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The Art of Asset Location

When it comes to buying or selling your home, most of us already know that the price depends on three things: location, location, location. Asset location is a similar, if less familiar rule that applies to your investments. By managing asset location within your portfolio, we help you keep as much of your wealth as possible – even after the tax man takes his cut. Given how deep that cut can be, it’s another way we add value to your total experience as an investor.

Asset Location: A Working Definition

Let’s begin by noting that asset location should not be confused with asset allocation. The two are related, but separate beings, like cousins or siblings.

Why Do It?

There’s empirical evidence that asset location is worth the extra effort it takes. Financial commentator Michael Kitces points to a Morningstar analysis indicating that a well-executed asset location strategy can add as much as a half-percent to your bottom line each year [1]. That’s $500/year for every $100,000 invested (which, we might add, can represent a good chunk of your advisor’s fee returned to you). Why leave that money sitting on the table?

Why You (Probably) Need an Advisor to Assist

It makes intuitive sense that, by locating your most heavily taxed investments within your tax-sheltered accounts, you can minimize or even eliminate their tax inefficiencies. But it’s not as easily implemented as you might think.

First, there is only so much room within your tax-sheltered accounts. After all, if there were unlimited opportunity to tax-shelter your money, we’d simply move everything there and be done with it. In reality, challenging trade-offs must be made to ensure you’re making best use of your tax-sheltered “space.”

Second, it’s not just about tax-sheltering your assets; it’s about doing so within the larger context of how and when you need those assets available for achieving your personal goals. Arriving at – and maintaining – the best formula for you and your unique circumstances involves many moving parts.

Never Heard of Asset Location? Here’s Why

We don’t see asset location frequently covered in the popular financial press. Why is that? We believe it’s in part because a large swath of the financial industry ignores the need. You’ll typically only see asset location planning offered by an advisor (like Hiley Hunt Wealth Management), who is well-positioned to provide objective counsel and oversight for your larger holdings. In the absence of this oversight, you’ll find:

While most investors may not be aware when they are missing out on effective asset location, the resulting money they may unnecessarily lose to taxes can be very real. We look forward to continuing to incorporate asset location in its proper place within your overall wealth management. Can we answer additional questions? Let us know!

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management

 

[1] Michael Kitces, “Asset Location: The New Wealth Management Value-Add For Optimal Portfolio Design,” March 6, 2013; and Morningstar Tries to Quantify The Value of Financial Planning,” November 12, 2012.

Three Key Investment Strategies Hidden in Plain Sight #1: Being There

If you’ve ever dabbled in graphic design, you’re familiar with the concept of white space. When viewing an illustration, we typically pay the most attention to the visible ink on the page, such as a paragraph of text, a bar chart or an entertaining illustration. White space is the essential empty areas in between that are hidden in plain sight. We barely notice them … until they’re not there.

When making investment decisions, most people likewise assume that the most eye-catching ink matters the most: an alarming economic forecast, an exciting Initial Public Offering, hot trading tips. But there’s a catch. This evident assumption does not hold up under evidence-based scrutiny. In reality, you have little or no control over how the most obvious news impacts your investments. The most exciting action has already been priced into any trade you might make well before you decide to make it.

Instead of fixating on the headline news, consider that liberating financial white space. There, hidden in plain sight, you’ll find a number of powerful investment strategies that are freely available and far more within our control. In this series, we’ll introduce three of our favorite “plain sight” investment strategies:

1. Being there

2. Managing for market risks

3. Controlling costs

We emphasize these – and we think that you should too – because (1) they’re simple enough to apply once you know they’re there, (2) they can have a significant impact on your investment experience, and (3) we see too many investors ignoring them at their peril.

 

Plain-Sight Strategy #1: Being There

To receive a return on your investment, first you must invest (and stay invested).

Bottom line, you cannot expect your stash of cash to grow when it is lying fallow. It’s hard to imagine a more basic principle than that, so why do so few investors manage to embrace it? The answer is found in a sentiment you may have heard before: Investing is simple, but, it’s not easy.

It’s relatively simple to accept the notion of no pain, no gain. To earn returns, you must put your assets at risk in ventures that are expected to compensate you for your faith that they will succeed … if they do. Then you must patiently await the desired success, knowing that it is expected but not guaranteed. The riskier the ventures, the less certain the outcomes, but the more you can expect to earn for enduring the uncertainty … if you do.

Instead, many investors panic when market risk arises and move their money to the proverbial sidelines. They also fret that they’re going to miss the boat when the market surges, so they pile into whatever is the latest success story. To cite just one of many analyses of these tendencies, a 2014 Federal Reserve economic synopsis looked at performance from 1984–2012 and found annual damage of up to 5 percent attributable to return-chasing behavior. The report concluded: “[P]oor investment timing caused by return-chasing behavior has a significant impact on portfolio performance.”

By chasing and fleeing hot and cold markets, you’re undesirably buying high and selling low. You’re also disregarding decades of empirical evidence that informs us that one of the best ways to capture long-term market growth is to build a solid, individualized plan, and to then stick to your plan by riding out the market’s near-term ebbs and flows.

With this simple strategy, you’re trusting that the market will continue to do what it has done for many decades when viewed from a long-term perspective: It has grown.

Why is it that so many investors ignore this common-sense strategy – be there and stay there – and instead cut the cord during turbulent times?

To echo our aforementioned sentiment, it’s simple to understand how the market’s gains and pains are so closely related. But it’s never easy to endure the pain when it occurs – whether that’s in the form of plummeting markets or tempting trends. Like a first-time skydiver, you cannot know how you’re going to feel and what you’re going to do about a free-fall until you’re in it. Behavioral finance informs us that, thanks to our most basic instincts, we’re subjected to a host of financially damaging biases – loss aversion, recency, herd mentality and many others – that lead us astray during these sorts of “fight or flight” market conditions.

This is why you want to prepare for your investment leaps well in advance, preferably with an evidence-based adviser at your side to help you maintain your resolve. In our next piece, we’ll introduce our plain-sight strategy for managing challenging market risks and temptations, so you can be best equipped in your quest for long-term investment success.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management

More Evidence on the Evidence: The Thinkers Who Have Influenced Our Thinking

Why do we refer to our approach as evidence-based investing? As we introduced in our related article, “Evidence on the Evidence,” we believe that the evidence – especially the kind that has been peer-reviewed and time-tested – is at the root of everything else we do to help investors achieve their personal goals through sound strategy. The alternative – trying one’s luck at stock-picking and market-timing – is a much tougher (and likely more costly) pursuit.

This begs the question: Which specific evidence has borne the most fruit over time? An exhaustive account of every meaningful contribution would be a lengthy list indeed, but it helps to be familiar with the most important insights that, in aggregate, offer investors a clearer pathway through the market’s daily twists and turns.

For our purposes, most of the tenets underlying today’s evidence-based investment strategies originate in the 1950s with Modern Portfolio Theory, so we’ll begin there.

Modern Portfolio Theory (MPT)

Harry Markowitz, “Portfolio Selection,” The Journal of Finance, 1952

Modern Portfolio Theory (MPT) represents one of the greatest equalizing breakthroughs in financial economics, paving the way for a radically different approach to investing. Prior to MPT, it was generally assumed that the best way to invest was to look at each security (or hire someone to do so), pick a few of the “best,” and hope you were right. For every winning trade, there had to be an equal and opposite losing one in the market’s transactional zero-sum game. This meant that individual success was a dicey proposition indeed, especially net of costs.

MPT suggested that investors could abandon the cut-throat competition and play with rather than against the forces of the market by adopting a portfolio-wide approach to capturing returns. It introduced several, now widely accepted principles, including a strong relationship between market risk and expected returns, and the vital role that diversification plays in managing that risk. Most importantly, MPT described a way for any participant to earn market returns, simply by being patient and waiting for the market to do its thing.

Separation Theorem

James Tobin, “Liquidity Preference as Behavior Towards Risk,” The Review of Economic Studies, 1958

The Separation Theorem played an important role by proposing that investors could form portfolios of riskier stocks (equity), but temper that risk by offsetting it with an allocation to bonds (fixed income). Today, it’s widely assumed that a portfolio should consist of an appropriate mix of stocks and bonds reflecting the investor’s individual risk tolerances. In the 1950s, this notion was groundbreaking.

Capital Asset Pricing Model (CAPM)

William F. Sharpe, “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk,” The Journal of Finance, 1964

How does the market set its prices? CAPM offered us some early, data-driven insights on this front. The Separation Theorem indicated that investors might be better off ignoring individual stock performance and focusing instead on their portfolio’s relative overall exposure to stocks versus bonds. This also was known as the single factor of general market risk. Sharpe expanded on the theme by analyzing newly available data on historic rates of returns. While CAPM left considerable room for additional inquiry, it established a stronger, data-driven platform from which to build.

Efficient Market Hypothesis (EMH, or “Random Walk” Pricing)

Eugene F. Fama, “The Behavior of Stock-Market Prices,” The Journal of Business, 1965; and Paul Samuelson, “Proof That Properly Anticipated Prices Fluctuate Randomly,” Industrial Management Review, 1965

In the mid-1960s, Samuelson, Fama and others contributed to what collectively became the Efficient Market Hypothesis. Complementing CAPM price-setting, EMH also crunched available data to determine that a security’s next price seemed effectively unpredictable – like trying to track a drunkard’s “random walk.” Instead, prices were generally established by the market’s collective wisdom in lieu of individual “smart” trades. The evidence continued to mount that investors seem better off consistently capturing wide swaths of the markets’ expected risks and rewards, instead of trying to chase individual stocks or particular market climates.

Behavioral Finance

Amos Tversky and Daniel Kahneman, Judgment under Uncertainty: Heuristics and Biases,” Science, 1974

Parallel to financial economics, behavioral finance empirically analyzes the “human factor” in factor-based investing. Tversky and Kahneman published one of the earliest inquiries in this ongoing field, describing a number of behavioral biases to which investors seem predisposed. Particularly as improved brain-imaging techniques have advanced, so too has our understanding of what is going on in the deepest recesses of our brains that may be causing us to make seemingly irrational investment decisions, to the detriment of our end returns.

The Role of Bonds/Fixed Income

Eugene F. Fama, “Term premiums and default premiums in money markets,” Journal of Financial Economics, 1986

Turning to the bond side of the bond/stock mix, Fama and others have shed additional light on why it is usually a good idea to diversify one’s portfolio into a measure of stocks and bonds. With bonds, the primary risks – and thus sources for expected returns – include a bond’s term (its maturity date) and credit rating (the likelihood it might default on its obligations). These and other differences contribute to a relatively low correlation between stock and bond markets’ differing risks, expected returns and price movements. This in turn helps us understand why bonds are better suited to serve as a stabilizing rather than a returns-generating force within an investor’s total portfolio, offsetting stocks’ more volatile mood swings.

 The Three-Factor Model

Eugene F. Fama and Kenneth R. French, “Common risk factors in the returns on stocks and bonds,” Journal of Financial Economics, 1993

In one of the most important advances beyond the single-factor model for stock pricing, Fama and French provided key, data-driven evidence indicating that three distinct market factors went further than a single factor in explaining why one stock portfolio would be expected to perform better or worse than another over time. This became known as the Three-Factor Model. The three factors include: the market factor (stocks vs. bonds), the size factor (small-company vs. large-company stocks) and the stock-price factor (value vs. growth companies, typically as measured by price-to-earning ratios).

The Three-Factor Model has been monumental in enabling fund companies to create practical, low-cost solutions for building diversified portfolios in which holdings can be tilted toward or away from each of these factors, so investors can efficiently tailor their expected levels of risk and return.

International Diversification

Steven L. Heston, K. Geert Rouwenhorst, and Roberto E. Wessels, “The structure of international stock returns and the integration of capital markets,” Journal of Empirical Finance, 1995

In our related article, “Evidence on the Evidence,” we explained that one way to differentiate persistent results from fleeting patterns is whether the results are repeatable in other samples. In financial economics, this often means determining whether a factor shows up in multiple markets around the globe. This landmark study (among others) shored up existing evidence by testing a number of markets across a dozen European countries and the U.S., and finding that they shared multiple risk factors in common. The study also initiated exploration into potential benefits of diversifying not only across risk factors, but also across various global markets.

What Does the Future Hold?

In the latest capital market research, scholars cited here as well as the next generation of their peers have been exploring whether the Three-Factor Model should evolve into a model incorporating additional factors – such as stock-price momentum, company profitability and company reinvestment costs. Do these factors represent additional, distinct sources of expected return? If so, can we expect them to remain persistent over time? Can they be practically implemented after the costs involved?

These are the questions unfolding even as we publish this piece. They get to the heart of why we feel an evidence-based investment approach is crucial to our own and our clients’ well-being. We begin by harnessing the most robust evidence available to us today, using the practical solutions that have been built from that evidence to help our clients invest confidently toward their long-term goals. Keeping a watchful eye on additional evidence as it emerges, we also remain vigilant to new possibilities, applying the same criteria we described in “Evidence on the Evidence” to assess their credibility.

In this context, we believe the best way to participate in ever-volatile markets was, is and will remain those strategies and solutions that are grounded in the most durable academic evidence. While we can never promise certain success, evidence-based investing gives investors their best shot at likely success. That’s one factor we don’t see changing over time.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management

The Evidence on the Evidence: How Do You Know What (and Whom) to Heed?

There’s a reason we refer to our strategy for building durable, long-term wealth as evidence-based investing. There are a number of other terms we could use instead: Structured (getting warm), low-cost (definitely), passive (sometimes), smart beta (maybe), indexing (close, but) … the list goes on. But because the evidence is at the root of what we do, we believe it should also be at the root of what we call it.

That said, there is a great deal of evidence to consider, and some purported findings seem to contradict others. How do we know which evidence to take seriously and which are false leads?

Evidence-Based Investing: A Never-Ending Story

First, it’s worth noting that academic inquiry is never fully final, nor does it allow for absolutes in our application of it. As University of Chicago professor of finance and Nobel laureate Eugene F. Fama has said, “You should use market data to understand markets better, not to say this or that hypothesis is literally true or false. No model is ever strictly true. The real criterion should be: Do I know more about markets when I’m finished than I did when I started?” [Source]

With this caveat, there are still a number of important qualities to seek when assessing the validity of a body of academic evidence.

A Disinterested Outlook – Rather than beginning with a point to prove, ideal academic inquiry is conducted with no agenda other than to explore intriguing phenomena and report the results. It is then up to us practitioners to apply the useful findings.

Robust Data Analysis – The analysis should be free from weaknesses such as data that is too short-term or too small of a sampling; survivorship bias (wherein returns from funds that went under during the analysis period are disregarded); apples-to-oranges benchmark comparisons; or plain, old-fashioned faulty math.

 Repeatability and Reproducibility – Results should be repeatable in additional studies across multiple environments and timeframes. This helps demonstrate that the results weren’t just random luck or “data mining.” As AQR fund manager and founding principal Clifford Asness describes, “If a researcher discovered an empirical result only because she tortured the data until it confessed, one would not expect it to work outside the torture zone.” [Source]

Peer Review – To ensure that all of the above and more is taking place as required, scholars are expected to publish their detailed data sets, methodologies and findings in a credible academic journal or similar forum, so their credentialed peers can review their work and either agree that the results appear to be valid or refute them if they are not.

The Alternative: Data Foolery

If our emphasis on deep and diligent peer review sounds like it doesn’t really apply to you and your tangible wealth, think again. Echoing the sentiment about lies, damned lies and statistics, when faulty conclusions are inappropriately applied, the results can send countless investors astray, with real dollars lost.

Consider this fascinating exposé by journalist John Bohannon, “I Fooled Millions Into Thinking Chocolate Helps Weight Loss. Here’s How.” The evidence-based sting operation happened to take place within healthcare, but similar lessons apply to finance.

Bohannon began by conducting a deliberately flawed “study” to serve as a glaring example of poorly done research. He intentionally used a paltry data set of 15 participants in a one-shot clinical trial, and then heavily tortured the resulting data to extract a technically accurate if essentially meaningless conclusion that chocolate consumption contributed to weight loss.

Next, Bohannon mined his familiarity with the scientific publishing industry to submit his study to several journals that had questionable reputations with respect to their screening processes. Despite full disclosure of the study’s many weaknesses, Bohannon observed that his paper “was published less than 2 weeks after [our] credit card was charged.” He and his cohorts then launched an aggressive PR campaign to a global media who was apparently more interested in printing exciting sound bites than substantiating the validity of the sources involved.

The title of his resulting exposé, tells us how the story ended. A blitz of television, Internet and print media coverage suggested to audiences around the globe that they might want to go on a chocolate diet to lose weight. Faulty evidence in, garbage conclusions out.

The Preeminence of Peer Review

The point is not to dismiss all evidence as bogus. The point is that substantive, meaningful peer review remains an essential component in separating real academic evidence from the wider glut of sloppy work that all too often occupies headline-grabbing news. Peer review also enables scholars to reference and build on their colleagues’ best work, which enables collective insights into important subjects to deepen and expand over time.

That’s why the evidence that survives the gamut of academic peer review, and has withstood the test of time is the evidence that we are most interested in applying to a set of orderly (if never certain) principles to guide our practical, evidence-based investment strategies.

The Adviser’s Essential Role: Separating Fact from Fiction

As evidence-based advisers, we are continuously scanning the work being presented to the public, filling in the due diligence that might have been missed, and translating the results with an eye toward helping investors appropriately view the big picture that emerges.

Of all the ways we can go about investing, which ones are expected to best serve our clients’ personal interests and financial goals? Equally as important, which are more likely to distract or detract from our efforts? The evidence-based answers to these vital questions explain why we pay so much attention to qualities such as fund structure, cost management, patient trading, and global market exposure (beta) according to index-like asset classes. It’s also why we advise against trying to chase or flee current market trends or pick popular stocks, despite what seemingly erudite talking heads seem to forever be recommending.

This is evidence-based investing. This is the essential difference between building a manageable investment strategy that reflects your personalized goals versus succumbing to chaotic, nerve-wracking guess-work in an ever-noisy world of market mayhem. We choose the evidence.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

Tax-Efficient Portfolios, Tax-Efficient Teamwork

In Part I of our series on Tax-Wise Investing, “You and Your Investments,” we explored how to engage in year-round tax-wise investing by adopting your own best practices as well as by favoring fund managers who are likewise keeping a tax-efficient eye on their offerings. There are two other important areas to tend to as part of your due diligence: your investment portfolio’s tax-efficient management and your advisers’ tax-efficient teamwork.

Proper Portfolio Management: The Art of Asset Location

Beyond tax-wise management of the individual funds in which you’re invested, some categories of investments are inherently more tax-efficient than others. For example, stock funds are usually more tax-efficient than bond funds (with many caveats that we won’t go into here). A plain vanilla U.S. stock fund tends to be more tax-efficient than funds seeking to capture the expected premium returns from smaller, less liquid markets. And so on.

This means that another vital way to manage your taxable income is to practice wise asset location, which is a fancy way of saying that you should place the least tax-efficient funds within your tax-sheltered retirement accounts, where the inefficiencies are more effectively rendered moot. The reverse is true for your most tax-efficient holdings. You want to keep them out of your tax-sheltered accounts, where their tax-efficient advantages are often lost.

The concept is simple enough, but implementation can be tricky. First, there is only so much room in your tax-sheltered accounts. Challenging trade-offs must be made to ensure you’re making best use of your available tax-sheltered “space.” Effective asset location also involves considering other tax-planning needs, such as the ability to harvest capital losses against capital gains, donate appreciated shares to charity, implement a step-up in basis, and take foreign tax credits. While these opportunities have more or less importance depending on your goals and circumstances, they become unavailable for stocks held in tax-sheltered accounts.

In short, arriving at – and maintaining – the best asset location formula for you and your unique circumstances is something of an art as well as a science. That’s one reason why it’s important to have a well-coordinated adviser team, to ensure that you’re making best use of all of the wealth-building opportunities available to you, including but not limited to asset location.

Organized Alliances: Do Your Advisers Get Along?

It’s important to manage your investments tax efficiently. But what about when it comes time to transfer your wealth – bequeathing it to heirs and making meaningful donations? And what about your tax filings themselves? Is your accountant aware of what your investment manager is up to, and are both of them informed of pertinent details related to your estate planning?

In short, are key members of your financial team – your estate planning attorney, investment adviser, tax professional, insurance providers and others – acting in isolation or in coordinated concert with one another? Even if each is seeking to best manage tax-related events within his or her specialized area of expertise, if there is little or no coordination among their activities, unnecessary (taxable) gaps or overlaps may occur when key communications break down.

Putting It Together: The Tax-Wise Wealth Manager

Tax-efficient investing can add considerable power to your net wealth – the kind you and your family get to keep after taxes and expenses have taken their toll. But making the most of the many opportunities can be daunting if you’re going it alone. As we’ve covered in this series, tax-wise investing includes:

All this and more is why the final piece in the puzzle is to engage a wealth manager like Hiley Hunt Wealth Management to organize the many moving parts and players involved, keep an eye on it all over time, and help you and your specialized team members make adjustments when appropriate. The savings achieved can more than offset your investment in ongoing oversight of your tax-wise wealth. That’s a good idea, any time of the year.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

Tips on Tax-Wise Investing

While “tax season” may imply that there is an optimal time to think about your income taxes, the best way to minimize your annual tax liability is to engage in year-round tax-wise investing, with ongoing best practices in:

  1. Your personal tax-efficient habits
  2. Your fund managers’ tax-efficient habits
  3. Your investment portfolio’s tax-efficient management
  4. Your advisers’ tax-efficient teamwork

You and Your Investments

There are a number of personal habits you can embrace that make for tax-efficient investing. Here are a few to get you started.

Have a plan … and follow it. Investing according to a plan, preferably in the form of a written Investment Policy Statement, makes everything else we’re about to describe easier to accomplish. By clearly defining and documenting what you plan to achieve with your investments and how you plan to achieve it, you and your financial team are best positioned to ignore the inevitable, often tax-incurring distractions along the way. A detailed investment plan also serves as your reliable guide for resolving any conflicting priorities when balancing tax efficiency versus other considerations within your overall wealth management. 

Avoid hyperactive trading. Bottom line, the more trading you do in your taxable accounts, the more “opportunities” you create to be taxed on the proceeds. The fewer trades that are required to accomplish your investment plan, the better off you’re likely to be when taxes come due. (See how that plan is already coming in handy?) 

Make good use of tax-sheltered accounts. It stands to reason, the more assets you can hold in tax-sheltered or tax-free accounts such as IRAs, Roth IRAs, 401(k)s, 529 college saving plans and health savings accounts (HSAs), the more opportunities you have to avoid or at least postpone the tax ramifications otherwise inherent in building capital wealth.

 

Inside Your Investments: Not Every Fund Is Created Equal

Next, consider your individual investments. Let’s say, for example, that your investment plan calls for holding a diversified mix of domestic and international stocks in your taxable accounts. Unless you’re planning to invest directly in thousands of individual securities (which we generally advise against), you will need to choose one or more funds to make up the desired mix. That’s where the challenge begins because, even if two funds share identical investment objectives, one may be considerably better than the other at tax-efficiently managing its holdings on your behalf.

It’s easy for fund managers and investors alike to ignore this important detail, because not all dollars lost to a fund’s tax inefficiencies show up in its published returns. Some of them may show up as annual capital gains distributed to fund shareholders (i.e., you), who must pay taxes on the gains at their individual tax rate – whether or not the share value of the fund itself has gone up, down or sideways.

In his article, “After a Bad Year for Funds Prepare for a Tax Hit,” Wall Street Journal columnist Jason Zweig reports this particular “gotcha.” When a fund that has dramatically plummeted in value is forced to sell highly appreciated holdings to meet shareholder redemptions, all shareholders must then share the burden of paying taxes on those realized gains, even if the fund value itself has declined. Ouch.

To minimize such scenarios and otherwise soften the blow of your fund’s taxable trading activities, it’s worth seeking out managers who exhibit best tax-management practices, especially for funds that you plan to hold in your taxable accounts. Following are some traits to seek. 

Avoid actively trading funds in favor of evidence-based investing. Just as you should minimize your own hyperactive trading, your fund managers should do the same by heeding the academic evidence on how markets operate. Most managers try to “beat” the market by actively picking individual stocks or forecasting when to be in or out of it. Instead, look for mangers who are seeking to build lasting value by patiently participating in the long-term growth expected from the return factors being targeted. Evidence-based investing is not only a more sensible overall approach, it also is typically more tax-efficient. 

Avoid hyperactive shareholders. As implied above, it’s best to invest in funds in which your fellow shareholders are less likely to panic-sell during bear markets. Undisciplined investors may force a fund manager to liquidate appreciated holdings to fund their flight, incurring distributed capital gains that you, as a fellow shareholder, must shoulder along with them. Investors who form personal investment plans, adopt an evidence-based strategy and choose like-minded fund managers to help them implement their plans should be better at retaining their resolve, even during volatile markets. T

Seek out tax-managed funds for your taxable accounts. Some fund families offer versions of their evidence-based funds that are deliberately tilted toward favoring tax-friendly trading over maximizing gross returns with no regard to the taxable consequences. Tax-friendly trading can include practices such as avoiding incurring short-term (more costly) capital gains, and more aggressively realizing available capital losses to offset gains. For additional insights, we recommend reading Larry Swedroe’s article, “Start Paying Attention To Tax Efficiency,” which describes a study that quantifies some of the costs and benefits of tax-efficient management.

Next Up: Tax-Efficient Portfolios, Tax-Efficient Teamwork

Beyond the best practices you can adopt within your personal investing and fund manager selection, there are a few more strategies for ensuring excellence in your year-round tax-wise wealth practices. We’ll cover these in the second half of our tax-wise investment series. In the meantime, let us know today if we can assist you with your own tax-wise investing.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

I’m a Single Parent. How Can I Get Ahead Financially?

As a single parent, you need to understand the financial strategies that can stretch your income and help you lay the groundwork for a secure future. Consider the following lessons to help improve your family’s bottom line:

Identify Your Goals

You can’t have a financial plan without first defining your financial goals. Start by recording all of your short-, medium-, and long-term financial goals.

For example, a child’s education could be one of the biggest expenses in your future. Setting aside money for emergencies and planning for retirement are other important goals you’ll need to keep in mind while raising a family. Don’t let day-to-day concerns distract you from such important goals. Plan for today and tomorrow.

Be a Better Budgeter

To pursue your family’s goals, it’s necessary to manage your household’s cash flow. That involves tracking income and spending, eliminating unnecessary costs, and living within the confines of a realistic budget.

For example, if you spend $2 each work day on a take-out coffee, that amounts to about $40 each month. By eliminating that minor expense from your budget, you could easily save almost $500 per year.

Say No to Debt

High-interest credit card debt can make it extremely difficult to get your budget in order. If you have an outstanding balance, consider paying it off as aggressively as possible. The savings in interest alone could allow you to address other important financial goals.

It’s also a good idea to review your credit history, commonly referred to as your credit report, to make sure that the information it contains about your past use of credit is accurate.

Capitalize on Tax-Advantaged Accounts

Once you free up some cash, apply it toward your goals. But first, learn about the savings and investment opportunities available to you. Keep in mind that tax-deferred investment accounts may enable you to grow the value of your assets more significantly than taxable accounts. Examples of such accounts include 401(k) plans and IRAs for retirement planning.

For college goals, Section 529 college savings plans. These plans are state-sponsored investment programs that allow tax-free withdrawals for college expenses. College savers who contribute to their home state’s 529 plan may be eligible for state tax breaks.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

The Social Security Reset

As many people know, delaying the receipt of Social Security provides an increased benefit until age 70. Many times the amount of the increase is misunderstood. It is often substantial, especially if the benefit is taken before Full Retirement Age!

It’s a little known fact that you can reset your Social Security payment amount during the first twelve months after initiating the benefit. We find that the best way to illustrate the details of how this change can be made is through an example:

Let’s say that you chose to take your reduced Social Security benefit at the early retirement age of 62 and lets say that benefit amount is $1000 per month. If you had waited until the Full Retirement Age of 66, your benefit would have been 33% greater or $1,333 per month. As you can see, this is a significant difference! Once you learn about the disparity in lifetime benefit you might change your mind on which benefit to take. And you are entitled to do so, as long as it has been within the first 12 months of receiving your benefit.

To have a Social Security reset you must payback all of the money you received within the first 12 months of starting payments.

 There is no interest or penalty for choosing to reset your Social Security benefits. Once you payback the amount received, you can re-apply for benefits at your new attained age or wait until a later date.

An important note to remember is that you can only do this once and you cannot revoke the decision once you have made the election to reset your payments.

 Consult a Professional

Unfortunately, most people make Social Security decisions without consulting a professional. You may be surprised to learn that the Social Security office is not allowed to give advice on strategies that would help maximize your potential benefit. An expert in Social Security planning can take into account variables such as your current age, life expectancy, and financial assets in order to help you identify an election planning strategy best suited to maximize your lifetime Social Security benefit.

Don’t miss out on tens if not hundreds of thousands of dollars in lifetime Social Security benefits by making an uninformed decision. Call or email us today to arrange a time to discuss your unique situation.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

The Vital Role of Rebalancing

If there is a universal investment ideal, it is this: You want to buy low and sell high. What if we told you that there was a process for automatically doing just that? You’d rush to use it, wouldn’t you? Guess what – there is. It’s called rebalancing. Helping you rebalance your portfolio so you’re consistently buying low and selling high while staying on track toward your personal goals is another way that HHWM seeks to add good value as your investment advisor.

Portfolio Rebalancing: How It Works

When we create your portfolio, we do so according to particular percentages defined in your personalized Investment Policy Statement (IPS). As the markets shift around, your investments tend to stray from their original, intended “weights” or allocations. Rebalancing is the act of shifting those allocations back where they belong.

To illustrate, imagine your portfolio is supposed to be half stocks and half bonds. When the stock market outperforms the bond market, you end up with too many stocks relative to bonds. Or of course the reverse can happen. Either way, you’re no longer at your intended 50/50 mix. To rebalance your portfolio, we can sell some of the now-overweight assets, and use the proceeds to buy assets that have become underrepresented, until you’re back at or near your desired mix.

Did you catch what just happened? Not only are we keeping your portfolio on track toward your goals, but we’ve just bought low and sold high. Better yet, the trades were not a matter of fancy guesswork or emotional whims. The feat was accomplished according to your carefully crafted, customized plan.

15-07-02 Rebalancing_InfoGraphic-bearmkt-SKU_06-24-13-2

Portfolio Balancing: A Closer Look

Rebalancing is a little more complicated, in that it’s a plural versus singular activity. First, we build a balance between stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns. Then we typically divide these assets among stock and bond subsets, again according to your unique financial goals. For example, we are likely to assign percentages of your stocks to small- vs. large-company and value vs. growth firms, and further divide these among international, U.S., and/or emerging markets.

The reason for these relatively precise allocations is to expose you to the right amount of expected market premiums for your personal goals, while offsetting the market risks involved by spreading them around the globe.

We also use passively managed funds for implementation, so we can maintain improved control over your portfolio. An actively managed fund typically has much wider latitude to vary its underlying make-up as it tries to time the market. For example, in a bear market, a passively managed stock fund remains steadfastly invested in stocks. Its actively managed counterpart is more likely to sell off some of its stocks and move to cash. That means its unwitting fund holders are likewise selling stocks (low) and rebalancing into cash. They’re also likely paying more for the “privilege” of losing control over their asset allocation (with no expected benefit gained).

Striking a Rebalancing Balance

In short, rebalancing with passively managed funds is integral to helping you succeed as an investor. But like any power tool, it should be used with care and understanding.

It’s scary to do in real time. Everyone understands the logic of buying low and selling high. But when it’s time to rebalance, your emotions make it easier said than done. This is where we come in as your advisor, to help prevent your emotions from interfering with your reason. To illustrate, consider a couple of real-life scenarios.

Costs must be considered. Besides combatting your emotions, there are practical concerns. If trading were free, we could rebalance your portfolio every day with absolute precision. In reality, trading incurs transaction fees as well as potential tax liabilities. To help us achieve a reasonable, middle ground, we have guidelines for when and how to cost-effectively rebalance. We also use any new money added to your portfolio to perform efficient rebalancing whenever possible. We’re happy to go over the rest of our guidelines with you anytime, if you’d like to know more.

The Rebalancing Take-Home

Rebalancing using passively managed funds makes a great deal of sense once you understand the basics: It gives you a clear, evidence-based process and effective, low-cost solutions for staying on course toward your personal goals through rocky markets. It ensures you are buying low and selling high along the way. What’s not to like about that?

At the same time, rebalancing within your globally diversified portfolio requires both emotional resolve as well as informed management, to ensure it’s being integrated consistently and cost effectively. Helping you periodically rebalance your portfolio is another vital way Hiley Hunt Wealth Management seeks to add value to your investment experience.

How much house can I afford?

With interest rates at historic lows and growing concern about a rise later this year, we have been fielding many questions about home buying and affordability. Most people have an idea of what they “think” they can afford but they come to us asking what they should do in comparison to where we see how our other clients allocate their cash flow.

Rules of Thumb:

Your total housing expense (principal, interest, taxes and insurance) should never exceed 28% of your pre-tax income. For example, if your household income is $100,000 before taxes, you should not spend more than $28,000 a year or $2,333 per month on housing.

Your total debt payments (housing, cars, credit cards, student loans, etc.) should never exceed 36% of your pre-tax income. For example, if your household income is $75,000 before taxes, you should not spend more than $27,000 per year or $2250 per month on all debt payments.

*Disclaimer, these are “rules of thumb” obviously you must individualize for your personal situation and their may be some circumstances where these rules do not apply or may be adjusted. For example, if you have no debt except your mortgage you may be able to spend 29% to 30% pre-tax payment, instead of the prescribed 28%.

 Rock Star Status

What’s the right amount to spend on housing if you want to be a “financial rock star”? In my experience, when our clients spend between 20% and 23% which leaves cushion for meeting a 15%-16% income allocation for annual savings toward wealth building.

 Let’s run an example

John and Sally have the following financial information:

John’s Earned Income: $45,000

Sally’s Earned Income: $75,000

Total Household Income: $120,000

Rules of thumb:

John and Sally’s top end housing expense: $2800 per month

John and Sally’s top end total debt expense: $3600 per month

John and Sally have no debt outside of their mortgage except for car payments. They really like to have nice, new cars so they are currently spending $1050 per month on car payments. If they want to keep these cars they should spend less than $2550 on housing to keep their total debt payments below the recommended 36% of pre-tax income ($3600-$1050= $2550).

Assuming that John and Sally choose a 30 year mortgage with an interest rate at 4.50% APR, pay 2.2% per year in property taxes and $1450 per year in insurance then they could afford a $345,000 property at the high end of our rule of thumb. If they want to shoot for “rock star” status and have housing expense be only 21% of their pre-tax income they should spend $285,000 on a property with the same assumptions as above.

 

High End Rock Star
House Value $345,000.00 $285,000.00
Monthly Principal & Interest $1,748.00 $1,445.00
Monthly Property Taxes $633.00 $523.00
Monthly Insurance $120.00 $120.00
$2,501.00 $2,088.00

 

It comes down to values

Ultimately, the amount you choose to spend on housing comes down to a values decision. We believe that great financial planning should enable you to spend lavishly on the things you care about and cut mercilessly on the thing you don’t. Money is a finite resource, regardless of how much you have, and there are an infinite number of things you could choose to spend on. The trick is to determine what you value enough to spend your hard earned resources on. At Hiley Hunt Wealth, our role is to help you find that place where your money and your values meet.