Reap What You Sow: What Is Tax-Loss Harvesting?

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Tax-loss harvesting is a term used in the financial world that describes an interesting tax savings strategy. It can often be a confusing concept so let’s start with the definition of harvest. Harvest is the process of gathering crops after they have ripened and are ready to be picked. The crops are then stored in a silo for future use to provide food during a time when it is not readily available.

So how can a farming concept help to reduce taxes? Let’s take the concept of the harvest out of the farm and “plant” it right in the middle of Wall Street to better explain how tax-loss harvesting works. It’s a strategy that allows an investor to offset gains that they have realized in one investment with losses they have incurred with another investment.  If you own an investment that increases in value, you have a capital gain. If you own an investment that decreases in value, you have a capital loss. Any investments you currently own have “unrealized” gains or losses- you have either made or lost money on paper. Once you sell an investment you will have a “realized” gain or loss. If you have realized gains, you will owe taxes, however, if you sell an investment for a loss, that gain can be reduced or even wiped out completely depending on how much it is, which then reduces your tax liability overall. The strategy of tax-loss harvesting, however, harvests losses as they incur, to store them up in your “silo” to use against any future gains.  This only works in a taxable account and does not benefit you in a retirement account.

Here is an example of what this looks like:

Tax Loss Harvesting

There are a lot of moving parts to consider, so it is important to consult a tax professional before you harvest.  If you are to attempt this, there are some important things that you will need to understand prior. Understanding of the wash sale:  If you sell an investment for a loss, you cannot purchase that same investment (or one that is highly correlated) back within 30 days of that sale, otherwise it is considered a Wash Sale; your loss gets washed away, which means you can’t claim the loss.  Another important concept to understand is short term vs. long term investments.  Short term investments are investments owned for less than one year and are taxed as ordinary income, while long term investments are held for a year or more and have a different tax rate (either 0%, 15%, or 20% depending on your tax bracket, which may be lower than your income tax rate).  Short term losses first offset short term gains, and long-term losses offset long term gains.  Then you can offset any short-term gain with a long-term loss after all long-term gains have been offset.  Like I said- a lot of moving parts. 

Market volatility is inevitable.  At Spotlight Asset Group, we take advantage of the volatility and we harvest losses opportunistically. As losses are realized and then immediately reinvested, we are lowering your cost basis and buying securities at a lower price in order to take advantage of the market rebound. If you are in the market for the long run and have a proper allocation in place that fits your long-term goals and financial needs, taking advantage of this strategy may add value to your bottom line and more money in your pocket.

Kristin Sweis

Join the Spotlight Asset Group Newsletter

Recent Posts

Newsletters

Tax-loss harvesting is a term used in the financial world that describes an interesting tax savings strategy. It can often be a confusing concept so let’s start with the definition of harvest. Harvest is the process of gathering crops after they have ripened and are ready to be picked. The crops are then stored in a silo for future use to provide food during a time when it is not readily available.

So how can a farming concept help to reduce taxes? Let’s take the concept of the harvest out of the farm and “plant” it right in the middle of Wall Street to better explain how tax-loss harvesting works. It’s a strategy that allows an investor to offset gains that they have realized in one investment with losses they have incurred with another investment. If you own an investment that increases in value, you have a capital gain. If you own an investment that decreases in value, you have a capital loss. Any investments you currently own have “unrealized” gains or losses- you have either made or lost money on paper. Once you sell an investment you will have a “realized” gain or loss. If you have realized gains, you will owe taxes, however, if you sell an investment for a loss, that gain can be reduced or even wiped out completely depending on how much it is, which then reduces your tax liability overall. The strategy of tax-loss harvesting, however, harvests losses as they incur, to store them up in your “silo” to use against any future gains. This only works in a taxable account and does not benefit you in a retirement account.

Here is an example of what this looks like:

Tax Loss Harvesting

There are a lot of moving parts to consider, so it is important to consult a tax professional before you harvest. If you are to attempt this, there are some important things that you will need to understand prior. Understanding of the wash sale: If you sell an investment for a loss, you cannot purchase that same investment (or one that is highly correlated) back within 30 days of that sale, otherwise it is considered a Wash Sale; your loss gets washed away, which means you can’t claim the loss. Another important concept to understand is short term vs. long term investments. Short term investments are investments owned for less than one year and are taxed as ordinary income, while long term investments are held for a year or more and have a different tax rate (either 0%, 15%, or 20% depending on your tax bracket, which may be lower than your income tax rate). Short term losses first offset short term gains, and long-term losses offset long term gains. Then you can offset any short-term gain with a long-term loss after all long-term gains have been offset. Like I said- a lot of moving parts.

Market volatility is inevitable. At Spotlight Asset Group, we take advantage of the volatility and we harvest losses opportunistically. As losses are realized and then immediately reinvested, we are lowering your cost basis and buying securities at a lower price in order to take advantage of the market rebound. If you are in the market for the long run and have a proper allocation in place that fits your long-term goals and financial needs, taking advantage of this strategy may add value to your bottom line and more money in your pocket.

Kristin Sweis

Recent Posts

Quarterly Newsletter October 2019

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Read the latest Spotlight Asset Group company news, market updates and employee Spotlight in the October 2019 Quarterly Newsletter.

Click here to read the article.

Join the Spotlight Asset Group Newsletter

Recent Posts

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Read the latest Spotlight Asset Group company news, market updates and employee Spotlight in the October 2019 Quarterly Newsletter.

Click here to read the article.

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Financial Abuse

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October is National Domestic Violence Awareness Month.  Financial Abuse occurs in 99% of all domestic violence cases* and is a form of abuse that can sometimes be difficult to diagnose.  When people think of domestic abuse, they typically think of physical abuse where you can see the physical signs that something is happening.  However, other forms of abuse, such as financial and emotional abuse, are not as obvious.  Financial abuse is the silent form of domestic violence and is one of the most powerful forms of abuse and most difficult to escape.  Seven out of eight victims of financial abuse go back to the abuser because of this. **  Financial abuse doesn’t just have to be between a couple, it can occur with caretakers and seniors or with legal guardians.  Financial abuse occurs among all different ethnicities, ages, and economic backgrounds.

What is financial abuse? Financial Abuse is the act of blocking or controlling access to financial assets to ensure the victim is dependent on the abuser. The abuser can be a domestic partner, a caretaker, guardian, or present in any situation where one is in control of someone.  The goal of the abuser is for the victim to become completely financially dependent, to where they do not have the means to make it on their own.  In many cases, it comes across as being loving or endearing because that person is saying they will help you and take care of the finances to relieve you of the burden.  This leaves the victim trusting this person and unaware that the abuser is using their power to hide money, spend or gamble it away, or rack up debt in the victim’s name.

There are also forms of financial abuse that are more violent, such as going to the victim’s place of work and causing them to lose their job, forbidding them to work, or forcing them to work long hours or be the breadwinner while the abuser does not contribute financially to the relationship.  Other forms of financial abuse include giving someone an allowance or withholding money, refusing to pay for basic needs for the family, not allowing the victim to see bank accounts, ruining the victim’s credit, or forcing the victim to write bad checks or sign a false tax return.  Financial abuse can often take years to recover from in terms of rebuilding savings and credit.  Some victims may need to file for bankruptcy just to start over.

Financial abuse can have long lasting effects that make it very difficult for a victim to leave an unhealthy situation because, for example, they are not left with enough money to break free and get out on their own.  Coupled with poor credit, this can make it that much harder to start over. Raising awareness and educating people on the signs is important, especially when approximately 78% of Americans do not recognize financial abuse as a form of domestic violence.  There are many services that can help victims**, and the first step is figuring out this is happening.  Sometimes the victim doesn’t realize it’s happening until they try to leave an abusive relationship and find their accounts drained.  Stay involved in your finances, if someone is upset that you are asking questions or want to be involved there may be a larger problem.  Make sure to have all your account user names and passwords and check them regularly.

Hiring a trusted financial professional as a fiduciary also adds checks and balances.  As an advisor, we can see if there is a sudden change in the investment behavior of one of our clients, if they are suddenly writing large checks to a family member regularly, or one of the parties is slowly draining the account over time.  When we call to talk to a client that may be elderly, are they afraid to say something on the phone for fear their caregiver may harm them?  We need to be aware that this is an issue so that we can see the signs and help our client’s before it goes too far.

If you or someone you know are a victim, below are links to some resources that you can contact for help.

*https://centerforfinancialsecurity.files.wordpress.com/2015/04/adams2011.pdf

**https://money.usnews.com/money/blogs/my-money/2011/04/26/how-to-stop-domestic-financial-abuse

https://www.huffpost.com/entry/7-ways-to-help-victims-of-financial-abuse-break-free_b_59e751d3e4b0153c4c3ec41e?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAABmP1dIt6D20gPNXlLml6rDfT5paoV8GJ-WHRJpCzTLHsXnWTU8TQXxwkgEhphFgLNsdCMqGFEfsR5ORgZqaQNXqRMUmgxj0QM0uY65_Uk-3liHgou0zB6P9cD7YzNZXUkIwCwswPSPBMR2k3DzrJAVuYNA-3PpNLZ1vt89nPxJz

https://www.verywellmind.com/financial-abuse-4155224

For help:

www.nnedv.org

https://www.womenslaw.org/about-abuse/forms-abuse/financial-abuse/all?gclid=EAIaIQobChMI_oi1lMG_4wIVhYbACh2P0Q8wEAAYAiAAEgIW0fD_BwE#node-27115

National Domestic Violence Hotline 1-800-799-SAFE

 

Kristin Sweis

Join the Spotlight Asset Group Newsletter

Recent Posts

Newsletters

October is National Domestic Violence Awareness Month.  Financial Abuse occurs in 99% of all domestic violence cases* and is a form of abuse that can sometimes be difficult to diagnose.  When people think of domestic abuse, they typically think of physical abuse where you can see the physical signs that something is happening.  However, other forms of abuse, such as financial and emotional abuse, are not as obvious.  Financial abuse is the silent form of domestic violence and is one of the most powerful forms of abuse and most difficult to escape.  Seven out of eight victims of financial abuse go back to the abuser because of this. **  Financial abuse doesn’t just have to be between a couple, it can occur with caretakers and seniors or with legal guardians.  Financial abuse occurs among all different ethnicities, ages, and economic backgrounds.

What is financial abuse? Financial Abuse is the act of blocking or controlling access to financial assets to ensure the victim is dependent on the abuser. The abuser can be a domestic partner, a caretaker, guardian, or present in any situation where one is in control of someone.  The goal of the abuser is for the victim to become completely financially dependent, to where they do not have the means to make it on their own.  In many cases, it comes across as being loving or endearing because that person is saying they will help you and take care of the finances to relieve you of the burden.  This leaves the victim trusting this person and unaware that the abuser is using their power to hide money, spend or gamble it away, or rack up debt in the victim’s name.

There are also forms of financial abuse that are more violent, such as going to the victim’s place of work and causing them to lose their job, forbidding them to work, or forcing them to work long hours or be the breadwinner while the abuser does not contribute financially to the relationship.  Other forms of financial abuse include giving someone an allowance or withholding money, refusing to pay for basic needs for the family, not allowing the victim to see bank accounts, ruining the victim’s credit, or forcing the victim to write bad checks or sign a false tax return.  Financial abuse can often take years to recover from in terms of rebuilding savings and credit.  Some victims may need to file for bankruptcy just to start over.

Financial abuse can have long lasting effects that make it very difficult for a victim to leave an unhealthy situation because, for example, they are not left with enough money to break free and get out on their own.  Coupled with poor credit, this can make it that much harder to start over. Raising awareness and educating people on the signs is important, especially when approximately 78% of Americans do not recognize financial abuse as a form of domestic violence.  There are many services that can help victims**, and the first step is figuring out this is happening.  Sometimes the victim doesn’t realize it’s happening until they try to leave an abusive relationship and find their accounts drained.  Stay involved in your finances, if someone is upset that you are asking questions or want to be involved there may be a larger problem.  Make sure to have all your account user names and passwords and check them regularly.

Hiring a trusted financial professional as a fiduciary also adds checks and balances.  As an advisor, we can see if there is a sudden change in the investment behavior of one of our clients, if they are suddenly writing large checks to a family member regularly, or one of the parties is slowly draining the account over time.  When we call to talk to a client that may be elderly, are they afraid to say something on the phone for fear their caregiver may harm them?  We need to be aware that this is an issue so that we can see the signs and help our client’s before it goes too far.

If you or someone you know are a victim, below are links to some resources that you can contact for help.

*https://centerforfinancialsecurity.files.wordpress.com/2015/04/adams2011.pdf

**https://money.usnews.com/money/blogs/my-money/2011/04/26/how-to-stop-domestic-financial-abuse

https://www.huffpost.com/entry/7-ways-to-help-victims-of-financial-abuse-break-free_b_59e751d3e4b0153c4c3ec41e?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAABmP1dIt6D20gPNXlLml6rDfT5paoV8GJ-WHRJpCzTLHsXnWTU8TQXxwkgEhphFgLNsdCMqGFEfsR5ORgZqaQNXqRMUmgxj0QM0uY65_Uk-3liHgou0zB6P9cD7YzNZXUkIwCwswPSPBMR2k3DzrJAVuYNA-3PpNLZ1vt89nPxJz

https://www.verywellmind.com/financial-abuse-4155224

For help:

www.nnedv.org

https://www.womenslaw.org/about-abuse/forms-abuse/financial-abuse/all?gclid=EAIaIQobChMI_oi1lMG_4wIVhYbACh2P0Q8wEAAYAiAAEgIW0fD_BwE#node-27115

National Domestic Violence Hotline 1-800-799-SAFE

Kristin Sweis

Recent Posts

Quarterly Newsletter July 2019

Newsletters

Read the latest Spotlight Asset Group company news, market updates and employee Spotlight in the July 2019 Quarterly Newsletter.

Click here to read the article.

Join the Spotlight Asset Group Newsletter

Recent Posts

Newsletters

Read the latest Spotlight Asset Group company news, market updates and employee Spotlight in the July 2019 Quarterly Newsletter.

Click here to read the article.

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The Pitfalls of Emotional Investing

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People often make decisions based on emotion instead of rational deliberation. For example, that one friend you have who bought a new car they couldn’t afford because it but felt so incredibly nice to sit in it. I have a confession: that wasn’t a friend, it was me. The car was a black Ford Mustang. After finalizing the purchase and paying cash for the car, I remember reviewing my bank account and realizing I only had $11 to my name. Oh, and the car too.  I was seventeen years old at the time and it was certainly not a sound investment decision on my part, it was an impulsive and emotional decision. I did have a lot of fun with that car if you’re wondering. But the truth is, if I put that hard-earned cash to better use by investing it and enjoying compound growth over several years, I would have been much better off. With the benefit of hindsight and years of experience and financial education, I now realize that the opportunity cost of that car was much more than the initial purchase price.

When it comes to investing, human behavior may cause us to make decisions based on emotion and not on fundamentals or rational deliberation. It’s a natural tendency. If you’ve been investing for some time you will certainly remember the tech bubble of 2000. Leading into that market, you could have invested in almost any tech start up and seen overnight success. But as we all know, that soon came to a screeching halt. The market is largely driven by supply and demand paired with fear and greed, as illustrated in the diagram below. Leading up to the tech bubble, investors saw doubledigit returns and got greedy. This was followed by fear, or in this case, shear panic in 2002 following the Nasdaq drop of nearly 77% from top to bottom.

Consider some of the market corrections we saw in 2018 that were partly fueled by social media tweets about looming trade war concerns. Did large companies all announce poor earnings? No. Did the Fed make significant announcements or changes to rates at the time? No. Did job numbers or GDP reports come in much lower than expected? No. If nothing fundamentally changed, what caused the rise and fall of stock prices in those volatile times? Emotion.

Studies by Dalbar’s Quantitative Analysis of Investor Behavior (see the chart by J.P. Morgan, below) have shown that, over the last twenty years, the average investor has experienced a return of just 2.1% while the S&P 500 returned 8.2%.

 What accounts for this difference of more than 6% return on investment? A lot of it can be blamed on emotional decision-making, lack of discipline, and failure to diversify. Consider the lag effect and confidence when markets are high and peaking. This is generally a time that many investors are buying into the market, when in fact this is the ultimate time to sell and become more defensive or conservative. On the other hand, when markets are at the bottom it is a great opportunity to purchase stock or to take more aggressive positions. Think back to the 2008 financial crisis, when the S&P 500 lost 38% in a single year and every analyst featured on CNBC feared that the world was coming to an end. During that time, CNBC interviewed Berkshire Hathaway’s Warren Buffet. I vividly remember the interview. Buffet, always the contrarian, compared the opportunity in the market to toilet paper being on sale at Walmart: he wouldn’t run away, he would be a buyer. A simple analogy from one of the smartest investors of our time.

During the crisis, many investors were pulling money out of the markets and moving it to cash to “wait on the sidelines.” After watching the Dow Jones Industrial Average drop from its peak of over 14,000 points in October 2007 to under 7,000 points by March 2009, and then climb back above 10,000 in less than nine months, I remember asking people when they were going to get back in. Most of them had no response, no plan. Many people never took the time to assess their re-entry point and timidly sat on the sidelines in cash, some never reinvesting back into their portfolios. Today’s market is almost double that of the pre-crisis peak. If these investors had stuck to their game plan, patiently waiting out only a few years of recovery following the worst crash since the Great Depression, they would have realized significant gains today and would have been even better off than they were before the crash.  

Emotion can lead some investors to concentrate their portfolio in too few individual positions as well. I’ll never forget talking to a client, during the decline of General Motors, about the importance of diversification in his portfolio. This gentleman was a high school dropout who retired as a janitor, sweeping up the manufacturing facilities at one of the GM plants. He understood the importance of saving money and had fully invested his 401(k) in GM stock during a rising time for the company and auto industry. At the time of his retirement, he found himself not only fully invested in GM stock in his 401(k), but also his IRA, his wife’s retirement accounts, and their taxable nonretirement assets. This gentleman’s net worth was nearly $3,000,000 at the time of his retirement, not bad for a high school dropout. Despite conversations about his concentration risk and the importance of diversification and exit strategies, he stubbornly stayed invested in GM stock until all his combined accounts were worth less than $200,000 and GM neared bankruptcy. He was in denial for a long time, but he eventually realized that he let his emotions take control. The company he loved, and for which he worked so hard for nearly 50 years, was not the company he should have bet his entire retirement on. He was emotionally attached to GM because of his history with the company and the fond memories he had from his years of working there. He also was overconfident, as he had seen nothing but increases in GM’s production and the consistent growth of the auto industry, and he was comforted by the leadership he worked under during his tenure. This emotional attachment and overconfidence lead to one individual stock comprising his entire portfolio.

Technology has only exacerbated the problem with emotional investing and decision-making. Today, self-directed investors can get market information almost as quickly as a professional wealth manager, and quotes in real time. With this immediate flow of information, many investors make knee-jerk reactions to news because they fear monetary loss or missed opportunities. Part of what separates these self-directed investors from professional wealth managers is the ability to manage the emotional side of the markets through established processes and deliberative analysis. As professional wealth managers, our job is to take all the available data, sort through it, make sense of it, and act in accordance with pre-established goals and objectives, leaving emotion out of the equation.

As an advisor, it’s easy to discuss long-term trends with clients in the face of a poor year or a poor quarter. It is another thing to have that discussion during the boom years. If the markets have shown us anything over the years, it is that they themselves have no concept of emotion, fear, or greed. They just keep chugging along. Therefore, investors shouldn’t make decisions based on emotion, fear, or greed.  This is easier said than done. It is difficult for some investors to grasp the concept of a strategy coming to fruition over several years, as opposed to the instant gratification of immediate investment success. I often find myself reminding my clients that their net worth was built over a lifetime and their investments should work equally as long and hard for them. The idea of the “get rich quick” scheme is simply not a realistic investment strategy. As advisors, we must act as educators and coaches of our clients, keeping them on track and helping them overcome the urge to make poor emotional investment decisions.

It’s no secret why most investors enjoy their best returns in their 401(k) plans. It’s not because they offer a better investment array or product offering. To the contrary, most 401(k) plans limit the investment options to a select group of mutual funds and limit the number of transactions allowed in a given time period. So why are their returns often so much better? It is because, within a 401(k) plan, employees are forced to diversify, stay disciplined, and dollar cost average into a defined investment plan that works over the life of their career.

The moral of the story? Stay disciplined while investing. Despite market movement and volatility, think logically and strategically about your investments. Good, sound financial planning is often the foundation to helping determine the right amount of risk and type of investment strategy you need to be confident, comfortable, and to stay the course. 

Any time you have questions regarding your account, please reach out to your Spotlight Asset Group Wealth Manager. If you are not an existing client but are interested in discussing your financial situation with a professional advisor, contact us today.

 

Brad Tatar

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People often make decisions based on emotion instead of rational deliberation. For example, that one friend you have who bought a new car they couldn’t afford because it but felt so incredibly nice to sit in it. I have a confession: that wasn’t a friend, it was me. The car was a black Ford Mustang. After finalizing the purchase and paying cash for the car, I remember reviewing my bank account and realizing I only had $11 to my name. Oh, and the car too.  I was seventeen years old at the time and it was certainly not a sound investment decision on my part, it was an impulsive and emotional decision. I did have a lot of fun with that car if you’re wondering. But the truth is, if I put that hard-earned cash to better use by investing it and enjoying compound growth over several years, I would have been much better off. With the benefit of hindsight and years of experience and financial education, I now realize that the opportunity cost of that car was much more than the initial purchase price.

When it comes to investing, human behavior may cause us to make decisions based on emotion and not on fundamentals or rational deliberation. It’s a natural tendency. If you’ve been investing for some time you will certainly remember the tech bubble of 2000. Leading into that market, you could have invested in almost any tech start up and seen overnight success. But as we all know, that soon came to a screeching halt. The market is largely driven by supply and demand paired with fear and greed, as illustrated in the diagram below. Leading up to the tech bubble, investors saw doubledigit returns and got greedy. This was followed by fear, or in this case, shear panic in 2002 following the Nasdaq drop of nearly 77% from top to bottom.

Consider some of the market corrections we saw in 2018 that were partly fueled by social media tweets about looming trade war concerns. Did large companies all announce poor earnings? No. Did the Fed make significant announcements or changes to rates at the time? No. Did job numbers or GDP reports come in much lower than expected? No. If nothing fundamentally changed, what caused the rise and fall of stock prices in those volatile times? Emotion.

Studies by Dalbar’s Quantitative Analysis of Investor Behavior (see the chart by J.P. Morgan, below) have shown that, over the last twenty years, the average investor has experienced a return of just 2.1% while the S&P 500 returned 8.2%.

 What accounts for this difference of more than 6% return on investment? A lot of it can be blamed on emotional decision-making, lack of discipline, and failure to diversify. Consider the lag effect and confidence when markets are high and peaking. This is generally a time that many investors are buying into the market, when in fact this is the ultimate time to sell and become more defensive or conservative. On the other hand, when markets are at the bottom it is a great opportunity to purchase stock or to take more aggressive positions. Think back to the 2008 financial crisis, when the S&P 500 lost 38% in a single year and every analyst featured on CNBC feared that the world was coming to an end. During that time, CNBC interviewed Berkshire Hathaway’s Warren Buffet. I vividly remember the interview. Buffet, always the contrarian, compared the opportunity in the market to toilet paper being on sale at Walmart: he wouldn’t run away, he would be a buyer. A simple analogy from one of the smartest investors of our time.

During the crisis, many investors were pulling money out of the markets and moving it to cash to “wait on the sidelines.” After watching the Dow Jones Industrial Average drop from its peak of over 14,000 points in October 2007 to under 7,000 points by March 2009, and then climb back above 10,000 in less than nine months, I remember asking people when they were going to get back in. Most of them had no response, no plan. Many people never took the time to assess their re-entry point and timidly sat on the sidelines in cash, some never reinvesting back into their portfolios. Today’s market is almost double that of the pre-crisis peak. If these investors had stuck to their game plan, patiently waiting out only a few years of recovery following the worst crash since the Great Depression, they would have realized significant gains today and would have been even better off than they were before the crash.  

Emotion can lead some investors to concentrate their portfolio in too few individual positions as well. I’ll never forget talking to a client, during the decline of General Motors, about the importance of diversification in his portfolio. This gentleman was a high school dropout who retired as a janitor, sweeping up the manufacturing facilities at one of the GM plants. He understood the importance of saving money and had fully invested his 401(k) in GM stock during a rising time for the company and auto industry. At the time of his retirement, he found himself not only fully invested in GM stock in his 401(k), but also his IRA, his wife’s retirement accounts, and their taxable nonretirement assets. This gentleman’s net worth was nearly $3,000,000 at the time of his retirement, not bad for a high school dropout. Despite conversations about his concentration risk and the importance of diversification and exit strategies, he stubbornly stayed invested in GM stock until all his combined accounts were worth less than $200,000 and GM neared bankruptcy. He was in denial for a long time, but he eventually realized that he let his emotions take control. The company he loved, and for which he worked so hard for nearly 50 years, was not the company he should have bet his entire retirement on. He was emotionally attached to GM because of his history with the company and the fond memories he had from his years of working there. He also was overconfident, as he had seen nothing but increases in GM’s production and the consistent growth of the auto industry, and he was comforted by the leadership he worked under during his tenure. This emotional attachment and overconfidence lead to one individual stock comprising his entire portfolio.

Technology has only exacerbated the problem with emotional investing and decision-making. Today, self-directed investors can get market information almost as quickly as a professional wealth manager, and quotes in real time. With this immediate flow of information, many investors make knee-jerk reactions to news because they fear monetary loss or missed opportunities. Part of what separates these self-directed investors from professional wealth managers is the ability to manage the emotional side of the markets through established processes and deliberative analysis. As professional wealth managers, our job is to take all the available data, sort through it, make sense of it, and act in accordance with pre-established goals and objectives, leaving emotion out of the equation.

As an advisor, it’s easy to discuss long-term trends with clients in the face of a poor year or a poor quarter. It is another thing to have that discussion during the boom years. If the markets have shown us anything over the years, it is that they themselves have no concept of emotion, fear, or greed. They just keep chugging along. Therefore, investors shouldn’t make decisions based on emotion, fear, or greed.  This is easier said than done. It is difficult for some investors to grasp the concept of a strategy coming to fruition over several years, as opposed to the instant gratification of immediate investment success. I often find myself reminding my clients that their net worth was built over a lifetime and their investments should work equally as long and hard for them. The idea of the “get rich quick” scheme is simply not a realistic investment strategy. As advisors, we must act as educators and coaches of our clients, keeping them on track and helping them overcome the urge to make poor emotional investment decisions.

It’s no secret why most investors enjoy their best returns in their 401(k) plans. It’s not because they offer a better investment array or product offering. To the contrary, most 401(k) plans limit the investment options to a select group of mutual funds and limit the number of transactions allowed in a given time period. So why are their returns often so much better? It is because, within a 401(k) plan, employees are forced to diversify, stay disciplined, and dollar cost average into a defined investment plan that works over the life of their career.

The moral of the story? Stay disciplined while investing. Despite market movement and volatility, think logically and strategically about your investments. Good, sound financial planning is often the foundation to helping determine the right amount of risk and type of investment strategy you need to be confident, comfortable, and to stay the course. 

Any time you have questions regarding your account, please reach out to your Spotlight Asset Group Wealth Manager. If you are not an existing client but are interested in discussing your financial situation with a professional advisor, contact us today.

 

Brad Tatar

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Best Interest and Best Intentions

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An SEC vote aimed at helping retail investors could end up adding to their confusion.

Tomorrow, the Securities and Exchange Commission (SEC) will vote on a package of rulemaking proposals aimed at protecting retail investors by, among other things, requiring brokers to act in the best interest of their customers. While the SEC’s intentions are good, I fear that the focus on labels (broker versus adviser) and on legal distinctions (“best interest” versus “fiduciary duty”) will only add to the confusion faced by many retail investors.

The world of wealth management can be a confusing, daunting place for the average investor. At the same time, there has never been more information available to the investing public. This apparent paradox is a problem that regulators and consumer advocacy groups have tried to address for years by, among other things, mandating more disclosures and imposing “plain English” requirements. Unfortunately, even the best intentions often have unintended consequences. Recent regulatory efforts seem to have added to the confusion by moving the concepts of “suitability” and “fiduciary duty” to the forefront, and those with a financial interest in the confusion (i.e. broker-dealers, investment advisers, and other financial professionals) have taken advantage.

Let’s take a step back and examine where all the confusion comes from. The financial services industry is populated by several types of financial professionals, including financial planners, insurance agents, accountants, estate planning attorneys, brokers, and investment advisers. Each of these professionals has different duties and legal obligations, including the fiduciary duty owed by investment advisers to their clients (which means they are held to the highest standard of conduct and must act in the best interest of their clients) and the duty of fair dealing owed by a broker to a customer (which, in part, means that they will only make recommendations to buy securities that are suitable for the customer).

These various players used to stick to their own turf and serve distinct needs of the investing public. For example, brokers typically buy and sell securities for their customers and, in return, the customers pay the broker commissions on the transactions. As long as a transaction is suitable for a customer (i.e. appropriate for the customer’s investment objectives), a broker can recommend a security that paid the broker a higher commission even if there were suitable alternatives that were cheaper for the customer (and therefore generated smaller commissions).  On the other hand, investment advisers provide regular and continuous investment advice, usually to high net worth clients, for a fixed, asset-based fee. While there can be other fees involved, all fees have to be clearly disclosed to a client before the advisory relationship begins.

These days, any given financial professional or entity might offer two or more products or services (insurance, financial planning, estate planning, stock trading, and investment management), this includes companies that are registered as both investment advisers and broker-dealers. These so-called “hybrids” act as investment advisers in some situations and as brokers in others. Needless to say, the duties, legal obligations, and compensation structure of such companies can be murky at best.

The SEC introduced its current proposals way back in April of 2018 in an attempt to clear up the confusion. These proposals are intended to “enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.”[1]  Easier said than done.

The most ambitious of these proposals, known as Regulation Best Interest, has garnered the most attention. It would require broker-dealers to “act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer [and] … make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.”  Another proposal is “an interpretation to reaffirm and, in some cases, clarify the [SEC’s] views of the fiduciary duty that investment advisers owe to their clients,” which, as the SEC says, includes the obligation to “act in the best interest of its client.”[2]  The SEC believes that “[by] highlighting principles relevant to the fiduciary duty, investment advisers and their clients would have greater clarity about advisers’ legal obligations.”

As an aside, it seems reasonable to assume that any investment professional will act in the best interest of their clients or customers. However just because they are supposed to act a certain way doesn’t mean that they will. The SEC’s website is full of enforcement actions against investment advisers that failed to uphold their fiduciary duties.

These two proposals have yet to be implemented by the SEC, but they have already sparked a fierce debate among brokers and advisers, some of whom believe that all financial professionals should be held to the fiduciary standard and others who think there was nothing wrong with the status quo. The proposals also appear to have spurred a new wave of marketing, with some firms touting the fact that they are fiduciaries and that they don’t accept commissions and others talking more about their low brokerage fees.

The additional disclosure and marketing prompted by the SEC’s proposals is great, but I fear that in all the noise of the suitability/broker vs. fiduciary/adviser argument that the real jewel of the SEC’s proposals is being missed. People who are looking to hire a financial professional shouldn’t do so based on a label, the label is only one part of the equation. Investors needs to take a deeper look under the hood to find out exactly what they are getting.

The SEC’s third proposal aims to allow investors to do just that by requiring brokers and advisers to provide their clients with a new short-form disclosure document, referred to as Form CRS (short for client relationship summary), that would “provide retail investors with simple, easy-to-understand information about the nature of their relationship with their investment professional” and supplement other, more detailed disclosures. For advisers, those detailed disclosures would be those found in Form ADV, which advisers are already required to provide to their clients. For brokers, the detailed disclosures would be those required under Regulation Best Interest (which, again, has not been enacted).

I believe that Form CRS would make a real difference in the industry by laying out the key distinctions between an independent investment adviser (i.e. an investment adviser that is not also a dually registered has no broker-dealer affiliation) and a broker-dealer. Moreover, for clients of an investment adviser, the ADV is typically the primary source of the adviser’s disclosures. But the ADV can run dozens of pages long and is often drafted by a law firm hired by the adviser. They often contain so much legalese and such detailed disclosure language that it can be very difficult for most people to read and understand, if they even bother to read it at all. As a result, it is easy to miss a lot of the important disclosures relating to fees, conflicts of interests, and regulatory events. Form CRS can be a better vehicle for disclosing these key issues in a simple, straight-forward way. Form CRS is supposed to be no more than four pages long and would disclose the services offered, fees and costs, conflicts of interest, and any regulatory disclosures such as disciplinary events and complaints.

At Spotlight Asset Group, we felt so strongly that Form CRS is the direction the industry needs to go that we came up with our own document ahead of the SEC finalizing any of these rules. Our “Prospect Proposal” is a two-page document that highlights all of the information we feel is important for prospects to know before they sign up with us as a client.  This includes the services we will provide, the fees they will be charged as both a percentage and as a dollar amount, any additional costs like trading commissions or expense ratios, any material conflicts of interest we may have, and how their individual investment adviser representative is compensated. If at some point we have a regulatory or disciplinary item that should be disclosed, we would disclose it in our Prospect Proposal. We are working to implement the use of the Prospect Proposal across the firm because we believe that it is important to be completely transparent with our clients at the outset of the relationship. Not only is this fair, it serves to set the tone for an open dialogue and cooperative partnership with our clients. As noted in a recent Intelligent Investor editorial by Jason Zweig of the Wall Street Journal, this dialogue is the real key to a good relationship between a financial advisor and their client.[3]

I think such upfront disclosures are vitally important and should become the standard for all financial professionals. While the current disclosure documents lay out an adviser’s duties or a broker’s obligations, in my 15 years in the investment business I can count on one hand the number of clients who have asked questions about disclosures in an ADV or other document. It doesn’t happen often because a lot of people don’t read them. Wouldn’t it be better if a financial professional had to proactively go through all relevant information with a prospective client or customer before they signed on the dotted line? That is the argument we should be focusing on, not a confusing discussion about who is a fiduciary and what that means.

[1] See  SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals at https://www.sec.gov/news/press-release/2018-68 (April 18, 2018) (emphasis added).

[2] See Regulation Best Interest, Release No, 34-83062, available at https://www.sec.gov/rules/proposed/2018/34-83062.pdf  (April 18, 2018) (emphasis added).

[3] Jason Zweig, A New Rule Won’ Make Your Broker an Angel, available at https://www.wsj.com/articles/a-new-rule-wont-make-your-broker-an-angel-11559313036?mod=hp_lead_pos11 (May 31, 2019).

Stephen Greco, CEO

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An SEC vote aimed at helping retail investors could end up adding to their confusion.

Tomorrow, the Securities and Exchange Commission (SEC) will vote on a package of rulemaking proposals aimed at protecting retail investors by, among other things, requiring brokers to act in the best interest of their customers. While the SEC’s intentions are good, I fear that the focus on labels (broker versus adviser) and on legal distinctions (“best interest” versus “fiduciary duty”) will only add to the confusion faced by many retail investors.

The world of wealth management can be a confusing, daunting place for the average investor. At the same time, there has never been more information available to the investing public. This apparent paradox is a problem that regulators and consumer advocacy groups have tried to address for years by, among other things, mandating more disclosures and imposing “plain English” requirements. Unfortunately, even the best intentions often have unintended consequences. Recent regulatory efforts seem to have added to the confusion by moving the concepts of “suitability” and “fiduciary duty” to the forefront, and those with a financial interest in the confusion (i.e. broker-dealers, investment advisers, and other financial professionals) have taken advantage.

Let’s take a step back and examine where all the confusion comes from. The financial services industry is populated by several types of financial professionals, including financial planners, insurance agents, accountants, estate planning attorneys, brokers, and investment advisers. Each of these professionals has different duties and legal obligations, including the fiduciary duty owed by investment advisers to their clients (which means they are held to the highest standard of conduct and must act in the best interest of their clients) and the duty of fair dealing owed by a broker to a customer (which, in part, means that they will only make recommendations to buy securities that are suitable for the customer).

These various players used to stick to their own turf and serve distinct needs of the investing public. For example, brokers typically buy and sell securities for their customers and, in return, the customers pay the broker commissions on the transactions. As long as a transaction is suitable for a customer (i.e. appropriate for the customer’s investment objectives), a broker can recommend a security that paid the broker a higher commission even if there were suitable alternatives that were cheaper for the customer (and therefore generated smaller commissions).  On the other hand, investment advisers provide regular and continuous investment advice, usually to high net worth clients, for a fixed, asset-based fee. While there can be other fees involved, all fees have to be clearly disclosed to a client before the advisory relationship begins.

These days, any given financial professional or entity might offer two or more products or services (insurance, financial planning, estate planning, stock trading, and investment management), this includes companies that are registered as both investment advisers and broker-dealers. These so-called “hybrids” act as investment advisers in some situations and as brokers in others. Needless to say, the duties, legal obligations, and compensation structure of such companies can be murky at best.

The SEC introduced its current proposals way back in April of 2018 in an attempt to clear up the confusion. These proposals are intended to “enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.”[1]  Easier said than done.

The most ambitious of these proposals, known as Regulation Best Interest, has garnered the most attention. It would require broker-dealers to “act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer [and] … make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.”  Another proposal is “an interpretation to reaffirm and, in some cases, clarify the [SEC’s] views of the fiduciary duty that investment advisers owe to their clients,” which, as the SEC says, includes the obligation to “act in the best interest of its client.”[2]  The SEC believes that “[by] highlighting principles relevant to the fiduciary duty, investment advisers and their clients would have greater clarity about advisers’ legal obligations.”

As an aside, it seems reasonable to assume that any investment professional will act in the best interest of their clients or customers. However just because they are supposed to act a certain way doesn’t mean that they will. The SEC’s website is full of enforcement actions against investment advisers that failed to uphold their fiduciary duties.

These two proposals have yet to be implemented by the SEC, but they have already sparked a fierce debate among brokers and advisers, some of whom believe that all financial professionals should be held to the fiduciary standard and others who think there was nothing wrong with the status quo. The proposals also appear to have spurred a new wave of marketing, with some firms touting the fact that they are fiduciaries and that they don’t accept commissions and others talking more about their low brokerage fees.

The additional disclosure and marketing prompted by the SEC’s proposals is great, but I fear that in all the noise of the suitability/broker vs. fiduciary/adviser argument that the real jewel of the SEC’s proposals is being missed. People who are looking to hire a financial professional shouldn’t do so based on a label, the label is only one part of the equation. Investors needs to take a deeper look under the hood to find out exactly what they are getting.

The SEC’s third proposal aims to allow investors to do just that by requiring brokers and advisers to provide their clients with a new short-form disclosure document, referred to as Form CRS (short for client relationship summary), that would “provide retail investors with simple, easy-to-understand information about the nature of their relationship with their investment professional” and supplement other, more detailed disclosures. For advisers, those detailed disclosures would be those found in Form ADV, which advisers are already required to provide to their clients. For brokers, the detailed disclosures would be those required under Regulation Best Interest (which, again, has not been enacted).

I believe that Form CRS would make a real difference in the industry by laying out the key distinctions between an independent investment adviser (i.e. an investment adviser that is not also a dually registered has no broker-dealer affiliation) and a broker-dealer. Moreover, for clients of an investment adviser, the ADV is typically the primary source of the adviser’s disclosures. But the ADV can run dozens of pages long and is often drafted by a law firm hired by the adviser. They often contain so much legalese and such detailed disclosure language that it can be very difficult for most people to read and understand, if they even bother to read it at all. As a result, it is easy to miss a lot of the important disclosures relating to fees, conflicts of interests, and regulatory events. Form CRS can be a better vehicle for disclosing these key issues in a simple, straight-forward way. Form CRS is supposed to be no more than four pages long and would disclose the services offered, fees and costs, conflicts of interest, and any regulatory disclosures such as disciplinary events and complaints.

At Spotlight Asset Group, we felt so strongly that Form CRS is the direction the industry needs to go that we came up with our own document ahead of the SEC finalizing any of these rules. Our “Prospect Proposal” is a two-page document that highlights all of the information we feel is important for prospects to know before they sign up with us as a client.  This includes the services we will provide, the fees they will be charged as both a percentage and as a dollar amount, any additional costs like trading commissions or expense ratios, any material conflicts of interest we may have, and how their individual investment adviser representative is compensated. If at some point we have a regulatory or disciplinary item that should be disclosed, we would disclose it in our Prospect Proposal. We are working to implement the use of the Prospect Proposal across the firm because we believe that it is important to be completely transparent with our clients at the outset of the relationship. Not only is this fair, it serves to set the tone for an open dialogue and cooperative partnership with our clients. As noted in a recent Intelligent Investor editorial by Jason Zweig of the Wall Street Journal, this dialogue is the real key to a good relationship between a financial advisor and their client.[3]

I think such upfront disclosures are vitally important and should become the standard for all financial professionals. While the current disclosure documents lay out an adviser’s duties or a broker’s obligations, in my 15 years in the investment business I can count on one hand the number of clients who have asked questions about disclosures in an ADV or other document. It doesn’t happen often because a lot of people don’t read them. Wouldn’t it be better if a financial professional had to proactively go through all relevant information with a prospective client or customer before they signed on the dotted line? That is the argument we should be focusing on, not a confusing discussion about who is a fiduciary and what that means.

[1] See  SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals at https://www.sec.gov/news/press-release/2018-68 (April 18, 2018) (emphasis added).

[2] See Regulation Best Interest, Release No, 34-83062, available at https://www.sec.gov/rules/proposed/2018/34-83062.pdf  (April 18, 2018) (emphasis added).

[3] Jason Zweig, A New Rule Won’ Make Your Broker an Angel, available at https://www.wsj.com/articles/a-new-rule-wont-make-your-broker-an-angel-11559313036?mod=hp_lead_pos11 (May 31, 2019).

Stephen Greco, CEO

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