Taxable Investing

As the name suggests, taxable investing is the process of investing assets whereby gains, losses and income will be taxed in the year received. The goal of investing taxable funds is to maximize the after-tax return earned by those funds. Tax-aware investing adds an additional layer of complexity and oversight to ensure any tax due is minimized as much as possible. Having said that, investors must be cautious when making investment decisions based on potential tax consequences rather than investment reasons. There is no benefit from not selling a security with a large gain because taxes will be due only to see that investment turn to a loss as the investment rationale disappears.

As you can see from the example below, taxes can have a significant impact on returns. Depending on whether the security is sold for a short-term or long-term gain or loss, a 25% pre-tax return can be lowered to 16.25% or 21.25%. A loss has similar effect while a net 5% portfolio gain turns into 3.75% after-tax. Eunoia works with you to make sure we achieve the best possible after-tax return for your portfolio and your situation.
 

Qualified Investing

Qualified investments are specific account types which are defined by the IRS. Largely, they exist in order to assist in the building of savings for retirement, and more recently, college. With a qualified plan, you receive an upfront tax deduction (or reduction) now, but will have to pay taxes on the entire amount in the future, or when you begin withdrawing. With accounts geared toward retirement, Required Minimum Distributions (RMDs) are due by age 70 ½ at the latest, although you can begin withdrawing funds by age 59 ½ without incurring a 10% penalty. College savings plans, designated as 457 plans, are called nonqualified, but they are technically tax-advantaged deferred compensation plans, which are similar to qualified plans.

The most common qualified plans are;

When investing qualified investment assets many make the mistake of taking extraordinary risk in the hopes of making extraordinary gains while they work their way toward retirement. The hope, they reason, is that this additional risk will reap additional gains, which will in turn, make their retirement come sooner or be more lavish when it comes. While the logic is laudable and the outcome plausible, we must be vigilant with our hard-earned assets at all times and make sure that we are not unnecessarily gambling with our future.

Eunoia Financial does not accept that taking high risk at all times is the best long-term strategy. History has shown that markets periodically, and for specific reasons, become overly extended and suffer dramatic losses. Eunoia believes it is in these times that a lower risk profile can reap large rewards. After all, gaining 100% followed by losing 50% puts you right back where you started. In this scenario, Eunoia would prefer to gain 75% through lower risk investments and lose 25% doing the same, for a full-cycle gain of 31%.
 

 
Additionally, Eunoia Financial believes a comprehensive investment plan, which incorporates the risk and reward profile of qualified accounts, is the most responsible investment plan.

401(k) and Other Company Plans

While 401(k)s are widely known and used, other types of company plans offer similar benefits. Most accept pre-tax income contributions and can be matched, or partially matched, by employers. Depending on the plan, there are limits to the employee contributions as well as the employer matching contributions. Companies may also limit their contributions more than the legal limits as well.

The most common mistake people make with these plans is to limit their own contributions to the minimum amount necessary in order to gain the maximum contribution amount from their employer. For example, a company might match a maximum of 100% (up to 3% of income) of an employee’s contribution into the plan. Thinking that they will then save 6%, the employee commits to a 3% self-contribution. While the math is accurate, there is nothing preventing the employee from saving more, and in nearly every case, should do so. A 6% self-contribution, with a 3% company match, saves 9% of income. The difference between these two savings rates adds up over time.

For example, if we assume a worker begins saving 6% and 9% of a $100,000 income at age 25, earns an average 2% raise each year, and earns 8% average investment returns – after 41 years of working (when he/she will turn 65), saving 6% grows to $2,121,028 while saving 9% grows to $3,181,542.

If that’s not convincing enough, 2% raises of $100,000 after 41 years means this worker will earn $220,804 upon retirement. Replacing that income through savings requires a 10.4% return in the 6% contribution scenario, while it only requires a 6.9% return with the 9% scenario. Meaning, one can maintain their standard of living during retirement through prudent investing after saving 9% per year while the person saving 6% has to either lower their standard of living, or invest more aggressively to achieve the same standard of living while retired. For better or worse, numbers just don’t lie. Saving more now can only be a good thing.
 

Self-Employment Plans

If you own your own company, part of a company, or work for a small company, you may have an option to contribute to a self-employment plan. These are similar to company sponsored plans like a 401(k) but often allow higher contributions. Despite the constant need for investment, and re-investment in your business, Eunoia encourages those in this situation to “pay themselves first” and make regular contributions to their savings plan.

IRAs

IRAs, and similar, are not sponsored by a company and do not earn any matching contributions. Accounts of this type were designated by the government to help those not working to also save for retirement. The stay-at-home mother, early retiree or student are oft-cited examples. Like employment, or self-employment plans, people whose situation allows for IRA investment should do their best to maximize contributions.

Pension Plans

The original retirement savings plan, pension plans are wholly funded by the company or organization. Today, pension plans are mostly offered to local, state or federal employees as companies have opted for different plans. Largely this is due to the wholly-funded nature of the plan. Most employers don’t want to contribute the necessary funds for their employee retirement. Also, in many high-profile examples, companies have raided the pension plans of their employees for various purchases or expenses, leaving the employees a note due rather than actual cash in their plan. Employees therefore have grown un-trustful of pension plans and whether the funds will actually be there for them during retirement. Most prefer accounts in their names and untouchable by management.

Annuities

An annuity is an insurance product that pays out income and can be used as part of a retirement strategy. Annuities can be a popular choice for investors who want a steady source of income during retirement (or another period). With an annuity, you make an initial investment and in return it makes payments to you on a future date or series of dates. The income you receive from an annuity can be doled out monthly, quarterly, annually or even in a lump sum payment. The size of your payments are determined by a variety of factors, including the length of your payment period. You can opt to receive payments for the rest of your life, or for a set number of years. How much you receive depends on whether you opt for a guaranteed payout (fixed annuity) or a payout stream determined by the performance of your annuity’s underlying investments (variable annuity).

While annuities can be useful retirement planning tools due to their guaranteed payouts, they can also be a lousy investment choice for certain people because of their notoriously high expenses. For this reason, while exceptions can be made for specific situations, Eunoia Financial will be hard-pressed to recommend an investment in an annuity for any client… ever.

Private Equity and Venture Capital

Private equity and venture capital are non-liquid, or low-liquid, investments. Private equity focuses on buying, owning and running entire companies while venture capital is typically focused on partnerships with start-ups to help fund growth. Either way, funds are raised using a pooled investment vehicle specific to the particular purpose. Each investor owns a percentage of the pool and will earn payouts over time or in one lump sum if/when the company is sold. Due to the low liquidity and riskiness of some of these ventures, returns can often be quite high. However, the potential risk can also produce negative returns or in the extreme case, be an entire loss as the company’s strategy or product does not pan out and eventually goes bankrupt. Due to the low liquidity and extreme return potential, Eunoia believes these investments should be considered supplemental to a more stable investment plan and only done with funds not necessary for regular expenses.