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Investors have begun feeling good about the stock market again, and I don't blame them. With blue chip stocks up about 20 percent this year and the Nasdaq Composite Index showing a gain of more than 40 percent, there are genuine reasons to celebrate.
However, this is no time to get carried away. We'll all be better off if we temper our enthusiasm by recalling some of the lessons learned during the stock market bubble of the late 1990s.
And just what did we learn?
Mark Riepe, senior vice president of the Charles Schwab Center for Investment Research, cites two of the most valuable lessons:
- Owning a lot of stuff doesn't mean you're diversified. It's not how many stocks or funds you own that matters, but how you have positioned your investments. Ideally your portfolio should include large and small stocks representing different sectors of the economy, some foreign holdings, some bonds and some cash. Know what you own.
- Paying capital gains taxes isn't so bad. Many investors refused to sell stocks at their peak because they didn't want to pay taxes on their capital gains. Now they don't have to worry because the market decline wiped out most or all of their gains. It's especially dangerous to put off a sale if the stock represents a major portion of your portfolio.
To those two lessons, I'll add three of my own:
- Trees don't grow to the sky. Many investors built their retirement plans around an assumption that stocks would return more than 20 percent a year, but those big gains couldn't be sustained. It is more realistic to base your plans on modest assumptions.
- Earnings matter. At the height of the tech boom, investors threw money at stocks of companies that had never turned a profit. Some of them never did. Ultimately, a company's value depends on its ability to earn a return on investors' capital.
- It's a lot easier to tolerate risk when stocks are going up. I hope the market decline helped you define for yourself your true tolerance for risk. The environment has changed, but you would be smart to keep your stock investments below the level that kept you awake at night during the previous three years.
Q. I am 60 years old, receiving Social Security as a divorced widow and working part time. I am told by Social Security that I cannot make more than $960 gross per month. I have the opportunity and am willing to work more hours, but if I exceed the limit I will be penalized. To me this makes no sense and does not aid the economy. Why should people like me who are willing to work be held back by the government?
That's the law. Earnings restrictions apply to Social Security beneficiaries who are younger than normal retirement age. Since you apparently were born in 1943, your full retirement age is 65 years, 8 months. At that age, you will be able to earn as much as you like with no reduction in benefits. Until that age, your Social Security benefits will be reduced $1 for every $2 you earn over the limit, which is $11,520 in 2003 and $11,640 in 2004.
You still come out ahead by working, although the net benefit is obviously reduced. If that troubles you, consider applying your talents and energy to volunteer work, and perhaps to lobbying your representatives in Congress to change the law more to your liking.
Q. Why don't I ever see anything written about using 10-year averaging for a lump sum retirement plan withdrawal? I was born in 1934 and am eligible to do this. I am trying to determine whether I should take a lump sum with the one-time opportunity to use a lower tax base, or roll the money over into another IRA after using the 10-year averaging. Can you help?
Not much is written about this for two reasons. One is that fewer people are eligible every year. This option is only available to people born before 1936 who have not already rolled over retirement plan money to an IRA. The second reason is that determining the best approach requires analysis of each individual situation.
I can clear up one point of confusion. Your choice is between 10-year averaging and a tax-free rollover. You do one or the other, not both.
- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.