You Have to let it Simmer

Credit: justingun at FreeDigitalPhotos.net

One of the questions I get most often is why investment advisors don’t jump in and out of the market. Most recently I was asked “Why don’t investment advisors drastically change their portfolios when something bad has clearly happened?”

The answer you have probably heard, and maybe even from me, is because frequently trading your portfolio begins to cease looking like investing and begins to resemble gambling. How many people do you know that often come back from Vegas with more money than they left with? You don’t jump in and out of the market because to do so effectively you have to correctly time the market twice; you have to have the insight to know when to sell high when most investors will be pouring in money in a euphoria and you have to have the insight to know when to buy low when most investors will be sprinting for the exits in temporary fear. Even if you do somehow manage to time the market correctly, you’ll be burdened with more transaction fees and taxes as a result of your more frequent trading. That’s why most professional investment advisors don’t jump in and out of the market, and as far as jumping in and out of the market after something bad has clearly happened, professional investment advisors don’t do that because the "bad event" has already occurred and some of the market’s biggest gains often come on the heels of something less than ideal.

After 9/11 did you want to be invested? Think back to 2008-2009 right after Lehman Brothers collapsed and the Great Recession began. Did you really want to be invested? What about in 2011 after the credit rating of the United States was downgraded? Did you want to be invested then? At the time of those events, my answer would have been no. When events like that happen in the future, my answer will be no again, but it has to be yes. You have to stay invested.

Check out the link below to visuals from Putnam Investments. I found these incredible statistics as I was researching and working on my correspondence with the individual who most recently inquired about market timing.

https://www.putnam.com/literature/pdf/II508.pdf

Two of the Dow Jones Industrial Average’s biggest days occurred within eleven months of 9/11! Seven of the Dow’s best days since 2001 occurred between October 2008 and March 2009! One of the Dow Jones’ biggest days in the last 15 years occurred within a week of the unprecedented US credit downgrade! If you had invested $10,000 in the Dow at the beginning of 2002 and stayed invested, you would have had around $28,700 by the end of 2016 and have averaged an investment return of around 7.3% per year. If you had jumped in and out of the market and missed those ten best days I just mentioned that were relatively right after 9/11, the Great Recession, and the US credit downgrade just happened, you would have only had around $14,700 by the end of 2016 and averaged an investment return of around 2.6% per year! If, instead of the ten best days, you missed the twenty best days, you would have only had $9,600. You would have lost money over a fifteen year period due to missing twenty days!

I love to cook. One of my specialties is spaghetti with a homemade meat sauce. It’s ground beef slowly cooked with salt, pepper, Worcestershire sauce, and hamburger seasoning. I carefully dry the cooked meat on some paper towels on top of a plate. The meat then joins my pot of tomato sauce and I add in garlic salt, pepper, and Italian seasonings. I then slowly melt in some parmesan cheese to make the sauce richer and a little thicker. Like my mother taught me, I always taste with a clean spoon, but I keep sampling and throwing in a little more of this and that until it’s just about right. Then I put a lid on the pot and let it simmer. It’s only after simmering with an occasional stirring that all the ingredients truly come together and I end up with my desired result. Long-term investing is similar. Add the proper ingredients, tweak a little as needed to taste, and prudently monitor, but you’ll only get your desired result if you let it simmer.

-Tom

Best Financially or Best For You?

Credit: stockimages at FreeDigitalPhotos.net

Some people might think my job is to make my clients as much money as possible. Some people might think my job is to make my clients the highest rate of return on their investments as possible. Generating investment returns within a client-agreed-upon degree of risk is the job of an investment advisor, but as a wealth advisor, my job is two-fold. Not only do I serve as my client’s investment advisor, I’m also charged with being my client’s financial advisor. Of course, I’m always plenty focused on investment strategy, but I’m simultaneously focused on helping my clients get what they want out of their lives.

For example:

• How much cash should you hold? From a strictly financial perspective, conventional wisdom says three to six months’ worth of living expenses if you’re still working and one years’ worth of living expenses or more if you are retired. That is my baseline recommendation with my clients, too, but if you find yourself constantly worked up about what is going on in the world and holding a little more cash would lead to less stress during the day and better dreams at night, then go for it! It’s not necessarily best financially, but it may be best for you.
• How should your portfolio be allocated? Based on an investor’s age, stage in life, and withdrawal requirements, historical return patterns generally lead most good investment advisors to roughly the same recommended allocation, but what if bear markets cause you indigestion and angst to almost a medical level? Given current interest rates and bond yields, it is absolutely critical to have enough allocated to stocks to have a chance to sustain or grow a portfolio over the long-term and to have a shot at protecting your purchasing power against inflation, but within reason, if your indigestion and angst could be soothed by having a few more CDs and bonds and a few less stocks, then why not? It’s not necessarily best financially, but it may be best for you.
• How much should you withdraw? Financially speaking, it’s rarely advised to withdraw unnecessarily from your investment assets, but if you don’t, what is going to happen?  You may end up with some slightly happier heirs?  Your favorite charity may one day receive a bigger check? So often I see people do everything in their power not to withdraw money from their hard-earned assets because they are trying to keep their nest egg as big as possible. Now if a client’s financial stability or financial security is even remotely endangered by a potential withdrawal or their rate of withdrawals, I certainly raise the issue, but there are times after people have shared their dreams with me where my advice is for them to simply spend some of their money. You’ve always wanted that sports car? Get the car. You’ve always wanted to take your entire family on a beach vacation? Take the vacation. You want to help your family financially now when they need it versus later after your death when they potentially won’t? Help your family now. You want to give a substantial gift to a charity or cause you support so you can see the impact? Give the gift. It’s not necessarily best financially, but it may be best for you.

In my opinion there are two kinds of returns: your return on your investments and your return on your life. I would advise that you always be reasonably cautious when it comes to your financial situation, but when it comes to your comfort, confidence, happiness, satisfaction, and fulfillment, strongly consider that what may be best for you may not always be best for you financially. Return on investment is important, but so is return on life!

-Tom

Normal Investors – Overconfidence

Credit: stockimages at FreeDigitalPhotos.net

There I was at the starting line of the famous Peachtree Road Race. I was finally old enough to be a part of the 4th of July tradition I’d watched my dad do every year of my life. I was stoked. I was a soccer player and I ran after the ball for a full hour without stopping every Tuesday, Thursday, and Saturday, so this so called “10-k” was going to be a piece of cake! When our wave started, I took off. My dad stayed with me for the first bit and then he started telling me we needed to slow down to save some of our energy for the finish. What did he know? Besides, a few runners were actually passing us! I think that first mile may have been my only career eight minute mile, but boy, by the fifth mile of the race, twelve-year-old Tom knew his dad was right.

I like to think I was a pretty cool guy in high school. In some ways I was. In some ways I was probably not. Being an avid ultimate Frisbee player with some of my band buddies was probably not my coolest hour, but we sure did have fun. We were good, too. So good that word travelled and some friends on the cross country team challenged us to a game one Saturday. Cross country whatever! I was in great shape! For a solid week my band friends and I went over and over how bad we were going to destroy our cross country friends. I think that was the last day I enjoyed running…

Of course there was that accounting test my junior year in college. I was tired. I wanted to do something other than study. Besides, I had things under control. I usually did well on tests. My scholarly roommate and fellow accounting major urged me to go over that small little bit the professor glossed over about a couple of terrible things called deferred tax assets and deferred tax liabilities. I actually remember saying, “If he asks me about that on the exam, he can have it!” I cannot tell you how much I ate those words. Literally, my roommate waited for me to look up and make eye contact across the room so he could give me that told you so look. Yes, yes he did.

I like to think I’m a pretty self-effacing guy, but from time to time in my life, I’ve been overconfident. Most of the times when I’ve been overconfident, it hasn’t worked out too well. Most of the time when investors are overconfident, it doesn’t work out too well, either. Humble pie doesn’t taste so good!

What? You don’t think you’re ever overconfident? Well let’s see about that. Do you consider yourself an above-average driver? You might be, you might not be, but studies suggest as many as 95% of people think they are above-average drivers, and that’s just impossible. Statistically, 50% have to be above-average drivers and 50% have to be below-average drivers. In the Atlanta metro area, I dare say a lot of people are the latter! Either way, overconfidence is the fourth tendency that I would suggest many normal investors have.

I think overconfidence is a pretty natural thing. I think that people tend to value their own judgments and opinions over those of others, even if other people are “experts.” Think home projects, grilling, sports, parenting, politics, etc. In the investment management world I believe this is why many investors have a little trouble letting someone else professionally manage their portfolio. They value their own judgments and opinions, they want to be in control, and they want to see action in their portfolios. This leads to many "do-it-yourselfers" trading more in their portfolios than I would typically recommend, and that usually means more trading fees and expenses, more taxes, and a lower investment return over the long-term. Consider this chart presented by Saturna Capital that assumes a 7% annual return for ten years and a 23.8% tax rate:

Lower turnover (aka less trading) typically means higher portfolio values. Be an investor, not a trader!

Finally, I wanted to share an interesting study that I came upon done in 2001 by the Quarterly Journal of Economics. They studied portfolio turnover and the investments of male and female households and they found that single men trade the most, married men trade second most, married women trade the third most, and single women trade the least. Guys, based on what we learned from the chart above, I think that means the women are right again!

If you enjoy investing and you like the rush of trading, I encourage you to carve away a small portion of your assets and make it a hobby. It’s one thing to open a box with a zillion pieces, not completely read the instructions, watch a video online, and tell your wife you’ve got it under control - maybe you do, maybe you don’t. It’s another to be overconfident when it comes to your family’s nest egg!

-Tom

Next up: status quo

You Might Be Well Diversified If...

Credit: MR LIGHTMAN

You are probably familiar with comedian Jeff Foxworthy’s “You Might Be a Redneck” routine. If you’re not, you should be! His routine is hilarious, and since I was born and raised in the Southeast, I've seen some of what he is talking about. I’ve seen driveways where it doesn’t look like the boat has left the driveway in 15 years. I’ve seen people whose dog and wallet were both on a chain. I’ve seen yards where if someone mowed them, I believe they might just find a car! It’s funnier when he does it, but you get the point. Either way, it got me thinking about an idea for today’s post…

By now you’ve probably gotten the year-end statements for most of your investment accounts, and if you’ve looked at them closely, you might have noticed 2014 was kind of a weird year for stocks. I say it was a weird year for stocks because some of the classes of stocks had very different returns. U.S. stocks ended up having a pretty good year after some ups and downs, but international stocks finished the year down for the most part. If you took a closer look at U.S. stocks, you likely found that the stocks of large U.S. companies (“large cap stocks”) did pretty well, but the stocks of smaller U.S. companies (“small cap stocks”) were not up nearly as much as their larger counterparts. Small cap stocks were even negative for a good portion of the year!

Statistically speaking, the S&P 500 (an index that represents large cap stocks) was up between 13% and 14% for 2014. The Russell 2000 (an index that represents small cap stocks) was up around 5% for 2014. The MSCI EAFE (an index that represents international stocks) was down around 5% for 2014. Why do I tell you all of this? To share with you that, if you had a stock portfolio filled with large cap stocks, small cap stocks, and international stocks, you probably didn’t end up with the 13% to 14% return “the market” had in 2014 that the television pundits, radio hosts, and investment newsletter writers keep talking about! As Jeff Foxworthy might say, you might be well diversified if you did not end up with the S&P 500’s return!

I’ve also heard it said that you know you are well diversified if there is always part of your portfolio that you are “mad” at. I’m not sure that’s always the case, but there is definitely some merit to that statement. If you were mad at your bonds in 2013 when the stock market roared, I bet you were pretty pleased with them in 2008 and 2009 when the stock market took a dive. If you were mad at your stocks in 2008 and 2009, I bet you have been pretty pleased with them the last five years or so. So all in all, you might just be well diversified if there’s usually a part of your portfolio that you aren’t pleased with.

If what I’ve said so far hasn’t really applied to you because you only own one stock or a couple of stocks, I’d offer two things. First, concentration in a single stock is how you can accumulate and/or evaporate wealth - not preserve wealth. Second, you might be well diversified if you can’t name every holding in your portfolio from memory!

As your friend and someone who wants you to do well and make as much money as you can, I wish you were completely invested in the S&P 500 last year and got that 13% to 14%. However (and please read my next words very carefully), as your humble financial blogger and a financial advisor who believes in the long-term investment strategies of diversification and compounding, I certainly hope you didn’t!

-Tom

What You Need to Save to Reach $1M

Credit: cooldesign

There is something magical about one million dollars. A lot of people seem to view it as the line between rich and not rich. I don’t buy that as I’ve seen plenty of people with less than seven digits who are personally and financially wealthy, and I’ve seen plenty of people with seven digits or more who are personally “starving” and somehow still feel financially poor. Now that I have car payments and house payments and see taxes and health insurance expenses deducted from my paycheck, I can also see how, over time, someone could go through a million dollars. I think it’s the act of having to use a second comma to write out "$1,000,000” that makes it such a big deal.

I don’t know whether you’re trying to become a millionaire or not. I don’t know whether you’re going to have a pension, what your Social Security may or may not look like, or what type of lifestyle you are looking to sustain in retirement, so I can’t really tell you that a million dollars will even be enough for you. Besides, who knows what taxes will look like when you are ready to retire? Who knows what inflation will be between now and then? What I can tell you is that saving and investing is important, and that saving and investing sooner rather than later can have a critical impact on your future outlook.

Below, please take a look at a graph showing how much you would need to save per year, based on when you start saving (assuming a flat, six percent annual rate of return), to reach one million dollars by age 65.

For me personally, all of these annual savings figures represent a significant amount of money, but some of them look a lot more feasible than others. If you start saving early by living below or at least within your means, you save diligently paycheck after paycheck, and you have a little bit of luck and good fortune, I think most people should have a shot at saving up a lot of money for retirement - maybe even a million bucks! That being said, if someone keeps buying the latest gadget or accessory, living paycheck to paycheck, and carrying on like there is no tomorrow, starting to save at age 55 or so is not going to be a lot of fun, and more frighteningly, it might not even do that much good.

In short, no matter how old you are or how much you can save, I’d suggest you start saving now! In the words of the hit novel and movie franchise The Hunger Games, by saving now, the odds will be ever in your favor.

-Tom

The Lightning Round: Take 3

Credit: FreeDigitalPhotos.net

Thanks to all of you for the many questions I received. Some of you even submitted more than one! You asked the questions, and now it’s time for me to share my answers to five of them...

1. I recently sold my house and have the profits sitting in a money market account. I'm relatively young,  have no more debt to pay off, already contribute to my work retirement account, have my rainy day fund, and would still like to put this profit toward my future as well. Is having this money sitting in a money market account the best “bang for my buck" or is there a better way to invest it?

- Anonymous                   

First of all, congratulations on selling your house for a profit! Real estate is not always a profitable investment, but it is certainly nice when it works out. Let me get this straight - you’re debt-free, you’re contributing to your 401(k), and you have set aside enough cash to form an adequate rainy day fund? Well done! You are certainly on a path towards financial success!

There are a lot of things you could do with the excess cash you have in your money market account that would provide you a bigger “bang for your buck.” Unfortunately, given current interest rates, the difference between burying your excess cash in your backyard and leaving it in your money market account earning interest is just not that much. I don’t know the ins and outs of your financial situation, but for someone in your shoes I’d usually suggest you redeploy some of that excess cash and put it to work for you. I’d suggest you consider increasing contributions to your 401(k) plan, opening and contributing to a Roth IRA, or opening and funding a diversified brokerage account. For simplicity’s sake, I’d probably lean towards increasing your 401(k) contributions. For 2014, you can contribute up to $17,500 per year (and if you’re age 50 or older, you can contribute up to $23,000 per year), and any additional contributions you make could be a nice boost to your long-term retirement savings. If you’re contributing to a Traditional 401(k) (not a Roth 401(k)), these additional contributions could also lower your 2014 tax bill, which makes increasing your contribution amount kind of a win-win. Two other things to consider, though: 1) Your 401(k) investment returns could provide you a much bigger “bang for your buck” than you would get in a cash account, but you could also see the value of your money go down in the short-term or during market downturns. 2) My guess is that your money market account balance will go down over time to help you sustain your current lifestyle if you decide to contribute more to your 401(k) going forward because your take-home pay will decrease to facilitate that change. I say that because I don’t want you to be surprised or concerned. By contributing more to your 401(k) going forward, you are essentially slowly and surely reducing your cash on hand and putting your excess cash to work. Just remember, if your money market account gets lower than you would like, you can adjust your 401(k) contributions back down to a level that will allow you to normally sustain your desired cash balance.  

Please let me know if you would like to discuss further.

2. Can you explain, in layman's terms, what supplemental income needs to be reported come tax season and how to do so? For example, I sell Thirty-One on the side and it's not a lot of money, so I'm curious if I even need to report it, and if so, how?

- Amanda                         

When it comes to miscellaneous supplemental income tax law implications in layman’s terms you’re asking a lot (just kidding), but I’m happy to try to translate. Your question is a great one and addresses a common misconception held by many taxpayers. Per the IRS, taxpayers “must also report other income such as: cash earned from side jobs, barter exchange for goods and services, awards, prizes, contest winning, and gambling proceeds…. It is a common misconception that if a taxpayer does not receive a form 1099-MISC or if the income is under $600 per payer, the income is not taxable. There is no minimum amount that a taxpayer may exclude from gross income.”

If you have income outside of basic things like your wages, salary, interest, and dividends, it really is best to talk with your CPA, and if you don’t have one, find one. That’s because supplemental income is tricky. I think you’ll agree that based on the IRS wording above, it’s pretty clear that supplemental income must be reported, but what is not always clear and most of the time cannot be put in layman’s terms is where to actually report the income. In some cases it might belong on Form 1040 itself, in some cases it might belong on Schedule C, in some cases in might belong on Schedule E, and in some cases, it might also need a Schedule SE (Self-Employment Tax) filled out, too. There could also be an opportunity to reduce the amount of your supplemental income you will be taxed on by specifically listing any expenses (such as travel expenses or postage expenses) you personally incurred by generating that supplemental income, but of course these expenses might belong on Schedule A, but then again, they could belong on Schedule C or Schedule E depending on how you actually generated the supplemental income. I’m about to answer your question, but for non-Thirty-One supplemental income earners I wanted to make two points: 1) See why the tax law really needs to be reformed and simplified? 2) If you have supplemental income, you probably need more than do-it-yourself tax software to make sure you get it right and report the supplemental income in the most tax-efficient (and legal) way possible.

So, I dug and dug for Thirty-One-specific tax guidance and was able to find buried on page 16 of their Consultant Guidebook some surprisingly helpful advice:

“Yes, you’re required to report your commissions and other earnings from your Thirty-One business as income in your tax filings each year. Your other earnings include your Overrides, free products, hostess and other business credits, etc. For tax purposes, you are “self-employed” and it’s important that you keep complete and accurate records of your business income and expenses.
There are some tax benefits for self-employed individuals that may allow you to deduct certain business expenses. We strongly recommend that you talk with your own tax advisor to learn how the tax laws apply to your Thirty-One business.
As a Consultant, you’re a self-employed, independent contractor of Thirty-One. You’re not an employee of Thirty-One and we won’t issue you a Form W-2.
The U.S. Internal Revenue Service (“IRS”) requires us to issue a Form 1099 to every Consultant who earns $600 or more during the previous calendar year. By January 31st of each year, we’ll issue you a Form 1099 for the previous calendar year. Your Form 1099 will include all of your earnings from your Thirty-One business, including your commissions and the other earnings described above.
You’ll have to report the income from your Thirty-One business on Schedule C of your federal income tax return. Because you are self-employed, you may be able to deduct certain business expenses like the use of your vehicle or home office. You can discuss this with your tax advisor and/or contact the IRS for more information at www.irs.gov or (800) 829-1040.
Also, if your state and/or city collect income tax, you may need to file income tax forms with them too.”


I hope this is what you were looking for. To recap in layman’s terms: you have to report the income, you are deemed to be self-employed, you are deemed to be an independent contractor, and Thirty-One will send you a 1099 by 1/31/15 for Tax Year 2014 to get you started. As always, I’m happy to help you specifically address your tax situation offline, but I really think you’re going to want the services of a paid tax preparer as well!


3. For the life of me, I do not understand the ad valorem tax. I've read a few government documents on it, but none of them are explicitly clear. Can you please explain for us new-to-Georgia folks? 

- Amanda                         

Sure, I’ll be happy to. Don’t you love it when people explain things in a way that’s so complicated no one can understand it?

On March 1, 2013, Georgia changed the way it taxes motor vehicles. For people who have cars that were purchased before March 1, 2013, nothing changed: you renew your tag right before your birthday and you get to pay an annual ad valorem tax (sometimes nicknamed the “birthday tax”) as part of that process. (An ad valorem tax is a tax based on value.) For people who have bought cars (or will buy cars) since March 1, 2013, the rules have changed: you no longer have to worry about paying an annual ad valorem tax when you renew your tag, but you do have to pay a title ad valorem tax all at once when you buy a new motor vehicle. The title ad valorem tax is calculated based on the fair market value of your new vehicle (less any trade-in value you may have gotten from your old car and less any discounts or rebates you may have received from the dealer) times 6.75%. I know the new title ad valorem tax has the words “ad valorem” in it just like the old tax, but try to ignore that and just think of the new tax as a sales tax of sorts. The new tax is essentially tax pain all at once as opposed to slow tax pain by a lash every time you have a birthday.

A couple of additional “nuggets:”
     - The title ad valorem tax also applies to purchases of used vehicles.
     - If you’re a Georgia resident and you buy your car out of state, you’ll still get to pay the Georgia title ad valorem tax even if you've already paid another state's tax.
     - If you transfer the title of a vehicle within your family, you will trigger a reduced title ad valorem tax.
     - The title ad valorem tax rate is scheduled to increase to 7% in 2015.


I hope that’s clear as mud. If it’s not, please let me know. Here are two other links that might help you: 1) a Georgia Department of Revenue Title Ad Valorem Tax Calculator and 2) a FAQs page about the new rules.

4. I have an opportunity to move to a state that I would prefer not to live in for a really good job opportunity. What should I be thinking about financially as I weigh the pros and cons? 

- Anonymous                    

Nice question, and one I’ve never been asked. Whatever you decide, congratulations on earning the opportunity to take the job!

If the job opportunity was something you were really excited about in a state you were really excited about, I don’t think I’d try to be a wet blanket on your job opportunity as long as it was financially lucrative. I believe there are more currencies in life than just money, such as time, happiness, and fulfillment, so I wouldn’t want financial implications to unnecessarily sway your decision. That being said, since the situation you are describing is "only" a really good job opportunity in a state that you are less than excited about, I can definitely see digging into the financial implications a little bit more.

I’d advise you to consider your new state tax rate versus your current state tax rate. I’d look into what your new property tax rates would be, and maybe even more importantly, how much a suitable home would cost you in your new state versus your current state. I’d look into potential cost of living differences in terms of utilities, transportation, and groceries. Once you factor in the cost of the physical move with these cost adjustments, versus any change you would experience if you took the job in terms of compensation and benefits (don’t forget benefits like 401(k) matching, paid time off, health insurance, etc.), I think you may be better able to gauge whether taking the job would be financially good for you or not.

If you’d like more specific assistance, I’d be happy to try to help you. I have also come across this nifty, little tool developed by the National Center for Policy Analysis that attempts to help you determine how much you will gain or lose by moving to another state, and I’d suggest you check it out. I’m not trying to dismiss your question in any way, but unless it really comes down to financially making it or financial ruin (which you should be able to figure out pretty quickly), I’d spend more energy on considering how your potential move could affect your family and friends, what amenities you might gain or lose, how stable your potential new employer is, and what your growth potential in your new role could be.


5. Do you recommend taxable bonds or municipal bonds for your clients?

-David                              

That’s a very good question and is a question that all investors should ask their financial advisors or brokers and CPAs. (Actually, financial advisors or brokers should be discussing this with their clients and their clients’ CPAs, but that’s a different story.)

As I respond to so many “general” questions, I must also respond to this one: it depends. Bond investors are typically looking for investments with high yields and less volatility than the stock market. They basically have two general bond types to choose from: taxable bonds and municipal bonds. Taxable bonds are typically issued by corporations and offer a higher interest rate, but an investor will have to pay federal and state taxes on their gains. Municipal bonds are typically issued by state and local governments and offer a lower interest rate, but an investor will not have to pay federal taxes on their gains. If the municipal bond is from the state or a locality in the state that the investor resides in, the investor may very well not have to pay any state taxes on their gains either!

So, in summary, I recommend both taxable bonds and municipal bonds to the clients I work with, and in some cases, a combination. If someone is in a 25% tax bracket, they’d much rather have a 5% municipal bond than a 6% taxable bond that would only yield 4.5% after taxes. If someone is in a 10% tax bracket, they’d much rather have a 6% taxable bond that would yield 5.4% after taxes than a 5% municipal bond. My recommendations are client-specific, and under the right circumstances, could even be bond-specific. The one other general comment I can throw your way is that in light of municipal bonds usually having lower interest rates than taxable bonds, municipal bonds rarely ever make sense inside a tax-deferred investment account such as a 401(k) or IRA. A 401(k) or IRA is already pretty much exempt from income taxes until you take a withdrawal or distribution, so the potential after-tax “savings” of municipal bonds would really be of little to no value in these types of accounts.


I hope that helps!


Thanks again for all of the questions. The Lightning Round is a lot of fun for me, but please always feel free to reach out to me with your financial questions year round!

-Tom

Start Strong, Finish Stronger

Credit: stockimages

Many retirees (or soon-to-be retirees) have a retirement plan based on what is called a “three-legged stool.” They have their pensions (leg 1), their Social Security (leg 2), and their investment assets (leg 3). They worked hard, they went through a lot, and I don’t begrudge them a bit.

If you’re like me and in the early stages of your working marathon that some people like to call a career, it is easy to get caught up in things such as fancy dinners, “flashy” clothes, and expensive gadgets. It’s a lot more fun to think about surround-sound systems, exotic vacations, and big houses than to think about retirement planning. The problem is, I believe our future well-being depends on just that. I believe the three-legged stool is headed to a museum, and younger people, like me, need a new blueprint. I don’t know many people early in their career who are working toward vested pensions, and I’m not willing to make a big bet on Social Security income as we currently know it still being here 20 or 30 years from now. So, if you ask me, the three-legged stool is looking more like a peg leg for us younger folks. Unless you’re willing to walk the plank (yes, that was a pirate pun), it’s important to realize that the ability to retire in the future is probably going to come down to leg 3: investment assets.

 

If it’s going to come down to investments, you’re going to need to get it right. You need to read the fable of “The Tortoise and the Hare” and take “slow and steady” to heart. You need to invest in an appropriate, long-term strategy. You need to make significant progress towards retirement during the first and second decades of your income-earning life, so you can have a decent chance of having significant assets during the last and second-to-last decades of your life.

• Slow and Steady - Saving $100 a month in your bank account, raising your contributions to your employer’s 401(k) or retirement plan by 1%, and opening a Traditional or Roth IRA account that you’re not sure you can fully contribute to can feel almost silly. It seems like a drop in a bucket, and it is, but it’s a drop in your bucket. It’s the first steps on your journey of a thousand conference calls, staff meetings, and expense reports. The hardest part about beginning a savings plan, implementing a family budget, or taking on a debt reduction plan is starting it! Brief sprints of financial progress and long periods or “naps” where you live at your means (or beyond you means) will make you resemble the hare, and you may not win your race. To be honest, you might not even be able to finish! Dedicated, repetitive steps of saving 10% from every paycheck, increasing your retirement plan contributions every time you get a raise, making those annual IRA contributions, and making 13 payments instead of 12 on your mortgage are how you and the tortoise win the race. I think Aesop may have been a financial planner in his free time…
• Invest Appropriately - I keep reading articles about how the market downturn in 2008 and 2009 has really spooked people in their 20s and 30s (millenials). For example, a recent study by UBS found that on average, millenials have half of their assets in cash and less than one third of their portfolios in stocks. I get it, I really do. Our grandparents’ home values went down like lead balloons, our parents’ investment accounts went down like an ACME anvil on Wile E. Coyote, and we couldn’t get jobs even though we went to college and did everything that was asked of us, but we cannot live in fear. My short-term market crystal ball is still in the shop, but I can tell you that plopping all of your assets under your mattress, in a bank account, in a bunch of bonds, or in an annuity with a minimal, yet allegedly “guaranteed,” return is not going to get it done. Young workers need to make diversified, tax-sensitive, and fee-conscious investments, but they also need to act their age! Long-term, 50% cash, 33% bonds, and 17% somewhere else is for grandpa and grandma - not for working millennials who have a longer time frame for their assets to significantly appreciate.
• Make Progress Early - I cannot emphasize how much higher the odds are that you will be in a good financial position if you start planning for retirement now as opposed to six months before you want to retire. Little things like building up an adequate emergency fund so you don’t have to raid your portfolio and sell when markets are down, making the contributions needed to your employer’s retirement plan to get their maximum match, and paying extra towards long-term debts may not seem like much now, but there will be a day when you look back, and you will smile. I wrote about the unbelievable power of compounding earlier this year, but it is worth restating that a dollar saved in your 50s is not the same as a dollar saved in your 30s! Progress towards your retirement goals at any point is great, but the sooner you can start packing away funds towards your future needs, the greater the chance that you will have meaningful compounding in your favor. If you start strong, you’ll have a much greater chance of finishing stronger.

 

The How to Retire Early Series will continue on next week by considering real estate and the pivotal role it can play in retirement planning. I hope you’ll check it out.

 

-Tom

Why You Need to Save Now

Credit: Stuart Miles

Whether they choose to or not, I would wager that most people know they need to be saving money for retirement. After all, unless you’re planning to work until the day you die, or you’re willing to make do solely on your Social Security income (and any pension income), how could retirement be possible? What concerns me is that most people seem to wait until their 40s and 50s to really start saving for retirement. Don’t get me wrong, a dollar saved for retirement is a good thing at any time, but let’s be clear: A dollar saved in your 50s is not the same as a dollar saved in your 30s!

Let’s say you want to have $1 million saved by retirement at age 60. At an 8% annual investment return, you would need to have put in a whopping $5,500 per month every month from age 50 on in order to hit that goal because you’d only have 10 years to save and potentially grow your money. If you had started at age 40 and had a 20-year time horizon, you’d only need to stash away around $1,700 per month. If you started at age 30 and had 30 years before retirement, you’d need to save around $700 per month, and if you were incredibly ambitious and started at age 20 with 40 years to go, you would theoretically only need around $300 per month in order to hit your retirement goal. Now there will be years where the market roars (like last year), years where the market dives, and years where the market stays about flat, but do you see my point? I don’t know about you, but I’d rather save $700 per month in my 30s than $5,500 per month in my 50s!

In light of these figures, I issue you a challenge: Consider increasing your 401(k) or retirement plan contributions by a few percentage points. If you were lucky and got a raise at the end of last year, you can probably do this without feeling the extra withholding from your pay check. Even if you didn’t get a raise at the end of last year (and should have!), I’d still encourage you to bump up your contribution rate a few dollars or percentage points. Please don’t do this if you are truly fighting to make ends meet, but if you can, I really believe that making a slight, mostly painless adjustment could lead to a much better retirement picture.

I want you to know that I practice what I preach. I just finished filling out the required form to raise my contribution rate to my 401(k) a few percentage points. It is my hope and expectation that this will allow me to retire sooner as I will have more dollars saved with a longer time horizon to grow.

Do you accept my challenge?

-Tom

Trading vs. Investing

Credit: rattigon

Last week I ended up waiting in line for a fairly long time while my car’s emissions were tested at a very busy car maintenance facility. I had come straight from work, so I was still dressed up in a suit and tie, and in hindsight, I guess I might have looked a little out of place at a Jiffy Lube. Another customer who had finished reading the same sports section of the newspaper I had, and seemed to be even less interested in the Judge Judy rerun playing in the background than I was, decided to strike up a conversation with me. I’m fairly social and am always up for meeting new people, so it wasn’t too difficult to chitchat until he asked me what I did. When I responded that I was a financial planner and investment advisor, he countered with, “So, you’re a stock trader?” I politely replied, “Of sorts,” but that’s not what I do; that’s not even what I recommend. A harmless conversation with a nice stranger at a Jiffy Lube was not the place to dive into the important differences between trading and investing, but it got me thinking that today’s post just might be!

Trading and investing might be synonymous to some people, but not to me. In my mind, “trading” usually means the frequent buying and selling, or sudden buying and selling, of financially significant quantities of a handful of securities. When I think of the term “investing,” I think of a long-term time horizon, occasional and strategic buying and selling, and a well-diversified portfolio. Before you stop reading and accuse me of splitting hairs, please let me give you three reasons why trading is not investing, and why I believe investing is better. 

• Taxes – Let’s say a single lady makes around $75,000 this year. When you look at the 2013 federal tax brackets, she falls in the 25% bracket. This lady is doing pretty well for herself, but she’s doing even better considering that she bought 5,000 shares of Bank of America stock in August of 2012 for $8 a share. She likes “dabbling” in the market from time to time, and she felt she had made a great pick with Bank of America, but now she wants to buy another stock, so she sold the 5,000 Bank of America shares in June of 2013 for $13 a share. Because she held those Bank of America shares for less than a year, her gain must be taxed at her ordinary income tax rate, so her investment will land her roughly $18,750 after federal taxes (((5,000 shares x $13 sales price) – (5,000 shares x $8 purchase price)) x (1 - 25% tax rate)). If she had treated those Bank of America shares as a longer-term investment and sold them in August of 2013 (after she had held the position for a year) for the same $13 a share, the federal long-term capital gain tax rate of 15% would have applied! Her investment could have landed her roughly $21,250 ($2,500 more than $18,750) after federal taxes (((5,000 shares x $13 sales price) – (5,000 shares x $8 purchase price)) x (1 - 15% tax rate)) even though the theoretical sales price was the same! There are certain situations where selling a security with a short-term gain makes plenty of sense, but it’s always worth considering the potential tax benefits of longer-term investing versus the potential tax consequences of shorter-term trading. 
• Costs/Fees – Whether someone is into stock trading or investing, there are times when new securities need to be bought and old securities need to be sold. In my book, transactions should always have a strategic aim, be executed for tactical, security-specific reasons, or be completed to free up cash, but everyone should remember that transactions are not free. There are costs and fees to facilitate transactions, and depending on your investment custodian and/or investment advisor, these costs and fees could range all over the place. For argument’s sake, let’s consider E*Trade’s fee of $9.99 per trade. If someone were to make 10 trades a year through E*Trade, they would incur around $100 in fees. That might be peanuts to some people, but $100 worth of fees on a $10,000 brokerage account is a loss of 1% of the total account! That means, at best, those fees would dampen the positive performance of someone’s $10,000 brokerage account, and at worst, those fees are just additional salt in the wound of the negative performance of someone’s $10,000 brokerage account. Costs and fees are too insignificant to drive a stock trader or a stock investor’s transaction decisions, but they are significant enough to consider, particularly if the number of transactions is excessive and/or the account’s value is relatively small.
• Diversification – When I was a senior in high school, there was a statewide contest to see which group of economics students could grow the largest fantasy investment portfolio over a three month period. The rules were that participants could only place trades at the end of the day and could only buy stocks that were trading at more than a dollar, so I quickly convinced my group that the only way we were going to get enough stock price movement to have a chance to win was to go all-in on a single stock that was trading near a dollar that was scheduled to have an earnings announcement in the next couple of days. (PLEASE NOTE I ADVISE AGAINST THIS STRATEGY AND IN NO WAY RECOMMEND IT UNDER ANY CIRCUMSTANCES WHATSOEVER.) As luck would have it, the company whose stock we picked announced that they had beaten earnings expectations and were in talks to be bought out, so the stock soared. The problem was that two other groups of students in the state had done the same thing, and we were all tied in first. My group elected to sell the next day with the hopes that the stock would return to orbit, but the other two groups held on as the stock eked up a few more pennies, thus landing us in third. First place in the state won fame and fortune, and third place won a T-shirt, so we decided to roll the dice again with our all-in, single-stock strategy by buying shares in a company that had an upcoming earnings announcement. This time, the company we picked failed miserably compared to expectations, and some of their executives had decided to leave, so the stock fell like a lead balloon filled with lead balloons. Our strategy had hit us a home run once on the very first try, but as we tried it again and again for the rest of the contest, we lost and lost. We actually finished second to last in the state. I told you that long story because I wanted to share my powerful, first lesson in why diversified investing is better than non-diversified trading - singles and doubles over the long term are a lot better than one home run and a lot of strikeouts in the short term!

If you enjoy trading, that’s wonderful, but call it what it is: a risky hobby. If you’re trying to reach financial independence or if you are trying to maintain financial stability, I urge you to invest, not trade. Trading is sexier, and it may make you feel like you are actually doing something about your holdings more often, but the tax effectiveness, cost effectiveness, and diversification benefits of letting the market do its thing over time are hard to argue with.

 

Are you a stock picker says he? No. I’m an investment advisor says I!

 

-Tom

Year in Review

Credit: Danilo Rizzuti

Assuming the Mayans are wrong, and thankfully we know they are (leap year wasn’t a part of their calculation, so the apocalypse date has already passed), it’s time to start thinking about New Year’s resolutions. I love coming up with resolutions, and frankly, I think it’s important to periodically consider aspects of your life and reflect on how they could, and should, be better.

I have 3 resolutions for 2013:

1. Lose the remaining 14 lbs of my 2012 goal- Hey, I lost 11 lbs. this year, but I didn’t quite make my goal of 25 lbs. Comfort food is so good, and exercising in the cold weather is so hard…
2. Do less- Many of my friends and family often compare me to the Energizer Bunny, but I saw the bottom of my fuel tank a couple of times in 2012. I need to get a little more rest and set aside a little more time to do what’s important with the important people.
3. “Attack” the mortgage- My wife and I are going to still contribute to our retirement plans, but we are going to make a conscientious effort to pay as much extra principal in 2013 as we possibly can. This will strengthen our financial position, give us a guaranteed rate of return (our mortgage interest rate), and allow us to work towards lowering our fixed monthly expenses.

I wouldn’t begin to tell anyone (well, at least most people) what their personal resolutions should be, but I thought I’d take this last 2012 blog post and offer a few financial resolutions that might help you in 2013:

• Attack any long-term debt you may have by making an “extra” payment in 2013. As this example shows, if you make this resolution a habit, you may be able to cut substantial costs and shorten how long you will be in debt by more than you might think. I’m talking like $56,000 and 6 years off a $200,000, 30-year mortgage!
• Save an extra amount from each of your paychecks. Maybe this is $50 a paycheck, maybe it’s $500. The amount does not matter; the action does. Do something as simple as putting this extra money in an envelope or as complicated as setting up an automatic deposit to a different account, but give this a try. If you keep this resolution, you will have a nice, little sum set aside at the end of 2013 that can create or strengthen a “rainy day fund,” be used to fund an IRA contribution, or be used as a “jump-start” towards a major purchase.
• Increase your contributions to your employer’s retirement plan. You are probably having to fill out a lot of 2013 enrollment and benefit election forms anyway, so you might as well adjust your retirement plan contributions and add 1% to whatever you are already contributing. 1% more coming out of your check probably won’t hurt much now, but 1% more invested compounding year after year in a tax-deferred account could end up being a pretty sweet sum when you finally head towards your retirement home on the beach.
• Collect your change. It depends how often you pay with cash, but if you throw all your spare change in an old shoebox, a chic-looking jar, or even a very manly looking piggy bank, you may be surprised what you end up with by the end of 2013. It sure would be nice right about now to have a jar full of change to help buy that perfect Christmas gift for my wife…

I hope you will try one of my suggested resolutions or come up with at least one financial resolution on your own, but before I sign off for 2012, there are a few more things I want to mention:

First, I’d once again like to thank Kenny Wuerstlin for designing my banner and logo, Andrew Davis for helping me edit my content, and my lovely wife, Lindley Presley, for her grammatical editing and blog expertise.

Second, I’m very proud that, in its first year, 2MuchCents.com had a little more than 6,600 page views from 10 different countries. Let me assure you though, we’re just getting started! In 2013, we’ll unravel technical topics like family gifting, long-term care insurance, and the risks of a fixed income portfolio. We’ll also take a look at how rational investors are (or aren’t), why I don’t think you should always let a “tax tail” wag your dog, and how you can spend everything (though I don’t advise trying).

Finally, let me thank you for checking out my weekly ramblings. I appreciate your questions, your ideas, and your encouragement. I hope that at least a little of what I have shared has been interesting, educational, and maybe even helpful. Please continue to let me know how I can use my training and experiences to try to help, please keep telling me what financial topics you are interested in, and pretty, pretty please keep sharing your favorite posts with your family and friends. There’s no telling where 2MuchCents can go in 2013!

I hope you and your family have a healthy, happy, and financially successful 2013!

-Tom

A Rate of Return You Can Actually Count On

Credit: Stuart Miles

I find it quite funny how many people I come in contact with think that financial advisors know what the stock market is going to do. I find all the people that claim they know what the stock market is going to do to be even funnier.  I would know what the stock market is going to do if I could only get a copy of the Wall Street Journal a day early. Even the best of the best stock-pickers are only making very educated guesses.

What I can tell you is that in the long run, the stock market is going to grow and go up because it always has. I can give you a bucket of frequently successful investment strategies to try. I can even tell you statistically that over long periods of time the stock market goes up an average of about 8% a year, but I can’t give you specifics.

In spite of acknowledging my crystal ball shortcomings and all the market fluctuations in recent years, I have good news. Today, I can tell you something you can do that will give you a rate of return you can actually count on. 

Do you have a school loan, car loan, furniture loan, or a mortgage? If you do, I can almost guarantee your rate of return; your interest rate.

Frequently people are focused on owning more houses, more property, more jewelry, and more cars. They want more cash and more possessions; essentially more assets. It is a relatively simple concept, but paying off debt (lowering your liabilities) is just as good to your financial position as putting it in the bank or investing it. At times, it can even be better.

Let’s say you have $100. You have three options: 1) Put it in the bank, 2) Put it in the stock market, or 3) Pay off your student loans.

1.       If you took option 1 and put it in the bank, in one year you would have earned approximately $0.50 because interest rates are so low (per Bankrate.com, Interest Checking Yield is currently .50%).

2.       If you took option 2 and put it in the stock market, in one year you would have something. As I stated earlier, neither I nor anyone else can tell you what you will have. It is my belief that the market is slowly recovering, but there are some more peaks and valleys to be seen over the next few years. So, let’s say you get ½ of that average long term return we talked about earlier (1/2 x 8% = 4%). That would mean you would have earned approximately $4.00.

3.       If you took option 3 and put that $100 towards your student loans, you would have saved yourself $6.80 because the current interest rate for student loans is 6.8% (per direct.ed.gov). You saved $6.80 because if you had not paid that $100 towards your loan, you would owe $6.80 more at the end of the year than you did at the beginning of the year.

So I ask you, would you rather make $0.50, $4.00, or save $6.80? Of course you and I would take the $6.80. However, there is that risk that the stock market might do better than we thought and earn more than that $4.00 or even our $6.80 we saved. All that being said, with so much international and market uncertainty, you should at least consider the value of going with a rate of return you can actually count on and use any extra cash you may have sitting around to pay towards any of your liabilities that have a relatively high interest rate.

-Tom