Controlling Volatility Matters

Often, I talk to people who believe that the best way to invest is to continuously try to find investments that are outperforming all the rest, and that diversification hurts performance because you may own “losers” as well as “winners”. Aside from the fact that most academic research shows the extreme difficulty in continuously choosing only the best performers over longer periods of time, consider this:

Of the following two hypothetical investments, which would you rather own?

                                 High Volatility             Lower Volatility
Initial Investment         $100,000                    $100,000
Period 1 Return              50%                             10%
Ending Value               $150,000                    $110,000
Period 2 Return             -50%                            -10%
Ending Value                $75,000                     $99,000
Total Return                  -25%                            -1%

In the recent downturn, some of the strongest sectors are also some of the weakest year to date or over the last year.

Owning assets that may move in different directions can reduce volatility in a portfolio and may also increase return over time. Studies have shown that if you combine non-correlated assets (assets that don’t always move in the same direction) you can create a portfolio that has a higher return than any of the included assets individually, with volatility that is greatly reduced. 

Volatility can become more damaging when you are withdrawing assets from a portfolio. Being forced to sell an investment after it has dropped in value to fund the required withdrawal can greatly reduce long-term returns. Having some less volatile assets in a portfolio that can be sold to create the needed liquidity may give you the time needed for a volatile asset to recover. 

Matching your long-term target return with the amount of risk you are willing to take helps you build an investment portfolio that can reduce volatility and make more sense within the structure of an overall plan. Targeting risk adjusted returns that are designed specifically for you to reach your own real life financial goals can give you a clearer (and less volatile) roadmap to success.

Volatility can become more damaging when you are withdrawing assets from a portfolio. Being forced to sell an investment after it has dropped in value to fund the required withdrawal can greatly reduce long-term returns. Having some less volatile assets in a portfolio that can be sold to create the needed liquidity may give you the time needed for a volatile asset to recover.

Matching your long-term target return with the amount of risk you are willing to take helps you build an investment portfolio that can reduce volatility and make more sense within the structure of an overall plan. Targeting risk adjusted returns that are designed specifically for you to reach your own real life financial goals can give you a clearer (and less volatile) roadmap to success.

written by Albert J. Bartolomeo, CFP®

Broad Reach Wealth Management

Buy Sell Agreements

Business Succession Planning is very often not addressed, especially by small businesses. Buy-Sell Agreements are important and sometimes even crucial to the survival of a business in the event of an owner’s death, disability or retirement. 

Generally, it is preferred by business owners to buy out the surviving spouse of a partner in the event of that partner’s death, rather than have the surviving spouse become a new partner. Often, the surviving spouse has no expertise or experience in the business and would prefer a cash buyout as well. In the event of a shareholder’s long-term disability, that shareholder may begin to feel a small sense of guilt by continuing to maintain ownership and a full share of the profits, while no longer contributing any value. Also, the remaining partners who are operating the business on a daily basis may begin to feel a little negative about the disabled partner. A retiring shareholder/partner may look to the other shareholder/partners for a buyout, and again issues may arise when the retired partner no longer contributes. With some comprehensive planning, business owners can make arrangements to ensure timely tax efficient ownership transfers if the death, disability or retirement of a partner occurs.

A well-constructed buy-sell agreement can benefit the business by helping to maintain the continuity of management of the business and by helping to avoid problems or conflicts that may arise if the deceased or disabled partner’s family maintains ownership and has different views than the remaining partners. It can benefit the family of the deceased or disabled partner by providing much needed liquidity for living expenses, and it can benefit the remaining partners by allowing them to continue with operations as planned.

A buy-sell agreement can be funded with liquid assets, but many times those assets are not sufficient. Therefore, it is very common to use life insurance and disability buyout insurance to provide a cash lump sum needed.

The buy-sell agreement can be structured in many different ways and it is important to consult with an experienced attorney and other advisors when drafting the agreement. The buyout provisions can be structured as a lump sum payment or as installment payments. A buy-sell agreement can be constructed as a cross-purchase agreement or a redemption agreement. If a shareholder/partner is bought out by the remaining shareholder/partners, it is generally referred to as a cross-purchase agreement. If a shareholder/partner is bought out by the business itself, this is generally referred to as a redemption agreement. The structure of the business, unique aspects of the business, and estate, income and gift tax issues must be considered, among other things, in determining whether to use a cross-purchase agreement or a redemption agreement. The financial situation of a shareholder’s family must also be considered when determining whether the buyout should be a lump sum or an installment note.

Business succession planning is complex and care must be taken in developing a plan. The business valuation methods must be determined and ongoing valuations must be accurate and acceptable to all concerned (including the IRS for estate tax purposes). The plan must be structured properly and legal documents must be drafted properly. Broad Reach Wealth Management can work as a team with your other advisors (attorney, CPA, etc…) to help you protect your business and your family in the event of death, disability or retirement of a shareholder/partner.

Written by Albert J. Bartolomeo, CFP®

Broad Reach Wealth Management

Wills vs. Revocable Living Trusts

The foundation of a good estate plan is usually a properly executed will, a revocable living trust, or a combination of the two. Since a revocable living trust is considered a will replacement, there is a lot of confusion around the differences and if both are necessary. Many people are fine with just a will, while some would be able to accomplish their objectives with just a revocable living trust. Others should have a revocable living trust and a will that tranfers any probate assets not owned by the trust at the time of death into the trust. This is known as a "pour over will". 

Through our comprehensive financial planning process, we help our clients determine how to structure their estate plan. Each person is different and the use of different estate planning tools, such as wills and trusts, is determined by, among other things, their marital status and family issues, the types of assets owned, the size of their estate and their own specific objectives and unique circumstances.

My intent here is to give you a sense of what these two estate planning tools are and how they differ, not to tell you which is better in different circumstances. It is important to structure your estate plan properly and it must be based on your own specific circumstances and assets. Therefore, we highly recommend seeking specialized professional help in developing and implementing your estate plan.

Wills

A Will is a validly executed document that disposes of an individual’s property and other owned interests through probate at death. A will can set up certain types of trusts, fund existing trusts, name trustees and guardians for minors, give instructions for paying creditors, etc…, but it must be executed through probate.

Probate is the process used to make an orderly distribution of property from a decedent to beneficiaries. The probate process is characterized by court supervision of property transfers, filing of claims against the estate by creditors, and publication of a last will and testament for decedents dying with a will. Probate can be a long and costly process and can be avoided in part or in full through the use of such things as a revocable living trust or owning property jointly.

It is important to understand that retirement plans, such as IRAs and 401(k)s do not pass through the will. As long as an individual (or a properly worded trust for the benefit of a minor – care must be taken here!) is named beneficiary through the use of a beneficiary designation form, these assets are not subject to probate. Please review your beneficiary designations to make sure that you have completed them properly and that they are up to date with your current wishes.

Life insurance, annuities and transfer on death accounts (TOD) also are not subject to probate if beneficiary designations are handled properly.

Revocable Living Trusts

A Revocable Living Trust is a trust set up during one’s lifetime. It is considered a will replacement and is not subject to probate. Usually the grantor names himself or herself the trustee during lifetime. While the grantor is alive, there are no income or gift tax consequences with funding the trust, since it is not considered a completed gift. The trust is revocable and can be changed or terminated by the grantor. The grantor has all rights to principal and income as if the assets where owned individually (or jointly). At the grantor’s death, the trust becomes irrevocable, and either terminates with the corpus distributed to the remainder beneficiaries according to the terms of the trust, or continues until a later date.

There are some advantages to having a revocable trust as part of an estate plan. Assets can remain in trust after the grantor’s death, giving the grantor control over how they are used, by whom and to whom they may be ultimately distributed. Trust assets avoid probate, which potentially lowers cost and speeds up delivery to beneficiaries. Also, in avoiding probate, there is greater privacy. If you own real estate in a different state than the one you reside in, a revocable trust is a valuable tool. Without it, your assets are subject to probate in the state in which you reside and ancillary probate in the other states in which real estate is located.

Written by Albert J. Bartolomeo, CFP®

Broad Reach Wealth Management