2 Minutes With Magis Wealth Planning 6/9/17

“2 Minutes With Magis Wealth Planning” is published on the second Friday of every month.  It is comprised of five brief thoughts that we’ve come across during the course of our daily reading and research.  It summarizes data points that we find both relevant and interesting on various topics including investments, retirement, taxes, industry news, etc. 

 

  • Through the first five months of the year, almost 50% of the S&P 500 Index’s total return has come from only 14 companies, with the top 5 comprising about 33% of the total return (with AAPL leading the way). Some have said that this is an argument against  However, we agree with a recent article by Bob French at Retirement Researcher that it is, in fact, the exact opposite. Without diversification in a top-heavy market like has occurred this year, you have to be able to correctly predict (or guess) which stocks are going to be the market drivers in that given year.  It seems easy in retrospect – no one claims to be surprised that AAPL is up ~33% year to date.  However, it is actually underweighted in actively traded global mutual funds when taken collectively compared to AAPL’s market capitalization.  So, taken as a whole, professional money managers have been wrong about AAPL this year so far.  Of course, AAPL performed in line with the S&P 500 Index last year and actually underperformed in 2015.  The point is, predicting the future is not easy, and while diversification doesn’t result in homeruns, it ensures you don’t miss out completely.   https://retirementresearcher.com/five-companies-comprise-sp-500-returns-death-of-diversification/

 

  • It’s not always easy to make the transition from saving for retirement to spending in Many retirees spend less than they can afford in order to avoid dipping into their nest egg for fear of running out of money later in life. Here’s some useful advice from Santa Clara University finance professor Dr. Meir Statman (as penned in his recent WSJ article): Don’t put off spending for enjoyment if you have an adequate retirement portfolio, because most people are less inclined to spend money as they get older due to physical limitations or personal reasons (e.g. illness or death of a spouse). A household headed by an 80 year old spends 43% less than a household headed by a 50 year old, which is why we do a detailed cash flow projection every year with our clients – to help identify if they can (or should) be spending more money. And to provide them with the peace of mind (based on real data) that it’s financially prudent to do so.   https://www.wsj.com/articles/the-mental-mistakes-we-make-with-retirement-spending-1492999921

 

  • Other nuggets of wisdom from Dr. Statman from the same article: 1) Don’t wait until you’re gone before bequeathing the majority of your estate – this deprives you of the joy of giving.  2)  Don’t try to beat the market – to do so requires a higher risk level at a time when most can’t afford to do so because their working years (i.e. “human capital”) are behind them.  3)  Be careful not to cross the line between frugality and miserliness – it prevents people who have enough money from enjoying it.  4) Young people tend to underestimate their longevity while older people tend to overestimate it.  He cites data that a person reaching age 65 today can expect to live until their mid-80’s with 25% living past age 90 and 10% living past age 95.

 

  • An article in the June edition of the Journal of Financial Planning cites several alarming statistics, including that 64% of Americans do not have a will and only 71% of Americans do not have either a medical directive or a general power of attorney. These basic estate planning documents are not difficult or very expensive to put in place, but are important to have – but not for you.  These documents go a long way in easing the burden for your loved ones being left behind.

 

  • The Chart of the Month: This chart shows that while the S&P 500 Index has finished in positive territory about 80% of the time over the last 20 years, it is also very common to have rather large market corrections during the year.

SP500 Dips

Bear Markets and the Danger of “Safe” Investing

March 9th, 2017 marked an interesting anniversary in the world of investing.  On this date, we celebrated the eight year anniversary of the current bull market which as of this writing, remains intact. It is the second longest bull market in history (the longest being October 1990 to March 2000) and during this period the US stock market (S&P 500) has returned over 250%!

What’s interesting is just how fearful the investing world seems to be given the crazy news cycle marked by Trump’s latest tweets, constant political wrangling, North Korean missile tests and a Russian conspiracy de jour.    Mix in above average stock valuations (relative to history) and it’s no surprise that we are hearing more and more of our clients indicating they want “safe” investments for what they think will most certainly be a market crash. market-correction-bear

Now we have long believed and written many times that we don’t know what the stock market will do in the next few days, weeks or months.  What we do know is that bull markets do inevitably end, and yes, there will be a bear market (defined as a 20% decline in stocks) again at some point.  We just don’t know exactly when this will happen, when it will end and when we should re-enter the market.

However, we do know that when bear markets do end (with an average return to prior levels of about 3.3 years), it’s best to be invested in order to take advantage of what is typically a strong rebound.

But herein lies the conundrum, if we know a bear market is coming, shouldn’t we invest our portfolio in “safe” assets like 100% bonds?   Quite simply:  No- not if we are investing for the long term.

The reason for this is, as indicated by the oxymoronic title of this blog post, it can be very dangerous to be safe when investing over a long period of time.  By forgoing risk and accepting “safe” returns from say a 100% bond portfolio, we are ironically, taking on even MORE risk by sacrificing the underappreciated magic of compounding returns over the long term.

To illustrate this, we have designed a draconian scenario comparing two basic investment portfolios over a 20 year period.

Here is the scenario:  A 45 year old couple starts with a healthy $750,000 portfolio and wants to retire at age 65 with $3,000,000.  They commit to contributing $15,000 per year to their portfolio.  Since they think we’re going to have a bear market soon, they are concerned they won’t reach their goal.  So in our simplistic scenario, they have two choices The “Safe” Portfolio and the “Dangerous” Portfolio.  Let’s define each:

The “Safe” Portfolio:  100% bonds, comprised of 50% short term US government bonds and 50% intermediate term US government bonds.  The starting point is $750,000 and the investor contributes $15,000 per year as they save for retirement over 20 years.  For annual growth, we will assume historical returns (from 1926 – 2016) of 4.31% per year.

The “Dangerous” Portfolio:  60% stocks (60% large cap US, 20% small cap US, 20% international) and 40% bonds (50% short term US government bonds and 50% intermediate term US government bonds). Again, the starting point is $750,000 and the couple contributes $15,000 per year.  Annual growth in this portfolio is assumed to be the historical growth rate of 8.74%.

The “Bear Markets”:  As you would expect, without the stomach-churning bear markets the higher returning portfolio with stocks will be much higher after 20 years of compounding.  But what if we added two loud and nasty “growls” from the Bear?  What if we added a bear market of a 20% stock market decline (0% decline for the “Safe” portfolio and a 12% decline for the “Dangerous” portfolio) in Year 2 and then another awful bear market in Year 16?  For this awful Bear in Year 16, we’ll assume a repeat of the historically worst annual return of each portfolio in the last 50 years.  For the 100% bond portfolio, it’s a 1.15% decline- not bad at all.  For the “Dangerous” Portfolio it’s a 20% decline- ouch!

The Result:  What might be surprising to some, is that even with two terrible bear markets, the “Dangerous” Portfolio far out performs the “Safe” Portfolio.  Looking at the chart below, we see that our retirement saving couple will NOT reach their goal of a $3,000,000 portfolio in retirement because their “safety” cost them dearly.  In fact, the difference between these portfolios is $935,000 with the “Safe” Portfolio at $2.027 million and the “Dangerous” Portfolio at $2.963 million!  That is VERY expensive safety!!!

safe investing

Now we must temper our conclusions with a few “real world” factors.  First, as our couple moves closer to retirement we would certainly monitor and modify the allocation to align with their retirement date.  Second, we would also implement “psychological firewalls” to help keep the couple fully invested in a growth portfolio.  This typically includes a tailored portfolio of individual high quality bonds, providing assurance of cash flow as retirement approaches.  Third, in order to keep this simple, this scenario does not assume systematic re-balancing of the portfolio, which we also execute for clients.

But the bottom line is this:  No one really knows when the next bear market is coming even though we all know the next bear market IS coming.  But even if it comes in 2018 and even if there’s a worse decline 5 years before retirement (in this scenario), it is still much more beneficial to stay vigilant about keeping a balanced portfolio.  Because the irony is, our attempts to keep a safe & conservative portfolio actually results in taking on much more risk that we thought.  In this case, the “price” for this risk is almost $1,000,000!

2 Minutes With Magis Wealth Planning 5/12/17

“2 Minutes With Magis Wealth Planning” is published on the second Friday of every month.  It is comprised of five brief thoughts that we’ve come across during the course of our daily reading and research.  It summarizes data points that we find both relevant and interesting on various topics including investments, retirement, taxes, industry news, etc. 

  • Jack Bogle, the founder of Vanguard and pioneer of index investing, has been a long-time staunch advocate of passive vs. active funds. So he made headlines recently when he said that “if everybody indexed, the only word you could use is chaos, catastrophe. The markets would fail.”  However, he also said that the chance of everybody indexing is 0%.  He believes indexing could comprise 75% of the market without posing a significant risk, compared to the 20-40% that it comprises today.  https://www.bloomberg.com/news/articles/2017-05-06/bogle-says-if-everybody-indexed-markets-would-fail-under-chaos
  • Leveraged ETFs have been growing in popularity, but most people that own them probably don’t fully understand the associated risks. Leveraged ETFs are exchanged traded funds that provide 2x or 3x exposure to an underlying index or asset class using derivative contracts (called swaps).  In summary, these are extremely complicated financial products that are intended to deliver 2-3x daily returns – and since the leverage gets reset/rebalanced every day, they tend to dramatically underperform the multiple of the index they’re tracking. The bottom line is that leveraged ETFs were created as trading instruments and are not meant to be bought and held, but the vast majority of investors that own them are not aware of this.  Unless of course they read the prospectus – which almost no one does.  https://www.bloomberg.com/view/articles/2017-03-23/sec-may-regret-the-day-it-allowed-leveraged-etfs
  • From the sad but unfortunately true file: We recently received a call from an 89 year old widow after she met with “a very nice man” at a local investment management office.  She owns a small portfolio of stocks and a condo that she currently rents out.  She said this “nice man” advised her to sell all of her stock and her condo “immediately for whatever she could get” – even if she had to take a big loss on the sale.  He then recommended that she invest 100% of the proceeds (or about $300,000) into an annuity.  He did NOT ask to see her tax returns to see if doing so would incur an exorbitant (and unnecessary) tax liability, he did NOT ask about other sources of income, he did NOT ask about her living expenses, he did NOT ask about her estate planning wishes, and he did NOT compare his recommendation to any other alternatives.  He also did NOT tell her that he would likely receive a commission check for somewhere between $15,000 and $30,000 if she took his advice.
  • The Chart of the Month below comes from this article in Bloomberg View which explains that elevated stock valuations aren’t necessarily a signal of a market top in and of themselves. Past market peaks have come at both high and low market valuations, high and low inflation rates, high and low dividend yields and high and low bond yields. But one common thread in 11 of the last 15 bear markets has been a U.S. recession, which is typically only evident after the fact. https://www.bloomberg.com/view/articles/2017-03-06/calling-a-top-in-stocks-has-become-a-cottage-industry
  • Chart of the Month:

Bear Markets Since WWII Source: Ben Carlson; Bloomberg View

Announcing Christian Brandetsas – Associate Advisor

We are pleased to introduce our latest addition to the planning team at Magis Wealth Planning.

Christian Brandetsas joined Magis Wealth Planning as an Associate Advisor in March of 2017 after working for PNC Bank as an ACCEL Retail Bank Development Program Associate.  While at PNC, he earned his series 7 and 66 licenses. At Magis Wealth Planning, Christian has already begun working towards his Certified Financial Planner ® designation.

Christian

Christian is a native of Mentor, Ohio. He graduated from Notre Dame-Cathedral Latin (NDCL) high school in Chardon, Ohio.  In May 2016, Christian graduated from John Carroll University where he earned a Bachelor of Science in Business Administration (BSBA) majoring in Management.

During his college years, Christian interned for three different companies: Cleveland Clinic, Swagelok, and Open Doors Academy. On campus, Christian was a Resident Assistant for two years and Senior Resident Assistant for one year. Christian also went on and led a missionary trip through John Carroll’s Campus Ministry Department, where he traveled to Ecuador and Jamaica.

In his free time Christian enjoys exercising, reading, cooking, and spending time with his girlfriend and family.

“I chose to work for Magis Wealth Planning because I believe in the integrity of what the firm stands for. The genuine commitment to always seeking to do more (the Latin translation of “Magis” means “more” and “better”) and to provide exceptional value for our clients is something you don’t find at most firms. I have always loved being able to help people in any way I can, especially in the area of personal finance – a passion of mine. Coming to work every day, enjoying what I do, and believing in the mission of the company is a great feeling. I am very blessed and grateful for the opportunity to join the Magis Wealth Planning team.”

2 Minutes With Magis Wealth Planning 4/14/17

“2 Minutes With Magis Wealth Planning” is published on the second Friday of every month.  It is comprised of five brief thoughts that we’ve come across during the course of our daily reading and research.  It summarizes data points that we find both relevant and interesting on various topics including investments, retirement, taxes, industry news, etc. 

  • With tax day right around the corner, recent IRS data indicates the likelihood of getting audited has decreased for five consecutive years. The IRS audited ~1.2 million individual tax returns, or about 1 out of every 120 of all individual returns filed (i.e. 0.8%) in 2015. Details by AGI are in the Chart of the Month below, but in summary your chances of being audited are less than 1% if your adjusted gross income is above $25,000 and below $200,000.  Over 70% of all audits in 2015 were correspondence done by mail (vs. field audits).  Which brings up a side note – don’t fall for phone scammers claiming to be calling from the IRS.  The IRS does NOT call people!    https://www.irs.gov/uac/enforcement-examinations
  • A recent article in the Wall Street Journal addressed the ongoing debate of whether low cost passively managed investments are as good as or better than actively managed funds. The tone of the article is slanted toward passive and cites recent statistics that indicate 82% of all U.S. funds underperformed their respective benchmarks over the 15 years ending 12/31/16. Obviously we are firm believers in low cost passive investments as our own research suggests actively managed funds have a difficult time overcoming the high fees they charge. But investment advice isn’t free and investment risk and personal goals and circumstances must be factored into the asset allocation process.  An investment plan is not the same as a financial plan.    https://www.wsj.com/articles/indexes-beat-stock-pickers-even-over-15-years-1492039859
  • We mostly agree with another recent article in the Wall Street Journal titled “Why Your Financial Adviser Can’t Be Conflict Free”. The author makes the assertion that all advisers have conflicts (regardless of what they tell you) and he cites several examples to make his case, including that advisers can make more money if they:
    1. advise clients to roll over a 401(k) account instead of leaving it in a former employer’s plan
    2. sell proprietary investment products
    3. recommend borrowing for a large purchase rather than drawing down investible assets
    4. charge higher fees to manage stock vs. bond portfolios

Our thoughts: While these blanket claims are true for the vast majority of investment advisory firms out there, none of them apply to our business model – asset based annual fee (regardless of location), with no other outside compensation. We also think it’s important to note that regardless of the business model, there are many advisers that act ethically and in the best interest of their clients.  The mere existence of inherent conflicts doesn’t prevent someone from doing the right thing, but proper disclosure and client awareness are crucial. https://blogs.wsj.com/moneybeat/2017/04/07/why-your-financial-adviser-cant-be-conflict-free/?emailToken=JRrydf5zYnqSi9Ayb8wW8BgNRINNVr7TFgk

  • Chart of the Month:

IRS Audits by AGI

Source: 2016 IRS Data Book;  https://www.irs.gov/uac/soi-tax-stats-examination-coverage-individual-income-tax-returns-examined-irs-data-book-table-9b

 

Benefits of the Front Page

It’s that time of year again:  while some may think we might be referring to the Masters’ Golf Tournament (maybe our favorite sporting event, coming up in a few weeks), we’re actually referring to something much less pleasurable:  income tax filing.  This year, the deadline is April 18th and for many people it’s annoying at best and downright terrifying at worst.masters image

Without proactive tax planning, most people are staring at either a Turbo Tax screen or their accountants’ mystifying tax documents and ultimately just want to know one thing:  “Will we have to write a check to Uncle Sam or will I be getting some cash back?”

It doesn’t have to be this way.  In fact, as integrated financial advisors we think it’s prudent to always be cognizant of federal and state income taxes, typically our clients’ largest expenditure each year. (DISCLAIMER:  We are not CPAs, nor enrolled agents so this should not be construed as formal tax advice as all families’ tax situations are different.  You should consult your CPA or enrolled agent for specific tax advice.)

tax guyEven though we are not CPAs nor enrolled agents we still partner closely with CPAs to ensure our clients are always compliant with tax laws and regulations.  This means our CPA-partners fill out tax forms, research the applicable issues, sign the returns and work with tax authorities, if necessary.

As financial advisors, nobody is more involved in our clients’ financial lives. For this reason, we believe staying sharp on taxes throughout the year is essential, and potentially profitable, for our clients.   Realizing this, we always try to employ what we think might be an underappreciated approach to tax planning:  the “front page” deduction.

“Front page” deductions are those tax deductions that actually lower AGI (adjusted gross income) on the “front page” of the federal tax return (Form 1040).  These tend to be more “valuable” because they can positively impact other parts of the tax return, much more so than the typical, and similar, “Schedule A” deductions (a.k.a. itemized deductions).  Why is this?  In general, because other Schedule A deductions use the AGI number as the basis to determine how much of these expenses can be deductible.

For example, if you have lower AGI you could see a larger tax deduction for:

  1. out-of-pocket medical expenses
  2. miscellaneous deductions (such as financial planning and tax preparation fees)
  3. casualty losses and others

In addition, you could also lower the amount of social security income that would be taxable (assuming you are currently taking social security).

But the trick is to lower the AGI in order to benefit more from those deductions.  This can be accomplished by employing the “front page” deductions.  For instance, instead of contributing to a charity and deducting it on Schedule A, maybe our retired clients should use a Qualified Charitable Deduction as part of their IRA required minimum distribution.  Also, as financial advisors we keep a sharp eye on those investment accounts and try to offset capital gains with capital losses during the year so as to either lower the capital gain income (on the front page) or maybe even maximize the $3,000 annual allowable capital loss.  Other examples include contributing to Health Savings Accounts and ensuring all expenses for a small business are fully (and legally) recognized as offsets to income.

This may all sound too nerdy for some but if we illustrate with an example, you may sit up and take notice at the material tax savings which could be realized by knowing how to employ these strategies.

Let’s say we have a retired married couple with the following gross income totaling about $118,000

  • $8,000 of interest & dividends
  • $5,000 of capital gains
  • $50,000 of IRA distributions
  • $40,000 of Social Security income ($34,000 taxable)
  • $15,000 of consulting work income

And let’s say they have the following expenses, some of which are deductible:

  • $10,000 of out-of-pocket medical expenses ($300 is deductible because their income is so high)
  • $8,000 of real estate taxes
  • $10,000 of charitable contributions
  • $7,500 of tax and financial planning fees

Overall, we estimate this couple would owe about $10,372 in federal income tax or about 12.8% of taxable income – not too shabby.

But, what if we made the following changes (with all other deductions remaining the same) with “front page” deductions to lower our AGI and the tax burden?

  • Make a QCD (qualified charitable distribution) to donate the $10,000 directly to charity from our RMD instead of donating from our checking account and deducting on Schedule A
  • Maximize the contribution to the HSA (if qualified) and pay most medical expenses with these funds
  • Incorporate a tax-loss harvesting strategy in taxable investment accounts to deduct the maximum $3,000 capital loss each year
  • Document and deduct $5,000 of expenses related to the consulting work

By making these changes, we have lowered our taxable income from $80,640 to only $50,246 which means our tax bill is now only about $5,841 – an annual savings of over $4,500!

In our minds, this illustrates the difference between financial planning and having “an investment guy”.  Sure, it may not be the latest & greatest stock tip (which usually crashes & burns anyway) but tax savings is real cash flow.  In addition, these savings can compound year after year adding materially to families’ net worth.

The point is this:  taxes can be confusing, boring, scary and annoying all at once.  But knowing how the 1040 tax return works can add substantial value when combined with prudent investment advice. This is why when we meet with our clients on the various financial topics throughout the year, we always have our ears open for how to lower that AGI and potentially lower the tax liability, putting real money back in our clients’ pockets.

Comments?  Questions?  Feel free to enter them below and we’re happy to address.

2 Minutes With Magis Wealth Planning 3/10/17

“2 Minutes With Magis Wealth Planning” is published on the second Friday of every month.  It is comprised of five brief thoughts that we’ve come across during the course of our daily reading and research.  It summarizes data points that we find both relevant and interesting on various topics including investments, retirement, taxes, industry news, etc. 

  • Warren Buffett’s annual “Letter to Berkshire Shareholders” was published recently and had some interesting food for thought as always. Stick with low cost index funds because actively managed funds rarely outperform them, net of fees – very similar to what we advise our clients. What about the smooth talking “financial advisors” that make a lot of promises about outperformance and recommend “proprietary strategies” and fancy (and expensive) funds? He quotes an appropriate old adage:  “When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.”  Clink Here to Read Warren Buffett’s Letter
  • Here’s a link to an interesting research paper that explores whether a group of funds that outperform their benchmarks in one period can continue to do so in subsequent periods. Conclusion: Not very likely. Picking fund managers solely on past performance is not a winning strategy.   Click Here for the Research Note
  • The race to the bottom continues: Last month we mentioned that Charles Schwab had lowered its standard commission price to $6.95 per online stock or ETF trade (lowest in the industry at the time). Well, last week they lowered it again to $4.95 per trade, matching Fidelity (who had lowered their trading commission from $7.95 a week prior in response to Schwab).  We suspect this downward spiral will continue – which is good news for investors.
  • If you are or know a teacher or a public employee paying into the state pension system, here’s an interesting article that was recently published in The New York Times which compares the teachers’ pension fund in Puerto Rico to a legalized Ponzi scheme. The article includes an interactive map that compares teachers’ pension plans by state.  Ohio was one of 6 states that received an “F”. Click Here to Read the New York Times Article
  • Chart of the Month: Pie chart that shows the breakdown of federal expenditures according to the Congressional Budget Office (CBO) and how it is expected to change in the next 30 years. Bottom line: Entitlements are crowding everything else out, which suggests that taxes will probably need to go up in the future.  We think this underscores the potential benefit of strategic Roth conversions (e.g. taking advantage of low income years in retirement before RMD’s).

CBO Federal Spending Chart

Source: Wall Street Journal Daily Shot 3.6.17; OFFIT Capital. h/t Anne