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    Dr. David E. Marcinko’s professional memberships included: ASHE, AHIMA, ACHE, ACME, ACPE, MGMA, FMMA, FPA and HIMSS. He was a MSFT Beta tester, Google Scholar, “H” Index favorite and one of LinkedIn’s “Top Cited Voices”.

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R.I.P. Lon Jefferies MBA CFP®

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***

Dear ME-P Readers and Subscribers

It is with a heavy heart that we inform you that Lon Jefferies passed away unexpectedly this weekend due to complications inherent with a seizure disorder.  We are extremely saddened by Lon’s all-too-soon departure.  He was a vital contributor to this Medical Executive-Post and Financial Planning industry writ large; and he will be greatly missed.

***

Lon Jefferies

http://www.NewWorthAdvice.com

***

As you know, Lon was an excellent financial planner and prolific blogger.  To his credit – one of the variables he planned for  – was the possibility of a life altering event such as this.  With this foresight, Lon chose to align his financial planning services with his team at Net Worth Advisory Group.  Lon’s plan ensures that each client can continue to receive the same high level of financial planning and assistance going forward, while allowing his beneficiaries to receive some residual income.

Our most sincere sympathies go out to Lon’s new bride Jen, his parents, and their families.

With best regards and sincere sympathy.

Dr. David Edward Marcinko MBA CMP® MBBS

[Publisher and Editor-in-Chief]

***

Deception in the Financial Service Industry

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Why There Has To Be Occasional Market Corrections

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Why Invest … At all!

DJIA plummets 470 today!

By Lon Jefferies CFP MBA lon@networthadvice.com | http://www.networthadvice.com 

Lon JefferiesWhy do we invest in the stock market? To make money so we can improve our standard of living, right?

Notice that we aren’t investing just to get our money back. If we simply wanted our money back, we would place the money in a savings account at a bank where we would likely be able to access it any time and know that we could redeem it at full value.

However, making money is better than simply getting our invested dollars back, so there has to be a trade off for receiving that additional benefit.

Market Corrections

Of course, the trade off is that investing in the market involves more risk than simply depositing money in a bank account. The additional return that is required by investors for investing in an asset that could potentially lose money is called the equity risk premium. There must be a potential downside in exchange for the larger reward that can be obtained by investing in the stock market. Otherwise, no one would ever deposit money into the more secure bank accounts and people would always invest in the stock market generating superior returns. Unfortunately, this would make things too easy, and as we have learned our whole lives, the easier a goal is the less reward we get for achieving that goal. That is why positions that can only be filled by a select few individuals with rare talents (CEOs, doctors, Lebron James) are handsomely compensated.

By now, most people know that over a sufficiently lengthy period of time, the stock market has historically produced returns of approximately 10% per year. This seems like a simple and easy way to make money, so why don’t all investors buy stocks and hold them for extended periods of time? The fact that we aren’t all rich suggests that buying stocks and allowing the market time to do its thing isn’t easy. This is because enduring risk and suffering losses creates negative emotions that get the best of many investors, causing them to sell at the wrong time and stop investing new dollars.

Yet, when we refer back to the concept that the tougher the task the greater the reward, we should be happy that buying and holding stocks isn’t easy because it makes the strategy more profitable.

For this reason, the next time the market goes through a correction or even a crash, wise investors should be grateful. Market volatility causes unsuccessful investors to sell when prices are down and increases the rewards for those who can stick with their investment strategy by holding their assets or even buying new positions.

***

coffee

[Publisher Dr. DE Marcinko’s Grateful Bear Market ReSet and ReLaxation Time]

***

Supply and Demand

Supply and demand suggests that when the markets are decreasing in value, more people are selling assets than buying. The people who are selling their investments at a loss create an equity risk premium for those who can endure market volatility. This increases the reward for successful investors by both providing an opportunity to buy assets when they are inexpensive, and reminding the marketplace that investing in volatile positions is unpleasant. Of course, things that are unpleasant aren’t easy to accomplish, which means there is a large benefit for achieving those things.

Thus, market corrections are great for successful investors because it is volatility and easily-rattled buy-and-sell investors that enable buy-and-hold investors to make significant profits over the long term. In fact, it wouldn’t be possible for stock market investors to make money without periodic intervals of unpleasantness as it is this discomfort which causes some investors to sell and creates an equity risk premium for the rest of us.

***

Japan and world markets tumbling - dollar stronger

[Japanese Markets]

***

Great Fall of China

Until the Great Fall of China recently, it has been easy for investors to buy and hold for the last six years as the market has been nothing but accommodating since early 2009.

However, when things get too easy, it reduces our reward for being a long-term investor because everyone can do it. For this reason, we need the market to experience a correction at some point to shake out the unsuccessful investors, causing them to sell assets and create an equity risk premium once more.

Assessment

When the next correction occurs, you can either sell assets and create a risk premium for others, or you can stay invested and take advantage of the money unsuccessful investors leave on the table. Successful investors with a sufficiently lengthy investment time horizon remind themselves of this concept frequently so that when the market experiences a decline they aren’t overcome by fear but grateful for the opportunity provided by the short-sighted. 

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Tools for Navigating the Market Pullback

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On Stock market uncertainty?

By Lon Jefferies CFP MBA lon@networthadvice.com | http://www.networthadvice.com 

Lon JefferiesOn August 24th 2015, the Dow Jones Industrial Average opened the day decreasing in value by more than 1,000 points, equating to a -6.42% decline. One of the most volatile days in memory continued, with the DOW fighting back to nearly even by mid-day, down only 98 points or about -0.60%.

Unfortunately, the bounce couldn’t be maintained through the market close with the DOW ending the day down 588 points, off about -3.6%.

How are investors to deal with this level of uncertainty?

First and foremost, remember that this is what diversification is for. It is easy to look at a major market index like the DOW or the S&P 500 and equate the performance of those assets to the performance of your portfolio. However, the first thing investors should remind themselves is that they don’t have a portfolio consisting of only large cap stocks, which is what is measured by both the DOW and S&P 500 index.

In fact, most investors don’t have a portfolio consisting of just stocks. Many investors who are nearing or enjoying retirement may have a portfolio that is closer to only 50% or 60% stocks. If an investor only has 50% of his portfolio invested in stocks, only 50% of the portfolio is invested in the asset that declined in value by -3.6% on August 24th, meaning the individual’s portfolio likely only decreased by about -1.80%. While a -1.80% decline is not pleasant, it is hardly catastrophic.

The next step is to remind ourselves that temporary sharp market declines are common. Morgan Housel, one of my favorite financial writers, noticed that the correction the market is currently experiencing is still not nearly as bad as the correction that took place in the summer of 2011 when the DOW lost 2,000 points in 14 days (a loss of about -15.5%). Mr. Housel points out that no one now remembers or cares about that short-term correction. These market pullbacks will always come and go, and the world will continue to turn.

Additionally, it is useful to acknowledge that while we tend to remember dramatic and shocking market decreases, stocks tends to be an efficient investment over time. Another one of my favorite financial journalists, Ben Carlson, pointed out in his blog that when investors think of the ‘80s the first thing that comes to mind is usually the Crash of ’87 when the Dow lost -22% in one day (Black Monday). However, U.S. stocks were up over 400% during the decade. Similarly, even though stocks are up 200% since March of 2009, many investors have spent the last five years trying to anticipate the next 10% – 20% correction. In retrospect, an investor would have clearly been better off riding the equities rollercoaster during both the good and bad times and ending with a 200% gain rather than being out of the market in an attempt to avoid a small temporary decline. Given a long enough investment time frame, this has always been true and I believe this will continue to be the case.

Finally, as I pointed out in a previous article, it is useful to recall that market corrections are actually a good thing for long-term investors. Fear among investors is what creates the equity risk premium that enables stocks to produce superior investment results when compared to investments with no risk such as CDs and money markets, which essentially experience no growth after accounting for inflation. When investors forget that equities can go both up and down in value, everyone wants to invest their money in stocks. This excess demand inflates asset purchase prices to the point that owning equities is no longer profitable. Market declines reintroduce risk to the investing public, and it is the presence of risk that makes stocks an appreciating asset. Thus, for those who don’t intend to sell their investments for 10+ years, short periods of volatility are a positive because they recreate the equity risk premium which raises rates of return over time.

***

Bear + A Falling Stock Chart

***

Logical steps

These are all logical steps for mentally dealing with market corrections. For those who need it, Josh Brown from CBNC proposes a less logical step for tricking your mind into embracing the market pullback. During scary market environments, Mr. Brown proposes that you identify a couple of stocks you’ve always felt you missed out on. Have you always wished you got in earlier on Apple, Google, Netflix, Chipotle, etc? A market correction like we are experiencing might be the perfect opportunity to become an owner of a great stock at an attractive price. Why not set a number for each of these stocks – say, if they drop in value by 20% – and if those targets are met you commit to buying some shares?

This strategy truly enables you to use lemons to make lemonade. It provides an opportunity to buy shares of companies that you have always wanted without overpaying for them. This mental trick can actually cause you to hope that the market correction continues because you are now hoping for a chance to buy. Rooting for a further correction can certainly make volatile market periods more tolerable.

As I mentioned, this mentality isn’t completely logical because the rest of your portfolio will likely need to decline in value in order to afford you the opportunity to purchase those coveted stocks. However, implementing this strategy is a bit of a mental hedge that enables you to get something good out of whichever direction the market turns. Think of promising yourself a fancy dinner if your favorite sports team loses – of course you don’t want your team to lose, but even if they do you still get something positive out of it.

Assessment

I’m confident that most of my clients already know that selling in the middle of a market correction is not a good idea. Still, I acknowledge that doing nothing as the market seems to be collapsing around you can be nerve-racking – even though it has historically been an appropriate response. Hopefully these mental strategies and tricks enable you to stick to your long-term buy-and-hold investment strategy which has always proved to be profitable given a long enough time frame.

NOTE:

–On a side note, I had zero clients call or email expressing a desire to sell positions yesterday. This enabled everyone to participate in today’s market bounce. Smart clients rule. 

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners(TM)

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Using Deposits and Withdrawals to Rebalance Your Portfolio

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Benefits of portfolio rebalancing well documented

[By Lon Jefferies MBA CFP®] http://www.NetWorthAdvice.com

Lon JefferiesThe benefits of rebalancing a portfolio are well documented. Constant and routine rebalancing forces a physician or any investor to lighten the portfolio positions that have recently performed well and use the resulting funds to buy more shares of the assets in the portfolio that have remained flat or even declined in value. In other words, rebalancing causes the investor to sell high and buy low.

Most financial professionals recommend rebalancing your portfolio at least once a year (I rebalance my clients’ portfolios on a semi-annual basis).

However, the tax status of an investment account can have a significant impact on a rebalancing strategy. While investments within a tax-advantaged account like a traditional or Roth IRA can be sold without tax implications, selling appreciated assets in a taxable investment accounts will create a capital gains liability.

Consequently, while rebalancing within a tax-advantaged account should be a no-brainer, investors should carefully consider the tax implications that may result from rebalancing a normal investment account.

***

prt_320x212_1397595292

[Routine Portfolio Rebalancing]

***

For this reason, investors should view every deposit to or withdrawal from a taxable investment account as a chance to rebalance. Depositing new money is a free opportunity to buy more of the positions in which the portfolio is underweight.

Example:

For example, suppose an investment account of $100,000 has a target asset allocation of 50% stocks and 50% bonds ($50,000 invested in both). After a year in which stocks made 10% and bonds were flat, the portfolio would consist of $55,000 of stocks and $50,000 of bonds, for a total account balance of $105,000. If at this point the investor would like to invest an additional $5,000, the entire contribution should be placed in bonds, bringing the actual portfolio allocation back to 50% stocks and 50% bonds ($55,000 in each).

Of course, this same strategy can be implemented regardless of the size of the additional contribution. If the investor wanted to contribute $10,000 in year two, the total account value would be $115,000 ($105k current balance + $10k new money). In order to get back to our 50% stock and 50% bond targets, we would want $57,500 in each position. With $55,000 already invested in stocks, we would only want to invest $2,500 of the new money into stocks and place the remaining $7,500 into bonds, bringing both portions of the portfolio up to their targets.

Taking withdrawals from a taxable investment account should also be viewed as an opportunity to rebalance. Rebalancing via withdrawals may not be free as it is when rebalancing is done when new funds are deposited because appreciated assets are likely sold, creating a tax liability. However, when a withdrawal is taken from a taxable account, it is still wise to sell overweight asset categories to produce the funds needed for the distribution.

Example:

Let’s return to our previous example of a 50% stock and 50% bond target portfolio that had grown to $55,000 of stock and $50,000 of bonds. If the investor then wanted to withdraw $10,000, he could take the entire distribution out of bonds which would allow him to free up the amount needed without creating a tax liability. However, the resulting portfolio would consist of $55,000 of stocks and $40,000 of bonds – a ratio of approximately 58% stocks and 42% bonds.

This is a significantly more volatile portfolio than the target 50% / 50% portfolio. For example, in 2008 a portfolio that consisted of 50% large cap stocks and 50% long term government bonds lost -7.16%. Meanwhile, a portfolio of 58% stocks and 42% bonds lost -11.93% over the same period – a 66.6% increase in volatility.

Alternatively, I’d suggest using the $10,000 withdrawal to rebalance the portfolio, bringing the resulting $95,000 portfolio back to 50% stocks and 50% bonds ($47,500 in each). Of course, to do this, the investor would liquidate $7,500 of stocks and $2,500 of bonds. Although this could potentially create a small capital gains tax liability, this is a tax bill that will need to be paid at some point anyhow, and the investor will maintain a portfolio with the target amount of volatility.

Further, remember that the long-term capital gains rate (which applies to any capital assets held for over a year) is a favorable tax rate. For single filers with a taxable income of less than $37,450 and joint filers with a taxable income of less than $74,900, the capital gains tax rate is actually 0%!

Additionally, for single filers with a taxable income of between $37,450 and $406,750 and joint filers with a taxable income of between $74,900 and $457,600, the capital gains tax rate is only 15%. Consequently, the investor can likely rebalance the portfolio back to the target allocation via the withdrawal while incurring only a nominal tax bill.

***

healthfinance

***

Assessment

While rebalancing provides a significant increase in investment return over long time periods, tax implications should be considered when determining whether or not to rebalance a taxable investment account. However, depositing money to or withdrawing money from these accounts provides a favorable opportunity to obtain the return premium rebalancing creates while minimizing tax implications.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

Physicians are notoriously excellent at diagnosing and treating medical conditions. However, they are also notoriously deficient in managing the business aspects of their medical practices. Most will earn $20-30 million in their medical lifetime, but few know how to create wealth for themselves and their families. This book will help fill the void in physicians’ financial education. I have two recommendations: 1) every physician, young and old, should read this book; and 2) read it a second time!

Dr. Neil Baum MD [Clinical Associate Professor of Urology, Tulane Medical School, New Orleans, Louisiana]

http://www.CertifiedMedicalPlanner.org

Enter the CMPs

Doctors Going Granular on Investment Risk

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It is Not What You Think!

[By Lon Jefferies MBA CMP® CFP®]

Lon JefferiesA new logic has been surfacing amongst the top minds in the financial planning industry.

Many of my favorite financial authors – Warren Buffett, Josh Brown, Nick Murray, Howard Marks, and others – have proposed the need to redefine the word “risk.”

Risk” vs “Volatility”

Most investors and financial advisors tend to utilize the words “risk” and “volatility” interchangeably. We measure how risky a portfolio is by examining its potential downside performance.

For example, we review how much a similar portfolio lost during 2008 or when the tech bubble popped in 2000-2002. When doing this, we are really talking about volatility rather than risk. Volatility – usually measured by standard deviation – reflects how much a portfolio is likely to increase or decrease in value when the market as a whole fluctuates. Risk, however, is quite different.

Two Threats

Josh Brown characterizes risk as the possibility of two threats:

  1. The possibility of not having enough money to fund a specific goal, which includes the possibility of outliving your money
  2. The possibility of a permanent loss of capital.

Example:

In a dramatic example of how volatility is different from risk, consider a retiree with a $10 million portfolio who only spends $50,000 a year. Next, assume the investor experiences a two-year period in which during the first year his portfolio loses 50% of its value and in year two the portfolio earns a 100% return. Thus, after year one the portfolio would only be worth $5 million and after year two it would again be worth $10 million.

Clearly, this is a very volatile portfolio that is subject to a wide range of potential performance outcomes. However, is this portfolio truly risky to the investor? According to Mr. Brown’s first factor, the portfolio is not risky because the investor will have enough money to fund his $50k per year retirement regardless of whether his portfolio is valued at $10 million or $5 million. Additionally, the portfolio is also not risky according to the second factor in that the investor didn’t experience a permanent loss.

Investors tend to view stocks as risky assets because their returns have a large standard deviation (variation from a mean). Similarly, we tend to view money market equivalents such as CDs and savings accounts as very safe investments because their returns have less dispersion, and consequently, are more predictable.

However, rather than considering stocks to be risky and cash equivalents to be safe, it would be more accurate to consider stocks an investment with high volatility and cash to be a holding with low volatility.

***

hacker

***

What is the difference?

Suppose it is determined that you need an average rate of return of 6% over time to achieve your retirement goals. Historically, over a sufficiently significant period of time, stocks have returned an average of about 10% per year while cash equivalents have returned about 3% per year. Consequently, if these averages continue in the future, you actually have a very low chance of reaching your retirement goal of not outliving your money if you place money in the “safe” investment of a cash equivalent, while you would actually have a high probability of reaching your retirement goal if you place money in a more volatile basket of stocks.

By this metric, cash is actually the more risky investment because investing in it would increase the probability of outliving your funds. Meanwhile a basket of stocks, if given enough time to achieve its historically average rate of return, is actually the safer investment as it gives you a higher probability of not outliving your nest egg.  Thus, while a portfolio of stocks will almost certainly experience more short-term volatility, over an extended period of time it very well may be a safer investment for ensuring your retirement goals are met.

Further, Mr. Brown proposes that the muddying of definition between risk and volatility is something a portion of the financial service industry has done on purpose. Brown suggests that the easiest way to sell someone a product is to first convince them they have a need. If hedge fund managers, insurance agents, and annuity salesmen can make consumers believe that volatility is equal to risk, and that since their products minimize volatility they must also minimize risk, they can achieve more sales.

However, even if an annuity can eliminate downside volatility, if it limits potential return to an amount that is insufficient to achieve the investor’s long-term goals, the investment is still more risky than an investment with more short-term volatility but a higher probability of long-term success.

***

Bell Curve

***

Assessment

Next time the market goes through a correction, remember that the drop in your portfolio’s value is a reflection of the potential volatility your portfolio is capable of experiencing. Yet, recall that as long as you don’t sell your assets and suffer a permanent loss of your investment capital, you can allow the market time to recover and achieve its historical rate of return.

Doing so will ultimately make your investment strategy less risky than utilizing investment options that experience less volatility because it maximizes the probability you will eventually achieve your long-term financial goals.

More:

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

This book was crafted in response to the frustration felt by doctors who dealt with top financial, brokerage, and accounting firms. These non-fiduciary behemoths often prescribed costly wholesale solutions that were applicable to all, but customized for few, despite ever-changing needs. It is a must-read to learn why brokerage sales pitches or Internet resources will never replace the knowledge and deep advice of a physician-focused financial advisor, medical consultant, or collegial Certified Medical Planner™ financial professional.

Parin Khotari MBA [Whitman School of Management, Syracuse University, New York]

http://www.CertifiedMedicalPlanner.org

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Do You Have a Taxable Investment Account – Doctor?

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Is it Time to Harvest?

[By Lon Jefferies MBA CFP®]

Lon JeffriesTax harvesting is the process of selling assets for the purpose of creating either long-term capital gains or losses to minimize your tax bill. This procedure is usually conducted near the end of a calendar year.

While many people are familiar with the concept of tax loss harvesting, fewer physicians or clients are familiar with the more recently developed process of tax gain harvesting. Between these two procedures, virtually everyone with a taxable (not tax-advantaged) investment account should make adjustments to their portfolio before the year ends.

Who Qualifies For the 0% Capital Gains Rate?

First, it is important to understand that capital gains (the growth on investments within a taxable, non retirement investment account) are taxed differently than ordinary income (wages, pensions, Social Security, IRA distributions, etc.). While short-term capital gains (recognized on the sale of assets held less than a year) are essentially considered ordinary income, long term capital gains, or recognized gains on assets held more than a year, are taxed at advantageous tax rates. While ordinary income tax rates range from 10% to 39.6%, capital gains tax rates range from 0% to 20%.

Second, it is crucial to understand what enables a taxpayer to qualify for the 0% capital gains rate. If a taxpayer is in the 10% or 15% ordinary income tax bracket, they qualify for the 0% long-term capital gains rate.

For a married couple filing jointly, the 15% tax bracket ends at $73,800 of taxable income ($36,900 for single taxpayers). Thus, if a married taxpayer has a taxable income (which includes long-term capital gains but is also after deductions and exemptions) of less than $73,800, all their long-term capital gains will be tax free. If the taxpayer is in a tax bracket anywhere between 25% and 35% (taxable income of $73,800 and $457,600, or between $36,900 and $406,750 for single tax filers), they will pay long-term capital gains taxes at 15%. Only those in the top tax bracket of 39.6% (married taxpayers with a taxable income over $457,600 and single taxpayers with taxable income over $406,750) will pay capital gains taxes at 20%.

Tax Loss Harvesting

During the calendar year, assets have been purchased and sold in most taxable investments accounts. The sale of an asset creates a net gain or loss, both having tax implications. Investors should have an understanding of what their long-term capital gains tax rate will be so they can determine whether a taxable gain or loss is preferable.

For instance, an individual who does not qualify for the 0% capital gains tax rate may wish to minimize the amount of taxable gains they recognize during the year, which would reduce their tax bill. If the investor currently has a net long-term capital gain (which is probable after the strong year the market had in 2013), then it is likely worthwhile to sell any assets in the portfolio that are currently worth less than the investor’s purchase price. This tax loss harvesting would reduce the net gain recognized during the year and lower the investor’s tax bill.

In some cases, by taking advantage of all potential losses within a portfolio an investor has the ability to negate all capital gains created during the year, completely eliminating their capital gains tax bill. Further, the IRS will allow investors to recognize a net capital loss of up to a -$3,000 per year. This -$3,000 loss can be used to lower the taxpayers ordinary income. This is particularly advantageous in that the capital loss reduces a type of income that is taxed at higher tax rates.

Harvesting Gains

Harvesting gains from a taxable portfolio is a more recently developed concept. Once the 0% long-term capital gains tax rate became a permanent part of the tax code with the passing of the American Taxpayer Relief Act of 2012 (signed January 2nd, 2013), in some scenarios it began making sense to recognize long-term capital gains on purpose to potentially avoid a larger tax bill in the future.

Suppose a taxpayer’s taxable income is consistently $65,000 a year. Additionally, suppose our hypothetical taxpayer won’t withdraw funds from his taxable account during the next few years, but may need a large lump sum distribution five years down the road. Recall that the 0% capital gains rate ends when a married taxpayer’s taxable income (which includes long-term capital gains) exceeds $73,800. Consequently, this hypothetical taxpayer has the ability to recognize $8,800 ($73,800 – $65,000) in long-term capital gains every year without increasing his tax bill. If this $8,800 in gains is recognized every year by simply selling and immediately repurchasing appreciated assets, he would raise the cost basis of his investment by $44,000 ($8,800 gain recognized annually for five straight years). He could then sell and withdraw that $44,000 without creating a tax liability.

Alternatively, if the investor does not harvest gains during the years when no distributions are taken, withdrawing $44,000 of gains five years down the road would create a sizable tax bill. He would still be able to recognize $8,800 of gains tax free in the year of distribution, but the remaining $35,200 of gains would cause his taxable income to be over the $73,800 limit, eliminating access to the 0% capital gains rate. That $35,200 would be taxed at the 15% capital gains rate, creating a federal tax bill of $5,280. With proper planning, this significant tax bill can be avoided.

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Portfolio analysis

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The Bottom Line

Tax harvesting has no purpose in tax-advantaged retirement accounts such as IRAs and 401ks because all distributions from these accounts are taxed as ordinary income. However, taxable individual or trust investment accounts can almost certainly benefit from tax harvesting. Speak to your accountant and financial planner to understand whether capital gains or losses are desirable for you this year and determine the amount of taxable gains already recognized. This will help you determine what type of harvesting should take place.

Tax harvesting can be a difficult and confusing concept. However, a competent financial planner who utilizes this procedure within your taxable investment account can significantly lower your tax bill. Speak to your adviser to ensure you are reaping the tax benefits available to you.

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Financial Planning MDs 2015

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My Stock Market Forecast for 2015

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All Forecasts Will Be Wrong

[By Lon Jefferies MBA CFP®]

Lon JeffriesThe investment media is a rare industry in which professionals are rewarded for making bold projections but never punished for being wrong. The more outlandish a pundit’s forecast the more attention it receives.

Yet, surprisingly little consideration is given to how accurate the prediction turns out to be.

At the beginning of 2014, there were some widely-accepted expectations regarding the investment environment.

Let’s review those predictions and analyze how precise they really were.

Interest Rates

In a study conducted by Bloomberg at the beginning of the year, all 72 economists surveyed predicted higher interest rates and falling bonds prices in 2014. Consequently, investors were questioning whether they should reduce or eliminate the bond portion of their portfolios until the rate increase occurred.

So, have we experienced this rise in interest rates?

On January 1st, 2014, the yield on the 10-year Treasury note was 3 percent. On November 13th, the yield on the same note was 2.35 percent. That’s right — interest rates actually decreased significantly during the year. As a result, intermediate U.S. government bonds (ticker – IEF) produced a return of 7.38% during the year. Not bad for the conservative portion of your portfolio!

Quantitative Easing

The most widely promoted fear among forecasters was that the phasing out of the Federal Reserve’s quantitative easing (QE) program would diminish stock returns. Prognosticators worried that the Fed would lower the amount of loans the government would buy from commercial banks, thus reducing the amount of money available for new businesses to borrow leading to less innovation and the creation of fewer jobs.

But, was the reduction of quantitative easing a legitimate fear? In fact, this possibility came to fruition. In December of 2013, the Federal Reserve was buying $85 billion of financial assets from commercial banks each month. The Fed reduced this amount during every meeting it held this year, finally eliminating the action completely in October.

However, the elimination of Quantitative Easing did not have a negative impact on the unemployment rate, which declined from 6.7% in January to 5.8% in October. Further, the S&P 500 has gained 12.31% year-to-date (as of 11/13/14). Clearly, fading out the Quantitative Easing program didn’t have the negative impact on stocks that many pundits expected.

Increased Volatility

Another widely held viewpoint at the beginning of the year was that 2014 was likely to be more volatile than anything experienced in 2012 or 2013. There was talk about valuations and P/E ratios being too high, concern about the war in Ukraine (ISIS wasn’t even in the headlines yet), and endless noise about unfavorable weather patterns impacting the market.

So, has 2014 been a wild ride? Since 1929, the S&P 500 has experienced either a rise or a decline of more than 1% during 23% of trading days. In 2014, the S&P 500 moved more than 1% only 15% of the time. Less movement equates to less volatility, so again forecasters were inaccurate.

2015 Forecasts

Bloomberg News recently published a story titled Predictors of ’29 Crash See 65% Chance of 2015 Recession, in which the grandson of a prognosticator who luckily forecasted the Great Depression is still getting attention for a guess his grandfather made 85 years ago. If giving credence to forecasters isn’t ridiculous enough, suggesting there is a gene for forecasting is insane!

The article doesn’t mention that the same grandson made similar headlines with the same forecast in both 2010 and 2012; of course, those predictions did not work out so well. You will start hearing many 2015 projections soon, so pay no heed.

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glasses

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Ignore the Pundits

The most significant lesson inherent in these numbers is that market expectations are essentially useless. Despite their abysmal track record, the news media loves forecasters because they capture attention and fill space. Unfortunately, pundits making projections are rarely held to their inaccurate forecasts and are allowed to continue making a living showing they have no greater knowledge than the average investor.

Of course, this is not to say that interest rates will never rise, that bond values will never decline, and that the market won’t return to the roller coaster it is. In fact, all those things are certain to happen. Unfortunately, anyone who contends to know “when” likely doesn’t actually know anymore than you or me. For this reason, having and sticking to a diversified investment strategy that coincides with a detailed financial plan is the most probable path to financial success.

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On The Next Stock Market Correction?

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Remember the Ace Up Your Sleeve!

By Lon Jefferies MBA CFP® CMP®

Lon JeffriesAfter the historic growth the stock market has experienced since early 2009, many physician investors have felt that a healthy pullback may not be a completely negative thing.

After all, we certainly don’t want another bubble, or stock prices that are clearly out of line with the earning potential of the underlying companies.

Unfortunately, market corrections never feel healthy when they occur. Physicians, investors and almost all people get uncomfortable when the market declines, the media fans the flames by giving investors reason after reason to be afraid, and worries that this is the beginning of the next crash begin to develop.

While many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10% — right when the media can officially throw around the word “correction.”

Of course, we have no idea when the next drop will occur, but why not mentally prepare ourselves by exploring what has traditionally happened to stock prices once that 10% decline is crossed?

The Data

Ben Carlson, an institutional investment portfolio manager, looked at the S&P data going back to 1950, and found that there have been 28 instances when stocks fell by 10% or more. Thus, on average, the market has entered an official correction every 2.25 years. The last market correction occurred in 2011, so another 10% drop at this time would correlate pretty close to the average amount of time between corrections.

Obviously, the market has done pretty well since that last temporary correction in 2011. Clearly, such a drop is quite normal and far from historically concerning.

  • S&P 500 Losses of 10% or More Since 1950
  • Total Occurrences: 28 Times
  • Average Loss: -21.6%
  • Median Loss: -16.5%
  • Average Length: 7.8 Months
  • Greater Than 20% Loss: 9 Times
  • Greater Than 30% Loss: 5 Times

Your Advantage

Are you thinking “I don’t think I can stomach that median loss of 16.5%?” Then it’s time to pull out the ace up your sleeve. Remember that the data above represents the historical performance of the S&P 500 – an index that is composed of 100% stocks. A capable financial planner would ensure you have an asset allocation mix between stocks, bonds, and cash that represents your tolerance for risk.

Consequently, your portfolio likely isn’t 100% stocks. In fact, the appropriate allocation for an average investor approaching or already enjoying retirement might be closer to only 50% stocks. This means that on average, your portfolio should decline only half as much as the S&P 500 during market downturns.

This ace may bring the loss endured by our sample investor with a 50% stock portfolio down to around 8.25% during the median decline. Are you now back in the “manageably unpleasant” range? If so, you likely have an appropriately constructed portfolio. If not, your risk tolerance may need to be reevaluated to ensure you are not exposing your nest egg to a larger loss than you can endure.

Avoid Harmful Reactions to the Market

Although the recent market pullback produces what seems like a foreign feeling, we’ve been here before. The S&P 500 declined in value by 18.64% over a 5 month period in 2011. However, an investor with a 50% stock portfolio likely only saw their account values drop around 9%-10% — still not fun, but manageable.

Assessment

Of course, we don’t know whether the market will continue to bounce back or again drop into official correction territory. If you continue to hear about the broad markets declining, remember that the average historical correction has been far from catastrophic, and that you have the ace of an appropriate asset allocation up your sleeve.

Financial Planning MDs 2015

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

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The [Negative] Short-Term Implications of Investment Portfolio Diversification

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Delving Deeper into Asset Allocation

By Lon Jefferies MBA CFP®

Lon JeffriesAsset allocation is one of the key factors contributing to long-term investment success.

When designing a portfolio that represents their risk tolerance, investors should be aware that a portfolio that is 50% stocks is likely to obtain approximately half of the gain when the market advances but suffer only half the loss when the market declines.

This general principle frequently holds true over extended investing cycles, but can waiver during shorter holding periods.

Case Model

For example, a fairly typical physician client of mine who has a 50% stock, 50% bond portfolio has obtained a return of 4.62% over the last 12 months, while the S&P 500 has obtained a return of 14.31% over the same time period (as of 10/30/14).

An investor expecting to obtain half the return of the index would anticipate a return of 7.15%, and by this measuring stick, has underperformed the market by over 2.50% during the last year.

What caused this differential?

Answer

The issue resides in how we define “the market.” In this example, we use the S&P 500 index as a measure for how the market as a whole is performing. As you may know, the S&P 500 (and the Dow Jones Industrial Average, for that matter) consists solely of large company U.S. stocks.

Of course, a diversified portfolio owns a mixture of large, mid, and small cap U.S. stocks, as well as international and emerging market equities. Consequently, comparing the performance of a basket of only large cap stocks to the performance of a diversified portfolio made up of a variety of different asset classes isn’t an apples-to-apples comparison.

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Stock_Market

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Frequently, the diversified portfolio will outperform the non-diversified large cap index because several of the components of the diversified portfolio will obtain higher returns than those achieved by large cap holdings.

However, the past 12 months has been a case where a diversified portfolio underperformed the large cap index because large cap stocks were the best performing asset class over the time period. In fact, over the last twelve months, there has been a direct correlation between company size and stock performance (as of 10/30/14):

  • Large Cap Stocks (S&P 500): 14.92%
  • Mid Cap Stocks (Russell Mid Cap): 11.08%
  • Small Cap Stocks (Russell 2000): 4.45%
  • International Stocks (Dow Jones Developed Markets): -1.05%
  • Emerging Market Stocks (iShares MSCI Emerging Markets): -1.04%

Since large cap stocks were the best performing element of a diversified portfolio over the last 12 months, in retrospect, an investor would have obtained a superior return by owning only large cap stocks during the period as opposed to owning a diversified mix of different equities. Does this mean owning only large cap stocks rather than a diversified portfolio is the best investment approach going forward? Of course not.

Year after year, we don’t know which asset category will provide the best return and a diversified portfolio ensures we have exposure to each year’s big winner. Additionally, although large caps were this year’s winner, they could easily be next year’s big loser, and a diversified portfolio ensures we don’t have all our investment eggs in one basket.

Financial Planning MDs 2015

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

Assessment

Don’t be overly concerned if your diversified portfolio is underperforming a non-diversified benchmark over a short period of time. As always, long-term results should be more heavily weighted than short-term swings, and having a diversified portfolio is likely to maximize the probability of coming out ahead over an extended period.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Is it Time to Reduce Your Bond Exposure?

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On Investment Portfolio Analysis

By Lon Jefferies MBA CFP®

Lon Jefferies

For the last half-decade, investors have been continually concerned about rising interest rates and the effect they may have on the bond portion of their investment portfolio.

The fear is that if interest rates rise, the bonds currently held by investors will be outdated and provide investment returns that are less than what new bonds issued at the higher yields would return.

Concerned?

There is validity to this concern – if an investor could buy a bond yielding 4% on the open market, why would anyone buy a bond that yields only 3%, unless they could do so at a significant discount? Given that today’s interest rates are considerably lower than historical averages and expected to rise in the future, would now be a good time to sell some of the bonds in your portfolio?

Consider the Timing

First, let’s consider one of the most basic principles of investing – that markets are unpredictable. Are we certain that interest rates will rise, and are we confident this rate increase will happen soon? I’d contend the answer to both questions is no.

Actually, the majority of investors have believed interest rates would rise since the first round of quantitative easing took place in 2009, and have suspected rates would rise in every calendar year since.  Quite simply, this has not happened. In fact, interest rates are currently lower than they were during the majority of 2009 despite five years of buzz about interest rate hikes.

During this five-year period, how have bonds performed? From 2009 through 2013, the Barclays Aggregate Bond Index (AGG) returned 5.93%, 6.54%, 7.84%, 4.22%, and -2.02%, respectively. Bonds only declined once during the five-year period, by a relatively nominal -2.02%, and still averaged a compound rate of return of 4.86%—not bad for the conservative portion of a portfolio.

Additionally, various bond categories have done even better than the Aggregate Bond Index, which consists of just U.S. government and corporate bond holdings. For instance, emerging market bonds (EMB) achieved a compounded return of 9.30%, while high yield bonds (HYG) returned 12.26% annually over the same five-year span. An investor whose bond portfolio was diversified among a range of asset categories has far from suffered since the expectation of a rate increases began.

Will You Miss the Stability of Bonds?

Let’s also consider the consistency of bonds. Since 1980, the Aggregate Bond Index has achieved a positive return an astonishing 31 out of 34 years (91% of the time!). Given this data, perhaps bonds aren’t as likely to decline in value as some investors think.

Equally amazing, although the bond index has achieved an annual return as high as 32.65% during this time period (in 1982), the largest loss it ever suffered in a calendar year over the same period was just -2.92% (in 1994). Over the entire 34-year period, the index obtained an average annual gain of 8.42%. Bottom line: Over the last 34 years, bonds have offered a lot of return for relatively little risk.

Diversification: the Most Important Factor

Not putting all your eggs in one basket is another basic principal of investing, and the primary motivation for having a significant portion of your portfolio allocated in bonds. It is important to remember that for an investor with a long-term perspective, equities will likely provide the majority of investment growth and return in a portfolio while bonds are needed to reduce volatility and risk.

For example, while a portfolio that was 100% stocks suffered a 38.6% loss in 2008, a portfolio that was 50% stocks and 50% bonds suffered a loss of only 14.5% the same year—still not pleasant, but much more manageable.

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healthcare costs

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Correlation

Bonds reduce risk in a portfolio because their return has a low correlation to the return of stocks. How low? Since 1928, both the S&P 500 and the 10-year treasury note have lost value during a calendar year only three times (in 1931, 1941 and 1969). That is less than 4% of all annual periods!

Further, since the Barclays Aggregate Bonds Index was created in 1973, the index has never decreased in value in the same year as the S&P 500. Amazing, but true! Clearly, bonds are fulfilling their role as a diversifier and reducing the volatility in your portfolio.

There is Always a Role for Bonds

Despite the continuous threat of rising interest rates, bonds have continued to perform. More importantly, history illustrates that mixing bonds with stocks smoothes out the investment results of your portfolio.

Assessment

Don’t get sucked in by the media buzz. Bonds are too valuable an asset to disregard.

The Author:

Lon Jefferies is a Certified Financial Planner with a fee-only approach to ensure the client’s best interest is the top priority. He isn’t paid commission and gains nothing through recommendations but his client’s satisfaction. He has contributed to national publications like The Wall Street Journal, The New York Times, USA Today, Morningstar.com and Investment News.   

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Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Are All-Time Stock Market Highs Really That Bad?

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The 30th all-time high for the S&P 500 in 2014 alone

By Lon Jefferies MBA CFP®

Lon JefferiesLast week, the S&P 500 achieved an all-time high, exceeding the 2,000 level for the first time ever during intra-day trading. The index ended the day at 2,001 almost exactly triple the market low of 666 achieved in March of 2009 during the global financial crises. Yesterday, it reached another high; 2,007.

Believe it or not, this was the 30th. all-time high for the S&P 500 in 2014 alone.

Fearing the Phrase

Many investors fear the phrase “all-time high,” believing it implies stocks have already captured the gains available in the market and that there is nowhere for the value of these equities to go but down. However, all-time highs are perfectly normal in the stock market. In fact, since 1950 there have been over 1,100 new all-time closing highs achieved by the S&P 500. That is 6.8% of all trading days or roughly 1 out of every 15 days the market is open that it’s closed at a new high level!

In addition, while it is true the S&P 500 hit a new nominal high, it is still significantly under its high when adjusted for inflation. In fact, Will Hausman, an economics professor at the College of William and Mary, calculates that the S&P 500 hit its true high – its inflation-adjusted high – of 2,120 on January 14, 1999. By that metric, 15 years ago the S&P 500 was 10% higher than it is now. Put that way, it is possible the market could continue to appreciate at its current pace without valuations exceeding their historical peak.

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graph

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Market highs not necessarily bad

My goal is to point out that the phrase “all-time high” isn’t necessarily bad when relating to the stock market.

Now, just because stocks are at all-time high levels certainly doesn’t make them immune to a decline or even a crash. Stocks were at all-time high levels before the tech bubble of 2000 popped, and if by measured by the NASDAQ index, the market still hasn’t fully recovered. However, stocks aren’t required to decline just because they are at levels unattained before.

Assessment

Physicians and all investors don’t need to feel the need to sell their equity investments or not invest new dollars in the market just because the S&P 500 is at a number we haven’t yet seen. My favorite quote regarding the subject comes from financial columnist Nick Murray: “If you think the market is “too high,” wait until you see it 20 years from now.”

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Is it Fire Drill Time for Physician Investors?

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Catastrophes and “Black Swans” Happen

An ME-P Special Report

By Lon Jeffereis MBA CFP® CMP®

Lon JeffriesHistory tells us that over a long enough time span catastrophes are likely to occur. Fires, flooding, earthquakes – none can be prevented and all can be potentially devastating. While these events can’t always be avoided, we can prepare for these “black swans.”

Running practice fire drills enables us to act appropriately during misfortune while maintaining emergency food storage ensures we won’t starve when tragedy strikes.

Just as physical calamity can turn lives upside down, financial upheaval can lead to an unrecoverable loss. Fortunately, we have the ability to prepare for financial uncertainty in the same way we prepare for other exposures. As the current bull market is now both the fourth longest in history (64 months) and the fourth largest (+192% gain), now would be a perfect time to ensure you are prepared for the next market pullback.

Run a Portfolio Fire Drill

You can run a fire drill for your portfolio by understanding the loss potential of your holdings. It is critical to recognize that the amount of volatility your portfolio will experience in declining market environments is dependent on your asset allocation – how much of your account is invested in stocks vs. bonds. The larger the percentage of stocks in a portfolio, the more the portfolio’s value will increase during bull markets but decrease when the market declines. Let’s look at the historical performance and risk levels of a range of diversified stock-to-bond ratios:

Asset Allocation – Risk & Return (1970-2013)

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Portfolio Allocation Average Annual Return Large Loss 08′
100% Stocks 10.85% -39%
80% Stocks20% Bonds 10.33% -30%
60% Stocks40% Bonds 9.99% -20%
50% Stocks50% Bonds 9.76% -15%
40% Stocks60% Bonds 9.49% -11%
20% Stocks80% Bonds 8.85% -4%

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After determining the asset allocation of your portfolio, ask yourself how you would respond to another market correction like we experienced in 2008. For this exercise, considering loss in dollar terms is particularly productive. For instance, if 80% of your portfolio is invested in stocks, you might be able to convince yourself that you could sustain a 30% loss. However, supposing you have $500k invested, a 30% loss would mean your portfolio is suddenly depleted to $350k — $150k of hard earned money just evaporated. To many, the thought of losing $150k is more uncomfortable than the thought of a 30% loss.

Next, picture every media outlet sending warnings day after day about how the market is only going to get worse. Imagine yourself checking what the markets are doing multiple times a day and constantly being disappointed that it is another day of losses.

Lastly, visualize your occasional friend, neighbor or family member bragging about how he got out of the market before the collapse and telling you how you are a fool for not doing so.

***

Accidents Happen

[Accidents Happen]

How would you respond in such an environment? Would you have a hard time sleeping or digesting your food? It’s critical to be honest with yourself. If you would stray from your long-term investment strategy by selling after a market drop and waiting for the market to recover, your current portfolio may be too aggressive. If so, scale back the assertiveness of your portfolio by reducing your stock exposure now because selling stocks during a market decline is the last thing you want to do.

Sound financial planning suggests individuals should scale back the assertiveness of their portfolio as they approach retirement. While a young worker with 30 years until retirement can afford to be aggressive and has time to recover if a large loss in suffered, a person who is closer to retirement can’t afford to endure a significant loss right before the invested funds are needed to cover life expenses.

Maintain an Emergency Financial Storage

As stocks and bonds are the long-term portion of your investment portfolio, cash equivalents are your tool for dealing with short-term spending needs. Before even investing, everyone should have an emergency reserve holding enough cash to cover three to six months of expenses. These funds should only be tapped in the event of a job loss or a medical emergency.

Be Prepared

Additionally, investors who are taking withdrawals from their portfolio in order to meet cash flow needs should also have the equivalent of two years of necessary withdrawals in cash at all times. These funds should be used to cover living expenses during the next market correction. Having this emergency financial storage will prevent you from having to take withdrawals in a down market and allow your portfolio time to recover.

Assessment

No one knows when the next bear market will come. However, just like winter follows every fall, market corrections will ultimately come after every bull market.  Preparing for such a financial downturn will ensure you act appropriately when the time comes and prevent financial catastrophe.

BOOK: Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

Conclusion

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When Financial Assets Get a ½ Step-Up in Cost Basis

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Unique to Spouses

By Lon Jefferies MBA CFP®

Lon JeffriesMany doctors are aware that when the owner of a taxable asset passes away, the party that inherits that asset does so at a stepped-up cost basis.

For example, suppose a husband owns a stock in a taxable investment account that he purchased for $100,000 but is now worth $150,000. If the husband sells the stock, there will be taxes due on the $50,000 of growth, or the difference between the current value and the cost basis.

However, if the husband passes away and a wife inherits the stock, the wife’s cost basis gets increased to the full $150,000, the value of the account on the date the husband passed away. This enables the wife to sell the stock and keep the full $150,000 of value without paying taxes.

Jointly Owned with Rights of Survivorship

However, what happens to assets that are owned jointly with a right of survivorship when one spouse passes away? Did you know in this scenario, it is possible for assets to receive a ½ step-up in basis? The formula looks like this:

(Date-of-death fair market value + Old basis) / 2 = New Basis

In a practical example, suppose John contributes $10,000 to a joint account with a right of survivorship and Jane contributed $5,000 to the same account. When John passes, the account is valued at $20,000. This will cause Jane to get a step-up in basis to $17,500 on the taxable account.

($20,000 + $15,000) / 2 = $17,500

Jane receives a ½ step-up in basis on each position within the investment account. She is unable to claim a full-step up on one stock within the account and no step-up on other assets.

Unique to Spouse

Notice that even though the spouse’s contributed different amounts to the account, they each share a full 50% share of the property for inclusion in their estates. However, this is unique to spouses with right of survivorship and the issue is more complex if the parties involved are not married.

Spouses

Assessment

To be clear, this step-up only occurs on taxable assets like physical property or taxable investment accounts. A step-up does not occur on tax-deferred investments like IRAs or 401(k)s.

Conclusion

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How Much Social Security Is Actually Taxed?

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As much as 85 percent may be taxable

By Lon Jefferies  MBA CFP®

Lon Jefferies

If Social Security is your only source of income, it is unlikely that your monthly benefit is subject to taxation.

However, people like doctors and other medical professionals with substantial income outside of Social Security may have to pay federal income taxes on their benefits. In fact, it is possible that as much as 85 percent of your Social Security payout is taxable.

The Determination

To determine whether you are required to pay taxes on your benefit, the first step is to determine what the federal government deems your “combined income.” Your “combined income” is one-half of your Social Security benefit, plus all other income received during the year. Other income might include wages earned, capital gains recognized, dividends and interest collected, pension benefits received, and IRA funds distributed during the year.

Example:

For instance, consider a retired couple that receives an annual pension benefit of $20,000, takes an IRA distribution in the amount of $10,000, and receives $15,000 in Social Security benefits. This couple’s other income would total $30,000 (the pension and the IRA distribution). One-half of the Social Security benefit, or $7,500 would then be added to the other income to create a “combined income” of $37,500.

If a couple filing a joint tax return has a “combined income” of less than $32,000 ($25,000 for individuals), then all Social Security benefits are free of taxation. However, if the figure is between $32,000 and $44,000 ($25,000 and $34,000 for individuals), then as much as 50 percent of the Social Security benefit may be taxable. Further, if the “combined income” is greater than $44,000 ($34,000 for individuals), than as much as 85 percent of the Social Security payout may be taxable.

The “Combined Income” Threshold

So should couples do everything necessary to keep their “combined income” below $32,000 (the 50 percent threshold), or even $44,000 (the 85 percent threshold)? Fortunately, the tax system is progressive, meaning that just because a couple might fall in the bracket causing as much as 50 percent of their Social Security benefit to be taxable, not all of their benefit is necessarily taxed as such.

Example:

For instance, our sample couple with a “combined income” of $37,500 might be concerned that they are paying taxes on 50 percent of their Social Security benefit because that is the bracket they fall in. This would cause half of their $15,000 Social Security benefit, or $7,500, to be taxable. Fortunately, it is only the $5,500 of benefits received that pushes the couple’s “combined income” over and above the $32,000 threshold that is actually considered 50 percent taxable. As a result, only $2,750 (half of the $5,500 of “combined income” over the $32,000 threshold) of Social Security benefits is taxable. In this instance, the taxpayers are only paying taxes on 18 percent ($2,750/$15,000) of their Social Security benefits.

Getting Granular

Now suppose our imaginary couple received not $15,000 in total Social Security benefits, but $15,000 each, leading to a total benefit of $30,000. Assuming the same $20,000 pension benefit and $10,000 IRA distribution, the couple’s “combined income” would now be $45,000 (half of the $30,000 in Social Security benefits received plus the $30,000 of other income).

This provides another illustration of how the progressive tax system prevents higher-income taxpayers from feeling the need to do everything they can to get their “combined income” under the $44,000 threshold just to avoid the 85 percent bracket. First, a “combined income” of $45,000 clearly fills the entire 50 percent bracket of $32,000 – $44,000. Consequently, the entire $12,000 of Social Security benefits received within that range will be 50 percent taxable (or $6,000 of benefits received will be taxable). Additionally, another $1,000 of benefits over and above the $44,000 threshold will be 85 percent taxable, meaning another $850 of benefits are taxed. This means a total of $6,850 ($6,000 from the 50 percent taxable bracket, and $850 from the 85 percent taxable bracket) of Social Security benefits received will be taxable. Still, however, of the $30,000 of Social Security payments received by our couple, only 23 percent ($6,850/$30,000) ends up being taxable.

Taking this one step further, we can deduce that income outside of a Social Security benefit (the combination of pension benefits, IRA distributions, capital gains, etc) must be greater than $44,000 for there to even be a possibility that as much as 85% of a Social Security benefit would be taxable. If this other income portion of the “combined income” is less than $44,000, then at least some of our Social Security benefit will fall in the 50 percent threshold, if not the 0 percent threshold.

Benefits

The Calculations

Here is a useful calculator to determine the taxability of your Social Security benefit.

The point of this exercise is twofold. First, understanding the factors that may cause a Social Security benefit to be more or less taxable provides us with an advantage from a financial planning perspective. Second, it is important to realize that just because our “combined income” passes a threshold causing some of our Social Security benefit to be taxable doesn’t mean that the resulting tax liability is catastrophic.

Assessment

In fact, once realizing that the increase in tax liability from having some additional income is so inconsequential, some retirees may be more likely to spend and enjoy their retirement, which is the point of financial planning in the first place.

Conclusion

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A 2014 Stock Market Mid-Year Review

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What Do We Know?

[A SPECIAL R&D REPORT FOR THE ME-P]

By Lon Jefferies MBA CFP®

Lon JefferiesIf you pay close enough attention to the news media you’ll eventually learn that much emphasis is placed on pundits’ forecasts, but very little consideration is given to how accurate the projections turn out.

When 2014 started, there were some pretty widely-accepted expectations regarding the investment environment. Let’s take a minute to review those anticipations and analyze how precise they turned out to be.

Interest Rates

One of the most universally accepted beliefs going into 2014 was that interest rates were on the cusp of rising, and that consequently, bond returns would drop. (Of course, this has been the expectation for around five years now, but that is a discussion for a later time.) Investors were questioning whether they should reduce or eliminate the bond portion of their portfolios until the rate increase occurred.

So, have we experienced the rise in interest rates we were expecting? On 1/2/14, the yield on the 10-year Treasury note was 3%. As of 6/30/14, the yield on the same note was 2.516%.

That’s right — interest rates have actually decreased over the last six months. Did those who stuck with their investment strategies and maintained their bond positions experience a decline in their portfolio’s value?

Here is how a variation of different bonds have performed year-to-date (as of 6/30/14):

  • US Government Bonds (IEF): 4.89%
  • US TIPS (TIP): 5.25%
  • Corporate Bonds (LQD): 5.37%
  • International Bonds (IGOV): 5.66%
  • Emerging Market Bonds (LEMB): 6.42%

Equities

How about the equities side of the portfolio?

In January, predictions for stocks were all over the map — some predicted a full out correction (a loss of more than -20%), some predicted that we would keep chugging along at 2013′s pace, and most predicted something somewhere in between. There were, however, many factors that were a common cause of concern.

So, was the reduction of the Fed’s Quantitative Easing a legitimate fear? In fact, this possibility has come to fruition. In December, the Fed was buying $85 billion per month of financial assets from commercial banks and other private institutions. The Fed has reduced this monthly amount during every meeting it has held this year, and that amount is now down to $35 billion per month. However, the key question is what impact has this had on the stock market.

Here is how a wide basket of equities have performed year-to-date (as of 6/30/14):

The most widely accept fear among equity investors was the phasing out of the Fed’s Quantitative Easing (QE) program. Investors worried that the Fed would begin lowering the amount of loans the government would buy from commercial banks each month, which would lower the availability of capital in the economy.

Historically, less money in the system leads to less investing in new businesses, less innovation, and fewer jobs created.

  • Large Cap Stocks (IVV): 7.08%
  • Mid Cap Stocks (IJH): 7.57%
  • Small Cap Stocks (IJR): 3.30%
  • Foreign Stocks (IEFA): 4.34%
  • Emerging Markets (IEMG): 4.70%
  • Real Estate (IYR): 16.09%
  • Commodities (DJP): 7.32%
  • Gold (GLD): 10.27%

Volatility

The last widely-held viewpoint at the beginning of the year was that 2014 was likely to be a year more volatile than anything we had experience in 2012 or 2013. There was a lot of clatter about valuations and PE ratios being too high, concern about the war in Ukraine, a consensus that China was about to experience a drastic decline in both imports and exports, and a general feeling that the market was due for a significant (if not healthy) pullback.

Additionally, how much have we heard about unfavorable weather patterns over the last six months?

Managing a Stock Portfolio

Lessons Learned

Of course, all of this is not to say that interest rates will never rise, that bond values will never decline, and that the market won’t return to the roller coaster it is.

In fact, all those things are certain to happen. Unfortunately, anyone who contends to know the uncertain part of this equation — when — likely doesn’t actually know anymore than you or me. For this reason, having and sticking to a diversified investment strategy that coincides with a detailed financial plan is the most likely path to financial success.

The most significant lesson inherent in these numbers is that market expectations are essentially useless. Near the beginning of the year, the vast majority of experts anticipated interest rates to rise, bond values to drop, and volatility to increase. Unfortunately, pundits making projections are rarely held to their inaccurate forecasts and are allowed to continue making a living showing they have no greater knowledge than the average investor.

Assessment

So, has 2014 been a wild ride?

The S&P 500 dropped by -5.51% from 1/22/14 – 2/03/14, and by -3.89% from 4/2/14 – 4/11/14. These are the only declines of more than 2% that the S&P 500 has experienced all year!

Additionally, as of 6/30/14, the S&P 500 has now gone 54 consecutive trading days without an up or down move of greater than 1%, the longest stretch since 1995! By historical standards, 2014 is considered to be a very smooth ride.

More:

Stock Market at New Highs!

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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