When people prepare their taxes they are often surprised at the amount of gain that is on their 1099 from the mutual funds that they own. I am often asked, "How can my mutual fund distribute gains in a down market?"
The answer is evident if you look through the mutual fund to the underlying portfolio. The mutual fund portfolio manager will often build up cash heading into downward trending market and may have sold stocks that had accumulated gains over the life of the holding. As the mutual fund manager attempts to accumulate cash in preparation for the down market these gains may be triggered. These gains are accumulated over many years consequently the tax has been deferred for this same period. This is especially the case with value funds that have low turnover ratios.
If you have a net loss in the fund then you can simply sell all of the fund by the end of the year and this negates the gains. If you still have a net gain in the fund then this strategy does not work. But you should consider yourself fortunate if you have a gain.
You should look at your mutual fund as a portfolio rather than just one investment. It provides a convenient way to diversify for the individual making smaller investments. It has economies of scale that you may not get purchasing individual stocks as well as expert management, in most cases. Mutual funds provide the best managers within their respective specialty. This is why I only use mutual funds.
I can explain this in greater depth just contact me.
The first thing that any planner worth his/her salt does for a client is to establish an emergency fund. An emergency fund is made up of investments with liquidity and serves a multitude of purposes. Among these is covering unforeseen expenses, satisfying deductibles, car repairs, and home repairs.
Benefits of having an emergency fund:
Covering higher levels of deductible making insurance policies much more affordable.
It can be used to cover unforeseen expenses.
As a source of liquidity when markets are too volatile to sell off investments.
Used to cover loss of income due to extended medical leave or loss of employment.
A recent article I found in the Wall Street Journal stated that thirty-eight percent of the individuals surveyed weren't prepared to cover even a $500 car repair or a large medical bill. This is a result of living paycheck to paycheck. A good rule of thumb is to have three to six months of living expenses in reserve. The fund is accumulated a little at a time.
An Emergency fund should be kept in money market funds or as an alternate in short-term bond funds with low volatility investments.
Charles Shearman is a Certified Financial Planner with 32 years experience as a financial planner.
I am often asked the question, what do I need to consider when daftng a trust. Below I have listed the top 3 items I think are important when creating a trust.
First you need to consider the beneficiaries. What are their ages and their spending habits? Are they a minor or an adult? They will have very different needs and you will have different decisions to make for different situations. For a minor, you need to provide your spouse or the minor directly with income as well as a way to pay for college. If some of them have been to college and others have not you need to determine when to make distributions from the trust and how long you keep the money in, and trust.
Next you have to determine how many distributions you make from the trust. I suggest to clients that they make more than one but not more than three. The reasoning behind this is that two gives them a second chance and handling the money. However if they have not learned their lesson by the time they receive the third distribution they probably are a lost cause.
The final main decision are the trustees. While corporate trustees such as banks provide for a knowledgeable trustee, you don't know who you're going to get when your trust actually comes into existence. A private trustee, although less expensive, may not know what to do.
These are the main decisions you need to make. Although there are many more decisions that have to be made. You should consult with an attorney before drafting any trust documents.
Now is the time to do some tax planning before year end. You should defer as much income as you can through the use of a 401(k) if you have access to one. It is good to at least contribute enough to get the company match. This is free money and often results in a minimum of 50 to 100% return on the amount invested in the first year depending on what your company will match. You can always deduct any contributions you have to a traditional IRA up until you file your tax return.
Deductible expenses are::
Healthcare expenses
Taxes both property taxes, the BMV allows you to pre-pay a full year in addition to the remainder of this year at the time that you are getting your initial plates, and state income taxes make sure to pay all the taxes you owe during the year in which they are incurred.
Charitable contributions
Miscellaneous expenses such as lockboxes or moving expenses.
Business expenses if you have a closely held business many things that are not deductible otherwise may be deductible under your business. These may include meal and entertainment expenses, auto expenses, and advertising expenses to name a few.
These are but a few of the items you can consider if you have the leftover cash.
Starting into the new year is the prime time to plan for the future. Basic planning is dependent on three things, cash flow planning, tax planning, and projecting your asset growth based on these two previous categories.
Cash flow planning consists of projecting future revenue streams as well as future expenses. An estimation of your future expenses needs to be as accurate as possible. Things such as capital expenses, buy a new car, or buying a new house needs to be included with the ongoing expenses. It pays to be specific with these items even though you might be off by the year in which they occur.
Tax planning is based on the revenue you project and the deductible expenses that you incur. These items should already be in your cash flow projections and the two projections need to be interactive with each other.
The net worth projection needs to be based on the taxes, cash flow, and pure asset growth. Items such as the net cash flow need to be included in the investment detail of the projection. As well as the purchase of capital assets, the car, the new house, need to be added to the assets already on the books. You may find it advantageous to have the net cash flow to flow in and out of a cash account.
You may seek professional help with this task. A true comprehensive planner is out there you simply need to do your homework. Professionals come in two forms, the fee only planner who charges by the hour and the commission-based planner who collects commissions on the products that he puts in place. Make sure you understand how they are compensated. They should have to disclose this in their presentation. Above all they should be a Certified Financial Planner (CFP)
Now that we are approaching year end, it is important to take stock of your closely held business. We can do this by comparing your company to another company in the same industry or a group of companies in the same industry. You should check your inventory levels to make sure that they aren't too high. Sometimes after a number of years if you might have a buildup of non-sellable inventory. If this is the case you need to clean this up. Valuing your business should be done in two forms net cash flow should be determined without extra ordinary expenses and updating your payroll to match percentages in your industry based on your sales. Once you have completed this, a multiple for your industry should provide a value to you. You need to compare that to your net asset value. If your net asset value is greater than your income value then you have a problem. You are either not doing something right or you have non-income producing assets on the books. This might be items excess inventory or items that are not related to your primary business. You should do this at the end of each year to not only determine whether your business has increased in value but to determine whether you're operating efficiently.
If you need to have a basic retirement plan, one with limited paperwork maybe a simple IRA is for you. With a simple IRA you have the increased contribution levels with much additional paperwork. With contributions up to $12,000 with a catch-up provision of an additional $2500 for those over 50, these are fairly attractive plans without much in the way of paperwork. Overall they provide for low-cost operation with increased contribution limits.
Life Insurance is not as mystical as it may seem. When you
strip away all of the riders you are left with one of four types of policies.
These policies are annual renewable term, whole life, universal, and variable
universal. These differ in cost and risk and it is important to know what you
are looking for.
Annual Renewable Term Insurance is pure insurance. It is a
pay as you go type of policy with costs increasing every year. This type of
policy is good for a young family, because it allows one to buy a larger policy
than a whole life when you have a greater need for coverage and you are still
healthy. This would cover such things as your mortgage and children’s education
in years where sufficient income is not available to pay for a whole life
policy.
Whole Life Insurance is permanent insurance. In other words
if you pay your premium you will always have coverage. This type of policy is
good for middle aged individuals who have a health issue or want to have burial
costs covered. Partners in business can buy whole life policies on each other.
After the death of one of the partners, the remaining partner would be able to
use this insurance to buy the remainder of the company from the deceased’s
estate. The premium on this type of insurance remains the same. A percentage of
this premium is put towards its cash value and the rest is put towards the
insurance itself. Over time the amount towards its cash value declines and the
cost for insurance increased. This is due to the well known fact that getting
older puts you at greater risk to shuffle off this mortal coil, kick the
bucket, or join the choir invisible. But even as you age the premium doesn’t
change.
Universal Life Insurance is a combination of cash value and
term insurance. This allows you to contribute at a minimum the cost of
insurance and additionally as much cash value as you want to with some coverage
limits. You can’t contribute more than a certain percentage of the policies
worth in cash value. This allows you to have a greater amount of term, and
later in life contribute to cash value as you are able to. Unlike a Whole Life
policy the premium is not guaranteed to stay the same. Just as with a Term
policy you are subject to any price hikes the
insurance company puts in place. This would be a great
policy for those who want to hedge their bet, get an affordable insurance
premium, and still be able to build cash value as their income increases.
Variable Universal Life Insurance is similar Universal except
that you are responsible for the investment of your cash value. You are given a
selection of pseudo mutual funds to invest in. These funds may be stock, bond,
or international funds allowing your cash value to participate in the returns
or losses of their respective markets. If you or your financial planner (for
example Charles T. Shearman CFP of Prospero Financial) is market savvy, this
may be the appropriate insurance policy for you.
These are the basis for all life insurance policies. Make
sure to carefully examine any policy you are thinking about purchasing. Riders
can substantially modify the look of the policy, but the underlying policy is
one of these four. Understanding what your policy can do for you or your estate
is very important, both when choosing, and when cashing it in.
When establishing your estate plan, trusts can serve as a way to put your intent into the estate plan even after your death. The trust is funded from the estate. In an estate, property passes by ownership first where jointly owned assets are passed to the joint owner, contracts with a named beneficiary are second (i.e. IRAs, Insurance Policies), and lastly only what is left over flows through your will. Many people establish elaborate trusts only to have them unfunded at their death because they have everything titled jointly with their spouse.
Testamentary Trusts
The most common trust is a Testamentary Trust. This trust is drafted as a part of your will and is funded at the time of your death. This is the next step up from having only a simple will. While this is a perfectly acceptable form of trust, this lacks several of the advantages which Living Trusts provide.
Living Trusts or Inter-Vivos Trusts
These are the next step in the sophistication of your estate plan. This form of trust can be funded during your lifetime or upon your death. A living trust can be the beneficiary to contractual assets. In addition, the will would divide your assets into two baskets; personal property and invest property. This means that all of the personal property are disposed of through the will and the remainder are investment assets which are transferred into the trust.
Irrevocable Insurance Trusts
These are drafted in addition to or in place of the two other trusts. This trust is named the owner and beneficiary of your insurance policies. Since they are irrevocable they are not included in your estate at your death. A neat trick is to make it the owner of a term policy. That way if you later decide that you don’t want the trust, if you are insurable, then you simply don’t fund the policy and it defaults thus rendering your trust irrelevant.
Items of Note
With any of these trusts the terms are open to your intent. Regarding distribution, you can distribute income and principle as you see fit. You will probably want to make the terms of all your trusts similar if not identical. Children with special needs require specific care to be drafted within the trust so as not to disrupt their disability services.
This is an oversimplification of the trust law and you should consult your attorney before establishing your estate plan.
I have always had medical professionals as clients. One
thing this has taught me is that being smart enough to pass med school doesn’t
necessarily translate into financial intelligence. Doctors, as well as any
professionals who have a steadily increasing salary at the start of their
careers, can often make purchases that hurt their cash flow down the road once
their income plateaus. This makes it all the more important to develop an
emergency or “slush” fund early in your career no matter what your occupation.
Then later in life, once your rainy day money has grown, the finer things are
less of a strain on your bank account. The two main purchases that can set an
individual up for financial distress are expensive cars and big houses. Making
the right buys can lead to a life of comfort,
if done correctly.
Fancy Cars
When individuals jump up into the six figure income bracket
one of the first things they want to do is buy an expensive new car. What they
fail to realize is that when they drive their so called “investment” off the
lot, it loses thousands in value immediately. Their new car will then continue
to lose value until the wheels fall off. But Chuck, “How am I supposed to show
off my financial superiority while I’m on the go?” It’s simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350.
You’ve worked hard to bring in the money and its time to reward yourself. A new
SLK350 costs over $55,000. A used last year model costs $36,000. Paying an
extra nineteen grand for that “new car” smell seems quite ridiculous. Any other
investment that declined in value by 35% its first year would make you furious.
Even for individuals with more modest tastes, a Honda Civic loses four thousand
in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the
sucker who has to unload their bad investment in a year’s time.
Living Large
The other mistake many make is
purchasing a house that is too big early in their careers. If your job is
putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash
out of your pocket for the next fifteen to thirty years. We at Prospero
Financial always push to develop a solid emergency account before purchasing an
expensive home. Buying a less expensive home allows you to build that emergency
fund faster. You will then be able to
make a larger down payment on your next home. This will give you more equity to
build on. You will need 20% equity in the property in order to avoid private
mortgage insurance and decrease your mortgage payment.
As unpredictable as the housing market is, you
want to make sure that your house and property are sellable when the time
comes. Choosing your neighborhood wisely can make a huge difference in the
future. Picking the right house in that neighborhood can be just as important.
The most expensive house in a neighborhood will be the hardest to sell. When
prices in housing go up your palace might increase in value, but a home is
worth nothing if there’s no one to buy it. The cheapest house in the
neighborhood can be just as tough. Look for a home that is in the upper middle
price range for the neighborhood you are moving into and you will have made a
safe choice if you ever need to liquidate the property. Lastly, when it comes time to sell a house, you need to leave yourself at least six months
time to keep from leaving money on the table. Selling a home can be profitable,
as long as you make smart decisions along the way.