Don’t Be A Victim!

tax theftIn today’s technology driven world, the unfortunate reality is that cyber breaches will happen. The Internal Revenue Service recently announced that cybercriminals gained access to personal data from more than 700,000 taxpayer accounts in 2015. A majority of the information is taken from the IRS database, but hackers are beginning to use aggressive and threatening phone calls or emails impersonating IRS agents to gain information directly from taxpayers. It’s important to know how to protect yourself from these unsolicited phone calls and emails and what to do if your information has been compromised.

 

The IRS, and many states, are now encouraging tax returns to be electronically filed. Many people believe by electronically filing, they are more susceptible to having their information compromised. This is not accurate. These cybercriminals are attacking the IRS online application called “Get Transcript.” This application allows for taxpayers to obtain prior-year tax return information. Whether a taxpayer files electronically or not, each taxpayer has the ability to pull this type of transcript. By accessing prior year tax data, cybercriminals are able to file false returns with more accuracy, making it harder for the IRS and states to detect. The IRS estimated that the government paid out about $5.8 billion in fraudulent refunds to these cybercriminals in 2013.

 

If the IRS detects that a suspicious return has been filed, they will send a letter to the taxpayer asking to verify certain information. However, most taxpayers become aware of suspicious activity when they try to electronically file their return. The IRS will reject any return immediately if their database shows a duplicate filing for any Social Security number (SSN). This is an advantage of electronically filing versus paper filing. If a taxpayer’s return is rejected and suspects fraudulent activity has occurred, the IRS recommends paper filing your return and attaching a completed Form 14039, Identity Theft Affidavit. Going forward, the IRS would offer free credit protection and issue a specific identification number to use with the filing of future tax returns.

 

While fraudulent returns are out of taxpayers’ control, taxpayers are able to limit the personal information they release. Scammers have started using phone calls, emails and text messages impersonating IRS agents to gain information directly from taxpayers.  These scammers use the IRS name, logo and fake websites to try and steal money and information.

 

The IRS has seen an approximate 400 percent surge in phishing and malware incidents so far in the 2016 tax season. The phishing schemes cover a wide variety of topics including, information related to refunds, filing status, confirming personal information, ordering transcripts and verifying PIN information. Some of their emails will include links that carry malware which can infect taxpayers’ computers and allow criminals to access personal information.  If a taxpayer happens to receive a suspicious email, the IRS asks taxpayers to forward the email immediately to phishing@irs.gov.

 

The impersonated telephone scammers are typically aggressive and want the taxpayer to act immediately. The scammers will ask taxpayers to pay their tax over the phone or even ask for personal information if a refund is due. These scammers will also leave voicemail messages asking for an urgent callback. If a taxpayer is suspicious about a phone call, they should hang up immediately. The IRS asks that the taxpayer contact TIGTA immediately using their “IRS Impersonation Sam Reporting” webpage https://www.treasury.gov/tigta/contact_report_scam.shtml or by calling 800-366-4484.

Here are several tips that will help avoid these scams:

 

The IRS will NOT:

  • Call and demand immediate payment. The IRS will not call about payments without first sending a bill or notice in the mail.
  • Demand tax payments and not allow taxpayers to ask questions or appeal the amount owed.
  • Require a taxpayer to pay an outstanding payment using credit or debit cards.
  • Ask for debit or credit card numbers over the phone.
  • Threaten to bring in local police or other agencies to arrest the taxpayer if they do not pay.
  • Threaten taxpayers with a lawsuit.
  • Initiate correspondence with taxpayers using email or text message.

 

Here at DWM, we advise our clients and other taxpayers to get their CPA, or tax professional, involved immediately with any correspondence from the IRS, especially ones involving tax-related identity theft. Corresponding with the IRS can seem overwhelming, so get help. For those clients that self-prepare their returns, we ask that you let us know if you receive any notices or suspect suspicious activity involving your tax information. We’ll do everything we can to help you not become a victim.

Ask DWM: How Does the Likely Fed Rate Hike Impact Your Asset Allocation and Investments?

janet-yellen

Investors and markets are watching this week’s Fed meeting very carefully. Fed Chairwoman Janet Yellen and Fed officials appear to be moving toward raising short-term interest rates this year. Most expect September will mark the time of the Fed’s first rate increase since 2006. A key challenge for the Fed will be the communication of where future rates are going.

We all remember two years ago when Fed Chairman Ben Bernanke created a “taper tantrum” (and threw all markets in chaos for one month) when he signaled it was thinking about ending the QE program. Chairwoman Yellen wants to avoid that and has recently been emphatic that she expects rate increases to be slow and gradual once they start. In fact, in a March speech in San Francisco, she used the term “gradual” or “gradually” 14 times.

The U.S. economy is making progress, with strong job gains and rising wages. Auto sales are way up and factory machines are humming. Small business and consumer sentiment is up as are retail sales. The Producer Price Index rose slightly higher than expected. This data is likely too strong for investors or the Fed to ignore. So, yes, it looks like a rate hike will likely occur this year.

Of course, none of us can control when the Fed will raise rates, what rates will be longer term and how well the Fed communicates the future. We can, on the other hand, control our asset allocations and our investments. That’s where our focus should be.

Let’s revisit our annual DWM seminar in October 2013 entitled “Rising Interest Rates: Should I Be Concerned?” Here’s a quick summary of the key points that are still valid today.

  • The bond bull market may be over.
  • Bonds still play a vital role within an overall portfolio as do all of the asset classes.
  • Equities typically perform well in rising interest rate environments, with the “sweet spot” being when the 10 Year Treasury Bond rates are between 3% and 4%.
  • Use of multiple asset classes lead to non-correlation effects that ultimately lead to better long-term results.
  • One needs at least 15% in alternatives to make a difference.
  • Stay invested.

So, focusing on asset allocation, you should start by revisiting your risk profile. This includes risk capacity, risk tolerance and risk perception. Your risk profile is unique. You need to look at your long-term financial goals and plan and honestly assess how you are “wired.” It’s not as simple as looking at your age. We work with clients in their 80s who have an aggressive risk profile and clients in their 30s who have a conservative risk profile. Your risk profile will determine your asset allocation and therefore your portfolio mix of equities, fixed income and alternatives. In the long-term, your asset allocation is the primary (90%) determinant of the return of your portfolio.

2013 was a watershed year for fixed income. For three decades, fixed income had always been an asset class with low risk and good returns. The “taper tantrum” signaled the start of the end of the bond bull run making fixed income riskier and reducing the likelihood of 8% annual returns going forward. Given this change in risk/return characteristics within the fixed income area, the same risk tolerances score from prior years may not necessary lead to the same asset allocation mix. Hence, many DWM clients reduced their allocation to fixed income in 2013, some quite significantly.

At the same time, DWM fixed income holdings were re-positioned in an effort to reduce risk and potentially increase returns for an expected rising interest rate environment:

  • Reduced duration (when interest rates rise, bond with the longest maturities suffer the greatest drop in price)
  • Added international developed and emerging exposure
  • Added floating rate exposure with very low duration and ability to perform in rising markets
  • Continued diversification through low cost vehicles
  • Kept credit quality solid

So, with all the uncertainty regarding when, how high, and how often the Fed raises rates and how the markets will react to these changes, we suggest you focus on what you can control. If you haven’t already done so, now is a great time to review your asset allocation and your investment holdings. Our DWM clients know that is one of the highlights of our meetings with them, hopefully quarterly or even more often when appropriate. For others, we’re happy to help provide a second opinion. Just give us a call.

Is the 4% Withdrawal “Rule” Reliable?

DiceRules of thumb can be great, except when they don’t work. Take the 4% withdrawal rate rule, for example.

This rule, developed twenty years ago, is used to forecast how much people can spend annually in retirement without running out of money. Let’s say a couple has $1,000,000 and has just retired. The rule says if they spend $40,000 (4%) from the portfolio and increase this annual withdrawal by the inflation rate, their $1 million nest egg should last for the rest of their lives.

Historically, an average annual return on a balanced allocation strategy portfolio was roughly 7% from 1970 until 2014, while annual inflation was 4%. Hence, a real return of 3%. The conditions during those four decades are different from today. The decades of the ’80s and ’90s produced average equity returns close to 20% per year. The bond bull market produced returns of almost 9% per year for the last three decades. During this time, the “rule” could have worked fairly well for some people. Today, however, there are a number of problems with this rule.

First, inflation forecasted returns and longevity have changed greatly. Inflation has been negative over the last twelve months and has averaged less than 1% per year over the last three years. Forecasted returns, of course, vary widely and no one can predict the future. A conservative estimate might be a 2% real return (3% nominal less 1% inflation, or 5% nominal less 3% inflation). Longevity is increasing. Hence, for many people, their calculations should be based on an eventual age of 100.

In an article from this past Sunday’s NYT, Professor Wade Pfau at the American College of Financial Services put it this way: “Because interest rates are so low now, while stock markets are also very highly valued, we are in unchartered waters in terms of the conditions at the start of retirement and knowing whether the 4 percent rule can work in those cases.”

Second, the 4% rule never took into account non-linear spending patterns of retirees, other goals, other retirement resources, asset allocation, taxes and stress testing the plan.

There’s a much better way to do this, though it takes more thought and time and a disciplined process. For those who value their financial future, it’s worth the effort. Here are some of the elements that you need consider:

Start with your goals. At what age do you want to achieve financial independence (freedom to retire)? What will be your likely spending patterns during retirement? What will your housing be? What will be your likely health care costs? Are there any other needs, wants or wishes you have for the future?

Retirement resources. The calculation needs to include not only the investment portfolio, but also other income sources, such as social security, pension, rental income or part-time work. The calculation also needs to review all assets, not simply the investment portfolio, and determine the amount, if any, of proceeds from the sale of those assets that could be used in the future to fund goals.

Asset allocation. Varying allocations will likely produce varying results of returns and volatility. The plan should be calculated using the appropriate allocation strategy. Returns should be calculated in two ways- historical and forecasted.

Taxes. Income taxes can have a huge impact on a plan. Allocation of investments into appropriate (taxable, qualified, Roth) accounts can make a real difference. Tax-efficiency throughout the plan is imperative.

Stress Testing. The calculations need to be done using a “stochastic” process such as Monte Carlo simulation rather than a linear one. A Monte Carlo simulation is a tool for estimating probability distributions of potential results by allowing for random variations over time. The world does not operate in a straight line and linear projections can be greatly upset (and therefore of little value) when outliers come into play. In addition, stress testing involves looking at the potential impact of negative factors in the future, including living longer, social security cuts, lower than expected investment returns, and/or large health care costs.

In short, the old 4% withdrawal rule is not a good way to predict whether or not you will fulfill the goals you have for you and your family. However, there is a process that can provide reasonable assurance and one you should expect from your wealth manager, like DWM, as part of their package of services for you. It can be a little complicated but should be customized for your particular situation. It will take some time and effort. It requires discipline and monitoring. However, if you value your financial future, it’s well worth the effort.

So Many Numbers: Which Ones Are Important?

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

Now, knowing a little more about our number system and with numbers seemingly everywhere, where do we focus our attention? Here are five key numbers that have a big impact on your ability to meet your financial goals:

Percentage of your paycheck that goes to savings/investments. This may be the most important decision in your life. By saving early, you can have a portion of earnings grow in a compound fashion for decades. Furthermore, by “paying yourself” off the top, you limit the amount available for everyday living expenses during your working years. This discipline helps you in two major ways to obtaining early financial independence- first, by creating the fund for “retirement” and second, by reducing the expenses you will likely have during “retirement.” BTW- there is no magic percentage. Everyone’s circumstances are different. Consider an amount of 10-20% of your gross pay.

Your Annual Living Expenses. Monitor your expenses for last year and group them in three categories- needs, wants and wishes. Review the data from a long-term perspective. Spending a considerable amount now on wants and wishes will obviously reduce the amount available in future years. It’s all about choices and accountability. For the most part, you alone can determine and control your level of expenses.

The Asset Allocation of Your Portfolio. This is one of your most important investment decisions. Based upon your risk profile you need to determine how best to split up your investment funds between stocks, bonds and alternatives (which can include real estate). Studies show that 90% of your investment returns are the result of your asset allocation.

The Net Returns on Your Portfolio. Research shows that fees really matter. A $1,000,000 portfolio that earns 5% net per year will grow to $4.3 million in 30 years. The same portfolio that earns 4% net per year will grow to $3.2MM. The difference is $1.1 million- a 26% reduction. Over long periods, loads, commissions, high operating expenses and management fees can be a significant drag on wealth creation. Low cost passive investments are best for stocks and bonds. Make sure you understand and monitor all fees charged to your portfolio. Make sure you are getting real value for all the fees. And certainly, know what your net returns have been, are expected to be and how they compare to the appropriate benchmarks.

Your Effective (average) and Marginal Tax Rate. Tax costs on earnings, investment returns and other income can be huge, particularly as a result of the increases caused by the Affordable Care Act. You and your advisors should know your tax rates and use them as a key factor in decision making and investment strategy. Furthermore, proactive planning designed to minimize taxes is a must for you and your advisors.

Over the last 45 years, I have worked with clients of all ages, income levels and circumstances. A common thread among those who have achieved or are achieving their financial goals is that they all knew of and monitored these five key numbers regularly, making adjustments as appropriate. And, of course, they use objective, proactive, value driven advisors like DWM to help them as well.

Why not make it a New Year’s Resolution to know and monitor these five key numbers for your financial future? It could change your life.

Why You DON’T Want to Load Up on The S&P500

The most popular of all market indices, the S&P500, which is made up of the 500 largest domestic public companies, just hit an all-time record high. It is up around 3.5% Year-To-Date (through May 13, 2014) and also is outperforming most of the other equity investment styles, i.e. mid cap, small cap, international, emerging in that same time period. So what’s not to love about it?!?

Whereas our DWM Core Equity Model currently has about a 35% weighing in large caps, we have received a few questions about why our models don’t have more. Several questions have also arisen about why we have the allocation that we do toward small caps, which have suffered so far this year, down over 3%.

There are a few main reasons which I’d like to explain here:

  1. U.S. large caps stocks alone do not provide appropriate diversification – We constantly are preaching about asset allocation and how by adding multiple asset classes one can bring non-correlation benefits to your overall portfolio, which produces a smoothing effect to the return profile, minimizes the downside, and ultimately leads to better long term results. The same concept applies within an asset class. So the more investment styles within equities – large cap, mid cap, small cap, international, emerging – the better, thus ultimately leading to better long term results.
  1. The biggest factor in investor under-performance is from chasing returns; i.e. buying after a streak of hot performance and selling off after a period of weakness. So don’t get caught up in the “investment style du jour”. Large caps are in vogue right now, but that certainly is not always the case. Take a look at the chart below.

Randomness of Returns

As this chart depicts, in both US and non-US markets, there is little predictability in asset class performance from one year to the next. Studying the annual data in the slide reveals no obvious pattern in returns that can be exploited for excess profits, strengthening the case for broad diversification across many asset classes. Investors who follow a structured, diversified strategy are more likely to capture the returns wherever they happen to occur.

That being said, over the past 50 years, academic research has identified variables that appear to explain differences in average returns among stocks. The variables (or premiums) that have stood up to rigorous testing are considered dimensions of expected returns. One of these dimensions is “size effect”. In 1981, Rolf Banz observed that small company stocks tended to have higher returns than large company stocks, as measured by their market capitalization. The size effect provided a more detailed framework for understanding the dimensions of equity performance. No one is certain why small cap stocks have offered an average return premium over larger cap stocks, but many economists assume that markets rationally discount the price of such securities to reflect higher systematic risk.

The chart below shows that this small stocks size effect premium is actually quite significant, leading to an increased annual return of 3.58% since 1927.

US Size Premium

So what’s not to love about small caps then?!? The small cap premium is great, but one can also see that this size premium is neither consistent nor predictable, as the chart above demonstrates. Another reason why we chose not to load up in any one area but to diversify. Therefore, a minority allocation of 15-25% of your total equity portfolio may be appropriate for small caps.

In conclusion, don’t get caught up in the latest fad and chase short-term outperformance by putting all your marbles in one basket such as the S&P500. Instead, think long-term and diversified. Diversified global investors who maintain a long-term outlook are the ones that are rewarded.