What Does Financial Structure Mean? | Brandon Averill, Justin Dyer | AWM Insights #92

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Episode Summary

Financial Structure is a household’s entire net worth, human capital, and tax rate evaluated in a comprehensive and holistic framework.

No matter how many different accounts you have, you only have one effective tax rate.

A portfolio is only one part of your Net Worth. Other assets should not be ignored.

Human Capital, often the greatest asset on a personal balance sheet, should also be counted.

Priorities are everything you want to achieve in life and the financial structure should be tailored to achieve those outcomes.

 
 
 

Episode Highlights

  •  (0:40) Markets are struggling and have finished down for three out of the last four weeks.

  • (1:03) The Federal Reserve has pivoted to be more “hawkish” and is speeding up the end of QE and signaling faster interest rate hikes.   

  • (2:40) The Omicron variant is having less of an impact on the market as it is proving to be less deadly than previous variants. 

  • (3:25) HSBC and Wells Fargo are settling currency trades between each other on the blockchain. A great tangible benefit and use case for the blockchain.

  • (4:05) Reddit has filed for an IPO and will go public early next year.

  • (4:15) The Build Back Better bill currently in Congress is not going to pass before the end of the year. Joe Manchin has shut it down and will be pushed to January.

  • (5:20)d Chair Jerome Powell has publicly said he can’t predict interest rates.

  • (7:10) Financial Structure is the big picture of one net worth, one effective tax rate, and knowing the value of your human capital.

  • (8:25) Planning is an ever present item. Waiting until the last minute means you most likely have already lost out on the opportunities.

  • (9:00) Roth Conversions and Backdoor Roth strategies.

  • (9:30) Mutual funds are required to pay out their capital gains in the fund. These distributions can sometimes be massive short term capital gains.

  • (10:35) Turnover in funds, meaning they are churning their holdings through frequent buying and selling can mean a huge tax bill.

  • (12:15) Because of the reporting, no one really sees the tax drag this causes for investors.

  • (13:15) Tax loss harvesting is a strategy to bank losses to offset future gains while staying fully invested.

  • (13:50) A dynamic trading system allows the opportunities to be exploited throughout the year and doesn’t wait until an arbitrary date.

  • (14:40) Integration with tax planning, investments, financial strategy, insurance, and estate planning keeps.

  • (15:40) Many times tax preparers don’t understand tax loss harvesting and many other financial planning strategies.

  • (16:15) Donor Advised Funds and giving appreciated assets maximize impact for both you and the cause you care about.

  • (17:10) Instead of selling and donating cash, gift the shares directly to the DAF and receive a deduction for the value of the appreciated asset.

  • (18:40) A Donor Advised Fund explained.

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+ Read the Transcript

Brandon Averill (00:06): Hey everybody, welcome back to AWM Insights. It's Brandon and Justin and as you know, this is a podcast for our clients. We discuss relevant topics in the private and public markets while also tackling a broader investment lesson. Today we're going to dig into the power of the integrated financial structure, really a tantalizing tagline there but you will all get into more of what that means and the power of it. But before we do Justin, why don't you hit on what's going on in the markets.

Justin Dyer (00:38): Markets continue to struggle as of late, a lot of that is largely due to what's going on with the Fed. The Fed or the Federal Open Market Committee to be specific, just met for the last time this year and they meet over a two day period and then release a statement. Leading up to that there's been a lot of headlines I'm sure most people have seen that, that they're getting a little bit more aggressive with respect to their stance on what they call tightening within this new interest rate cycle. And this most recent meeting certainly continued that, their pivot to be a little bit more hawkish, is the term you'll see. Just means that they're going to be more aggressive in pulling back their supportive policies and potentially increasing interest rates.

Justin Dyer (01:27): So that's been a big factor and big, big variable that the markets are really trying to digest over the last three, four weeks. Chances are we're going to have the third negative week for the S and P 500 over the last four. We're recording this on Friday, don't know what the market will close at exactly. But yeah, there's a lot of this year end information that the market is really trying to digest, kind of get into that year end planning aspect of that topic. And this is a global phenomenon, central banks are really stepping up trying to get at least ahead of the inflation narrative. In most cases, economists around the world do think that inflation has peaked or will peak in the next couple of quarters. There's no crystal ball, not saying that's what we believe.

Justin Dyer (02:18): You know us, we don't try and predict the future but from a narrative stand endpoint, central banks are really trying to get ahead of this. One of the more positive items around this and then I'll move on from the esoteric world of Fed central bank policy, is throughout their statements the pandemic has become less and less of a concern and issue. And you're seeing that in the Omicron data so far, at least what I'm seeing that the case severity is less, which hopefully sticks and continues and we continue to get out of this pandemic. On the crypto side or really more specifically the blockchain, we've talked a lot about blockchain crypto earlier in the year and I think we touched on it last week. But this is a really cool tangible picks and shovels where I'm excited to see this whole new industry go, is HSBC Bank and Wells Fargo they've agreed to settle their paired currency trades on the blockchain.

Justin Dyer (03:20): What does that actually mean? Basically it means that they can trade currency, whatever that currency may be incredibly efficiently. It's cheaper for them to trade currency between each other, as opposed to paying the higher fees that they used to do. You're going to continue to see innovations like that on the blockchain, really drive in efficiencies within financial markets and within many, many different spaces. It's the same technology that cryptos exist on but it's different than cryptocurrency. And again, we talked about the picks and shovels approach and that's a perfect example of it. Moving on, Reddit which certainly made headlines earlier in the year as a source for crazy meme stock frenzy is going public at some point, probably in the new year. Build Back Better, the big milestone Biden legislation doesn't look like it's going to pass before Christmas. He's not going to get a nice Christmas present, might be getting coal on his stocking, I guess. Those who want to think about it that way-

Brandon Averill (04:23): Those coal miners from West Virginia, are holding it up for him.

Justin Dyer (04:26): There you go. And then the Boss sold his music catalog for a half a billion dollars, that is a substantial amount of money. Continuing a trend with these incredibly talented musicians with incredible music catalogs, trying to really capitalize in on that phenomenon. And then just fun fact of the year, the impossible cheeseburger was GrubHub's top order of the year, with plant based meal more than five [xing 00:04:56] from last year, which is a pretty amazing statistic. It will be fascinating to watch that trend, see if that continues going on.

Brandon Averill (05:05): So you hit on a lot of good stuff there, Justin. Before we dig into today's topic, I'd love to even hit on... You talked about the Fed coming out and discussing inflation, interest rate projections, et cetera. And I actually heard this morning on, I think it was an NPR segment, the Fed Chair, Jerome Powell, even talking about he has no real idea and we'll be judged five years from now on whether we made the right move. So I think it's just another good evidence of when we talk about these projections of where interest rates are going, even some of the smartest best in the world have no idea. They need to make some predictions because they have to take actions and you have to make some assumptions. However, to me it showed how incredibly difficult it is to predict where markets are going to go or where interest rates specifically are going to go.

Justin Dyer (06:02): It's a great point and they do have to predict because I mean, it is their job to do that but I do think just to touch on them, my thought from that which you're alluding to. The most important aspect of that is they have the humility, if you will or the appreciation that there is uncertainty out there and they know that they're not going to predict this with any... Well, I shouldn't say with any certainty but they know that there's an element of uncertainty that alludes them and it's healthy to think that way and have that approach.

Brandon Averill (06:41): I think the fantastic part about that is the humility. If we could only get some of the CNBC or Fox news talking heads to adopt some of that humility and not old Cramer doesn't talk in his absolute, it'd be pretty amazing. Anyways, back to the topic at hand, really this integrated financial structure and what do we mean by that? We've talked about it throughout the year but it's really pairing your entire net worth. You have one effective tax rate, you have one net worth but it's really looking at it and making decisions with that in mind. And this really came to the forefront here when we were talking, before this about what do we address today. And there's talks on many podcasts coming from many different angles, end of the year what should we be doing?

Brandon Averill (07:32): And you made a good point, the real tale sign is if this is the first time you're talking about these things this year, you probably didn't do it appropriately. So there's a lot of stuff flying around, we are going to talk about some of the things that you should be considering. That you're going to hear this time of year from other people but again, with the under it worth really emphasizing that if this is the first time that you're starting to think about these things you probably missed out. And so you need to start a little earlier next year, so maybe this is even the kickoff for 2022 is better appropriate for this discussion. But Justin, maybe hit on what are some of the things people are going to hear as we head into the end of the year but really should be covered throughout the year.

Justin Dyer (08:23): And I would underscore, planning is an ever present item, it's not just something that you wait till the last minute on. If you're doing that, to your point Brandon, you're probably missing out. I mean, you should still be doing these things but yeah, you've probably missed out on getting a little bit more ahead of these things throughout the year. So a lot of the common topics. Roth conversions, does it make sense to take your IRA assets and put it into a Roth IRA, pay taxes on that conversion but realize the benefit of tax free, what becomes tax free growth in the Roth over time, that's a big topic. But again, that doesn't have to wait till the end of the year but that is obviously a big topic that's coming up.

Brandon Averill (09:09): Especially on non deductible stuff. Justin, I mean, we should be operating on a more effective calendar, if we're waiting till the end of the year to make some of those decisions, really losing out potentially on some time opportunity there, I would think.

Justin Dyer (09:23): Yeah, no doubt, no doubt. I mean, yeah, time value of money. Then one thing that is unavoidable at the end of the year, just by the way of how mutual funds are managed. Is if you're mutual fund investor, what typically happens towards the end of the year is just due to the legal structure of a mutual fund, they are required to pay out their net realized capital gains within that fund. That is a taxable event to investors that are holding those in taxable accounts. And so working around those capital gain distributions, getting ahead. We plan sometime in November, we capture all the estimates that are happening and then does it make sense to try and avoid that distribution? Does it make sense to sell out of that mutual fund to avoid the distribution, go into an ETF that wouldn't make a distribution and then buy it back 31 days later as an example. That's a set of analysis that we do towards the end of the year but considering the tax side of it.

Brandon Averill (10:27): Take a little tangent there for me though Justin too, because what we also see is if you're not integrating your finances, you end up in some of these... Maybe what causes the cap gains distributions, turnover in funds, et cetera. I mean, some of these active funds it's absolutely mind blowing what's happening at this time of year. So it's a little bit of a tangent but it is, I guess that integrated approach throughout the year when you're making investments, you should be considering what my might happen towards the end of the year.

Justin Dyer (10:59): No doubt about that and that is a one of many rubs against actively managed mutual funds where, to your point Brandon, I mean, some of these that I've seen are north of 11% distributions. Where you're paying taxes on that again, if you're holding it in a taxable amount or account, excuse me whether you want to or not. And if you're not paying attention, you're just going to get that tax bill at the end of the year and it could be substantial. In some cases these are short term capital gains distributions as well not long term capital gain distributions. So it gets exactly to your point, that paying attention to tax efficiency is incredibly important and funds pooled investment vehicles that disregard that because, whether they just don't take it into consideration. They're actively managed. They have a ton of turnover that takes away from your rate of return.

Justin Dyer (11:57): They don't have to quote that, I mean, this is the unfortunate side of this, is it's hard to quantify. I shouldn't say it's hard to quantify, it's actually not hard to quantify the math is actually quite straightforward. But the way reporting is required, performance is required to be done, no one ever really sees the true bottom line impact of that. You can find it if you dig into certain research databases and whatnot but it's not front and center. And it's unfortunate because it truly pulls from your bottom line rate of return, which feeds in to your effective tax rate, it feeds into your single net worth as well. And if you're not thinking about these, you are leaving money on the table.

Brandon Averill (12:42): Yeah, no doubt about it. And what about our favorite end of the year? Because apparently everybody just starts to think about tax loss harvesting at the end of the year but dig into that, I mean, why is the not a mistake?

Justin Dyer (12:55): Well, again not necessarily a mistake but you're potentially missing out. I think 2020 last year, not this prior year is a great example, where you... It's something you want to be looking at throughout the year, because let's go back to 2020 again, using that as an example. March of 2020 COVID reared its ugly head, economies around the world shut down, markets had no clue what was going on. No one really did, there's all of a sudden this... We've talked about uncertainty in markets not liking that... All of a sudden this huge increase in uncertainty around the world markets plunged down over 20%, in some cases, that's a perfect time to tax loss harvest.

Justin Dyer (13:40): If you're not taking advantage of that in the moment, again you're leaving money on the table and using a dynamic trading system allows us to do that where we're constantly looking at opportunities unique to each and every investor in their portfolio to take advantage of that. It's not, hey, it's December 15th, let's run a report and see where gain and losses lie on that arbitrary day. It's silly, again with the cap gain distribution, yeah, maybe that analysis makes sense but if you're not doing this throughout the year on a consistent basis you are likely leaving money on the table.

Brandon Averill (14:19): With the underlying message I'm starting to hear as you walk through some of these things is, it's also incredibly complicated at times to take all these different factors into place. And I think that's where the integration comes in, is if you are having to individually coordinate with your CPA and go find out what your personal tax situation is. Now you're talking to your investment guy and then some people have a separate financial planner and I mean, you can just imagine what gets dropped or what falls through the cracks in that process. But even when you have an integrated team, this is the power, it's being able to look through these things, discuss these things, think about the entire year and really proactively plan.

Justin Dyer (15:04): Well, one piece related to that as well is when your team is segmented, chances are one element there doesn't appreciate planning or doesn't understand what the other is doing. I mean, that's what you're getting at with integration. I can't tell you how many times I've heard in the past where we come across to client with, "Yeah, here's my advisor, here's my tax guy, they don't talk." Or, "My tax guy thinks our advisors is doing a bad job because he sees losses on the 1099." And you're like, "Well, no, those were tax losses that were harvested. Your actual rate of return, your end portfolio value is positive but that benefited you from a tax perspective." And yet the CPA did the tax prepared doesn't capture or understand that or appreciate that concept. So again, left hand not talking to the right hand can really hurt you at times.

Brandon Averill (16:05): Totally, no doubt about it. Well, let's end on one thing that I think certainly this season drives people towards a gift mentality, we would hope that you're doing this throughout the year. But one big piece of advice I think most people have very little knowledge of or don't think about, is gifting in a very effective way. And one way we want to highlight is just donating appreciated assets. And I mean, Justin maybe even hit on, I think some people get paralyzed by, I don't know where I'm going to gift throughout the year, et cetera. But there are vehicles like donor revised funds out there. But what is the power of giving, donating appreciated assets as opposed to just cash.

Justin Dyer (16:50): It's a great question, great topic. And to your point, I think really, really underappreciated unfortunately. But to answer your question specifically, I mean, just think about it this way, so you have a fund or an investment, it could be a stock, it could be a mutual fund, it could be an ETF highly appreciated. Instead of selling that, realizing the gain, taking the cash and giving it to a charity of your choice. What you can do is take some equivalent share amount that represents the value or dollar amount you want to gift, whatever it may be, $10,000. You take those shares you gift those shares directly. So not only do you get a tax deduction based on the value of that gift, you're also eliminating the need to ever pay taxes on that appreciation, on that gain as well.

Justin Dyer (17:46): It's a triple benefit, it's a benefit to the charity, it's a benefit to you because you get a deduction and it's also a benefit to you for not having to pay taxes, there's two tax benefits there. To your point on, I don't know where to give or what vehicle, the donor advised fund is a phenomenal vehicle for, I mean, arguably almost any size of gift. It makes sense for hundreds of millions of dollars in my opinion and really can compete with people who are thinking about foundations at that level, just because of the flexibility, low cost ability to still manage it, et cetera, et cetera. But it also works for people who are giving small amounts, a couple thousand dollars or something around that.

Justin Dyer (18:33): And essentially what it is, is a donor advised fund and there are many of them out there, the big custodians have options, there's also independent companies that are out there. But what it is, is the donor advised fund itself is a charity, is technically a 501(c)(3). So when you gift those shares in the perfect example into that donor advised fund, you're getting a tax deduction at that point in time. But what's really cool, is that it goes and then sits in a dedicated account if you will within that donor advised fund within that 501(c)(3). And you get to recommend or you get to choose where that money then is gifted out from that point on. So you go into a 501(c)(3) and then the 501(c)(3) gifts it to the charity of your choice. And it's all incredibly integrated and super user friendly and really, really powerful and really, really efficient product for gifting purposes.

Brandon Averill (19:36): That's a great, great description and just encourage anybody that has any interest in that, wants to learn more, we'd love to talk to you about it. We love having the discussions, especially around giving and really taking your pro-activeness and having an impact on the rest of the world. So hopefully you took some getaway from today's episode, as always head over to awminsights.com, we got some downloadable stuff there and we would love to hear from you. But until next time, own your wealth, make an impact and always be a pro.