Monthly Archives: November 2017

Financial Fact | 3 Steps to Understanding Mutual Funds & ETFs: Questions and Considerations for an Educated Investment Decision

 

If you’re looking to purchase a mutual fund or an Exchange Traded Fund (ETF), you should take the following steps to ensure you’re making the most tax-efficient decision:

 

 

Step One: Analyze the fund’s gross investment performance across the past five years.

 

Ask: What is the historical average of the fund’s investment performance across years one, three, and five?

 

Step Two: Compare the investments of the mutual fund and ETF.

 

Ask: Are the investments equivalent?  What kind of stocks is each fund investing in (i.e., technology, financial, etc)?

 

Step Three: Assess your existing investments and additional accounts subject to annual tax payments.

 

Ask: Are you investing in a qualified account such as an IRA or a Roth? Are you investing in any additional taxable account that pay taxes annually?

 

If you are investing inside of a qualified entity, the most important factor to consider is the fund’s net return over a one, three, and five year historical average.  In addition, if you are investing after-tax dollars, it’s pertinent that you examine the fund’s total returns across prior years, and through a tax-sensitive lens, to avoid encountering unexpected taxes down the road.

 

Mutual Funds and Capital Gains (4)

However, such an assessment can be tricky because of the multiple variables that must be accounted for.  For a mutual fund, when they have gains, an actively managed account may have sales that create a taxable event like selling a stock that has appreciated.  Those gains flow out to the individual mutual fund shareholder and are taxable in the year of sale.  On the other hand, ETFs do not actively sell positions that they believe have ran their course.

  

For example, consider that stock has increased from $10 to $50, and appreciation is not expected to occur in the near future. Under such conditions, a mutual fund’s active manager may decide to sell all, or part of the position, which results in an immediate tax liability. Despite the taxes incurred by selling the stock, there is an upside. Mutual funds are subject to the active involvement and decision making of the designated manager, thus enabling the fund manager to take some of the profits now to avoid risking all of the appreciation.

 

Yes, a manager has more authority regarding trade activity for mutual funds than they would an ETF. However, a mutual fund manager will have less control over the potential tax liabilities associated with the fund. Therefore, the success of a mutual fund is generally dependent on the market knowledge and strategic decision making abilities of its manager. In contrast, an ETF will ride out the market behavior and historically maintains a low turnover rate, thus requiring less involvement on behalf of the investor and/or manager.  

 

Mutual funds and ETFs, like most things in life, are not black and white. Investors must both research the available investment options and apply this information to the context of the past, present, and future of the individual’s financial journey. Essentially, you should 1) compare the returns of the mutual fund to those of the ETF, and 2) reduce the mutual fund return on an annual basis by taxable distributions that you have received multiplied by your personal taxable bracket. 

 

If you have any questions about this article, feel free to contact a member of the WJA team for more information about the options available to you.

Willis Johnson & Associates is a registered investment advisor. Investing in mutual funds and ETFs involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss. Past performance is not indicative of future results. Willis Johnson & Associates does not offer tax or legal advice. For assistance with these matters, please consult your tax or legal advisor.

 


 

person1

Robert Cope, MS

CONNECT WITH ME ON LINKEDIN

 

Robert (Bobby) Cope recently joined Willis Johnson & Associates as a financial paraplanner in May of 2017, as a recent college graduate. Bobby graduated Summa Cum Laude from the University of Alabama Honors College in May of 2017. For Bobby, entering the financial planning profession allows him to not only assist the associate wealth managers of the firm in daily operations but more importantly assisting client’s in many other facets of their lives.

 
 
 
 

 

Thoughts From Willis | A Year of Blessings: Giving Thanks at Willis Johnson & Associates


Once again, it’s that special time of year when we all take a moment to gather with loved ones, overindulge on turkey and pumpkin pie, and most importantly, express our gratitude for both the blessings and the challenges we’ve faced thus far.


 

For Houstonians, 2017 has been particularly tumultuous. Throughout the year, we witnessed families, communities, and the Houston area as whole come together to navigate the hardships and celebrate the victories we encountered. All of us at Willis Johnson & Associates are proud to be a part of such a resilient and charitable community.

 

As summer came to a close, Hurricane Harvey unleashed destruction and chaos across south Texas.  While many families are still picking up the pieces, we know Houstonians will continue to help provide relief to those affected by the storm.

 

Our firm was very fortunate as none of our employees, and few of our clients, suffered severe damages as a result of Hurricane Harvey. Unfortunately, Patsy and I are have just begun repairs to restore the damage our home incurred as a result of the Addick’s Reservoir flood, and we are looking forward to a late spring move-in. Unlike many others in our position, we were fortunate enough to lease a temporary apartment until our home is habitable. The Johnson family will be forever grateful to those who have supported us throughout this event, and we hope our fellow Houstonians can take the time to enjoy the holiday festivities in the midst of their own recovery efforts.

 

On a more positive note, WJA surpassed its quarterly goal for three consecutive terms, which propelled the firm’s steady growth over the course of 2017. This achievement has allowed Willis Johnson & Associates to attract and hire additional top-tier professionals capable of enhancing the value we deliver to the corporate professional, and enabled our team to continue our commitment  to providing top-notch service and technical expertise.

 

I believe WJA’s consistent success can be primarily attributed to our team’s unique financial planning expertise. Willis Johnson & Associates provides financial planning services focused around the goals and needs of corporate executives and professionals. We’ve accompanied hundreds of these individuals along the road to retirement, and this repeated experience has given our firm an in-depth understanding of the corporate professional’s life journey which allows us to take a proactive approach to helping them obtain their financial goals.  

 


“If you are really thankful, what do you do? You share.”

W. Clement Stone


 

Copy of Constant Contact thanksgivingdinnerThe WJA team is dedicated to delivering the utmost value in everything they do. Our primary goal is to become our clients’ most trusted advisor and help them successfully reach their retirement goals to fulfill their life vision. In doing so, we strive to become recognized and respected as an industry leader in the Houston area. 

 

 

Throughout the course of 2017, Willis Johnson & Associates was ranked #11 on the Houston Business Journal’s list of the 2017 Top Wealth Management firms*, recognized by Financial Advisor magazine as one of the top 400 financial firms in the nation** of 2017 with more than $250 million AUM, named to the 2017 edition of the Financial Times national 400 Top Financial Advisors*** with more than 10 years experience and more than $300 million in assets under management, and most recently, WJA was awarded a place on the 2017 University of Houston’s Cougar 100**** list of the fastest growing Cougar-owned businesses across the globe ranked by their two-year revenue growth.  Again, none of this would be possible without the commitment of the WJA team and the trust our clients place in us, for which I am exceedingly grateful. 

 

As we approach the end of the year at Willis Johnson & Associates, I’d like to personally thank each of our clients for allowing us to be a part of your life journey. On behalf of myself, Nick, Patsy, and the WJA family, we hope you and your loved ones have a happy, blessed, and safe Thanksgiving holiday.

 

 

Let’s not forget to thank the Houston Astros for giving our city a much needed win.

We are blessed to call our home team the 2017 World Series Champions.

#1

Go ‘Stros!

 

 

 

Happy Holidays,

 

Willis Johnson, CFP®

President and CEO

 

*Ranked by Assets Per Local Client.
**Ranked by discretionary and non-discretionary assets under management as reported on Form ADV.   
***Financial advisers from across the broker-dealer channel applied for consideration, having met a set of minimum requirements. The applicants were then graded on six criteria: assets under management (AUM); AUM growth rate; experience; advanced industry credentials; online accessibility; and compliance records. There are no fees or other considerations required of advisers who apply for the FT 400.”
****To be considered Cougar-owned, the company must be 51 percent owned by a Cougar or cumulatively by a group of Cougars. Cougar-led companies are considered those with a CEO, president, managing partner or chairman who is a Houston Cougar. Only companies that submit an application are eligible. The 2017 Cougar 100 list was ranked by two-year revenue growth.
Third-party rankings and recognitions are not a guarantee of future investment success and do not ensure that a client or prospective client will experience a higher level of performance or results. These ratings should not be construed as an endorsement of the advisor by any client nor are they representative of any one client’s evaluation.

What Nick’s Reading | 401(k) Loans vs. Home Equity Loans: The Real Cost of Borrowing from Your 401(k)

Whether you’re facing home repair expenses from Hurricane Harvey, college tuition costs, or another immediate financial need, it’s pertinent to gather the funding from a suitable source to avoid major tax and investment return ramifications.

 

We often encounter clients who consider their 401(k) to be the first resort when they need extra cash. However, we consider this perception to be misguided, especially if an individual has access to home equity at a reasonable rate. In addition, such an assumption can lead to costly mistakes if your unique financial situation is not taken into account. In this article, I’m going to tell you why this misconception is so prominent and what you should consider before borrowing from your 401(k).

 

Of course, before you take out any debt, ask yourself if the expense you’re funding is sensible.  Would you be better off delaying, or avoiding the expense entirely?  It’s important to live within one’s means, and even if you hold home equity or vested balance funds in your 401(k), you should avoid borrowing from this source. However, we understand that life is full of surprises, and situations do arise in which a 401(k) loan may be the best, or only choice.

 

The “Pros” of 401(k) Loans: What You Don’t Know Can Cost You

People often perceive 401(k) loans as a first-choice option when borrowing a large sum of money. This is due to its generally low interest rates, and the fact that a credit check or an underwriting are not required for an individual to qualify. The Treasury Regulation 1.72(p)-1 requires that 401(k)s charge “commercially reasonable” rates on any loan. Most employers interpret this as the Prime Rate plus one or two percent. Therefore, with today’s low rates, 401(k) loans are available at five to six percent interest.  

 

The second reason people choose to take out 401(k) loans is because they are borrowing money from themselves. They believe they can pay themselves back and get a “guaranteed” five to six percent on their 401(k) money without incurring significant loss. This is especially attractive when they do not see themselves likely to achieve over five to six percent with the current market.

 

On the contrary, I have seen clients shy away from refinancing their mortgage with a cash out, or tapping home equity with HELOC (Home Equity Line of Credit) loans. I’m not entirely sure why this is, but I believe that many people have a goal of eventually paying off their real estate debt, and retiring debt free.

 

The Cons of 401(k) Loans: Tricky Taxes

Let’s consider the following example to further explore the long-term ramifications of borrowing from one’s 401(k). William has $50,000 in his 401(k) plan that he would like to take out to assist in funding his daughter’s medical school costs. He is a conservative investor and has the $50,000 in a bond fund within his 401(k), which generates a 3% return.

 

William decides to use money from his 401(k) to fund the expense because, according to his beliefs, he will get the most for his money via this method. He will repay himself at a 5% rate, which William believes will result in an overall higher net return over time. William is partially correct. By essentially borrowing from himself, he will generate a higher return in his 401(k) than he had before. However, he did not consider the long-term cost of the 2% increase. William must front the 5% from cash flow to pay it back. In addition, the interest he’s paying to himself is not tax-deductible (unlike home equity financing).

 

Most importantly, once the interest is paid into the 401(k), it becomes pre-tax tax money. Thus, when William reaches retirement and withdraws the interest from his 401(k), once again, it will be subject to tax penalties. Essentially, the interest payment is a contribution to his 401(k) with after-tax money that does not retain any of its after-tax properties. Instead, the interest payment is treated as pre-tax money, and William will pay ordinary income taxes on the same loan amount twice over.

 

 


As Michael Kitces says, “401(k) loans don’t really pay yourself interest, they just add tax-inefficient dollars to your 401k!”


 

Tapping Home Equity

So, now let’s talk about home equity. First, you must have equity in your home available for you to utilize this option and lenders generally only permit the borrowing of up to 80% of this equity. Second, tapping home equity to fund one off expenses can be prohibitively expensive if you do not have excellent credit. Borrowers with FICO scores above 750 tend to receive the best rates. If you do not have equity in your home, or an excellent credit score, funding your one off expense with a home equity loan may not be the best option for you.

 

There are a few options to tap your home equity including a second mortgage, a Home Equity Line of Credit (HELOC) loan, and a cash out refinance. It’s important to know the difference between each option, which you can learn about here. 

 

Breaking Down the MathCopy of 401(k) vs. HELOC

Consider that William decided to finance his daughter’s medical school tuition with a $50,000 flat-rate home equity loan instead of a 401(k) loan. The interest rate on the home equity loan is 5%, William is in a 33% tax bracket, and the home equity loan’s interest is tax-deductible. 

 

Let’s compare the cost of borrowing for a HELOC loan versus a 401(k) loan. We will assume the headline rates of the 401(k) and HELOC loan are both 5%. However, a borrower will pay taxes on the 401(k) loan twice, once when they are paid their salary, and again in retirement when they withdrawal the pre-tax money from their 401(k). Thus the cost to borrow can be calculated by dividing the amount borrowed by (1 – current tax rate), or (borrow rate) / (1 – ordinary income tax rate). As an alternative, with the HELOC loan the borrower can receive a tax deduction on interest paid. The effective after-tax borrowing rate can be calculated by multiplying the amount borrowed by (1-current tax rate), or (borrow rate) * (1 – ordinary income tax rate).

 

Let’s refer back to William from our previous example. If William borrows money using a 401(k) loan at a 5% rate and his marginal ordinary income tax rate is 33%, then William’s after-tax cost to borrow will be 5% / (1-.33), or 7.5%. If William borrows the same amount using a HELOC loan and his marginal ordinary income tax rate is 33%, then his cost to borrow will be 5% * (1-.33), or 3.3%. Thus, the HELOC loan is the more tax-advantaged option for William’s financial situation.

 

Low Rates Make Home Equity Even More Attractive

Interest rates are nearing historic long-term lows and an individual with great credit will likely qualify for an exceptional rate on the loans they take out (sometimes as low as 4%). One of the greatest advantages of tapping home equity for your borrowing needs is that, under the right conditions, interest payments are tax deductible, which will reduce the loan’s overall interest cost for the borrower. Thus, William’s situation would be better suited for a home equity loan as he will pay less in after-tax borrowing costs over time than he would with a 401(k) loan.  

 

If you’re expecting to fund a large expense, be sure to thoroughly research and compare your available options. While borrowing from a 401(k) may be the right choice for some, the long-term cost of its associated interest fees may outweigh its perceived benefits.

 

Remember, what you don’t know can cost you, and can potentially affect your long-term financial goals.  If you have any questions, please consult your financial advisor, or contact a member of the WJA team for more information before you make a decision

 

 

Willis Johnson & Associates is a registered investment advisor. If you borrow from your 401(k) you have five years to repay the loan. If you lose or switch jobs, the loan must be repaid usually within 60 to 90 days. The IRS will count the loan as a taxable distribution if you don’t pay it back on time. You will owe income taxes, plus a 10% federal income-tax penalty if you’re younger than 59 1/2, on the unpaid balance.
This material is intended for informational purposes only and should only be relied upon when coordinated with individual professional advice. Please speak to an investment professional before implementing any advice here. Willis Johnson & Associates does not provide tax or legal advice.

 


nickNick Johnson, CFA®, CFP®

CONNECT WITH ME ON LINKEDIN

 

Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.

 

As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.

 


 

Market Update | The Markets (as of market close October 31, 2017)

Despite continuing drama in the White House and the fury of Mother Nature, stock growth remained steady for much of October. Favorable corporate earnings reports, a strong jobs sector, and growing consumer income overcame any trepidation investors may have had. Each of the benchmark indexes listed here posted monthly gains, led by the large caps of the Dow, which gained over 4% for the month and is up over 18% year-to-date. The tech-heavy Nasdaq has remained steady throughout the year, reaching new highs in October. The small caps of the Russell 2000 gained less than 1.0% for the month, but is up over 10.0% since the end of 2016.graph 1

By the close of trading on October 31, the price of crude oil (WTI) was $54.54 per barrel, up from the September 29 price of $47.07 per barrel. The national average retail regular gasoline price was $2.488 per gallon on October 30, down from the September 25 selling price of $2.583 and $0.258 more than a year ago. The price of gold increased by the end of October, closing at $1,271.80 on the last trading day of the month, down $18.04 from its September 29 price of $1,289.84…Click here for full article. 

Allow Us to Accompany You on Your Journey