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What's Up Magazine

Financial Wellness for 2018

Feb 01, 2018 09:00AM ● By James Houck
If you’re like me, when it comes to finances, you have one eye on the black and another on the red…at all times. The flow of money, investments, and the economy in general is always front of mind and there’s a plethora of apps that feed our need to track and act upon our financial whims…both good and bad. To help us get a handle on the year’s financial trends and a leg up on legal adjustments, new tools, tech, and advice, in general, about how to manage our wealth and debt obligations, we turned to several local fiduciaries. 

The following Q&A session with them is telling. Our participating financial professionals are: Brion Harris, Managing Partner, Premier Planning Group; Chris Koomey, President, Online Trading Academy, Washington, D.C.; Greg Ostrowski, Managing Partner, Scarborough Capital Management; and Carlos Sera, Managing Principal, Sera Capital Management, LLC.

This group could help you shape a better financial profile. Let’s get started.

What market trends are you keeping an eye on for 2018?

“As we enter 2018, keep an eye on investor sentiment. Investor sentiment can be an important contrarian indicator. I also like Robert Schiller’s definition of a bubble, which goes as follows: ‘A situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase and bringing in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.’”–Brion 

“The U.S. stock markets continue their charge up heading into the New Year. The key trends we are tracking relate to interest rates and the U.S. dollar and how they may impact the stock market. High yield corporate bonds (lovingly known as junk bonds and trackable by the ETF HYG) are showing signs of breaking down. If this continues, this will serve as a canary in the coal mine of a likely U.S. stock market downturn. Short and intermediate interest rates have been rising which will eat into profits of highly leveraged companies. The U.S. dollar has lost more than 10 percent of its value this year. If this trend continues into 2018, look for higher consumer prices which will feed into an economic slowdown. We are already seeing the weak dollar pushing up oil and consumer prices, so if the downtrend in the U.S. dollar continues or accelerates there will be opportunities to take advantage of these market shifts.”–Chris

“The last few years have been characterized by extremely low volatility which is just a capital markets term for uncertainty. This seems out of sync with the perceived level of political and social volatility. I expect these two will at some point cease to diverge and start to converge. When this convergence begins, there will be opportunities for those that see it and act.”–Carlos

“There’s been a lot going on, be it in terms of tax changes, geopolitical tension, oil prices, etc. However, if I were to pick one trend to watch, it would be the 10-year Treasury. As the economy has improved, the Federal Reserve has slowly peeled off the bandaid of economic stimulus, lately in the form of steadily raising short-term lending rates. We believe that as we start to see the 10-year approach the 3 percent level we may begin to see a slowdown in the market momentum we’ve seen the past several years. In effect, money has been ‘cheap’ for quite some time allowing for attractive lending on homes, cars, and for companies when raising capital or issuing debt. As money becomes more ‘expensive,’ we may start to see some economic slowing.”–Greg

What financial regulations and/or deregulations will impact consumers in 2018?

“The federal regulations relating to the financial services industry that were developed in the aftermath of the last market meltdown are in the process of being dismantled. Regulators’ enthusiasm for enforcing whatever regulations are left is also markedly low. Even with the previous regulatory regime, financial services companies were brazenly stealing from their clients so consumers need to be on high alert. I believe a credit monitoring service is mandatory and, even then, you can’t trust the companies that are supposed to be looking out for you. My biggest concern is the lack of attention to cyber security. Basically, everyone’s information has been hacked and the government is actually reducing protections in this environment.”–Chris

Should I consider investing in the varied and niche mutual funds versus index funds?

“There’s no one right or wrong way to invest and there’s long-standing debate on passive vs. active strategies. Both management styles, in my opinion, can play an integral role as part of a portfolio. Low-cost index funds can be a great way to get cheap exposure to parts of the market where it’s harder to get manager outperformance; whereas, more active management styles can be useful in more challenging parts of the market like small-caps or international exposure or potentially during a market downdraft. As a Certified Financial Planner, I like to start the investment conversation centered around risk, timelines for the investment, potential themes such as a focus on socially conscious or eco-friendly investments, among other things, and then we sort of back into what types of investments can best support our desired strategy.”–Greg  

“You shouldn’t. There is no rational reason for anyone to invest in a mutual fund. If you have enough assets ($1 million plus) for passive investing to make sense, then low cost index funds or low-cost Exchange Traded Funds (ETFs) are the only logical solution. Generally, most people would get their best results by putting 60 percent in a low-cost S&P 500 vehicle, such as SPY, and 40 percent in a low-cost, long-term bond vehicle, such as TLT, and rebalancing quarterly or annually. Mutual funds made sense in the 20th century when direct market access was costly, inefficient, and hard. Those days are long gone.”–Chris

“The average time a person holds a given mutual fund, whether actively managed or a passively managed index fund is slightly over two years. This means, it doesn’t really matter how you choose to express your opinion, what matters is how well you trade on your opinion since a two-year holding period means you are a trader and not an investor.”–Carlos    

What are the pros and cons of investing in a 401K versus Roth IRA?

“401Ks come in two flavors, traditional tax deferred 401K and a Roth tax free 401K just like IRAs. More than half of the existing 401K plans have a Roth 401K option and there is no cost for employers to add this option, so it should really be more like 100 percent availability.  
“There has been a relatively low rate of adoption of Roth Retirement plans, about 6 percent of total, largely due to the financial services industry’s aversion to them and the lack of positive education surrounding them. The financial services industry generally makes the argument that you pay the same taxes in either case, but this is only true when you use a low return vehicle like those hawked by the financial services industry. If you can generate double and triple digit returns from your assets then the benefits of the Roth opportunity are monumental. I do not understand the financial services industry’s aversion to the Roth, but can only figure it’s because it gives individuals more control and flexibility over their own assets.
“Relating to taxes, the general rule of thumb is you want to defer taxes as long as possible, which supports the traditional 401K and IRA. With the Roth, you pay your taxes up front but then have 40 or so years when you can extract your returns and your assets on a tax-free basis. Paying taxes once, so you can get 40 tax-free bites at the apple, looks like a good trade to me and a good reason to deviate from the rule of thumb.   
“Basically, the Roth 401K and Roth IRAs allow you to generate tax-free income from your assets for the second half of your adult life (age 59 ½ to 100 and beyond). You have the opportunity to not pay any taxes after the age of 60 or put another way, all taxes that you pay after the age of 60 are voluntary or due to your lack of appropriately focused planning. Think about that whenever you write a tax check after the age of 60. You can hold a wide variety of assets in Roth 401Ks and Roth IRAs, including cash flow businesses, angel investments, intellectual property, real estate, and financial trading, but you need to have enough assets positioned in a Roth to have it make sense.
“Generally, you should contribute enough to your company 401K, Roth, or otherwise, to maximize the company match. If you want to contribute up to $24,000 if you are over 50 or $18,000 if you are under 50 it may make sense to contribute more to your 401K. For most people, maximizing contributions to an IRA, Roth or otherwise, works better. Individuals over 50 can contribute up to $6,500 and individuals under 50 can contribute up to $5,500. Contributions to a 401K are constrained by the choices your employer allows you to make while IRAs give you the flexibility to use your assets just about any way you want to generate income and build wealth.  
“Small business owners have the greatest ability to benefit from tax deferral and tax-free planning.  
“Roths represent the best estate tax planning tool available today. While the estate tax impacts a remarkably few number of people everyone has the ability to leave their Roth assets to their children and grandchildren who then get the benefit of tax free income for the second half of their adult lives.”–Chris

How should potential investors with accrued debt approach their debt obligations versus investing desires?

“Generally speaking, people should wage war on their debt obligations first. It tends to be a noose around investors’ necks that should be dealt with swiftly and aggressively. There are exceptions. If the debt is very low interest, say 3–4 percent, you could make the argument that you could earn more with your investments, but if it’s much over that, it’s kind of a defeating purpose to invest first when you’re just continuing to accrue interest on the debt.”–Brion 

“So much depends on an individual’s unique circumstances, but, generally speaking, if you have debt with rates that are on the higher side, more than 6 percent for example, it may not be a bad idea to try to pay these off prior to dedicating money toward investments. The reason is that what you’d owe on a higher percentage may be equal, if not more, than what you could get in terms of a return from an investment. But if the rates are lower, paying off the minimum and investing the rest could let you build your investments, and give you a tax advantage. Other factors—like whether or not you’ve started to build an emergency fund or whether or not you work for a company that has a 401k matching contribution—should also be considered.”–Greg 

“The first rule of personal finance is to spend less than you make. The second rule is to make more than you make. Individuals need to be looking for multiple avenues to expand their income through their efforts and through their assets. Productive debt is used to generate income and wealth over and above the cost of servicing that debt. Successful investors balance periods of leveraging up with productive debt with periods of deleveraging and reducing debt based on their goals at a given period of their life. Embracing and managing risk and using it to generate a greater reward is what investing is all about.

“Accrued debt servicing is part of an individual’s baseline income needs. Often it makes sense to incur more productive debt to generate sufficient income to eliminate accrued debt and the new productive debt.”–Chris

 What are the pros and cons of debt consolidation and what are several consolidation methods to consider?

“Be careful with loan consolidation. It may be tempting to take all of your loans and consolidate them, thus lowering your overall monthly payment and locking in a lower fixed interest rate. But in this case, chances are the terms of your loan were extended significantly. This will likely increase the amount of payments you’ll have, and could cause you to owe significantly more in interest over the years.”–Greg

What non-education investment instruments do you suggest a parent establish for their children?

“Save early; save often! It’s a phrase I use all the time when talking to fellow parents about encouraging their kids to learn about money and investing at an early age. To that end, investments in companies (conceptually) like a Disney or Apple can be a great way for kids to engage with money in a different way. They can start to connect the dots of commerce as both a consumer and a shareholder, learning about business, buying/spending habits, compound interest, and more.”–Greg 
“While for most people cash value life insurance is too expensive and does not yield enough to be helpful in building real wealth, for parents looking to provide some financial protection to their children, cash value life insurance can be a good option.  
“Cash value life insurance will preserve the assets transferred and should provide some returns to balance inflation. Policies that allow for loans will allow your children to take out debt against the policy and pay interest to themselves rather than a third party. Some children may not qualify for life insurance at a later date, so establishing a policy earlier can be a great benefit to them.”–Chris

What investment instruments are most-recommended to parents seeking to invest in their child’s education?

“Most every state has a 529 plan which allows people to contribute larger sums for individuals to attend approved educational institutions. Many states have prepaid tuition plans. While Coverdell education accounts exist, the amounts that can be contributed are so small as to render them
impractical for most purposes.
“529 plans allow people to contribute up to five years of annual gifts at one time ($15,000 in 2018 times five = $75,000) and then take a state tax deduction up to the amount of the contribution over time. The donor retains control of the money. Money grows tax-deferred and gains are tax-free when paid directly to approved educational institutions. If money is not used by that individual, it can be used by a close relative of the donee. 529 plans are high-fee vehicles and often have constraints related to their investment options. 529 plans do provide flexibility as the approved educational institutions list goes well beyond traditional four-year colleges.
“Pre-paid tuition plans sound like a good idea but lock you into your state’s educational system, the quality of which can change drastically over the course of a decade or two. I have never been given a clear idea of the return the money would receive if a state institution is not attended so I am not sure if the lack of flexibility is worth it. Also, the ability of schools to add on fees and
raise room and board makes this an incomplete solution that a 529 more than makes up for.”–Chris

Should out of state education investment plans be considered? Are there any highly recommended states in the mix?

“Generally, the best options are to use a state you are a resident of due to the state tax deduction. Virginia is highly regarded as is Illinois, Nevada, and Utah but don’t make it too complicated. Stick close to home.”–Chris

Thoughts on robo-investing applications and theirconsumer appeal?

“Robo-investing as originally conceived has been a monumental failure. It was an approach targeted at millennials based on the theory that they would rather interact with a robot/algorithm than with a person. This concept of not interacting with a person has been around for a hundred years. It’s called a mutual fund. Guess what? Everyone wants to interact with a person and this has reduced robo-advisory to the status of a mutual fund.”–Carlos   

“Robo-investing and fintech are rapidly changing the dynamics of the markets. Wall Street employment is being reduced and traditional trading firms are struggling to maintain their levels of profitability. In some ways, they serve to prop up the market because everyone is doing the same thing but at some point, this will present a massive downside risk to the market.”–Chris

It has been said that Treasury Bonds are the bedrock of our financial system (of the U.S. economy); if the U.S. defaults on its debt obligations, what do you think that would mean for the end consumer?

“For the U.S. to default on its debt obligations, it probably means that Japan and Europe have already defaulted. We currently function in a global environment where government debt as a percentage of what we produce is beyond anyone’s expectation and well beyond what economics text books tell us. This translates to mean—no one has a clue. Why? Because when something that shouldn’t happen in fact happens, it means there is a reason that we don’t yet understand.”–Carlos  
“If the U.S. defaults on its debt obligations, we will experience global chaos and massive economic destruction. Consumers would need to shift their behavior to become survivors. Sorry to sound apocalyptic but this is not an exaggeration.”–Chris

Which icons of investing have most influenced your career? Do you have a favorite quote
or nugget of wisdom?

“What I’ve taught my son about investing. Investing for a living is not like most professions. There are days that you should do absolutely nothing. Doing nothing that day is better than doing something. So, nothing is often better than something. But to do nothing, you must first be able to recognize when to do nothing. This means you must have tools to measure what is happening in the markets and these tools must be able to provide the type of feedback or signal that tells you what to do on a daily basis.”–Carlos    

“It’s all too easy at times to let emotion drive investment decisions. But as Nobel-prize-winning behavioral economist Daniel Kahneman once said, ‘If there is time to reflect, slowing down
is likely to be a good idea.’”–Greg 

“James O’Shaughnessy got me started in the financial world with his extensive quantitative research into what worked in the markets but I have shifted to more practical guidance the more I have been involved with the markets. The great philosopher, boxer and businessman, George Foreman informs us that, ‘The question is not at what age I want to retire, but at what income.’
“American humorist Will Rogers lets us know that, ‘Even if you are on the right track, you will get run over if you just sit there,’ and ‘The best time to start thinking about your retirement is before the boss does.’
“Ben Franklin, the First American, offers us, ‘You may delay but time will not.’
“The late, great Yogi Berra informs us that, ‘The future ain’t what it used to be.’
“Winston Churchill inspires us to ‘Never give up. He who dares wins.’”–Chris