Do You Have Money In Them?

In the early 2000’s, we had the technology bubble.  More recently, we had the real estate bubble.  Now, I see two new bubbles that may be developing – and may be putting your nest egg at risk.  I’m talking about bonds and gold.

The reason I won’t be surprised if there ends up being a bubble in bonds is that I just saw a statistic stating that year to date close to $150 billion dollars has gone into bond mutual funds. And in the same time period, over $50 billion dollars have been taken out of stock-oriented mutual funds.  If my math is correct, that’s about $100 billion dollars that has flown from money market accounts into bond mutual funds.

When you think about it, that’s the herd mentality in action. After all, the real estate bubble was at its peak when it seemed like everybody was jumping into real estate, with “flip this house” and “preconstruction condos” and “flip the contract” and all that craziness.  When I see a huge migration of money into a particular area, to me, that means a bubble may be forming.  This could be the case with bonds.

Interest rates are at historical lows. Bonds go down in market value when interest rates go up. So if you’ve got money in a bond mutual fund, you need to be very aware of any increase in interest rates, because a raise in interest rates will cause the value of your bond mutual fund to go down.

Note that I’m not talking about individual bonds.  When you hold those until maturity, you get your money back even if the value goes down.  You just need to be careful about bond mutual funds and all the money that’s flocking in to them. The question you want to ask yourself is “what’s my exit strategy? How will I know when it’s time to get out of my bond mutual fund?”  Now is the time to develop your exit plan.

The other bubble that might be forming up is gold.  If you haven’t heard, gold just hit an all-time high. It crossed over $1,300.  And that makes me kind of nervous.  I’m not worried that gold can’t or won’t go higher, and I’m certainly not suggesting that the floor is getting ready to fall out from under gold. I’m just talking about being careful.  Right now, when the media is saturated with advertisements to buy gold and nationally syndicated radio talk show hosts are peddling gold, I’m reminded, again, of the real estate bubble.

Remember all that advertising for “make money in real estate seminars” and home study courses and workshops? They were all over the place. But I haven’t seen those kinds of advertisements lately, have you? That’s how I feel when I see “sell your gold”, and “we buy gold “and “get your gold coins” everywhere.  When an investment is suddenly advertised all over the place, that suggests to me that maybe we’re closer to the top in the cycle — regardless of what the investment is.

My advice is simply to be careful and not put too much money in those areas. And if you’re already in…make sure you have an exit strategy – know when it’s time to get out and have a plan to do it.

This year’s been a little bit frustrating for investors.  The sideways movement of the market obviously isn’t what any of us want.  And if you have money in mutual funds, you may very well find yourself in a situation where your mutual fund is showing flat returns, and maybe even a modest loss for the year — but at the end of the year or next year, you’re going to get a 1099 showing a capital gain!

That’s one of the disadvantages of mutual funds. They have to report and distribute capital gains by year-end – it’s just the internal activity going on in the mutual fund. So even if you haven’t sold your shares, if there have been capital gain activities or capital gains in the fund, you’re going to have to pay tax on those gains even though you personally may show little or no profit.

That’s one reason why we think ETF’s (Exchange Traded Funds) provide a better tax planning opportunity.  With ETF’s, you got investment diversification that’s similar to a mutual fund, but when it comes to taxes, it’s treated more like a stock. You don’t pick up a gain or a loss on your Exchange Traded Fund until you actually sell the fund. So that gives you better control of your individual tax situation.

So as we head in towards the end of the year, and end of year year-end tax planning, this is something to think about.  It could be time to re-think your investment strategy. If you’ve got money in mutual funds know and understand what the capital gain distribution is going to be, you may find that that distribution is going to far exceed what your gains are for the year — especially in a year like we’ve just gone through.

If you’re not already using Exchange Traded Funds, that’s something that you want to look into, for now and for the future.

Today, I want to take a closer look at mistakes that could cost you big money when it comes to your financial security and a worry free retirement. This might be a little controversial, and that’s okay.  My purpose here is to get you thinking, and maybe further review and evaluate your own situation.

1. Spreading your money around means a smoother ride.

This seems to be a very popular philosophy or strategy held by just about everybody in the financial world.  But I believe that approach has serious flaws. Just look back to the bear market of 2000-2003 and what happened there. I remember telling clients don’t worry, rarely does the market decline three years in a row.  Well, guess what happened in the third year of that bear market? The market went down again and the losses were equal to the prior two years combined!

So that was evidence enough for me to figure out that this theory of asset allocation, strategic allocation, pie chart investing, always have a certain percentage in US and foreign stocks and bonds and so forth is flawed.  And we saw further proof that the concept is flawed in 2008 when there were hardly any safe havens.

2. Base your investing strategy on the results of a risk tolerance questionnaire.

Some people believe that you should take some kind of a questionnaire to figure out how much risk you’re able to live with and then design an investment strategy that basically guarantees you experience that level of risk. I don’t think that makes any sense whatsoever.

How does that align with your own personal goals and how you want to live life? What if you only need to take half as much risk to have good odds of keeping and reaching your goals that your risk profile indicated you’re willing to live with? Why on earth would you want to subject yourself to more risk than was necessary?   Besides that, I’m a firm believer that if you take same questionnaire and fill it out in the middle of a bull market, the results would be significantly different than if you filled the questionnaire out in the middle of a bear market.

3. Investing in multiple mutual funds will give you plenty of diversification.

I meet a lot of people who think they’re diversified because they have money in 10, 15, 20, even 30 different mutual funds. But when we drill down into the mutual fund holdings, more often than not we find that they’re concentrated in one area of the market — usually large-company US – with little or no exposure in international or a small-company.

This is fine if the demand for stocks is focused on large-company US, but why on earth would you want to have most of your account allocated to large-company US if the demand, and therefore increasing prices and higher profit opportunities were in areas like, say, international or technology?

So the bottom line that I really want to share is I believe that the commonly accepted strategic asset allocation — always have a fixed percentage of your money in certain investment categories; rebalance periodically; and just stay invested at all times — is flawed.  I believe a better strategy is based on supply and demand — pushing money into areas that are in highest demand while avoiding areas that are in weakest demand.    A more dynamic strategy like this will help you stay on top of a changing market and see the type of returns you deserve.

In the game of life, you get to write your own rules

One of the biggest lessons I’ve learned from working with so many people over the years is that happiness really is more a function of your mindset.  It’s about being honest with yourself.  What is it that you really truly need, not want but need, to be happy?

When I think about happiness, I think about my friend Jimbo – or as hundreds, maybe even thousands of people know him — Jimbo the hotdog guy. Jimbo has a life that most people would find, at least on the surface, very appealing.  I mean, who wouldn’t want to work six months on the beach in the summertime, and then go to Mexico for six months in the winter on vacation?

Jimbo’s job is literally selling Cokes and hot dogs on the beach in the summer.  His uniform, of course, is a T-shirt and a swimsuit. And I think he might be the happiest guy on the face the earth. Regardless of what’s going on, he’s always got a smile on his face.

But there are some things about Jimbo’s life that other people might not consider ideal.  He lives in a manufactured home – some people would call it a double-wide – that he owns free and clear. He just got air conditioning a couple of years ago. His cars are ancient.  He pays cash for everything.

Can you imagine living in Florida in the summer without air conditioning?   Jimbo did, for around 14 years.  And when he goes to Mexico every winter, he drives. He doesn’t fly because the lifestyle he’s chosen doesn’t generate a huge six-figure income. It’s probably barely a five-figure income.

And yet somehow Jimbo has managed to be happy.  Why? Well, he’s figured out what he needs to be happy. It doesn’t take a million-dollar or a multimillion dollar bank account.  It’s about understanding what brings him joy and satisfaction and being content with that.

And you get to do that too.  In the game of life, you get to write your own rules.  Only you get to decide what makes you happy.

Whether you’re in the market for a new or used car, most people hate going through the drill of haggling with car dealers.  If that’s not your idea of a fun way to spend the day, you may not be aware that there is a really good alternative out there to help you get a good deal on the car you want.  I call them automobile brokers.

Automobile brokers can find you either a new or used vehicle for essentially the dealer wholesale cost, plus a service fee you pay to the broker.  Automobile searches can be done on a nationwide basis, and if the numbers make sense a vehicle can be shipped or delivered and still end up costing you less money.

How much less money?  Well, an informal survey from the discount auto purchase program we’ve made available to our clients for several years now, says that most folks are saving anywhere from $3-$5,000 on the vehicles they purchase, new or used.

Another good way to save money on a car is to consider a slightly used vehicle.   When you purchase a car that’s two or three years old with average to below average mileage, the original buyer takes the hit on depreciation and you end up with an almost new vehicle.

If you’re set on a new vehicle, make sure that you negotiate the best price, and that you own the vehicle long enough to recover and recoup the depreciation. That means if you plan to trade cars every two or three years, you will be better off in a slightly used vehicle. On the other hand, if you’re going to buy a new car and hang onto to it until you run it into the ground, then buying new is a more viable option.

Of course, when it comes to the question of used vs. new, some people feel more comfortable with new.  They know they have the warranty and a dealership for repairs.  But in some cases, people are a little misinformed about how vehicle warranties work.  Typically, with any vehicle, the factory warranty stays with the vehicle whether you’re the original purchaser or not.

My own experience with nearly new vehicles has always been that any of the dealership service mechanics are more than happy to work on your vehicle, whether you bought it from that particular dealership or not.  Everyone is looking for service and repair work and will be more than happy with your business.

Other people might worry about the history of a used vehicle.  A Carfax can be helpful, but Carfax doesn’t pick up everything.  The information is as good as the insurance claim information available — so if a previous owner handled a repair with cash, and it doesn’t show up in the insurance claims system, then it’s not going to show up on a Carfax.  It’s always best to have an experienced mechanic look at a car – or to use an automobile broker service with an experienced mechanic on hand.  It’s always better to have an expert as part of your team when it comes time to purchase a vehicle.

Studies suggest and research shows that well over 70% of adults still don’t have basic estate documents in place.  And I guess that’s understandable. Who wakes up in the morning in eager anticipation, thinking, “Today’s the day to talk about my estate documents?”   Nobody I know of.

But regardless of how old you are, everyone of legal age should have these basic documents in place; a will, a durable power of attorney, a health care power of attorney and a living will.

Everybody knows what a will is for – it directs who gets what assets and property upon your death. But what happens if you’re incapacitated either physically or mentally, whether it’s temporary or more permanent?

Since you haven’t passed away, the terms of your will don’t kick in. This is where you need to have what’s called a durable power of attorney. This essentially means that you’re giving somebody power of attorney to act on your behalf, making decisions on your behalf from a financial and legal respect if you are unable to do so.

There is also the health care power of attorney or health care surrogate.  This is when you give a specific person permission to tell your doctor what sort of care you want and what sort of procedures you desire if you’re unable to communicate your wishes yourself.

This leads me to the living will, which I think is kind of a misnomer, as a living will is a document where you give medical providers permission to end your life.  Specifically, a living will authorizes your doctor to withdraw life support if it appears you’re going to be in a continual vegetative state and have no chance of recovery.

DO NOT do this on your own. There are numerous websites and books and fill in the blank forms available all over the place – but if you make even a small mistake, your heirs may end up paying legal fees and court costs that far exceed the price you would have paid to have an attorney do it right first time.  A ballpark figure probably would be somewhere in the $300-$500 range, which I consider ‘cheap insurance’, not expensive legal fees.

The death of a spouse can be a painful and confusing time.  Unfortunately, it can also cost the surviving spouse big money in the form of overpaying on their taxes.

You probably know that if you inherit an asset and then turn around and sell it, you’re only taxed on the increased value from the date that you inherited the asset. For instance, if you inherit a stock worth $100 from a friend or family member and they only paid $10 for it, you can turn around and sell the stocks at $100 and pay zero tax on the $90 profit!

So here’s where we see mistakes being made by surviving spouses when a couple buys an asset and own it jointly. We’ll use that same $100 stock as an example.

Say you and your spouse buy stock in a joint account for $10. Now it’s worth $100. Your spouse passes away and you want to sell the stock. What are your profits for tax purposes?   If you’re like a lot of people, you instinctively remember what you paid for the stock –$10.  And when you report that profit you report it as $90. Which is wrong!

You would actually be over-reporting your taxable income.  Why?  Because you haven’t adjusted your tax basis (cost) as a surviving spouse.  When you stop and think about it, you actually inherited a portion of that stock. You owned 50% of the stock, but your spouse owned 50% of the stock.

What this boils down to is the fact that you get a stepped-up basis on your spouse’s interest in the asset.  For that same $100 stock, you should adjust your cost to $55. Meaning you would only pay tax on a $45 profit.

This is a common mistake we see too many surviving spouses make when it comes to selling assets that were accumulated during their marriage.  If you have a friend or family member who is a widow or a widower, make sure that they’re aware of this provision so they don’t unintentionally overpay on their taxes.

Because I can tell you this; the IRS is not going to call you up and say, “Hey wait a minute, you paid too much. Here’s the correct amount.” Although they’ll be more than happy to contact you and let you know if they think you underreported or under-paid!

If you are a do-it-yourself investor and are using mutual funds, how could you do it better?  Look at lower-cost alternatives to mutual funds, and use ETFs (exchange traded funds).

You could go from trading mutual funds to investing in individual stocks. I’ve known folks (but they are rare) that have done just fine getting in and out of stocks over time and taking a long-term view of the market.

Unfortunately, I’ve seen way too many folks trading stocks with results far below an index like the S&P 500, the NASDAQ or the Dow.

Expertise is the first roadblock to trading stocks.  The second?   It takes a ton of time.  You’ve got to stay on top of the research. You’ve got to stay on top of the trends.

Of course, if you are going to buy-and-hold, you could argue that there’s no time involved in that.  And sure, if you don’t mind being on a roller coaster ride once in a while, you can sit there and not worry about it and tell yourself, “Hey I bought this blue chip, and it’s going to do fine in the long-haul.” I’m pretty sure Enron was a blue chip at one time – and we all know what happened there. Which is why you need to stay on top of things.

The last roadblock to trading stocks (vs. mutual funds or ETFs) is…more volatility!

One stock vs. a basket of stocks, is going to be much more volatile. And that means a roller coaster ride. And for the most part, I don’t know a whole lot of folks that are comfortable not paying attention to how much money they have or how much risk is involved.

So what’s another, less stressful alternative? Hire a professional to handle it for you. One that uses low cost investments, like ETFs, as opposed to high cost mutual funds.  A professional has the expertise you don’t, the time you don’t, and can keep you from being a victim of your own emotions, keeping you off the roller coaster and on the path to steady growth.

I can’t tell you, honestly, how many times I’ve heard someone say, “I’m not happy with my broker, but I don’t really pay him, so I can’t really be that upset.”   And when I tell that person that while they might not see the money coming out of their account, they’re still paying the broker, the person almost invariably says,

“Oh no, I don’t. I don’t pay them anything.”

Then I show them their account statement, and we look at all the different mutual funds or variable annuities that they hold, and I explain that these companies are paying the broker or brokerage firm.  Brokers usually don’t fully disclose the fact that they are getting paid by a company for selling people their mutual funds or annuities. At least not the total amount they’re being paid. So when clients find out, they’re usually shocked beyond belief!

It’s different with a Fee-Only® company like ours.  We’re an investment advisor and wealth manager. We actually ‘do’ real financial planning.  And we charge our clients a fee – we disclose it right up front so our clients know exactly what it is.

People can’t really make an apples-to-apples comparison between us and those brokers who deal in mutual funds because we don’t have mutual funds that pay us. We’re paid by our clients, not the investment company! So we provide advice and make decisions that are in our client’s best interest. And we can do that because we’re not being paid by anybody else.

Let me explain how this might make a difference in your financial life.  Say you have $100,000 invested with your broker and you are in mutual funds. I’ll use an example of the US mid-small-cap group of mutual funds. And I’ll compare it to something called an exchange-traded fund, an ETF, that our firm might use. It’s a fund as well, but it’s a completely different animal than a mutual fund. The major difference really is the cost.

With mutual funds, the average costs that you don’t see (it’s disclosed, but it’s not easy to find) is 1.43%, per year. So if you have $100,000 invested, you’re actually paying $1,430 per year. Now compare that with an exchange traded fund (ETF). The average cost for this type of fund is .51%, or about ½%. On the same $100,000 account your yearly fees would be $510.

That’s a savings of over 64%! ($510 vs $1,430)…but what does that mean for you?

Over 10 years assuming an average 8% return you’d have $19,100 more in your account!  What would you do with an extra $19,000?

That’s the difference in the fees and costs that most mutual fund and annuity brokers don’t show you! (Note: The costs are at least double with a variable annuity!)

Most people know that if they take money out of an IRA before turning age 591/2, they have to pay a 10% penalty tax on the money. But did you know that there are actually some exceptions to the tax code? If you follow them to the tee, you can pull money out of your retirement account and avoid the 10% penalty tax. Here’s how;

If you have a short-term need for money, you can use the 60 day roll-over rule. If you pull money out of an IRA and redeposit the money within 60 days, the money isn’t considered taxable income and don’t have the 10% penalty tax. You can only do this one time every 12 months, so you need to keep good records to make sure you don’t take more than 1 distribution in any 12 month time period.

If you have money in an employer sponsored retirement plan like a 401k or 403b, you can take your money out after age 55 without incurring a penalty tax. Here’s how;

You have to separate from service with that company after you turn 55, and then take your distribution in order to avoid the 10% penalty tax. If you leave the company before your actual 55th birthday, as long as you turn 55 within that same calendar year, the 10% penalty will not apply, because you’ve turned 55 the year in which you separated service.

But what if you don’t have money in an employer retirement plan and/or you’re not yet 55 and you want to have access to your money and will need it longer than 60 days?

Then you could tax advantage of section 72t distributions. It allows you to set up an IRA account to take what the IRS calls a — series of substantially equal periodic payments — those payments will then avoid the 10% penalty tax.

Payments need to run for at least 5 years or until you turn 59 ½ (whichever time period is longer). Just be warned — the penalty if you don’t follow these rules is severe. If you violate the rule, all the prior years distributions are subject to the 10% penalty tax – in addition to the regular income tax you will have already paid on the distributions.

Sometimes, folks will start a 72t payment plan, and then they come into more money/income and wind up with taxable income that’s higher than what they had originally planned for. Then it becomes a numbers-crunching situation. Do you stop the payments and pay the penalty tax or do you continue the payments? Depending on your circumstances, it may make sense to terminate the 72t payment schedule.

Whenever possible, we encourage folks not to utilize a 72t payment schedule. You have to ensure that you maintain the integrity of the payments to avoid paying the penalty tax down the road, and to a degree you limit some of your flexibility. But under the right set of circumstances, a 72t plan can be a viable planning strategy.

Note: Please keep in mind that this article is for informational purposes only and should not to be relied upon as advice. It is merely a reminder that there are many choices you have available to you, and that planning is the only way to find the right answers for your situation! As with any financial issues, make sure you get the right information before making a decision! If you have any questions, we’ll be glad to help you!