Declarations of Independence

Politics...As Usual

DWolford — Fri, 11 May 2012 17:54:21 +0000

Being in our DC office this morning gets me thinking about politics again. Now that it seems the contestants for the upcoming presidential election have been determined, the interesting question is 'what does it mean for me?' Amidst the uncertainty, it is a safe bet that the next President will have a huge effect on your portfolio. Personally, I’m not sure that the effects vary much depending on who wins. A couple of prognostications from the crystal ball:

- I believe taxes will be going up for high earners. While the 'Buffett Rule' of a flat 30% tax on million-dollar incomes is probably a political non-starter (since it would require the replacement or retooling of a lot of moving parts in the tax code), there is thought that the debate is merely to soften up resistance so that some higher marginal rate above the current top rate of 35% (where it has been since 2003) can be introduced, or the threshold (currently $388K) can be lowered. Capital gains rates are on the table, too—and I wouldn't be surprised to see the long-term federal real-estate gains tax (currently 15% or 25% if depreciated over time) go up OR its threshold (currently $250K single/$500K joint for gains on primary residence) come down, since so many families are underwater on their mortgages and don't have an immediate hope of bagging gains in a sale. It's easy to make that kind of change when few are affected, but in due course, when the real-estate market does rebound, it will have already been put in place and revenues could be significant. This type of change could happen either in a first-term or second-term presidency as raising taxes on high earners enjoys high voter approval from both left and right.

- I may be out there on this one, but I would not entirely rule out a Value-Added Tax (VAT), at least on certain items. Or call it a national sales tax ... either way. Consumption taxes (like VATs) will be perceived as having a chilling effect on economic recovery, but slapping them on 'luxury' goods or services would only hurt high-earners, who have little of the political bullhorn -- and who, in truth, are going to grumble but still keep consuming. That's certainly been the case in Canada, where in Ontario (Canada's most populous province) a Harmonized Sales Tax (HST) of 13% was enacted in 2010, effectively almost doubling the consumption taxes on services. Nearly three-quarters of Ontarians opposed it, but in it went, and two years later people still complain, but it isn't going away. Ontario made the tax more politically palatable by providing low-income citizens with tax credits (read HST rebates), effectively accomplishing the goal of income redistribution and countering criticisms about the regressive nature of consumption taxes. This type of change is more probable, in my view, to happen during a president's second term as it would likely be a campaign headache for an incumbent seeking a second term.

Bottom line— taxes for many of those reading this will be going up ... we just don't yet know which ones or by how much. All of which makes it difficult to do good tax planning. In any case, there are still a couple of sensible tax planning topics you should discuss with your advisor:

accumulated carry-forward losses you have from previous years, which will be more valuable in a rising-tax environment;
the timing of large charitable or other deductible items, which would be more valuable under a higher tax rate (though the President has proposed lowering the tax break on charitable contributions from 35% to 28%, which may make it better to make donations this year);
if converting a Roth IRA could generate non-taxable income for your retirement; and
whether selling investments in 2012 for 2013 cash flow may make sense.

Lastly I would suggest incorporating slightly higher figures for taxes in your next Monte Carlo Analysis -and of course when the tax structure is finally clarified (which won't be until after the election!), make sure to review your entire portfolio structure with your Advisor to ensure that it is optimized for your goals and any changes in the tax code.

Disclosure: The information provided is for educational purposes only and is not intended to be, and should not be construed as investment, legal or tax advice. The information is subject to change and, although based upon information that Convergent Wealth Advisors considers reliable, is not guaranteed as to its accuracy or completeness. Convergent Wealth Advisors makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. In accordance with Treasury Regulations Circular 230, any tax discussions contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter addressed herein.

Tags:

Taxes,

Wealth Management

It's Tax Time!

BBancroft — Thu, 12 Apr 2012 16:45:27 +0000

It's tax time. We can't control the tax laws (we are, of course, registered as Independents), but we can control how we respond to them. Being aware of taxes during the initial investment process and while managing the portfolio means you are best positioned to keep as much of what's yours as possible, which helps you achieve financial independence that much sooner. Simply put, our goal is to manage your portfolio as tax-efficiently as possible.

It starts with the type of investments we recommend—these investments have been evaluated on an after-tax performance basis, are liquid, and have been reported on a 1099. That helps make the tax reporting as simple as possible. When we first implement our strategy, we are sensitive to the tax impact of the changes in the portfolio. When possible, we transfer your assets over to us in kind, which allows you the flexibility to hold appreciated securities as part of our strategy. For positions that aren't part of our strategy, we seek to balance the benefits of diversification with the pain of realizing gains and, with your input, devise a plan to either liquidate the position or work around it. We also consider the type of accounts you have. In an effort to optimize your tax efficiency, we place the tax-inefficient investments in your tax-deferred (or tax-free) accounts (and vice-versa). For example, we might place a stock index ETF, which has low turnover, in your taxable account (or use a tax-enhanced strategy if the investment minimum can be met) and a high yield bond fund in your IRA.

Once your portfolio is set up to maximize potential after-tax returns, we seek to manage the portfolio efficiently by generally holding positions longer than one year to gain favorable long-term capital gains tax treatment. Generally, the shifts we make in the portfolio are expected to play out over 12-24 months. We are aware of when mutual funds pay out taxable distributions and avoid buying them immediately before they do so. We are also opportunistic. When the market falls, there may be an opportunity to capture a tax loss while maintaining exposure to the same asset class by selling the original investment and buying a related index ETF for 30 days before switching back into the original investment.

At the end of the day, you are best positioned to get the return of our strategy with tax losses that can be used to offset future gains. As a last measure, we review portfolios for these same potential opportunities at year-end. Finally, part of our service includes confirming you or your accounting professional have the information needed to file your taxes. With your authorization, your accountant can have access to your online portal and access the 1099s in a secure fashion.

When you hire us, you hire us to be objective and look out for your best interests. Just like market losses, fees, and over-spending, we believe taxes are a risk to your long-term financial independence and need to be proactively managed on an ongoing basis. It is all part of our solution designed to help you achieve your financial independence as soon as possible.

Tags:

Taxes

Know Thyself

DWolford — Thu, 22 Mar 2012 20:21:50 +0000

Getting the right portfolio or finding the right advisor probably depends more on what you know about yourself than on what you know about investments or what you know about your advisor. And when it comes to money, self-knowledge—like financial independence—doesn’t come cheap.

A lot of what we learn about ourselves comes from: (1) our parents, (2) our experiences, and (3) how we react to other people’s experiences.

Our values about money are initially shaped by our parents’ values, and then they change as we learn from our experiences and those of others. My parents grew up in the Depression and so were and are savers, frugal about spending and somewhat fearful about the prospect of losing money. So I started off conservative and with a defensive posture about money—more concerned about not losing it than I was about making it.

As time goes by, life experiences teach us what really makes us tick and how we are different from our parents. Seeing my 401(k) take a big hit during the Time of Darkness (2008-2009) reminded me that my fear of losing money was still very much a part of my personality, at least on a visceral level. But by that time I had ridden through a few highs and lows in the market (though not as steep and scary as that one), and I had learned that as long as I was working and earning I could pretty much control the urge to look at my account balances (on bad days anyway).

The experiences of others are a bit harder to learn from, but I’ve tried to be a student of others whenever they’ve been willing to share. There are a million smart people in this world, and when you run into one, learn all you can—especially about the experiences they’ve had that you haven’t. This will give you a safe way to think about how you might react if you had been in their shoes.

So what does this have to do with picking the right advisor and the right portfolio? Here’s what to look for—and look out for. Look for an advisor whose first priority is listening—one who listens more than he or she talks, learning from you about you—because you are the only one who can provide that insight. Watch out for advisors who tell you how smart they are, how much they know, how they are the best. They have it backwards. There’s nothing wrong with them telling you about their qualifications, of course, but those only demonstrate a general competency and not an ability to connect with you and your needs.

After finding out about you, a good advisor will ask probing questions to help you to identify the type of investor you are—what motivates you, what frightens you, what you think about when you think about money.

In addition to what they now know about you, a good advisor will help you learn from others’ experiences because he or she has probably seen it all by now (and I mean that in a good way!).

So when you’re looking for an advisor, look for one who first and foremost spends time getting to know you. But even before that can happen, you have to get to know yourself. You both deserve it!

Tags:

Investor Behavior

Proactive Versus Reactive Portfolio Management

BBancroft — Wed, 29 Feb 2012 20:49:35 +0000

I often hear prospects complain that their current advisor is reactive and only makes changes when prompted to do so. At Independence, we take a proactive approach to managing the portfolio. We review each asset class to determine if there are any meaningful deviations from historical norms. We make shifts (within predetermined bands) in our allocations in an attempt to capture opportunities or mitigate risks created by those deviations. Because we expect those shifts to work out over the course of 18-24 months, we aren’t churning the account trying to capture every short-term movement in the markets. It is impossible to time the market perfectly, which is why we take more of an intermediate-term approach.

As an example of our proactive approach, we are currently underweight fixed income in our portfolios. Bonds still have a place in our portfolios, since they are relatively safe when equity markets sell off, but as you can see from the chart below, interest rates are historically low. The Fed has announced they will keep interest rates low for the foreseeable future, but with rates that low, it will be a challenge for bonds to maintain their purchasing power. The table below shows that when rates rise, total returns for bonds lag. The table also shows that high yield corporate bonds perform better than traditional bonds when interest rates rise. For all of these reasons, we are underweight traditional bonds and overweight high yield bonds in our portfolios.

Source: HFR, Ibbotson Associates U.S. IT Government Bond annualized total return from 1950 to 1982 and 1982 to 2011.

You can see this shift was based on research using long-term data to identify a meaningful deviation from historical norms. This is a shift we proactively implemented on behalf of our clients and continue to evaluate on an ongoing basis. With Independence, you can rest assured we are continually evaluating your investment strategy and will proactively make changes when appropriate.

Tags:

Wealth Management

The "Dirty Dozen"

DWolford — Thu, 23 Feb 2012 19:51:28 +0000

If you are reading this blog, chances are that you are quite successful in terms of your income, savings, or both. Financial independence is something you've likely worked your whole life (and not just your adult life) to achieve. From studying hard in grade school to college and possibly getting advanced degrees—or if not college, perhaps starting a business or emigrating to the U.S. to start a new life—you've done everything you could to become successful and provide better things for yourself, your children, or the causes you care about. You've probably made plenty of sacrifices along the way, traveling for work instead of spending time with your family, not partying the night before the big exam, and so on. All this work and sacrifice—with the promise of success at the end of the line—used to be called “the American Dream.”

No longer. If you are successful—and I don't even mean those “one percenters” (meaning you have an income just north of $300K a year)—you are vilified in the press as elite, wasteful, probably having too big a carbon footprint, and in general just plain selfish. Some of you may even send your children to—gulp—private schools!

I know people who won't buy a new car because the residents of the subsidized housing down the street might vandalize it because it means that the owner is “rich.” You want it, you worked for it...too bad...If everyone doesn't get one too, you're out of luck.

According to the IRS website, people earning more than $100,000 a year—probably a good many of you—accounted for about 12.4% of all tax returns. Success, it seems, is still reasonably rare. If you now feel good about being in the top dozen percent, you'll be really interested to learn that you and your fellow twelve percenters pay 74.6% of ALL of the Federal tax collected that year. Um... seems to me that after that you should probably treat yourself to that new car because I'm betting you've bought plenty of them for other people by now.

Success sure isn't what it used to be. And it's not just taxes (which by the way you'll likely soon be paying more of, no matter what the political landscape). After all the schooling, the work, and the sacrifice, most of us can still be sent packing from our jobs with two weeks' notice. They say athletes have to make a lot each year because their careers are short. True, but most working professionals have even less security in their jobs—for a lot less pay—so it's not like you can plan on 30 years and a gold watch on retirement. The bottom line is this: You made yourself successful, and you will need to make yourself independent. No one else is going to help you—except perhaps an advisor who respects you and your success.

Tags:

Investor Behavior

M&Ms, Mutual Funds, and Managed Accounts

BBancroft — Thu, 16 Feb 2012 13:11:54 +0000

Education is a large part of being an advisor at Independence. Every day there is an opportunity to educate our clients and prospective clients on our process and strategy. I’ve found the more they understand, the better relationship we have. We become a trusted advisor rather than simply an expert for hire. One educational opportunity that has presented itself recently is comparing mutual funds to separately managed accounts (SMAs).

Often prospects come to us thinking mutual funds are inferior to SMAs, when in reality we believe they should be indifferent. Managed accounts offer investors some advantages, most of which revolve around control: control over gains and losses, as well as control over what underlying stocks you own. Some investors may want to restrict the manager from holding certain securities based on their own beliefs or because they have a large position in a certain stock or industry they don’t wish to expand. Your customizations have the potential to disrupt the manager’s strategy and affect the manager’s performance. For that reason, we normally recommend people support their causes with donations from the portfolio, rather than invest in a suboptimal way.

Your control over your gains and losses can be helpful in certain situations where you want to harvest losses in a year in which you had large gains. If a mutual fund experiences redemptions, it may be forced to sell underlying positions, causing you to realize gains you wouldn’t have otherwise realized in your separately managed account. What you may not realize is having control over your gains and losses can work against you as well. If the account holdings rise in value and you want to sell something, you will incur gains. But if a mutual fund does well and has inflows, the cost basis of the positions in the fund get spread out over higher levels and allows the mutual fund manager more flexibility to limit gains by selling the highest cost lot first. You can execute tax loss harvesting in a portfolio of mutual funds, too. The ability to control may be necessary for some people, but for most of us, the added control is generally over-hyped.

The worst misconception is that SMA managers have more investment talent than mutual fund managers. Nothing could be further from the truth. The structure of the strategy doesn’t pre-determine the performance of the strategy. That’s like saying M&M’s of different colors taste differently. Blue M&M’s have the same chocolate inside them that green M&M’s do. Only the wrapping is different. What matters is what is inside. If a mutual fund’s strategy is in favor, it will do better than a separately managed account whose strategy is not in favor. The differences in the structures don’t matter as much as the underlying strategies. An experienced advisory firm can help you select the most appropriate structure and strategies. Independence uses both mutual funds and managed accounts, but the decision is based on the underlying strategies, not the structures.

Tags:

Investments

Hope Springs Eternal

DWolford — Wed, 01 Feb 2012 19:26:19 +0000

It’s 60 degrees in Washington DC today, which is unseasonably warm. So warm, in fact, that I find myself half convinced that spring is just around the corner. But I’m afraid to believe because when the cold comes back—as it will—I know I’ll be all the more bitterly disappointed.

Signs of spring appeared in the capital markets early this month, too, with world markets continuing a warming trend started in mid-December. There seems to be a cautious optimism about the economy taking form, tempered of course with European downgrades and concerns about global economic growth. A new season of political theatre offers some amusement, if not always of the most uplifting kind, and the tent cities of the “occupiers” are thinning out. Can we convince ourselves that the worst is behind us? Is hope back in style?

The fable of “Pandora’s Box” may be a useful guide here, and not just because Greece is on everyone’s mind. According to myth, Pandora was the first woman on earth. The gods gave her a curious container, but cautioned her never to open it. Curiosity being what it is, Pandora opened the lid a crack to have a peek at the contents, and out rushed a horde of winged creatures—all of the evils of the world: hunger and disease and war and, probably, 2008’s market meltdown. Try as she might, Pandora couldn’t get any of the evils back in the box … it was too late and the evils had taken flight. But at last she noticed that one creature was still clinging to the underside of the lid—a lovely little creature called Hope.

Very inspiring, to be sure. “Hope springs eternal,” and all that … but something I never got an answer to in Mythology class was why Hope, something most of us view as so positive, was inside a jar full of evils? My theory is that hope can be positive, and maybe most of the time it is. But misplaced hope can be delusion, and hope clung on to too long after its expiration date can be just as putrid as pessimism. So it is well in investing, as in life, to enjoy the moment without drawing too many firm conclusions about where the moment is leading. My guess—though I hope I’m wrong—is that spring’s not quite here yet, no matter how warm it is today.

Tags:

Investor Behavior

Failing to Plan Is Planning to Fail

BBancroft — Thu, 26 Jan 2012 13:19:06 +0000

As unpleasant as it is to consider, emergencies happen. By definition, emergencies happen when they are least expected. Most of us plan for the biggest emergency there is—our own passing—by employing a sensible estate plan or buying life insurance. There is another type of emergency for which we probably haven't properly prepared: a national disaster. The Federal Emergency Management Agency (FEMA) has recommendations for your home survival kit that include obvious items such as flashlights, food, water, and first aid kits. That kit is definitely important, but what about a survival kit for your finances?

Within the last couple years, FEMA produced the Emergency Financial First Aid Kit (EFFAK), which is an organizational tool designed to help you maintain financial stability in the event of an emergency. It can be found here: http://www.citizencorps.gov/downloads/pdf/ready/EFFAK_2010_FEMA.pdf

How many of us have $20 saved just in case of an emergency? FEMA has experience with emergencies and has thought of things less obvious than flashlights and batteries. I encourage you to put your own family's kit together. You can keep it in a safe at home and online in your document vault on the Independence by Convergent online portal. It is another opportunity to plan for the worst. Like Yogi Berra said: "The future isn't what it used to be."

All the News That's Print to Fit

DWolford — Tue, 17 Jan 2012 13:23:40 +0000

When yesterday I was gently reminded by a colleague on our Marketing team that my next blog post was due, I replied that I'd do my best to think of a topic. The pressure was on as I boarded a train for our New York office...

On the train I spied someone reading her copy of The New York Times, whose slogan famously is “all the news that's fit to print.” I started thinking about my impending blog post, and the pressure to fill up some space, and came to the conclusion that I had something in common with many of today's journalists—and particularly financial reporters—in that I have some blank space to fill by such and such a time, whether or not I have anything “that’s fit to print.”...

My point is that many clients are frustrated—and frightened—by the constant stream of consciousness (or perhaps “scream of consciousness” if you watch Mad Money) financial news from around the world, appearing in their inboxes and newsfeeds and mailboxes 24/7. Today the headlines say that “Earnings Season Brings Hope to Investors!,” but tomorrow's may well be “Markets Plunge on Euro Despair!” What to believe? And when to believe it?

Well, journalism—like the market itself—may be rational over the long term, but it certainly isn't over the short term. And more and more news actually creates events, instead of reporting on them. Just as you should think about putting in place a long-term asset allocation that is designed to meet your needs—and then don't for heaven's sake look at your portfolio every day!—so should you take the daily news with a grain of salt. Or better yet, turn off CNBC, line the birdcage with the newspaper, and stop following the pundits' tweets. Remember, they're all looking to fill space, every day, every moment, with news that's print to fit.

Tags:

Investor Behavior

Hope for the Best, Plan for the Worst

BBancroft — Thu, 12 Jan 2012 21:45:11 +0000

Happy New Year! I am sure we said the same thing to each other a year ago, hoping for the best 2011 possible. Twelve months later, we know 2011 wasn’t the best year in terms of returns for most investors. To put things into perspective here are 2011’s major asset class index returns and drawdowns (largest peak-to-trough declines):

Source: Convergent Wealth Advisors

As volatile as our markets were, they pale in comparison to the volatility around the world. We have a saying in our firm: “Hope for the best, but plan for the worst.” Among the various strategies we employed, part of our “plan for the worst” this year included an allocation to what we call Opportunistic funds. The goal of the Opportunistic bucket is to provide portfolios with the same benefits that hedge funds offer without limiting diversification or liquidity. Since we haven’t found one mutual fund or ETF that offers the market exposures we are looking for, we’ve combined a number of managers in such a way that in our mind will help protect during market drawdowns while offering some growth potential when things recover.

Overall, having this allocation helped last year by protecting capital when the markets sold off. The annual index return for the Opportunistic bucket was 4.3% while its largest drawdown was only -6.0%; simply put this asset class earned twice as much as the S&P 500 with only a third of the risk. As our investors head into 2012 we are maintaining our allocation to these Opportunistic strategies as it’s our belief they will again be an integral part of navigating what may be another volatile year.

Let’s hope for a healthy and prosperous 2012, knowing we have a plan in place if it doesn’t turn out that way!

Tags:

Investments