8 Wealth Issues: Tax Efficiency

What it means, why it counts

When Sonia and I decided to open the doors to our practice we knew we wanted to take a different approach. I was tired of seeing a disconnect between people’s long term financial goals and the potential impact of taxes. We were determined to make tax efficiency a core piece of our financial planning services—and accomplished this through building an in-house tax team.

In this month’s 8 Wealth Issues column, I wanted to spend some time on the idea of tax efficiency as a financial planning issue worth considering.

A little phrase that may mean a big difference. When you read about investing and other financial topics, you occasionally see the phrase “tax efficiency” or a reference to a “taxsensitive” way of investing. What does that really mean?

The after-tax return vs. the pre-tax return. Everyone wants their investment portfolio to perform well. But it is your after-tax return that really matters. If your portfolio earns you double-digit returns, those returns really aren’t so great if you end up losing 20% or 30% of them to taxes. In periods when the return on your investments is low, tax efficiency takes on even greater importance.

Tax-sensitive tactics. Some methods have emerged that are designed to improve after-tax returns. Money managers commonly consider these strategies when determining whether assets should be bought or sold.

Holding onto assets. One possible method for realizing greater tax efficiency is simply to minimize buying and selling to reduce capital gains taxes. The idea is to pursue long-term gains, instead of seeking short-term gains through a series of steady transactions.

Tax-loss harvesting. This means selling certain securities at a loss to counterbalance capital gains. In this scenario, the capital losses you incur are applied against your capital gains to lower your personal tax liability. Basically, you’re making lemonade out of the lemons in your portfolio.

Assigning investments selectively to tax-deferred and taxable accounts. Here’s a rather basic tactic intended to work over the long run: tax-efficient investments are placed in taxable accounts, and less tax-efficient investments are held in tax-advantaged accounts. Of course, if you have 100% of your investment money in tax-deferred accounts, then this isn’t a consideration.

How tax-efficient is your portfolio? It’s an excellent question, one you should consider. But this brief article shouldn’t be interpreted as tax or investment advice. If you’d like to find out more about tax-sensitive ways to invest, be sure to talk with a qualified financial advisor who can help you explore your options today. What you learn could be eye-opening.

Thisinformation has been derived from sources believed to be accurate. Please note- investing involves risk, and past performance is no guarantee of futureresults. The publisher is not engaged in rendering legal, accounting or otherprofessional services. If assistance is needed, the reader is advised to engagethe services of a competent professional. This information should not beconstrued as investment, tax or legal advice and may not be relied on for thepurpose of avoiding any Federal tax penalty. This is neither a solicitation norrecommendation to purchase or sell any investment or insurance product orservice, and should not be relied upon as such. All indices are unmanaged andare not illustrative of any particular investment.  Marketinglibrary.net content contributed to this blog post.

Perspectives from Above the Noise – Week of February 24, 2014

U.S. stock indices have recouped their losses from January’s emerging-market-led selloff and are once again flirting with fresh all-time highs. The release of the minutes from the Fed’s Jan. 28-29 meeting, the last one chaired by Ben Bernanke, made some interesting headlines. The Fed attributed much of the decline in labor-force participation to demographic shifts rather than cyclical weakness in the economy. That’s important because it would seem to support the Fed staying the course on scaling back its monthly bond buying over the course of this year.

The minutes did not reveal a great deal of concern over economic slowdown, and the Fed Atlanta Fed President Dennis Lockhart said later that he was “looking through” this winter’s soft-patch of economic data. It appears that only dramatic economic deterioration would cause the Fed to change its taper course. But very muted consumer inflation readings gives the Fed ample flexibility to fine-tune its policies.

For the week, the S&P 500 lost 0.13%, the Dow dropped 0.32%, and the MSCI EAFE (developed international) added 1.57%.

Here are the 3 stories this week that rose above the noise:

Why This Is Not 'a Mature Bull Market'

We are in the sixth year of the current bull market that began in 2009. Only a handful of bull markets have made it into their sixth year and JPMorgan’s Chief U.S. Equity Strategist Tom Lee feels this bull market still has legs and explains why he feels it is not a mature bull market. In Lee’s view, several factors will provide longevity to this bull market including aging infrastructure that needs replacement, record consumer wealth, historically low borrowing costs, and retail investors returning to stocks. Lee mentions several positive long-term catalysts for U.S. equities, but equities have been volatile in 2014 and that trend may continue throughout the year because of stretched equity valuation, Fed tapering, emerging market growth concerns, and recent weakness in U.S. economic data.

Greed Turning Losers to Leaders in Russell 1000 Index

Several metrics we follow that are designed to measure investor sentiment entered 2014 indicating a potentially excessive level of optimism. A Bloomberg article details another sign of frothy investor sentiment which is the recent outperformance of speculative and non-profitable companies. We view this as another anecdotal indication that greed and overconfidence has returned to equity markets which increases the risk of a market correction in the coming months.

Home Prices in 20 U.S. Cities Increase at Slower Pace

U.S. home prices increased 13.4% over the trailing 12 months ending December 2013, a slight deceleration from the 13.7% increase in the 12 months ending November 2013. Price appreciation is slowing as rising mortgage rates combined with harsh winter weather cool home purchases over the past few months. Positively, smaller increases mean more homes will remain affordable as the labor market improves, helping maintain the rebound in residential real estate that has boosted growth.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of February 17, 2014

Expanding on the rally that began the previous Thursday, U.S. stocks strung together their best weekly gains in 2014 last week. The rally erased most of this year's losses caused by emerging-market turmoil and softer economic data. Bullish investors increasingly dismissed this year’s economic weakness as weather-related disruptions masking ongoing recovery.

The key fuel for the rally, though, was provided by Janet Yellen's first appearance before Congress as the Fed Chairwoman, replacing Ben Bernanke after eight years at the helm. Yellen is a known commodity to financial markets, having served as the Fed's Vice Chair since 2010 and the President of the San Francisco Fed prior to that. Markets liked what they heard from Mrs. Yellen as she delivered both continuity of policy and consistency of message with other recent Fed communication. The bulls also applauded some better-than-expected Eurozone GDP data with the French, German and Dutch economies all providing positive surprises.

For the week, the S&P 500 gained 2.32%, the Dow increased 2.28%, and the MSCI EAFE (developed international) added 2.48%.

Here are the 3 stories this week that rose above the noise:

Is Shrinking Stock Market a Bullish Sign?

Adam Shell, writing in the USA TODAY, details an interesting phenomenon that has developed in the U.S. equity market over the past 15 years, which is a shrinking number of publicly traded companies. The article examines theories behind the decline in public companies, including two severe bear markets and regulatory changes, along with discussing the possibility that the shrinking supply of public companies has had a positive impact on stock prices. Ultimately, in our view, the long-term value of companies is likely to be determined by future free cash flows rather than changes in the number of public vs. private firms or a trend toward fewer and larger publicly traded companies. Nonetheless, the reduction in the number of public firms may have played a cyclical role in recent market gains and may contribute to continued short-term improvement in investor sentiment toward the equity market.

Emerging Stocks Rise to Three-Week High on Record China Lending

Despite a strong performance from developed market equity indices last year, emerging stocks posted negative performance and have lagged this year, as well. Since emerging economies represent about half of global GDP, investors are watching performance of their stock markets in 2014 as a potential leading indicator of the health of the global economy. In this regard, the rebound in emerging equities to a three-week high last week was encouraging. A Bloomberg article recaps some of the reasons behind the rally which included record Chinese lending. The Chinese credit figures helped the Shanghai Composite Index erase a slump of as much as 5.9% this year.

Forget High Prices, Gasoline Demand to Fall

Bank of America-Merrill Lynch recently came out with research projecting a fall in gasoline prices based on a variety of factors. In the short term, they cite weakening economic data as a catalyst for falling gasoline prices. Over the long term, there may be downward pressure on gasoline prices because of stricter vehicle fuel standards and rising gasoline inventories from increased oil production. As stated in the article, most of the new cars in the U.S. are getting 18% more miles per gallon than cars produced in 2007. Despite the recovery in the U.S. economy, demand for gasoline has remained relatively flat because of improving fuel efficiency. Weaker demand will keep a lid on fuel prices and ultimately be a catalyst for stronger economic growth.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of February 10, 2014

Investment markets finally turned positive last week, with key employment numbers driving the movement. The U.S. Department of Labor said on Friday that the United States created 113,000 jobs in January, well below the consensus economist forecast of 180,000. December’s report was revised only modestly from +74,000 to +75,000, although a larger weather-related revision had been expected. However, the November data was also revised up from +241,000 to +274,000, creating a three-month average of 154,000 payrolls growth. Healthcare, one of the consistent contributors to job growth, failed to deliver new January jobs, perhaps reflecting confusion over the rollout of Obamacare. The government sector also continued to shed jobs in areas like the U.S. Postal Service. Some of the 30,000 government cuts may have been a holdover from the government shutdown.

For the week, the S&P 500 gained 0.81%, the Dow increased 0.61%, and the MSCI EAFE (developed international) added 0.76%.

Here are the 3 stories this week that rose above the noise:

Boomers Turn On, Tune In, Drop Out of U.S. Labor Force
The U.S. labor force participation rate is near its lowest level since 1978 (63 percent) and the biggest contributor to the decline is retiring baby boomers. In fact, 80 percent of the decrease over the last two years was directly caused by retiring baby boomers according to Federal Reserve research.

Many economists predict that labor force participation will remain low for the foreseeable future. Individuals over age 55 will make up 25.9 percent of the labor force by 2022, ahead of the current level of 20.9 percent. The labor force participation rate is only 40.3 percent in that group versus 81 percent for individuals aged 25 to 54.

A shrinking labor force has a negative impact on GDP growth and changing demographics may keep the U.S. economy from reaching growth rates seen in the decades leading up to the 2008-2009 recession (3 percent plus) on a consistent basis going forward.

Home Prices Rose in Fewer U.S. Markets in Fourth Quarter

Home prices continued to rise during the fourth quarter in the majority of U.S. cities, according to data from the National Association of Realtors. However, as detailed in a recent Bloomberg article, the percentage of cities showing year-over-year price gains declined to 73 percent from 88 percent in the third quarter, which may be an early indication that momentum in the housing market is cooling in response to higher interest rates and decreasing affordability.

Given the important role the rebound in housing has played in boosting consumer confidence in recent quarters, this potential loss of momentum in housing prices bears close watching in the coming months.

Bulls Return to Unloved Europe

With investors exiting emerging markets, European equity markets are beginning to see more attention. Interestingly, research and investment firm Gavekal has found that since the start of the year, stocks of European companies that derive a significant portion of their revenue directly in the Eurozone have outperformed their more export-dependent counterparts.

“With financial and cyclical conditions improving considerably in the Eurozone, and risks rising in emerging markets, the most domestic focused Eurozone companies now look more and more like the new defensive plays,” said Francois-Xavier Chauchat, an economist at GaveKal.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of February 3, 2014

It was clearly a “risk-off” week in global markets with equities tumbling and investors seeking the perceived safety of U.S. Treasuries. Stocks suffered their worst start to the year since 2010 with the Dow finishing the month down a little over 5%. Gold, however, ended the week in negative territory despite the spike in volatility.

Many bulls pointed to the still intact long-term uptrend, calling the selloff simply a healthy short-term pullback after a strong year-end rally. Some of the excessive bullish sentiment has been worked off in January’s selling. The bears, on the other hand, cited softer economic data (including durable goods and new home sales), mixed earnings results, reduced liquidity in the form of more Fed tapering, and growing fears of emerging market contagion. China’s purchasing managers’ index (PMI) also slid to its lowest level since July, barely hanging above the threshold for expansion.

For the week, the S&P 500 lost 0.43%, the Dow fell 1.14%, and the MSCI EAFE (developed international) dropped 2.3%.

This year the market has caught a lot of people by surprise as the performance of many asset classes are not living up to expectations. The consensus expectation was for bonds to spike in January, but surprisingly the 10-year Treasury is now at 2.61% down from 3% at the end of last year. On the equity side, the market was expected to continue last year’s climb, but most U.S. indexes have started the year off by dropping more than 5%. Prognosticators have also been incorrect with regards to the yen and gold, as both assets have started the year on the positive side despite negative predictions. However, many long-term trends remain intact, so shorter year-to-date price movements may provide opportunities for investors to re-enter prior trades or themes at more attractive levels.

Here are the 3 stories this week that rose above the noise:

Emerging Markets – Don’t Panic

Global equity markets have pulled back due, in part, to concerns over emerging markets. Recent events in Turkey and Argentina have eerie echoes of the early stages of the 1997-1998 emerging-market crisis. Could 2014 bring a repeat? An article from The Economist provides a measured look at the bull and bear case, ultimately siding with the bulls. They cite arguments from the International Monetary Fund that most emerging markets are far less vulnerable than they were in 1997. They have flexible exchange rates, higher reserves (a whopping $7.7 trillion in total), smaller current account deficits (only two of 25 have deficits above 5% of GDP) and their debts are lower and more likely to be domestic currency.

January Auto Sales Are No Cause for Panic

U.S. auto sales dropped to a 15.24 million annualized pace in January, the first contraction in vehicle sales since September 2013, as most of the country suffered through extremely cold weather and record snowfall in some regions. The disappointing auto-sales numbers look concerning in light of recent weakness in other major economic data points. However, January is historically a weak month for auto sales, the weather last month was abnormally severe, and sales were strong in the West where the weather was good. The consensus expectation among industry analysts is for auto sales to increase to 16 million in 2014, ahead of 15.6 million vehicles sold in 2013, which would be the first time auto sales reached 16 million since 2007.

Emerging-market Rout Seen Enduring on Low Real Rates

A recent Bloomberg article provides a summary of the ongoing emerging-markets concerns that have been a big driver of recent market volatility. The article provides some evidence that emerging currencies will remain under pressure due to real interest rates that are still too low. If central banks in emerging economies are forced to increase interest rates in order to stabilize currency markets, that in turn would likely lead to a further slowing of economic growth. This dynamic has turned investor sentiment toward emerging markets extremely negative in recent weeks and explains why investors will continue closely watching developments in emerging currency and debt markets in the coming weeks.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.