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May The Odds Be Ever In Your Favor

Blueberries

 

The Hunger Games was a bestselling novel that was subsequently made into a movie.  Both were awesome.  The setting is one where the Capital is abundant in riches.  The outlying 12 Districts are all living in poverty.  Every year there is a lottery and one boy and one girl from each District are selected to compete in the Hunger Games.  This is a televised competition and the children are forced to fight to the death.  There is only one winner.

A popular quote from this book and movie is, “Happy Hunger Games! And May the Odds Be Ever in Your Favor.”

Fortunately we aren’t fighting to the death with your financial planning.  We are however talking about yours and your family’s financial future.  So here is what you need to do to have the Odds Be Ever in Your Favor.

Start Young

 

This goes without saying which is why it needs to be said.  The sooner you start working on your financial plan, the more you increase your odds of success.  Time is on your side.  With that said, we can’t turn the clocks back.  You need to begin where you are and go forward.  It is never too late to start.  It always helps to be able to say, “I Did the Math.”

Risk Management

 

I know risk management is just a fancy term for insurance.  That’s fine.  This really needs to be addressed first.

We will all face some risks in our life.  Some we can and should insure against.  Insurance is just a form of sharing the risk with the insurance company.

For folks with dependents, life insurance is a must.  Dependents are minor children and could be a spouse or other family member.  The death benefit from the life insurance is designed to help your dependents maintain a similar lifestyle to the one they had before the breadwinner passed away.  For married couples with a nonworking spouse, home mortgage and plans to contribute to their child’s college education, the death benefit needed could be a meaningful number.

Disability insurance is also key coverage to have.  First, check with your employer to see what coverage they offer employees.   If this coverage is not sufficient, discuss with your insurance agent what your options are.

The state will regulate the minimum coverage you will need for your auto insurance.  The bank where you have your mortgage will tell you what the minimum is for your homeowners insurance.  Work carefully with your insurance agent to see that have adequate coverage.  The minimum amounts rarely work well.  Also, be sure to ask your agent about an umbrella policy. Here is Why Everyone Needs a $1 Million Umbrella Policy (or More).

Pay Yourself First

 

I’m sorry.  You’ve heard this countless times.  Do you need to hear it again?  No, not if you are indeed paying yourself first.  If you aren’t, then yes you do need to hear this again.  Then you need to act on it.  It’s important to know that Only The Thrifty Survive.  Paying yourself first however doesn’t do you a lot of good if you haven’t taken care of getting the appropriate insurance coverage and setting up an adequate cash reserve fund first.

To get ahead, you will need to live beneath your means.  This is tough to do if you are trying to keep up with the Jones’s.   The Jones’s are everywhere, and boy do they like to spend money.   Frequently money they don’t even have.

Hire the Right Advisors

 

For most folks managing their financial plan is not something they should do on their own.  They will need to have a team of advisors that work together.  Your team will typically include a Financial Advisor, CPA, Estate Planning Attorney and Insurance Agent.

Face it, most of us have very busy (some would argue too busy) lives.  Work, family, helping children with homework and yard work on the weekends are just some of the things we need to be engaged with every week. Who has time for financial planning?  That’s why you need to hire a competent team to work together and assist you with your plans.

What you will invest for these services is a fraction of what the benefits you should receive if you hire the right people.  The key here is don’t delegate, collaborate!  Don’t have them work for you.  Have them work with you.  Don’t just hire them and walk away.  Understand your options and their recommendations.  Ask detailed questions.  If you are looking for a financial advisor here is 6 Questions to Ask Your Prospective  Financial Advisor.

Manage Your Costs and Taxes

 

The current Bull Market started in 2009 and is still going in 2016.  Heck of a run, isn’t it?  What else happened other than the good times rolling?  Well, some investing basics were forgotten.  What was forgotten?  Managing taxes and investment expenses certainly was.  During the market is rising who cares about these details?  When returns are 10% a year who cares about taxes and inflation?  Not me, just make more money, taxes and inflation are just the cost of doing business.  Well, this has changed, just a wee bit.  So, returns might not be 10% a year, year after year, as far as the eye can see.  Sorry, I meant to say 10% positive rate of return.  So investors will just settle for the long-term average of, oh, say 9% and extrapolate this for the next sixty years or so.  Well, maybe this isn’t the best assumption to make.  Hey, don’t get me wrong, I’m an optimist.  Capitalism, which our country was founded on, not only works but is cool.  It’s that Darwin survival of the fittest thing.  What should investors be looking at?  With those outsized returns from this Bull Market of almost seven years, what’s going to happen in the future?  Another seven years of party time?  Not likely.  If rates of return in the future are less than the long-term average, managing your taxes and investment expenses becomes very important and it’s something you can control.  It’s important to understand the 4 Things Every Investor Can Control.

Let’s take a look at taxes.  There’s a tax break with certain capital assets, which includes stocks, and bonds.  There’s a distinction between ordinary income and capital gains tax rates.  Now, the highest federal income tax on ordinary income is 39.6%.  For most long-term capital gains, the tax rate is 15%.  For taxpayers in the lower two ordinary income tax brackets the capital gains tax is 0%.  Higher income taxpayers pay a 20% long term capital gains rate. The key is to understand the holding period for long-term capital gains.  Capital assets need to be held longer than a year to qualify as long-term.  Most qualifying capital assets held longer than a year are only taxed at 15%, which is a good thing.  Short-term capital gains, those held one year or less, are taxed as ordinary income.  Between federal and state income taxes, Connecticut taxpayers in the maximum tax bracket can easily be paying over 46% on short-term capital gains.  So, most long-term capital gains are taxed at less than half the short-term gains rate.  The question is, which would you want, short-term or long-term capital gains?  You don’t have to think too long (no pun intended), do you?  Long-term capital gains tax rates are clearly preferable.  Be cautions here.  I’m just referencing the huge tax advantage long-term capital gains tax rates have over short-term gains.  When deciding whether to sell a capital gain asset that has been held short-term, look at it strictly from an investment standpoint.  Don’t think, “If I can hold on another six months, the gain will be long-term.”  In other words, don’t let the tax tail wag the dog.

Now it’s more advantageous to own equities in taxable accounts as opposed to tax-deferred accounts.  There are several reasons for this.  First, the federal income tax rate on qualifying dividends is only 15%. For taxpayers in the maximum federal income tax bracket this means the tax paid on dividends can go up to 39.6%.  Second, as mentioned above, most long-term capital gains are also taxed at only 15%.  Finally, $3,000 of net capital losses can be deducted annually on an individual income tax return with any excess capital losses carried over into future years.  Taxable distributions from tax-deferred accounts like 401(k)’s and IRA’s are subject to ordinary income tax, so there’s no tax benefit to owning equities in tax-deferred accounts.  This doesn’t mean investors shouldn’t own any equities in their tax-deferred accounts, it’s just that there’s no tax advantage with it.  For many investors a significant portion of their net-worth is invested in their 401(k)’s, IRA’s and their home.  Investors that have a large portion of their investment portfolio in tax-deferred accounts will likely need to have some equities in them.

The other area to monitor is investment expenses.  Investors can go online, buy stocks and pay modest commissions.  This is how many do-it-yourself-investors manage their investments.  That’s fine, some investors have the time and interest to do this.  Some may even do a reasonably good job.  Like home brewed beer, some batches taste good.  Most of the time however, it’s obvious a German wasn’t the brew master.  It’s the same with many home brewed financial plans; there are a lot of bad batches, which costs time and money.

Online brokers may have low costs.  Do-it-yourself-investors however need to figure out what their time is worth.  Go to work every day then head home to help the children with their homework.  On the weekends there are the kids’ activities and a long list of chores to do.  Even if you don’t have children or are an empty nester there’s still plenty to do.  Monday night it’s off to the local community college for computer class and Thursday night is golf league.  Do you really want to be spending your free time researching the market, trying to keep up with the constantly changing income tax laws and becoming an estate planning expert?  I doubt it.  Most people don’t have the time for this, which means delegating these duties to a financial advisor.

For investors that hire a financial advisor there are also costs.  Financial advisors could work for a fee-based, commissions or a combination of the two.  What’s the best arrangement?  Well, I’m sure you realize you can get good or bad advice under any method.  Paying a fee however gives the advisor an incentive to continue servicing the account.  You may or may not get this service level in a commission arrangement.  Additionally, a fee-based arrangement eliminates any potential conflict of interest.  This means a fee-based financial advisor can provide independent and objective advice.  A commission arrangement creates a potential conflict of interest.

Enjoy the Ride

 

All of this planning sounds good, and is so necessary. With that said, you will need to enjoy the ride.

Face it, stuff happens.  Sometimes things happen that aren’t a whole lot of fun.  Getting a divorce, becoming disabled or having a child or grandchild go to rehab is not on most folks bucket list.  With that said, they do happen.  While we can wear our seat belts when we drive, take our vitamins daily and Diet and Exercise, we must realize that things happen.  Many of these things we can’t plan for or insure against. Enjoy the ride while you can.

 

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon and not necessarily those of Raymond James.

 

Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James.  All opinions are as of this date and are subject to change without notice. The information contained herein is based on current tax laws which may change in the future. You should discuss any tax or legal matters with the appropriate professional.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This article includes hypothetical examples for illustration purpose only and does not represent an actual investment.  Actual investor results will vary. Past performance is not a guarantee of future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

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