The Investment Scientist

Archive for February 2012

Financially Secure Retirement

According to Shlomo Benartzi, a University of Chicago economic professor, 50% of Americans don’t save for retirement. Of the other 50% who do save, only 11% save enough, according to their own estimates, which are probably optimistic.

This is not surprising to this financial advisor. For nearly all of my clients, I have created a savings and investment plan for them. The plan is designed so that they can live the lifestyle they desire in retirement. They are all committed to the plan. But while the commitment is there, the will power is not. When it comes time to implement the plan, they can always find important spending that justifies putting off saving to another day.

My clients are all very educated and highly intelligent. Why do even they have a hard time saving enough for a secure retirement? It all boils down to two words: instant gratification.

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[Guest post by Jeremy Bendler] As a sole proprietor, you would report net income or loss from your business on your personal income tax return. However, there are several important rules that you should be aware of:

(1) For income tax purposes, you will report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income (i.e., “above the line,” and not as itemized deductions subject to the 2%-of-adjusted-gross-income floor). If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”

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Morgan Stanley Smith Barney

Recently, a number of people came to me for advice with one thing in common: they all had a financial advisor from Morgan Stanley Smith Barney. These advisors all promised them that they could beat the market because Morgan Stanley, as a major institution in Wall Street, has extraordinary investment research resources.

I am just amazed how the financial industry (not just Morgan Stanley) uses the same trick to seduce people. Unfortunately, people fall for it over and over without fail.

If Morgan Stanley’s research is so good that it can beat the market, why can’t the company use some of that research to help its own stock price. I did a comparison of Morgan Stanley’s stock (MS) and the S&P 500 and found the following: Read the rest of this entry »

This morning, I got an unexpected call from a client of mine. He asked me how the little one was.

My younger son was born with nasal cleft and lipoma corpus callosum, a benign form of brain tumor. This Friday, he will go into surgery to fix his cleft.

My client was calling to ask for his name, so that he can ask his rabbi to pray for him.

I am not Jewish but his gesture has sent positive shivers down my spine. This is why my job is so rewarding and why I am passionate about what I do.

Only a fool invest without rules” – Jason Zweig

Young People

A client of mine asked me to teach his young son how to save and invest. The following are some rules I wrote down for him.

1. How much to save?

This is just a rule of thumb. If you start investing in your 20s, you need to put aside 10% of your income; if you start in your 30s, 15%; 40s, 20%, 50s, 25%.

The client’s son is a 26-year-old college grad, who is making about $48,000. Based on the rule of thumb, he needs to save $4,800 a year. That averages to $400 a month.

To make saving simple and painless, open a brokerage account, then set up an automatic bank payment of $400 a month to the account.

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Tax Form

Up until 2011, the burden for determining the cost basis of securities transactions for income tax purposes was shouldered by taxpayers.

In other words, the IRS was informed about how much investors sold securities for, but the tax agency relied on investors to provide the purchase prices.

Tax officials long suspected that many taxpayers overstated their cost basis in order to pay less tax. In response, the Treasury Department pushed for legislation that would require cost basis reporting by investment firms.

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Last year, while the S&P 500 was largely flat, small cap value and emerging markets were down significantly. No wonder some clients of mine got a bit edgy.

What a change one month has made! As of Feb. 5, these two asset classes have roared back with a vengeance. See the table below.

2012 Year to Feb 5th 2011
DFA US Small Cap Value 12.74% -9.74%
DFA Emerging Mkts Value 19.44% -26.50%
DFA Intl Small Cap Value 12.74% -19.41%

The lesson here: when we see big losses like -19%, -26%, we can view them as a financial Armageddon or as a buying opportunity. The latter position is mentally much harder to take, but it almost always pays off. 

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

[Guest Post by Christopher Guest] There are ways a person could use the two year window provided in the Tax Compromise of 2010 to leverage a person’s gifting opportunities, reducing a person’s taxable estate. One strategy that can be used and would not consume any, or only minimally consume, your lifetime gift tax exemption is the Grantor Retained Annuity Trust, or “GRAT.” A GRAT is a form of irrevocable trust that allows the grantor to take a calculated risk to lower the grantor’s taxable estate.

The grantor transfers specific assets or property into the GRAT. The language in the GRAT stipulates that every year the grantor will receive a fixed payment, i.e. an annuity payment, back from the trust over a fixed number of years. A typically time period for a GRAT is 2 to 5 years. At the end of the term, the remainder beneficiaries get whatever is left. For gift tax purposes, the value of the gift is calculated on day one, when the trust is created and funded, but the gift value is discounted, as discussed below.

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Last month, I was approached by a plastic surgeon whose money was with Morgan Stanley Smith Barney. He was looking for someone who could beat the market: not just promise to beat the market, like his financial advisor, but actually deliver.

I told him that I can’t beat the market, I can only help him capture the market. I could see a wisp of disappointment flash across his face.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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