Category Archives: Investing

Gamification of Trading

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The suicide of a 20-year-old experimenting with trading on the Robinhood platform
has many calling for new regulations on trading. I think new regulations on the “Robo”
interfaces are required but not on trading. Robo platforms, like Robinhood, provide a
software interface that makes trading more like a game.

Brokerage firms have been on a serious race to engage directly with the young and the
inexperienced. Robinhood, E-Trade, TD Ameritrade, Charles Schwab, Interactive
Brokers, Fidelity, Merrill Lynch, and many others have all embraced commission-free
and zero-minimum balance trading on platforms that focus only on the upside
of trading. These platforms are more reminiscent of an animated game than a
serious financial transaction. Even those who have managed to make a little money on
day trading often fail to understand that there are tax consequences. They usually
reach out for assistance when they receive from these brokerage firms an unexpected
1099 with a large tax liability.

It is clear that what we need is more clarity on what is a game and what has real life
consequences.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Your Portfolio Allocation and Emotional Reactions: The Coronavirus and Portfolio Discipline

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Here we go again – we’ve been down a similar road before, so none of this is news to those who have been with us through prior overreactions by market participants.

Volatility is part and parcel of participating in the market. When fear grips the market, selloffs by those who react to that fear provide portfolio opportunities for those who understand and adhere to a strategy. It is AIKAPA’s strategy to maintain your risk allocation and either ride out the volatile times or rebalance into them. Meaning that if you don’t need cash in the short-term, we buy when everyone else is selling.

As news of the Coronavirus (or other events outside of our control) stokes fear and uncertainty on a variety of fronts, it is only natural to wonder if we should make adjustments to your portfolio. If you are reacting to fear, then the answer is a resounding NO. On the other hand, if you are applying our strategy in combination with an understanding of the impact on business, then the answer is likely YES. When an adjustment is indicated we look for value and BUY while selling positions that are relatively over-valued. If the market continues to respond fearfully (without a change in value) then we will likely continue to buy equities and may sell bonds to fund those purchases. The only caveats to this strategy are that we must know that you don’t have short-term cash flow needs, that we stay within your risk tolerance, and that we are buying based on current value (keep in mind that value is based on facts not fear).

If you feel compelled to do something, then consider the following:

  1. Contact your mortgage broker and see if it makes sense to refinance (likely rates will drop soon after a significant market decline).
  2. Seriously examine the impact this has on your life today and let’s talk about changing your allocation once markets recover.
  3. Review the money you’ve set aside for emergencies and prepare for potential disruptions if these are likely.
  4. Business owners should consider the impact (if any) on their business, vendors and employees. Particularly important will be to maintain communication with all stake holders and retain a good cash flow to sustain the business if there is a possibility of disruptions.
  5. Regarding your portfolio, if you have cash/savings that you want to invest, this is a good time to transfer it to your account and have us buy into the market decline.

Market changes are a normal part of investing. Risk and return are linked. To earn the higher returns offered by investing in stocks, it is necessary to accept investment risk, which manifests itself through stock price volatility. Large downturns are a common feature of the stock market. Despite these downturns the stock market does tend to trend upwards over the long-term, driven by economics, inflation, and corporate profit growth. To earn the attractive long-term returns offered by stock market investing, one must stay invested for the long-term and resist the urge to jump in and out of the market. It has been proven many times that we can’t time stock market behavior consistently and must instead maintain portfolio discipline (if you want a historical overview of markets, see the “Market Uncertainty and You” video on our website www.aikapa.com/education.htm).

It is your long-term goals and risk tolerance that provide us with our guide to rebalancing and adjusting your portfolio, not short-term political, economic or market emotional reactions. In your globally diversified portfolio, we will take every opportunity to rebalance and capture value during portfolio gyrations. This IS the benefit of diversification and working with AIKAPA.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Cyber-crime, Phishing, Robocalls, and Wanting to do Good

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Almost every day there is an article in the news about financial fraud. Much of it impacts seniors, like the telephone scam now doing the rounds that has fraudsters posing as Social Security representatives. However, we are all at risk, especially if we believe we are too young, too smart and too vigilant to fall for a scam. Sadly, scam artists are very sophisticated, intelligent, and focused so that they’ve become experts at separating people from their money. Only last month, “Shark Tank” magnate, Barbara Corcoran, was tricked out of nearly $400,000 through an email phishing scam in which fraudsters convincingly posed as her assistant.

A lot of financial fraud targets seniors or those in high pressure situations because cognitive agility decreases as we age or when we are stressed. Furthermore, seniors who live alone are particularly vulnerable.

Here are several things you can do to protect yourself and loved ones from financial fraud:

  1. Simplify your financial life. One of the best things you can do to reduce the chances you’ll be taken advantage of is to reduce the number of accounts you have and the number of financial institutions you work with. Fraudsters are experts at catching people off guard, posing as others and making their prying questions sound both reasonable and plausible. Make it a habit not to respond to phone calls regarding finances unless you know the person at the other end and never trust emails involving finances without first verifying the source.
  2. Limit access to and block large transactions. The first step in preventing fraud is to limit the money that can be easily accessed by not keeping large sums in checking accounts. Keep large accounts with a separate institution so that it takes a day or two to make a transfer. Next, if your bank allows it, set alerts for large transactions or block transactions over a certain size. Always use a credit card for online purchases since they give you the ability to reject a charge, while your debit card will automatically pay from your account.
  3. Always use maximum security on email accounts that you use for financial communications. We’ve seen most cyber fraud through yahoo.com and gmail.com accounts prior to the additional security currently available.
  4. For large transfers, particularly during hectic times, involve a trusted financial partner and NEVER accept changes to the receiving account and contact over email (or a call from someone you don’t know). It is better to halt the process entirely or at least confirm with a known financial entity than to change course midstream during a cash transfer. Most of the successful fraudulent transfers have been during escrow for a new house purchase or sale. The methods used are creative and ever improving.
  5. Families should plan their spending ahead and NOT respond to charitable requests on the fly. It is not unusual for seniors to receive many robocalls and mail requests from real charitable organizations because they know that seniors want to do good. It is not unusual for seniors to spend more on charitable donations made ad hoc than was planned. Make a point never to donate based on a phone call or last-minute request at a checkout unless that is part of your charitable plan for the year. I recommend families sit together and come up with an annual plan for charitable donations. When charitable opportunities present themselves defer them for review at your next family charitable giving gathering.
  6. For seniors or those facing high stress situations, you may want a backup notification sent to your spouse, financial caretaker, or a trusted person for high value transfers. If your bank does not provide for such alerts, then make it a standard practice never to make high value transfers without extensive planning and verification.
  7. For seniors, it’s important to have a potential financial surrogate in place long in advance of cognitive decline. Identify a trusted family member or friend or trusted professional to be your financial caretaker and start conversations long before you feel you need to turn over your finances. Consider providing view-only access to a trusted person so that they can help you monitor your account activity and be notified of large transactions and suspicious activity. It is a good idea to involve them with your tax preparation and filings as well.
  8. Due to the number of data breaches in recent years (that have exposed thousands of people’s Social Security numbers and other sensitive data), it has become increasingly possible for fraudsters to open accounts in another person’s name. On a regular basis, personally monitor your credit history with all three major credit agencies for new activity that you didn’t initiate.
  9. I’m personally uncomfortable with ongoing Credit Freezes unless you can monitor and implement them yourself at minimal cost and without involving a third party. Using a credit monitoring service is not recommended since you are involving an unregulated third party and, in any case, will only alert you after you’ve been victimized. The recommended approach when this happens is to freeze your credit at all 3 major credit agencies. Keep in mind that though this is often recommended by cybersecurity experts it can become a major hassle for you. Freezing your credit can be an issue for you if a company needs to legitimately verify a transaction with your credit history (this is the case for some insurance and bank transactions). Unfortunately, freezing your credit is sometimes the only way to prevent attempts to open a new account in your name, and maybe the preferred or only option for seniors.

Financial fraud is rampant. However, with a bit of preparation, a support system, and communication, you can significantly reduce the odds that it happens to you and your love ones.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Death and sepulcher – facing the inevitable

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Benjamin Franklin famously wrote, “in this world nothing can be said to be certain, except death and taxes.” In all the years that I’ve worked with clients to create a financial path for their long-term wishes in life and after they are gone, I’ve covered a huge spectrum of topics. Until now, I’ve never asked clients about their “right of sepulcher” (the right of sepulcher means the right to choose and control the burial, cremation, or other final disposition of a deceased person). I recognize that, for some, this topic may seem a tad morbid. The cautionary tales of contentious and messy celebrity funerals that follow (suggested by Amy F. Altman, an associate at Meltzer, Lippe, Goldstein and Breitstone) may provide you with some perspective and may help you consider how you and your loved ones feel about your right of sepulcher.

  • Litigation surrounding the 2007 death of actor, model and TV personality Anna Nicole Smith made headline news for weeks as her mother and the guardian of her infant daughter battled for the right of sepulcher. Ultimately, the daughter’s guardian prevailed and Anna was buried in the Bahamas next to her late (and recently deceased) son.
  • Boston Red Sox Hall of Famer Ted Williams’ death in 2002 resulted in a spectacular rift between his children over the disposition of his remains. His eldest daughter argued that Williams’ will clearly stipulated cremation, BUT his son had been given power of attorney and his father’s health proxy and he wanted his father cryogenically preserved. Eventually, the son won out, largely because the daughter could not afford the cost of litigation.
  • Legendary actor Mickey Rooney died in 2014. His estranged wife wanted him buried in a shared plot purchased before they had separated. Rooney’s conservator (court appointed guardian) had other ideas and a costly tug-of-war ensued. In the end, his wife capitulated, recognizing that burial in a Hollywood cemetery befitting Rooney’s status was appropriate.

These cases, regardless of age, underscore the importance and value of discussing with loved ones your preferences for disposition. The laws regarding rights of sepulcher vary widely by state. If permitted under state law, completing a “disposition of remains form” together with advanced directives seems an appropriate start. This will create clarity with respect to the sensitive issues surrounding burial.

As with all legal documents you need to first understand what it is that you really want, which can take a long time to fully grasp and may require delicate discussions with loved ones and personal introspection. Leaving aside what I consider the more important question regarding life support for now, you can first deal with the question, do you want to be cremated, or perhaps cryogenically preserved? Do you want to be an organ donor? Would you like your funeral to take place at home or at a funeral parlor? Do you want a formal service or commemorative event? Though you’ll be gone, these are all options that may well prove to be important (and costly if mishandled) to those you leave behind.

At times, I think that there is so much to do while we are alive that taking time to consider what will happen after we’re gone seems inconsequential and entirely unimportant, but this may not be the case for loved ones. Let me offer an example.

Recently, a client shared that over the course of a dinner conversation with his parents they casually revealed their preference to be cremated. This came as an enormous shock. “Never in a million years,” he said, “would I have predicted that this was my parents actual wish.” This is a man who has made every effort to ensure he is in touch with the real wishes of his aging parents. “I would have got it wrong,” he said, adding “a split second’s worth of conversation set me straight.” He felt like a huge weight was lifted from his shoulders.

The person to whom you give the right of sepulcher may gain much by having even a short conversation about your wishes, regardless of your age.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Understanding Longevity Risk and Your Retirement

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The oldest person alive today is Emma Morano of Vercelli, Italy who turned 117 this November. She was born in 1899! Queen Victoria was still on the throne of England and William McKinley was president of the United States. If you’d asked Emma in 1917 if she could imagine living long enough to see 2017, would she have imagined such a long life? Most Americans do not live as long as Emma, but in general we are living longer and healthier lives. The number of centenarians is on the rise. Longevity – long life – can have obvious perks, but also poses a conundrum in terms of finances. To help us plan for longevity we use “longevity risk” to measure the likelihood that you’ll run out of wealth before you’ll run out of life. In our planning we like to ensure that we mindfully set longevity at the right level for each person.

Few, if any of us, have advance knowledge of precisely when our time will come, so questions like this often boil down to statistics. You’ll sometimes hear that the average life expectancy for females is age 83 and age 81 for males, BUT are these appropriate target-end dates for your retirement plan? The truly important challenge is coming up with the best end-dates for retirement that will allow you to enjoy your wealth early while leaving enough assets to comfortably support you later in life.

In retirement planning, the variation in life expectancy can range quite dramatically and yet we find that client expectations generally fall into two categories, (1) those who want to make absolutely sure they don’t outlive their wealth, and (2) those who have a definite expiration date in mind, say 80 years of age, and believe that planning for life beyond that age is simply not relevant or realistic. The latter are often operating on some assumption based on, for example, both parents dying in their late 70s or not long after retirement.

At the risk of sounding morbid, but with the goal of having your retirement plan more fully represent your expected end of life target date, I want you to consider three facts that most often cause people to underestimate their longevity (in turn, this may help you understand why we sometimes encourage you to increase your target-end date):

Life expectancies that are often quoted may not be relevant since they are often calculated at birth. Life expectancy on reaching age 60 or 65 should be much higher than those quoted at birth since some will die before they reach this age. In fact, life expectancy for a 65-year-old, non-smoker is much higher. As an example, a 65-year-old female of average health has a 50% chance of reaching age 88 (see the table below) but once she reaches age 88 she has a much higher chance of reaching age 95.

longetvity_table

  1. Life expectancy is often calculated using mortality rates from a fixed year instead of projected to future expected mortality rates. Social Security Administration (SSA)’s period life tables are based on real mortalities in any given year. Though valuable, since they are real, they underestimate the observed trend for increased survival. As mentioned above, we perceive our survival based on our own anecdotal experiences. The question to ask ourselves, is this correct or is this an underestimation?
  2. Finally, we find that the population on which longevity risk calculations are based may not be appropriate. If we work with an aggregate US population life expectancy (as does the SSA period life tables) we must include a correction for socioeconomic and other factors that are known to impact mortality rates and could underestimate our lifespans. To-date there is evidence to indicate a positive link between income, education, long-term planning, and health. Yes, someone who plans and prepares appears (statistically) to live longer.

In case it is still not clear – let me explain. When planning retirement projections, the length of retirement greatly impacts planning choices (planning for 20 versus 45 years may require different strategies given the same wealth). Considering your specific longevity risk necessitates that we prepare for the contingencies that apply to you. There may be good reasons to target a lower longevity, but for most we will likely need to include, at the very least, a reasonable adjustment for expected increased longevity. This often means distribution of existing assets and thinking about end-of-life questions (a topic most prefer not to address too closely). If you are expecting a longer life, consider accumulating a pool of longevity assets (like some are doing to cover for potential Long-Term Care contingency) or purchasing a longevity annuity (this asset would only be used if you live past a certain age and, therefore, accumulate what are called mortality credits that can provide a good income late in life, but would be lost if you wind up passing sooner).

Obviously, estimations are just that, estimations. Still, a thoughtful scientific approach ought to be the foundation for retirement projections, never speculation or conjecture. Like Emma, some of us will be blessed with a long life, even inadvertently. One way or the other, I want all of us to feel that we’ve had a life well spent, and that will depend largely on how well we’ve planned for possible contingencies in your life.

This educational piece was drawn from my work with clients, www.longevityillustrator.org, the Social Security Administration period life tables, and a recent academic publication by Wade D. Pfau, Ph.D., published in The Journal of Financial Planning, November 2016, vol 29, issue 11, pp 40.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What makes a portfolio “good”

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What are the ingredients of a good portfolio?

If you do a little research, you will likely discover the three characteristics or criteria of a ‘good’ portfolio: (1) it should be diversified, (2) uses indexes, and (3) keeps costs low. All valid characteristics, to a point. In reality, this amounts to an over simplification that tells only part of the story. Applied to a poorly constructed portfolio, these characteristics will not help you create a good portfolio and you will not feel the confidence you need to see you through a market downturn. So, what is the best recipe for a ‘good’ portfolio—one that doesn’t cause you anxiety and keeps you up at night while generating long-term reasonable returns?

Here is my list of five ingredients for an effective long-term portfolio:

1.      HAS A STRATEGY. First and foremost, your portfolio should follow a strategy that you believe will be effective. You need to understand and believe in it enough that you can allow it to capture value over time (while others are off chasing the latest trend). At AIKAPA we use a global investment strategy that leans towards value (rather than growth) allocations.

2.      IS DIVERSIFIED. Select a diversification that represents your strategy and provides exposure to asset classes that behave significantly different from each other. In AIKAPA’s portfolio we are diversified across equities (that include large and small US and non-US equities) and across bonds, each global asset class providing opportunities to capture value. Using the chart below, you can compare global asset classes and how their volatility and returns differ from each other.

august_nibbles_asset-class-return-risk-for-2000-2005

3.      IS LOW-COST/HIGH-QUALITY (i.e., often an index fund). Implementing your diversified strategy needs to be completed using low cost, high quality securities. Use of baskets of securities (such as proven index funds) to represent chosen asset classes in your portfolio will permit the needed diversification while eliminating the risk associated with the failure of any one company (mutual funds or exchange traded funds are the baskets we use for your portfolio).

4.      IS LOCATION SENSITIVE and TAX MINDFUL.  Being mindful and “tax sensitive” when purchasing securities and locating them in the appropriate type of account can result in higher NET gains. Tax free, tax deferred, and taxable accounts should hold securities that will provide needed diversification, but will also yield the best AFTER tax returns. This approach is termed asset LOCATION selection. Taxable accounts are particularly valuable in the short and long-term but should hold assets that will not dramatically increase personal tax liability (particularly for those already in the higher tax brackets). As an example, two similar US Small capitalization funds can create very different tax liability simply by the level of “turnover” inside the fund. This turnover is often caused by frequent trading by the fund managers and can significantly reduce after tax net returns.

5.      IS REGULARLY REBALANCED. Finally, we have rebalancing of a portfolio. Rebalancing by conventional wisdom is what enhances your long-term returns by periodically selling what is overpriced (over-valued) and buying those that are underpriced (under-valued). The reality is not quite that simple. Automatic rebalancing software, for example, is tempting owing to its simplicity, BUT can lead to high turnover and reduced gains. Keep in mind, rebalancing has at least two different purposes. Rebalancing across unlike return assets (for example between equities and bonds) will result in a decrease in long-term returns, while reducing volatility (or risk). Yes, you trade some upside to reduce the downside. On the other hand, rebalancing between similar return assets (such as, between equity funds of large and small capitalized companies) will capture gains and lead to enhanced long-term returns as long as you don’t trade too often.

Assuming you’ve got all the correct characteristics in place, a ‘good’ portfolio ensures you’ve got adequate exposure to the market while assuming a measured level of risk, tax sensitivity, and an appropriate degree of rebalancing.

At the end of the day, a good portfolio can only succeed if you believe in the strategy and, most importantly, allow it to perform as designed over the long-term. To do this you, you must be certain that it is a good portfolio for you.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Money Battles and the pitfalls of financial infidelity

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Let’s face it, making important financial decisions can be stressful at the best of times. When life partners fail to see eye-to-eye on finances it can lead to discord if they don’t have a way of working through their differences. It’s no secret, when compared to other types of marital disagreements, arguments over finance are the strongest predictors of divorce.  Financial decisions get even harder to make as we grow older—the habits of the past increasingly difficult to break. Add a touch of procrastination to the mix and you’ve got the potential for real trouble. It’s no wonder then, how easily decisions affecting retirement can turn into a battle over money, when so much is at stake. The best way to avoid unpleasant (and generally unnecessary) confrontations over money is to have a process in place. Let me explain . . .

Ideally, couples will create a money decision-making process early enough in their relationship that it becomes almost second nature—ensuring financial discussions are honest, frank, frequent and cordial. Both partners must be kept up-to-date on the family’s financial dealings and how those dealings align with understood and accepted goals. From our experience, monthly or at least quarterly meetings to discuss/review finances are invaluable.

This isn’t to say, every penny must be accounted for. Each partner must feel that they have reasonable autonomy and freedom to act within an allotted budget, BUT both must be clear that there are boundaries. Some couples set a specific dollar amount above which they must check with their partner and/or reach out to their financial advisor when especially tough financial decisions arise. For example, couples are well advised to discuss in detail funding a child’s college education, their retirement budget, or when to cease working.

Fights over money can be avoided if both partners have a handle on household finances, and moreover, feel their voice is included in all financial decisions.

If one partner pays all the bills and takes care of all the investments, the other partner over the long-term will begin to feel they are not a full participant in the relationship (or at least, they ought to feel that way). To counter this possibility, some choose to exchange roles for part of the year. Others have a regular monthly meeting to be sure that both are indeed aware of the family’s finances. AT A MINIMUM, all couples should go over how to access the family’s financial information (bank accounts, retirement plans, insurance, and investment accounts, etc.) AT LEAST ONCE PER YEAR.

When one partner takes on the financial responsibility for the family the inequity can (unintendedly or not) lead to “financial infidelity.” Financial infidelity occurs when one partner hides their spending on things they feel strongly about despite a clear agreement to the contrary by the couple. As an example, one partner might secretly fund their child’s business venture. I’m aware of one case where this actually happened. The situation was not revealed until the death of the offending life partner. The surviving partner’s betrayal was made all the worse by the fact that their retirement assets were depleted without his/her knowledge. The child that benefited from the covert funding, moreover, was not in a position to repay the surviving parent.

To avoid or at least reduce the likelihood of conflict over money, here are a few helpful guidelines:

  1. Communicate on expenses early, frankly, openly and honestly
  2. Meet regularly to review finances
  3. Update goals and ensure all parties are on the same page

When speaking of goals, articulate them out loud (i.e., verbally or in writing) and be sure to include your goals for both the present and the future.

The decision-making process itself should be reviewed as part of your conversation. For example, how do you determine your life-style budget, your savings goals, and what happens when you encounter expenses that fall outside of your budget for some reason?

As large financial decisions approach (such as retirement funding), the reality will undoubtedly generate much needed discussion. This conversation can turn into conflict if one side of a partnership is not in touch with family finances and family goals. Those who opt to avoid financial conversations will invariably find themselves in “money battles” that can seriously erode trust and faith in the relationship.

Facing major financial decisions, such as when, how and where to retire, needn’t be a source of discomfort or conflict. Far from it. If there is a reasonable process in place, the experience can be part of a shared life experience, an opportunity for optimism and mutual support.

I should add, in closing, that being single and unattached, doesn’t make you less susceptible to the stress imposed by major financial decisions like those discussed above. In fact, the “internal conflict” may be worse without someone to bounce things off of. If you are on your own, the same guidelines apply, but your “partner” in this is your trusted financial advisor.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Should you be a landlord in retirement?

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As you would expect, we often think about ways to supplement client retirement income and diversify a client’s finances beyond their market portfolio.

Owning one or more rental properties (commercial real estate) can provide a steady source of income and cash flow during retirement, with the added advantage of building owner equity (owner wealth). Once established, rental properties can also be a great resource to meet both planned and unexpected life events. And since they can be depreciated on your income tax, rental properties can provide a significant tax advantage while the asset actually gains in value. All this said, owning a rental property, let alone more than one, is not for the faint of heart. Without regular attention and constant re-appraisal, they can become a major headache and a huge liability.

The path to becoming a commercial real estate investor (a fancy way of saying “landlord”) often begins, innocently enough, with owning a single family home and then, for whatever reason, deciding to convert it to a rental. In this case, the property may need to be adapted in some fashion to accommodate renters. Others will approach a real estate agent with the deliberate intention of purchasing a rental property, in which case the property may be “turn key,” requiring little, if any, alteration. Whichever way you start out, the following are just some of the things you need to take into account before you commit to becoming a landlord in your golden years.

Commercial real estate requires at least 20%-30% down payment and an ongoing source of cash flow to fund expected and unexpected expenses. This means your equity will be locked in your property and only available through the available cash flow stream.

Real estate can be a great addition to an investment strategy, but rarely prudent as a sole investment. Unlike your portfolio, which will have fixed expenses, be liquid and globally diversified, your real estate will be impacted by local conditions with unexpected expenses and periods of poor liquidity. Expenses that are predictable include mortgage, taxes, landlord-specific insurance policies (both property and liability). Less predictable expenses are maintenance and repair costs as well as tenant related expenses. For those in control of their family cash flow, it is this difference that makes rentals a good consideration as a secondary investment and as part of their financial plan.

Like all investments it takes time and due diligence to generate a stable positive cash flow from rental properties – luck alone will not suffice. The price you set for rent is all important as are the expenses you incur. You need to be sure to cover your operating expenses which can include mortgage, property tax, insurance, maintenance, bookkeeping and accounting fees, utilities and if you use a management company you must also include their fee. In addition, the rent must provide you with a reasonable return based on cash flow, not just property appreciation, since you can’t sell the property to pay for ongoing expenses. The property must remain competitive with the local rental market and your cash flow able to cover expenses that may not be deductible in the year they are spent (a roof is an example of an expense that is depreciated and not deductible).

In addition to the financial considerations cited above, you will have legal obligations that are based on local laws and regulations pertaining to rental housing. A broken water pipe, furnace or refrigerator? Round-the-clock availability for emergencies is your responsibility. You can, of course, assign or pay for someone to take care of such things, but the legal responsibility will still be yours (always have sufficient liability and property replacement insurance). You are likely to be held liable for tenant or visitor injuries if due to unsafe conditions, especially in the common areas. Safety and habitability is paramount. On a regular basis, you must make sure structural elements are safe, the electrical, potable and wastewater infrastructure is sound, that trash containers are provided, that any known or potential toxins (such as mold or asbestos) are properly managed, that rodents or other vermin are kept clear off the premises.

However you come by your rental property, you will have to choose whether you should be your own property manager (directly overseeing and paying for maintenance yourself) or to take a more arms-length approach by contracting with a property management firm. Some clients hand these tasks to a family member who wishes to work part-time while others hand it over to a professional. A property manager can help those who wish to limit their day-to-day responsibilities, especially if you aren’t the handy sort or aren’t physically up to the task, but then you will have to cover the additional expense. Property managers, in simple terms, are hired to find tenants, maintain the property, create budgets, and collect rents. You will want to hire someone who knows about advertising, marketing, tenant relationships, collecting rent, maintenance, plus local and state laws in the location that you have the property. As the property owner, you can be held liable for the acts of your manager. It’s prudent, therefore, to hold the rental property in an entity that can provide some legal protection. Costs for contracting a property manager will usually run about 8% of rental income for management and about the same for engaging new tenants—this can eliminate your profit but if properly priced will provide you with a sustainable model well into retirement.

Finding reliable tenants is always a challenge, even if you employ a property manager. Tenants need to be able to pay their monthly rent, keep the property in good condition, and follow policies in the lease or rental agreement. You’ll find it easier to find good tenants if you select a property in an area experiencing low vacancies and high demand. Unfortunately, this means the property will also cost you more.

You should be prepared to have to deal with (or have someone deal with) evictions, wear and tear on your investment, unauthorized sub-lets, termination without proper notice, smoking, illicit drugs, pet odor and damage, parking and waste management issues, advertising, noise (including sometimes difficult neighbor relations), and other eventualities. Or, you can get lucky and find perfect long-term tenants! Realistically, as you age these tasks may become too stressful, eventually requiring you to hire a property management company or engage a (younger) interested and motivated loved one to take on this role. Either way, you must put this in writing as part of your purchase plan—including when you want this to happen, who this person should be, and finally, when the property should be sold.

During retirement some will love the ability to work part-time at managing their properties (even if only in a limited manner) whereas others will find it too complicated for their ideal retirement life. Invariably a well-managed property can generate ongoing income and create owner equity that will be a godsend in retirement or as an alternative to your market portfolio. Unfortunately for some, the process can become too complicated and stressful. So much so, that they avoid the tough decisions and derail their entire retirement plan. Being a landlord is very much an individual decision.

The bottom line is that rental property cash flow can generate a stable income during retirement, and can provide needed equity to fund contingency plans (such as disability, long-term care, health care needs, legacy) but profiting requires planning and annual review. It is a business that needs your ongoing attention or it will become a major liability. Even with the help of a property management firm, you may wonder in what way you can really consider yourself “retired” owning and managing rental properties.

Like any other financial investment, do your homework, and moreover, make sure it fits with your long-term financial goals and vision for a rewarding life.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Caregiving for a Parent or Elder Can be Rewarding

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As I read the latest survey which found Americans unprepared for the complex and unpredictable realities of longevity and caregiving, I thought about my own experience. In my case, planning with parents for their wishes has allowed for open and frank conversations that helped to develop trust and understanding. It provided a chance to resolve and express unspoken sentiments and a time to see parents/in-laws as peers. It was also a time for them to share life enriching experiences. In the process of helping them plan for their lifestyle choices and care, I learned something more about them, myself and my family. In my situation it allowed me to recognize how much value I place on having intellectual and meaningful activities.

It was interesting to read, in the survey of caregivers, (called C.A.R.E.—Costs, Accountabilities, Realities, and Expectations) that 60% said caring for two aging parents can be more demanding than caring for two children (ages 3-5). It also found that 66% said that the extra costs involved would have a large financial impact on them, and, perhaps more significantly, 38% said they had not planned for these costs. Most respondents believe the shortfall would be offset from cuts to discretionary living expenses, retirement savings, or from another source of income.

This survey is particularly worthwhile because it reveals a disconnect between the perception and the reality of caring for an elder. The perception is that caregiving is mostly about grocery shopping, cooking and laundry. Whereas, experienced caregivers know that although chores and emotional support play a large part, it is financial support and personal hygiene that are the most stressful and anxiety building aspects of caregiving. The lesson here is that you can best assist your parent or elder by pointing out this disconnect—help with chores is fine and may be necessary, but thinking through how caregiving will be financed and how their physical needs will be met is paramount to avoiding serious challenges.

As they plan their caregiving you should encourage them to agree on the signs that will be used to indicate it is time to seek further assistance with their finances and physical care. It is during these caring conversations about their wishes that you can volunteer ways in which you are willing and able to be of help (but only after you’ve examined your own retirement plan).

As the off-spring of a parent that raised a family, that may have managed a firm and made countless complicated decisions during their careers, it can be difficult to envision your mother or father sometime down the road when logging onto the Internet or even frying an egg seem onerous tasks. A key ingredient to helping them along is to examine honestly what lies ahead and plan accordingly. Encourage them to remain connected to family (they will benefit from increased meaningful contact with a loved one) and to build a fiduciary team for their physical, mental and financial wellbeing. With the right type of built-in support along the way, their retirement can truly be the “golden years,” an immensely satisfying and productive time.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Converting Sweat Equity to Personal Wealth

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If you are a small business owner, you’re probably familiar with the term “sweat equity.” Essentially, sweat equity is a measure of the added interest or increased value that you’ve created in your business through plain hard work (that is to say, through physical labor and intellectual effort). Typically, business owners just starting out don’t have the necessary capital or don’t want to hire a large staff to run the business or to purchase high-tech, so they put in untold extra hours, do much of the work themselves and try to “think smart” in terms of marketing or production. They often use this opportunity to develop a clientele and a business process they enjoy. If well designed it can be profitable, but at some point the owner must put in place strategies that can convert business profit into personal wealth.

In other words, to be considered a truly viable business, at least two things must happen (there are others, but for the purposes of this article we’ll just focus on two). One, you must evolve the business to the point where it is sustainable with only the amount of personal labor you want to dedicate and in a way that allows you to maximally build Owner Wealth while covering business cash flow needs. Moreover, the goal is a process that gives you a sense of accomplishment and satisfaction. This is what we call a “life-style” business. Or two, you must organize and prepare the business to a degree or footing that it can be sold for a profit, at least enough and in a manner that will allow you to retain the profit as personal or “Owner Wealth.”

I should note, for those who are not self-employed, that employees can also generate sweat equity for their firm by creating additional ways to increase the bottom line. For startups, you may defer your vacation and even put off earnings. All these things add value to the company, but employees will expect to receive some form of compensation either in the form of existing benefits (bonus, parental leave, or nonqualified plans) or in shares of company value.
As a business owner, the first question you must ask yourself is “What do I want my life to look like while I’m creating this equity, and what do I want to accomplish in the long term?” Once you answer this question, and only then, can we come up with a proper plan to support your direction.

It is our experience that business owners without such a plan likely encounter challenges that can undermine their ability to convert their equity to personal wealth. These challenges come either in terms of selling the business or ensuring that the life-style business is sustainable. For instance, there is a good chance that instead of generating wealth to your maximum potential, you’ll be funding Uncle Sam (and the California Franchise Tax Board) and coping with cash flow problems.

Presupposing your business is already generating profits, a well-tailored plan can (at least potentially) make a big difference in terms of retaining or accumulating Owner Wealth. Aside from using earnings to support current lifestyle, your business can create benefits that permit the owner to retain earnings for future use and reduce current tax liability, particularly important in California, where the tax liability on business owners with profitable business can exceed 50% of their business profit.

For example, a business owner with sweat equity from their start-up or life-style business that yields around $500K per year (after business expenses) might have a tax liability of $110K (IRS only) or $155K in California (see table below). Using available benefit tools/strategy an owner can (in this scenario) build wealth annually of about $230K. Much of their wealth is built from deferring taxable income and lowering their tax liability to $45K (or $70K within California).

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Allowed to grow over 5, 10, or 20 years this strategy could (at a conservative 5% annual return) yield wealth of $1.3M, $2.9M and $7M respectively for the business owner. On its own, tax and benefit planning can yield a high conversion of sweat equity to Owner Wealth.

When starting a business, the last thing we ever think about is how we’ll exit from it and collect on all the hard-earned sweat equity we’ve invested. We’re usually focused on creating value and determining how we can generate sufficient earnings. Yet for some businesses it is only from a well-designed and planned sale that the owner will realize any personal wealth from their risk and hard work. For the owner of a life-style business, selling your firm may seem akin to selling off your first-born, but there comes a time in all our lives when such decisions are unavoidable, even advantageous. At the very least, it may be worth considering selling part interest in the business as a way of reducing workload and simultaneously augmenting Owner Wealth.

As an owner ready to sell you will want to be confident that you are choosing the right time, securing the best price, and structuring the transaction wisely. You’d be well advised to seek expertise in selling your business (particularly new entrepreneurs), and give plenty of thought to how it will impact Owner Wealth, which is all too often overlooked.

When considering how to exit from their business, entrepreneurs need to at least follow these 7 steps to maximize Owner Wealth.

  1. Plan your exit well in advance since the best fit team and solution may take time to identify and develop.
  2. Understand and acknowledge your emotional connection to the business. It can be deeply personal and leave you unsatisfied if not fully addressed – regardless of profit.
  3. Prepare the business for the sale so that it is financially attractive to the financial advisors of potential buyers.
  4. Choose experienced individuals in your specific type of business to guide you through the process of selling your business BUT include your personal advisor to ensure that the best exit also meets with your personal financial goals. Again, building a team that is right for you.
  5. Think clearly about family succession – don’t make assumptions on how your family or key employees feel about the business.
  6. Gauge the interest for a friendly buyer from co-owners, family, employees, vendors, and even customers.
  7. Develop a thorough wealth strategy plan. The wealth strategy plan should NOT be just about the business but should address how your efforts will be used to build your personal wealth and meet your personal goals.

Take the time to know yourself, know your goals and make absolutely sure your financial advisor has a clear picture of your objectives. Together, your plan will convert all that valuable sweat equity into wealth to fuel your dreams.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com