Tips for Preventing Fraud

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You can also have an impact on safeguarding your information and assets by following these guidelines and applying caution when sharing information and executing transactions. This checklist summarizes common cyber fraud tactics, along with tips, best practices, and actions to take if you suspect a breach.

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THE BENEFITS OF
INTERNATIONAL DIVERSIFICATION

Investing in stock markets across the globe offers exposure to a broader range of economies, industries, and sectors than are found in the US market alone. As the saying goes, however, there’s no such thing as a free lunch. The diversification that’s provided by investing internationally often helps over the long term, but there’s no guarantee that these benefits will materialize in any specific period.

A striking example of a period of time when international diversification helped tremendously was during what is often called “the lost decade” for US equities. Pictured in Figure 2, US stocks generated virtually no returns during this ten year stretch from 2000 through 2009, while international markets delivered solid gains. A portfolio consisting only of domestic US equities during this time period would’ve suffered heavily.

In addition to the diversification provided by investing in the largest international developed countries, emerging markets offer access to fast-growing economies that tend to have lower correlations with the US market. Although emerging markets can be more volatile, they also have the potential for higher returns, which, when combined with US and international developed stocks, can help reduce overall portfolio risk.

These diversification benefits can come with a price tag from time to time, however. For the ten years ending September 30th, the US has outperformed International Developed and Emerging Markets indices. Much of this underperformance can be attributed to the dominance of US mega-cap technology stocks, such as the Magnificent 7, which have driven much of the US market’s growth.

Despite the recent lag in International and Emerging Market stock performance, they remain vital components of a well-diversified portfolio. By maintaining exposure to a broad range of markets, investors can better navigate periods of US market underperformance and benefit from the growth of economies outside the US.

‘Uncertainty is underrated’:
Here’s the real reason markets reward
those who stick around

By David Booth
June 24, 2024

David Booth is the founder and chairman of Dimensional Fund Advisors. This article is not intended as investment advice.

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Given all that is going on in the world, investors have questions. Will the Federal Reserve cut interest rates, and if so, by how much? Who will win the U.S. presidential election, and will it impact markets? How will global events affect my family and finances? A lot remains uncertain, which can naturally make investors uneasy.

For many people, uncertainty is something to avoid or at least mitigate. People often talk more about the downside to uncertainty than its upside. There’s even a term, loss aversion, that reflects how a loss can feel more painful than a gain of an equal amount can feel rewarding.

However, I have a different view: Uncertainty is underrated. Without it, there would be no surprises, no joy in watching sports, and no 10% average annualized return on the stock market over the past century.

All investments involve risk—there is no guarantee of success. Investors can be rewarded for taking on the risk of not knowing exactly how things will play out. If there was no uncertainty, returns would be predictable and there would be no difference between putting your money in a savings account and investing it in the stock market.

Th ink back to the beginning of the pandemic. At the end of March 2020, the S&P 500 Index was down nearly 20% for the year. Yet investors who stayed in the market were rewarded. At the end of 2020, the S&P 500 Index was up 18.4% for the year, a 38% turnaround from its March lows. March 2020 was a scary time for almost everyone. No one knew what was going to happen. Yet even in those dark moments, I had faith in human ingenuity. When people are met with challenges, they are resilient and work to solve them. Companies are no different. Investing in the stock market means investing in the power of human ingenuity to adapt and innovate.

Because of uncertainty, life is one cost benefit analysis aft er another, and we have no choice but to manage risk. At the extremes, some people may try to completely ignore risk, while others might try to eliminate it. Most of us fall somewhere in the middle.

We manage risk with our health, work, family, and just about every other aspect of our lives—including investing—because while few things are certain, we still have to make decisions big and small. For example, we can’t control the weather, but we can carry an umbrella if it looks like it might rain. And while we can’t predict stock market returns, we can manage the risk in our investment portfolios.

What to avoid

One way of managing risk is to eliminate some of the things you shouldn’t do. When you want to improve your health, you might eliminate fried foods, soda, and sweets from your diet, which can increase your chance of a healthier outcome. It’s the same with investing. Eliminate bad habits, like attempting to predict the unpredictable by trying to time the market or pick winning stocks.

Think of everything that has happened in the past 25 years, including:

• The dot-com bubble.
• 9/11.
• The Global Financial Crisis
  and Great Recession.
• The COVID-19 pandemic.

It would be natural to want to time when to exit and re-enter the market. To put the implications of doing so into perspective, consider a hypothetical $1,000 investment in the Russell 3000 Index made at the beginning of 1999. This turns into $6,449 for the 25 years ending Dec. 31, 2023. Over that same period, if you missed the Russell 3000’s best week, which ended Nov. 28, 2008, the value shrinks to $5,382. Miss the three best months, which ended Jun. 22, 2020, and the total return dwindles to $4,546. See what I mean?

What to do

Positive ways of dealing with risk can help you potentially capture the benefits of what scientific research has shown us. With health, that means exercising more, getting regular checkups, and eating more fruits and vegetables. With investing, that means ensuring our portfolios are diversified across regions and asset classes. While it doesn’t guarantee making a profit or averting a loss, diversification allows us to reduce our risk while potentially capturing the returns of the market.

Since we know risk is unavoidable—and it’s the source of investment returns—you want to find the amount of risk that is right for you. For example, Treasury bills are considered a relatively safe investing asset whose prices don’t fluctuate as much as stock prices. However, Treasurys have provided, on average, a lower return than the stock market. Those tradeoffs can be weighed against your specific needs and preferences, and it’s always good to be prepared for a range of outcomes. The more committed you are to a philosophy and a plan you can count on when you are experiencing the ups and downs of uncertainty, the more likely you are to succeed as a long-term investor.

You are already better at this than you think.

You know more about investing than you think you do, because investing is all about risk and reward, just like every other part of your life. In investing and in life, some years are better than others, but the important thing is to be able to persevere so you’re ready for what comes next. That’s why I see uncertainty as a positive force and have faith in the ability of people to find better ways to manage risk. I’ve worked with thousands of investors during my five decades in finance and seen how, when they manage risk better, they live a better life. Instead of trying to predict your future, plan, adapt, and figure out the most sensible solutions for you.

You may not only be underestimating uncertainty—you may also be underestimating the positive impact of embracing it.

Figure 1

STUDIES ON STOCK CONCENTRATION

NEW TAX SAVING STRATEGY

TAKES OFF

While both death and taxes remain inevitable, our new tax-saving strategy can help delay at least one. We have been using individual stock portfolios to aggressively harvest tax losses for some 20 years (the strategy has just recently made its way to the mass market under the moniker “Direct Indexing”). Our new Flex strategy, which we began to roll out at the beginning of this year, represents the latest and most advanced effort to maximize after-tax returns. Unlike previous strategies that involve swapping stocks when they fall below their original cost basis, Flex takes tax loss harvesting to a whole new level.

By using margin and shorting (which may sound intimidating), we buy favorable stocks and short less favorable stocks. Definitionally, we benefit when stocks we’re long go up in price and when stocks we’re short go down in price. Thus, we’re able to capture losses whether stocks go up or down and later use them to offset capital gains which reduces our ultimate tax bill.

Figure 2 compares the live results of this strategy to the target US market return of the Russell 3000 and even shows the tax benefits. Results will vary, but Flex can significantly benefit clients with liquidity events (think the sale of a company or property), minimize portfolio capital gains taxes, and enhance the effectiveness of charitable giving. Although this strategy is not appropriate for all clients, in the right situation it’s designed to significantly reduce yearly tax bills.

Figure 2

DESIGNED TO PERFORM BEFORE AND AFTER TAXES
Flex 145 All Cap Equity Composite Net of Fee Performance, as of March 31, 2024

Tax Smart Strategies for Account Withdrawals

Understanding the best way to tap your IRAs and other accounts
can help you preserve your savings and lower your tax bill.

By Sandra Block
June 19, 2024

One of the upsides of retirement is that for the first time in years, you have control over your time. If you want to spend the afternoon watching Bonanza reruns, well, no one is going to stop you.

Retirement also gives you more command over your money. While you’re working, you have limited control over how often or how much you’re paid, which limits your ability to lower your taxes. But if you’re drawing retirement income from a combination of different types of accounts, you can control not only the amount you withdraw but also the sources of those withdrawals — and that could have a big impact on your taxes now and in the future.

Conventional wisdom has long held that retirees should take money from their taxable brokerage accounts first, followed by traditional IRAs and other tax-deferred accounts, with Roth IRAs and Roth 401(k)s coming last. The logic behind this strategy is that it gives your tax-advantaged accounts more time to grow. Money in tax-deferred accounts isn’t taxed until you take withdrawals, and withdrawals from a Roth are tax-free as long as you’re 59 1/2 or older and have owned the account for at least five years.

But in recent years, some retirement experts have questioned whether this is the most effective way to lower taxes on your retirement income and preserve your savings for your later years. Postponing withdrawals from your tax-deferred accounts could eventually lead to large, taxable required minimum distributions (RMDs currently start at age 73).

And since those withdrawals are taxed at ordinary income tax rates, which range from 10% to 37%, large distributions could push you into a higher tax bracket and trigger Medicare high-income surcharges, says Wade Pfau, professor of retirement income at the American College of Financial Services and author of Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success.

Roger Young, a certified financial planner and thought leadership director for T. Rowe Price, agrees. The conventional withdrawal sequence “bunches a lot of taxable income in the middle period, where pretty much all of your income is taxable,” he says.

Retirees who have a mix of accounts could generate income more tax-efficiently by withdrawing from a combination of taxable and tax-deferred accounts, as well as making strategic conversions to Roth accounts, while remaining in a low tax bracket, Pfau says. One way to accomplish this goal is to withdraw enough from your taxable accounts to cover spending needs and income taxes. After that, calculate how much you can withdraw from your tax-deferred accounts and convert to a Roth while remaining within your desired tax bracket.

In 2024, a married couple who fi les jointly can have up to $94,300 in taxable income and fall within the 12% tax bracket; for singles, the cutoff is $47,150. These thresholds are close to the points at which taxpayers can qualify for a 0% tax rate on long- term capital gains and qualified dividends (assets held for more than a year are subject to rates for long-term gains). In 2024, the 0% rate applies to capital gains and qualified dividends for singles with taxable income up to $47,025 and married couples with joint taxable income up to $94,050.

Taking strategic withdrawals from a mix of taxable and tax-deferred accounts while remaining within these thresholds provides two benefits. You’ll pay taxes on your tax-deferred withdrawals at a low rate and reduce the size of those accounts, which will shrink your RMDs. You may also qualify for the 0% capital gains rate on income from your taxable accounts.

Meanwhile, you’ll pay taxes on conversions from a traditional IRA to a Roth at a low rate, which will increase the amount of tax-free income you’ll have available in later years. Ideally, you should use assets from your brokerage or other taxable accounts to pay taxes on the conversions, Pfau says.

If you postpone Roth conversions until you’ve depleted those accounts, you may have to use funds from your IRA to pay the tax bill. That’s not the end of the world, he says, because you’ll still benefit from having future tax-free income (and if you’re 59 1/2 or older, you won’t pay a 10% early-withdrawal penalty on those distributions). But it reduces the amount of money you’ll be able to invest in the Roth.

Taxes on Social Security

Converting funds in your traditional IRAs to a Roth can help reduce your taxable income later in life because, ideally, a large percentage of your withdrawals will come from your Roth. This will help you avoid what Pfau calls the Social Security “tax torpedo,” which occurs when up to 85% of your benefits are taxed.

The formula for calculating tax on Social Security benefits is based on what Social Security defines as your provisional income (sometimes referred to as combined income), which is based on half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, including withdrawals from traditional tax-deferred accounts; dividends, interest and capital gains from taxable investment accounts; and interest from municipal bonds.

If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50% of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85% of your benefits will be taxable.

These thresholds aren’t adjusted for inflation, which means the percentage of retirees who pay taxes on their benefits has increased dramatically since the tax was signed into law more than 30 years ago. More than half of retirees pay taxes on a portion of their Social Security benefits, according to the Center for Retirement Research at Boston College.

Withdrawals from a Roth aren’t included in your provisional income, so increasing the size of your Roth accounts through strategic conversions can help lower taxes on your benefits. If you’re able to delay filing for Social Security until age 70, which will maximize the amount of your monthly payouts, you’ll have more time to reduce the size of your tax-deferred accounts and convert some of your funds to a Roth, T. Rowe Price’s Young says.

Charitable Giving

If you plan to give funds in your tax-deferred accounts to charity, you may not need to accelerate certain withdrawals as much as you would otherwise.

One strategy that can reduce your RMDs — and your tax bill — is to make qualified charitable distributions (QCDs), which are donations made directly from your IRA to qualified charities. You can make a QCD as early as age 70 1/2, but when you reach the age at which you’re required to take distributions, the charitable distribution will count toward your RMD.

Although a QCD isn’t deductible, it will reduce your adjusted gross income, which will in turn reduce the provisional income used to calculate taxes on your Social Security benefits. In 2024, you can donate up to $105,000 directly from your IRA to a qualified charity.

Alternatively, if you’re worried about giving away money you may need for long-term care or other late-in-life expenses, you can leave funds in your IRA to charity. The charity won’t have to pay taxes on the money, and you can leave more tax-friendly assets to your heirs. But this won’t absolve you from taking RMDs and paying taxes on those withdrawals while you’re still alive.

Your Estate and Taxes

Shifting more of your assets to Roth accounts won’t just lower your taxes in your later years. It could also benefit your heirs if they end up inheriting money in those accounts.

Under the SECURE Act of 2019, most adult children and other non-spouse heirs who inherit a traditional IRA or other tax- deferred account from an owner who died on or after January 1, 2020, have two options: Take a lump sum and pay taxes on the entire amount, or transfer it to an inherited IRA and deplete the account within 10 years of the death of the original owner.

Depending on whether the original owner was taking RMDs when he or she died, the heirs may also have to take yearly withdrawals based on their life expectancy, which could mean paying taxes during their highest-earning years. (Spouses still have the option of rolling inherited IRAs into their own IRAs.) Because of confusion about the rules, the IRS has waived the RMD requirement for non-spouse heirs the past few years and is doing so again for 2024.

The 10-year rule also applies to inherited Roth IRAs, but heirs aren’t required to pay taxes on the withdrawals or to take RMDs. That gives them plenty of flexibility, including the ability to wait until year 10 to deplete the account, thereby taking advantage of more than a decade of tax-free growth.

If you have a large brokerage account with significant appreciation, you may want to consider preserving some of those assets for your heirs. Under current tax law, inherited investments receive a “step-up” in their cost basis to the current fair market value when the original owner dies. If your heirs turn around and sell those investments right away, they won’t pay tax on any gains, no matter how much the investments have increased in value since you purchased them.

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance.

Do Elections Impact the Stock Market?

Politics and economic prosperity are much less connected than the press might have you believe. As the 2024 presidential election looms large, investors often contemplate its potential impact on financial markets.

As with every investment, it’s useful to take a look at the historical data. Analysis reveals a compelling pattern: the S&P 500 has delivered positive annual returns in 20 out of 24 presidential election years from 1932 through 2020. As seen in Figure 1, regardless of the political affiliation of the incoming administration, markets have historically rewarded disciplined investors over the long term, underscoring the disconnect between political party and investment performance.

While the political landscape may shift, the fundamentals of sound investing remain steadfast. Rather than being swayed by short-term fluctuations, investors are encouraged to adopt a rational approach, anchored in empirical evidence. As the countdown to November 5 begins, let us remain constant in our knowledge that whichever party presides over the Capitol, markets will continue to function as they always have.

Figure 1

THE MARKET AND US PRESIDENTIAL ELECTIONS
Hypothetical Growth of $1 invested in the S&P 500: January 1926-March 2024

Nobel Laureate Daniel Kahneman Left An Important Message On Market Psychology

By Hersh Shefrin
April 8, 2024

The late psychologist Daniel Kahneman had an important message for investors, analysts, and economists: Be careful when you treat the market as if it were a person.

Kahneman, who passed away this past March, was a Nobel laureate in economics. He received the accolade in 2002. That year, he also
gave a presentation at Northwestern University, and discussed investors’ tendency to personify the market. Below are excerpts from that event.

Kahneman: Does The Market Have A Psychology?

This talk is meant to be about psychology and the market.

If you listen to financial analysts on the radio or on TV, you quickly learn that the market has a psychology. Indeed, it has a character. It has thoughts, beliefs, moods and sometimes stormy emotions.

The main characteristic of the market is extreme nervousness. It is full of hope one moment and full of anxiety the next day. It often seems to be afraid of economic good news, which make it worry about inflation, but soothing words from the chair of the Fed make it feel better.

The market is swayed by powerful emotions of like and dislike. For a while it likes one sector of the economy, but then it may become discouraged, suspicious, and even hostile.

The market is generally quite active, but occasionally it stops to take a breather. And sometimes it catches its breath and takes profits. In short, the market closely resembles a stereotypical individual investor.

Kahneman: What Accounts For The Tendency To View The Market As A Person?

The tendency to ascribe states of mind to entities that don’t have a mind is a characteristic of an early phase of cognitive development, as when a child says that the sun sets because it is tired and going to bed. And we can recognize it in ourselves as grown-ups: when I play Snakes and Ladders, it is sometimes hard to avoid the impression that this green object is full of energy, whereas the yellow one is a bumbling mess that will never get anywhere.

Why do adults engage in this kind of animistic thinking about the market? What does it do for them? I am arguing, of course, that this thinking happens automatically. But it also has a function, as a way of making sense of the past, which creates an illusion of intentionality and continuity. I am using intentionality here as philosophers do, to denote beliefs as well as desires.

The personification fosters an illusion of predictability. The point is that intentional interpretations of behavior generate expectations of future behavior. And it is a psychological fact that the tendency to produce such expectations will persist indefinitely, even if they are reinforced on a strictly random schedule.

Kahneman: Does The Theoretical End Justify The Theoretical Means?

Analysts are not the only ones who think of the market as a person. People who write models with representative agents obviously do something of the same general kind. Some of my best friends have written such models.

As a psychologist I have always liked these models, especially when they are written in a language I understand.

But this is an instance in which my friends do something that they oppose and even ridicule in other contexts. They make assumptions that they know are not true, just because these assumptions help them reach conclusions that make sense.

In fact, of course, agents are not all alike and the differences among them surely matter.

Realism will be improved by having two types of agents, with different psychological makeups.

Kahneman: How Do Institutional Investors and Individual Investors Compare?

If I have time, I will speculate in a completely irresponsible fashion about possible similarities and differences between individual and institutional investors.

We know from Terry Odean’s famous result that individual investors pay about 3.4% plus transaction costs whenever they have a significant idea about changing their portfolio. It seems plausible that there is someone on the other side of these transactions, and likely that these are institutions.

Terry and Brad have begun to investigate some plausible hypotheses about differences in the trading behavior of individuals and institutions.

They seem able to do very well without any real inspiration from psychology, but I think that an effort to find out which psychological principles that describe representative individuals also apply to representative institutional investors, is very worthwhile.

I should report on preliminary results from research I undertook by taking Burt Malkiel to lunch. He actually does not believe that institutions are smarter than individuals. But this may not be the last word. For example, Burt could not answer my question about whether the disposition effect also applies to institutions.

Conclusions:

In his long career, Kahneman left much for us to ponder about financial vulnerabilities. The need for care when personifying the market is a case in point. He wanted us to realize that individual investors, institutional investors, analysts, and economists are all prone to the illusion of predictability.