Getting ready to file your taxes? Pay attention!

As we head into tax season, many of you have received tax reports – commonly referred to as “1099s” – from your investment firm.

The IRS requires that 1099-MISC forms must be mailed by January 31^st,  but issuers are not required to file copies of all 1099 Forms with the IRS until the end of February.

We frequently advise our clients to delay filing their taxes until March at the earliest.  That’s because the tax code is so complex that errors are inevitable.  As a result, investors often receive “corrected” 1099 forms after the February deadline has passed.  This may result in a change in the tax owed.  Those who use tax preparers or CPA firms may need to have their tax re-calculated, increasing the cost to the investor.

We note that Morgan Stanley has admitted to providing erroneous information to its clients.

Apparently Morgan Stanley’s reporting system sometimes generated an incorrect cost basis for its clients’ stock or bond positions, which threw off capital gains tax calculations following the sales of the securities, the paper reports. The errors affected a “significant number” of the firm’s 3.5 million wealth management clients for tax years 2011 through 2016, according to the paper. But around 90% of the under- or overpayments were less than $300 while more than half were less than $20, a Morgan Stanley spokesman tells the Journal.

It is always a good idea to check the accuracy of the statements you receive from your custodian.  There may be erroneous or missing information.  In many cases where securities were purchased years ago, the custodian does not have the cost basis of stocks or bonds that were sold.  In those cases the investor is responsible for providing that information.  If you do not provide that information, the IRS may assume that the cost basis is zero and tax you on the full amount of the proceeds of sale.

On a final note, many clients have asked us how long they need to keep records for tax purposes.  The primary IRS statute of limitations was three years. But there are many exceptions that give the IRS six years or longer. Several of those exceptions are more prevalent today, and one of them has gotten bigger.  The three years is doubled to six if you omitted more than 25% of your income. “Omitted” can mean to not report at all, or it can mean that the amount of income was under-reported by 25% or more.

If you have questions about your tax forms, or wonder where you can get assistance to determine the cost basis of securities bought or gifted long ago, give us a call.

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Why do smart people use financial advisors?

What is the real value to hiring a financial advisor, and who uses them?  What is the value proposition?  What makes one car with four doors and wheels worth $300,000 and other $30,000?  Although we might have an answer, the answer differs from person to person.

People use financial advisors for many reasons.  Some use them because they absolutely need them, others because they want them. Paying a fee for advice and guidance to a professional who uses the tools and tactics of a CFP™ (CERTIFIED FINANCIAL PLANNER™) and an experienced Registered Investment Advisor who is a fiduciary can add meaningful value compared to what the average investor experiences.

Many middle-class investors are anxious about their finances and are not interested in learning the details of managing their money.  This anxiety often results with money left on the sidelines because they don’t know what to do or are afraid of making mistakes. That means earning a fraction of 1% at the bank when the Dow Jones Industrial Average (DJIA) is up over 25% in the last 12 months.

There are others who are interested in learning about investing and may want to hire an advisor to “look over their shoulder.”  They want to hire an “investment coach.”

A third category are people who hire professionals because they are busy doing things that are more important to them: building a career or a business, being with family, or living an active retirement.  They hire an expert to manage their money the same way they hire a lawyer for estate planning, a CPA to prepare their taxes, and a doctor to keep them healthy.

A fourth category is people who were making their own investment decisions but ended up making a huge financial mistake.  This leads me to a story about a really smart, highly paid high tech executive who is very knowledgeable about investing; but he hired an advisor:

It’s not because he lacks the knowledge or interest, obviously. Rather, he figured out he had behavioral blind spots and understood he was at risk of great financial loss. He’s paying someone just to take that risk off his plate.

Determining your goals, controlling risk, managing portfolios well, and knowing your limitations – knowing you have “blind spots” – has led many smart people to hire an advisor.

Vanguard, the hugely successful purveyor or no-load mutual funds (that appeal to do-it-yourselfers) estimates that a financial advisor is worth about 3% net in annual returns.  They attribute this to the seven services that a good advisor provides:

1. Creating a suitable asset allocation strategy.
2. Cost-effective implementation.
3. Rebalancing
4. Behavioral coaching
5. Asset location
6. Spending strategy.
7. Total return versus income investing.

If you have an advisor but he is not meeting your objectives, ask us for a second opinion.  If you don’t have an advisor but may want one, we offer a free one-hour consultation to see if we are compatible.

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What does “diversification” mean?

 

To many retail investors “diversification” means owning a collection of stocks, bonds, mutual funds or Exchange Traded Funds (ETFs).  But that’s really not what diversification is all about.

What’s the big deal about diversification anyhow?

Diversification means that you are spreading the risk of loss by putting your investment assets in several different categories of investments.  Examples include stocks, bonds, money market instruments, commodities, and real estate.  Within each of these categories you can slice even finer.  For example, stocks can be classified as large cap (big companies), mid cap (medium sized companies), small cap (smaller companies), domestic (U.S. companies), and foreign (non-U.S. companies).

And within each of these categories you can look for industry diversification.  Many people lost their savings in 2000 when the “Tech Bubble” burst because they owned too many technology-oriented stocks.  Others lost big when the real estate market crashed in late 2007 because they focused too much of their portfolio in bank stocks.

The idea behind owning a variety of asset classes is that different asset classes will go in different directions independent of each other.  Theoretically, if one goes down, another may go up or hold it’s value.  There is a term for this: “correlation.”  Investment assets that have a high correlation tend to move in the same direction, those with a low correlation do not.  These assumptions do not always hold true, but they are true often enough that proper diversification is a valuable tool to control risk.

Many investors believe that if they own a number of different mutual funds they are diversified.  They are, of course, more diversified than someone who owns only a single stock.  But many funds own the same stocks.  We have to look within the fund, to the things they own, and their investment styles, to find out if your funds are merely duplicates of each other or if you are properly diversified.

You need to look at a “portfolio x-ray” which will show you how much overlap there is between two or more mutual funds.

Only by looking at your portfolio with this view of diversification can you determine if you are diversified or if you have accidentally concentrated your portfolio without realizing it.

Piracy risk

Most of us are aware of the risks we take every day, but we ran across an interesting article recently that involved a risk we had not considered: being captured by pirates.

Believe it or not, in certain parts of the world, it’s happening.

Impoverished areas dotting the coasts of Nigeria, Somalia, Malaysia, Indonesia and the Philippines have been virtual breeding grounds for partially-organized collections of criminals seeking to steal, hijack, kidnap and murder their way to fortune.

We have seen news reports of pirates attacking oil tankers and holding them for ransom.  The peak of this occurred in 2011.  Since then, shippers have improved security, hired armed escorts and received military assistance.

 This modern era of the 21st century pirate is being successfully stunted, yet maritime kidnappings for ransom are on the rise. Although the number of pirate attacks is decreasing throughout the world, the number of kidnappings taking place during those attacks is increasing. Internationally, pirates kidnapped 62 persons in 2016, all of whom were or are still being held for ransom.

Pirates realized that it’s easier to capture people and spirit them away that to deal with ships that can’t be hidden.  People are smaller and pound-for-pound a great deal more valuable.  So we now have a new growth industry: Kidnap and Ransom (K&R) Insurance. If you are planning to travel to the pirate infested waters of Southeast Asia or off the coast of Africa you may want to check out the rates for K&R insurance.  For a premium you’ll get unlimited funding for a crisis response team whose sole mission is to get you safely home.

If you plan to take your yacht through the South China Sea or the Malaccan Straights this is something you may want to consider.

Meanwhile, in this part of the world, we’ll keep an eye on the risks with which we are more familiar: market fluctuations, tax changes, interest rate increases, economic trends and even those things we can’t foresee known as Black Swans.   Stay safe.

A good Registered Investment Advisor is a “Life Coach.”

People who are not familiar with Registered Investment Advisors (RIAs) too often view them as stock brokers.  They are not; they are held to a higher standard and are focused on the client, not the money.  RIAs are trusted advisors who put their clients ahead of themselves.    They are fiduciaries that are skilled in the art making good financial decisions.

Younger professionals who are building careers would do well to find an RIA as their financial guru, a “Life Coach.”  It takes time, experience and a high level of expertise to manage money well.  The young lack that expertise but have the biggest advantage of all: time.  They are in a perfect position to build wealth with the least amount of effort if they can lean on experts who can show them how to navigate the risky ocean of investing.  Just as important, they need a wise guide who can advise them on managing their income.  Too many people, even those with six figure salaries, live paycheck to paycheck.  Knowing what to spend and how to save is the role of the advisor.

This is very important for the independent professional – the doctor or lawyer.  Focused on building a practice, they need someone to advise them on managing their money wisely.

For the business owner, the entrepreneur, it’s even more important.  There is no career track and the challenge of building a business often results in poor money management.  Excessive debt can lead to bankruptcy, a common result in many industries that depend on debt financing.  A good advisor can help the business owner create a personal portfolio that’s independent of his business.  At the same time he can advise the owner the best way of financing his growth.

Once the business is established the owner needs guidance setting up retirement and benefit plans for himself and his employees.  This all part of the RIA’s skill set. And finally, as the business matures and the owner starts thinking of retirement, the advisor provides the guidance to transition the individual and his family to life beyond work.

That’s the point at which the coach gets the pleasure of knowing he’s done a good job as part of a winning team.