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2017 August Newsletter

Paul Sutherland, CFP®
By: Paul Sutherland, CFP®

The 4th Industrial Revolution

It’s interesting how our world works. On the one hand, we admire success, yet on the other we often dismiss it. For example, many thought Jeff Bezos’s Amazon would be just another book retailer. Now, he and his company are considered revolutionary and an enormous success. However, as Einstein once said, “It’s all relative!” And Aristotle was known to start his arguments by stating “Let’s define the definitions!”

I’m fascinated by the whole idea of success. It is, for sure, relative, as illustrated by this story: A young man comes upon a very well-dressed older man crying on a park bench. He asks what the matter is: “Are you poor? Do you have a family? Have you lost someone?” Through tears, the older man replies, “I am very wealthy, my children love me, as do my grandchildren, and my wife is supportive and loving and my best friend. I have a happy life.” The young man asks, “Sir, then why are you sad and crying?” To which he replies, “I don’t know where I live.”

So what is success? It seems that today one’s financial status and fame are the key elements for most who try to define “success.” All you need to do is go to the magazine rack and see all the beautiful, rich, and famous people on the covers who seem overwhelmingly successful and admired. However, from what I can conclude from my own life experience working with successful and happy people, it seems that “rich and famous” are not the things pursued by most people whom I consider successful. Instead, good relationships, friends, family, enough financial resources to be comfortable (plus perhaps a little bit extra), happiness, and health appear to be the elements that most people I know would list as making up a successful life.

But does success imply happiness? In this essay I’m simply trying to explore the idea that “things, they are a changin’.” Amazon’s smart-guy-in-charge, Jeff Bezos, remarks, “If you want to build a successful, sustainable business, don’t ask yourself what could change in the next 10 years [that could affect your company]. Instead ask yourself what won’t change, and then put [all] your energy and efforts into those things.”

I’ve been contemplating this statement for quite a few days, off and on. And a quote from Albert Ellis keeps coming to mind: “Happiness depends on our interpretation of events.” In other words, it’s how we perceive success, and that is always subjective.

The four boys who keep our house messy and loud are very verbal and often argue, fight, and tease. Basically, they are at the stage when they are developing and are learning conflict-resolution skills. They can all be quite happy playing with the smaller soccer ball, until an older or younger brother walks by holding the big new green soccer ball that a friend from England brought a few weeks ago for all four boys to share. “I want that ball! He should share!” soon goes the cry. Every parent, sibling, or grandparent reading this knows what happens next. In our home, we listen to our kids and help them develop their communications skills. We don’t want them to assume that it’s the job of their parents, teachers, preachers, or govern­ments to create peace. Instead, it’s their job to reconcile the differences so that they can learn the requisite communi­cation, cooperate, and team-oriented relationship skills while young. Still, we frequently must intervene – to remind them that hitting, grabbing, or name-calling are not allowed. 

The point I am making is simply “We are happy till we find something better – or something that we perceive is better.” I cringe as I write this, because many readers obviously possess emotional intelligence and are more mature, balanced, thoughtful, and adept at reasoning than most, otherwise you would not be hiring FIM Group to manage your wealth. You are less likely to care about the new, green ball when the old, smaller one works just as well. And when your friend shows you his zippy new car, you admire it but climb into your own, perhaps older, car and think “This works just fine.” 

If you never want to be criticized, for goodness' sake don't do anything new.

— Jeff Bezos

Economics is about the behavior of people: how they act. And, while you and I are “people,” we are not the market. We are the 1%. If you make over $32,000 annually, which is below what almost every wage earner in the U.S. makes, you are in fact in the 1% of global top income earners. The net worth number for the global 1% is more than $770,000, which includes a home, pensions, investments – everything. So, if we wish to watch where the world is going, squinting at the 1% doesn’t tell us a whole lot.

Instead, we should leave our bubble-world and see what’s really going on. 

In America and the rest of the developed world, we are buying less consumer goods. We are spending but find we are happier traveling, having a nice meal with family or friends, and hanging out with our friends and kids; we really don’t care if the shirt they are wearing was bought in the last 15 years. Most clients reading this letter would likely look at their lives and agree they are buying less and paying more for experiences that nurture relationships, healthy living expenses, kids’ education, philanthropy, and they don’t feel that more is needed. 

So, what won’t change? We will still want to be healthy and happy. We will still want our families to be healthy and happy. We will want our children and grandchildren and those we consider our responsibility to be educated. We will want economic security, to be safe, and to have the income to support our desired lifestyle (and a bit extra, to boot). We will want to have a roof over our heads and be able to eat, have running water, electricity, and other basic needs. 

The Huffington Post listed the top 10 things in life that people want more of but can’t seem to get enough of: Happiness, Money, Freedom, Peace, Joy, Balance, Fulfillment, Confidence, Stability, and Passion. If this list is true, we in the U.S. and the rest of the developed world need to look at what our fellow citizens truly will want. And it seems that it isn’t stuff, but rather entertainment, food, healthy living, good health care products and services, more time of our own, the capacity to communicate easily with loved ones, the ability to travel for good experiences and to see friends and family. As investors, those are the areas we are looking at. 

The developed world is much different than the world of African countries and developing countries throughout Asia. The median annual wealth per capita in India is $608 and in Africa it’s $411 – not a lot of money to buy cars, refrigerators, books, pots and pans, food, education, health care, cooking oil, or charcoal. These countries are a market, and we are telling their people that they should want cigarettes, beer, sugary drinks, and KFC. Thankfully, many of them already realize that having skills and education, plus opportunities to express those skills, are the way out of poverty. So, education is a huge business, but it is in dramatic, gut-wrenching change as we move from printed books to digital ones and from teachers who tell you what to memorize to ones who help you become a self-directed, confident learner.

The changes we are seeing are huge areas of opportunity. Change, after all, is the only constant. There will be winners and losers, as the world we live in moves to what Klaus Schwab, founder and chairman of the World Economic Forum, calls the 4th Industrial Revolution. As he states in the opening paragraph of his article about this revolution, “We stand on the brink of a technological revolution that will fundamentally alter the way we live, work, and relate to one another. In its scale, scope and complexity, the transformation will be unlike anything humankind has experienced before.” (We have a link to the article at FIMG.net; or just Google “4th industrial revolution” to find the article.)

The common question that gets asked in business is, 'why?' That's a good question, but an equally valid question is 'why not?'

— Jeff Bezos

The world will always be a’changin’. What will still exist 10 years or 1,000 years from now is our desire to care for each other, for relationships, for health, for happiness, for food, for safety, for positive enjoyable experiences, for meaning, for resources and sufficient income to support the life we desire. We at FIM Group will continue spending our time being future-oriented, searching for what will be next. As we move through the 4th Revolution, we will encounter many opportunities – but we will not overpay for them, nor will we invest in the overhyped areas. Instead, we will stay the course. 

Renée Egelski, CFP®
By: Renée Egelski, CFP®

Positioning Your Income/Assets to Enhance Financial Aid Eligibility

What does it mean to enhance your financial aid eligibility?

If you qualify for federal financial aid, there are a number of strategies you can try to implement to enhance the amount of aid your child will receive when you apply for financial aid. The idea is to lower your expected family contribution (EFC), which in turn raises your child’s aid eligibility. Although some of these strategies can be employed as late as the base year (the tax year that your FAFSA, or Free Application for Federal Student Aid form, will rely on), others can be implemented years before your child will be starting college.

For the 2018/2019 school year, families will be able to file the FAFSA as early as October 1, 2017, using their 2016 tax information. 

It is important to note that these strategies are perfectly legal and are not in any way meant to undermine the federal financial aid process. These strategies simply examine the federal methodology and take advantage of its rules regarding which family assets and income are included in determining a student’s financial aid eligibility.

Tradeoffs

Colleges don’t use the same formula as the federal government in determining aid eligibility.

The primary drawback of implementing specific strategies to take full advantage of federal financial aid is that you increase your chance for aid under the federal system only. Colleges have their own formula for determining which students are most deserving of campus-based aid, and that formula may not recognize a strategy that is successful under the federal methodology (i.e., home equity, explained below).

The increased financial aid may consist entirely of loans.

If you are successful at reducing your total income and assets under the federal methodology and thus increase your child’s financial aid package, there is no guarantee that a portion of the increased aid package will consist of grants or scholarships (which do not have to be paid back). Instead, your child’s additional aid package could consist entirely of loans that will need to be paid back by you or your child.

You may not want to disrupt an otherwise sound investment program.

It is generally not a good idea to drastically change your overall financial planning scheme for financial aid reasons only. Ideally, any changes you make should be in line with your overall financial planning picture.

Strategies to reduce available income

There are a number of steps you can take to reduce your adjusted gross income (AGI) under the federal methodology for determining financial aid. The lower your AGI, the less money you will be expected to contribute toward college costs and the higher your child’s aid eligibility.

Remember, you apply for financial aid each year. Thus, you should consider the following strategies for each of the years you will be applying for aid, not just for the initial application. 

Time the receipts of discretionary income to avoid the base year.

Your income in the base year will directly affect your child’s financial aid eligibility in the corresponding academic year. Although it is highly unlikely that you will be able to defer your weekly (or monthly) paycheck, it may be possible to defer other types of discretionary income beyond the base year. For example, if possible, you should try to:

  • Defer receiving employment bonuses until after December 31 of the base year.
  • Minimize capital gains and interest in the base year.
  • Avoid unnecessary pension and IRA distributions in the base year.
  • If you are on an expense account, ask your employer to reimburse you directly so that any reimbursement amounts do not artificially inflate your income. 

Pay all federal and state income taxes due during the base year.

Paying all federal and state income taxes due during the base year is advantageous for two reasons: It reduces the amount of available cash on hand, and you can deduct the total amount of federal and state taxes you pay during the base year on the FAFSA.

Leverage student income protection allowance.

For the academic year 2017/2018, the first $6,420 of income a student earns is not considered in determining a child’s total income. This is known as the student’s income protection allowance. However, everything a student earns beyond the allowance is assessed at 50% for financial aid purposes. In other words, the federal government expects your child to contribute 50% of all income earned over the allowance (after taxes). 

Strategies to reduce available assets

You can take a number of steps to reduce the amount of assets that will be included under the federal methodology. Under this formula, the federal government includes some assets and excludes others in arriving at your family’s total assets. The lower your assessable assets, the less money you will be expected to contribute toward college costs and the higher your child’s aid eligibility.

It is important to remember that the relevant date for determining whether you own a particular asset is the date that you submit the FAFSA. Consequently, the following strategies can 
be implemented up to the time you complete the FAFSA.

Nonreportable Assets

Equity in Family Home, Retirement Assets, Annuities & Life Insurance Cash Values, Household Possessions, Family Farm/Small Business

Reportable Assets

Savings & Investments, Property, College Accounts

(Note: CSS/Financial Aid PROFILES do include nonqualified annuities, while some include life insurance cash values and many include a portion of the family’s home and the value of a family business or farm.)

Use cash to pay down consumer debt.

The federal methodology does not care about the amount of consumer debt you may have. So, if you have $10,000 in assets and $10,000 worth of consumer debt, the federal government still lists your total assets as $10,000. When you use available cash to pay down consumer debt, you reduce the amount of your cash on hand.

Use cash to make large purchases.

Another strategy to reduce cash on hand (an assessable asset) 
is to make large planned purchases in the base year. Such items may include a car, furniture, or a computer. Remember, the idea is not to go out and spend the money on any old thing; rather, the purchase should have been previously planned.

Custodial accounts in the name of a child (UGMA) are considered a student’s asset for purposes of the FAFSA. 

To limit impact, spend these accounts down two years before the student’s freshman year of college. Under the law, assets must be spent on products or services that benefit the child (summer camp, computer, academic tutoring, and the like). UGMAs may also be liquidated (appreciation will be subject to capital gains tax) and invested in a 529 plan in the parent’s name, which would be considered a parental asset for FAFSA.

Increase home equity.

The federal methodology does not count home equity as an asset in determining your child’s financial aid eligibility. So, using assessable assets to pay down the mortgage on your home is one way to reduce these assets and benefit yourself 
at the same time.

Although the federal government does not include home equity in determining a family’s total assets, some private colleges do include home equity in deciding which students are most deserving of campus-based aid. In addition, some colleges may expect parents to borrow against the equity in their homes to help finance their child’s college education.

Leverage parents’ asset protection allowance.

Once the parents’ assessable assets are totaled, the federal methodology grants parents an asset protection allowance, which enables them to exclude a certain portion of their assets from consideration. The amount of the asset protection allowance varies, depending on the age of the older parent at the time the child applies for aid (the idea being the closer the parents are to retirement age, the larger the asset protection allowance). For example, if parents are married and the older parent is 50 or older when the child applies for financial aid, the asset protection allowance is $21,200 for the 2017/2018 academic year.

Once parents determine what their asset protection allowance will be, one strategy is to consider saving an equal amount of money in assets that are counted under the federal methodology. Then, any savings above this amount can be shifted to assets that are excluded by the federal methodology, such as home equity or retirement plans.

Use student’s assets for the first year.

Under the federal methodology for financial aid, the federal government expects a child to contribute 20% of his or her assets (includes Trust assets that designate the child as a beneficiary) each year to college costs, whereas parents are expected to contribute a maximum of 5.64% of their assets. 
If assets have been accumulated in a child’s name, parents may want to consider using these assets to pay for the first year of college. By reducing the child’s assets in the first year, the family will likely increase its chances to qualify for more financial aid in subsequent years.

Use grandparent-owned 529s during the last one or two years.

Distributions from a 529, whether owned by a parent or a student, are considered a parental asset, while distributions from a 529 owned by a grandparent are considered the student’s income. 

Gift appreciated assets.

Appreciated assets can be gifted to a student. If the student is 24 or older, the capital gains tax will be based on their own tax bracket (including, possibly the 0% long-term capital gains rate). If the student is under 24, single, and attending college full time, a gift is subject to parent’s income tax rates for gains, under the “kiddie tax” rule. Therefore, gift any appreciated assets to a student who can avoid kiddie tax (married, not a full-time student, age 24 or older, or attending college and generating enough earned income to cover at least half of their own support). Note that these gifts will be assessed 
as a student’s assets and that any gain from the sale will be included in their income, so it is best to utilize this strategy 
in the last one to two years of college.

A word about merit aid 

Colleges often use favorable “merit aid” packages to attract certain students to their campuses, regardless of their financial need. The availability of college-sponsored merit aid tends to fluctuate from year to year and from college to college as schools decide how much of their endowments to spend as well as the specific academic and extracurricular programs they want to target. As a family researching college options, exploring college merit aid is probably the single best thing you can do to optimize your bottom line.

If you want to get an estimate ahead of time of how much financial aid (whether need-based or merit) your child might qualify for at a particular college, visit the college’s website and fill out its net price calculator, which all colleges are required to have on their websites. 

Besides colleges, a wide variety of groups offer merit scholarships to students meeting certain criteria. There are websites where your child can input his or her background, abilities, and interests and receive (free of charge) a matching list of potential scholarships.

Helpful Websites

Collegesavings.org, Savingforcollege.com, Efcplus.com
Ncagonline.org, Collegeboard.org, Finaid.org, Collegeabacus.org

Sources used: Michael Kitces, www.kitces.com, Forefield Advisor, 
www.foremostadvisor.com

Investment Team Spotlight: Ichigo Inc.

Summary Snapshot

Ichigo Inc (Ticker: ICHIF
www.ichigo.gr.jp)

Share Price/Market Capitalization: $2.84/US$1.4b

Investment Thesis: Ichigo is an opportunistic, Japanese commercial real estate company with a flexible, cycle-resilient business model. The company has a solid pipeline of growth opportunities and a strong balance sheet to pursue them. We believe its shares trade at a significant discount to its sum-of-parts fundamental value.

Company Description: Ichigo is an integrated commercial real estate business with three core operating segments. Its “Value-Add” segment is an opportunistic property investment business. Here, management focuses on “B-class” office, retail, and hotel properties in Japan’s largest cities with $10–$50m acquisition prices (currently 98 assets with an aggregate cost of approximately $1.7b). These tend to be smaller buildings than the trophy mega-projects where much larger real estate firms like Mitsui and Mitsubishi roam, but larger than the sub-$10m space, where capital (from individual investors) is abundant and barriers to entry are few. Ichigo’s team opportunistically buys underperforming properties and adds value with refurbishment or redevelopment and strong property management activities. Then, after improving and stabilizing the income characteristics of the properties, the company sells the building and recycles the capital.

Ichigo’s second core business is asset management. In this segment, the company runs three listed Japanese real estate investment trusts (REITs) focused on office, hospitality, and green energy assets (Ichigo Office, Ichigo Hotel, and Ichigo Green). This is a high-margin business where the company leverages its know-how and platform to earn base management fees, transaction fees, and performance fees. As market conditions allow, management targets doubling its assets under management in the Hotel REIT and growing assets in the newer Green REIT 5x, where pipelines to meet these targets are already in place. Ichigo is also pursuing opportunities to manage assets on behalf of high-net-worth individuals.

Ichigo Hongo Building

The company’s third business is clean energy, where it owns and operates solar plants and is currently developing wind farms. Ichigo’s portfolio of solar plants now totals 28 facilities with 98 mega­watts of power generation capacity. It manages an additional 15 solar plants on behalf of Ichigo Green. This is a relatively low-risk business, as Ichigo takes on projects whose output is essentially fully contracted for 20 years under government-guaranteed, feed-in-tariff rates.

Ichigo’s business model is meant to be flexible and cycle-resilient. The company’s fixed costs are managed at levels covered two times by recurring revenues from rent, asset-management fees, and contracted solar power sales. This gives management flexibility around the timing of property sales, so that it can maximize profit in the Value-Add segment and can thrive through property cycles. 

Management is currently executing on a medium-term strategic plan centered on core business growth, new business initiatives, and continued emphasis of triple-bottom-line sustainability. On the new business front, Ichigo recently entered Japan’s self-storage real estate segment via a small acquisition of 20 highly automated facilities. Management sees profitability in this niche area as nearly twice that of its existing segments and strives to scale that up to be a meaningful financial contributor. 

Since Ichigo has cooled off over the past year along with the overall Japanese real estate market, we believe there is compelling value in the company’s shares. Although the company pays a modest dividend (around 2% on our initial cost), we expect that most of our total return will come from price appreciation. Its shares trade at more than a 30% discount from our sum-of-parts estimate of fair value. We expect that, as the company demonstrates the effectiveness of its flexible model, this discount will close in our favor.

Hawaii

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Suite D
Kahului, HI 96732
p: 808.871.1006
f: 808.871.1433

Michigan

111 Cass Street
Traverse City, MI 49684
p: 231.929.4500
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1837 E. Main Street
Onalaska, WI 54650
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f: 608.779.0304

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