The Importance of Discipline

Benjamin Graham’s famous book, The Intelligent Investor, offers insight into the most important trait in investing, discipline. Graham explains you don’t have to be smarter than the rest, just more disciplined than the rest.

We often think investment success is achieved by picking the next hot stock or manager/fund that’s been beating the market, but that is a flawed approach. In the words of Graham, “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”

While all advisors and managers strive to outperform the markets over time for their clients, the single biggest thing a good advisor can do is be there to act as your behavior coach.

Many studies show investors are often their own worst enemy, letting emotions drive their financial decisions. This ultimately means doing the wrong thing at the wrong time for the wrong reasons. Advisors are there to work with you to help you determine your goals and craft a long-term plan funded with a long-term portfolio. Together, you continue working the plan through all the cycles of the economy, and all the fads and fears of the market. (more…)

How the TAP Annuity Works for Washington State Employees

When planning for retirement, Washington State employees have lots of options. The employer-based retirement for the Washington Public Employees Retirement System (PERS 3) is one part defined benefit (pension) and one part defined contribution. The state’s contribution and obligation is on the pension side and is based on a formula that creates a guaranteed lifelong income stream for the participant. The employee’s contributions are put into an investment account (the defined contribution portion of the plan) like a 401(k) where you can choose between a few investment options. Returns and payments from investments in the defined contribution plan aren’t guaranteed and are subject to risk; however, they have the potential to grow at a faster rate than your pension benefit.

Once retired, you can either withdraw from the defined contribution portion like a regular retirement account or turn part or all of this account into a guaranteed income stream through the plan’s Total Allocation Portfolio (TAP) annuity.

What is the TAP annuity?

The TAP annuity provides a guaranteed income stream with a 3% automatic inflation increase each year. Furthermore, your beneficiaries receive a refund of any undistributed portion of your investment in the TAP annuity upon your death. For example, if a retiree contributes $200,000 into the TAP Annuity and passes away five years after retirement, having only received $60,000 in monthly income, their heirs would be entitled to a refund of $140,000. (more…)

Why It’s Important to Keep Track of Improvements to Your House

Whether you live in a popular residential market like Seattle, San Francisco or New York, or have simply lived in the same home for several decades, it’s more common than ever that households are incurring taxable gains when they sell their home.

Taxable gains from the sale of a primary residence occur when the gain from the sale is above the $250,000 gain exclusion for an individual and $500,000 for a couple. This gain exclusion is available to households that meet the following criteria:

  • You’ve used the home as your primary residence for two out of the past five years (use test).
  • You’ve owned the home for two out of the past five years (ownership test).
  • You did not use the home sale exclusion in the past two years.

The gain is calculated by subtracting selling expenses and your adjusted cost basis in the property from the sale price. The adjusted basis is what you previously paid for the home plus the cost of improvements. Since you are subject to federal capital gains taxes, state taxes (where applicable) and the 3.8% Medicare surtax (in many cases as the taxable gain can be sizeable), keeping track of your improvement history can lead to significant savings on your taxes.

What’s considered an improvement?

The IRS provides the following examples of common improvements to your home that will increase your basis. (more…)

Why Unrealized Gains/Losses Isn’t the Best Way to Look at Performance

When trying to figure out your own performance, it’s common to look at your unrealized gain and loss first on your statement (Charles Schwab, Fidelity, TD Ameritrade). The problem with trying to evaluate performance based upon the gain and loss column alone is that it doesn’t reflect your total return and the impact of rebalancing.

Rebalancing entails selling assets that have grown beyond your target and buying assets that have fallen below your target, meaning, selling overvalued securities to buy undervalued securities. When rebalancing occurs, the assets sold likely had a large unrealized gain. Once sold, that gain is wiped out and the proceeds are re-invested in an asset that may show an unrealized loss or a much smaller gain. Rebalancing helps avoid your portfolio drifting too far from your target allocation of stocks, bonds and specialized investments to reduce your risk if the stock market were to decline. Furthermore, rebalancing takes advantage of the shift over time in which assets are in or out of favor.

Total return takes into consideration changes in the price of the asset (unrealized gain/loss), dividends, interest and capital gains distributions received. For many investments, such as more income focused mutual funds, most of the return comes from the components of total return that are not reflected in the unrealized gain or loss column on the statement. Below is the formula to calculate total return. (more…)

How to report a backdoor Roth IRA contribution on your taxes

In practice, the process of making a backdoor Roth IRA contribution is straightforward, but the documentation and reporting at tax time may be confusing. Whether you work with a professional tax preparer, use tax software such as TurboTax or complete your taxes by hand, understanding the mechanics of the money movements can help ensure you file your taxes correctly.

Let’s say you make a contribution to your Traditional IRA. If your income is too high to qualify for a deduction for the IRA contribution, the contribution is considered non-deductible. Your advisor doesn’t let the custodian (such as Charles Schwab, Fidelity or TD Ameritrade) know whether the contribution is deductible – you report it at tax time on IRS form 8606, Nondeductible IRAs. You use the form to keep track of basis in your Traditional IRA, and basis in this sense means after-tax contributions, to make sure you don’t pay tax on those exact dollars twice.

After you make the non-deductible IRA contribution, it’s converted, i.e., transferred from your Traditional IRA to your Roth IRA account. From that point on, those dollars are now Roth IRA assets and aren’t subject to future tax on earnings. If the conversion is never made, you’ll have basis, i.e., after-tax contributions in your Traditional IRA that you’ll need IRS form 8606 to keep track of. This ensures you aren’t subject to income taxes on withdrawals of that basis in the future, such as in retirement.

Around tax-time, you’ll receive a 1099-R from your custodian showing the distribution from your Traditional IRA that was converted to your Roth IRA the previous year. After tax time, closer to May, you’ll receive an information reporting Form 5498 that shows the contribution you made to the Traditional IRA, and the amount that was converted to Roth IRA for purposes of reconciliation and recordkeeping.

Let’s walk through the reporting process for a backdoor Roth IRA. (more…)

Things to Remember Around Tax Time if You’ve Made a Qualified Charitable Distribution

Form 1099-R is issued around tax time to report distributions you took during the previous year from a retirement account. Among other things, this form tells you and the IRS how much was withdrawn in total, how much of the distribution was taxable and whether there was any withholding for federal and state income taxes.

For those who gave part or all of their required minimum distribution directly to charity through making a qualified charitable distribution (QCD), this amount is still included in the taxable portion of your total distribution on form 1099-R. As you’ll see, the QCD is included in your gross distribution (box 1) and taxable amount (box 2a); however, the box for “taxable amount not determined” (box 2b) will be checked. Whether you work with a professional tax preparer, use software like TurboTax or prepare your own taxes by hand, it can be easy to forget that the QCD portion of your distribution should not be included in your taxable income on your tax return. It’s important to keep a record of any QCDs made during the year and hold on to the receipts or letters that you receive from the charities confirming receipt of the funds. (more…)