8 Wealth Issues: Investment Strategies

Why Globally Diversified Portfolios have (& should have) Lagged the S&P 500

Those who have heard me speak about the media’s influence on investor’s decision-making know that I believe in a phenomenon I call “The Creation of Crisis”—whereby 24-hour news outlets fill airtime by making “vital” news stories out of non-stories. These crises can have impact on investor behavior, which in turn has potential impact on investor’ process. This can also work the other way, and is why I believe many investors have felt frustration with portfolio performance throughout 2014.

In this month’s 8 Wealth Issues blog entry, I thought it would be a good idea to look at why continuing to emphasize the institutional process of investing is still a better idea than benchmarking against the S&P 500.

Diversification is essential, yet it comes with trade-offs. Investors are repeatedly urged to allocate portfolio assets across a variety of investment classes. This is fundamental; market shocks and month-to-month volatility may bring big losses to portfolios weighted too heavily in one or two classes.

Just as there is a potential upside to diversification, there is also a potential downside. It can expose a percentage of the portfolio to underperforming sectors of the market. Last year, that kind of exposure affected the returns of some prudent investors.

The media insists on reporting on about 1.5 asset classes: The Dow Jones Industrial Average & S&P 500 are both Large Cap US-based indices, and NASDAQ is a US technology-based index which has many Large Cap companies in it. It is a POOR comparison to any risk-based managed investment strategy.

Sometimes diversification hinders overall performance. The stock market has performed well of late, but very few portfolios have 100% allocation to stocks for sensible reasons. At times investors take a quick glance at stock index performance and forget that their return reflects the performance of multiple market segments. While the S&P 500 rose +11.39% in 2014, other asset classes saw minor returns or losses last year.1

As an example, Morningstar assessed fixed-income managers for 2014 and found a median return of just +2.35% for domestic high yield strategies. The Barclays U.S. Aggregate Bond Index advanced +5.97% in 2014 (that encompasses coupon payments and capital appreciation), while the Citigroup Non-U.S. World Government Bond index lost -2.68%.1,2

Turning to some very conservative options, the 10-year Treasury had a +2.17% yield on December 31, 2014; & Bankrate found the annual percentage yield for a 1-year CD averaged +0.27% nationally, with the yields on 5-year CDs averaging +0.87%; last year’s average yields were similar.3,4

Oil’s poor 2014 affected numerous portfolios. Light sweet crude ended 2014 at just $53.27 on the NYMEX, going -45.42% on the year. (In 2008, prices peaked at $147 a barrel). Correspondingly, the Thomson Reuters/CRB Commodities Index, which tracks the 19 most watched commodity futures, dropped 17.9% in 2014 after slips of 5.0% in 2013, 3.4% in 2012 and 8.3% in 2011. At the end of last year, it was at the same level it had been at the end of 2008.5,6

The longstanding MSCI EAFE Index (an International index tracking Europe and the Asia Pacific region) lost -7.35% for 2014. At the end of last year, it had returned an average of +2.34% across 2010-2014. So on the whole, equity indices in the emerging markets and the eurozone have not performed exceptionally well last year or over the past few years.7

Why favor an Institutional Process? I sometimes get the question “Why wasn’t I allocated more” to the best performing asset class? Active investment management with an institutional risk-managed process is about both tilting portfolios TOWARD perceived opportunities and AWAY from too much risk—given the client’s comfort with a particular level of risk. For most people an over-allocation to the Large Cap Domestic asset class may have shown to be an unnecessary amount of risk. History tells us that a patient, well considered investment process tied to goals based in a financial plan gives us the best probability of long-term financial success. It also gives the investor a better, more consistent experience. The downside to employing this process is the myopic view: In a year like 2014 when the S&P 500 does well and everything else doesn’t, your diversified portfolio also doesn’t.

In most year’s I do not hear complaints about why managed portfolio’s didn’t beat the best performing asset class. But when the best performing asset class is the only index the media tracks, I understand why it could become a question.

8 Wealth Issues: Fiscal Fitness

A Look at Baseline Financial Health Ratios

In this month’s 8 Wealth Issues blog, I thought I would address the concept of what our practice refers to as “Fiscal Fitness.” New clients to our practice sometimes do not understand what I am referring to, but this is the foundation for sound financial planning. This involves capturing an accurate picture of your current financial condition—documenting what all of your assets are worth, less any liabilities; as well as building a cash-flow model that is true to your income and spending habits.

Fiscal fitness goes beyond this as well. It includes being organized with financial documents, and managing your wealth so that you can feel confident making future financial decisions. Often helping clients make financial decisions comes in “stress-testing” the impact of those decisions within your current financial plan.

Baseline financial health, however, can be brought back to 4 ratios. These are:

Monthly Surplus/Monthly Income

After you pay all of your monthly obligations, how much money do you have left? This is your monthly surplus and if you divide this amount by your total monthly income, you’ll get an idea of how well you manage your finances and also, an ideal percentage of that income you can put away for savings. When calculating your monthly obligations, be sure to include everything — all of your bills, credit card bills, your house payment, groceries, and even your magazine subscriptions.

It is important to note that you should add back in any 401k contributions into your monthly income, as this is periodic savings mechanism and that is exactly the ratio we are looking to measure here. This ratio can identify whether or not you could be putting more toward tax advantaged retirement savings.

Cash and Liquid Assets/Monthly Expenses

For this ratio, you want to add in all of your cash assets, like cash on hand, cash in the bank, money market account balances, and money you have in CDs (do not include cash in retirement accounts). If you divide that total by the total amount of all of your monthly expenses, you’ll get an idea of how long you can sustain your household in the event of an emergency situation, like illness or job loss. For self employed people or single income households, this can be a crucial ratio to be mindful of.

Of all the items I look at when assessing a clients Fiscal Fitness, it is the presence of an adequate emergency fund that is most often missing. Not having this ratio in good health could cause you to have to invade retirement savings in the event of loss of income—which in turn may cause tax headaches and penalties.

Cash and Liquid Assets/Net Worth

Your net worth is the difference between your assets and your debt. To calculate your net worth, add up the value of all of your assets. This includes everything, ranging from the value of your home, to the estimated value of your furniture, to all of your cash and cash assets. Subtract your debts (your credit card balances, mortgage, etc.) from this amount. There are also some online net worth calculators you can use to walk you through the process.

Once you’ve determine your net worth, divide your net worth by all of your cash and liquid assets (your bank account balances, CDs, money market accounts, etc.). This will give you the percentage portion of your net worth that is held in liquid form. Too high of a ratio means you could have too much cash at hand and therefore your money is likely not working for you adequately. Conversely, a common mistake I see is people reaching for growth by putting short term money in risk-based investments. Be mindful of time horizon.

Monthly Debt/Monthly Income

This is your debt to income ratio and it helps determine how much of a lending risk you are. Banks use this ratio as a baseline for determining loan approvals & mortgages. The lower your debt-to-income ratio, the better chance you have of receiving credit from lenders in most cases. Ideally, 36 percent is the highest debt-to-income percentage you should have. You can calculate this ratio on your own by dividing your total monthly debt (credit card payments, student loans, mortgage payment, etc.) by your monthly income.

These ratios can help you set a good baseline for financial health and making sound financial decisions. Please be sure to contact our practice if you would like help in looking at all the aspects of Fiscal Fitness or any of the other 8 Wealth Issues we help with tackling. The beginning of a new year is a great time to turn over a new financial leaf.

Happy Holidays.

Citations.
Personal Finance Cheat Sheet – “How Financially Healthy Are You? Find Out Using 4 Ratios”

This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

8 Wealth Issues: Taxes

The Tax Effect; Taking Taxes Into Account When Saving & Investing

In this month’s 8 Wealth Issues blog, I thought it important to focus on the inter-play between taxes and investing. Many people have been surprised by their tax bill for 2013—and with taxes certainly not decreasing, let’s look at how investment strategies can lead to potential higher “pay as you go” capital gains and interest income taxes.

How many of us save and invest with an eye on tax implications? Not that many of us, according to a recent survey from Russell Investments (the global asset manager overseeing the Russell 2000). In the opening quarter of 2014, Russell polled financial services professionals and asked them how many of their clients had inquired about tax-sensitive investment strategies. Just 35% of the polled financial professionals reported clients wanting information about them, and just 18% said their clients proactively wanted to discuss the matter.1

Good financial professionals aren’t shy about bringing this up, of course. In the Russell survey, 75% of respondents said that they made tax-managed investments available to their clients.1

When is the ideal time to address tax matters? The end of a year can prompt many investors to think about tax issues. Investors’ biggest concerns may include any sudden changes to tax law. Congress often saves such changes for the eleventh hour. Sometimes they present opportunities, other times unwelcome surprises.

The problem is that your time frame can be pretty short once December rolls around. You can’t always pull off that year-end charitable donation, gift of appreciated securities, or extra retirement plan contribution; sometimes your financial situation or sheer logistics get in the way. It is better to think about these things in July or January, or simply year-round.

While thinking about the tax implications of your investments year-round may seem like a chore, it may save you some money. Your financial services professional can help you stay aware of the tax ramifications of certain financial moves.

Think about taxes as you contribute to your retirement accounts. Do you contribute to a qualified retirement plan at work? In doing so, you can lower your taxable income (and your yearly tax liability). Why? Those contributions are made with pre-tax dollars. In 2014, you can contribute up to $17,500 to a 401(k) or 403(b) account or the federal government’s Thrift Savings Plan. If you are 50 or older this year, you can put in up to $23,000 into these accounts. The same is true for most 457 plans. This can reduce your taxable income and lower your tax bill.2,4

Think about where you want to live when you retire. Certain states have high personal income tax rates affecting wealthy households, and others don’t levy state income tax at all. If you are wealthy and want to retire in a state with higher rates, a Roth IRA may start to look pretty good versus a traditional IRA. Withdrawals from a Roth IRA aren’t taxed (assuming the Roth IRA owner follows IRS rules), because contributions to a Roth are made with after-tax dollars. Distributions you take from a traditional IRA in retirement will be taxed.2

What capital gains tax rate will you face on a particular investment? In 2013, the long-term capital gains tax rate became 20% for high earners, up from 15%. On top of that, the Affordable Care Act Surtax of 3.8% effectively took the long-term capital gains tax rate to 23.8% for investors earning more than $200,000.2,3

Greater capital gains taxes can actually be levied in some cases. Take the case of real estate depreciation. If you sell real property that you have depreciated, part of your gain will be taxed at 25%. The long-term capital gains tax rate for collectibles is 28%. Own any qualified small business stock? If you have owned it for over five years, you typically can exclude 50% of any gains from income, but the other 50% will be taxed at 28%. Lastly, if you sell an asset you’ve held for less than a year, the money you realize from that sale will be taxed at the short-term rate (i.e., regular income), which could be as high as 39.6%.2,3

Are you deducting all you can? The mortgage interest deduction is not always noticed by taxpayers. If a home loan exceeds $1.1 million, interest above that amount may not qualify for a deduction. Itemizing can be a pain, but may bring you more tax savings than you anticipate.2

A tax-sensitive investing approach is always specific to the individual. Therefore, any strategy needs to start with an in-depth discussion with your tax or financial professional. With growing concern over government entitlement programs and rising debt, taxes are likely on the rise. It is important to incorporate strategies to help mitigate taxation of your investments into your financial plan.

Citations.

1 - russell.com/us/newsroom/press-releases/2014/russell-survey-advisors-say-tax-aware-investment-strategies-not-top-of-mind.page? [4/29/14]
2 - foxbusiness.com/personal-finance/2014/08/07/investments-and-tax-planning-go-hand-in-hand/ [8/7/14]
3 - bankrate.com/finance/money-guides/capital-gains-tax-rates-1.aspx [3/27/14]
4 - irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014 [11/4/13] 

MarketingPro, Inc.contributed to this blog post.  This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

8 Wealth Issues: Retirement Planning

Two 2014 court decisions you need to know about

In this installment of our 8 Wealth Issues blog, I thought it important to focus on two recent court decisions that clients need to understand as they will effect your retirement nest egg. These include a ruling on the tax treatment of rollovers & the asset protection of inherited IRAs.

One Indirect IRA Rollover per Year
What was once allowed is now prohibited. In 2008, an affluent New York City couple made a series of withdrawals and transfers among contributory IRAs, rollover IRAs and non-IRA investment accounts, all with the long-established 60-day deadline for tax-free IRA rollovers in mind. As esteemed tax attorney Alvan Bobrow and his wife withdrew and rolled over a series of five-figure sums within a six-month period, they assumed their actions were permissible under the Internal Revenue Code. In January 2014, a U.S. Tax Court judge ruled otherwise.1

Starting in 2015, you are allowed one IRA-to-IRA rollover per 365 days - period. A subtle but important change has been made. Publication 590 has long stated that a taxpayer can generally only make one tax-free rollover of any part of a distribution from a single IRA to another IRA during a 12-month period. That didn’t preclude a taxpayer from making multiple IRA-to-IRA rollovers using multiple IRAs during such a timeframe.1,4 So beginning next year, you can only make a tax-free IRA-to-IRA rollover if you haven’t made one within the past 365 days.3

Don’t grumble just yet. If you want to move money between IRAs more than once next year, there is still a way you can do it. The new IRS rule change doesn’t apply to every type of IRA “rollover.” Here’s the good news. IRS Announcement 2014-15 states: “These actions by the IRS will not affect the ability of an IRA owner to transfer funds from one IRA trustee directly to another, because such a transfer is not a rollover and, therefore, is not subject to the one-rollover-per-year limitation of § 408(d)(3)(B).”3

In other words ... the new restriction does not apply to trustee-to-trustee transfers.

Inherited IRAs are not protected from bankruptcy
The other court case that was recently decided involved inherited retirement assets. In the case of Clark v. Rameker, the Supreme Court decided unanimously on June 12 against Heidi Heffron-Clark and her husband Brandon C. Clark, finding that an IRA Ms. Clark inherited directly from her deceased mother in 2000 isn't eligible for protection from creditors. The couple had filed for Chapter 7 bankruptcy back in 2010, and at that time identified the inherited IRA — then valued at $300,000 — as exempt from the bankruptcy estate.

The court's decision was unanimous, and held that Inherited IRAs differ from traditional IRAs in 3 ways:

1. Holders of inherited IRAs cannot invest additional money into the account, whereas those with traditional and Roth IRAs can do so.

2. The tax code requires inherited IRA holders to withdraw the money from the account, either taking all of the money in the IRA within five years after the death of the owner or taking minimum annual distributions each year.

3. Inherited IRA holders may also take all of the money out at any time and for any purpose without penalty. Roth and traditional IRA holders, meanwhile, are subject to a 10% penalty for withdrawals before age 59.5.

Those three characteristics led the court “to conclude that funds held in such accounts are not objectively set aside for the purpose of retirement,”5

Conclusions

In light of these two court decisions, people should be reminded of two things. Planning needs constant review in light of decisions in Washington that affect the assumptions we make in financial plans. Reviewing the uses & purposes of different accounts and their application to your financial life is vitally important. The other consideration people should make is in regard to making IRA rollover and transfer decisions. Be sure you understand the tax ramifications as you make these requests and work with a professional who can ensure that your deferred savings stays deferred.

This information has been derived from sources believed to be accurate This article is for informational purposes only. It is intended to be accurate and authoritative in regard to the subject matter covered. It is presented with the understanding that we are not engaged in rendering legal or tax advice through this article. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. IRS Circular 230 Disclosure: Any discussion pertaining to taxes in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.

Citations.
1 - wealthmanagement.com/retirement-planning/seeing-double [2/4/14]
2 - marketwatch.com/story/new-ira-rollover-rule-coming-in-2015-2014-04-04 [4/4/14]
3 - irs.gov/pub/irs-drop/a-14-15.pdf [4/16/14]
4 - tinyurl.com/lnd86vs [4/24/14] 5 – investmentnews.com/article/20140623/FREE/140629977# [6/23/14]

8 Wealth Issues: Estate Considerations

Going beyond “just the documents”

Did you know that dealing with California probate court can take at least eight months, and sometimes drag on for as long as several years? Additionally, the cost of probate can range from 3 to 7% of the total estate value. With proper estate document preparation through a reputable attorney, it is fairly simple to avoid the probate process for your heirs, but there are other estate considerations that are sometimes overlooked in the estate planning process.

In this month’s 8 Wealth Issues column, I wanted to spend some time discussing estate and legacy considerations. We will be covering some of these at our next client workshop as well.

Essential Documents. Most attorneys will prepare the essential estate documents in negotiated packaged pricing. These typically include a will & trust and springing durable powers of attorney for finance & healthcare. The power of attorney for finance is important for someone to have access to your accounts in the event of your incapacity (think about the ability of a spouse to access your retirement accounts).

Choosing an Executor/Successor Trustee. Selecting someone to administer your affairs after your passing is an important part of the process, but so is communicating this fact to that person. Simply naming someone in your will is not enough. We encourage clients to sit down with the person to be sure they understand your wishes, the resources they should turn to with regard to your assets, and how you would like your estate administered. Be sure you revisit this choice, for as life progresses, you may wish to re-name your designee for any number of reasons.

Taxes: Estate Tax & Income Tax Considerations. We all have an asset exemption for estate tax purposes. This exemption has changed considerably over the years based on the laws set forth by the Federal government. Some states also have estate taxes (currently California does not).

There are also income tax considerations for certain inherited assets. The most common surround tax-qualified retirement accounts and annuities. Your heirs may have options on the treatment of these distributions, and we encourage you to communicate that to them before it’s too late. For instance, Stretch/Beneficiary IRAs can be a great preservation strategy for an inherited retirement account. Oftentimes beneficiaries do not know about these options.

Conduct a Beneficiary Check. Certain types of assets pass outside of probate (and/or outside of your trust). We encourage clients to revisit who is named on retirement accounts, life insurance policies, and transfer on death designations. Often life events dictate a need to update your beneficiary (e.g., divorce).

Specific Bequests, and the Threats to Them. I have had clients tell me that they want to be sure that there is something specific left for someone specific—be it a family heirloom or an exact dollar amount. These bequests can be made as part of the trust, but sometimes the challenge can be in making sure that there is enough money left at the end of your life. As we plan for longer and longer retirements, people’s nest eggs need to last longer. Additionally the cost of a health event that would necessitate a care situation can be devastating to any planned legacies. Long term care insurance can sometimes help with covering these costs and ensuring legacy goals.

Your Legacy: Estate Transition & Administration. What isn’t often talked about in the estate planning process is the value of communicating your plan with loved ones. I have spent time with many clients who had to piece through parent’s estates, and often discovered how certain assets “worked” from an inherited standpoint. Some people do not realize that their trust will need to file a tax return in the year that it distributes assets. This estate transition work and the actual administration of assets is a value-added service our practice provides. I can tell you that those who have had a family-oriented meeting before the inevitable tend to have a smoother path.

This information has been derived from sources believed to be accurate This article is for informational purposes only. It is intended to be accurate and authoritative in regard to the subject matter covered. It is presented with the understanding that we are not engaged in rendering legal or tax advice through this article. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. IRS Circular 230 Disclosure: Any discussion pertaining to taxes in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.

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.