One of my clients recently sent me a newspaper ad for CDs with surprisingly attractive rates. This CD promoted by Sun Cities Financial Group touted a 4.85% rate on an FDIC-insured CD with a 6-month term.
According to Bank rate, the current national average for a 6-month certificate of deposit is 0.27% APY, with their top yield being 2.00% APY. So how can a tiny local non-bank that you’ve never heard of beat the rates of even online banks by over 2.5%?
The firms running the ads are quick to state they are not banks. Instead, they “help consumers locate insured banks nationwide” or are “a leader in locating superior banking and insurance products.” Technically, they are “CD brokers.” The Sun Cities website explains the company is “engaged in the business of placing deposits or facilitating the placement of the deposits of third parties with FDIC-insured depository institutions.” The FDIC and SEC have some words of warning about this type of activity, which we’ll get to shortly. It turns out that the advertised rate isn’t the CD rate. I did some research and found a few other ads. One ad hinted at this by stating, “Yield may include a bonus.” The other was more explicit, stating: “Yield includes an interest bonus of 3.00%, plus 1.25% annual percentage yield.” These non-bank salespeople are supplementing bank CDs from other FDIC-insured banks with their own money to reach the advertised rate. Questionable? Yes. Scam? Well, maybe not.
Here’s how it works…
- You have to go to the company’s office (taking a page from the time-share marketing playbook).
- While you’re in the office availing yourself of the company’s “superior bank product location service,” you’ll be pitched on life insurance or an annuity. From their perspective, you’re a perfect candidate for such high-commission products. You’re in the market for a conservative, guaranteed rate of return and you’ve proven by buying the CD that you have money to invest. The fact that it’s a short-term CD means it won’t be long before you have that money available for the product they’d prefer to sell you.
- There you will be told about two or three banks they have “located” offering CDs at attractive rates (more in line with what you’ll find through com) Once you open a CD at one of the banks, the company promoting the high rate will pay you the difference in the form of a bonus, in some cases sending the bonus money along with your check to the bank where the CD will be held. For example, say they locate a bank offering a 6-month CD paying 1.25% APY. If you deposit $10,000, in six months, you will have earned $62.50 ($10,000 x 1.25% = $125, which is then divided in half based on the 6-month term). The CD broker covers the remaining 3.6%, or $180.
- You write the check for the CD directly to an FDIC-insured bank, with which the sales office is not officially affiliated with. This CD has a realistic rate, say 1.5% APY or similar.
- After a week or two, enough to make sure your funds cleared, the insurance people will cut you a check which together with the bank’s interest, add up to the advertised APY (assuming they are still in business).
Of course, the company hasn’t made any money from you yet. In fact, they’ve spent $150. When we asked one such company about this, the CD was described as a “loss leader.” They compared it to a grocery store that promotes $2 steaks with the hope that you’ll buy other things while you’re there. And what might those “other things” be in a case such as this? Insurance products.
According to the FDIC, a deposit broker “can be anyone from one person working alone from home to someone affiliated with a major financial-services firm. There is no federal or state licensing or certification process to become a deposit broker, and the FDIC does not examine, approve or insure deposit brokers.” It adds, “CDs sold by brokers can be complex and may carry more risks than traditional CDs sold directly by banks,” and “There have been a few cases reported of unscrupulous deposit brokers allegedly misleading or defrauding investors.”
The SEC agrees: “Since brokered CDs are sold through an intermediary, you’ll need to take extra steps to avoid fraud.” Recommended precautions include: thoroughly check the background of the deposit broker, identify the issuer (CBS’ Roth found the bank he was steered to had the lowest “Safe & Sound” rating from Bankrate.com, only one out of five stars), ask about your deposit broker’s record-keeping, and find out what happens if you need to withdraw your money early.
Next, you should check if the extra interest is worth it since you’ll have to deal with paper checks. If you are writing a check from a bank account that isn’t earning interest, that is some lost days of interest right there. Since you’ll be receiving the CD funds as a check as well, that’s another few business days of potential lost interest. Finally, you should be sure only to write the check to an FDIC-insured institution. You should interact with them directly to ensure a safe transfer of funds and proper opening of an account. Double-check the CD renewal guidelines, so you are not stuck rolling the CD over for another 3 months.
Better yet, say no to any CDs that come with sales-pitch strings attached. The small interest bonus you’ll get in exchange for hearing them out likely isn’t worth your time—or the risk of them convincing you to buy their high-commission products. Deceptive financial advertisements, and bait and switch tactics, existed well before the Wall Street collapse and still do. I wouldn’t wait for regulators to start protecting the consumer, as this may not happen in our lifetimes. It’s up to us to practice little financial self-defense. Always be skeptical of any financial product, as well as the tactics that people use to sell them. Here’s a list of other companies that I found offering similar ads. Some are pretty shady in my opinion and pretend to be an elite broker supplying high-yield bank CDs. Others are pretty transparent about the fact that they are offering a carrot for you to listen to their pitch.
- Sun Cities Financial Group (http://www.scfg.com)
- First Fidelity Tax & Insurance (http://www.firstfidelityamerica.com)
- American First Assurance (http://americanfirstassurance.com)
- Integrifirst USA (http://integrifirstusa.com)
I wouldn’t trust any of these guys with a $9.99 cut-n-paste GoDaddy website and a rented office with any of my details.
It still comes as a surprise to so many people that the outcome of key estate planning strategies often hinges on fluctuations in interest rates. So, changes in rates should sway the choice, or timing, of these strategies. Some estate planning strategies generate more benefits when interest rates are low, while others provide more benefits to you and your loved ones when rates are higher. With interest rates rising and set to rise more, you should consider interest rate trends when deciding whether to accelerate or delay the implementation of your estate plan.
Let’s look at the six major strategies that are affected by rate changes.
- Family Loans
These are very flexible and simple ways family members can make loans between each other. They’re very popular because these loans typically carry no interest rate or very low-interest rates, which is why they’re often called interest-free or low-interest loans. This strategy is better when interest rates are low. Keep in mind that the loan must be a real loan (expect the principal to be repaid at a certain time). There should be a written agreement that lists the interest rate charged and a payment schedule. Otherwise, the IRS might treat the transfer as a gift or other transaction.
There are two main reasons to consider the family loan:
- A family member wants to arbitrage the investment. That is borrowed at a lower rate than the income and/or capital gains generated from the principal and keep those benefits.
- A family member wants to pay a lower interest rate than a commercial lender would charge, while the lender might earn a higher yield than is available through a safe investment, such as a money market fund. Picture a parent or grandparent sitting on significant cash earning 1% at the bank. They could carry the mortgage of their grandkid or refinance their 7-9% student loan and get a better return.
One way to make a family loan is to charge at least the minimum interest rate required by the tax code. When you do that, there are no special income or gift tax consequences. As loan repayments are made, the interest portion is income to the lender, and the rest of the payment is tax-free. The Internal Revenue Service (IRS) publishes a monthly update to the applicable federal rates (AFRs) and 7520 rates. The AFR is calculated by the IRS under Section 1274(d) of the Internal Revenue Code (Code) and is used for many purposes. One of its most common applications is to establish the minimum interest rate that can be charged on an intra-family loan without income or gift tax consequences. Planning professionals and their clients should take note of fluctuations in these rates and be mindful of planning opportunities that come with rate changes. The AFR rate for March 2018 and the preceding six months, for a 10 year and longer loan (compounded annually) is 2.88%. This is huge savings. For example:
- If Jim was looking to purchase a home in Southern California and needed $500,000 in lending, he could pay 4.5% for the current cost of a 30-year fixed mortgage or he could reach out to his grandfather, Paul, who has more money than he needs due to a pension and rental income. Paul could charge him 2.88% and save Jim ~$450/month and over $150,000 in total interest!
Another way to make the loan is to charge no interest or less than the IRS minimum rate. In that case, the interest not charged is a gift from the lender to the borrower. If the interest plus other gifts to the borrower for the year are less than $15,000, there are no real consequences, because that’s the amount of the annual gift tax exclusion. Any excess over the $15,000 exclusion will reduce the lender’s lifetime estate and gift tax exemption, or will be a taxable gift. Details of those exceptions are in IRS Publication 550, beginning on page six under the heading “Below-Market Loans.”
- Grantor Retained Annuity Trusts (GRATs)
A grantor retained annuity trust (GRAT) is a good way to transfer the gains from appreciating assets to loved ones. It generates more benefits when interest rates are low. In a grantor retained annuity trust, you set up an irrevocable trust (removed from your estate) funded with assets you expect will have a fairly high appreciation rate. This can be technology stocks or a closely held business.
The trust pays you annual income over a period of years. The total income payments equal the original trust principal plus the IRS minimum interest rate. The AFR rate for March 2018 and the preceding six months, for no longer than 3 year (compounded annually) is 1.96%. At the end of the trust term, whatever remains in the trust is transferred to the other beneficiaries after the trust expires, usually your children or grandchildren. A grantor retained annuity trust usually should be short-term. Most tax advisors say a two to three years trust term is best.
Your loved ones receive the investment return of the trust that exceeds the minimum interest rate, and there are no estate or gift taxes due. For example:
- Grandma Sue, 65, puts her $5 million of Apple stock in a GRAT with a three-trust term. During that three year period, the Apple stock had an annualized return of 22%. The investment gains from Apple above the annual annuity of principal and IRS minimum interest rate of 1.96% is transferred from the trust to her grandkids.
To make incurring the costs of creating the trusts worthwhile, they should be funded with at least $250,000 of assets that are expected to generate a total return well above the IRS minimum interest rate. If the trust assets don’t earn more than the minimum rate, your heirs won’t receive anything. The result will be the same as if you hadn’t created the trust, minus the fees related to it.
- Charitable Remainder Trusts
These trusts come in two forms: charitable remainder unitrust (CRUT) and charitable remainder annuity trust (CRAT). Both of them provide more tax benefits when interest rates are higher because a higher APR will result in a higher income tax deduction for the remainder interest in a charitable remainder trust. For either trust, you create an irrevocable trust and fund it with money or property, preferably appreciated long-term capital gains property. The trust pays you income for life or a period of years. The charitable remainder unitrust pays you a percentage of the trust’s value each year as income. The charitable remainder annuity trust pays you a fixed amount each year, regardless of the trust’s value. After the income period, the remaining property in the trust is transferred to charity. Hence the name Charitable Remainder Trust.
Two main reasons to set this up:
- You don’t owe capital gains taxes on appreciated property transferred to the trust, because it is a charitable trust.
- You receive a charitable contribution deduction when the trust is funded. The deduction is the present value of the property the charity is expected to receive at the end of the trust.
The amount of the deduction depends on how long the trust is expected to last and on the current IRS interest rate. There are assumptions that will need to be made and is best to run different scenarios factoring cost basis, marginal tax bracket, and expected return
- Charitable Lead Annuity Trust (CLAT)
The CLAT is sort of the opposite of the charitable remainder trusts. In the CLAT, you create an irrevocable trust and fund it. The trust pays fixed annual income to a charity for years. After the period ends, the assets that remain in the trust are transferred to a beneficiary you named. It could be you, your spouse, a child, or a grandchild.
You might receive a charitable contribution deduction for the charity’s stream of income from the trust, depending on the details of how the trust is structured. If the remainder beneficiary is someone other than you and your spouse, the present value of the remainder interest is a gift from you. If the trust earns more than the IRS minimum interest rate, the excess will pass to the beneficiary free of estate or gift taxes.
So, a lower IRS interest rate means better results for you and your beneficiary. Also, the lower the applicable interest rate (APR), the higher the charitable contribution deduction because the lower APR will provide a higher present value and thus greater tax deduction
- Qualified Personal Resident Trust (QPRT)
This trust is used to minimize estate and gift taxes when transferring a residence or vacation home to the next generation. The tax results are better when interest rates are higher. You transfer the title of the real estate to an irrevocable trust. You reserve the right to use the home as your own for certain years. After that period expires, the property belongs to the beneficiaries of the trust, who usually are your children or grandchildren. If you want to continue using the property, you’ll have to pay a fair market rent. That’s why it’s best to use the QPRT for a second home, not your principal residence.
The property will be out of your estate after the term of years ends. When the property is transferred to the trust, you’ll be treated as making a gift of the property’s present value when the trust terminates to the beneficiaries. The higher current interest rates are, the lower that value will be. So, you’ll either use less of your lifetime estate and gift tax exclusion or pay less in gift taxes as rates rise.
If you pass away before the trust term ends, the property will be included in your estate and treated as though the trust wasn’t created.
- Charitable Gift Annuities
In a charitable gift annuity, you transfer money or property to a charity in return for a promise that you will be paid a fixed annual income for the rest of your life. The annuity payments will be less than from a commercial annuity, and the difference is your gift to the charity. There’s a tradeoff with charitable annuities, but they probably have more benefits when rates are higher.
There are two tax benefits of the charitable annuity that fluctuate with interest rates.
- You receive a charitable contribution deduction when you transfer money or property to the charity. The deduction is the present value of the charity’s eventual gift.
- The second benefit is that, when the charity makes payments to you, part of each payment is tax-free as a return of your principal. The rest of each payment is taxable income.
The main benefit is the charitable contribution deduction, and it is greater when interest rates are higher. Lower interest rates at the time the annuity is created, however, increase the tax-free portion of each annuity payment.
- Long-term Property Sales
There are several estate planning strategies used to transfer property to the next generation while minimizing estate and gift taxes. They are installment sales, private annuities, and self-canceling installment notes. They usually are used to transfer interests in businesses or real estate from parents to their children or later generations. What they have in common is the estate tax planning benefits are greater if they are implemented when interest rates are low.
Generally, under these strategies, the parents sell the property to the younger generation by transferring the property in return for promises from the younger generation to make payments to the parents over time. Each of the strategies has detailed rules that must be followed, and there are different situations in which each is more appropriate. If you have a business or valuable real estate, talk to an estate planner about the options.
- Real Estate
Rising interest rates often signal a healthy economy (assuming that inflation is stable), which usually bodes well for the real estate industry. This is important those who are executors or trustees that are monitoring commercial property and those that cannot sell their real estate due to significant tax consequence (depreciation recapture).
If interest rates continue to rise and lenders sense the need to protect themselves against a potential decrease in property value, they could eventually tighten lending standards further and require more equity from borrowers as they seek to increase their loan-to-value ratios. Lenders can tighten lending standards in a variety of ways, such as requiring more equity or collateral from the borrower, limiting lending for borrowers deemed less creditworthy and reducing exposure to riskier properties, markets or types of financing (such as construction lending vs. refinancing). This is critical when attempting to refinance before a payment balloon.
Cost of capital is a major consideration, as higher rates mean that the “rental price of money” has gone up. This could lead to borrowers paying more interest to lenders (a good thing for financial institutions). However, it could also lead borrowers to get smaller loans in the first place if they calculate that they would not be able to keep up with interest payments on a larger loan, forcing them to either put up more equity or target lower-priced properties. Further, riskier loans (like construction loans) and riskier assets may be even harder to finance efficiently, given the added risk premiums.
Higher capital costs could also increase default risks. These may be bad for lenders, too… that is unless they are non-traditional “vulture” players employing a loan-to-own strategy and secretly hoping for defaults to seize properties. In an extreme situation, if these defaults start to spread, they can ultimately be bad for the economy as a whole.
If a creditor sues you and gets a judgment, it has a whole host of collection methods available to get its money from you, including wage attachments, property levies, assignment orders. There are only 3 ways to get rid of judgment: 1) Vacate it; 2) Satisfy it, or 3) Discharge it. In your analysis of which approach is best for you, you should follow that same order: First, can I vacate the judgment? If not, can I satisfy the judgment? If not, can I discharge the judgment in bankruptcy? The judgment will be filed with the court, and once that happens, it is public record. That means it will likely end up on your credit reports as a negative item.
Unpaid judgments can remain on your credit reports for seven years or the governing statute of limitations, whichever is longer. Once judgments are paid, they must be removed seven years after the date they were entered by the court. Beginning last July 2017, the credit bureaus will exclude judgments that don’t contain complete consumer details or have not been updated in the last 90 days. Lastly, if a judgment was entered against you in California, it can show up on your credit report for ten years, or even 20 years if the creditor renewed it on time.
1) Is vacating the judgment an option for me? If you contested the case (answered the lawsuit) and the court entered a judgment against you, vacating the judgment will be very unlikely. If however a default judgment (you did not answer the lawsuit) was entered against you, you should determine if you can have the judgment vacated (or what is sometimes referred to having the judgment “set aside”). In order to vacate a judgment in California, You must file a motion with the court asking the judge to vacate or “set aside” the judgment. Among other things, you must tell the judge why you did not respond to the lawsuit (this can be done by written declaration).
The reason and the timing of your motion are very important and really should not be done without the assistance of a lawyer. Generally speaking, if you had no actual notice of the lawsuit (for example, you were not served properly), you have two years from the date the judgment was entered against you to make the motion. If you knew about the lawsuit but did not timely respond, you have 6 months to make the motion based on “excusable neglect.” Missing the court date because of a serious illness or because a court officer gave you incorrect information, for example, would be considered excusable neglect. Forgetting about or ignoring the case does not qualify as excusable neglect. The horror story I hear all too often is that the judgment is more than 2 years old, the consumer never knew about it, and now nothing can be done about it. The 2-year limit is a law that needs to be changed.
If your motion is successful, the judgment is vacated, and you then get to contest the case. When you can contest the case, you have a lot more options regarding how to resolve the case. Settlements of contested cases are usually far better than settlements of judgments. You may even be able to win the case. Either way, the judgment creditor no longer has the ability to levy your bank accounts, garnish your wages, or lien your property.
2) How do I satisfy the judgment? This means to settle the judgment and have the judgment creditor file a “Satisfaction of Judgment” with the court. Around the courthouse there is a saying, “Slow money is better than no money”. Judgment creditors routinely settle judgments for less than the full balance.
So you may be able to negotiate a discount on the debt, in return for a lump sum payment. If a large payment isn’t financially possible, a stipulated judgment allows you to pay in monthly installments, shielding you from garnishment, levies, and liens on your property. Most creditors are happy to do that, rather than get an uncollectible judgment. This is a lot easier than having to chase down your assets and avoids the possibility that your income and property is exempt from seizure. For example, seizing your car will mean hiring a towing service and, in some jurisdictions, paying for 30 days of bonded storage.
Many post-judgment debt settlements are concluded with a phone call from a bankruptcy attorney, giving the debtor more leverage. When creditors’ lawyers hear from a bankruptcy attorney’s office, they understand that bankruptcy is a reality, which ratchets up the pressure on them to make a deal. Settlements may wipe out as much as 75 percent or 85 percent of the debt if most or all of the payment can be made promptly.
Do not make payments unless you have a clear WRITTEN agreement that states exactly how much is to be paid and when. Never enter into an agreement that states something to the effect: “we will review/reassess this payment arrangement in 6 months”. Once a settlement is complete, get a satisfaction of judgment signed by the creditor, and make sure it is filed with the court and reflected on your credit reports.
3) Should I Discharge the judgment through bankruptcy? Among the choices for dealing with a judgment, declaring bankruptcy is the nuclear option. Notable exceptions are judgments based upon fraud and elder abuse. Bankruptcy is a powerful weapon for wiping out debt but comes with serious consequences for the debtor who pushes the button. Having assets and income to protect are an important hallmark of a need to file bankruptcy. According to the Office of U.S. Courts, the average Chapter 7 consumer bankruptcy case filed in 2012 had nearly $116,000 in total assets and median monthly income of $2,764. In fact, California is one of the few states that gives you two separate lists of assets you can exempt (http://www.courts.ca.gov/documents/ej155.pdf). You can’t mix and match between the two exemption schemes, however, so you’ll want to scrutinize each and select the list that will work best for you.
Filing a bankruptcy petition will place an automatic stay on the judgment and any enforcement actions, including wage garnishment, while you work with the court to reorganize your finances.
In a Chapter 7 bankruptcy, the trustee will sell the property you can’t exempt and use the funds to pay unsecured debts—such as credit card balances, personal loans, and utility bills. In Chapter 13 bankruptcy, the trustee doesn’t sell your nonexempt property (the more property that is exempt, the less you have to repay). Instead, you keep it and pay the value of it to your unsecured creditors through your three- to five-year repayment plan. Before you can wipe out debt in a Chapter 7 bankruptcy, you must meet income qualifications by passing the “means test.” You’ll provide your family income on the means test forms. If it exceeds the median income of your state, you can subtract particular expenses. The needed income charts and pre-set expense guidelines are on the U.S. Trustee’s website (select “Means Testing Information” in the left column). The same data gets used to determine the length and amount of a Chapter 13 bankruptcy payment.
California, being a large state, has four bankruptcy courts, most of which have multiple locations serving various geographical areas. Each office often has a webpage where you can access information. The Central District serves Los Angeles (http://www.cacb.uscourts.gov/). Costs for legal fees are typically around $1,500 or more, limiting the bankruptcy option. Other drawbacks include restrictions on filing bankruptcy again — such as an eight-year wait for filing another Chapter 7 case — and a 10-year demerit on your credit report. For those reasons, bankruptcy may be more useful as a bargaining tool in settlement talks than as a plan of action.
If bankruptcy is not an option for you, and the judgment is more than 2 years old, the only real option you have is to satisfy/settle the judgment. Until you are able to do that, do everything you can to frustrate the judgment creditors ability to enforce the judgment. For example, do not leave your money in the bank to be attached.
4) Am I Judgement Proof? People with few assets and modest income may be “judgment-proof,” because legal protections exempt them from collection. But that does not mean you can ignore a judgment. It takes work to determine that your wages and belongings are protected from seizure by a complex web of state and federal exemptions. And you should take steps to head off wrongful collection attempts on your exempt property before they happen. It is important to know that, even if you’re judgment proof, you may be made uncomfortable by having your employer told to deduct sums from paycheck.
Most importantly, just because a judgment creditor levies on your property or attaches your wages, it doesn’t mean that the creditor is entitled to take the property. California law limits the amount that a creditor can garnish (take) from your wages for repayment of debts. California’s wage garnishment limits are similar to those found in federal wage garnishment laws (also called wage attachments). For most debtors, creditors cannot garnish more than 25% of their wages after deductions (http://www.courts.ca.gov/11418.htm). If your wages are low, however, California law protects even more of them (and even more than does federal law). Be careful if you are self-employed. With non-earnings garnishments, a creditor can seize one-hundred percent of an expected compensation, such as sales commissions, contract payments, or receivables. However, this is a one-time seizure of income. Non-earnings garnishments are not ongoing like wage garnishments. While traditional wage garnishments are limited by law to disposable income from paychecks, creditors seeking compensation through a non-earnings garnishment can levy your bank accounts, income received from rental properties, and other sources.
Every state exempts certain property from creditors (https://saclaw.org/wp-content/uploads/lrg-exemptions-from-the-enforcement-of-judgments.pdf). This means that creditors simply cannot have that property, no matter how much you owe. Also, you may be able to keep property that isn’t exempt if you can prove to the court that you need it to support yourself or your family. When filing for Chapter 7 or Chapter 13 bankruptcy, California allows you to choose between two different sets of exemptions (you must choose one system or the other). Exemptions protect your property in any bankruptcy chapter that you file. Generally, debtors with substantial home equity prefer System 1 while System 2 is more beneficial for debtors who have valuable property other than home equity. Be sure to compare each set and choose the one that works best for your situation. In addition to the exemptions found in System 1 or System 2, you might also use any applicable amounts in the federal non-bankruptcy exemptions.
Any time the sheriff or marshal levies against your property, you must be notified. You can request a hearing, which is usually called something like a claim of exemption hearing, to argue that it will be a financial hardship on you if the property is taken, or that your property is exempt under state law. If you lose that hearing and your wages are attached, you can request a second hearing if your circumstances have changed, causing you hardship (for example, you have sudden medical expenses or must make increased support payments).
When you are notified of a property levy (such as a bank account attachment) or an assignment order, you will be told in writing how to file a claim of exemption — that is, how to tell the judgment creditor you consider the property unavailable. The period in which you must file your claim is usually short and strictly enforced — don’t miss it.
Complete and send a copy of your claim of exemption to the judgment creditor. In some states, you’ll also have to serve it on the levying officer, such as the sheriff. The judgment creditor will probably file a challenge to your claim. The judgment creditor may abandon the attachment, levy, or assignment order, however, if it’s too expensive or time-consuming to challenge you. If the creditor does abandon it, your withheld wages or taken property will be returned to you. If the judgment creditor doesn’t abandon the attachment, levy, or assignment order, the creditor will schedule a hearing before a judge and you’ll have to convince the judge that your property is exempt or that you need it to support yourself or your family. This is your opportunity to defend yourself from having your wages or other properties taken. You must do all that you can to prepare for this hearing if you want to keep your property. If you have high income one month, bring in pay stubs to show that you usually make less. Or, if your bills are higher than average, bring copies. Think carefully about your income and financial situation. There may be other creative but truthful ways to show the judge that your property is exempt or necessary to support yourself or your family.
The judge will listen to both you and the judgment creditor if the judgment creditor shows up. Sometimes the judgment creditor relies on the papers already filed with the court. The judge may make a ruling or may set up an arrangement for you to pay the judgment in installments.
This has not been an easy quarter for investors, especially those that are late to party. One of the themes for the last few months is the return of volatility. As you can see in the chart below, the US stock market was giving you above average stock market returns while exhibiting below average stock market volatility. The one-sided gravy train came to a screeching stop on January 26th.
Over the course of the past 3 months, the S&P 500 experienced 6 trading days of +/-2% moves, juxtaposed to 2017 when we saw zero such moves, which has resulted in a bumpier ride for equity investors. But has the ride for stocks been particularly bumpy this year? The reality is that daily moves of 2% or greater up or down are not all that uncommon. Since 1980, U.S. equities have averaged 15 such occurrences a year, with years of above-average incidents tending to be clustered together.
It is reasonable to expect significant daily moves to continue from time to time this year, as investors debate the effects of higher interest rates, the direction of inflation, the impact of fiscal stimulus, the evolution of trade tensions and the timing of the next recession. Clearly, there is more to consider and digest this year compared to last year, with risks to the outlook now to both the upside and the downside. However, while the market may swing meaningfully from one day to the next, investors should be careful not to overreact to new information one way or the other.
2% daily moves are not all that uncommon
Number of daily moves greater than 2% up or down, S&P 500 price index
Global Risk is Rising
- With the announcement of steel and aluminum tariffs and the more recent tariffs of up to $60 billion on Chinese imports, trade war concerns are elevated. At this point we believe the evidence suggests that the situation won’t deteriorate from a trade spat to a trade war, as both Canada and Mexico are exempted from the steel and aluminum tariffs; while FactSet is reporting that the United States is continuing to negotiate exemptions for the European Union and Australia—not exactly the mark of a trade war. Fortunately, we haven’t seen a trade war in over 90 years for a lot of good reasons, including economic destruction they caused in the 19th century, increased globalization, longer supply chains, and The World Trade Organization dispute resolution process.
Fair & Balance – Now let’s look at the positives:
- Corrections are always unnerving, especially because they tend to be processed over time as opposed to condensed moments in time. Traditional stock market fundamentals remain supportive of an ongoing bull market. The U.S. economy doesn’t look to be anywhere near a recession, which has historically accompanied bear markets. The Index of Leading Economic Indicators rose again in March, continuing a robust uptrend. These leading indicators include initial unemployment claims, which recently hit a 45-year low.
- According to Thomson Reuters, the estimated first quarter year-over-year growth rate for S&P 500 is 18.5%, which would be the highest rate of growth in seven years. That’s a pretty high bar to reach, but judging by the optimism shown in recent readings from the Institute of Supply Management, the National Federation of Independent Business, and The Conference Board’s CEO Confidence Survey, it should be a pretty optimistic tone coming from much of the corporate sector.
- The U.S. economy should have a tailwind that is just beginning due to the tax cuts that the majority of Americans are now incorporating into their budgets. Additionally, we can put worries of another government shutdown to bed, as a new spending bill—the merits of which can certainly be debated— passed, which should add to near-term economic growth. Caveat: the timing of fiscal stimulus—coming much later in the cycle than is typically the case—does elevate the risk that inflation heats up, which could push the FOMC to tighten more quickly.
Blah Blah Blah…. So What?
Sharp moves and stocks continuing to flirt with correction territory have been the hallmarks of the market lately. This probably isn’t the start of a bear market, but it doesn’t “feel” like a bull market right now. The current trend is missing conviction as the jittery stock market hops up and down. But that behavior isn’t unusual after a pullback. In fact, based solely on prices, it’s too soon to tell if this is a cyclical/non-recession bear market or just a bull market correction. In either case, stocks tend to bounce around before re-establishing a trend. We expect this to continue to be the case as there are still a variety of factors affecting the markets; including worries over global trade and the potential for increased regulation in the tech sector, balanced by the confidence seen in robust M&A activity and expectations for double-digit earnings growth for the first quarter.
While unnerving at times, we continue to believe the economic and earnings environment should support a continuation of the bull market, albeit with more volatility, some elevated risks, and bumpy charts in the near term. We continue to espouse the benefits of periodic and disciplined rebalancing to take advantage of this volatility, along with reasonably long time horizons.
This is why working with a financial planner that has a tax background is critical. Lionshare Partners LLC was registered to do business on December 12th, 2017 and less than two months later one of my blogs is already obsolete. I recently wrote about the decisions behind choosing a S Corp or C Corp as the entity for your operation. Well with the new tax law dropping the top corporate rate to 21% and shuffling the deck on tax strategies it is critical you meet with your tax advisor soon to discuss the best situation for your ongoing enterprise. After all, as your business grows and evolves, what is the likelihood that the same choice of entity that worked for you five years ago still works today?
And what’s funny is for the last 31 years, the choice of entity for the majority of entrepreneurs has been a binary one: they will be an S corporation, or they will be a partnership (LLC). Why? Think about the pre-2018 corporate landscape: corporate-level income was taxed at 35% (compared to top tax rate of 39.6% for individuals). A subsequent distribution of cash was taxed to the shareholder at a top rate of 23.8%. And a distribution of appreciated assets by a corporation to a shareholder was treated as if the corporation sold those assets for fair market value.
So, the question you need to ask when meeting with your tax advisor is “Should my business be a C Corp?” There are several reasons to consider the move besides the lower tax rate on profits. For example, the cash method of accounting is now available until average gross receipts exceed $25 million. Tack on the benefits of the new 100% asset expensing rules, a top corporate rate of 21% on personal service businesses, the doubling of the estate tax exemption, and the pre-existing benefits afforded only to C corporations that tax reform did nothing to dilute: For example, the ability to provide tax-free fringe benefits to shareholder/employees, and an exclusion from gain on the sale of stock held longer than five years under the recently-expanded Section 1202. Add all these things up, and C corporations can no longer be an afterthought.
Yes, ask your tax advisor about the Section 1202. This is one of those crazy capital gains exclusions exploited by Private Equity firms and often missed out by ordinary small business owners. But the Section 1202 allows the potential to sell your C corporation stock after five years without paying tax. Yeah, you heard me!
Make sure you run some long-term (10 year) projections with an exit (liquidation event) to truly see which entity works best for you. Because a C corporation might “lose the battle” each year relative to flow-through entities by paying slightly more in tax, the owner of that C corporation can sell their stock (Section 1202) and exclude the gain under Section 1202 (not available to S corporations or partnerships). That large tax savings at the exit could be ultimately matters in terms of overall tax savings.
Generally speaking, the two levels of tax would still make a corporate operation less advantageous than a flow-through entity. However, if you do not pay out dividends–and are rather planning to re-invest a majority of profits back into the business as part of a long-term strategy (like a manufacturer) –then the C corporation is a solid option. If you have multiple business lines under one entity, it could make sense to break them into separate businesses to take advantage of the reduced corporate rate and other aspects of the new law. Consequently, corporations with shareholders taking significant bonuses at year-end will not necessarily benefit by a move to a C corp because some of those bonuses will have to be treated as dividends.
Other items to consider before changing your business taxing structure include:
- Owners’ ability to deduct losses at personal level with pass-through treatment versus having the losses trapped inside the C-Corporation structure.
- Lack of step-up on sale for buyer.
- Accumulating appreciable assets C-Corporation, double taxation structure.
Be mindful if you are on the “I got screwed list” under the new tax code that do not qualify for the pass-through deduction. This list is corporation that are professional services — which could encompass legal counsel, financial consulting, athletes, doctors, or freelance design work. If this applies, you should consider taking the time to re-organize, and there are workarounds to avoiding being double taxed.
Lastly, for those who wish to move quickly, the process of converting to a C corporation could theoretically take less than a week. California is one of the states that allows for “statutory,” or streamlined, conversions. Briefly, to convert a California LLC to a California corporation, you need to: adopt a plan of conversion; and file Articles of Incorporation containing a statement of conversion with the Secretary of State.
This is an important distinction and should be understood prior to getting your revocable living trust reviewed by an Estate Attorney. A Trust Amendment is a legal document that changes specific provisions of your trust but leaves all of the other provisions unchanged. This is useful for minimal changes – adding or deleting specific bequests (property you think you kids want but can careless about), changing successor trustee, updating beneficiaries/successor trustee’s legal name due to marriage.
Contrast that with a Trust Amendment and Restatement, which completely replaces and supersedes all of the provisions of the original Revocable Living Trust. The closest analogy I have for a restatement is when your grandpa loses his cool playing Monopoly and flips over the board. So the restatement is useful for significant changes – adding a new spouse as a beneficiary, completely cutting out a beneficiary, changing from distributions to children to distributions to charity (or vice versa). Also if you have already made 3-4 simple trust amendments over the last decade and you’re going to make another change then consider consolidating all of the changes with a complete amendment and restatement. This will make it easier for the successor trustee (generally you kids) by having a single document rather than a bunch of separate amendments.
A couple of housekeeping items. You don’t change the original name of date of the trust with either an Amendment or Restatement. This is so you don’t have to re-fund (title property to the trust) the trust. Don’t make the changes yourself and slip it back into the drawer. Work with an estate attorney to prepare the Trust Amendment because the it must be signed with the same formalities as the original trust agreement. So let’s not potentially void or have your trust ignored.
This is an interesting question and depending on who you talk to will probably result in dramatically different answers. Attorneys tend to push for the Limited Liability Company (LLC) more than necessary, and insurance brokers tend to push for more insurance coverage than necessary. Therefore, some people will advocate for a “belt and suspenders” approach of having both a high amount of liability insurance and an LLC. Well, the cost of both insurance and an LLC ($800/yr in CA) plus the cost of a property management firm (8 – 12% of the monthly rental value of the property, plus expenses) will significantly decrease the profitability of your properties. A lot of investors form an LLC as a magic solution. A few clicks of the mouse on Legal Zoom, pick a cool sounding name, get some business cards and website, and suddenly you have your foolproof LLC. This is the reason most estate investors want an LLC. Limited Liability means that owners of an LLC cannot be held liable for acts or debts of the LLC. If the LLC is sued, the plaintiff could potentially win a judgment for the value of everything owned by the LLC, but the plaintiff can’t go after the financial assets of the owners of the LLC.
So, let’s take a step back and explain what an umbrella policy is. An umbrella policy is an additional layer of protection on top of your existing insurance policies. It provides protection against a wide variety of perils across all your assets. Let me give you an example:
Chad owns a rental property with $250,000 of equity and has a landlord policy with $500,000 of liability coverage and an umbrella policy with an additional $1,000,000 of coverage ($10k deductible). The current tenant has a party with people on the upstairs balcony. The balcony collapses, causing serious injury to 7 people. Chad gets sued for $1,650,000. The first layer of protection is the rental dwelling insurance covering the first $500,000. After paying the $10k deductible, your second layer of defense, the umbrella policy, pays the next $1,000,000. Chad would then be left with a total out-of-pocket liability of $150,000.
When reviewing my client’s insurance policies, this is a risk exposure that tends to be underfunded and tends to be the least understood. Not all umbrella policies are the same, and these are insurance companies and not charities. So, they are also in the business of risk, so they will exempt and/or exclude items that you assumed were covered. It’s best not to wait until a claim is filed before figuring out if it is covered. With that said, there are (3) great advantages to having an umbrella policy:
- Protection that travels with you – An umbrella policy provides a very comprehensive layer of protection against threats you might not have any protection from today. It provides insurance against incidents that happen away from home (your dog bites somebody in a park), libel and slander, and a variety of threats to your finances that aren’t protected through other mechanisms.
- It is cheap and simple – I’ve found coverage for a $1,000,000 umbrella policy for as low as $250/year, and the cost goes down the more coverage you seek. Coverage for a $10,000,000 umbrella policy is available around $1,000/year. It is also really simple to manage. One check, one company, for covering both your personal and business (rental properties) liabilities.
- Covers all your properties, regardless of location – An umbrella policy will cover all your rental properties throughout the U.S., regardless of what state they are in. An LLC is specific to the state it’s formed in. If you have an LLC formed in California and you want it to operate in Texas, you’ll need to file paperwork (and pay fees) to register the LLC in Texas. If you’re going to file paperwork to allow your California LLC to operate in Texas, you might as well just create a new LLC in Texas and have a bit more protection.
Remember the first layer of protection as a landlord is through your rental dwelling insurance policy (landlord policy). Note that a rental dwelling insurance policy is a different policy from the homeowner’s policy that you have on your primary residence. A homeowner’s policy insures not just your house, but also your furniture, clothing, etc. The rental dwelling insurance policy only covers the actual structure, but it does provide higher liability insurance. It’s also important to note that your insurance company provides legal representation in addition to the stated coverage and your insurance company has no incentive to negotiate a settlement at any amount over their stated coverage. This means that you’ll still need to hire a lawyer if you’re sued for an amount greater than your landlord policy + umbrella policy. I recommend my clients require that their tenants carry renter’s insurance. A renter’s insurance policy will cover their possessions as well as provide some liability insurance for incidents that happen on the property that they are responsible for. If the renter has insurance, there is less reason to go after you and their insurance means you’re less likely to be sued.
Since the most likely scenario is one where there are no issues and no claim, the vast majority of individual investors are better off with an umbrella policy. If you have lots of individual rental properties, then the LLC fees could eat into your profits if you have a separate LLC per property. The fees vary from state to state, and some are more expensive upfront, some are more expensive each year, etc. There is an initial filing fee to set up the LLC, an LLC formation fee ($200-$1,000), and a licensing fee for each year the LLC is active.
- Arizona – Both low initial cost & low yearly cost
- Texas – High initial cost ($300), No yearly cost (assuming revenue <$300k)
- California – Low initial cost, high yearly cost ($800)
But you can’t be cheap and try to cram multiple properties into a single LLC because you are losing much on the protection of having an LLC in the first place.
If you have a small number of large or valuable properties (significant equity), then an LLC doesn’t help much because most of your net worth is probably already tied up in the property. If you have a mortgage-free $5,000,000 duplex in Santa Monica and get sued, even though you had an LLC you can still lose the property in a judgment and be effectively wiped out financially.
A scenario where having an LLC makes sense is if you have lots of expensive properties. Putting each property in an LLC prevents a single large liability from wiping out your entire net worth. This is for the real estate investor who has 15 San Diego rental properties that were purchased decades ago and each property is currently worth $1,500,000. This is a net worth of $22,500,000, so you don’t want an incident at one rental property to allow a judgment beyond $1,500,000.
However, if you choose to go the LLC route there are (3) major considerations to understand:
- Transferring property into an LLC – Before the LLC will offer you any protection, you first have to move your properties into an LLC. This is a major inconvenience to a lot of investors. Especially if you have a mortgage and have to get the lender to agree to transfer to avoid triggering due-on-sale clause (balance of your loan is immediately due), which rarely happens. When transferring real estate, too many real estate investors opt for Quit Claim option most likely due to its common parlance amongst investors when discussing the transfer of real estate. A Quit Claim Deed transfers bare legal title to the grantee without any warranties of any sort. Think of it like the “AS IS” clause in a real estate purchase and sale agreement. A Warranty Deed on the other hand guarantees free and clear title of any defects. This is important because you want the guarantee that the transfer of property is valid to ensure you have the LLC protection. So go with the warranty deed.
- Outside Liability – An LLC will protect assets from a lawsuit against your LLC, but it will not protect you if you get sued personally (car accident for texting/driving). If you act as the property manager, there’s liability from that as well. Maybe you didn’t warn the new tenant about an issue with the property when they moved in – you’ll be sued as the property manager AND your LLC will be sued as the owner. Most importantly, an LLC is a business entity. So, function like one or a plaintiff attorney can try to “pierce the corporate veil” and flow a lawsuit directly to a personal judgment. This means having separate books, LLC bank accounts, annual compliance (holding yearly meetings, documenting them with contemporaneous meeting notes, formally passing new bylaws, etc.). There are paralegals who will do this for $200.
- Anonymity – Some landlords don’t like the idea of tenants knowing who they are or where they live. Especially when dealing with the prospects of raising rents and evictions. So the LLC can be used to provide an initial layer of anonymity. Real estate ownership is public record, so it’s not too complicated to find out who owns a given parcel. You can go down to the county recorder’s office or pay for third-party online search services. So by transferring ownership of the property to the LLC, a property search will reveal the LLC as owner. So don’t use your name for your LLC. Make it abstract like Red Leaf Development. If a potential Plaintiff does some additional digging, it is not hard to find out who the owner of the LLC is. This is common when you’re the registered agent and/or the LLC address is your home address and has completely blown your anonymity efforts. You’d need to set up a third-party to be the registered agent and rent a PO Box to use as the mailing address for your LLC. Lastly, if you’re also acting as the property manager (or otherwise involved with the property) and/or have a mortgage lien in your name, then any anonymity measures will be trivial.
I’ve been in the personal finance field for about a decade, and I continue to see asset protection strategies for prospects as a significantly overlooked part of the comprehensive financial planning process. If you have rental properties or any corporate entity, it is important to understand your exposures, layers of protection, & have them reviewed.
I’m always on the lookout for proposed policies that impact pensions. There are two considerations for both federal and private pension beneficiaries. The explosion of private pension transfers in 2017 and the president’s fiscal 2019 budget includes a few proposals to reduce retirement benefits for federal civilian workers. The president’s budget proposes four changes to the Federal Employees Retirement System (FERS): 1) increase the employee’s contribution so that employers and employees each pay half of the normal cost; 2) eliminate the cost-of-living adjustment for FERS retirees; 3) calculate FERS benefits based on high-5 rather than high-3 years of earnings; and 4) eliminate a special benefit available to those who retire prior to 62. The eliminating of the cost of living adjustment will significantly affect retirees.
With pension liabilities becoming extremely expensive to maintain, increased longevity, low-interest rates, and the popularity of the 401(k), many companies are looking for de-risking avenues. Pension risk transfers have generally become more popular for employers who have to make annual payments to the Pension Benefit Guaranty Corp., a federal agency, to insure against their future inability to pay plan participants. Employers pay both a flat rate (per-participant) and variable rate (on underfunded amount), which have respectively doubled and tripled since 2013. According to Millman, a consulting firm, corporate pension plans were 84% funded on average at the end of 2017.
Single-premium pension buyouts are the most popular type of pension risk transfer. Employers transfer their pension obligations to an insurance company by purchasing a group annuity contract for all or a portion of the plan participants. The insurer then makes monthly payments to participants and relieves the employer of their associated pension liabilities. Funding for the block of liabilities must be at 100% to do a transaction. According to the LIMRA Secure Retirement Institute, which tracks insurance data, single-premium pension buyout sales ballooned 68% in 2017 compared to the prior year.
Employers will look to two major tailwinds to position themselves to a funding position for a pension risk transfer. Economists are predicting that Jerome Powell and the Feds will raise interest rates three or four times this year. Rising interest rates will likely improve pension funding ratios in the coming years. Further, a lower corporate tax rate could provide a boost to pension transfer deals by making funding a pension to 100% sooner more appealing. The Republican tax measure, signed into law in December, lowers the corporate tax rate to 21% from 35%. Many employers have until Sept. 15 (if they are calendar-year tax year) to make a pension contribution and have that contribution be tax deductible at the higher 35% tax rate. If they wait longer, their contributions would be deductible at the lower 21%. This 14% rate differential is very important to funding up the pension plan because those savings create additional funding which makes de-risking easier to do.
With low-interest rates, it is easier for companies to borrow to get their plans to a status of being fully-funded. According to Scott Kaplan, head of Prudential’s pension risk transfer business, an employer doing a pension risk transfer for a retiree population can typically expect to pay between 101%-105% of the associated liabilities. Large employers can do these pension risk transfer to certain blocks of participants, such as active employees, retirees receiving benefits, and terminated vested participants.
There are risks that participants need to be aware of if their pension is being offloaded. MetLife Inc., for example, has been in the spotlight recently for failing to pay benefits to thousands of pension clients after MetLife had lost track of those pensioners. This isn’t the first time insurers have been admonished for not doing enough to reach clients. In recent years, Metlife and others came under scrutiny from regulators who accused them of holding on to benefits people hadn’t claimed, rather than turning them over to states or policyholders. Many insurers now use a government database known as the “Death Master File” to double-check whether clients are still alive.
Risks are building in the markets but so is bearishness. Though markets are going to do what they are going to do in short-term, we have learned there are still not a lot of natural sellers, and if the market gets too offside, you can bet the other side for a trade.The fast money is now so short-term focused, especially the growing number of HFTs that don’t hold overnight risk, they have no patience and must cover quickly especially if the market begins to move against them. I do believe investors are going to get a chance to buy stocks and much lower levels, however.
The stock market went stock market in February. After closing January at 2,823.81, the S&P 500 ended February down 3.89% at 2,713.83. Prior to the normal and much-needed correction, the S&P 500 was at its most expensive level in 14 years. While stock valuations remain an issue, I believe these high valuations are justified if corporate earnings continue to rise, the economy remains strong, no imbalances or surprises emerge, and interest rates stay relatively low. I talked about this last month in avoiding naïve extrapolation. With February finishing the month down, the U.S. stock market experienced its first monthly drop in fifteen months. So, RIP to the positive feedback loop that markets are a one-way trade to easy money because of ______. Add the weak hands that jumped in late and panicked at the first sight of red in their portfolio and the environment was ripe for a selloff.
The closest analogy I have is akin to dating in Los Angeles. Person A (apparently harmless Stock Market) spends the first 8-12 months pretending to be someone else in a full Daniel Day-Lewis effort to convince Person B (the suddenly risk friendly investor), who is also pretending to be someone else, that they are the perfect match and strangely have everything in common, “What!? You also think Tyler Perry’s Boo 2! A Madea Halloween is the greatest movie of all-time?” Things are going well. Both parties are sticking to their false narrative with only minor slippage. The relationship gets too comfortable, reality creeps in as the false personages sheds, and finally someone throws their soup at the waiter and claims 9/11 was an inside job.
The point is. There is volatility in all aspects of life. With work, with your children, with your partner, with your business and dreams, and definitely with your investments. Accept it and expect it. Don’t let the confidence nor doomsayers’ rhetoric change a sound strategy. Wallstreet needs Mainstreet to buy their products and churn their accounts. Financial media needs ad revenues via clicks or viewers so they can never run segment that is, “Hey folks, markets are acting normal, the best action is to do nothing and focus on the personal finance at-risk items you can control. Check back in this summer for a quick update.”
If you’re truly worried and notice how the anxiety/angst has made you a Debbie Downer, then it’s time to re-evaluate your portfolio and assess your bear market strategy. This is important. There needs to be a tangible game plan that you refer to when things get rough and they will at some point. I know some investors have jettison components of their asset allocation due to recency bias and the lack of performance relative to U.S. Growth stocks. That herd mentality becomes dangerous as investors reduce the amount and degree of hedging and risk management components in their portfolio. When everyone rushes to the exit at the same time prices collapse and it takes a while for the market to catch a bid.
Investors who used the cheaper online advisory platforms have learned the hard way during the 1,000-point Dow sell off on February 5th when they were unable to login to place trades. Those that use robo-advisory services – from the likes of Vanguard and Charles Schwab to pure players Betterment and Wealthfront – suffered from spotty access and being shut out of their trading platforms altogether.
I’m a big fan of the “Rocky” movies. Duke, played by Tony Burton, is famous for playing both Apollo Creed’s and Rocky’s corner man in the “Rocky” movies. In Rocky IV, Rocky heads to Russia to avenge the death of Apollo Creed and fight Ivan Drago. Sadly, Tony Burton passed away two years ago, but what I remember most from him in the films is the overly simplistic & succinct advice he would yell at Rocky between rounds after he just took 2,453 unanswered blows to the face. I would love to create a mobile app that is just a pop up of Duke’s intense face followed by random quotes from Rocky IV anytime an investor without a plan tries to panic sell. So the next time the President starts a trade war or the market opens down 2% for no reason and your portfolio takes a shot to the face…This pops up followed by one of these lines:
“Be a rock for me!”
“Be strong! No Pain!”
“Brace Yourself. It’s All-right”
“You’re doing fine. You’re doing great.”
“Don’t go down. Don’t go down.”
At this point, I expect volatility to continue in both the equities and fixed income markets as the Federal Reserve, European Central Bank, and other central banks pursue a tightening monetary policy. New Fed chairman, Jerome Powell, declined to raise the Federal Funds target rate at its February meeting, but the board has indicated that at least three – and possibly four – small rate hikes could be in store for 2018. The Fed is expected to raise rates by 0.25% in March. Historically, it is not the raising of rates by the Fed that has been the downfall of stocks but rather the rate of increases and after they have finished raising rates.
In addition to a gradual rate increase, the Fed began a long-term effort to trim its $4.5 trillion balance sheet in October 2017 by ending its policy of purchasing Treasury issues and mortgage-backed securities. With liquidity marginally diminishing, interest rates could rise, affecting stock and bond prices. These mandates will be tough with the federal budget deficit on track to blow through $1 trillion in 2019, along with a weak U.S. dollar, and threats of trade wars.
Know what you own. The cost, the risk, & the bear market strategy. When you wake up to the S&P 500 down 2-3% remember the words of the late Tony Burton, “Be a rock for me. Be strong. No Pain.”
Forget Bitcoin. The red-hot M&A market for RIAs (Registered Investment Advisors) shows no signs of slowing down. Research and investment banking firm Echelon Partners reports deal volumes in 2017 were on track to set a new record breaking 150 transactions. According to industry estimates, there are between 10 to 20 qualified buyers are lined up for every current seller. So much for buying low and selling high.
Private Equity (PE) firms are now investing more than $3 billion a year into the advisory space and PE firms do not suffer fools. Once an RIA accepts PE money, that RIA will be held to very high –and often escalating expectations. In almost every case, the PE ownership is limited to a term of about a half-dozen years before the private equity fund needs to provide its investors with liquidity. This means the RIA will have a “carousel” relationship with new PE firms which will have even higher expectations – not to mention potential changes to management team or philosophy. This is akin to dating a different version of the J.K. Simmons’ character in the movie Whiplash (watch it ASAP) every 6 years – “Do you think you’re out of tune?”
SEC Commissioner Kara Stein, believes ownership concentration affects the willingness of companies to compete. A study by Jose Azar (IESE Business School), stated common ownership by institutional shareholders pushed up air fares by as much as 7% over the 14 years starting in 2001 because the shared holdings put less pressure on the airlines to compete. So, as RIA firms take on more cheap debt or PE ownership investment to purchase growth, ask yourself how will that affect the quality of services and the availability of your advisor, as they will be forced to do more with less.
Keep in mind, PE firms have a fiduciary obligation to the investors in their funds – and not to you. PE firms typically extract fees and “special dividends” from their portfolio companies which will fund them with additional debt. These fees and special dividends are tools with which PE firms use to extract profits up front. Lenders and other creditors carry the risks. Effectively extracting equity and income that can be used to reduce fees or improve services from clients to the passive investors.