It is difficult to compare gift vs. estate vs. generation skipping tax rates and how they are computed, especially considering the “inclusive” vs. “exclusive” treatment of various pieces. So I did a calculation that “normalizes” them to equivalent terms.

Assuming a taxpayer has already used up all of their exemptions and exclusions, and ignoring the three-year look-back on transfer taxes paid, if the taxpayer gifts/leaves funds to their (U.S. citizen) spouse or charity, there is no tax impact. However, if they chose to have the spouse or charity get less (by leaving or gifting it to someone else), a portion will go to tax and a portion to those recipients. This seems like a better way of thinking about the efficiency of those transfers because they are in the same terms.

In other words, at a “cost” of $X total, what percentage will the government get and what percentage will the children or grandchildren get? You might assume that the current rates, 40% for the generation skipping tax and 40% for gift/estate tax, will equal 80% if both apply; but it is a lot more complicated than that.

The short version below is ranked in order of efficiency:

Of course, many options are available for planning around those rates, but I do think the comparison is interesting, and I haven’t seen it laid out this way anywhere else. Also, if the asset is an IRA or something similar that is considered IRD (Income in Respect of a Decedent) you will have income taxes to contend with as well (and an offsetting deduction for the federal estate taxes attributable to the IRD asset).

Short selling is selling a security (typically a stock) one doesn’t own in hopes of buying it back later at a lower price. It is just the reverse of the normal practice of buying first then selling (which is called being “long” the security). Because short sellers are predicting a price decline, and will profit if they are correct, they are much maligned. In times of market turmoil they are invariably blamed and frequently there are calls to ban or restrict short selling. This is unfortunate because short sellers serve a very important function.

First, it might be helpful to further describe exactly what short selling is. If a trader gets paid on the opening transaction he or she is short. If the trader pays on the opening transaction, he or she is long. There is a stigma with short selling, but it is done all the time. If a contractor wins a bid to build an office building, the contractor is then “short” bricks, drywall, labor, etc. He or she has sold all of those for a fixed price without actually owning them at the time he or she sells them.

Incorporating all known information into prices (including negative opinions) aids price discovery (this is the technical term for finding what the “real” price is). We shouldn’t want prices high, we should want them right, and short sellers help reduce bubbles and volatility. In the long run prices will always approach their correct level; temporary imbalances because all opinions can’t be expressed don’t raise the long-term return on the investment.

It is understandable that when prices go down folks want someone to blame, and people with negative opinions who are selling are a convenient target, the theory being that the short sellers can drive the price down and then buy to cover their positions without those buys driving the price back up and removing the profits. Not only is that probably not possible to do, but notice that people don’t get worked up about the reverse – buying to drive the prices “too high” and then selling at a profit, even though it is exactly the same thing. Knowingly disseminating false rumors (positive or negative) to move a stock is securities fraud regardless of whether the investor is long or short. Short sellers have a very tough time in the first place because stocks have an upward trend. This is one of the reasons we are biased against it as a strategy – there is a headwind. Further discouraging short sellers is the frequent existence of uptick rules, the difficulty of locating shares to borrow, etc.

In my view structural difficulties should be eliminated if at all possible. For example, I don’t see why you should have to locate shares to borrow to sell short. You should be able to create “synthetic” stock. If someone wants to be short and someone else desires to be long, there is no reason not to have a derivative transaction where they settle up later based on the value of the underlying without forcing them to actually locate it and borrow it as is required now. This does lead to two slight issues for the long side since the stock wouldn’t actually be owned: dividends would not receive the qualified treatment for taxes, and there would be no voting rights. I envision these “synthetic” shares trading alongside the regular ones with small discounts because of those two detriments. Assuming adequate collateral requirements to protect the long side of the transaction, I imagine the spread would be very small.

In short, you should be thankful for short sellers.  They take significant risk and incur sometimes substantial costs (in the course of seeking a profit for themselves, of course) that help make prices more accurate reflections of the underlying values of securities.

We frequently find circumstances in which a financial advisor’s lack of knowledge of some specific tax-related techniques may have cost the client money. Upon asking a number of financial advisors and CPAs about these situations, the unawareness on these points in particular appears to be widespread:

• Net Unrealized Appreciation or NUA. Assume that you have a 401(k) with employer stock that was purchased far below the current value. Upon separation from service and prior to doing an IRA rollover, you may take the stock out directly (in-kind distribution). You will pay ordinary income taxes on the amount of the original purchase price, not the current market value. When the stock is then sold, the remaining gain is at capital gains rates, not ordinary income rates. Three circumstances will make this technique more advantageous: 1) the original purchase price is very small relative to the current fair market value of the stock; 2) you will need the money shortly anyway, so the continued tax-deferral is less of an issue; 3) the spread between the ordinary income rate and capital gain rate is high. All of these factors do not have to be true, but to the extent they are, the advantage of using the NUA tax treatment is greater.

• Losing tax basis in a permanent insurance policy. If you are surrendering a permanent insurance product for less than the premiums paid, you should probably do a 1035 exchange into a low-cost annuity instead. In spite of my well-known dislike of variable annuities in most situations, in this case, you will get tax free earnings until the “losses” from the insurance are earned back. Moreover, you can even add additional funds to the annuity to accelerate the time to achieve break-even from a tax perspective. This means the poor tax treatment (all ordinary income) of the annuity never comes into play.

• The earlier withdrawal date from a 401(k). Funds may be withdrawn from a 401(k) upon separation of service without a 10% penalty at age 55 not 59½ as with an IRA. This is without a 72(t) (substantially equal periodic payment) schedule. In other words, if you are retiring at age 56, the funds that may be needed prior to 59½ probably should not be rolled over to an IRA without some further thought and analysis.

One of our newer clients asked a question a while back that comes up occasionally, “How do I know if you are doing a good job?” It is a great question. I’m not sure I have a great answer, but this is my attempt at it. First, I will give eight tips for finding an advisor in the first place, followed by eight tips for evaluating the advisor once you have hired them, and finally I will comment on the obvious factor that oddly (or so it would seem) didn’t make either list.

Consumer advocates who advise individuals searching for an advisor generally recommend finding one who:

1. is a fee-only (not “fee-based” or “fee-oriented” – these terms are designed to confuse the investor) registered investment advisor. This means that they are legally a fiduciary and are required to put their client’s interests first. In addition, since the advisor is only getting paid by the client, potential conflicts of interest are minimized (though not eliminated).
2. is credentialed. At a minimum the advisor should be a Certified Financial Planner (CFP) and, if your portfolio is larger, a Chartered Financial Analyst (CFA). There are hundreds of credentials, but a great many are simply marketing tools that can be obtained by paying a fee and taking a short true/false test. The CFP (for financial planning) and the CFA (for investment management) are widely considered the gold standards.
3. has a clean regulatory record.
4. takes a holistic view of your finances. A good advisor will make sure your overall house is in order (insurance, estate planning, etc.) before addressing your investment portfolio. Even when addressing the portfolio, the rest of your situation should influence it. To give just a few examples, a retiree with a mortgage and an entrepreneur both should have a lower risk portfolio, an investor with a long-term fixed-rate mortgage needs less inflation hedging than a pensioner, etc. A good test of this is to note whether the advisor recommends things they don’t offer (such as an umbrella liability policy, or updated wills) and reviews your tax return for opportunities even though they don’t do tax preparation. These are signs they truly have your interests at heart.
5. is willing to provide references. This isn’t fool-proof of course. An advisor is unlikely to provide a reference that won’t say positive things, but it can still shed some light on their level of service among other things.
6. doesn’t talk about beating the market or potential returns, but rather about how to reduce risks and make reasonably sure you can reach your financial goals.
7. is experienced. It does help to have been around the block a time or two. (I believe vicarious experience from studying market history is probably even more important, but it is hard to know whether the advisor has that.)
8. has low fees. The industry standard is one percent of assets under management (per year) or less for larger accounts.

All of those items are good when selecting an advisor initially, but still don’t answer the original question. After the advisor is hired, how do you know if they are doing a good job? Your advisor is probably doing a good job if he or she:

1. is always happy to explain why they are doing what they are doing.
2. generally uses inexpensive investment vehicles (primarily index funds and other passive-type funds).
3. doesn’t make many changes to the portfolio once it is initially invested. Most activity – even by professionals – removes value rather than adds it. A cautious, even, temperament is crucial to long-term success.
4. proactively contacts you about changes to income, gift, and estate taxes, etc. and is responsive when you reach out to them.
5. doesn’t tell you what you want to hear. This may seem odd, but good salespeople tend to agree with you and want you to be happy above all. Thus if you are worried about the stock market (2008), they will agree with you about lowering your risk level. If you are excited about the stock market they will agree with you about raising your stock exposure (1998). Similarly, a good advisor generally won’t be investing in whatever the latest fad is.  A good advisor is frequently pushing back against the reigning emotion of the time – even yours.
6. is focused on the long-term and provides a long-term perspective. For example, permitting (or even encouraging) a client to spend more than their portfolio can realistically support will be just fine – for a decade or two. A good advisor is planning for, and cautioning you about, the consequences in the very long run.
7. doesn’t pretend they can predict the direction of the market in the short run. No one can reliably do this, but even if they could they certainly wouldn’t be working as your advisor. (They would either be an extremely wealthy retiree or be running a hedge fund.)
8. broadly diversifies your investment portfolio. As an expert witness I have testified for clients who were put into portfolios almost exclusively composed of high yield (junk) bond funds or REITs. While many things can have a place, items such as these should be a very small part of a portfolio.

The astute reader who has gotten this far (who, first of all, should be commended for their endurance) may have noticed that I have not put a seemingly obvious item on either list above – returns. Why would I leave out past performance in selecting an advisor, or current performance for an existing advisor? There are a few reasons:

1. You will never have a long enough track record. I have explained this at length elsewhere but to know a portfolio manager who has been beating the market by 2% annually (which is enormous) actually has skill would require a track record 56 years long. (This is a difference of means test assuming 2% alpha, 20% standard deviation, and 90% correlation with the benchmark.) Thus, realistically, you will never know with any high degree of confidence whether a portfolio manager is skillful. I wish it were otherwise, but it simply isn’t.
2. Good performance may just mean extra risk. An advisor who placed a client in an inappropriately risky portfolio will nonetheless look like a genius when the market is going up. There is an old Wall Street saying, “don’t confuse brains with a bull market.”
3. Underperformance may just mean prudence. Good investment advisors had their clients appropriately diversified in the late 1990’s and thus trailed the market (remember “irrational exuberance?”) by a wide margin. While those advisors were vindicated in the early 2000’s many had already lost a significant number of clients – who frequently returned to them with much diminished portfolios.

So, while it is somewhat counter-intuitive, there are many factors that are useful in evaluating your financial advisor, but performance isn’t one of them.

We are all prone to a variety of mental mistakes including (but not limited to) anchoring on irrelevant information, searching for confirming evidence rather than disconfirming data, extrapolating from small and recent data sets, etc. Some time ago I created a checklist of things to think about when making a decision – particularly an investment decision, but most of the factors generalize. Here is my checklist:

• Clearly define the question/problem (not the symptom).
• Create a Pro/Con List (Ben Franklin).
• Determine the distribution of outcomes.
  • Best Case?
  • Worst Case?
  • Expected Case? (the sum of the possible outcomes times their probability)
  • Standard Deviation? (the spread or range of the outcomes)
  • Skewness? (the range of outcomes is skewed to the positive or negative)
  • Excess Kurtosis? (outliers occur frequently)
• Check for biases.
  • Do I have feelings of euphoria, excitement, fear, or worry? (decide when dispassionate)
  • Am I anchoring on irrelevant data?
  • Am I narrow framing? (decisions should be made in the broadest appropriate context)
  • Is “everyone” doing it? (be wary of “going along with the crowd”)
  • Has the paradigm shifted? (past data may no longer be relevant)
  • Am I overconfident? (almost certainly unless suffering from clinical depression)
  • Have I considered sunk costs? (these are not relevant to the decision)
  • Have I searched for disconfirming evidence?
  • Have I overcome status quo bias?
• Is a decision required? Or is the lack of a decision a decision?
• Is there a correlation with another risk exposure?
• Have I identified all the alternatives?
• Have I conducted a pre-mortem?
• Is there empirical data? If so,
  • Is there data mining?
  • Have I tested out of sample?
• Are there theoretical underpinnings independent of the data?
• What if the decision is wrong?
  • Can poor outcomes be mitigated?
  • Can the bet be hedged?
• Does this decision maximize happiness?
• Does this decision minimize regret?

I should also note that a good decision is not the same thing as a good outcome, though they should be correlated. For example, investing all of your retirement funds in lottery tickets or one single stock is a bad decision even if you happen to win the lottery or the stock skyrockets. Conversely, investing in the market (prudently, with an appropriate asset allocation, etc.) is a good decision even if the market subsequently crashes.