SECURE – Update on New Retirement System Legislation

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Two weeks ago, the House of Representatives almost unanimously passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, adopting their version of long-awaited retirement legislation that can now be introduced for deliberation on the Senate side and ultimately head to the President’s desk.   While Congress has discussed this for many years, these policy changes come at a time when life expectancy has increased and a greater number of American retirees must ensure that they don’t outlast their savings. The bill is now in the Senate Finance Committee, where action has slowed as a handful of Finance Committee members have some issues they want addressed before agreeing to vote on it.  

The marquee provisions in the House bill, estimated to cost $16.8 billion over 10 years, include providing tax credits and removing barriers for small businesses to offer retirement plans and boosting the minimum age for required minimum distributions (RMDs) to begin from 70½ to 72 years old. Other significant changes written in the House bill would make it easier for tax-deferred retirement plans, like 401(k)s, to offer annuities and also repeals the age cap for contributing to individual retirement accounts, currently 70 ½. There are also beneficial measures for part-time workers, parents, home-care workers and employees at small businesses, as well.

As reported by the May 23rd WSJ article, the House legislation also repeals a 2017 change to the “Kiddie Tax” that can boost tax rates on unearned income for low and middle income families that had caused surprise tax increases for many, including many military families of deceased active-duty service members . This policy change would also benefit survivors of first responders and college students receiving scholarships. This provision helped accelerate the passage of the bill to resolve a problem for military families right before Memorial Day.

To help pay for these changes, the House bill limits the “stretch IRA” provisions for beneficiaries of inherited IRAs. Currently, beneficiaries can liquidate those accounts over their own lifetimes to stretch out the RMD income and tax payments. The House bill would cut the time down to 10 years, with some exemptions for surviving spouses and minor children.  

A handful of Republican Senate members have some concerns about the House bill, including the House’s resistance to a provision that allows 529 accounts to pay for home-schooling costs. The Senate Finance Committee has introduced a bill closely resembling the House legislation – the Retirement Enhancement and Savings Act. Republican Senators are considering whether to make even broader policy changes than the House bill.

Here are the key items included in the House bill that are of most interest for our DWM clients:

IRAs if you are over 70 ½ – This bill would increase the age for the required minimum distributions (RMD) to begin from 70 ½ to 72. This will allow the accounts to grow and save taxes on the income until age 72. Also, there would no longer be an age restriction on IRA savings for people with taxable compensation – the age had previously been 70 1/2.

401(k)s – Small business employers would be allowed under this legislation to band together to offer 401(k) Plans to their employees, if they don’t offer one already. Long-standing part-time workers would now be eligible to participate in their employer’s Plan and new parents would be allowed to take up to $5,000 from 401(k)s or IRAs within a year of the birth or adoption of a child. Employers would also be required to provide more comprehensive retirement income disclosures on the employee statements and it would be easier for employers to offer annuity options in their 401(k) Plans.

Student Loans/529s – The House version of the bill would allow up to a $10,000 withdrawal from a 529 to be used for student loan repayment.  

At DWM, we are always watching for legislative changes that might affect our clients and will continue to report on these important developments. Please don’t hesitate to contact us with any questions or comments!

The Beauty in Roth Accounts

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The most common type of retirement accounts are traditional Individual Retirement Accounts (IRAs) and company sponsored traditional 401(k) plans, both of which are funded using pre-taxed dollars. The goal of these accounts is to accumulate retirement assets by deferring current year taxes and reducing your taxable income. Later, when funds are withdrawn, either voluntary or as part of a required minimum distribution upon reaching age 70.5, the accumulated earnings and contributions are subject to ordinary income tax. In addition to this, if you are below age 59.5 and you withdraw funds you could be subject to an additional 10% tax penalty.

“Cue the Roth IRA.” One alternative to popular IRAs and traditional 401(k) plans is the Roth IRA and Roth 401(k) (“Roths”). Contributions to both consist of after-tax funds. The accumulated earnings and contributions are not subject to income tax upon withdrawal. In addition to this, there are no required minimum distributions for Roths until the account has reached a non-spouse beneficiary. Although no current tax break is received, there are several arguments as to why Roth accounts can be a significant attribute to your portfolio and to your estate planning. As we will discuss below, the Roth has the ability to grow income tax-free for future generations.

 Contributions:

Funding a Roth account can occur in one of two ways; either through yearly contributions, currently limited to $6,000 per year if below age 50 and $7,000 if above age 50 for 2019 Roth IRA accounts. In addition to this, contributions may be limited for Roth IRAs if your income is between $193,000 and $203,000, for married filing jointly, and you are ineligible to contribute if your income is higher than these figures. Roth 401(k) contributions limitations are currently set at $19,000 per year per employee, with an available catch-up contribution of up to an additional $6,000 if age 50 or older. Contributions to Roths are typically more beneficial for young people because these funds will likely grow tax-free for a longer period of time and they generally have a lower current income tax bracket.

Conversions:

The IRS allows you to convert traditional IRAs to Roth IRAs without limitation. You simply have to include the converted amount as ordinary income and pay the tax. Converting traditional IRA funds to Roth is certainly not for everyone. Generally speaking, conversions may only be considered beneficial if you are currently in a lower tax bracket now, than when the funds will be distributed in the future. If you are in the highest tax bracket, it may not make sense to complete a Roth conversion. If you do not have available taxable funds, non-IRA funds, to pay applicable taxes, then a conversion may not be the best strategy for you. Lastly, conversion strategies are not usually recommended if you will have a need for your traditional IRA or Roth funds during the course of your lifetime(s).

Example:

In the right circumstances, a Roth conversion strategy may hold great potential to transfer large sums of after-tax wealth to future generations of your family. For example, let’s assume a conversion of an $800,000 traditional IRA. Of course, this would typically be done over the course of several years to limit the amount of taxes paid on the conversion. However, following the completion of the conversion, these funds will continue to grow tax-free over the course of the converters’ lifetime (and spouse’s lifetime). Assuming a 30 year lifespan, at an average rate of 5% per year, this would amount to close to $3,500,000 at the end of 30 years; a $2.7 million tax-free gain. For the purpose of this example, let’s also assume these Roth funds skip over the converters’ children to a future generation of four potential grandchildren. Split evenly, each grandchild would hypothetically receive $875,000. At this point, the grandchildren generally would be required to take a small required distribution, however, the bulk of these Roth funds would grow-tax free until the grandchild reaches 85 years of age.  Assuming they receive these Roth funds at age 30, it’s possible each grandchild could receive $5,600,000 of tax-free growth, assuming a 6% average yearly returns. For this example, the estimated federal tax cost of converting $800,000 in IRA funds may be close to $180,000, assuming conversions remain within the 24% tax bracket year-over-year. An estimated state tax cost may vary by state, however, some states such as IL, TN and FL do not tax IRA conversions. Now, if we multiply the $5.6 million times 4 (for each hypothetical grandchild) and add the $2.7 million of appreciation during the first 30 years, this is a total of $25.1 million of potential tax-free growth over 85 years. This obviously has the potential to be a truly amazing strategy. Note that because of the rules that enable people to stretch out distributions of an inherited Roth, the people who benefit the most are young.

To review if Roth strategies may be a good addition to your overall planning, please contact DWM and allow us to assist you in this process.

Ask DWM: Should We Invest in Real Estate?

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Great question.

 

Let’s start with some basic concepts.  Real estate is an illiquid investment. You can’t buy or sell it in a day or two like liquid investments. It is somewhat uncorrelated to the stock market returns- which is good.  While it is smart to consider adding real estate as a portion of your overall investment portfolio, you don’t want to have too much in illiquid investments. We suggest a rule of thumb is that real estate, excluding your house, should be at the very most 40% of your overall investment portfolio.  So, if your investment portfolio (both liquid and illiquid) is $1 million, real estate should at most be $400k.

Location. Location. Location. Appreciation in value over time is key. This will impact the ultimate sales price when you sell your investment property and the rental income amounts while you hold it. Historically, US real estate has increased, on average, about 3% per year, similar to inflation. However, location can produce tremendous differences. Charleston real estate has done very well in the last ten years, though some areas of the Lowcountry haven’t done so well. Chicago’s market overall has been flat for the last ten years, yet there are areas that have done very well and areas in the suburbs that have lost significant value.  Investing in a piece of real estate is not like buying shares in an S&P 500 index, where your investment will rise as the market will rise. Rather it is a singular investment in one piece of property, subject to both the general market risks and the specific risks of the property.

Would you be prepared to self-manage the investment property? Do you have the skills, time and patience to handle phone calls or texts, perhaps in the middle of night, from an upset tenant?   If you decide to have someone else do the property management, it won’t be cheap- likely 10% of your rental income.

Let’s look at the key metric- your likely return on investment. We start by calculating the “net operating income” (“NOI”), which is the cash flow of the property, assuming there is no financing, and compare this to the purchase price.  For example, let’s say you think you can buy a property for $500,000 that will rent for $3,000 per month. You need to include an amount for estimated vacancies/rental commissions- let’s use 8%. So, the hypothetical annual net rent would be $33,120. Now, let’s look at expenses- taxes might be ½% to 1% or more of the property value. There may be homeowner association fees and/or repair costs. And, there will be insurance-perhaps an amount equal to the real estate taxes. Just for simplicity, let’s say all of those expenses combined are 1 ½% of the value of the property. Based on a $500,000 property, expenses might be $7,500, assuming you do the property management yourself. Therefore, in this example, NOI would be $25,620 ($33,120-$7,500) or 5% of the investment.

The hypothetical total return on the investment is NOI + expected appreciation. Let’s say this property would be sold in 6 years for $650,000. Assuming you sell it using a broker, there would be a 6% commission. So, net proceeds of $610,000. This would represent a 3.5% annual appreciation on the property. Therefore, your total expected return in this example would be 8.5% (5% net operating income + 3.5% appreciation).

We haven’t talked yet about financing and taxes. If you get a loan at less than your NOI (5% in our example), your total return will increase slightly as you are benefitting from leveraging. If the rate is higher than NOI, the total return would be a little less. Depreciation is a non-cash expense that can reduce the taxable income on the property during your ownership. Any depreciation taken has to be “recaptured” (given back) when you sell the property. Depending on your personal circumstances, you may be able to take losses on rental property and you may be eligible for a 20% Qualified Business Income Deduction. Financing and taxes are generally not the key determining factors in deciding to buy the property, but may have some impact on the total return.

We generally suggest a minimum threshold for expected total return on real estate investments to be 9% or more. If a balanced liquid investment portfolio is expected, over a long-term, to have a total return of 5-7% net of fees, a real estate investment should be at least 3% more. Real estate investments are illiquid, riskier (due to lack of diversification) and, if you self-manage, will require time, skill and patience.

Under the right circumstances, investment real estate can be a nice addition for a portion of your investment portfolio. At DWM, we are very familiar with real estate. We understand the pluses and minuses for a portion of your investment assets. In 50 years of marriage, Elise and I have purchased and sold over 40 properties, some of which were our home and some were investment properties. Real estate investment has helped increase our income and net worth.

If you think you might like to invest in real estate, or, if you already own real estate and wonder if you should be adding more or subtracting some or all of it, give us a call. Once you’ve assembled all the facts (cost, income, expense, appreciation), we’re happy to help you review the NOI and total return and discuss how investment real estate fits into your overall investment strategy. We don’t do property valuations and we certainly can’t guarantee your future results, yet we’re happy to provide competent, independent and valuable input as you determine whether or not you should invest in real estate.

 

 

 

 

 

Billionaire Investor Ray Dalio: “Capitalism Needs Reform”

 

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Ray Dalio is the founder of Bridgewater Associates, one of the world’s largest hedge funds. Bloomberg ranked him as the world’s 79 wealthiest person earlier this year. Like many of us, Mr. Dalio was “fortunate enough to be raised in a middle-class family by parents who took good care of me, to go to good public schools, and to come into a job market that offered me equal opportunity.” He has lived the American Dream. America created the first truly middle-class society; now, a middle class life is increasingly out of reach for many of its citizens.

Mr. Dalio “became a capitalist at age 12, using earnings from part-time employment to start an investing career.” Mr. Dalio has been a macro global investor (making predictions on large-scale world events) for 50 years, which required him to gain a practical understanding of how economies and markets work. (In 2007, Bridgewater predicted the coming global financial crisis that hit in 2008-09). Mr. Dalio has learned that capitalism can be an effective motivator to make money, save it, and invest it, rewarding people for their productive activities that produce a profit. “Being productive leads people to make money which provides capital resources, which when combined with ideas can convert them into the profits and productivities that raise our living standards.” Even communist countries, including “communist China” have made capitalism an integral part of their systems.

As part of his work, Mr. Dalio has studied what makes countries succeed and fail. In short, “poor education, poor culture (that impedes people from operating effectively together), poor infrastructure and too much debt cause bad economic results.” The best results come from more equal opportunity in education and work, good family upbringing, civilized behavior, and free and well-regulated markets.

So, how is the US doing?

“Capitalism Is Not Working Well for Most Americans” says Ray Dalio. His research looked at the differences between the haves and have-nots in American- those in the top 40% and those in the bottom 60% of income earners. He found the following key stats:

  • There has been little or no real income growth for most people (the bottom 60%) for decades.
  • The income gap is about as high as ever and the wealth gap is the highest since the 1930s.
  • Most people in the bottom 60% are poor- they would struggle to raise $400 in the event of an emergency.
  • The economic mobility rate is now one of the worst in the developed world- US people whose fathers were in the bottom income quartile have very little chance of moving up to higher quartiles.
  • Many of our children are poor, malnourished and poorly educated.
  • Low incomes, poorly funded schools and weak family support for children lead to poor academic achievement, which leads to low productivity and low incomes of people who become economic burdens on the society.
  • The US scores in the bottom 15% of developed countries on standardized educational tests. High poverty schools really push our average test scores down.
  • Poor educational results can lead to students being unprepared for work and having emotional problems which manifest in damaging behaviors, including higher crime rates.

And, most importantly, he found that the income/education/wealth/opportunity gap reinforces the income/education/wealth/opportunity gap.

 These gaps weaken us economically because:

  • They slow our economic growth because a large portion of our population doesn’t have money to spend
  • They result in suboptimal talent and human development and, in many cases, lack of having a job that honors the dignity of one’s work
  • They result in a large percentage of our population detracting from our GDP, not contributing to it.
  • In addition, these gaps can cause dangerous social and political divisions that threaten our cohesive fabric and capitalism itself.

In conclusion, Mr. Dalio suggests capitalism is now producing a self-reinforcing feedback loop that widens the income/wealth/opportunity gap to the point that capitalism and the American Dream are in jeopardy. Ray Dalio believes what is needed is a long-term investment program for America that achieves good “double bottom line” returns on investments; producing both good economic returns and good social returns.

The nice bump in economic growth brought on by tax reform has already started to fade. GDP growth is expected to be less than 2% next year. While capitalism has likely worked very well for most of us, who are in the top 40%, it hasn’t worked so well for the bottom 60%. Let’s hope our politicians, of both parties, focus on long-term investments for our country with double bottom line returns. That could really make a difference in long-term economic growth.

Not All Winners: Tax Refunds Down $6 Billion from Last Year

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At the end of March, 2019, the Treasury had issued $6 billion less in tax refunds than the same period a year ago. The refunds still have averaged around $3,000 each and the number of returns processed is similar to last year, but there are roughly 2 million fewer refunds so far in 2019. Many taxpayers are shocked- getting smaller refunds or having to pay, when seemingly nothing has changed in their situation.

We cautioned our readers about this a year ago (March 15, 2018), in “How to Avoid a 2018 Income Tax Shock.” We pointed out the Tax Cuts and Job Act (“TJCA”) brought about a number of changes. It reduced itemized deductions, lowered tax rates, eliminated exemptions, and produced new tax withholding tables in early 2018 that reduced withholding, thereby increasing net paychecks. So, for those families who have used their annual refund as a forced saving mechanism, it was a huge disappointment this year. They received little or no refund-yet, in fact, they had already received their refund money with each enlarged paycheck which, studies show, was spent, not saved.

Wealth Management magazine reported today that “Fewer RIAs (Registered Investment Advisers) See Client Benefits From Tax Act.” Craig Hawley, head of Nationwide Advisory Solutions, authored a recent study on TCJA which indicated that “the benefits of tax reform were not as widespread as originally expected.” This is no surprise to us at DWM- we anticipated winners and losers. We didn’t expect the benefits to be widespread and they haven’t been.

Our DWM clients represent a very diversified group. We are pleased to work with clients of all ages, from teenagers and others in our Emerging Investor program to Total Wealth Management clients in their 20s to their 90s. We work with lots of folks whose primary income is W-2 income and others whose primary income comes from their businesses and still others whose income comes primarily from their investment funds and retirement programs. While we don’t prepare any tax returns, we are very involved in tax projections and tax strategy for our many families. Here is the anecdotal evidence of the 2018 impact of the TCJA we have seen:

1)For younger people, their taxes were slightly less, but their refunds were down or they had to pay.

2)Those with significant personal real estate taxes, particularly those in IL, CA and NY, in many cases paid more in income taxes than 2017 due to the fact that most of the large real estate taxes they paid were not deductible.

3)Business owners, except for those in the excluded “Specified Service Trades or Businesses” (such as doctors, lawyers, CPAs and wealth managers), did exceptionally well under TCJA. They were able to qualify for a 20% “Qualified Business Income Deduction” from their income and get lower rates as well. For example, if a business owner’s share of the profit was $1,000,000, only $800,000 of it was taxed and that was at lower rates producing tax savings of over $125,000 as compared to 2017.

4)Many retired couples with no mortgage and few itemized deductions were able to take advantage of the new $24,000 standard deduction ($26,600 for those over 65) instead of using their itemized deductions and this saved them taxes.

5)Overall, TCJA brought winners and losers. Generally, business owners (not in service businesses) and those in the highest tax brackets saw the biggest reduction in income taxes. Certainly, benefits have not been widespread.

At DWM, we regularly prepare tax projections for our clients and encourage everyone to know, at least by the 3rd quarter, what their 2019 tax status might be. It’s really important to go through this process to avoid tax shocks and, maybe, even find some opportunities to reduce your taxes for 2019. Please contact us if you have any questions.

Ask DWM: What is an Inverted Yield Curve and What Does it Mean to Me?

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Great question. Historically, an “inverted yield curve” has been a signal that recession was on the way. As with so many things these days, though, the old “rule of thumb” may not apply. Here’s why:

yield curve is a graph showing interest rates paid by bonds. The chart is set up with the horizontal axis representing the borrowing period (or “time”) and the vertical axis representing the payments (or “yield”).   We all would typically expect that loans over a longer period time would have a higher interest. That’s “normal.”  For example, if a 30 year mortgage rate is 4%, a 15 year mortgage rate might be at 3.25%.   A one year Certificate of Deposit might earn 1% or less and a 5 year C.D. might be 2%. The situation is referred to as a “normal” or “positive” yield curve in that interest rates are higher as the borrowing period gets longer and the curve slopes upward, see below:

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However, rates don’t always work that way. At the end of last week, the three-month Treasury bills’ yield 2.46% was higher than the yield (2.44%) for 10-year treasuries. This situation technically produced an inverted yield curve, since a shorter period had a higher rate. This also happened three months ago. Historically, “curve inversions” have tended to precede major economic slowdowns by about a year.

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Inverted yield curves are unusual because they indicate lenders (or investors) are willing to earn less interest on longer loans. This is most likely to happen when the economy is perceived to be slowing down and faces a meaningful risk of recession. Historically, curve inversions have occurred about a year before the each of past seven recessions in the last five decades, though a recession doesn’t necessarily occur every time we see a yield curve inversion.

The U.S. economy has slowed already from the average growth rate of 2018; mainly as a result of the 35-day government shutdown and reaction to the Federal Reserve’s (“Fed”) reports of slower growth and a moratorium on interest rate hikes. Some economists feel the economy may slow even more due to the tax-cut stimulus being only a one year spike, headwinds from trade tensions with China, political uncertainties and global polarization and fragmentation.

However, other factors point to strong economic growth. We do have a solid labor market which drives consumption. Average monthly job creation is well above what might have been expected this late in the business cycle. Further, more workers have been attracted back into the labor force and wage growth has been 3%; a rate in excess of inflation. Business investment should rise and government spending is higher.

In short, an inverted yield curve is not a perfect predictor of recessions. A different portion of the yield curve inverted three months ago in December and the markets in early 2019 have rebounded sharply as fears subsided. Also, many economists believe the drop in 10-year Treasury yields is due to non-U.S. economic headwinds, like Brexit as well as the unwinding of the Fed’s balance sheet after Quantitative Easing. They believe it’s not because of serious weakening of U.S. economic fundamentals.

The current inverted yield curve may or may not be the bellwether of a coming recession. These days, there is not a simple cause and effect relationship between an inverted yield curve and recession. More likely will be the resolution or non-resolution of uncertainties such as Brexit, trade tensions, political matters and global peace. Stay tuned and stay invested for the long-term.

Money and Time

 

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As the old saying goes, “Time is Money.” One of the great laws of business is that time equals money: The more time you can efficiently utilize, the less time you waste and the more money you make. Some may call this the opportunity cost of laziness. By being lazy you essentially give up the opportunity to make money. You’ve likely heard the phrase in some form or another a thousand times before, and it makes sense. However, have you ever considered it the other way around?

It may feel strange saying it out loud at first, but the saying can go both ways. Money is time. Time is one of the most valuable resources on earth. Thinking of money in terms of time is one of the best ways to adopt a healthy attitude about spending and stop splurge spending. If you know the true cost of your dollar you may be more inclined to save it.

To start, you must factor in all hours spent at or around the office, commuting, and at seminars over the course of a year. Once you’ve established the number of hours spent on work-related items, you will then have the denominator for your true hourly wage calculation.

The next step will be establishing any costs associated with your work. There are a lot of people who are unaware their job may actually have costs associated with it. Aside from the amount of time spent at work, most spend a considerable amount in preparation for their job. The cost associated with job preparation includes gas and care repairs for daily commuting, daycare costs, coffee, work clothes, and some may even include the occasional happy hour after work. Once you’ve established the amount of money you spend on your job on a weekly or annual basis, then subtract this number from your weekly or annual salary. Now subtract taxes to arrive at your net salary.

Now we are ready to calculate your true hourly wage. Take your net salary, add back any retirement plan contributions you may have been making, and divide this by the number of hours spent on work-related items to arrive at your true hourly wage.

Example:

Let’s assume an employee works 40 hours per week, spends 10 hours on work-related items. This employee gets paid $40,000 a year, spends $8,000 per year on work-related items, and pays about 20% ($8,000) in taxes between state and federal per year. The true hourly wage of this employee would be $9.23 per hour ($24,000 divided by 2,600 work hours per year). Compare this to a naked eye analysis of this employee’s salary, $19.23 per hour, and you will notice a $10 per hour difference for this employee. This means each dollar this employee spends costs him or her more than 6 minutes at work.

Knowing the true cost of your dollar, you may find yourself reluctant to splurge on that next big item. It’s important to remember that the relationship between your money and your time isn’t always that straightforward. While you can certainly calculate the cost per hour of use for a given splurge item, (a $160 chair used for 480 hours a year and used for five years will have a cost per hour of $0.06), this should not be the only consideration in spending. For both spending your time and your money, there is always at least one item we can all spend it on: That which makes you happy.

What will be Your Legacy?

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In the last few years, Elise and I have really gotten into our own family histories. Both sides of Elise’s family came from England, one in the 1830s and one at the turn of the century. My family tree is more diverse. I am 25% German, 25% Finnish, 25% Italian, and, I just recently found out, 25% Jewish. My German ancestors came to America in 1855 and the others came at the turn of the century.

As Elise and I looked back at not only the DNA of our forefathers and foremothers, but also the culture, traditions, stories and values passed on to us, we realize what wonderful legacies we have been given. In a way, we’re all standing on the shoulders of our ancestors.

In the past few years, there’s been a huge increase in people exploring their family history. Ancestry.com sold 1.5 million DNA kits a year ago on Black Friday. The DNA test uncovers your origins. And, Ancestry.com and others have huge online databases and have put together family trees that you can review and expand. This search has caused us to again look at our potential legacy and what it will be. Do you wonder what your legacy will be?

Legacy is defined as “something transmitted by or received from an ancestor or predecessor from the past.” In the simplest terms, it is everything you have worked for in your life. Certainly, that includes money and property, but it’s much more than that. It includes what you have achieved in your work life and your family life, as well as other social relationships and achievements that you ultimately leave behind.

Your estate, on the other hand, is the sum total of everything you own-all of your property (real, tangible and intangible). Your estate requires an “estate plan” to provide for your desired succession of assets, while minimizing taxes and administrative hassles.   If you desire to pass on more than just your assets and transfer your spiritual, intellectual, relational and social capital, you need a “legacy plan.”

The question is not “Will you leave a legacy,” but “What kind of legacy will you leave?” Why not be proactive and intentional in creating your legacy? Why not structure your life in a manner that helps you achieve your purpose and greatest success and safeguards those accomplishments for transfer to future generations? Why not develop and maintain your legacy plan?

If we think of our legacy as a gift, it places an emphasis on the thoughtful, meaningful, and intentional aspects of legacy, as the consequences of what we do will outlive us. What we leave behind is the summation of the choices and actions we make in this life and our spiritual and moral values.

What do you want to leave for your family, the community, your partner or the world? Your legacy can be huge; perhaps a world-changing cause. But it doesn’t need to be a grandiose concept. Instead of wanting to leave a legacy that inspires people to help starving children in the world, you, for example, may relate more with leaving a legacy with your family and friends of how you were kind, accepting and open to others, which might help inspire them to do the same.

A good place to start is to think about the ancestors, mentors and associates whose legacy you admire. What actions can you take to inspire others in the same way?

We encourage you to give some thought to your legacy plan. We’re all creating our legacy every day, whether we realize it or not. And, here at DWM, we’re focused on protecting and enhancing not only your net worth, but your legacy as well.

 

 

“The Two Most Powerful Warriors are Time and Patience”- Leo Tolstoy

 

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Good investing can be boring, yet effective! Specifically, investors with a long investing timeline should build a diversified, low-cost portfolio with an appropriate asset allocation and stick with it. Rebalance regularly to sell high and buy low. Don’t try to time the markets by getting in and out. Yes, this is boring, particularly with the volatility we are enduring, but it’s what it takes to generate solid returns over the long haul. Patience and time are powerful warriors and our friends.

Take a look at the average risk and returns for various asset styles over the last 20 years, which includes the 2008-09 financial crisis and 2018. The best performers, with higher returns and lower risk, are in the upper left hand corner:

 

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Bonds have relatively low risk and have produced decent returns over the period, particularly the first 15 years. Small cap and mid cap stocks have outpaced large cap stocks (e.g. Dow Jones and S&P 500) over time, with better returns and similar volatility (risk). Non-US stocks have trailed US stocks. Emerging markets stocks have produced very good returns, but with larger volatility swings. REITs have produced a 10% annual return with a risk factor about equal to U.S. stocks. The diversified composite “12 Index Portfolio” has produced a nice return of 6.8% annually (better than large cap stocks with 5.6%) with about 2/3 the risk of stocks.  Please note that during this 20 year period, the inflation rate was 3.2% per year. So, the 12 Index Portfolio produced an annual “real return” of 3.6% over the last 20 years.

Investors get in trouble when they lose faith in the markets and their allocation, react to the current market pain and go all cash or move to the “hot” asset classes for better returns. That approach generally ends badly for investors as the markets will correct themselves over time (as we have seen December 2018 losses recovered in January 2019) and hot asset classes go “cold” as the pendulum swings to the next “hot” asset style right after they jump in.

The 12 Index portfolio in this chart is composed of all the asset styles shown, equally weighted. Overall, this allocation is 50% equities, 33% fixed income and cash, and 17% alternatives; what we would term a “balanced asset allocation,’ appropriate for a “balanced risk profile.”

This balanced allocation will never be the top performer in any year. And, it won’t be the worst. It is designed to deliver middle-of-the-road, steady returns. Patience and time produce the results.

Investors need to also understand that time is their friend. “Time in the market beats timing the market.” Here’s another chart showing the growth of $1 since 1990, all invested in the S&P 500:

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The black line represents an investor who stayed in the market every day and turned her $1 into $14. The red line represents the investor who missed the 25 best days (roughly one a year) and turned her $1 into $4. The gray line represents the return an investor could have received by simply investing in five-year treasury notes, turning $1 into $4.

Getting out of the market is easy; getting back in at the right time is very difficult. In the last couple of months, for example, the equity markets (using the MSCI AC World Index) are about level from December 1, 2018 until last Friday, February 8th. However, if an investor got cold feet and got out in mid-December and waited to get back in until mid-January, they would have lost 3.5% on their equity returns. Timing the market is not a good idea- unless you own a crystal ball, can implement perfect end of day execution on buys and sells, have no transaction costs, and don’t mind paying taxes on realized gains.

Patience and Time are two powerful warriors-they are your friends. Let them do the heavy lifting.  Invest for the long-term. Yes, slow and steady wins the race. It may not make for great cocktail conversation, but boring investing can be very effective.

FIREd up about Early Retirement

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There is a recent trend among Millennials and younger Gen Xers that is generating a great deal of interest. The concept is defined by the acronym FIRE – financial independence/retire early. A WSJ article from November follows the rigid budget and sacrifices of Sylvia, who wants to retire in 2020 with $2 Million at age 40. The current rage to extreme early-retire by using frugality, intense saving and/or
investment strategies to achieve financial independence is becoming a popular notion. This purportedly comes from the 20 to 40 somethings who have a ‘burning’ desire to not be chained to a job, but rather want to freely choose how they spend their time. The FIRE followers want the freedom of financial independence to allow comfortable “retirement” at an earlier than usual age.

FIRE and the discussion around it has inspired many recent blogs, podcasts, articles, books and even a documentary coming out this year called “Playing with FIRE”. Playing with Fire follows a family as they “test their willingness to reject the standard narrative of adult life, which basically prescribes: go to college, take out tons of student loans, buy a new car, take on a mortgage, buy another car and lots more stuff you don’t need, then work for 40+ years to pay for it all. If you’re lucky, you might be able to retire at 65 and not have to eat cat food.” Now that is cynical!

On the surface, however, retiring early sounds like a reasonable goal… we are all striving for some level of financial independence, after all. At DWM and as financial advisors, we definitely believe that controlling spending and sticking to savings goals are the keys to reaching financial independence. Most of us would consider these good money habits to be a common sense approach to life – live below your means, save more, be less materialistic- but what does it take to actually achieve an extreme early retirement in your early 40s or even 30s and make sure you have enough money for the rest of your life? FIRE followers believe extreme saving and frugality is the path. As the Investment News article describes it “Followers of FIRE amass savings voraciously and live on bare-bones budgets. They aim to stockpile enough money to fund a retirement lasting roughly double that of the average American.” Apparently, the retirement savings number that they strive for is based on a future 3-4% percent withdrawal rate that might have to last 60 years!

FIRE followers advocate aggressive savings goals of 50-75% of earnings and following strict budgets to achieve this. They focus on cutting back or even cutting out all non-essential spending like going out to eat, vacations or bigger houses and newer cars. Or like Sylvia from theWSJ article reportedly does, search for the brown bananas and borrow Netflix passwords. This might be where we should talk about quality of life!

On top of that, the unknowns in this strategy could wreak havoc on the best-laid plans. Some in the FIRE movement live austere lives now and plan to continue the austerity into the future to maximize
their savings. All well and good as long as nothing unexpected happens. How about the often unforeseen or underestimated expenses that come from having kids or running into health problems? We can try to predict the impact on our portfolios from inflation, the economy, the markets, investments, but we really can’t say absolutely what will happen in the future. We know that healthcare costs are increasing and becoming a large spending item in normal retirement, especially before Medicare begins. We know that we can’t predict what will happen to Social Security. We certainly can’t predict our life spans – whether short or long – nor are we ever as ready as we would like for emergencies and crises like natural catastrophes, death of a loved one or chronic illness. We just don’t have a crystal ball!

There is also an underlying degree of cynicism in this mindset that our working life is focused solely on the goal of amassing “more stuff”. What about the satisfaction and connection that comes from building a career and a level of accomplishment and expertise in a field? Many of us have had several varying career paths and, had we jumped off after the first one, what would we have missed? What inventions or discoveries or achievements would humanity miss out on if the productivity and challenges that are gained from a lifelong career were cut short?

Successful financial independence does come from hard work, discipline and a measure of frugality and sacrifice – we can all agree on this. At DWM, our goal is to help guide you toward achieving your goal of financial independence, whether you keep “working” or spend your time in other ways – as you wish. We try to minimize some of the risks by planning for as many of the “What Ifs” as we can and hope that, by charting a course, we can help you breathe easier as you plan for the future. We want you to be “fired up” for your whole life and find satisfaction and quality of life during your saving and accumulating days, as well as your spending and legacy days. We think this is possible by following a balanced, moderate and careful financial plan. We can certainly get fired up about that!