3 Rules to "Rig the Game"

Photo by Dave Gough

“The game is rigged.”

Anybody remember Merrill Lynch CEO, David Komansky, publicly apologizing back in 2002 for Merrill’s analyst, Henry Blodget, publicly hyping a stock called “Infospace,” while privately referring to it as a “piece of junk”? Then NY Attorney General Elliot Spitzer said, “This was the way things worked at Merrill Lynch.”

“The house always wins.”

Dozens of leading brokerage houses, including Bank of America, Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley, Wachovia Capital, Wells Fargo, UBS, and others collectively paid hundreds of millions of dollars in penalties for their roles in defrauding investors through misconduct that led to or arose from the 2008 financial crisis. The transgressions included concealing from investors the risks, terms, and improper pricing of complex structured products and/or making misleading disclosures to investors about mortgage-related risks and exposure.

“They don’t build those big buildings on Wall Street on winners.”

In 2014, ten of the biggest brokerage firms payed $43.5 million dollars in fines according to FINRA.org, “for allowing their equity research analysts to solicit investment banking business and for offering favorable research coverage in connection with the 2010 planned initial public offering of Toys"R"Us.”

At times, it can seem that the fat cats have stacked the deck against the average investor. However, if you follow a few simple rules, you can swing the odds in your favor in spite of so many of the brokerage companies putting profits ahead of their customers.

Rule #1 - Have a long-term perspective. Imagine you were a recent college graduate in December 1972 and you received congratulatory gifts totaling $1000. Avoiding the temptation of applying your windfall towards a new car with an average price of $3200, you are able to invest the entire amount in the S&P 500® index. That wasn’t actually possible then, nor is it now, but we’re imagining. Vanguard was still a couple of years from opening their doors, so you probably couldn’t have even approximated this feat without incurring substantial commissions or sales charges, but for the sake of imagination let’s pretend that you could.

Here is how your hypothetical $1,000 investment made on 12/31/1972 would have looked at the end of subsequent years, along with what may have been some typical thoughts:

1973  $853    “I knew I should have waited.”
1974  $627    “I wonder if I’m the only fool still invested in stocks?”
1975  $860    “I should have bought a car!”
1977  $990    “I could be earning 10% a year in CDs!”
1982  $1,913 “Time magazine said stocks are dead?”
1992  $8,509 “I’m glad I didn’t put it all in CDs!”
2002  $21,107 “The bubble has burst!”
2008  $23,769 “How much have we lost this year?”
2012  $42,082 “Glad I didn’t panic in 2008!”
2014  $61,400 “I am an investing genius!”

You should know that the past can’t predict the future, and that expenses and taxes would have led to these results being somewhat lower, but this is a powerful example of the benefits of patience and compounding.

Rule #2 – Keep it simple. “Listen, here’s the thing. If you can’t spot the sucker in your first half hour at the table, then YOU are the sucker,” said the character, Mike McDermott in the 1998 film, Rounders. The investment industry thrives on selling products that are profitable to them and confusing to you. If it sounds too good to be true, it probably is.

Similar to advice suggesting you stop smoking, exercise more, and eat your vegetables, we practice and preach diversification, keeping costs down, and disciplined rebalancing. If someone is pitching an approach much more complicated than that, start looking for the sucker at the table.

Rule #3 – Be courageous. Warren Buffet famously shared, "I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy." To muster the necessary courage to follow this advice, it can be helpful to remember that courage is only possible if you are scared.

Comprehensive financial planning coupled with psychometric risk profiling can help you better understand what may be necessary to achieve your goals, from a resources as well as a risk perspective. That’s why we offer these services to all ATX Portfolio Advisors’ clients.

There is no certainty year to year that any investment approach will beat another, but by following these three rules you can “rig the game” in your favor, no matter what junk the fat cats are peddling this year.

It’s Not Just Holiday Season

Photo by Diariocritico de Venezuela

We’ve all seen the videos of throngs of bargain seekers battling it out for the cheap TV or gaming consoles. People camping out on the sidewalks outside of big box stores have become an annual staple of the news after the Cowboys game on Thanksgiving. Black Friday and Cyber Monday represent the start of the shopping frenzy that is so important to retailers’ bottom lines, otherwise known as the holiday season.

But this past Tuesday also marked the beginning of another hectic but important time, for philanthropy. Per GivingTuesday.org , “Observed on the Tuesday following Thanksgiving (in the U.S.) and the widely recognized shopping events Black Friday and Cyber Monday, #GivingTuesday kicks off the charitable season, when many focus on their holiday and end-of-year giving.”

The most recent figures from The Chronicle of Philanthropy shows that in 2012 the Austin metro area contributed $1,216,197,000 to charity, which was about 2.7% of our Adjusted Gross Income (AGI). Many of us wait until December to even think about our charitable plans for the year. Whether it’s the spirit of the season or tax deadlines that motivate our altruism, there are often overlooked ways to effectively increase the amounts we give and/or the tax savings we receive.

A 2005 US Treasury paper, Basic Facts on Charitable Giving, revealed that about 76% of charitable gifts occur in the form of cash. If that’s the case, donors and charities alike may be being shortchanged by HOW most of this giving occurs.

When the urge to give hits, you can effectively give more to your causes if you look to your brokerage accounts instead of your checkbook. The increase is made possible due to the way gains on appreciated property, such as a stock or mutual fund, are treated. Typically, profits are subject to capital gains taxes (and in some cases a Medicare surtax) when the security is sold.

But when you give the property directly to a charity, not only are you entitled to a tax deduction for the fair market value up to 30% of AGI, you also won’t be on the hook for the capital gains tax on the appreciation (up to 20% on securities held > 1 year) or the Medicare surtax (3.8%).

So why don’t more folks take advantage of this? I asked some local charities for their thoughts.

The Eanes Education Foundation, supports the local school district where my children attend middle and high school. I asked Executive Director, Wally Moore, if they have a preference of cash versus property donations. His response was, “We love to receive the gift in the form that the donor likes to make it. We know as a fundraising organization that it’s important to offer a variety of ways for our donors to support us. It is worth noting that the gifts that we receive of appreciated assets are well above our regular average gift.”

He did point out, however, that there are some gifts that they may not be as well equipped to handle. Real estate, restricted stock, business interests, mineral rights, and even life insurance policies were examples of assets that smaller charities may lack the infrastructure or expertise to liquidate or deal with the compliance with various IRS regulations and laws.

This is where a Donor Advised Fund (DAF) can provide an ideal solution. A DAF, is a philanthropic vehicle established at a public charity. Donors make a charitable contribution, receive an immediate tax benefit, and then recommend grants from the fund over time. The DAF liquidates the property and manages the assets until the donor makes a grant recommendation.

A DAF can be thought of as a charitable savings account where you make contributions when you have the desire or need, such as a high income year or prior to liquidating a highly appreciated asset. You then can determine what causes you want to support later, or do so at a level or pace that is not dependent on year to year changes in your financial situation.

Austin Community Foundation is a public charity in Austin which grants more than $20 million annually, mostly through DAFs, to charities in Austin and beyond. I reached out to CEO, Mike Nellis, for his perspective.

“For people who want to give to local emerging needs and join a community of givers, Austin Community Foundation may be the perfect giving partner,” says Nellis.  “Individuals, families and companies can open a donor advised fund in order to gain tax benefits this year—but don’t need to choose which charities they wish to give to until later. We also can accept gifts of complex assets that some other charities can’t. Some families also enjoy using their donor advised fund as a way to share their philanthropic values across generations.”

According to their website, those complex assets include stock, real property, life insurance, retirement plan assets, closely held securities, tangible personal property, and other non-liquid assets.

DAFs are also offered at most major investment companies. Costs and features can vary, so it is wise to shop around or consult with an advisor with experience in incorporating philanthropy into your gift and estate planning. If you anticipate a liquidity event or have other unplanned wealth that you would like to discuss how to manage, let’s get acquainted. No camping out required.