What to Do with A Capital Gain?

The bull run continues. The Dow Jones has risen 292% from the abyss in 2009, and it’s now the longest running bull market in stock market history. The move has produced some monster capital gains and it’s possible you may be sitting on a few stocks with large profits. What can you do if you own a portfolio full of profits?

Let’s look at a few ideas you can employ if you own stocks or funds with large capital gains in a taxable account.

Hold. If you have gains, you don’t have to do anything. Holding on to existing positions allows you to defer gains and taxes for as long as you want. If you still believe in your holdings, let your profits run.

Family. You can give your shares to your children, but you won’t get a tax deduction. It will reduce your estate and increase theirs. Your children will inherit your cost basis.

Charity. Donating your shares directly to a charity will allow you to deduct the contribution from your taxes at fair market value. The charity will benefit because they can sell your shares free of taxation and use the proceeds to fund their cause.

Donor Advised Fund (DAF). A Donor Advised Fund allows you to transfer appreciated shares to this instrument. Once inside the DAF, you can sell your existing shares and purchase new investments without realizing a capital gain. You can deduct the contribution from your taxes and then distribute the proceeds to charities you support. The deduction from your taxes occurs in the year of contribution, not in the year of distribution. You don’t have to distribute the proceeds immediately, so if you’re not sure which charities to support you can defer payment until you identify organizations you want to help. For example, if you transfer $100,000 worth of Amazon stock to your Donor Advised Fund you can sell it and reinvest the proceeds, and then send a portion of the money to your favorite charity. The funds inside your DAF will continue to grow tax-free.

Call Options. A call option replacement strategy allows you to sell your equity shares and purchase a corresponding share amount in the form of a call option. The ratio is 100 shares to 1 option. If you own 1,000 shares, you can purchase 10 option contracts. This strategy allows you to sell your stock position but retain ownership in the company at a reduced amount.  For example, 1,000 shares of Amazon is currently worth $1.86 million. The January 2019 $1,860 strike price has a current price of $162 per contract, so 10 contracts costs $162,000 (10 x 100 x 162). The contract value is about 10% of the market value of the common stock. If you sold your shares, you can use a small percentage of the proceeds to buy the option and diversify the remainder. The downside for this strategy is that you’ll pay tax when you sell your shares. Another disadvantage is the call option has a finite life, it will expire on January 18, 2019. If Amazon is trading above $1,860 at the time of expiration, the call option will finish in the money and you can take your gains. If Amazon is trading below $1,860, your option will expire worthless and you’ll lose 100% of your money.

Put Options. If you want to hold your shares, but you’re concerned about a drop in the price, you can purchase a put option. A put option will increase in value when a stock falls. It’s short term insurance against a market decline. This strategy allows you to retain your stock, but at a price. Insuring your position will get expensive, especially if you repeat the process a few times a year. For example, the January 2019 $1,860 strike price is currently $135. Protecting 1,000 shares will cost you $135,000. If Amazon falls below the $1,860 strike price at expiration, you’ll make money. If Amazon closes above $1,860, you’ll lose 100% of your proceeds.

Charitable Remainder Trust (CRT). This trust allows you to transfer your shares to a CRT, sell your holdings, and receive income from the proceeds. At your death the remainder of the trust is delivered to a pre-determined charity. The stock, once transferred, can be sold free of taxation and then you can reinvest the proceeds into a diversified portfolio of stocks or funds.  Your contribution to the trust qualifies for a charitable deduction. The amount of income you may receive from the trust is between 5% and 8% of the portfolio value.

Exchange Fund. As the name implies, you exchange your current shares into a fund to receive shares in a basket of stocks. This will allow you to defer your gains. The minimum is steep, and you’re required to hold the fund for several years.  In addition, 20% of the fund assets must be held in non-investment assets like real estate which may hinder your liquidity efforts. According to a Forbes article on exchange funds, the minimum investment for some funds is $5 million with a required holding period of seven years. This strategy is best suited for individuals who own concentrated stock positions.[1]

Private Annuity. This is a popular strategy that can benefit you and your favorite charity.  The private annuity works well with colleges and universities. If you donate your stock to your alma mater, they can establish a private annuity for you, so you can receive income for life. Your alma mater can sell the stock free of taxation and use it to fund their operations. You’ll get a deduction and an income stream.

The only difference between death and taxes is that death doesn’t get worse every time Congress meets. ~ Will Rogers

July 25, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

 

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. Options involve risk and are not suitable for every investor. Please consult your CPA or tax advisor before implementing any of these strategies to see if it makes sense for your situation.

 

 

 

[1] https://www.forbes.com/sites/agoodman/2016/01/10/one-way-some-wealthy-investors-can-avoid-big-capital-gains-taxes/#1680ec4f324e, Andrew Goodman, 1/10/2016

10%

Ten percent has been the average annual return for the S&P 500 since 1926. One dollar invested in 1926 grew to $7,347 by the end of 2017.[1]  Because of the 91-year average most investors expect (demand) a 10% return every year. In fact, when analysts give their stock market return projections for the coming year the answer is usually 10%. It’s a safe prediction because of the history of the index.

Despite the historical average annual return, the index has never closed at 10%. The closest it came to the average was 2004 when it returned 10.9%.

The road to average is paved with euphoria and despair. From 1982 to 1999 the index averaged 18.5% per year. From 2000 to 2012 it returned a paltry .6% per year. The best one-year return, after World War II, was 1954 when it soared 52.6%. The worst year occurred in 2008, plummeting 37%.[2]

During the Great Depression the market fell 85% and because of the Oil Embargo of the ‘70s it dropped 41%.  It declined 43% throughout the Tech Wreck and 37% amid the Great Recession.

To date, the S&P 500 is up 4.64%. It started the year at 2,695 and by the end of January it had already risen 6.5%. The gains didn’t last long as the market rolled over in February, falling 10% from its all-time high.  From the low of 2,581 it has rallied back to its current level of 2,820.

Most investors don’t allocate 100% of their assets to a single fund or index. A diversified portfolio is the norm but some question whether it’s better to concentrate or diversify. To create wealth, concentrate your holdings and to preserve it, diversify.

Concentration in technology stocks is working well in 2018. A portfolio of FANGs – Facebook, Amazon, Apple, Netflix and Google (now Alphabet) is up 35%. A diversified portfolio of large, small, and international mutual funds mixed in with some bonds is up a measly .81%.[3]

I know these results all too well as my daughter’s account is soaring due to a few of the FANGs, one of which she’s owned for more than 17 years. My account, on the other hand, is well diversified and it’s flat for the year.

As we venture into the second half of the trading year focus more on your long-term goals and less on stock market averages. The market has delivered exceptional returns for decades and the future will be similar. Of course, some years it will rise and others it will fall. As it rises don’t get overly excited or too depressed when it falls. In the long run, a well-diversified portfolio will deliver you market returns and if you capture them you’ll do better than most investors.

I’m optimistic on the future of the market – stay invested my friends!

It’s a wonderful thing to be optimistic. It keeps you healthy and it keeps you resilient. ~ Daniel Kahneman

July 25, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. 

[1] Dimensional Fund Advisors 2018 Matrix Book

[2] Ibid

[3] Morningstar Office Hypothetical Tool. The diversified portfolio consists of VOO, VB, VXUS and BND.

Planting Seeds

Pastor Rick Warren of Saddleback Church recently wrote a devotional about reaping and sowing. His article focused on planting seeds and waiting for them to grow. He mentioned how people get irritated over the delay between the time a seed is planted and when it bears fruit.[1] Patience is a virtue.

In another post, he highlighted how one kernel planted does not equal one kernel grown, but it can yield 100 times the original amount. For example, one tomato plant can produce 200 tomatoes in a single season.[2]

At 2005 years old, General Sherman is one of the largest trees on the planet at close to 275 feet high and 103 feet in circumference.[3] It probably grew fast in some years, slow in others. It has lost a branch or two, but it’s still growing. It has survived rain, fire, wind, and snow. To my knowledge, no human hand has helped it grow. A single seed sprouted, and the rest is history – a long history!

Investing and gardening have many similarities. It requires patience and discipline to create generational wealth.  Most people start small by investing what they can, when they can. It’s better to invest today with a small amount of money rather than waiting to try to accumulate a large sum before putting your money to work, remember General Sherman started off as a tiny seed.

If you invested $100 per month in the Vanguard 500 Index fund from 1976 to 2018 your account balance would be worth $879,716 today.[4] The fund generated an average annual return of 10.93%. Despite the stellar growth, it experienced a few down years – seven to be exact. It had 12 years where it delivered returns between 1% and 10%. So, 45% of the time it made less than 10%. The patient person was rewarded for staying the course. The impatient one probably didn’t reap the benefits. In fact, the 15-year average annual return for the fund was 9.17%. The investor return was 7.94%.[5]

The buy and hold investor was rewarded by the gravitational pull of the markets and the constant drip of saving monthly.

If you’ve had the opportunity to plant several trees, bushes, or flowers, you know some will grow fast and others will grow slow. They’ll sprout and bloom throughout the year. This is true for investments, especially in a diversified portfolio. If you own several investments, you’ll experience different growth patterns. This year a few technology stocks are leading the market. In 2017 international investments outperformed US companies. In 2008 bonds outperformed stocks.  Investments, like plants, will grow on their own terms. However, if you stay committed to your entire portfolio over time it will bear fruit.

Plants take time to grow. There’s no such thing as instant maturity. No farmer goes out, plants the seed in the ground, comes back an hour later, digs it up, and expects it to have grown. You’ve just got to let it be. Leave it covered, and let God grow it in his time. ~ Rick Warren

July 24, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

 

 

 

 

[1] https://pastorrick.com/you-will-reap-your-harvest-in-just-the-right-time/?roi=echo7-33557633288-52999209-08bdf0f509462d040172c456356cf79e, July 19, 2018

[2] http://www.thejournal.ie/readme/giy-gardening-opinion-3864153-Feb2018/, Michael Kelly, 2/24/2018

[3] https://en.wikipedia.org/wiki/General_Sherman_(tree)

[4] Morningstar Office Hypothetical Tool, 8/31/1976 to 6/30/2018

[5] Morningstar Office Investor Returns

Buy Stocks, Bonds Suck.

Bold predictions are nothing new on Wall Street. Every soothsayer, fortune teller, oracle, and expert has an opinion or three as to where the stock market is heading.

In 1991, Jack Vander Vliet, then head of Dean Witter’s Inter-Capital Division, made the bold prediction that the Dow Jones would reach 10,000 by 2000.[1]  It doesn’t seem like much of a forecast today with the Dow trading north of 24,000.  At the time, however, it was bold. The Dow Jones was trading at 2,736, a far cry from 10,000. For it to breach 10,000 it would have to average 15.5% per year. When he made the prediction, the 10-year average annual return for stocks had been 15.3%, so his forecast wasn’t farfetched.

I had the opportunity to hear Mr. Vander Vliet speak at investor workshops where his rallying cry was: “Buy stocks, bonds suck.” He was not a fan of bonds. As I mentioned, the 10-year average annual return for stocks was 15.3% while the return for bonds was 14.2%.[2] The two asset classes were performing extremely well, well above their historical returns. It was surprising, given their returns, that he hated bonds.

Since 1991 stocks have returned 10.3% per year, bonds 8.1%. Stocks did outperform bonds, but there is more to owning bonds than total return. One of the best reasons to own them is that they’re negatively correlated to stocks. During the Tech-Wreck (2000-2002) stocks fell 43% and bonds rose by the same amount, 43%. During the Great Recession (2007-2009) stocks fell 37% and bonds rose 26%.[3] An allocation to stocks and bonds gave you solid returns with less risk.

How did his prediction turnout? In April 1999 the Dow closed above 10,000 – 8 months ahead of schedule!  I would amend his rallying cry to read: “Buy stocks, bonds don’t suck, and they may help my portfolio through diversification and asset allocation!”

We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard. ~ JFK

July 19, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

[1] http://articles.mcall.com/1991-01-28/business/2788104_1_portfolio-managers-fund-manager-mutual-funds, Dan Shope, The Morning Call, 1/28/1991

[2] Dimensional Fund Advisors 2018 Matrix Book

[3] Ibid

Croatia

Croatia is the second smallest country to reach the World Cup Final, a tiny nation of 4.1 million people located on the shores of the Adriatic Sea. It ranks as the 128th largest country in the world and accounts for about .054% of the global population. If it were a state, it would rank 27th nestled between Kentucky and Oregon.

UBS gave Germany a 24% chance to win the World Cup after running 10,000 simulations.[1] Brazil, Spain and England were also expected to finish strong. The 17-page report highlighted all the reasons why Germany would win along with the odds for each country. Croatia was given a .2% chance to win.

Large countries, with all the pomp and circumstance, get the major headlines, small countries not so much. Like countries, large-cap stocks get most of the press. Companies like Facebook, Amazon, Apple, Netflix, and Google make news and move markets. Small-cap stocks are an afterthought.

Small-cap stocks are doing well this year, up 11.5%. This sector of the market has benefited from what they don’t have. They don’t have a large international presence so they’re (fairly) immune to the trade war and a strong dollar.

The Microcap sector is also performing well. They account for about 3% of the U.S. equity market with an average market-cap of about $500 million. Apple, by comparison, is approaching one trillion. The Dimensional Fund US Micro Cap Portfolio (DFSCX) has generated an average annual return of 12.13% since 1981. A $10,000 investment when the fund opened is now worth $656,638. Year-to-date it has risen 10.02%.[2]

Small cap outperformance is not new. Since 1980, the Russell 2000 Small-cap index has returned 11% per year. Dating back to 1926, $1 invested in small-cap stocks grew to $22,985 by the end of 2017. While large-cap stocks ended with a value of $7,347.[3]

As you build your portfolio don’t ignore small companies because they can give your investments a big boost.

Piglet noticed that even though he had a very small heart, it could hold a rather large amount of gratitude. ~ A.A. Milne

July 17, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

[1] https://www.bloomberg.com/news/articles/2018-05-17/germany-will-win-the-world-cup-ubs-says-after-10-000-simulations, Adam Blenford, May 17, 2018

[2] Morningstar Office Hypothetical Tool

[3] Dimensional Fund Advisors Investment Principles

1994

Major League Baseball had a tough year in 1994 due to a strike by the Major League Baseball Players Association. The strike caused the cancellation of the World Series, the first time since 1904. It was a bad year for baseball and a lousy one for investors.

The U.S. stock market barely budged in 1994 as the S&P 500 returned a paltry 1.3%. Long-term government bonds fell 7.8%; emerging markets dropped 7.3% and Real Estate Investment Trusts (REITs) produced a small return of 2.7%. The commodity sector did well generating a return of 16.6%.[1] Sound familiar?

What made 1994 so frustrating was the previous year saw stellar returns from stocks and bonds. The S&P 500 returned 10.1% and long-term government bonds gained 13.2%.

What happened in 1994? Alan Greenspan and the Federal Reserve surprised markets by raising interest rates and Fortune Magazine called it the “Bond Market Massacre.”[2] The Fed Funds rate started the year at 3.04% and finished at 5.5%, an increase of 2.46%.

When markets do nothing, investors get antsy and suffer from boredom. When this happens, they make changes to their portfolio by chasing returns and pouring money into hot sectors.

In 1994 investors sold stocks and bonds because the Federal Reserve was aggressively hiking interest rates. A rising rate environment is not good for stocks or bonds.  How did the markets fare since 1994?

Investors poured money into the commodity sector because of its stellar performance. With a strong economy and rising rates, investors chased this hot sector. However, those who allocated money here made just 2.6% per year from 1994 to 2017, barely outpacing inflation. A $10,000 investment grew to $18,046[3]

Buying bonds when rates rise hardly makes sense, but if you purchased long-term government bonds in 1994, you made 7.4% per year through 2017. A $10,000 investment grew to $51,653.[4]

The S&P 500 returned 9.7%. A $10,000 investment grew to $84,091. From 1995 to 1999 the S&P 500 rose 144%![5]

REITs returned 10.4%. A $10,000 investment grew to $97,339.[6]

Today, investors are frustrated by the lack of performance with stocks and bonds. The stock market is puttering along, the bond market is falling, and international investments are trending down.  It feels like 1994 all over again.

Here are a few thoughts to protect yourself from doing something that may harm your long-term performance.

First, do nothing. Don’t chase returns. Don’t make dramatic portfolio changes. The best course of action, at times, is to let your portfolio find its footing. The long-term trend is still in force.

Diversify your accounts across sectors and markets. In 1994, international markets and U.S. Treasury Bills performed well. This year, small-cap stocks and growth companies are enjoying excellent returns.

Buy bonds for your account despite rising rates. They should be included in your portfolio for safety and income.

Rebalance your portfolio on an annual basis. This will keep your asset allocation and risk level intact. It’s also a great way to automate the buy low, sell high strategy.

A financial plan is paramount if you want to be a successful investor. It will help you to stay focused on your goals.  It would be great to earn double digit returns every year, but it might not be necessary for you to achieve your financial goals. Most financial planning professionals use single digit returns when forecasting projections for their clients.

In 1995 the World Series returned, and Major League Baseball has been doing well ever since. I’m sure our global markets will be fine also. Play Ball!

But if we hope for what we do not see, we wait for it with patience. ~ Romans 8:25

July 10, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. 

[1] Dimensional Fund Advisors 2018 Matrix Book.

[2] http://www.businessinsider.com/1994-federal-reserve-tightening-story-2013-1, Matthew Boesler, January 25, 2013

[3] Dimensional Fund Advisors 2018 Matrix Book.

[4] Ibid

[5] Ibid

[6] Ibid

Are You Content?

We are a people in pursuit of more. If it’s bigger, better, or faster, then we must have it. Social media allows us to view the good life of others in real time and this is causing angst for many.

Facebook depression is real. According to phys.org: “If the research is any indication, you may actually be finding Facebook and other social media sites aren’t so great for your mental health. Instead of feeling blissfully open and connected with your friends, you feel inadequate or maybe even a bit depressed.”[1]

In another study, researchers found people became more depressed after spending time on Facebook: “Exposure to the carefully curated images from others’ lives leads to negative self-comparison, and the sheer quantity of social media interaction may detract from more meaningful real-life experiences.”[2]

Trying to keep up with the Joneses can also be financially damaging to your health. A study of lottery winners in Canada found that the neighbors of lottery winners were more likely to go bankrupt. The non-lottery winners tried to keep up financially by spending aggressively, investing in speculative investments, and borrowing more money.[3]

What does the Bible say about being content?   

Yet true godliness with contentment is itself great wealth.  After all, we brought nothing with us when we came into the world, and we can’t take anything with us when we leave it.  So, if we have enough food and clothing, let us be content. But people who long to be rich fall into temptation and are trapped by many foolish and harmful desires that plunge them into ruin and destruction.  For the love of money is the root of all kinds of evil. And some people, craving money, have wandered from the true faith and pierced themselves with many sorrows. ~ 1 Timothy 6:6-10 

Not that I was ever in need, for I have learned how to be content with whatever I have. I know how to live on almost nothing or with everything. I have learned the secret of living in every situation, whether it is with a full stomach or empty, with plenty or little. For I can do everything through Christ[ who gives me strength. Even so, you have done well to share with me in my present difficulty. ~ Philippians 4:11-14 

Don’t love money; be satisfied with what you have. For God has said, “I will never fail you. I will never abandon you.” ~ Hebrews 13:5

Investors struggle with contentment particularly if they feel they’re missing out by not owning the hot stocks. Stocks such as Facebook, Amazon, Netflix and Google (FANG) are soaring to new heights and investors could become depressed if they don’t own these highfliers. In a situation such as this, they’ll sell assets to chase winners and move to a more concentrated portfolio.

Concentrating on a few hot stocks is not new.  Microsoft, Intel, and Cisco were Wall Street darlings during the technology boom of the ‘90s. From 1995 to 1999 these three stocks generated an average annual return of 80%. A $75,000 investment in 1995 grew to $1.3 million by the end of 1999.

How have they performed since? From January 2000 through June 2018 they’ve averaged 3.2% per year, dramatically underperforming the S&P 500. Investors who felt as if they were missing out jumped in at the top only to see their account values fall by 83% during the Tech Wreck.

The fear of missing out is not limited to stocks. Last year, Bitcoin soared 148% from November to December. This explosive burst started a feeding frenzy as investors rushed to buy more Bitcoin. It has since fallen 65%. It will have to return 192% to get back to its all-time high!

How can you be content with your investment portfolio?  Here are a few suggestions.

Plan. Creating a financial plan will give you a picture of your situation allowing you to focus on your goals, not your neighbors. The plan will be your road map to help you achieve your financial goals on your terms.

Budget.  Your budget will help you live within your means. If you make $2 and spend $1, you’ll feel rich because you can invest and spend money without fear of going bankrupt by trying to keep up with the Joneses.

Diversify. A portfolio of low-cost mutual funds will give you broad exposure to thousands of companies including the highfliers. In addition, you’ll own companies of various sizes sprinkled around the globe.

Serve. Go serve those in need. Unfortunately, there is an abundance of people who need your help. Volunteering in your community can pay huge dividends to both you and the people you’re serving. In fact, volunteering can be beneficial to your health.[4]

Give. Giving is another way to help those in need. If you’ve been blessed with financial resources, can you distribute a percentage to groups and organizations your support?

List. Make a list of the good things happening in your life, I’ll bet it’s more impressive than you think!

Being content takes practice and patience. It’s hard work to live within your means and socially unacceptable to many. However, knowing that you’re stewarding your resources well should bring you peace, joy, and contentment!

My crown is called content, a crown that seldom kings enjoy. ~ William Shakespeare 

July 5, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

[1] The secret history of Facebook depression, January 22, 2018, Dr. Kate Raynes-Goldie

[2] https://www.cnbc.com/2017/04/12/study-using-facebook-makes-you-feel-depressed.html, by Todd Haselton, 4/12/2017.

[3] https://www.bloomberg.com/news/articles/2018-05-29/keeping-up-with-the-joneses-neighbors-of-lottery-winners-are-more-likely-to-go-bankrupt, May 29, 2018, Peter Coy

[4] https://nypost.com/2018/04/24/volunteering-is-great-for-your-health/, 4/24/2018, Jeanette Settembre, Moneyish