Common Investor Mistakes During Market Corrections

Common Investor Mistakes During Market Corrections

 

When it comes to investing, market corrections are inevitable. Since 1950, there have been 37 declines in the S&P 500 of 10% or more—or approximately one every two years. Enduring these corrections is the price we pay as long-term investors striving to meet our financial goals. How we act during these time periods is what separates the rookies from the professionals and can dramatically alter how successful we are in achieving those goals.

We all tend to have a higher risk tolerance when markets are performing well. During a review with our financial advisor in the comforts of a home or office, we can easily imagine a world where stocks might be 10% to 20% cheaper on paper and how that may impact our financial goals. However, when we think about future risks in the markets, we tend to underestimate how we will feel in the moment. We lose sight of what else is happening in the world that is causing the markets to decline and how that might impact us personally. This year is no different, and the laundry list of reasons is long:

  • The war in Ukraine is costly
  • Inflation is the highest in 40 years
  • The Federal Reserve is tightening monetary policy
  • The supply chain is a mess
  • Mortgage rates are rising at the same time housing prices are at all-time highs
  • The pandemic is not over
  • Market valuations are too expensive, and we are overdue for a reset

The bottom line is, there is always a reason for why we experience market volatility, and how that impacts us personally can create stress, fear, and anxiety. When we let our emotions take over, we naturally have an urge to do something about it. These emotional reactions can lead to mistakes that can reduce the probability of meeting our finance and investment goals. Below are common mistakes investors make during market corrections and steps we can take to help mitigate costly errors.

 

Mistake #1: Looking at the market daily

When headlines are scary, the daily moves in the stock market are volatile and unpredictable. Checking the market or your portfolio frequently will only heighten any fear and anxiety and may result in poor investing decisions. During difficult markets, it is important to remember that you have an entire team working for you at Merriman. We have designed your portfolio using decades of academic research to weather all types of market environments so you can have peace of mind. We are also here to take on any blame for when things do not go as planned. You should take advantage of the resources at Merriman and schedule a time with your advisor to help refocus on your long-term plan.

 

Mistake #2: Deviating from an investment plan or not having a plan at all

Another reason you have an advisor at Merriman is to create an investment plan that aligns with your goals, return expectations, and risk profile. The plan is a customized, long-term strategy meant to withstand multiple market cycles. If you have the urge to change your plan during a market correction, then have a conversation with your advisor and ask the following questions: Have my long-term goals changed? Am I still on track to meet those goals? If I deviate from my investment plan, how will that impact the probability of successfully meeting my goals? These questions will help reduce any reactionary emotions and shift your mindset back to the big picture.

 

Mistake #3: Trading more frequently or trying to time the bottom

Day trading and market timing strategies are automated systems that utilize algorithms and programmed rules designed to execute trades in milliseconds. This places the human day trader at a significant disadvantage. While the data supports that day trading or attempts to time the market are not additive to long-term returns, market corrections can be an excellent time to be a buyer.
However, it is vital to have an investment plan in place so you are prepared to execute in the moment. As an example, a rebalancing strategy is one method that is highly effective for long-term results. This removes emotions from the equation and allows for a disciplined plan of attack during market downturns.

 

While your feelings play a vital role in determining the right long-term strategy for you, we cannot let emotions dictate our investing decisions, particularly during market corrections. This can lead to short-term mistakes that, left unchecked, can have negative impacts on your retirement goals. A disciplined investing approach based on facts, not emotions, is the winning formula.

 

 

 

Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.  Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. As always please remember investing involves risk and possible loss of principal capital and past performance does not guarantee future returns; please seek advice from a licensed professional.

To Exercise or Not to Exercise: What to Do When You Have Options in a Private Company

To Exercise or Not to Exercise: What to Do When You Have Options in a Private Company

 

Working for a startup or a smaller private company can be exciting. You may be creating cutting-edge technology or providing services or products that will fill a need within an industry. It also means you may have the opportunity to become a significant stakeholder in your company before a single share of stock has been sold to the public. If you’ve been granted options in a private company, you may be asking yourself, “Is the potential reward of exercising my options worth the risk?”

This answer is a complicated, nuanced one that will depend on each individual and the company’s circumstances. That being said, I’ve done my best to distill some of the most important lessons learned in helping clients navigate whether to exercise options in their company while it is still private.

 

Never invest more than you’re willing to lose.

Your company is doing great things and you strongly believe that you’re moving in the right direction. You wouldn’t have chosen to take the risk of working for this company if you didn’t believe so. The inconvenient truth is that so many bright, promising startups or private companies fail each year. A lot of this has nothing to do with the company itself but is simply the result of factors outside its control—like the general market conditions at the time the company was anticipating raising another round of funding.

Before your company goes public or has a liquidity event, there isn’t a readily available market for you to sell any of the shares you received when you exercised. Until your company has actually gone public, there is a reasonable risk the shares you hold from exercising could be worth nothing. Companies are also taking longer and longer to reach a point at which they are ready to go public or IPO. You must go in with an expectation that you could be waiting 10 or more years for the opportunity to sell your shares in the open market. If the possibility of losing 100% of your investment makes your palms sweat, you likely will want to wait until your company is actually public before you exercise your options.

 

Do take on an amount of risk appropriate for your situation.

It is important to understand the risks and the worst-case scenario of exercising options in a company that is not yet public. On the flipside, exercising options in a private company can have tremendous outcomes for those who were able to buy in at an earlier stage. Before deciding how much to exercise in your company while it is still private, first take a look at your list of financial goals and priorities:

  • Do you have a sufficient emergency fund of at least three to six months of expenses set aside in cash in a savings or checking account?
  • Are you maximizing savings into the retirement accounts available to you? Have you evaluated whether you’re on track to meet your target retirement date with your current rate of contributions?
  • Are you saving enough for other major goals like your kids’ future college expenses?

If you can say yes to all these questions and are willing to accept the risk, then by all means, allocate a certain portion of your income or savings toward exercising options in your company. It is almost always much less expensive to exercise options while your company is still private than after it has gone public. This is because the valuation (409a) while the company is private is usually much lower than the price at which the company will be valued once it is public. A significant increase in valuation will mean a much larger tax bill per option that is exercised.

 

Understand the tax consequences.

Options are complicated. The type of options you receive will dictate your exercise strategy and the resulting tax implications. You cannot simply look at the cost to exercise as your total cost to purchase shares in your company. It is important to be aware of your company’s most recent 409a valuation, which will determine the amount of income you are recognizing each time you exercise an option. You will be paying tax on income for shares you still cannot sell and may not have an open market for anytime soon. Exercising stock options without fully understanding the tax impact could mean receiving a surprise tax bill and not having enough cash set aside to cover it.

If you exercise Non-Qualified Stock Options (NSOs), your company will withhold 22% of the income recognized for federal taxes. This may or may not be enough to cover your total tax liability for the exercising depending on the amount and makeup of your other income. You’ll want to estimate the additional taxes you may owe due to the exercise of NSOs and make estimated tax payments or set aside enough funds to cover the tax liability when you file.

If you exercise Incentive Stock Options (ISOs), your company will not withhold any amount for federal taxes, and you will be expected to cover the entire tax liability through estimated tax payments. Incentive Stock Options can also create what is called Alternative Minimum Tax (AMT), which is complicated to calculate and track on an ongoing basis.

 

Ask for help.

There are certain projects in my home I’m willing to tackle and certain projects I’m more than happy to hand off to professionals. Paint the guest room? No problem. Rewire and update the electrical in my kitchen? You better believe I’m leaving that entirely up to the capable hands of a licensed electrician.

When we talk about options, and especially options in a private company, we are entering a territory where the DIY approach can fail you miserably. Employ the help of a finance or tax professional who has expertise and experience navigating private company stock option strategy. You don’t want to be in the position of wondering why you have tax bills that are much higher than what you were expecting or realize that failing to file a form by a certain deadline is going to cost you thousands of dollars in the future. A qualified professional can help you determine the appropriate amount of risk to take, given your current financial situation and goals, while providing peace of mind that there are no major tax surprises on the horizon.

Is your company the next Apple? I have no idea. What I do know is that the future rarely plays out exactly how you expect it will, for better or for worse. All we can do is make our best calculated bet with the information and resources we have at the time. After that, all that’s left to do is embrace the adventure.

 

 

Disclosure: The material is presented solely for information purposes only are not intended to provide specific advice or recommendations for any individual. The information presented here has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be relied upon as such.

 

The Roth Rulebook

The Roth Rulebook

 

When preparing for retirement, it can be important to save money in different types of accounts to give you flexibility when it comes time to spend those funds. One of the most powerful and misunderstood types of accounts is the Roth. A Roth account is an after-tax retirement account that can be in the form of an IRA or an employer-sponsored plan such as a 401(k). The after-tax component means you pay tax on the front end when receiving the income, and in exchange, you can receive tax-free growth and tax-free withdrawals if you follow the rules of the Roth. There are three components to consider: contributions, conversions, and earnings. Contributions and conversions refer to the principal amount that you contribute or convert, while earnings refer to the investment growth in the account. There are contribution and eligibility limits set by the IRS each year, but today we will focus on withdrawing funds from a Roth IRA to maximize the after-tax benefit.

 

Roth Contributions

After you contribute to a Roth IRA, you can withdraw that contribution amount (principal) at any time without paying taxes or the 10% penalty. That is an often-overlooked fact that can come in handy.

Example: Ted is 38 years old and decides to open his first Roth IRA. He contributes $5,000 to the account immediately after opening it. Two years later, Ted finds himself in a financial bind and needs $5,000 for a car repair. One of the possible solutions for Ted is that he could pull up to $5,000 from his Roth IRA without paying any tax or penalty.

 

Roth Conversions

A Roth conversion is when you move funds from a pre-tax account such as a traditional IRA. You will owe income tax on the amount that you convert. This can be a powerful strategy to take control of when and how much you pay in taxes. There is no limit to how much you can convert.

When it comes to withdrawing money used in a Roth conversion, five years need to have passed or you need to be at least 59.5 years old to withdraw the conversion penalty-free. It is important to remember that each conversion has a separate 5-year clock.

Example: Beth is 50 when she executes a $40,000 conversion from her IRA to her Roth IRA in January 2020. In March 2025, Beth finds herself needing $40,000 for a home renovation. One of the possible solutions is that Beth could pull up to $40,000 from the conversion that she did over five years ago even though she is under 59.5.

 

Earnings

When it comes to withdrawing earnings from growth that has occurred after contributing or completing a conversion, you must wait until age 59.5 and five years need to have passed since you first contributed or completed a conversion. If you don’t follow both of those rules, then you could have to potentially pay income tax on the growth and a 10% penalty.

Example: With our previous examples above with Ted and Beth, even though they can withdraw their contribution and conversion respectively, neither of them can touch the earnings in their Roth accounts until they are 59.5 and have satisfied the 5-year rule.

 

Other Important Details

There are a few other exceptions that allow a person to avoid the penalty and/or income tax, such as a death, disability, or first-time home purchase.

For ordering rules, when a withdrawal is made from a Roth IRA, the IRS considers that money to be taken from contributions first, then conversions when contributions are exhausted, and then finally earnings.

 

Strategies 

  • Have a thorough understanding of the rules before withdrawing any funds from a Roth account.
  • Speed up the 5-year clock.
    • You can technically satisfy the 5-year clock in less than five years. You can make contributions for a previous year until the tax filing date (typically April 15th, but as of this writing, it may be April 18th in 2022). This means that a contribution on April 1st, 2022, could be designated to count toward 2021, and the clock will count as starting on January 1st, 2021. This shaves 15 months off the 5-year clock! Note: Conversions must be complete by the calendar year’s end (12/31), but you can still shave 11 months off the 5-year clock.
  • Start the 5-year clock now!
    • Even a $1 contribution or conversion starts the clock for you to be able to harness tax-free gains, so start as soon as possible.
  • After the passing of the SECURE ACT in 2019, most non-spousal IRA beneficiaries must now fully distribute inherited IRAs within ten years. This means that an inherited Roth IRA owner could potentially allow the inherited Roth to grow tax-free for up to ten more years and then withdraw those funds tax-free. If it fits into an individual’s financial plan, this can be a tremendous tax strategy to take advantage of.

 

Roth accounts can be incredible but also very confusing. As advisors, we figure out the best way to use these accounts to your advantage in terms of maximizing growth and minimizing taxes. If you have any questions about how you can best utilize a Roth account, please don’t hesitate to reach out to us. We are always happy to help you and those you care about!

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Nothing in these materials is intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be relied upon as such.

When Can I Expect My Tax Forms?

When Can I Expect My Tax Forms?

 

We know there’s a lot to keep track of at tax time and we often get asked, “When will I get my tax forms?” Here’s a quick guide of roughly when you can expect to have your tax forms available from your custodian. We encourage you to sign up for electronic tax form delivery for notifications about their availability, ease of access, and security.

Schwab

To ensure timely tax reporting while limiting corrections, Schwab produces its Form 1099 Composite in two separate production runs, depending on the types of investments held and when trades were last placed in the account. If you are a Merriman client, your account(s) will likely be included in the second production run.

First Production run | Posted online and begin mailing forms: February 2
Second Production run | Posted online and begin mailing forms: February 16
Both production runs | Tax software download/export: Available February 18

Source: Schwab

 

You can sign up for electronic tax form delivery by logging into www.schwaballiance.com and selecting the Paperless option in the Service tab.

 

Tax Form Corrections

If Schwab receives updated information from issuers of securities after the initial tax form has been mailed, Schwab is required to send a corrected Form 1099 Composite, with the revisions clearly highlighted, within 30 days of being made aware.

 

 

TD Ameritrade

TD Ameritrade has already posted some 2021 1099 tax forms. If you received at least $10 in dividends or interest, or had a closing transaction or certain reportable corporate actions, an IRS Form 1099 will be issued.

The 1099 forms currently available are for clients who:

  • Had reportable activity as a result of trading and/or dividend or interest income from equity stocks, and
  • Did not hold investments deemed highly likely to reclassify income distributions, requiring a corrected 1099 tax form.

TD Ameritrade will alert clients who have a valid email address on file once their 2021 Consolidated Form 1099(s) and corrected form 1099(s) (if issued) are available for them to view online.

You can sign up for electronic tax form delivery by logging into www.advisorclient.com. then selecting My Profile > Communication Preferences.

 

Clients Who Will Be Excluded from This First Mailing

Clients who had a high probability of income reclassification or cost basis reporting related to fixed-income products were not included in the initial 1099 batch. Their 1099 tax forms will be available in the coming weeks, allowing more time to capture such changes in the original form and reducing the likelihood these clients will receive a corrected form (which could potentially require the refiling of their tax returns).

 

 

Fidelity

Similar to Schwab and TD Ameritrade, Fidelity does multiple 1099 production runs to minimize corrections needed. Depending on the client’s holdings and when transactions occurred in the account, these are the three possible timelines:

 

You can sign up for electronic tax form delivery by logging in at www.fidelity.com and selecting Your Profile (tab) > Preferences > Communication Options. In the electronic/paper mail delivery section, click Update.

 

 

Flourish

1099-INTs have been posted for all applicable accounts. You can log in to www.flourish.com and click on the Documents tab to access your 1099(s), which are dated December 31st, 2021.

Please note: Flourish does not issue 1099-INTs for clients if their combined account(s) do not generate $10 or more of interest in any given year. This does not imply that clients are not required to report interest if under $10. Clients should consult with a tax professional if they have any questions.

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.

 

How Do Incentive Stock Options (ISOs) Impact Alternative Minimum Tax (AMT)?

How Do Incentive Stock Options (ISOs) Impact Alternative Minimum Tax (AMT)?

 

One of the most common areas where we see clients introduced to Alternative Minimum Tax is when Incentive Stock Options (ISOs) enter the financial picture.  To learn more about AMT and how it is calculated, so you can avoid a shock, check our blog post from last week.

ISOs can be a tremendous benefit to creating wealth, but they are often misunderstood and can pack a large surprise if not appropriately planned for.  Here are a few key terms to get us started:

  • Grant Date/Amount– Original date and number of shares awarded
  • Vesting Date– The date at which you are allowed to exercise your options
  • Exercise Price– Price paid for options, usually discounted from the current share price.
  • Bargain Element– Difference between exercise price and fair market value (FMV); drives potential AMT liability

ISO preferential tax treatment is attained when the shares are sold one year after exercise and two years after grant. When this criterion is met, the gains upon the sale will be considered long-term capital gains, as opposed to short-term gains which are taxed at current income rates.

 

Qualifying vs Disqualifying Disposition:

 

Qualifying Disposition
  • Exercise and sell one year after exercise and two years after grant – AMT liability in the year you exercise, and gains are considered long-term capital gains
  • Exercise and hold – AMT liability in the year you exercise but no additional immediate tax liability because the shares have yet to be sold

 

Disqualifying Disposition:
  • Exercise and sell within one calendar year – no AMT liability and gains are taxed as regular income
  • Exercise and sell within 12 months, across two calendar years – AMT liability in the year you exercise, and gains are taxed as regular income
  • Exercise and sell more than one year from exercise but less than two years from grant – AMT liability in the year you exercise, and gains are split between regular income rates for the bargain element and capital gains depending on holding period

 

The AMT tax liability mentioned in the scenarios above is determined based on the difference between the exercise price and the fair market value (FMV) of the shares on the date of exercise. AMT may result in a larger tax bill than a typical year without exercising options and thus will directly affect your household’s cash flow.  The good news is that when you end up paying AMT related exercising ISOs, you will likely receive an AMT tax credit, which can be used to offset your federal income tax bill in future years.  This is a great reason why involving a CPA to help keep track of all the moving pieces is highly recommended.

The 83(b) Election is an alternative approach to divesting company stock. If your company allows, you have 30 days from the grant date to notify the IRS and your company of the 83(b) election. This involves paying tax on the exercise price from the grant at regular income rates; there would be no AMT implication and depending on when you sell the shares, you would later realize short- or long-term capital gains. For shares which you expect to increase in value, this can provide a fantastic tax break. This is however considered a risky approach because the shares could lose value and you would have overpaid on taxes by making this election.

Please reach out to us if you would like to work through your specific situation.

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.

 

What Is Alternative Minimum Tax (AMT) And Does It Affect You?

What Is Alternative Minimum Tax (AMT) And Does It Affect You?

 

Alternative Minimum Tax (AMT) is not something everyone is exposed to, but when you are, it can often create confusion and add a layer of complexity to financial planning that many are not prepared for.  This article will help outline how AMT may affect your financial situation.

The Alternative Minimum Tax was created in the 1960s with the intention of preventing taxpayers with substantial income from utilizing various deductions in order to dodge the traditional federal income tax system. The AMT system runs parallel to federal income tax for individuals, trusts, and estates. Corporations were also once subject to AMT until this was repealed by the Tax Cuts and Jobs Act in 2017. AMT is calculated to determine if taxpayers are paying their “fair share” in a given tax year. For individuals, the AMT system recalculates income tax using fewer deductions and exemptions – for example the standard/itemized deduction – and then adds back specific tax preference items to an individual’s gross income. 

A few of the preference items that we often see that affect AMT are listed below. There are several other influencing factors which are less common, and for the sake of this article, have been left out. IRS Form 6251 has the full details.

  • Capital gains from exercise of stock options (i.e., Incentive Stock Options)
  • Qualifying exclusion for small business stock
  • Interest on private activity bonds
  • Deductions for accelerated depreciation

Once the Alternative Minimum Taxable Income (AMTI) is calculated, the annual AMT exemption is applied to determine what amount is subject to AMT rates. In 2021, the AMT exemption is $73,600 for single filers and $114,600 for married filing jointly. The exemption begins to phase out for single filers at $523,600 and at $1,047,200 for married filing jointly.

After determining the minimum tax base, the AMT tax rate of 26% is applied on the first $199,900 (as of 2021).  Amounts above this figure are then subject to the second and final AMT tax rate of 28% to determine your overall AMT liability. After all is said and done, you will owe the higher of the two, traditional tax liability or AMT liability.

One of the most common areas where we see clients introduced to AMT is when Incentive Stock Options (ISOs) enter the financial picture. ISOs are often awarded by companies in lieu of direct compensation (i.e., annual salary), as a way to incentivize an employee to help grow the value of the company. Please check our blog upcoming blog post for specific details regarding Incentive Stock Options and the impact of AMT.

The majority of taxpayers don’t encounter AMT, but when they do, it can be a complete surprise.  Here at Merriman, we take a comprehensive approach to fully understand your financial landscape. In most situations, it is wise to involve a CPA when facing the AMT due to the complexity and varying timelines that affect cash flow. Please reach out to Merriman if you would like to discuss your situation in greater detail.

Watch for our upcoming blog post which will go into further detail about Incentive Stock Options (ISOs).

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.