The Investment Scientist

Archive for the ‘wealth management’ Category

lead_720_405.jpgThe recent market volatility reminds me of an ancient Greek historian, Thucydides. He wrote “The History of Peloponnesian War,” about the war between the then reigning power Sparta and rising power Athen. He famously wrote: “What made war inevitable was the growth of Athenian power and the fear which this caused in Sparta.”

Fast forward to two thousand five hundred years later. A Harvard University political scientist, Professor Graham Allison coins the term “The Thucydides Trap” to describe the power dynamic between the reigning power and the rising power. Through an extensive study of historical precedents, he found there are sixteen cases where a major nation’s rise has disrupted a dominant one. Twelve of these ended in wars. For example, the rapid industrialization of Germany rattled Great Britain’s established position at the top of the pecking order, leading to the first World War.

In his book “Destined For War: Can America and China Escape the Thucydides Trap?” Allison argues that this historical metaphor is the best lens through which to observe the US-China relationship.

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150106094958-market-correction-1024x576.jpgAs of yesterday’s closing bell, the Nasdaq Composite is already in correction territory, down more than 12% from its high. However, the other two indices have yet to reach the correction stage, which is marked by a drop of at least 10%: the Dow is down 8.4% while the S&P 500 9.4%.

I am going to look at the recent market drop from two perspectives: statistical and economical.

Looking through the lens of statistics, a correction is long overdue. Why? Well, the historical odds of a correction are once every two years, those of a bear market once every five years. Yet the last time we had a correction was in 2011, seven years ago. Is it well-overdue?

Looking through the lens of economics, there are two exogenous economic forces that are influencing the market. One is the Trump tax cut, the other is the Trump trade war. These two forces are driving the market in opposite directions.

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Recently, some of my clients asked me a very good question: “Why is my portfolio not doing as well as the S&P 500 index? Shouldn’t we invest more in US stocks?”

The answer is very simple. US equity is only one component of their portfolio, and it happened to do the best this year. The best component of the portfolio will always do better than the whole portfolio. That does not mean we should not diversify.

In fact, I hear similar questions all the time. Seven years ago, it was “Why didn’t we invest more in emerging markets? There’s no way the US market will do better than emerging markets.” Five years ago, it was “Why shouldn’t we put everything in gold? All of my friends are investing in gold.” In each case, I had to twist their arms to get them to stay invested in US stocks, and now they are thanking me.

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hdhp-300x180.pngIn my last newsletter I wrote about how a Health Saving Account (HSA) is the best retirement saving vehicle with triple tax benefits. However, not everybody can have a HSA – you must have a High Deductible Health Plan (HDHP.) Those of you who have traditional PPO/HMO health insurance are not eligible.

This begs the question, who should use the HDHP with a HSA? Here are the simple answers followed by a discussion.

  1. High income folks especially those in top three tax brackets of 32%, 35% and 37% should use a HDHP.
  2. Healthy folks should use a HDHP.
  3. Low income folks who are frequently sick should stay with PPO/HMO.

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Health-Savings-Account-Speedometer.gifJust this week I get an email from a client of mine asking me if she should contribute to her HSA (health saving account) and if so, how much. So I thought this would be a good time to talk about HSAs.

What is a HSA?

A HSA is a tax-advantaged savings account for health care purposes for folks who enroll in a qualified high-deductible health plan (HDHP.)

HSAs were brought about by President George W. Bush in the same legislation that added prescription drug benefits to Medicare. It was established without much fanfare because at the time all the sound and fury was about the prescription drug benefit. Little did we know that one and a half decades later, it would be becoming more and more popular in the corporate health insurance marketplace.

How does it work?

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irrevocable-trust.pngMany successful families use irrevocable trusts for tax mitigation, wealth transfer and asset protection. In the last few articles, I discussed how an investor with a concentrated highly appreciated position can use a irrevocable charitable remainder trust to diversify concentrated risk, save taxes and benefit a charitable cause.

The caveat with irrevocable trusts is that granting families have to give up a measure of control. The trouble is that many families give up too much control than they need to. The result: they potentially put their goals at risk.

A physician client of mine created a irrevocable life insurance trust (ILIT) years ago to benefit his children. He named his sister, who loved his kids, as sole trustee. Unfortunately over the years, they became estranged and now she does not even return his calls. His trust is effectively in limbo.

What could he have done to avoid this situation?

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adhesionactif.jpgAfter my last article, “How to Deal with ConcentratedHighly Appreciated Position,”a reader asked me exactly how much he can save in taxes.

I’ll use  him as an example. He owns an investment property that he bought many years ago for $200k that is now worth $800k.

If he sells his investment property outright, he will need to pay a capital gain tax of the amount (800-200)*20% = $120k.

He can set up a CRT (charitable remainder trust), put the property in it , so when he sells it, the capital gain tax is exempt. That’s a savings of $120k right there.

But does he need to give all of that to charities? The answer is no. In fact he can take out money from the trust for his personal use.

Depending on how he takes out money, a CRT can be either a CRAT (charitable remainder annuity trust) or a CRUT (charitable remainder unit trust.)

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Author

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

Twitter: @mzhuang

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