The Markets

Ouch!

It was no fun to be an investor last week. The week prior, a commentary in The Wall Street Journal’s blog, MoneyBeat, offered this insight:

“Falling oil prices are thought to be good for stocks because they stimulate consumer spending and hold down inflation. The lower costs support economic growth, boost corporate earnings, and lessen pressure on the Federal Reserve to raise interest rates. The stock market loves that mix.”

That was not the case last week. A selling spree, sparked in part by concerns related to energy, led to virtually every major world stock index (every one that Barron’s follows, anyway) moving lower. The single exception was the Shanghai Composite and that was flat.

It seems the International Energy Agency’s prediction that demand for energy would grow more slowly in 2015, combined with the fact supply of some resources has been growing, addled investors and they sold everything but the kitchen sink. Even industries that may be helped by lower energy costs – consumer goods, consumer services, health care, and others – lost value. In the United States, stock markets delivered their worst performance in more than three years, according to Barron’s.

Have investors lost sight of the fact the United States has a consumption-driven economy?

The Federal Reserve Bank of St. Louis reported personal consumption – how much Americans are spending on goods and services – was 70 percent of gross domestic product (the value of all goods and services produced) in the United States during the third quarter of 2014. Lower energy prices tend to put more money in the pockets of consumers so they can spend more and that can help the economy grow. In fact, U.S. News reported, “…approximately every penny decline in the price of a gallon of gasoline translates to about $1 billion in additional disposable income for American households.”

It’s interesting to note consumers – a group that overlaps with investors in a Venn diagram – are more confident than they have been in almost eight years, according to data released by the University of Michigan and cited by Barron’s.

Tax Alpha

Taxes are the most important drag on today’s investment returns ‐ greater than inflation, transaction costs or even management fees. Recent studies performed showed that taxes reduced returns by up to three percentage points. Recent tax increases should also increase these percentages significantly, making it more important than ever to manage tax drag and create positive “Tax Alpha” for clients.

With the recent tax changes and introductions of the 3.8% NIIT tax (net investment income tax), 20% capital gains rate, 39.6% income tax rate, and personal exemption and itemized deduction limitations, America has shifted from a two dimensional tax system to a five dimensional system. Virtually every financial decision now needs to be analyzed through this prism. The complexity of going from a two dimensional system to a five dimensional system is exponential, not linear, which requires a quantum leap in tax analysis methodology, tax strategy and tax planning software tools. The increased value created in an investment portfolio by understanding tax saving strategies we call “Tax Alpha”

There are now seven different ordinary income tax brackets – 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%, and three different capital gains tax brackets from 0% to 20%. Furthermore, if you combine these tax brackets with the new 3.8% NIIT, there are even more possible tax brackets; i.e., some high income taxpayers may be subject to a 43.4% tax rate on ordinary investment income and a 23.8% tax rate on long‐term capital gains.  When taking into account the phase‐out of personal exemptions (PEP) and limitations on itemized deductions (Pease) as income rises above the applicable threshold amounts, the tax rates increase even further. (www.irs.gov)

The increased value created in an investment portfolio by using tax saving strategies our office uses is described as “Tax Alpha” Put another way, it is your after‐tax excess return (after‐Tax Alpha) minus your pre‐tax excess return (pre‐Tax Alpha) based on the appropriate benchmarks.

Generally, an index is used as the appropriate benchmark (e.g., the Russell 1000 for U.S large cap stocks). Research indicates that many portfolios don’t consistently beat their benchmarks on a pretax basis, often producing negative alpha on an after‐tax basis. That is why creating Tax Alpha is important. If pre‐tax alpha is positive, tax planning can increase the excess.

Given the growing realization of the power of “Tax Alpha”, is your advisor providing it to your portfolio?  My office has over 50 different Strategies working with:

1. IRA & Roth IRA
2. Capital Gain/Loss
3. Dividend Income
4. Option
5. Qualified Plan Distributions
6. Charitable Planning
7. Strategic Planning
8. Tactical Planning
9. Trusts & Estates