Jarvis Financial

We live in a culture that is addicted to the fool’s errand of trying to outsmart the stock market. Almost daily our media outlets contain stories of “investors” that have hit it big by somehow outsmarting the market.

 The promotion of this addictive substance is not just limited to the media. Most financial services firms proclaim their value as the ability to outperform the market. In today’s jargon, this is called “achieving higher returns with lower volatility.”

Like all addictions, the quest for outperformance is exciting. Never mind that no one can consistently outperform the markets (least of all with lower volatility) many addicts are encouraged by their occasional successful pick. These occasional successes are, at least psychologically, enough that they can ignore their countless bad choices.

While picking the next Google may make for great bragging rights, it won’t help you achieve your financial goals, nor will it compensate for purchasing Apple at 700, or gold at $1,900 only to watch them fall 30% while the general market continues to rally.

Like the songs of the mythical sirens, we must not allow ourselves to be lured to our doom. If, as your advisor, all I could do was to prevent you from falling off the wagon of timing and selection, I will have provided a service worth multiples of my fee.

For a more detailed and academic explanation of while timing and selection is akin to the pursuit of alchemy, I encourage you to read a Random Walk Down Wall Street and Simple Wealth, Inevitable Wealth.

There are only two kinds of people in the world: People with too much class to say “I told you so,” and people like me.

On March 9, 2009 the S&P500 closed the day at 676, a 50% decline from the highs it has seen just two years prior. At that time, essentially the entire world was screaming “THE END IS HERE.” Dozens of books were published with titles such as “The Great Depression Ahead.” As the markets began to recover, we were told that it was a temporary rally and that the bottom would fall out at any minute.  Even today, any piece of bad news is held out as ”evidence” that the end is near.

During this entire saga (and forever more), I assured you that this was a temporary event and that long-term, equities still gave us our greatest opportunity for financial success.

For the first time since 2007, the S&P500 closed the day above 1,500 (1,502.46 to be exact).

5. Since 2008 more than $1T of investor money has flowed into bond funds. At some point, likely when rates go up and bond values collapse, this money will flow back into equities.

One of the many reasons I remain optimistic about the future is that in the long-run, the pessimists are always wrong.  Let’s look at just one of many glaring examples, oil. 40-years ago (1972) four scientists from MIT published a book titled The Limits to Growth.  Among other forecasts, these scientists predicted that the earth would run out of oil and copper no later than 2022. 

While the threat of “peak oil” was nothing new, this book seemed to prove the pessimists beliefs.  So where are we today? In 1980 the total proven world oil reserves stood at 1 Trillion barrels. Since 1980 the world has consumed essentially 1 Trillion barrels of oil. However current reserves stand at 1.5 Trillion barrels.  In other words, in the last 30-years we have consumed all of the oil that was believed to be in the earth in 1980, while at the same time discovering an additional 1.5 Trillion barrels of oil. 

This number does not include the estimated 4.8 Trillion barrels of oil believed to be accessible in shale reserves, nor does it include an estimated 6 Trillion barrels of oil in the Canadian tar sands.  All together this amounts to some 300 years of oil at current consumption rates.  Add the massive amounts of recoverable natural gas discovered in the last few years and we have a virtually unlimited supply of hydrocarbons (for better or worse).  Lest we forget about copper (also forecasted to be depleted by 2022), discoveries in the last ten years have given the world a 185,000 year supply.

How is this possible and where did the authors of Limits to Growth go wrong? The consumption forecasts made in Limits to Growth are shockingly accurate. However, while they forecast exponential consumption, they failed to account for exponential technological advancements.  Pessimism is always wrong in principle. But pessimism about natural resource-particularly about our ability to innovate so as to use less and less of them relative to output-is especially foolish.

For more reading, check out Everything You Know About Peak Oil is Wrong by Charles Kenny of Bloomberg Business Week (January 26^th, 2012).

Like all projections, the capitalized profits model is certainly no guarantee of future results.  It does however give us just one more reason to be confident in the fact that the declines are temporary and the advance is permanent.

While “giving it 110%” is a tired (and illogical) motivational line, when it comes to the IRS and your favorite charity, a 110% is possible. Donations made to charity can typically be deducted at 100% of their market value.

For example a $10,000 donation to St. Francis Hospital will reduce your taxable Income by $10,000. Certainly a generous donation, but it falls short of its full tax savings potential. Instead of donating cash, you could donate a stock or mutual fund that has unrealized capital gains.

For example, say you paid $1,000 for a stock that is now worth $10,000. Upon selling this stock you would have to report the $9,000 gain on your tax return. This gain would be subject to a tax rate as high as 35%. If instead you donated this stock to your favorite charity, you would avoid paying taxes on the $9,000 gain and would still be able to  deduct the full value of the donation. In other words, your $10,000 gift of stock would reduce your taxable income by $19,000 ($10,000 for the donation and $9,000 for the taxable gains that were avoided). In this ideal scenario, your donation resulted in a 190% reduction of your taxable income.

As always, there are limitations and restrictions that should be discussed with your accountant and qualified financial planner.

Tax-free income is the Holy Grail of financial/tax planning.  There are very few (legal) methods for obtaining tax free income.  One of these few methods is through ROTH IRA accounts.  Unfortunately Congress has imposed several restrictions on ROTH IRAs including income and contribution limits.  Generally speaking, most people are limited to contributing $5,000 annually (plus an extra $1,000 catch-up contribution for those over age 50), and only if their income is under $122,000 filing Single or $179,000 filing Married Jointly.

There are at least three strategies for overcoming these restrictions.  A handful of employers offer a ROTH 401k option to their employees.  With the ROTH 401k an individual could contribute up to $16,500 annually (plus an extra $5,500 catch-up contribution for those over age 50), with no income limitations.  Unfortunately these plans are not widely available and ROTH 401k contributions replace your traditional 401k contributions.

The second strategy is to make “back-door” ROTH contributions.  This two-step process is perfectly legal, but it requires careful planning.  Step one requires making non-deductable IRA contributions.  In other words you add $5,000 to your IRA account without receiving a tax deduction.  Step Two: a short time later you convert these funds into a ROTH IRA.  The only tax due in this process would be on any growth that occurred between your non-deductable IRA contribution and the date of your ROTH Conversion.

Before attempting this back-door ROTH contribution, you will want to talk with a qualified financial or tax planner about potential pitfalls due to the “cream-in-the-coffee” rules.

The third strategy is through ROTH IRA conversions which I will discuss another day.

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