Financial Literacy: Money Matters!

As you all know, we provide proactive financial advice on matters such as investment management and value-added services such as tax planning, risk management and estate planning to name a few.  Something you probably didn’t know is that earlier this year, we launched a campaign to promote financial literacy for children and young adults!  It is called the Young Investors program.  Some of our clients have recently become the first recipients of this new program!

Financial literacy is a person’s ability to recognize and use the money and other resources he or she has to get what is needed and wanted.  Another way of saying this is that financial literacy is being able to set goals for using financial resources, make plans, and use the plans to meet financial demands and achieve goals.  To achieve financial literacy, a person needs to have experiences with money.  That is why it is important that children begin to learn about money and its use when they are young.

You might not know this, but financial literacy availability for young children is scarce, primarily because the school systems lack time and budget resources to incorporate financial education into the curriculums.  In fact, only 16 states require any instruction in economics between Kindergarten and 12th grade.  Even worse, only 7 states require students to take courses in personal finance.

There’s been a greater awareness of this educational need in the past 10 years and some financial-literacy advocacy groups have begun to take some steps to fill this educational void.  Some have responded by offering summer camps to young children whose parents want to teach their children the basics of money management.  Feedback from many of the attendees is that, believe it or not, they had fun!  Of course, we want to join in on the fun, and we are also excited to be a part of the solution.

We know that a financial foundation is best achieved when started early, reviewed, as well as reinforced often.  It’s important to teach young children even before they are in school about the concept of money, and that it’s not all about spending!  For example, something simple that a parent can start as early as age 3 can have lasting effects for the future.  Consider this:

Activity: Tell your toddler that you’ll give him a cookie now if he wants it, but you’ll give him two cookies if he waits an extra ten minutes. See what he chooses and try to encourage him to wait for the extra cookie.

Lesson Learned: Be patient and wait for a bigger payoff, rather than always going for instant gratification.

Although it might not look like much, it sets the stage for a less impulsive, more thoughtful response, and hopefully not just one involving money in the future!

Thinking about the scenario above, in an article I read the other day from the Wall Street Journal on personal finance summer camps, a 12 year old boy cited some camp attendance takeaways such as stopping and pausing before making purchases and long term planning!  I suppose it’s true that small things do matter!  And more interesting feedback from the camp directors is that many children ages 10-14 didn’t know what stock and bonds were.  Some thought the investments were a form of real estate.  Clearly, more attention needs to be given to this area.

We love the opportunities these summer camps offer and hope to provide some of our own financial education to our client families year round.  With our financial literacy agenda, our Young Investor program is structured with several tiers of age appropriate interactions and dialogue starters on financial matters for our clients to have with their children or grandchildren.  Age appropriate financial suggestions, tools, links to pertinent financial articles and fun activities to engage their minds are some of the content we will be sharing.  With the importance of starting as early as possible, we literally start at the very beginning, with newly born children/grandchildren, and capture all ages through the early 20s.  Specifically, we break out the tiers in roughly 5 year intervals, so age 0-5 years is the first group, 5-10 years is next, then 10-15 years, with 15-20ish years being the last group.  Our goal is that by age 25, the child or grandchild will be more than ready to begin a lifetime of investing!

Even after your children and grandchildren start their careers, it is our hope that they will join our Emerging Investor program, where they can establish their own brokerage accounts with Charles Schwab and have some of the same great DWM advantages and services as their parents and grandparents.  We are happy to help them by protecting and growing a diversified portfolio to preserve assets and provide moderate growth with minimal risk.

With our help, the young children of today will come to ask for financial assistance and have some of the best mentors in their lives, YOU!  And we all know that money is not an elective in life, so let’s keep the dialogue going with our young generation and keep providing them with good ‘sense’!  We hope you find this program to be a valuable experience.  As always, please let us know your thoughts or if you need financial assistance with a young investor in your life.

Tax Efficient Investing

Think of these opposites:  Good/Bad.  Rich/Poor.  Gain/Loss. Joy/Sadness.  Investment Returns/Income Taxes.  Yes, Uncle Sam is happy to take all the joy out of your investment returns and tax them.  That’s why tax efficient investing is so important.

You have three types of investment accounts: taxable, tax deferred or tax exempt.  For taxable accounts, you must pay taxes in the year income is received.  Retirement accounts, IRAs and annuities are examples of tax deferred accounts, in which you pay tax on the income when you take it out. Tax-exempt accounts, like Roth IRAs and Roth 401ks, are not taxed even at withdrawal.

Strategy #1:  Know Your Bracket.  The tax brackets have changed for 2018.  The top federal marginal rate of 37% will hit taxpayers of $500,000 and higher for single filers and $600,000 for married couples filing jointly.  There can be a huge difference between taxes on current ordinary income and taxes on long-term capital gains. Capital gains are the appreciation on your holdings over time and often represent a very significant portion of your total investment return.  Securities held for over a year generally qualify for long-term capital gain taxes, which are taxed at 0% to 20%, with most investors paying 15%. The difference between ordinary and capital gains taxes on your investment income can be substantial.

Strategy #2:  Asset Allocation includes Asset “Location.”  Tax efficient investments should be in taxable accounts, tax inefficient investments should be in tax deferred or tax-exempt accounts.  For example, bonds are tax inefficient.  Interest earned on bonds in taxable accounts is income in the year received and is taxed at ordinary income tax rates.  However, bond interest earned in a tax deferred account is also taxed as ordinary income, but only at withdrawal, when presumably you might be at lower income and tax levels.  Hence, bonds should generally be located in tax deferred accounts, such as IRAs and 401ks.

Stocks are more tax efficient. First, the qualified dividends received on stocks are taxed at the capital gains tax rate, which is likely less than your ordinary income tax rate. And, second, the largest part of your investment return on equities is often your capital gain, which is also generally at 15% tax and is only paid when you sell a security.  Hence, stocks and equity funds are tax efficient and generally should be located in taxable accounts.  Conversely, holding equities in retirement accounts is not generally a good idea because even though the tax is deferred, the ultimate withdrawals will be taxed at ordinary rates, not capital gains.

Alternative investments, which are designed to be non-correlated with bonds and stocks, may generate more ordinary income than tax-efficient income.  Hence, they should generally be located in tax deferred accounts.  Tax-exempt accounts, such as Roth accounts, can hold tax efficient and tax inefficient holdings. Hence, tax-exempt accounts are already tax efficient and can hold all three asset classes; equity, fixed income and alternatives, in appropriate asset allocations without any income tax cost.

Strategy #3:  Grow your Roth Assets.  Because Roth assets are tax-exempt and, therefore, 100% tax efficient, they are the most valuable investment asset you can own; both in your lifetime and your heirs.  Roths only have investment returns, no taxes.  Furthermore, Roth accounts, unlike traditional IRA accounts, do not require minimum distributions when you and/or your spouse reach 70 ½.  Upon your passing, the beneficiaries of your Roth assets can “stretch them” by allowing them to continue to grow them tax-free. However, the heirs will be required to take minimum distributions.

Roths can be funded in a number of ways.  If you have earnings, you can make Roth contributions of $5,500 per year ($6,500 if you are 50 or over) if your income is below a certain threshold.  In addition, if you are working for a company with a 401k plan, that plan may allow Roth 401k contributions. In this case, there are no earnings limitations and you can contribute $18,500 ($24,500 if you are 50 or over.)  You can also convert IRAs to Roths.  This is done by paying income tax on the difference between the amount converted and the cost basis of the IRA. There is no limit of the amount you can convert.  The concept is “pay tax once, have the Roth grow tax-free forever.” Oftentimes this conversion takes place after retirement but before age 70 ½ and is done in an annual installment amount to keep the tax implications within a given tax bracket.   We encourage you and/or your CPA to look at this possibility.

Strategy #4:  Do an Income Tax Projection.  Tax projections are really important, particularly in 2018, with all the new changes brought on by tax reform.  The projection provides information as to your income, deductions, tax bracket, estimated taxes (to minimize surprises and penalties) and, hopefully, also possibilities for tax savings.  We prepare “unofficial” tax projections for our clients for these very reasons.  Investment management must consider income taxes.

Ultimately, your return on investments is your gross return less the income taxes.  Therefore, we encourage you to make your investment portfolio operate as tax efficiently as possible and accentuate the positive; good, rich, gain, joy and investment returns.  Rather than the negative; bad, poor, loss, sad and income taxes.  You should make yourself happy, not Uncle Sam.

Happy Labor Day: Fun Facts!

Labor Day in the 21st century means time for beaches, BBQ, ballgames and quality time with family and friends. For many, Labor Day signifies the last days of summer. But don’t worry, the official end of summer is September 21st so you still have some time to catch some waves and rays. Although Labor Day always falls on the first Monday of every September, there is a lot more to this holiday weekend than an extra day off from work and great sales. From a survey done by WalletHub, here are 10 facts about Labor Day that you may not know:

  1. 133 million Americans will enjoy a BBQ this Labor Day

 

  1. The average Labor Day shopper will spend $58

 

  1. 25% of Americans plan to get out of town

 

  1. The top three Labor Day destinations include New York City, Chicago, and Las Vegas

 

  1. Labor Day is America’s third favorite holiday behind Christmas/Chanukah and Memorial Day

 

  1. There are approximately 89 running races held over Labor Day weekend

 

  1. The number one hardest working city in America is San Francisco with an 8 hour average work day, and the laziest city in America is Columbia, SC with an average work day of 7.3 hours

 

  1. Labor Day is the unofficial end of hot dog season in America. From Memorial Day to Labor Day there are 818 hot dogs eaten per second

 

  1. Most Americans believe Labor Day is only an American holiday when really it was started in Canada

 

  1. Last but not least, yes, you really can wear white after Labor Day!

From everyone here at DWM, have a great Labor Day Weekend and enjoy some time with the family!

Mother Nature is in Charge!

Americans are getting a little disaster weary.  From the horrific wildfires out west to torrential rains and flooding all summer in the east, it has been quite a year.  And in the south and east, we all know what August means…hurricane season is upon us!  Mother Nature is getting on our nerves in 2018!

How can we protect ourselves to minimize the risks to our homes, our property and our livelihoods?  Mitigating risks from catastrophic events starts with prevention and planning by both government and individuals.  Prevention can start with using damage-resistant building materials, having elevated home designs, enforcing safe building codes, developing flood plain management systems, securing or removing hazards ahead of storms and by having evacuation or escape plans in place.  FEMA has an 81 page guide of Mitigation Ideas to deal with earthquakes, landslides, floods, hurricanes, hail, lightning, tornadoes, severe winter weather and more.  https://www.fema.gov/media-library-data/20130726-1904-25045-2423/fema_mitigation_ideas_final_01252013.pdf  There are many threats coming from our environment, but many things that can be done to lessen some of the painful aftermath of these occurrences.

We certainly can use property & casualty insurance to plan and prepare for the worst.  In hurricane-prone areas, for example, we have riders for “named storm” or “wind and hail” coverage that comes with our homeowner’s insurance.  The costs of the insurance can be reduced by increasing the amount of a deductible you want to have or, in other words, how much you can afford to pay out of pocket for repairs after a storm.  We also look for extra coverage for those circumstances when there is a widespread event like a hurricane that may drive costs up with higher demand for labor and materials.  Homeowners may want to have an extended coverage rider built in to help with those higher costs.  It is important to evaluate what your risk tolerance is for these situations and how much you want to pay to transfer some of the risk to the insurance company.  If your home is destroyed or badly damaged, do you have a comfortable level of protection for you and your family?

There has been much discussion on the 50 year old National Flood Insurance Program, as well. President Trump recently signed the legislation to extend the debt-ridden program until November 30th.  That means not dealing with necessary reforms until after hurricane season and mid-term elections.  The federal program, which is some $20 billion in debt to the U.S. Treasury, offers subsidized flood insurance to coastal or flood-prone areas where private insurers have pulled out or made it unaffordable.   As it is, the NFIP provides coverage with caps on claims for homes at $250,000 and on property at $100,000.  Many higher-value property owners may choose to also carry “excess” flood insurance to bridge the gap between the federal program caps and the value of their homes and property.

Unfortunately, the reduced premiums from about 5 million NFIP flood insurance policies nationwide cannot adequately support the claims that have come from recent events, including storms like Sandy, Katrina, Harvey, Maria, Irma and Matthew.  And hurricanes aren’t the only cause of flooding.  We have seen some of these epic rainstorms cause significant inland flooding and damage.   As the head of the SC Department of Insurance said recently, “our entire state is in a flood-zone.”  And this may be true for many areas in the South, East and Midwest.  It is clear there is a need for a flood program that can provide support for affected residents after a storm, especially as we see changing climate conditions and rising sea levels. Lawmakers thus far have been unable to find a bi-partisan fix to the financially strained system.

As homeowners and members of our communities, we should certainly do our share to prepare for these natural events and make sure we have a solid plan in place for our families and our property.  We can maintain our property, keep our own emergency fund and can participate in the insurance coverages available to help protect us.  And we should hope and expect that our legislators – local, state and national- will compromise to find solutions to reform existing programs and to prepare disaster plans that can assist all of us in the event of a catastrophic event.

At DWM, we use a holistic approach to evaluating your financial plan, including risk management.  We will help you review all of your property & casualty insurance policies to ensure that you have appropriate coverage for you and your family.  Let’s hope Mother Nature stays peaceful for the rest of the year!

Innovation: Showcasing Efficiency and Tightening Security

Companies in the 21st century are constantly looking for way to move their services to the next level of the digital age. Accessibility, convenience, and speed are major factors that industry leaders always look to improve upon, and Charles Schwab & Co., Inc. is no different.

Over the past few weeks, Schwab has put on several presentations in cities across the nation to showcase their technological advancements in a series they call Schwab Solutions. At DWM, we were lucky enough to attend one of these presentations and learned of a lot of exciting new features and opportunities that we believe can assist our clients. Here are some of the highlights:

  • E-Signature->For existing clients looking to open a new account at Schwab, we can utilize a new process called e-signature to send the documents over to your Schwab portal. Simply let DWM know your intention to open a new account, and we can work up the forms to do so. Once the forms are ready, we can send a request for your e-signature, which will send a notification to your Schwab Alliance account. This will assist in opening your account faster, more securely, and with no paper waste!
  • E-Approval->For check and journal requests (moving money from one account to another at Schwab), we can follow a very similar process to the e-signature process, with e-approval! Once again this reduces processing time, paper waste, and improves document accuracy. Schwab is also working to bring this feature to MoneyLink requests, so stay tuned for that improvement!
  • Mobile Deposit->The Schwab app also allows investors to scan/take a picture of the front and back of a check and upload them for deposit, usually within the same day!
  • The Schwab platform itself is receiving an overhaul in the coming months, which should provide clients with a much sleeker, more intuitive experience. A major difference to come will be a personal value chart, which will display a simplified net worth statistic based on the accounts at Schwab, as well as the ability to add in accounts outside of Schwab (think 401ks)!
  • In addition to the aesthetical changes, the Schwab portal now has much more client interactivity than before, which will allow investors to update various information on their accounts all from within the website, no paperwork involved. These various services include:
    • Updating accounts in case of address change
    • Beneficiary updates on IRAs
    • Tax withholding percentages for IRAs

As with any technological advancement, new security challenges often emerge, and Schwab, as well as DWM, are your first line of defense against these threats. For Schwab’s part, they have bumped up security in some major ways:

  • Whenever a new device is used to access a Schwab portal, a text or e-mail is sent (depending on how the security of the specific account is set-up), to ensure that fraudsters are not trying to access your account information electronically.
  • In addition, Schwab offers a security feature called two-factor authentication, which allows for an app on your phone to provide a six-digit code to follow your Schwab Alliance password, further ensuring that only the account holder can access their sensitive information.
  • Finally, one further security measure clients can choose to utilize is called Schwab Voice ID. With this service, a client calls in and answers some basic questions to the Schwab Alliance team, through which their Voice Biometrics system analyzes the quality of your voice. Then, if any suspicious activity occurs in your accounts, Schwab will call and verify the activity with you, using the Biometrics system to ensure that the voice on that end of the line is actually the account holder.

As far as DWM goes, our stance and determination in protecting our clients’ information remains resolute. We are completely committed to client security, and will continue to both provide education to keep our clients informed of rising threats, as well as keeping ourselves up-to-date about viral issues and staying abreast of any suspicious account behavior. For example, one of the most dangerous areas regarding theft and fraud currently going on are real estate scams. Hijackers will find a way into legitmate e-mail threads regarding wire information for a client buying property, and provide phony wire information. As a result, verbal verification is the new normal. As part of our safeguarding protocol, DWM will be calling the client and/or the title company to verify these wire instructions to ensure that everything goes as planned.

At DWM, we are passionate about protecting our clients and helping them shape their financial future, worry-free. This is seen throughout our wealth management process, from investing to account management, to financial planning. We aim to help clients notice and avoid any landmines that might be hiding in their long-term financial plan. Providing safer, more efficient ways of accessing and updating their accounts, while also actively monitoring for suspicious activity and ensuring accuracy is an effective method of doing so.

Please feel free to stay updated on Schwab’s technological advancements through their “Client Learning Center” page found here:

http://content.schwab.com/learningcenter/

Please also feel free to contact DWM with any questions or concerns regarding either advancements or safety.

At DWM, we are passionate about protecting our clients and helping them shape their financial future, worry-free. This is seen throughout our wealth management process, from investing to account management, to financial planning. We aim to help clients notice and avoid any landmines that might be hiding in their long-term financial plan. Providing safer, more efficient ways of accessing and updating their accounts, while also actively monitoring for suspicious activity and ensuring accuracy is an effective method of doing so.

HERE COME THE MILLENNIALS!

In only 12 years, 75% of American employees will be Millennials.  By then, even the last of the Baby Boomers will be 66 and on social security (though a few of us might still be working).  Generation X is a smaller cohort and some of its 54-65 year olds will already be retired.  The oldest Generation Zers will only be 34 at that time.   Yes, in 2030, the Millennials, aged 35 to 53, will be the backbone of the economy and country.

What an exciting time to be alive!  Can you imagine all the changes that may occur in the next 12 years?  Just consider that just 14 years ago Blockbuster Video had 9,000 stores and is now down to one last store in Oregon. 2004 was also the year Facebook was launched.

Yes, new reality can be exciting and challenging.  The Millennials bring with them their own expectations of life, work and values.  Those organizations and communities that embrace generational diversity will undoubtedly thrive in a volatile, uncertain, complex and ambiguous future.

Jennifer Brown, author of “Reversing the Generation Equation: Mentoring in the New Age of Work,” indicates that Millennials “possess the most diverse attitudes, tendencies and requirements of any preceding generation and they are bringing that to work and life and demanding to be welcomed, valued, respected and heard.”  They’ve grown up with being in the center of the activity and expect to stay there.

The Pew Research Center’s “Millennials in Adulthood” takes a look at just how unique this generation is and how the social, political and economic realities in their formative years have shaped them.  Due to a disconnect between Millennials and many organizations not willing to meet them half-way, it’s no surprise that Millennials have experienced greater job dissatisfaction than Generation X and Baby Boomers.

A study conducted by Deloitte showed that 56% of Millennials have “ruled out working for a particular organization because of its values or standard of conduct.”  49% have declined a task assigned to them that was thought to go against personal values or rules of ethics.  According to the study, Millennials are seeking a good work/life balance (more than monetary compensation), their own homes, a partner, flexible working conditions and financial security.  Furthermore, this group does not necessarily defer to seniority as seen in previous generations. For them, respect must be earned.  Which brings us to the concept of “Reverse Mentoring.”

Jack Welch of GE was one of the early pioneers of reverse mentoring.  Twenty years ago, as technological changes were sweeping our country, Mr. Welch encouraged 500 top-level executives at GE to reach out to people younger than them to learn about the internet.  Since then, reverse mentoring has gone beyond technological learning and expanded into ideas, advice and insights.  Organizations such as PWC and AARP are among those who have launched programs.

At PWC, the young mentors are in their early 20s and have been working long enough to understand how it works and short enough to still have a fresh perspective.  The AARP Foundation created a Mentor Up program in 2013 where teens and young adults come together with older generations to keep them current and connected with the younger world.  The young mentor the older mentees on technology and health and fitness.  They also exchange Valentine’s Day cards.  In short, intergenerational connections were made, skills exchanged, understanding obtained and mutual respect and admiration were achieved.

At DWM, we have two excellent young team members; Grant Maddox in Charleston and Jake Rickord in Palatine.  We are just starting a reverse mentoring program at DWM where Grant and Jake will be the mentors and Brett, Jenny, Ginny and I will be the mentees.  Once a month, we set aside lunch time for the mentor to share a topic, theme or idea they are interested in sharing and to explain two-way learning opportunities.  We invest time to learn, get to know one another better and increase our trust and respect for each other.  We are also starting to dismantle the old paradigm that “seniority always knows best.”

Our goal is generational diversity and respect for all.  Yes, the Millennials are coming. And, yes, they come with the most diverse attitudes, tendencies and requirements of any preceding generation.  As they say in World Cup Champion France, “Vive la Difference.”

DWM 2Q18 MARKET COMMENTARY

‘Confusing’. If you look that word up in a dictionary, you’ll see something like “bewildering or perplexing” as its definition. Confusing could be a good way to describe the state of the market. On the one hand, you have a U.S. economy that may have come off one of its strongest quarters in years. On the other hand, there is continued threat of higher interest rates and a tumultuous trade war.

Before looking ahead, let’s see how the major asset classes fared in 2Q18:

Equities: Stocks were mixed in 2q18. Certain pockets did well whereas certain ones did not. For example, the Dow Jones Industrial Average Index was down 0.7% on the quarter and now in the red for the 2018 calendar year (-1.8%). The Dow’s multinational holdings are more prone to trade-related swings, whereas small caps*, up 7.8% for 2q18 & 7.7% YTD (Year-to-date as of 6/30/18), are not. Emerging stocks**, -8.0% 2q18 & -6.7% YTD, did not fare well. This brewing trade war between the U.S. and China, along with rising interest rates and the rising U.S. dollar, are causing many investors to flee from these so-called riskier areas. We think a good general proxy for global equities is represented by the MSCI AC World Index, which was up a modest 0.72% for the quarter, and now about flat (-0.2%) for the year.

Fixed Income: Yields continued to go up, boosted by the same concerns as last quarter: increasing expectations for growth and inflation in the wake of the recent $1.5 trillion tax cut. The Barclays US Aggregate Bond Index, dropped a modest 0.16% for the quarter and now down 1.6% YTD. TheBarclays Global Aggregate Bond Index fell 2.8% (and now down 1.5% YTD) as emerging market bonds suffered for same reasons as mentioned above for emerging market equities.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, registered a +0.4% for 2q18 and now off only 1.3% for the year. Gold*** suffered, -3.5%, however REITs**** and MLPs† had nice quarter returns of 5.8 and 11.5%, respectively.

Like others, you may be thinking something like this right now: “Thank you for providing color on the various assets classes, but I’m still confused. How did a balanced investor fare overall? And where do we go from here?”

Overall, most balanced investors had modest gains for 2q18 and are pretty close to where they were when they started the year.

As for looking forward, we think the area causing the most confusion and uncertainty is the tariff trade war issue. A lot of this is political noise which has weighed down stock prices. What has been, or will be, enacted is quite different than what is being discussed. We are hopeful that the countries can eventually reach a compromise on trade.

In the meantime, the US economy is red hot, with GDP nearing 5.0% and unemployment levels near lows not last seen since 1969. The upcoming earnings season should be exquisite! But all of these positives get analysts worried that the economy may overheat. The Fed’s goal is to raise interest rates enough to keep enough pressure on the brakes of this economy to control inflation, but not too much where it comes to a screeching halt. That being said, inflation is a little bit above the Fed’s target level and as such we would expect to see the Fed continue to raise rates gradually, perhaps for the next 4 -5 quarters. They’ll most likely need to stop at some point as the economy cools when some of the Tax Reform stimulus wears off in the second half of 2019. It’s not an easy job.

“I’m still confused – should we be worried about a recession in the near future?” While we don’t see it happening any time soon, it definitely is an increased possibility, and at some point, will inevitably occur. The goal is to be prepared for it. Don’t let emotions get in the way. Stay diversified and stay invested. Trying to time the market is a losing proposition. A good wealth manager can help you stay disciplined.

The good news is that the next recession will most likely be milder than the last couple for a few reasons including the following:

  • Economies, both here and abroad, are simply more stable than in the past.
  • Valuations are fine today. The forward 12-month PE (Price-to-Equity Ratio) of the S&P500 is right in-line with its 25-yr average of 16.1. International stocks, as represented by the MSCI ACW ex-US Index are even cheaper, trading at a 13.0 forward PE.
  • The Fed certainly does not want another 2008 on its hands. They will continue to be friendly to market participants.

SP GRAPH EDITED

 

Still confused? Hopefully not. But if you are, talk to a wealth manager like DWM. If you look at antonyms for confusion, you will see words like “calm”, “peace”, and “happiness”. That’s what our clients want and what we seek to provide them.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

**represented by the Russell 2000 Small Cap Index

**represented by the MSCI Emerging Markets Index

***represented by the iShares Gold Trust

****represented by the iShares Global REIT

† represented by the UBS AG London BRH ETracs Alerian MLP ETF

At DWM, our job is wealth management. We look to help our clients secure their financial futures through comprehensive financial planning and prudent investment management. Today, I’d like to focus on the investment management part which adheres to our philosophy of protection first, growth second.

Some readers may be familiar with DWM’s approach to investment management. At its core, it starts with the identification of our clients’ goals and constraints. We do this by identifying their goals, risk tolerance, return objectives, income needs, time horizon, and other special requirements. As every client is unique, so is each client portfolio.

We then match the characteristics of their goals and constraints with a specific Asset Allocation mix tailored to them. For example, x% equities via the DWM Core Equity Portfolio, y% fixed income via the DWM Core Fixed Income Portfolio, and z% alternatives via the DWM Liquid Alternatives Portfolio.

But many of our readers may not know the logistics of building those three DWM exclusive portfolios. Here is a little bit of the secret sauce:

The three major asset classes of equities, fixed income, and alternatives are further broken down into subclasses, which also have different exposures, risks, and potential returns. For example, we divide the equity portfolio into different sectors and market capitalizations, as well as between domestic and foreign stocks. We also pay attention to value vs growth. Then, in the fixed income portfolio, we split out exposure into government debt, corporate debt, and international debt, while paying special attention to credit risk and duration.

From there, there are several ways to go about choosing the securities to fulfill the subclasses. Our affiliation with Charles Schwab & Co- and its investment platform which makes most of the public investment universe available to us, there are lots of securities – some great, some not so great – to choose from.We further filter by looking at the following:

  • What type of exposure do we want to have in that subclass (for example, is market-cap weighted okay or is better to use a different methodology like factor-weighting)?
  • Total price to own and trade that security (e.g. the Operating Expense Ratio “OER” and ticket charge if applicable)
  • Volume: does the security trade enough for our firm to take a position for our clients’ portfolios
  • Security vehicle (ETF or Mutual Fund): both come with different characteristics
  • How do the securities complement one another, keeping in mind that non-correlating assets maximize your diversification benefits

It should be noted that from a risk management perspective we aren’t big fans of individual stocks. In fact, we began phasing out the use of individual stocks within our DWM-managed portfolios over a decade ago. Why?

  1. Company-specific risk: When allocating percentages of your portfolio to individual stocks, you run the possibility of the company represented by said stock going bankrupt or having a similar setback that can greatly increase the overall risk of your portfolio.
  2. More diversification with low-cost mutual funds and exchange-traded funds: With MFs and ETFs, we can incorporate the exposures to different individual stocks in one bundle, without having to have the aforementioned company-specific risk.

As you can now see, a lot goes into building and maintaining a portfolio. Once the initial portfolio is established with the appropriate weights to various investment style exposures, it is anything but “set and forget”. These “weights” or allocations to asset classes and the underlying investment styles can significantly fluctuate and will need to be rebalanced. Or we may find that we want more or less exposure to a specific area and thus adjustments are needed. Furthermore, new products – some great, some not so great – come to the market every day. If we identify one that is potentially a better fit to our model and it passes our due diligence process, we will make changes accordingly, whereby we execute trades via our sophisticated channels.

In conclusion, portfolio management is constantly evolving. Ongoing education and research is paramount to a solid investment management practice. At DWM, we don’t take that responsibility lightly. Through diligence and care, we seek to help our investors make their money work harder by eliminating the unforeseen landmines in their portfolio. Diversification, low-cost mutual funds/ETFs, and consistent portfolio monitoring are wonderful tools that DWM implements to help accomplish this hefty task, and keep our clients on track to meeting their financial goals.

TAX REFORM: THIS YEAR’S CHRISTMAS GIFT OR A FUTURE CHRISTMAS COAL?

On top of the regular holiday season’s festivities, this year we’re watching the proposed “Tax Cuts and Jobs Act” likely making its way to the President’s desk for signature. The “joint conference committee” announced yesterday that they have a “final deal” and Congress is scheduled to vote on this next week.  Before we review what we specifically know about the bill (not all details have been released as of this morning) and provide some recommendations concerning it, let’s step back and review it from a longer-term perspective.

Since last year’s election, stock markets have been on a tear- up over 20%, mostly driven by increased corporate profits, both here and abroad.  U.S. GDP is growing and unemployment is close to 4%.  Most economists believe that now is not the time for a tax cut, which could heat up an already expanding economy to produce some additional short-term growth and inflation. The Fed reported yesterday that the tax package should provide only modest upside, concentrated mostly in 2018 and have little impact on long-term growth, currently estimated at 1.8%.  So, tax cuts now will not only likely increase the federal deficit by $1.5-$2 trillion over the next decade, but will take away the possibility of using tax cuts in the future, needed to spur the economy when the next recession hits.  Certainly, we would all like lower ta

xes and even higher returns on our investments, but we’d prefer to see longer-term healthy economic growth with its benefits widely shared by all Americans and steady investment returns, rather than a boom-bust scenario and huge tax cuts primarily for the wealthy that may not increase long-term economic growth.

As of this morning, December 14th, here are the current major provisions:

Individual

  • Income Tax Rates.  The top tax rate will be cut from 39.6% to 37%.
  • Standard deduction and exemptions.  Double the standard deduction (to $24,000 for a married couple) and eliminate all exemptions ($4,050 each).
  • State and Local Income, Sales and Real Estate Taxes.  Limit the total deduction for these 

    to $10,000 per year.

  • Mortgage Interest.  The bill would limit the deduction to acquisition indebtedness up to $750,000.
  • Limitations on itemized deductions for those couples earning greater than $313,800.  Repeals this “Pease” limitation.
  • Roth recharacterizations.  No longer allowed.
  • Sale of principal residence exclusion.  Qualification changed from living there 2 of 5 years to five out of eight years.
  • Major items basically unchanged.  Capital gains/dividends tax rate, medical expense deductions, student loan interest deductions, charitable deductions, investment income tax of 3.8%, retirement savings incentives, Alternative Minimum Tax, carried interest deduction (though 3 yr. holding period required.)
  • Estate Taxes.  Double the estate tax exemption from $5.5 million per person to $11 million.

 

 

Business

  • Top C-Corporation Tax Rate.  Reduce to 21% from 35%.
  • Alternative Minimum Tax.  Eliminated.
  • Business Investments.  Immediate expensing for qualified property for next five years.
  • Interest Expense.  Limit on expense to 30% of business interest income plus 30% of adjusted EBITDA.  Full deduction for small businesses (defined as $25 million sales by House, $15 million by Senate).

Another key issue, the top rate on pass through organizations (such as partnerships and S Corps), is yet to be determined. However, it appears that a reduction of 20% to 23% will be available to pass-through income, subject to W-2 minimums and adjusted gross income maximums. This would produce an effective top rate of 29.6% on pass through income.

If all of that see

 

ms confusing, you’re not alone.  Lots of moving parts and lots of details still to be clarified. Even so, if the bill passes, you will have been smart to consider the following:

Recommendations:

1) Because the bill would limit deductions for local income, sales and real estate taxes, you should make sure that you have paid all state income tax payments before December 31, 2017. If you are not sure, pay a little extra.

2) Also, make sure you pay your 2017 real estate taxes in full before 12/31/17. Because Illinois real estate taxes are paid in “arrears” it will be necessary to obtain an estimated 2017 real estate tax bill (generally due in 2018) by g

 

oing to your county link and then paying this before 12/31/17.  Let us know if you need help on this.  In the Low country, while our CPA friends indicate that paying 2018 real estate taxes in 2017 should be deductible, as a practical matter, there appears to be no way to get an estimated tax bill for 2018 and prepay your 2018 real estate taxes in 2017.

3) Meet with us and/or your CPA in early 2018 to review the impact of the Act, assuming it becomes law, on your 2018 income tax planning. It will be important to review the various strategies that may be available to make sure you are paying the least amount of taxes. 

Yes, tax reform may be here before Christmas. Not sure what it will be: a wonderful gift for this year’s holiday or perhaps a lump of coal in our stockings for Christmases to come.  Stay tuned.

DWM 3Q17 Market Commentary

“Train Kept A Rollin’ All Night Long…” The US economic expansion continued on during the third quarter of 2017. It is the third longest expansion since World War II and is now closing in on 100 months.  There were plenty of negatives that tried to slow it down. Politically, we had the debt ceiling deadline, a failed attempt to repeal Obamacare, and a war of words with North Korea. Even the lives and economic losses from the likes of Hurricane Harvey, Irma, Maria, western wildfires and two Mexican earthquakes – amounting to what could be the most expensive year for natural disasters ever – couldn’t slow this train down.

Thing is: the positives outweigh those negatives. At the end of the day, the market is powered by companies’ earnings. And those earnings have been robust and are expected to continue to be! And it’s not just domestically; growth is accelerating at a global level with Eurozone businesses and households more confident about their prospects than at any time in more than a decade. Japan has shown decent growth and inflation this year. And emerging markets are enjoying better fundamentals with more credible politics. Choo! Choo!

We are big believers in asset allocation which is why we showcase the major asset classes each quarter. Here’s how each fared:

Equities: The S&P500 rose 4.5% on the quarter and is now up 14.2% year-to-date (“YTD”). Sounds excellent, but actually a more diversified benchmark, the MSCI All Countries World Index, which includes US large cap stocks, US smaller cap stocks AND international stocks, did much better, up 5.3% quarter-to-date (“QTD”) and now up 17.3% YTD. We’ve been saying for some time that domestic large cap stocks in general look pretty “frothy” and hence it’s not surprising to see this rotation out of domestic large cap stocks into other cheaper equities. The other thing at play is the renewed interest in the so-called “Trump trade”. The areas that moved post-Trump Presidential Election, like small cap and value, have ‘steamed ahead’ in the last few weeks from the renewed hope of possible tax cuts. In just September, the Russell 2000 outperformed the S&P 500 by 4.2% and the Russell 3000 Value outperformed the Russel 3000 Growth by 1.6%.

Fixed Income:  During the quarter, the Fed announced that they are pushing ahead with an aggressive schedule for rate increases. We are happy to see the Fed take this path toward “normalization” while the economy is strong. The US needs to get back to higher rates so that the Fed has “some coal for their engines” if things go bad. That said, this announced path has succeeded in boosting inflation expectations, which has pushed up yields in both the 2-year and 10-year US Treasury notes, with the latter closing the quarter at 2.3%, its first quarterly gain of 2017. For the record, the Barclays US Aggregate Bond Index gained 0.9% in the third quarter and is now up 3.1% for the year. The inclusion of global fixed income assets led to better results with the Barclays Global Aggregate Bond Indexregistering +1.8% for 3Q17 and +6.3% YTD.

Alternatives:  Let’s take a look at a few ‘alts’ we follow. Gold gave back a little in September, but registered a +3.1% 3Q17 return represented by the iShares Gold Trust. With 2017 going down as one of the worst natural disasters year on record, the alternative exposure to reinsurance-linked securities (sometimes referred to as ‘catastrophe’ securities) took a hit. One would have thought oil would have suffered from the hurricanes as well, but demand was strong and with slowing US production, oil prices (WTI) ended the quarter up 12.2%. For the record, the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 1.6% for the third quarter and 2.8% YTD.

For balanced investors, It’s been a pretty nice three quarters to start 2017. Looking forward, this bull market train can continue to roll, and a case can be made that returns can even get stronger given the great economic fundamentals around the globe. If Washington can get something done relative to a tax cut, look for stocks to accelerate into year-end.

Of course, there will always be (rail) road blocks. We are thrilled to see inflation measures move toward the Fed target range around 2%, but there are many out there concerned that inflation might ‘chug’ right through those target levels and create havoc on the back-end. Furthermore, the announced and about-to-start-very-soon Federal balance sheet reduction is an unprecedented experiment. And it’s not just the US attempting this.  Global central banks at some point need to do some house-cleaning and will be reducing their balance sheets as well. There is a huge risk something can go wrong and send this train off track. Lastly, we don’t think the markets are adequately pricing in the geopolitical risk out there, which some would say is approaching multi-decades high. Frankly, when a small probability risk is hard to price in, the market usually just shrugs it off. With trading activity so light recently and little risk currently priced into the market, things could get ugly very quickly if anything goes wrong.

In conclusion, these are challenging times. It’s not easy to navigate the terrain out there. So make sure you have good direction and management. Don’t fall victim to a bad conductor and wind up like Ozzy Osbourne “going off the rails of a crazy train!” Make sure that your engineer is keeping you on track. At DWM, we engineer our clients’ portfolios to ride safely through the peaks and valleys that this train has and will travel through. With the right team at the controls, you can make your journey a pleasant one.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT