Year-End Portfolio Tax Planning

With only a few weeks remaining in 2010, now is a great time to make any tax-planning adjustments.

Step 1 is determining your general current capital gains and gross income situation.   Do you have carry-forward tax losses?  What are your current 2010 realized net short-term and long-term capital gains?   What are your unrealized capital gains?  What is your 2010 “ordinary income” situation looking like?

Answering these questions gives you a starting point for year-end tax planning.

For example, if you have big long-term capital gains because you sold a bunch of company stock to make a down-payment on a vacation property, you make ask yourself, “is paying 15% tax on these gains a good deal, or do I want to try to offset them with a few capital losses?”

Or, you may ask the inverse question…  “I have a bunch of unrealized long-term capital gains;  Should I sell now and realize them for the ‘bargain price’ of 15% tax?”

Some of these financial questions are tough to answer.  That is why I pay my CPA $80/hour to help me answer them. [This is a bargain price; my previous CPA was $150/hour.  Finding a good one for $80/hour was a godsend!]  If your struggling to answer them, I’d encourage you to set up an appointment with your CPA, or if you don’t have one a local CPA.   Bring your best answers or guesses, and you might be surprised how much they can enlighten you in one short hour.

A little year-end tax planning could save you $500, $1000, possibly several thousand dollars.  If you have to pay $80, $100, or even $250, for this I’d say its money well spent.

Making Personal Finance Personal

Previously I started blogging about the very different approaches my parents took with respect to money and investing.  In this blog post I continue that discussion with a story of how I became even more passionate about investing.

My parents divorced not long after I started attending college.  Because of the way divorce law works, my Mom received the majority (perhaps two-thirds) of the family assets plus a fairly significant monthly alimony payment.  Over the next ten years Dad rebuilt his financial life, benefiting from the remarkable 90’s bull market and intelligent investing.  Over that same period, Mom’s financial fortunes floundered.  I witnessed both financial journeys as a powerless spectator.

The sad irony is that Dad, the savvy investor, was willing to listen to my investing ideas, whereas Mom stubbornly refused almost all of my investing advice.  I saw Mom make one bad investing decision after another.  She put the house on the market but could not sell it because her asking price was about $100K too high.  She loaned money to business partners without a written contract… money that was never paid back.  Most upsetting to me:  She let her investment adviser, Sam W., manage her IRA, losing money with highly under-diversified utilities stocks and funds in the midst of this tremendous bull market.  The contempt and disappointment I feel towards Sam still lingers with me to this day.  That Mom blindly trusted this man, who likely had little interest in her well-being, and shunned her son’s financial advise left me with stunned disbelief.

I was interested in investing from the time I learned about compound interest at around the age of 9.  I was fascinated by the math of computing compound interest monthly, daily, hourly, continuously.  I was intrigued by the concept of companies, shareholders, stock exchanges, and business.  But it was in watching and living the real-world consequences of my parent’s good and bad investing actions, that my lifelong passion for investing was forged.

These experiences are probably why I am so driven to help people avoid making big financial blunders.  I’ve seen and felt the effects of load funds and self-serving financial advisers.  I’ve seen the impact of poor diversification.  I’ve seen the tears of losing a home, losing a business… due to poor financial choices.

I’m often looking for ways and words to become more persuasive.  I’m looking for ways to help people build interest and confidence in shaping their own financial destinies.  I’m working to develop tools to simply and explain the financial world.  I’m working to create this financial education blog which will someday become part of a personal finance book.

Finance is my passion.  This passion is often hard for people to understand.  Perhaps this blog article will help people understand.  Probably some of my readers share a passion for personal finance and investing.  If you have a similar passion, I hope you will consider sharing your financial stories that shaped your financial lifestyle.

8 Questions to Ask your Financial Advisor/Manager (or Self)

  1. What is the average weighted expense ratio for all my holdings?
  2. How much, if anything, did I pay in commissions in the last 12 months.
  3. What was my rate of return in the last 12 months? (post all fees and expenses)
  4. How does that compare to the to rate of return in the S&P 500 in the same time period. (inclusive of dividends)
  5. What is the 12-month standard deviation of my investment portfolio? (a measure of risk)
  6. What is my asset allocation between stocks, bonds, and other?
  7. Do any of my holdings have loads?  If so why?
  8. How diversified are my holdings?

Bonus: Please update me on my portfolio’s tax efficiency and tax efficiency strategy.

Feel free to take good notes, and, if you like, send the answers to me.  I’d be glad to give you my personal assessment/opinion.

More Hypothetical Proprietary Fund Ideas

While the Σ1 Fund is currently a real 100% privately-held investment vehicle, all language and speculative plans about its future are currently (9/28/2010) STRICTLY THEORETICAL.  There is currently no SOLICITATION or even OPPORTUNITY for anyone other than Balhiser LLC shareholder(s) to invest in the fund.  Further, there is currently no SOLICITATION nor OPPORTUNITY to invest in Balhiser LLC at present. Thus the HYPOTHETICAL and SPECULATIVE language is merely just words at this point and time.  It is entirely possible that outside investors NEVER be given the opportunity to invest.

I’m wondering… should I revise my $10K minimum investment.  Perhaps $5K-$9K with a ~2% up-front load ($5000 yields $4900 of principal, $5000 yields $5100).  Increments above $5K are $1K with an up/down choice.  Increments are also $1K for investments over $10K.  Additional subsequent investments for current investors are $2K minimum with $1K increments.  Withdrawals minimums are $5K or %100 plus optional $1K increments.  Additional fund investments are subject to the same early withdrawal penalties as initial investments.  ALL requested redemptions are FIFO by default.

Distributions (realized capital gains, dividends, etc) are annual.  How they are distributed is TDB.  My initial inclination is that there is an ex-dividend date on the last trading day of each month, and dividend income is distributed in proportion to #months held * #shares.  Distributions are re-invested by default. Non-reinvested distributions are held in a non-interest-bearing manner until $500 is reached, upon which the total distribution will be paid in full by ACH or check.  Non-reinvested dividends may be paid, upon request, before the $500 minimum is reached, but a distribution-collection fee of $50 will be assessed.  For shareholders with >= $100K NAV none of these distribution restrictions or fees apply.

75% of redemption fees will be paid to Balhiser LLC, the remaining 25% will be paid to the Fund.

Requirements for potential investors:

  • Minimum of 5 years experience investing in stocks, bonds, ETFs, and/or mutual funds.
  • Acknowledgment that this is an investment of at-risk capital that may be subject to forced liquidation without notice during volatile and illiquid market conditions. This could result in severe or even total loss of investment.
  • Acknowledgment that options WILL be part of the Fund’s holdings/obligations.  While the primary target use of options is “covered-call” writing the notion of “covered” is not strict.  The fund may consider an RNM (Russel 2000 mini call option contract) to be “covered” by ownership of “an appropriate amount” of SPY (S&P500 ETF) shares.
  • Acknowledgment that ETF futures contracts may part of the Fund’s holdings/obligations.
  • Signed (and notarized) legal waiver that specifies that in exchange for participating in this fund, fund participant, fund participant beneficiaries and/or heirs, agree to hold legally blameless the fund manager and Balhiser LLC  for losses sustained by the Fund.
  • Solid familiarity with E-mail and the Internet and Internet-based “paperless” documents and communication.

In exchange for these concessions, the fund manager agrees to the following “skin-in-the-game” and transparency conditions:

  • So long as fund assets (or total net unredeemed funds invested) exceed $50K, the fund manager and/or Balhiser LLC will maintain a minimum of $25K invested in the Fund.
  • So long as fund assets exceed $50K, the fund manager and/or Balhiser LLC will reinvest all fund net distributions and net fund management proceeds into the Fund.
  • So long as FE>$50K. Fund manager and/or Balhiser LLC will be subject to same fees, terms, and conditions as all other investors PLUS will have to provide an ADDITIONAL 60-day advance notice to all fund shareholders (via email or other means) prior to any sale of holdings in the Fund.
  • 100% of Balhiser LLC/fund manager redemption fees (fees incurred for “personal” withdrawals) will be paid to the Fund.
  • End-of-month NAV reports will be delivered by email to shareholders. (delivered within 5 business days)
  • Subject to NDA: Unaudited Annual Report detailing complete fund holdings (delivered within 20 business days). Disclosure to CPA is permitted.
  • Subject to NDA: Upon request unaudited inter-year report (delivered within 30 business days). A $250 fee applies.  Disclosure to CPA is permitted.  Fee is waived once per year for investors with >= $100,000 invested in the Fund.

Base Management Fee Rates (similar, but not identical, to an expense ratio)

  • 7.8 basis points per month (0.078%) of previous close-of-month fund NAV.
    [~0.95% in simple interest, or ~0.9772% compounded annually]
  • Base management fee reduced by:
    • 10% for investors with >=    $50,000 NAV (or $50K net unredeemed investments).
    • 25% for investors with >=   $100,000 NAV (or $100K net unredeemed investments).
    • 33% for investors with >=   $250,000 NAV (or $250K net unredeemed investments).
    • 50% for investors with >= $1,000,000 NAV (or $1M net unredeemed investments).

Small Investors: The Best of Times

The small investor has some truly excellent options these days.  Two in particular are just this side of awesome.  The first is index ETFs (exchange-traded funds).  The second is low-cost online trading.  ETFs and cheap online trading form a powerful combination for the small investor.

In addition, the wealth of online investment information is voluminous, and in many cases free.

So for the small investor (whom I define as someone with < $1,000,000 of net assets to invest), 2010 is a pretty great starting point to get serious about personal finance

I recommend that before you embark, that you have at least a 3-month emergency fund and little to no credit-card debt.  If this doesn’t describe your financial situation, this article doesn’t currently apply to you.  [Please consider paying down those credit cards and then saving up a modest rainy day fund!]

However, if you meet these basic criteria consider the following suggestions:

  • Open a Vanguard account with a minimum of $3000.  Put those first funds in either the Prime Money Mkt Portfolio or the Tax-Exempt Money Market
  • Keep putting spare money into Vanguard.  Once you hit $10,000 to $25,000, consider other Vanguard offerings.  If you are unsure of what to invest in, call a Vanguard adviser.
  • Consider maxing out your 401k contribution, if your income permits.  Keep that “rainy day” fund in mind.  A rainy-day fund is cash, money market, or diversified short-to-intermediate AA or better rated bonds or CDs.  Stocks, mutual funds, etc. don’t count for rainy day cash.
  • Keep that Vanguard account.  If your tax situation permits, consider making Roth IRA contributions.  Vanguard is a good place to hold these, Fidelity is another.
  • Once you’ve got your rainy-day fund to 9 months or more, and can maintain solid 401k and Roth IRA contributions, congratulations.  You may be read to become a “big-time small investor”.

Enough preamble.  Let’s assume you are ready.  Now what?

You can select any number of online brokerages and invest for less than $9 per trade.  That includes option trades.  Some even allow futures trades.  So, the world is your oyster.

However, prudence is crucial.  There are just so many opportunities, options, pitfalls.  May I make a few suggestions?

  1. Start by investing in ETFs.  Consider, SPY, VTI, BND, VEU,  and, now, VOO.  These are excellent diversified ETFs with very low expense ratios.
  2. Want to dabble in individual stocks?  Diversify.  If you buy some tech stocks, also buy some consumer goods, or basic materials, or utilities.
  3. Want to dabble in options?  Try starting with writing (selling) covered calls on your ETFs.
  4. Futures?  Think once, think twice.  Do some research and think a third time.  The just maybe you might given them a try.  But, please, please do so with caution. [Note futures contracts require a margin account… please tread carefully with margin (aka leveraged) investing.]

That is just a start.  Might I also point out that an investor today could construct an excellent life-long portfolio with just VTI, BND, and VEO… re-balancing annually as age and situation dictate?  As age 60 approaches, mixing in a few laddered CDs (bank certificates of deposit) is not an unreasonable option.  Owning and paying-off a home is also a reasonable retirement goal.

I, however, am now content to fully adopt a reasonable and prudent approach.  I also dabble with a small Crazy Ivan Account (CIA), and with (limited) option strategies.  I also incorporate rental real estate into my investing mix.

The point I want to emphasize is that there are so many opportunities for the modern small investor.  It is easy to feel overwhelmed by the choices.   But, by starting with the basics — Vanguard mutual funds, low-cost diversified ETFs, and online investing — it is possible to construct and manage very solid personal portfolios.

Best wishes.

Balhiser LLC Financial Handbook

Even though it is very unlikely that Balhiser LLC will do any hiring in 2010, it makes sense to lay out a rough sketch of expectations and policies.   In many ways I’d like to follow the HP Way as outlined in David Packard’s excellent book.  So here is a first pass.

Balhiser LLC is:

  • A for-profit financial company seeking to produce long-term returns for its shareholders.
  • A company where every employee is a shareholder.
  • An innovative, conservatively-managed company that values bold ideas and prudent actions.
  • As true of a meritocracy as humanly possible.

While I as president retain final say-so, salary and other financial information will be governed as follows (as permitted by law):

  • Transparency.  All employees and stockholders will have access to the company’s financial books.  This includes salary, other compensation, and ownership information.
  • Employees will play a key role in hiring their co-workers.
  • Employees will, as much as possible, have say-so on who is on their project team.
  • Friendly competition between project teams is encouraged.
  • Competition between project team members is generally discouraged.  Teamwork is strongly encouraged.
  • Salary and compensation adjustments will be based on the following (in descending order of precedence):
    • Company performance
    • Project performance
    • Individual performance
  • Company performance is #1 because without reasonable performance the wants of the shareholders and employees simply cannot be met.
  • Project performance is #2.
  • Individual performance is #3 because:
    • It is often difficult to measure objectively.
    • Competition between individuals for salary, position, etc is frequently at odds with teamwork.
    • Time spent on “getting credit” and “looking good” is time wasted.  What matters  is enjoying work, finding solutions, and making money.
  • In the long term individual performance is still rewarded because:
    • The teams with the strongest individual performers will tend to be more successful.
    • The importance of project team success will result in high-performers being highly sought-after.
    • Long-term low performance that is detrimental to the team is unlikely to be tolerated by the team.

As a final bit here is what currently constitutes Balhiser LLC:

Business:

  • Invests company resources to make cash-flow and profit.
  • Financial commentary and general (not-individualized) investment advice.
  • Financing long-term investments and constructing a long-term financial portfolio with a strong balance sheet.

Assets:

  • An investment property (that is currently generating positive cash-flow).
  • A business checking account.
  • A handful of websites/domains.
  • Over 75 articles on various financial topics.
  • A computer, and other office equipment.
  • A modest collection of accounts receivable.

Disclaimer:    The Crazy Ivan Account (CIA) is not a Balhiser LLC asset.  Commentary about the CIA is.

Free your Mind and Bogle the Broker. A Zen Guide to Investing.

Zen is uncomplicated.  Investing is uncomplicated, until it isn’t.

I like the short Zen story about attention.  It starts out

There’s an old Zen story: a student said to Master Ichu, ‘Please write for me something of great wisdom.’

Master Ichu picked up his brush and wrote one word: ‘Attention.’

Simple. Right?

On some level the concepts are simple.  They are also profound.  On some level Zen is remarkable, stunning.  On another level unremarkable.

Investing concepts are similar.  Simple, profound.

Possibly the most difficult investing thoughts to grasp and put into action are the most simple.

  • Save.
  • Balance.
  • Own.
  • See.

I believe these simple words capture all you need to know to be a wise investor.  Like ‘attention’ these ideas benefit from lots of practice.

To ‘Save’ is easy for some, difficult for others.  Investing starts with savings.  For those not born into a great inheritance savings is crucial.  Savings is the art of spending less than you make.  The art of delayed gratification.   Keeping some of your income and keeping it safe.  For many the verb ‘save’ is easy in the way that the verb ‘diet’ is easy.  Simple concept, challenging action.

‘Balance’ is a deceptively simple term.  Martial arts train balance.  Speed skating, ice skating, and tight-rope walking showcase balance.  In the investing arena ‘balance’ refers to two key ideas: diversification and emotional equanimity.  Diversifying means balancing risks between different types of assets.  Emotional balance means “Caring about your investments, but not THAT much.”

To fully ‘own’ your investments you must understand, control, and value them.  In the same way that a stable master may own and value a prize horse without understanding veterinary medicine, a stock holder may own  and value a stock without being a financial comptroller.  An owner cuts out the middlemen and makes decisions.  An owner weighs decisions and responsibilities carefully because the financial buck stops with her and no one else.

Finally, to ‘see’ your investments you must see beneath the surface.  You see that all investments inevitably change.  You see that some good investments go bad.   You see the fog that shrouds some investments so thickly that you move on by.  You see that taxes are constantly changing and possibly that an accountant may see the ever-changing tax waters more clearly than you.

That’s it.  To invest with wisdom is to save, balance, own, and see.

Now for a curve ball.   If you have been shot by poison arrows, first carefully remove them.  Do not dwell on the cause of their intrusion into your flesh.   After you have recovered, you may be tempted to ask “Why was I shot?”.  It is the ‘why’ that takes most of the ‘attention’.  The same is true for investing.   The ‘why’ is the tricky, time-consuming, complicated part.

I believe that for the beginning investor the why can be unimportant.   For the enlightened investor the why is also unimportant.    The journey to investing enlightenment is about discovering the why and then letting it go.

Creative Finance

The last few weeks have been busy for Balhiser LLC. First the small biz was denied a $50,000 line of credit from a bank despite an excellent credit credit score, collateral and cash flow. That’s where creative financing come into play. It occurred to me, as president of Balhiser LLC, that the real estate venture was a good investment, and the the bank had made an error by rejecting the application on the basis of “industry: real estate”. I came up with the idea of a risk-sharing loan that would pay the lender a percentage of gross revenue from the income property in proportion to the loan-to-value of the property. The “angel” lender turned out to be a non-bank individual. The terms of the gross revenue agreement include a minimum 6-month term at which point the loan becomes callable and repayable in full or in part.

The lender gets a good deal because they realize proportional gross revenue. Balhiser LLC gets a good deal because it receives financing to close the capitalization gap with a non-bank lender sharing the revenue risk. The classic win-win business deal. So long as the property goes unrented no “interest” is due.

As it turns out, a 12-month lease on the property was signed on January 27th. If all goes according to plan both my small biz and the private lender will do reasonably well. The lender stands to receive just over 8% return.

Real Estate Diversification

Balhiser LLC is entering the real estate investing world. As president, I am working on the last steps of financing a payoff and transfer of a ~$175,000 property to Balhiser LLC. So far, I have secured 65% of the capital and financing. Financing the remaining 35% is in the works, and I am hopeful that a line of credit Balhiser LLC has applied for will help close the gap. Alternately, I am prepared to liquidate some of my Vanguard portfolio, as required to complete the transfer.

The goal is to lease the property, a 3 bedroom townhouse, for $1150/mo. Info about the property is available here.

Investing can be more than just stocks, bonds, ETFs, and options. It is exciting to extend Balhiser LLC into the arena of real estate investment.

Investor’s Thanksgiving Thanks

As we reflect on Thanksgiving, here are some personal finance things I am thankful for:

  • Decimal stock pricing. Remember all those pesky fractions?  Decimal pricing is so much easier.  And the spreads are much better too.
  • Online stock trading. I don’t know about you, but I don’t want to talk to a broker.  I want fast quotes and cheap trades without the conversation.
  • Free online financial data. Thank you all you online publishers of stock data.  It’s 2:00 AM and I just have to know the market premium on the BEP closed-end fund — No problem.
  • Index funds. Thanks John Bogle and others for these diversified, tax-efficient, cost-efficient funds.
  • Good financial planning. Thanks, Dad, and others along the way who taught me money management, investing, and financial planning.
  • 401K, IRA, and Roth IRA accounts. These tax advantaged accounts were spectacular ideas, and they work.
  • Good accountants. Thanks for helping me make some sense of the US tax code.
  • Buying opportunities. Every now and again a great investment comes along and a great price.  Doubling my money on PCU comes to mind.  Such opportunities are what make investing fun for me and keep me searching for the next great buy.
  • Dividends. Even when stocks are down, many still pay dividends. A lot of stocks are currently repaying 3% dividend yields. These quarterly dribbles of cash do feel good to receive.

For investors, there is a lot to be thankful for.  Yes, our equity investments are generally down, and our economy is lethargic. Equities have been a wild ride to nowhere in the last decade.  But bonds and, yes, in many places even real estate have fared much better.  And as long-term investor I am excited about the prospects finding buying opportunities.  I wouldn’t say equities are cheap, but I am thankful that they are not all that expensive either.  I am looking forward to the next 10, 20, 30+ years of investing.