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Politics and Investing Don’t Mix

When it comes to your investment portfolio, should you ignore the noise coming out of the White House? Or should we be making changes?  What does Trump mean for your investments? 

Here are the most common questions I’ve faced on this topic in recent months and my answers:

No. 1. How will Trump affect the economy and the stock market?

We start with an overlooked truth: Presidents, regardless of party, get too much credit for when things go right and too much blame when they go wrong.

The president is but one part of the government, which accounts for less than a quarter of the economy, though obviously it has a huge impact on markets and the broader economy through foreign policy, regulations, tax policy and spending.

Yes, Donald Trump can and will affect the economy and the markets. But we should not put all of our focus on the marginal impact of the president while giving short shrift to more important things such as corporate revenue and earnings, the Federal Reserve, interest rates, inflation, congressional spending, employment, retail sales, Supreme Court decisions, and, of course, valuations.

Like all presidents, if he does good things it will be supportive of the markets; if he commits major errors – such as starting a trade war or gets the U.S. into a serious shooting war – it will be detrimental.

No. 2. Why is the market rallying when some predicted stocks would fall if Trump were elected?

One explanation for the market’s post-election enthusiasm for Trump was based on expectations of tax reform, tax cuts, infrastructure spending and deregulation.  However, that was a post-hoc narrative.  The simple fact that markets in Germany, France and Japan rose more than in the U.S. since the election suggests that something else is at work.

My explanation is that the global recovery from the financial crisis continues apace, slowly repairing and rebuilding from that event. If you insist on singling out an explanation for why global markets are rising, look no further than the robust recovery in corporate earnings, especially in Europe.

As for forecasts of a Trump crash, that – like mostothers – was simply wrong – at least so far.

 

No. 3. How can you say politics doesn’t matter to markets?

Let me be precise: Politics can and occasionally does matter to markets – especially in the short term – but just much less than many people assume.

If I told you the president was going to be impeached, and the markets will continue to power higher for a few years, you might think I was batty. But that is what happened when Bill Clinton was impeached in 1998.  The next year, the Standard & Poor’s 500 Index rose more than 21 percent, and the Nasdaq Composite Index gained more than 85 percent. Yes, it would all end badly the next year, but the impeachment was irrelevant to the dot-com bubble popping.  

So too was the accusation that President Barack Obama was a Kenyan-born Marxist who was hell-bent on “Killing the Dow”.  When he left office early last year, the Dow was about 15,000 points and nearly 300% higher than the day he took office.

And when President George W. Bush introduced unfunded tax cuts, many economists assumed that the deficit would balloon, inflation would soar, and jobs would be wiped out.  Two of those three things never happened, and the market rose 94 percent.

If you let your political ideology get in the way of your investing decisions, the results are never pretty.

 

No. 4. The Trump news flow is overwhelming.  What should we do?

I think we all hoped that once the election was over, we could go back to our normal lives without the incessant parade of campaign news.

No such luck.

Investors need a way to sequester the noisy news flow out of the White House.  It is too easy to let the relentless and disturbing headlines throw off well-designed long-term financial plans.  Investors must read the news, but not let it interfere with thinking clearly.

Look, let’s be honest about the commander-in-chief: He is the world’s leading Twitter troll, a man whose main goal is to interrupt your thinking, misquote and insult other people, engage in rhetorical sleight of hand, and impugn the integrity of those trying to do honest work. What all trolls want is a reaction, something Trump has achieved to great success.

The first rule for sanity on the internet is “Do not feed the trolls”.  No one can really ignore the president of the United States, but it’s probably best to view much of what he says or tweets as minor background noise.

No. 5. You keep saying not to worry about who is president; but surely you do worry about him, right?  

Yes, as a citizen I do worry about the president’s rampant prevarications and the degraded culture he has created.

The search for facts and reliable information is the bedrock of modern civilization and well-functioning markets.  Agnotology (culturally constructed ignorance) is dangerous and worrisome.  Exaggeration is one thing.  Living in an alternate universe is another.  I have no interest in returning to the dark ages before the Enlightenment.  However, that seems to be the direction in which we’re headed, and some people seem to think it will make them the most money.  

It likely won’t, and now more than ever, truth remains the best disinfectant. 

No. 6. But I’m really worried about the increased polarization of social media, the propagation of “alternative facts”, increased tribalism, a decline in civil discourse and the resulting damage being done to our institutions and our democracy.  What should I do?

First, listen dispassionately.  One of the reasons I engage on social media is to seek out people who disagree with me.  If they can make an intelligent argument about another point of view, it is time well spent. I used to think that 140 characters cannot possibly enough to have an intelligent discussion. While that may still be the case for some topics, for the most part, I now believe that if you cannot express it in 140 characters, you are on a rant. And by all means, there’s the right time for long form analysis; given that you have read up to this point, I presume you agree.

Let me quote from a Financial Times article that, in my assessment, goes to the core of human behavior: 

“We humans are social creatures. Given a choice between being right on a partisan question (abortion, guns, globalization, climate change) and having mistaken views that our friends and neighbors support, we would rather be wrong and stay in the tribe. ... in surveys of views on climate change: college-educated Republicans and Democrats are further apart on the topic than those who are less educated.”

Second, strive to keep an open mind and genuine curiosity.  Aside from the hot button issues listed, I would add to that many of our democratic institutions have been vilified for partisan purposes:  The FBI, the CIA, the judiciary, and the Federal Reserve.  It’s easy to self-select social media friends, select internet sites or cable news channels that reinforce our biases and deepest fears.  Fear can lead to ignorance and conspiratorial thinking.  This media can be manipulated to exploit a person’s political views in order to instill fear and sell grand conspiracy theories.  Fear and ignorance can destroy our democratic institutions in the face of conspiratorial boogey men such as the current Breitbart, Alex Jones/InfoWars and Fox News narrative of an evil “Deep State” that will take away our freedoms.  Much of this panders to the fears of the “browning of America” and stokes anger among the intellectually disabled while masquerading as alternative news. 

... the evidence suggests that curious people are less subject to the temptations of partisanship. When the national conversation becomes polarized, we need to encourage curiosity about how things work rather than them-and-us tribalism.

I'm here to tell you, politics and investing don't mix.

This is a statement that rocks one of our most fundamental and most cherished beliefs. Like many of you, I too have very strong political convictions that affect how I see the world.  Whether you sit on the left or on the right, I have some bad news:  Your politics can kill you in the markets.

As a student of investment theory, I’ve learned that understanding behavioral psychology, statistics, cognitive biases, history, data analysis, mathematics, brain physiology, even evolution can help us make better investing decisions.  Indeed, these are all key to learning precisely what not to do.  While making good decisions can help your portfolio, avoiding bad ones is even more important.

We humans make all the same mistakes, over and over again. It's how we are wired, the net result of evolution. That flight-or-fight response might have helped your ancestors deal with hungry saber-toothed tigers and territorial Cro-Magnons, but it drives investors to make costly emotional decisions.

And it's no surprise.  It's akin to brain damage.

To neurophysiologists, who research cognitive functions, the emotionally driven appear to suffer from cognitive deficits that mimic certain types of brain injuries. Not just partisan political junkies, but ardent sports fans, the devout, even hobbyists.  Anyone with an intense emotional interest in a subject loses the ability to observe it objectively: You selectively perceive events.  You ignore data and facts that disagree with your main philosophy. Even your memory works to fool you, as you selectively retain what you believe in, and subtly mask any memories that might conflict.

Studies have shown that we are actually biased in our visual perception – literally, how we see the world – because of our belief systems.

This cognitive bias is not an occasional problem – it is a systematic source of errors.  It's not you, it's just how you are built.  And it is the reason most people are terrible investors.

How does this play out in the world of investing?  Let me share two examples. I don't pick favorites: Both Democrats and Republicans are implicated.

Back in 2003, the dot-com crash had about run its course. From the peak of the market in March 2000 to the March 2003 trough, the Nasdaq had gotten crushed, losing 78 percent of its value.  Yes, Seventy Eight Percent!

As Federal Reserve chief Alan Greenspan took rates down to 1 percent, the Bush administration passed $1 trillion in tax cuts. As someone else once said about the stock market, "Give me a trillion dollars, and I'll throw you one hell of a party."

Yet many of my Democrat friends on Wall Street – fund managers, traders and analysts – were highly critical of the tax cuts.  At the time, I heard all the reasons why they were so bad: They were deficit-busters, unlikely to create jobs, giveaways to the wealthy.

While those critiques may have been true, they were also irrelevant to equities.  As armchair policy wonks obsessed over these issues, they missed the bigger picture: Liquidity is a major factor in how the economy and stock markets perform.  Trillions of dollars in fresh cash was very likely to goose equities higher.  (Sound familiar?)  Indeed, the impact of the tax cuts did just that. Combined with Greenspan's ultra-low rates, you had the makings of a cyclical bull market rally.  From 2003 to 2007, the Standard & Poor's 500-stock index – the usual benchmark for equities – gained 100 percent.

And my politically active friends on the left missed most of it.

Fast-forward six years to the credit crisis in 2008. The S&P 500 had fallen 58 percent. By March 2009, op-eds in the Wall Street Journal were already blaming the crash on President Obama (took office two months earlier).

But conditions were forming that would hasten the end of the sell-off.  Markets were deeply oversold. Once again, the Fed chair was cutting rates – this time, it was Ben Bernanke, and he took rates down to zero.  In a panic, Congress forced the accounting rule-making body to be more accommodative to the banking sector. FASB 157, as it is known, ended mark-to-market accounting – essentially allowing banks to hide their bad loans.

All these factors suggested that a substantial rally from the market lows was coming. Historically, average gains in post-crash bounce-backs were 70 percent.  The easy money to the downside had been made, and it was time to stop betting that the markets were heading south.  If history held true, we were looking at the mother of all bear market rallies.

By that March, I was explaining this to clients.  But the greatest pushback this time around came from across the political spectrum.  My GOP family and friends were lamenting the occupant of the White House.  I heard things like "Obama is a Kenyan, a Muslim, a Socialist.  He is going to kill business."

What followed was the single most intense six-year rally in Wall Street history.  By the end of the Obama administration, the US stock market had more than tripled!  

And some of my politically active friends on the right missed most of it.

Remember, the cycle of booms and busts are surprisingly regular occurrences.  What some people call a "100-year flood" actually happens far more frequently – since 1929, there have been 18 crashes.

It's just as important that an investor participate in the cyclical bull markets, capturing the rally as well.  All things considered, missing the downside and catching the upside makes for a pretty decent investment strategy.  If only…

You need not be a mathematical wizard to learn this lesson.  When you are in the polling booth, vote however you like; But when you are reviewing your investing options, it is best to do so with a cold, dispassionate eye and stick with a well-designed investment plan designed for both good times and bad.

Summary:

Whatever fears you have based on the current state of our politics, you are not alone. These fears and the risks involved are already baked into market prices.  

There are many variables that drive market prices.  US government policy is but one of dozens of factors.

Your portfolio is constructed like a well-built car.  It is 60% engines (for growth), 20% brakes (for safety) and 20% seat belts and air bags (for crash protection).  Like your car, your investment portfolio is designed to get you to your chosen destination, as quickly, efficiently and safely as possible.  Don’t let politics interfere with the job its designed to do.   

Bill

 

Credit to Alex Merk, President and CIO of Merk Investments for many of the words and ideas included in this month’s blog.

 

 

 

 

 

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How “tax reform” will affect YOUR wallet

The most significant changes under tax reform is the tax treatment of businesses. Unlike changes to the individual tax scheme, which are temporary and somewhat piecemeal, the changes to the business tax scheme are permanent and fairly comprehensive. 

Changes in tax law always results in winners and losers.  This time is no exception.  Here’s a quick synopsis of the five biggest winners and losers with the new tax law:

Winners

·       Stockholders/owners of C-Corporations.  The maximum tax rate on C-Corps is permanently reduced from 35% to 21%.  

·       Self-employed taxpayers with pass-through income.  S-Corps, LLCs and partnerships  now benefit from a permanent new 20% deduction on qualified business income (subject to income limits).  

·       CPAs who prepare tax returns.  The law adds complexity in tax planning for higher income individuals, even as some lower income taxpayers with basic tax returns may find some simplification due to loss of many deductions (i.e. more people will use the one-page Form 1040EZ, which some have incorrectly referred to as a “postcard”). 

·       Married couples earning less than $600,000. They benefit from a temporary elimination of the marriage penalty built into the tax rate schedules. 

·       Parents of young children who plan to send their kids to private schools.  They can now utilize 529 college-savings plans to cover much of the cost of private elementary, middle and high school using these tax-advantaged plans.

Losers

·       Individuals, families and businesses who pay for health insurance.  The elimination in 2019 of the Affordable Care Act’s “individual mandate” (that requires all citizens to maintain health insurance or face penalties) will raise premiums by an estimate 10% for those who are insured.  Hospitals and State governments may be negatively impacted by having to provide higher cost emergency room treatment to potentially larger number of uninsured and indigent patients.   

·       High income taxpayers in mostly blue states.  Many will lose part of their deductions for state and local income taxes, sales taxes and property taxes, potentially reducing their ability to itemize deductions at all.  The states with the highest combined income tax, property tax and sales tax rates are New York (12.7%), Connecticut (12.6%), New Jersey (12.2%), Illinois (11.0%), California and Wisconsin (11.0%).

·       Homeowners and Realtors.  Many homeowners will lose all or part of the benefit of real estate tax and interest deductions.  These provisions may also negatively affect all homeowners.  Realtors who sell homes may also be hurt if limits on the deductibility of mortgage interest, home equity loan interest and property taxes negatively impact home prices and home sales activity.  

·       Virtually all US taxpayers …if the law is allowed to expire.   Only the business entity tax law changes are permanent.  Owners of the C-Corps, S-Corps, LLCs and partnerships get a permanent tax break.  All other taxpayers will see any benefits under the new law expire in 2025 unless a future Congress and President decide to extend them or make them permanent.

·       Kids under age 24 with taxable income.  Young people who are dependents on their parents return will now pay 37% tax on income over $12,500 (due to changes in the calculation for “kiddie tax”).

·       Future generations.  $1.5 trillion added to the national debt ($1.0 trillion assuming the CBO’s best-case scenario for added revenue growth).

 

And now the details…  Here’s a summary of the two dozen tax law changes that have the greatest impact on most Americans:

1. Bigger Standard Deduction, Goodbye Exemptions

A hallmark of the new law is the near doubling of the standard deduction to $12,000 on single returns, $18,000 for head-of-household filers and $24,000 on joint returns … up from $6,350, $9,350 and $12,700 in 2017. As under present law, individuals age 65 or older and blind people get even higher standard deductions. Two 65-year-olds filing a joint return, for example, would add $2,500 to the $24,000 standard deduction. An individual taxpayer age 65 or older would add $1,550, bringing the standard deduction to $13,550.

Congressional analysts say bulking up the standard deduction will let more than 30 million taxpayers avoid the hassle of itemizing write-offs on their tax return because the bigger standard deduction would exceed their qualifying expenses.  However, that isn’t true for many since personal exemptions are being eliminated simultaneously.  

In exchange for the bigger standard deductions, personal exemptions (the $4,050 deduction for each exemption claimed on the return) are eliminated.  A married couple with four kids would lose $24,300 in exemptions in exchange for the $11,300 boost in their standard deduction. 

2. Say Hello to a Higher Child Tax Credit and a New Family Tax Credit

Starting in 2018, the $1,000 tax credit for each child under age 17 is doubled to $2,000, with $1,400 of the credit refundable to lower income taxpayers. Additionally, the package significantly increases the income phase-out thresholds. The credit begins to phase out for couples with adjusted gross incomes over $400,000 (up from $110,000 in 2017) and $200,000 for all other filers (up from $75,000).

In addition to the enhanced child tax credit, there is a new, nonrefundable credit of $500 for each dependent who is not a qualifying child including, for example, an elderly parent or disabled adult child. This credit would phase out under the same income thresholds. 

 3. Tax Bracket Bingo

The proposal to shrink the number of income tax brackets to four was left on the cutting room floor. The new law keeps seven tax brackets, but with different rates and different break points. For example, not only is the top rate lowered from 39.6% to 37%, but that rate also kicks in at a higher income level. And, note that whatever new bracket you fall in, more of your taxable income will be hit with lower rates. (On the other hand, restrictions or elimination of some tax breaks probably may mean more of your income will be taxed.)  The marriage penalty is eliminated for those in the lower brackets, but remains in place for couples earning combined income of $600,000 or more.    

Here are the current tax brackets and the new ones set to apply for years 2018.

 

 

4. Squeezing Homeowner Tax Breaks

Lawmakers decided to reduce – from $1,000,000 to $750,000 – the amount of debt on which homeowners can deduct mortgage interest. The limit applies to mortgage debt incurred after December 15, 2017, to buy or improve a principal residence or second home. Older loans are still subject to the $1 million cap.

The law also bans the deduction of interest on home-equity loans. And this change applies to both old and new home-equity debt. Interest accrued on home-equity debt after December 31, 2017, is not deductible.  Taxpayers with home equity loan debt should consider refinancing if their total loan amount is $750,000 or less and if they have enough other deductions to exceed the standard deduction.

A proposal to extend the time you must own and occupy a home to qualify for tax-free profit when you sell it was dropped from the final legislation. As in the past, the law allows you to shelter up to $250,000 of such profit, or $500,000 if you’re married, as long as you have owned and lived in the house for two of the five years before the sale.

5. Deduction for State and Local Taxes

One of the most valuable tax deductions allowed for individuals—the write off for what you pay in state and local income, sales and property taxes—is getting squeezed.

Starting in 2018, the new law sets a $10,000 limit on how much you can deduct of the state and local taxes you pay. A plan to limit the write-off to property taxes only was scrapped. You can deduct any combination of state and local income or sales taxes or residential property taxes, up to the $10,000 cap. 

Don’t assume that you can beat this crackdown by prepaying 2018 taxes before December 31, 2017. Although a fourth quarter 2017 estimated state income tax bill due in January or a property tax bill due in January that covers 2017 can be paid in 2017 and deducted on your 2017 return without being subject to the new limit, Congressional tax writers specifically noted that prepaying 2018 taxes won’t earn a fatter deduction.

(Note this: Even under the new rules, property and sales taxes will remain deductible for taxpayers in a business or for-profit activity. For example, if you own a residential rental property, you can continue to fully deduct property taxes paid on that property on Schedule E.)

6. Casualty Losses

Going forward, the new law greatly restricts the opportunity for individuals who suffer unreimbursed casualty losses from sharing the pain with Uncle Sam. Under the old rules, such losses were deductible by those who itemize to the extent the loss exceeded $100 plus 10% of their adjusted gross income. Starting in 2018, the law allows a deduction of such losses only if they occur in a presidentially declared disaster area. 

There’s the opposite of a crackdown for 2016 and 2017 losses in presidentially declared disaster areas. The new law permits individuals who suffered such losses to deduct the loss without reducing the write-off by 10% of adjusted gross income. To be deductible under this rule, the loss must exceed $500. Also, for covered losses, the deduction is available even for those who claim the standard deduction.

7. Estate Tax Dodges a Bullet (again)

Efforts to kill the federal estate tax fell short, but the new law doubles the amount that can be left to heirs tax-free in 2018, to about $11 million for couples and about $22 million for married couples. The amount will rise each year to keep up with inflation.

But, as with many changes in the law, this one expires at the end of 2025, when the tax-free amount will revert to earlier levels.

The law does not change the rule that “steps up” the basis of inherited property to its value on the date the benefactor died. As in the past, any appreciation during the life of the previous owner becomes tax-free.

8. Medical Deductions Survive . . . and Get Healthier 

Despite efforts to eliminate the deduction for medical expenses, the new law is actually more generous than the old one. Under the old rules, medical expenses were deductible only to the extent they exceeded 10% of adjusted gross income. For 2017 and 2018, however, the threshold drops to 7.5% of AGI. Come 2019, the 10% threshold returns.  

9. Alimony Becomes Tax Free . . . but Not Until 2019

A big change is coming for divorce. In the past, alimony paid under a divorce decree was deductible by the ex-spouse who paid it and treated as taxable income by the recipient. Starting with alimony paid under divorce or separation agreements executed after December 31, 2018, the reverse will be true: Payors will no longer get to deduct alimony, but the payments will be tax-free for the ex-spouse who receives them. (That’s the same rule that has and will continue to apply to child support payments.)

10. Status Quo for Teachers' Tax Break

The Senate wanted to double to $500 the tax deduction teachers can claim for using their own money to buy classroom supplies. The House wanted to eliminate this write-off all together. In the end, neither happened. The deduction stays at $250 for teachers regardless of whether or not they itemize.

11. Squeezing Commuter Benefits

The new law eliminates, starting in 2018, the rule that allows employers to deduct up to $260 a month per employee for the cost of transportation-related fringe benefits, such as parking and transit passes. Employees can still use pre-tax money to cover such expenses, but employer subsidies may dry up. The new law puts the kibosh on the federal bike commuter benefit that had allowed employers to provide employees up to $20 a month tax-free to cover bike-related expenses. 

12. Tax Breaks for Students Survive

The effort by the House of Representatives to eliminate the deduction for interest paid on student loans and to begin taxing tuition benefits earned by graduate students were snubbed by the Senate. Neither proposal made it into the new law.

As under the old law, you can continue deduct up to $2,500 a year of interest paid on student loans. This write-off can be claimed by those who take the standard deduction, but it phases out at higher income levels. Also, tuition waivers and discounts received by graduate students will retain their tax-free status.

The new law also declares that, if a student loan is discharged due to the borrower’s death or permanent disability, the amount discharged will no longer be considered taxable income. 

 13. A Reprieve for Dependent Care Plans

The House of Representatives called for preventing working parents from setting aside pre-tax money in dependent care flexible savings accounts to pay for child care costs. The Senate blocked the effort, so the tax break remains in the law. Parents can continue to set aside up to $5,000, pre-tax, in these accounts.

14. No More Roth Do-Overs

The new law will make it riskier to convert a traditional individual retirement account to a Roth. Under the old law, you could reverse such a conversion—and eliminate the tax bill—by “recharacterizing” the conversion by October 15 of the following year. Starting in 2018, such do-overs are done for. Conversions will be irreversible.

15. Investors Control Over Tax on Capital Gains

For a while, it looked like Congress might restrict the flexibility investors have to control the tax bill on their profits. Investors who have purchased stock and mutual fund shares at different times and different prices are allowed to choose which shares to sell in order to produce the most favorable tax consequences. You can, for example, direct your broker to sell shares with a high tax basis (basically, what you paid for them) to limit the amount of profit you must report to the IRS or, if the shares have fallen in value, to maximize losses to offset other taxable gains. (Your gain or loss is the difference between your basis and the proceeds of the sale.)

The Senate called for eliminating the option to specifically identify which shares to sell and instead impose a first-in-first-out (FIFO) rule. The oldest shares would be assumed to be the first sold. Because it is assumed that the older shares likely have a lower tax basis, this change would trigger the realization of more profit sooner rather than later. 

In the end, though, this idea fell by the wayside. Investors can continue to specifically identify which shares to sell to arrange for the most favorable tax outcome.  CMMS uses the “High Cost” method of selling partial lots which means that the current taxable gain is automatically minimized.

16. The Zero Percent Capital Gains Bracket Survives

The new law retains the favorable tax treatment granted long-term capital gains and qualified dividends, imposing rates of 0%, 15%, 20% or 23.8%, depending on your total income.

In the past, your capital gains rate depended on what tax bracket you fell in. But, with the changes in the brackets, Congress decided to set income thresholds instead. For example, the 0% rate for long-term gains and qualified dividends will apply for taxpayers with taxable income under about $38,600 on individual returns and about $77,200 on joint returns.

17. Like-Kind Exchanges Survive ... But Only for Real Estate

Generally, an exchange of property is a taxable transaction, just like a sale. But the law includes an exception when investment or business property is traded for similar property. Any gain that would be triggered by the sale of such property is deferred in the case of a like-kind exchange. This break has applied to assets such as real estate and tangible personal property such as heavy equipment and art work.

Going forward, though, the new law restricts its use to like-kind exchanges of real estate, such as trading one rental property for another. It’s estimated that the change would cost affected taxpayers more than $30 billion over the next ten years.

18. Fewer Taxpayers Need Fear the AMT

Originally, both the Senate and the House bills called for eliminating the alternative minimum tax, a parallel tax system developed more than 40 years ago to ensure that the very wealthy paid some tax. Taxpayers who may fall into the AMT zone have to calculate their taxes twice to determine which system applies to them. In a last-minute change, though, the new law retains the individual AMT, but limit the number of taxpayers ensnared by it by significantly hiking the AMT exemption. (The new law does abolish the corporate AMT.)

19. Tax Relief for Passthrough Businesses

The new law slashes the tax rate on regular corporations (sometimes referred to as “C corporations”) from 35% to 21%, starting in 2018. The law offers a different kind of relief to individuals who own pass-through entities—such as S corporations, partnerships and LLCs—which pass their income to their owners for tax purposes, as well as sole proprietors who report income on Schedule C of their tax returns. Starting in 2018, many of these taxpayers will be allowed to deduct 20% of their qualifying income before figuring their tax bill. For a sole proprietor in the 24% bracket, for example, excluding 20% of income from taxation would have the effect of lowering the tax rate to 19.2%.

 

The changes to the taxation of passthrough businesses are some of the most complex provisions in the new law, in part because of lots of limitations and anti-abuse rules. They’re designed to help prevent gaming of the tax system by taxpayers trying to have income taxed at the lower passthrough rate rather than the higher individual income tax rate. For many pass-through businesses, for example, the 20% deduction mentioned above phases out for taxpayers with incomes in excess of $157,500 on an individual return and $315,000 on a joint return. At the end of the day, most individuals who are self-employed or own interests in partnerships, LLCs or S corporations will be paying less tax on their passthrough income than in the past.

21. Deductions (That Lots of People Take) Get the Ax but Two Credits Survive

The new law eliminates a popular deduction for moving expenses. The deduction, which was available to itemizers and non-itemizers, allowed taxpayers to deduct the cost of a job-related move. Going forward, only members of the military can claim it. 

The new law also repeals all miscellaneous itemized deductions subject to the 2% of AGI threshold, including the write-off for tax preparation fees, unreimbursed employee business expenses and investment management fees.

The House of Representatives version of the tax overhaul wanted to scrap the credit for the elderly and the disabled, which is worth up to $1,125 to qualifying low-income taxpayers. It also unplugged the credit for plug-in electric vehicles, which is worth of up $7,500. The Senate refused to go along, though, so both tax breaks will continue.

22. Kiddie Tax Gets More Teeth

Under the old law, investment income earned by dependent children under the age of 19 (or 24 if a full-time student) was generally taxed at the parents’ rate, so the tax rate would vary depending on the parents’ income. Starting in 2018, such income will be taxed at the same rates as trusts and estates … which will produce a much higher tax bill. The top 37% tax rate in 2018 kicks in at $600,000 for a married couple filing a joint return. That same rate kicks in at $12,500 for trusts and estates . . . and, now, the kiddie tax, too.

22. Affordable Care Act (aka “ObamaCare”) Individual Mandate: Dead or Alive?

The new law does repeal the “individual mandate” – the requirement that demands that you have health insurance or pay a fine. But not until 2019. For 2018, the mandate is still in place. 

23. Wither Withholding?

The new law is causing quite a ruckus in payroll offices around the country. Under the old law, the amount of tax withheld from paychecks was based on the number of allowances employees claimed on W-4 forms. And, the number of allowances was tied closely to the number of exemptions the worker claimed on his or her tax return. Starting in 2018, there are no exemptions, so there’s a mad scramble going on to figure out how to set withholding under all the new rules. 

The new law orders the Secretary of the Treasury to come up with a new system, but also says 2018 withholding can be based on the old rules. Keep an eye out on this one.

24. 529 Plans Aren’t Just for College Anymore

The new law allows families to spend up to $10,000 a year from tax-advantaged 529 savings plans to cover the costs of K-12 expenses for a private or religious school. Previously, tax-free distributions from those plans were limited to college costs.  This is a big win for 529 Plan providers as taxpayers with young children enrolled in private schools will be motivated to contribute more to these plans.

 

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Stop Worrying… Embrace the Security Freeze

The recent cybersecurity attack that hit the credit reporting agency Equifax has been called the worst data breach in the history of the modern era.  While this may be true, it’s likely your data was stolen long before the Equifax fiasco.    

A majority of Americans (64%) had already experienced at least one type of data theft, before the Equifax breach was reported, according to Pew Research Center.  Most are unaware.  

If you ever used Yahoo mail, you were likely part of the Yahoo data breach, announced in 2016, that impacted an estimated 1 billion user accounts.  Or perhaps you had your health insurance with Anthem, who reported in 2015 that as many as 80 million current and former customers had been impacted.

Earlier this year the U.S. Office of Personnel Management announced that data on 4 million government employees was compromised.  A few weeks later, Sally Beauty, a nationwide retailer, announced that they found their customer information available for sale on a Russian website.  It was the same website that offered stolen credit card data in the wake of the massive data breaches at Home Depot and Target.   

Cleaning up after your identity is stolen can be a nightmare.  My suggestion is that you use the recent Equifax disclosure as a wake-up call.  Get out in front of this problem before discovering that someone opened a new credit card or filed for a phony tax refund in your name.    

If your response is to do what each of the breached organizations suggest — to take them up on one or two years’ worth of free credit monitoring services — you might sleep better at night but you will probably not be any more protected against crooks stealing your identity.  Credit monitoring services aren’t really built to prevent ID theft.  The most you can hope for from a credit monitoring service is that they give you a heads up when ID theft does happen, and then help you through the excruciating process of getting the credit bureaus and/or creditors to remove the fraudulent activity and to fix your credit score.

In short, if you have already been victimized by identity theft (fraud involving existing credit or debit cards is not identity theft), it might be worth paying for these credit monitoring and repair services or sign up for any free services offered by the offenders.  If you are not offered free monitoring and would prefer not to pay monthly fees for the rest of your life to LifeLock or a similar service, and don’t mind putting up with a myriad of ads, there is a free alternative.  Go to CreditKarma.com to sign up for a free account and you’ll get access to free credit monitoring. If they notice any suspicious activity, you’ll get an alert.  Plus, Credit Karma also gives you free access to your credit scores and reports, as well as tips on what factors are impacting your credit.

If you want to be more proactive, a monitoring service is simply not enough.  I strongly advise you to consider freezing your credit file at the major credit bureaus. 

There is shockingly little public knowledge or education about the benefits of a security freeze, also known as a “credit freeze.” Also, there is a great deal of misinformation and/or bad information about security freezes available online.  As such, I thought it best to approach this subject in the form of a Q&A, which is the most direct method I know how to impart knowledge about a subject in way that is easy for readers to digest.


Q:  What is a security freeze?

A:  A security freeze essentially blocks any potential creditors from being able to view or “pull” your credit file, unless you affirmatively unfreeze or thaw your file beforehand.  With a freeze in place on your credit file, ID thieves can apply for credit in your name all they want, but they will not succeed in getting new lines of credit in your name because few if any creditors will extend that credit without viewing your credit file first.  And because each credit inquiry caused by a creditor has the potential to lower your credit score, the freeze also helps protect your score, which is what most lenders use to decide whether to grant you credit when you truly do want it and apply for it. 

 

Q:  What’s involved in freezing my credit file?

A:  Freezing your credit involves notifying each of the major credit bureaus that you wish to place a freeze on your credit file.  This can usually be done online, but in certain circumstances you may need to contact one or more credit bureaus by phone or in writing.  Once you complete the application process, each bureau will provide a unique personal identification number (PIN) that you can use to unfreeze or “thaw” your credit file should you need to apply for new credit in the future.  Depending on your state of residence and your circumstances, you may also have to pay a small fee to place a freeze at each bureau.  There are four consumer credit bureaus, including Equifax, Experian, Innovis and Trans Union When you do a credit freeze, it is imperative that you freeze your credit with all three bureaus.

 

Q:  How much is the fee, and how can I know whether I have to pay it?

A:  The fee ranges from $0 to $15 per bureau, meaning that it can cost upwards of $60 to place a freeze at all four credit bureaus (recommended).  However, in most states, consumers can freeze their credit file for free at each of the major credit bureaus if they also supply a copy of a police report and in some cases an affidavit stating that the filer believes he/she is or is likely to be the victim of identity theft.  In many states, that police report can be filed and obtained online.  The fee covers a freeze as long as the consumer keeps it in place.  Equifax has a decent breakdown of the state laws and freeze fees/requirements.  Also, if you were subject to the recent Equifax breach, Equifax will waive their freeze fee for the first year.

 

Q:  What’s involved in unfreezing my file?

A:  The easiest way to unfreeze your file for the purposes of gaining new credit is to spend a few minutes on the phone with the company from which you hope to gain the line of credit to see which credit bureau they rely upon for credit checks.  It will most likely be one of the major bureaus.  Once you know which bureau the creditor uses, contact that bureau either via phone or online and supply the PIN they gave you when you froze your credit file with them.  The thawing process should not take more than 24 hours.

 

Q:  I’ve heard about something called a fraud alert. What’s the difference between a security freeze and a fraud alert on my credit file?

A:  With a fraud alert on your credit file, lenders or service providers should not grant credit in your name without first contacting you to obtain your approval — by phone or whatever other method you specify when you apply for the fraud alert.  To place a fraud alert, merely contact one of the credit bureaus via phone or online, fill out a short form, and answer a handful of multiple-choice, out-of-wallet questions about your credit history.  Assuming the application goes through, the bureau you filed the alert with must by law share that alert with the other bureaus.  Consumers also can get an extended fraud alert, which remains on your credit report for seven years. Like the free freeze, an extended fraud alert requires a police report or other official record showing that you’ve been the victim of identity theft.

 

Q:  Why would I pay for a security freeze when a fraud alert is free?

A:  Fraud alerts only last for 90 days, although you can renew them as often as you like. More importantly, while lenders and service providers are supposed to seek and obtain your approval before granting credit in your name if you have a fraud alert on your file, they’re not legally required to do this.

 

Q:  If I thaw my credit file after freezing it so that I can apply for new lines of credit, won’t I have to pay to refreeze my file at the credit bureau where I thawed it?

A:  It depends on your state. Some states allow bureaus to charge $5 for a temporary thaw or a lift on a freeze. However, even if you have to do this once or twice a year, the cost of doing so is almost certainly less than paying for a year’s worth of credit monitoring services. The Consumers Union has a handy state-by-state guide listing the freeze and unfreeze fees.

 

Q:  Is there anything I should do in addition to placing a freeze that would help me get the upper hand on ID thieves?

A:  Yes; periodically order a free copy of your credit report. By law, each of the three major credit reporting bureaus must provide a free copy of your credit report each year — via a government-mandated site: annualcreditreport.com. The best way to take advantage of this right is to make a notation in your calendar to request a copy of your report every 120 days, to review the report and to report any inaccuracies or questionable entries when and if you spot them.

 

Q:  I’ve heard that tax refund fraud is a big deal now. Would having a fraud alert or security freeze prevent thieves from filing phony tax refund requests in my name with the states and with the Internal Revenue Service?

A:  Neither would stop thieves from fraudulently requesting a refund in your name.  However, a freeze on your credit file would have prevented thieves from using the IRS’s own Web site to request a copy of your previous year’s tax transcript — a problem the IRS said led to tax fraud on 100,000 Americans this year and that prompted the agency to suspend online access to the information.  If you become the victim of identity theft outside of the tax system or believe you may be at risk due to a lost/stolen purse or wallet, questionable credit card activity or credit report, etc., the IRS recommends that you contact their Identity Protection Specialized Unit, toll-free at 1-800-908-4490 so that the IRS can take steps to further secure your account.

The IRS issues taxpayer-specific PINs for people that have had issues with identity theft.  If approved, the PIN is required on any tax return filed for that consumer before a return can be accepted. To start the process of applying for a tax return PIN from the IRS, check out the steps at this link.  You will almost certainly need to file an IRS form 14039 (PDF), and provide scanned or photocopied records, such a driver’s license or passport.  Understand, however, that the IRS does not approve all PIN requests, and the approval process seems to be quite delayed and haphazard at best.

 

Q:  Okay, I’ve got a security freeze on my file, what else should I do?

A:  It’s also a good idea to notify a company called ChexSystems to keep an eye out for fraud committed in your name. Thousands of banks rely on ChexSystems to verify customers that are requesting new checking and savings accounts, and ChexSystems lets consumers place a security alert on their credit data to make it more difficult for ID thieves to fraudulently obtain checking and savings accounts.  For more information on doing that with ChexSystems, see this link

 

Q: If I freeze my file, won’t I have trouble getting new credit going forward? 

A: If you’re in the habit of applying for a new credit card each time you see a 10 percent discount for shopping in a department store, a security freeze may cure you of that impulse. Other than that, as long as you already have existing lines of credit (credit cards, loans, etc) the credit bureaus should be able to continue to monitor and evaluate your creditworthiness should you decide at some point to take out a new loan or apply for a new line of credit.

 

Q:  How do I get started?

A:  Here are detailed instructions on how to freeze and thaw your credit with each agency:

EQUIFAX CREDIT FREEZE

  • Credit freezes may be done online or by certified mail – return receipt requested.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • If your PIN is late arriving, call 1-888-298-0045. They will ask you for some ID and arrange for your PIN to be sent to you in 4-7 days.
  • Unfreeze: Do a temporary thaw of your Equifax credit freeze by snail mail, online or by calling 1-800-685-1111 (N.Y. residents dial 1-800-349-9960).
  • Info on freezing a child’s credit with Equifax can be found here.
  • If requesting a freeze by mail, use the following address:
      • Equifax Security Freeze
        P.O. Box 105788
        Atlanta, GA. 30348

EXPERIAN CREDIT FREEZE

  • Credit freezes may be done online; by certified mail – return receipt requested; or by calling 1-888-EXPERIAN (1-888-397-3742). When calling, press 2 then follow prompts for security freeze.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • You can also freeze a child’s credit report. The information contained at this link is applicable for all three credit bureaus. You must first write a letter to each bureau to learn if your minor child has a credit report and if so, then you can proceed to freeze it.
  • Unfreeze: Do a temporary thaw of your Experian credit freeze online or by calling 1-888-397-3742.
  • Info on freezing a child’s credit with Experian can be found here.
  • If requesting a freeze by mail, use the following address:
    • Experian
      P.O. Box 9554
      Allen, TX. 75013

TRANSUNION CREDIT FREEZE

  • Credit freezes may be done online, by phone (1-888-909-8872) or by certified mail – return receipt requested.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • Unfreeze: Do a temporary thaw of your TransUnion credit freeze online or by calling 1-888-909-8872.
  • Info on freezing a child’s credit with TransUnion can be found here.
  • If requesting a freeze by mail, use the following address:
    • TransUnion LLC
      P.O. Box 2000
      Chester, PA 19016

 

Q:  Anything else?

A:  Beware of related phishing & other scams.  Criminals will use every tactic they’ve got to take advantage of this situation.  With so many Americans worried about whether their information was exposed and if they are at risk, crooks are going to tap into that fear in order to trick you into handing over your personal information.

If your information was not exposed, you still may receive a fake email, text or phone call from a criminal offering to help or asking for your information to either determine whether you were affected by the Equifax hack or to help you protect yourself.

But even if you fall for one of these scams, with a credit freeze in place, the criminals won’t be able to carry out fraud in your name.

With scams related to the hack expected to pop up everywhere, here are some tips to help you protect yourself, your money and your identity:

  • ID thieves like to intercept offers of new credit and insurance sent via postal mail, so it’s a good idea to opt out of pre-approved credit offers. If you decide that you don’t want to receive prescreened offers of credit and insurance, you have two choices: You can opt out of receiving them for five years or opt out of receiving them permanently.  To opt out for five years: Call toll-free 1-888-5-OPT-OUT (1-888-567-8688) or visit www.optoutprescreen.com. The phone number and website are operated by the major consumer reporting companies.To opt out permanently: You can begin the permanent Opt-Out process online at www.optoutprescreen.com. To complete your request, you must return the signed Permanent Opt-Out Election form, which will be provided after you initiate your online request. 
  • Be wary of unexpected emails containing links or attachments: If you receive an unexpected email claiming to be from your bank or other company that has your personal information, don’t click on any of the links or attachments. It could be a scam. Instead, log in to your account separately to check for any new notices.
  • Call the company directly: If you aren’t sure whether an email notice is legit, call the company directly about the information sent via email to find out if it is real and/or if there is any urgent information you should know about.
  • If you do end up on a website that asks for your personal information, make sure it is a secure website, which will have “https” at the beginning (“s” indicates secure).
  • Look out for grammar and spelling errors: Scam emails often contain typos and other errors — which is a big red flag that it probably didn’t come from a legitimate source.
  • Never respond to a text message from a number you don’t recognize: This could also make any information stored in your phone vulnerable to hackers. Do some research to find out who and where the text came from.
  • Don’t call back unknown numbers: If you get a missed call on your cell phone from a number you don’t recognize, don’t call it back. Here’s what you need to know about this phone scam.

If your questions weren’t answered here or you need additional guidance, give me a call or send an email.  I want to help.


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When is your Financial Independence Day?

On July 4, 1776, a small band of colonial leaders declared independence from the Kingdom of Great Britain.  The American Revolution changed the course of world history forever and launched a nation that no other has since rivaled. 

In the spirit of the heroes of the American Revolution, would you be willing to consider declaring your own revolution...your Declaration of Financial Independence? 

5 Stages of Wealth

To get where you want to go you need to know two things.  You need to know where you are and you need to know where you want to end up.  Let's set the context by describing what I call, the five stages of wealth.

Wealth Stage 1.  Your cash flow (including your paycheck) is sufficient to pay all of your bills (on time!) plus consistently invest 10% of your gross income. This puts you on the pathway to financial independence. 

Wealth Stage 2.  Cash flow from your investments is equal to your earnings contributions (10% of gross pay).  I call this 'one to one'...where for each dollar you are contributing to your long-term investment program, the pot of money you've created is also projected to contribute (earn) a dollar.  For example, you're investing $10,000 per year and your investment portfolio of $120,000 is expected to have total average earnings of $10,000 per year (over the long term). 

Wealth Stage 3.  Expected cash flow from investments is equal to your paycheck.  Congratulations!  You are financially independent!  At this point, you would expect to be able to tap your investments each month for an amount that would cover your expenses (including inflation) indefinitely.  For example, if it takes $4,000 per month to pay your bills and you had a portfolio of stocks and bonds worth $1,200,000; using a 4% annual withdrawal rate you should be able to meet your current and future lifestyle expenses. 

Wealth Stage 4.  Cash flow from your investments is equal to two-times the income needed to pay your bills.  We define this as 'Wealthy'.  You now have enough cash flow from investments to pay all your bills with a substantial margin which allows you to raise your lifestyle, make charitable and family gifts, etc. 

Wealth Stage 5.  Cash flow from your investments is five-times or more what is needed to pay your bills.  We define this as 'Rich'.   

Which wealth stage best represents your situation?  When I was describing the 5 Stages of Wealth to one client, he said, "I'm not at stage one yet.  How would you describe that stage?"  "Financial stress," was my reply.  If you're having trouble paying your bills or are not saving and investing at least 10% of your gross income for the long term you're either in la-la land or feeling stressed out.

If you are not where you should be at this point in time, here are a few tips to get you started:

1.  Automate your investment program:  Ten percent of gross income is the minimum needed to put you on the path to financial independence so just do it!  Start with a a repetitive monthly contribution to a Roth IRA and your employer's retirement program, particularly if they match contributions. 

2.  Attack bad debt:  Bad debt is anything you borrow money to buy that is expected to go down in value.  First commit to avoid creating any new bad debt, then put in place a plan to automatically pay off your debt as fast as you can.

3.  Adjust your lifestyle:  Adjust your spending patterns to compensate for items number one and two above.

4.  Hire a coach:  Accelerate your success by hiring a coach, someone who has the experience to take you further, faster.  If you wanted to transform your fitness and physical appearance, hiring a nutritionist and personal trainer would be a good place to start.  In the financial world consider hiring a Certified Financial Planner™ practitioner

At the time, the idea of a small group of colonialists taking on the world's mightiest country would have seemed impossible.  They proved anything is possible to those with vision and an unwavering commitment to never give up until they achieved success. 

If you decide what you want, set in motion a plan to achieve it, and never give up until the deed is done, you, too, can create the life of your dreams!  Happy Fourth of July!

Bill

 

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Market Pullbacks May Not Be Worth Waiting For

By William Neubauer, CFP MBA, Comprehensive Money Management

I have noticed that many retail investors are currently sitting on cash and waiting for an opportunity to get back in the market. Many of these people either pulled their money out of the market after the Financial Crisis, or raised cash before or after significant political events like Brexit, or the US and European elections.

Psychologically, the degree of cash on the sidelines can cause an investor to join the ‘gloom and doom’ camp, where they no longer cheer for economic progress, but rather look forward to the next economic shortfall or political misstep to justify their bearish positioning.

Some in this camp may have felt their prayers were being answered on May 17, when the S&P 500 registered its steepest decline since September 9 and finally appeared to be taking in all the news coming out of Washington. However, those hopes for a more significant pullback were quickly dashed over the rest of the week as the S&P 500 recovered more than 50% of its decline, and MSCI EAFE made new multi-year highs.

With so much money on the sidelines or hiding in low-risk assets and a lack of market weakness, I think there are two questions worth asking: 1) Is a market pullback likely? and, 2) Is a pullback worth waiting for?

Is a pullback likely?

I believe with fairly high conviction that over the next 12-18 months, the market is likely to experience a pullback. However, I am skeptical that such a pullback will be at the time, to the degree, or for the reasons that many investors have been expecting. One reason I do not prefer significant cash holdings is that the next pullback may happen from higher levels and therefore not present an entry price that is any lower than where the market stands today. A second reason I think investors with cash could be disappointed is that I do not envision a pullback that will be deep enough to justify the decision many investors made when raising cash last summer or fall. That is because, in our view, the recent and significant improvements in economic data and political landscapes around the world have created greater unease for those with cash on the sidelines. Investors with high cash now appear more determined to get invested, leading to pullbacks that have been both shorter and shallower than normal, which can be seen in the two charts below

Finally, a pullback may not come for the reasons many investors expect. The old saying “a watched pot never boils” has an application to markets, in our view. Markets are most affected by the unexpected, and investors are becoming accustomed to Trump’s war with the media. With so much media attention currently focused on President Trump, the market is constantly assessing the likelihood of his administration achieving their economic agenda. For example, small-caps and material stocks, which were viewed as the obvious and disproportionate beneficiaries of Trump’s tax and infrastructure plans, have already retraced 80-100% of their relative post-election gains. In fact, we may have gotten close to the point that the bigger surprise to Wall Street would be the President’s economic agenda getting back on track.

Is a pullback worth waiting for?

I believe the answer is “no” for investors with time horizons beyond five years. That is because, for investors with longer time horizons, I believe successful timing of a market entry or exit level (market timing) can be difficult, costly, ultimately may not materially impact long-term returns, and may conflict with the efforts of an investment manager.

Market Timing is Difficult:  Market timing, which involves dramatic shifts in a portfolio’s asset allocation based on the price movements of a market, is notoriously hard. Professional market timers  regularly admit that only about half of their trades are profitable. I do not regard the tactical portion of our investment process as market timing, since our trades are typically smaller shifts and generally based on reasons that extend beyond simple price movements.

The experience of market timers is less predictable than that of long-term investors, who have historically benefitted from the fact that the US large-cap stocks have risen in value 62 months out of 100 since 1926 (source: CRSP). The odds have been even better for investors when market valuations are close to fair value when measured by our Price Matters® methodology, as they are now (Table 1). Given the different investment experiences of these two groups of investors, it begs the question, why would a long-term investor accept historically poorer odds by trying to time the market?

Table 1: Returns of Large-Cap Stocks When Valuations Are Close to Fair Value (plus or minus 10%) Using CMMS’s Price Matters® Methodology

Source: Riverfront Investment Group, calculated based on data from CRSP 1925 US Indices Database ©2017 Center for Research in Security Prices (CRSP), Booth School of Business, The University of Chicago. Data from Jan 1926 through March 2017.

Market Timing Can Be More Costly in Today’s Environment:  When an investor is being “paid to wait” as their cash is accumulating interest at the bank or yield on short-term bonds, the long-term costs of market timing can be less punitive. However, today’s low interest rate environment does not pay an investor to wait, and in fact, I believe it imposes somewhat of a penalty on money that remains on the sidelines. With short-term rates at less than 1% and inflation running over 2%, as measured by the Consumer Price Index (ex-food and energy), cash on the sidelines loses purchasing power every day it remains idle.

Market Timing May Not Materially Impact Returns of Long-Term Investors: In our view, the longer an investor’s time horizon, the less important market timing is. I believe the old Wall Street adage that “successful investing is not about timing, but about time in” holds merit for most long-term investors for two reasons. First, over long time horizons, the US stock market has generally recovered its losses, as evidenced this year with most broad US market indexes hitting all-time highs. Second, long-term investing gives the investor the benefit of experiencing what Albert Einstein called “one of the most powerful forces in the universe”: compound interest. Compound interest allows a $100 dollar investment growing at 10% annually to return more than 6.7 times an investor’s initial money after 20 years. Investors who employ market timing tend to be un-invested or underinvested more frequently and are thus unlikely to experience the full benefits of compound growth. Table 2 shows how missing out on the first 1, 2 or 3 years of a 20-year time horizon can impair potential long-term returns. In our view, the risks posed by a strategy focused solely on market timing are simply not worth the potential return for the long-term investor. If done successfully, the positive impact to the portfolio is unlikely to be significant; but, if done unsuccessfully, the negative repercussions could be substantial.

Table 2: Compound Interest: Investing early can make a big difference in long-term returns

Market Timing Can Conflict With the Efforts of an Investment Manager:  The motivation for waiting on the sidelines is often a result of investors feeling like they already missed out on a bull market. While it may be true that some markets can hit levels of overvaluation that make them poor investments, investment managers with broad mandates are paid to identify and seek to avoid those markets.  At CMMS, we have been reducing our exposure to US equities, recognizing that the US bull market is now 9 years old, and I have been buying equities in developed markets outside the US, such as Europe and Japan, where I believe valuations are still considerably cheaper than they are in the United States.

An Alternative Strategy to Market Timing

Long-term investing deserves entry and exit strategies that are consistent with the investor’s goals and objectives and are based on a sounder footing than one’s ability to forecast market movement over short periods of time. I believe the goal of a long-term investor should be to get invested as soon as possible, while minimizing the risk of committing all their capital prior to a significant market pullback.

There are a number of strategies that can be used to accomplish this goal, and the strategy I have devised blends what I believe to be the best ideas from several strategies and tailors them to the long-term investor. It is a three-pronged plan I describe as: Immediately, Opportunistically, and Eventually.

·        Immediately: Based on our view that the US market is around fair value and markets outside the US remain ‘cheap’, I prefer an approach of putting a portion of our cash to work immediately.

·        Opportunistically: After not experiencing a pullback of greater than 3% thus far in 2017,I believe there is probably a pullback on the horizon. Therefore, I am inclined to hold onto a portion of our cash for an opportunity to invest at lower levels. Considering the short and shallow nature of pullbacks over the past six months, I set modest pullback targets of 3-6%.

·        Eventually: For the final portion of cash, I often set a date or series of dates over the next 3 to 6 months to invest the remaining proceeds. Once the dates are selected, I believe it is important to adhere to the investment discipline regardless of the market levels at those times.

 

William Neubauer, CFP, MBA

Comprehensive Money Management Services LLC

Additional Sources: 

Doug Sandler, CFA at ETF Strategist Channel

Charts by Riverfront Capital 

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Contact Info

Comprehensive Money Management Services LLC
535 Vilabella Avenue
Coral Gables, FL 33146
Phone 305-662-7757
Fax 305-402-8409
Email: This email address is being protected from spambots. You need JavaScript enabled to view it.

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Disclosures

Comprehensive Money Management Services LLC (“CMMS”) is a Registered Investment Adviser located in Coral Gables, Florida. The firm is registered with the State of Florida Office of Financial Regulation. CMMS and its representatives are in compliance with the current filing requirements imposed upon Florida-registered investment advisers and by those states in which CMMS maintains clients.

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