Investing

The Effect of Taxes on Stock Returns

Key Takeaways:

  • Tax rates remain low historically speaking.

  • But, tax rates tend to have little empirical effect on stock market returns.

  • Whenever tax rates change, there’s an opportunity for investors, retirees and their advisors to arrange their portfolios in a tax-efficient manner and to create valuable tax savings. 

In theory, the much ballyhooed reduction of taxes on both the personal and corporate level would seem to be great for the economy and for investors, but history suggests that tax rates have little impact on investor returns.

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Figure: Tax Rates and Stock Returns. Sources: Standard & Poor’s, Bloomberg, Tax Foundation

The chart above plots both the maximum federal income tax rate by year and the average annual return of the S&P 500 for the past five years, both through the end of 2012. These returns are smoothed over five years to make the trend easier to see and to help us focus on longer-term effects. A number of interesting patterns emerge from the figure.

First, you’ll notice that tax rates were much higher in the past. If you believe in mean reversion, as is often the case with investment management, then tax rates could be going higher. Indeed, we have seen higher rates this year, and there is talk of further increases. Even after the latest increase, however, rates are still low compared to where they have been. And no one is discussing increases of the magnitude that would bring tax rates to where they were in the 1950s through the 1970s.

Another thing to note from the figure is the relation between tax rates and stock returns. In particular, there is not much of a relation at all. Correlations are actually slightly positive, although not statistically significant. Rather, we have had both high and low stock returns when taxes were higher and high and low stock returns when taxes were lower. While it may seem intuitive that higher tax rates are a threat to stock returns, the historical evidence simply does not back this up.

What the trends mean for advisors

The effects of taxes are not just financial; they contain emotional and political ramifications as well. Emotionally, investors may complain and worry about the impact of higher tax rates at the personal, corporate and estate level. While nobody likes having more money taken out of their paychecks, remember that rates are relatively low, historically speaking. You should also note that stocks can do quite well during periods of higher tax rates, too. One should generally be wary of discussing politics, but note that tax-efficient techniques are found on both sides of the aisle.

Another crucial point is that investors generally did not pay the highest tax rates seen in the chart. Instead, they used tax shelters and other tactics to keep their effective tax rates much lower. While the tax reform that brought about lower rates also ended many of the tax shelters that were used, there are still a variety of techniques that investors can utilize to lower their taxes. These techniques include:

  • Tax-sensitive investments in taxable accounts.

  • Funding tax-deferred and tax-exempt accounts and using them for effective asset location.

  • Integrating tax considerations in decisions such as estate planning and charitable contributions.


Conclusion


If you or someone close to you has concerns about the implications of tax reform on their investments or tax situation, we’d be happy to discuss with you please click here to schedule a call.


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Don’t Sell Your Business

There are better options

Key Takeaways:

  • Selling your business—or selling at the wrong time—can be a big mistake that you’ll regret for a long time.

  • If you sell your business, make sure you act like a bank if you hold paper.

  • Winding down your business can be much more satisfying and profitable than selling it to a third party or an outsider.

  • Simple is often a better way to leave your business than via a complicated strategy.

We spend lots of time talking with business owners about various strategies for exiting their businesses. Too often, we find owners choose strategies that just don’t serve them well.

If you choose the wrong exit strategy, what should have been a great retirement filled with joy turns into a nightmare.

Consider this scenario.

You’ve decided to sell your business. You’ve found a business broker who finds you a buyer. There’s only one problem: Your broker tells you that the buyer wants to pay you only 40 percent up front, and you are going to need to “be the bank” and finance the rest of the purchase.

After much soul-searching, you decide to go through with the transaction. After all, you’ve worked hard your whole life, and you know that the culmination of your business career is the sale of your business.

So, you’ve sold your business. You no longer control what happens. And to make matters worse, you’ve not treated the sale the same way that a bank would.

A year goes by and you find that your payments from the buyer start arriving late. You call the buyer and he tells you that he’s lost 20 percent of your clients and, because of that, he’s having a hard time getting the cash to pay you.

You have a choice: You can take back your business (with the attendant legal hassles) or you can hope that the buyer gets the business he needs in order to pay you. Neither choice is very attractive. You don’t feel you want to rebuild your business. Instead, you just sit by and hope things don’t get worse.

Another six months pass by, but instead of your payments being late, they just stop coming entirely. Again, there is little that you can do about this. You’ve sold your business and agreed to the buyer’s terms. There is nothing in your sales agreement that allows you to take over the business immediately. You’re forced to take the seller to court to get your damaged business back.

In the time that you’re working the legal system, you learn that your buyer has not only lost the majority of your clients, he’s also damaged the business so badly that there’s nothing you can do to salvage the situation. Now the money you planned to get from your business for retirement isn’t going to be there.

What do you do now?

First, don’t do a transaction like this.

If you sell your business to someone else and you have to act as the bank for the transaction, then for goodness sake, act like a bank! This means you need to do a thorough credit review of the person or group buying your business.

If you are providing financing, make sure that you get all the guarantees up front that a bank would get. This includes making sure that your buyer provides you with a personal guarantee. Not only do you want a personal guarantee, you also want to make sure there are real assets behind the personal guarantee.

When you make it easy to walk away, you’ll find that buyers will stop paying when life gets tough … and it always gets tough. If you really want to collect all the money from your sale that you’re entitled to, then be prepared to say NO to a sale unless you get a personal guarantee and appropriate security agreements from your buyer.

Better yet, try a different way to leave your business.

Selling your business is not always the best option. We have worked with many owners using a different strategy. We call this the “wind down.” Instead of selling your business, you make your business smaller.

The wind down is very simple: You find a home for 80 percent of your clients and you keep the top 20 percent of your clients—the ones who add the most value to your business.

Remember the 80/20 rule.

The reason this strategy works so well is because of a simple truism that exists in most business. Over the time you’ve been in business, you have accumulated many accounts on your books that you wouldn’t take today.

When you first started your business, you would take any client who walked in the door, right? Twenty years later, you’re still serving that client. They take up lots of time and don’t provide much in the way of revenue. It’s really OK for you to tell them that you’re retiring and that you’re going to help them find a great new home.

If you look at your book of business and only focus on the top 20 percent of your clients, you’ll likely keep 80 percent of your revenue, remove 80 percent of your costs and make much more money working just one day a week.

Isn’t that a much better way to leave your business? There is only so much golf that you can play and there are only so many trips that you can take. Wouldn’t it be nice to keep your hand in an industry that you’ve grown to love?

You’re going to have to do a few things.

If you decide the wind down is for you, here are some things you’ll have to do to get your practice ready.

  • Find a home for the 80 percent of the clients you want to let go. Think about giving these clients away to a good home with a younger planner. You don’t need the hassle of hoping you get paid for that part of your business and it’s more important to find these clients a good home than it is for you to be paid for the referral.

  • You’ll need to find a way to service the clients you do keep. If you jettison 80 percent of your business, you’re not going to need the staff that you presently have. You won’t want to keep your back office intact. There are many professional service firms that would be more than happy to take over your back office for a relatively small fee.

  • Have a disaster plan in place. As you age, you’re going to want to continue to decrease the number of clients you serve. There’s even a possibility that before you wind down your business completely, a health issue could keep you from serving even the small group of clients you’ve retained. Have a plan in place for reassigning your clients if you can’t serve them anymore.

It’s really not very hard.

Unless you really hate the business you’re in and the business is based on you, a wind down is a much more profitable and satisfying way to leave your business. Setting up a business to pursue a wind-down strategy has fewer moving parts and is much easier than trying to sell your business to a third party. We’re always in favor of the simple solution and hope you are too.

What do you think? Are you willing to give the wind down a shot?

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Understanding Value Investing

Investors continue to grapple with the concept of “value” in value investing. But for those willing to bear this risk, value stocks have ultimately provided the reward of higher returns. Here’s how to unlock the potential of value stocks.


Key Takeaways:

  • A value stock generally has a low price relative to various measures of a company’s worth, including the company’s book value, sales, earnings and cash flow.

  • Value stocks can be seen as being riskier than growth stocks in regard to both their company-level characteristics and their exposure to economic cycles.

  • For those willing to bear this risk, value stocks have ultimately provided the reward of higher returns.



Keys to unlocking the potential of value stocks. A quant perspective.

Investors continue to grapple with the concept of “value” in value investing. No single unique definition of value exists. Generally speaking, a value stock has a low price relative to various measures of a company’s worth, including the company’s book value, sales, earnings and cash flow. These company attributes tend to correlate with other measures that intuitively seem risky to investors, such as the company’s financial and operating leverage, its profit margins and variability of its financial results. Thus, looking across the cross section of companies one can invest in, value stocks are often seen to reflect concerns about a company’s profitability, stability and survivability. The different value metrics all reflect these concerns to varying degrees.

Real-world example

Consider for example two well-known stocks, Alphabet (Google) and Bank of America. The first is a growth company, with a price-to-book ratio of about 4.1 placing it so that the vast majority of stocks are cheaper. Alphabet has low debt, earnings have been growing nicely for years and there is a consensus that it is a very successful company. B of A is a value company whose price-to-book ratio of about 1.1 makes it cheaper than the vast majority of publicly traded U.S. stocks. It has a large amount of debt, and while its earnings grew nicely through 2007, they have vacillated since. B of A is widely viewed as having made several missteps during the financial crisis of the past several years.

This example illustrates the basic concepts of the risk argument. Certainly Google might be riskier by some metrics; for example, as a newer company some would consider them a greater risk. Nor will B of A necessarily outperform Google going forward. The latter has been a growth stock since inception and has continued to have strong returns. But generally the relationship between risk characteristics and value measures holds across stocks, and generally value stocks have outperformed their growth stock counterparts.

Impact of economic cycle

This value risk also manifests itself over time through exposure to the economic cycle. When times get tough, companies that have greater leverage or lower profitability will tend to suffer the most. The same holds true for smaller stocks. This can be demonstrated by considering returns of the value and size risk premiums during recessions and expansions. Returns for these premiums have been quite strong during expansions, but those returns fall dramatically during recessions. Recessions have been far fewer than expansions, and so these risks have historically paid off over time. And the risks from economic cycles are hard for investors to avoid.

Timing one’s entry and exit from the equity market can be very difficult. Recessions are often labeled as such well after the fact. Bear in mind the joke that “economists have predicted 10 out of the last 5 recessions.” And some of the highest returns to these premiums come right as or after a recession ends, so those trying to time their entry risk missing out on the strongest returns of the recovery. But for some of those willing to bear the risks, the rewards ultimately have followed.

The plot shows rolling 12-month returns to the Fama-French size factor (Small minus Big Company Returns - SMB) and value factor (High Value minus Low Value Companies - HML).

  • When these lines are above zero, small-size company returns beat large-company returns and value-company returns beat growth-company returns. These are superimposed over recessions, shown in gray. Data is from Kenneth French’s and National Bureau of Economic Research’s websites.

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  • One can see that during recessions, value and smaller stocks truly show their risk characteristics and tend to lag their growth and larger counterparts. This adverse exposure to the economic cycle is another display of value’s risk characteristics.

  • Conversely, during economic good times value and small stocks recover and out-perform quite nicely. The chart below provides historical averages that offer numerical confirmation of the patterns seen in the plot.

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Conclusion

Value investing continues to be popular, in part because it has worked well historically. There are a number of good explanations for this. We have focused on the risk explanation and have provided evidence that we find compelling. Value stocks are certainly not a sure thing, and they can disappoint at the worst times economically. But because of this risk, value stocks also can be viewed as ultimately providing the reward of higher returns for those willing to bear that risk.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

IPOs: Profiles Are High. What About Returns?

August 2019

Initial public offerings (IPOs) often attract initial public interest—especially when familiar brands become broadly available to investors for the first time. In recent months, investors have had the opportunity to buy shares of ride‑hailing networks Uber and Lyft, workplace productivity services Zoom and Slack, and other high-profile businesses ranging from Pinterest to Beyond Meat.

Dimensional’s Research team studied the first-year performance of more than 6,000 US IPOs from 1991 to 2018 and found they generally under performed industry benchmarks.

Click here to read more:

IPOs: Profiles are High. What About Returns?

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Key Questions for the Long-Term Investor

Focusing on what you can control can lead to a better investment experience.

At some point, most investors ask themselves questions like: “Do I have to outsmart the market to be successful?” or “Will a fund with strong past performance do well in the future?” A few key principles can help provide answers and improve the odds of investment success in the long run.

Whether you’ve been investing for decades or are just getting started, at some point on your investment journey you’ll likely ask yourself some of the questions below. Trying to answer these questions may be intimidating, but know that you’re not alone. Your financial advisor is here to help. While this is not intended to be an exhaustive list it will hopefully shed light on a few key principles, using data and reasoning, that may help improve investors’ odds of investment success in the long run.

Click here to read more:

Key Questions for the Long-Term Investor

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Don’t Let Your Brain Play These Tricks on You

5 common behavioral finance traps

Key Takeaways:

  • Understanding both the “how” and the “why” of irrational behavior can be invaluable to investors.

  • Research shows that many individuals are overconfident, under-diversified, short-sighted and often swayed by the media.

  • Learn how to protect yourself from your basic instincts.



Imagine world full of “rational” people who could maximize their wealth while minimizing risk. The ratings would be terrible for every cable-TV money show and there would be a lot fewer financial advisors in business. Rational individuals would assess their risk tolerance honestly and then determine an investment portfolio that met their income needs within their risk comfort zone. However, we know that most individuals are NOT capable of being rational—research has proven this time and time again.

Behavioral finance encompasses a body of theoretical and empirical academic research that seeks to explain how and why people, especially investors, do not act in a rational manner.

First let’s look at how investors behave irrationally:

  • Their portfolios are not sufficiently diversified.

  • They trade actively with high turnover and high transaction costs.

  • Too much of their wealth is tied up in their employer’s stock or in their own company’s stock if they’re a business owner.

  • They’re over-concentrated in or stocks of companies within their own industry or their immediate geographic area.

  • They tend to buy, rather than sell, companies that are mentioned positively in the news.

  • They tend to sell their winning investments while holding onto their losing investments far too long in a futile chase back to “break-even.”

Now let’s look at five common reasons why individuals behave so irrationally:

1) Recency bias.  We tend to make our decisions—especially financial ones—based on what happened to us most recently. Suppose a stock we just unloaded zoomed up by 50 percent a week after we sold it. Ouch! Then suppose there’s an earnings miss on another stock we’re holding, even though our disciplines might tell us to sell it. We’re scared to death that the same timing mistake we just made will happen again – i.e. the stock will zoom back up right after we sell it.

2) Anchoring.  In one sense it’s about having a mental stake in the ground to give you a framework for making decisions. For example, news about new market highs is blaring every day (Dow 26,000!  S&P 2,800!). And people are saying to themselves: “New highs! New highs! It must be time to sell.” But think about it. New highs are usually a positive sign for the market. We get anchored into these numbers and they distort our thought process. As a general rule, introverted people tend to be more skeptical. And that mindset can really hurt us in our investing because you miss out on opportunities or give up on an investment too quickly. On the flip side, extroverted people tend to be optimistic most of the time, but that can also hurt you as an investor, because you tend to expose yourself to too much risk—again and again.

3) Mental accounting/fallacy of breakeven.  Picking winners is not the big problem for most investors (do-it-yourselfers and many pros). The problem is that they can’t let go of their losers. When you’re holding on to your losers, your ego gets in the way. You tell yourself: “I’m know I’m right about this stock, the market just hasn’t recognized its value yet.” Or, you tell yourself, “I did so much work analyzing this stock, I can’t bail on it now.” So, you start doing all kinds of mental accounting and then at the end you tell yourself that you’ll sell the stock just as soon as it gets back to breakeven. And that’s an ABSOLUTE KILLER in investing.

When you hold on to a losing investment for too long trying to get back to break even there’s an opportunity cost. All those months and years that your money is tied up waiting to get back to breakeven means it can’t be deployed elsewhere in a more profitable investment.

4) Confirmation bias. Let’s say you have a great investment thesis, but you want it confirmed before you pull the trigger on it. So, you run around trying to get confirmation bias from all your smart friends, your broker and the Wall Street pundits whose picks you typically like.  Unfortunately, you’ve got a self-selected group of people who generally share your world view. If you’re honest with yourself, you’ll see they’re wrong more often than right.

Confirmation bias illustrates the danger of following the news media all day long and the danger of blindly following managers who have had the “halo effect” (i.e. hot hand) for the past several years. So you dive in and start following them and it often doesn’t work out. Remember those elite gurus who predicted that the housing crisis 10 years ago would trigger the global financial crisis. They made a fortune! So many investors piled into their funds waiting for them to work their magic again—and a decade later they’re still waiting.

5) Gambler’s fallacy. This occurs when you believe a purely random event is really NOT really random and that it’s going to continue to happen into the future. You start loading up now on FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) because you think they’re going to stay hot forever. You predict the next coin flip is going to land heads because the last 20 flips also landed heads. In reality, you have no way of knowing which side is going to land facing up. It’s completely random, just like so much of investing is. Most of the time, we have no control over what’s going to happen in the market. This fallacy that you actually have control due to some event that is random that you think is NOT random.

Conclusion

Behavioral finance literature serves as a reminder why it so important to protect yourself from you basic instincts—especially when markets are volatile. Safeguarding your wealth is a responsibility, not just to yourself, but to your family and the causes you support. Don’t hesitate to contact me if you suspect that you, or someone close to you, might be drifting from your long-term financial plan.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Can I Do a Net Unrealized Appreciation (NUA) Distribution?

Many companies offer company stock as a type of profit-sharing bonus in order to encourage company stock ownership for employees.  This is typically rewarded to employees within their 401(k) or other retirement account.  Unfortunately, as with all 401(k) distributions, withdrawals are taxed at ordinary income rates.  To combat this, the IRS allows for the capital appreciation of the stock to be taxed at long-term capital gains rates, as long as certain requirements are met.  Read on to see if you could qualify for a NUA.

Do you have employer issued stock in an employer retirement plan?

If you have no company stock, you won’t be eligible for an NUA distribution.  If you do have appreciated company stock in a retirement plan, read on.

Is it phantom stock or stock options?

Unfortunately phantom stock and stock options are not eligible for NUA treatment.  If you have other company stock, read on.

Do you have investments in the retirement account, other than employer issued stock (such as mutual funds)?

NUA distributions require the entirety of the account to be distributed, but non-qualified distributions from retirement funds could trigger taxes and penalties.  To avoid this, roll all non-employer stock to a Traditional IRA. 
Was part or all of the employer stock distributed in-kind to a taxable brokerage account?

To be eligible for the NUA distribution, the employer stock must be distributed directly to taxable account.  Additionally, the distribution must occur after one of the following events to be eligible: death, disability, separation from service, or reaching age 59.5.

If you meet all of the above requirements, you will be eligible for a NUA distribution.  Check out this flowchart to learn more.

NUA distributions can be complicated and difficult to coordinate with the retirement plan sponsor.  Numerous mistakes can be made in the long process that will disqualify you from receiving NUA treatment.  If you have questions regarding NUA distributions or retirement planning in general, please give us a call at 303-440-2906 or click here to schedule a time to speak with us.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Pursuing a Better Investment Experience

Key Principles to Improve Your Odds of Success

  1. Embrace Market Pricing

  2. Don’t Try to Outguess the Market

  3. Resist Chasing Past Performance

  4. Let Markets Work for You

  5. Consider the Drivers of Returns

  6. Practice Smart Diversification

  7. Avoid Market Timing

  8. Manage Your Emotions

  9. Look Beyond the Headlines

  10. Focus on What You Can Control

Click here to read more:

Pursuing a Better Investment Experience

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Quarterly Market Review

Second Quarter 2019

This report features world capital market performance and a timeline of events for the past quarter. It begins with a global overview, then features the returns of stock and bond asset classes in the US and international markets.

The report also illustrates the impact of globally diversified portfolios and features a quarterly topic.

Click here to read more:

Quarterly Market Review

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Why Can’t You Make Better Decisions? Ask Your Ego

Key Takeaways

  • Investing is a psychology game, not an IQ game.

  • Research shows human decisions are made with 80 percent emotion and 20 percent logic—maybe 90/10 when it comes to investing.

  • Why is it so hard to let go of your losers?

 

As some of you may remember, University of Chicago professor, Richard Thaler won the Nobel Prize in economics last year. Thaler is relatively young by Nobel laureate standards, and his primary field of study (behavioral finance), is somewhat controversial to many in the numbers-driven financial advisory world. The idea that psychological research should even be part of economics has raised eyebrows for years.

 

So what is behavioral finance?

Behavioral finance encompasses a body of theoretical and empirical academic research that seeks to explain why people, especially investors (both retail and institutional), do not act in a rational manner. Think of the moniker “behavioral” as describing how and why individuals behave the way they do.


As Warren Buffet has explained many times: “Investing is a psychology game; not an IQ game.” Research shows that human decisions are made with 80 percent emotion and 20 percent logic. Some would argue the ratio is now closer to 90 percent emotion and only 10 percent logic.

Take the “disposition effect.” That’s the all-too-common situation in which investors hold on to their losers and sell their winners. It’s one of the main reasons that investors--both pros and do-it-yourselfers underperform--they can pick winners pretty effectively, but they cannot sell their losers.

Our egos are a big part of the problem. Our egos are what drive the emotional difficulty of parting with a stock that you spent so much time analyzing.  “How can I be so wrong?” you ask yourself. “Eventually my thesis will prove correct.”

Wrong!

An advisor’s job is to help you manage your behavioral biases during different stages of the market cycle. In this long-running bull market, investors start to get short-term memory lapses. In particular, greed kicks in and investors become tempted to move all their assets into equities. You and your advisor should work together to extract emotion from investment decisions and to mitigate unnecessary risk wherever possible.


Our egos get in the way

Why do we think we are so good at financial decision making when the odds are stacked against us? The simple answer can be traced to ego-- the ultimate roadblock to sound investing. According to Ryan Holiday, media strategist and best-selling author of Ego Is the Enemy, the answer is most often NO.

“One might say that the ability to evaluate one’s own ability is the most important skill of all,” wrote Holiday. “Without it, improvement is impossible. And certainly ego makes it difficult every step of the way. It is certainly more pleasurable to focus on our talents and strengths, but where does that get us? Arrogance and self-absorption inhibit growth. So does fantasy and vision,” Holiday added.

From where we sit at our firm, hubris is prevalent due to the market’s all-time highs; but again human biases are coming into play.  The 2008 crisis left us with the biggest investing hangover in modern market history. As a result, portfolio managers are scared to death about missing the next correction instead of the hyper-bullish you usually see around equities when markets are at record highs.


Many of my colleagues believe greed has kicked in, but some investors still can’t shake the nightmare of 2008-09 from their memories. Looking at the question from a different angle, we should ask: “Is the index’s standard deviation higher today?” The answer to that question is yes! That’s why it’s essential to make sure your advisors know about all your changing life circumstances, financial needs and ever-changing concerns. Understanding one’s investment psyche has become harder due to recent market volatility and geopolitical events—threats to the long-running bull market that the media constantly reminds us about.

Conclusion

As valuations continue to rise above the top quartile, many fundamental analysts can’t get their arms around being long. The problem is that they are only measuring the ‘P’ in price to earnings–the ‘E’ essentially stands for emotion.

If you or someone close to you has concerns about the viability of your current investment decisions for the near-term and long-term, please don’t hesitate to reach out. We’re happy to help.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Timing Isn't Everything

Over the course of a summer, it’s not unusual for the stock market to be a topic of conversation at barbeques or other social gatherings.

A neighbor or relative might ask about which investments are good at the moment. The lure of getting in at the right time or avoiding the next downturn may tempt even disciplined, long-term investors. The reality of successfully timing markets, however, isn’t as straightforward as it sounds.

OUTGUESSING THE MARKET IS DIFFICULT

Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.[1] The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.

Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.[2]

[1]. In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.

[2]. Mutual Fund Landscape 2019.

Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, said it well in a recent interview with Dimensional:

“Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.”

TIME AND THE MARKET

The S&P 500 Index has logged an incredible decade. Should this result impact investors’ allocations to equities? Exhibit 1 suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 went on to provide positive average annualized returns over one, three, and five years following new market highs.

In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index,  Stocks, Bonds, Bills and Inflation Yearbook ™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

CONCLUSION

Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

7 Financial Tips for Recent Grads

Key Takeaways

  • Monthly cash flow is king. Developing both short-term and long-term strategies within that balance will develop money habits that can lead to long-term success in life.

  • Budgeting software can be very helpful. But as with retirement calculators, budgeting tools are only as accurate as the inputs and assumptions you plug in.

  • It’s never too early to start saving for retirement.


As the old saying goes: “Give a hungry person a fish and you’ll feed them for a day. Teach them how to fish and you’ll feed them for a lifetime.”

 

Recent grads are transitioning from student life to the workforce, from being focused on their education to focusing on their careers. Every student’s financial situation is different. Here are some tips that young people can use to get their financial lives off to a great start.

 

The facts are frightening:

  •  For today’s college grads, average student debt is almost $40,000.

  • Too many people are on the path to running out of money well before they die.

  • More than half of U.S. adults (including the wealthy) don’t have up-to-date financial, estate and gift plans to protect themselves and their families.

 

This lack of financial knowledge places a HUGE amount of pressure on the individual, their families and friends, employers, nonprofits; as well as on the ultimate safety net of the state and federal government.

 

Don't let you or your loved ones become one of these alarming statistics! Here are seven fundamental financial tips to help the recent grads in your life get off to a good start:

 

1. Create a “grown up” budget. One of the most important transitions for most new college graduates is taking responsibility for their finances—all their finances. With the financial freedom of a new job, it may seem they don’t need to manage their money. But with new expenses, such as rent, utilities and car payments, plus your student loan bills, it can be easy to overspend. A good budget not only gives them a snapshot of income versus regular bills--it provides peace of mind knowing when they can afford a night out or an impulse buy. Software programs such as Mint or You Need a Budget can be a big help.

NOTE: Like the retirement calculators you see online—budgeting tools are only as good as the information and assumptions plugged into them. Encourage the young adults in your life to consult with a qualified financial advisor to help them plug in the right inputs and assumptions.

2. Deal with your debt.  Whether it is from student loans or credit cards, it is important to focus on reducing your debt. Graduating with debt can be debilitating, but having a plan to pay off debt can help grads get back in control of their finances. Focus on paying off debt with higher interest rates first, like credit cards. When possible, make extra payments. Paying off debt early will lower interest charges and can save money over the life of the loan.

3. Retirement planning starts now.  It may seem odd to think about retirement when you are just starting out in the workforce, but in many ways, the first contributions are the most important. Encourage new grads to take advantage of their employer’s 401(k) as soon as they are eligible. Waiting just one year to contribute to your 401(k) could lower the retirement nest egg by up to $100,000. Waiting 10 years could drop their 401(k) by half.

4. Save for emergencies. While often neglected, planning for emergencies should be a priority. Having an emergency fund can help with anything from an unexpected car repair to high medical bills to major household repair to job loss. Always keep three to six months’ worth of normal living expenses on hand. Creating an emergency fund is as simple as setting up a direct deposit from one’s paycheck to a savings account.

5. Upgrade your accounts. Graduation is a good time to reevaluate your bank and credit card accounts. As young adults join the workforce and become responsible renters or homeowners, financial needs will change—A LOT! The checking account they were eligible for as a student may not provide the flexibility or benefits they need now. Check what other account options the bank offers. Be sure to shop around to make sure they have the right accounts, and the right bank, for their new financial situation.

6. Upgrade credit cards. Used correctly, credit cards are an essential tool to establish good credit history. Good credit can lower the interest rate on auto loans and home loans. The credit cards that students are eligible for are generally entry-level cards that have a higher interest rate and fewer rewards and benefits. New grads should look for credit cards that give the most rewards for their normal spending habits and financial goals. If they think they may occasionally carry a balance, they should look for a card with a low interest rate. If their goal is to travel, look for a card that offers plenty of mileage rewards.


7. Hire a financial planner/mentor. New grads might not think they have enough income or assets to use a professional financial advisor, but they’d be surprised to see what they own, what they owe and what they’ll need going forward. Among other things, a planner can help them decide whether to consolidate student loans, whether to save for retirement using a Roth 401(k) or traditional 401(k), how to invest their money, how much life insurance to buy, and so much more.


Note to parents and grandparents:
A great graduation gift would be a one or two-hour consultation with a qualified and competent financial planner.

Conclusion

Life is full of transitions.
Some will be good, others will be a challenge. Having a network of family, friends and financial advisors in your corner will make it substantially easier for new grads to roll with the punches and adjust to their ever-changing life circumstances. As always, I’m here to help if you have concerns about your tuition financial plans.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

The Randomness of Global Equity Returns

Investment opportunities exist all around the globe. 

Across more than 40 countries, there are over 15,000 publicly traded companies.[1] If you listen to the news, however, some countries may seem like better places to invest than others based on how their economies and stock markets are doing at the time. Fluctuations in performance from year to year only add to the complexity, providing little useful information about future returns.

Daunted by the prospects of sorting it out, some investors look to the place they know best—their home market. There can be good reasons, such as tax benefits, for prioritizing an investment close to home, but too much home bias could mean underweighting or missing out on part of the investment universe.

Australia, for example, represents 2% of the global equity market. An Australian who aims to build a global equity portfolio may have cause for investing a greater amount at home. However, this would come with the tradeoff of reduced investment in other countries. The same is true for a Japanese investor, whose home country represents 8% of the global equity market. Even the US equity market—the world’s largest by far—is only about half of the global opportunity set.

Fortunately, no one needs to be an expert in every region to benefit from the opportunities those regions present. Equity markets process information continuously, leveraging knowledge from millions of buyers and sellers each day as they set security prices. Investors can trust market prices to provide an up-to-the-minute snapshot of global investment opportunities.

Because prices do such a good job incorporating information about securities in every market, they also offer the best prediction of future prospects. No sensible story or compelling empirical research suggests investors can consistently outguess those prices and pick winning countries. A well-diversified global portfolio can help capture the returns of markets around the world and deliver more reliable outcomes over time.

READING THE CHECKERBOARD

The tables in Exhibit 1 illustrate 20 years of annual equity returns for developed and emerging markets. Each color represents a different country. Each column is sorted top down, from the highest-performing country to the lowest.

Taken together, these tables powerfully demonstrate the randomness of global equity returns. In either table, pick a color in the first column and follow it through to the right. Does any country seem to follow a pattern that gives clues about its future performance?

[1]. Number of countries and publicly traded companies data provided by Bloomberg.                                                                

First Capture.JPG

Consider the performance of the US and Denmark, shown in Exhibit 2. Is it immediately clear which country had the higher return over the past two decades?

Denmark, in fact, was the best performer among all developed markets, with an annualized return of 9.1%. Surprisingly perhaps, Denmark had the best calendar year return only once, in 2015. The US, despite some strong returns in the last several years, placed ninth overall with an annualized return of 4.9%. Bear in mind, Denmark represents less than 1% of the global market cap available to investors.

Second Capture.JPG

FROM FIRST TO WORST

Denmark also provides an example of the unpredictability in short-term results. After posting the highest developed market return in 2015, Denmark had the lowest return in 2016. Countries have also moved in the opposite direction, from worst to first, in consecutive years. In 2000, New Zealand had the lowest return among developed markets followed by the highest return in both 2001 and 2002. In emerging markets, Hungary and Russia went from the bottom two performers in 2014 to the top two performers in 2015.

GOING TO EXTREMES

In a single year, the difference between the return of the highest-performing country and the lowest can be dramatic, as shown in Exhibit 3. Among developed markets over the last 20 years, the difference between the best and worst performers has ranged from a low of 24% in 2018 to as much as 81% in 2009. The differences in emerging markets are even more pronounced, ranging from 39% in 2013 to 160% in 2005. In fact, the difference in emerging markets has exceeded 100% in several years.

These extreme differences in outcomes, combined with the examples of countries that experienced sharp reversals in their return rankings, highlight the risk of trying to predict future returns by looking at the past and emphasize the importance of diversification across countries.

Third Capture.JPG

NOW THE GOOD NEWS

This evidence of the randomness in global equity returns, though, is not bad news for investors. Rather than trying to guess which country is going to outperform when, investors committed to a well-structured, globally diversified portfolio are better positioned to capture the performance of the global markets, where and when it occurs.

Over the last 20 years, every dollar invested in a globally diversified strategy, shown by the Dimensional Global Market Index in Exhibit 4, nearly tripled.

A globally diversified approach can deliver more reliable outcomes over time with less volatility than investing in individual countries. This can help investors stay on track, through all kinds of markets, toward their long-term goals.

lAST cAPTURE.JPG

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Exit Planning for Business Owners, Part 2

It’s not only about what to do next but when to do it. See our timeline for making the most of your exit

By Robert J. Pyle, CFP®, CFA, AEP®

Key Takeaways

  • Don’t get so immersed in selling your business that day-to-day operations start to slip.

  • The most important driver of your business valuation is recurring revenue and contracts.

  • Make sure your advisors have experience transacting a business like yours—and don’t wait until the last minute to inform them of your plans to sell.

As we discussed in Part 1, exit planning is a multi-year process, not a spur of the moment decision. Most experts say you need to start planning three to five years out. The last thing you want to be doing on the way to your closing is making frantic calls to your attorney or CPA to track down financial statements or contracts the buyer is demanding to see. I can’t tell you how many accountants and lawyers have told me this is how they first learn about a client’s intention to sell their business. Ouch!

Exit Planning for Business Owners Timeline Graphic 3 Revised.png

5 Years Out: Steps to consider

Obtain a professional valuation of your business

Approximately five years before you plan to sell, you should get a professional business valuation (BV) of your enterprise. You want a fair and objective value for your business so you can get a sense of how it compares to other businesses in your industry and how much you can expect to net from the sale. A BV should also tell you your business's market position, financial situation, strengths, and weaknesses (which you can hopefully correct before putting your venture on the market).

You want to find a BV specialist who focuses on valuing your specific type of business or someone who has helped sell a business similar to yours. The most important driver of BV is recurring revenue. The more contracts you have in place with recurring revenue, the better for your valuation.

Get your financials in shape

 

This is also the time to get all of your financial statements in order. Don’t be a do-it-yourselfer here. Hire a competent CPA or bookkeeper to ensure your financials are accurate and consistent. This is also when you have to STOP running lots of personal expenses through your business. Buyers want to see clean expenses for the business only. Don’t procrastinate. You need to go cold turkey here!

Having clean, well-organized books is critical for giving potential buyers an accurate picture of your business. When it comes time to sell, you will have to explain EVERY line item and whether the line item in question is a one-time expense or an ongoing charge. You also need three to five years of accurate financials so buyers can get a sense of any cyclicality or industry trends affecting your business. Your CPA should specialize in working with small business owners. A few designations to look for are Certified Exit Planning Advisor (CEPA) by the Exit Planning Institute and a Certified Valuation Analyst (CVA) by the National Association of Certified Valuator and Analysts.

Consult your financial and tax advisors 

The buyer is going to look at what you pay yourself in terms of W2 salary and, if you are an S-Corp, what your distributions are from the company. From there, the buyer can estimate how long it will take to get their money back on a discounted cash flow basis.

Get your advisory team in place

Start interviewing attorneys and accountants who are proficient in mergers and acquisitions. Strongly consider hiring an intermediary--either a business broker or an investment banker--to represent you and help you through the selling process. 

Hiring a good investment banker will usually result in a higher sale price and/or better deal terms for the owner. Investment bankers typically have industry expertise and knowledge of possible buyers, plus they can screen possible buyers for you. Investment bankers also know how to structure and negotiate the sale. A business broker may or may not have the skills of an investment banker, but he or she will be able to market your business, help you find the best buyers and set a realistic asking price.

 

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3 Years Out: Steps to consider

Organize your legal paperwork
 

Review your incorporation papers, permits, licensing agreements, leases, customer and vendor contracts, etc. The buyer will want to know about customer contracts you have in place and when those contracts expire. The buyer will also want to know about contracts you have with vendors, and when those contracts expire. Most buyers will be anxious to know when they can contractually change to their preferred vendors.


Start your succession plan
 

Retaining your top managers and sales professionals is critical for the success of your business post- sale. Employment contracts and bonuses are key to retaining these top performers. You also want non-compete and non-solicitation agreements in place, so your key people don’t leave and take your best customers/clients with them. This is especially true if your sale is contingent on an earn-out basis.

 

Know the true profitability of your business

Most privately held businesses claim a variety of nonoperational expenses. Make sure you have supporting documentation for these expenses. For example, your business may be paying for your personal automobile lease. Also, there may be infrequent expenses you have incurred during the past three years that should be excluded in a buyer's analysis of recurring cash flow.

There could be one-time expenses such as software conversion fees or location moves that should be excluded from the annual expenses.


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1 Year Out: Steps to consider

REALLY know your reason for selling
 

Buyers are always curious as to why a seller wants to exit a business. Owners have a myriad of reasons for wanting to sell, but it could be a simple as wanting to retire and see the world. Perhaps they know a relative who hung on to their business for too long, so they were never able to retire fully before they or their spouse got too ill to travel.

 

Keep your eye on the ball 

Don't let your business performance decline because you're overly focused on selling your business. A sudden drop in revenue will only give buyers additional negotiating power to lower their offer. If you are immersed in selling your business and focus exclusively on revenue rather than profit, you could make the common mistake of taking on high-maintenance new clients or customers that increase your topline revenue, but decrease your profit margin and thus will be a drain on your business. Focus on bringing in profitable new business only.

 

Spruce up your “curb appeal”


Make sure your place of work is clean and tidy, and that any necessary repairs have been made. If there is equipment required to run your business, make sure it’s all in working order. Make any outdoor improvements to landscaping, signage, etc.  


Conclusion


Selling a business is one of the hardest and most emotionally wrenching transactions you may ever do in your life…..don’t be a do-it-yourselfer or a Last Minute Louie. There are so many things to consider to prepare for the sale, and what to do after the sale, you need someone to help you through this transition. If you or someone close to you is considering selling their business, please don’t hesitate to contact me. I’d be happy to help.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Matrix Book 2019

Check out this video from Dimensional:

The Matrix Book is a unique a tool for seeing decades of returns and telling stories about investing. In this video, Joel Hefner explains how a globally diversified approach can help investors stay on track toward achieving their long-term goals.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Mutual Fund Landscape 2019

Each year, Dimensional analyzes returns from a large sample of US-based mutual funds. Our objective is to assess the performance of mutual fund managers relative to benchmarks.*

This year’s study updates results through 2018. The evidence shows that a majority of fund managers in the sample failed to deliver benchmark-beating returns after costs.

We believe that the results of this research provide a strong case for relying on market prices when making investment decisions.

The global financial markets process millions of trades worth hundreds of billions of dollars each day. These trades reflect the viewpoints of buyers and sellers who are investing their capital. Using these trades as inputs, the market functions as a powerful information-processing mechanism, aggregating vast amounts of dispersed information into prices and driving them toward fair value. Investors who attempt to outguess prices are pitting their knowledge against the collective wisdom of all market participants.

So, are investors better off relying on market prices or searching for mispriced securities?

Mutual fund industry performance offers one test of the market’s pricing power. If markets do not effectively incorporate information into securities prices, then opportunities may arise for professional managers to identify pricing “mistakes” and convert them into higher returns. In this scenario, we might expect to see many mutual funds outperforming benchmarks. But the evidence suggests otherwise.

Across thousands of funds covering a broad range of manager philosophies, objectives, and styles, a majority of the funds evaluated did not outperform benchmarks after costs. These findings suggest that investors can rely on market prices.

Let’s consider the details. Download the full report here:

Mutual Fund Landscape 2019

*In the study results, “benchmark” refers to the primary prospectus benchmark used to evaluate the performance of each respective mutual fund in the sample where available. See Data Appendix for additional information.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

The Uncommon Average

May 2019

“I have found that the importance of having an investment philosophy—one that is robust and that you can stick with— cannot be overstated.”

—David Booth

The US stock market has delivered an average annual return of around 10% since 1926.[1] But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?

Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.


[1]. As measured by the S&P 500 Index from 1926–2018.

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TUNING IN TO DIFFERENT FREQUENCIES

Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.

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Conclusion

While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals during different market environments. 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

The Index Bogeyman

Over the last several years, index funds have received increased attention from investors and the financial media. Some have even made claims that the increased usage of index funds may be distorting market prices. For many, this argument hinges on the premise that indexing reduces the efficacy of price discovery. If index funds are becoming increasingly popular and investors are “blindly” buying an index’s underlying holdings, sufficient price discovery may not be happening in the market.

But should the rise of index funds be a cause of concern for investors? Using data and reasoning, we can examine this assertion and help investors understand that markets continue to work, and investors can still rely on market prices despite the increased prevalence of indexing.

Click here to read more:

The Index Bogeyman

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Lessons from the Matrix Book, 2018

Check out this video from Dimensional:

The Matrix Book is a unique a tool for seeing decades of returns and telling stories about investing. In these videos, Joel Hefner shows how the Matrix Book can illustrate some of the tradeoffs associated with investing as well as how investors can improve their chances of having a successful investment experience.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Perspective on Premiums

Investors may be tempted to extrapolate recent returns into the future, which can lead them to abandon their investment philosophy at potentially inopportune times. While negative outcomes are disappointing, investors should view them with the proper perspective and stay the course.

When you leave your server a tip, do you round it to a whole-dollar amount and often in multiples of $5? Does a 60th birthday seem more significant than a 59th? If you answer yes to these questions, you’re not alone. Most of us prefer round numbers. This preference leads many investors to review results by calendar year and to consider 10-year periods when evaluating long-term returns. People tend to place greater emphasis on the latest period due to recency bias and to extrapolate recent results into the future. For these reasons, we should put recent performance into the proper perspective.

Click here to Read More:

Perspective on Premiums

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.