Welcome to the New JDH!

Announcement, JDH Blog, JDH Newsletter

It’s been a whirlwind few years at JDH. Three new members joined our team. We moved in a massive way from being a paper-based firm to a digital firm. We’re even introducing online client portals this fall.

How did we choose the new logo?

We launched into a series of firm meetings to discuss: what are the firm’s goals? How do we see ourselves in the context not only of the firm but in the greater community? What makes us different than other wealth management firms?

We realized that starting conversations with the intent of improving the lives of those we encounter is a central piece of each of us here at JDH Wealth. With that in mind, we decided to find a new image that really speaks to who we are and what we want to accomplish. We dropped the word “management” from the logo, for the purposes of clarity of intent.

We took our name and built it into a symbol of growth, of goals, of aspirations – all with JDH Wealth as the support structure holding those up.

We’re pleased to share with you this rebirth of the JDH Wealth logo, and look forward to supporting you now and in the future.

July 20, 2018/by Sadie Pettit

Financial Illiteracy’s High Cost

JDH Blog, Larry Swedroe, The BAM Alliance

by Larry Swedroe, Director of Research, 6/14/2018

It’s a great tragedy that despite its obvious importance to everyone, our educational system almost totally ignores the field of finance and investments. This is true unless you go to an undergraduate business school or pursue an MBA in finance.

Eighteenth-century English poet Thomas Gray wrote, “Where ignorance is bliss, Tis folly to be wise.” When it comes to investing, ignorance certainly is not bliss—it pays to be wise. Just ask investors who lost tens of billions of dollars in the Bernard Madoff scandal. Without a basic understanding of how capital markets work, there is no way individuals can make prudent investment decisions.

The sad fact is that surveys have shown fewer than half of U.S. workers have even attempted to estimate how much money they might need in retirement, and many older adults face significant retirement shortfalls. While educational achievement is strongly positively associated with wealth accumulation, research also has found financial literacy has an even stronger and larger effect on wealth.

Households that build up more net wealth may be better able to smooth consumption in retirement, and financial literacy enhances the likelihood people will contribute to their retirement savings. Compounding the problem of lower savings is evidence that less financially literate households experience lower risk-adjusted returns.

Financial Literacy Research

Milo Bianchi contributes to the literature on financial literacy with the study “Financial Literacy and Portfolio Dynamics,” which appeared in the April 2018 issue of The Journal of Finance.

Using data obtained from a large French financial institution, Bianchi observed portfolio choices in a widespread investment product called assurance vie, in which households allocate wealth between relatively safe and relatively risky funds—predefined bundles of bonds or stocks—and are able to rebalance their portfolios over time. Assurance vie contracts are prevalent in France, being the most common way households invest in the stock market.

Bianchi then combined this data with responses to a survey he conducted with the financial institution’s clients. The survey, which ranked investor sophistication levels on a scale between one and seven, allowed him to obtain a broader picture of clients’ financial activities outside the company and of their behavioral characteristics. While investments in assurance vie may not cover a household’s entire portfolio, they often represent a substantial portion of investors’ financial wealth.

The author’s final database incorporated portfolio information at a monthly frequency for 511 of the financial institution’s clients over the period September 2002 to April 2011. On average, the assets it covered were approximately 50% of a household’s financial wealth.

Following is a summary of his findings:

Financial literacy correlated with demographic variables; in particular, education and wealth.
Financial literacy was negatively correlated with being female—a gender gap that had been observed in prior studies.
An additional unit of financial literacy was associated with a 3.5% increase in the probability of holding stocks.
More literate households experienced higher portfolio returns.
Controlling for various measures of portfolio risk, the most literate households experienced yearly returns approximately 0.5% higher than the least literate households, relative to an average return of 4.2%. These magnitudes were in line with those found in a recent study of Dutch households.
There was no evidence that, overall, households with higher financial literacy choose riskier portfolios. Instead, their risk exposure varies systematically with market conditions, allocating more to risky assets when they have higher expected returns. A 1% increase in the expected excess return of risky funds was associated with a 2% increase in the risky share for each unit of financial literacy.
Decomposing the observed changes in the risky share over time into active changes due to portfolio rebalancing and passive changes induced by differential returns to risky versus riskless funds, Bianchi found that passive changes were relatively more important for less sophisticated households. For the least sophisticated households, passive changes accounted for 64% of the total change in the risky share over 12 months. For the most sophisticated households, by contrast, passive changes accounted for 30%. This demonstrates that households with lower financial literacy display greater portfolio inertia. More educated, older and female investors display lower levels of inertia.
More literate households were more likely to act as contrarians. Rebalancing, they tended to move their wealth toward funds that had experienced relatively lower returns in the past.
The returns more sophisticated households actually experienced tended to exceed the returns they would have earned without rebalancing their portfolios. More sophisticated households were more likely to buy funds that provided higher returns than the funds they sold.

Conclusion

Findings such as these demonstrate that financial illiteracy is costly. The fact that our educational system has failed to provide much of the public with what I would consider even a basic level of financial literacy certainly is a tragedy. (The research shows this is not a U.S.-only problem.) But perhaps the bigger tragedy is that so many apparently would rather watch some reality TV show than “invest” the time and effort to become financially literate.

I have now authored or co-authored 16 books on investing, presenting the evidence from academic research. This has been my way of trying to reduce financial illiteracy and help prevent investors from being sheared by the wolves of Wall Street. Others, such as John Bogle and William Bernstein, have written outstanding books on the principles of prudent investing.

The only problem is that the sales of Harlequin romance novels (not that there is anything wrong with them) are far greater than the sales of books on modern portfolio theory and efficient markets, providing one explanation for why investors continue to use nonfiduciaries as their advisors and adopt active management strategies—strategies with a high likelihood of failure.

The bottom line is that the greatest investment you can make, and the one with the highest expected return, is an investment in your own financial literacy. Remember, if you think the price of financial education is too high, just try the price of ignorance.

This commentary originally appeared June 4 on ETF.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

June 20, 2018/by Matt Delaney

The Risk and Return Implications of ESG

JDH Blog, Larry Swedroe, The BAM Alliance

by Larry Swedroe, Director of Research, 6/11/2018

Environmental, social and governance (ESG) investment strategies—along with the narrower category of socially responsible investing (SRI)—have gained quite a bit of traction in portfolio management in recent years.

In 2016, funds based on such strategies managed about $9 trillion in assets from an overall investment pool of $40 trillion in the United States, according to data from US SIF. In addition, the organization’s 2016 survey of sustainable investment assets found that in the U.S., climate change was the most significant environmental factor influencing asset allocations.

Value Play In ‘Sin’ Stocks?

While ESG investing continues to gain in popularity, economic theory suggests that if a large enough proportion of investors chooses to avoid “sin” businesses, the share prices of such companies will be depressed. They will have a higher cost of capital because they will trade at a lower price-to earnings (P/E) ratio.

Thus, they would offer higher expected returns (which some investors may view as compensation for the emotional “cost” of exposure to what they consider offensive companies).

Academic research has confirmed that the evidence supports the theory.

Higher Fees OK

Interestingly, Arno Riedl and Paul Smeets, authors of the study “Why Do Investors Hold Socially Responsible Mutual Funds?”, which appears in the December 2017 issue of The Journal of Finance, found that investors are willing to pay significantly higher management fees on SRI funds than on conventional funds, and that a majority of them expect such funds to underperform relative to conventional funds.

In other words, investors understand there is a price (in the form of lower expected returns) for expressing their social values, and are willing to pay it.

Impact On Risk?

Jeff Dunn, Shaun Fitzgibbons and Lukasz Pomorski of AQR Capital Management contribute to the literature concerning ESG investing with their February 2017 study, “Assessing Risk through Environmental, Social and Governance Exposures.”

While other studies focused on the impact of ESG/SRI investing on returns, the authors’ focus was on the risk side of the strategy. Just as it is logical to expect that investors shunning certain stocks should lead to those stocks having higher future returns, it is also logical to hypothesize that companies neglecting to manage their ESG exposures may be exposed to higher risk (a wider range of potential outcomes) than their more ESG-focused counterparts.

Risk Of ESG Neglect

The authors used the MSCI ESG database (often referred to as intangible value assessment, or IVA, data) and Barra risk models to determine whether there was any link between the two. The IVA methodology covers a large cross section of companies around the world (more than 5,000 companies as of December 2015 accounting for 97% of the market cap of the MSCI World Index) and assesses how much each company is exposed, and how well it manages its exposure, to a range of environmental, social and governance issues affecting its industry.

Dunn, Fitzgibbons and Pomorski employed the Barra GEM2L risk model to determine forward-looking (ex-ante) risk estimates. Specifically, a stock’s returns are assumed to be driven by a combination of its loadings on systematic risk factors and by firm-specific “idiosyncratic” effects, which are assumed to be uncorrelated across assets. The authors’ sample period is January 2007 to December 2015.

Following is a summary of their findings:

ESG exposures are informative about the risks of individual firms. This finding is robust to a wide variety of controls and various stock universes (U.S., developed and emerging markets).
Stocks with the worst ESG exposures have total and stock-specific volatility up to 10-15% higher, and betas up to 3% higher, than stocks with the best ESG exposures.
ESG scores may help forecast future changes to risk estimates from a traditional risk model. Controlling for contemporaneous risk model estimates, poor ESG exposures predict increased future statistical risks. The magnitude of the effect was relatively modest: A deterioration of ESG score from the 75th to the 25th percentile is associated with about a 1% increase in risk. While this increase might seem small, it may simply reflect the fact that ESG captures risks that are long-run in nature and that may not materialize in the short-to-medium term.
Across the three dimensions of ESG investing, the social and governance pillars show the strongest correlation to risk. The environmental pillar is only insignificantly related to the various risk measures.
Stocks in the first (worst) quintile of ESG scores had greater earnings volatility and were less profitable than stocks in the fifth (best) quintile. They also had more exposure to the value factor. Furthermore, they had lower Ohlson scores (a measure of default risk). Additionally, they were smaller companies. Each of these findings is related to risk and highly statistically significant. Stocks in the first quintile also had more exposure to the momentum factor than stocks in the fifth quintile. This also was statistically significant.
Consistent with theory and prior research, stocks in the first quintile of ESG scores earned 1.8% higher returns than stocks in the fifth quintile. However, while certainly economically significant, this difference was not statistically different from zero at the 5% confidence level (t-stat of 1.2). (Note that this lack of statistical significance could be due to the limitation of the short period covered by the study.) The higher returns might be a premium that investors earn for the displeasure of holding such stocks, possibly as compensation for the additional risks (such as greater earnings volatility, less profitability and greater default risk) these stocks exhibit.

What Risk Exposures Convey

Dunn, Fitzgibbons and Pomorski concluded: “ESG exposures convey information about risk that is not captured by traditional statistical risk models.”

They added: “While the effect is modest in magnitude, it is consistent with ESG exposures conveying some information about risk that is not captured by traditional statistical risk models. Overall, our findings suggest that ESG may have a role in investment portfolios that extends beyond ethical considerations, particularly for investors interested in tilting toward safer stocks. ESG exposures may inform investors about the riskiness of the securities in a way that is complementary to what is captured by traditional statistical risk models.”

The authors included this note of caution: “It would be surprising if ESG were a first-order driver of a stock’s risk beyond what is already captured in a well-constructed statistical risk model. ESG may convey information about, say, the likelihood of a governance scandal, but such a scandal may not materialize for the average company over a relatively short horizon we study here. Moreover, ESG exposures are fairly persistent and stocks with poor ESG profile tend to be poor ESG also in the future.”

The bottom line is that, while ESG investors seem likely to be sacrificing some returns to express their social preferences through their investments, it also seems likely there may be some offsetting benefit, though it may be marginal, in the form of reduced portfolio risk.

This commentary originally appeared May 29 on ETF.com

June 6, 2018/by Matt Delaney

Choosing the Right College Savings Plan

Articles, JDH Blog

by Sue Stevens, Wealth Advisor, Buckingham Strategic Wealth

The advantages of a college education are numerous: potentially higher income levels over a lifetime, learning about subjects that can help in finding a job or meeting people that may help you throughout your life. But the costs can be intimidating. The most important step is just starting to save something. Once you’ve crossed that hurdle, you need to figure out where to put your savings. There are lots of college investment vehicles, so let’s take a closer look at what some of the most popular offer.

529 College Savings Plans

Perhaps the most commonly used type of college savings vehicle is the 529 College Savings Plan. These plans are typically sponsored by individual states or financial institutions. No matter which plan you invest in, your child can use that money to attend college anywhere in the country. You gift money to these plans and as long as your child uses the money for “qualified education purposes,” the earnings are tax-free. See the chart at the end of this article for what qualifies as an expense.

You can gift up to $15,000 (2018) per person each year. This is known as the “annual exclusion” amount for gift tax purposes. There is a special exception for 529 plans that allows you to contribute up to five times the annual exclusion, or up to $75,000 (2018) per child, in any one year. Just keep in mind that you’ve then used up the annual exclusion for that five year period.

If your child doesn’t use all the money in his or her 529 plan, you can transfer it to another “qualified beneficiary’s” plan. Qualified beneficiaries would include siblings, parents (or ancestors of either), nieces or nephews, aunts or uncles, first cousins, sons-in-law, daughters-in- law, fathers-in-law, mothers-in-law, brothers-in-law, sisters-in-law and spouses of any relatives previously listed.

Note: The ability to use 529 Savings Plan money for another beneficiary is a unique feature that is not available when you use college savings vehicles like UGMA/UTMA accounts. Those accounts are strictly for the named beneficiary.

Parents (or owners) maintain control of the assets in a 529 plan until distributed and the assets are factored into the financial aid formulas at a more advantageous rate.

There are, however, some disadvantages to 529 college savings plans:

You are limited to changing investments twice a year.
Although the number and quality of investment choices within 529 plans has improved, you are limited to the options offered by your chosen plan.
Pay attention to the costs of the Sometimes costs can be higher than you would find in alternative types of investments.
Any assets not used for qualified education expenses will subject the earnings in the plan to income tax and a 10% You can avoid this by “rolling over” the plan to another qualified beneficiary.
In some cases, especially with high net worth families, the annual gift tax exclusion may be better used in another way. For example, tuition can be paid directly to the school and not count toward the gift tax. If a Family Trust has been established, you may want to use your annual gift tax exclusion to fund the Family Trust.

But if the advantages outweigh the disadvantages for you, how do you choose among all the possible 529 College Savings plans available? The most important factors to consider are:

State Tax Advantages:
Many states offer tax deductions for residents investing in their state’s 529 plan. Some states also offer generous matches for first time enrollment in their plans. This may serve as an attractive incentive, but you can’t ignore other factors, such as fees and investment choices, especially when the tax advantage is relatively small.

Note: Since the Tax Cuts and Jobs Act of 2017, states are now scrambling to rewrite their own rules about what qualifies for a tax deduction. Withdrawing money for private K-12 qualified expenses may have unintended consequences like being required to repay prior state deductions or pay tax on investment gains. Every state is different, so you’ll need to do a little research to learn more. (Read http://time.com/money/5093099/529-plans-k12-expenses-tax-bill/.)

Investment Choice:
Having the “right” investment alternatives in the plan is critical. Especially in volatile markets, you need to have investment options that give you confidence. Many plans have added fixed income choices that should help do just that.

Fees and Expenses:
Not only do you pay a fee to the managers of the 529 plan, but you also pay a fee for the individual mutual funds the plan invests in. Both of these costs need to be accounted for when comparing the total expenses of various 529 plans. You do not want to make the mistake of choosing a plan with a low management fee, only to find out the individual funds in it have very high expense ratios or vice-versa.

The Tax Cuts and Jobs Act of 2017 expands how you can use 529 College Savings Plans assets. Now you can also take up to $10,000 a year to apply to private K-12 qualified education expenses. But this brings with it some additional considerations:

How will that affect the state tax deduction you took when you made the contribution? Will you have to pay part of that back?
Should you invest the money for K-12 differently because you have less time for the money to compound?
If you take out money for K-12, will you derail the growth you were planning on to pay for college expenses?
Will having the money available for K-12 change the financial aid calculations for what parents have to contribute for private school?

Alternative College Savings Vehicles

Not everyone will choose to use a 529 College Savings Plan, so let’s take a look at other savings alternatives:

UGMA/UTMA (Uniform Gifts to Minors Act/Uniform Transfers to Minors Act):
A UGMA/UTMA account is probably the most common type of investment account for a child other than a 529 plan. The appeal is that you can invest in anything–stocks, bonds, CDs, mutual funds–at just about any brokerage or bank. The money has to be used for the benefit of the child and can’t be used for normal parental obligations. At age 18 or 21, depending on state law, the money belongs to the child and can be used for any purpose. This type of account is a disadvantage for financial aid as it is counted as the child’s asset and is subject to a higher percentage in the financial aid formula.

Note: Investment income earned above $2,100 is subject to “kiddie tax” rules. With the new tax law, instead of being subject to parents’ rates, this income is now subject to potentially higher trust rates.

Coverdell Education Savings Account (ESA):
Coverdell accounts allow you to contribute $2,000 a year from all sources that can be used for elementary and secondary school expenses as well as qualified college costs. To be eligible to contribute, your income can’t be over $110,000 (single) or $220,000 (married filing joint). Beneficiaries must be under age 18 when the account is established. Any income earned on these assets is not taxed federally. They offer the ability to invest in just about anything–like a UGMA/UTMA. They are counted as a parent’s asset in the financial aid formula.

Traditional Brokerage Account:
Some parents choose to forgo the tax advantages of other types of college savings accounts so that they maintain control of the assets. For example, some parents will fund a 529 plan to cover the cost of four years of public college. To the extent the child wants to go to a more expensive school, parents pay that portion of the cost out of savings in their own names.

U.S. Savings Bonds:
There are limited advantages for college savings with U.S. Savings Bonds. To get the tax savings in 2017, your income must be less than $93,150 (single) or $147,250 (married filing joint), you must be over age 24 and the money must be used for tuition and fees. There is a $10,000 maximum annual purchase for electronic I-Bonds and EE-Bonds ($15,000 if you purchase a $5,000 paper I-Bond with your tax refund).

IRA:
Typically an IRA holds assets earmarked for retirement. But some people choose to use the money for college costs. You can avoid the 10% penalty if you use the money for college costs from a traditional IRA. You can withdraw contributions from a Roth IRA (but not earnings) without penalty. Overall, we would tend to recommend using these plans for retirement and not for college funding.

529 Prepaid Tuition Plan:
529 Savings Plans (as described previously) are not the only kind of 529 plan. There are also Prepaid Tuition Plans, although these plans have had a number of problems. Prepaid tuition plans were designed to lock in the future cost of tuition, but as state governments have hit their own financial difficulties, these plans may not be able to deliver on those promises. In general, we would not recommend investing in this type of plan.

2503c and Crummy Trusts:
High net worth investors may have additional factors to consider when thinking about funding college for their children. There are a couple types of trusts, 2503c and Crummy, where money can be put aside for future uses including college. One of the more important considerations in these situations is where the annual gift tax exclusion amount can best be used. There are legal costs associated with setting up these trusts, so they are not for everyone.

Once you’ve decided to start putting aside money for your children’s education and formulated a strategy to do so, choose the college savings tool that makes the most sense for your family and your unique financial circumstances. The costs associated with a college (or a private K-12) education can add up quickly, so be sure that the investment vehicle you select is the right one for you.

Download this table as a PDF »

May 29, 2018/by Matt Delaney

Investing Lessons from a Poker Player

JDH Blog, Larry Swedroe

by Larry Swedroe, Director of Research

As expert poker player Annie Duke explains in her book, “Thinking in Bets,” one of the more common mistakes amateurs make is the tendency to equate the quality of a decision with the quality of its outcome. Poker players call this trait “resulting.”

In my own book, “Investment Mistakes Even Smart Investors Make and How to Avoid Them,” I describe this mistake as confusing before-the-fact strategy with after-the-fact outcome. In either case, it is often caused by hindsight bias: the tendency, after an outcome is known, to see it as virtually inevitable.

Duke explains: “When we say ‘I should have known that would happen,’ or, ‘I should have seen it coming,’ we are succumbing to hindsight bias.” She adds that we tend to link results with decisions even though it is easy to point out indisputable examples where the relationship between decisions and results isn’t so perfectly correlated.

For example, she writes, “No sober person thinks getting home safely after driving drunk reflects a good decision or good driving ability.” The lesson, as Duke explains, is that we aren’t wrong just because things didn’t work out, and we aren’t right just because they turned out well.

Don’t Judge Performance By Results

“Fooled by Randomness” author Nassim Nicholas Taleb put it this way: “One cannot judge a performance in any given field by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).”

Here’s an example from poker. With one card remaining to be drawn, there are just two players left in the hand. Player X calculates that he has an 86% chance of winning. Based on those odds, he makes a large bet. Unfortunately, he loses the hand, just as he would expect to occur 14% of the times he faced the same situation. If he engaged in resulting, he would change his betting strategy because he would conclude that it was wrong to make such a bet. However, we know that if he made the same decision each time he faced those odds, over the long term, he would be expected to come out way ahead.

Let’s look at another example of resulting. John Smith, a hypothetical investor, works for Google and has nearly his entire portfolio invested in Google stock. He became a multimillionaire based on that strategy. John believes concentrating all your eggs in one basket—a basket that, as a senior executive, he could watch closely—is the right strategy. He thought diversification was only for investors who don’t have his sophistication. Of course, many other, similar situations turned out entirely differently, despite using the same strategy of concentrating risk in what you know. That’s why the saying “the surest way to create a small fortune is to start out with a large one and concentrate your risk” offers such good counsel.

Flawed Strategy

Among the once-great companies whose stock prices collapsed are Polaroid, Eastman Kodak, Digital Equipment, Burroughs and Xerox. However, despite the fact that there are far more Polaroids than Googles—showing John’s strategy is flawed—his outcome convinced him the strategy was right.

As Duke points out, once a belief becomes lodged, it becomes very difficult to dislodge. It takes on a life of its own, leading us to notice only evidence that is confirming, and causing us to experience cognitive dissonance. We then work hard to actively discredit contradicting information, a process called motivated reasoning.

Making matters worse is that research shows being “smart” actually makes certain behavioral biases worse: The smarter you are, the better you are at constructing a narrative that supports your held belief.

Duke cites the research of Richard West, Russell Meserve and Keith Stanovich, who tested the blind-spot bias. They found we are much better at recognizing biased reasoning in others but are blind to recognizing it in ourselves.

Surprisingly, at least to me, West, Meserve and Stanovich also found that the better you were with numbers, the worse the bias—the better you are with numbers, the better you are at spinning those numbers to suit your narrative. Quoting Duke: “Our capacity for self-deception knows no boundaries.” So, what does this have to do with investing?

Invest By Playing The Odds

When it comes to investing, there are no clear crystal balls. Just as in poker, the best we can do is put the odds in our favor and invest (bet) accordingly.

As I recently discussed, using factor data from Dimensional Fund Advisors from 2007 through 2017, the value premium (the annual average difference in returns between value stocks and growth stocks) was -2.3%. Unfortunately, resulting, hindsight bias and recency bias led many to conclude it was a mistake to invest in, or overweight, value stocks.

Another way to look at the situation is that, over 10-year periods since 1927, value stocks outperformed growth stocks 86% of the time—the same percentage as in the aforementioned poker hand. The value premium’s now-decade-long underperformance was not unexpected, in the sense that in 14% of the alternative universes that might have shown up, we expected value stocks to underperform.

Similarly, again using Dimensional Fund Advisors data, the market-beta premium has been negative (U.S. stocks underperformed riskless one-month Treasury bills) in 9% of the 10-year periods since 1927.

In other words, investing is risky. To be successful, you must accept that fact there will be periods, even very long ones, when the right strategy leads to poor outcomes. Even at 20-year horizons, the market beta premium has been negative 3% of the time. That is why Warren Buffett has said investing is simple, but not easy. It takes discipline to earn risk premiums.

Summary

One of the hardest things for investors to do is to stay disciplined when their strategy delivers poor results. It certainly is possible that the strategy was wrong. To determine if that is the case, look to see if the assumptions behind the strategy were correct. Seek the truth, whether it aligns with your beliefs or not. For investors, the truth lies in the data. When your theory isn’t supported by the data, throw out your theory.

While it’s certainly not an investment book, investors can learn many lessons from Duke’s “Thinking in Bets.”

This commentary originally appeared May 11 on ETF.com

May 29, 2018/by Matt Delaney

Homeowner’s Insurance & the Bucket Brigade

Articles, JDH Blog, Tim Delaney

The Bucket Brigade

Prior to the epic Wine Country fires in Northern California this past October, very few people, and I mean very few, even knew of anyone who lost their home to a fire, let alone lost a home themselves. Now with over 5,000 homes destroyed, just about everyone in the North Bay either lost a home or knows someone who did.

As the fires began to come under control, those of us who lost our homes turned our attention to the fine print of our homeowner’s insurance policies. Unfortunately, we were in for a shock: most of us were underinsured.

For those of you who did not lose a home, now is the time to scrutinize your homeowner coverage to see what types of coverage (or as I call them, “Buckets of Money”) you have. Odds are very high that you are underinsured unless you have been proactive with your insurance agent. Here is a quick rundown on the various “Buckets of Money” that can exist in your homeowner’s policy:

The Buckets

The Dwelling A Building Coverage Bucket

The Dwelling A Building Coverage Bucket is the maximum amount you will be paid on a total loss of the structure. Divide the coverage by your total square footage to get a coverage per square foot. For example, if you have a 2000 square foot (SF) home, and your Dwelling A coverage is $400,000, you have $200/SF of coverage. Then contact a builder to see if you can actually rebuild for that amount of coverage.

For those who had lived in their homes for a few decades but had not been in contact with their insurance agent about keeping the coverages current, we generally found ourselves woefully underinsured, often to the tune of hundreds of thousands of dollars.

The Replacement Coverage Bucket

The Replacement Coverage Bucket provides additional coverage over and above your Dwelling A coverage for either rebuilding your existing home or purchasing another home. Replacement coverage is generally based as a percentage of Dwelling A coverage. I have seen these figures range from 10% up to 100%, or higher. For example, if you have 50% replacement coverage, you would have another $200,000 of coverage to spend on rebuilding or replacing your home. This would bring you up to a total of $600,000 of coverage ($400,000 plus the extra $200,000) or $300/SF for a 2000 SF home.

Debris Removal Bucket

Someone needs to clean up your lot after your home has burnt down. This bucket of money will usually be a percentage of your Dwelling A coverage, like 5% to 10%.

The Building Code Upgrades Bucket

The Building Code Upgrades Bucket covers the cost of bringing the replacement home up to current building codes. In Sonoma County, our building code now requires sprinklers in new home construction. The cost of installing those sprinklers will be a building code upgrade.

The Personal Property (PP) Bucket

The Personal Property (PP) Bucket covers the replacement of your home contents. Imagine you were to pick up the home, turn it upside down and shake it. Everything that fell out would be considered PP. This is generally a percentage of your Dwelling A coverage.

There are two components to the PP coverage: Actual cash value (ACV) and replacement cost value (RCV). ACV is the RCV less depreciation based on age and condition. RCV is the value the carrier will pay you once you finally buy the replacement item at the store. For example, assume you own a shirt you bought eight years ago. It or something comparable currently retails at $100. Further, assume the shirt depreciates or loses 5% value every year. After eight years, a total of 40% (5% x eight years) or $40 ($100 x 40%) has been lost to depreciation. The ACV would be $60 and the RCV would be $100.

The insurance carrier would pay you $60 now for the ACV, and then pay you the remaining $40 once you have bought a replacement shirt.

The Additional Living Expenses (ALEs) Bucket

The Additional Living Expenses (ALEs) Bucket pays temporary living expenses, such as rent, while you are displaced, waiting to either rebuild your home or buy a replacement home. Some policies have a term of how long ALEs will be paid out, such as 24 months.

There can be some unique coverages in one’s policy not discussed in this article. Insurance policies are not created equally. Every insurance carrier has different contractual terms, so it is important to read through the policy to understand what you are paying for.

The Bottom Line

The bottom line is this: To completely lose your home while underinsured can be a major game changer, and it can happen to anyone. Contact your insurance agent immediately to review your coverages, and use this article as a guide.

December 22, 2017/by Tim Delaney

Changes

Dimensional Fund Advisors, Investment Strategy, JDH Blog, JDH Newsletter

by Timothy J. Delaney, Founding Partner

JDH Wealth Management is now in its 18th year of business. When I look back over those years, I am amazed at where we started and where we are today. I also think back to the many changes to our world during this time, of which I will discuss two of them.

The first one is the introduction of the iPhone about 10 years ago. Until then, no one, even Steve Jobs, could have envisioned how one device would so change our world. (Watch him introduce it to the world for the first time.) Besides being a phone, it also became our clock, flashlight, camera, timer, compass, music player, video player, texter, emailer and many other uses. Prior to this invention, who would have guessed land lines would be a thing of the past?

The other big change was the method of investing. Prior to the development of mutual funds, the only way to invest in a company was to buy its stock. As a kid growing up in the 60s, I can remember my dad reading the Wall Street Journal and looking at pages and pages of individual stock prices. Then in the 70s and 80s, mutual funds really captured the investing public’s attention. However, the philosophy for investing, whether stocks or mutual funds, was to buy large US companies, hoping to hit some home runs with the individual stocks or the mutual fund manager would outperform others and beat an appropriate benchmark.

Investment Strategy Innovations

The investment industry has changed over the last few decades. Academic research regarding stocks and investment management has spurred on these changes. One of the implications from extensive research is that professional money managers cannot consistently outguess and beat the stock market. This is supported by years of industry performance data.

Fortunately, I was exposed to this academically based, passive approach to investing in the late 1990s. Prior to this, I was just like most other investors, always believing that hope springs eternal. When I started JDH in 2000, I had changed my investment philosophy to align with this passive investment approach. So much so, it became one of our core investment principles.
The research continues to prove this was the correct move back then, and still to this day. As this academically based research evolved, another core investment principle was developed, which was small companies have higher expected returns than large companies and value companies have higher expected returns than growth companies.

Eugene Fama was one of the pioneers of this research for which he was awarded the Nobel Prize in Economics in 2013. (You can read his curriculum vitae here.) He is also a member of the Dimensional Fund Advisors (DFA) Board of Directors. DFA is the primary mutual fund company we use to implement our investment philosophy.

If you own mostly large US “blue-chip” stocks, which I refer to as some of the large US companies of the past 10-40+ years, this research and our real world interactions over the past 20 years shows that you are missing out on significant long-term growth opportunities in your portfolio. You would be missing higher expected returns by not having allocations to small, value and international asset classes.

These concepts of diversification and exposure to small, value and international stocks were all new to me more than 20 years ago. I adopted them when most people didn’t. They have changed my life and the lives of our clients. When we first began working with DFA in 2000, they were maybe the 40th largest mutual fund company in the world. Today, DFA manages $460 billion and is the 6th largest mutual fund company in the world.

Just as technology and the world changes, the financial world is continuously changing. We keep learning, researching and monitoring, all with the goal of providing you and your family with a better investment experience.

Have you and your investments evolved and changed for the better over time? Are you using the optimal method? Are your friends and family?

April 3, 2017/by Tim Delaney

Getting to Know JDH Staff: Sadie, The Little Drummer Girl

JDH Blog, JDH Family, JDH Newsletter

Gracious, it’s hard to believe I’ve been with JDH almost six months! On the one hand, the time has flown by and on the other hand, it feels as if I’ve been here for years already.

It’s been a pleasure getting to know some of you in the past few months, and I look forward to meeting more of you at our upcoming Broadway Under the Stars event on June 17th and August 12th. Since I’m going to be sticking around here for a while, I thought I’d tell you a little more about myself.

One of my interests, which I’m sure I share with more than a few of you, is music. I started out singing and dancing along to Cats in my living room when I was five. (Sadly, no home movies of those glorious performances still exist.)

I had a deep fondness for scarves, even then.

I learned to love folk music from my mother and Pink Floyd from my dad; classical choral pieces from my choir director in church; fifties crooners from my grandmother; punk and jazz from dorm-mates in college; and the blues from an amazing, year-long road trip in my early thirties. Fun fact: my mother couldn’t carry a tune in a bucket when I was born. We spent so much time together commuting to theatre rehearsals and singing along to musicals in the car that we now can sing harmonies together!

After a friend taught me how to play guitar, I ended up recording my own album as a singer-songwriter. Here I am regaling friends at an impromptu farm concert:

Music and nature: a winning combination.

I joined a Dixieland band a few years ago, where I started out playing washboard and graduated to a full drum kit. Dixieland is such a fun style for a drummer. It’s full of whistles, kazoos, washboards, and cowbell hits. The Sebtown Strutters, as we named ourselves, can be seen from time to time playing at the Community Market in Sebastopol or at private events throughout the county.

Next time we speak, tell me about the music in your life! Do you listen to music at home? In your car? Have you played an instrument? Are you a shower singer? I’m a firm believer that everybody can make music, and I encourage it in every way I can.

Musically yours,

Sadie

March 21, 2017/by Sadie Pettit

Save Social Security for Later, When You Need It Most

Articles, JDH Blog, Tim Maurer

by Tim Maurer, Director of Personal Finance

I think we’ve been looking at Social Security retirement benefits all wrong. In the long-running debate about when to take Social Security — as early as age 62 or as late as age 70 — the focus has been on timing your claim to get the most money, in total, out of the social safety net.

This is a circular argument that will never be fully decided until the Social Security recipient in question dies. So let’s shift the focus from the question “How do we get the most out of Social Security?” to “How do we get Social Security when we need it most?”

Simply put, you’re more likely to run out of money at the end of retirement than at the beginning.

Behavioral science explains why we are all so prone to preferring money today over tomorrow. It’s called “hyperbolic discounting,” and behavioral economists plead that we meaningfully overvalue money now, unfairly discounting money later.

But the risk of making less money in your early retirement years is dwarfed in comparison to the risks of longevity and inflation in the latter stages of retirement. And the probability you will outlive your money meaningfully decreases if you wait to take Social Security.

Prove it!

Let me show you through an example that, while hypothetical, is no doubt close to reality for many.

We’ll consider three couples, the Earlies, the Fullers and the Laters. Each couple:

Retires with $1 million in tax-deferred retirement savings.
Has an identical 50 percent equity, 50 percent fixed-income portfolio.
Has a pretax retirement income need of $90,000 per year.
Will supplement their Social Security income with the retirement savings necessary to fulfill their income needs.
Includes one household member who will receive the maximum in Social Security benefits and one who will receive 50 percent of the maximum.

The only difference is that the Earlies retire and begin taking Social Security retirement benefits at 62, the Fullers at 67 and the Laters at 70.

This hypothetical case study is designed to result in an academic probability that each couple will not run out of money, and applies more than 3,000 iterations of randomized historical market returns for the respective retirees’ portfolio allocations.

Then, we show the likelihood that each couple will have at least one dollar left in retirement savings at the end of four different time periods — 20, 25, 30 and 35 years into retirement.

Therefore, if you see a result of 47 percent in the 25-year column of the table below, it means the couple represented still had at least one dollar left in their retirement savings at the end of that period in nearly half of the thousands of iterations run. In other words, that couple had a 47 percent chance of not running out of money 25 years into retirement. Statistically, a probability of 85 percent or better is favorable.

The findings

What did we find? If you die early enough — within 20 years of your retirement date — you have a reasonably good chance to outlive your money regardless of when you take Social Security. The Earlies hit the golf course fully five years before the Fullers, but it’s not clear that they’ve suffered for it at the 20-year mark.

At 25 years, however, there’s a greater than 50 percent chance the Earlies have run out of money and now must ask their kids to pay their greens fees. At 30 years their probability of solvency has dropped to 30 percent, and at 35 years they’re likely relying on their reduced Social Security benefit for all of their income.

Why do the Earlies fail? Because in order to meet their income needs with a reduced Social Security benefit, they put too much pressure on their portfolio to pick up the tab. They were forced to take an effective withdrawal rate of 5.62 percent in their first year of retirement.

How do the Fullers look? Pretty good. Buoyed by a Full Retirement Age (FRA) Social Security benefit and beginning with a reasonable 4 percent effective rate of withdrawal from their portfolio, at 20 and 25 years into retirement, they’re in the 90 percent-plus range. But if they plan on seeing their faces on a Smucker’s jar, their probability of success declines to 67 percent when they’re 35 years into retirement.

As you’d guess, the Laters are solid. Because of their increased Social Security benefit, they require only a 3.26 percent portfolio withdrawal rate in year one. Statistically, they ride off into the sunset and should have the funds to test the boundaries of science in their pursuit of longevity.

If you suspect you’ll die early — and have lineal or medical justification for that belief — you might justify taking Social Security as early as you can (although a lesser-earning spouse could still benefit from your higher benefit when you’re gone). And please forgive the inherent insensitivity in this analysis, which presumes the Earlies, Fullers and Laters all have a choice in taking their benefits at various points in time. Many retirees don’t, and if you need to retire and take early Social Security for any number of valid reasons, of course you should do just that.

But if you hope to have a longer retirement — 30 or 35 years, especially — your chances of not outliving your retirement savings improve greatly if you delay Social Security. Waiting is like purchasing longevity and inflation insurance for what will hopefully be a long and prosperous retirement.

This commentary originally appeared January 1 on CNBC.com

The opinions expressed by featured authors are their own and may not accurately reflect those of JDH Wealth Management. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

January 30, 2017/by Matt Delaney

Tax-Loss Harvesting in Inclement Markets

Articles, JDH Blog, Michael J. Evans, The BAM Alliance

In some alternate universe, there may be markets where nobody ever experiences any loss and every investment just keeps growing. In our world, we know better. While markets are expected to climb over time, periodic downturns happen. When they do, they can leave you feeling left out in the cold. That’s why it pays to look for opportunities to leverage inclement markets through year-round tax-loss harvesting.
Tax-Loss Harvesting: An Overview
The concept of tax-loss harvesting is relatively simple. I’ll go into more detail in a moment, but the general goal is two-fold:

1. Realize a loss for tax purposes. When appropriate, sell assets at a loss and use the losses to offset taxable gains on other investments.

2. Keep assets in the market according to your investment plan. Buy a similar holding (one that’s not “substantially identical”) until you can reinvest those assets as originally intended without running afoul of the IRS’ “wash sale rule.”

In other words, tax-loss harvesting is not about abandoning your carefully crafted asset allocation by panic-selling a losing holding. It’s about achieving an available tax break while sticking to your disciplined investment strategy throughout.

What Is the Wash Sale Rule?

There are often several mutual funds and ETFs that make good substitutes for one another from a practical perspective. But when tax-loss harvesting, you cannot claim a deductible loss on a sale if you (or your spouse, for joint filers) sell a security at a loss and then buy the same security or a “substantially identical” one within 30 calendar days before or after the transaction. If you violate either of these conditions, the IRS’ wash sale rule will typically disallow the loss for current income tax purposes. Thus, it’s important to use caution in choosing “similar” funds.

A Tax-Loss Harvesting Illustration

It might help to see an illustration. Assume you purchase a fund for $10,000. Two months later, it’s trading at $7,000. You decide to harvest the short-term, $3,000 loss (short-term because the fund was held less than a year). With a 35 percent ordinary federal income tax rate, this can result in a $1,050 tax savings.

At the same time, you take the $7,000 from the sale and invest it in a similar holding. After 31 days, you can reinvest it back where it came from. As long as the market eventually recovers and the fund returns to the level at which you originally bought it, you’ve effectively lost nothing while gaining a $1,050 tax break.

There Is No “Tax-Loss Harvesting Season”

Maybe it’s because tax-loss harvesting is associated with tax planning, but many investors (and even some advisors) treat it as a strictly year-end task.

This is a mistake. Losses can occur any time of the year, and vanish by year-end. On the one hand that’s good, because it means your investments are no worse for the wear (if you remained invested). But if you skip the opportunity to also tax-loss harvest when the (hopefully) temporary losses occur, you miss the chance to lower your tax bill while you’re at it.
How It Works (and How It Doesn’t)
Now that you understand the basics, let’s cover some of the finer points. In a December 2015 MarketWatch article, Robert Powell shares BAM ALLIANCE Director of Investment Strategy Kevin Grogan’s advice: “Most investors should do tax-loss harvesting as long as the loss is large enough.”

But what is “large enough”? As I’ll explain in a moment, tax-loss harvesting opportunities are best considered on a case-by-case basis, but in the aforementioned article, Grogan offers some general starting points: For stocks, start with at least a $5,000 or 5 percent loss and for bonds start with at least a $5,000 or 2 percent loss.

There are additional factors to help you decide when a loss seems ripe for harvesting.

Transaction costs: Clearly, it won’t make sense to harvest a tax loss if the trading costs are going to erase the benefits. For example, say your tax break would be $100. You’re better off staying put if it’s going to cost you $80 to complete the trades involved (selling the holding, reinvesting in a similar one, and then ultimately repurchasing the initial investment).

Asset location: You cannot harvest losses from holdings that are in tax-sheltered accounts (such as IRAs or retirement plans). Because realized gains in these accounts are not taxable to begin with, they cannot be offset with any losses.

Market uncertainty: There can be times when the market is so extraordinarily volatile that you are better off just remaining seated. Remember, your goal for tax-loss harvesting is to sell at a loss AND invest in a temporary replacement holding that is similar (but not “substantially identical”). You then typically want to swap back to your original holding after 31 days. This ensures your portfolio remains true to your greater wealth plans.

When it’s time to complete a swap, it works best when the price of your replacement holding is the same or lower than the price you paid for it. Why is that so? Taxes. When you sell the replacement holding, if it’s gone up in value, you’ll incur short-term taxable gains, which could cost you more than the loss harvesting will save you.

Because highly volatile assets often incur large gains or losses over very short periods, tax-loss harvesting should be carefully executed if the market is highly unstable. For example, some advisors employed tax-loss harvesting where appropriate following the passage of the June 2016 Brexit referendum. Depending on your individual holdings and your ability to focus on careful execution, it might or might not have made sense for you to do the same.

Why Are Short-Term Losses More Valuable?

In our earlier illustration, we mentioned harvesting a short-term loss. Why would that matter? Again: taxes. Short-term losses are first deducted against short-term gains that are otherwise taxed at higher ordinary income tax rates. Long-term losses are first deducted against long-term gains that are otherwise taxed at lower capital gains rates. Thus, short-term losses are considered more valuable to your tax management efforts, especially if you are in a higher tax bracket.
The Takeaway
Given that periodic market losses are inevitable and inherent to investing, I’d recommend making the most of them when they occur. So consider employing year-round tax-loss harvesting as part of your overall wealth strategy – while also ensuring that the tax-loss harvesting “tail” doesn’t inappropriately wag the portfolio management “dog.”

Michael J. Evans, Founder, The Cogent Advisor

The BAM ALLIANCE

Michael J. Evans is founder of The Cogent Advisor, an independent member of the BAM ALLIANCE.

Prior to founding The Cogent Advisor, Michael was a veteran commodities trader on the Chicago Mercantile Exchange for more than 20 years. He remains a proud member of the exchange.

Michael currently serves on the DePaul University College of Commerce Finance Advisory Board as well as the Lane Tech Alumni Association and The Irish Fellowship Club of Chicago. He holds a bachelor’s degree from the DePaul University College of Commerce and completed the graduate certificate program in Financial Planning at DePaul.

Visit Michael’s blog, The Cogent Advisor
Follow Michael on Twitter, @CogentAdvisor

As a “Chicagoan to the core,” we’re sure he had a wonderful day yesterday, the day the Cubs won the World Series.

November 3, 2016/by Matt Delaney