October 21, 2014

Lessons from a Castle in the Clouds

While on our vacation to the Northeast seeking out beautiful fall leaves, quaint bed and breakfasts, and scrumptious cider doughnuts, my wife and I also paid a visit to Thomas and Olive Plant’s mountaintop estate, Lucknow. The old residence was impressive, but the views were truly breathtaking; hence the more commonly heard name, Castle in the Clouds.

As we learned from our tour guide, Thomas Plant’s story was initially a fairy tale. Thomas did more than achieve the American Dream as he rose from a relatively poor immigrant to a millionaire shoe manufacturer with a castle in the clouds, literally. Unfortunately, though, there was not a happily ever after. Thomas Plant committed three very common financial mistakes that would consume his hard-earned wealth and leave him at the mercy of his creditors on his deathbed.
  1. Lack of Diversification – I cannot reiterate how important it is to not have all of your eggs in one basket. For whatever reason, as a fifty-one-year-old retiree with more money than he could have ever imagined, Thomas Plant decided to put a lot of his money into one thing, Russian bonds. His timing could not have been worse. In 1917, the Russian Revolution would forever change the fabric of Russia, and also cost Thomas Plant most of his investments.
  2. Losing at Poker Mentality – You know how when you are already losing at poker you often find yourself betting more aggressively in hopes that you will recoup your losses? Well some of that typical behavior seems to carry over into the investment world. Thomas Plant was probably more than a little miffed about his Bolshevik bond returns (or the lack thereof), so he decided to double down by investing a lot of the money he still had in sugar futures. Don’t understand sugar futures? Don’t feel bad; neither did Thomas Plant! He had already lost a considerable amount of money, so he decided to invest even more aggressively with the hope of making his money back. That doesn’t usually end well.
  3. Too Much Real Estate – I may have some dissenters on this one, but I think it’s important to realize that real estate is not exactly an investment. Real estate is land, a house, or a building. Historically, it often goes up in value over a long enough period of time, but not always. Real estate is not as liquid as cash or stocks and bonds, so someone cutting it too closely financially with too much invested in real estate could very well find themselves trying to sell at an inopportune time or when they don’t want to.  Real estate can also require debt, upkeep, insurance, and property taxes. Even if you are renting your real estate to someone, these expenses can be a hole in your financial bucket, slowly draining away your wealth. Believe me when I tell you that Thomas Plant’s house was awesome. It had a pool table, a knight in shining armor, a long driveway, and even a secret passage, but it also chewed up a considerable portion of his net worth to build and maintain. After his bond debacle and failed “all in” with sugar futures, Thomas Plant didn’t have much more than his house. Try as he did, he couldn’t sell his house when he needed to (as the Great Depression was in full swing), and Lucknow was eventually auctioned off. His creditors happened to be friends, so they were kind enough to let him live in his Castle in the Clouds until he died, but according to our tour guide, the bank actually changed the locks before Olive Plant got home from the hospital the day her husband died!
Thomas Plant seemed like a nice enough guy. He did a lot of things right, but he also did a few things wrong that cost him dearly. Please don’t let any of the mistakes Thomas Plant made cost you your castle, wherever it may be.

October 07, 2014

Donor Advised Funds

Credit: Renjith Krishnan
Do you want to give money to a good and noble cause, but haven’t really found one that you like? Do you already give cash or appreciated stock to several charitable organizations, but wish you could give more? Are you already giving about as much as you realistically can and still wish you could give more? Perhaps you’ve had a really good year at work, you sold a business, or one of your stock holdings shot up like a rocket, and you want to give charitably over time and not all in one year? If you or anyone you know can relate to the above scenarios, you are not alone, and I may have just the solution you have been looking for: a donor advised fund.

A donor advised fund is an account that is maintained by a sponsoring charitable organization and lets donors give to charity with greater flexibility while still realizing the tax benefits associated with charitable gifting. In English, if you wanted to open a donor advised fund, you would open an account with a sponsoring charitable organization such as Schwab Charitable or Fidelity Charitable, and you would contribute your donations directly to them. This would allow you to lock in your immediate tax deduction just as if you had given a check to the American Heart Association. However, with a donor advised fund, you don’t have to immediately distribute your contribution. For example, if you gave $2,000 worth of appreciated Apple stock in 2014, you could distribute the contribution in 2015, 2021, or whenever you like. You could certainly distribute the funds in 2014 if you wanted to, but you wouldn’t have to, because once you contributed the Apple stock to your donor advised fund, it’s no longer yours. Essentially, you made an irrevocable gift, but you reserved the right to direct where the distribution goes at a later date.

By contributing to a donor advised fund and not immediately distributing your contribution, your contribution “lingers” in your account for a longer period of time. During this time, your contributions can be invested, and any growth will be tax-free. As with any investment, the value of your account could go up and it could go down, but your deduction won’t change (remember, you locked that in at the value of your donation when you originally contributed). This ability to let contributions linger can give a donor time to decide which organizations they want to benefit, and it can give a donor’s invested contributions time to grow and one day potentially offer a greater monetary benefit to a particular charity than the smaller, initial contribution could have offered. (That being said, I know of plenty of good charitable organizations that need money now to advance their cause and further their mission, so you’ll have to personally weigh immediate impact versus long-term financial magnitude.)

If you have a big tax year or your income stream is pretty sporadic (a lot one year, a little for a few years, then a lot again one year), donor advised funds can really be a good fit for you. If you’re charitably inclined, your CPA and financial advisor are probably encouraging you to give in those good income years so that you can fulfill your charitable desires and hopefully maximize your charitable deductions. As we discussed earlier, a donor advised fund will allow you to lock in your donation in that high tax year, but it will also allow you to give as you wish. Another way of saying this would be that a donor advised fund lets someone make charitable contributions sporadically and strategically (to their donor advised fund) and charitable distributions (to qualifying charitable organizations) smoothly, or however they wish.

Finally, what happens if you pass away and still have money left in your donor advised fund? Well, there are several possibilities. You could name charitable beneficiaries that would receive whatever is left in your account, or you could name another person or people as your contingent successor(s) to direct the distribution of assets left in your donor advised fund. Simply naming a charitable beneficiary is smooth and clean, but I have seen cases where naming spouses and children as contingent successors has worked really well. It allows contingent successors to benefit organizations they feel strongly about, and it also powerfully instills how important “giving back” was to the deceased one last time.

A donor advised fund is not for everyone, but I think it’s a pretty nifty tool considering all of the flexibility it offers. It’s sort of like having your own private foundation!