Stocks vs Real Estate

The comparison is often made between investing in Real Estate vs investing in the Stock Market.   There are many strong points to both arguments, but as an Investment Advisor, I am going to argue the side of why the stock market is a better long term investment.  Note, I am not inferring you should not buy a home, nor am I inferring that you should exclusively put all of your money in the stock market.  This argument is just in terms of where you should put extra money that you would like to grow for retirement or other purposes.

Here are 6 advantages of investing in stocks over investing in real estate.

1.Effort/Work

Whether you are flipping homes, renting properties, or developing land, there is a whole lot more hands on work and extra time as compared to ownership of stocks.  If you have an investment advisor, you could realistically spend absolutely no time “working” on your stock ownership and still get the growth of the market.   Lucky for you, stocks don’t have furnaces that break, or water pipes that leak.

2. Diversification

Diversification is a very important concept.  The old saying is don’t put all your eggs in one basket.  Diversification in Real Estate would involve buying homes, apartments, commercial property, and farm land etc., all in different areas of the country.   You would have to have quite a bit of money to be fully diversified.  With the stock market, if you are invested in a Matson Money Fund, you can start with one dollar and be invested in about 12,000 stocks throughout the world.

3. Liquidity

Liquidity is how easy it is for you to sell.   Stocks are extremely liquid, with most stocks being sold within seconds of offering them for sale.   With Real Estate, it can take weeks, months, or sometimes years to sell or rent out a property.

4. Costs

The cost of owning property could include all or most of the following; real estate agent fee, property taxes, maintenance, utilities, mortgage interest, and insurance.   The cost of owning stocks usually only includes an investment advisor fee, and mutual fund management fee.

5. Debt

When investing in real estate it is almost always tied to taking on debt, because of the large amounts of money needed to buy a property.   Taking on debt automatically increases the risk level with any investment.   With stock based mutual funds, you can start with $1, and never have any debt to worry about.

6. Return

There is a lot of variables that come into play when comparing returns of real estate investing vs stock based mutual funds.  You can really cherry pick numbers to make either side look much better than the other.  Just comparing actual long term growth in prices of real estate vs prices of stocks, stocks win that competition easily.  But if you include rental income, it can obviously increase your overall real estate investment return. With that though, you have to consider the risk of not being able to rent it out.

If you are looking for a way to get a high return with lower risk and little hassel, my opinion is that your #1 option is to put your money in stocks, via a diversified Roth IRA or 401k.

Feel free to comment with your thoughts.

By Jimmy Hancock



References

  1. Kennon, Joshua. “Should You Invest in Real Estate or Stocks?” The Balance. N.p., 17 Oct. 2016. Web. 12 May 2017.

What are the Cost’s Associated with Investing?

There are many different ways in which costs are charged to your investment portfolio.   Many of these are hidden and are basically untraceable.  Today we are going to discuss a few of the hidden costs, and a few of the transparent costs.

Costs you should know about

Management Fee/Commission

Whoever your investment advisor is is making a percentage of their money from your portfolio.  This is necessary, but you need to make sure that the fee or commission you are being charged is not over the top. You will usually be charged just commissions or just a fee, not both.

If your working through an advisor that works on Commissions, then he legally cannot charge you more than 8.5% as a shave off the top of any new money coming in.  That is a big percentage.  For example, if you transfer in just $10,000 to an advisor that works on Commissions, they could take $850 out of the $10,000 thus lowering the value to $9,150 right off the bat.  Commissions are also dangerous because it makes the advisor more focused on the sale and initial transfer then he is on helping you ongoing.  He gets almost all his money upfront.

A management fee is a percentage charged each year as a much smaller percentage than commissions.   If your manager is trying to actively trade, he will usually charge a higher fee.  Management fees are based off of the total amount invested.

Mutual Fund Loads

A lot of mutual funds come with loads.  These are additional costs to you that are basically penalties.  They can be for different reasons, but many times it is to keep you from switching out of the fund.  They can either be front end loaded, or back end loaded, meaning the charge comes when you buy in, or when you sell out.  They also can charge you if you move your money out before a certain time frame.  Not all mutual charge a load, so make sure your funds are no load funds.

Hidden Costs

Trading Cost

One of the main hidden costs comes from the Bid Ask Spread.  The Bid Ask Spread is the difference between the buy price and sell price of a stock.  The guy on Wall Street who actually performs the trade gets paid the difference.  There is a cost to you every single time a stock is bought or sold by a fund.  If your mutual fund is being actively traded by a manager trying to beat the market, then more likely than not they are losing you money on the way.   If you are invested in institutional funds, aka passively managed funds like with Matson Money, then the trading cost you pay is minimal.

Expense Ratio

The expense ratio is how the mutual fund company pays for their operational costs.  Operating expenses are taken out of a mutual fund’s assets and in turn lower the return to the fund’s investors.   Usually retail mutual funds that are popular due to advertising have very high expense ratio’s.  This is another cost that comes to you in the form of a lower return.  The actual amount that it is costing you is very hard to quantify.   You want to invest in funds with very low expense ratios.

There are a few other costs involved as well, but are only for specific accounts and situations.  These costs are not necessarily a bad thing as long as they are kept low, and reasonable.  Even with these costs, investing in stocks is the greatest wealth creation tool on the planet.  To limit you costs you need to avoid actively traded funds and managers, and invest in a diversified efficient portfolio.

We try to keep our costs low by not charging any commissions, and instead charging an annual management fee based on the total amount invested.  We don’t charge to meet or set up new or additional accounts.   We also keep costs lower by avoiding actively trading within clients accounts.

By Jimmy Hancock

References

1.Bold, Adam. “4 Hidden Costs in Investing – US News.” US News RSS. US News and World Report, 8 Feb. 2011. Web. 22 Sept. 2014. <http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/02/08/4-hidden-costs-in-investing>.

2.”Expense Ratio Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 24 Sept. 2014. <http://www.investopedia.com/terms/e/expenseratio.asp>.

Are Investment Fees Tax Deductible?

Everyone is looking for tax deductions this time of year, so I am going to help you out with a possible tax deduction that often get overlooked.  When I get asked if investment fees are tax deductible, I say, “it depends”.   If your investment fee along with other miscellaneous deductions, such as tax prep fees or unreimbursed employee expenses,  total to be above 2% of your Adjusted gross income, then you qualify for the deduction.   If your investment balance is much higher than your current income, then you will likely be able to use this deduction.

The following is more info from an article from David Marotta.

“If your expenses are close, you gain from lumping most of your expenses every other year. For example, if your AGI is $100,000 and your miscellaneous expenses average $2,500 a year, in most years you will only get a $500 deduction. But if you can pay the same bills in January and December of one year, you might be able to have $5,000 in deductions one year and zero the next. That means you could have a $3,000 deduction every other year. In next year’s 28% tax bracket, this would save you $560 more in taxes.

Even if you can’t deduct investment management fees directly, you can still pay a portion of the fee with pretax dollars. Investment management fees can be deducted directly from the accounts for which they were charged.

Many fee-only advisors charge a percentage of assets under management. But they can also prorate those fees back to the accounts they are managing. For traditional IRA accounts, the fee is not considered a withdrawal and therefore is not a taxable account. The fee is considered an investment expense. Thus this fee is being paid with pretax dollars. And the cost is discounted to clients by their marginal tax rate.

I’ve seen advisors take their entire management fee from IRA accounts. I don’t think that is warranted by the letter or the spirit of the tax code. Any fee taken from an IRA account should be justified as a fee for the management of a pretax account. You can’t simply start paying your bills from an IRA as a nontaxable withdrawal.

Similarly, any management fees paid directly from an IRA account should not be listed as a miscellaneous expense on Schedule A trying to qualify for an additional tax deduction. Only expenses paid from a taxable account should be listed as a miscellaneous expense.

There is no advantage in trying to pay the entire fee from a taxable account in an attempt to boost your deductions. If you pay $2,500 in management fees, it is better to pay $1,000 from an IRA with pretax dollars than to pay for it separately to get a $500 tax deduction. Any amount paid from an IRA is equivalent to getting that same amount as a tax deduction.

Although getting money out of a traditional IRA tax fee is an advantage, taking management fees out of a Roth IRA is not. There are limits on getting money into a Roth account where it will never be taxed again. We recommend paying the portion of management fees prorated to a Roth account out of your taxable account. This allows as much money as possible to stay in your Roth.

One of the advantages of working with a fee-only financial planner is that fees can be taken from the accounts under management or paid separately, depending on which is more advantageous. If fees are stuck on commission-based products, you can’t choose to pay the fees for a Roth account separately from a taxable account in order to allow the Roth to grow unimpeded.

This is another advantage to having fees based on assets under management rather than a separate fee or an hourly charge. Management fees are easily justified taken directly from accounts including IRA accounts where you can pay with pretax dollars.

Many advisors charge a percentage of assets under management and then offer comprehensive wealth management advice without an hourly charge. This is ideal. If these charges were separated, less of the fee could be paid with pretax dollars.

No one likes to pay fees. Hidden fees in many ways are easier psychologically. We recommend that when you need unbiased financial advice, seeking a fee-only financial planner makes sense. And it helps knowing there are tax-efficient ways to pay management fees.”

 By Jimmy Hancock

Reference

Marotta, David. “Are Investment Management Fees Tax Deductible?” Forbes. Forbes Magazine, 25 June 2012. Web. 12 Nov. 2014. <http://www.forbes.com/sites/davidmarotta/2012/06/25/are-investment-management-fees-tax-deductible/2/>.

Income Tax Refund. Digital image. Cutiebootycakes.blogspot.com. N.p., n.d. Web. 30 Jan. 2017.

Picking Winning Stocks

buy sellYou think you can pick winning stocks consistently, and I’m here to tell you that you can’t.   But even if I cannot convince you that you can’t pick stocks, I hope to at least convince you that it is not in your best interest to try.   We look at examples like Warren Buffet and see how much success he had “stock picking”. But the funny thing is that Warren Buffet believes that the best strategy for most investors is to buy low-cost index funds.

Bad Advice

The most dangerous advice in investing is often that which seems most practical, which is why the worst investing advice you will likely ever receive is that you should try to pick “good” stocks and sell “bad” ones. Yes it seems very sensible and almost too obvious that you should try to do this.  You will get this advice like this from innumerable sources, including a lot of investment advisers, friends, work associates, and most especially Wall Street/investment media. But…You should ignore it.

If you pursue a stock-picking strategy, you are almost certain to lag the market.

Stock pickers always underestimate the number of variables that are involved in the pricing of stocks.  There are literally trillions of variables that could occur on any given day that could change the price of a stock instantly.  Stock prices are based on every single investor which all have different feelings about companies, reasons for investing, and regional bias.

The big problem for investors is that even though stock-picking usually hurts returns, it’s extremely interesting and a makes for a great conversation. If you are wanting to wean yourself of this bad habit,  the first step is to understand why it’s so rarely successful. The quick answer is that the overall market provides most investment returns, not particular stock picks, so stock pickers get credit for gains that came merely from being invested in stocks generally.

Although it is relatively easy to pick stocks that beat the market before costs (just like a monkey you have a 50% chance), it is much harder to do so after costs are added in. So lets say you happen to pick stocks well enough to boost your return by a couple of points, the expenses you rack up along the way (ie. research, trading, taxes) will usually more than offset your gain.

Most stock pickers believe that they are among the 1% of investors who happen to beat the market after costs, and, for inspiration and encouragement, they point to legends such as Warren Buffett and Benjamin Graham. But as I mentioned before, such investors often don’t know that even Buffett has said that the best strategy for most investors is to buy low-cost index funds and that the great Benjamin Graham eventually changed his mind to advocate a passive approach to investing.

Stock picking is not only a dangerous activity for you to be involved in as an individual investor, but it is also dangerous to invest in mutual funds that employ stock picking strategies.  These stock picking strategies are used in most of the mutual funds out there, also known as active investing.  These mutual fund managers think they have a crystal ball and can predict the best stocks and drop the worst ones.

The Opposite of Stock Picking

Instead of stock picking, invest in a globally diversified portfolio managed by a low fee investment coach that will help to educate you on the investing process.  Instead of constantly turning the portfolio over by stock picking and active trading, buy and rebalance when necessary.  Long term you will see the fruits of your decision.

By Jimmy Hancock

References

1.Blodget, Henry. “Why the World’s Greatest Stock Picker Stopped Picking Stocks.” Slate Magazine. N.p., 22 Jan. 2007. Web. 28 Jun. 2016. http://www.slate.com/articles/arts/bad_advice/2007/01/stop_picking_stocksimmediately.html.

2.Stock Market People. Digital image. Opinion-forum.com. N.p., Aug. 2012. Web. 28 June 2016. <http://opinion-forum.com/index/wp-content/uploads/2012/08/stock_market.jpg>.





How to Beat the S&P 500

The S&P 500 is a grouping of the 500 largest companies in America.  It is a very popular thing to invest in for many reasons.  First of all, it is made up of incredible companies that we all know and love like Google and Apple.   But, another reason is, the business and financial media puts a lot of emphasis on shoving the current price and up or down movement of the S&P 500 in our faces every single day. For people that don’t know as much about investing, why would they even think there is something else to invest in then the S&P 500.

We recently met with a young man that was investing in only a low cost S&P 500 index fund.  He could not understand how he could pay a higher fee for a diversified portfolio, and end up with a huge advantage long term.   Let me explain further.

There are over 13,000 total stocks in the world that are available to invest in.  So the 500 stocks in the S&P 500 make up less than 5% of the total stock market.  So you cannot really consider yourself diversified if you invest in only 500 stocks in one country that are all very large companies.   If you could, wouldn’t you want to be more spread out into different countries, different industries, and different sizes of companies.  That way when 1 industry or country has major issues, your portfolio isn’t killed.

I’m here to tell you it is possible to beat the S&P 500 in terms of annual return, be more diversified, and lower your risk (Standard Deviation) all at the same time.

The mountain chart below shows that 3 globally diversified Matson Money Portfolios, with risk levels below or similar to the S&P 500 have absolutely blown away the returns of the S&P 500 for the long term 15 year period of 2000-2014.  And the Matson Money Portfolios shown below are Net of Fees, meaning this is the return after all fees are taken out. 1.

S&P

As you can see, the S&P 500 (100% stocks) was well below the Balanced Growth Portfolio, (50% stocks, 50% fixed income) the Long Term Growth Portfolio (75% stocks, 25% Fixed Income), as well as the Aggressive Growth Portfolio (95% stocks, 5% Fixed Income).    If you invested $100,000 into the S&P 500, your gain would be $86,482 at the end of 2014, which is about half the $162,523 gain you would have received investing in the Aggressive Growth Portfolio with Matson Money over the same time period.

Although the S&P 500 is popular, and has been up lately, that doesn’t mean you can forget the long term projections and academic studies that have proved again and again that a efficient diversified portfolio beats the S&P 500 in the long term.

By Jimmy Hancock

References

  1.  Matson Money. IsSomethingWrongWithOurPortfoliosPowerpoint. N.p.: Matson Money Inc., 6 Apr 2016. PPT.

Do Hedge Funds Beat the Market?

gurusAre you missing out on the supposedly huge amount of profits to be made by investing with a “Guru” in his Hedge Fund?

Hedge funds are like mutual funds, but they are managed by self titled “experts” who charge an enormous fee to try and beat the market.  Hedge funds and Investing Guru’s are built on the premise that a smarter guy with a faster computer can make miracles possible by uncovering inefficiencies in the market or predicting the future.  They are attractive to so called “sophistocated investor” who wouldn’t be caught dead investing in boring index funds.

Do Hedge Funds Beat the Market?

“According to a report by Goldman Sachs released in May, hedge fund performance lagged the Standard & Poor’s 500-stock index by approximately 10 percentage points this year, although most fund managers still charged enormous fees in exchange for access to their brilliance. As of the end of June, hedge funds had gained just 1.4 percent for 2013 and have fallen behind the MSCI All Country World Index for five of the past seven years, according to data compiled by Bloomberg. This comes as the SEC passed a rule that will allow hedge funds to advertise to the public for the first time in 80 years.” 1

Studies continue to come in showing real data of the horrible returns of hedge funds vs. the whole market.

“Harken back to a decade ago. Your broker recommends an investment in a hedge fund. Your registered investment adviser disagrees. She recommends you invest in an index fund composed of 60 percent stocks and 40 percent bonds. You go with the broker’s recommendation. You don’t want “average” returns. You want your money managed by the best minds in finance.

Fast forward to today. According to a Harvard Business Review blog, a composite index of more than 2,000 hedge funds returned 72 percent over the past decade. The index fund, which took significantly less risk, had a return of about 100 percent, while charging much lower fees.

You would think these dismal returns would have dealt a crippling blow to the hedge fund industry. Not so. Hedge funds remain the darling of many pension plans. According to the same blog, hedge funds that go long and short on stocks and invest in equity derivatives managed a mere $865 billion a decade ago. Having demonstrated their lack of investment skill, these fund managers now manage more than $2.4 trillion. Go figure.” 2

Takeaway

Hedge funds are flashy and somehow popular, but if you want long term growth in your retirement accounts you should stay as far away from them as possible.   Instead, invest in a diversified portfolio,  and find an investment coach who will educate you especially in down markets.

by Jimmy Hancock

References

1. Kolhatkar, Sheelah. “Hedge Funds Are for Suckers.” Bloomberg Business Week. Bloomberg, 11 July 2013. Web. 14 July 2014. <http://www.businessweek.com/articles/2013-07-11/why-hedge-funds-glory-days-may-be-gone-for-good>

2. Solin, Dan. “The Fleecing of Investors Continues.” The Huffington Post. TheHuffingtonPost.com, 17 June 2014. Web. 17 July 2014. <http://www.huffingtonpost.com/dan-solin/the-fleecing-of-investors_1_b_5487788.html>.

Are you Paying Too Much in Hidden Costs?

feesThere are many different ways in which costs are charged to your investment portfolio.   Many of these are hidden and are basically untraceable.  Today we are going to discuss a few of the hidden costs, and a few of the transparent costs.

Costs you should know about

Management Fee/Commission

Whoever your investment advisor is is making a percentage of their money from your portfolio.  This is necessary, but you need to make sure that the fee or commission you are being charged is not over the top.  If your working through an advisor that works on Commissions, then he legally cannot charge you more than 8.5% as a shave off the top of any new money coming in.  That is a big percentage.  For example, if you transfer in just $10,000 to an advisor that works on Commissions, they could take $850 out of the $10,000 thus lowering the value to $9,150 right off the bat.  Commissions are also dangerous because it makes the advisor more focused on the sale and initial transfer then he is on helping you ongoing.  He gets almost all his money upfront.  A management fee is a percentage charged each year as a much smaller percentage than commissions.   If your manager is trying to actively trade, he will usually charge a higher fee.  You will usually be charged just commissions or just a fee, not both.  

Mutual Fund Loads

A lot of mutual funds come with loads.  These are additional costs to you that are basically penalties.  They can be for different reasons, but many times it is to keep you from switching out of the fund.  They charge you if you move your money out before a certain time frame.  Not all mutual charge a load, so make sure your funds do not have a load.

Hidden Costs

Trading Cost

One of the main hidden costs comes from the Bid Ask Spread.  The Bid Ask Spread is the difference between the buy price and sell price of a stock.  The guy on Wall Street who actually performs the trade gets paid the difference.  There is a cost to you every single time a stock is bought or sold by a fund.  If your mutual fund is being actively traded by a manager trying to beat the market, then more likely than not they are losing you money on the way.   If you are invested in institutional funds, aka passively managed funds like with Matson Money, then the trading cost you pay is minimal.

Expense Ratio

The expense ratio is how the mutual fund company pays for their operational costs.  Operating expenses are taken out of a mutual fund’s assets and in turn lower the return to the fund’s investors.   Usually retail mutual funds that are popular due to advertising have very high expense ratio’s.  This is another cost that comes to you in the form of a lower return.  The actual amount that it is costing you is very hard to quantify.   You want to invest in funds with very low expense ratios.

There are a few other costs involved as well, but are only for specific accounts and situations.  These costs are not necessarily a bad thing as long as they are kept low, and reasonable.  Even with these costs, investing in stocks is the greatest wealth creation tool on the planet.  To limit you costs you need to avoid actively traded funds and managers, and invest in a diversified efficient portfolio.  

By Jimmy Hancock

References

1.Bold, Adam. “4 Hidden Costs in Investing – US News.” US News RSS. US News and World Report, 8 Feb. 2011. Web. 22 Sept. 2014. <http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/02/08/4-hidden-costs-in-investing>.

2.”Expense Ratio Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 24 Sept. 2014. <http://www.investopedia.com/terms/e/expenseratio.asp>.

Stock Picking or Gambling?

stock market tickerThere are so many unknown variables when picking individual stocks (literally trillions), that is why it is impossible to consistently guess which ones are going to go up or when they are going to go down.

Stock picking is not only a dangerous activity for you to be involved in as an individual investor, but it is also dangerous to invest in mutual funds that employ stock picking strategies.  These stock picking strategies are used in most of the mutual funds out there, also known as active investing.  These mutual fund managers think they have a crystal ball and can predict the best stocks and drop the worst ones.

Are you Gambling with Your Money?

The lure for stock speculators is similar to the gambler… the excitement that is felt and experienced when they hit the big winner. When we watch the markets we see big winners every day. Similar to walking through a busy casino, we see winners all of the time. This preys on wish fulfillment…why not me?

Just one big winner keeps them coming back until they can break their addiction. Just like the gambler, this usually does not happen until they hit bottom, after the inevitable several big losers in a row.

Time is Money

When picking individual stocks, it becomes an obsession. They check the news and the price almost every day. They think about the stock almost every day, if not every day. I have seen it happen over and over again.  These days time is money, and being obsessed over your investments takes a lot of time away from more important things.

Add in the Cost

Another main reason stock picking is detrimental to your growth in your portfolio is the cost.  Everytime there is a buy and sell of a stock, there is a cost to you the investor, whether that is direct or through a mutual fund.  These costs are even higher if you do online trading.  The costs can add up quickly and lead to poor returns, even if you are able to temporarily guess which stocks are going to do well.

Solution

Instead of stock picking, invest in a globally diversified portfolio managed by a low fee investment coach that will help to educate you on the investing process.  Instead of constantly turning the portfolio over by stock picking and active trading, buy and rebalance when necessary.  Long term you will see the fruits of your decision.

By Jimmy Hancock

What are the Hidden Fees associated with Annuities?

scaredIt’s not that there’s anything wrong with an investor paying fees for certain investments in their portfolio, but when it comes to annuities the key is ‘transparency,’ notes the WSJ’s article on getting to the bottom of hidden annuity fees.

What are some of the fees carried by a popular annuity choice among investors, namely the variable annuity?  In the case cited by the WSJ, an annuity holder was paying the following:

* Administrative expenses: 1.4%

* Special rider to ‘lock in returns:’ 1.1%

* Mortality expense fee, wrap fee and adviser fee: 5.8%

* Surrender fees vary

The grand total of 8.3% in fees, in this case, turned out to be higher than the annual return on the annuity, plus a surrender fee of $10,000 to get out of their annuity contract.

Annuities and the 403(b) retirement portfolio.

Generally, for non-profit organizations, or public education entities, employees are usually enrolled in a 403(b), which is their tax-advantaged retirement account. Like a 401(k), employee contributions are channeled to the fund via salary deferrals to help the account continue to grow tax-deferred; and, when it’s withdrawn, that’s when the income is taxed. Where do insurance products like a variable annuity fit into a 403(b)? In short, it doesn’t, according to Neal Frankle, a financial writer on Money/US News.

“To add insult to injury, many plans offer fixed or variable annuities, which adds even greater expense to the mix. It makes absolutely no sense to buy an annuity inside a retirement account, and I can’t understand why any plan would have such provisions, but they often do.”

A traditional IRA, or Roth IRA, are reasonable alternatives to consider, Frankle notes.  There is no point in putting an annuity in any retirement account, because of the extreme fees you pay along the way.

Annuities may have their place and serve a purpose, but if you are looking for long term growth in your retirement account without fees cutting into gains, look for a low fee retirement plan that is well diversified.

By Financial Social Media and Jimmy Hancock

Are Investment Fees Tax Deductible?

tax deductI was looking for a specific answer to this question and I found this great article from David Marotta on Forbes Magazine so I thought I would share on the blog.

“I often get asked, “Are investment management fees tax deductible?” The answer is not a simple “yes” or “no.” Like many tax questions, the answer is “It depends.”

Investment management fees are a tax-deductible expense. They can be listed on Schedule A under the section “Job Expenses and Certain Miscellaneous Deductions.”  Line 23 includes investment expenses. These expenses get added into unreimbursed employee expenses, tax preparation fees, safe deposit boxes and other qualifying expenses.

Unreimbursed employee expenses can include professional dues, required uniforms, subscriptions to professional journals, safety equipment, tools and supplies. They may also include the business use of part of your home and certain educational expenses.

All of these miscellaneous deductions are totaled. You only receive a tax deduction for the amount that exceeds 2% of your adjusted gross income (AGI) from line 38 of your Form 1040. If your cumulative expenses are under 2% of AGI, you will not get a deduction.

For most of our working clients, their miscellaneous deductions fall far short of the 2% AGI threshold. But when clients retire, they are much more likely to qualify.

If your expenses are close, you gain from lumping most of your expenses every other year. For example, if your AGI is $100,000 and your miscellaneous expenses average $2,500 a year, in most years you will only get a $500 deduction. But if you can pay the same bills in January and December of one year, you might be able to have $5,000 in deductions one year and zero the next. That means you could have a $3,000 deduction every other year. In next year’s 28% tax bracket, this would save you $560 more in taxes.

Even if you can’t deduct investment management fees directly, you can still pay a portion of the fee with pretax dollars. Investment management fees can be deducted directly from the accounts for which they were charged.

Many fee-only advisors charge a percentage of assets under management. But they can also prorate those fees back to the accounts they are managing. For traditional IRA accounts, the fee is not considered a withdrawal and therefore is not a taxable account. The fee is considered an investment expense. Thus this fee is being paid with pretax dollars. And the cost is discounted to clients by their marginal tax rate.

I’ve seen advisors take their entire management fee from IRA accounts. I don’t think that is warranted by the letter or the spirit of the tax code. Any fee taken from an IRA account should be justified as a fee for the management of a pretax account. You can’t simply start paying your bills from an IRA as a nontaxable withdrawal.

Similarly, any management fees paid directly from an IRA account should not be listed as a miscellaneous expense on Schedule A trying to qualify for an additional tax deduction. Only expenses paid from a taxable account should be listed as a miscellaneous expense.

There is no advantage in trying to pay the entire fee from a taxable account in an attempt to boost your deductions. If you pay $2,500 in management fees, it is better to pay $1,000 from an IRA with pretax dollars than to pay for it separately to get a $500 tax deduction. Any amount paid from an IRA is equivalent to getting that same amount as a tax deduction.

Although getting money out of a traditional IRA tax fee is an advantage, taking management fees out of a Roth IRA is not. There are limits on getting money into a Roth account where it will never be taxed again. We recommend paying the portion of management fees prorated to a Roth account out of your taxable account. This allows as much money as possible to stay in your Roth.

One of the advantages of working with a fee-only financial planner is that fees can be taken from the accounts under management or paid separately, depending on which is more advantageous. If fees are stuck on commission-based products, you can’t choose to pay the fees for a Roth account separately from a taxable account in order to allow the Roth to grow unimpeded.

This is another advantage to having fees based on assets under management rather than a separate fee or an hourly charge. Management fees are easily justified taken directly from accounts including IRA accounts where you can pay with pretax dollars.

Many advisors charge a percentage of assets under management and then offer comprehensive wealth management advice without an hourly charge. This is ideal. If these charges were separated, less of the fee could be paid with pretax dollars.

No one likes to pay fees. Hidden fees in many ways are easier psychologically. We recommend that when you need unbiased financial advice, seeking a fee-only financial planner makes sense. And it helps knowing there are tax-efficient ways to pay management fees.”

 

Reference

Marotta, David. “Are Investment Management Fees Tax Deductible?” Forbes. Forbes Magazine, 25 June 2012. Web. 12 Nov. 2014. <http://www.forbes.com/sites/davidmarotta/2012/06/25/are-investment-management-fees-tax-deductible/2/>.