The 5 Biggest Financial Planning Mistakes Made by Tech Professionals | Mistake #2

The 5 Biggest Financial Planning Mistakes Made by Tech Professionals | Mistake #2

 

 

I love working with the tech community. I started my career at Microsoft and have since been inspired by the creative and innovative minds of folks working at tech companies large and small. I also enjoy working with tech employees, because as a personal finance nerd, I get to help people navigate the plethora of benefits available that are often only available at tech companies. Between RSUs, ESPP, Non-Qualified or Incentive Stock Options, Mega Backdoor Roth 401(k)s, Deferred Compensation, Legal Services, and even Pet Insurance, it is the benefits equivalent of picking from a menu of a Michelin three-star-rated restaurant.

 

Through my own experience as a tech employee and my experiences now as an advisor working with tech professionals, I’ve identified some of the biggest financial planning mistakes that can hold the tech community back from achieving financial independence and success.

 

Mistake #2 – Building and Maintaining Concentrated Stock Positions

 

I consider a concentrated position to be any investment that comprises over a quarter of your investable assets. It can be easy to accumulate a concentrated stock position in the same company that is responsible for your paycheck. If you receive stock as part of your compensation, without a disciplined plan to sell shares on an ongoing basis, you will continue to accumulate more and more company stock. Over the past several years, countless families have become wealthy because of the stock compensation they’ve received and its seemingly never-ending climb in price. While the strategy of holding onto RSUs and ESPP over the recent past has worked out incredibly well, we know that continuing to maintain a concentrated stock position is incredibly risky if you want to ensure you maintain your newly built wealth.

 

There are two explanations for not reducing a concentrated position that I hear most often: (1) My company has outperformed the rest of the market several years in a row. If I believe in my company and our growth prospects for the future, why would I sell? (2) If I sell my company stock now, I’ll have to pay a significant amount of tax on the gain. Let’s debunk each of these as reasons not to diversify:

 

(1) Typically, returns of a single stock position are intensely more volatile than the returns of a market index. This can work out in your favor, or it can work to your detriment. Historically, about 12% of stocks result in a 100% loss.* In addition, approximately 40% of stocks end up with negative lifetime returns, and the median stock underperformed the market by greater than 50%.* This means that a few star performers drive the positive average returns of the market. The odds of randomly picking one of these extreme winners is 1 in 15.* If you’ve been lucky enough to hold one of these outperformers, I encourage some humility around acknowledging that maybe being in the right place at the right time has attributed to your rapid accumulation of wealth.

 

Companies that achieve such success and become the largest company in their sector may become subject to what is called the winner’s curse. Since the 1970s, data shows that sector leaders underperform their sector by 30% in the five years after becoming the largest company in that sector.* Over a long time horizon, you are probably more likely to obtain positive investment returns by ensuring you hold the future Microsofts and Amazons of the world through broad diversification, not concentration.

 

(2) I hate to tell you this, but unless you hold onto an investment until you die, you will have to pay tax on the growth at some point. I encourage people to think of paying long-term capital gains taxes as a good thing, because it means your investments went up and you made money. A surprisingly small fluctuation in stock price can wipe out any benefit of delaying the recognition of capital gains tax. As advisors like to say, “Don’t let the tax tail wag the dog.” If you’d like to discuss your situation, don’t hesitate to contact me.

 

Be sure to read our previous and upcoming blog posts for additional mistakes to avoid as a tech professional.

Source: * Avoid Gambler’s Ruin: Bridging Concentrated Stock and Diversification 

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.

Should I Set Up a Traditional 401k for My Business?

Should I Set Up a Traditional 401k for My Business?

 

Whether you recently transitioned to being self-employed or have been a business owner for years, you may have wondered what the best way is to save for retirement. While it is commonplace for established companies to offer a retirement plan to their employees, many self-employed individuals may not realize the potential for significant retirement savings by establishing their own plan.

However, the decision as to which type of plan to choose is far from simple. There are a multitude of questions a business owner must ask themselves before they can identify the best fit for their goals and preferences. To assist in this decision, the following flowchart poses the most pertinent of these questions.

 

 

Whether you are considering a SIMPLE IRA or are curious how a defined benefit plan can help you achieve your savings goals, Merriman’s team of knowledgeable advisors are here to help you make the most optimal selection. Please don’t hesitate to contact us if you have questions about your unique 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.

Spring Document Cleaning

Spring Document Cleaning

 

It’s almost spring, which means it’s time for some spring cleaning—and this spring’s focus is paperwork. I don’t know about you, but I don’t love paperwork. I’ve spent years working toward zero paper, and I’m now finally down to a handful of documents. I’ll share some tips below so you can minimize your paperwork, too!

Document delivery. If you’re tired of getting statements for your accounts or bills in the mail, try signing up for e-delivery instead. This will help save time and energy opening and sorting mail and having to dispose of it as well. Don’t forget to proactively visit the proper websites to check those statements and pay those bills.

Document retention. We all know we need to hang onto certain tax, asset, and legal documentation, but sometimes the specifics can be tough to remember. Here’s a quick list of the most common situations where you’ll need to keep documentation. Please see this checklist for a detailed list.

Income tax returns. Keep at least three years of state and federal tax returns and supporting documentation on file. Supporting documentation includes records that prove any income, deductions (including medical expenses), or credits claimed (W-2, 1099, end-of-year statements from banks and investment accounts). Depending on the state (like CA), you may need to keep tax returns for longer than three years. If you think you forgot to report income and it’s more than 25% of your gross income, keep six years of tax returns. If you are claiming a loss for worthless securities or bad debt deduction, keep records for seven years.

Investment accounts or bank accounts. Consider keeping the most current statements on file and the end-of-year statement until you complete your tax return.

Retirement accounts. Consider keeping documentation on any contributions, withdrawals, and conversions. If you made non-deductible traditional IRA contributions, keep Form 8606 until the account is fully withdrawn to track cost basis.

Debt (student loans, mortgage). Keep the loan documents until the loan is paid off. Once the loan is paid off, keep documentation proving that the loan has been paid in full.
Property (automobiles, real estate). Consider keeping any deeds, titles, settlement statements, or bills of sale until you sell the property. Keep documentation showing purchase-related fees that were capitalized until you sell the property.

Home improvements. Keep any receipts related to home improvements as they may be used to substantiate any adjustments to the cost basis for your property.
Insurance policies. Keep the most current policies on file.

Estate plan. Keep a copy of your Will, Trust(s), Powers of Attorney (General and Healthcare), Living Will or Healthcare Directive, and beneficiary designations on file, and store the originals in a safe place.

Document storage. To reduce your paperwork, try storing these must-keep documents on your secure personal computer. Of course, with this storage method, it’s important to back up your electronic files and have firewall protection.

Document disposal. Please remember to shred any documentation that contains sensitive personal information, such as your Social Security numbers or account numbers. A personal shredder should do the trick and will be less expensive in the long run if you’re disposing of documents each year.

Password organization. How are you currently storing and keeping track of your passwords? I recommend using a cloud-based password manager like LastPass where you can store all your passwords in one place and only need to remember the “master” password to access them. LastPass has a random password generator to help you create complex passwords that are more difficult to hack. LastPass also offers two-factor authentication and doesn’t allow your “master” password to be reset to keep your account secure.

Digitize your photos. Does your paperwork include old family photos you’ve been meaning to digitize? Try sending them to a digitizing service like Legacy Box where they’ll scan and save them to a thumb drive, DVD, or the cloud. Legacy Box works with tapes and films, too. While this service may seem pricey, it might be worth paying someone to digitize those photos as they are priceless memories and should be backed up sooner rather than later in case something happens to the physical copies.

Inform your family. Make sure your family knows where you keep your documents and what your “master” password is in case something happens to you. This is especially important for estate planning documents. Having these conversations ahead of time will help alleviate the stress on your loved ones of not knowing what to do or where to find things.

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.

 

The 5 Biggest Financial Planning Mistakes Made by Tech Professionals | Mistake #1

The 5 Biggest Financial Planning Mistakes Made by Tech Professionals | Mistake #1

 

I love working with the tech community. I started my career at Microsoft and have since been inspired by the creative and innovative minds of folks working at tech companies large and small. I also enjoy working with tech employees, because as a personal finance nerd, I get to help people navigate the plethora of benefits available that are often only available at tech companies. Between RSUs, ESPP, Non-Qualified or Incentive Stock Options, Mega Backdoor Roth 401(k)s, Deferred Compensation, Legal Services, and even Pet Insurance, it is the benefits equivalent of picking from a menu of a Michelin three-star-rated restaurant.

 

Through my own experience as a tech employee and my experiences now as an advisor working with tech professionals, I’ve identified some of the biggest financial planning mistakes that can hold the tech community back from achieving financial independence and success.

 

Mistake #1 – Not Optimizing Benefits

 

We all are familiar with the paradox of choice. Most people, when faced with a long list of complicated benefits that even some financial professionals struggle to understand, will focus on the areas that are familiar and disregard the rest. Who wants to spend their free time reading about ESPP taxation or the mechanics of Roth Conversions on after-tax 401(k) contributions? Chances are that if you work for a growing tech company, you have very little free time to begin with.

 

While it may not be the most enjoyable use of your evenings or weekends, I can’t emphasize enough how valuable it is to invest the time to learn how to optimize your benefits now. Choosing to invest additional savings in your Mega Backdoor Roth 401(k) over a taxable brokerage account may shave a couple of years off your retirement date. Maximizing HSA contributions and investing the growing account balance can provide for a substantial amount of money to pay for high healthcare costs if you retire before you are Medicare eligible (age 65). Making strategic Roth Conversions during lower income years, such as in early retirement or during breaks from paid employment, can save hundreds of thousands of dollars in future taxes over the course of your lifetime. The list goes on, trust me.

 

If I don’t exercise for a week, or even a month, I probably won’t notice a significant difference in my overall health. If I keep telling myself that I’ll start a workout routine, but years go by without investing my time and energy into making the plan a reality, my physical fitness will take a toll, and I will also lose out on all the amazing benefits that exercising regularly provides. I may look back with regret at some point later in life that maybe certain health issues could have been minimized or prevented if I had spent the time to prioritize what is truly important. It is critical to think beyond how something may impact us in the short term and recognize the long-term impacts of choosing to continue to put something on the back burner. Ask yourself, what impact will this have on my life if I wait a year to prioritize my personal finances? What effect will it have on my life if I wait ten years to prioritize my personal finances? Chances are that impact is even greater than you think. If you want help assessing and optimizing your benefits, don’t hesitate to reach out to me.

Be sure to read our upcoming blog posts for additional mistakes to avoid as a tech professional.

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.

 

Is It Time to Hire a Financial Advisor? | 5 situations when the answer could be yes

Is It Time to Hire a Financial Advisor? | 5 situations when the answer could be yes

 

 

A financial advisor is a professional who is in charge of guiding an individual or entity towards their financial goals in the most efficient way. At Merriman, we love taking on the burden of financial planning so our clients can get back to spending their time and energy doing the things they love.

 

Thrive Global describes the financial sector as complex and dynamic, with assets and trends changing and interdependent with other factors, and a financial advisor has the skills required to study these processes and trends. However, only 17% of Americans hire a financial advisor, with the rest either managing their own finances or simply winging it. But in a time where debt and living expenses are increasing, having and following a financial plan is more important than ever. If you find yourself in any of the following situations, you should consider hiring a financial advisor:

 

You’re starting a new business

Starting a new business can be a costly endeavor, as it involves expenses and procedures you wouldn’t immediately be aware of, such as filing for a certificate of formation and providing initial reports and paying their respective filing fees. A financial planner can advise you on the best structure to form your business in, taking into account startup costs, annual taxes, and filing fees. LLCs in Washington need to be aware of the taxes they need to pay at the federal, state, and local levels, as well as a sales tax and state employment tax. All of these can become overwhelming to keep track of, especially if you’re a budding business, and a financial planner can help you get it all sorted out.

 

You’re a DIY investor

A simpler investment plan is usually better; however, this isn’t true with financial planning. An overall financial plan should also consider factors such as retirement planning, tax planning, and insurance planning. Market Watch explains that DIY investors would still need a financial advisor in order to be sure that nothing is being missed out. Clients don’t realize that an advisor will do more than just manage their portfolio and help with investment plans. Financial advisors can take charge of a range of money-related management tasks, such as making a comprehensive saving and spending plan and guiding the client towards making sensible financial decisions.

 

You’re starting a family

Raising a child is not cheap: It costs an average of $233,610* to raise a child for the first 17 years of their life. Having a financial advisor can help you review your finances to see if you can actually afford being a parent. An advisor can also help you plan when to start saving for your child’s college expenses, while also keeping your retirement plan on track and leaving space for a growing family. They can help settle any future inheritance as well as ensure that your children will be taken care of.

 

You’re close to retirement age

Though you may have a retirement plan, the financial decisions you make in retirement might be more complex than the decisions you’ve had to make in the years leading up to it. A financial advisor can help you consider what you should do so you don’t end up outliving your money. Even when you’re already in retirement, a financial advisor can help you manage a spending plan. You might even consider an investment plan as well, and an advisor will help you make decisions that won’t sacrifice what you already have.

  

You’re financially illiterate

There is a financial literacy crisis in America, but financial advisors can help solve this problem. Americans would rather talk about anything else, such as religion, politics, even death, rather than personal finances. Aside from the embarrassment, another major factor that makes money talk taboo is that it is considered rude to talk about it with other people. However, talking about money is the first step to being a financially literate person. Advisors let their clients ask anything without judgment, creating a learning environment that empowers people to expand their knowledge about their own financial situation.

 

The circumstances requiring a financial planner aren’t just limited to the points discussed above. Overall, it’s important to plan for your financial future. Read our “Why Do I Need a Financial Plan?” for a deeper understanding of why a financial advisor is the right person to develop a financial plan for you. And to learn more about the value that a financial advisor can provide, check out the “10 Reasons Why Clients Hire Us.” If you would like to start looking for an advisor to help you with your plans, get in touch with us to discuss the necessary steps.

Article written by Ellie Hartwood
Exclusively for Merriman

 

Source: *https://www.usda.gov/media/blog/2017/01/13/cost-raising-child#:~:text=Middle-income, married-couple,Where does the money go?

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.

Pitfalls of Buffered and Levered ETFs to Achieve Your Financial Goals

Pitfalls of Buffered and Levered ETFs to Achieve Your Financial Goals

 

The marketplace for exchange-traded funds (ETFs) grows each day, and more and more different and innovative products are being created. One new type utilizes derivatives. A derivative is a financial object that derives its value from an underlying financial security. An example of this is what is called an option. An option is a contract between two parties that gives the buyer the choice to buy or sell a security at a predetermined fixed price. The original purpose for options was to balance risk in a concentrated portfolio. You could hedge a bet by securing a selling price or buying price of a stock. Nowadays, some ETFs are using derivatives for very different purposes, such as increasing their exposure (levered ETFs) or setting a buffer on the equity returns (defined-outcome ETFs). While these ETFs are innovative and flashy, it’s important to think about the ramifications of investing in such a product.

A levered ETF uses either derivatives or borrowed capital to increase exposure to the underlying assets (e.g., stocks). This increase is a double-edged sword. Not only are the ups larger but the downs are larger as well. In a portfolio, the increase in the drawdowns makes the leverage ineffective for increasing risk-adjusted returns, unless paired with volatility or drawdown-reducing strategies such as trend following. In March of 2020, the S&P 500 Index fell by -12.5%. For a theoretical 2x levered portfolio, the drawdown would have been -25%. An unlevered portfolio would need a return
of 14.3% to get back to breakeven. A 2x levered portfolio would need a return of 33.3% to get back to breakeven. Astute readers will notice that 33.3% is MORE than double 14.3%. This simple aspect of leverage is one of the many reasons it should be taken on with caution. Successful investing is often more about not losing than it is about winning.

These ETFs offer certain upsides and downsides. These upsides and downsides are calculated for the lifetime of these funds. Depending on when the investor buys into the fund, they could experience a very different return, including one outside of the promised range. This limitation can particularly be a problem if the market increased prior to the purchase, as the upside return at that point can be severely capped. The forward-looking return of these products decreases exponentially as the market increases.

Levered ETFs also suffer from underperformance compared to their benchmark. This drag comes from the imperfect way that leverage is acquired either through derivatives or borrowed capital. Out of 22 standard levered ETFs in the market today, every single one of them has underperformed their prospectus benchmark when the same amount of leverage was provided for the past five years. We believe this underperformance, when combined with the issue of large drawdowns, high tax costs due to inefficiency of derivatives, and high fees, makes these levered ETFs ill-advised as long-term investments.

Another new instrument that has captured the attention of many is the so-called “buffer ETF.” Buffer ETFs advertise guaranteed returns in a specific range. While these products offer a solution to specific problems, like the levered ETFs, we believe they are an ill-advised investment for long-term investors looking to grow their principal or provide income in retirement.

The biggest drawback of buffered ETFs is that investors pay too much for the downside protection that they receive.

The most widely held products advertise options for reducing annual downside risk by 9%, 15%, or 30%. In return, the investor relinquishes upside growth.

The plot below shows how the annual return distribution of a buffered approach compares to the return of the underlying index. The index is represented by the historical annual returns of the S&P 500 minus 0.05% which is an estimated cost for a low cost S&P 500 index fund. The buffered approach simulates applying a 9% reduction in downside risk and capping the upside at 15%. It is intended to be representative of the types of products currently on the market. It also includes a 0.75% reduction to simulate the fees associated with typical defined-outcome products.

 

 

The plot shows clearly that while the buffering provides some downside protection in large drawdown years, there have been very few of those historically. Let’s see how this affects an investor’s outcome in some real-life scenarios.

For the years 2017, 2018, and 2019, the S&P 500 has returned 22%, -4%, and 32%. A 13% buffer ETF would have reduced the cumulative 53% gain to an approximate 25% gain. When we apply this same methodology of a 15% top buffer and a -9% bottom buffer to the S&P 500 since 1928 (94 years) on an annual basis, we get a stark difference in returns. During the 94 years surveyed, the S&P 500 index minus an average index fund expense ratio (“Net S&P 500 Index”- see important disclosures regarding these calculations below) had an annualized return of 10.2%, while a the model for a rolling buffer ETF on the S&P 500 Index starting January 1st would have a return of 6.1%. To further illustrate this point, for example, start with $100,000 and invest it for 25 years, and at these annualized rates of return an investor may see the Net S&P 500 Index outperform the rolling buffer ETF model by $600,000. This underperformance can seriously affect the probability of successfully reaching one’s goals.

While an investor is buying drawdown protection by using a buffer ETF on a 5-year timescale since 1928 this has only yielded better returns 18% of the time as compared to utilizing alternative vehicles in seeking to protect against downside risk. Historically, a more efficient and higher return way of decreasing downside risk is using fixed income solutions such as treasury bonds. By way of an example utilizing the historical data described above, if an investor used 20% of the portfolio allocated to 5-year treasury bonds and the rest to the S&P 500 index model referenced above, the investor has reduced the historical possibility of underperformance to 13% and will maintain, pursuant to the historical data, a return that’s over 3% of the buffer ETF model. When done with multiple types of fixed income and alternative asset classes such as reinsurance or alternative lending the probability of underperformance continues to decrease. Do take note that the return and underperformance possibilities are based upon historical performance data and, therefore, future performance is in no way guaranteed and may be subject to wide variances due to unforeseen market, economic and other conditions. Peace of mind is something we all seek. In many cases, purchasing insurance to guard against risks one can’t control is an excellent choice. However, if the premium you pay is greater than the insurance you receive, it doesn’t make financial sense.

The bottom line for most of these derivative investments is that while they seem very attractive on the surface, once you look at the mechanics and nuances, they turn out to be ineffective at generating the solid risk-adjusted returns most investors need and want to meet their financial goals.

 

 

IMPORTANT DISCLOSURE AND DATA INFORMATION

The distribution graph is for illustrative purposes only, and is not 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. The information portrayed in these materials represents model performance and characteristics for the Merriman Model S&P 500 Index Fund or the Buffered S&P 500 and may not reflect the impact that material economic and market factors may have had on the adviser’s decision making. The make-up of any actual advisory program portfolio may differ as compared to the model portfolio provided herein, and is not meant to be representative of any one client or portfolio. In addition, the actual results of any of the adviser’s client portfolios may have been, or may be, materially different than the results of the hypothetical portfolio set forth herein. Market conditions, client restrictions, world events and any other macro variables may have a substantial impact on any of the adviser’s advisory program portfolios. The performance information does include the deduction of advisory fees and execution related fees, except custodial fees. To determine the Net S&P 500 Index, the average expense ratio used was determined by taking three of the largest and most liquid S&P 500 Index ETFs and averaging their fee. (IVV @ 0.04%, VOO @ 0.03%, and SPY @ 0.0945%) This averaged to 0.058% and then rounded down to 0.05% for ease of use and due to industry wide fee compression. The performance information does reflect the reinvestment of dividends and earnings. The information used for S&P 500 columns is based on historical index returns from 1928-2019. The information used for the “buffered” column is based on simulated data as described in the article. All data calculations are available upon request.

The information provided should not be considered a recommendation to purchase or sell any industry, sector or particular security. There is no assurance that any industry, sector or security discussed herein will remain in a client’s account at the time of reading this material or that any industry, sectors or securities sold have not been repurchased. The industries, sectors or securities discussed herein do not represent a client’s entire account and in the aggregate may only represent a small percentage of an account’s holdings. It should not be assumed that any of the securities, transactions or holdings discussed were, or will prove to be profitable, or that investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. All investing entails the risk of loss.

The S&P 500 index includes 500 leading companies in the US and is widely regarded as the best single gauge of large-cap US equities. Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. The holdings and performance of Merriman client accounts may vary widely from those of the presented indices. 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 Wealth Management unless a client service agreement is in place.