Commentary: Invest for your reasons - not theirs

A couple of months ago I wrote an article entitled Pushing on a String.

If you remember, the gist of the article stated that after cutting interest rates for the 12th time, Alan Greenspan & Co. must have felt as if he had been pushing on a string, since the economy was still just sputtering along and unemployment continued to rise. In other words, the Fed Chairman was not getting his desired results from his rate cutting activities.

Also mentioned in the article was the fact that with the Fed rate now set at 1 1/4 percent there wasn't much ammunition left for the Federal Reserve to use in order to try to once again kick-start the economy.

So with monetary policy somewhat depleted, President Bush announced his fiscal attack on the slowing economy by presenting his tax stimulus plan to the nation during the second week of January.

Personally, I believe this stimulus package is designed for political reasons rather than economic ones. I also think the major portion of his agenda, making dividends tax free, does right a wrong, but maybe this isn't the appropriate time.

In other words, dividends shouldn't be taxed twice as they currently are, but the economy currently needs an immediate stimulus and not correction of an injustice.

Overall, my guts tell me making dividends tax-free is not a great way to give the economy an instant boost, nor does it help to reduce unemployment. But discussing the pros and cons of the tax package is not the purpose of today's column.

Rather this column is really more philosophical in nature. Whenever the government makes a change in their monetary or fiscal policy, the goal of the change is to modify its citizen's financial behavior.

In order to influence our behavior, the government offers us either rewards or penalties. One time the government might want us to consume more goods and services and in other instances they may encourage us to save more for retirement. They accomplish this change in behavior by altering monetary or fiscal policy.

Each investor needs to understand whether or not the desired behavior modification is the correct course of action for themselves. One major rule of investing is never make an investment solely based on tax consequences. The investment objective should always be primary to any tax considerations. Tax consequences should only come second in any investment decision.

It is paramount to understand, that when the government tinkers with fiscal policy the final results don't always turn out to be in the best interest of the investor.

For example, back in 1998, the Roth IRA was introduced. The concept of the Roth IRA was a 180-degree turnaround from the Traditional IRA.

The Traditional IRA allows for tax deductible contributions with retirement withdrawals taxed at ordinary income rates. The Roth IRA does not allow for yearly contribution deductions, but allows for tax- free withdrawals at 59 1/2 years of age.

In order for the government to generate some additional tax revenues they allowed for conversions of existing Traditional IRA's into Roth IRA's as long as you paid the ordinary income tax due on the amount transferred.

Unfortunately, for those that fell asleep at the switch, when the stock market took a nose dive in the spring of 2000 many individuals that had transferred their IRAs have come to realize they had paid tax on phantom income since their assets depreciated.

To only make matters worse, losses within a Roth IRA cannot be written off. And to add insult to injury, if your tax bracket remains the same during your retirement years, the ultimate tax benefit between a Traditional IRA and a Roth IRA are exactly the same over time.

So allowing for the conversions made money for the government with increased tax revenues, but the unsophisticated investor that transferred, lost part of their nest egg to taxes with really no tax benefit for themselves if their tax bracket remains constant at retirement.

So before you start juggling your portfolios to take advantage of the much hyped tax-free dividend proposal, make sure that investment philosophy serves you well.

Rule of thumb: if you are not currently invested in tax-free vehicles, then this proposal probably doesn't offer you much by owning dividend paying stocks.

If your investment objectives call for growth, stick with growth stocks. In the long run this tax package will benefit a growth company with earnings just as much as a dividend paying stock with earnings.

Also keep in mind that no one knows at this time exactly how this proposal will affect the overall stock and bond markets. One thing we do know for sure is that the plan will never be accepted by Congress in totality.

After all, it is more political than economical and by my definition politics means compromise.

Therefore, don't spend too much time looking for the stocks that will benefit from the proposed rules. Let the so-called pros try and figure out the ultimate effects the plan will have on different asset classes, and you the investor stick to your investment strategy.

If dividend paying stocks have a place in your portfolio, this tax program will be in your best interest. If income stocks don't belong in your investment scheme, then stay away from them.

Bottomline: When it comes to investing, invest for your reasons and not someone else's.

David R. Clogg, ChFC is an account executive at Chapin, Davis. He can be reached at 410-435-3200 or visit his Web site at www.theeducatedinvestor.info.

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