Sam Bankman-Fried (SBF) became a headliner in newspapers throughout the media, financial and otherwise, in November of 2022, quickly attaining the status of a “Mini-Madoff” shyster. Like Bernie Madoff, SBF was formerly a well-known figure only in a smattering of households. Suddenly, a boatload of money disappeared virtually overnight, and SBF (the term brought to us by the acronym-obsessed mainstream media, or MSM) became a household word, rivaling Bernie Madoff in scope, size, and the element of surprise at his collapsing empire.
Unique, due to his age and the magnitude of the collapse, SBF has been shown to be a consummate liar and fake. His supposedly altruistic motive, wanting to make profits for the benefit of charities, was a cover for personal self-aggrandizement. Turns out, he loved the lifestyle, frequent accolades in financial media, and comparisons to superstar investor Warren Buffett. His headliner company, FTX, purchased an arena name in Miami. It has been shown that SBF made several illegal (large) campaign donations in 2022.
FTX had been touted by several celebrities, and SBF was treated as a must-have interview on financial media. His amazing success led to comparisons with giants such as Buffett. Meanwhile, SBF and a few friends were living large in the Bahamas, spending lavishly on real estate and lifestyles. Then, like a $12 hobbyist’s weather balloon over Lake Huron, his empire crashed and burned. Details of the SBF/FTX saga are left to biographers and media investigators.
Our purpose is to simply ask the pointed question, “What could possibly go wrong?” In November of 2022, the Ponzi-like scheme quickly unwound. FTX assets were frozen by the SEC, and the rest of the story is as predictable as it is well known. Real money was lost in quantities great and small. SBF morphed from the next Buffett to the next Madoff in less time than it takes to tell the story.
I have no idea what people were thinking when they chose to (1) get involved with crypto, and (2) trust a poorly groomed kid, possessing little or no standing, with billions of their real American dollars.
SBF apparently proved the declaration by P. T. Barnum that, “There’s a sucker born every minute.” He rivaled Barnum in sales ability, which apparently was outsized for a man of (only recently) 31 years of age.
Crypto is based on something we cannot see or touch and is hyped by famous people. It was supposedly created by Satoshi Nakamoto, someone no one can find.
At least Madoff dealt with real money instead of crypto. Small consolation, I suppose, for the big losers.
Van Wie Financial is fee-only. For a reason.
Almost everyone has experienced some stress from incurring a significant unexpected expense, which is the reason financial planners advise clients to establish and maintain a significant Cash Reserve, even before attempting to fund long-term goals. “Running out of money before running out of month” is a common problem, articulated by far too many Americans. Whether new tires, appliance repairs, A/C failing during a Florida summer – these and other emergencies strain individual and family cash flows.
What really irks many Americans are unexpected tax bills. Some surprises are preventable, such as planning for taxes on 1099 (gig) income, but the worst scenario for an unexpected tax bill arises when the tax does not result from some cash payment received by the taxpayer. One of the most common forms of imputed income is fringe benefits supplied by an employer to an employee. Use of company cars, some insurance benefits above limits, and other items add to W-2 income but do not have a matching cash flow. Tax on these items can also be planned, and withholding adjusted to avoid surprises.
Insatiable governments are constantly searching for new sources of revenue. One of the most insidious tax proposals of modern times was Bill Clinton’s proposed imputed rent income. Under that proposal, IRS would estimate how much a homeowner would pay to a landlord to rent an equivalent property. This amount would be imputed as taxable income. I dubbed this potential cash flow conundrum Taxation Without Monetization. “Monetization” means developing a cash flow from an item or idea.
Over recent decades, several attempts have been made to tax accumulated wealth, in addition to current income. Attempts have also been made to tax unrealized increases in the value of various assets owned by taxpayers. Some of you may remember the Florida Intangible Tax, which Governor Jeb Bush abolished, as he had promised. Since wealth has no inherent cash flow of its own, and income derived from some assets that comprise wealth is already taxable, taxing non-revenue-generating assets constitutes Taxation Without Monetization.
This week, another example of Taxation Without Monetization hit investors who had used the Crypto Lending firm, Celsius Network, which filed for bankruptcy. Investor assets were frozen when the filing occurred. But that didn’t stop Uncle Sam from sending a tax bill to the bilked investors. Problems with Crypto Lending will be discussed later, and we’ll focus on the tax side. Interest earned, but not paid to investors, is taxable income. This creates Taxation Without Monetization. It could have been avoided.
One big Celsius loser, in his own words, “put all my eggs in one basket, and I’m wiped out.” He’d have done much better by investing in eggs.
Van Wie Financial is fee-only. For a reason.
Exchange-Traded Funds (ETFs) are similar to Mutual Funds, which should surprise no one who realizes that one business grew out of the other. Each begins as a collection (pool) of financial assets, typically stocks, and bonds. Once assets are in position, differences begin to take shape. While traditional Mutual Funds have been in existence for over 100 years, ETFs recently celebrated 30 years since their inception in 1993.
I like to picture a Mutual Fund, Exchange-Traded Fund, or similar asset pooling technique like this. Using a stock fund as an example, picture a stack of stock certificates, representing the entire holdings of the fund. Now, take a big electronic knife to slice the stack, cutting a series of equal vertical pieces, each containing a small part of every asset. Individual or institutional ownership is represented by the number of shares held at any point in time.
Distinctions include methods of buying and selling shares, the tax treatment of income, gains, and losses resulting from the ownership, and costs incurred while shares are owned. By law, Mutual Fund shares are bought from, and sold to, only the Fund Company itself. Trading is limited to off-hours, meaning when the major Stock Exchanges are closed. ETFs are bought and sold among and between traders, over an Exchange, during trading hours.
Costs of ownership favor Exchange-Traded Funds, which require less day-to-day management, partially due to trading simplicity. Unless a particular Mutual Fund consistently outperforms a similar ETF over time, most investors see no point in absorbing the extra internal costs of the Mutual Fund.
Perhaps the most significant feature of ETFs is the advantageous tax treatment granted by the IRS to owners of ETF shares. Traditional Mutual Funds are required by law to distribute to shareholders, at least annually, all net dividends and capital gains realized within the fund itself over a specific time period. For shares held in taxable accounts, this creates a tax liability for the owner. Since many owners choose to reinvest their payouts in new shares, the taxes must be paid from other sources.
ETFs are not required to distribute dividends and gains, and many choose to hold back the cash to grow the share value. Taxes are paid when shares are sold, generally with proceeds from the sale. During times of down markets, shares are often sold below their cost, generating a tax loss that can be used to offset gains from other sources, or from differing time periods.
Investors everywhere are discovering that ETFs are increasingly useful in portfolio construction and management. Happy Birthday, ETF Industry. We celebrate your very existence.
Van Wie Financial is fee-only. For a reason.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
In 1791, securities traders first met under a Buttonwood tree on Wall Street. As the business grew, the Buttonwood traders organized and formed the New York Stock Exchange, where individual securities were bought and sold. Over time, more Exchanges popped up, and the Securities business boomed (on and off, anyway; research the Crash of 1929).
Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
In order to illustrate the importance of the ETF, a little history is useful. Wall Street was named for a wooden wall constructed in 1652 by Dutch settlers in New Amsterdam (Manhattan Island today), who were defending their territory against an expected invasion by England. The wall was demolished in 1699. Notable events from the area formerly protected by the wall include the drafting of our Bill of Rights in 1788 (by George Washington), while New York City was still the Capital of the United States.
In 1791, securities traders first met under a Buttonwood tree on Wall Street. As the business grew, the Buttonwood traders organized and formed the New York Stock Exchange, where individual securities were bought and sold. Over time, more Exchanges popped up, and the Securities business boomed (on and off, anyway; research the Crash of 1929).
Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
Acronyms are all the rage in Washington, D.C., where “alphabet agencies” abound, politicians become famous (infamous?) using their initials (AOC, JFK, etc.), and significant legislation is deceptively named, and then assigned gobbledygook acronyms. On Wall Street, acronyms are used to simplify concepts that are meaningful, if complex. One such acronym is ETF, which is short for Exchange-Traded Fund. Recently, the ETF celebrated its 30th birthday, having been launched by the American Stock Exchange on January 29, 1993.
In order to illustrate the importance of the ETF, a little history is useful. Wall Street was named for a wooden wall constructed in 1652 by Dutch settlers in New Amsterdam (Manhattan Island today), who were defending their territory against an expected invasion by England. The wall was demolished in 1699. Notable events from the area formerly protected by the wall include the drafting of our Bill of Rights in 1788 (by George Washington), while New York City was still the Capital of the United States.
In 1791, securities traders first met under a Buttonwood tree on Wall Street. As the business grew, the Buttonwood traders organized and formed the New York Stock Exchange, where individual securities were bought and sold. Over time, more Exchanges popped up, and the Securities business boomed (on and off, anyway; research the Crash of 1929).
Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
Acronyms are all the rage in Washington, D.C., where “alphabet agencies” abound, politicians become famous (infamous?) using their initials (AOC, JFK, etc.), and significant legislation is deceptively named, and then assigned gobbledygook acronyms. On Wall Street, acronyms are used to simplify concepts that are meaningful, if complex. One such acronym is ETF, which is short for Exchange-Traded Fund. Recently, the ETF celebrated its 30th birthday, having been launched by the American Stock Exchange on January 29, 1993.
In order to illustrate the importance of the ETF, a little history is useful. Wall Street was named for a wooden wall constructed in 1652 by Dutch settlers in New Amsterdam (Manhattan Island today), who were defending their territory against an expected invasion by England. The wall was demolished in 1699. Notable events from the area formerly protected by the wall include the drafting of our Bill of Rights in 1788 (by George Washington), while New York City was still the Capital of the United States.
In 1791, securities traders first met under a Buttonwood tree on Wall Street. As the business grew, the Buttonwood traders organized and formed the New York Stock Exchange, where individual securities were bought and sold. Over time, more Exchanges popped up, and the Securities business boomed (on and off, anyway; research the Crash of 1929).
Individual stocks were expensive to buy and sell, and access to most Americans was effectively denied, due to excessive trading costs. In 1744, Netherlands native Abraham van Ketwich created the first pool of securities designed to allow access to the masses, and the mutual fund was born. Throughout centuries, stock trading and mutual fund investing grew into the powerhouse capital generator that drives our economy today.
Mutual funds, for all their contributions to wealth creation, have inherent drawbacks. Internal expenses are relatively large, and tax complications arise from the Tax Code’s treatment of dividends and capital gains within mutual funds. Trades are performed only after regular Stock Exchange hours, and all trades are to and from the Fund Company itself. Recognizing flaws in the system, 70+-year-old Nate Most set out to revolutionize stock and bond trading in 1987. He succeeded in 1993, 30 years ago, and never looked back.
So was born the Exchange-Traded Fund, or ETF, which addressed all the shortcomings of mutual funds. Internal fees, as well as trading costs, were dramatically reduced, the tax treatment is fair and controllable, and trading is done electronically during Exchange hours. And the rest, as they say, is history. Next week we will explore the beneficial intrinsic attributes of the ETF.
Van Wie Financial is fee-only. For a reason.
Last week, we began a discussion of possible reactions to recent substantial increases in interest rates. The Federal Reserve (FED) has been pumping up rates in a quest to stifle rampant inflation, which (ironically) was not caused by low-interest rates. Any time substantial interest rate changes occur, there will be economic winners and losers, depending on both individual situations and reactions.
Indications are that we have nearly reached the high point in this interest rate cycle. With this understanding, we are looking today at a lesser-known fixed-income (bond) investment. Most people react negatively to any mention of bonds. In our financial planning practice, we frequently hear people say, “I hate bonds.” Understanding some basic concepts and characteristics of certain types of bonds will clear the air as to their purpose and importance in portfolio construction, management, and success.
Bonds are debt instruments, as opposed to equity instruments (stocks). They can be issued by governments or other organizations, and come in many flavors, so to speak. Today we are looking at Zero Coupon Bonds (Zeroes), so named because they do not pay interest until maturity. Instead, they are purchased at a discount, and upon maturity are redeemed at face value.
Prior to maturing, all bonds have market values, determined in the secondary, or resale, market. The easiest way to depict bond price action is to picture a seesaw, with bond prices on one end, and interest rates on the other. When one goes up, the other reacts by going down, and vice-versa. The magnitude of the change in market price reflects time to maturity. Longer maturities incur more volatility than short-term bonds. With interest rates set to decrease sometime in the foreseeable future, long-term bonds are currently priced low. But Zeroes are the most volatile of all bonds and are presenting a golden opportunity to leverage future interest rate decreases.
A primary setback for owners of Zeroes involves the mismatch between interest credits versus payments. Owners receive imputed interest, but no cash is paid. In taxable accounts, this creates a tax liability, without the corresponding cash inflows until maturity. Ingenuity indicates that owning Zeroes in tax-deferred, or even tax-free, accounts, defers any tax liability until the funds are withdrawn from the account. In the case of Roth IRAs, no tax will ever be due on imputed interest, changes in market value, or maturity, if held that long.
Zeroes can be purchased individually or using ETFs designed especially for the purpose. We prefer Government Zeroes to minimize long-term risk.
Portfolio planning is part science and part art form. Finding a qualified investment advisor is always a good start. Look for the CFPâ designation.
Van Wie Financial is fee-only. For a reason.
For many years, Americans have experienced an unprecedentedly low-interest rate environment. Winners during this period included nearly all borrowers, as mortgages and other financing instruments were essentially on sale. Interest rate increases imposed by the Federal Reserve (FED) over the past year have been “in your face,” both numerous and substantial. Borrowers with variable-rate loans, potential homeowners, people with credit card debt, etc., all have been impacted by frequent and harsh rate elevations.
Losers in our prior low-rate environment included many savers, who watched their fixed-income investment yields nearly evaporate. Money Market Funds, CDs, and Bond Funds were largely shunned for lack of monetary returns. Hit hardest were older savers seeking to protect their principal, while receiving supplemental income. These people are becoming today’s winners, having been presented with income opportunities not seen in many years.
For today’s discussion, we will concentrate on the familiar Certificate of Deposit, or CD. Short-term investments (less than 5 years) can now be safely invested, with CD yields in excess of 4%. Perhaps not show-stopping rates, but compared to former pathetic yields, these new rates constitute a virtual windfall. In our financial advising and investing business, we are currently purchasing CDs for clients, and deployed idle cash into rewarding assets. But not every opportunity is a “no-brainer.”
Laddering refers to the practice of dividing income investments (CDs, Bonds, or even annuities) into units with staggered purchase and maturity dates. Laddering is meant to take advantage of varying interest rates, which normally increase with additional time to maturity. While rates are not yet aligned in a normal fashion (the yield curve is inverted), excellent opportunities exist in the 1 to 3-year range. Many investors are accustomed to renewing their income investments as maturity dates are reached. In a rising rate environment, renewal rates are generally superior to expiring rates.
Most people understand that surrendering a CD early carries a financial penalty, typically two or three months of interest. What may not be intuitive is the number of actual dollars involved in surrendering low-interest-rate CDs. Assuming a 1% CD yield for $100,000, quarterly interest is only $250. Replacing the CD with a 4.5% yield pays a quarterly rate of $1,125, for a net gain of $875 quarterly. For a common penalty of 3 months’ interest, the net gain is well worth the process of surrendering the unexpired CD.
If you currently own any CDs with time remaining to maturity, this is an opportune moment to exercise some creativity by evaluating the costs and benefits of an early surrender.
Van Wie Financial is fee-only. For a reason.
Financial advisors get up every morning dreading reading the day’s financial headlines. If any significant portion of financial headlines were to actually come true, we would not have a country, much less an investment portfolio that actually rewards investors. Some days we just ignore headlines, and other times we get riled up by the attention-seeking “experts.”
Such a day happened last Monday, when on a single page of a commonly visited financial website, three consecutive headlines, each crafted to receive “clicks,” read:
- “Banks Could Seize Your Accounts”
- “The End of the Dollar”
- “Stocks Risk 22% Slump”
Beginning a day like that is enough to send an otherwise sane investor into a tizzy. Multiply that by 100+ clients, and you get an idea how much more frustrating financial advising becomes. Fear is the enemy of advisors and clients alike. Overcoming fear is difficult enough without a daily gobsmacking in the media. Fear is overcome by education and knowledge. Our mission at Van Wie Financial is to counteract and overcome fear using knowledge and facts.
How much truth is behind these headlines? Can banks seize your funds? Yes, they can, if triggered by one of the rare elements in banking and tax laws. Don’t pay IRS, and they might freeze your account. If the bank goes under, Dodd-Frank allows the bank to use your funds while working out the bankruptcy. You get stock shares, and hope they become worth something. Choose your bank wisely, and be sure your deposits are insured. That’s on you.
Is the Dollar doomed? Will it be replaced by government-created crypto? If I said “No,” and someone else “Yes,” who would you believe? Imagine the complexity of a change of that magnitude, add in the number of politicians who would be bombarded with angry constituents, and draw a rational conclusion. Political suicide is shunned by Congress.
Do stocks risk a 22% slump today? Every single day of your life, stocks risk a 22% decline. Likewise, they risk a 22% spurt, and in actuality, even more.
Why is the media replete with such headlines? Could it be that the authors (read: advertisers) are selling something? Perhaps precious metals, newsletters, or annuities, there is always something they want you to buy, and they are willing to scare you into purchasing. Had you not read those headlines, would you be scared by highly improbable scenarios?
Van Wie Financial is fee-only. For a reason.
Portfolio Diversification is rarely disputed as fundamental to investing success. Problematic, however, is finalizing a definition of the term “Diversify.” To many, the answer lies in the number of individual stocks held in an investor’s portfolio. Not only is there disagreement as to “that number,” but in practice, the very premise is debatable.
Prominent among early papers on the subject is a study by John Evans (Evans) and Stephen Archer in the 1968 Journal of Finance. Versions of their results permeate much of today’s financial literature. Evans concentrated on stocks, and specifically the number needed to determine the best 1-year results. Disputed conclusions in Evans included:
- Stock index funds are unnecessary, as 60 to 80 stocks can produce results similar to indexing
- Active portfolio managers should only hold 20 to 30 stocks to prevent “de-worsifying” into 60 or more stocks
- “Do-it-yourselfers” should hold small handfuls of stocks, as they can’t pay sufficient attention to a greater number of holdings
Read that list again, and if you understand the logic, please notify us, as we remain confused by their conclusions.
Unfortunately (in my opinion), far too many investors, apparently in lockstep with their advisors, believe that Portfolio Diversification may be satisfied by the number of individual stocks held in an investor’s portfolio.
Thankfully, there has been extensive research on this very subject, mostly disputing Evans. One recent synopsis is by Yin Chen (Chen) and Roni Israelov of advisory firm NDVR in Boston. While Evans concentrated on one-year volatility, Chen looked at total return over a 25-year period.
Chen found that portfolios holding more stocks were not ever more volatile than those with fewer holdings. Logically, we need to understand the value of experiencing more or less volatility. Greater volatility produces a larger upside potential, but also a greater downside risk. For reasons both mathematical and psychological, less downside risk is most investors’ preference over time, so long as upside potential is sufficient. Losing portfolio value is more painful for most investors than gaining a similar amount is rewarding.
No pure stock portfolio can match results from fully Diversified Portfolios utilizing multiple Asset Classes, and no number of individual stocks will produce better results, in the absence of unusually good luck.
Simply put, whether 20 stocks, 60 stocks, or 500 stocks, the portfolio remains under-diversified in the absence of multiple Asset Classes. We should all focus on the overall process of Portfolio Diversification.
Van Wie Financial is fee-only. For a reason.
Diversified portfolios are the 8th wonder of the modern world. OK, maybe not that spectacular, but extremely important to millions of investors. In a world where individuals are increasingly responsible for their own financial futures, risk (defined as variability of returns) must be mitigated, while allowing (and encouraging) growth in the overall portfolio. A tall order, to be sure. Alone, no individual Asset Class provides both safety and opportunity.
While researchers have identified three key elements of success in portfolio construction and management, multiple studies have concluded (1) Market Timing is insignificant as a driver of long-term success, (2) Securities Selection contributes very little to overall results, and (3) Diversification amongst Asset Classes is the main element of success. In practice, properly mixing assets from various Asset Classes drives over 90% of long-term portfolio returns.
It stands to reason that more attention should be paid to Diversification than to those other two factors combined. Why, then, do so many advisors and investors concentrate on the Selection and Timing of buying and selling individual stocks? Or, if I might, trading?
Primary Asset Classes include Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Real Estate, Cash (and equivalents), and Alternatives, such as Commodities. Diversification involves the selection of portfolio assets from at least two, and preferably more, of these categories.
Even the smallest portfolios can benefit from Diversification. For young and/or novice investors, an all-stock portfolio may be exciting, but their portfolios will benefit over time from Diversification into other Asset Classes. Many people choose Target-Date Funds, which are often called Retirement Date Funds. These funds are diversified, using Bonds and, frequently, International Stocks. Simple to buy and sell, especially in these days of commission-free trading, these funds provide excellent Diversification to even the smallest investors.
Certified Financial Plannersâ (CFPsâ), operating as Registered Investment Advisors (RIAs), apply Asset Allocation techniques to develop and manage individual portfolios, based on individual risk tolerance and the financial goals of investors. For assistance in finding Advisors working in these arenas, we suggest the Certified Financial Planner Boardâ website (letsmakeaplan.org), and the National Association of Personal Financial Advisorsâ website (napfa.org). When shopping for a Financial Advisor, look for the “fee-only” designation to be sure the Advisor is a fiduciary at all times. Do not be fooled by claims of “fee-based” advisors, who are not required to act as fiduciaries at all times.
Next week we will address the age-old dilemma regarding how many stocks are required to sufficiently diversify a portfolio.
Van Wie Financial is fee-only. For a reason.
Last week, we discussed the value of accepting Personal Responsibility for our own financial futures, including starting and/or contributing to an Individual Retirement Account, or IRA. Our primary focus was on potential 2022 tax savings. Our suggestion was to open (or contribute to) a Traditional IRA, in which all contributions are deductible for qualified Account Owners. 2022 contributions can be made up to Tax Filing Day in 2023, but the benefit will still be reaped for 2022.
Today, we shift our focus to the Roth IRA, which does not provide current income tax relief, but provides other worthwhile benefits later, when withdrawals made by Account Owners will be tax-exempt. Despite not having to open a 2022 account and contribute until early next year, there may be a good reason for new investors to open an account in the remaining few days of 2022.
Maximum benefits from a Roth IRA are not realized until the account has been open for 5 years, and until the Account Owner reaches age 59-1/2, at which point withdrawing earnings becomes tax-free. Before the 5-year period is satisfied, contributions may be withdrawn at any age with no tax due, but prematurely withdrawing earnings may require income tax and/or a 10% tax penalty, depending on age.
The full 2022 credit is a result of how the 5-year holding period is calculated. A Roth IRA opened before the end of the year will have satisfied Year 1 at midnight, December 31, 2022. Year 2 starts on January 1, 2023, and satisfies the entire second year of the requirement. This means that on January 1, 2026, the 5-year holding period is considered complete.
Anyone desiring to open a Roth IRA and satisfy the 5-year qualification period can still open an account with a small initial deposit before this year-end. Most custodians will allow a new account to be opened online, or by appointment in a local office. Some banks and credit unions can open a Roth IRA in person, and a deposit can be made, so long as a minimum opening deposit is made.
Another strong argument for starting a Roth IRA lies in the generous rules for making future withdrawals for education, home purchase, etc. Rules can be found on the irs.gov website, or on the website of the custodian you choose to hold the account.
With few exceptions, opening a Roth IRA before year-end will provide benefits to the owner of the account. If you qualify, why not take this opportunity to establish another block in your retirement income foundation? Do it now, and you may be able to receive full benefits sooner, rather than later.
Van Wie Financial is fee-only. For a reason.