Paragon Perspectives

How long can a good thing last?  This summer has been quite mild in comparison to the past several Texas summers, but as many of us know, one strong high pressure system can change all of that.  The stock market and Texas weather may have a few things in common. Over the last 18 months the stock market has been performing well, but how long will it last and is there a bubble brewing?   


We at Paragon Financial Advisors manage client assets primarily for the long term, depending on the client’s goals, objectives, and risk tolerance.  When constructing an investment portfolio consideration is given to diversification, current investment environment, and which investment vehicle is the best fit for a portfolio (ETFs versus actively managed funds for example). This quarter's newsletter discusses three different investment topics.


The first article is a market commentary which outlines strengths and weaknesses in the economy.  The second article “ETFs Versus Actively Managed Funds” discusses what one should consider when choosing between ETFs and Actively Managed Funds.  The last article examines some broad points on types of diversification: the normal diversification between stocks and bonds and the diversification within a certain asset class. 


How long will this current bull market last and is there a bubble brewing in the stock market?  Only time will tell for sure! Therefore, we will continue to review economic data, asset allocations, and asset diversification to guide us as we move into the remainder of this year and into next year.


Sincerely,


David Hailey CTFA® CFP®


If you did not receive a copy of this quarter's newsletter please email info@paragon-adv.com to request a copy. 

IRAs and Creditors

As a general rule, IRAs are assets protected from creditors—i.e. IRAs cannot be attached by creditors to satisfy debts or judgments incurred by the IRA owner. However, the Wall Street Journal (Friday, June 13, 2014, page  A6, electronic copy found HERE) reported on a unanimous ruling by the US Supreme Court that changed that protection for some IRAs.


According to the new ruling, inherited IRAs (IRA accounts transferred from the original IRA account holder to a non-spouse beneficiary) are not protected from creditors. IRAs (original and transferred to spouses) are subject to restrictions that do not apply to IRAs transferred to non-spousal beneficiaries. Therefore, since the non-spouse beneficiary has complete access to the full account penalty free (but still subject to income taxes), the Supreme Court ruled that the IRA assets can be attached by creditors.

Given the amount of money in IRAs and the ageing baby boom generation, such non-spousal transfer will become more common. Prudent debt management will prevent some problems; however, judgment awards may still apply.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Tax Day

Well, April 15^th has come and gone.  Following that date, many taxpayers become intimately familiar with Ms. Pelosi’s comment about having to pass Obamacare to find out what’s in it.  The increased tax paid by many individuals has caused us to evaluate (again) some tax strategies for investing.  We have always maintained that the “tax tail shouldn’t wag the investment dog;” however, tax impact certainly warrants consideration all other things being equal.

 

Many events can impact taxes in the investment arena.  After all, the primary goal of investing is to maximize the after tax return to the portfolio for the risk level chosen. Three general rules apply:

1. Avoid taxes if legally possible
2. Defer taxes until a future date
3. Then if 1 and 2 are not practical, pay the taxes at the lowest rate possible.

With these general rules in mind, let’s discuss some investment strategies with income tax ramifications.

Investment selections

The investment chosen has tax ramifications.  Mutual funds buy and sell stock throughout the year.  Those transactions generate capital gains (hopefully) which are passed on to the mutual fund owner who is responsible for the income taxes on the gain (in taxable accounts) Therefore, portfolio turnover (how often the mutual fund manager buys and sells) can be a factor in investment selection.  Index funds generally have lower turnover than actively managed funds.  Municipal funds can provide income free from income tax and the Obama care surtax.

Investment Location

Some accounts defer taxes until the future (IRAs, 401(k)s, and other tax qualified plans.  As such, these accounts are generally more suitable for investments with a higher known return (such as taxable bond funds in a historical interest rate environment).  Note that losses on investments are not deductible when they occur in such a qualified account.

Tax Loss Harvesting

This strategy utilizes general rule 1: don’t pay taxes.  In taxable accounts, gains on one investment may be offset by the loss on another investment, a net zero addition to taxable income.   You can also offset ordinary income up to $3000 per year with losses that exceed gains.

Withdrawal Strategies

As a general rule, spend from taxable accounts first, and then from tax deferred accounts.  Some caveats to this general rule exist.  IRAs have required minimum distributions (RMD) requirements that begin at age 70½. If these RMD amounts are such that they might increase the tax bracket in later years, consideration should be given to earlier withdrawal.

Roth IRA Conversion

Roth IRAs do not allow tax deductions for contributions to the account; however no required minimum distribution is required from the account and the investments grow tax free (not tax deferred).   Contribution limits apply to such an account depending on the investor’s income level.  Funds from existing qualified accounts can be rolled into a Roth IRA regardless of income earned.  A Roth conversion strategy does require payment of taxes on the amount rolled into a Roth account.  It works best if the investor has outside funds with which to pay the taxes.  Planning techniques exist for these conversions that we will not discuss here but that do potentially affect taxes on the amount converted.

At Paragon Financial Advisors we do not prepare taxes and urge you to consult your tax professional for your personal circumstances.  However, we can assist you in planning your investment strategies to minimize the “April 15^th” effect.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Long Term Care Considerations

In a previous blog found HERE, we discussed  general  guidelines  of planning for long term care.  We will now discuss further considerations in this blog.

Cost of Care

The majority of individuals provide for long term care through insurance.  The cost for those policies has been changing (increasing premiums or reducing benefits) over the past few years.  For example:

1. Women frequently pay more because of their longer life expectancies and more expensive claim history.
2. Age at the time long-term care begins also affects policy costs:  the younger the applicant, the lower the policy premium. Determining when to purchase a policy requires a cost/benefit analysis.  The younger you are, the longer you pay premiums but at a lesser premium rate.

Eligibility Requirements

 

A study by the American Association of Long Term Care Insurance (see Kiplinger Retirement Report, Vol 21, number 3, March 2014) showed that insurance rejection rates of policy applicants) factored in both age and medical conditions.  Twelve percent of applicants below age 50 were rejected.  The rejection rate rose to 17% for those age 50-59; 25% for those age 60-69; and 44% for applicants in their seventies.

 

Gate Keepers

 

When evaluating long term care policies, one should carefully analyze the “gatekeepers.”  These are the provisions which must be met before the policy will pay benefits.  Analyzing their provisions for benefit payment s is critical and should be done for your individual circumstances.

 

How To Pay

 

Some recent changes have been made that may allow an applicant to pay long term care premiums more “efficiently.”  Premiums can be paid with tax-free rollovers from cash value life insurance policies or deferred annuities.

 

You can also use money tax free from a health savings account.  Since contributions to such accounts are limited (based on individual age), these plans will cover only a portion of the insurance policy cost.

 

Paragon Financial Advisors does not sell insurance or any products.  On the other hand, we do assist our clients in planning for the cost of long term care.  Please call us if you would like to schedule an appointment to discuss your circumstances.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financialplanning and investmentmanagement.

Long Term Care Expenses

As the American population ages, they face the prospect of long term care expenses.  Some families faced this problem with their own aged parents and are now trying to decide how to handle the possible need for themselves.  As people evaluate their options, they are facing several factors.
 
Cost of Care
 
According to the insurer Genworth, the median US rate for a private nursing home room in the US is approximately $84,000 per year.  In Texas, that figure is $65,000 and in the Bryan/College Station area, it is $62,963.
 
Assisted living facilities cost $41,400 (median US; Texas is $42,270; and Bryan/College Station is $44,400. The annual inflation rate in Texas has been approximately 5% for assisted living facilities.
 
Method of Provision
 
Several alternatives to fund long term care are available:
 

1. Insurance policies—Long term care insurance has been a method used by many to pay for care. However, this market is changing.  Some long-term care policies written in past years are not meeting actuarial assumptions; therefore the insurance caregivers are attempting to modify these contracts.   Newer polices are more expensive or have reduced benefits.  Policy premiums obviously vary depending on age and health of the policy applicant. In some cases, women are being charged more than men because their claims are longer (longer life expectancy) and more expensive.
2. Self Fund- -Individuals may plan to pay long term care costs from their assets.  In this case, the obvious questions arise:
• How long will the care be required?
• What will be the inflation rate on cost of care?
• What will be the rate of return on assets reserved for long term ca
3. “Coinsurance” Planning- Individuals may opt for reduced insurance benefits and plan to supplement those benefits with personal funds.  You have many options available for long term care insurance policies; determining the appropriate policy requires considerable evaluation to ensure the policy you purchase best meets your needs.

If you are self funding, we recommend that you reserve at least three years (inflation adjusted) needs per person based on the cost of care in your area.

Paragon Financial Advisors do not sell insurance (or any products).  However, we do assist our clients in the evaluation of planning options to provide for long term care expenses.  Please call us if you would like to schedule an appointment to evaluate your circumstances.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

2013-A Great Year in the Market

Last year (2013), the Dow Jones Industrial Average rose 32.4%. Sounds like a phenomenal increase, doesn’t it. A plus 32% increase is, indeed, an impressive increase. However, in this case, a little more analysis is warranted. Why did the market increase so much? The following data are from Standard & Poor’s and J.P. Morgan Asset Management Guide to the Markets-US (as of 12/31/2013).

Price/Earnings Multiple Expansion

 

Of the 32.4% increase, 18.4% (or 57% of the total increase) was due to an expansion in the price/earnings multiple. Investors buy stock in anticipation of a future earnings stream from the issuing company. The price to earnings ratio represents “how many times” the company’s earnings that investors are willing to pay for the stock. In 2013, that price/earnings multiple expanded from approximately 14 times to over 16 times. Quantitative Easing (the Fed’s buying of Treasuries and mortgage backed securities) figures prominently in this increase; the Fed’s buying drove interest rates so low that stock became a more viable investment (even with the increased risk).

 

Dividend Increase

 

Dividends accounted for 2.8% of the 32.4% gain (9% of the total increase).

 

Earnings

 

Corporate earnings accounted for 11.2% (or 34%) of the total 32.4% increase in 2013. What about those earnings? How were they obtained? In many cases, earnings were driven by expense reduction, not increased revenues. A company can do only a finite amount of expense reduction and still remain in business.

 

What Does This Mean?

 

Given the above, how likely are we to continue such growth? Ninety one percent of the gain was driven by factors that may not be in play going forward.  At Paragon Financial Advisors we believe that the equity markets offer significant long term benefits; however, the ride from “here to there” can be bumpy. Come visit with us about ways to try to manage the risk in reaching your long term financial goals.   Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

               

Investment Diversification

One of the basic axioms of investing is portfolio diversification. Simply put, an investor should not “put all eggs in one basket.” Prudent investing includes allocating your investment dollars among asset classes (stocks, bonds, cash, etc.) and different investment styles (large cap value, small cap growth, international, etc.). That allocation should be done in accordance with the investor’s goals and objectives; generally the higher the allocation to stocks, the greater risk in the portfolio. One of the factors that may not be considered is the investor’s job or employment. What do we mean?

First, one of the greatest destroyers of wealth is the necessity to liquidate investments in a down market to meet necessary living expenses. Therefore, anyone in a tenuous job situation should ensure an adequate cash/fixed income reserve to cover living expenses in the event of job loss. This reserve may mean a lower exposure to stocks. A corollary to this job situation is the entrepreneur or small business owner who may face significant new challenges in view of tax changes and health care requirements under the Affordable Health Care Act. Risk in the business environment might indicate more stable fixed income investments in the investment portfolio would be advisable.

Second, and a more likely scenario, is a concentration of investments and employment. Does an employee have most (all?) of their 401(k) investments in company stock? Some dangers exemplified here are wealth tied to the company (think Enron) or industry. Frequently investors will have investments associated with their profession/industry—perfectly logical given their understanding of the industry. However, such concentrations can pose special risks. A downturn in the industry can potentially affect both employment and ancillary investments. The downturn in the housing industry resulted in declines in home building employment and associated businesses that supplied the industry.

At Paragon Financial Advisors, we try to assist our clients in doing a through risk analysis. That risk analysis includes two components: 1) the investor’s risk tolerance, and 2) risk exposure to things of which the investor may not be aware such as the situations discussed above. Please give us a call if we can assist you.   Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.