Archive for October 2017
A few days ago I got the news that Richard Thaler won the 2017 Nobel Prize for Economics. If you don’t know about his work yet, you should. He, Danield Kahneman (2002 Nobel Prize) and the late Amos Tversky are considered the founding fathers of Behavioral Economics. His insights have a great deal of practical application and here I am trying to sum it up in one page for you.
Does The Stock Market Over-react?
This is the title of his paper published in The Journal of Finance in 1985. I read the paper for the first time when I was a PhD student at Carnegie Mellon University. The short answer to the question posed by his title is YES. He found that the market tends to overreact and reverse itself. When you look at five year intervals, stocks that did best in the previous five years tend to underperform over the next five years compared to stocks that did worst in the previous five years. What can you learn from that? Don’t be a hot stock (or fund or sector) chaser.
Myopic Loss Aversion
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President Trump unveiled his tax reform proposal two days ago. I must say that it by and large follows the contour of my best guess from six months ago. Here is an updated summary:
- Corporate tax rate will be reduced from 35% to 20%.
- Estate tax will be eliminated.
- The number of tax brackets will be reduced from seven to three, with the top rate going down from 39.6% to 35%.
- The standard deduction will double while personal exemptions and many itemized deductions (with the exception of mortgage interest and charitable donations) will be eliminated.
However, there is one big surprise that will affect many small business owners and maybe even physicians/dentists in private practice.
That is, the tax rate on pass-through earnings will be set at 25%!
I own such a pass-through entity, MZ Capital Management, through which I deliver my wealth management services. The earnings of the firm are not taxed at the firm level, rather they pass through to my tax return as personal income, thereby subject to my personal income tax rate. Since I am in the second highest tax bracket, the marginal tax rate on my pass-through income is currently 35%. (If I had not set up a defined benefit plan for myself, my marginal tax rate would have been 39.6%. This belongs to another article on tax mitigation.)
The Investment Scientist 