One thing that has been a hallmark of FIM Group’s management over the years is our desire for transparency. Every client sees each investment transaction in their portfolio, via a trade ticket that is mailed or emailed in real time when the transaction happens. We internally call this “allowing our clients to see how sausage is made,” including the good, the fantastic, the crummy, the not so good, the works –everything!
For example, recently we extended maturity a few months on the US Treasury 8.75% coupon bonds of 2020 in client accounts. We sold the 8.75% coupon Treasuries maturing May 15, 2020, for the 8.75% bonds maturing August 15, 2020. The “cost” of this “swap” was around $4.00 for each $10,000 face of the bonds, but we got a few extra months of locked-in interest of around 2.5% so we felt it was worth it. Because the 8.75% bonds were bought at a premium, we purchased them in client tax-free retirement accounts only to save on tax hassles. In tax-paying accounts we bought the straight 2.5% US Treasuries of May 31, 2020, at a price that would give us a gain if held to maturity, thereby avoiding the tax complexity of the higher-coupon premium bonds. Both give similar yields, and in addition in taxable accounts the Treasuries are exempt from state and local taxes.
A strategic question: Will we hold them to maturity in 2020? Most likely not, yet they are a good parking spot for some of the cash that we have in portfolios. If the US moves into a recession, they might even go up a bit in price and could be sold for a capital gain profit in addition to the yield.
Our brains are wired to lust to have things be less complex. This has an upside to help us maintain our mental and emotional health. “Don’t sweat the small stuff” is the familiar mantra. The evil-twin downside to oversimplifying is that we might miss the elegance and benefits of complexity, or we might ignore the fact that things really aren’t that simple in relationships, life, and work; in maintaining our mental, physical, and emotional health; and, most of all, in investing. Investing is complicated, of course, but we have numerous tools to help with us manage that complexity. We see some of these tools in the evolution of regulations. Regulations have typically been oriented toward protecting investors, by requiring companies to be more transparent and timelier in reporting significant business information and such. Also, tools have been created to control costs for clients, help them diversify, and receive some advice in creating a portfolio containing the factors they would like that portfolio to embrace. ETFs (exchange-traded funds), open-ended mutual funds, trusts, holding companies, and separately managed accounts (which is what FIM Group does) all come to mind. When I was a kid, mutual funds were a modest part of the investing world. By 1968, the number of mutual funds was greater than the number of stocks on the New York Stock Exchange! By 2017 there were more than 10,000 funds in the US alone. Funds are intended to help simplify but, as with any investment vehicle, funds must be analyzed with both expertise and understanding. Today the world has more than 9,000 ETFs, all designed to help investors as well as investment professionals increase investment returns, decrease risks, build in diversification, and provide a vehicle to add other factors that can enhance performance easily and at a low cost. Sometimes this is better, but at other times it is not.
Early in FIM Group’s history we rarely used funds, except to gain access to international or specialized markets in cases where it was impossible (or too expensive) to enter the market or hard to gain the diversification required to minimize risks and optimize returns. In today’s world of instant information, the availability of incredibly low transaction costs, plus sophisticated technology systems, we can access ETFs and other funds that capture attributes and factors that might tilt a portfolio’s positive and reliable return potential much more efficiently than we could do it by a process of constructing portfolios one security at a time. So we will again be using some funds that meet rigorous criteria and help tilt our portfolios toward having a mix of characteristics that can create consistent, predictable, forward progress more consistently – but of course not without some ups and downs now and then.
In addition to the bond swap mentioned above, another sausage-making investment switch we recently made was actually toward simplifying the portfolios a bit from the point of view of “what would our investment team do today?” Each time we walk into a review meeting, we like to imagine that our client’s portfolio is 100% in cash and therefore ready to invest. This discipline helps us get rid of investments we think won’t carry their weight into the future, and it also enables us to sell investments that simply don’t pass muster and replace them with new investments that we believe have better compelling value. Even if the investment we sell takes a loss, we will take it to buy something we “love” and believe is worth more per investment dollar than what we may own today. We might also switch to an investment primarily because its predictability is better than what we already own, due to company-specific characteristics, diversification, or price.
We have a number of individual REITs that we like a lot and that fit in well with the more diversified ETFs we will be adding to the portfolios. The European-oriented Land Securities Britain PLC, British Land, and [French] Mercialys are all currently yielding in excess of 5%, so they round out our portfolios well, allowing us to keep our diversified exposure to the real estate market. Of course, nothing is guaranteed, but our portfolios benefit in at least four ways from international real estate: (1) real estate tends to be a more stable asset; (2) the real estate securities we own pay great current cash dividends; (3) they have appreciation potential and we believe they will grow in shareholder/company value; and (4) if the US dollar is weak, we can possibly even gain the bonus of currency appreciation.
Over the past few years, we have purchased a number of high-yielding US REITs that are US-based, pay great dividends, and add both income and stability to portfolios. On balance, they have been a profitable addition to our portfolios and have performed especially well this past year. Currently we are selling off some of the holdings to purchase or swap into the more income- and yield-oriented funds and ETFs. For our retired clients, we like their portfolios to generate a lot of current income to fund their retirement income needs. Naturally, we want to optimize the potential for consistently increasing both dividends and capital gains. So the transactions you have seen in your portfolios are coming from this position of our using the latest tools at our disposal to construct portfolios. Our first job is to construct portfolios that from a modeling, common sense, and historical perspective should provide performance predictability in any market well into the future.
Last year was horrible, no fun at all, so it’s comforting to know that our portfolio additions, subtractions, and such made throughout the year (and especially during the opportunity-creating carnage of December) rewarded us with nice performance. Investing is like a race with no finish line, so we have not sat on our hands in 2019. The portfolio changes made, as discussed earlier in this newsletter and others, should continue to give us good performance through 2019 and well into the future. We like dividends, income, and cash flow, so we expect that going forward a lot of our performance will come from dividends and income. Also, we will be adding some diversified ETFs that possess characteristics that we believe will add significant factors to tilt our portfolios toward continued success. While the new wave of ETFs may be a bit more boring than individual stocks, they have factors that we believe will add positive attributes to our portfolios that it would be both silly and unproductive to ignore.
In the past I have been quite critical of indexed ETFs and funds. We are not buying the index funds. While many people think “indexing” is synonymous with ETFs and funds, please understand that this is not true. Just because something is an ETF or a fund does not mean it is actually indexing. We are buying funds on your behalf that have factors we believe will perform. We are not “dumbing down” your portfolio by using indexed ETFs, though I must admit that if we think an index makes sense we would buy it. As I’ve stated many times in our monthly newsletter, our job is to preserve wealth and make it grow. It is not to be attached to any one invest-ment “style,” as that can be counterproductive, since markets, business processes, economic forces, and investment tools are constantly changing. We are always alert to these changes. So expect to see us be quite busy as we rebalance, reinvest sells, and create new buys in your portfolio. Things change, and we see 2019 as a pivotal year for us to use all the tools at our disposal to create a portfolio that will work. We still carry some cash as well as government bonds that can be quickly redeployed into equities or longer-term, higher-yielding assets if things get bouncy, like they were at the end of last year. We take our work seriously here, and we work hard to have each client portfolio designed according to the proven, time-tested factors we believe will perform well in environments like we have today and expect into the future.
When the Tax Cuts and Jobs Act of 2017 was passed, the law increased a taxpayer’s standard deduction and reduced the amount of itemized expenses that can be deducted. While this naturally hamstrung the tax advantages of making standard charitable contributions, it also increased the effectiveness of another charitable gifting strategy that was made permanent in 2015: qualified charitable deductions, or QCDs.
Now, before we get too far ahead of ourselves, it’s important to note that QCDs are only available to owners of traditional IRAs who are age 70½ or older. Still here? Excellent! A QCD, in plain English, is a distribution from your IRA that goes directly to a qualifying charity and is not included in your taxable income. This last bit – the fact that the QCD is excluded from income and therefore does not increase AGI (adjusted gross income) – is what makes this such a powerful strategy. Here are some additional tips and things to consider when determining whether a QCD is appropriate for your situation:
QCDs cannot be made from an employer plan, and the donation amount is capped at $100,000 per individual for 2019.
Although a QCD can be made by the individual retirement account owner or their beneficiary, the owner of the IRA must be at least age 70½ at the time of the transaction. If you are not reaching 70½ until later in the year, wait until then to make the QCD.
The QCD must be a direct transfer to a qualifying charity (more on this in the next bulleted item). A check payable to the charity and mailed to the IRA owner will qualify as a QCD. If an IRA owner receives a check payable to them from their IRA and later gives those funds to charity, that is not considered a QCD.
The QCD recipient must be a qualifying charity, not a donor-advised fund, a private foundation, or a charitable gift annuity.
Even if you are able to itemize and deduct charitable deductions, a QCD still might be preferable because the amount is excluded from income and therefore does not affect your AGI, while a straightforward charitable contribution that’s then deducted will affect it.
A QCD can both satisfy your required minimum distribution for the year and reduce your taxable income, resulting in significant tax savings. For tax filing purposes, you will receive a 1099-R form for the IRA distribution, in addition to a donation receipt from the qualifying charity.
A QCD is one of the best ways to make charitable distributions if you have charitable intent and are 70½ or older. Please contact your FIM Group/Mercer advisor if you have questions or would like us to model whether a QCD in 2019 is right for you. Our team can also assist in processing the paperwork for this planning strategy, which will need to begin by November 2019 as a result of deadlines set by Schwab, Fidelity, and the IRS.
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