The summer is over, the kids are back in school, and just when you think you might have some time to relax, you ask yourself, “How on earth am I going accomplish all of my goals before year-end?” Well, you are not alone. I find that creating a checklist of ‘to do’ items is enormously helpful in accomplishing my goals, and emotionally satisfying as I knock items off my list. With this in mind, I have created a simple, yet pretty comprehensive, financial check list for you to share with your advisers and put your mind at ease as you enter the fourth quarter.
Each of our financial check lists will vary somewhat, but you may be surprised at how many items apply to you. Further, setting your financial priorities and tackling your most relevant items now, will allow you to enjoy a more relaxing and satisfying holiday season come November and December.
If you are unable to meet with each of your advisers, I would be happy to review this financial check list at our earliest convenience without charge. Simply give me a ring at 617.945.5157, or shoot me an email. If you would like to share a few items from your own check list, please be sure to leave a comment at the end of this article. Let’s get started!
A Financial Check List for You and Your Advisers
1) Tax Related Considerations
- Review your long-term capital gains. Are they meaningful? Do you have long-term capital losses available to offset the gains? Are there long-term losses that you should realize before year-end to offset your taxable long-term gains?
- Review your short-term capital gains. Are they meaningful? Do you have short-term capital losses available to offset the gains? Are there short-term losses that you should realize before year-end to offset your taxable short-term gains?
- Explore whether you (and your spouse) have used up your lifetime gift tax exemption of $5+ million each. If not, consider making tax-free intra-family gifts. For even greater tax-efficiency consider making generation-skipping transfers to a trust for the benefit of your grandchildren. See my earlier article, What High Impact Tax Planning Can you do in September?
- Counterintuitive as it may seem, review with your team of advisers the appropriateness of making taxable intra-family gifts. This is not a crazy idea, and you can learn more about this from my earlier article The Advantages of Making Taxable Lifetime Gifts.
- Begin estimating your 2013 tax liabilities (both state and federal) to avoid being surprised later on by how much you owe. Work with your advisers to think about sourcing the required cash, potentially even through a line of credit, where your private banker can be of assistance. See my article Read This If You Still Think You Don’t Need Credit and see my brief video Innovative Investment Solutions, A New Perspective on Credit.
- If you have an offshore bank account, ask your CPA what you can do to minimize draconian forfeitures and fines that could be applicable, depending upon your situation. Offshore accounts are more common than is generally appreciated and are a red flag for tax authorities in the U.S.
2) Insurance Considerations
- Consider spending some quality time with both your life insurance adviser and your estate planning counsel in the same room. While the prospect of having this meeting may not fill you with excitement, it could turn out to be an important conversation both in terms of tax/liquidity management and estate conservation for your intended beneficiaries.
- Review your property and casualty insurance portfolio. There are a myriad of small factors that taken together, can dramatically impact the cost and efficacy of your coverage. You may be spending more than you think, or more than you need to. On the other hand, there may be inappropriate gaps in your coverage.
3) Investment Strategy Opportunities
- Have an offsite meeting of your investment committee and key advisers to evaluate your long-term asset allocation targets. Are the targets still suitable? How does your portfolio conform to your targets? Are you comfortable with the divergences between your targets and your actual exposures? Some investors have a large asset allocation target to bonds, based on a 30-year bull market in bonds. This may be a good time to review those choices.
- Similarly, review your liquidity preference. As a result of the Great Recession, a lot of investors developed an ultra-high liquidity preference. Can you tolerate more illiquidity in your portfolio than you currently employ? If so, how would you and your advisers like to deploy an increased illiquidity budget?
- If you want to rebalance your asset class exposures there may be a need to give some managers advance notice of your intentions. It is not uncommon for hedge funds to allow only annual exits with 60 or 90 day notices, so now is the time to review required notice provisions.
- Assess your cash flow needs (e.g., taxes, living expenses, both family and charitable gifts and capital calls) and whether you can use your cash flow requirements to reallocate assets back toward your long-term asset allocation targets.
4) Investment Tactics
- Review each of your investment managers with your investment committee to see if any managers should be put on a watch list, or are candidates for replacement.
- Has your view of passive asset management (e.g., index-related mutual funds and ETFs) vs. active asset management (e.g., mutual funds and managers who emphasize security selection expertise) changed? Do you want to shift more of your exposures in favor of active or passive management?
- What opportunistic investments may be worth embracing before year-end? Are there asset types that have languished and whose time has come? Your advisers may have perspectives to share with you on this topic.
- Take a close look at your balance sheet, asset allocation and performance reports. Are you getting all of the information that you need? If not, what are you and your team going to do about it and when?
5) Take a Poll
- Ask each of your advisers what their key issues are in your situation, and prioritize their ideas. Odd as it may sound, some advisers are bashful or reticent about pushing their agendas. So get your top advisers to go on record about what they see as priorities in managing your investment/financial affairs, and what they want you to do about those priorities.
I hope that you find my financial check list inspiring, rather than discouraging. If you have a Private Investment Counselor, he/she is in your life specifically to help you examine all of these things. If you don’t have such a person in your life, consider whether you need one. If that isn’t the right answer for you, then divide-and-conquer by carving up the list and getting your existing advisers to help you.
What have I overlooked? Please leave a comment, including items that you would like to add to my financial checklist, just below this article. If you prefer, please give me a ring at 617.945.5157, or shoot me an email.
Happy Dog Days of Summer! In the spirit of warm days, cool breezes and light reading, I want to share with you some thoughts about philanthropy that I acquired from a ‘fire side chat’ with Warren Buffett and his sister Doris.
I had the pleasure of hearing Warren and Doris Buffett speak at a Massive Open Online Course (MOOC) developed by Rebecca Riccio, Program Director, Northeastern (University) Students4Giving. The course is called GivingWithPurpose, and it is sponsored by the Learning by Giving Foundation , established by Doris Buffett to teach younger generations about philanthropy. Part of Rebecca’s course includes interviews with leading American philanthropists, and the first interview (a.k.a., fireside chat) was with Warren and Doris Buffett.
What can the Buffetts teach us about philanthropy? You guessed it, plenty. The beauty of Riccio’s interviews is that they apply to all ages and offers us ‘regular folk’ an opportunity to sit in on intimate interviews with America’s leading philanthropists. Let me share with you six (6) highlights from the Warren and Doris Buffett interview:
1) Giving is a Lifelong Journey
The Buffetts’ father was a strong role model who helped Warren and Doris develop a passion for giving. Warren Buffett has, in turn, been very influential in modeling philanthropy for his children. Warren’s remark, “The chains of habit are too light to be felt, until they are too heavy to be broken,” sends a clear message about forming constructive habits. Build good giving habits early and be a model for others. A related quotation of the Buffetts’ is: “Have the right heroes and march in their footsteps.”
2) When Does a Journey of Giving Begin?
For the Buffetts, their journey of giving began in their 20’s. However, now-a-days I have noticed that children are introduced to philanthropy in their teens, through both their families and schools. If you wish to share your thoughts about when to start teaching children about philanthropy, please comment below.
3) Find a Style of Giving that Works Best for You
Warren Buffett described himself as a ‘wholesale donor.’ Why? Because he prefers donating to foundations, such as the Bill and Melinda Gates Foundation, Learning by Giving, and his own children’s foundations, which select the ultimate beneficiaries. He places his money with direct donors whose causes, values and sense of mission he shares.
Interestingly, Doris is a ‘retail donor.’ Her style is both hugely labor intensive and, as she remarks, “enormously joy intensive.” Doris’ philanthropic style is passionate, businesslike and unsentimental, as she performs intensive due diligence. Despite their different giving styles, both Doris and Warren agree that: 1) the process of giving is intensely personal, 2) you must find your passion and follow it, and 3) you need to do so in a way that works best for you.
4) Narrowcasting is a Fine Thing
Warren Buffett mentioned a conversation that he had with Tom Watson, the founder of IBM, in which Tom Watson said, “I’m no genius, but I’m good in spots. I concentrate on those spots.” In philanthropy, the message is that you cannot solve all of the world’s problems. Find your focus and your passion and don’t get distracted. Doris, for instance, has had great success with prisoner education and higher education for battered women.
5) Have Metrics for Success and be Prepared to Fail
It is wise to measure the results of your philanthropy. That is, establish metrics going in and measure the results of your contributions. Philanthropy is a realm in which intractable challenges can be tackled, so know what constitutes success for you and don’t be afraid of failure. In the words of Warren Buffett, “The rewards of success may outweigh the risk of failure. Don’t be too risk adverse and don’t assume that you will always succeed.” Quoting Walter Lipman, Warren Buffett said, “We sit in the shade of trees planted by others,” and he went on to say that, “we have a responsibility to plant more trees, to provide shade for those less fortunate than we are.”
6) Don’t Define Philanthropy Narrowly
If you do not have money to give, you may have time, talent or expertise to give to causes you feel passionately about. Or, you may be able to contribute a combination of time, talent, expertise and money.
I hope that this ‘summer reading’ has inspired you to share your thoughts and comments about philanthropy with your friends and family. I believe we are a nation of givers and have benefitted greatly from the good will of others.
If you would like to rate this article or leave a comment, please do so below. If you would like to suggest a topic for a future article or talk with me personally, please give me a ring at 617.945.5157 or shoot me an email. In the meantime, happy summer!
F. Scott Fitzgerald is often quoted for saying that, “The rich are different than you and me.” This begs the question, “How are they different?”
Three economists set out to answer this question by studying the investment strategies, portfolios and behaviors of a good-sized group of wealthy families in the United States. What they found out is valuable to a wide range of investors, regardless of your net worth. This week I review the findings of their unpublished report and include my personal observations.
The study, which examined 260 families with an average net worth of $90 million from 2000 – 2009, was also reviewed by the Wall Street Journal in an article entitled, How the Rich Play the Market.
Four Lessons Learned from Wealthy Investors:
- Active Trading Is Uncommon. The families that were studied were not active traders, and they were thoughtful about taking tax losses. In my experience, many private investors are reluctant to take a loss because they perceive it as a sign of failure. Further, some investors will continue to hold an investment even after they have lost confidence in it, hoping that it will recover and they will break-even. Unfortunately, sometimes the investor’s loss of confidence is warranted and the investment does not recover as they had hoped. One way to be disciplined about taking tax losses is to invest in a tax-aware index-tracking fund or account. As the description suggests, this type of account provides you with an investment return that closely tracks a capital markets index (e.g., the S&P 500). The account manager is tasked with harvesting tax-losses on a regular basis and reinvesting sales proceeds so as to track the target index. This allows investors to take full advantage of tax losses, while remaining fully invested in their target asset allocation.
- Diversification Can Be Helpful. The study found that wealthy families own a substantial number of individual securities, mutual funds and exchange traded funds. This is consistent with my client-related experience as well. Diversification allows you to achieve a broad range of asset exposures (e.g., home and other developed country equities, emerging and frontier markets equities, large cap, mid cap and small cap exposures, global fixed income, natural resources and commodities, and real estate). However, less well-executed diversification can also be inefficient, if you are paying fees to active managers with overlapping mandates. Avoid paying fees to active managers to create a portfolio that essentially looks a lot like an index fund.
- Private Investments Are Typically Embraced. One conclusion, which may or may not be universally applicable to my readers, is that the families in the study invested 20% of their assets in hedge funds, private equity funds and private direct investments. Based on my professional experience, wealthy individuals and families often invest 10% to 20% of their portfolio in hedge funds, and are likely to invest another 10% in private equity venture capital, direct company investments, natural resources and real estate partnerships. Many investors, however, do not have the appetite to allocate more than 20% of their assets to investments with limited liquidity. Further, they are unlikely to have the necessary research to access the best hedge funds or private equity/venture capital and private investments. Similarly, Diana Frazier, a co-founder of FLAG (a global private-investments management firm), is often quoted as saying, “Private investments are not an asset class; they are an access class.” Fees can be steep, liquidity is constrained and manager research is extraordinarily important. Accordingly, if you wish to emulate other wealthy families in private investments then it is important to seek the best conflict-free professional advice.
- Rebalancing Can Make A Real Difference In Your Investment Results. The study concluded that wealthy families understand and undertook asset class rebalancing. However, I was disappointed to learn that these families, who were likely to be well-advised, were not disciplined about rebalancing their assets in the Financial Crisis. Specifically, when equity values were impaired and the value of high quality long-term bonds had appreciated, these investors were over-allocated to bonds and under-allocated to equities. Nonetheless, they failed to rebalance away from the bonds into equities at fire-sale prices. As a consequence, their aggregate portfolios fell from $8 billion to $3 billion – a stunning 63% decline over the 2008 / 2009 period! During this time, the S&P 500 fell severely (36%), but less drastically than the results of the study-families. A more successful approach would have been for those investors to sell some of their bonds and to invest their proceeds in equities, rebalancing their overall portfolios back to their long-term asset allocation targets.
It is hard to rebalance into an asset class that is declining, because one does not know when it will hit bottom. It is equally hard to rebalance out of an asset class that is appreciating, because one does not know when it will hit the top. However, in recalling the simplest investment concept, it is generally good to ‘sell high and buy low,’ and the 2008 Financial Crisis offered investors this very opportunity. I do not recommend liquidating an entire asset class that has appreciated to invest in an asset class that is falling, nor do I necessarily recommend rigidly re-balancing to your long-term targets. However, I do recommend re-balancing toward your long-term asset allocation targets when your actual exposures differ substantially from your targets.
If you have perspectives to share about how you manage the investment assets that you are responsible for, I invite you to leave a comment below. If you prefer, you can contact me personally at Jack@RGPIC.com or ring me at 617.945.5157.
As Will Rogers once said, “Why not go out on a limb? That’s where the fruit is.” In the investment environment his remark translates to, “no risk, no return.” For decades investors have been told that bonds are the safest investment, and perhaps rightly so. For the past 30 years interest rates have continually declined. The interest rate on the 10-year U.S. Treasury bond has averaged 6.6% and many investors believed that their bond principal was pretty risk-free. Fast forward to April 11, 2013, when the interest rate on the 10-year bond had fallen to 1.82%. Will bond rates fall to zero, or will interest rates rise? Both outcomes carry a measure of risk because when interest rates rise the value of outstanding bonds falls, putting your bond principal at risk.
So, bonds do in fact carry some level of risk. Further, bond managers take a series of measures to enhance investment returns, which can increase your risk profile in ways that you might not fully understand. I am not suggesting that you abandon bonds; I am suggesting that you learn about the risks that you embrace when you invest in bonds. Having this type of transparency in your bond portfolio will help you fully to understand your exposure to risk and to evaluate your risk tolerance for your principal.
Here are some basic considerations that will help you assess the amount of risk in your bond portfolio and your risk tolerance for your principal:
- Length Matters
Bond managers talk about two dynamics: 1) maturity, the length of time it takes for your bonds to mature and for you to get your principal back, and 2) duration, a more subtle measure of maturity, accounts for the timing and size of your bonds’ coupon (or interest) payments. While duration is a better measure of risk than maturity, it is more complicated and maturity is okay for today’s discussion.
Generally speaking, the longer the maturity of a bond, the higher its coupon (or interest) payments will be. Further, the longer the maturity (or duration) of a bond the more profoundly its value will be impacted by changes in interest rates. For example, in a falling interest rate environment your long-term bonds’ interest payments will remain relatively high and the value of your bonds will increase. However, when interest rates rise, the value of your long-term bonds’ interest payments will be lower than newer bonds,and the principal value of your long-term bonds will decrease.
- Hanging Out In Short-Term Bonds May Not Help
So if long-term bonds are at risk in a potentially rising interest rate environment, why not keep it simple and hang out in short-term bonds? Well, there is a good reason that such an approach is not gratifying. As I mentioned earlier, ‘no risk no return.’ Super short-term high quality bonds offer almost no yield. As of April 10, 2013, the one-year U.S. Treasury yield was 0.13% (or about 1/10th of 1% a year). The point is, the U.S. Federal Reserve Board’s policies are designed to make high quality short-term bonds as unattractive as possible so that investors will buy higher yielding long-term bonds, or ideally invest in equities or other assets.
- Transparency Counts
Now we get to the fine print. You may think that you know how long-term your bonds actually are, but there is always the fine print. In the caveats there may be language about “assumed prepayments” (which typically refers to mortgage-backed bonds). Prepayments tend to shorten the term of a bond portfolio when interest rates fall. Or perhaps there is some language about the “call-adjusted duration,” which also tends to shorten the term of a bond portfolio when interest rates fall. However, in a rising interest rate environment (which could be on the horizon),there will be less predictable prepayments and calls, which may lengthen the term of your bond portfolio and may put your principal value of risk. As an investor, you need to understand the fine print and the term of your bond portfolio absent prepayments and calls. Your Private Investment Counselor can help you explore the real term of your bond portfolio.
- Quality Is An Important Driver
In the 1980s, investors and bond managers used to talk about “junk bonds.” Today, this term has been replaced by “high yield bonds” and “the credit portion of your portfolio.” Whatever the euphemism, we are talking about junk bonds. They aren’t illegal or immoral, but understand that they embody more risk than super-high quality bonds. Risk is okay, but you need to understand what risks you are adopting. How much of your bond portfolio is in “high yield” (a.k.a., junk bonds)? What is the quality of these bonds? Be sure that the quality of your bond portfolio is consistent with your particular needs.
- Currency May Be a Factor
Non-home-country bonds may, or may not, be a wonderful thing to have in your portfolio. Just be certain that you are willing to embrace the currency risk associated with these bonds. Some non-home-country bonds may be denominated in your home-currency and some may not. Are you comfortable with both the credit risk of the bond issuer and the currency risk associated with the bonds? The credit quality of issuers is dynamic and in recent years, the credit quality of some sovereigns has declined while the credit quality of others has risen. Further, some of the so-called emerging markets (e.g., Chile) are better credit risks than some of the old-line European bond issuers.
By way of summary, no risk no return. If you want to earn an investment return on your bond portfolio then you need to accept some risk. Otherwise, you should hold cash, which offers virtually no investment return. The key is to identify and understand the risks that are present in your bond portfolio and to evaluate whether those are the appropriate risks for your situation.
As always, if you would like to discuss transparency and risk management, please drop me an email at Jack@RGPIC.com or give me a ring at 617.945.5157. Meanwhile, please leave a comment in the Comment section just below this article, allowing us to have a lively interchange amongst my readers. Thank you.
I was recently approached by two separate families about how to manage their investment committees. Both families have significant resources and are striving to get the most value from their investment committee members. In my 2012 Investment Assessment Survey, the majority of respondents said they wanted to receive more decision-making support from their investment committee and improve coordination and communication among their advisers. This reinforces the point that investment committee dynamics are vitally important and deserve more attention than one might think.
The purpose of an investment committee is to oversee your portfolio and to help you achieve your long-term financial and investment goals. An investment committee with high functioning dynamics is much more likely to deliver superior investment outcomes than a dysfunctional one. However, an investment committee can unwittingly become dysfunctional when adviser recommendations conflict, personal biases interfere with rational decision-making and advisers do not share the same understanding of your goals.
Improving the performance of your investment committee involves several dynamics including: having the right number and types of members, determining voting privileges, deciding how much involvement the family should have, etc. Below I advise you how to enhance your investment committee dynamics and I offer practical recommendations for improvement. You may want to peruse some of my other articles related to investment committees as well:
- Best Practices for Selecting Personal and Institutional Trustees
- Multiple Advisers Can Make Investment Decision-Making as Clear as Mud
- 7 Guidelines for Building a Successful Investment Committee
Ten Keys to Successful Investment Committee Dynamics
- Committee Composition
- Total number of members: the correct number of committee members is idiosyncratic to your family or institution. However, an investment committee with four to seven voting members is generally workable, efficient and effective. Any more can be unwieldy and fewer may not offer enough diversity of perspectives.
- Representation of principals: having a mix of both voting and non-voting principals can enhance your breadth of vision and expertise. This is especially so if some principals are genuinely not interested or engaged in the topic at hand.
- Contrary to what one might think, voting members should not be investment-related vendors (e.g., strategy consultants, bankers, asset managers, etc.). The role of these presenters is to make recommendations to the investment committee, not to vote on their own recommendations. This approach will also help to reduce potential conflicts of interest.
- There is a growing trend to include a compensated committee member who is not a vendor or member of the family/institution, with years of direct professional investment experience. This is exactly what I do as a Private Investment Counselor (learn more by clicking here to see Investment Committee Services on my website).
- Vendors should not think that they own a seat at the table for every meeting. While your trustee and strategy consultant might need to attend every meeting, this is not necessarily true of all vendors. For example, it is unlikely that your attorney, CPA, life insurance or property & casualty insurance professionals need to attend every meeting. However, they might be invited to present periodically. Proactively managing the composition of meeting attendees allows you to add fresh views.
- This can be a tough one, as some committees won’t hire a manager unless the portfolio manager presents to the committee at their customary location. However, some of the most desirable managers would not consider deploying their portfolio manager’s precious time in such a wanton manner. (This is especially true of exciting hedge funds, successful venture capital funds and alike.) Would it be okay for a subcommittee to meet with those managers at the managers’ offices? Think about it.
- Some committees consider it necessary and prudent to meet with every manager on their roster every year. Review your calendars, frequency and length of meetings and consider whether this is credible and productive.
- Successful committees typically schedule their meetings far enough in advance so their members can make every meeting. This is the most effective way to build continuity and a shared vision. Committee members who fail to attend every meeting can significantly degrade committee dynamics.
- Holding quarterly in-person meetings is generally suitable. Skype, GoToMeeting, and professional video conferencing are also wonderful technologies that can be highly effective for some meetings. However, they do not replace a small group of persons meeting in person several times a year.
- What time of day should you hold your meetings? If you want to engage your next generation (a.k.a. NexGen), then you may want to consider holding some meetings at non-traditional times, such as weekends and evenings. (Please click here to see “Three Key Elements for Engaging Your Next Generation in Legacy Planning”)
- Committee members need to know each other as individuals, and to build personal communication, rapport and understanding. I recommend holding at least two dinners each year on the evenings prior to meetings. Does this interfere with your personal and family time? You bet it does. The payoff is neither obvious nor immediate, but it will maximize your team’s dynamics and effectiveness over the long-term. This is especially so when your committee has to deal with the inevitable stress in the investment markets or during periods of family/institutional stress.
- Preparing for meetings in the taxi on the way to the meeting is not okay.
- Be sure to get meeting materials in everyone’s hands at least a week prior to the meeting.
- Ask committee members to email presenters (e.g., investment strategy consultants, private bankers, etc.) significant questions at least 2 business days prior to meeting. This should give your presenters sufficient time to prepare thoughtful, timely responses.
- Know your committee. Some committees can meet for a day and half, or even two days in a row. Others find that 4 hours is their limit.
- Do not try to “put three pounds of nails in a two pound bag.” Design agendas that respect your committee’s attention span.
- Subcommittee meetings can supplement shorter full-committee meetings. This is a tool worth considering, particularly for specialized investment assets.
- Think actively about what location is most stimulating and engaging for your committee. Some committees always meet at the same place, while others meet at different locations based on the convenience of various committee members.
- Some committees also move their location in an effort to see more of their asset managers and prospective managers. Others may meet in different global capitals to increase their global perspectives.
- Oftentimes, families are more comfortable meeting at a vacation home in casual attire instead of a formal office or conference room (remember to mix business with pleasure).
- Strong committee dynamics can be fostered by lengthy tenure. However, some turnover can introduce new blood and perspectives. There is a balance that should be managed thoughtfully.
- Develop a schedule by which one vendor is reviewed each year and each vendor is reviewed every four to six years. You may want to engage a facilitator to interview the committee members as well as principals and non-voting committee attendees.
- During this process, an opportunity to adjust the composition of your committee might come to light. Even when vendors are retained, periodically shining a bright light on your relationships can improve service levels.
- While you are at it, do a self-review every four to six years. You may want to have a retreat to find ways to enhance your effectiveness using a facilitator.
If you approve, disapprove or would like to share your thoughts on this article, I encourage you to leave a comment below. Engaging a dialogue can be valuable to all of my readers, and your thoughtful comments are welcomed. Naturally, I will be delighted if you ring me (617.921.7440) or shoot me an email with your thoughts, comments and suggestions.
Tax time is approaching and if you are looking for ways to reduce your long-term tax burden then you have come to the right place. With all due respect to Uncle Sam, when it comes to paying taxes what you keep is just as important as what you make. During tax time most people focus on what they can do to reduce their taxable income. This is a good start, but it is not innovative enough.
A more innovative way to minimize your tax burden is to plan ahead by making a taxable gift during your lifetime vs. through your estate. You might be thinking, “Jack, I already reached the maximum tax-free giving amount set by Congress, why would I possibly want to make a taxable gift?” First, the concept of paying gift taxes now to avoid paying more estate taxes later is pretty powerful, even if you have exceeded your tax-exempt gift amount. Second, if you make the gift through an irrevocable trust, then you get to keep the income during your lifetime (this is covered in more detail below).
This week’s article reveals the financial and cash flow benefits of making a taxable lifetime gift vs. estate gift. (Pssst… If you have not already done so, consider taking advantage of the enormous tax-free giving opportunity that was scheduled to be dramatically reduced at the end of 2012; and is still in effect. Please click on the title to read What High Impact Tax Planning Can You Do in September?)
Financial Benefits of Taxable Lifetime Gifts
Say for example that you have exceeded your lifetime gift exemption, and all further gifts will be taxed as lifetime gifts or estate transfers.
(For the sake of simplicity, I will ignore the favorable impact of your annual gift tax exclusion as it will only serve to make your lifetime gifts more attractive.)
Let us assume that you have budgeted $1.5 million to cover the gifted amount as well as the federal tax that will be paid upon the gift’s transfer. Let us also assume that gift and estate tax rates are both 45%. How much money will your beneficiary vs. Uncle Sam receive if you make the gift during your lifetime vs. as an estate transfer?
||$ 465,300 (45% of $1,034,000)|
||$1,499,300 (pretty close to your $1.5 million budget)|
||$ 675,000 (45% of your $1.5 million budget)|
The arithmetic is pretty compelling: taxable lifetime gifts are hugely more tax efficient than taxable estate transfers. Given a budget of $1.5 million, your beneficiary will receive roughly 25% more money if you make the gift during your lifetime vs. through your estate. This is because with estate transfers, the donor’s estate has to pay an estate tax on the estate resources that are being used to pay estate taxes. This is essentially a tax-on-the-tax, a double whammy that is not present with lifetime gifts.
“But wait there is more” (to quote the Ginzu knife infomercial). Some states, and local jurisdictions in other countries, have their own estate or inheritance tax and do not have a lifetime gift tax. This provides further incentives for making taxable lifetime gifts. Furthermore, if the asset being transferred is one that may appreciate in value, (such as an investment in a prospering enterprise), then removing that taxable appreciation from your estate may offer yet another important tax benefit for making a lifetime gift now.
Cash Flow Benefits of Taxable Lifetime Gifts
Going back to the original question, “Jack, I already reached the maximum tax-free giving amount set by Congress, why would I possibly want to make a taxable gift?” Suppose that you are concerned about cash flow because you need the income from your assets to pay for living expenses. If so, then you may want to speak with your Private Investment Counselor, attorney and accountant about structuring an irrevocable trust. An irrevocable trust can provide you and your spouse with the lifetime income from the gift and your beneficiary with the principal upon your death. Additionally, only a portion of the trust will be a taxable gift, further improving the tax efficiency of making taxable lifetime gifts.
If you are not concerned about cash flow, then you might consider gifting the entire amount to receive the tax efficiencies and the added pleasure of watching your beneficiary enjoy your gift during your lifetime.
Have I convinced you that making a taxable lifetime gift now vs. through your estate will reduce your overall long-term tax bite? It would be terrific if you would be so kind as to leave a comment, question and/or share your thoughts about taxable giving. If you would prefer to address this matter with me directly, please ring me at 617.945.5157 or drop me an email.
Talking to your family about legacy planning can be like going to the doctor. You know you need to do it, but you might worry that it could be hard. Further, the longer you postpone it the more likely it is that problems will arise. I have seen families wince with pain at the thought of talking with their children, or more broadly their next generation (NexGen), about legacy planning. Some even defer these conversations entirely. The NexGen can feel equally uncomfortable discussing legacy planning with senior family members if they are not properly prepared or engaged.
If you can relate to these issues then you are not alone. Wealth transfer, philanthropic values and wealth education have consistently taken a back seat to investment strategy and spending management in my annual investment assessment survey. Further, these conversations can be emotionally charged. However, they are profoundly important to private investors as they search for ways to involve future generations in legacy planning.
This week’s article focuses on three key elements for successfully engaging your next generation in legacy planning. If you would like to read related articles about governance policies and legacy planning that I have written in the past, please visit governance policies and legacy planning (click on the underlined words to read the articles).
Three Key Elements for Engaging Your Next Generation in Legacy Planning
- A Stake
It is nearly impossible to engage your NexGen in your investment process unless they have a meaningful stake in the outcome of your investment process today, versus next year or next decade. The amount of income and access to capital you provide them with is highly situation-specific.) Giving your NexGen access to income (e.g. cash distributions and/or other capital is hugely valuable in getting their attention. It also demonstrates that you trust and respect them, which will likely encourage them to play a constructive role in your investment affairs. However, providing the NexGen with a stake is not enough to fully engage them in legacy planning.
- A Vote
Engaging your NexGen in your investment process also requires that you provide them with a vote. After all, who would want to read detailed investment reports, participate in meetings and address topics which are not their truest passions unless their vote is taken seriously? If you do not want to give NexGen members voting privileges immediately, then consider a period of on-the-job training in which they attend calls and meetings before they are given voting privileges. Just be sure that this training period is not too long, lest it will undermine the trust and respect you have demonstrated in providing them with a stake.
- A Voice
Once you give members of your NexGen a stake and a vote you might think that you have done everything you possibly could do to bring them onboard. A generation or two ago you might have been right, but not today. If you want to increase your chances of successfully engaging the NexGen in your investment affairs, then you need to give them a voice too. You may be asking, “Whatever is he talking about?” If you really want to engage with your NexGen members, you need to invite them to help shape agendas. Otherwise, they will be voting on issues they may not care passionately about, which will not truly capture their attention and devoted participation. Providing NexGen members with a voice gives them an opportunity to contribute constructively to the range of alternatives under consideration.
Providing your NexGen members with a stake, a vote and a voice is not always easy. When you give NexGen members a stake, they may not use the cash distributions or capital as you wish they might. When you give them a vote, you may not reach the same outcomes that you might have achieved on your own. When you give them a voice, you may be drawn into areas that do not reflect your highest priorities. Such results can cause friction.
There is certainly no fool-proof way to engage your NexGen in legacy planning, but based on my experience, the risks of not engaging your NexGen members far outweigh the risks of engagement. Providing NexGen members with a stake, a vote and a voice allows your governance profile to evolve with each generation based on their needs and desires. Further, it allows you to identify potential leaders, coach NexGen members yourself and/or select others who can coach them.
As always, if you would like to discuss any of these topics in more detail, I would be happy to speak with you at our mutual convenience. Feel free to ring me at 617-945-5157 or send me an email at Jack@RGPIC.com.
What did we learn in 2012 that we can benefit from in 2013? For one thing, we can take a look at the results of my 2012 Investment Assessment Survey to see what worked and what didn’t work for investors. These insights are based on my professional expertise and investor responses, 80% of whom are asset owners responsible for managing their individual and/or their family’s assets. It also includes responses from advisers, and although there is some overlap, the findings that I am going to share with you over the next few months are based primarily on the asset owner’s perspective.
This week’s article focuses on investment strategy, which was ranked the most significant factor influencing investor decision-making for the third year in a row. In the months that follow, I will also discuss spending management, since what you spend is as important as what you make. In addition, investors are increasingly recognizing the importance of governance, and I will be discussing intergenerational planning in more detail in 2013. If you would like to read a refresher on spending management and governance, please read my prior articles on spending management and governance (click on the underlined words to read the articles).
Lastly, I would like to thank those of you who chose to complete my survey. Your time and comments are invaluable and very much appreciated.
As we enter the New Year, here are two lessons that we learned about investing from 2012:
- 2012 Investment Strategies: What Worked and What Didn’t
- When the Unexpected Happens, How Do You Stay Out of Harm’s Way?
2012 Investment Strategies: What Worked and What Didn’t
In 2012, investment strategy was named the most significant factor influencing decision-making for the third year in a row. However, the vast majority of respondents (70%) were not satisfied with their 2012 investment results. Does this mean that their investment strategy had a nick in its armor? Perhaps, but nearly one third (30%) of respondents were very satisfied with their results. Given the fact that these are very challenging times, this second group of respondents was most likely advisers and/or asset owners who were well advised.
Going back to investment strategy, since investment strategy was ranked the number one factor influencing investment decisions, then why were the majority of respondents not satisfied with their results? Was it their investment strategy or something else? My experience tells me that it may have been something else. Specifically, investors likely had an investment strategy but did not stick with it. Given the fact that it is very difficult to stick with a strategy when the world around you is going awry, this is not surprising. However, investors who stray from their investment strategy, particularly during choppy times, often find that it is a recipe for disappointment.
For assets owners and advisers who tried to outguess the markets, there were several turns of events that made it nearly impossible to get it right:
- No one thought that interest rates could possibly decline further so investors generally reduced the duration of their bond portfolios. They purchased more short-term bonds and shunned long-term bonds. However, long-term interest rates continued to decline as the Fed engaged in ongoing “quantitative easing.” This drove up the prices of long-term bonds and investors in long-term bonds ended up coming out ahead.
- Investors were caught off guard by the strength of the U.S. dollar. Going into 2012, investors expected the U.S. dollar to be weak due to the growing federal deficit and the Fed’s ongoing easy money policy. Further, investors breathed a sigh of relief over Europe’s fiscal crisis when the European Central Bank (ECB) stepped forward to support the Euro. To the extent that U.S. investors held international assets, they expected a declining dollar to provide a wind at their backs. However, the dollar remained unexpectedly strong and U.S. investors in non-dollar assets got the wind in their face.
- Hedge funds in general dramatically underperformed in 2012 relative to long-only equities. If you invested in hedge funds you probably did not lose money, but you probably did not make as much money as you did with your long-only equities. In 2012, the U.S. stock market (S&P 500 Total Return) was up over 15%, whereas many good hedge fund programs were up only about 6%.
When the Unexpected Happens, How Do You Stay Out of Harm’s Way?
Without a crystal ball (click here to link to article) it is nearly impossible to outguess the market. However, when the market has an unexpected turn of events, what can you do to stay out of harm’s way? At the risk of sounding boring, you develop an investment strategy addressing all the Opportunity Classes (see graphic with this link), articulate it, and stay with it. Investors who try to outguess markets often find out the hard way how demonstrably difficult it is to get tactical asset allocation right (such as the ones I mentioned above). If you developed a long-term plan and stuck with it in 2012, congratulations, you likely fared well. If you tried to outguess the market and were less fortunate, here are my recommendations:
- Do not sit on mounds of cash. It will be eroded by inflation. Inappropriately high levels of cash can prevent you from taking advantage of opportunities in long-term investments. In 2012 for example, returns for long-only global equities in so-called developed countries were in the neighborhood of 15%.
- Do not fire your hedge fund managers because they did not do as well in 2012 as your long-only managers. Hedge fund managers protect investors in adverse markets. The possibility of a down market remains a risk, an environment in which successful hedge fund managers should continue to protect you.
- Again, develop a long-term investment strategy, articulate it, and stay with it. Revisit it annually and facilitate its gradual evolution over time.
As always, if you would like to discuss any of these factors in more detail, I would be happy to speak with you at your earliest convenience. Feel free to ring me at 617-945-5157 or send me an email at Jack@RGPIC.com.
‘Tis the holiday season and year-end approaches. This is an excellent time to reflect on our blessings, celebrate our accomplishments and set goals for the New Year. It is also a good time to lend a hand to those less fortunate. This week I would like to share with you some of the things for which I am most thankful, as well as some of my goals for the New Year.
My family is a constant source of connection and support, for which I am grateful. My daughter Katie is in graduate school and doing a supervised internship in the Boston area. My stepdaughter Kat graduated from college in Philadelphia and is also living in the Boston area. It has been a true joy to be able to spend time with both daughters. Of course, I am proud of my stepdaughter Jen who will be graduating from college this spring. My three brothers and I (who are scattered across the US) enjoyed a mid-year reunion with our mother in the Midwest who turned 95 years old this year — a blessing.
I am enormously thankful to live in a gloriously successful country and to have been spared by various natural disasters. This has made me even more mindful of those less fortunate, and I will make it a point to be more helpful, however modest my contributions relative to the scale of the victims’ needs.
Naturally, I am immensely grateful for the blessing of my clients’ confidence and support. Their success and satisfaction is, and will continue to be, the mission of my enterprise. Equally well, I am blessed by the assistance of dedicated, thoughtful and creative professional service providers, without whom I would not be able to serve my clients nearly so effectively.
My goals for the New Year include re-doubling my efforts to ‘give back’ more, while at the same time growing my business. I have the capacity to serve a few more clients and am looking forward to doing so in the New Year. In that vein, I have expanded my practice to include project consulting for endowments and private practices. You will learn more about my Investment Management Assessments in 2013. I also serve as the Chief Investment Officer of my family’s investment fund and have decided to open it up to a select group of private investors.
My top priority for 2013 will be to continue to provide the highest quality service to private clients and endowments who have asked me to assist them in developing and implementing their investment strategy. This is, and will remain, my touchstone.
If you are so inclined, please share with me the things for which you are most thankful and your goals for the New Year, especially those where I may be of assistance. As always feel free to ring me at 617.945.5157, or to send me an email at Jack@RGPIC.com.
Warmest winter holiday wishes,