OAKLAND, N.J. – July 25, 2018 – Dr. Laura H. Mattia, MBA, CFP®, CDFA®, has joined Stonegate Wealth Management, LLC as a Partner & Managing Director of Stonegate’s Sarasota Office. You may view the press release here:
OAKLAND, N.J. – July 25, 2018 – Dr. Laura H. Mattia, MBA, CFP®, CDFA®, has joined Stonegate Wealth Management, LLC as a Partner & Managing Director of Stonegate’s Sarasota Office. You may view the press release here:
Many people aspire to having a second home down the shore or in some other vacation spot. Buying one is a huge financial commitment that may place a serious drain on your resources, and costs can be high for something you may only use 4-8 weeks a year. Costs include:
Consider that a vacation home costing $500,000 (in NJ) might cost:
Property Taxes: $6,000
Maintenance: $7,500 (1.5%)
Flood Insurance: $1,000 +
Mortgage Interest: $19,000 (400,000 mortgage, 5%, 30 years, first year interest)
Opportunity Cost on Down Payment: $6,000 ($100,000 down payment; 6% assume rate of return on invested assets).
Utilities: $2,000 – $5,000 (can vary widely depending on air conditioning use, off season use, etc.)
On the low end that second home may cost you $43,000 per year!
Renting the Home
You could defray some of the costs by renting the home part of the season, a home at the NJ shore might rent from $1000 – $3500 per week depending on location and size of the home. A problem with this is that you will need to rent it during peak season so it will not be available to you for much of the summer unless you limit the rental to say 8-10 weeks. If you do you might realize $16,000 – $25,000 and possibly cut your carrying costs in half. Unfortunately, that rental income will come with a price: dealing with tenants who will not treat the property as carefully as you do and you may need a place to store personal items to protect them from abuse and theft from tenants. Renting the home dramatically defeats the purpose of having the second home. We also did not mention that you will probably owe a realtor commission for the rental and you may want to consider hiring a property manager with a local presence to take care of issues that might arise.
Purchasing a second home means you will feel obligated to vacation there every year. You may end up going there instead of traveling to other places because of this “obligation.” On the other hand, it may be a place where you can spend time with your family and become the social center for family and friends.
You may want to consider instead, renting a home someplace for a few weeks. There are several advantages to that:
Know the Costs
We have created a spreadsheet that can estimate the costs of purchasing and owning a second home. Contact us if you would like us to analyze the costs for you.
Choosing a financial planner or advisor can be a daunting task, especially if you are faced with trying to determine how they are paid, how competent they are, and what credentials are actually important. Let’s discuss each of those “three C’s.”
Advisors may be paid through commissions, fees or a combination of both. When an advisor “sells” you a financial product like a mutual fund or an insurance policy they are paid by the insurance company or brokerage firm that “creates” the product. Some advisors are only paid by you; they may charge you for a detailed analysis of their finances and/or they may charge you a percent of any investments they manage for you. There are also advisors that both receive commissions and also are paid by you (“fee-based”) for a plan or for asset management. Whomever you hire, it is important to understand how they are paid since it might (but not always) affect the types of advice you receive. An advisor that charges for a plan or an asset management fee and cannot receive commissions is generally considered a “fiduciary.” A fiduciary is someone that works for you and must legally act in your best interests not their own. Generally, advisors that are compensated this way and act as “fiduciaries” have the fewest conflicts. They should be diligent in disclosing to you any conflicts that might still exist and how they will either avoid the situation that leads to the conflict or how they will “manage” it.
(CFP® certificants will be required to act in your best interests for financial advice regardless of their method of compensation beginning in October 2019.)
With fee-only advisors you always know the cost of the relationship since you pay them directly, with commission based advisors you may not have a clue since sadly there is no requirement that they disclose how much they earn from products they might sell you.
How can you tell your advisor is competent? It sure is difficult but there are some things to consider. First do they have a certification? There are plenty of advisors out there who do not, yet they have official sounding titles like “wealth advisor.” We’ll describe the education and certification that real advisors should have below. Besides having a designation or certification you may want to drill in on the advisor’s core competency by asking some pointed questions, including “how many years experience do you have,” and “what are your specialties?” Make sure the advisor has formal training in areas they claim as specialties. You may want to ask to view a sample analysis they did for a client (any advisor should have a sample with names changed or blacked out). When you look at the sample plan make sure it has at least the following sections:
That is just a partial list. Not all advisors will have competency in every area so it is important to discover how they deal with that. For example, Fee-Only advisors cannot sell products but they may recommend you purchase more life or disability insurance. Do they have a list of trusted outside experts that they work with? Does that list include attorneys, insurance agents, and possibly accountants?
There is one membership organization that has pretty specific requirements for their members, that is the National Association of Personal Financial Advisors (NAPFA). Their members are required to:
While even those strict requirements are not a guarantee that the advisor is competent it does certainly increase the chances that they are prepared to properly assist you.
The financial planning field is saddled with a plethora of titles and supposed certifications. It seems as if this is meant to make things more confusing for the consumer who is trying to get good advice. We suggest you ignore all titles like “wealth manager” or “financial consultant” and instead ask what actual education and certifications the person has. While many certifications exist the most important are the ones that require a broad background in many aspects of financial planning. There are two that fit that bill, CERTIFIED FINANCIAL PLANNER™ (CFP®) and Chartered Financial Consultant (ChFC). The CFP® designation is more widely known and it requires that certificants take a comprehensive exam, and a course that requires them to actually write a financial plan. The CFP® designation is owned and awarded by the CFP® board a non-profit organization that protects the mark and also sets high standards for the behavior of its certificants. The ChFC requires more course work but it’s certificants do not have to take a comprehensive exam, they do have to write a financial plan though.
The CFP® board has adopted a very strong set of ethical requirements for their certificants including a new requirement that they act as Fiduciaries whenever they are providing financial advice (beginning October 2019). That strong requirement does not exist for ChFC certificants.
You may encounter many advisors with both designations. You may also encounter advisors who have continued their education and received an advanced degree in the field including a Masters or PhD. Advisors who have done that should be considered the educational “elite” in the field.
One other designation worth mentioning is the Chartered Financial Analyst (CFA) which is owned and awarded by the CFA Institute. While the designation is only focused on investment analysis and management, advisors who hold the designation have acquired very deep knowledge in that specialty. The designation requires that applicants pass 3 exams that are roughly 6 hours in length and the course material includes statistics, economics, investment analysis, portfolio management, etc. Roughly 8-15% of candidates actually finish and receive the designation. Like the CFP® designation certificants are required to adhere to a very strict set of ethical standards. If you are hiring an advisor to help manage your portfolio this designation is important.
We suggest you consider advisors who are fee-only, act as fiduciaries and hold the CFP® or ChFC designation as a minimum.
Assessing your risk tolerance is an essential component of planning. It drives how you should be invested based on your personality and how you might respond emotionally to market declines. There is a critical second component to the planning process as it relates to investing, an assessment of your risk “capacity.”
Determining your ability emotionally to accept risk drives how you should be invested. In 2008 if you were fully invested in the S&P 500 index your portfolio would have declined in value by 38%. We like to put that in dollar terms: a $1M portfolio would be worth $620,000 at the end of that year. Some people can accept that type of decline because they are confident of two things: markets do recover (albeit how long it might take is guesswork) and they have plenty of time before they need to touch their assets. In that sentence we have demonstrated both the person’s risk “tolerance” and their risk “capacity.” Unfortunately, many people in retirement cannot accept that large a decline and they may not have enough time for things to recover.
Assessing risk Tolerance:
Risk tolerance questionnaires are usually the method used to assess your risk tolerance. Until recently we used a type of questionnaire that asked questions of a more qualitative nature, for example: “How much could your investments drop before you felt uncomfortable?” The questionnaire we used was one that was created after years of academic research that relied on the responses from thousands of completed questionnaires to create a formula for translating responses into a risk “number.” We used that system for many years, recently though we adopted a different approach that assesses your risk tolerance using questions that explore how you might respond to the trade offs between gaining an uncertain percent on your portfolio with the possibility of a relatively significant loss vs a certain but small loss. Questions that show the types of trade offs that exist in investing real dollars might be better ways to capture your feelings about risk than qualitative questions that do not. Responses to the questions lead to a “risk number” that is on a scale of 0-100. For perspective the S&P 500 is assigned a risk number of 78. Risk numbers can be used to match your tolerance with a portfolio that has a similar risk profile, which is quite useful.
Assessing Risk Capacity:
Risk tolerance is half the equation, assessing your capacity for risk is just as important. Risk capacity is simply defined as how much money you can afford to lose without having to change your plans. Creating a financial roadmap helps you understand your risk capacity, knowing how much income you need from your portfolio each year to support your lifestyle will drive your risk capacity. For example, if you need to withdraw 5% from your investments annually that combined with a 20% decline in the market can turn a portfolio worth $1M into one worth $750,000 after just one year. If you have trouble adjusting to a cut in your spending and you still need to withdraw $50,000 from your investments suddenly your 5% withdrawal has become a 6.7% withdrawal, something that is not sustainable for a very long time. Your risk capacity can be increased by having some liquid assets available to act a “shock absorber” during market declines. A combination of 6-12 months reserves in a very liquid account like a safe money market account and having the equivalent of 3-5 years’ worth of your spending needs in fixed income can help improve your capacity to take risk on the remainder of your portfolio. We spend a lot of time here working to determine your risk capacity and helping with strategies to improve it.
The NAPFA Board of Directors has elected Stephen C. Craffen to the position of 2018-19 NAPFA National Chair. Steve will serve as Chair-elect until his term begins on September 1, 2018. He was first elected to the Northeast/Mid-Atlantic Region Board (NEMA) in 2008, and was elected 2013-14 NEMA Board Chair. In 2015, Steve was elected to the NAPFA Board of Directors. His election to the 2018-19 Chair position will allow him the opportunity to guide NAPFA into the future, and influence the financial planning profession as a whole.
It is important to manage a portfolio in a tax-wise fashion to help maximize your return in the long run. There are several strategies that can be used to do that, here we discuss them.
|Preferred Account Type||Note|
|Natural Resources||Tax Deferred||High recurring ordinary income|
|Alternatives||Tax Deferred||Frequent tax events|
|International Bonds||Tax-Deferred||High Income tax free not available|
|Real Estate||Tax-Deferred||High income does not qualify for special dividend rate|
|Bonds||Either||Can purchase tax-free municipals in a taxable account|
|International Stock||Taxable||Dividends not qualified but not as high as other asset-classes|
|Domestic Large||Taxable||Dividends taxed as qualified|
|Domestic Small||Taxable||Dividend rate low, taxed as qualified.|
Knowing what tax bracket, you are in and in particular what marginal bracket you are in is important in determining which strategies are most useful to improve the net after tax return for your portfolio. Proper tax management of a portfolio can improve your net return (after expenses and taxes). Some estimate that your realized return can be as much as .25% higher annually.
Stephen C. Craffen
Steve was interviewed by a couple of his NAPFA friends at “Zebra Smash”, the discussion was focused on Modern Portfolio Theory and the advancements that have been made over the years. You can listen to the interview here:
Estate planning for families that include children from parents who have been married a couple of times can be complex. Sometimes ensuring that all the children are treated fairly means you may need to take measures to protect their inheritance if you die prematurely. Your current spouse may not have any emotional tie to them so they could disinherit them either innocently or with malice.
Consider the following example of a husband and wife who both have children from prior marriages and have a child together:
Consider the following:
Those are just two of many possible sequences of events. While every scenario cannot be anticipated some estate planning techniques can reduce the risk that someone’s children are not left out in the cold. Here are two.
QTIP Trust (Qualified Terminal Interest Property) – Is a testamentary (created through a will at someone’s death) trust used by married couples to control the disposition of assets in their estate after the death of their spouse. John’s will would create the trust and specify which assets that he owns individually will be in the trust. Assets he leaves to the trust will qualify for the unlimited marital deduction if his executor makes a QTIP election on his estate tax return. A requirement for those assets to qualify for the unlimited marital deduction is that his wife Mary must receive all the income generated by the assets for the remainder of her life. The assets in the trust will also be counted as part of her gross estate at her death. John though has designated who will receive the assets at his wife Mary’s death and that choice is irrevocable. Using this estate planning technique, he can make sure that his children are never disinherited.
Mary can also include this type of trust in her will to protect her the legacy of her son from her first marriage.
Unfortunately, a QTIP trust is not the most appropriate technique if a person has the bulk of their assets in IRA’s, 401K’s, or other qualified types of accounts that will become subject to the Required Minimum Distribution rule. The reason is complex and related to the requirements that all income from the assets in a QTIP trust be distributed to the remaining spouse every year. The definition of income for an IRA may clash with the definition of income under some state’s rules regarding trusts.
Irrevocable Life Insurance Trust (ILIT) – Another and perhaps more appropriate method of protecting children in a mixed family circumstance is life insurance combined with an Irrevocable Life Insurance Trust (ILIT). Here a trust is created while the spouse is living (unlike a QTIP which is typically created at death through a will). The trustee of the ILIT applies for life insurance on the life of the spouse and the trust owns the policy, the spouse pays the policy premium each year by gifting funds to the trust. The trust is created for the benefit of whomever the spouse selects, in this case possibly a child. At the death of the spouse the life insurance is paid to the trust which may then invest the proceeds and pay the income to the child, provide them with rights to the principle under certain conditions (maintenance, education, support, or health) and perhaps gradually pay the corpus out to them at specific ages (25, 30, 35, for example). This type of trust has other benefits including protection of the assets from the child’s creditors. This is a short and simple summary of this type of trust which could accomplish many of a parent’s goals for the protection or creation of a legacy for their children, one not affected by remarriages. It does come at a cost though, the cost of life insurance and the requirement that the spouse be insurable. It is also recommended that the spouse consider setting this trust up when they are younger and the cost of life insurance is less.
Here is a summary of the 2 approaches:
|QTIP Trust||ILIT Trust|
|When Created||At First Spouse’s Death||During Lifetime|
|How Funded||Assets that qualify for marital deduction||Life insurance purchased by trustee|
|Duration||Does not benefit child until second death||Benefits children at the death of their parent (first death)|
|Income Beneficiary||Must be spouse to qualify||Child(ren) or anyone chosen|
|Restrictions||IRA’s are not appropriate to fund the trust||Can be life insurance but may also gift other assets (not IRA’s)|
|Cost||Typical costs for trust management||Life insurance premium and typical trust management costs.|
|Advantage||Spouse controls disposition of assets after their death||Benefits children at their parent’s death (no wait for the second death of a step-parent).|
|Disadvantage||Child may not receive inheritance for years. Asset may be depleted by remaining spouse||Cost of life insurance.|
This is a brief non-technical summary of a couple of approaches to consider if you do have children from prior marriages.
Stephen Craffen MS, CFA, ChFC
Steve was asked by reporter Karin Price Mueller (Star Ledger) to respond to some questions about current market conditions:
Retirement should be the time when you are less stressed and should have fewer worries, after all you no longer have the stress of the commute or your job. Many find those worries replaced with others including fears they might run out of money or be forced into a diminished lifestyle. Those fears are justified; inflation increases your expenses and diminishes the value of any fixed income you receive, health care costs are a great unknown, or you may live much longer than predicted increasing the chance you could outlive your resources. Guarding against some of those dangers by having the correct mix of assets to provide enough growth without taking on excessive risk may be challenging.
The risk that you might outlive your assets may be dramatically increased if you happen to retire at the “wrong” time. What happens for example if your timing is poor and you just happen to retire before a market decline? What does that mean for your portfolio? A declining market combined with the withdrawals you may need to make to create that “retirement paycheck” will put a severe strain on your portfolio and dramatically increase the odds that you may run out of money especially if you live for 20 or more years in retirement.
This risk, commonly called “Sequence Risk” or order of return risk (bad timing combined with withdrawals), is a risk that can devastate the portfolio of retirees.
An example will make it much clearer:
If you retired in 1996 and had a portfolio of $100,000 all invested in an S&P 500 index you would have experienced the following sequence of returns.
If you were withdrawing $6,000 per year to meet your income needs in retirement your portfolio would have grown to $162,548 and your withdrawals would have been $60,000 for a total of $222,548.
Now consider an alternative universe where the order of returns is reversed as follows:
With the same $100,000 portfolio and annual withdrawal of $6,000 your portfolio would be worth $125,691, combined with the $60,000 in annual withdrawals it totals only $185,691. Now the $6,000 withdrawal represents 4.8% of your portfolio instead of 3.7% in the original scenario. If you were not making withdrawals the sequence would not have mattered, your portfolio would be worth the same with either pattern of returns, $238,673. There is no impact if you are not making withdrawals. (People in the “accumulation” phase of their life may benefit from dollar cost averaging.) It is the timing of the withdrawals that particularly impacts prospects for your invested assets. Selling an asset that has declined in price dramatically limits your ability to capture the upside during market recoveries. Managing sequence risk means you need to try to avoid the sale of asset classes that are in the throes of a bear market. Here are some suggestions:
Have enough in fixed income (bonds) – If you have a portfolio of $1,000,000 and need to withdraw $40,000 each year, have enough in bonds to guarantee the $40,000 is available for 7-8 years in case a bear market is very severe. That means having no more than 70% of your portfolio in riskier, growth assets.
Reduce your withdrawal rate – Manage your discretionary expenses so you can reduce the demands on your portfolio until the market recovers. There are various rules based approaches we’ve studied.
Have more recurring income through your Social Security claiming strategy or by buying immediate income annuities – Delaying Social Security till age 70 may dramatically increase your monthly income. Turning some of your portfolio into a steady income stream by annuitizing it can enable you to invest differently since you know you have a safe income floor.
Consider a Reverse Mortgage – Establish a Home Equity Conversion Mortgage (HECM) early on in retirement to act as a backup source of funds to tap during market declines.
We will discuss these strategies in future blogs.
Understanding your exposure to “Sequence Risk” and having a strategy to overcome it may be critical to your retirement.
Stephen C. Craffen, CFA