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October 2018 Sell-Off Recap: To Buy the Dip or Not to Buy the Dip?

The 3 percent to 4 percent plunge in the major American indexes earlier this month is unsettling for investors who have grown accustomed to low U.S. market volatility in recent years. What’s more disturbing is that most of the traditional hedges against such a large equity sell-off, both within and across market segments, did not work well.

Yet neither of these developments should come as a great surprise given the following five factors that also point to what’s ahead:

1. After years of seemingly unquestioned central bank support — including the so-called “Fed Put” — stock and bond markets are transitioning away from a world where liquidity injections underpin asset prices and moving toward a greater role for fundamentals. Almost by definition, this is a volatile process: Think of a plane changing engines while flying at a high altitude. Turbulence is to be expected.

2. Unusual divergence in economic performance and policies within the advanced world is complicating this liquidity-to-fundamentals market transition. U.S. growth is increasingly outpacing other countries’, powered by the combination of higher household income, increasing business investment and government spending. In addition, the Federal Reserve is well ahead in normalizing monetary policy, after ending quantitative easing, hiking interest rates eight times, publishing the timetable for reducing its balance sheet, and signaling further rate increases for both this year and next.

3. The resulting dispersion in asset prices has placed some extra strains on markets. And it’s not strictly a matter of divergence. There are also a wide range of views on whether other countries will eventually converge with the U.S. in achieving higher growth or whether the U.S. will be pulled down.

4. Trade tensions are adding to the uncertainties about the market transition. Specifically, it’s not yet clear how long it will take China to realize that the least bad alternative for its development is to pursue the same path that other countries (South Korea, Mexico and Canada) ultimately followed — that is, make concessions to the U.S. It also isn’t clear what concessions would satisfy the Trump administration.

5. Finally, technical conditions in markets are not helping by amplifying large moves in the short term rather than tempering them. Over the longer term, success in the ongoing transition in the liquidity-fundamentals paradigm will place markets on a more solid footing. So will repricing that allows traditional stock-bond diversification to provide better risk mitigation. The short term, however, is likely to be quite volatile.

Q&A: I own a small law firm. Should I use a Simple IRA or 401(k) for Retirement?

Often, small legal firms opt for a SIMPLE IRA, only because there are no administrative costs associated with operating this plan. In some cases this can be a big mistake, especially if you have the ability to contribute significantly more to a 401(k) plan. While it is true that SIMPLE has no administrative cost, the biggest cost of using SIMPLE vs. a 401(k) is the income tax on the money that could be contributed to a 401(k) instead. For those in the highest tax brackets, this cost can be as high as 50 percent.

What are the advantages and disadvantages of SIMPLE IRA vs. the 401(k) plan, and how can you make an informed decision on selecting the best type of plan for your practice?

Breaking down the differences
SIMPLE IRA is easy to set up and terminate, and it can be opened at a discount brokerage such as Vanguard so you can have access to high-quality, low-cost investments. No third-party administrator (TPA) is required—operating a SIMPLE IRA is relatively straightforward and can be done by the law firm owner without much assistance. The 401(k) with profit sharing requires the services of a TPA, so there is an added administrative cost and higher complexity compared with SIMPLE. However, a 401(k) with profit sharing allows for a significantly larger contribution.

SIMPLE IRA vs. 401(k) rules of thumb
There is a good rule of thumb that can help you determine which plan might work better for you. A SIMPLE IRA might be a better plan for your law firm if (together with your spouse) you can contribute less than $40,000 a year and/or the cost of 401(k) employer contributions is high (with less than 70 percent of plan contributions going to the owner and spouse). On the other hand, a 401(k) with profit sharing might be a better plan if (together with your spouse) you can contribute close to the plan maximum (approximately $55,000 if both you and your spouse are under 50) and your 401(k) employer contribution is reasonable (with more than 70 percent of plan contributions going to the owner and spouse).

The decision can be straightforward if you fall into either extreme, but what if you are somewhere in the middle? What if you can contribute the maximum, but your employer contribution expenses are relatively high? For those in the highest tax brackets, higher plan expenses might still justify selecting the 401(k) over SIMPLE.

What you’d need to do first is to get a plan design illustration from the TPA that takes into account your firm’s demographics to see what your potential plan contributions and expenses would be. Once you have an illustration, your retirement plan adviser should do a 401(k) vs. SIMPLE side-by-side analysis that takes into account your specific situation so that you can select the right plan for your firm.

SIMPLE vs. 401(k) example
The biggest downside of SIMPLE is that it has a lower contribution limit than the 401(k) plan. When you are just starting your own law firm and have a significant amount of student and firm debt, SIMPLE might be a perfect plan for you. However, when your debt is mostly paid out and your firm profits grow, so does your highest marginal tax bracket.

For many attorneys, some of their income might fall into the highest federal and state tax brackets, 39.6 percent for federal and as high as 13 percent for state (if you are in CA). Thus the cost of keeping your money after-tax might be as high as 50 percent, so the key to successful tax planning will be to shelter as much of your highest tax-bracket income as possible, which can be accomplished with an appropriately designed 401(k) plan.

Some attorneys might even want to go an extra step and set up a Cash Balance plan together with the 401(k), to shelter even more of their income from taxes. Whether your spouse is working elsewhere or not, you can (and should) hire your spouse, provided that the numbers make sense—this can potentially give you tax and income benefits.

While the 401(k) employer contribution for a small large firm can be lower, it can also be higher for a larger practice with more employees and partners. However, if the law firm has several partners, employer contribution expenses will be shared among the partners, so per-owner expense for a large law firm can be lower than for a smaller one. Many smaller law firms with only two to four employees can have significantly lower employer contributions and when employees are significantly older than the owners, the profit sharing plan might not be a viable option.

If employees do not participate in a SIMPLE IRA, the owner does not have to match their contribution, and if they do, the owner will have to pay them a 3 percent match. Similarly, there is a 401(k) plan design that uses only matching—rather than profit sharing—that works the same way: employees get a match only if they participate, and get nothing if they don’t.

Even though the cost of having a 401(k) plan for this practice is higher than the cost of a SIMPLE, a 401(k) plan can provide the owner the means to save significantly more money for retirement while lowering his or her tax liability.

Summary
SIMPLE IRA can be a great startup plan, but eventually your law firm will need a 401(k) plan, as those in the highest tax brackets can benefit significantly from making higher 401(k) contributions, which translate into larger retirement savings. There are a number of other reasons why a 401(k) plan might work better for some practices.

A 401(k) plan design can be customized, which can afford advantages over the SIMPLE’s standard design. For example, you can exclude some highly compensated employees from a 401(k), but you can’t do that with SIMPLE. If you hire a highly paid associate, he or she will have to participate in a SIMPLE, but he or she can be excluded from participating in a 401(k) plan. A SIMPLE IRA has a single hard-coded design, while your 401(k) plan can be custom-designed to minimize your employer contribution while maximizing your own.

The 401(k) will also give you the ability to make backdoor Roth contributions, Roth salary deferrals, or in-plan Roth conversions, and accept incoming rollovers—none of which are allowed with the SIMPLE IRA plan. If you are 50 or older, a 401(k) also allows a $6,000 catch-up contribution, while a SIMPLE’s catch-up is only $3,000. If you are not an expert at investment management, a 401(k) can be a great platform through which you can get personalized investment management advice and services from an ERISA (Employee Retirement Income Security Act) 3(38) fiduciary adviser.

Both SIMPLE IRA and 401(k) have a number of advantages and disadvantages, and without a complete analysis it can be difficult to decide which one would be better for a specific law firm (unless you happen to fit neatly into the examples discussed above). To make the right decision, you will need to do an accurate cost vs. benefit analysis, which includes a 401(k) plan design study and side-by-side comparison of the best 401(k) plan design with a SIMPLE IRA for your specific situation.

Monthly Letter From CEO, Chris Jackson (October 2018)

It’s a good thing we have mighty brains, because humans are pretty useless in the face of danger. Sometimes doing what you think is the right thing can lead so adverse consequences. For example, survivalist experts and African safari guides often advise travelers never to turn their back and never to run when confronted by a lion. Yet, when faced with one of Africa’s apex land predators, who has the courage to take the advised steps of making direct eye contact–without breaking it–while backing very slowly away. If the lion charges you then you throw your arms out to make yourself look bigger and make as much noise as possible because lions will often do one or two mock charges (running towards you but suddenly stopping a few paces away) before a full-on attack. Most often, this will make them reconsider and run off.

With the recent market sell-off, where we are seeing a lot of down days and not a ton of rallies, I can sense the angst and uneasiness when talking to prospects and clients. There are two things we can be relatively sure about. That the market will keep crashing and that there will be another recession. Bear markets often overlap with recessions but not always. Just like a lion charging toward you and survival is based on your ability to be level-headed plus the courage to confront the danger.

This always boils down to why you are investing. Do no buy a security without having a sell strategy. Do not invest with a money manager unless you can understand and articulate your bear market strategy. For those select few, once you win the game, stop playing. Don’t gamble more than you can afford to lose. Having it and losing it seems to be heavy on the minds of many near-retirees who see record equity prices and who have lived long enough to know that bull markets don’t last forever. They can end very badly. Severe bear markets near a retirement date can delay retirement plans and even permanently lower a standard of living in retirement. The solution is to gradually shift the game away from growth of capital and toward preservation of capital, though not entirely.

For those younger households, who still have careers that let them buy more equities at bargain prices after a correct because they are dollar-cost averaging into their 401k, getting an employer match, and ‘hopefully’ reinvesting the tax savings their portfolios will recover even faster than the market. When dividends are included, the U.S. market recovered from the Great Depression relatively quickly.
Nonetheless, let these recent market moves be a wake-up call and ask yourself the following questions:

• Do I have the emotional capacity to maintain my current strategy? Will I let negative cognitive and behavior bias cause me to make irrational investing decisions?
• For those approaching retirement, do I have at least 5 years of required portfolio income in short-term investment grade fixed income, so I don’t have to sell my equities in a bear market?
• Have I let my asset allocation run too aggressive during the last two years of abnormally low market volatility?
• How did my current portfolio perform during the Great Depression?
• Should I rebalance my performance?
• Are my fixed income (bonds) strategies talking on too much risk?
• What do I have that can be redeployed when assets classes move to distressed levels?

Should I Refinance?

I often get this question when screening questions from prospects or during financial planning workshops. Like so many personal finance questions, these are unanswerable without more information provided by the questioner.

Should I retire?
Should I get married this year?
Should I exercise my stock options?

These contingent questions are useless when no additional information is provided. So, “should I refinance?” is a loaded question for me because a mortgage refinancing strategy can have a variety of purposes, and that the success of your refinance depends on a range of factors that vary with your purpose.

Let’s look at five good reasons to refinance your mortgage:

1. Lower your Interest Cost
Most borrowers contemplating the refinance of a fixed-rate mortgage want to know whether the financial gain from a lower interest rate more than offsets the refinance costs. This is less important as a motivation than it was a year ago because of the rise in rates that has since occurred. It remains relevant, however, to borrowers with older higher-rate mortgages who for one reason or another failed to refinance when rates were at their lowest.

It’s important to run the numbers to measure the benefits of a rate-reduction refinance relative to the refinance costs. Whether you have one mortgage that will be refinanced into another mortgage, have both a first and a second mortgage that will be refinanced into one new mortgage or have one mortgage carrying private mortgage insurance and will be refinancing into a combination first and second mortgage without mortgage insurance.

2. Liquidity – I need to Raise Cash

Another reason borrowers refinance is to raise cash. While cash-out refinances are priced higher than rate-reduction refinances, this is not in itself a deterrent to the borrower who needs cash. What matters to that borrower is whether the cost of the cash-out refinance is larger or smaller than the cost of raising the same amount of cash with a second mortgage.

3. Risk Management – Reduce the Risk of Higher Rates on an ARM

Borrowers who now have an adjustable rate mortgage (ARM) and are concerned about rising interest rates have their own reason for considering a refinance. They want to know whether the likely loss from retaining their ARM exceeds the cost of eliminating the risk by refinancing into a fixed-rate mortgage.

4. Cash-in Refinance

Some borrowers have mortgage interest rates above the current market but they can’t refinance into a lower rate because their house value has depreciated. They want to know whether paying down the balance on their existing fixed-rate mortgage in order to lower the cost of refinancing into another fixed-rate mortgage would yield a satisfactory rate of return.

5. Eliminate High-Cost Short-Term Debt

Borrowers who are burdened with short-term debt may want to know whether it pays to consolidate such debt in a cash-out refinance. Here the borrower is comparing the cost of consolidating the short-term debt in a new and larger first mortgage, or in a second mortgage.

Don’t make assumptions or rely on a generalized rule of thumb. Instead run the numbers and see if the refinance will actually improve your balance sheet or cash flow.

Q&A: What are my tenant rights in Los Angeles?

Proposition 10 has failed at the ballot box, leaving the state’s limits on rent control intact. Proposition 10 would have repealed a California law that limits how cities enact rent control. Its defeat is a blow to tenant activists in Los Angeles, and a win for landlords.

With the resurgence of cities as centers of economic energy and vitality, a majority of millennials are opting to live in urban areas over the suburbs or rural communities. Sixty-two percent indicate they prefer to live in the type of mixed-use communities found in urban centers, where they can be close to shops, restaurants and offices. They are currently living in these urban areas at a higher rate than any other generation, and 40 percent say they would like to live in an urban area in the future. As a result, for the first time since the 1920s growth in U.S. cities outpaces growth outside of them. So, it’s important for tenants to understand their rights.

The city of Los Angeles is one of just 15 California cities with rent control regulations on the books, and the local rules do more than keep down monthly payments for tenants. They also provide protections from eviction and financial resources in the event a renter is forced to move out of their apartment. Let’s be clear, the City of LA does not have rent control. There are no limits on how much an apartment here can cost unlike rent-controlled units in other cities. Instead, LA has the Rent Stabilization Ordinance (RSO).

If you do not live in Santa Monica, West Hollywood, Beverly Hills, or the city of Los Angeles, whether your apartment is rent-controlled depends mainly on what type of housing it is and when it was built. Single-family homes are almost never subject to rent control (though they are in rare cases in Santa Monica and West Hollywood); duplexes, triplexes, and apartment buildings, on the other hand, are fair game. Date of construction also matters. In Los Angeles, only buildings built and occupied before October 1, 1978 have rent control restrictions. The date varies city-to-city. In Santa Monica, it’s April 10, 1979; in West Hollywood, it’s July 1, 1979; in Beverly Hills it’s February 1, 1995. In the city of Los Angeles, it’s easy to check on the date of construction for your building—and whether it’s covered by the RSO. Just enter your address into ZIMAS (http://zimas.lacity.org/), the city’s property database. An outline of the property will appear on the map and a sidebar will pop up on the lefthand side of the screen. In the “assessor” tab, you’ll find the building’s date of construction and in the “housing” tab you can find out whether it’s under rent control.

The Los Angeles Rent Stabilization Ordinance (RSO), addresses allowable rent increases for rent controlled units, which can range from 3% to 8% and for July 1, 2017 through June 30, 2018 landlords can raise the rent once every 12 months by the annual allowable increase of 3%. What tenants fail to acknowledge is the landlord’s right to raise the rent by an additional one percent (1%) for each of the two utilities supplied (gas and/or electricity). What is even more surprising with the RSO is at the same time the landlord raises the rent, if the written lease so provides, the landlord may also raise the security deposit (and last month’s rent if applicable) once every 12 months by the annual allowable percentage increase (previously 3%). And a landlord who is planning to improve his rental, may apply for special rent increases based on an application for Primary Renovation, Capital Improvements, Rehabilitation, or a “Just and Reasonable” rent adjustment which must be submitted to and approved by the Rental Board.

As a Los Angeles tenant, there are (3) additional items to be aware of:

1) If a landlord serves a written thirty (30) Day Notice of Rent Increase and provides the tenant a copy of the Registration Certificate, they may collect $12.25 from each tenant in June (50% of the annual $24.51 registration fee paid to the Rent Stabilization Division) and also collect the annual $43.32 Systematic Code Enforcement Program (SCEP) fee if paid in full by the landlord by increasing the rent $3.61 per month.

2) The special circumstances which allow the landlord to raise the rent substantially. The Landlord can raise the rent by 10% percent (within the first 60 days) for each additional tenant / occupant of a rental unit exceeding the number of initial occupants allowed in the original rental agreement. The Landlord can raise the rent nineteen percent (19%), plus 2% if the landlord provides the gas and electricity, If a landlord has not increased the rent since May 31, 1976.

3) Though the RSO provides that the rent may be raised to any amount upon re-rental if vacancy is based on certain reasons, there are certain vacancies that the Los Angeles RSO requires the rent to a new tenant to remain the same as that for the prior tenant. Examples include: (1) an eviction to recover the unit for the use of the landlord, his immediate family. or a resident manager; (2) an eviction based on the prior tenant’s illegal acts; (2) an eviction based on the tenant’s refusal to sign a new lease with the same terms as are in the RSO; and (3) an eviction based on the tenant’s refusal to allow the landlord reasonable access to the unit.

Tenants living in rent-controlled units can be evicted, but benefit from stronger legal protections than those living in non-rent-controlled buildings. This is referred to as a “just-cause eviction.” The city outlines fourteen legal reasons for a landlord to evict someone from a rent-stabilized unit. Eight of these are the result of actions (or inactions) by the tenant. The other six are not attributable to any faults of the tenant, but they are allowed nonetheless. Failure to pay rent, violating the terms of the lease, being a nuisance, using the apartment for illegal activity and not being the person who signed the lease (or someone approved to live in the unit) are five obvious reasons for an at-fault eviction. California law states a landlord can move to evict a tenant with only three-day advance written notice for these faults. In turn, tenants have up to three days to correct them to avoid eviction.

The only other common cause for eviction is through California’s Ellis Act, which allows landlords to mass-evict tenants when taking a property off the rental market. That could mean tearing the building down, for instance, or redeveloping it as for-sale condos. In these cases, landlords are required to pay relocation fees to help tenants find and move into a new place. Fees range from $8,050 to $20,050. The amount depends on how long tenants have lived in the building, how old they are, and how much money they earn.

Passed in 1985, the Ellis Act is another piece of legislation despised by tenant advocates, who argue that it encourages property owners to replace affordable apartments with new construction or pricey for-sale units. According to a report from the Coalition for Economic Survival, more than 23,000 apartments in Los Angeles have been cleared of renters between 2001 and 2017. In Beverly Hills, eviction protections are weaker, but landlords still have to cover a tenant’s moving expenses when asking them to move out through no fault of their own. After an Ellis Act eviction, a building must remain out of the market for five years. Yet the L.A. Tenants Union has found units available on AirBnB immediately after an eviction, as well as instances of new tenants moving in while evicted tenants move out, and emptied buildings being immediately sold to developers to build new apartments in their place. Whatever the reasons for a no-fault eviction, the landlord is required to compensate a tenant for relocation. According to HCID, payment “depends on whether the tenant is an Eligible or Qualified tenant, the length of tenancy, and the tenant’s income.” A Qualified tenant is 62 or older, disabled, or has minor dependents living with them. All other tenants are considered Eligible. Current relocation rates run $7,550–$19,500 per leaseholder.

In order to make rent-controlled units available to new tenants, landlords often resort to “cash for keys” offers, in which they effectively pay tenants to leave. Under LA’s rent control laws, this is legal as long as landlords first inform tenants of their rights and notify the city of the agreement. Tenants have 30 days to cancel the agreement in case their landlord isn’t following through with the terms of the buyout. There’s also no reason that tenants have to agree to the offer. Those who wish to continue living in their current apartment can simply turn the money down.

If a tenant does not live in rent-stabilized housing, a landlord may evict them for any reason. However, the law requires that tenants receive advance written notice depending on the length of occupancy. A landlord terminating a month-to-month tenancy must offer sixty-day notice to someone who has lived in a unit for more than a year, or thirty-day notice for less than a year. Usually, that notice does not have to state the landlord’s reason for eviction. This is one of the key arguments for expansion of RSO: anyone in a unit built after 1978 is susceptible to a sudden eviction with nary an explanation. Trying to secure new housing on a sixty-day notice in the middle of a worsening affordability crisis only adds to the anxieties and vulnerabilities of tenants across the city.

Monthly Letter From CEO, Chris Jackson (July 2018)

In his 2014 book “The Zero Marginal Cost Society, “Jeremy Rifkin writes about technology’s leading roles in bringing about changes to lifestyles and society during the first half of the 21st century. One of the key themes for the 21st century will be a “zero marginal cost society” that will reduce the marginal cost of goods and services to near zero. In other words, we will soon enter into an age in which we can obtain many goods and services free of charge without going through markets.

A rather academic explanation may be helpful here. The marginal cost is defined as the cost a corporation needs to shoulder when it increases the goods or services it provides by one unit. For example, the marginal cost of renewable energy is near zero. Once solar panels are installed on a roof, they generate electric power at a close to a zero-marginal-cost. The same is true of wind power generation. Some well-known universities in the United States are offering massive open online courses (MOOC) free of charge and with unlimited participation and open access, enabling anybody in any part of the world to receive a university education. Since the marginal cost of such courses is zero, students do not have to pay tuition.

The interesting shift we are seeing in the retail investor landscape is the move to a ‘Zero Marginal Cost Investor’. The marginal cost to offer index funds or commission-free trading is now zero. The investor can now replicate an index and do not have a direct cost (There will be an in-direct cost, if you end up paying for broader services within the brokerage firm that is priced to recoup the lost-leader expenses). Fidelity Investments just beat all of the low-fee index fund competition to a move long expected: It will be the first fund company to offer core index funds (Fidelity Zero Total Market Index Fund and the Fidelity Zero International Index Fund) without any management fee and regardless of how much they invest in either fund. In addition, Vanguard announced its move to make all ETF trading free on its brokerage platform this month. Now there will be no restrictions, and no minimums required, to use the free-trading feature with any ETF. ETF experts expect Vanguard rivals to fire back with their own enhanced free-trading offers. All of the established players in the financial services sector also face pressure from venture capital-funded start-ups, such as Robinhood, which offers a free brokerage trading app and has been growing rapidly — in May Robinhood surpassed E-Trade in a number of users for the first time.

What does this mean for retail investors? First, they shouldn’t overact to the news and race to put all their money in this free index fund. Vanguard’s Total Return Index Fund cost 0.04%, and Schwab’s Total Return Index Fund cost 0.03%. The presumption that a difference of 1-3 basis points matter is more marketing than quantitative. The difference in expense ratios among Vanguard, Fidelity, and Schwab matter far less than which index is tracked and how well it is tracked. Being the market has been a more successful and reliable strategy that is trying to beat the market. Review your current fund holdings. What do they cost? How have they performed relative to its benchmark? Is it tax-efficient? Most importantly, are you paying too much to simply mirror the market or even underperform the market?

Audit your investments. Know what you own. It’s your money and your responsibility. Everyone doesn’t need a financial planner, but everyone needs a financial plan. If you don’t have the time, knowledge, technology and intellectual intrigue, then find a flat-fee fiduciary to help stop the potential hemorrhaging for your financial security.

July 2018 Market Recap: Job Gains, the Fed, and Accelerating Earnings Growth

The stock market posted its largest monthly gain since January as rising corporate earnings and strong GDP growth numbers helped overcome concerns over tariff and trade issues. The S&P 500 Index moved up 3.60% in July after several months of lackluster results. Through the first seven months of 2018, the S&P 500 is up 5.34%. (The S&P 500 Index is a market-cap-weighted index that represents the average performance of a group of 500 large-capitalization stocks.)

July’s jobs report, which showed that the U.S. economy added 157,000 jobs and the jobless rate fell to 3.9%, highlighted the continued strength in the U.S. labor market. While July’s headline figure came in slightly lower than expectations, net revisions to the previous two months showed an impressive increase of 59,000 jobs. In addition, through 2018, monthly job gains have averaged 215,000, and wage gains have increased gradually. It is also encouraging to see another strong gain in manufacturing payrolls, which increased by 37,000. We believe that July’s jobs report did little to change the narrative of the Federal Reserve (Fed), which announced last week that it would keep its federal funds rate unchanged. Although, if the economy continues to grow moderately, wages keep rising, and inflation stays near its 2% target, we expect the Fed to continue quarterly increases in short-term interest rates. In addition, the Fed is steadily reducing its bond purchases to shrink its balance sheet. These actions mean monetary policy will slowly reduce the amount of stimulus for the economy, but we don’t think conditions have become tight enough to start to slow activity. JPMorgan Chase CEO Jamie Dimon recently commented that the expansion is only in the “sixth inning,” which is consistent with ISI Evercore’s recession model that shows the next recession is still years away.

Accelerating earnings, a steadily improving labor market, and a patient Fed all point to continued support for consumer spending, which accounts for nearly 70% of economic growth. A healthy consumer and a strong economy provide a good environment for stocks, in our view, although we still expect to see volatility given the ongoing trade headlines. It’s also important to not let rising rates keep you from owning investment-grade bonds – they still help reduce swings in the value of your portfolio when stocks drop because they tend to decline less or even rise. Higher rates make bonds more attractive for current income, too.

Volatility may have you thinking it is crazy right now and that it hasn’t been like this in a long time. The truth is that we’ve gone through an extended period of time with little or no volatility. The expansion from quantitative easing coming out of the Great Recession led to a prolonged period of super low volatility that began to feel, for many, like the norm. Well, the reality is, the volatility we are experiencing in the market today is back to more normal behavior. Downward movement of 1% or more on the S&P 500 will occur, on average, around 15-20 times per year. So that volatility is normal even though it isn’t what we’ve been experiencing over the last several years.

There is unlikely to be a shortage of market excitement in the final months of the year. The US mid-term elections will be particularly important, so some consideration of the likely outcomes and market impact is a worthy exercise in these quiet summer weeks. Whether growth outside the US reaccelerates will also be an important factor shaping markets in the second half of the year. But with some trade tensions still unresolved and later cycle risks looming on the horizon, a more balanced approach to risk is appropriate. Investors should think about adding fixed income and alternatives selectively to provide downside protection but without increasing the vulnerability of portfolios to rising interest rates.

Three Award-Winning Financial Planning Considerations for Actors/Writers

With the passing of the Tax Cuts and Jobs Act of 2017, many actors, writers, directors, and other professionals in the entertainment industry will likely see their taxes increase beginning in 2018. The entertainment professionals who earn wages are being hit the hardest because employee business deductions will no longer be allowed in 2018 going forward. Prior to the passing of the new bill, entertainers receiving a W-2 were able to deduct the costs for their union dues, agent commissions, talent managers, accountants, attorneys, and other ordinary business expenses. Altogether, those business expenses typically add up to roughly 20 percent to 35 percent of an artist’s income but will no longer be deductible going forward. The disallowance of these expense deductions will have a particularly negative impact on the entertainment industry.

Loan Out Corporations – To be or not to be?

In light of the new tax reform changes, many accountants are advising their entertainment clients to form a loan-out corporation for them to deduct their business expenses. Under a normal employment arrangement, a movie, TV show, or theater production would hire the individual actor, writer, or director. Under a loan-out arrangement, the individual would incorporate and set up a loan-out company. The loan-out company would employ the individual and “lend out” their services to the movie, TV shows, or theater production. Prior to the enactment of the Tax Cuts and Jobs Act of 2017, the main benefit of the loan-out corporation was a full benefit of the business expenses otherwise limited on the personal returns, as well as avoiding the alternative minimum tax. Under the new law, loan-out corporations remain unaffected whereas entertainers receiving a W-2 can no longer deduct any business expenses to offset their income. The benefits of having a corporation fall into three basic categories, business expenses, pension plans and medical expenses.

Here is a list of common reasons performers set up loan out corporations:
1. One of the major benefits of having a loan-out corporation is the ability to manage tax payments and cash flow. Many entertainment professionals work on numerous projects every year which means they are on some different payrolls. Generally, professionals without a loan-out corporation are paid W-2 wages. The problem with this is that since the professional is on numerous payrolls with irregular pay periods, the tax withholdings could be more than necessary.

2. Another tax planning benefit of utilizing a loan-out corporation is the ability to take advantage of Qualified Pension and 401ks. In the case of an S-Corporation, certain shareholders are able to deduct health insurance premiums. In addition, pension contribution limits can be more than double that of a standard 401(k) plan when administered properly. The S-Corporation election is one of the ways to reap the immediate benefit. Service providers can save money on FICA taxes by receiving a “reasonable salary” from the corporation and allowing the remaining profit to pass-through to their tax return as ordinary income taxed only at their ordinary, marginal tax rate. As for medical and other business expenses, a “C” corporation can adopt a medical reimbursement plan, which in effect, allows the corporation to pay all of your medical expenses directly to the doctor or hospital and take a tax deduction of all amounts paid (less amounts covered by medical insurance). These can include costs for mental health, eye care, chiropractic, etc.

3. The other factor to consider is the new section 199A 20% “Qualified Business Income Deduction” calculated on your net business income. This new tax change for 2018 provides an additional deduction based on your net corporate business income. For folks in creative fields, there are 2 limitations in the calculation. Individuals in the arts are considered as part of the laws “specified service businesses” and are thus limited to the 20% deduction but ONLY if their taxable income is less than $157,500 if single and $315,000 if married (after that it phases out). This is a deduction not available to an employee, but if a performer were to set up a “loan out” corporation, they might be able to avail themselves of this new tax benefit.
The question then becomes, when does this make any sense for me? We feel the individual would need at least $100k to $125K in gross income before the loan out corporation would make any sense financially, but this would also depend on the level of expenses one was going to lose under the 2017 Tax Cuts and Jobs Act legislation. Consequently, this is a movable calculation depending on the mix of gross income and expenses.While a loan-out corporation seems like a great alternative to mitigate the increased tax burden for entertainment professionals, it may not be the best solution for everyone. Entertainers must consider the costs associated with incorporatingwhich include attorney fees to set the entity up (at least $1,000), the annual report filing fee of$125, the cost of the corporation return preparation at +/- $700, cost of payroll processing +/- $500, a minimum $800 corporate franchise tax per year (for California residents), and additional payroll taxes, which include the employer’s portion of social security taxes (as high as $9,800 or 7.65 percent of wages paid up to about $128,000), workers compensation insurance at $300 and $300-$400 in Federal and state unemployment taxes. The additional costs of incorporating may offset any tax benefit received, and government compliance can be an administrative burden for the entertainer. This means that the corporation adds over $13,000 of additional expenses for the business owner. By forming a loan-out corporation, an entertainer is also forfeiting their opportunity to claim unemployment.Ideally, we want the corporation to SAVE you at least this amount in taxes, so the performer is at break even with the loan out corporation.

These fees can go significantly higher (up to 5-6% of your gross income) if “business management” services are also provided, although some firms are now charging a fixed monthly fee for these services rather than a percentage of gross income. Business management involves turning over almost all responsibility for your finances to a business manager. They, in turn, pay all of your corporate and personal bills, invoice production companies for your services and monitor the collection of income, assist with insurance and real estate issues, provide investment guidance, etc.In addition to federal and state corporate and payroll taxes, the City of Los Angeles enacted legislation requiring all loan-out corporations “doing business” in the City to pay a business tax (however, corporations generating less than a certain threshold in gross income may be exempt from this tax).

With an S corporation structure, the one we prefer for smaller operations, the performer will claw back the heretofore lost deductions plus some FICA tax savings and perhaps (depending on income levels) section 199A 20% “Qualified Business Income Deduction” that will generally offset the additional fees and taxes the corporation incurs. If you are dealing with larger amounts of income, one might look at the C corporation and the ability to defer income into other years by using a fiscal year-end as well as some additional employee benefit options that the C corporation structure provides.
The final advantage I often mention in this structure is that generally speaking, your chances of getting audited by the Internal Revenue Service drop substantially inside the corporation. That is because the Internal Revenue Service does not do as much sampling or DIF scoring of business returns like they do on personal income tax returns. Secondarily the Internal Revenue Service does not require 3rd party 1099 reporting when the payment is made to a corporation. Consequently, the business will not receive 1099’s.

Don’t ignore the low-hanging fruit

For those consistently working actors, they know the QPA (Qualifying Performing Artists) is and has been, virtually worthless for many years as the qualifying threshold is unrealistically low (adjusted gross income of $16,000 or less before deducting expenses as a performing artist).However, for those actors, who are getting started, stage performers or don’t book a ton of workthis is a great way have your performing-arts-related business expenses deductible whether or not you itemize deductions.If you meet all the requirements for a qualified performing artist, include the part of the line 10 amount attributable to performing-arts-related expenses in the total on Form 1040, line 24 (or Form 1040NR, line 35), and attach Form 2106 to your return.

One of the best ways to build savings when starting your acting career is to fully fund a Roth IRA. In 2018, you can put $6,500 (If under 50) into a Roth IRA (grows tax-free and distributions are tax-free). The contributions can be withdrawn without taxes or penalty (the earnings cannot be withdrawn until age 59.5). But if you’re 18 or older, not a full-time student and are not claimed as a dependent on another person’s return, then you can take the Saver’s tax credit. The amount of the credit is 50%, 20% or 10% of your Roth IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (phased out at $63,000). Remember a tax credit is a dollar for dollar reduction of your tax bill.

Book your own kids

As the owner of a business, you have the advantage of being able to hire your child to work in your business, and that creates tax-saving opportunities for both you and your child.They can do print modeling, video, and social media marketing for your business.The new standard deduction means that a single taxpayer such as your child can earn up to $12,000 in W-2 wages and pay not a penny in federal taxes.Especially if you’re already paying them an allowance or putting money away for college. As a California resident, you do not get a state tax deduction for contributing to your child college saving 529 plan (as a few other states do).

When you hire the child under age 18, the Form 1040, Schedule C business and the partnership with only the child’s parents are exempt from Social Security, Medicare, and federal unemployment taxes. The S and C corporations and the non-spouse partnerships do not qualify for this benefit. They have to pay the payroll taxes on all employees—period. There is no parental benefit. (Similarly, the self-employed individual or the spouse-only partnership with a child age 21 or over does not qualify for any employment tax breaks.)

Talk with your tax advisor to see if you qualify for the tax-favored educational assistance program. If so, you can hire your child age 21 or older. Grant the education program to all your employees, including your employee child. Now, you may deduct up to $5,250 of your employee-child’s college tuition and book fees. The $5,250 is the annual, per-employee limit on Section 127 educational assistance.

When Disaster Strikes Does Your Homeowners Policy Have Your Back?

One of the big lessons of last year’s major hurricanes and current California wildfires is in many instances; homeowners couldn’t fully repair their damaged homes with insurance proceeds because they didn’t understand until too late what their policies did and didn’t cover. And in general, over the past couple of decades, insurers have made it tougher on consumers. Increasingly, they have made home policies less generous and more complicated, shifting risks and costs off their books and onto policyholders. As insurance rates go up, people will go without, and that’s not acceptable.

A perfect example is Earthquake insurance. Your standard homeowners insurance policy doesn’t cover earthquake damage and destruction. That’s because the standard homeowners policies sold these days are a variation of a standard form called the HO-3. The more recent versions of the HO-3 have very limited coverage for household water damage leaks and pipes and expressly exclude coverage for a flood event and any type of earth movement,like what happens during an earthquake.That’s assuming you’re able to obtain earthquake coverage at all. According to the Actuarial Foundation’s and the Federal Alliance for Safe Homes’ “If Disaster Strikes, Will You Be Covered?” report, “the closer a home is to a fault line, or sits on soil types with greater exposure to loss in an earthquake, the more limited insurance options may be because of the extreme risk of earthquake loss.”If you are able to obtain it, though, you’ll likely be required to prove that your home has been bolted to its foundation before an insurer will extend this sort of endorsement or coverage to you—a renovation that can cost as much as $6,000 depending on where you live as well as the size and style of your home. You also may have to agree to a property inspection or show that you’ve properly secured certain fixtures, like hot-water heaters, using strapping guards.

A major question to consider is, with all these natural disasters dominating the headlines, will this drive up home insurance rates for everyone in 2018? You would assume so. The insurance market is already overdue for an upward correction. So for most of us, it’s a good bet that home insurance rates will rise somewhat, but not enough to give you a heart attack.Homeowners in some, but not all, high-risk areas could face big increases or even problems getting insured at all.Along with — and because of — the recent disasters, there’s growing concern about what climate change may bring, which may soon put more upward pressure on rates.

Understanding what is and is not covered by your homeowners insurance policy can be daunting. If you’re like most, your policy is in an envelope somewhere, and you probably haven’t referred back to it for a while (maybe even since buying your home). Well, find that envelope! Because in addition to understanding just where you’re protected, you may be able to make some simple changes that can save you money.

Homeowners insurance is no place to skimp, but we’ve found eight smart ways for you to save:

1. Wildfire damage is covered by standard home insurance, too. The key here is to make sure that your particular policy provides you with enough coverage. Review your policy to see if it’ll allow you to rebuild your home from the ground up, should the need arise. Also, your insurance company may require you to make a few changes to the exterior of your house and the property that surrounds it if they’re located in an area that’s especially vulnerable to wildfire.

2. Hazard insurance on a standard homeowners insurance policy covers many natural disasters, like tornadoes or hurricanes. Other natural disasters, including floods, mudslides, and landslides, aren’t covered by most homeowners insurance companies. That’s why you should always refer to your policy documents for information about coverages under your particular policy.Hurricane Harvey showed last year that flooding could damage properties outside the highest-risk zones and leave empty-handed homeowners who aren’t required to buy flood insurance. People with federally backed home mortgages must purchase the coverage if they are in a designated high-risk flood area. The government policies provide up to $250,000 for rebuilding and $100,000 for contents for roughly $600-a-year policy. Consumers typically have a 30-day waiting period after purchase before the government policies take effect. A small number of private-sector insurers also provide the coverage, typically for amounts that kick in above the federal policy limits. Just make sure your policy doesn’t include an “anti-concurrent cause.” This type of clause limit(s) coverage when multiple perils combine to cause loss or damage. Wind and water is a good example.

3. For affluent families, you should consider a flood policy for the peace of mind, even if not required under terms of a mortgage. During Hurricane Harvey’s aftermath, the U.S. Army Corps of Engineers released reservoir water that caused additional flooding in areas not initially affected.

4. Check your policy limits. The maximum payout in a standard home policy may be insufficient to rebuild and replace contents. Homeowners often fail to increase policy limits if they upgrade their homes. In the past 10 years, about 10% of residential properties nationwide had remodels worth more than $25,000, according to data provider BuildFax. Homeowners also can find that their policy limits are inadequate when everyone in a disaster-hit area seeks building materials and contractors’ services simultaneously, driving up costs.

5. Homeowners also need to be aware of another pitfall: Insurers sometimes provide “actual cash-value coverage,” which takes depreciation into account, rather than replacement-cost coverage. Actual cash value could fall short of covering replacement, leaving the policyholder to foot more of the bill.

6. Make a list. Homeowners should inventory possessions and store the list outside the home. People with expensive items like jewelry can get specialized coverage.After wildfires in California last year, the state insurance department asked insurers to immediately pay policyholders for living expenses and a portion of personal contents, without requiring a very time-consuming inventory when someone had just lost everything. Many insurers agreed to waive the inventory requirement partially.

7. When you renew, scour the fine print. Especially if you’re in a recently affected area. Insurers have been known to quietly change the terms, moving more risk to the homeowner rather than raising the premium. Apparently, they hope you won’t notice. Don’t be afraid to shop around. Different insurers calculate risks in different ways, so another company’s formula might come out in favor of a lower rate. Plus, some companies offer new customers attractive rates, while loyal customers find their rates creeping up. (What the heck?!) They’re counting on you not to shop around. Just make sure you’re comparing the same coverage and the same replacement value. I tell all my clients that you can always save money on insurance, but you won’t necessarily have enough coverage.Many companies offer discounts if you take certain steps to prevent damage to your home — steps that you should consider anyway. For example, installing hurricane shutters or fire-resistant roofing, or participating in a Firewise community program.

For many people, their home is their greatest asset, so it is crucial to avoid being underinsured. To properly insure your home, it is important to ask your insurance professional three key questions: Do I have enough insurance to rebuild my home and replace all my possessions? Do I have enough coverage for additional living expenses?Do I have enough insurance to protect my assets?