EMERGING MARKETS ARE ON THE MARCH - BUT USE CAUTION

The conventional wisdom is that small-cap and emerging market stocks are the global canaries in the coal mine. They are the first to keel over when global markets are predicting a recession. But they're also the first to perk back up again, and often rocket to substantial gains - when capital markets are predicting a recovery ahead.

If that wisdom holds true, the canary has awakened! After having taken a shellacking in 2011, thanks largely to investor skittishness about Greece and the Eurozone sovereign debt crisis, emerging market stocks are up, and up strongly, in the first quarter of 2012. For example, India is up more than 25% year-to-date. Russia and Brazil are up 20% each.

As a result, investors are pouring money back into emerging markets, trying to get in on the action. For example, Thailand reported a 14 million bhat outflow of capital in the first half of 2011. But some 9 million bhat flowed back in in the second half - and the flows continue. Thai stocks are also up nearly 20% in the first quarter of 2012.

You can't ignore emerging markets anymore: They make up nearly half the world economy, according to the International Monetary Fund. And that figure is growing fast, as China drags the rest of the Asian economy with it into the modern era.

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But be careful! Yes, these economies are growing at several times the rate of modern western economies. Why? There's no secret sauce: They are buoyed by strong balance sheets, loads of available investment capital thanks to savings rates in Asia that dwarf those in the U.S. and Europe, and favorable demographics. Countries like Indonesia, India, and Thailand have young populations just now entering the prime of their earning years, even as the U.S. and Europe see our own baby booms transition into retirement.

Studies at Stanford University and the University of Florida have found that high growth does not necessarily translate to big stock market profits: There are too many variables at play. For example, these countries might post high nominal rates of return in local currency terms. But they usually have higher inflation than the U.S. as well - and investors frequently wind up treading water, once you consider inflation.

Although a recent study projects that India will be the world's biggest economy by 2050, there is a lot to suggest that the current boom in emerging market stocks is getting a little long in the tooth: China was recently forced to loosen its monetary policy after rumblings of an impending collapse of an urban real estate bubble. If Chinese growth slows down below about 5% - robust by Western standards, but considered very slow by Chinese standards of late- it could take Asian emerging market stocks with it.

Furthermore, don't expect the raw index funds to give you adequate diversification. The MSCI Emerging Market index grossly over-weights the Asian tiger economies and China, at the expense of important opportunities in Eastern Europe and elsewhere.

Globally, we are also seeing a substantial move of assets into emerging markets as institutional investors reassess their approach to diversification. In the past, a 5% to 10% allocation to emerging markets was considered a lot for an institutional fund. But as emerging markets approach half the global economy, we are starting to see model portfolios approach 20% and 30% allocations toward emerging market stocks, in some cases.

Here are the keys to keep in mind: Don't invest looking in the rear view mirror. Don't chase the hot markets. Not all returns are created equal. China picks its winners and creates growth through massive stimulus and private/public partnerships. India, on the other hand, has a strong entrepreneur culture; Keep costs down and turnover low. Liquidity is an issue in small markets. Open-end funds have trouble dealing with sudden massive inflows and outflows. To avoid this, use closed-end funds and ETFs. Balance any broad emerging market index exposure with more specific counterweights in Eastern Europe, South Asia and South America.

If you can keep these in mind, emerging markets can be an excellent source of diversification, with low correlation to standard assets in the U.S. And there's still room for growth in emerging markets thanks to an expanding middle class in many countries driving domestic demand, and the increasing globalization of the world economy drawing manufacturers to these locales.

CAPITAL GAINS TAXES: WHAT WILL THE NEW YEAR BRING?

If you sell an asset at a profit, Uncle Sam is going to want his cut. And beginning January 1, 2013, he is going to be taking a bigger chomp.

Under current law, capital gains on assets held for more than a year are not taxed at all if your income places you in the 10% or 15% tax bracket. If your tax bracket is 15% or more, under current law, the tax on your long term capital gains is 15%.

For short-term gains, the tax is the same as your top marginal ordinary income bracket - up to 35%. As of 2013, however, those rates change substantially: Long-term gains will be taxed at 20% (or 10%, for those in the 15% tax bracket).

Also, at the same time, there will be no more separate, lower tax bracket for dividends from qualified U.S. corporations. All dividend income will be taxed to the individual shareholder at ordinary income tax rates. This is going to have a big effect on some of those who rely on dividends for income, and taxes on this income for larger portfolios will more than double.

Unearned Income Medicare Contribution Tax. Also beginning in 2013, capital gain income will be subject to an additional tax, called the unearned income Medicare contribution tax. This will slap on an additional 3.8% tax on all net investment income, or ordinary income over and above a certain amount per year - currently $200,000 for singles, and $250,000 for married couples. The tax will also apply to gains on real estate transactions - which will become a significant planning consideration for those involved in the real estate market. The $250,000 exemption for single taxpayers and $500,000 exemption for married couples on the sale of a qualified personal residence will still apply, however, for the purposes of calculating the unearned income Medicare contribution tax. If your home qualifies, you will only be subject to the 3.8% tax on gains exceeding the exemption.

Those whose earnings are below this threshold are not subject to the 3.8% tax. For those who are, this tax is in addition to the 2.9% Medicare contribution tax currently assessed on ordinary income, for a total of 6.7%.

Because the 3.8% applies to all "net investment income" over and above the exclusion, it will also potentially increase taxes on dividend income as well as on capital gains. At the same time, the top marginal income tax rate will rise from 35% to 36.9%.

CHOOSING IMMEDIATE OR DEFERRED ANNUITIES

Deferred Annuities. For the following reasons, deferred annuities are great for those who are constructing long-term retirement plans:

• Payments made on income taxes will be deferred until the money is withdrawn.
• There is a death benefit with deferred annuities. Individuals who die before collecting on their annuity will be glad to know that their heirs will receive their contribution payments. In addition, heirs will receive any investment earnings minus the amount of cash withdrawals made, if any, during the annuity owner's life.
• In contrast to an IRA or 401(k) product, there are no limits placed on annual contributions for a deferred annuity.

Immediate Annuities. These products allow individuals to take a lump sum of money and convert it into an annuity. By doing this, the individual will receive a regular income. As a general rule, payments begin approximately one month following the purchase of the annuity product. Immediate annuities give owners financial security by offering structured payments for the remainder of the individual's life. This means that it is impossible to outlive the annuity, which is a very attractive benefit. In addition to possessing this excellent feature, immediate annuities also offer owners the following advantages:

• Owners may supplement their current income. For those who are nearing retirement age, it's best to think about transferring funds from another investment or savings account into an immediate annuity. It's also possible to transfer proceeds that come from a deferred annuity into an existing immediate annuity.
• If annuity payments are classified as earnings, owners must only pay taxes for that specific portion of their immediate annuity. There is no tax for the portion that is classified as the principal amount, which is the original deposit made with money that has already been taxed.
• Immediate annuities may be variable or fixed, which makes them similar to deferred annuities in this respect. Immediate annuity payments that are fixed are connected to the amount the individual decides to contribute, the interest rate established at the time of purchase and the age of the individual. Payments made to the owners of these annuities will not rise or fall. However, immediate annuity payments that are variable will fluctuate based on the specific investments the owner chooses.

Deciding which type of annuity to purchase might seem confusing. Since each individual's circumstances vary, it's best to speak with one of our agents for assistance in analyzing personal data and determining the best choice for a specific situation.

* Liquidated earnings are subject to ordinary income tax, may be subject to surrender charges and, if taken prior to age 59 1/2, may be subject to a 10% federal income tax penalty. Guarantees and payment of lifetime income are contingent on the claims paying ability of the issuing insurance company.