What’s The Appropriate Risk Level In Your Investment Portfolio? Order A Tesla.

Have you ever purchased a Tesla automobile?  The ordering process is rather remarkable: your car is custom made to your specifications, then either delivered to your nearest service center or directly to your front door.  Every option, from paint to battery to roof to wheels, is designed by you.  Tesla eschews the days of shopping from the limited inventory of an automaker car lot, an experience that invites compromise in favor of immediacy (“I can drive it home today!”).  The Tesla ordering process requires an investment of time, energy, and patience by the purchaser to document what he/she wants and then wait while the car is manufactured and delivered.  While this approach might drive the stereotypical social-media gorging Millenial to the looney bin, it likely contributes to Tesla’s high customer satisfaction ratings, as it engages the consumer, with their input at the forefront, encouraging satisfaction with an outcome of their own making.  Would you rather have a product sold to you or designed by you? 

The best process for the allocation of your investment portfolio is no different than ordering a Tesla.  It first requires input from you along six axes:

1) Current inventory of assets (homes, cars, investment securities, retirement benefits, etc.)4) Projected future earnings and net savings
2) Current inventory of liabilities (monthly fixed and variable expenses, including outstanding debt)5) Financial and life goals (including large discretionary purchases, family size, education, and retirement)
3) Current age and projected lifespan (health factors, etc.)6) Investment risk preferences

With these variables defined, a financial professional can lead you through finalization of the “car” specifications.  By defining the aspects of the future you envision, especially your life goals, the probability of achieving them can be quantified and adjusted, just as you change the car options and view them on a virtual image while weighing their costs. 

What you want vs. What you can afford

You want to buy a house in five years, but you aren’t saving much and you have an aversion to investment risk?  You will likely need to spend less now and increase your investment risk appetite to meet the goal.  You’re 50 years old and want to retire at 60, but your asset balances are average for your age and income, you are in good health with a long expected lifespan, and you also want to buy an expensive boat in two years?  You will likely need to compromise on the new boat purchase or target a later retirement age, or both.  And so goes the configuration process: it’s a give and take based on what you have and what you want, often in concert with software that can quantify risk and return probabilities, encapsulate variables like negative sequence of returns risk, and project cash flows based on savings, costs, and asset flows.  This process can produce a probability of success score for each goal, quantifying the impact of the specifications you choose.

Let’s distill these examples even further.  What “options” on the “car” can you really control?  Recall the 6 axes defined above.  Three of them can change moving forward (Dynamic column), while the other three (Static column) are fixed at the point of analysis, like standard equipment on every “car” model.  Thus, choosing the right “car” is really an exercise in moving three financial levers: savings, goals, and investment risk.  Further, two of those levers, savings and investment risk, have limits on their spectrum: only so much of future earnings can be saved (given reasonable spending needs), and only so much investment risk can be taken (without borrowing/leverage, which is another subject entirely).  The lever with the most flexibility: financial/life goals.  Thus, financial planning is an exercise in setting reasonable goals given limits in what can be achieved through savings and returns on invested assets.   Other preferences around savings and investment risk may also reduce your life goals, such as wanting a high standard of current living or a low risk investment portfolio for peace of mind.   Of course, the “standard equipment”, like a high current level of assets (perhaps inherited or earned through your career) or young age, may help to facilitate your life goals.  The point is to go through the detailed process of understanding the “standard equipment” and picking the “options” on the “car” until you determine a model that you can accept… and afford.  

Once you’ve come to a good conclusion on reasonable specifications for the “car”, it’s sent off to the manufacturing plant for assembly.  It’s here where the appropriate investment risk model is married to your accepted goals and financial variables.  As a best practice, the risk models are delineated by “high risk” and “low risk”, where the most important factor in the model is the proportion of assets allocated to each category, with the “high risk” category offering a higher expected return at the expense of greater investment return variability.  Engineering of the asset classes that lie within each category, and, to a lesser extent, the underlying investments themselves, can add value to the assembly of the “car”, but by far the most important decision, one that has the greatest effect on portfolio returns, is the allocation of assets to “high risk” investments vs. “low risk” investments.  In the Tesla metaphor, the correct “assembly line” (risk model) to produce the “car” (risk:return ratio, savings rate, goals, etc.) you need was determined in the configuration process described above.  The investment advisor’s job is to flip the right switch, initiate the right assembly, and maintain the “plant and equipment” (research and analysis on asset categories, classes and investment options) so that the car is produced with minimal defects.   Once in service, ongoing “car maintenance” (risk rebalancing, tax loss harvesting, risk model calibration, etc.) is necessary, but Tesla being the innovator that it is, many of these updates are delivered remotely through a software upgrade to its operating system!  So, too, should an advisor’s service offerings be minimally invasive to you, occuring in the background while the “car” continues to run.

Of important note, the Tesla you buy today may not be the Tesla you need at a future point in time.   For instance, the investment risk model that’s appropriate during the asset accumulation (working) phase of your life may be fundamentally different than the one you need during decumulation (retirement).  A viable risk planning strategy is to accumulate to the point that an assumed “low risk” return on a portion of your asset base (including Social Security, defined benefit pensions, annuities, etc.) covers your essential retirement expenses, assumed inflation, and taxes, with the residual allocated to “high risk.”  Prior to that point, an aggressive risk profile across the asset base, paired with a savings strategy, may be appropriate to grow the nest egg to an acceptable level.  Thus, allocation of investment risk is a living, breathing exercise that requires regular analysis, especially as you approach and achieve major financial goals or life circumstances change.  

Elon Musk built Tesla, Inc., into a car (and energy/storage) company that has more equity value than competitors that produce 100 times as many cars.  It did so by tailoring each car to its customers’ needs based on their input, gaining their buy-in during the configuration process, and retaining it through superior manufacturing, maintenance and service offerings.  Use this paradigm when thinking through your financial life.  Know that the goals you achieve are based on the goals that you design; make sure your circumstances drive the design, and be an active participant and decision maker in that process.  Choose an advisor with an assembly plant that has a robust investment risk model as the manufacturing equipment and a maintenance and service offering that makes necessary changes and updates with minimal inconvenience to you.  Finally, make sure to assess your “car” needs at inflection points in your life, especially around retirement and other financial goals.   In short, go order and own a Tesla: it’s the best financial blueprint out there.  

Where Should I Invest My Money? [And The Fall Of The Greek Empire]

It’s the most common inquiry in the investment industry (neck-and-neck with, “When can I retire?”): “Where should I invest my money?”

While it’s a very simple question to ask, and admittedly an important, pertinent one, it’s quite ambitious to expect a thoughtful response in that narrow context.  Asset allocation requires a complex alchemy of both science and art, applied to your specific circumstances.  Given the popularity of this question, let’s pull back the curtain on the “Great and Powerful Oz” and define what steps are necessary to devise and apply an asset allocation model for you:

  1. Identify available investable asset classes with sufficient liquidity and volume for retail investors.
  2. Identify the investment vehicles that capture each class identified in step #1 with sufficient diversification at the lowest possible cost.
  3. Codify each asset class based on a 3-tier evaluation process:
    • Expected future returns based on historical data
    • Historical volatility
    • Historical correlation with other asset classes
  4. Re-frame the expected return, volatility, and correlation of each asset class based on current and expected future macroeconomic and geopolitical trends.
  5. Filter and exclude asset classes based on the output of steps #3 & 4.
  6. Categorize each remaining asset class into risk tiers based on the results of steps #3 & 4.  
  7. Determine an appropriate weight for each asset class per risk category.
  8. Define the appropriate risk allocation for the investor in question, taking into consideration his/her available assets, expected future earnings, liabilities and life goals. See: https://www.ebis-blog.biz/whats-the-appropriate-risk-level-in-your-investment-portfolio-order-a-tesla/
  9. Determine the tax circumstances and mix of account types (taxable, tax deferred, tax free) of the investor and adjust the allocation model accordingly.

Thus, synthesis and application of this process cannot be done without a significant modeling effort, and, most importantly, input from you.  Further, it makes answering that ubiquitous investment question impossible in the span of an elevator ride.    “Where should I invest my money?” should really be, “What process do I need to engage in to determine an appropriate risk allocation for my assets?” 

Recall Alexander the Great.  He was a military genius in the fourth century BC who failed to lose a battle in his expansion of the Greek empire to northern Africa, across Mesopotamia, and all the way to northwestern India, defeating barbarians, Berbers, Persians, and Ashvakas in the process.  However, he can be faulted for his strategic planning, as his military expansion depleted Macedonia’s physical and human resources to the point that it fractured into four autonomous states following his death and ultimately fell to Rome after the third Macedonian War.  And Alexander’s dying wishes?  The further conquest of Arabia and the entire Mediterranean basin, followed by circumnavigation of Africa, a feat not accomplished for another 1,700 years until the Portuguese sailor Vasco da Gama turned the Cape of Good Hope during the Age of Exploration.

The Alexander metaphor applies to your financial affairs.  In other words, don’t be overly ambitious with your investment approach.  Realize that investing is an involved process that requires quite a bit of strategic planning and input from you: tax status, assets, life goals, etc.  Looking for a quick fix like a hot stock or investment tip falls victim to the thirst for empire building that took Alexander to the far reaches of the earth and ultimately led to the fall of the Greek state.  It circumvents a process that serves you best in the long-term; work with an investment professional to navigate the nine steps above knowing that your own preferences and financial variables, requiring your input, are some of the most important drivers of the solution.

Alexander: the anti-investor

TAX CUTS AND JOBS ACT: Winners, Losers, and Investment Strategies

The Tax Cuts and Jobs Act (TCJA) is a 500+ page piece of legislation passed by both houses of Congress and signed into law on Friday, December 22, 2017, with most of its provisions affecting taxes in 2018 and beyond.  It’s a massive piece of legislation that some analysts feel is the most extensive overhaul of our taxation system since the Tax Reform Act of 1986 under President Reagan.  It touches most aspects of our economy, from taxes and incentives for individuals, trusts and estates, sole proprietors, partnerships and corporations to a major change in healthcare with the repeal of the individual mandate under the Affordable Care Act (ACA).  It is worth noting that almost all of the individual tax changes are due to expire at the end of 2025, a budgetary strategy GOP senators used to pass the bill with a simple majority, rather than a filibuster-proof 60 votes.

Rather than recount every detail of TCJA, here we link two chart-based summaries of TCJA:



Below we try to distill its major provisions into a set of Winners and Losers, with commentary on how the law’s changes will affect tax-paying investors, and what to consider in positioning your investment portfolio accordingly. 


  1. The U.S. economy, through the repatriation of U.S. corporate profits held overseas in foreign subsidiaries through a clawback provision in TCJA.  Cash assets will be taxed at a rate of 15.5% and non-cash assets at 8%.  Corporations can then use that net-of-tax capital for domestic purposes: research and development, capital purchases, hiring, debt refinancing, stock buybacks, dividends, etc.  The increased revenue to the IRS through this measure will partly offset the cost of the tax cuts, although TCJA is projected to increase the national debt by between $1.4 – $2 trillion over 10 years.
  2. For-profit C-corporations that pay U.S. taxes, with their tax rate lowered by 14 percentage points to 21%, with AMT eliminated and full expensing of short-lived capital assets for 5 years.  With a territorial corporate tax system now adopted by the IRS, corporations are free to invest and produce in whatever global tax domain is most advantageous.  By extension, corporate profits and associated equity share-holders stand to benefit. 
  3. Fossil fuel energy companies eager to extract natural resources from the Arctic National Wildlife Refuge, which is now open to commercial exploration under TCJA.  By extension, native species of flora and fauna in the area could stand to suffer from associated habitat changes/degradation and commercial exploration disasters, such as oil spills. 
  4. Owners/partners of pass-through businesses entities (non-services related, including Architects and Engineers, above $157.5/$315k income and all businesses below those levels) that can now deduct 20% of Qualified Business Income (QBI) on personal returns, subject to some limitations on level of W2 wages paid by the firm.  The law especially favors passive owners who don’t collect a salary from the business, who could potentially receive a 20% deduction on all of that income.   The law could introduce unintended consequences for businesses, with some employees moving to sever employment in favor of establishing a pass-through entity and contract/consult-back agreement with their former employer or other businesses.  This provision includes shareholders of REITs, who will now enjoy deductibility of 20% of dividend payments, while the trusts retain full deductibility of interest on debt.  Shareholders of REITs in taxable accounts will specifically benefit.  The nonpartisan Congressional Budget Office (CBO) reported that under TCJA individuals and pass-through entities like partnerships and S corporations would receive about $1.125 trillion in net benefits (i.e. net tax cuts offset by reduced healthcare subsidies) over 10 years.
  5. Investment managers of private investment vehicles, like hedge funds, venture capital, private equity, and real estate.  The tax treatment of carried interest remained largely unchanged, despite GOP political promises to repeal it, allowing these managers to have their investment performance income taxed at the same rate as long term capital gains from public stocks: 15 – 20% plus the 3.8% investment surtax (for high income earners), as opposed to ordinary income at a top rate of 37%.  Under TCJA, the time period that an investment must be held to qualify for the advantageous carried interest tax treatment did lengthen from 1 year to 3 years.
  6. The wealthy, with a marginal tax rate deduction of between 2.6% – 4.6%, depending on income levels, from the highest bracket (39.6%) under old law.  In addition, people paying Alternative Minimum Tax (AMT) have their exemption floor and ceiling phase-out amounts move significantly higher, e.g., ceiling phase out moved from $164k to $1MM for a married couple.  For many folks AMT exposure was caused by high itemized deductions for state and local income and property taxes and lots of personal and dependent exemption deductions. Those breaks were disallowed under the AMT rules. With the new limits in deductions for state and local taxes, the elimination of personal and dependent exemption deductions, and larger AMT exemption deductions, many previous victims of the AMT will find themselves off the hook, starting next year.  For those with the ability to exercise incentive stock options (ISOs) – one of the AMT triggers –  the AMT rules become much more accommodative to that income stream under TCJA.  Further, the Pease Limitation was repealed, which limited deductions based on income levels, effectively removing a 1-1.2% surtax for upper income earners. High income earners now have no limitations on their itemized deductions – $261,500 single/$313,800 married previously. Thus one could argue that the top marginal tax rate dropped from 40.8% to 37% with repeal of Pease and the TCJA top income rate reduction from 39.6% to 37%. The Tax Policy Center estimates that a new 20% tax deduction for pass-through income, a doubling of the estate tax exemption, lower ordinary income tax rates, and a more generous alternative minimum tax will send 65.3% of TCJA’s individual benefits to people in the top 20% of the income spectrum, with the top 1% getting a $50,000 tax cut on average in 2018.
  7. Heirs to the wealthy, with a more than doubling of the estate tax exclusion under TCJA to $11.2MM single/$22.4MM married.  Conversely, estate planning attorneys will likely lose a large chunk of business from those clients who fall below the new thresholds and use their services under existing law.
  8. Low income and middle class tax-payers.  Income tax rates are reduced under TCJA in 2018 at all income levels from $9,525 to $157,500 (single) and $19,050 to $400,000 (married filing jointly).  Amazingly, the $37,951st dollar earned under the old tax law was taxed at a higher rate than the $157,499th dollar will be taxed under TCJA (single filer), with a similar spread for those married filing jointly ($75,901 – $314,999).  Changes to exemptions and deductions under TCJA will affect realized income as well, with most filers in these income ranges projected to see a tax benefit.    
  9. Families/head of household with children or dependents.  House Speaker Paul Ryan has spoken publicly about his desire to increase family sizes, thus expanding the tax base, to offset the cost of aging Baby Boomers. TCJA contributes in this regard, at least through upper middle class income families (ironically, there is still a marriage “penalty” in TCJA for those married couples earning over $600k to $1MM).  The tax law does eliminate personal exemptions, which incentivized additional dependents, but it Increase the child/dependent tax credit by $1k/$500, respectively, which is a net benefit for those making less than $200k single/$400k married, where child tax credit is eliminated/reduced.  Analyzed holistically, the expanded standard deduction under TCJA isn’t enough to make up for the loss of personal exemptions for families, which could have previously claimed a $4,050 (in 2017) personal exemption per family member, but is trumped by the increased benefit of the child tax credit.  Examples: A family of 5 would have had 5 x $4,050 = $20,250 of personal exemptions, plus a $12,700 standard deduction, for a total of $32,950 in deductions. Under the new law, the new standard deduction remains at just $24,000. In fact, even adding two children – such that the family could have claimed 4 personal exemptions – leaves the family with a smaller deduction under the new rules than existed under prior/current law.  Under the new rules, the couple’s joint Standard Deduction would be $24,000, instead of $28,900. However, the couple will now be eligible for 2 x $2,000 = $4,000 of child tax credits, assuming they meet income thresholds. As a result, while they may pay $1,225 in additional taxes due to the loss of $4,900 of deductions (assuming prior 25% rate), the addition of $4,000 in new child tax credits means their net tax liability is still reduced by $2,775.
  10. Families who want to save for the cost of primary education (k through 12), other than home schooling.  529 plans were expanded, with $10k/per year per child now available from these plans to fund those costs, tax-free.  Conversely, the expansion of 529 payout eligibility, which favors the high cost of private schools, may cause lower enrollment/funding at public schools.
  11. Divorcees who receive alimony, who, in a reversal of current law, will pay no tax on this income under TCJA.  Conversely, those paying alimony will lose the deduction for that expense, beginning in 2019.  Nominally, many analysts believe this change will lower divorce rates, as the higher income earner will have a financial disincentive to separate, which is in-line with House Speaker Ryan’s stated objective of increasing the U.S. birth rate to widen the tax base.
  12. Those with high medical expenses, which can be itemized deductions if in aggregate they are above 7.5% of Adjusted Gross Income, reduced from from 10% in 2017 and 2018.  Note that the standard deduction was approximately doubled, negating itemized deductions for many people moving forward. 
  13. Tax preparers, tax lawyers, and financial planners with increased work due to 500+ pages of new tax laws and an overall tax code that many would argue is equally if not more complex than before, at least for individuals (example: capital gains rates will be based on current tax brackets, not the new thresholds under TCJA).  The boon to these service professionals may be offset somewhat by elimination of personal deductions for tax preparation and investment advisory expenses (under miscellaneous deductions), which could lessen their appeal to those who itemize deductions. 
  14. Potential future victims of sexual harassment in the workplace.  Corporations can’t deduct costs associated to sexual harassment cases from their income if they are subject to a nondisclosure agreement as part of the settlement, which may provide an incentive for companies to invest in employee education, stricter workplace guidelines, more extensive employee vetting, etc. in this area. 


  1. Foreign governments that lured U.S. businesses to their shores to shelter corporate profits from U.S. taxation, which will lose future taxation on that capital under TCJA.  TCJA requires repatriation of those profits, with cash assets taxed at a rate of 15.5% and non-cash assets at 8%.  The lowered U.S. corporate tax rate to 21% could spur an international corporate tax war, with each sovereign government doing its best to court multi-national corporations, which would have unpredictable consequences for their own tax revenue streams.
  2. The Internal Revenue Service and the U.S. Treasury, which will lose significant revenue due to TCJA, to the tune of an estimated $1.455 Trillion in additional U.S. debt over 10 years, according to the Congressional Budget Office.
  3. Potentially entitlement programs, such as Medicare and Medicaid, which must receive mandatory cuts based on the debt expansion enacted under the tax law, unless new legislation is passed to avoid it (which the GOP has pledged to do).  Regardless, the budget will be under pressure for cuts to counter-balance the lost revenue from the tax cuts, and that points to entitlement reform, something Speaker Paul Ryan has pledged for 2018. The Tax Policy Center (TPC) estimated 72% of taxpayers would be adversely impacted in 2019 and beyond, if the tax cuts are paid for by spending cuts separate from the legislation, as most spending cuts would impact lower- to middle-income taxpayers and outweigh the benefits from the tax cuts.
  4. Charities and non-profits, which stand to lose contributions with the approximate doubling of the standard deduction, nullifying the tax benefit of giving for some Americans.  Estimates are 2-7% less giving under TCJA, even though the ceiling for charitable giving was increased to 60% of Adjusted Gross Income from 50%.  Some givers may skip giving in some years in order to double or triple, etc. their contribution in one year to reap a tax benefit, creating uneven cash flows and difficult revenue forecasting for recipients, unless dispersed periodically through a donor advised fund.  In addition, highly compensated employees at non-profits incur an excise tax of 21% on salaries over $1MM.
  5. Sectors of residential real estate.  TCJA includes numerous provisions that are unfriendly to residential real estate: mortgage interest deduction reduced to debt below $750k from $1MM (for reference, 64% of mortgages in New York City are for > $750k); Home Equity Line Of Credit (HELOC) (or any home equity indebtedness not used to improve the home) interest no longer deductible; a $10k state and local tax (SALT) cap on property, income and sales taxes (for reference, 4.1MM Americans pay > $10k in property tax alone); the standard deduction approximately doubled, negating the mortgage interest and property tax deductions for many Americans.  TCJA could prove specifically harmful to housing at both 1) the higher end of home prices above the mortgage interest deduction cap and equivalent property tax deduction cap, and 2) the lower end of home prices that don’t equate to an itemized deduction benefit under the new rules. 
  6. Those buying insurance through the Affordable Care Act exchanges, which under TCJA no longer require insurance to avoid a tax penalty, beginning in 2019.  With fewer people electing to buy insurance without the mandate, CBO projections are 13MM fewer people insured and annualized health care premium price increases of 10% or more.
  7. Those residing in high income/sales tax & property tax states.  TCJA institutes a deduction cap at $10k for State and local tax (SALT) deductions for both single and married filers, with an approximate doubling of the standard deduction, effectively punishing tax-payers in states with high costs in these areas.  These high SALT states are primarily located along the north Atlantic and Pacific coasts.    
  8. Those who disproportionately rely on CPI-U inflation (normally low-income earners taking advantage of the earned income tax credit), as TCJA now employs a chained CPI-U calculation (which is generally lower than CPI-U) for yearly increases in thresholds, such as deductions, credits, and exemptions, due to inflation.  This change means these values are worth less through time, as they won’t rise as quickly under the new CPI calculations, and all taxpayers will be pushed into higher tax brackets at a quicker pace, as the inflation calculation which sets their boundaries rises at a slower pace.
  9. Single filers with taxable income between $385k – $416.5k in 2018.  In a strange anomaly in the TCJA tax brackets, these filers are the only group to see a tax increase as a result of the tax changes.  All other filers, including all those married filing jointly, will see a tax decrease based on the new law’s tax brackets.  (Note: This analysis does not consider application of changes in exemptions, credits, and deductions, which are specific to each filer and can significantly alter taxable income.) 
  10. People who incur unreimbursed business expenses or expenses to move for work. The miscellaneous deductions category, subject to a floor of 2% of AGI, was eliminated under TCJA, which now disallows deductions for unreimbursed business expenses.  Also, tax filers can no longer use an above-the-line deduction for moving expenses or receive a tax-free benefit from an employer who pays for them (they will be considered taxable income). 
  11. Those employees with funds in deferred compensation plans.  TCJA changes the timing of taxation of deferred compensation plans to the point at which the funds lose the risk of forfeiture (become fully vested), not when they are paid.  This change could result in large, unexpected income streams for some employees in 2018, unless the deferred compensation plans are restructured. 
  12. Children (under 19, students under 24) who have unearned income, e.g., an inherited IRA. For income over $12.5k, children are now taxed at 37% trust tax rates, instead of their parents’ rates.  This change will punish children with unearned income other than those who have parents in the highest marginal tax bracket.
  13. Owners of non-real estate investment property (classic cars, boats, airplanes, etc.), who planned to enter into a 1031 exchange with a counterparty to avoid capital gains on sale.  Beginning in 2018, 1031 exchanges are permitted for real estate only.


  1. Review allocation to domestic equity.  Regardless of how the re-patriated capital and increased profitability from decreased corporate tax rates is used, e.g., share buybacks, dividends, research & development, debt restructuring, capital expenditures for business expansion (which a Yale survey pegs at only 14% of increased profits), it is likely to have a stimulative effect on equity prices, all else held equal.  Potential international corporate tax competition through the new territorial tax system could also increase profits of domestic corporations. 
  2. Review allocation to high-yield debt.  TCJA limits the deductibility of net interest expense to 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years, and 30 percent of earnings before interest and taxes (EBIT) thereafter.  For firms with significant debt, forcing a high nominal interest rate, this new law could negatively affect taxes due, even with the lowered corporate rate, and possibly force credit downgrades.  Bond expert Jeff Gundlach commented earlier this month, “There’s probably going to be some unintended consequences [of the tax bill]; it will probably harm some companies and some sectors [in the high-yield market].”
  3. Reconsider Roth Conversion Strategies.  Re-characterizations of Roth IRA conversions are no longer allowed after 2017.  That means early calendar year conversions (benefiting from potential intra-year gains) in anticipation of income levels will prove more risky, and likely move some conversions to year-end when income levels are known (and a Roth conversion is deemed appropriate based on its increased income recognition).  This tax law change also affects conversions into down markets when more shares could be converted at the same dollar amount with a re-characterization, albeit in a different tax year.  It means one must commit to the tax consequences of the conversion and the market levels at the time of the conversion. 
  4. Consider placement of REIT investments in taxable accounts. Given that REITs are considered a pass-through entity, where their income stream will receive a full 20% deduction under TCJA, their placement in a taxable account will prove advantageous against other investments that produce ordinary income (depending on the magnitude of the income stream).   Note that at every income level under TCJA, investments that produce qualified dividends and long-term capital gains will be taxed at lower levels than income on REITs, so proper analysis of potential distributions from each type of investment is necessary to locate it in the appropriate tax-free, tax-deferred, or taxable account.
  5. Consider holding off buying a new home/speed up the sale of an existing home, depending on your tax circumstances.  As detailed in Losers section, there are four TCJA changes working against the tax appeal of residential real estate, especially at the low and high ends of the price spectrum.  If you are considering a transaction in real estate in the near future, consider how the new law would affect what you are buying and/or selling, as well as its effect on mortgage rates (see below).  Note that the mortgage interest deduction limitation only applies to new purchases, which could incentivize some people to remain in their existing homes (especially since they can refinance existing loan principal moving forward under the old limits).
  6. Consider refinancing short term debt to long-term debt, reconsider asset duration, and beware of inflation.  The fiscal provisions in TCJA could prove economically stimulative, especially for corporations, which may lead to higher interest rates and increased borrowing costs, with higher inflation.  The Federal Reserve could need to counteract the loose fiscal policy of TCJA, combined with a U.S. economy that has grow over 3% in two straight quarters, with tighter monetary policy.  This tightening would likely take the form of higher interest rates, set through the target Federal Funds rate and Discount rate, combined with unwinding its bloated balance sheet, increased to over $4.5 trillion from the Global Financial Crisis, a process which began in Q4 2017.  In addition, interest rates will receive upward pressures with the U.S. Treasury in need of significant additional debt issuance to finance TCJA. For investments in debt, consider the full term-structure of interest rates when determining the duration of an investment strategy.  Increasing short-term interest rates, the only rates set directly by the Fed, may not affect longer maturity bonds to the same degree, as they can be less sensitive to short-term changes in economic dynamics.  Also consider investments that are inflation-hedged, like TIPS and commodities, or less inflation sensitive, like variable rate debt and real estate.  Conversely, lock into debt, such as student loans or mortgages, for longer periods of time, which will lower your cost of debt if interest rates increase and see its principal value erode if inflation increases.
A Winner & A Loser

Roth IRAs: When Should You Take Distributions?

The benefits of contributing to a Roth IRA are significant, as it, along with Healthcare Savings Accounts, enable not just tax-deferred investment compounding, but tax-free investment withdrawals (if certain conditions are met, see below) without a required schedule.  Thus, it’s financially beneficial to house tax-inefficient investments, with a high expected return, in a Roth account and let the investments “ride”, i.e., let them appreciate through time with no forced withdrawals.  

That may seem obvious, but less apparent is the answer to the sticky question, “When should I start taking distributions from my Roth IRAs?”  The knee-jerk reaction might be, “As far down the road as possible,” as, again, the Roth structure has so many tax advantages to benefit long holding periods:

  1. Tax-free investment compounding
  2. No Required Minimum Distributions (RMDs) during the contributor’s lifetime
  3. Advantageous estate transfer rights to spouses, who retain the no RMD rule
  4. Tax-free withdrawals (based on 5yr/5yr rule on contributions & conversions: earnings on contributions are tax-free if withdrawals start no earlier than 5 years from the beginning of the tax year of initial contribution, and conversion principal is penalty-free on withdrawal if the same 5 year holding period applies – and shorter if the Roth contributer reaches age 59.5 within 5 years/is already that old)

However, point #4 deserves further analysis.  What if you own both pre-tax IRAs/401(k) assets and Roths and sit in a marginal tax rate today that is higher than the one projected during the years you are required to take distributions from your traditional IRAs (which are taxed as marginal income)?  If, in this circumstance, you take a distribution from an IRA for cash-flow needs, does it make sense to avoid taxes and withdraw from a Roth?  Like the answer to any sticky question, it depends.  The variables to consider are two “spreads” (the difference between two values): the distribution time spread and the distribution tax spread.  

As an illustration, consider Julio, who lives in California and currently sits in the highest marginal federal and state tax brackets (cumulatively 52.9%) and is 65 years old.  In his 70s, Julio expects to relocate to Florida and recognize income placing him in the 25% federal tax bracket.  Julio comes from an excellent gene pool for longevity and expects to live to 95, at which time he’ll pass his assets to his son, Raul, 30 years his junior.  Assuming Julio has $100,000 in IRA assets, split evenly across Roth and traditional IRAs, does it make sense to take a $10,000 distribution from a Roth or traditional IRA in these circumstances?  To answer, consider the two “spreads” in question: distribution time spread and tax spread.  The distribution time spread is the average additional tax-free investment time in a Roth that is lost by taking a Roth distribution today.  In our example, we assume the average distribution age in the traditional IRA is 80 years old, while in the Roth, Raul is forced to take the distribution on average 15 years after his father’s death at 95, equating to a 30 year spread.  The distribution tax spread is the difference between the traditional IRA tax rate today and when the funds are distributed as RMDs (assume Roth distributions meet requirements and are tax free): 27.9% in our example.  So, if Julio takes a Roth distribution, he gains a positive distribution tax spread of 52.9% (he pays no taxes on the distribution) today, and pays 27.9% less in RMD taxes on that money in later years.  However, he loses 30 years of tax-free compounding as a negative distribution time spread and must pay 1% in annual investment taxes during that period (assume the funds are re-invested in a taxable account, incurring a 1% annualized tax cost – on investment income, dividends, capital gains, etc.).  Running a financial cash flow analysis using a 5% assumed portfolio return, the Roth distribution wins: the total, after-tax future portfolio value is highest taking money from the Roth, not the traditional IRA.  The tax savings is too much to overcome with the negative distribution time spread vs. a traditional IRA: the economic difference is about $18,000 over 45 years.  Thus, considering the intricacies of your personal situation is key to making the right IRA distribution decision.  

In summary, while in most circumstances it makes sense to keep investments housed in a Roth IRA for as long as possible, make sure to assess your current and future tax situations if you’re contemplating an IRA withdrawal.  It boils down to analysis of two spreads: the distribution tax and time spreads.  Depending on your projected lifespan and that of your beneficiary(ies), if you are older than 59.5 years of age and your marginal tax rates today are higher than projected during your RMD years, a Roth distribution can make sense.  It did for Julio.

Finally, the answer to that earlier sticky question is much easier if the Roth IRA is inherited by a non-spouse, in which case the IRS requires distribution of funds based on an expected lifetime actuarial table.  The distributions remain tax-free.

Sticky Questions

Frontier Markets Investing: Pros & Cons

Frontier markets is a relatively new term in the investing lexicon.  The term represents the smallest capital markets across the globe, those that are normally excluded from global capital indexes, unlike emerging markets, which are generally included.   Countries considered under the umbrella of frontier markets include Kuwait, Argentina, Nigeria, Romania and Pakistan, among over 30 constituent countries, representing a broad geographical mix.  The first index used to track them was established in the year 2000, and the first investable, liquid funds were available in 2008.  The track record on performance and risk is thus short compared to emerging and developed markets.

Should investors put their money into frontier markets?  This linked article (Frontier Equity Markets) provides an analysis of many of the variables to consider in this asset class.  We summarize with our own Pros & Cons lists here:

Frontier Markets

1) Low correlation within and across asset classes, improving diversification1) Political risk
2) Low historical currency risk, as many frontier markets have their currency pegged to the U.S. dollar2) High investment costs, both in local markets and via basket funds
3) Higher equity risk premium than other markets3) Very low market capitalizations
4) High absolute returns and low risk historically relative to other equity classes 4) Low liquidity of underlying capital, leading to large cap index bias
5) Low relative valuations5) Potential restrictions on capital flows and foreign ownership
6) Potential new countries, markets and frontier index expansion 6) Migration of countries from frontier to emerging indexes
7) Easily investible, with a number of basket products7) Short track record of investment performance and risk factors
8) Economic freedom scores of constituent countries comparable to emerging markets8) Lack of market regulation in some countries, which can lead to insider trading, market manipulation, etc.

On the Pros side, the diversification profile of the asset class, the historical risk/return relationship, and its investability stand out.  Historically, frontier markets have offered an attractive correlation profile to other major asset classes, one of the most important factors to consider for an investment in a portfolio context.  These metrics, however, have shown some erosion in recent years, although more data is needed to differentiate a paradigm shift from statistical noise.  In addition, the asset class has shown low cross-correlation within its own shell, meaning the constituent countries show low correlation to each other.  In short, the data show it has potential as an attractive diversifying asset class.  Further, the frontier markets showed the highest return with the least amount of risk compared to emerging and developed markets over the period from early 2000 through late 2012, with similar results in the nearly five years since that study.  That positions the asset class as a relative unicorn, as risk and return are normally correlated, with lower risk delivering lower returns.  Finally, there are sufficient investable products in the marketplace, with the largest mutual fund and ETF focusing on frontier markets both showing assets in excess of $600MM as of end July 2017.  

For Cons, the political risk, high investment costs and short track record are all important to consider.  Without a doubt, the largest concern is political risk.  Unlike domestic investing, and even most western capital markets (save for Brexit and Italy’s Tower of Pisa-like right leanings), frontier markets entail considerable political risk, where capital markets can be tossed into uncertainty or even turmoil by governmental actions both within and across its borders.   Consider the invasion of Kuwait by Iraq in 1990, the Argentinian nationalization of a controlling stake in oil and gas company YPF S.A. in 2012, or the impeachment of Dilma Rousseff in Brazil (although considered an emerging market) last year, and political risks become very apparent.  Second, investment costs are high, with some mutual funds charging in excess of a 2% expense ratio, and the available ETFs charging between .70 – .80%, high for that format.  Further, the ETFs can trade at discounts and premiums as high as 3.5%, an extreme range that seems to be exacerbated in volatile markets, exactly when investors want the ability to trade at net asset value.  Finally, given the short historical period to track this asset class, with the earliest index dating to 2000, it’s important to temper extrapolations and understand that the available time series of data is very limited.  

In summary, frontier markets for investors are very much like a bag of Skittles for kids: a rainbow of flavors, some of which you love, but others you might not like.  The asset class offers attractive return attributes as well as significant risk factors.  As we are big believers in an asset allocation meritocracy, irrespective of market capitalization, this asset class certainly deserves consideration, especially as a supplement for an international and/or emerging markets allocation.  However, it should be considered as a peripheral investment given the list of cons outlined above, and investors should fully understand the risks before investing. 

Volvo All Electric? Not The Only Presage For The Oil Industry…

Volvo Group recently announced its strategy to produce nothing but hybrid and all-electric vehicles within two years (Volvo All Electric or Hybrid), becoming the first major automaker to eschew the internal combustion engine.  While this development might not seem stunning given the rise of Tesla Motors and increasingly common electric vehicle charging stations, it’s significant given the scope: Volvo produced over 530,000 cars last year on record sales, up 6%.  By comparison, Tesla produced just over 80,000 all-electric vehicles in 2016.  In that context, the rise of electric and hybrid vehicles becomes quite apparent, especially when including the record pre-order sales of the Tesla Model 3, rumored to be well over 400,000.  

Will other major car manufacturers follow suit?  One could speculate so, given the migration in consumer preference toward everything green, combined with regulation that is forcing all industries to change.  Nowhere is that more apparent than in the Golden State, where California law-makers have instituted a legislative trifecta across energy marketplaces, emissions standards, and renewable energy consumption.   On Monday, California legislators, in a bipartisan vote, passed a law extending the state’s cap-and-trade energy marketplace, which makes carbon polluters pay economically for their actions while mandating reduced carbon emissions, through 2030.  California already has the toughest vehicle emissions standards in the U.S., and was granted an exception by the EPA under the Clean Air Act for the stricter standard, and in March upheld plans to require a doubling of fuel efficiency of new cars to 54.5 mpg by 2025.  Finally, the California Assembly looks poised to pass bill SB100 in the current legislative session, which would require utilities within the state to produce 100% of its power from renewable sources by 2045.  As a preparatory step to combat intermittency, or the periods when energy sources such as wind and solar fall short of demand, earlier this year San Diego Gas & Electric unveiled the world’s largest lithium-ion battery energy storage center: a 30-megawatt plant.  If California, the world’s 6th largest economy, is any indication, the migration away from fossil fuels is happening… quickly.

Further, over 100 influential corporations globally have voluntarily agreed to consume all of their energy from renewable sources through the RE100 initiative.  These corporations and the California government may be at odds with a U.S. federal executive branch focused on reneging on global climate deals and relaxing carbon standards, but that conflict appears to be an anomaly on the global stage, with nearly every other western government encouraging renewables adoption, in-line with consumer and corporate demand.  

What do all of these developments presage for the oil industry?  Bad news.  Global warming science was the first domino to fall in this chain reaction of consumer attitude, regulation, and legislative action to curb carbon emissions.  As consumers, corporations, and local governments like California make clear, consuming fossil fuels is like serving haggis for dinner: if you eat it, there’s a physical price to pay, and, regardless, you lose all respect for the dinner hosts.  Not a winning recipe for investment success; best to limit your investments in oil and gas commodities and the corporate producers of them.  

Volvo CEO Hakan Samuelsson announced that all Volvo cars will be electric or hybrid within two years.

Taxation of Insurance Payouts by Product: A Quick Reference

Insurance products are incredibly complex.  The policies can have documentation longer than most novels, filled with legal jargon, caveats, restrictions, riders, hidden fees, and a host of other variables that can at times make your mind spin.  And those are the straight-forward policies.  In addition, each type of insurance, from life to health to property and casualty, has a distinct tax profile for the money that owners/beneficiaries receive.   Many people struggle to understand the tax implications of these payouts.  

Here we try to alleviate some of the mystery, with a quick reference to the general tax payout profile of the most common insurance products.  Of course, each insurance policy is unique and can be structured according to the provider’s desire to create a new product or differentiate from competitors, so make sure to read each policy in detail and consult a tax professional to fully understand its tax implications.

ANNUITY – Generally taxed as ordinary income, unless premiums were paid with after-tax money, in which case the amount of payments received, up to the value of the after-tax premiums, is not taxed.  For immediate annuities and deferred annuities that are ultimately annuitized, the proportion of taxable payment is uniform across periods and is set based on the IRS’ estimate of one’s life expectancy (with adjustments for joint & survivor policies).  For deferred annuity withdrawals, the value of the withdrawal is considered from interest and earnings (and taxed as ordinary income) until those amounts are exhausted.  Income tax is owed on deferred annuity lump-sum payments and annuity death benefits, e.g., period certain and deferred annuities, above the after-tax premiums paid. There are some scenarios where an appreciated annuity can be exchanged, via a 1035 exchange, to a long-term care or long-term care/annuity hybrid policy and avoid taxation if that new policy triggers a pay-out.  

A special kind of annuity, one created through a structured settlement for personal injury, harassment, discrimination, etc., and paid by the defendant through a 3rd party insurance company, avoids payment taxation (Periodic Payment Settlement Act of 1983). 

TERM LIFE – Free from income tax, but subject to estate tax above the federal threshold ($5.45 MM in 2016) and state-level estate tax in some states, if policy was owned by the deceased.   If policy was owned by the beneficiary or someone other than the deceased, there are no estate tax implications. 

PERMANENT LIFE – Death benefits follow same rules as Term Life, but dividends earned on the cash value of these policies are taxed, depending on whether one previously claimed the insurance premiums as deductions (if after-tax, the dividends are return of premium and not taxed up to the total value of premiums paid).   Interest earned on the cash value is taxed as income unless reinvested in additional insurance premiums.  

PROPERTY (Home, Auto) – Generally not taxable if receiving payments for damage or loss.  Common exceptions: 1) Real-estate investment property, where the payout is treated as capital gain if not reinvested in the property in a timely manner; 2) Car claimed as a deduction for business purposes, which triggers a capital gain if the payout is greater than the claimed deduction. 

HEALTH – Generally not taxable, except in the case of domestic partners, where an employer-sponsored health plan pays the premiums for the employee’s domestic partner.  In these cases, that premium is considered taxable income, unless the domestic partner qualifies as a dependent of the employee.  If the domestic partners get married, the tax consequence of the premiums goes away. 

DISABILITY – Benefits are taxable depending on whether one previously claimed the insurance premiums as deductions (if after-tax, the benefits are not taxed).  Given that benefits are usually less than one’s salary and one is generally dependent on the benefits when payable, take caution when paying for these policies with pre-tax funds.  Taxes will further reduce the funds that are paid out and available to cover the costs of living.

LONG-TERM CARE – Benefits generally not taxable, unless one claimed the premiums as deductions or the benefits exceed the cost of care, e.g., pro-bono home care by a family member, which can make that portion of the benefit taxable.

When reviewing your insurance options, keep these general tax attributes in mind.  Insurance is often touted as having tax advantages, but, as outlined above, it really depends on the type of product (and potentially unique riders within the individual policy), its owner, and how the money was contributed at origination, among other variables.  

The Privileged Population of Technology & the Downturn of Manufacturing: What it Means for P2P Lending

Many new investable asset classes have emerged in the FinTech revolution, the most prominent of which might be peer-to-peer (P2P) lending, which allows retail investors to lend money directly to other individuals.  The yields are very attractive, ranging from 6% – 30%+ depending on credit quality and loan term (3-5 years), effectively allowing the average Joe to become a bank, democratizing the yield spreads that were once solely the domain of large financial institutions (think credit card interest rates that you can now charge someone else).  

So what’s the catch?  The loans are unsecured and can be used for any purpose.  If the debtor defaults, there is no collateral to buffer losses (you get back whatever a collection agency can recover).  The debtor can simply not pay and allow the default event to damage his/her credit rating.  So, while banks have large departments dedicated to credit analysis, allowing for robust credit modeling before loans are made, the retail investor relies on the FinTech platforms that have emerged to facilitate these loans, e.g., Lending Club, Prosper, etc.  If they model credit risk effectively, investors will benefit and vice versa.  However, they are new to this game and are being tested by recent socioeconomic developments.

As this article, Tech & Subprime Crunch, outlines, the services sector, especially technology, is driving job growth (over 3% in 2015, highest in a decade), while goods-producing manufacturing has contracted in recent years and is projected to remain stagnant through 2024, in spite of recent political momentum that suggests otherwise.  That’s led to an 8% increase in tech wages in ’15, thanks to increased demand, while manufacturing wages are at risk of stagnation or even decline.  It’s a diverse problem that becomes quite evident when one reviews the most common jobs by state, revealing that Truck Driver is the most common, with driving of all sorts employing 4.1 million people at the end of 2016.  Not only is truck driving a direct outgrowth of manufacturing, it’s at risk of being radically changed or eliminated via driverless technology (just as robotics endangers the assembly line worker)… Technology wins again!


What effect has the change in employment trends had on retail credit?  Default rates at the low end of the credit spectrum have increased, presumably as the less-skilled workers find jobs hard to secure and wages stagnant, coupled with moderate inflation, effectively decreasing their standard of living and putting additional strain on their debt burden.  P2P lending platforms have responded by increasing interest rates, primarily in the three lowest credit tiers per platform, from 2% – 6.3% in 2016.  One might argue that a higher interest burden on the shakiest credits isn’t a recipe for better debtor performance or increased net interest margin; perhaps more astute credit vetting is the better path.  But, again, these new P2P platforms are new to the racket of credit analysis, and there will be a learning curve as they improve their credit models and learn from their mistakes.  

What’s the take-away for investors?  P2P investing is an attractive, relatively new asset class that expands the available universe of return drivers for retail investors (just 10 years ago, corporate and government bonds were the only choices for debt invesments), which may improve an investor’s risk/return profile.  But it’s not without its risks, macro-economically and operationally.  As the socioeconomic profile of America changes and the credit capacity and expertise of the P2P platforms evolves and matures, it’s best to take a conservative approach in one’s allocation.  Stick to the highest credit grades available on P2P, where the most credit-worthy borrowers reside (theoretically primarily in the expanding service sector), requiring less-robust credit modeling by these nascent platforms.  

Marriage, Divorce, and Social Security: What You Need to Know

Are you married and close to filing for Social Security benefits?  Divorced but married for at least 10 years in the past?  If so, there are some important variables to consider in your Social Security claiming strategy. 

In this linked article (Kitces on Spousal Benefits), financial planning guru Michael Kitces outlines the claiming options available to people affected by these scenarios, which potentially makes them eligible for the spousal benefit.  The claiming strategy hinges on eligibility and entitlement, as defined by the Social Security Administration.  Here’s the visual summary and commentary:


  • If you are at least 62, married for at least a year and your spouse is already receiving his/her own Social Security (SS) benefit, you are entitled claim 50% of your spouse’s benefit at full retirement age (as defined by SS Administration).  
  • You can claim a spousal benefit before your full retirement age, but benefits are reduced by 8.33% per year for the first 3 years of early claim, and 5% per year beyond that.  There is no additional spousal benefit for delaying beyond full retirement age.
  • If you are also entitled to your own SS benefits (having collected them in your own working career), you will collect whichever benefit is higher (yours or your spouse’s) based on the deemed filing rule (unless caring for a child who is under 16/disabled or you are disabled).
  • Some meet a special exception for a Restricted Application (born on January 1, 1954 or earlier), in which case you can receive the spousal benefit while delaying your own benefit (and accumulating a higher payout), but you must not claim before your full retirement age for the Restricted Application to be valid.


  • If you are currently at least 62, unmarried, but have been married for at least 10 years to someone in the past, and at least 2 years have passed since that divorce, and that former spouse is at least 62, you are entitled.
  • You can claim a spousal benefit before your full retirement age, but benefits are reduced by 8.33% per year for the first 3 years of early claim, and 5% per year beyond that.  There is no additional spousal benefit for delaying beyond full retirement age.  
  • Spousal benefits for divorcees are nullified if you remarry, although you would then be subject to the married spousal benefit rules with your new spouse.
  • If you are also eligible for your own SS benefits (having collected them in your own working career), you will collect whichever benefit is higher (yours or your ex-spouse’s) based on the deemed filing rule (unless caring for a child who is under 16/disabled or you are disabled).
  • Some meet a special exception for a Restricted Application (born on January 1, 1954 or earlier), in which case you can receive the spousal benefit while delaying your own benefit (and accumulating a higher payout), but you must not claim before your full retirement age for the Restricted Application to be valid.  

Benefits Strategy The penalty for early claiming is more severe for spousal benefits than individual benefits, so it generally makes sense to delay claiming until your full retirement age if your individual benefit (even at age 70) is less than the spousal benefit, you are healthy and your genetics project a long lifespan (82 years old is about the breakeven point on the differential between claiming at 62 vs. 66).  If you meet the requirements for a Restricted Application, take advantage of it if you have the financial wherewithal to delay your claim until your full retirement age.  It allows you to collect your spouse’s or ex-spouse’s benefit while accumulating a higher payout on your own benefits; ideally wait until your full retirement age to claim the spousal benefit and delay your own benefit until age 70, which compounds at a rate of 8% over those interim years.

The Irony of Amazon

Amazon.com may well be the most innovative, best-run company on the planet.  Their ability to anticipate technology and execute a strategic vision evokes the Jobs-era lineage of Apple: the first online bookstore; the largest online retailer; an electronics giant with the leading personal assistant device, Echo; the world’s largest provider of cloud storage services; a successful media development studio, garnering 11 Emmys and 3 Oscars; a nascent logistics and delivery business using drones, shipping, trucking and air freight; a grocery and convenience store business that eliminates checkout lines; artificial intelligence and machine learning services, applied across industries.  Some analysts are predicting Amazon will synergize many of these technologies to marginalize brands, revolutionize the retail experience, and become the first trillion dollar company.  Wow.  See here: 

 At the heart of all this success is the brain of Jeffrey P. Bezos.  This month he released his annual letter to shareholders, in which he outlines his strategy to keep Amazon a “Day 1” company, his metaphor for rapid innovation, agility, and execution.  It’s a four-pronged approach: 1) Obsess over Customers; 2) Resist Proxies; 3) Embrace External Trends; 4) Implement High-Velocity Decision Making.  A very interesting read (linked here: Amazon 2017 Letter to Shareholders).  

In the 2017 letter, he re-prints his letter to shareholders from 1997, when Amazon truly was a Day 1 company, an online bookseller having just increased annual sales by close to 1000% to $148MM.  What struck me was a single bullet point hiding in the middle of that 1997 letter: a list of eight long-term strategic partnerships to further stoke Amazon’s growth.  It includes the names of a bygone internet era, like AOL, Excite, Netscape, and Prodigy.  Being old enough to remember that era, the letter was like a trip in the Hot Tub Time Machine, reliving the scratchy lullaby of dial-up connections.  From an investing standpoint, it was a reminder of the natural selection that occurs in business: amazingly, 20 years on, every single one of those eight strategic partners no longer exists as a stand-alone entity (if you include Verizon’s acquisition of Yahoo!, due to close later this year).  In addition, every one of those eight companies has lost significant value from their valuation peaks.  Let’s take a survey:

  1. America Online: Once a leading dial-up service and internet content provider, it merged with Time Warner in the largest-ever merger transaction.  Its stock valuation declined significantly after missing the trend away from dial-up to broadband, leading to the spin-off of Time Warner.  Re-imagined as a media brands and advertising technology company and sold to Verizon Communications for $4.4 billion in 2015.
  2. Yahoo!: The highest-read news and information website, with over 700 million visitors every month in 2016, with related web information services.  Yahoo! nonetheless failed to translate their readership into profitability, agreeing in 2016 to sell their internet business to Verizon Communications for $4.8 billion, down from a peak valuation of over $100 billion.
  3. Excite: One of the most popular web portals and search engines in the 1990s, it merged with broadband provider @Home in 1999 to form Excite@Home.  In 1999, Excite’s CEO George Bell reportedly turned down an offer to acquire Google for $750,000.  Within two years of the @Home merger, its stock valuation had dropped 90% from a peak of $35 billion and the combined company declared bankruptcy in 2001.  
  4. Netscape: Once the dominant web browser and credited with creating JavaScript and the SSL security protocol, it lost significant market share to Microsoft’s Internet Explorer in the first browser war, declining from 90% market share in the mid-90s to less than 1% in 2006, with support ending in 2008.  Company acquired by America Online in 1999 for $10 billion.  The source code for the Netscape browser was transferred to Mozilla Foundation and ultimately released as the free product Firefox.  
  5. Geocities: The third most visited site on the web in 1999, it gained popularity for creating “cities” based on content, e.g., Hollywood for entertainment, that users could develop for free with its service.  Acquired by Yahoo! in 1999 for $3.57 billion, the Geocities service was shut down within 10 years after Yahoo! changed the terms of service and scrapped the community theme. 
  6. AltaVista: One of the most-used search engines in the late 1990s, it lost market share to competitor Google and unsuccessfully launched a web portal to compete with Yahoo!.  AltaVista was acquired by Yahoo! in 2003, which changed the underlying search technology to its own and eventually shut down AltaVista altogether in 2013.
  7. @Home: A vanguard in broadband internet cable service, at its peak it provided internet service to 4.1 million subscribers.  Merged with Excite in 1999, but following the dot-com bubble and the collapse of internet advertising, the combined company was bankrupt within 2 years and the broadband business was sold in bankruptcy liquidation to AT&T for $307MM, down from a peak valuation of Excite@Home of $35 billion.   
  8. Prodigy: The first consumer online service to use a graphical user interface, the company morphed through the years into a dial-up internet and web hosting service, and ultimately a DSL service that by 2000 was the fourth largest connectivity provider with 3.1 million customers.  Went public in 1999 but was taken private by AT&T in 2001; by 2005 AT&T was trying to sell the Prodigy brand and by 2011 had dropped support for all legacy Prodigy services.  

From these examples, it’s not hard to conclude that technology is a brutal blood sport, an eat-or-be-eaten exercise in survival.  Amazon has not only survived, but been crowned King of the Jungle on many technology fronts, and bears the fruit of this stature, having recently climbed to a valuation of over $430 billion (4th highest globally), a welcome outcome for its long-term shareholders.  The other 8 partners?  Not so much.  And it’s not a technology anomaly.  To point: on average, 22 companies on the S&P 500 are de-listed every year and over half of its constituents are different today than in 2000.  It thus begs the question: what’s the trick in identifying the next Amazon, and avoiding the losers?  The short answer: it’s very, very difficult.  An infinite number of causes and conditions need to align for a company to achieve Amazon’s success: hiring and retaining the right people, gaining approval from regulators, making the right acquisitions/avoiding takeovers, creating the right capital structure, managing business line risk, investing in the right products and services, exceeding client expectations, avoiding the bureaucratic weight of largess, anticipating competitor threats, etc.  It’s a daunting task to do all of them exceptionally well concurrently.  To put an exclamation point on it: even with Bezos’s magic mix of corporate governance (now public for every other manager to try to emulate), Amazon will need all the same variables to break their way in the future to repeat their past success – and the current stock price already bakes in that probability!  Does betting on Amazon being the next Amazon, continuing to be a dominant Day 1 company, sound a bit like gambling on number 9 at the roulette wheel?

But isn’t Bezos just different?  Another takeaway might be “Don’t bet against Jeff Bezos”: he’s a genius, like Steve Jobs, Elon Musk, and Warren Buffett; I like investing in geniuses.  Don’t be lulled into the assumption that intelligence equates to corporate success and can be easily repeated or prognosticated.  To wit, Warren Buffett’s investment performance through his investment holding company, Berkshire Hathaway, underperformed the S&P 500 over the trailing 5 years in 2013, and it’s been very close over every 5 year period since 2011.  Myron Scholes and Robert Merton were geniuses for a while until the collapse of Long Term Capital Management proved otherwise.  The same can be said for Steven A. Cohen, Bill Gross, and Bill Miller: all had impressive returns for a period of time, followed by disappointment.

What makes much more sense for investors?  Diversify.  Don’t make big bets.  Focus on the factors of return available in current capital markets, and capture them according to your risk tolerance in a tax-efficient, low cost manner.  Let natural selection occur without obsessing over it, permitting the rising tide of capitalism to lift your boat [a diversified domestic large-cap stock portfolio averages an annualized compound return of around 10% over long periods].  Remember, there’s irony dripping from Bezos’s 1997 letter, given the ultimate fate of his chosen strategic partners (all of which were admired, industry-leading companies at the time).  While some hit it big at the Amazon one-armed-bandit, over the long term it’s much better to be the casino, not the gambler at the slot machine.  

Adventurer or Retreater: What’s Your Retirement Path?

In Nancy Schlossberg’s new book, Too Young to Be Old, she outlines six primary paths followed by retirees.  Will you be a ‘Continuer’, engaging in some activities similar to those during your career, only without the income?  An ‘Adventurer’, chasing an unrealized dream or interest?  A ‘Searcher’, walking a multitude of paths, trying to find a niche that works?  A ‘Retreater’, taking time to relax, decompress, and just be?  And so on…

As you progress through your working life, take a moment to contemplate each of the scenarios researched by Ms. Schlossberg.  Why now?  Each option has a financial profile, and thus can affect your target retirement nest egg.   For instance, the ‘Continuer’ and ‘Retreater’ likely spend less in the early retirement years relative to their working years than the ‘Adventurer’ and ‘Searcher’, who incur new expenses following or determining their interests.  Have you heard that the average person spends about 75% of their pre-retirement income in retirement?  In actuality, research by Morningstar (Estimating the True Cost of Retirement, 2013) shows that the spending range is quite wide, from under 54% to over 87%.  It can be of great advantage in your financial plan to project where on that spectrum you will fall.  If you’re going to be The Most Interesting Man in the World, paddling across the Atlantic Ocean in a solar kayak…. you’re going to need to pay for it.  Let’s start planning now.


Want to get an extra $7.75k in your IRA?

It’s possible.  Only it isn’t an IRA.  It’s a Health Savings Account (HSA), available to anyone who is subject to a high-deductible healthcare plan ($1.3k individual/$2.6k family; out-of-pocket limits also apply) outside of Medicare and Medicaid.  The details underlying these accounts are almost too good to be true:

  1. There are no restrictions on earned income, i.e., anyone can contribute, regardless of salary or lack thereof.
  2. Contributions are fully deductible, either as a line-item deduction (itemization not needed) on your Federal return, or through a pre-tax payroll deduction at your employer (and some employers match your contributions).
  3. Contribution limits in 2016: Individual $3,350 ($4,350 if over 55), Family $6,750 ($7,750 if over 55).
  4. Contributions grow without being taxed for as long as they remain in the account.
  5. Withdrawals are permitted without penalty or tax consequence throughout your life if used for qualifying health care costs (including long-term care insurance premiums).  After age 65, withdrawals can be made without penalty for any reason, although they will be taxed as ordinary income if not used for qualifying health care costs.  
  6. There are no withdrawal requirements or required minimum distributions (RMD) from these accounts, unlike Flexible Spending Accounts or traditional IRAs and qualified retirement plans, e.g., 401(k), etc.

Thus, the accounts offer the best of both traditional and Roth IRAs (tax deductibility, tax free growth and tax free withdrawals if used for qualified purposes), without the downsides (RMDs, taxes on contributions, conversions, or withdrawals).  In addition, it’s a sneaky way to add to your retirement savings, whether or not you need the funds for health care costs, as withdrawals can be used for any purpose after age 65 (vs. 59.5 for an IRA) without penalty.  In short, it’s a savings unicorn.  With companies increasingly offering high deductible health care plans as part of their benefits packages (19% of workers in 2016, according to Kaiser Family Foundation), and the popularity of bronze plans under the Affordable Care Act (Obamacare), a large number of Americans are eligible for an HSA, yet likely too many fail to take advantage of their unique characteristics.  

As the tax deadline for 2016 approaches, consider making a HSA contribution if you are eligible.  It’s a tax-cagey way to hedge your health care costs while increasing your retirement readiness at the same time.


Should Grandma Pay For College?

Paying for college is a concern for most families with children.  Why not consider Grandma (or any other extended family member) as a resource?  It can be a prudent move if, 1) Grandma, etc. plans to leave the child money in her estate anyway and 2) the child qualifies for Federal financial assistance through the Federal Student Aid application (FAFSA).  A little known secret: the FAFSA calculation for expected family contribution (EFC) excludes assets held for the benefit of the student (as in a 529 plan) if the asset owner is not the student or parent.  If the student uses the pledged assets for education expenses, those sums must be recognized by the student as income under EFC in the year they are received.  It creates a planning opportunity to shelter assets that can be used in the final year of a student’s education, when the EFC calculation no longer affects aid.  Moreover, Grandma can pay education expenses for the student directly from her own funds when they are incurred, without incurring a gift tax or having the payments count toward her annual gift exclusion or lifetime exemption.

But what if you lack a benevolent Granny?  Don’t let that deter the education savings plan for your children.  The burden of education savings looms large for most families, with college costs rising at about a 5% rate over 10 years through 2015 (over twice the rate of overall inflation), with studies showing the average total cost of public in-state undergraduate universities at almost $25k per year (almost $100k overall) and private universities at almost $50k per year (almost $200k overall) in 2017.  Savings must cover the education costs that grants, scholarships, work-study and loans do not.  If you resolve to save for these costs, where should these savings go?  There are two primary tax-advantaged education savings vehicles, with the following attributes:

Coverdell Education Savings Accounts (ESA)

  • Contributions limited to $2k per beneficiary per year
  • Considered an asset of parent for FAFSA 
  • Can be withdrawn tax-free if used for any level of education expense, K through post-graduate
  • Beneficiary changes permitted, but it is a non-revocable contribution (beneficiary cannot be the donor)
  • Account control passes to beneficiary at age of 18

529 Plans 

  • Contributions potentially deductible on state tax returns depending on state laws
  • Contributions considered a gift and eligible for $14k annual gift exclusion, with a one-time 5 year contribution ($70k individual/$140k per couple) without gift tax consequences.  High contribution limit ($100 – $350k) per donor.
  • Considered an asset of the donor for FAFSA
  • Can be withdrawn and used for college, vocational, and post-graduate expenses (tuition, room/board, books, supplies) without tax consequences
  • Remains an asset of donor, with beneficiary changes permitted
  • Some education institutions may soon match 529 withdrawals with grants.  Washington College in Maryland recently announced a program to match up to $2.5k in 529 plan withdrawals for qualified expenses per student.  

529 plans are sponsored by states to accommodate the state-specific tax laws on contributions, so pick one with full knowledge of your tax situation.  Between the ESA, 529, and potentially taxable savings for pre-college expenses, families have tools to help shoulder their education cost burdens.  It takes planning and forethought, however.  The benevolent Granny wouldn’t hurt, either.

Get me GoPro!

It’s late 2014, shortly after the IPO of GoPro, Inc., the maker of the popular HERO mobile video recorder.  “Get me GoPro!” she said, excitedly.  “Everyone is using it – on the water, snow, bike trails – I see it everywhere.  I want that stock!”  

We should all be so enthusiastic about capitalism.  Technological innovation and new product development are the lifeblood of new revenue streams, and, if managed well, increased profitability and a rising stock price for the companies that deliver them.  However, her statements gave me pause.   A popular product does not necessarily equate to a profitable business over the long-term (see: Twitter, Fitbit, Palm, Blackberry).  What is GoPro’s capital structure, profit margins, expense and revenue forecasts, user growth rates, and new product strategy?  Technology changes faster than Lady Gaga at the Superbowl.  Without a diversified product line, one bad product launch or missed technology trend could sink the company; not to mention the endless cash that a tech behemoth like Google, Apple, Amazon, Microsoft, etc. could throw at its own competing product if the market opportunity looked attractive.  

Not wanting to dampen her enthusiasm, I said, “If you really like that company, take a small amount of money and invest in it, but don’t invest more than you are willing to lose.  Treat it as entertainment, not as a core investment.  It could end up being Apple, but it could also be Enron.”

Fast forward to March 2017, following two bad quarterly results, a botched product launch of its new drone product, Karma, and a combined 470 job cuts in a move to dramatically cut expenses.  GoPro stock has fallen as much as 94% from its valuation peak in October 2014.  

Granted, the anecdote could just as easily have been Facebook and its meteoric rise.  It’s a reminder that picking individual securities is just buying risk.  Instead of concentrating your bets on a few securities, we counsel the lessons embedded in Modern Portfolio Theory (MPT): diversify across and within asset classes.  There are so many recent innovations in finance, creating asset classes never before available to retail investors.  From a risk perspective, that’s exciting.  It means you don’t have to find the next Facebook and avoid GoPro.  The real trick?  Defining available asset classes, their return drivers, and how to combine them in a way that suits your risk tolerance.  

Get me MPT! 


Are we all just too giddy?

As Mohamed A. El-Erian writes in the article linked below, domestic debt and equity markets reacted quite dramatically to the Trump economic platform, with interest rates spiking across maturities and equity markets rallying in the two months following the presidential election last November.  There was indisputably a surge in positive economic sentiment.  Yet, aside from a spike in short-term interest rates following Federal Reserve policy disclosure last week, these markets have been uneven, moving sideways with volatility, thus far this year with no discernible trajectory.  What gives?  

As El-Erian theorizes, sentiment is ephemeral.  Markets want to see some legislative meat on the bones of this pro-growth animal.  Initially, traders reacted to the promise of reduced corporate taxes and regulation, increased military and infrastructure spending, and re-negotiated trade deals favoring domestic production.  What has followed in the two months since inauguration has fallen short of those assumptions: a rash of executive orders on immigration and a new “repeal and replace” health care bill introduced in the House of Representatives, both of which have little effect on securities markets (save for sector-specific investments).  In short, the recent executive and legislative actions, their chosen “policy sequencing”, weren’t the economic panacea that many had hoped for. 

So, what is needed to sustain the giddy markets realized late last year?  Enacted reform that favors legitimate economic expansion:

  1. Substantive, bipartisan legislation on corporate tax reform, pushing top marginal rates down to the 15-20% range trumpeted from legislative leaders and the president, coupled with incentives for repatriation of profits and disincentives for tax inversions.  New corporate tax incentives for high-growth industries to hire in America.  
  2. Sensible regulatory reform that retains consumer safeguards and risk monitoring, while removing restrictions that are preventing corporate capital investment and R&D.  Industry-specific advisory panels, advised by senior corporate management and not lobbyists, can help guide this effort.  
  3. A spending bill that upgrades infrastructure and directly improves trade prospects (rail, highway, seaports, airports, etc.).  Couple it with innovative ideas coming out of the Treasury department, such as new, longer-maturity treasury bonds that allow government to lock-in low capital costs.
  4.  Re-negotiated trade agreements that level the playing field in areas like environmental protection and workers’ rights, without implementing trade quotas and tariffs that inhibit commerce.  
  5. Enhanced job re-training programs to entice the long-term unemployed and displaced to re-enter the workforce in high-growth industries.  With official unemployment figures contracting to close to 4.5%, a lack of skilled workers will soon become a significant impediment to economic expansion.  

As theorized by Sir Isaac Newton, no object moves without a force acting on it.  The White House and Capitol Hill need to re-focus on priorities that will economically help America.  Do so, and that sanguine, giddy smile, the collective “animal spirits” in financial markets, has a good chance to return.