Investor Principles for Success

Investors big and small, sophisticated and simple, struggle to get the investment returns they desire. DALBAR and Associates and others have documented the performance shortfall for years, but few tangible solutions exist to close the gap between actual returns and expected returns. From what I’ve observed, I believe the core of investors and their advisor’s failure is in not asking the question, “What is the investment for? What is the savings goal?” prior to making investment decisions.

* DALBAR; Blackrock

By consequence investors have failed to keep up with the performance of even the most passive investment. As mentioned, the success or failure of the individual investor is well documented by DALBAR and Associates. In the ten years leading up to 2016, investor returns (for asset allocation funds) were 1.89% per year. This return is far less than what a bond index (e.g. Barclays Agg.) would have yielded at 4.51%. The moral of the story? Individual investor behavior is a major contributing factor to under-performance. 

ASK THE QUESTION

Both advisors and individual investors must ask the question, “What is this investment for?” In other words, what are you trying to accomplish by foregoing spending right now and instead saving those dollars? Answering this question will create a goal/objective for the savings and will lead to investments that optimally align with the stated goal.

Consider for example Jane, a 25 year old investor with two different saving goals: 1) save for a house; and 2) save for retirement. It is fine if Jane thinks, “I’d like to be aggressive because I’m an aggressive person,” but that posture aligns much better with the retirement account that has 35-45 years before it is needed than it does for the house savings account with a 3-5 year saving and investing timeline. Because aligning investments with both the goal and the timeline is crucial when investing, ask the question, “Why am I saving. What is this for?”

BE DISCIPLINED

After you’ve answered the question for yourself and made the corresponding investments to align with your stated goal and timeline, it’s all about discipline. If like Jane you have a three to five year savings goal, then the objective would be a stable portfolio. But what if, during that time, Jane thought to herself, “The stock market is doing so well and my friend has made so much money investing in XYZ stock, maybe I’ll try and make a little more too.” While that is a fine thought, in the context of the goal and timeline, to act on it would be undisciplined. If the goal is to buy a house and it’s a short-term goal, the action for Jane is to maintain a stable job, budget her income, and stay disciplined to her investment plan since these will be key drivers in her ability to save for and purchase a house...not the stock her friend bought.

A lack of investment discipline may also impact the long-term investor. What if Jane made some aggressive choices for her VERY long-term retirement account? One day, the same friend who bought XYZ stock tells Jane, “I sold my stock. It was getting crushed. The market is crashing.” Jane may very easily feel that she made the wrong decision by investing “aggressively” in her retirement account and in reaction, sell. Being disciplined is about sticking to a prudent investment strategy based on your needs and timeline. For Jane, discipline may look like HOLDING these more volatile higher-earning investments not based on the short-term return but rather her long-term goals.

If the stated saving goals were aligned with the right investments, then there would be minimal volatility in the short-term house savings account. Similarly, with a longer-term goal (retirement) in place, Jane would expect to see more volatility with higher long-term returns than with the more stable investments she made for the house.

BE PATIENT

Whether you are an advisor or an individual investor, if you’ve asked the right questions and you have an investment plan to accomplish your goals, then be patient and wait for that plan to play itself out. If you’ve done the work upfront, then your probability for success will be much higher than if you failed to ask the question and go through the process.

Looking at the poor performance of the individual investor leads me to conclude two things: 1) too many investors have not asked the right question upfront to make an investment plan to meet their specific goals; and 2) those who may have started out by asking the right question have failed to stay disciplined to their objectives.

In summary,

1.       Ask the questions: “What is the purpose of these funds? What is the point of saving instead of spending?”

2.       Be disciplined

3.       Be patient

Sources: *BlackRock; Bloomberg; Informa Investment Solutions; Dalbar. Past performance is no guarantee of future results. It is not possible to directly invest in an index. Oil is represented by the change in price of the NYMEX Light Sweet Crude Future contract. Contract size is 1,000 barrels with a contract price quoted in U.S. Dollars and Cents per barrel. Delivery dates take place every month of the year. Gold is represented by the change in the spot price of gold in USD per ounce. Homes are represented by the National Association of Realtors’ (NAR) Existing One Family Home Sales Median Price Index. Stocks are represented by the S&P 500 Index, an unmanaged index that consists of the common stocks of 500 large- capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Bonds are represented by the BBG Barclay U.S. Aggregate Bond Index, an unmanaged market-weighted index that consists of investment-grade corporate bonds (rated BBB or better), mortgages and U.S. Treasury and government agency issues with at least 1 year to maturity. International Stocks are represented by the MSCI EAFE Index, a broad-based measure of international stock performance. Inflation is represented by the Consumer Price Index. Average Investor is represented by Dalbar’s average asset allocation investor return, which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/16 to match Dalbar’s most recent analysis.

---

---

Related Articles

It’s the most wonderful time of the year. No not Christmas; one of the biggest sporting competitions of the year is underway – the NCAA March Madness! For the next few weeks NCAA Men & Women’s Basketball teams will complete against one another to see who will make it to the ‘big dance’ and who will go home crying. Tough competition, major upsets and bragging rights are experienced by both basketball teams and fans alike. Across the world numerous individuals have filled out brackets, making a guess on who will win/lose in the tournament. For every person who is competing there are just as many strategies in choosing their winners. Here are a few used in Human Investing’s office:

• Choosing the better ranked team (Each team is seeded 1-16, with 1 as the strongest team in their region.)

• If mascots were to fight who would win

• Consider a team’s (average margin of victory) x (Conference RPI)

• Let colors be your guide – pick your favorite team colors

• Flip a coin

• Ask your kids to help

• Following the crowd

• Google isn’t a bad strategy either

At the end of the day there are upsets and sometimes the most absurd strategy comes out ahead. When it comes to investing, left to their own devices most people have a similar experience with picking an investment strategy as they do with filing out a march madness bracket. Unfortunately for investors, the verdict is out: they aren’t doing a very good job. By the end of 2016, the S&P 500 had a 20yr annualized return of 7.68%. For the same time period, the average investor had an annualized return of only 2.29%, trailing the S&P significantly by 5.39%.*

*Dalbar; Blackrock

See the effects of the annualized return of stock and bonds on $10,000 over 20 years, compared to the “Average Investor.” A gap of over $33,000, jaw dropping. 

*Dalbar; Blackrock

The decisions investors make about how to diversify, the time they choose to get into or out of the market, fees they pay or underperforming funds they choose cause them to generate returns far lower than the overall market.

Don’t leave your retirement savings to chance. Have a process:

1.     Build an investment strategy that is tailored to your goals and time line:

• Start by answering the “Why.” Why are you investing? Is it to cover the cost of living at retirement so that you can continue to provide for you and your family? Or is it something else?

• Only after the “Why” should you figure out the “How.” Do you feel comfortable managing your investments yourself? If you don’t, get help.

  • Invest in a Target Date Date fund, built for an investment timeline that matches your date of need to utilize your investment dollars.

  • Hire an advisor to customize and implement an investment strategy based on your “Why.” Human Investing can help, come talk to us.

2.     Know yourself, know your risk: 

• Be aware and understand how your investments perform and react in different markets. Make sure you are comfortable with the risks associated with your investment strategy. If you are not, its time to go back and reassess the “How” of your financial plan.

• Having a plan and understanding how your investments work can help you stay the course and block out the noise which may hinder the decision-making process. A plan can help us approach our important financial decisions rationally rather than defaulting to impulse.

3.     Maintain & Monitor:

• Keep tabs of your account. Check in but avoid making frequent changes.

• Rebalance: Take a moment to rebalance your portfolio. As investments perform differently in different markets, ratios of investments in your portfolio will naturally change overtime. Bringing your portfolio back to the intentional investment ratios by rebalancing annually is a great habit. Automate this process if possible.

• Update your investment plan as life changes.

Don’t leave your retirement to the flip of a coin or by following what everyone else is doing. Whether you need help building a strategy to save for retirement or want pointers on how to fill out your March Madness Bracket, let us know. Human Investing is here to help.

Further Reading: Identifying your investment Risk 

Sources: *BlackRock; Bloomberg; Informa Investment Solutions; Dalbar. Past performance is no guarantee of future results. It is not possible to directly invest in an index. Oil is represented by the change in price of the NYMEX Light Sweet Crude Future contract. Contract size is 1,000 barrels with a contract price quoted in U.S. Dollars and Cents per barrel. Delivery dates take place every month of the year. Gold is represented by the change in the spot price of gold in USD per ounce. Homes are represented by the National Association of Realtors’ (NAR) Existing One Family Home Sales Median Price Index. Stocks are represented by the S&P 500 Index, an unmanaged index that consists of the common stocks of 500 large- capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Bonds are represented by the BBG Barclay U.S. Aggregate Bond Index, an unmanaged market-weighted index that consists of investment-grade corporate bonds (rated BBB or better), mortgages and U.S. Treasury and government agency issues with at least 1 year to maturity. International Stocks are represented by the MSCI EAFE Index, a broad-based measure of international stock performance. Inflation is represented by the Consumer Price Index. Average Investor is represented by Dalbar’s average asset allocation investor return, which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/16 to match Dalbar’s most recent analysis. 

---

Highway 212 by Matt Duncan

While working with employees at retirement plans over the years, one thing I’ve realized is that being disciplined to save for retirement is challenging and there are many obstacles to doing it successfully. For those living the northwest, saving for retirement can be particularly hard due to the average wage vs. the cost of housing.

Income vs cost of living

When thinking about specific clients that truly save well, regardless of income, a theme that I see is all of these people have a specific mindset towards saving and understand how to achieve short term and long term goals. Over the past month I’ve had a few things cross my life about perspective and goal setting that I wanted to pass along:

First order vs. Second order consequences

A book that I’m in the middle of listening to is by a famous investor Ray Dalio who is the founder of Bridgewater Investments, the largest hedge fund in the world at 160 billion. Dalio, is one of the most successful investors of our time and has some truly unique ways of managing his team and thinking through problems. One passage that really stuck out to me is:

“I’ve come to see that people who overweight the first order consequence of their decisions and ignore the effects of second-and-subsequent-order consequences rarely reach their goals. This is because first-order consequences often have opposite desirability’s from second order consequences resulting in big mistakes in decision making. For example, the first order consequence from an exercise plan (pain and time spent) are commonly considered undesirable, while the second-order consequences (better health and more attractive appearance) are desirable.”

This principle holds true for investing towards retirement as well. By saving a $100/month for their future, a person is giving up something today (coffee, vacation, entertainment) in order to have a more desirable retirement. In other words, this is a first-order consequence and second order consequence type of decision. While this concept is not a unique one, I’d never heard it explained this way and it resonated with how I view decision making.

What’s your “This” in order to get “That”

A friend of mine made the comment a few weeks back “Has your company done the whole let’s set goals for 2018 and never check back in on them again movement?” Unfortunately, corporate goal setting has that stereotype. Often, because it’s true. Luckily our company has Jill, a mother of four and a low tolerance for time wasting activities. She recently implemented a quarterly system for goal setting and tracking. Our team has high hopes for this new system and we’ll ultimately see how it goes. My big takeaway from our time talking about goals was the video she presented by Dr. Henry Cloud called “Start Small”. In this video he speaks to how we all want to get to the big goal but have a hard time setting and sticking to smaller goals.

For some of the guys in our office this meant going on the TB12 diet plan to prepare for our upcoming middle aged athletic endeavors (for me my city league basketball team starting in late January. Wish me luck!).

For you, similar to the Dalio piece, maybe this means looking at what your long term goals is (i.e. having X amount of money at retirement) and shrinking that down to what do I need to do this month/this week in order to get a little closer to that goal.

At the end of the day, the phrases “mindset” and “goal setting” can sound really cheesy, and when done poorly can lead to nothing. However, when we look at our collective social circles and see people who have reached their goals (whether those be physical, business or relationships) often times they are using mindsets like the ones Dalio and Cloud are talking about. Hopefully these can be somewhat inspirational when it comes to putting away additional funds towards your savings goal.

If you have questions or would like to have a conversation about your retirement plan, please don’t hesitate to email or call our team!

---

---

Related Articles

Happy New Year from your Advisors at Human Investing! Now that 2018 is in full swing we wanted to check in to make sure you are staying up with your New Year's resolution of saving appropriately. You may already know but the 2018 limits of how much you can save may differ from 2017 amounts. See below for your 2018 contribution limits. Want help making sure you are maximizing your retirement savings, we're here to help. Call our office at 503-905-3100 with any questions. Click here to be directed to the IRS website for further information.

---

Archive

• Charts
• Contribution Limits
• Current Events
• Financial Planning
• Investments
• Managing your Portfolio
• News
• Nike Benefits
• Retirement
• Retirement Planning
• Saving and Spending

He’s making his list and checking it twice. Are you?

Make this year-end check list a gift to yourself.

Tax Overhaul – What you can do in 2017:

In light of the latest tax overhaul, millions of Americans will change the way they calculate deductions when filing taxes. With state and local tax deductions being capped at $10,000 and an increase in the standard deduction ($12,000 for single filers and $24,000 for married couples filing jointly), affected tax payers will not get value in itemizing deductions. Considering these changes, here are a few ways to be proactive with your tax bill in 2017:

• Accelerate Donations: Make charitable contributions in 2017 that you won’t be able to itemize in 2018.

• Bunch Future Donations: This is for those who plan to make charitable contributions in 2018 and beyond. If your donation will not increase your deduction above the standard deduction, save your donations for a year in which your donations will allow you to deduct more than that of the standard deduction.

• Utilize a Donor-Advised Funds: An investment account for the sole purpose of contributing to charitable organizations you care about. You can contribute cash, securities or other assets (such as bitcoin) into a Donor-Advised Fund and grow your donation tax free before contributing to the 501(c)(3) of your choice. In most cases this would allow you to take an immediate tax deduction.

• Gift Your Stock: Considering recent market growth, donate appreciated investments such as appreciated shares of stock. The donor is able to immediately deduct the full market value (up to certain limits) without paying capital-gains tax on growth.

• Make your Mortgage Payment in 2017: If you will have a mortgage payment due January 1, 2018, pay it by December 31 for 2017 deduction purposes. This is in light of the future $10,000 per return cap on state and local tax deductions (SALT).

Save:

A qualified retirement account like a 401k allows you to save large sums of money on a tax deferred basis. For the year 2017 an individual can save up to $18,000, with an additional catch up contribution of $6,000 for those 50yr or older. Saving today is the most impactful means for you to grow your retirement savings, as a bonus you are able take advantage of the tax benefits that come with contributions. See the impact of saving using our Retirement Calculator

Rebalance your portfolio:

Avoid unnecessary risk, take a moment to rebalance your retirement accounts and reassess your investment allocation. With stocks1 up 15.46% and bonds2 up 2.02% annualized over the last 5 years (see graph), you could be taking on some additional risk with an out of balance retirement account. Taking the time to rebalance your portfolio can help disperse some of this risk.

This graph shows $10,000 invested in both Vanguard Total Stock Market Index Fund Admiral (VTSAX)1 and Vanguard Total Bond Market Index Fund Admiral (VBTLX)2 in December 2012. $10,000 invested in stocks would have grown to over $20,000 while bonds would have grown to just over $11,000.

Unsure about your investment portfolio? Want to make sure that it aligns with your goals and timeline? Human Investing has tools to help.

Contribute to your Health Savings Account (HSA):

For those in high-deductible health insurance plans you can save $3,400 pre-tax dollars to your HSA. Have a family? You can save $6,750. Age 55 or older? Save an additional $1,000. To learn more about the cost of health care at retirement and the advantage of the triple tax benefit of a Health Savings Account see our blog post about healthcare at retirement.

Contribute to a 529:

Such contributions must be made before the end of the year to take advantage of any state-income-tax benefits or to be eligible for the federal gift-tax exclusion. Starting in 2018 per the tax overhaul, 529 accounts can be used not just for college education but also K-12 expenses.

Call Human Investing:

Let’s Talk. Human Investing is here to help. 503.905.3100

Source: WSJ.com, Laura Sanders.

---

---

Related Articles

This past week I went on what has turned into a weekly running date with a buddy of mine. In addition to discussing our anticipation for the 2nd season of Stranger Things and who was going to binge the show fastest, my friend brought up an article he saw in The Wall Street Journal a few weeks ago. Knowing that I work at Human Investing, he asked: “I read something about how Morningstar Fund Rating are kind of bogus. Have you heard anything about that?”

Oh I had heard about it and I had many thoughts. Selecting a fund for investors has turned into murky waters over the past few years as it seems like many organizations are pushing their own agendas - explaining why their fund or fund process is best. In response to my friend and to the Wall Street Journal’s Article on Morningstar’s fund rating process

"https://www.wsj.com/articles/the-morningstar-mirage-1508946687"  I wanted to do a quick Q&A on a prudent process for selecting a fund or funds that fit into your portfolio.

These are the types of questions that are essential to ask yourself when selecting a fund:

Q: I haven’t read the WSJ article about Morningstar and it’s very long, can you summarize it for me?

A: Sure! In short multiple reporters did a yearlong investigation asking the question, “Is the Morningstar rating system a good guide for investors when looking to invest capital?” Their takeaway was that it is not and in my estimation they are somewhat right.

Q: Did Morningstar Respond to the article?

A: Yes. Morningstar took this article very seriously and gave multiple responses including this one  http://news.morningstar.com/articlenet/article.aspx?id=831740. I really enjoyed this paragraph and believe that it represents how investors should use Morningstar ratings:

“The star rating system has been a useful starting point for research that tilts the odds of success in investors favor.”

Q: In a nutshell should I use the star rating as my only means for choosing a fund?

A: No

Q: Okay so if star ratings aren’t the best way to judge a fund, then what should I do?

A: Now you are asking the right questions! As a fiduciary (someone who by law must act in the best interest of another) for many 401k plans here are a few bullet points that our firm typically recommends when selecting a fund:

• Regression to the Mean: Just because a fund or an asset class has recently outperformed its peers it doesn’t mean that trend will continue. More times than not it means the opposite is more likely. If you are currently selecting your funds based on short-term past performance, it might have worked out recently but you are playing a losing game in the long term.

• Passive over Active: By selecting a passive (index fund) over an active manager you are often accomplishing two things.

  • First you are reducing your overall investment costs which is an immediate savings to you.

  • Second you are subscribing to the idea that indexes historically outperform active managers. Historically this has been a true statement. The chart below speaks to indexes beating active managers in their respective asset classes 85% of the time over a 15-year period!!!! There are active managers who have outperformed their benchmark, however the deck is stacked against investors when trying to determine who that manager is.

• Behavior Management: You can do everything right when investing in a fund, but if an investor panics and sells out of an investment at the wrong time all of their good decisions are immediately lost by their behavior. Understanding the rocky road of long term investing is essential to selecting a fund(s) that fits your needs

• Risk Management: In line with behavior management is also understanding your risk and the risk of the fund you are investing in. If you knew there was the potential of your fund losing half its value how would that affect your decision to invest in the fund?

Solution

Whether you’re investing through your employer’s retirement plan or outside that plan, often a great solution is to use an age based target date fund or a risk based constant risk model (i.e. aggressive, moderate or conservative allocation fund). Both fund types look to take holistic approach to diversify risk and create an allocation either based on your age or risk profile. It’s important to check if these options use index funds as the component parts to ensure you are aligning with the aforementioned investment strategy.

Our team recognizes that tracking your investments may not be your full-time job. If this blog post or the WSJ article sparks any questions, please don’t hesitate to reach out as we would welcome talking through your investment selection process and make sure you are maximizing your investable dollars!

  #1: Know Where You Stand Financially

Whether because of singleness, divorce or death of a spouse over 90% of women will be managing their money alone at some point in their future. Because women tend to save less and live longer, it is critical that women start looking out for themselves financially!  The good news is there is always time for course correction. Below are a few tips to help you know where you stand financially.

1. Get involved in your household finances. Don’t be afraid to have the hard conversation with your significant other - your future may depend on it. Some couples find it helpful to set up a financial date night. Set some guidelines for the conversation. It can be an emotional topic so try and keep it light and educational.

2. Make sure you and your significant other are fully maximizing employee benefits, especially any employee match to a retirement plan, life insurance, and disability benefits.

3. If eligible contribute to IRAs; learn about and take advantage of the spousal IRA.

4. Have jointly owned as well as individual bank and credit card accounts. Speak with your trusted advisor about how you can protect one another in the event of a death or disability - you want to have access to accounts if you need them.

5. Most importantly, know where all the money is and keep log-in credentials for all accounts stored safely.

#2: Have a Plan

Envision retirement! Whether it is around the corner or 30 years away it is important to envision what you would like your future to look like and then plan for it. Whatever your income may be, it is never too early or too late to create a plan.  In our experience clients that have gone through the planning process tend to have more contentment, assurance of their future and unity with their partners.

A financial plan can help answer questions such as:

1. Are you saving enough?

2. Are your assets allocated properly?

3. Are you properly insured?

4. What will happen to your assets when you die?

5. How will you know if you have saved enough and can retire?

#3: Don’t Forget to Budget!

In our experience clients that budget tend to have a high rate of success at reaching their financial goals. When we take stock of what we are spending it is amazing to discover how trivial things may be eroding our wealth accumulation day by day. And you don’t need to re-create the wheel: there are some great budgeting tools out there that can help. One tool we like to refer clients to is YNAB (You Need a Budget). You can do research and find all kinds of tools and apps.  Many are quite user friendly and have apps that you and your significant other can both use.

#4: Put Your Money to Work and Ask for More!

1. Part of any good investing strategy is putting your money to work for you. If you are afraid to invest talk to your financial advisor about your fears and how you feel about taking risk. There are many different strategies to accomplish your goals. By expressing your fears, exploring the options and educating yourself you will be equipped to face your fears and overcome them or at least minimize them. The sooner you address your fears around investing the quicker you can put your money to work.

2. Ask for a raise! Although the gender pay gap is closing there are still many women that are not making as much as their male counterparts. One reason for this is that women are less likely to ask for a raise and advocate for themselves. Equip yourselves by working to achieve job goals, deepen your level of expertise and research what others are making in similar positions. At your next review present your findings and then be prepared to ask for that raise. You might be pleasantly surprised by the response you receive. Commit a portion of those new dollars towards your long-term goals and get them invested.

#5: Consult with Your Trusted Advisor

Having an advisor to assist and guide you on your journey can be a game changer.  Don’t be afraid to ask your advisor the simple and complex questions so you can be involved in the conversation.  If your advisor is not a good fit, look for someone you feel comfortable with, can trust and can easily talk with.  An advisor can provide you with accountability, a roadmap for retirement, counsel in turbulent times and help with financial discipline.  They can also be a huge asset in the event of a death or family emergency.  We have helped many families navigate these difficult situations as an added support.

---

Related Articles

Do you participate in an employer’s retirement plan in which you own your employer’s stock? Before selling shares or rolling your account over to an IRA, you should consider a special election that could save you significant tax dollars. For taxpayers with employer stock held inside a qualified employer plan, the IRS allows a special election to distribute those shares at their cost basis and recognize the appreciated gain at preferential capital gain tax rates (avoiding “ordinary” income tax rates). This strategy is known as “Net Unrealized Appreciation” and is outlined in IRS code section 402(e)(4). The net unrealized appreciation is referring to the excess fair market value (FMV) of your employer shares over their cost basis. The election creates an immediate income tax liability on the cost basis of the distributed shares, but allows for continued deferral and favorable tax rates on the embedded and future gain.

There are three requirements to qualifying for and executing an “NUA” election strategy. First, the stock must be distributed out of your employer plan “in kind.” Transferring stock “in kind” means you take distribution of the stock itself, not its liquidated cash value. Second, the NUA election must be made as part of a lump sum distribution in a single tax year. You can make the NUA election on all or a portion of your employer stock and make a tax-free rollover with the rest of your account. The rules only stipulate that the entire account must be distributed/rolled over in a single tax year. Lastly, the lump sum distribution must transpire from one of four situations: death, attaining age 59 ½, leaving the company, or disability.

Below is a chart that outlines the tax treatment of employer stock distributed in an NUA election (www.kitces.com)

For example, let’s say you were a Nike employee and inside your 401(k) you hold 150k of Nike stock. Those shares have been purchased inside your 401(k) over a 20-year career and have an average cost basis of 50k. You retired last month and are looking to roll over your 401(k) assets into an Individual Retirement Account (IRA). Before making the rollover, you decide to make the NUA election on all your Nike stock. The distribution of those shares at their cost basis is immediately taxable at your ordinary income tax rates (i.e. 33% * 50k = $16,500). Those assets are now outside a qualified plan and all embedded and future appreciation can be realized at capital gain rates. Let’s say you then held those Nike shares until they were worth 200k. That 150k gain (200k FMV – 50k basis) would be taxable at 15%, or $22,500. So, in total with an NUA election, you paid $39,000 in Federal income tax. In contrast, by not making the NUA election, and rolling the entire 401(k) into your IRA there is no immediate income tax bill on the rollover, but all embedded and future gains are taxed at ordinary income tax rates. So, using the $200,000 fair market value assumption, and a lower 25% Fed tax rate, your tax bill would be $50,000 when drawn out of the rollover IRA account. The NUA election would have saved $11,000 in Federal income taxes.

Because there is a tradeoff between recognizing income immediately on an “in kind” stock distribution (NUA election) and a full retirement plan rollover, the cost basis in those employer shares is a significant consideration. The lower the cost basis in the shares, the better. Studies have shown unless your cost basis is 50% or less of the stock’s FMV at the date of distribution it is hard to make a case for the NUA election, and a full rollover to an IRA likely makes the most sense (www. kitces.com).

That said, everyone’s situation is different and there are varying factors that may lead to one recommendation over another. Even your desire for charitable giving may weigh in on the decision. For example, let’s say you were to make the NUA election and receive 100 shares with a cost basis of $40 and a FMV of $100; this would create 40k of gross income in the year of distribution. But, if you were to donate 40 of those 100 shares to a charitable organization or donor advised fund, you could create an offsetting 40k charitable contribution deduction. This offsetting deduction could mute the immediate income tax impact and leave you with 60 shares (60k value) that can appreciate at preferential tax rates outside of a retirement account.

There are a multitude of taxpayer specific situations and profiles that may or may not support making the NUA election. So, if you hold employer stock in a qualifying retirement plan and are getting close to retirement, looking to rebalance the account, or sell out of any of those employer shares, please reach out to us and see if an NUA election strategy makes sense for you.

If you would like to talk with one of our advisors please call Jill Novak at 503-905-3100.

---

Related Articles

Exciting news from the Human Investing office:  In the year 2017 alone five babies will be born into the families of Human Investing (2 girls and 2 boys already, with 1 boy on his way)! For myself and the other new parents in our office, 2017 has already been a year of much joy, little sleep, ‘dad jokes’, cliché parenting sayings and a bunch of finance nerds trying to figure out how to care for their little ones and save for their college education. Here’s what we came up with. First the cost –

In recent years, the average rate of inflation in college costs has been about 5%.

Source: National average cost data © 2017 The College Board, “Trends in College Pricing 2016.”

Parents like my wife and I and others in the office may have different goals and philosophies on how much we would like to cover for our child’s education expenses - whether a dollar amount, like $50k, or a percent of the education expense. Whatever the philosophy, we understand the need to save. But what is the best vehicle to do so? Here are a few of the most common options and some important considerations to take into account when saving or choosing an account type:

• 529 Savings Plan: 529 accounts allow you to set aside after-tax contributions that grow tax free. The balance can be used for qualified higher education expenses, such as tuition, room and board, and books. States may offer 529 plans to residents, often with tax breaks or additional incentives - check your state here.

• Coverdell Education Savings Account (ESA): ESAs allow you to set aside after-tax contributions that grow tax free. Account value can be used for expenses not exclusive to college. Unlike 529 plans, there is flexibility to use ESAs for qualified education expenses from Kindergarten through Graduate School.

• Roth IRA: The Roth IRA can be used as a combination retirement account and educational savings vehicle. Your after-tax (Roth) contributions can be invested for retirement purposes and college expenses can be withdrawn with exemption to early withdrawal penalties. Additionally, the value of your Roth IRA will not hurt chances for financial aid eligibility as it is not considered assets on the Free Application for Federal Student Aid (FAFSA).

• Uniform Gifts to Minors Act and Uniform Transfer to Minors Act (UGMA/UTMA): The original college savings account, UGMA/UTMA assets are transferred to the child’s account and are invested on their behalf until he or she reaches age 18 – 21 (defined by state). At this time, the beneficiary can use dollars for whatever they wish. With a UGMA /UTMA you can realize $1,050 of gains tax-free per year. Note: UGMA/UTMA is in the child’s ownership for FAFSA purposes.

* This data is provided by www.savingforcollege.com and is subject to change. The numbers provided reflect 2017 regulation and will fluctuate with time. Please contact a trusted tax professional to understand exact tax implications.

The consensus: If you are looking to maximize saving for college and want to make it a family affair (any one can contribute) then the 529 is the best option. If you are not sure about college for your child but would still like to save for their future, then other great options like a UGMA/UTMA may be beneficial. Want to talk about what type of account is best for you or share baby stories? Let’s talk, Human Investing is here to help.

---

---

Related Articles

  It has been widely reported that Equifax, one of the three main credit reporting companies, suffered a major data breach that exposed Social Security numbers and other vital information of millions of people.

About 143 million people in the United States were affected by this breach. Data was available to hackers in May and July. The hackers had access to Social Security numbers, dates of birth, addresses, credit card numbers and other information.

Before we share some steps to help protect your credit, we want to go over exactly what is included on your credit report:

Personal Information

Name, address, Social Security number, date of birth and employment information. This information is not used to score your credit.

Trade Lines

Credit accounts. Lenders report on each account you have established with them. This includes the type of account (credit card, mortgage, auto loan, etc.), date accounts were opened, credit limit, account balance and payment history.

Inquires

Inquiries occur when a lender asks for a copy of your credit report. The inquiries section is a list of everyone that has accessed your report within the last two years.

Public Records and Collections

Public record information from state and county courts. Overdue debt from collection agencies, bankruptcies, foreclosures, suits, wage garnishments, and liens are also included.

What is not on your credit report

A few things not included in your credit report are your bank account number(s) and balances and investment account number(s) and balances.

So, what action can you take?

There are a number of steps that you can take to protect your credit and identification.

The first, confirm if you have been impacted by this incident. You can do this by visiting https://www.equifaxsecurity2017.com/potential-impact/ and entering your last name and the last 6 digits of your Social Security number. Additionally, Equifax has setup a dedicated call center to answer basic questions regarding the breach. You can contact them directly at 866-447-7559. Be prepared for long wait times.

If you have been impacted, it may be wise to take one or more of the following steps to protect yourself.

Do a Credit Check

Consider checking your credit with the three credit agencies, Equifax, Experian, TransUnion. This can be done for free by visiting https://www.annualcreditreport.com/. If you see suspicious activity on your report contact the affected entity and the reporting agency.

Freeze Your Credit

A credit freeze will make it more difficult for someone to open a new account in your name. It cannot, however, stop a thief from using one of your current accounts. To apply for new credit, you will need to unfreeze your credit.

Monitor

At a minimum, closely monitor your credit card and bank account activity. Most banks and credit cards offer alert services which can be configured to send you an email when there is activity on your accounts. Contact your bank or credit card company immediately if you see suspicious activity.

ID Theft Protection

Sign up for an ID theft protection plan through companies like LifeLock, Experian, and IdentityForce. These services provide the monitoring and protection on your behalf. Fees for this range from $10 to $30 per month.

Take caution with phone calls or emails that claim to be from the credit agencies especially Equifax.

If you have any questions please feel free to call our office at 503-905-3100 to speak with either myself or Jill Novak.

With a week or so left of summer we come to the close of an enjoyable schedule of vacationing, traveling, summer reading, and relaxing. One book I’ve been reading talks about the timing of making investment changes based on your financial plan and if there is a “best” time. The author uses the analogy of conducting life-boat emergency drills. When done while the ship is in port during calm seas, these drills can make the difference between surviving the storm or sinking. Careful, thoughtful planning and strategizing during times of peace can provide the greatest probability of surviving an emergency. Similarly, in the context of investing, the best time to discuss asset allocation and how much is in growth assets like stocks (more volatile) versus income assets like bonds (less volatile), is when the markets are in a calm, low volatility state. Currently the Volatility Index (VIX) is near a 27-year low. This is 80% below the October 2008 peak in volatility during the housing and financial crisis. Applying the analogy of the sea, we are currently in port with lake level waves. October 2008 was like being in stormy high seas in the Alaskan Bering Sea. It would be extremely difficult to make sound investing decisions during the peak of a market storm with heightened volatility.

With that said, today is the day to discuss the risk reward trade-off, where to take the risk, and how much is appropriate based on your financial plan. Your financial plan, not the markets, should dictate how much you have in stocks versus bonds. The best time to make changes (if the plan dictates) is during seasons like the one we are currently in when market volatility is low. Using specially designed software to show what “risk-reward” looks like, the visual below is a comparison of a 100% stock allocation versus a balanced 50/50 stock to bond allocation. This shows the volatility of a particular allocation and the normal range based on historical events. You can see the financial benefits and drawbacks to certain allocations at differing times. Does your plan suggest more growth or more income? Due to historically low volatility, this is a great time to reassess your plan and investments.

Considering the market, we can also draw upon the analogy (and one we in Oregon are currently living through) of forest fires. While devastating, these fires clear out the excesses and overgrowth to reset the clock of growth and life. The markets act in much the same way. After many years of growth and abundance there comes seasons of cleansing where the inefficiencies and excesses in the market are reset. These resets come in the form of recessions and market corrections. On average, there is a 20-30% correction every 5-6 years. Fires are a normal part of the environment where we live and the markets where we invest. While we can’t predict exactly when these events will occur, we can plan, prepare and make appropriate adjustments to weather them with as minimal damage as possible. Take the time today. If you would like to talk with one of our advisors please call Jill at 503-905-3100.

Two Things to Consider When Managing Your Employee Stock Options.

Stock options are an interesting benefit. Instead of giving you actual shares of company stock, your employer gives you the “option” to buy a certain number of shares at a particular price. While options can be a tremendous benefit, they are frequently mismanaged causing you to either take too much risk or to miss out on most of the benefit. If you’ve been given employee stock options there are a couple of things to know.

First, there are a different types of stock options: Non-qualified Stock Options (NQs), Restricted Stock Units (RSUs), Incentive Stock Options (ISOs), etc. Second, the value of your stock options may differ from owning actual shares of stock. Understanding how options pricing works is key to getting the most from this potential benefit.

For this post, I’m going to focus on non-qualified stock options. Non-qualified stock options have a few moving parts that can have a major impact on your ending value - or whether there is any value at all.  When an employer, such as Nike or Intel, gives non-qualified stock options, they come with a particular grant price.  The grant price is the price at which you have the “option” to buy your shares of stock. Having an understanding of the stock price vs. the grant price will help you maximize the value and minimize your risk of loss.

The grant price is the key difference between owning actual shares of stock and a stock-option. Unlike owning actual shares of stock, your options value is based on the difference between the grant price and the actual stock price, not the value of the stock price itself. Therefore, if the actual stock price is greater than the grant price, your options have monetary value. If the stock price is below the value of the grant price, then your options have no value.  For example, if you have 1000 shares of Nike options with a grant price of $65 and the actual stock price is $58, then that particular grant would be worth $0.

Here are two common mistakes I see employees make:

Mistake #1 – Selling Too Soon

Until the stock price exceeds your grant price by a significant amount, you will have only a partial benefit. For example, let’s assume the following:

• You were granted 1000 shares

• The share price is $60

• Your grant price is $57

Since the stock price is $3 more than your grant price, your options would have a value of $3000 ($3 of value per share x 1000 shares). While $3000 is a nice amount of money, it would only equate to 50 shares of actual stock ($3000/$60=50 shares). If you sell at this point in time you would effectively lock in a value of 50 shares instead of the full 1000 that you were given. As the stock price increases, your effective number of shares increases as well.

To show how this works, let’s assume the stock price increases to $80/share. How do your 1000 options look now? The new stock price of $80 gives you a value of $23/share ($80 - $57 = $23). Your new options value is $23,000 ($23 x 1000 shares). At this price, you’d have the equivalent of 287.5 shares ($23,000/$80=287.5).

In addition, you will notice that while the stock price went up from $60 to $80 in our example (an increase of 33%), your option value increased from $3000 to $23,000 (an increase of 667%). This is a phenomenon that is unique to stock options and one that can provide a lot of upside benefit. However, as you’ll see below, it can also expose you to more risk than you might think.

Mistake #2 – Holding on too long

For those of you who’ve seen some nice growth in your options over the years, you are possibly taking a lot more risk than you need to.  As you saw in our previous example, option value can rise significantly greater than the price of the stock itself. The flip side is that if the stock price declines, your options will go down in a greater percentage than the stock itself. Again, this is caused by the fact that you were not given 1000 actual shares of stock, but the “option” to buy 1000 shares at a price of $57/share.

To further demonstrate this, let’s use the reverse of the example above. If the stock price goes from $80 down to $60, a person who owns actual shares of that stock would lose 25% of their account value. However, since you have a grant price of $57 your options would go from $23,000 down to $3000.  That’s a loss of 87%!

Summary

Without a strategy for managing your stock options, you could be leaving a tremendous amount of money on the table and/or exposing yourself to a lot of unnecessary risk.

There’s no guarantee how any stock will perform in any given time-period, but with a proper strategy you can maximize your option value and minimize your risk, helping you stay on track with your financial goals.

If you would like help putting a strategy together to make sure you’re maximizing your options, give us a call at 503-905-3100.

---

Related Articles