Outcomes = Events + Response

Being an investor can be complicated, challenging, frustrating, and sometimes frightening. This is exactly why it is important to have an investment philosophy you can stick with, one that can help you stay the course, and respond rationally to unexpected events.

This simple idea highlights an important question: How can investors maintain discipline through bull markets, bear markets, political strife, economic instability, or whatever crisis du jour threatens progress towards their investment goals?

Over their lifetimes, investors face many decisions, prompted by events that  are both within and outside their control. Without an enduring philosophy to inform their choices, they can potentially suffer unnecessary anxiety, leading  to poor decisions and outcomes that are damaging to their long-term financial well-being.

When they don’t get the results they want, many investors blame things outside their control. They might point the finger at the government, central banks, markets, or the economy. Unfortunately, the majority will not do the things that might be more beneficial—evaluating and reflecting on their own responses to events and taking responsibility for their decisions.

Some people suggest that among the characteristics that separate highly successful people from the rest of us is a focus on influencing outcomes by controlling one’s reactions to events, rather than the events themselves. This relationship can be described in the following formula:

e + r = o (Event + Response = Outcome)

Simply put, this means an outcome—either positive or negative—is the result of how you respond to an event, not just the result of the event itself. Of course, events are important and influence outcomes, but not exclusively. If this were the case, everyone would have the same outcome regardless of their response.

Let’s think about this concept in a hypothetical investment context. Say a major political surprise, such as Brexit, causes a market to fall (event). In a panicked response, potentially fueled by gloomy media speculation of the resulting uncertainty, an investor sells some or all of his or her investment (response). Lacking a long-term perspective and reacting to the short-term news, our investor misses out on the subsequent market recovery and suffers anxiety about when, or if, to get back in, leading to suboptimal investment returns (outcome).

To see the same hypothetical example from a different perspective, a surprise event causes markets to fall suddenly (e). Based on his or her understanding of the long-term nature of returns and the short-term nature of volatility spikes around news events, an investor is able to control his or her emotions (r) and maintain investment discipline, leading to a higher chance of a successful long‑term outcome (o).

This example reveals why having an investment philosophy is so important. By understanding how markets work and maintaining a long-term perspective on past events, investors can focus on ensuring that their responses to events are consistent with their long-term plan.

An enduring investment philosophy is built on solid principles backed by decades of academic evidence. Examples of such principles might be: trusting that prices are set to provide a fair expected return (markets work); recognizing the difference between investing and speculating (long-term perspective); relying on the power of diversification to manage risk and increase the reliability of outcomes (Diversification); and benchmarking your progress against your own realistic long-term investment goals (monitoring progress).

Combined, these principles might help us react better to market events, even when those events are globally significant or when, as some might suggest, a paradigm shift has occurred, leading to claims that “it’s different this time.” Adhering to these principles can also help investors resist the siren calls of new investment fads or worse, outright scams.

It can be difficult for investors to develop a rational investment philosophy. And even the most self-aware find it hard to manage their own responses to events. Investing will always be both alluring and scary at times, but a view of how to approach investing combined with the guidance of a trusted professional can help people stay the course through challenging times. Keeping an objective view and separating emotions from investment decisions is incredibly difficult for most investors.  By building knowledge and confidence, however, we are better equipped to remain disciplined in our responses even to the most extreme market events.

Class Dates – Fall 2018 10/17-10/24

We are pleased to announce Our Fall 2018 Class dates! 

Wendnesday, October 17    –  Class 1: Fundamentals

Monday, October 22   – Class 2: Retirement Income and Taxes

Wednesday, October 24   – Class 3: Investments and Legacy

Classes are 5:30-8:30 PM

Please add your name to one of our email lists if you would like to be notified about dates and times for our next Retirement Planning Workshop in Partnership with Western Carolina University’s Office of Professional Growth and Enrichment.  We hold our classes at WCU’s new Biltmore Park Campus.  Tuition is $79 per person (or couple) and includes workbooks and other bonus material.

 

REGISTER THROUGH WCU TODAY!

(Click link above to register for Retirement Planning Today through WCU’s website)

 

For More Information From Instructors

 

 

Course Description:
In partnership with Western Carolina University Office of Professional Growth and Enrichment, we are pleased to offer a Retirement Planning workshop.  This course is designed to deliver comprehensive, objective information to help you achieve your most important financial goals.  The course covers many key aspects of planning for retirement such as:

  • Retirement lifestyle planning
  • Goal Setting
  • Retirement Planning Roadblocks and Mistakes
  • Income tax planning
  • Retirement income and expenses
  • Risk management
  • Social Security Planning
  • Investment management
  • Estate planning

As an educational experience, Retirement Planning Today contains something for everyone. We address financial issues that pertain to the self-employed as well as employees of corporations and government agencies. The course is designed to teach you how to build wealth and align your money with your values to accomplish your goals in life. Whether you plan to retire 20 years from now or have just recently retired, the information you learn in this class can deliver rewards throughout your lifetime. You went to school to prepare for your career. Now it’s time to prepare for your retirement.

Instructors: Joel Kelley, CFP® and Jacob Sadler, CFP®

 

Having a Plan

In our most recent Market Review, for the 1st Quarter 2018 we provide a general report and perspective on global market activity. 

1st Quarter 2018 Market Review

 

Embarking on a financial plan is like sailing around the world. The voyage won’t always go to plan, and there’ll be rough seas.  But the odds of reaching your destination increase greatly if you are prepared, flexible, patient, and well-advised.

A mistake many inexperienced sailors make is not having a plan at all.  They embark without a clear sense of their destination. And once they do decide, they often find themselves lost at sea in the wrong boat with inadequate provisions.

Likewise, in planning an investment journey, you need to decide on your goal. A first step might be to consider whether the goal is realistic and achievable. For instance, while you may long to retire in the south of France, you may not be prepared to sacrifice your needs today to satisfy that distant desire.

Once you are set on a realistic destination, you need to ensure you have the right portfolio to get you there. Have you planned for multiple contingencies? What degree of “bad weather” can your plan withstand along the way?

Key to a successful voyage is a good navigator. A trusted advisor is like that, regularly taking coordinates and making adjustments, if necessary. If your circumstances change, the advisor may suggest you replot your course.

As with the weather at sea, markets can be unpredictable. A sudden squall can whip up waves of volatility, tides can shift, and strong currents can threaten to blow you off course. Like a seasoned sailor, an experienced advisor will work with the conditions.

Once the storm passes, you can pick up speed again. Just as a sturdy vessel will help you withstand most conditions at sea, a well-diversified portfolio can act as a bulwark against the sometimes tempestuous conditions in markets.

Circumnavigating the globe is not exciting every day. Patience is required with local customs and paperwork as you pull into different ports. Likewise, a lack of attention to costs and taxes is the enemy of many a long-term financial plan.

Distractions can also send investors, like sailors, off course. In the face of “hot” investment trends, it takes discipline not to veer from your chosen plan. Like the sirens of Greek mythology, media pundits can also be diverting, tempting you to change tack and act on news that is already priced in to markets.

A lack of flexibility is another impediment to a successful investment journey.  If it doesn’t look as though you’ll make your destination in time, you may have to extend your voyage, take a different route to get there, or even moderate your goal.

The important point is that you become comfortable with the idea that uncertainty is inherent to the investment journey, just as it is with any sea voyage. That is why preparation and planning are so critical. While you can’t control every outcome, you can be prepared for the range of possibilities and understand that you have clear choices if things don’t go according to plan.

If you can’t live with the volatility, you can change your plan. If the goal looks unachievable, you can lower your sights. If it doesn’t look as if you’ll arrive on time, you can extend your journey.

Of course, not everyone’s journey is the same. Neither is everyone’s destination. We take different routes to different places, and we meet a range of challenges and opportunities along the way.

But for all of us, it’s critical that we are prepared for our journeys in the right vessel, keep our destinations in mind, stick with the plans, and have a trusted navigator to chart our courses and keep us on target.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services: 828.225.1730

What is a CCRC?

Today a growing number of Americans are faced with a complex set of personal and financial decisions about how and where they want to live as they age.  An important factor in these decisions is how to address the significant risk posed by long term care expenses.  The three most common strategies to allow most people to manage the issue of long term care and aging are:

  1. Use all your assets – For some, there are few affordable options, and they rely on either family support or Medicaid to provide their long term care. Medicaid is the government provided ‘safety net’ form of health insurance and long term care protection. Eligibility for Medicaid requires that you have very little or no ‘countable assets’ and your sources of income will be scrutinized as well.  While a spouse who does not need long term care may retain some income and assets for their own use, relying on Medicaid may either require specific planning (well in advance) or spending down nearly all of your assets before it becomes available.
  2. Protect assets with insurance – For others, purchasing long term care insurance (or hybrid long term care insurance) to manage the risk of long term care expenses is an appealing strategy – particularly for those who wish to stay in their homes as long as possible. According to a survey conducted by AARP, 90% of people age 65 or older want to ‘age in place’ (in their home). However, the reality is that this strategy can quickly become impractical, dangerous, and isolating over time.  For those that plan to age in place, long term care insurance can become a critical piece of their financial picture. The key is to plan in advance, because premiums can be expensive, and will likely increase over time.  It is also important to keep in mind that not everyone will qualify for long term care insurance, and to make sure that you meet the health requirements for a long term care insurance policy.
  3. Have more than enough assets – For those who have a ‘critical mass’ of assets, it is possible to pay out of pocket for long term care expenses without jeopardizing the standard of living for a spouse, or compromising other financial objectives. While there is no one size fits all ‘number’ at which point you would pay out of pocket, generally investable assets of $2 Million or more, and a high ratio of guaranteed sources of income to living expenses are needed to consider this option.

There is a fourth strategy however, that for many individuals or couples can provide answers to many of these questions all at once.

  1. Live where you get your care – For those who want a single solution to meet their personal and financial situation in retirement, a Continuing Care Retirement Community (CCRC) can provide an appropriate solution to manage long term care treatment and expenses, while providing a living arrangement based on their level of independence and activity. So – what exactly is a CCRC and how do you evaluate it. We will analyze this question in different articles within our ‘classroom’ over time.  For now let’s start with:  What is a CCRC?

A CCRC is an age-restricted community that offers a continuum of care and living arrangements all on the same campus. Typically new residents must be age 65 or older; and living arrangements range from independent-living units, to assisted-living units, and then to skilled-nursing facilities.

These communities attract seniors who desire to live independently initially, but also want to know that they can receive needed care without leaving the community. This arrangement allows the resident to stay close to their spouse and friends as they move through different levels of care – and you know in advance about the quality, the options, and the location of the care you will receive.

CCRC’s often require a large entrance fee up front, but these vary widely depending on the community ($50,000-$1,000,000+).  In addition, residents pay a monthly fee.  Typically, the entrance fee may be returned in whole or in part when the resident leaves the CCRC, and another resident is found to occupy the unit. Once the new resident pays the entrance fee the former resident (or his or her estate) receives a refund. In exchange for the entrance fee, residents of the CCRC gain access to the community and the various levels of care, i.e. assisted living and skilled-nursing facilities.

As residents move from independent living to different levels of care, the monthly fee may increase – but not always (this also depends on the community). Typically, the larger the entrance fee, the lower the increase in monthly expenses for higher levels of care. Whether the monthly fee increases or not, residents generally pay less than the full-market rate for the care that they receive.  This fee structure, allows the resident to shift some of risk of long term care expenses to the community. Residents who do need care are essentially subsidized by residents who never need care. As a result CCRCs usually require prospective residents to submit financial and health information before they are admitted, and like purchasing insurance, it is better to plan this decision before a disqualifying health condition arises such as Alzheimer’s. It is possible for an applicant to be denied admittance due to health issues.

Also similar to a traditional insurance policy, the ability of the facility to provide care when needed depends on its financial stability, and its ‘claims’. If a higher than expected number of residents needs care, the facility may run into financial difficulty.  As a result, it is important to assess the financial strength of a community before entering.

CCRCs are also concerned that residents will run out of money and no longer be able to afford the monthly fee. To avoid the possibility that residents may become financially unable to stay in the community, facilities require prospective residents to submit financial information. An applicant may be denied admittance if the facility believes their assets and income will be depleted before death. While some communities establish reserves that are available to residents who can no longer afford to pay the monthly fee, this is not guaranteed and some communities may not have funds available.

CCRC Planning

If a CCRC is an option that you are considering as a part of your retirement plan, it is essential to develop a plan. The planning process allows you to decide on a retirement arrangement that is best suited to your needs – whether it is a CCRC or not.  Without planning, the questions, complexity, time, and analysis that are required can be overwhelming – and many people may either avoid making a decision all together, or make a less than informed decision that doesn’t fit with their situation.  For those who feel that a CCRC can provide a dependable living arrangement in retirement, and that want to explore the pros and cons of a CCRC – start the planning process sooner rather than later.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services, including retirement planning and CCRC planning.

 

Rebalancing: The How, When, and Why

If there is a universal investment ideal, it is this: Every investor wants to buy low and sell high.

What if we told you there is a disciplined process for doing just that, and staying on track toward your personal goals while you’re at it? Guess what…There is. It’s called rebalancing.

 

Rebalancing: How It Works

Imagine it’s the first day of your investment experience. As you create your new portfolio, it’s best if you do so according to a personalized plan that prescribes how much weight you want to give to each asset class. So much to stocks, so much to bonds … and so on. Assigning these weights is called asset allocation.

Then time passes. As the markets shift around, your investments stray from their original allocations. That means you’re no longer invested according to plan, even if you’ve done nothing at all; you’re now taking on higher or lower market risks and expected rewards than you originally intended. Unless your plans have changed, your portfolio needs some attention.

 

But Why rebalance?

At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future and there’s no reliable way to predict future returns.

Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork. This is what rebalancing is for: to shift your assets back to their intended, long-term allocations – systematically buying low and selling high.

 

Portfolio Balancing: A Closer Look

We’ve now shared a simple rebalancing illustration. In reality, rebalancing is more complicated, because asset allocation is completed on several levels. First, we suggest balancing your stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns. Then we typically divide these assets among stock and bond subcategories, again according to your unique financial goals. For example, you can assign percentages of your stocks to small- vs. large-company and value vs. growth firms, and further divide these among international, U.S., and/or emerging markets.

 One reason for these relatively precise allocations is to maximize your exposure to the right amount of expected market premiums for your personal goals, while minimizing the market risks involved by diversifying those risks around the globe and across sources of returns that don’t always move in tandem with one another. We, and the fund managers we typically turn to for building our portfolios are guided by these tenets of evidence-based investing.

It’s scary to do in real time. Everyone understands the logic of buying low and selling high. But when it’s time to rebalance, your emotions make it easier said than done. To illustrate, consider these real-life scenarios.

 

When markets are down:

Bad times in the market can represent good times for rebalancing. But that means you must sell some of your assets that have been doing okay and buy the unpopular ones. The Great Recession of 2007–2009 is a good example. To rebalance then, you had to sell some of your safe-harbor holdings and buy stocks, even as popular opinion was screaming that stocks were dead. Of course history has shown otherwise; those who did rebalance were best positioned to capture available returns during the subsequent recovery. But at the time, it represented a huge leap of faith in the academic evidence indicating that our capital markets would probably prevail.
 

Those who did rebalance were best positioned to capture available returns during the subsequent recovery.

 

When markets are up:

An exuberant market can be another rebalancing opportunity – and another challenge – as you must sell some of your high flyers (selling high) and rebalance into the lonesome losers (buying low). At the time, this can feel counterintuitive. But disciplined rebalancing offers a rational approach to securing some of your past gains, managing your future risk exposure, and remaining invested as planned, for capturing future expected gains over the long-run.

 

The Rebalancing Take-Home

Rebalancing using evidence-based investment strategies makes a great deal of sense once you understand the basics. It offers objective guidelines and a clear process to help you remain on course toward your personal goals in rocky markets. It ensures you are buying low and selling high along the way. What’s not to like about that?

At the same time, rebalancing your globally diversified portfolio requires informed management, to ensure it’s being integrated consistently and cost effectively. An objective advisor also can help prevent your emotions from interfering with your reason as you implement a rebalancing plan. Helping clients periodically employ efficient portfolio rebalancing is another way [firm name] seeks to add value to the investment experience

In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort

No one knows where the capital markets will go and that’s the point.

 

 

 

In our most recent Market Review, for the 4th Quarter 2017 we provide a general report and perspective on global market activity during the most recent quarter and for the full year 2017. 

4th Quarter and Full Year 2017 Market Review

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services

 

 

Tax Cuts and Jobs Act: Tax Reform Overview

 

The Tax Cuts and Jobs Act (TJCA) is sweeping tax legislation that fundamentally changes the individual and business tax landscape.

While many of the provisions in the new legislation are permanent, others (including most of the tax cuts that apply to individuals) will expire in eight years. Some of the major changes included in the legislation that affect individuals are summarized below; unless otherwise noted, the provisions are effective for tax years 2018 through 2025.

Individual Income Tax Rates

Brackets

Before After
10% 10%
15% 12%
25% 22%
28% 24%
33% 32%
35% 35%
39.6% 37%

The legislation replaces most of the seven current marginal income tax brackets (10%, 15%, 25%, 28%, 33%, 35%, and 39.6%) with corresponding lower rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The legislation also establishes new marginal income tax brackets for estates and trusts, and replaces existing “kiddie tax” provisions (under which a child’s unearned income is taxed at his or her parents’ tax rate) by effectively taxing a child’s unearned income using the estate and trust rates.

 

Single Returns  
If taxable income is: Then income tax equals:
Not over $9,525 10% of the taxable income
Over $9,525 but not over $38,700 $952.50 plus 12% of the excess over $9,525
Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,500
Over $200,000 but not over $500,000 $45,689.50 plus 35% of the excess over $200,000
Over $500,000 $150,689.50 plus 37% of the excess over $500,000

 

Married Individuals Filing Joint Returns  
If taxable income is: Then income tax equals:
Not over $19,050 10% of the taxable income
Over $19,050 but not over $77,400 $1,905 plus 12% of the excess over $19,050
Over $77,400 but not over $165,000 $8,907 plus 22% of the excess over $77,400
Over $165,000 but not over $315,000 $28,179 plus 24% of the excess over $165,000
Over $315,000 but not over $400,000 $64,179 plus 32% of the excess over $315,000
Over $400,000 but not over $600,000 $91,379 plus 35% of the excess over $400,000
Over $600,000 $161,379 plus 37% of the excess over $600,000

Standard deduction (Reverts to pre-existing law after 2025)

The legislation roughly doubles existing standard deduction amounts, but repeals the deduction for personal exemptions. Additional standard deduction amounts allowed for the elderly and the blind are not affected by the legislation and will remain available for those who qualify. Higher standard deduction amounts will generally mean that fewer taxpayers will itemize deductions going forward. Additional standard deduction amount remains if you are over 65.

Filing Status Before Tax Cuts and Jobs Act After Tax Cuts and Jobs Act
Single $6,500 $12,000
Head of Household $9,550 $18,000
Married Filing Jointly $13,000 $24,000

 

Itemized deductions

The overall limit on itemized deductions that applied to higher-income taxpayers (commonly known as the “Pease limitation”) is repealed, and the following changes are made to individual deductions:

  • State and local taxes — Individuals are only able to claim an itemized deduction of up to $10,000 ($5,000 if married filing a separate return) for state and local property taxes and state and local income taxes (or sales taxes in lieu of income).

 

  • Home mortgage interest deduction — Individuals can deduct mortgage interest on no more than $750,000 ($375,000 for married individuals filing separately) of qualifying mortgage debt. For mortgage debt incurred prior to December 16, 2017, the prior $1 million limit will continue to apply. No deduction is allowed for interest on home equity indebtedness – except for ‘acquisition indebtedness used to improve primary residence that secures the primary mortgage.

 

  • Medical expenses — The adjusted gross income (AGI) threshold for deducting unreimbursed medical expenses is retroactively reduced from 10% to 7.5% for tax years 2017 and 2018, after which it returns to 10%. The 7.5% AGI threshold applies for purposes of calculating the alternative minimum tax (AMT) for the two years as well.

 

  • Charitable contributions — The top adjusted gross income (AGI) limitation percentage that applies to deducting certain cash gifts is increased from 50% to 60%.

 

  • Casualty and theft losses — The deduction for personal casualty and theft losses is eliminated, except for casualty losses suffered in a federal disaster area.

 

  • Miscellaneous itemized deductions — Miscellaneous itemized deductions that would be subject to the 2% AGI threshold, including tax-preparation expenses and unreimbursed employee business expenses, are no longer deductible.

Personal exemptions

The new legislation eliminates the personal exemption.

Amount Before TCJA  After TCJA 
Personal Exemption Amount $4,050 per person N/A ($0)

Child tax credit

The child tax credit is doubled from $1,000 to $2,000 for each qualifying child under the age of 17. The maximum amount of the credit that may be refunded is $1,400 per qualifying child, and the earned income threshold for refundability falls from $3,000 to $2,500 (allowing those with lower earned incomes to receive more of the refundable credit). The income level at which the credit begins to phase out is significantly increased to $400,000 for married couples filing jointly and $200,000 for all other filers. The credit will not be allowed unless a Social Security number is provided for each qualifying child.

A new $500 nonrefundable credit is available for qualifying dependents who are not qualifying children under age 17.

Amount of Credit Before TCJA After TCJA
Maximum Credit per Qualifying Child $1,000 $2,000
Nonrefundable credit for dependants who are not qualifying children N/A $500

529 Plan Education Accounts

529 plan distributions can now be used tax-free for private elementary and secondary school expenses (for up to $10,000 in distributions per student each year), and includes both public, private, or religious schools. Homeschooling expenses are not eligible.

Alternative minimum tax (AMT)

The AMT is essentially a separate, parallel federal income tax system with its own rates and rules — for example, the AMT effectively disallows a number of itemized deductions, as well as the standard deduction. The legislation significantly narrows the application of the AMT by increasing AMT exemption amounts and dramatically increasing the income threshold at which the exemptions begin to phase out

 

Other noteworthy changes for individuals

 

  • The Affordable Care Act individual responsibility payment (individual mandate) (the penalty for failing to have adequate health insurance coverage) is permanently repealed starting in 2019.

 

  • In a permanent change that starts in 2018, Roth conversions cannot be reversed by recharacterizing the conversion as a traditional IRA contribution by the return due date.

 

  • For divorce or separation agreements executed after December 31, 2018 (or modified after that date to specifically apply this provision), alimony and separate maintenance payments are not deductible by the paying spouse, and are not included in the income of the recipient. This is also a permanent change.

 

  • Retirement Plans – Contribution levels to retirement plans remain the same

 

  • Capital Gains – No change to the capital gains tax rates or the ability to sell specific shares.

 

  • Estate Tax Exclusion – The act doubles the gift and estate basic exclusion amount to $11,200,000 (per spouse) This reverts to previous amount $5,100,000 in 2025.

 

 

Noteworthy changes for Businesses or Business Owners

 

  • Corporate tax rates – Instead of the previous graduated corporate tax structure with four rate brackets (15%, 25%, 34%, and 35%), the new legislation permanently establishes a single flat corporate rate of 21%. This provision will not expire in 2025.

 

  • Pass-through business income deduction – Individuals who receive business income from pass-through entities (e.g., sole proprietors, partners) generally report that business income on their individual income tax returns, paying tax at individual rates. For tax years 2018 through 2025, a new deduction is available equal to 20% of qualified business income from partnerships, S corporations, and sole proprietorships. For those with taxable incomes exceeding certain thresholds, the deduction may be limited or phased out altogether, depending on two broad factors: The deduction is generally limited to the greater of 50% of the W-2 wages reported by the business, or 25% of the W-2 wages plus 2.5% of the value of qualifying depreciable property held and used by the business to produce income.

 

  • The pass-through income deduction is phased out for certain businesses that involve the performance of services in fields including health, law, accounting, actuarial science, performing arts, consulting, athletics, and financial services. For those with taxable incomes not exceeding $157,500 ($315,000 if married filing jointly), neither of the two factors above will apply (i.e., the full deduction amount can be claimed). Those with taxable incomes between $157,500 and $207,500 (between $315,000 and $415,000 if married filing jointly) may be able to claim a partial deduction.

 

IMPORTANT DISCLOSURES

The information presented here does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

ABC’s of Behavioral Bias: A-F

Financial decision making is difficult – because we are human.  We are wired very well for certain things, and not so well for others.  In particular, when it comes to decision making, we are influenced (and often sabotaged) by our own internal bias.  In this first of our 3 part series on the “ABCs of Behavioral Biases.” we will introduce to you to four self-inflicted biases that can knock many investors off-course: anchoring, blind spot, confirmation and familiarity bias.

 

Anchoring Bias

 

What is it? Anchoring bias occurs when you fix on or “anchor” your decisions to a reference point, whether or not it’s a valid one.

 

When is it helpful? An anchor point can be helpful when it is relevant and contributes to good decision-making. For example, if you’ve set a 10 pm curfew for your son or daughter and it’s now 9:00 pm, your offspring would be wise to panic a bit, and step up the homeward pace.

 

When is it harmful? In investing, people often anchor on the price they paid when deciding whether to sell or hold a security: “I paid $11/share for this stock and now it’s only worth $9/share. I’ll hold off selling it until I’ve broken even.” This is an example of anchoring bias in disguise. Evidence-based investing informs us, the best time to sell a holding is when it’s no longer serving your ideal total portfolio, as prescribed by your investment plans. What you paid is irrelevant to that decision, so anchoring on that arbitrary point creates a dangerous distraction.

 

Blind spot Bias

 

What is it? Blind spot bias occurs when you can objectively assess others’ behavioral biases, but you cannot recognize your own.

 

When is it helpful? Blind spot bias helps you avoid over-analyzing your every imperfection, so you can get on with your one life to live. It helps you tell yourself, “I can do this,” even when others may have their doubts.

 

When is it harmful? It’s hard enough to root out all your deep-seated biases once you’re aware of them, let alone the ones you remain blind to. In “Thinking, Fast and Slow,” Nobel laureate Daniel Kahneman describes (emphasis ours): “We are often confident even when we are wrong, and an objective observer is more likely to detect our errors than we are.” (Hint: This is where second opinions from an independent source can come in especially handy.)

 

Confirmation Bias

 

What is it? We humans love to be right and hate to be wrong. This manifests as confirmation bias, which tricks us into being extra sympathetic to information that supports our beliefs and especially suspicious of – or even entirely blind to – conflicting evidence.

 

When is it helpful? When it’s working in our favor, confirmation bias helps us build on past insights to more readily resolve new, similar challenges. Imagine if you otherwise had to approach each new piece of information with no opinion, mulling over every new idea from scratch. While you’d be a most open-minded person, you’d also be a most indecisive one.

 

When is it harmful? Once we believe something – such as an investment is a good/bad idea, or a market is about to tank or soar – we want to keep believing it. To remain convinced, we’ll tune out news that contradicts our beliefs and tune into that which favors them. We’ll discount facts that would change our mind, find false affirmation in random coincidences, and justify fallacies and mistaken assumptions that we would otherwise recognize as inappropriate. And we’ll do all this without even knowing it’s happening. Even stock analysts may be influenced by this bias.

 

Familiarity Bias

 

What is it? Familiarity bias is another mental shortcut we use to more quickly trust (or more slowly reject) an object that is familiar to us.

 

When is it helpful? Do you cheer for your home-town team? Speak more openly with friends than strangers? Favor a job applicant who (all else being equal) has been recommended by one of your best employees? Congratulations, you’re making good use of familiarity bias.

 

When is it harmful? Considerable evidence tells us that a broad, globally diversified approach best enables us to capture expected market returns while managing the risks involved. Yet studies like this one have shown investors often, instead, overweight their allocations to familiar versus foreign investments. We instinctively assume familiar holdings are safer or better, even though, clearly, we can’t all be correct at once. We also tend to be more comfortable than we should be bulking up on company stock in our retirement plan.

 

Ready to learn more? Next, we’ll continue through the alphabet, introducing a few more of the most suspect financial behavioral biases.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Lessons For the Next Crisis

 

Did you happen to recall that we just passed an important 10-year anniversary?  It was in early October 2007 that the S&P 500 Index hit what was its highest point before losing more than half its value over the next year and a half during the global financial crisis.

Over the coming weeks and months, as other anniversaries of major crisis-related events pass (for example, 10 years since the bank run on Northern Rock or 10 years since the collapse of Lehman Brothers), there will likely be a steady stream of retrospectives on what happened as well as opinions on how the environment today may be similar or different from the period leading up to the crisis. It is difficult to draw useful conclusions based on such observations; financial markets have a habit of behaving unpredictably in the short run. There are, however, important lessons that investors might be well-served to remember: Capital markets have rewarded investors over the long term, and having an investment approach you can stick with—especially during tough times—may better prepare you for the next crisis and its aftermath.

BENEFITS OF HINDSIGHT

In 2008, the stock market dropped in value by almost half. Being a decade removed from the crisis may make it easier to take the past in stride. The eventual rebound and subsequent years of double-digit gains have also likely helped in this regard. While the events of the crisis were unfolding, however, a future of this sort looked anything but certain. Headlines such as “Worst Crisis Since ’30s, With No End Yet in Sight,” “Markets in Disarray as Lending Locks Up,” and “For Stocks, Worst Single-Day Drop in Two Decades” were common front page news. Reading the news, opening up quarterly statements, or going online to check an account balance were, for many, stomach-churning experiences.

While being an investor today (or during any period, for that matter), is by no means a worry-free experience, the feelings of panic and dread felt by many during the financial crisis were distinctly acute. Many investors reacted emotionally to these developments. In the heat of the moment, some decided it was more than they could stomach, so they sold out of stocks. On the other hand, many who were able to stay the course and stick to their approach recovered from the crisis and benefited from the subsequent rebound in markets.

 

It is important to remember that this crisis and the subsequent recovery in financial markets was not the first time in history that periods of substantial volatility have occurred. Exhibit 1 helps illustrate this point. The exhibit shows the performance of a balanced investment strategy following several crises, including the bankruptcy of Lehman Brothers in September of 2008, which took place in the middle of the financial crisis. Each event is labeled with the month and year that it occurred or peaked.

Although a globally diversified balanced investment strategy invested at the time of each event would have suffered losses immediately following most of these events, financial markets did recover, as can be seen by the three- and five-year cumulative returns shown in the exhibit. In advance of such periods of discomfort, having a long-term perspective, appropriate diversification, and an asset allocation that aligns with their risk tolerance and goals can help investors remain disciplined enough to ride out the storm.

Exhibit 1: Market Crisis and Recovery

 

Conclusion

In the mind of some investors, there is always a “crisis of the day” or potential major event looming that could mean the beginning of the next drop in markets. As we know, predicting future events correctly, or how the market will react to future events, is a difficult (and risky) exercise. It is important to understand, however, that market volatility is a part of investing. To enjoy the benefit of higher potential returns, investors must be willing to accept increased uncertainty.

A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times. A well‑thought‑out, transparent investment approach can help people be better prepared to face uncertainty and may improve their ability to stick with their plan and ultimately capture the long-term returns of capital markets.

 

 

 

Click the link below to read our original market summary from the 3rd quarter 2017.

3rd Quarter Market Review

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

 

 

Appendix 

Balanced Strategy 60/40 The model’s performance does not reflect advisory fees or other expenses associated with the management of an actual portfolio. There are limitations inherent in model allocations. In particular, model performance may not reflect the impact that economic and market factors may have had on the advisor’s decision making if the advisor were actually managing client money. The balanced strategies are not recommendations for an actual allocation.International Value represented by Fama/French International Value Index for 1975–1993. Emerging Markets represented by MSCI Emerging Markets Index (gross dividends) for 1988–1993. Emerging Markets weighting allocated evenly between International Small Cap and International Value prior to January 1988 data inception. Emerging Markets Small Cap represented by Fama/French Emerging Markets Small Cap Index for 1989–1993. Emerging Markets Value and Small Cap weighting allocated evenly between International Small Cap and International Value prior to January 1989 data inception. Two-Year Global weighting allocated to One‑Year prior to January 1990 data inception. Five-Year Global weighting allocated to Five-Year Government prior to January 1990 data inception. For illustrative purposes only.

In US dollars. Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index,12% Dimensional US Large Cap Value Index, 6% Dow Jones US Select REIT Index, 6% Dimensional International Marketwide Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10% Citigroup World Government Bond Index 1-5 Years (hedged), 10% Citigroup World Government Bond Index 1-3 Years (hedged), 10% BofA Merrill Lynch 1-Year US Treasury Note Index. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2017 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Citigroup Indices used with permission, © 2017 by Citigroup. Bloomberg Barclays data provided by Bloomberg. For illustrative purposes only. Dimensional indices use CRSP and Compustat data. Indices are not available for direct investment. Dimensional Fund Advisors Index descriptions available upon request. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Rebalanced monthly. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See Appendix for additional information.

Retirement Planning Class Materials – Fall 2017

 

 

 

 

During our Fall 2017 Retirement Planning Today class we had a number of questions, and discussed some material that was not included in the accompanying workbook.  Below, you will find the questions and answers from our two classes.  You will also find a PDF file of the slides that were included in our class presentation, but which are not included in the workbook.

 

Retirement Planning Today – Fall 2017 Bonus Slides

 

Can you transfer a 401(k) into an existing Inherited Traditional IRA – or should they be kept separate?

These accounts should be kept separate (unless you inherited an IRA as a spouse, and then re-registered the IRA as your own).  For non-spouse beneficiaries, if you have an existing Inherited IRA, this type of account will have its own set of rules, most importantly there will be required minimum distributions each year for that account.  You cannot comingle other assets with the inherited IRA.  See the following guide from Charles Schwab titlted ‘You’ve just inherited a retirement account, now what?

 

If you delay Social Security until age 70 and then begin your Required Minimum Distributions at age 70 ½ – there likely be will be an increase in taxable income in that year and beyond.  Are there any strategies to manage this bump in taxable income?

 For retirees who decide to delay Social Security until age 70, their benefit will increase 8% per year above their ‘Full Retirement Age’ Benefit.  In most cases, this provides important longevity protection by ‘locking in’ the highest possible Social Security income benefit – for life. 

As it also happens, age 70 ½ is when Required Minimum Distributions begin for retirees who have IRAs or Qualified Retirement Plans.  RMD’s are generally taxable as ordinary income.

So for some retirees, these two changes in income could result in an increased tax bill. Some strategies to mange this potential situation (always consult with your tax advisor first):

  • Consider IRA Qualified Charitable Distributions with some or all of your IRA RMD. Certain qualified distributions can be excluded from your taxable income. 
  • Consider Roth IRA conversions before age 70 ½ in order to reduce the size of future IRA RMDs.
  • Consider beginning IRA distributions before age 70 ½ in order to reduce the size of future RMDs.
  • If you have a health savings account, consider a one-time rollover contribution from your IRA into the HSA (annual limit may apply) before age 65.
  • If you have appreciated employer stock in a retirement plan, consider taking advantage of Net Unrealized Appreciation (which could potentially reduce the size of your future RMDs)

 

What are some examples of when to typically do a Roth conversion?

 Most often, the best times to do Roth IRA conversions are when there is a reduction in income (i.e. year of retirement or ‘gap years’ after retirement but before Social Security).  If your fundamental assumption is that your current tax rate is lower than what it will be in the future (when you might need Roth IRA distributions for income) then building Roth assets through  Roth Conversions may make sense. See the graphic below from financial writer Michael Kitces who shares this thought in a great graphic format.

                           ©Michael Kitces www.kitces.com (full article here)

Other important considerations for Roth Conversions are time (the longer the time for the Roth Conversion to grow the better) and estate planning (if you want to leave potentially tax free Roth assets to your non-charitable heirs).

 

 

 

When Rates Go Up, Do Stocks Go Down?

Should stock investors worry about changes in interest rates?

Research shows that, like stock prices, changes in interest rates and bond prices are largely unpredictable.1  It follows that an investment strategy based upon attempting to exploit these sorts of changes isn’t likely to be a fruitful endeavor. Despite the unpredictable nature of interest rate changes, investors may still be curious about what might happen to stocks if interest rates go up.

Unlike bond prices, which tend to go down when yields go up, stock prices might rise or fall with changes in interest rates. For stocks, it can go either way because a stock’s price depends on both future cash flows to investors and the discount rate they apply to those expected cash flows. When interest rates rise, the discount rate may increase, which in turn could cause the price of the stock to fall. However, it is also possible that when interest rates change, expectations about future cash flows expected from holding a stock also change. So, if theory doesn’t tell us what the overall effect should be, the next question is what does the
data say?

Recent Research

Recent research performed by Dimensional Fund Advisors helps provide insight into this question.2  The research examines the correlation between monthly US stock returns and changes in interest rates.3  Exhibit 1 shows that while there is a lot of noise in stock returns and no clear pattern, not much of that variation appears to be related to changes in the effective federal funds rate.4

For example, in months when the federal funds rate rose, stock returns were as low as –15.56% and as high as 14.27%. In months when rates fell, returns ranged from –22.41% to 16.52%. Given that there are many other interest rates besides just the federal funds rate, Dai also examined longer-term interest rates and found similar results.

So to address our initial question: when rates go up, do stock prices go down? The answer is yes, but only about 40% of the time. In the remaining 60% of months, stock returns were positive. This split between positive and negative returns was about the same when examining all months, not just those in which rates went up. In other words, there is not a clear link between stock returns and interest rate changes.

Conclusion

There’s no evidence that investors can reliably predict changes in interest rates. Even with perfect knowledge of what will happen with future interest rate changes, this information provides little guidance about subsequent stock returns. Instead, staying invested and avoiding the temptation to make changes based on short-term predictions may increase the likelihood of consistently capturing what the stock market has to offer.

 

Key Definitions

Discount Rate: Also known as the “required rate of return,” this is the expected return investors demand for holding a stock.

Correlation: A statistical measure that indicates the extent to which two variables are related or move together. Correlation is positive when two variables tend to move in the same direction and negative when they tend to move in opposite directions.

 

 

To read our most recent Market Review, for the 2nd Quarter 2017 – Click the link below !

Q2 2017 Market Review

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

 

 

 

Index Descriptions

Fama/French Total US Market Index: Provided by Fama/French from CRSP securities data. Includes all US operating companies trading on the NYSE, AMEX, or Nasdaq NMS. Excludes ADRs, investment companies, tracking stocks, non-US incorporated companies, closed-end funds, certificates, shares of beneficial interests, and Berkshire Hathaway Inc. (Permco 540).

 

  1. See, for example, Fama 1976, Fama 1984, Fama and Bliss 1987, Campbell and Shiller 1991, and Duffee 2002.
  2. Wei Dai, “Interest Rates and Equity Returns” (Dimensional Fund Advisors, April 2017).
  3. US stock market defined as Fama/French Total US Market Index.
  4. The federal funds rate is the interest rate at which depository institutions lend funds maintained at the Federal Reserve to another depository institution overnight.

 

Exhibit 1: Monthly US stock returns are defined as the monthly return of the Fama/French Total US Market Index and are compared to contemporaneous monthly changes in the effective federal funds rate. Bond yield changes are obtained from the Federal Reserve Bank of St. Louis.

Source: Dimensional Fund Advisors LP.

Results shown during periods prior to each Index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.

Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.