Category Archives: Financial Planning

Psychology of Money

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“Look at market fluctuations as your friend rather than your enemy, profit from folly rather than participate in it.” Warren Buffett

Excerpts from: The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel.

The book’s premise is that doing well with money has little to do with how smart you are and a lot to do with how you behave.

  • “Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.”
  • “Soft skills are more important than the technical side of money.”
  • “You think about and are taught about money in ways that are like physics (with rules and laws) and not enough like psychology (with emotions and nuance).”
  • “Finance is guided by people’s behaviors.“

“It’s been an ideal period for investors. A climate of fear is their best friend. Those who invest when commentators are upbeat end up paying a high price for meaningless reassurance. In the end, what counts in investing is what you pay for a business–through the purchase of a small piece of it in the stock market–and what that business earns in the next decade or two.” Warren Buffett

References:

  1. https://www.sloww.co/psychology-of-money-book/https://www.sloww.co/psychology-of-money-book/

Roth IRA

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“Roth individual retirement accounts were created to help middle class earners set aside money for retirement that they wouldn’t have to pay taxes on at withdrawal.” Barron’s

The Roth individual retirement account (IRA) was created to provide an alternative to making non-deductible contributions to traditional IRAs. Roth IRAs are funded with after-tax dollars, which means at withdrawal at age 59 ½ the money is tax-free. Comparatively, traditional IRAs are funded with pre-tax dollars, so distributions are taxed at withdrawal.

You’re taxed or penalized when you withdraw your Roth IRA contributions and earnings if your Roth IRA account isn’t at least 5 years old or if you’re not yet 59½. The earnings portion of the withdrawal may be subject to taxes and a 10% penalty.

The contribution limit for Roth IRA accounts is $6,000 a year in 2021 (or $7,000 for people 50 and older).

There are also income restrictions for Roth IRA.

  • Single individuals with modified adjusted gross incomes (MAGI) of less than $125,000 in 2021 can contribute up to the limit, but their contributions are phased out if their MAGI is between $125,000 and $140,000.
  • If individuals earn more than $140,000, single taxpayers cannot contribute to a Roth IRA. For married couples filing jointly, the threshold is between $198,000 and $208,000 in 2021. 

Individuals can also use Roth conversions, where they take money from a traditional IRA and move it into a Roth after paying a one-time income tax on the transferred assets since pre-taxed dollars converted to a Roth are taxable at ordinary income rates. These transfers can also be known as a “backdoor Roth,” because they’re working around income limits to push money into these ultimately tax-free accounts. 

References:

  1. https://www.barrons.com/articles/peter-thiel-roth-ira-propublica-51624558641
  2. https://www.edwardjones.com/us-en/investment-services/account-options/retirement/roth-ira

2 benefits of investing to meet your goal | Vanguard

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What’s your plan to reach your goal?

You could just add up whatever’s left over in your bank account after you pay your bills each month. But putting that money in a separate investment account instead can have major benefits.

It keeps you from buying something else

No matter how much you really want to check this savings goal off your list, it’s all too easy to spend the money on something else when it’s just sitting in your bank account.

Maybe you think that willpower alone will be enough to keep you on course. If so, that’s great! But what if it doesn’t?

The best way to ensure that your money goes toward your goal is to move it out of your bank account before you’re tempted to spend it. Keeping this money in a separate account also makes it easier to see the progress you’re making toward your goal.

It gives you a chance to reach your goal faster

Let’s say you want to save for a down payment on your first home. You expect to need about $10,000, and you budget $200 a month toward your goal.

Keeping the money in a bank account typically means you’ll earn a pretty low rate of return—0.5%, for example.

At that rate, it will take you a little over 4 years to reach your goal, during which you’ll deposit a total of $9,800.

If you instead invest the money in a moderate-risk mutual fund or ETF (exchange-traded fund) and earn an average return of 5%, you could reach your goal 4 months earlier—with total deposits of only $9,000.

By investing, you could reach your goal with less time and money

A bar chart showing that investing your money could help you reach your goal faster

References:

  1. https://investor.vanguard.com/other-savings-goals/

7 Investing Principles

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The fundamentals you need for investing success.  Charles Schwab & Co., Inc

1. Establish a financial plan based on your goals

  • Be realistic about your goals
  • Review your plan at least annually
  • Make changes as your life circumstances change

Successful planning can help propel your net worth. Committing to a plan can put you on the path to building wealth. Investors who make the effort to plan for the future are more likely to take the steps necessary to achieve their financial goals.

A financial plan can help you navigate major life events, like buying a new house.

2. Start saving and investing today

  • Maximize what you can afford to invest
  • Time in the market is key
  • Don’t try to time the markets—it’s nearly impossible.

It pays to invest early.  Maria and Ana each invested $3,000 every year on January 1 for 10 years—regardless of whether the market was up or down. But Maria started 20 years ago, whereas Ana started only 10 years ago. So although they each invested a total of $30,000, by 2020 Maria had about $66,000 more because she was in the market longer.

Don’t try to predict market highs and lows. 2020 was a very volatile year for investing, so many investors were tempted to get out of the market—but investors withdrew at their peril. For example, if you had invested $100,000 on January 1, 2020 but missed the top 10 trading days, you would have had $51,256 less by the end of the year than if you’d stayed invested the whole time.

3. Build a diversified portfolio based on your tolerance for risk

  • Know your comfort level with temporary losses
  • Understand that asset classes behave differently
  • Don’t chase past performance

Colorful quilt chart showing why diversification makes long-term sense. The chart shows that it’s nearly impossible to predict which asset classes will perform best in any given year.

Asset classes perform differently. $100,000 invested at the beginning of 2000 would have had a volatile journey to nearly $425,000 by the end of 2020 if invested in U.S. stocks. If invested in cash investments or bonds, the ending amount would be lower, but the path would have been smoother. Investing in a moderate allocation portfolio would have captured some of the growth of stocks with lower volatility over the long term.

4. Minimize fees and taxes; eliminate debt

  • Markets are uncertain; fees are certain
  • Pay attention to net returns
  • Minimize taxes to maximize returns
  • Manage  and reduce debt

Fees can eat away at your returns. $3,000 is invested in a hypothetical portfolio that tracks the S&P 500 Index every year for 10 years, then nothing is invested for the next 10 years. Over 20 years, lowering fees by three-quarters of a percentage point would save roughly $13,000.

5. Build in protection against significant losses

  • Modest temporary losses are okay, but recovery from significant losses can take years
  • Use cash investments and bonds for diversification
  • Consider options as a hedge against market declines—certain options strategies can be designed to help you offset losses

Diversify to manage risk. Investing too much in any single sector or asset class can result in major losses when markets are volatile.

6. Rebalance your portfolio regularly

  • Be disciplined about your tolerance for risk
  • Stay engaged with your investments
  • Understand that asset classes behave differently

Regular rebalancing helps keep your portfolio aligned with your risk tolerance. A portfolio began with a 50/50 allocation to stocks and bonds and was never rebalanced. Over the next 10 years, the portfolio drifted to an allocation that was 71% stocks and only 29% bonds—leaving it positioned for larger losses when the COVID-19 crash hit in early 2020 than it would have experienced if it had been rebalanced regularly.

7. Ignore the noise

  • Press makes noise to sell advertising
  • Markets fluctuate
  • Stay focused on your plan

Progress toward your goal is more important than short-term performance. Over 20 years, markets went up and down—but a long-term investor who stuck to her plan would have been rewarded.

References:

  1. https://www.schwab.com/investing-principles

Option Trading Principles: High Implied Volatility

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Implied volatility is a measure of what the options markets think volatility will be over a given period of time (until the option’s expiration), while historical volatility (also known as realized volatility) is a recording of how the underlying actually moved over a specified past period.

Volatility measures the rate at which a security moves up and down. If a security is moving up and down quickly, volatility will be high. Conversely, if a security is moving up or down slowly, volatility will be low.

Implied volatility (IV) shows how much movement the market is expecting in the future.

Options with high levels of implied volatility suggest that investors in the underlying stocks are expecting a big move in one direction or the other.

High implied volatility could also mean there is an event coming up soon that may cause a big rally or a huge sell-off. However, implied volatility is only one piece of the puzzle when putting together an options trading strategy.

Generally, option traders look to buy options when implied volatility is low since premiums are lower, in hopes of seeing the underlying stock move in a favorable direction along with an increase in volatility which will make premiums increase.

And traders look to write options when implied volatility is high as option premiums tend to be higher, in hopes of seeing the underlying stock move in a favorable direction to his/her position along with a decrease in volatility which would make premiums decrease.

This is a strategy many seasoned traders use because it captures decay. At expiration, the hope for these traders is that the underlying stock does not move as much as originally expected.

The general idea that options with high IVs are expensive and options with low IVs are cheap.

References:

  1. https://www.nasdaq.com/articles/is-the-options-market-predicting-a-spike-in-invesco-mortgage-capital-ivr-stock-2021-06-11
  2. https://www.nasdaq.com/articles/what-does-implied-volatility-really-mean-2020-10-29

June 2021 U.S. Monthly Jobs Report

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Missing 6.8 million jobs.

  • Nonfarm payrolls increased by 850,000 in June versus the estimate for 706,000.
  • The unemployment rate unexpectedly rose to 5.9% versus the 5.6% estimate.
  • Wages were up 0.3% for the month and 3.6% year over year, both in line with expectations.

Job growth leaped higher in June 2021, the U.S. Labor Department reported. Nonfarm payrolls increased 850,000 for the month, compared with the estimate of 706,000 and better than the upwardly revised 583,000 in May. The unemployment rate rose to 5.9% against the 5.6% expectation.

Currently, 6.8 million fewer jobs exist than before the pandemic. Millions of Americans have dropped out of the labor force.

Aside from ever-present concerns about pay and benefits, workers are particularly interested in jobs that allow them to work remotely at least some of the time. According to a Randstad survey of more than 1,200 people, 54 percent say they prefer a flexible work arrangement that doesn’t require them to be on-site full time.

Health and safety concerns are also very much on the minds of workers whose jobs require face-to-face interactions, the survey found.

The portion of the unemployed who have been out of work for six months or more rose.

Governors in 26 states have moved to end distribution of federal pandemic-related jobless benefits even though they are funded until September, arguing that the assistance — including a $300 weekly supplement — was discouraging people from returning to work.

References:

  1. https://www.cnbc.com/2021/07/02/jobs-report-june-2021.html
  2. https://www.nytimes.com/2021/07/02/business/economy/june-2021-jobs-report.html

Bobby Bonilla Day: The perfect example of the power of compounding

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Bobby Bonilla’s contract with the Mets is a brilliant example of the power of compound interest

For former baseball player Bobby Bonilla, July 1 and every July 1, from 2011 through 2035, marks his annual payday, when the New York Mets send him a a check for $1,193,248.20 as part of a deal set up 20 years ago.

In 2000, the Mets cut Bonilla from the team and terminated his contract early. The ball club owed him $5.9 million for that season. Bonilla and his agent chose to defer collecting what was owed and instead agreed to spread the payments out over 24 years, starting in 2011, with an 8% annual interest rate.

When all is said and done, the total payout will be $29.8 million on a $5.9 million initial investment.

Bonilla’s contract with the Mets is a brilliant example of the power of compounding. Compounding is when you earn interest on your earned interest and it can have a powerful impact on growing your money over time.

You and anyone can defer spending your cash by saving and investing it now, giving it ample time to grow. “When you are young, time is your best friend,” says Certified Financial Planner Vid Ponnapalli. “And the magic of compounding is your best resource.”

Putting away money now and combined with the power of compound interest helps you bank some flexibility for later.

Reference:

  1. https://www.marketwatch.com/story/this-retired-baseball-players-contract-is-the-perfect-example-of-the-power-of-compounding-2018-07-16
  2. https://www.marketwatch.com/story/what-is-bobby-bonilla-day-it-is-the-beauty-of-compound-interest-11625145948

Successful Investing Requires Mastering the Inner Game

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“When you learn how to control your emotions, you can derive more positive, productive meanings, even from seemingly negative events.” Tony Robbins

Inner game helps you improve yourself as you learn from your past life experiences. Learning to work on your inner game helps you develop a better outlook in life and this helps you develop your confidence as well. This new sense of self worth allows you be more successful personally and professionally, and with your over all interaction with other people.

To find your inner game, you have to know who you truly are, what you really want and how you want things to be done. This step is not easy. It takes a lot of self-reflection and looking back to your past mistakes and learning from them. It requires you to open your eyes and see yourself for who you really are now. Then try to look to the future and visualize how you want to see yourself after a couple of years.

It may take a lot of self-reflection, emotional intelligence and psychological understanding of your personal issues and how to deal with them. But the bottom line to becoming confident being the real you, is that you will have to overcome your insecurities, angsts, worries, and fears. If you fail to do so, these negative factors will reveal themselves in your personal and professional life and can cause problems.

When you get the real picture of who you truly are, you also have to learn to appreciate the traits that you have. Don’t focus on the things that you dislike about yourself. Real attractiveness come from within. Before anyone else appreciates your looks, you should be the one to appreciate it first. Know your strongest feature and use it to your advantage. If you believe that you look good then you will feel good about yourself too. Your self confidence will improve and this makes you more.

Inner Personal Scorecard

Warren Buffett frequently relates an interesting way to frame this topic:

Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover? 

Or. If the world couldn’t see your results, would you rather be thought of as the world’s greatest investor but in reality have the world’s worst record? Or be thought of as the world’s worst investor when you were actually the best?

Buffett’s getting at a rather fundamental model he’s used most of his life: The Inner Scorecard. When you have an internal scorecard, no one can define success for you but you.

What Buffett and a lot of other people who have been successful in life — true success, not measured by money — have in common is that they’re able to remember what we all set out to do: live a fulfilling life! Not get rich. Not get famous. Not even get admiration, necessarily. But to live a satisfying existence and help others around them do the same.

It’s not that getting rich or famous or admired can’t be deeply satisfying. It can be! I’m positive Buffett deeply enjoys his wealth and status. He’s got more “admiration tokens” than almost anyone in the world.

But all of that can be ruined very, very easily along the way by making too many compromises, by living according to an external scorecard rather than an internal one.

Controlling your emotions

According to James J. Gross, a psychologist and professor at Stanford University and best known for his research in emotion and emotion regulation, the inability to control, or regulate, your emotions is at the root of some psychological disorders including depression, social anxiety and borderline personality. And, no matter how psychologically healthy you think you are, you can benefit from learning how to better manage your emotions in investing and everyday life.

References:

  1. https://www.tonyrobbins.com/ask-tony/cycle-of-meaning/
  2. https://www.essentiallifeskills.net/5-effective-ways-to-control-your-emotions.html

Strategies to Reduce Taxes

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Taxes are one thing retirees tend to have a little control over, as long as they do deliberate tax planning.

Accumulating sufficient assets for retirement is a critical part of retirement income planning, according to Bill Thomas, Financial Adviser, Thomas Financial Services. However, it’s just as important to preserve what you’ve saved over the 25 or 30 years that you may live in retirement. That’s where deliberate tax planning comes in.

It is likely that taxes will increase during your retirement, potentially reducing your income and cash flow. Instead of fretting over increasing taxes, now is the time to figure out how to create a tax-efficient retirement where you can maximize deductions and credits while minimizing taxes.

Getting into the 0% tax bracket may be possible and easier than you think. All it takes is a smart tax strategy that allows combining tax credits and deductions, accumulating more long-term capital gains, or benefiting from qualified dividends.

You can legally decrease or completely eliminate your tax bill by taking advantage of some of the perks in the tax code.

Qualified dividends follow three rules:

  1. The dividend must have been paid by a U.S. corporation or a qualifying foreign company. The dividends must be deemed as qualified in the eyes of the IRS and cannot be listed as a non- qualified dividend.
  2. You’ve held the stock paying the dividend for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
  3. Use the long-term capital gains rates shown above to see the taxable income and filing status for the 0% tax brackets.

Being an investor requires a strategy to reduce your taxes. For many, it’s tempting to buy stocks and sell them as soon as the price shoots up. But if you hold on to your investments for an over a year — you’ll be eligible for long-term capital gains tax rates.

Simply put, it pays to be patient in the stock market. If you sell a stock that you’ve owned for a year or less, you’ll have to pay a short-term capital gains tax, which can be as high as 37%. Once you’ve held an investment over the one-year mark, you’ve hit the long-term capital gains threshold.

Getting into the 0% tax bracket may be easier than you think. All it takes is a smart strategy that allows you to combine tax credits and deductions, accumulate more long-term capital gains, or benefit from qualified dividends.

Make tax-smart investing part of your tax planning

The potential impact of tax-smart investing techniques over time. As the accompanying graphic shows, employing tax-smart investing techniques over time may have a significant impact on your long-term returns. The longer you apply these techniques, the greater the potential impact.

Each line represents a client’s hypothetical value from tax-smart investing techniques at various starting dates, based on a starting portfolio value of $1 million.

Though taxes might not be the first thing you think of when it comes to how you want to spend money in retirement, planning strategically can mean more income and cash flow for the things you love.

References:

  1. https://www.kiplinger.com/retirement/retirement-planning/602880/4-strategies-to-reduce-taxes-in-retirement
  2. https://www.msn.com/en-us/money/retirement/these-strategies-can-reduce-the-taxes-you-will-pay-on-retirement-accounts/ar-AAKcd4U
  3. https://www.fidelity.com/wealth-management/tax-smart-investing-planning

Roth IRA Conversion

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A Roth individual retirement account (IRA) is off-limits for people with high annual incomes.

If your earnings put Roth IRA contributions out of reach, a backdoor Roth IRA conversion is an option that lets you enjoy the tax benefits of a Roth IRA. A backdoor Roth IRA is a strategy that helps you save retirement funds in a Roth IRA even though your annual income would otherwise disqualify you from accessing this type of individual retirement account.

Backdoor Roth IRA conversions are mainly useful for high earners whose annual income (plus access to workplace retirement plans) already make them ineligible for tax deductions for traditional IRA contributions.

Who Benefits from a Backdoor Roth?

  • High earners who don’t qualify to contribute under current Roth IRA rules.
  • Those who can afford the taxes for a Roth conversion and want to take advantage of future tax-free growth.
  • Investors who hope to avoid required minimum distributions (RMDs) when they reach age 72.

A general rule of thumb with Roth IRA conversions is that you will owe taxes on any money that has never been taxed before.

Roth IRA Conversion makes little Tax difference f

A Roth conversion will not make a significant difference to your retirement standard of living, according to an exhaustive new study.

The study findings reveal that “…only if you’re in the top 1% of retirement savers will a Roth conversion move the needle more than a little bit in your retirement.” The study, “When and for Whom Are Roth Conversions Most Beneficial?,” was conducted by Edward McQuarrie, a professor emeritus at the Leavey School of Business at Santa Clara University.

Unlike many previous analyses of Roth conversions, McQuarrie adjusted all his calculations by inflation and the time value of money, likely changes in tax rates, and a myriad other obvious and not-so-obvious factors.

McQuarrie finds that only if you have millions in your IRA or 401(k)—at least $2 million for an individual and $4 million for a couple—will your required minimum distributions in retirement be so large as to put you into even the middle tax brackets.

Only for those select few will the potential tax savings of a Roth conversion be significant. For most of the rest of us, we’ll likely be in lower tax brackets in retirement years, with an effective rate of 12% or less. That almost certainly will be lower than the tax we would pay for a Roth conversion during our peak earning years prior to retirement.

Even if tax rates themselves go up, furthermore, it’s still likely that your tax rate in retirement will be lower than preretirement. That’s because you’ll likely be at your peak earning years prior to retirement, when you might be undertaking a Roth conversion, and therefore in a relatively high tax bracket.

Once you stop working and retire, and are living on Social Security and the withdrawals from your retirement portfolio, your tax rate will most likely be lower—even if the statutory tax rates themselves have been increased in the interim.

Backdoor Roth IRA conversions lets you circumvent the prescribed AGI limits if your annual earnings put direct Roth IRA contributions out of reach.

References:

  1. https://www.forbes.com/advisor/retirement/backdoor-roth-ira/
  2. https://www.marketwatch.com/story/to-roth-or-not-to-roth-11623431970
  3. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3860359