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Market Guesswork Can Come Back to Haunt.

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

People have been wondering what the stock market will do since they first began trading under the buttonwood tree in lower Manhattan.

I read an article – one of a zillion such articles that always get multiple opinions from people who invariably prove they never had a clue to begin with – yesterday by Gil Weinreich, writing for AdvisorOne,  You can find a link to it on the IFG Facebook page; and this from the article caught my eye:

“The most recent Chicago Booth/Kellogg School Financial Trust Index indicates that 47% of the public expects the stock market to plunge in the next 12 weeks, according to Wharton professor Olivia Mitchell. Mitchell’s own portfolio has outperformed the stock market since 1999, when she put all her investments in Treasury inflation-protected securities. Her difficulty today, however, is figuring out what to do now that TIPS are paying negative returns.”

The professor put ALL her investments in TIPS.   Translation:  She was ‘timing the market’.  Not the stock market, but the bond market.  And, she’s got lucky.    But, there was a price.    Those who ride high on one side are often in danger of getting ‘whipsawed’ on the other.   

The market giveth and the market taketh away. 

The professor isn’t alone.  Many intelligent people – the same people who would never build a home without a blueprint, or launch a business without a well thought-out business plan – often make investment decisions and asset allocations based on an outlook, which means it’s virtually always without a long-term written investment plan.  It’s important to note there is NO professionally-written plan on earth, for a home, business, or investments, that would use only one material, or concentrate all risk into one sector.

Risk concentration isn’t a strategy.  It’s a guess.  It’s a hope.  Yet, too many Americans do it all the time.  It’s called ‘chasing returns’.

It doesn’t work.

It’s never worked.

Some point to past successes, similar to the example above; but, those always end-up being short-term.  When you calculate the returns over time – and one might argue the professor’s track record since ’99 isn’t exactly short-term – it’s also true that returns are now negative and her investment life isn’t over yet – and won’t be for many years to come.

Anyone who’s attended a large gathering of financial types knows the room is always filled with better-than-average investors; yet, few – although the number may be closer to ‘none’ – can even beat the indexes consistently.

It’s not about being brilliant; it’s about being smart.  Being smart really all about knowing what you don’t know… it’s about managing risk, not money… you just do it with money…. And market risk is only one of them.

Jim

—————–

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  

The Independent Financial GroupAdditional IFG Links:

 

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Opinions expressed are those of the author.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Are Risk Questionnaires A Waste of Time?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Are these things worth anything? … or nothing.

Risk questionnaires have played a major role in retirement and investment planning for as long as I can remember; and I’ve used them no less religiously than any other advisor.   Frankly, I’ve always felt they were a little stupid.

Elmer Duckhunter walks into Brainy Smartsuit’s office at Behemoth Securities.  It’s a beautiful place, full of mahogany with lots of beautiful brochures in the lobby.   Brainy has been successful at Behemoth, gaining promotion to Sr. Vice President after selling more Secure Your Future product than anyone else in the office using the “Secret in a Box” software supplied by the product wholesaler. 

“How can I help you?”, Brainy asks.

“Well,” says Elmer, “I have a lot of money from all those Tractor Pulls I won and I think it’s time I began investing for my future.  What should I invest in?”

“I think I can help you, but first I have to know more about you!”

“Makes sense.  What do you want to know?”

Brainy pulls out the Behemoth Risk Assessment questionnaire.  “First, I’d like to know a little about how you feel about investing.”

“Okay.”  Elmer settles in.  “How many questions are there?”

Brainy smiles, “Just six.”

“Six?  You can learn everything you need to know about me with just six questions?”

“Trust me.  This is very scientific, “says Brainy.

“Okay.”

Brainy begins.  “On a scale of zero to 10, how much risk do you feel you can handle?”

“I don’t know.  What would a ‘five’ feel like?”, asks Elmer.

“Just pick one that you feel comfortable with, says Brainy.  “The people who prepare these know what they’re doing.”

Elmer thinks for a second.  “Well, back in 2007 I was a 9, but after the crash I was a 2.  Now, I don’t know what I am.  That’s why I’m here!”

“Well, I can’t tell you how much risk to take until you tell me how much risk you want; then, I can tell you what you told me and we’ll have the answer!”

“Huh?”

They both look at each other, then Elmer continues, “How much risk do I want?  Seems to me you should be telling me how much risk I need or don’t need!”

“But what if it’s more than you want?”, asks Brainy.

“I don’t know how much I want.  I need to know how much I should or should not have?

Brainy perks up.  “Now we’re getting somewhere.  What are your goals?”

“Simple”, says Elmer, “to retire with as much money as possible with as little risk as necessary.”

“How much is that?”

“How should I know?  You tell me.”

Brainy senses a lack of forward progress.  “Let’s come back to that.   Try this one:  If your portfolio went down, what would you do?”

“I’d probably ask you for advice!  Isn’t that your job?”  Elmer’s beginning to wonder if Brainy Smartsuit is so smart after all.  “Why are you asking me all this.  I just want to know what I should be doing!”

Brainy comes clean.  “We have regulatory compliance concerns.  We have to make sure what we recommend is consistent with how you feel about investing.”

“I’d rather have advice that’s consistent with what I need,” says Elmer.  Are you protecting me or your firm?

“Well, actually, both…”

“There are six of these?”  Elmer’s fed up.   He puts on his duck hunter cap with earflaps, and stomps out of the office.

Maybe these questionnaires can shed some light about attitudes; but, they don’t tell Elmer what he needs to know.  Elmer just wants to know what he should be doing and why.

Once he understands what and why, the rest gets easier.  Fear can exist only where there’s a knowledge vacuum.    When knowledge replaces ignorance, fear dissipates and understanding prevails.

Maybe questionnaires have zero to do with long term success for the client; but, they maybe do help sell more Secure Your Future product.

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The Independent Financial GroupSubscribe to IFG Insights letters for individual investors.

Visit IFG on Facebook:  Facebook.com/IFGAdvisory

Follow Jim on Twitter:  @JimLorenzen

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting and wealth management services for individual investors. Opinions expressed are solely those of the author and fictitious names were created solely for their entertainment value and are not meant to represent any person or organization living or dead.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com

Why don’t more people go to financial planners?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Bob Clark, in a recent AdvisorOne article, says the answer is “fear.” Many people are afraid of:

• Being embarrassed by their current financial condition

• learning their financial situation is much worse than they realized

• of getting beat up for not saving more

• of being told to do things they don’t want to do, such as going on a budget, saving more, or buying more insurance.

He’s probably right.  The old adage WIIFM (What’s in it for me) maybe best answers what people really want:  How to get their financial house in order and keep it that way forever; how to achieve their goals with peace of mind; how to minimize risk; how to feel good about what their future!

Jim

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The Independent Financial GroupJim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com, the IFG Investment Blog and by subscribing to IFG Insights lettersfor individual investors.  Keep up to date with IFG on Twitter: @JimLorenzen

Company Stock and NUA

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Getting ready to retire?  Wondering whether you should sell or roll-over your company stock?   That’s really a tax-treatment question, which means you should consult with your tax professional; but, here’s a little information you may want to review

What you should know:  Shares of employer stock get special tax treatment, and in many cases, it may be fine to ignore this special status and roll the shares to an IRA. This would be true when the amount of employer stock is small, or the basis of the shares is high relative to the current market value.

However, if you have large amounts of shares or low basis, it might be a very costly mistake not to use the Net Unrealized Appreciation (NUA) Rules.[1]

If your company retirement account includes highly appreciated company stock, one option is to withdraw the stock, pay tax on it now, and roll the balance of the plan assets to an IRA.  This way you will pay no current tax on the Net Unrealized Appreciation (NUA), or on the amount rolled over to the IRA.  The only tax you pay now would be on the cost of the stock (the basis) when acquired by the plan.

By the way, if you withdraw the stock and are under 55 years old, you have to pay a 10% penalty (the penalty is applied only to the amount that is taxable).

So, you can then defer the tax on the NUA until you sell the stock. When you do sell, you will only pay tax at the current capital gains rate, whatever it is at that time.  To qualify for the tax deferral on NUA, the distribution must be a lump-sum distribution, meaning that all of the employer’s stock in your plan account must be distributed.

Hypothetical Example:

Jackie just retired and has company stock in her profit sharing plan.  The cost of the stock was $200,000 when acquired in her account, and is now worth $1 million.  

  • The Rollover Option:  If she were to rollover the $1 million to her IRA, the money would grow tax-deferred until she took distributions.  At that time, the withdrawals would be taxed as ordinary income – for this hypothetical, let’s assume 35% federal.  When Jackie dies, her beneficiaries would pay ordinary income tax on all of the money they receive.
  • Withdrawing the Stock:  But if Jackie withdrew the stock from the plan rather than rolling it into her IRA, her tax situation would be different. She would have to pay ordinary income tax on the $200,000 basis. However, the $800,000 would not be currently taxable. And she would not have to worry about required minimum distributions on the shares. If she eventually sells the stock, she would pay the lower capital gains tax on the NUA and any additional appreciation.

Jackie’s beneficiaries would not receive a step-up-in-basis for the NUA. However, they would only pay at the capital gains rate. Appreciation between the distribution date and the date of death would receive a step-up-in-basis (we’ll assume a 15% capital gains rate); therefore would pass income tax-free.

With NUA

 

Without NUA

 

35% Tax on $200,000

$70,000

35% Tax on $1 million

$350,000

15% Tax on $800,000

$120,000

 

 

Total Tax

$190,000

 

$350,000

Let’s assume the stock value increases to $1.5 million in five years, and she decides to sell.

 

With NUA

Without NUA

Taxable Amount

$1.3 million

$1.5 million

Tax Rate

15%

35%

Potential Income Tax to Jackie

$195,000

 

Plus Amount Previously Paid

$70,000

 

Total Tax

$265,000

$525,000

Finally, assume that Jackie died in five years after the stock increased to $1.5 million. What would her beneficiaries have to pay?

 

With NUA

Without NUA

Taxable Amount

$800,000 $1.5 million

Tax Rate

15% 35%

Income Tax

$120,000 $525,000

Amount Receiving Step-Up in Basis

$500,000* 0

*Because 2010 is a transition year with estate taxes, there is a limit on the step up in basis of $1.3 million for capital gains.

Okay, now you know enough to be dangerous.  Next step:  Meet with your tax professional to (1) check for any possible tax law changes, and (2) plug-in your own numbers and tax rates, and (3) discuss any complicating issues this piece isn’t considering.

I have a report, entitled “Six Best and Worst Rollover Decisions”  available and there’s a link to it in our ezine that covers this topic.  You’ll find it in our Insights archive.  You might want to subscribe.


[1] IRS Publication 575

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IFG BlogJim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com, the IFG Investment Blog and by subscribing to IFG Insights letters for corporate plan sponsors and individual investors.  Keep up to date with IFG on Twitter: @JimLorenzen

Written by Jim Lorenzen, CFP®, AIF®

October 2, 2012 at 8:45 am

Abnormal Markets – Abnormal Times

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

When the Fed announced an open-ended QE3, the stock market rallied.  In fact, the market’s been trending up since 2009 after the meltdown when all the government spending began.  But, was that good?  Have those stock gains been real?

Since the meltdown, people have been chasing returns whereever they could find them, whether it was with high dividend-paying stocks or  buying gold – a demand largely fueled by all those tv commercials.

The financial industry, of course, has responded to both fear and greed by packaging yet another series of products, some of which come with either high or hidden costs… and sometimes both.

The question, of course, is whether all these “black box” solutions are really the answer… or whether the ‘basics’ are still relevant.

After all, companies that declare dividends are adjusting the price of the stock downward to compensate – you could arguably simply buy growth stocks that don’t pay dividends and simply sell what you need for income and still arrive at the same result! 

And, while gold has increased in value – in terms of the numbers of pictures of presidents you receive for each ounce – have you really received more value when adjusted for inflation?  Some say ‘yes’ but a J.P. Morgan study says something else.

We have more about this in our IFG Insights E-zine, which is appeared earlier this morning and is available in our archive.

It’s my guess much of the increase we’ve seen in virtually all equity categories, have been more nominal than real and are driven by the growth of debt.

We’ll see, won’t we?

Jim

—————–

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization. 

 

Three Retirement Rollover Mistakes to Avoid

Jim Lorenzen, CFP®, AIF®

IFG BlogPlanning to retire?  Contemplating a rollover?  Here are three ways NOT to do it.

1. Get a check from the company

Of course, this is just foolish. The company must withhold 20% from the payment, so that a person with a $100,000 account will have $20,000 withheld, and will receive a check for $80,000. In order to complete a tax-free rollover, the taxpayer must deposit that $80,000 in an IRA plus $20,000 from their pocket to complete a tax-free $100,000 rollover.

The taxpayer may eventually get the $20,000 withheld as a tax refund the following year, but that will not help their cash flow, as they need to complete their IRA rollover within 60 days of receiving the check from their qualified plan.

The bottom line is that people should never touch their qualified funds. The only sensible way to move funds is a direct transfer from the qualified plan to the IRA custodian and avoid withholding.

2. Rollover company stock

Shares of employer stock get special tax treatment, and in many cases, it may be fine to ignore this special status and roll the shares to an IRA. This would be true when the amount of employer stock is small, or the basis of the shares is high relative to the current market value.

However, in the case of large amounts of shares or low basis, it would be a very costly mistake not to use the Net Unrealized Appreciation (NUA) Rules.[1]

If your company retirement account includes highly appreciated company stock, an option is to withdraw the stock, pay tax on it now, and roll the balance of the plan assets to an IRA. This way you will pay no current tax on the Net Unrealized Appreciation (NUA), or on the amount rolled over to the IRA. The only tax you pay now would be on the cost of the stock (the basis) when acquired by the plan.

If you withdraw the stock and are under 55 years old, you have to pay a 10% penalty (the penalty is only applied to the amount that is taxable).

IRA owners can then defer the tax on the NUA until they sell the stock. When you do sell, you will only pay tax at the current capital gains rate. To qualify for the tax deferral on NUA, the distribution must be a lump-sum distribution, meaning that all of the employer’s stock in your plan account must be distributed.

3. Rollover after-tax dollars

Sometimes, qualified plan accounts contain after-tax dollars. At the time of rollover, it is preferable to remove these after-tax dollars, and not roll them to an IRA. That way, if the account owner chooses to use the after-tax dollars, he will have total liquidity to do so.

You can take out all of the after-tax contributions, tax-free, before rolling the qualified plan dollars to an IRA. You also have the option to rollover pre-tax and after-tax funds from a qualified plan to an IRA and allow all the money to continue to grow tax-deferred.

The big question is, “will you need the money soon?” If so, it probably will not pay to rollover the after-tax money to an IRA, because once you roll over after-tax money to an IRA, you cannot withdraw it tax-free. The after-tax funds become part of the IRA, and any withdrawals from the IRA are subject to the “Pro Rata Rule.”

The Pro Rata Rule requires that each distribution from an IRA contain a proportionate amount of both the taxable and non-taxable amounts in the account. The non-taxable amounts are called “basis.” In an IRA, the basis is the amount of non-deductible contributions made to the IRA.

————–Jim Lorenzen, CFP®, AIF®

This Guide is an excerpt from Six Best and Worst Rollover Decisions by Jim Lorenzen. 

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com, the IFG Investment Blog and by subscribing to IFG Insights letters for corporate plan sponsors and individual investors.  Keep up to date with IFG on Twitter: @JimLorenzen


[1]IRS Publication 575

Written by Jim Lorenzen, CFP®, AIF®

June 28, 2012 at 8:00 am

Underperform the Market and STILL Beat It?

The Independent Financial GroupJim Lorenzen, CFP®, AIF®

What?  Never beat the market and STILL end-up outperforming it? 

Could that be possible?

If you watch enough tv or read enough articles, blogs, newsletters and e-letters, you’ll soon easily conclude that the two most important investment concepts seem to revolve around one of two basic concepts: Outperforming the market and/or limiting expenses.

What if they’re both wrong?

While I’ve never promoted the idea of trying to outperform the market, I have often talked about controlling expenses.  After all, it’s logical, isn’t it?   Any money you save on expenses goes into your pocket!   Not rocket science.

But, what if I’ve been wrong, too?

What if we’ve all been looking at the wrong things?

What if all the financial advisors – the ones who’ve been talking about managing risk and limiting the downside – actually have been telling everyone the little-known secret:  It’s maybe about limiting `downside capture’!

Let’s take an example and, just too keep our comparison of performance outcomes `apples to apples’, we’ll make all expenses equal at zero.

The following hypothetical example reflects a fictional market return showing 20% swings each year over a ten year period and what would have happened to Portfolio A, which invested $100,000 in ‘the market’.  As you can see, even though 6 of the 10 years were ‘up’ years, including both the first and last year, and even though 3 of the last 4 years were ‘up’ years, the market portfolio achieved an annualized return of only 2.12% and a gain of only $22,306. 

What’s interesting is what happened in portfolio B!    Portfolio B’s management emphasis was not on beating the market.  In fact, during the ‘up years’ it underperformed the market by 20% each time!   But, while the managers captured only 80% of the upside, they were successful in capturing only 70% of the downside.    How important was limiting the downside?   Take a look!

Interesting!   Now this is a hypothetical mathematical excercise, to be sure; but, it does illustrate the importance of managing risk and how unimportant ‘beating the index’ actually is!   It also demonstrates another important principle:  While it’s important to limit expenses, you don’t want to get caught in a ‘race to the bottom’.  Managers who know how to ‘optimize’ portfolio performance just might be worth what they’re paid.

 ——————-

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.