The Investment Scientist

Archive for July 2013


Captive Insurance

I went to a conference for CPAs last week, and my biggest takeaway was a concept called captive insurance.

This is the concept of a business owner setting up an insurance company to insure the risk of his/her own business. Thus the name captive.

But what’s in it for one to have one’s own insurance company?

Tax Mitigation

It turns out that Congress has created legislation to encourage captive insurance – some would call that a tax loophole. IRC 831(b) states that small insurance companies ($1.2m or less in annual premium income) pay tax only on investment incomes. In other words, they don’t pay tax on premium income.

Can you see the tax loophole here? If a business pays its captive insurance company $1.2m in insurance premiums, the premium is deductible to the business and yet tax exempt to the captive insurance company. Depending on the tax structure of the business, this could mean a tax saving of 40% to 70%.

But tax savings aren’t the only major benefit!

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P2P Lending

P2P Lending

Last night I was “wasting” time on Google+, when I stumbled upon Joe Udo’s blog where he had written about how he made an 11.3% annualized return with P2P lending. The next thing I knew, it was past midnight and I just had spent three hours eyeballs deep in the subject.

Let me first tell you what P2P lending is. P2P stands for person-to-person or peer-to-peer. P2P lending is the practice of lending to strangers, enabled by technology and the web.

The two leading companies in this arena are LendingClub and Prosper. Between the two of them, they’ve enabled nearly $2 billion of lending between investors and borrowers. However, that still pales to the total US consumer credit of $1 trillion.

I am super excited about P2P lending! Let me tell you why.

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When I write a blog post, I like to drive home one and only one point at a time.

In my last blog post, the point I wanted to make was that cost matters. In case you didn’t notice, not only did I reduced my new client’s cost by 85 basis points, I also reduced the number of funds in her portfolio from 39 to 4.

With such a small numbers of funds, is the portfolio diverse enough?

Emphatically yes. In fact, it is much more diversified than the previous portfolio of 39 actively managed funds.

What I use are asset class funds; DFQTX holds all 5000+ stocks traded in the US equity market; DFTWX holds all foreign stocks; DFGEX holds all domestic and foreign REITs and of course VBTIX holds all bonds. With these four portfolios, you are holding all of the world’s productive assets. How much more diversified can you get?

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Fidelity logoIs a Fidelity Personal Retirement Annuity (FPRA) a good investment?

A client of mine recently asked me the above question. He is a high-income business owner who makes close to $1m a year and he has used up all of his available tax-advantaged investment vehicles. He is interested in this Fidelity product primarily because it is tax-deferred.

Now let me start out by saying that I love Fidelity. I custody all of my clients’ assets with them. Their advisor support team is fantastic and without Fidelity, I wouldn’t have been able to build my independent wealth management practice. FPRAs are also cheap compared to other variable annuities out there and if you absolutely have to buy a variable annuity, an FPRA is definitely the way to go. But…. I don’t recommend it.

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17 percent richerI got a new client recently. The first step I took was to totally redo his portfolio. His old portfolio looked something like this.

Fund Symbol        Expense
YAFFX                  1.26%
UMBWX                0.99%
TWCGX                 0.97%
SGRKX                  0.96%
SCETX                  1.20%
RYTFX                   1.39%
ODMAX                 1.36%
OAKIX                   1.06%
OAKEX                  1.41%
AEMGX                 1.31%

Altogether there were 39 funds in his portfolio. I skipped over a bunch in the list above, but anybody who has read my blog for any period of time should be nearly shouting out what’s wrong with this portfolio.

These Fund Expenses are Too High!

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teenreader1. Chuck Jaffe of MarketWatch’s, “No Such Thing as Risk Free Investments” informs us that instead of looking for risk free returns, investors should know the risks. To that end, you may want to read “Taking Investment Risks”, which summarizes nine types of investment risks and classifies them into good, bad and ugly. You may also like to read “Managing Investment Risks” which shows you how to “take the good risks, control the bad risks, and avoid the ugly risks.”

2. I read this news, “Investment Banks Eye Hedge Funds for the Masses” with alarm. It is not surprising though after the JOBS Act relaxed hedge fund (marketing) rules, bankers and hedge fund managers can’t wait to go after the average Joe’s pocket. Before you handover your money though, heed David Swensen’s warning, and read “Why You Should Avoid Hedge Funds.”

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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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