Paul Ferraresi

Following up on Part I…what are some of my core beliefs on investing?
First of all, and I include myself in this, people tend to be impatient. Good investing, especially from an individual standpoint, is where you have the luxury of not having to participate in the market at all times. You can pick and choose the most appropriate times when the odds and probabilities of success are highly in your favor. I try to keep that in mind as a professional investor as well.
It’s only through time and patience that you actually tend to build wealth through the power of compounding of returns. But doing that requires perseverance and saving, which involves sacrifice. One of the things I was most influenced by is the writing of Charles Ellis, who said you win by not losing and your primary objective in investment management is to control risk.
A successful investment requires a great deal of courage. And it requires steady nerves to invest in those areas where the greater opportunities are, even though that’s not where the consensus is, and it’s very lonely. The best opportunities to buy stocks occur when it’s been very hard to pull the trigger and buy, yet, all your disciplines would suggest that is exactly the right thing to do.
With the markets in wild disarray it reminds me of a quote I have been keeping in front of me lately. As Warren Buffett said: “Be fearful when people are greedy and greedy when people are fearful.” We have gotten to the point where it pays to be a bit greedy, because there are some unusual opportunities being created right now.
So when markets are either frothing, or, in a deep trough, keep in mind you can be out in the middle of the ocean and not know what’s ahead, so you need to be prepared for stormy seas. It just provides better ballast to a portfolio in case there are surprises. As much as you think you’ve got it all right at various points in time, you always want to protect yourself.

In my 35+ years as an investment professional, this past year for stocks and real estate, has been a real “doozie.” I will assure you 3-5 years from now you will look back to now as one of the greatest investment opportunities of a lifetime. I see so many people flocking to stores advertising 10-20-30% off various products. Yet, these same people, with the stock market on sale @ 40-50-60% off, are running from the “great companies of America.” But, that is a normal human reaction. An example… we as human beings are wired backwards from the factory. You see we are all trained that low prices are good for us and high prices are bad. A recent example… when gas prices were high motorist stayed home and did not buy. Now that prices have dropped in half…they are buying again.
Here is another example…if you went into the grocery store and a sign was up… manager’s special, today only, small can of tuna fish normally 99¢, now on sale for 39¢. If you liked tuna fish you would load up the cart. Next week you come in and see a sign… manager’s special small can of tuna fish normally 99¢, now selling for $4.25. You would tell the manager he was crazy, (probably run home go to the pantry and return the tuna from last week hoping to get $4.25)
Now the low price good, high price bad is true in everything but the stock market. When a stock price skyrockets from $10 to $50 everyone wants to buy at $50. Yet when the price drops from $50 to $10 no one wants to buy. IT IS ON SALE.
Do you buy tuna @ $4.25 and when the price is on sale @ 99¢ do you return the $4.25 cans you bought to the store and hope to sell them back at the sale price of 99¢? Is this making sense?

Assess the Ultimate Goal
Usually when you ask clients whether they plan to buy a second home for pleasure or investment, the response is “pleasure.” The follow-up questions should then be: “How long do you anticipate owning it?’ Then, “What, if any, growth rate do you expect on the value of the home?” Very rarely are there “rational” responses like “20-plus years” and a “5% or so return” (which is the approximate national residential 20-year average rate of return for a home).
Many buyers anticipate that the value of their second home will double, even though they say it is not an investment.
Often clients will buy on emotional and perhaps irrational factors. They will also base their decisions on some misguided information or misinterpreted facts. The following are some of the more common misconceptions:
A vacation home is a vacation home. A vacation home can be categorized in three different ways: personal, rental, and dual purpose. The one that pertains to your individual circumstance will depend on the days used and the days rented.
I always can deduct my mortgage interest on my second home. With so many affluent clients purchasing McMansions these days, it is not uncommon to see a large mortgage on their primary residence. Remember that you can generally deduct qualified residence interest on up to $1.1 million of home mortgage debt ($1 million worth of acquisition debt on up to two homes plus $100,000 of home equity debt on up to two homes). Any excess interest on home mortgage debt is generally nondeductible. Furthermore, the owner’s overall interest deduction may be lessened due to the itemized deduction phase-out rule for higher-income taxpayers (for 2007 the AGI level is $156,400). This rule is expected to sunset by 2010. As such, if nothing is done, in 2011 it will revert back to full phaseout. (Now there are legal methods that we use with our clients that allow them to deduct interest on well above the $1.1 mm limit)
I always have to report rental income. Rental income is completely tax-free for property that meets the rules for personal-use property, but has a very limited opportunity to generate rental income (generally 14 days or less). From a tax perspective, this can be quite a boom for clients with properties that can be rented at an exorbitant rate for a short time (e.g., properties located near a major golf event, Olympics, or Super Bowl location).
Vacation home donations are always a good idea. Unfortunately, the IRS considers vacation home donation days as personal use days, not rental days, since the owner did not receive a fair market rental for the use if the home. In addition to not qualifying for additional rentals expenses, the owner receives no charitable deduction for donating the use of the home to charity.
I can use the capital-gains tax exclusion ($500,000) upon sale. The exclusion applies only to principal residences.
A 1031 (tax-deferred) exchange can be done on a vacation home. A recent Tax Court ruling (Moore, T.C. Memo 2007-134) disallowed tax-deferred treatment for a personal vacation home. The court held that a couple’s exchange of vacation homes did not qualify for like kind exchange treatment because the homes were not held for investment purposes (as required by § 1031(a)).
Rental income will be offset by cost. With property prices still high, some clients may believe they will offset the cost of a second home by renting it. Unfortunately, clients forget that in order to cover their costs they often will have to rent it out at peak season, coincidently the weeks they want to use it the most.
This is a “business.” Many people say they manage their property and thus “materially participate.” In other words, they are in the business of renting real estate and are able to take losses against other taxable income.
You can go home again. And, finally, do not “impulse buy” while enjoying a vacation. If you have an interest in purchasing real estate at a great place where you vacationed last month, I suggest that you hold off until you have “felt out the neighborhood” for a while, meaning you should visit the location a few more times. You should focus on the commute to work, the community, people, activities, and amenities, and, very important, talk to as many locals as possible, particularly those who have owned vacation homes there for some time. Do you have a similar feeling of happiness each time you visit the location? Are your experiences consistent over time?
The financial ramifications as well as the emotional toll of purchasing vacation homes can be complicated. But understanding these rules and your expectations will open the door to some great discussions with your advisors.

The housing crisis and credit market upheaval that began last year have been creating a roller coaster ride for market participants with equity markets down across the globe by 30% or more in the last year. During times like these, emotions can overwhelm sound decision-making as investors panic and flee to the exits.

Ironically, this market also leads us to believe that there are now excellent opportunities in the market for investors that can remain disciplined and take the longer-term view necessary to see beyond the current economic problems.

I wish I had some eye-opening quick fixes for you, but frankly that’s exactly what got Wall Street into this crisis. We believe that turbulent times in the market are the most important times to stick with disciplined, conservative investment principles that have worked well over numerous market cycles.

By following the basics, investors can position their portfolios to outperform when the fear in the markets ultimately subsides. The flip side of volatility is opportunity for patient investors who are focused on finding undervalued assets with good growth prospects that the market will recognize in the next three to five years.

Since equity markets are near their average pullback in past recessions, we believe that the fundamental trend of rising equity markets across market cycles will pull markets upwards over three to five years. The markets will return back to their long-term trend line once it becomes clear that the negative effects of the housing and credit bubbles are diminishing.

While it may be difficult to focus beyond the latest headlines of bailouts and bank failures, with a prudent and patient approach, we believe that investors will look back at this time as one of the rare buying opportunities of a lifetime – so work with your advisor who can help you take full advantage of this great situation.

Well a new administration is in place and with the promise of higher taxes. As you look ahead and see deficits for as far as the eye can see, a war on terror that will last another generation, a bankrupt Social Security/Medicare system, and, a financial crisis not seen in a generation…you know that your taxes will go even higher than the new administration has told us their plan is.

Couple this with a Democratic near super majority Congress whose initial plan of business will be to eliminate the deduction for 401K, then, they plan take your 401K accounts and wrap your monies into a social security account…now you know why markets are shaky. You have been experiencing a classic bear market in stocks and real estate so what’s a body to do?? If you followed our advice over the years and fully diversified your portfolio you would be in fine shape. (All my comments are not personal…they are strictly business advice.)

In addition, for many years I have begged you to save 15-25% of your gross income and invest it, so as to minimize your risk. Well, now that the horse has left the barn and you want to close the door. What can you do?

Follow the principles I have taught you and have also been passed on by Doug Andrew in his many books.

• If you harvested your home equity and put it in a conservative side fund you would not have lost now that your home value has dropped. It is gone and there is nothing you can do.
• If you still have some home equity, then, get it out now before it drops more. The additional mortgage may be one if the few remaining deductions you will have.
• Maintain aggressive savings
• Reduce unnecessary expenses such as vacations or eating out. You are trading today’s benefits for your future security and peace of mind.
• Stop funding your IRA/401K for tax deduction beyond your company match level. You will find in retirement the tax you will pay on the distribution will be 10-15 times what you saved in taxes from the original deduction.
• I recommend my clients reduce taxable income via mortgage interest deductions.
• Invest your non performing home equity and "above the matched" 401K contributions into safe investments that earn more than 8% per year tax free (maximum funded equity indexed universal life policies structured by a highly skilled professional); you will enhance your retirement income substantially when compared to traditional retirement strategies. You will also eliminate the downside risk of stock market investing. You participate in the upside of the market but not the downside.
• The above strategy will allow you to fund this new retirement plan with indirect tax-offset deductible monies, it grows tax free, you can withdraw it tax free and when you die it transfers tax free.

The present monetary policy and future plans to "bailout" companies and "unqualified" home buyers will put inflation into a mode of full steam ahead.

Thus, place long term investment money into assets that will benefit during inflation…commodities, real estate, gold and natural resources. (Be Selective with your natural resource picks.) The new administration plans to punish oil companies and coal producers. Although the ultimate outcome will be higher energy prices stay away from direct investments and look toward essential services to these industries and companies.

The policies that have been outlined and promised will not be beneficial to Domestic Stocks. Work your allocation to place more in International Equities. Additional policies from this administration will not be good for medical, health care or pharmaceutical companies in the U.S. These asset classes are still considered good long term plays. Look for multinational companies that do a majority of their business outside the U.S. International health related companies will not be negatively affected by the new U.S. changes in health care. Any defense related companies will be negatively affected in this new administration. Offset these positions with higher allocations to hard assets to take advantage of fear, higher inflation and a weak currency.

Visit with your advisor to realign your portfolio quickly to take advantage of the mega shift coming in the investment horizon.

It is imperative that you now concentrate on aggressive tax planning. I haven’t seen such a demand from my clients for help in this area since the late 70’s during the Carter administration. Back then tax rates were at 70%. Since 1982 tax rates have dropped, tax revenue skyrocketed going into the Treasury and people concentrated on making prudent investments. Consequently, you saw a massive bull market in stocks and real estate from 1982 until 2008. These upcoming policies of the new administration are very similar to the Carter years, so let’s make money like we did under those policies in the late 70’s.

I am sure you can see a huge tax rise and a shift in U.S. stock market returns coming in everyone’s future. Tell me, are you going to be one of the masses and wait until the boat has capsized to then look for your life preserver? Or, do you want to get into the preserver now and safely get to shore?

Call or email if you are ready to build your wealth. Discipline or regret!!