Smart Money Moves Prior to Year-End

I love Christmas but I find Christmas-time stressful. Let’s face it, the world just seems to spin faster during December. We’re already busy with work and family and then we add a slew of fun things like holiday parties, office open houses, gift buying and decorating to our schedule. Who has time for all this fun?!

I’m sure you’ve seen and maybe even read end-of-year financial checklists. While well-intended, I’m sure, I laugh out loud when I read suggestions like, “compute all your expenses for the year in a spreadsheet and develop a budget for next year”, or “review all your estate planning documents to make sure they are up to date.” Yeah, right, I’ll get on that just as soon as I replace all the batteries in the smoke detectors and re-grout the bathtub.

So, in the spirit of the Holidays, here is my advice on what deserves your attention before the end of the year and, what is important, but can wait until January.

Spend a few minutes on these items now:


Whether you suspect you will receive a refund or pay Uncle Sam in April, there are a few things you can do now to reduce your tax liability and help yourself in the process:

• Check if you have contributed the IRS-mandated maximum to your retirement plans – 401(k) or 403(b). The limit for those under age 50 is $18,000 per year, while those of us 50 and over can contribute up to $24,000 per year. Note to UK employees, you may contribute to a 457(b) plan in addition to your 403(b). So, if you’ve maxed out your 403(b) contributions you can also contribute $18k or $24k to your 457(b). That’s a great UK benefit.

• You may also contribute to an IRA or Roth IRA depending on your income and whether or not you have a qualified retirement plan at work. The rules can be a bit convoluted but you may be able to make a tax-deductible contribution to an IRA for $5,500 or an after-tax contribution to a Roth IRA for the same amount. For instance, if you have a 401(k) or 403(b) at work and your adjusted gross income (AGI) is less than $99,000 if married and less than $63,000 if single, you may make a tax-deductible contribution to an IRA. If your income exceeds those limits, consider a Roth IRA contribution if you are single and your AGI is less than $118,000 or $186,000 if married. (You can actually contribute to an IRA or Roth until April 17, 2018)

• If your income is too high to allow a tax-deductible contribution to an IRA and you don’t already have one, consider an after-tax contribution to an IRA and then converting the IRA to a Roth IRA. That move won’t decrease your tax liability this year but is a good long-term tax strategy for high earners who can benefit from tax-free earnings until the assets are withdrawn after age 59 ½.

• This is a great time of year to reduce your taxable income by making a donation to your favorite charity or charities. And, if Congress passes a new tax law these rules may change for next year, so take advantage now and help those who really need it. Lisa and I favor God’s Pantry Food Bank, the YMCA and, of course, the University of Kentucky.

• Tax loss harvesting is a tool that can also reduce your taxable income. If you own investment assets in a taxable account – not your work retirement plan or an IRA – you may sell assets that have declined in value during the year and 1) Use the losses to offset any gains realized from selling assets that have increased during the year; or 2) Deduct up to $3,000 in losses from your taxable income. You may also carry forward losses to future tax years. But don’t sell an asset just to get the tax deduction if you think the investment has potential for the future.

Focus on these items when you have time now or in January:

Did you meet your short-term financial goals for the year?

How did your investments perform this year?

Did you make progress toward your long-term financial goals?

I will discuss these in the Friday, December 15 Lexington Financial Planner blog post.







These Six Traits Predict Your Ability to Build Wealth

I have a distinct memory of sitting on a tractor on my grandfather’s Nebraska farm as an adolescent and telling my father and brother that I was going to be a millionaire someday. My Dad laughed out loud and asked how I was going to manage that? I shrugged and said, “I just will.” I never had a get-rich-quick scheme or a vision to create the next Pay Pal, I just kind of had a gut feeling that I would go to college, get a good job, and save. In fact, I already had a good track record of saving, reaching my parents’ stated threshold of $1,000 before they would allow me to invest in the stock market. Fortunately, my wife is also a good saver and – with advice as clients of Moneywatch Advisors for 25 years – that has resulted in an accumulation of wealth greater than we imagined possible.

But what makes a person a good saver? Is it an innate skill that we have or don’t have? Can it be learned? Can a spender become a good saver?

The book, The Millionaire Next Door illustrated that wealth is what you accumulate, not what you spend. Wealthy people have figured out how to turn their income into wealth – savings – that can be used on their future selves.

So, are there traits that wealth builders – savers – have in common? What makes some people good at turning their income into wealth?

Sarah Fallaw, daughter of the Millionaire Next Door author Thomas Stanley, and an industrial psychologist Ph.D., has researched and discovered six distinct and consistent traits that predict if someone will be good at wealth building. They are:

Frugality – your willingness and ability to spend below your means;
Responsibility – do you believe you have control over your financial outcomes or do you believe wealth just happens to people?
Confidence – do you have the confidence to believe you’re capable of improving your situation?
Planning and Monitoring – can you set goals and monitor your progress?
Focus – do you have the discipline to avoid distractions and stay on track to your goals?
Social Indifference – do you feel a need to spend to display social status or are you socially indifferent to the spending habits of others?

Clearly, most of these traits are either innate or learned behaviors by the time we’re income-earning adults. But, Dr. Fallaw’s research shows that we can improve these traits – sometimes by ourselves and sometimes with help.

In fact, the investment firm Vanguard’s “Advisor’s Alpha” study has researched financial advisors around the country and found advisors add, on average, 3% in incremental return to a client’s investment portfolio annually. This means clients’ annual returns are, on average, 3% better if they use an advisor than if they go it alone. More important to this conversation is that 1.5% of that incremental return is related strictly to helping their clients change and/or improve their financial behaviors. Advisors help them develop and enhance those six traits that are important to building wealth.

Need to be more frugal? Maybe assistance developing a budget will help.

Need help setting goals and monitoring your progress? A good financial planner will make that the first exercise in the engagement.

Do you have a desire to become a “millionaire next door”? If so, really think about those six traits and, as honestly and objectively as you can, ask yourself how good you are at each one. And, then, what areas would benefit from some help?

Retirement or College – Which Comes First?

The term “sandwich generation” commonly refers to those people who are caring for aging parents and their children at the same time. Today, I introduce a new term – The Financial Sandwich Generation.

We often see clients in their mid-30’s to early 40’s attempting to save for their own retirements even while they pay off their own student loan debt. Adding to that balancing act, they are also having children and are now concerned with saving for their college educations too. We may actually be witnessing the very first generation that has to deal with three major obligations all at the same time – 1) Student loan debt; 2) Retirement; and now 3) College funding for their kids. Thus, the Financial Sandwich Generation. (Trademark pending)

So, how should this new generation prioritize their obligations? First, this should be approached similarly to the instructions we receive on an airplane before takeoff – you know, the ones we never listen to. They tell us that if the cabin loses pressure, oxygen masks will automatically drop from the ceiling panel above us. Put on your mask first, then assist your child. Those instructions should be our model for prioritizing our obligations as well. As a parent, that is the exact opposite of what we naturally want to do, right? We’re used to subrogating everything to our offspring – love, food, comfort of all types. So, all of a sudden, we’re expected to be selfish and put our needs first? Why and how?

Here is the recommended order and reasoning:

• To be blunt, you can borrow for college but you can’t borrow for your retirement. So regular, automatic contributions to your planned retirement accounts should take priority – pay yourself first.
• Next comes your student loan debts. After a nuclear Armageddon, only two things will still exist: cockroaches and student loan debt. Even bankruptcy can’t erase that obligation. So, make those regular payments.
• Finally, saving for your children’s college education will require smaller monthly contributions the earlier you are able to start.

Saving for college can be daunting if you pay too much attention to the headlines about tuition so let’s look at an example:

If paying retail is for suckers, so is paying the full sticker price advertised for tuition. Very few do. So, don’t think you have to save 100% of the expected cost of attendance. Most experts agree that saving enough for one-half of the expected cost will suffice. The rest can come from tuition discounts, scholarships, other financial aid and, as a last resort, student loans.

According to the College Board Trends in College Pricing, the total 4-year cost of an in-state public university (tuition, fees, room and board) for a child just born will be $137,757 when the child is ready to head to the dorm. So, your goal should be to save half of that amount – $68,878. A large number, yes. But, let’s break it down:

If you save just $160 per month for 18 years in an account that earns 7% per year, on average, you will achieve your goal. In Lexington, that’s about half what the cable company charges for internet, phone and a reasonable TV package, so cut the cord and put your money into some real value. (Sorry, couldn’t resist taking a jab)

As always, having a plan to balance all your competing financial needs will put you on the right path to achieving all your financial goals, while easing your worries.


96% of Stocks Are Losers – How to Buy the Winners

Have you ever dreamed about going back in time? What would you do if you could? Other than telling Rick to guard Grant Hill to prevent the pass to Christian Laettner during the 1992 NCAA tournament, I would buy Apple stock. Why Apple? Because in the history of the markets since 1926, Apple has generated more profit for investors than any other American company – $1 Trillion. Hendrik Bessembinder, a name built for Pig Latin if I ever saw it, is a professor of Finance at Arizona State who has studied stock return data and concluded that most stocks aren’t good investments at all – many don’t even beat the paltry returns of one-month Treasury bills. What?

In fact, only 4% of all publicly traded companies have accounted for 100% of the net wealth earned by investors in the stock market since 1926. That means 96% of stocks are losers. Dr. Bessembinder defines net wealth as total stock returns in excess of 1-Month Treasury bills, which averaged 3.38%, so the total actual returns of Apple and these 4% are even higher than indicated.

So, all we have to do is figure out which stock will do the best over the next 20-30 years and we will be set! Or, of course, travel back in time and pick Apple – which may actually be easier to do. Dr. Bessembinder said, “In a market where most of the big gains are attributable to a few big winners that are hard to identify in advance, it makes a lot of sense to diversify to avoid the danger of omitting the big winners from your portfolio.”

Consider this: If a non-diversified portfolio has $500,000, all in U.S. stocks, and the market declines by 20%, the portfolio will decline approximately $100,000 to $400,000. If you are within a few years of retirement, that can be quite frightening. Now, in order for your investment assets to grow back to their pre-downturn amount, the stock market must gain 25% to reach their original value of $500,000. Even scarier.

But, if your portfolio is properly diversified, it shouldn’t match the ups and downs of just the U.S. stock market and it shouldn’t decline as much when the market declines.

Here is how to ensure you own the big winners over the next 20 years and are properly diversified: First, pick funds that contain a large number of stocks rather than purchasing individual stocks themselves. Second, pick funds that are attempting to generate returns by using different strategies. For instance:

Growth Funds seek to purchase stocks of companies that they believe have the potential to increase sales and earnings;
Value Funds seek to purchase stocks of companies where the current stock price doesn’t reflect the company’s value;
Small Cap Funds invest in companies with small market capitalizations;
Mid-Cap Funds invest in, you guessed it, mid-sized companies;
Large Cap Funds invest in, of course, larger companies.

Furthermore, to truly diversify a portfolio one must also invest in asset classes that aren’t closely correlated with the stock market. In other words, they zig when the market zags, and vice versa. Asset classes such as:

Long Term Income assets that are designed to generate income, not necessarily appreciate in value;
Real Estate funds that invest primarily in the stocks of real estate companies and seek growth through both capital appreciation and current income and are often a good hedge against inflation;
International funds that invest in non-U.S. companies and seek returns through the growth of those companies.

As always, your financial plan should guide your actions and your portfolio should be constructed so it supports your long-term goals. Diversifying properly will help you achieve those goals faster and with fewer ups and downs.



How the Trump, House Tax Proposal Affects You

Back in late September the Lexington Financial Planner blog wrote about how President Trump’s tax proposal would affect you. Now, the House Ways and Means Committee has revealed their tax bill so let’s take another look. No talking points, no politics, just math. Uh, fun math. No, seriously.

While the income subject to tax may be higher for many of us, at least those of us with those pesky kids, our overall taxes may be changed little because the tax rates are spread out farther among brackets. See below for the proposed new rates based on taxable income:

While it’s impossible to capture every person’s circumstances, let’s take a middle of the road example and apply the new proposal. So, as in September, let’s start with our fictitious couple and how much they pay under current tax law:

Current law:

Chandler and Monica earn a combined $125,000 in salary and each contribute 5% pre-tax to their employer’s retirement plan. For simplicity sake, we’ll ignore other pre-tax deductions like their pre-tax cost of their employer’s health insurance plan, and call their Adjusted Gross Income (AGI) $118,750. (Gross income minus their retirement contributions) Unlike our friends on TV, they have two children.

Under current law Monica and Chandler have a choice between subtracting the standard deduction of $12,700 from their AGI or itemizing deductions. As you can see below, their itemized deductions are more than their standard deduction, so they obviously deduct the larger amount:

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• State and Local Income tax deduction – $9,797
• Property tax on their home – $2,000
• Charitable contributions – $1,000
Total: $18,375 (clearly more than the standard deduction of $12,700)

In addition to their itemized deductions, Monica and Chandler are also allowed to deduct $4,050 each as personal exemptions plus dependent exemptions for each of the kids, for a total of $16,200.

Finally, their AGI of $118,750 minus their itemized deductions of $18,375 minus their personal exemptions of $16,200 equals Taxable Income of $84,175 and Tax Liability of $12,521.

New Proposal:

Although mortgage interest and charitable contributions are still allowable as itemized deductions, state and local income tax deductions are not allowed. Property tax up to $10,000, however, can be included as an itemized deduction.

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• Property tax on their home – $2,000
• Charitable contributions – $1,000
Total: $8,578 (now less than the new standard deduction of $24,000)

Monica and Chandler are no longer allowed to deduct $4,050 for their 4 personal and dependent exemptions because those have been rolled into the proposed standard deduction.

As a result, Chandler and Monica find their itemized deductions are lower than the proposed new standard deduction – $8,578 is lower than $24,000 – so they use the higher number.

Finally, their AGI of $118,750 minus the standard deduction of $24,000 equals their taxable income of $94,750. Based on the new, compressed tax brackets it appears their tax liability would be $11,988 – a tax savings of $533.

In addition, the tax plan highlights indicate an increase in the Child Tax Credit but it doesn’t contain details about how those credits will apply. The credit for their two children could lower their tax liability further.

Key Takeaways:

• Thankfully, and correctly, the proposal keeps the current deduction levels for retirement plans such as 401(k)’s, 403(b)’s, 457(b)’s ($18,000 for those under 50, $24,000 for those 50 and over) and IRA’s and Roth IRA’s ($5500 for those under 50, $6500 for those 50 and over). That’s very good news and good for those of us without a traditional pension (most of us).
• Although a married couple with two children will likely have lower overall deductions than they do now, the lower tax rates may very well lower their overall tax liability.
• Those without children will likely see their deductions increase, and their overall tax liability decrease.
• For those of us with children under age 17, the child tax credit increases but details are still sketchy about any phaseouts based on income.
• The tax rates on capital gains and investment income from taxable investment accounts remains the same.
• For those high earners and those with stock grants from their employers, the Alternative Minimum Tax is eliminated.
• The mortgage interest deduction only applies to mortgages of $500,000 and less where the current amount is $1M.


Should Cal and Rick Pay Down Debt or Save for Retirement?

There is a natural, and understandable, instinct in most of us to want to pay off our mortgage as soon as possible. In fact, it’s considered a kind of rite of passage. Yep, the missus and I paid off the house and finally have the kids off the payroll, now we can save for our retirement! But, is paying down your house or other debt early really the right thing to do for your long-term best interest?

Let’s take a closer look at a couple of common situations people face:

1. Cal owns a home for him and his family that is reasonably-priced for his family’s income with a monthly payment that allows them to pay all their expenses with a little left over. What should they do with that “extra” money each month? Pay down their mortgage or save and invest for their future? From a math perspective, Cal’s decision should be based on his after-tax cost of borrowing versus his after-tax return on investing. So, let’s assume Cal has a 30-year mortgage at 4% interest and he and his wife are in the 30% tax bracket. The true cost of that debt is 2.8% because mortgage interest is tax-deductible. So, 4% rate minus 30% equals 2.8%.

Cal’s financial planner tells him that his investments – in his 401(k) and his wife’s 403(b) – should earn a 7% annual average return, if averaged over the long term. Since that rate of return is in tax-deferred accounts, we won’t deduct income taxes from the 7% return.

So, comparing where to put that “extra” money is quite simple, right? 7% is more than 2.8%, so that’s where the dollars should go. Carrying a low-interest mortgage and investing extra dollars into your retirement is a wise decision since your investments will have a better return than what the debt is costing you. In other words, Cal will be better off investing at 7% than avoiding a cost of 2.8%.

2. Rick has a good income because he went to a good university and graduate school but he has student loan debt. Should he put his “extra” money into paying down his student loans or into his retirement accounts? First, we would tell Rick to, at the very least, put enough into his retirement accounts to receive the match from his employer. Don’t give away the free money. After that, the calculation is the same as above. This time let’s assume the student loan interest rate is 6.5%. Let’s also assume that Rick’s financial planner tells him he can expect to earn an average of 7% over the long term from his investments. As a high-earner, Rick is in the 35% tax bracket. As most student loan debt is not tax-deductible, we won’t lower the interest rate for comparison. And, as above, Rick’s investments are in his work 403(b), we won’t lower the return number either.

So, should Rick pay down his loans or sock more into retirement? Although the student loan interest rate is lower than the rate of return from his investments, it is close enough that he should put that “extra” money into paying down his student loan debt. (We would recommend he explore refinancing his student loans to get a lower rate but that’s for another discussion)

Student loan debt is a deterrent to saving enough for retirement for many young people and all options should be explored in order to put your money to work for your future self as soon as possible.

Like many things, debt is okay in moderation and under the right conditions, if it helps us purchase things that will help us. Debt for a home with a competitive interest rate at a payment that allows you to pay your expenses and save for retirement – probably good. Six-month old credit card debt for Chinese food you can’t even remember eating – probably bad. As always, having a plan to retire debt and reach your goal of financial freedom will help get you to both faster.

If you want to examine your own personal situation, use the online calculator here:


FOMO or LA – What Type of Investor Are You?

Last week the economist Richard Thaler won the Nobel Price in Economics for his work that explains that people behave irrationally. Well, duh, right? Anyone who has ever been to a frat party can tell you all about irrational behavior. What Thaler did was apply this to economics by trying to measure and predict how humans will “misbehave”, or not act in their own best interest. Thaler believes most individual investors have behavioral biases that get in the way of rational decision-making and can have a negative effect on the long-term growth of their assets. Some of us have FOMO – Fear of Missing Out – and others have LA – Loss Aversion. In fact, most of us have both! Long-term investing success requires us to overcome those natural biases. But how?

We’ve all heard that we’re supposed to Buy Low and Sell High but, in fact, many of us, if left to our own devices, do just the opposite. When the market is rising, and the media talks about it a lot, we tend to get FOMO. If everybody else is getting rich, I want some of that too! Buy! Conversely, when the market is diving, we acquire Loss Aversion. I can’t stand to see my investments go down! Sell, sell!

In fact, this fear of losing money seems to be hard-wired in almost all of us. Thaler said, “…losses sting more than equivalently-sized gains feel good.” The sage philosopher and former boxer, Mike Tyson, said it this way – “Everyone has a plan until they get hit in the mouth!” In other words, we make poor decisions such as selling when the market dives and making paper losses permanent, even when we really know better.

Now, it should be noted the U.S. stock market is in the midst of an 8-year Bull run where there has been little volatility since the recession in 2008. So, many of us may not even remember how we reacted when the market last tumbled.

To see how our personal biases can negatively affect performance, the chart below shows how individual investors, the do-it-yourselfers, have fared much worse than they should have over a 20-year period (JP Morgan Market Insight):

To quantify this further, $100,000 invested in 1994 in the S&P 500 would be worth $581,370 by 2013, but only $163,862 if managed by the average investor on their own. That’s because most of us get influenced when the markets rise and fall and do the opposite of what is in our best interest when facing gains and losses – FOMO or LA hits us – and we irrationally Buy High and Sell Low.

So, how do you remove your emotions and invest with success?

• Analyze your long-term needs;
• Quantify your financial goals;
• Develop a plan with annual savings and investment returns goals;
• Structure a portfolio to support your plan;
• Rebalance your portfolio quarterly to stick to your plan.

Having a financial plan supported by a well-designed portfolio that allocates your investments appropriately for your individual circumstances will help remove your emotions and personal biases from the equation, resulting in better returns.