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6 Questions About 529 Plans

What parents need to know about saving for college

 

If you’re saving for your child’s higher education, you probably have a lot of questions besides “When did college get so incredibly expensive?” One popular savings tool that might puzzle you the most is the 529 Plan.

Started in the late 1980s and operated by states and financial institutions, the 529 College Savings Plan offers tax-advantaged ways to save for various costs of higher education. What else should you know? Here’s a list of commonly asked questions:

What can my child use 529 money for?

The money can pay for qualified expenses such as tuition, fees, books, supplies, computer-related costs and room and board for someone who is at least a half-time student. Pizza, burritos and beer don’t qualify, unfortunately.

How much can I contribute?

The answer is not as straightforward as with an individual retirement account or 401(k) retirement plan. Generally, contributions to a 529 Plan max out at $350,000 per beneficiary.

You also need to remember federal gifting tax laws. A gift of more than $14,000 to a single person in one year incurs gift tax. A 529 allows an individual to potentially contribute up to $70,000 (married couples up to $140,000) tax-free in one year to an account for a beneficiary. There are no age or income restrictions to contribute.

What if our relatives want to contribute?

Family members can either open a 529 account and name your child as the beneficiary or kick into an existing 529 that they don’t own. If your family members contribute to a 529 account that they do own, they receive a state tax benefit if their state offers such a deduction. Opening just one account for the beneficiary and letting your family help fund it is usually simpler.

Why use a 529 over a regular taxable account?

These accounts defer taxes and your contributions grow tax-free as long as you use the funds on the qualified expenses mentioned earlier. This beats paying the government for an after-tax account – but the latter does offer complete flexibility on where and how you can spend the money. A 529 doesn’t.

What if my child gets a full scholarship?

You will not lose scholarship money. You can withdraw from the 529 without penalty, though you do pay taxes on the earnings at the scholarship recipient’s tax rate. You can also use your 529 to pay for expenses that the scholarship doesn’t cover, such as room and board, books and other required supplies.

In addition, you can keep the 529 open with your child as beneficiary if he or she plans on graduate school, or you can also change the beneficiary and name another college-bound child.

What if my child does not want to go to college?

You can change the beneficiary to another family member (a sibling, first cousin, grandparent, aunt, uncle or yourself, for example), and the money goes toward that person’s education. Most plans allow you to change your beneficiary only once a year, but if your child has a change of heart and does decide to attend college, you can rename that child the beneficiary. Remember too that these funds can help pay for two-year associate degrees, as well as for trade and vocational schools.

A final option: Withdraw the money, or cash out the plan. You pay income tax and a 10% penalty on the earnings, but not on your contributions.

If unsure that your child is in fact headed to college, sit tight on cashing out. One thing you learn fast about young adults: life can always change.

Donor-Advised Funds

Americans donate billions to charity annually. If you give to charity, you need to know about one of the best tools to facilitate generosity: Donor-Advised Funds (DAFs).

DAFs date from the 1930s but did not become popular until the 1990s. DAFs act as vehicles for receiving gifts, often of appreciated stock, and then distributing cash grants to charities selected by the one making the donation. DAFs make the process of transferring appreciated stock and designating checks as simple as a bank’s bill-paying system.

All DAF donors receive a tax deduction on the date of transfer. You can also transfer stock during one calendar year and receive a deduction even if the DAF completes distribution of grant money to a charity in a subsequent year. According to Internal Revenue Service rules, you calculate the value of your donation and the resulting fixed deduction based on the average of the high and the low market price on the day of transfer. (You are responsible for computing
this value.)

After receipt, the stock you gifted is sold and the DAF, itself a charity, pays no tax on any capital gain realized. The proceeds may remain in cash or you may direct the DAF to invest those assets for potential further appreciation (usually in a professionally managed separate account). Any subsequent change in the value of the account does not change the amount you can deduct on
your taxes.

As the donor, you direct to which charities the DAF distributes assets. Officially, the DAF owns the assets and is not legally bound to use them as you direct, but it is exceedingly rare for a DAF to not follow the donor’s advice.

Most DAFs also maintain a database of 501(c)(3)  tax-exempt charities (based on those organizations’ IRS 990 filing) from which you chose. After you suggest an amount to gift and a charity to receive the gift, the DAF vets and processes your suggestion to ensure the organization qualifies as a public charity under the IRS code. DAFs also handle all record keeping and due diligence and can protect your identity if you want to give anonymously.

Donor-advised funds are the fastest growing charitable giving vehicle in the United States, with more than 269,000 donor-advised accounts holding over $78 billion in assets. To put that in perspective, the Bill and Melinda Gates Foundation has about $39.6 billion in assets.

Besides consider a DAF, here are other ways to make your charitable giving more significant:

Focus your effort. Passionate giving is more sustainable than spreading donations to every good cause or everyone who asks. Consider focusing your donations to just a few charities. Think through why you are giving and what you feel passionate about.

Find bang for the buck. Fund programs that produce the greatest effect for the least money and focus on long-term positive outcomes.

Include the next generation. You can include your children in the giving process or even help them gift some of their own money.

Talk to Your Financial Advisor. If you’re considering a DAF or want to learn more, give Hiley Hunt Wealth Management a call so that we can walk through the process together.

A Checklist for Retirement Planning

The time to begin planning for your financial future is now. So, when it comes to preparing for retirement, the earlier you start, the better. Here are some steps to help you achieve your overall objectives:

  1. Review your current financial situation by assessing your income and assets versus your expenses and liabilities.
  2. At first, determine a realistic amount to contribute regularly to your employer-sponsored qualified retirement plan, e.g., a 401(k) plan. Over time, try to maximize allowable contributions to your savings plan and take advantage of the company match, if offered.
  3. In 2017, you can contribute up to $5,500 into a traditional Individual Retirement Account (IRA) or Roth IRA. If you are age 50 or older, you can contribute an additional $1,000. Depending on your participation in other qualified plans, contributions to a traditional IRA may be tax deductible. Earnings for both traditional and Roth IRAs have the potential to grow on a tax-deferred basis.
  4. Work toward reducing your debt. Pay off large bills as soon as possible. Curb your spending to avoid taking on any new debt that could carry over into retirement.
  5. Consult with a qualified professional about your life, health, and disability income insurance policies to determine the amount of coverage for your current and future needs.
  6. Find out how much you can expect to receive in retirement from pension plans, veterans’ benefits, or Social Security. To get an estimate on your future Social Security benefits, visit www.socialsecurity.gov.
  7. Analyze which expenses are likely to decrease after you retire (clothing, commuting, etc.) and which are likely to increase (medical, travel, etc.), and plan accordingly.

If you adhere to your checklist, you may see your savings increase as you get closer to reaching your retirement income goals. Remember, it is never too early to start planning for your future.

Advanced Philanthropy: Private Foundations

For many affluent individuals, occasional gifts to a favorite charity may satisfy their charitable inclinations. The added incentive of an often substantial tax deduction, coupled with various estate planning benefits, is sometimes the driving force behind such charitable gifts. However, for some individuals, philanthropy is a far more serious endeavor, often involving a succession of substantial gifts of at least $5 to $10 million that may necessitate the need for control and general oversight. In such situations, a private foundation can be an ideal mechanism for managing a large, continuous charitable giving program.

How much do you know about private foundations?

Test your knowledge with this short quiz.

1.) True or False. The charitable deduction for contributions will be limited depending on the type of charitable organization that is ultimately receiving the gift from the private foundation and the type of gift being made.

2.) True or False. There are generally four types of private foundations: nonoperating; operating; company-sponsored; and supplementary.

3.) True or False. The three ways a private foundation can be structured are: a nonprofit corporation; a trust; and an unincorporated association.

Learn more about private foundations.

In its simplest form, a private foundation is a charitable, grant-making organization that is privately funded and controlled. When properly arranged and operated, a private foundation is an income tax-exempt entity, and tax deductions are permitted for individuals (donors) who donate to them.

Contributions to a private foundation are deductible for gift and estate tax purposes. The income tax deduction of gifts to a private foundation is a bit more complex. Generally, the deduction is based on the fair market value (FMV) of the gift (at the time of the gift) and is limited by the donor’s adjusted gross income (AGI). The charitable deduction will also be limited (to 20%, 30%, or 50%) depending on the type of charitable organization that is ultimately receiving the gift from the private foundation and the type of gift being made. Gifts that are not cash or publicly-traded securities, and that are valued at more than $5,000, require adherence to additional rules in order to ensure deductibility.

In addition to the advantages of a tax deduction (which is generally not exclusive to private foundations), private foundations may also offer an array of other benefits. Because a private foundation is typically established to manage a long-term charitable gifting program, it may, in turn, highlight the philanthropic presence and identity of the donor within the community and/or a particular charitable cause. It can also serve to create a family charitable legacy while, at the same time, protecting individual family members from the pressures of other charitable appeals. Finally, a private foundation can serve as an appropriate mechanism for controlling distributions to a charity(ies), as well as determining which charities the foundation will benefit.

On the Technical Side

When a private foundation is established, there are two issues that need to be addressed. First, what type of private foundation should the donor establish? And second, how should the private foundation be structured? There are generally three types of private foundations: 1) nonoperating; 2) operating; and 3) company-sponsored. Each type of foundation has specific characteristics that make it appropriate for a particular situation. There are also strict requirements and guidelines that must be followed for each type of foundation.

The most common type of foundation is nonoperating. Essentially, a donor, or group of donors, makes contributions to the foundation, which, in turn, makes grants to a charity(ies). In this case, the donor has no direct participation in any charitable work. There are several variations of this type of foundation.

On the other hand, in an operating foundation, the foundation may have direct involvement in charitable causes (e.g., an inner city youth center), while retaining the tax benefits of a “private” foundation (although, in some respects, operating similarly to a “public” charity). To qualify as an operating foundation, it must also meet several requirements and tests.

In addition, a company-sponsored foundation can be used when the majority of contributions are from a for-profit corporate donor. Generally, this type of foundation operates similar to a non-operating foundation. It is usually managed by corporate officers and has the added benefit of allowing some contributions to accumulate over time. This can help the foundation make continual grants when corporate profits are low (a time when, ordinarily, contributions would be otherwise forgone).

After careful thought is given to the type of foundation to be established, the foundation’s structure should be taken into consideration. There are three ways in which a foundation can be structured: 1) as a nonprofit corporation; 2) a trust; or 3) an unincorporated association.

There are a number of factors to be weighed when deciding on which structure is best. Generally, if the donor intends to keep the foundation in existence permanently, a nonprofit corporation or trust may be a better choice. Additional considerations include: state and local laws governing private foundations; the type of foundation; the type of donor; assessing the need or desire to make future changes or delegate responsibilities; and personal liability issues.

Complex, Yet Effective

Creating and maintaining a private foundation is much more involved than the use of more traditional charitable giving mechanisms (e.g., charitable remainder trusts (CRTs)). Therefore, legal and accounting professionals who have experience with private foundations must play a significant role in such an endeavor. In addition, due to the added complexity and need for highly specialized legal and tax expertise, the expenses for design, set-up, management, and grant administration in a private foundation will generally be substantial. Typically, a private foundation is only viable for individuals who intend on making periodic gifts in excess of $5 million.

Certainly, the private foundation allows today’s philanthropist the opportunity to manage substantial charitable gifts, as well as the ability to actually become involved in charitable work, if he or she so chooses. It also affords the donor the opportunity to be recognized for charitable giving, while solidifying his or her philanthropic legacy. This article serves as a general overview of a very complex planning area. Like all advanced planning issues, appropriate counsel should be sought in order to meet the goals and objectives of all involved parties.

Quiz Answers: 1) True; 2) False; and 3) True

Misperceptions About Market Corrections: Are You Prepared?

If you enjoy fine literature, we recommend all of Warren Buffett’s annual Berkshire Hathaway shareholder letters, dating back to 1965. While financial reports are rarely the stuff from which dreams are made, Buffett’s way with words never ceases to impress. His most recent 2016 letter was no exception, including this powerful insight about market downturns:

“During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy.”

This actually is a good time to talk about scary markets, since we haven’t experienced a severe one in a while.

For example, the CBOE Volatility Index (VIX), aka, “the uncertainty index,” is a generally accepted gauge of how confident (or not) investors are that the market is going to be volatile (or not) during the next little while. The lower the number, the smoother the presumed ride … although, as usual, there are no guarantees the markets will actually do as they’re told.

As of June 2, the VIX was hovering in the range of 10–16, year to date. To put this in context, the VIX peaked at about 60 during the bear market of 2007–2009. You’d have to go back just over a decade to witness similar periods of relative calm.

What should we make of these numbers? Scanning financial news, you’ll find the usual range of attempted interpretations: “We are worried about …” “Economic indicators suggest that …” “Geopolitical events are likely to …” and so on.

What else is new? While it’s highly unlikely the VIX will remain this calm forever, nobody can predict when it might turn, or why or how dramatically it may spike back up when it does. As always, we counsel against shifting your portfolio in reaction to near-term forecasts. This includes prognostications of perceived volatility, or lack thereof.

Instead, let’s use the relative calm as a perfect time to do a reality check on what scary markets really represent, and how to manage them when they occur.

How well-prepared are you today, in anticipation of tomorrow’s market downturns?

This brings us back to Buffett’s words of wisdom. Contrary to common perception, scary markets can actually be your friend. Some of your best returns are delivered in their immediate aftermath and, as Buffett suggests, there may be some “bargain” buying opportunities. BUT, you have to be there to benefit, which is why personal fear becomes your enemy if you panic and flee during the downturns.

So, how can we prepare? Instead of fussing over when the next market downturn may or may not occur, here are some great questions to consider:

Market Returns – Are you taking on enough stock market risk in your portfolio to capture a measure of expected returns when they occur (often unpredictably and without warning)?

Market Risks – Are you fortifying your exposure to market risks and expected returns with enough lower-risk holdings, so you won’t fall prey to your fears the next time markets tumble?

Personal Goals – Have you assessed whether your current portfolio mix is optimized to achieve your personal goals? Speaking of goals, have yours changed, warranting portfolio adjustments?

Personal Risk Tolerance – Have you been through past bear markets? If you discovered you’re not the risk-taker you thought you were (or, conversely, you sailed through with relative ease), does your current portfolio mix of safer/riskier holdings accurately reflect what you learned?

Actual Analytics – Have you carefully considered what a 30% or so market downturn would mean to you in real dollars and cents? Yes, it could happen. If it did, and you feel you’d be unlikely to hold firm with your current holdings, additional preparation may be warranted.

In short, you can prepare for the next down market by having a well-planned portfolio in place today – one you can stick with through thick and thin. Neither too “hot” nor too “cold,” your portfolio should be just right for you. It should reflect your financial goals. It should be structured to capture an appropriate measure of expected returns during good times, and allow you to effectively manage your personal fears throughout.

When is the last time you’ve thought about your portfolio from this perspective? If it’s been a while – or never – let’s talk. Because there’s never a better time than today to ensure you are well-prepared for tomorrow. Let us know if we can help.

 

Financial Planning & Investment Highlights of Q1 2017

If Q1 2017 had a theme song, it might be, “There’s a Kind of Hush All Over the World.”

There was the usual stream of global news. To name a few highlights:

In the meantime, markets marched onward:

In this context, as he’s been doing for more than 50 years, Warren Buffett published his annual Berkshire Hathaway shareholder letter. To put this quarter’s moves in proper perspective, here are two of our favorite bits of Buffett’s usual wit from this year’s letter:

Chasing trends: “This year the magic potion may be hedge funds, next year something else. The likely result from this parade of promises is predicted in an 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.’”

Following forecasts: “If 1,000 managers make a market prediction at the beginning of a year, it’s very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him.”

We’ve said it before. One of the few predictions we’ll make is that we’re almost certain to say it again: Unless your own life’s personal circumstances have changed, stay the course as planned. Whenever we can help with that, please let us know.

 

An Index Overview Part III: Index Mechanics – Interesting Idiosyncrasies

Market indexes. You read about them all the time, such as when the Dow Jones Industrial Average (the Dow) topped 20,000 points in early 2017 … and then broke 21,000 just over a month later. In our last piece, we explored what those points actually measure, which isn’t always what you might guess. Today, we’ll take a closer look at the mechanics of indexing, to gain a better understanding of why they do, what they do.

The Birth of Indexing

When you hear the term “stock index,” you’re in good company if the first thing that comes to mind is the S&P 500; some of the world’s largest index funds are named after it. We’ll talk more about index investing in our next piece, but we’ll note here that, despite its familiarity, the S&P 500 is a babe in the woods compared to the world’s first index. That honor goes to the Dow.

The Grand Old Dow

As described in “Capital Ideas” by Peter Bernstein:

“The first Dow Jones Average appeared in the Afternoon News Letter on July 3, 1884. It consisted of the closing prices of eleven companies: nine railroads and two industrials. [Charles] Dow’s idea was to provide an overall measure of the performance of active companies, at a time when an average day’s activity on the New York Stock Exchange was about 250,000 shares.”

Eleven companies, nine of them railroads, wouldn’t make for much of a market proxy these days! And yet the Dow still only tracks 30 stocks, as it has since 1928. Plus, it still uses mostly the same methods for tracking them. As expressed by James Mackintosh, a senior market columnist for The Wall Street Journal (the effective birthplace of the Dow): “It’s time to ditch the Dow. After 120 years, the venerable Dow Jones Industrial Average is an embarrassing anachronism, abandoned by professionals and beloved only by a media that mostly knows no better. It needs to be updated or, better, replaced.”

And yet, despite its flaws, the Dow persists. Markets are made of people, and people can be sentimental about their past. More pragmatically, the Dow serves as a time capsule of sorts, offering historical perspective no other index can match. It’s also just plain familiar. As its parent company the S&P Dow Jones Indices says, “It is understandable to most people.”

 How Do Indexes Get Built?

What about all those other indexes? New ones come along whenever an indexer devises a supposedly better mousetrap for tracking market performance. If enough participants accept the new method, an index is born.

That’s our free markets at work, and it sounds simple enough. But if we take a closer look at the various ways indexers track their slices of the market, what may seem clear at a glance is often seething with complexities just under the surface. Here are some (not all!) of the ways various indexes are sliced and diced.

Which Weighting?

How much weight should an index give to each of its holdings? For example, in the S&P 500, should the returns delivered by Emerson Electric Company hold the same significance as those from Apple Inc.?

There are many other variations on these themes. The point is, indexes using different weightings can reach significantly different conclusions about the performance of the same market slice.

Widely Inclusive or Highly Representative?

How many individual securities does an index need to track to correctly reflect its target market?

Tracking a Narrow Slice or a Mixed Bag?

What makes up “a market,” anyway? Consider these possibilities:

The Use and Abuse of Indexing

How well do you really know what your index is up to? Remember, in Part I of this series, we described how every index is a model – imperfect by definition. How might each index’s inevitable idiosyncrasies be influencing the accuracy of its outcomes?

We’ve just touched on a few of the questions an indexer must address. Like the proverbial onion, many more layers could be peeled away and, the deeper you go, the finer the nuances become.

One practical conclusion is that some indexes are much easier to translate into investable index funds than others. In addition, some lend themselves better than others to a sound, evidence-based investment strategy. In fact, indexes often may not be the ideal solution for that higher goal to begin with. In our next and final segment, we’ll explore the strengths and weaknesses inherent to index investing.

An Index Overview Part I: Indexes, Defined

Since nearly every media outlet on the planet reported the news, you probably already know that the Dow Jones Industrial Average topped 20,000 for the first time on January 25, 2017. But when a popular index like the Dow is on a tear, up or down, what does it really mean to you and your investments?

Great question. In this multi-part series, we’re going to cover some of the ins and outs of indexes and the index funds that track them.

What Is an Index?

Let’s set the stage with some definitions.

An index tracks the returns generated by a basket of securities that an indexer has put together to represent (“proxy”) a particular swath of the market.

Some of the familiar names among today’s index providers include the S&P Dow Jones, MSCI, FTSE Russell and Wilshire. It’s perhaps interesting to note that some of the current index providers started out as separate entities – such as the S&P and the Dow, and FTSE and Russell – only to consolidate over time. In any case, here are some of the world’s most familiar indexes (with “familiar” defined by where you’re at):

…and so on

Why Do We Have Indexes?

Early on, indexes were designed to offer a rough idea of how a market segment and its underlying economy were faring. They also helped investors compare their own investment performance to that market. So, for example, if you had invested in a handful of U.S. stocks, how did your particular picks perform compared to an index meant to track the average returns of U.S. stocks? Had you “beat the market”?

Then, in 1976, Vanguard founder John Bogle launched the first publicly available mutual fund specifically designed to simply copy-cat an index. The thought was, instead of spending time, money and energy trying to outperform a market’s average, why not just earn the returns that market has to offer (reduced by relatively modest fund expenses)? The now familiar Vanguard 500 Index Fund was born … along with index fund investing in general.

There are some practical challenges that prevent an index from perfectly replicating the market it’s meant to represent. We’ll discuss these in future segments. But for now, the point is that indexes have served investors across the decades for two primary purposes:

  1. Benchmarking: A well-built index should provide an approximate benchmark against which to compare your own investment performance … if you ensure it’s a relatively fair, apples-to-apples comparison, and if you remain aware of some of the ways the comparison still may not be perfectly appropriate.
  2. Investing: Index funds that replicate indexes allow you to indirectly invest in the same holdings that an index contains, with the intent of earning what the index earns, net of fees.

Indexes Are NOT Predictive

There is also at least one way indexes should NOT be used, even though they often are:

Index milestones (such as “Dow 20,000”) do NOT foretell whether it’s a good or bad time to buy, hold or sell your own investments.

Indexes don’t tell us whether the markets they are tracking or the components they are using to do so are over- or underpriced, or otherwise ripe for buying or selling. Attempting to use current index values as a way to time your entry into or exit from a market does not, and should not replace understanding how to best reflect your unique investment goals and risk tolerances in an evidence-based investment strategy.

In fact, market-timing of any sort is expected to detract from your ability to build wealth as a long-term investor, which calls for two key disciplines:

  1. Building a cost-effective, globally diversified portfolio that exposes you to the expected returns you’d like to receive while minimizing the risks involved
  2. Sticking with that portfolio over the long run, regardless of arbitrary milestones that an index or other market measures may achieve along the way

As one commentator observed the day after the Dow first broke 20,000: “Sensationalism of events like these [Dow 20,000] has the ability to trigger our animal spirits or our worst fears if we don’t have a long-term investment plan to keep them in check.”

So first and foremost, have you got those personalized plans in place? Have you constructed a sensible investment portfolio you can adhere to over time to reflect your plans? If not, you may want to make that a top priority. Next, we’ll explore some of the mechanics that go into indexing, to help put them into the context of your greater investment management.

Wealth Management for Women: What Makes a Great Advisor? Part 2: Goal Focused Planning

How often have you heard that “a penny saved is a penny earned”?

While I can’t claim credit for originating this succinct wisdom, it has served me well over the years — both personally and professionally — in helping my clients make smarter decisions about their money.

But at what point does a “penny saved” become an “experience missed”? When I was a child, my mother took us on wonderful vacations. We traveled to California; Hawaii; Florida; Washington, D.C.; and even Europe. Those were ever-lasting, life-altering experiences that I’m eternally grateful to my mother for. And now, as a parent of two children, I know all too well how expensive family travel can be!

But I often ask myself how much more money could my mom have set aside for her own retirement had we not taken those big trips? Could she have retired a couple of years earlier if that money had been invested instead of spent? The answers to those questions are probably “a lot” and “yes”; yet, I know my mom doesn’t regret a single dollar that she spent on those adventures with us.

The challenge for us all is to find a good balance between living life for today while also planning for tomorrow. That’s why Hiley Hunt Wealth Management advocates goals-based planning for our clients.

Goals-based planning puts the emphasis on what we think matters most: the achievement of your goals. How and where to invest are determined only after defining and then prioritizing your goals. Our goal-setting process is the foundation on which our clients’ financial plans are built.

This process affords a framework from which to make appropriate planning and investment decisions. During this exercise, you might find, as my own mother did, that spending money on creating memories is something that is very important to you. Although choosing to do something like this means that you are saving less money “in the present” for longer-term goals such as the creation of a retirement fund, it does not mean that you can’t successfully accomplish your short- and long-term goals. It simply means adjustments need to be made — you may need to plan to work a few years longer than you originally envisioned, commit to saving more after your children are on their own, or decrease the amount of money you plan to have available in retirement. Goals-based planning makes identifying these kinds of trade-offs possible.

Our financial planning and wealth management process is designed to lead our clients through a series of steps to help them identify goals and values, take stock of where they currently are, and develop a plan to get them where they want to go. The life path that each client travels is unique, so we map out personalized routes to enable each individual to reach his or her financial destination. If you are interested in working with a financial partner who is committed to helping you achieve your goals, contact us today for a complimentary consultation.

 

Structured CDs: Buyer Beware!

Most investors are familiar with Certificates of Deposit (CDs). You purchase one, and the bank pays you a bit of interest on it, plus your principal back. They don’t yield much, but they’re nearly as dependable as it gets. As such, CDs can often serve as sensible tools for offsetting the risk inherent to pursuing higher expected returns in the stock market.

Unfortunately, Wall Street’s product pushers have figured out a way to swipe the name from this traditional household workhorse and turn it into a monster money-maker … for themselves, that is. We’re talking about “structured” or “market-linked” CDs. The name may seem familiar, but the rules of engagement are quite a bit different.

A recent Wall Street Journal article, “Wall Street Re-Engineers the CD – and Returns Suffer,” exposed the ways that big banks are peddling these products. It starts with a tempting pitch that goes something like this: As long as you hold the product to maturity, your principal is returned. If the stock market goes up (as defined by whatever market “basket” the providers happen to choose) you also receive a percentage of the increase.

At a glance, what’s not to like about this sort of “heads you win, tails you don’t lose” appeal? Unfortunately, there are usually plenty of traps lurking in the fine print. Positive returns are typically capped to single-digit annual percentages, while negative returns can plummet much more steeply before they’ll no longer impact your end returns. And the fees can run into multiple percentage points of the structured CD’s face value.

The WSJ article reports (emphasis ours): “The adviser who actually sells the [structured] CD, for example, can get commissions of up to 3% of the CD’s value, according to information sent to brokers reviewed by the Journal. ‘Banks have to be delighted with these structured products,’ said Steve Swidler, a finance professor at Auburn University. ‘There’s virtually no risk to them, and [the banks] sit back and rake in fees.’”

It may be easy enough to overlook the significance of these costs and imbalances, especially if you’ve decided that you’re okay with paying extra for the promise that you will not lose your nest egg. But in fulfilling their role as a safe investment, structured CDs can be more than a little skewed in favor of the big banks. From the WSJ article:

Given how many other far less complex and costly ways there are to expect similar results, why start with an uphill climb? The WSJ article noted how one investor, a 79-year-old widow, was shocked to see her $100,000 investment immediately drop to $95,712 after incurring upfront fees. The fees had been disclosed in the 266-page description that came with her purchase, but she hadn’t read it. Would you have?

“This was not a CD as I know a CD,” she complained.

Our preferred approach?

These essential concepts may not be fancy or new-fangled, but unlike those allegedly higher returns that a structured or market-based CD is supposed to deliver, they’re far more likely to see you through to your own end goals.

 

Parenting Your Wealth in Uncertain Markets

In the face of political drama at home and abroad, it’s certainly been a summer for trying our patience, hasn’t it? For anyone who has ever been a parent or a child – that is, for everyone – there are several comparisons we can draw between good parenting and good wealth management. For both, plenty of patience is one of the most important qualities to embrace.

Patience Is Your Greatest Strength

As an investor, you probably have plenty of “those days” when you wonder whether your money is ever going to grow up. It doesn’t do as you hoped for. It misbehaves. It runs with the wrong crowd. It ignores your best efforts to protect it from harm.

But then there are those other days. Suddenly, your money hits a growth spurt, exceeding all expectations! It’s then that you realize that many of the greatest challenges you and your investments faced along the way are the same ones that are contributing to its strength and shaping its character over time.

In the Markets, “Unusual” Is Business as Usual

As much as we would prefer our wealth to mature in a calm, orderly way, there is solid evidence to demonstrate that returns are far more likely to occur in these sorts of anxiety-generating fits and starts.

For example, you may recall that January 2016 was an unsettling time in the market, with particularly petulant returns. Some pundits blamed China and oil and what-not. Especially in retrospect, there was no incredibly obvious reason; it was just in one of those moods.

On the flip side, in the wake of the June 23 Brexit referendum, when we might have expected the market to remain in a funk for a while, it took a dive but then mostly continued upward, especially in the U.S., where stock market indexes experienced a number of record highs in July.

During the January doldrums, Vanguard published an overview of how common it is for markets to lurch into correction territory or lower, despite their overall upwardly mobile track record. Vanguard observed, “Since 1928, the Standard & Poor’s 500 Index has spent 40% of the roughly 88-year span in some sort of setback – a correction or bear market. Over that same period, however, the index has produced an average annualized return of about 10%.”

Vanguard concluded: “A review of corrections and bear markets suggests that patience and discipline are the best responses to market turmoil.” Our point exactly.

No Favorite Child

That’s not to say that you should plan for 10% annual returns in your financial future. Most investors are wise to offset the heated risks involved in pursuing higher expected returns with an appropriate helping of “cooler” holdings. We also suggest employing global diversification to manage the market risks that you do take on. Spreading your risks among multiple kinds of holdings around the world can be compared to raising several children, without choosing a favorite. Each is expected to contribute in its own special way.

The Importance of Being There

What parents don’t have days when they wish they could bypass some of the drama and skip straight to the good stuff? And yet we know that child-rearing requires us to be there for our offspring 24×7, thick and thin, on good days and bad.

We also know that, even though we give it our all, there are no guarantees. The most you can do is the best that you can – day in, day out – with the most accurate information you can find. If patience is your greatest virtue, consistence and persistence are your power tools to maximize it.

So it should be with investing, where you should avoid the temptation to jump in and out of uncertain markets. We know they are going to often misbehave and sometimes disappoint. We even know that they may never deliver as hoped for. But once you have done everything you can to position your portfolio for the outcome you have in mind, you’ve also done everything you can to stack the odds of success in your favor. The rest is where that patience comes in.

The Power of Patience

Consider this article by Chicago Tribune financial columnist Jill Schlesinger, “Time in the market – not market timing – is the secret to investment success.” In it, Schlesinger shares stock market research dating back to 1927, finding that “for those who invest for a single day, the chance of losing money is 46 percent, but for those who invest with a 10-year investment horizon the chance of success improves dramatically – to 87 percent.”

The Wall Street Journal personal financial columnist Jason Zweig offers us a visual of the same phenomenon in his article, “Volatility: In the Eye of the Beholder.” There, he considers a year’s worth of S&P 500 returns:

“Viewed daily over the 12 months that ended March 31 [2016], the S&P 500’s moves look superficially like the EKG of someone having a heart attack. Viewed quarterly, they resemble a shruggie emoticon without the smirk. And seen over the full sweep of the last 12 months, the market’s moves look like a whole lot of nothing happening in slow motion.”

Zweig describes how time has a way of smoothing out the best and worst days, and tilting the odds in our favor. As a bonus, a patient investment strategy also tends to minimize trading activities, and the costs involved, which can further contribute to your end returns.

By thinking of your wealth from this perspective, it might help you take a deep breath and carry on as this year’s politics unfold – or whenever you face difficult decisions on how to best care for your precious holdings. By sticking with a disciplined plan, day in and day out, you stand the best odds for raising wealth that you’ll be proud to call your own in the end.

A “post-Brexit” Environment

There’s an interesting phenomenon playing out in the financial press, in the form of a missing word that speaks volumes about human nature. That word is: “referendum.”

Almost everywhere we turn, we’re seeing headlines referring to the “post-Brexit” environment. To imply we are in a “post-Brexit” environment is like stating that a newlywed couple is enjoying a “post-marriage” honeymoon. Current headlines really should refer to the “post-Brexit referendum,” because only the referendum is done. In it, a narrow majority of U.K. voters called for a disunion from the EU, but any actual Brexit is likely to be playing out for years to come. Only then will we be truly “post-Brexit.”

There is a practical reason for the lapse. The media must keep its headlines short and snappy, and “referendum” is neither.

We also suspect there are behavioral forces at play. For better or worse, it’s easier to wrap our heads around compelling conclusions, since neither we nor the markets know what lies ahead. As we saw illustrated this quarter, the markets react to each new piece of information by leaping upward, dashing downward or staying put. Sometimes these knee-jerk reactions end up being accurate, at least in hindsight; often, they prove to be irrational or just plain wrong.

In this context, it stands to reason that we’d rather think about the Brexit as an isolated event that we can make sense of right now. It’s much harder – and yet important – to accept the chronic state of uncertainty that is and always will be inherent to disciplined global investing.

This quarter and ongoing, we encourage you to continue focusing on your enduring relationship with the market. Your “partner” has its moments – that’s for sure. But you can expect happier outcomes by tolerating its tempers and abiding by the solid investment principles upon which your portfolio has been built to last: remaining globally diversified, absorbing risks in pursuit of expected rewards, managing costs, and staying true to your goals.

If we can answer any questions or meet with you to go over your general plans and goals, please let us know. Like you, we’re in this for the long-haul.