How To Preserve and Grow Your Wealth

Overview

Risk Tolerance

Diversification

Fees

Those fees add up to you working so someone else can retire! (source)

Asset Allocation

Lazy Portfolios and Robo Advisors

Sample Schwab Intelligent Portfolios recommendation
Sample Wealthfront recommendation

Market Timing

  1. When the market is up, the exuberance is contagious and you may feel that the bull market is just beginning. When the market is down and nobody is investing, will you be comfortable writing that check? For this reason, having an entry/exit strategy and sticking to it is often a wise choice. Otherwise, you may inadvertently sell low and then buy high.
  2. While you may be correct about the fundamentals, you can get killed by the timing. As economist John Maynard Keynes once famously said: “The market can stay irrational longer than you can stay solvent.”
  3. During bear markets, the best investments may be unproductive assets (more on that later).
  4. Each time you sell may trigger taxes (see section below). If your prediction about the market is incorrect (or just too early) this will add insult to injury.

Asset Classes

Stocks

(Source). Next time there is a bull or bear market and people say “this time it’s different”, please refer to this chart.

Bonds

(Source). While interest rates have been rising lately, they’re still very low.

% of Portfolio in Stocks = 120 - Your Age

Cash (USD or Foreign)

(Source). The USD is a terrible store of value.
  1. You believe other asset types are going to crash. Be careful with this reasoning as you may miss out on substantial returns by sitting on the sidelines and waiting for a crash that never comes (or takes 5+ years). You might be better off deploying some of the cash in investments you think will perform well in a recession. For example, I bought COST stock in 2017.
  2. You have come into a large amount of money at one time (e.g. an inheritance or the sale of a large investment) and you don’t want to try to time the market. You might do better deploying 10–30% of it per month in case the market collapses the day after you make your investments. This form of entering/exiting a position is known as Dollar Cost Averaging and is generally a good investment strategy.

Real Estate

REITs

  • Diversification
  • Don’t have to be a landlord, make improvements, deal with tenants or admin work
  • Accounting is simple and done for you

Commodities

Gold

(Source). It’s hard to figure out what makes gold prices move.

Bitcoin

Startup Investing

  1. New technology. The internet/mobile wave has passed. Now, there’s bitcoin, 3d printing, VR, etc. It feels much more niche than what’s come in the past (society moving to a digital world), though I do love bitcoin.
  2. Increase or decrease in government interference, which is generally making something legal (marijuana) or illegal (green energy benefiting from subsidies). Can border on shameful cronyism, and is relatively niche. In the case of subsidies, even government money isn’t enough to guarantee success (see Solyndra).
  3. Cultural change. These are hard to predict and generally smaller as culture shifts slowly. Uber/AirBnB are good examples here, though this is not usually strong enough; you need a combination with one of the above to create large opportunities.
  1. Scale. Even professional investors expect the majority of their investments to lose money. In order to have any reasonable chance at a positive return, you need to make many investments. You probably lack the time, deal flow, and potentially capital to do that effectively.
  2. Deal flow. What are the odds that the companies you cross paths with are going to be the next Google, Facebook, or Uber? You might have a chance if you run an accelerator like Y Combinator, are a famous Silicon Valley investor like SV Angel, or a big VC fund like Andreesen Horowitz. Statistically speaking, your college roommate’s cousin’s friend is not the next Mark Zuckerberg.
  3. Complex deal terms. Startup investing is more complicated than public markets because you’re not just backing a company, you’re also facing unique terms for each investment. While many early-stage companies use standardized language in SAFEs or Convertible Notes, there’s still lots of room for custom terms and side-letters. Seed investors often have to give up their rights to larger investors in future rounds.
  4. Liquidity. The lifecycle of a startup investment can often span 10 years, so you want to be sure you won’t need that money in the future (to buy a house, send a child to college, pay for a medical bill, etc). During that time you’ll have limited information rights, and your hot startup can turn into the next Theranos.
(source) Not surprisingly, every fund you talk to will tell you that they’re in the top quartile.

Hedge Funds & Private Equity (PE)

Taxes

  1. You’ve received proper tax advice and followed it correctly
  2. You’re not living in a Banana Republic that will change the rules after the fact, which famously happened in California in 2013.

Tax-Advantaged Accounts

  1. Instead of paying taxes on dividends (for investments held) or capital gains (when trading) each year, you only pay taxes when you withdraw from your retirement account (or in the case of a ROTH IRA never as you already paid taxes on those funds when you contributed). This compounding can really add up, as you’re able to reinvest funds that otherwise would’ve gone to the government over the years on account of realized gains, dividend payments, rental income, partnership profits, etc.
  2. There are often tax benefits for participation. If you’re an employee, you can contribute up to $18,500/year of your salary to your 401k as of 2018 and your employer can elect to make matching contributions of up to $36.5k/year as of 2018 (though few employers do), for a combined total 401k contribution limit of $55k. If you’re self employed, you can contribute up to $55k/year as of 2018 to your SEP IRA. However you do it, this is a potentially huge reduction in taxable income.
  1. You don’t have access to the funds until you are ~60 years old, unless you want to face steep penalties. Some hardship exemptions exist, but you shouldn’t contribute unless you’re expecting to lock the money up for your future.
  2. Under current rules, you must start taking minimum distributions at age 70.5 as of 2018. If you’re retired then and want access to those funds, this may be no problem.
  3. You’re implicitly trusting the government to not steal this money in the coming decades. In the event of government bail-in, the most likely scenario would be based on account size, so this is probably a better argument for tax-advantaged accounts to be a smaller % of your portfolio. It also may make sense to only contribute up to the limits (above) for taxable income reduction. That way, if the government later robs you of some of your retirement funds you are likely to have locked in the earlier benefit of lower taxes when you made the contribution.

Tax Loss Harvesting

(source). I’ve created a google spreadsheet with similar data as well.
  • If you live in state with a high state income tax (hello CA and NY!), your capital gains are taxed as income at the state level. This means that you could harvest losses today that would count against other state taxes now ($3k against earned income and an unlimited amount against other capital gains), and years later move to a retirement-friendly state with no state income tax (see State Residency section) when you retire. If you then sold that assets with a larger gain (remember it now has a lower basis from tax-loss harvesting), you’d only pay federal capital gains and never pay any state capital gains on that investment.
  • If you hold that investment until you die and are under the estate tax limit (see Estate Tax section), then your heirs will receive that asset with a stepped-up cost basis when you die (meaning taxes are never paid on the gain from that investment, including from the time of TLH). In this case, you get the tax benefit today while giving up nothing in the future! Of course for this strategy to work you have to one day die without selling off that position.
  • It’s risk-free. Unlike a ROTH IRA where you pay taxes today in hopes that the government will honor the agreement for you to not pay taxes in the future, with TLH you get the benefit today expecting to pay in the future. There’s always a chance there will be new tax programs in the future you can use to later defer/minimize those gains (like qualified opportunity zones), and TLH provides that optionality.

Progressive Taxation

Obamacare/ACA (Net Investment Income) Tax

Capital Gains

Municipal Bonds

1031 Like Kind Exchange

Primary Residence Capital Gains Exclusion

Rebalance through non-reinvestment of dividends

(source) These dividend payments may be especially important for retirees.

Foreign Tax Credit

Health Savings Account

Income vs Capital Gains Tax Rates

Yup, I quoted myself.

Marriage Tax Penalty (and Bonus)

529 Plans (College Savings Plan)

  • Tax-free investment returns can yield large savings.
  • While the beneficiary is typically your child/relative, unlike an irrevocable trust you remain in control of the account and can even change the beneficiary.
  • If your state has an income tax, you may get some benefit for your contribution, though restrictions apply (some details here and here)
  • 529 plans usually have higher admin costs, meaning they make more sense for longer time-horizons so the savings from compounding are larger. They also typically have fewer fund options to choose from.
  • 10% penalty (on gains only) if the funds are not used for qualified expenses, plus gains will be taxed as income; this could happen because your child doesn’t go to college, or you save too much money. There are restrictions on qualified expenses too (e.g. you cannot spend any extra funds on a car for your child). You can change the beneficiary to another child (or even yourself), and there is an exception if the child dies or becomes severely disabled.
  • Having a 529 plan may lead to a student receiving less financial aid, whereas an IRA won’t. However, parents of students who expect to receive financial aid may be better off without a 529 plan anyway. You can get a loan for college, but you can’t get a loan for retirement.
  • Gift limits for estate taxes still apply, but growth in principal is always tax free. You can also make a lump-sum gift of 5-years to start putting funds to work immediately.
  • As with all tax -advantaged accounts, there’s always the risk the government will change the rules after the fact. The risk is lower here since the time horizon is shorter vs a retirement account.
  • There are limits to how much you can contribute, and there are a host of minor rules/restrictions you’ll want to familiarize yourself with.

Charitable Giving

Taxes and Residency

State Residency

(Source) Some cities (like NYC) even have their own income taxes as well.

Country Residency

GDP has exploded during this time period, so the true picture is much worse (source)

Territory Residency

  • You must commit to being a resident of the territory for 10 years. In theory, if you move back to the mainland you might have to pay back the tax savings, though I’m not sure how often this is enforced.
  • You must mark your assets to market and pay mainland taxes before you are eligible for Puerto Rican tax rates. This means you can’t show up with a massive unrealized gain and then sell a large position.
  • Puerto Rico is constantly asking the mainland for a bailout, and one day they may get one. If they do, it will likely come with the requirement that they close the loophole for avoiding mainland taxes. If you’re going to move across the world for low taxes, be sure you’re actually going to get them!
  • Puerto Rico is far from the mainland and you may become isolated from many of your former friends.
  • Puerto Rico requires you to apply for bona-fide residency, which takes some time. You also have to invest in local businesses that meet certain criteria.
  • The island is not an economic hub. College graduation, literacy, english-speaking rates, and internet penetration is much lower vs the mainland. Alcoholism and unemployment rates are higher.
  • Puerto Ricans cannot vote in US elections.

Estate Tax (Death Tax)

Try not to die or receive an inheritance while living in one of these states! (source)

Random Tidbits

Which Brokerage to Use

Multiple Brokerage Accounts

Rebalancing

FDIC

Trust and Integrity

Life Insurance

Longevity Annuities

Revocable and Irrevocable Trusts

Frugality

You can’t take it with you

Credit Card Rewards

  • $0 annual fee. Many cards will waive the fee in their first year, but then the price increases after that. The other end of the spectrum are cards like American Express Platinum and Chase Sapphire Reserve that are expensive but provide tons of benefits (that may or may not be worth it to you).
  • High cash-back. Unless you’re trying to optimize everything around discounted first-class international flights, airline and other company-specific rewards cards are rarely worth the effort. Cash is king, and a card that automatically pays you each month for using it usually provides a much better deal since you can use that cash wherever you like.
  • No foreign transaction fees. Many cards charge up to 3% to transact in another country!
  • A generous signup bonus. This is a one-time benefit (and usually only applies to cards with annual fees), but these promotions can be generous.

Love What You Do and Never Work a Day in Your Life

(Source)

Conclusion

Acknowledgements

Beyond Wealth

Outro

Boats are definitely not a good investment

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https://www.michaelflaxman.com

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Michael Flaxman

Michael Flaxman

https://www.michaelflaxman.com

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