The Investment Scientist

Archive for the ‘wealth management’ Category


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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141223130506-charity-stocks-1024x576.pngAfter my last newsletter article “Top Ten Reasons to Avoid Exchange Funds” went out, I got an email asking how to deal with a concentrated highly appreciated stock position. To this, I replied, “It helps to have some charitable inclination.”

If you have no charitable inclination, no amount of gimmicks can get you off the hook of paying the huge capital gain taxes. At best, you can pay a hefty fee to have someone kick the can down the road by using exchange funds.

However if you are charitably inclined,  then a charitable remainder trust (CRT) is a great tool to save on taxes, reduce undiversified risk, create income and  benefit charities.

What is a CRT?

A CRT is a trust that lets you convert convert a highly appreciated asset like stock or real estate into lifetime income. It reduces your income taxes now and estate taxes when you die. You pay no capital gains tax when the asset is sold. And it lets you help one or more charities that you care about.

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Tojas_eltort.jpgA few days ago, I was approached by an employee of Nvidia regarding his $5mm worth of NVDA stock. A Morgan Stanley broker had pitched him the idea of using exchange funds to diversify his holdings and he wanted my second opinion.

If you are an employee of any of those high flying tech companies like Amazon, Facebook, Google, Apple, Microsoft, Netflix, and etc., you are likely to have been pitched such an idea. Talk to me before you execute anything.

So what exactly are exchange funds? Exchange funds are unregistered private-placement limited partnerships or LLCs designed specially for investors with concentrated positions in highly appreciated stocks to help them diversify without triggering taxes.

How do they work? Investors transfer shares of their concentrated stocks to the fund in exchange for an equal value of units of the fund. These transfers are not taxable since they are considered partnership capital contributions under the tax law. There are a few caveats to the law though: investors have to stay in the fund for a minimum of seven years and the fund must invest 20% of its capital in illiquid assets.

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

Twitter: @mzhuang

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