Intergenerational Planning: Time to Start Planting Seeds

Brett Horowitz

Brett Horowitz, CFP®, AIF® Principal, Wealth Manager

It takes the average recipient of an inheritance 19 days until they buy a new car.1

                Over the past several years, some of our clients have participated in client advisory boards in which they tell us what they want and what keeps them awake at night. One of the biggest challenges is bringing up finances and financial planning with their children. They are not alone. Intergenerational planning, in which families look at long-term financial needs together, is sorely missing. But to the surprise of many, it’s not just the parents who want this connection—it’s the kids as well. A study from MFS Investment Management reports that more than one-third of those in the “sandwich generation” (people ages 40 to 64) worry about aging parents’ financial issues in addition to their adult children’s financial issues.2 It’s about time to get everyone involved.

                According to the same study, less than half of the sandwich generation has prepared a list of assets, created a durable power of attorney or living will, purchased long-term care insurance, or established a trust. Further, even if they have checked off the boxes for these basic estate-planning tools, many have not communicated this information to their children.

Given that the older generation has been reluctant to have needed discussions, should we be surprised that the sandwich generation is concerned about their parents’ finances, yet hasn’t done anything to prepare their own children for what’s to come? All too often, the burden of managing a parent’s deteriorating health or financial situation falls to an adult child, who must step into a parent’s shoes at the last minute and try to cobble together information to form a basic plan. If a parent doesn’t discuss their specific assets with their adult children, and if no one knows they exist, those assets may not be used for their care. Assets may wind up being claimed by the state or federal government, adding to the more than $58 billion in abandoned property. Recent statistics suggest that 70% of families lose control of their assets when an estate is transferred to the next generation and 90% of the wealth is spent by the third generation. Why? About two-thirds of high-net-worth individuals have disclosed little about their wealth to their children, with the most common reason being that they do not feel that the next generation is financially responsible enough to handle an inheritance. Parents can head off this asset transfer problem, while at the same time avoiding divisive and costly family feuds, by taking the lead in these transformative conversations.

                The good news is that many of our clients have become more organized while working with us, and a lot of this information is in one place. But unless this information is disseminated to adult children, it remains stressful for everyone involved. Parents should suggest a family meeting with all their children at the same time to help ensure that their message is received uniformly. Having these conversations one-on-one may cause family members to fight, harbor grudges, or get confused, with the result that the discussion has the opposite of the intended effect.

For instance, parents may choose to leave money to their children in a trust, much to the dismay of the children, who may believe that this is being done to prevent them from having unfettered access. But perhaps the parent is trying to protect the children from creditors, due to having litigious jobs. Another reason could be a desire to protect money from a child’s former spouse. There could be estate or income tax reasons to form the trust in a certain way. Or it could be as simple as wanting to make sure that their frivolous-spending children do not run out of money within the first few years of receiving the inheritance. Parents may think that they are encouraging hard work by not disclosing their financial situation to their children, but they may in fact be fostering ignorance and anger.

These joint meetings may help a parent spell out their reasoning for how they are dividing their assets (including the house and personal belongings) and how they have decided who will be the estate’s executor, have durable power of attorney, or be the primary caregiver for minors. It’s much easier to understand what a parent wants to accomplish with their estate plan if they’re still around to explain it to their family. This doesn’t mean that specific numbers have to be included and that full disclosure be given, but it’s up to the parents to start the conversation and share what they are comfortable sharing.

In other cases, the parent is more interested in handing down values than money. Perhaps all that’s needed is a simple conversation about the importance of having a financial team—consisting of a financial planner, estate attorney, and accountant—establishing a financial plan, saving and investing money, and giving back to charity. So often we hear from clients that a discussion early in their childhood about money formed the foundation for their lifelong financial habits. If the situation is more complex, a family facilitator might need to be hired, someone who can broach difficult, personal, and possibly painful subjects, with the end result being a unified family that is more aware of each other’s feelings and goals. These conversations can be done at the 30,000-foot level if not everyone is comfortable sharing information, or they can be very specific. No one wants a child to feel entitled to expect a large inheritance, but as a parent, do you want your children completely left out of the loop?

                Our firm can help parents review their long-term financial plan with their children, discuss where accounts and important documents are located, and provide contact information for the parents’ financial team. The family should review the will/trust and communicate their wishes about health care preferences to avoid squabbles (who will ever forget the Terry Schiavo situation?). Getting everyone in the same place keeps the message consistent and unequivocally removes any doubts that may have been building. It’s not going to be the easiest of conversations, and all parties may start off anxious, but reticence about the subject will surely backfire. If parents are concerned about their children and children are concerned about their parents, doesn’t it make sense to get everyone together in a room to talk?

1 The source for cited statistics is a Time article, available at:


2 The source for cited statistics is an MFS study available at:


Feel free to contact Brett Horowitz with any questions by phone 305.448.8882 ext. 216 or email:

For more information on financial planning visit our website at

Could a reverse mortgage be right for you?


John R. Salter, CFP®, AIFA®, PhD Wealth Manager, Principal

If you are up late at night, you might have seen the TV commercials with your favorite stars of yesteryear and thought that reverse mortgages were only needed if you had nothing left—a last resort whenever every other option has been exhausted.

Changes to the FHA insured Home Equity Conversion Mortgage, or HECM, have changed the face of the reverse mortgage we once knew, opening the mortgage up to many more possible uses. In fact, the HECM program has been the focus of my research for the past few years as a faculty member of Texas Tech’s Personal Financial Planning program, where we have been searching for its possible uses in retirement planning to make sure you are able to sustain your standard of living for the rest of your life.

The HECM program can provide three main ways to utilize the equity built up in your home:

  • Line of Credit – The unused credit line actually grows over time, allowing a higher benefit in later years. The credit line can be borrowed against, and paid back with flexibility.
  • Monthly Payments – These payments, known as tenure payments, essentially convert home equity into annuity-like payments for as long as the owners remain in the home.
  • Lump Sum – A larger distribution from the home equity, often used for issues such as large home maintenance, paying off a traditional mortgage, etc.

Payback of the mortgage is flexible; the loan can be paid back at any time, but any borrowed funds plus interest are ultimately due upon sale or death of the homeowner (the owner or owners on the mortgage). The portion of the upfront fee to FHA and ongoing charges if funds are borrowed are used to make the loan nonrecourse, meaning that upon sale or death the amount due will not exceed the market value of the home. Beware, of course, that any funds used are a debt and have to be repaid at some point—it is, after all, a loan.

So how can this help you? If you and your spouse or co-borrower are over 62, you are eligible to qualify. Even if you feel you are wealthy, the program can contribute to your future financial well-being. I will outline a few quick ideas we have researched and find credible—we are working on many more. (Note that the program has changed to allow a second borrower to be under age 62 and be on the loan, but understanding and care must be taken before making this decision.)

Replace a home equity line of credit (HELOC) – A traditional home equity line of credit, although “free” to set up, has a few drawbacks. For one, the lender can reduce, call, or cancel the line of credit at any time; this cannot happen with the HECM program. In addition, payback with an HEMC is flexible and voluntary and the unused line of credit actually grows over time.

As a last resort, rather than waiting to establish a reverse mortgage later, do it today and let it sit. The interest rate environment is such that you can have a larger line of credit today compared to what it would likely be in the future. You may never use it, but you won’t be mad that you paid for home insurance all these years and never had to use it either.

Refinance your mortgage – Provides flexibility in repayment or stop payments altogether, or to refinance a resetting HELOC.

Increase income – The monthly payment option allows you to draw monthly payments for the rest of your life.

I would encourage you not to automatically dismiss the idea of a reverse mortgage. Take the time to learn more about it and find out how it may fit your needs. The program is complex, so there is no way to fit all of the details in this column, but you can find a lender that is more than happy to help educate you—there are many out there.

By John Salter, PhD, CFP®

John is a partner and wealth manager at Evensky & Katz/Foldes Financial Wealth Management and associate professor of personal financial planning at Texas Tech University. He can be reached at

References and Supplemental Reading

Pfau, Wade D. 2016. “Incorporating Home Equity into a Retirement Income Strategy.” Journal of Financial Planning 29 (4): 41–49.

Pfeiffer, Shaun, C. Angus Schaal, and John Salter. 2014. “HECM Reverse Mortgages: Now or Last Resort?” Journal of Financial Planning 27 (5): 44–51.

Salter, John R., Shaun A. Pfeiffer, and Harold R. Evensky. 2012. “Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions.” Journal of Financial Planning 25 (8): 40–48.


Thoughts before Funding a 529 Plan

Roxanne Alexander

Roxanne Alexander, CAIA, CFP®, AIF®, ADPA® Senior Financial Advisor

The new tax law was amended to allow tax-free distributions of up to $10,000 per year from a 529 plan for elementary and high school costs starting in 2018. This is an added benefit and can be an advantageous tax break for parents starting to save for their young child’s education.

College costs have outpaced inflation. According to The College Board®, the average 2014-2015 tuition increase was 3.7 percent at private colleges and 2.9 percent at public universities. However, looking back at the last decade, the 10-year historical rate of increase has been approximately 5 percent.

529 Basics — Opening a regular savings account/custodial account for your child is an option, but this comes without the benefits of a 529 plan such as the tax-free growth on earnings if the funds are used for qualified college expenses. Deposits to a 529 plan up to $15,000 per individual per year ($30,000 for married couples filing jointly) will qualify for the annual gift tax exclusion (for 2018). You can also front-load your investment in a 529 plan with $75,000 ($150,000 if joint with your spouse) and use this toward your gift tax exemption for five years providing there have been no other gifts to that child — this is not possible for a regular savings/custodial account for your child (you would only be able to gift $30K jointly). By adding a large amount up front, you allow the lump sum to grow over a longer time horizon vs. making smaller contributions over time. Contributions to a 529 plan do not have to be reported on your federal tax return.

Contributions to a 529 plan are not tax deductible (although some states do offer tax benefits), but the earnings grow tax free and are not taxed if used to pay for education. Another advantage compared to a custodial account is control; the named beneficiary has no legal rights to the funds, so you can ensure the money will be used for education.

A 529 account owned by someone other than the parent (such as a grandparent) is not considered an asset for financial aid purposes. Also, the value of a 529 account is removed from your taxable estate, yet you retain full control over the account.

How to choose a 529 plan? Research the underlying expenses of the mutual funds and review the investment options available compared to other plans. The age-based models may be the easiest to manage as the plan shifts to more conservative investments as the student gets closer to college age. You can choose any state plan no matter where you live, but if you reside in a state that provides tax breaks for using your state plan, you would likely want to start there. For example, New York residents get tax benefits for using their state plan. Keep in mind that you have the ability to move your 529 to another provider, but only one rollover is permitted per twelve-month period.

How much to fund? The amount to contribute to a 529 plan depends on several assumptions such as whether your child will attend a public college or a private college, the returns during the investment time horizon, and future college inflation. Funding varies widely depending on what you would like to achieve and the assumptions involved — and of course there is no right answer. If the beneficiary does not go to college, you can transfer the 529 plan to a sibling in the future or to another family member such as a cousin or grandchild. If you don’t have any eligible family members, the worst-case scenario is that you would have to pay tax and a 10% penalty on the earnings to take the money out for another purpose. Withdrawals from a 529 plan that are not used for the beneficiary’s qualified education expenses are taxed and penalized (subject to a 10 percent federal penalty and taxed at the income tax rate of the person who receives the withdrawal). If the beneficiary gets a scholarship, then the penalty is waived.

Avoid overfunding the 529 if possible as “qualified education expenses” do not cover all expenses related to college. Qualified expenses include tuition, on-campus room and board, books and supplies, computers, and related equipment. It may also make sense to save otherwise for expenses such as travel, cars/transportation costs, insurance, sports or club dues, and off-campus housing, etc., which are not considered qualified expenses but can easily add up.

Considerations if you have more than one child — If you have several children, it may make sense to fully fund the first plan for the oldest child and if the funds are not used, they can be transferred to the next child in line. You probably want to avoid fully funding all the plans in the event one child does not end up going to college, gets a scholarship, or starts a business. Some schools and some trade schools/programs do not qualify for 529 funds (for example, if a grandchild wants to go to a specific acting or cooking school). You can find out if your school qualifies by using this link:

Feel free to contact Roxanne Alexander with any questions by phone 305.448.8882 ext. 236 or email:


What Constitutes the Art of Practicing Financial Planning?

The below chapter is from “The Art of Practicing and the Art of Communication in Financial Planning” (Click here to purchase the book.)

Matt McGrath

Matthew McGrath, CFP® Managing Partner Wealth Manager

Why would one use the word “art” when describing the practice of financial planning?  The most highly qualified planners have gone through rigorous education and testing in order to acquire licenses and certifications.  They use a methodical process to establish the client-planner relationship.  This process includes gathering data, analyzing and evaluating the client’s status, developing and presenting recommendations; as well as implementing and monitoring those recommendations.  They use sophisticated software to run complicated analyses and they stay abreast of laws and regulations affecting a wide array of financial issues.  Where is the art?

The art of practicing financial planning can be found when professionals deploy a fundamentally sound process while injecting experience and judgment to develop advice in the best interest of the client.  Financial planning involves altering human behavior which presents unique challenges each and every single time.  It includes navigating an ever-changing body of knowledge and applying it to individual circumstances in order to arrive at a recommendation appropriate at that point in time.

Let’s start with the people.  At its core, financial planning is a “people” business.  Clients are looking to planners to guide them on some of the most important decisions of their lives.  Establishing trust and maintaining effective communication are crucial to the successful execution of the financial planning process.  Being technically proficient (i.e. “book smart”) does not necessarily translate to successful advice.  The ability to communicate the relevant details to clients in a way they understand and embrace is the key to effective planning.  Successful financial planners channel their inner teacher to convey facts, figures and details in a way that is easy to comprehend.  Many clients are intimidated by financial matters, and it takes skill to break through those emotional barriers and establish a level of comfort.

Of course, before attempting to communicate any advice, a good planner needs to start by listening to their client.  Understanding what is truly important to a client is crucial to establishing trust and rapport.  The last thing a client wants to hear is generic advice regurgitated from a book; they can find the information in countless places using any internet connected device.  What they want is someone who understands their personal concerns and goals and develops recommendations specific to them.  If a planner is doing all the talking in client meetings, then I would argue that they are not engaging in true financial planning.  Listening must always come first.  Meetings should involve meaningful two-way conversations, not a one-way presentation.

Keep in mind, when working with people, every situation is unique and emotions play a big part in the process.  People do not always behave in a rational manner.  It is not unusual for a client to come to tears during a meeting.  Money, finances and the future can be very emotional topics.  Therefore, the right advice on an issue may not necessarily be the one with the maximum financial outcome.  Client biases, fears and preconceptions can all have an influence on the ultimate advice.  A good planner will try to guide the client to a rational decision, but also has to acknowledge that a client needs to be able to live with the outcome.  Empathy is critical, as is the ability to interpret and understand the motivations of each client in order to develop advice appropriate for them.  The “people” side of financial planning can be very complicated and the ability to interact with others is a necessary ingredient in the art of practicing financial planning.

It is also essential to understand that financial planning is a journey, not a destination.  Changes occur every day.  Planners deal with a wide array of issues such as marriage, divorce, recessions, market crashes, retirement and, sadly, death.  Successful planning keeps up with these changes by adapting to the new circumstances in a way that keeps the client on the path to accomplish their goals.  Success is not measured by dollars or annual rates of return; nor is it defined by the creation of a beautiful comprehensive financial plan that goes in a drawer never to be seen again.  Rather, it is defined by the ongoing achievement of goals throughout one’s life.  It is an organic process that, for each client, takes on a life of its own.

The planning process often involves evaluating questions that have more than one potential answer.  Part of the art of financial planning involves evaluating those answers and helping someone choose the best one for their personal situation.  At the end of the day, the planner’s objective is to enable clients to make informed decisions.  I once had a client ask me if he should take his kids out of private school and I told him that’s not my call.  I can walk through his financial plan with him and help him understand the consequences of different decisions.  But in the end, the clients need to take ownership of their decisions and their lives.  Planners who cross this line are doing a disservice to their clients and robbing them of their true financial freedom.  A planner’s role is not to tell someone what they should do; it is to empower them to make appropriate decisions within the context of their unique lives.

The art of practicing financial planning exists in the less tangible aspects of the process.  This involves listening, assessing, analyzing, communicating and ultimately recommending a course of action.  Experience, judgment, trust and communication are crucial to the successful implementation of a financial plan.  Information is everywhere, but knowing what to do with it to help an individual achieve their specific goals is absolutely a form of art.  Like other forms of art, it is predicated on an underlying body of knowledge that must be successfully interpreted and executed under specific circumstances.  And like good artists, good planners will be greatly appreciated by their clients.

Feel free to contact Matt McGrath with any questions by phone 305.448.8882 ext. 206 or email:

Should I invest in Bitcoin?

Roxanne Alexander

Roxanne Alexander, CAIA, CFP®, AIF®, ADPA® Senior Financial Advisor

Bitcoin discussions have plastered the financial media over the last couple of weeks, making everyone wonder whether this new digital currency is the next bubble. Although there have been many innovations in digital currency markets and crypto-currency does have some advantages, before taking the plunge, make sure to look at the risks.

The Bitcoin concept was developed to create a new type of currency shielded from devaluation and dilution by government monetary policy. Only small amounts are being released, as coins are “mined.” The mining process gets more complex as computer algorithms are solved, which slows down the creation of additional coins over time, and ultimately controls the supply. Think of having a limited supply as demand increases — similar to the gold standard in which paper dollars were matched to the gold supply. This is no longer the case, as the United States and other governments print money as needed, thus devaluing their currency. Bitcoin was also developed to address a lack of access to money, high transaction costs, and forced reliance on middlemen — the big banks.

In my opinion, the recent run up in the value of Bitcoin is speculative. The more investors who rush to get a piece of the pie further increase the demand for a limited supply. Although there has recently been a huge return on Bitcoin and a few success stories, Bitcoin still has many potential downfalls such as technological risk, financial risk, legal risk, and tax risk.

Most concerning, there is no financial regulation in this space, so many bitcoin providers have gone out of business — leaving investors with no options to recover their assets. Once your bitcoin disappears, there is virtually no legal recourse to retrieve it. Transactions occur peer-to-peer and are operated by a decentralized authority. There is no bank or central government backing the currency.

Volatility and financial risk — Bitcoin experiences significant daily price swings, making it difficult to use as a currency. For example, you can buy an item such as a soda using Bitcoins in the morning only to find that you paid 10 times more for the soda by the afternoon. This unstable pricing makes Bitcoin less conducive to business transactions. Furthermore, many people are speculating rather than using Bitcoin for commerce; thus, few businesses accept it as payment. Bitcoin embodies the traits of a speculative investment rather than a currency; it is essentially a start-up and most start-ups do fail. Mismanagement and underfunding could crash the system. The volatility of Bitcoin trumps that of the stock market and if you get in at the wrong time, it might only be downhill from there. Should investors get spooked and decide to bail, you may find what you paid being sliced in half in a matter of days.

Technology and security risks — Do you trust computers? Currently, there are no individuals or organizations who can be held accountable if something goes wrong. The Bitcoin system is run and developed by volunteer programmers, so a bug or glitch could bring the system down quite easily. You access your Bitcoins via a private key to gain access to your digital wallet — if you lose this key, your bitcoins are gone for good. If you happen to get a computer virus, it can infect your Bitcoin wallet and steal your Bitcoins.

Tax issues — Bitcoins are treated as “property” as opposed to currency for tax purposes; consequently, the accounting can be a nightmare since you must constantly track the value and pay taxes only on capital gains.

Despite the illegal activity that was previously facilitated using Bitcoin, I do see potential uses of crypto-currency, particularly for smaller transactions which can bypass bank and credit card fees. However, without regulation there is still a huge risk for future development. If Bitcoin does evolve and regulations are created, there is a potential use for government spending since Bitcoins can be programmed. By sending currency in this manner, fraud and theft can be prevented since you can specify how the money should be spent. That being said, governments are unlikely to loosen control of monetary policy without a fight, meaning Bitcoin may take years to become a widely acceptable payment option.


Some useful links/books:

Bitcoin and the Future of Money: Jose Pagliery (2014)

Feel free to contact Roxanne Alexander with any questions by phone 305.448.8882 ext. 236 or email:

What You Need to Know About CDs

Kristin Fang

Danqin (Kristin) Fang, CFA, CFP® Financial Advisor

What is a CD and what do CDs provide?

As explained by Investopedia, “A certificate of deposit (CD) is a savings certificate with a fixed maturity date and a specified fixed interest rate, and can be issued in any denomination aside from minimum investment requirements.” CD maturity terms vary from one month to five years or even ten years with different interest rates determined by both the market interest rate and the maturity terms. The longer the term is, the higher the rate is. Additionally, there is usually a $1,000 minimum required for most CDs available on the market, and a CD with a greater than $100,000 minimum is known as a jumbo CD, accompanied by a higher interest rate for the same specified term. All CDs are FDIC insured up to $250,000 per account registration.

What is the difference between a Brokered CD and a Bank CD?

CDs issued directly by depositary banks are called bank CDs, while CDs offered by brokerage institutions are called brokered CDs. The brokered CDs are bulks of CDs bought by the brokerage firms, such as Charles Schwab or Fidelity Investments, and then re-sold to investors after slicing and repacking. The advantage of owning brokered CDs is diversification because you can buy different bank CDs from one brokerage firm and see the values and due dates all listed on one aggregated brokerage statement. This also helps you to track all your CDs easily. However, the disadvantage is the additional risk associated with owning CDs from banks that go under. Also, when buying brokered CDs, it is prudent to net the brokerage fees, although de minims in most cases, off their higher nominal interest rates when comparing them to the interest rates offered by bank CDs.

What is an Early Withdrawal Penalty?

With CD investments, you are restricted from withdrawing your funds before the maturity date unless you pay a penalty. The penalty usually takes up a few months’ worth of interest, depending on the issuing institution. This allows you to redeem your CDs before their maturity and opens the door to a more sophisticated CD investing strategy to be introduced next. Sometimes paying the penalty has a better outcome.

Advanced CD Investing Strategy

Regardless of the investment time horizon for your cash, you buy a five-year CD. Should the interest rate increase the following year, you’d then weigh your early withdrawal penalty against your interest income earned in the first year. If paying the penalty is the better option, then withdraw your entire CD portfolio and buy into a new five-year CD that offers a higher interest rate either from the same bank or from a different provider. In order to make this strategy work, a careful investigation of the early withdrawal penalty rules is key. Based on my research experience, some banks charge a lower early withdrawal penalty than others, for example, 180 days’ worth of simple interest versus 540 days’ worth of simple interest for a five-year CD. Let’s look at an example here:

You have $100,000 to invest for one year and are comparing a one-year CD offering 1% APR and a five-year CD offering 3% APR from the same bank. The early withdrawal penalty is 180 days’ worth of simple interest on the five-year CD.

Scenario 1: If you choose to invest in the one-year CD, your interest income after one year will be approximately $1,000 (1% multiplied by $100,000, to simplify the math from daily compounding to a simple interest calculation).

Scenario 2: Instead, if you choose to invest in the five-year CD, after one year, your gross interest income before paying the penalty will be approximately $3,000 (3% multiplied by $100,000), but you will need to pay approximately $1,480 ($3,000 gross interest divided by 365 days and then multiplied by 180 days) in early withdrawal penalty, which is equivalent to 180 days’ worth of simple interest, in order to redeem your five-year CD before its maturity date. This will net you approximately $1,520 in interest income ($3,000 gross interest income minus the $1,480 early withdrawal penalty), which is $520 more in interest income compared to Scenario 1. Clearly, with the additional $520 net interest income pocketed in Scenario 2, you are better off to invest in the five-year CD and pay the penalty at withdrawal in one year.

Below is a chart summarizing both scenarios:

CD Blog Picture

Caveat of using this strategy:

Please keep in mind that the outcome of this strategy depends heavily on the interest rates offered and the early withdrawal penalty levied by each bank. A prudent approach is to run the math thoroughly before taking any action, because banks adjust their CD rates periodically. For questions, please feel free to contact us at Evensky & Katz / Foldes Financial Wealth Management.

Feel free to contact Danqin (Kristin) Fang with any questions by phone 305.448.8882 ext. 222 or email:

Lagniappe: Some Final Takeaways

HRE PR Pic 2013

Harold Evensky CFP® , AIF® Chairman

I couldn’t resist using one of my favorite words—lagniappe. It means a little something extra, given at no cost, somewhat like the thirteenth doughnut in a baker’s dozen. Because there are so many topics and issues I could not cover in the previous chapters, here’s my lagniappe.

Small and Ugly May Be Beautiful. If you need more returns. One possible strategy, supported by decades of research, is to overweight a few market factors in your portfolio. Based on the original research of two well-known academics, Gene Fama and Ken French, you allocate some of your stock holdings to small companies and value stock. Over the long-term, you’re likely to be rewarded with a few extra percentage points of returns.

Maximize Quality of Life, Not Returns. It’s confusing, but after having designed many hundreds of retirement plans, it’s obvious that if you’re near or in retirement and depending on your portfolio to provide cash flow for your lifestyle, a higher allocation to bonds is likely to increase your likelihood of success at the cost of reducing the likelihood of making more money.

Hot Stocks Pay. If you’re an active trader in hot stocks, the activity will pay your broker but not you. Remember two old jokes: 1) Broker to a new client pointing out the window of his beautiful office overlooking the bay. “See that yacht; that’s my partner’s. The one next to it is Mark’s—he’s the broker next door—and the one next to that is mine.” The wise prospect asks, “Where are the clients’ yachts?” 2) How do I make a $1,000,000 in the market? Start with $2,000,000.

Safety versus Certainty. My friend Nick Murray shakes his head when he hears people talking about safe investments. He says (and he’s right): investors confuse safety with certainty. Putting your nest egg into insured CDs may offer the certainty that when they mature, you get your principal back with the promised interest; however, assuming you’re like most of us and find your expenses going up with inflation, over time your safe investment is likely to buy you less and less of the goods and services you need. This is called purchasing power erosion and it’s one of the biggest risks retirees face. The solution is to plan on a safe portfolio—one with bonds and stocks—and avoid the certainty of losing purchasing power with a safe investment.

It Doesn’t Cost You Anything Don’t You Believe It. Unless you’re the kind of person who believes in fairy tales. No professional can afford to work for free. Good investment advice is valuable, and people providing advice deserve and expect to be compensated. So it really angers me when an investor says they were told a service shouldn’t cost them anything.

 Two prime examples are bonds and variable annuities. When purchasing a bond, it’s true that you’re not charged a commission. That doesn’t mean you’re not paying compensation. Bonds are sold based on something called a spread. You might be offered a $10,000 bond at 102.5. That means your cost would be $10,250. The broker may have been told by his bond department: “This bond is available at 100.5. How much do you want to add?” To which the broker responds, “Two.” And the trader says, “Fine. Done at 102.5.” The result: you’re purchasing a bond with a 2 percent markup. The markup is the fee to the broker and brokerage firm. Again, there’s nothing wrong with paying a markup, but make sure you’re told how much it is. The good news is that you can check by going to , a website that provides the details of most bond trades.

A Variable Annuity (VA) is another investment product that, unfortunately, a small minority of unscrupulous brokers use to take advantage of clients. The line is: “Don’t worry. It doesn’t cost you anything. The insurance company pays me.” Although factually true, it’s massively misleading because it ignores the reality of where the insurance company gets the money to pay the broker. The money comes from you, the annuity purchaser. The practice is particularly egregious because VAs typically pay relatively high commissions to brokers and they have no break points, unlike mutual funds. On mutual funds the commission drops as the purchase size gets larger. The broker gets the same percentage on a VA no matter how big the purchase.

Duration, Shmuration. Who Cares? You should. You probably know, or at least have heard (especially if you read Chapter 7, “Getting Your Money Back”), that bonds are subject to interest rate risk. That’s the risk of being stuck with a poor investment if after having purchased a bond, interest rates rise.

Consider John, new owner of a $10,000 ten-year bond purchased when it was paying 4 percent. Five years later, interest rates are up and a new five-year bond of the same quality now pays 7 percent. If John wishes to sell his bond, he would be offering his now five-year bond paying 4 percent. There is no way someone will pay him $10,000 for a bond paying 4 percent when the buyer can purchase a similar quality bond paying 7 percent. So if the owner, John, wants to sell, he’d have to sell at a discount.

That discount is interest rate risk. Most investors equate this risk with maturity—they assume a ten-year bond has significantly greater risk than a five-year bond. Sounds reasonable but it’s not necessarily true. The problem is that focusing only on maturity leaves out an important factor—the coupon, which is how much the bond issuer pays annually. The higher the coupon, the sooner the investor has some funds back to reinvest at the new, higher rate so a high-coupon bond might have less interest rate risk than a shorter-maturity, low-coupon bond. For an approximate guide to the level of interest rate risk a bond has, ask about the bond’s duration. That number will provide a very rough guide to the potential loss in value if rates rise. The measure is 1 percent for every year of duration. So a bond with a five-year duration might be expected to lose 5 percent if rates go up 1 percent or 10 percent if rates rise 2 percent. Not a perfect measure but far better than maturity.

I’ll Keep an Eye on It. When I caution clients about the risk of a heavy concentration in a single investment, they often respond, “Harold, I understand, but I keep a careful eye on it.” That sounds wise. Unfortunately, as Professor Sharpe taught us about the unrewarded diversifiable risk, that’s false confidence. It’s a risk that can blindside you.

Think about the fact that many years ago a crazy person who put poison in some Tylenol bottles threatened the business of Johnson & Johnson or consider the Gulf oil disaster that almost buried BP. Years ago, I used to use as the example of a company building a major manufacturing facility over what turned out to be a toxic waste dump. Well, one day, using that story to persuade my clients to reduce their exposure to the stock they held in the company where they had both spent their careers.

Their mouths dropped open and they said, “Good Lord! You’re right! We’ll sell out.” It turned out that just a few years earlier their company had, in fact, developed a major research facility over what later turned out to be a toxic dump and it almost bankrupted the firm.

It doesn’t matter how blue the blue chip is, the risk is there. Many years ago I warned a trustee that a portfolio allocation to AT&T stock representing about half the portfolio value was a significant risk. Unfortunately, I wasn’t very persuasive and the trustee scoffed at my warning—after all, it was AT&T. About a year later the value dropped over 50 percent. The drop had nothing to do with my having a crystal ball; it might just as well have doubled in price. The point is that the risk is real.

Counting on Gurus to Predict the Future May Be Hazardous to Your Wealth. No question about it: when doing investment planning, you need to have some opinion about future market returns. In my office, I have all of the important elements, including extensive databases, sophisticated analytical software, an expensive crystal ball, and a Ouija board. The future is mighty cloudy and surprises even the best of us.

The moral? It’s not Buy and hold, it’s Buy and Manage. Make your best estimates about the future and be prepared to change. Just don’t put too much faith in any guru’s ability to tell you where the market’s going, no matter how confident he or she may be.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

The Efficient Frontier: How Much Risk Can You Stomach?

HRE PR Pic 2013

Harold Evensky CFP® , AIF® Chairman

Anchoring on the efficient frontier may sound like something out of Star Trek, but it’s not. It’s better.

Harold Evensky (HE): Mr. and Mrs. Curtis, good morning. I’m Harold Evensky and this is my partner, Matt McGrath. Welcome to Evensky & Katz. I always like to start by asking, “What brings y’all here?”

Mr. Curtis (Mr. C): Well, Harold, Vickie and I are thinking about retiring in just a few years. We’ve saved quite a bit and think we’ll be in good shape, but we had some friends who retired a few years ago, who thought they were in good shape only to discover that things didn’t work out quite as well as they expected and they’ve had to do some major cutting back in their lifestyle. We don’t want that to happen to us. The Hamptons said you helped them do some planning for their retirement so we thought we’d like to work with you to do the same.

HE: Wonderful. Let’s have some fun envisioning your future. And that’s the key—it’s your future. Our job is to empower you to plan that future. Suppose we start off with an introduction: “Modern Portfolio Theory and You.” Matt, may I have a blank sheet of paper from your pad? Thanks.

Here’s a simple picture of the investment world. On one axis, we’ll plot risk and on the other, return.

The Efficient Frontier Chapter Image file - .01.png

As you’d expect, cash would not be very risky, but it would not provide much in the way of return, whereas stock might provide a high return but at some risk. Bonds are somewhere in between.

With just these three choices, we could still design thousands of portfolios. For example, 99 percent bonds and 1 percent stock or 99 percent stock and 1 percent bonds. If I put dots on my graph for the risk and return combinations of all of these combinations, I’d fill up the picture with dots. Then, if I drew a line enclosing all of those dots, I would end up with a curved line that’s called the efficient frontier.

The Efficient Frontier Chapter Image file - .02

That means, at least theoretically, there is no best portfolio but rather an infinite number of best portfolios, depending on the risk one is willing to take. We know that everyone would like to have a portfolio with no risk and lots of return. Unfortunately, the real world of potential portfolios lies on or below the efficient frontier. So what does that mean for you?

Well, it means we have to do some planning, and then you’ll have a decision to make. First, as I said starting off, we need to make a best guess as to what return your portfolio would need to earn over time to provide you the money you need to accomplish all of your retirement goals. Then we need to make a best guess as to your risk tolerance. If we just focused on your return needs, we might conclude it was possible to achieve your financial goals with a portfolio allocated 90 percent to stock. But that might not work out very well if we faced a major bear market in a few years. After you saw your nest egg lose 40 percent, you’d call us and say, “Harold, we can’t stand it. Please sell our stock and put our money in cash!”

That’s why we define risk tolerance as the point of pain and misery you can survive—with us holding onto your belt and suspenders—just before you make that call to tell us to sell out.

With those two anchors, we can now revisit our graph. Suppose the results look like this.

The Efficient Frontier Chapter Image file - .03.png

We have two portfolios for you. Portfolio A is one that provides the return you need to achieve your goals, and B is one in keeping with your risk tolerance. Which one is right? In fact, both are, but our recommendation is to plan on Portfolio A. Why? Even though we believe you can live with more risk and would end up with more money, determining risk tolerance well in advance of a terrible market is more art than science. The consequence if we’re wrong and you bail out of the market that would be catastrophic. So why take that extra risk if you don’t need it to achieve your goals?

How about if we found a different outcome? Suppose we concluded that you needed Portfolio A to provide your needed return but had a risk tolerance associated with Portfolio B in this picture.

The Efficient Frontier Chapter Image file - .04.png

That’s not very good, because now you have to decide between eating less or sleeping less. In this case, our recommendation would be to readjust your goals to meet the return expectations of Portfolio B. Why? Again, when markets seem okay, it’s all too easy to say, “I’ll take a bit more risk.” But later, when it seems the world is coming to an end, you’re not likely to remember your willingness to hang in there.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Managing Risk: Smart Ways to Avoid the Bad and Manage the Good

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Harold Evensky CFP® , AIF® Chairman

Come and join me again in my Wealth Management class.

Good morning, everyone. I hope you all had a great spring break. Anyone do something especially fun?”

“Professor E, I went home to Istanbul to visit family. It was all too short a trip but it was wonderful seeing everyone, as I’d not been home in a long time.” [That was my ace teaching assistant, Cagla.]

“Henry, how about you?”

“Well, I’ve been working on my dissertation, so I hunkered down to move it along. I still have a lot to do but it feels good having such a good start.”

“Excellent. Is everyone ready to get back to the best class in the program? [Needless to say, the class offers a resounding confirmation.]

Okay, this afternoon we’re going to begin with a discussion about two Nobel laureates, Harry Markowitz and William Sharpe. I know you all have thoroughly read the assigned material including some of their seminal works, so my question is this: how would you describe the significance of their work to a client? Katie, why don’t you start with Professor Markowitz?

Katie: Professor Markowitz recognized that in investing we need to consider risk as well as return. That may seem pretty obvious today, but at the time, the sole focus of investors was on which investment would provide the highest return. To the extent risk that was considered at all, investments were simply categorized as conservative or speculative. In fact, for decades, there were lists of legally approved, “safe” investments for fiduciaries such as banks and trusts. For our clients, the significant insight Markowitz introduced was the concept that a well-designed portfolio of individually risky investments could actually result in a safer portfolio. Professor Evensky, may I use the blackboard to demonstrate?

HE: Of course.

Katie: Okay, picture two very volatile investments. Although we expect that over the long-term their returns will be positive, on an annual basis their returns may vary significantly. Basically, this is our expectation of traditional investments such as stocks.

Here’s a simple example:

Managing Risk Chapter Image file - .01.png

Although stocks A and B are both very volatile, they both trend up. As my graph demonstrates, if we were to invest half of our portfolio in A and half in B, we’d end up with an overall portfolio with almost no volatility. Unfortunately, in the real world, we can’t find investments that complement each other so perfectly, but we can find investments that don’t move in exactly the same pattern, or as a mathematician would say, investments that are poorly correlated. That’s the wisdom that Professor Markowitz introduced. So today we don’t think in terms of risky investments but rather in terms of complementary investments; that’s why professional advisors and wise investors are so focused on portfolio diversification.

HE: Well done, Katie. David, how would you explain Professor Sharpe’s contribution to your clients?

David: Well, I’d start with this picture:

Managing Risk Chapter Image file - .02.png

Professor Sharpe demonstrated that there are two fundamental types of risk—unsystematic and systematic. Unsystematic risks are those uniquely associated with individual investments. This kind of risk is considered unrewarded because it’s risk that provides no expectation of extra return.

There are many reasons an individual investment might fail. A company may be badly managed and go belly up, or it might be well managed but fall prey to unfortunate market conditions, such as an energy company facing a collapse in oil prices. From the investor’s standpoint, it doesn’t matter whether the business failure is due to poor management or market forces. If the business fails, the investor is the loser.

At least theoretically, an investor may eliminate this unsystematic risk by diversifying. For example, a real estate investor owning and renting out a single-family home that ends up unoccupied would face a total loss of income, but if he or she owned ten homes, a single vacancy would mean only a 10 percent loss. Here’s what unsystematic risk looks like in the stock market:

April 20, 2010 – BP Deepwater Horizon Oil Spill

Stock Price April 20, 2010 ……..……………….. $50.20

Stock Price Three months later ……………….. $28.74

I can buy a portfolio of five hundred of the bluest blue chips—all the stocks in the S&P 500—but if the market drops 20 percent, that means my diversified blue chip portfolio took a major beating. In my pie graph, that risk is the first wedge of systematic risk—market risk. Many investors say, “I know that and that’s why I buy only high-quality municipal bonds.” Well, as we know, bonds are subject to something called interest rate risk. That means if I buy a bond and a few years later interest rates go up, the value of my bond goes down.

Some astute investors respond by saying, “I know that. That’s why I buy only one-year CDs and roll them over. That way, when rates go up, I get the new, higher return.” That also sounds as if it makes sense, but rates can go down and the investor’s income can drop precipitously. That risk is called reinvestment risk. (See Chapter 18, “Flight to Safety.”) So, although many investors think of bonds as a simple, safe alternative to stocks, the reality is that they come with their own unique kinds of risks.

Finally, there is the last wedge—purchasing power erosion. We all know that throughout time the costs of things we buy and the services we need go up due to inflation. That’s the other real risk of depending on bond income as the sole source of cash flow. Many investors get in trouble by confusing certainty with safety. Bond returns may be certain, but when you factor in inflation as a primary source of income, they’re certainly not safe.

HE: David, well done. I believe your future clients will be well served by your educating them about the wisdom of the laureates.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Deducting Hurricane Casualty Losses on Your Tax Return

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David Garcia

David L. Garcia, CPA, CFP®, ADPA® Principal, Wealth Manager

Many of us in Florida or Texas endured major hurricane events in 2017.  If you suffered damage to property you may be able to deduct the property loss on your tax return as a casualty deduction.  The IRS has very specific rules that govern how much property loss you can deduct.  You’ll have to go beyond just estimating the value of the lost property.

First, you need to reduce any losses by the amount you are reimbursed from an insurance company since the deduction only applies to unrecoverable losses.  Next, you need to determine what your actual loss is.  The actual loss is the smaller of your tax basis in the property or the decrease in the fair market value.  Generally, your tax basis in the property is how much you bought it for.  For example, suppose you purchased a boat 3 years ago for $40,000.  The boat is now worth $32,000 and is destroyed in a hurricane.  For tax purposes, the loss is the decrease in fair market value since it is lower.

Once you’ve determined the actual loss you must reduce it by $100 and then by 10% of your adjusted gross income to arrive at the amount that you can claim as a deduction on your tax return.  To claim the deduction, you must be eligible to itemize your deductions on schedule A.  This means your total deductible expenses for the year exceed the standard deduction.

The government provides additional relief when the area you live in is a federally declared disaster area.  For example, you can claim the loss in the year of the disaster event or the prior tax year.  For further information, please click on the IRS links for Irma and Harvey below.

Feel free to contact David Garcia with any questions by phone 305.448.8882 ext. 224 or email: