to keep in mind: “No tree grows to the sky.”

In many cases, investors follow the herd, buying the latest hot asset for fear of missing the action. Even if they are lucky enough to buy before the frenzy starts, it’s not uncommon for them to buy some more as the asset approaches its peak, because they are just so sure the investment’s price will continue to rise. They can’t stand the thought that they might miss out on further gains.

Then the unexpected happens. Some news breaks that sends the asset price down ten, twenty, thirty percent or more, in a matter of days. Some, who now are underwater, buy more because they can’t stand the thought of losing.

Others hold on for sentimental reasons. They received a stock from their dad or their grandma. They can’t possibly sell a stock that was so good for all those years. Dad wouldn’t be happy.

We’ve written time and again about how important it is when you buy a stock, to set a price at which you will sell and then when it reaches that price – sell! And then, don’t look back. If you made a good profit, be happy that you did and begin looking for your next investment. Find something else that’s undervalued with good prospects. Surely there’s something else out there that is a better buy.

The event that causes the downturn in price is often quite unexpected (An oil spill, fraud, terrorism, a natural disaster, law suit, etc.). Others are more predictable. The price rises and rises with claims that it will still go higher. Often, we’re inundated with TV ads that tout the merits of the investment, seemingly hour after hour. It seems to us that the more ads there are on TV preaching the merits of an investment, the less likely the investment will continue to rise in price (think gold!).

A Wall Street Journal article this week by Carolyn Cui and Liam Pleven titled “From China, Signs That Gold’s Rally Isn’t Endless” (Friday, January 21) stated: “The precious- metals selloff accelerated on Thursday amid worries the rally of the past few years may be petering out and concerns that China will slam the breaks on its economy.” The article went on to say that on Thursday gold fell 1.7% and was down 5% for the year. Silver, the article noted, was down 11% for the year.

Just this last week, Steve Jobs announced he was taking a medical leave of absence from Apple. Apple stock dropped from $348 a share to $326 (a loss of 6.3% in just four days). It may not continue the downward trend, but who knows for sure?

Whatever you do, you need to avoid letting your emotions drive your investment decisions. You need to harvest that tree before it gets top heavy and falls to the earth; or before it gets diseased and begins to rot. Remember, no tree grows to the sky!

With interest rates so low the last few years and investors afraid to invest in stocks, there’s been a surge in bond buying. In more normal times, many people avoid bonds because bond returns are generally lower than stocks. Some view them as stodgy and have only turned to them recently because they are hungry for earnings of any kind.

Unfortunately, many investors don’t really understand the risks involved with investing in bonds. Many think bonds are safe investments. If you know what you’re doing they can be quite safe. But if you don’t know what you’re doing, you can lose much more than you might have ever thought. Following are some things to watch out for:

First of all, all bonds carry the risk of default, or credit risk. That’s the risk involved if the issuer of the bond defaults, typically due to bankruptcy. Do you recall how the bondholders of General Motors were recently left holding the bag when GM went through bankruptcy? Bonds are rated by various ratings agencies (e.g., Moody’s and Standard & Poor's) with somewhat differing ratings schemes. Moody’s uses the following ratings: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C, with “Aaa” the best and “C” the worst. Standards and Poor’s ratings are similar, ranging from the best, “AAA” to the worst, “D”. Both services provide the ratings free on the Internet. Moody’s requires a log in, but it’s free to register.

One way to mitigate the credit risk, besides buying high quality bonds, is to spread the risk by buying a bond mutual fund or bond exchange traded fund (ETF). By investing in a bond fund you will own a share of a large number of different bonds, thereby providing diversification and reducing the risk, should any one bond default. You can check the average credit quality of the mutual fund or ETF by looking the fund up, online, via the Morningstar® website at Morningstar.com. A mutual fund with an “AAA” average credit quality will be much less risky than a fund with a “BB’ average credit quality.

The other significant risk with buying bonds is interest-rate risk. When interest rates go up, bond prices come down and vice versa. It makes sense if you think about it. A $1,000 bond with a 5% coupon (i.e., the bond pays 5%, or $50 in interest annually) will drop in price to $833.33 if interest rates go up to 6% ($50 divided by $833.33 = 6%). In other words, if interest rates rise to 6% for similar bonds (i.e. similar credit quality and maturity), no would buy your bond for $1,000, since it’s only paying 5%. They would only pay $833.33, since that’s the amount that would provide a yield equivalent to other similar bonds.

You can eliminate interest-rate risk, if you hold the bond to maturity. If interest rates rise or fall while you own the bond, the bond price will fall or rise, respectively. As your bond approaches its maturity date, the price will move towards the bond’s face value (typically $1,000). As a bond approaches its maturity, the default risk gets smaller and smaller, and the interest rate impact on price diminishes to zero. Therefore, if you buy a very high quality bond and hold it to maturity, you can minimize the chances of losing anything on your investment.

Another way to mitigate interest-rate risk is to buy shorter term bonds when there is reason to believe that interest rates will rise. The longer the maturity, the greater the interest rate risk of a bond. With interest rates extremely low right now, long-term bonds carry much more risk than short-term bonds. The same holds true for long-term mutual funds versus short-term mutual funds. Thus, in the current environment, short-term mutual funds are safer than long-term mutual funds.

One way to measure a bond funds’ sensitivity to interest-rate risk is to look at the fund’s “duration”. Shorter duration bond funds are less sensitive to increases in interest rates than loner duration funds. Morningstar® provides bond fund durations on its website. A discussion of the details of duration is a subject for a later blog.

In summary, bonds have risks just like other investments. Understanding those risks can help you avoid losses in your bond investments. Purchasing bonds can be relatively safe if you know what you’re doing.

Sure, it’s nice to make a lot of money. Our years of experience, however, tell us that making a lot of money isn’t necessarily the key to a stress-free financial life or a successful, comfortable retirement.

What we have found is, that in most cases, the more people make, the more they spend and the more debt they take on. Often, people save too little and fail to anticipate what they will need in the future for their children’s college expenses or their retirement.

One rule of thumb suggests that you should save at least 5% to 10% of your gross income. These days, it may be prudent to save well in excess of that amount. With college costs increasing from 5% to 8% annually and concern about higher interest rates and higher inflation down the road, boosting your savings is clearly a smart thing to do.

With home prices still expected to fall further, paying down your mortgage may help you maintain positive equity in your home and will help prepare you for a retirement that is less stressful. Those who carry a mortgage into retirement have a much more difficult time making their resources last until life expectancy. And, with life expectancies increasing, longer retirements require increased savings.

When choosing a tag line for the Patterson Advisors’ logo, we wanted to emphasize that we help our clients balance their financial goals with their financial resources. Thus we chose the tag line “Helping Balance Your Means and Your Dreams”. For a stress-free life and retirement, we believe it’s more rewarding to live a more reserved lifestyle and have your finances in tune with your goals than to live a more aggressive lifestyle that stretches one’s resources beyond reason. People want a hassle-free retirement, most of all. More money is great, but it’s not everything.

Economic indicators continue to point to a slowly improving economy, yet there are still many signs that tell us to be cautious. Unemployment continues to be high and few expect it to drop substantially, anytime soon. There were worries about commercial real estate problems as well but so far it hasn’t become a big issue. Foreclosures on residential homes are still very high and there are still some concerns that some homes may have been foreclosed upon improperly. There is continued downward pressure on residential real estate prices and the expectation of more foreclosures in 2011 than in 2010.

The high levels of debt and projected deficits of the U.S. Government continue to worry us about higher interest rates and inflation, long term. Many believe that inflation will not be an issue in the near term. While there were worries about deflation last year, those concerns seem to be dissapating. Concerns about debt in Europe continue to surface periodically.

There is still significant uncertainty as a result of the new healthcare legislation and the new finance regulation. However, with the tax-cut and estate tax issues now resolved (at least for two years) and a 2% cut in Social Security taxes now in affect, we believe there should be some improved confidence in the economy that we hope will bode well for 2011.

So while there is a lot to worry about, there are also signs of improvement in the economy that gives us hope for a better year ahead in 2011. Yet, just as we see some light peak out from behind the dark clouds, another dark cloud is gathering - the threat of state and local government bankruptcies. We certainly hope our federal government doesn’t decide to bail them out. We already have too much debt at the federal level. Yet, we worry that if California and other states declare bankruptcy, it would spill over into markets other than the municipal bond market and could send the economy into a second recession. Let’s keep our fingers crossed that a double-dip can be avoided.

Our blog today marks the 200th time we’ve published in this space. When we started back in June of 2009, we worried about coming up with fresh ideas two to three times a week. While it can be taxing at times to decide on a topic, it’s probably been easier than we imagined.

Many of our blog topics stem from interactions with our clients. If our clients have a problem, many of our readers likely have the same or similar problems. Other topic ideas result from books we’ve read or articles in various magazines and newspapers including the Wall Street Journal and the Journal of Financial Planning.

We thought we’d take a moment today to first thank those of you who read what we have to say, particularly those who have given us positive feedback. We’d like to hear from those of you who read our blog, both its positive and negative aspects, so that we can hopefully continue with more of those things you like and change the things you don’t like. Please let us know via a comment or via an email to us. You can reach Erin at erin@pattersonadvisorsllc.com and Dave at dave@pattersonadvisorsllc.com.

If there are financial topics that you’d like to hear us talk about in general, please let us know. While we can’t promise we’ll answer everything of interest to you, we’ll do our best to meet your needs. Thanks again to all of you who have helped make our blog a success!

Many investors think they can time the general market or even specific sectors or asset classes. We’ve written time and time again about how difficult market timing is. You have to be right twice. You have to know when to get out of the market and then when to get back in. Being right in one of those instances is tough. Being right in both instances is really tough.

Over the last two years we’ve seen an exceptional drop in residential real estate prices, with nearly unprecedented numbers of foreclosures. Many predict more foreclosures in 2011 than in 2010. There has been some worry about commercial real estate, as well. While commercial real estate may not have been severely impacted in some parts of the country, in Michigan, wherever you go, you see empty offices, factories and stores.

It’s seems natural then, that investors should have shunned any type of investment related to real estate for the last two years. Many of our clients have, in fact, resisted investments in the real estate asset class and some have pushed us to sell their real estate holdings. We stood firm, however, and urged them to maintain their target portfolio real estate percentage, either buying or selling, depending on whether or not they were under-allocated or over-allocated, respectively, in the real estate asset class.

So what happened with real estate investments the last two years? A recent article in the Wall Street Journal titled “Real Estate Outruns the Stock Market Again” by A.D. Pruitt (Wednesday, December 29, 2010), noted that real estate stocks were “poised to end the year with gains that are twice as large as the broader stock market”.

The article went on to say: “REITs (Real Estate Investment Trusts), as measured by the Dow Jones All REIT index, were up 27% as of Tuesday’s close. While that is a smaller gain than last year, when REITS posted gains of 28.5%, the 2010 results handily beat the DOW Jones Industrial Averages….”

So why, contrary to logical thinking, did REITs perform so well? It was due to investors’ desire for income. According to the article, REITs were returning dividend yields of about 4% versus a return of 3.35% for Treasury bonds. If one looked at REIT prices alone, they might have thought they were over-bought in 2009 and due for a correction. Yet the yield for REITs, compared to Treasuries spurred investors on to continue buying REITs.

You might argue, therefore that astute investors should have anticipated the continued rise. That may well be, but sometimes asset classes continue rising for reasons not easily explained. Sometimes investors chase past returns. It may be that investors continue to buy more REITs in 2011 because they’ve done so well the last two years. Then again, there may be a correction in REIT prices in 2011.

The best approach, we believe, is to establish targets for all of your portfolio asset classes and then periodically (at least annually) rebalance them by selling if you are over-allocated and buying more if you are under-allocated. You won’t hit the peaks and valleys - but by doing so you remove your emotions from the process. Rebalancing, if done in a disciplined manner, forces you to buy lower and sell higher than the typical market timer.

It seems like a great time to buy a home and it is. Home prices are lower than anyone might have imagined two years ago and interest rates are way down, too. Property taxes have dropped significantly, as well. Yet, you need to keep one thing in mind before you rush out and buy a new home: In spite of all the positive things about buying now, you shouldn’t do so unless you plan to keep the home for some time.

Why is that, you ask? Although home prices have dropped substantially, they may not yet have bottomed out. A couple of recent articles in the Wall Street Journal support this view.

The first, titled “Housing Market Still Facing a Blizzard” by David Reilly (Wednesday, December 29, 2010). Mr. Reilly’s article discussed the fact that housing prices continued their downward trend for three straight months ending October, 2010 and prompted fears of a double-dip in housing prices. The article went on to say that while sales were up significantly in October, it was likely due to record-low mortgage rates which have since risen more than a half percentage point.

The other article we read was titled “Home Prices Are Still Too High” by Peter D. Schiff (Thursday, December 30, 2010). In his article, Mt Schiff makes a fairly strong case that home prices could easily decline another 20%. If they did, this would put them in sync with the long-term national trend line for home prices. Mr. Schiff argues that the long-term average annual increase in home prices has been 3.5%. If you compare the actual home price graph to the long term 3.5% increase-trend line, home prices are still 20% higher.

Mr. Schiff argues that housing fundamentals have not really improved. He says that government intervention is what has stopped the decline in house prices. Mr. Schiff believes that without government assistance (home-buyers tax credit, record low interest rates, government mortgage assistance, etc.) home prices would actually decline below the trend line.

Whether home prices continue to drop and by how much remains to be seen. It does seem that a further drop is likely in 2011 and perhaps even 2012. Even if the bottom is reached in 2011 or 2012, prices may remain low for several years. Buying now with a low down payment could put you underwater if prices drop 10% or more this year or next. Therefore, to be prudent, you may want to wait on buying a new home, if there’s any chance you may have to sell in the short term.

We occasionally discuss a quote from someone well known, regarding some aspect of money or investing. We find that these “words of wisdom” can provide some great advice for investors to follow. Today’s quote is a Latin proverb: “Believe nothing and be on your guard against everything.” It’s sad that this advice is so often true, that we have to be suspicious of most everyone who tries to sell us something.

A recent example illustrates this point. Just last week we received an email from a friend with a link to an Internet audio presentation. Our friend wanted to know our opinion of the presenter’s opinions. The presentation was very long (an hour or so?) and once you started it you had to essentially listen to the whole thing. There was no way to restart it where you left off, if you closed your Internet connection.

The gist of the presentation was that our economy will soon to collapse when the dollar is no longer recognized as the world’s reserve currency. We must admit, the presenter pointed out many economic issues that we are concerned about. Yet the long-windedness of his message reminded us of Shakespeare’s quote: “The lady doth protest too much, methinks”. We began to suspect the motive behind the presentation.

When we finally figured out how to view the written text without having to listen to the whole thing, we scanned forward to the end. The presenter offered five recommendations to prepare for our future demise. Each recommendation included an offer for a free document detailing what one should do. In each case, the presenter said he would shortly tell the reader how they could receive the various documents free of charge. How was this to be accomplished? By signing up and paying for a newsletter!

We suspected a sales pitch fairly early on and weren’t surprised by what we found. We decided to go one step further and check on the presenter’s background. It didn’t take long to discover that he had been fined $1.5 million by the SEC back in 2007 for securities fraud.

As we often say: “If it sounds too good, it probably is”. Be suspicious of promised returns. Be careful of who you trust with your hard-earned money. Do your own due diligence. It may take some time and effort but it will be well worth it.

Yesterday’s Wall Street Journal had almost the entire back section devoted to the New Year’s resolutions of well-known people. At this time of the year, most people think about what they might do differently going forward. Thoughts of a new year give us hope that a fresh start will solve many of our problems. It seems like the majority of people focus on their weight or their health. As an alternative, why not get a financial physical for the New Year?

Certainly your financial health is just as important as your physical health. This is particularly true these days, with unemployment so high and the prospect of higher interest rates, inflation and taxes looming in the not-to-distant future.

Spending some time answering the following questions will give you some good insight to your financial health as well as whether or not you could use some professional help. If you can’t answer many of the questions, you need to either start hitting the books or seek out an advisor. Here are some of the most important questions to ask yourself:

(1)What’s your net worth? Add up the value of all your assets and subtract your liabilities (mortgage balance, auto loan balances, credit card debt, etc). The result is your net worth. If it’s negative, you need to take drastic action ASAP.
(2)Do you have an emergency fund invested in liquid assets that equals at least six months of living expenses (six to twelve months is probably better)?
(3)Are you carrying credit card balances forward each month or do you pay off what you’re charged each month?
(4)Are you saving enough for your children’s college education? Do you even know how much they will need?
(5)If you have an advisor, do you know exactly how he or she is compensated?
(6)Do you know how much the fund fees are for the mutual funds you own?
(7)Do you a strategy for investing?
(8)Do you know the extent of your portfolio’s diversification? We believe your investments should be spread over at least eight to ten distinct asset classes. Most people who come to us for help are over-weighted in U.S. stocks.
(9)Are you properly insured? Do you have disability insurance coverage and an umbrella liability policy?
(10)Have you done any estate planning? If you have children, have you planned for a guardian in case you and your spouse are tragically killed in an accident?
(11)Do you know where your money is going? If your miscellaneous expenses are more than 5% of your budget, you need to get a better handle on your spending.
(12)Do you have any idea of how much money you’ll need for retirement? Are you saving enough?

If you found you had trouble answering a number of these questions, you might better skip the New Year’s resolution focused on losing weight or exercising more. Your financial health may be in jeopardy. Make 2011 the year you did something about it!