2014 November Newsletter

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

Strengths-Based Value Investing

When I was in high school, my dad sat me down and said, “The Chinese are going to be in the Olympics because Chinese ping-pong coaches work on what each player does best. If they have a great forehand, the coach has him practice the forehand 90% of the time. Not like here in the U.S., where the coach would have him practice his crummy backhand 90% of the time.” Dad’s point was that even though everyone has natural strengths (mine was in math), you still need to work on them. 

I really find it fascinating that I remember that conversation. For my dad, it was crucial that I understood the importance of building upon one’s natural strengths. (By the way, at the time, he was the coach, athletic director and school principal at Glen Lake School.) Now there are books and a whole “philosophy/science” about finding your strengths. Books like StrengthsFinder 2.0 and The SMART Parenting Revolution champion this “do what you do best” approach. As investors, FIM Group strives to use each team member’s skills – playing to their strengths to collectively grow, preserve and steward our client portfolios forward. 

Short-Term “Pain”

FIM Group’s 30 years have been guided by an investing style known as “value investing.” This style was championed by Benjamin Graham and made popular by the likes of Warren Buffett, Sir John Templeton and others. History shows that value investing works … as long as you work the paradigm. It is not a magic, get-rich-quick style of investing. Also, like anything worthwhile, applying value investing to creating and growing wealth takes work, discipline and patience. Technically, value investing is not “hard” to understand; simply, it’s about investing in companies that are, for one reason or another, currently “bargained-priced” – having the discipline to own them and, equally, having the discipline to sell them when they’re no longer bargains. 

Sounds simple enough, but usually investments get cheap by going down in price until their value is much more than the price you pay. It is hard to buy a company that is out of favor. Years ago I noticed that John Templeton owned Philippine Long Distance Telephone Company (PLDT) stock in his growth fund portfolio. He highlighted the name and gave his “5 cents” on why it was a bargain. We bought it, bought more of it when the price went down, and bought even more when the stock dropped as Ferdinand Marcos was kicked out of power by the People Power Revolution in the Philippines (around 1986). The stock dropped by half from where we had bought it, and naturally I got phone calls. “Paul, don’t you know that Marcos is getting kicked out and the communists are taking over?” My reply was centered on the fact that the company had a monopoly position in the Philippines, gave good dividends and had a solid balance sheet.

I also explained to clients that the country was 97% Catholic and, as a Filipino friend explained, “The communists are out in front of cameras while the Catholics are back home making babies – don’t worry, Paul, the country is not going communist. The [newspapers] are trying to sell papers, and 97% stability does not sell.” We sold the stock for a profit after the market recovered. This reminds me of one of the sayings of Sir John Templeton that would forever guide our investing principals: “Opportunity exists where perception is different than reality.”

A Truth

We are reluctant to give up a truth if giving up that truth does not serve us. It seems that, as a species, we are quite wired to allow ourselves to be deceived by all sorts of hogwash, mistruths and jargon if to seek the truth requires “work” or giving up our strongly held perception of reality. So in value investing, in contrast to technical or some forms of growth/momentum investing, truth is important. Value investors don’t buy stocks simply on speculation that they will be going up – we buy investments for very good reasons. We need to know the business model, book value, where earnings come from, what the competition looks like, whether or not management is competent, and if it comes at a great price, so we’re not paying too much for the value we are purchasing. The price and value bit of the equation is where the “art” of investing comes in. When we bought the Philippines Long Distance stock, we knew it was cheap at ~$4 per share, and we knew it was even a more compelling value at $2 per share. A value investor will reassess the landscape and buy more of the investment as its price goes down, being grateful for the good fortune of being able to buy still more at an even better price. This of course is hard to do and seems almost counter-intuitive. But it’s not counter-common sense. If an investment’s value has not changed, but its price is less than it was – it is, in theory, a greater bargain. And simple math says if I buy a stock at $10 expecting its real value is $15 – if I buy more at $5, I have a lot more profit potential, and less risk, embedded in the $5 priced shares. Sadly, I did not buy more PLDT at under $2 – a mistake I am glad I made in my formative years. Truth cuts two ways, and often the light of trust says, “Sell, and move on.” 

Today, we do everything electronically – but years ago I would sit in the file room, write out paper tickets for buys and sells, and paper clip them on the file. Then Linda, my assistant, would call in the orders and record them on the paper ledger and on our “electronic system.” One Friday afternoon, I wrote out about 87 tickets to purchase an electric utility out west. Linda entered the orders, and at around 4:30 that afternoon I got a call from an analyst with whom I’ve discussed the utility. He said that he had just been with the company and told me that they think they are going to have less growth than expected. After the call I told Linda, “Leave those 87 files out, because we are selling the utility stock we just bought when the market opens on Monday.” We had bought the company expecting it to grow a bit, but the information we based the buy on had changed. Not a lot, but enough; and the information really was based on someone’s “opinion.” 

Endowment Behavior 

But I had to ask myself one question, “Would I buy that investment today based on the current fact set?” My answer was “no,” so I sold it. We are wired to process information to support our made decisions – it is called endowment behavior and it really makes sense with math. For example, when selling the aforementioned utility, two possible “bad” things could happen: 1) the sold stock could go up and I’d miss the profit, or 2) the new investment bought with the sales proceeds could go down. Thus, two chances to feel “bad.”

If you simply hold the name, there is only one outcome that could cause grief – the stock could go down – so double the chances of grief if you sell. So most investors hold on to investments even after they really should sell them. Endowment behavior is very strong, and especially wreaks havoc with owners of very successful investments that have gone up a lot. They feel like they are letting go of their child. The antidote to endowment behavior is to ask the simple question, “Would I buy this investment today, at today’s price, with cash?” While it is easy to own an investment that you inherited and has appreciated significantly – it is often hard to let go and sell. We tend to benchmark its cost in our analysis of risk. For example, if the stock is now $100,000 the question must be asked, “Would you take $100,000 and buy the investment today with your ($100,000) cash?” If you answer no, then it is most likely best to take your big profit and sell.

Selling from Fear 

I do not wish to relive the 2008/2009 crazy period in the financial markets; however, those that were guided by fear were the losers. My son Keeston, after an economics class at college last year, asked me about that time and commented to me. “Seems that the people that got hurt during that period were the guys that panicked and sold at the bottom.”

He then followed on with, “Why would people sell something they paid a lot more for and lock in their loss.” I simply answered: “fear.” Fear is a stronger emotion than the opposite (love) and seems to cause people to lose their rational minds in the flow of the world events. Today, we see it with the Ebola crisis. Ebola is a manageable epidemic, we know the disease and the world knows what to do to contain it. We know that you can’t get Ebola by sitting on a plane that someone with Ebola sat in previously, yet I read a news story about some parents that would not let their kids go to school because the teacher had been on such a plane. Irrational? Yes. Many stocks in the travel industry are being affected by the Ebola scare. Should a travel stock drop because of the virus? If it represents travel to the affected area, for sure. But a share price drop seems irrational if its main markets are thousands of miles away. Once again, “Opportunity exists where perception is different than reality.” Under the scrutiny of common sense and truth-seeking, it seems illogical to me that the Ebola crisis will cripple the travel industry. The industry has handled wars, SARS, famines and financial crises with ease and grace. So for these reasons, amongst others, we have been buying some of the travel stocks on behalf of our client portfolios. 


When my dad stressed the strengths I had in math, he did not tell me to relax because it was easy for me. Rather he said, “Go do your homework.” When we look at an investment idea, no matter what the opportunity looks like on the surface, we still must do our homework. As Warren Buffett is known to have said, “[Value] Investing is simple, but not easy.”

Suzanne Stepan, CFA, CFP®
By: Suzanne Stepan, CFA, CFP®

The Great Blondin

Come one, come all to see the amazing Great Blondin tightrope across Niagara Falls!

Back on June 30, 1859, more than 25,000 people came and gawked at the first person ever to tightrope across the raging waters of Niagara Falls. More than 160 feet above the roaring falls, the Great Blondin walked without a single safety feature. With neither a body harness nor a net to catch him, he attempted the dangerous feat of balancing his way on 1,100 feet of rope. The bystanders held their breath as the remarkable acrobat safely reached the Canadian side and defied gravity. A mighty holler from the crowd erupted.

Once Blondin performed the incredible stunt, he eagerly came back to soak up the adoration from the audience again and again. The Great Blondin walked on stilts for one performance. Then he had a chair and a stove for which he stopped halfway, sat in the chair, whipped up a hot omelet and literally ate it. Excited yells encouraged him to push a wheelbarrow filled with 350 pounds of cement across. Another time, he carried his manager piggyback along the long rope. Each time, Blondin would creatively augment his pledge to egg on the horde of people, and the cries of approval would amplify louder. Then, one day, the Great Blondin boldly asked if the spectators thought he could move a man across the rope in a wheelbarrow. Based on the positive response, Blondin pointed to an agreeing man in the crowd and politely asked, “Sir, do you think I could safely carry you across in this wheelbarrow?” The man, not knowing Blondin’s pointed intent, replied, “Why yes, of course!” With a great big smile the Great Blondin replied, “Then get in.” The man bluntly declined the offer.

Due diligence is performing a comprehensive investigation to allow for more informed decision-making in evaluating costs, benefits and risks. For the man who rejected Blondin’s ride in the wheelbarrow, the decision was an uncomplicated “no, thank you.” Based on the facts presented, the man from the crowd was able to quickly run through the evaluation that his life was worth more than any benefit received from getting into the wheelbarrow. Being of sound mind, there was little to no benefit to be gained. Transparency of the associated risk helped the man to quickly perform his due diligence. Yet, costs, benefits and risks aren’t always as lucid as they were presented above. 

After the famous market crash of the late 1920s, President Franklin Roosevelt urged Congress to enact laws to thwart investing based on conjecture and hype. What emerged was the Truth in Securities Act, better known publically as the Securities Act of 1933. At the federal level, this Act was passed to improve investor protection. It was the most notable piece of federal legislation concerning the regulation of the offer and sale of securities. The primary goals of this legislation were twofold: companies issuing a financial security needed to fully disclose all relevant information to provide more transparency, and investors needed laws to protect them from receiving false information when investing in the securities. Protecting investors from ambiguous information in order for them to make more informed decisions about investments was the purpose. 

Prior to the Securities Act of 1933, irresponsible business and investment practices led to imprudent decision-making. Companies would enthusiastically endorse the worth of their companies to entice the purchase of their securities. Promises of large payouts with little to no disclosure of relevant financial information disclosed created a speculative frenzy. Yet, even with the law, it takes in-depth work to perform due diligence because not all information is front and center.

FIM Group performs research to confirm the purchase, hold or sale of the securities held in the portfolios we manage. Due diligence on a security is required to validate the information received and assess the potential risk. An analysis of both the current financial state and future prospects needs to be emphasized. The process is necessary to confirm material facts are reviewed. Managing a portfolio requires experience and expertise. Our invest-ment team constructs and customizes portfolios for clients. The discretionary authority held over the day-to-day investment decisions allows our clients to participate in investment opportunities.

At FIM Group, we take care to exercise due diligence in managing assets to avoid harm for our clients. It is with great care and responsibility that we at FIM Group perform due diligence. We must act prudently and responsibly to gather the necessary information to construct informed decisions on the actual and potential risks involved in any investment. It is our obligation to perform with a constant and earnest effort to give the appropriate attention in investigating any security bought, held and sold from the portfolios we manage. 

There are valuable investing-applicable lessons to be learned from the prospective wheelbarrow passenger: put excitement aside, assess risk rationally and take decisive action. Our team at FIM Group works to do just this each day with the portfolios we are entrusted to manage.
Put excitement aside: Stay emotionally neutral, seek opportunities when the herd emotion elevates to extremes. Examples include the greed-like emotion that developed during the dot-com bubble and the fear that was seen during the depths of the more recent global financial crisis
Assess risk rationally: Perform due diligence (company visits, analysis of public filings, competitive analysis), number crunching, fundamentals-based fair value estimation, downside scenario analysis
Take decisive action: Say “no thanks” with conviction to risk investing situations as it was with the Great Blondin’s prospective wheelbarrow passenger. It is more difficult to say “yes” when the headlines and macro developments are short-term ugly such as buying bonds in the early 1980s when inflation was running double-digits, buying stocks after the market plunged during the global financial crisis, and buying Russia-related stocks today. Decisive action is where real returns are made
Jeffrey Lokken, CFP®
By: Jeffrey Lokken, CFP®

Year-End Tax Planning for Individuals

Year-end tax planning is especially challenging this year because Congress has yet to act on a host of tax breaks that expired at the end of 2013. Some of these tax breaks may be retroactively reinstated and extended, but Congress may not decide their fate until the very end of this year (and, possibly, not until next year). These breaks include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the exclusion for up to $2 million of mortgage debt forgiveness on a principal residence. 

Higher income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately). 

The surtax is 3.8% of the lesser of: 1) net investment income (NII), or 2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his/her estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI. 

The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward year-end to cover the tax. For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax, since wages from each employer don’t exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be overwithheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed. 

Below is a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. 

Year-End Tax Planning Moves for Individuals

  • Realize losses on stocks while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. We have already begun this strategy in taxable portfolios.
  • Postpone income until 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2014. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year, or where lower income in 2015 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit. 
  • If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2014. 
  • If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion, that is, by transfer-ring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA, if doing so proves advantageous. 
  • It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015. 
  • Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2014 deductions even if you don’t pay your credit card bill until after the end of the year. 
  • If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withhold-ing of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2014 if doing so won’t create an alternative minimum tax (AMT) problem. 
  • Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2014, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes.

These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should
not be accelerated. 

mYou may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions (i.e., certain deductions that are allowed only to the extent they exceed 2% of adjusted gross income), medical expenses and other itemized deductions. 

mYou may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year. 

mYou may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year. 

mTake required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2014, you can delay the first required distribution to 2015, but if you do, you will have to take a double distribution in 2015 – the amount required for 2014 plus the amount required for 2015. Think twice before delaying 2014 distributions to 2015 – bunching income into 2015 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2015
if you will be in a substantially
lower bracket that year. 

mIncrease the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. 

mIf you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on December 1, 2014. 

mMake gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2014 to each of an unlimited number of individuals, but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax. 

Source: Thompson Reuters/Tax & Accounting


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