IRA Strategist

Validation is a good thing.

2009-03-23T12:46:49-05:00

You may recall my posts from last December 17 and February 25. The topic was the great opportunity to turn paper losses on your equity investments (anyone not have any of those?!) into a longer term asset by realizing the losses and carrying them forward to future years to offset anticipated gains. I think it's a great strategy.... still.

Here's an article from the Wall Street Journal on the same topic. It's a great reminder that there are oftentimes great opporutnities in the midst of misery!

Think twice before giving up control!

2009-03-23T12:26:34-05:00

Here's a troubling article from Jason Zwieg at the Wall Street Journal. It's about 529 plans, not IRAs, but it sheds some light on the risks of relying on investments that target the number of years before money is needed for college (or retirement!) and supposedly make changes as necessary, giving you (theoretically) peace of mind.

In particular, note the following excerpt:

Of course, the stock market was down 43% over the same period. But the popular "age-based option" for 529s is supposed to protect investors. It should work like this: A young child's account starts out primarily in stocks; with each passing year, more money moves into bonds and cash. By the time the student hits college, less than 20% of the money should be at risk in stocks -- limiting the potential damage from even an epic bear market to 10% or so.

That is vital. Students typically have a finite period, often only four years, during which they spend their 529 savings. They don't have the luxury of waiting for stocks to recover.

Nevertheless, some states pushed students into stocks or out of cash. Last April, Oregon doubled the stock exposure in its "1-3 Years to College" portfolio to 40%. In 2004, an in-college student in Rhode Island's aggressive age-based portfolio would have had 40% stocks, 31% bonds and 29% cash. By 2008, the equivalent was 40% stocks (including real estate), 55% bonds and a measly 5% cash.

My point here isn't to focus on the allocation between asset classes, but rather the risk of relying too much on investment experts to make decisions for you, even when well intended. A better alternative? Work with a trustworthy, well-qualified advisor who will keep you as informed as you want to be, and stay engaged!

Creating an Asset from Thin Air!

2009-02-25T15:09:37-05:00

If you're a regular reader of my blog, you may recall an entry near year end on the topic of turning lemons to lemonade. Well here's a real life follow up. For anyone who's been invested in the market for more than the past six months or so, there would be only a razor-thin chance that they would have anything but capital lossses to show for it (realized or unrealized). Couple that with the fact that the market continues to wallow in negative territory, with almost no optimism or confidence for near-term gains, I believe there is a great opportunity to lock in some of those capital losses and even re-entering your same positions at least 31 days later, with a real possibility of getting back in without missing a run-up in share price. Consider a client willing to take this risk (modest in my opinion). We closed two positions, both sound components of his asset allocation, which we agreed make sense for him to own long term. Upon sale, we locked in losses of over $200,000. After the 31st day (necessary to avoid the 'Wash Sale' rule), we looked for an opportunity to re-enter the same positions. In fact, we were able to repurchase both at a reduced cost basis from his original positions. The net effect? A reduced cost basis in two of his core holdings, coupled with capital losses that can be used to offset future capital gains, to avoid capital gains taxes. Considering the break down between short-term (less than one year) and long-term (one year or older) losses and his tax bracket, the value of these losses to my client is in the neighborhood of $60,000 in future capital gains avoided! The losses he doesn't use this year can be carried forward to future years. Oh, and assuming (a fair assumption) that capital gains taxes will rise in the not too distant future, the value of these losses will be even greater. Now, please understand that this strategy is hardly for the feint of heart. It involved risk, although to be clear, it was 'opportunity risk', specifically that the market price of the two closed positions would have run up significantly during those 30 days and cost more to get back into than when they were sold. But in the right situation, a good idea coupled with a calculated risk can result in the creation of an asset right out of thin air!

Who Needs a Financial Advisor?

2009-02-06T11:37:26-05:00

Who needs a financial advisor? In my opinion, everyone does. Just as I think everyone needs a doctor, a dentist, an optometrist, a real estate advisor, an attorney, or any other on a long list of professoinal service providers. Of course, I understand that the word 'need' is a bit tricky. In truth, no one really needs any of these professionals. But the fact is that in today's world, we can all benefit from the services of competent, trustworthy advisors and service providers. That is the key, of course, that they be competent and trustworthy!

Here's what you should expect from a financial advisor:

unbiased advice on your situation, with only your best interests in mind
an educated viewpoint that includes a broader perspective than your own
a willingness to educate you, i.e., to provide necessary information and to help you understand
someone who is a 'student of the business', i.e., who continually stays informed and up-to-date on issues and developments that relate to your situation
a compelling value proposition, i.e., someone who provides value to you and your situation that exceeds what you expect and for which you don't mind paying a commensurate fee

Here's a great article from the Wall Street Journal on the topic of how to choose a financial advisor.

It's a crazy world out there. Choose your counsel wisely.

Turn Lemons to Lemonade Before Year-end

2008-12-17T14:21:49-05:00

Good news! The market has rallied just over 20% since November 20! (Hip-hip-hooray!) Unfortunately, the bad news is that it's still down almost 37% this year. (Booo!) Okay, regardless of what you may think about how this could happen or what the future may have in store for us, it's time to make some lemonade out of our lemons. Specifically, it's time to be prudent about harvesting some capital losses.

Quite likely, you've seen articles on this subject already. They're common in the waning weeks of every year. Beyond the fundamentals of how capital losses work, here are two quick ideas for using the red ink you're still staring at on your investment statement:

First, remember that even though there is a 30-day wash rule on buying back an asset that you sell to capture a loss, there is no such rule on buying back an asset that you've sold to capture a gain. So, if you're fortunate enough to still have any investments that show gains, you can sell them, offsetting the gains by selling some of your losers, then immediately re-purchasing the winners at a new cost basis. Naturally, you only want to do this if you want to sell the losers anyway, or take the risk that they'll still be worthy of your investment dollars 31 days from the time of sale and buy them back.

Second, keep in mind that capital gains and losses on all assets are used to offset each other, and that unused capital losses can be carried forward indefinitely. The first part of that statement means that realized capital losses on the sale of common stocks could be used to offset realized capital gains on other investments, such as commercial property, collectibles, land, etc. The second part means just what it says. The implication of all of this is, as unlikely as it may seem, if you have substantial capital gains realized this year on any type of investment, you may also have an opportunity to offset those gains by harvesting some losses from your stock portfolio. Further, this opportunity won't go away because of the ability to carry forward any unused capital losses, which may help you in strategizing sales of appreciated investments in years to come.

Here's a great article from the Washington Times for further reading.

There's a lot to consider her, so don't be hasty. But have fun strategizing and be sure to run your ideas by your tax professional before taking any action.

Buy Your Retirement Home Now with IRA Money

2008-12-17T13:32:16-05:00

Here's a great idea for the right candidate: buy your retirement home now with IRA money. First, let's qualify a bit more who makes a good candidate for this idea. If you meet most or all of these criteria, you'll want to learn more:

Won't use the property personally until sometime in the future, at which time you will be 59 1/2 or older.
Have a substantial amount of money in your IRA. In this case, 'substantial' means that you have enough IRA money to either buy your retirement home for cash or for a down payment. (Yes, you can borrow money for this transaction too.)
Have a pretty good idea of where you want be in retirement.

Consider some of the reasons for pursuing this idea:

Real estate offers great diversification in terms of asset classes within an IRA.
There are great real estate buys in communities all across the country, including some of the most appealing traditional retirement destinations, like Arizona, Florida, Nevada and California, not to mention just about Any Other Place, USA. If you have a retirement destination in mind and have identified a piece of property or existing home in particular, you'd be wise to check out the details, as you may be able to buy that property now for what may seem like a bargain in years to come.

In addition, as mentioned earlier, such a purchase can also be accomplished by borrowing some of the money for the transaction. This would be done in the form of a 'non-recourse' loan, which means simply that in the event that you default on the loan, the lender can only recover the property against which the money was loaned, no more.

During the time that you own the property before using it, you can manage it as an investment asset. For instance, you can rent it. (Keep this in mind when you consider the idea. Ideally, the property can generate an income while you dream of using it yourself in the future.) The income and expenses along the way belong to your IRA. Naturally, you'd want there to be a profit, i.e., for the rental income to exceed operating costs and debt service, if any. If there is a profit, it would be considered income to your IRA and would remain tax-qualified money. At the point in time in the future that you actually begin to use the property, its value would become a distribution of your IRA. (There are some ways to minimize your taxes at that point in time, but they are the subject for another day.)

And yes, there are some important rules that must be followed. The biggest is that you can't benefit from the property personally until you take it as a distribution from your IRA. This means you can't live in it, full-time, part-time or any time. The penalty for doing so is severe. If audited and discovered, the value of the home would be considered an IRA distribution at the time of purchase and subject to early withdrawal penalties and taxes. You don't want to do that.

There are other rules that you want to be familiar with, including a whole category that relate to involving prohibited persons. An example is that you can't buy such a property from a family member. As you might expect, these rules get more detailed, so you want to get familiar with them if you consider this idea.

With all of that said, consider a few appealing scenarios:

You find a cool place to retire and a home at a great price. You buy the home for cash and then rent it out to a third party. You use the rental income to pay the property taxes and maintenance costs of the home and the remainder goes back into your IRA.
Consider the above scenario, but do it with Roth IRA money, in which case you avoid the later taxation altogether. (Or take advantage of the unique rules in 2010 that allow for reduced taxation on traditional IRA to Roth IRA conversions, then use the Roth IRA to buy the retirement home.)
Do the first scenario, but take out a non-recourse loan for a portion of the purchase price and use the rental income to pay your debt costs.

The ideas go on and on. You could also make such as purchase as tenants-in-common (TIC) with someone else, perhaps an elderly parent, who could use money that they may plan to leave you in their will later on. Or you could position non-real estate IRA money to generate a fixed stream of income to help pay the carrying costs on any debt you use to buy the retirement home. The bottom line to this discussion, like anything, is to consider the idea relative to your own unique circumstances. And as always, consult with your tax professional to make sure you're following all the rules.

The Untapped Potential of Self-Directed IRAs

2008-11-04T16:17:06-05:00

In my opinion, an untapped resource that many Americans have at their disposal is the flexibility of a self-directed IRA. In effect, this is a tool that enables an investor to act as his or her own investment manager and to take advantage of broad range of investments beyond the traditional ones like mutual funds, exchange traded funds, common stocks or bank CDs that most people consider when investing tax-qualified money. Instead, a self-directed IRA opens up possibilities that most people don't even know are available, such as

Investing in any type of real estate, which can be done either with cash, but can also include financing. The property can then be rented or leased to generate an income, or if raw land, can be developed and sold.
Starting or buying a business, which can take a variety of forms.
Investing in real estate-backed notes.
Buying real estate options.
Investing in options on common stocks or exchange traded funds

One point that should be made abundantly clear is that a self-directed IRA is not a path that an inexperienced investor should wander down. For that matter, in my opinion, even sophisticated investors should be careful about how much of their total tax-qualified portfolio they commit to what I would call 'non-traditional' retirement investments like those listed above. However, with all of that said, a self-directed IRA can provide a great alternative to growing a retirement account beyond the typical fixed-rate CDs or mutual funds that are tied to a stock market of which many investors have grown weary. When you consider that between October 2007 and October 2008, most broad common stock indices dropped 30-35%, is it any wonder that many investors are looking for alternatives? Add to that equation that most real estate markets are severely depressed and you have a scenario that's ripe for creative investing! Sadly, the vast majority of investors have elected to sit on the sidelines and do nothing. Of course, like anything else, if it was easy, everyone would be doing it, right?

A couple of closing thoughts. First, an excellent self-directed IRA custodian is Pensco Trust Company. I have had an account with them for several years and have found them to be an excellent partner. They also do a great job of providing education on self-directed IRA investing, which you'll find on their website. (I have no doubt that there are other excellent firms. Do a Google search for 'self-directed IRA custodians' and you'll be sure to find some others.) And second, an excellent primer on the topic of self-directed IRAs is the book "Retire Rich with Your Self-Directed IRA".

I'd Like to Introduce You to Your Assets

2008-11-04T15:09:08-05:00

Have you ever wandered around your house looking for something, only to realize that you've been carrying it in your hand?! For me, this happens only once in a great while (thankfully!), but I know the feeling. Or here's another one: have you ever been on the receiving end of a surprise party? I can remember that too, at 30, and at 50 (who me?). In both cases, you have your eyes opened to something that's been in front of you the whole time. In the case of the former, you wonder how you could be looking for something when it's been right in front of you. Regarding the latter, you think back to the clues you missed and can't believe you missed them. I think this is what it's like for many people regarding having a clear sense of their assets. What, you say?! No, not you! After all, you get a monthly or quarterly statement from one or more financial institutions showing your balance. No surprise there. True, but what I'm talking about are the 'hidden assets' you have, those being anything from some real estate that you've failed to see from a new or different perspective, to some special knowledge, skill or ability that you've taken for granted, overlooked, or otherwise failed to develop and leverage to your greatest benefit.

Here are some questions to ponder:

What would a qualified professional see among your financial and real assets that you don't see? What income potential would they find? What growth potential would they see lying dormant?
If you had to generate an income that you don't currently have, how would you do it?
What would your best friend say is a unique skill or ability that you have that could be used to generate an income?
If you were a hotshot CEO, hired to run '(Your Name Here), Inc.', what actions would you take? What would you discover upon analyzing the firm's assets and liabilities? How would you lead your company to profitability?

These questions relate specifically to my post on October 31, in which I shared a definition of 'financial independence'. This particular definition is one to which many people would aspire. For such people, whether currently engaged in a career or profession, or retired, these questions are extremely relevant.

What is 'Financial Independence'?

2008-10-29T10:47:12-05:00

The definition of 'financial independence' was revealed to me over 20 years ago in a conference room in the Windsor Auditorium, in Ontario, Canada. I was the product manager of the IDS Mutual Fund Product Group for American Express Financial Advisors (now Ameriprise), attending a conference of financial advisors, listening to a presentation about life insurance. Such a presentation has strong potential for being a real snoozer, except in this case, the presenter was a fellow named Joe Evanovich. This guy could make life insurance sing. He knew more on the topic than anyone I'd ever met, before or since. Beyond that, Joe had a very dry wit and terrific delivery. To be able to learn from someone like him, laughing all the way, was great fun.

I remember just a few things about the presentaiton that day. One was the topic. Another was where I sat. And the third was Joe's definition of 'financial independence'. That definition has stayed with me since I heard him say it. Here it is:

'Financial Independence' is the point at which your income and assets are sufficient so that work is optional and retirement is affordable.

That sounds simple enough, but ah, not so fast. There are some key words there that warrant some further thought. Those words are 'income', 'assets', 'work', 'retirement' and 'affordable'. Let's consider them one by one.

Income: When most people think about 'income', they think about working. For most of our adult lives, that's the common association we make. We have a job for which we're paid. (Unfortunately, for many people, they also feel that they don't get paid enough for the job they do, which often times is one they don't like. But those are different issues.) This type of income is commonly called earned income and it is in contrast to unearned income, which is derived from interest or dividends from investments, or income from rental property.

Assets: Typically, when we think of assets, we think of either financial assets, like common stocks, mutual funds or other types of investments, or physical assets, like our home, car, or other belongings. Naturally, another example of a physcial asset is a rental property that can generate unearned income. But there are other types of assets that we should consider. Those include any special or unique knowledge, skills or abilities we have that can be leveraged to generate earned income that wouldn't necessarily feel like work.

Work: Some people love what they do 'for a living'. Others don't, and for them, 'work' is a 'four-letter word' that conjures up thoughts of dreaded Monday mornings, getting through 'hump-day' and rejoicing in TGIF! However, keep in mind that when we 'retire' we also open ourselves up to the possibility of doing something completely different to generate earned income (maybe using some untapped knowledge, skill or ability?) than simply continuing on the path of whatever career we've had through the years.

Retirement: We all know by now that 'retirement' won't mean for Baby Boomers what it meant for our parents. The stereotypical retirement party, with the parting gift of a gold watch, sequeing into tee times and shuffleboard in Sun City has quickly morphed into a variety of lifestyles and workstyles for today's 'retirees'. Even the word 'retiree' is up for grabs.

Affordable: Affordability brings into play many variables, including lifestyle choices and decisions whether to 'work'.

As it relates to Joe's definition of 'financial independence', these five words each carry significant meaning and generate many thought-provoking questions, such as:

When I consider my income, am I considering both earned and unearned income?
As it relates to my earned income, can it be generated from an activity that I don't necessarily regard as work?
Have I considered all of my assets, including any special knowledge, skill or ability that might generate additional earned income?
Have I taken an inventory of my assets and whether they're positioned as well as they can be to generate both earned and unearned income?
How do I define retirement? Can it involve some type of work that I might not have previously considered in order to beome more affordable?
How do I define work?

Naturally, there are many more questions to consider, but hopefully the pump has been primed! In my mind, the bottom line to this definition of 'financial independence' is that it leads to thoughts and questions that make this 'pie in the sky' concept much more a possibility!