November 21, 2024

You are here: Home / Archives for equity holdings

Bucks: Let Diversification Do Its Job

December 31, 2012 by Leave a Comment

Carl Richards

Investors typically set up a diversified investment portfolio to reduce their risk. Just hold a good mix of different kinds of stocks, along with some bonds and cash, and your problems are over.

Right?

Not exactly. Diversification comes with its own risk. But before we get to the risk, let’s talk about how we define this term in the first place.

When people say diversification, they’re often talking about two separate things. First, there’s equity diversification where you split up the portion of your money invested in stocks among big ones, small ones, undervalued ones, international ones and so on.

The idea behind this strategy is that you can reduce your risk, since different types of stocks often behave differently depending on market conditions.

Sometimes, it works. Dimensional Fund Advisors reported that in 1998, the large company stocks that make up the S.P. 500 gained 28.6 percent while small-cap value stocks lost 10 percent. Then in 2001, the S.P. 500 was down 11.9 percent, while those same small-cap value stocks gained 40.6 percent.

Since it does help sometimes, equity diversification is a useful strategy. Do it. But you have to understand that equity diversification sometimes fails to deliver exactly what you expect it to and often fails when you need it most.

We saw this in 2008-2009, when almost every type of investment fell. Granted, diversification would have saved you from making a mistake like putting everything in Lehman Brothers stock, but you still saw equity holdings plummet.

If you think back to that time, you will most likely remember hearing people say that diversification was broken, that it no longer worked. I remember thinking that myself.

But remember, when that happens and people start running around again saying diversification doesn’t work, they’re talking about equity diversification. There’s another, more important type of diversification: the way you split your money between stocks, bonds, cash and other investments.

This portfolio-level diversification is the primary lever to help you manage the risk and return in your portfolio. Each type of investment plays a different role:

  • Stocks provide the growth.
  • Short and intermediate bonds provide more safety and a little income.
  • Cash is there for liquidity and to protect your money.

The idea is to balance these investments in a way that gives up some higher returns in exchange for lower overall risk. Essentially, you’ve given up the opportunity to hit home runs for the benefit of never striking out.

With that out of the way, let’s talk about the risk of diversification.

Whenever you diversify, if you’ve done it correctly, there will always be something in your portfolio that you’re in love with and something that you want to dump (or will at least be the source of concern, as bonds are now in some circles). Some investment or asset class will be doing fantastic compared to the rest of your portfolio, and something will be doing much worse than everything else.

The trouble is, you never know when all of this will change. The thing you want to buy more of now will someday become the thing you want to sell.

Think back to the example from 1998. Having lived through it, I can tell you it was awfully tempting to move all your money out of small-cap value stocks and into large-cap stocks. But that would have been a terrible decision given how well small-cap value stocks did just two years later.

The same is true when you diversify among stocks, bonds and cash. When the stock market is tumbling like it did in 2008, you want to move everything to cash, and it’s really hard to keep money in bonds or cash when the stock market is having one of those great years.

But here is the point. The risk of diversification is that you will bail on it as a strategy at exactly the wrong time.

That feeling you get — the one that says, I wish I could dump this lame investment so I could buy a whole bunch more of this incredibly hot one — can get you into trouble fast. The temptation is greatest when it would be the most catastrophic for you to succumb.

But that feeling is actually telling you that you’ve done the right thing: You’re diversified. So remember that when the current fad ends and today’s rejects come back into style, you’ll be okay. And you’ll be awfully glad you didn’t give in to the temptation to give up on being diversified.

The next time diversification appears to not be working, remind yourself that it is a long-term strategy that can’t be judged on your short-term experience. In other words, just because something isn’t working right this minute — or even right this year — doesn’t mean it’s broken. So instead of thinking, “I am a rocket scientist and I can come up with something better,” just let diversification do its job.

Then go for a hike in the mountains instead of sitting hunched over the sell button on your broker’s Web site.

 

Article source: http://bucks.blogs.nytimes.com/2012/12/31/let-diversification-do-its-job/?partner=rss&emc=rss

Filed Under: Your Money Tagged With: , ,

Economix Blog: Romney’s Tax Bill, European Style

January 26, 2012 by Leave a Comment

5:46 p.m. | Updated to correct income figure for Liliane Bettencourt.

PARIS — Perhaps it’s no surprise that the Republican presidential candidates Mitt Romney and Newt Gingrich have been so vociferous in warning against what they deride as President Obama’s efforts to turn the United States, as Mr. Romney put it, ‘‘into a European-style welfare state and have government take from some to give to others.’’

Because one thing is for sure: if they lived in Europe, they’d be paying more taxes.

View From Europe

Dispatches on the economic landscape.

We spoke with tax experts in Germany, France and Britain about how much tax they would expect a citizen of their countries to pay on an income similar to Mr. Romney’s. The short answer is, millions more.

None of our tax advisers, all of whom deal with wealthy clients, wanted to be identified, and they cautioned that there was no way to give more than a ballpark estimate without studying Mr. Romney’s tax forms in more detail themselves.

But for the sake of a simple comparison, let’s start with France, which has a top income tax rate of 48 percent, and a capital gains tax rate of 19 percent. (All income is also subject to a 13.5 percent social security tax that helps to pay for things like pensions, unemployment insurance and health care; in the United States, by comparison, the top ordinary income rate is 35 percent and the capital gains rate is 15 percent. Only the relatively small Medicare tax is applied to all earned income, while in 2010 and 2011 Social Security tax applied to only the first $106,800 of wage and salary income.)

In Paris, the hypothetical M. Romney’s effective tax rate would probably have been in the neighborhood of 35 to 40 percent, including the social security tax. While much of his income derived from capital gains, his dividends, interest and income from his private-equity holdings would mostly be taxed at ordinary income rates. At 40 percent, his bill would have been about $8.6 million. (France also gives generous tax credits for large families, but M. Romney’s five children are all adults now, so that would not be of much use.)

In the United States, Mr. Romney paid $3 million in income taxes on his 2010 income of $21.6 million, for an effective rate of 13.9 percent. His Social Security and Medicare tax bills would have been trivial by comparison.

In Britain, income tax rates top out at 50 percent. But most likely, a top London tax lawyer told us, the effective rate would be significantly lower, since Mr. Romney’s income from capital gains would have been taxed at 18 percent to 28 percent.

So, he said, an educated guess would produce an effective tax rate for Mr. Romney of ‘‘probably 30s rather than 40s.’’ At 35 percent, the tax on Sir Mitt’s $21.6 million would add up to about $7.6 million.

In Germany, high-earning workers pay individual income tax rates of up to 45 percent, though our adviser — a lawyer in Frankfurt with a top international firm — noted that an additional ‘‘solidarity surcharge’’ is tacked on top of that for an effective top rate of 47 percent. Mr. Romney, however, would benefit from the lower rate applied to private capital investments: 25 percent, with the solidarity surcharge bringing it up to about 26.4 percent. With most, but not all, of his income treated as capital gains, Herr Romney would probably pay about 30 percent, or $6.5 million.

As for Mr. Gingrich, who paid 32 percent in federal income tax on his $3.14 million in income, he would face mostly ordinary income tax rates in Europe, so he would probably have to fork over about 40 percent of his income if he lived in one of the major European countries.

Of course, many wealthy people find ways to avoid the tax collector (legally and illegally), even in the dreaded European welfare states. Just ask officials in Greece and Italy.

In fact, Mr. Romney may even have competition: Liliane Bettencourt, heiress to the L’Oréal fortune and the richest person in France, made headlines last year with reports that she paid only about 4 percent in taxes on an income of nearly 250 million euros, or $324 million.

After the uproar, Ms. Bettencourt and some other members of the French wealthy elite took a page from Warren Buffett’s book, and asked the government to raise their taxes.

This post has been revised to reflect the following correction:

Correction: January 25, 2012

An earlier version of this post misstated Liliane Bettencourt’s reported annual income. It was in the hundreds of millions of euros, not hundreds of billions.

Article source: http://feeds.nytimes.com/click.phdo?i=8940c13c2558deebf294fc83d58d6252

Filed Under: Economy News Tagged With: , ,

Economix Blog: Romney’s Tax Bill, European Style

January 25, 2012 by Leave a Comment

5:46 p.m. | Updated to correct income figure for Liliane Bettencourt.

PARIS — Perhaps it’s no surprise that the Republican presidential candidates Mitt Romney and Newt Gingrich have been so vociferous in warning against what they deride as President Obama’s efforts to turn the United States, as Mr. Romney put it, ‘‘into a European-style welfare state and have government take from some to give to others.’’

Because one thing is for sure: if they lived in Europe, they’d be paying more taxes.

View From Europe

Dispatches on the economic landscape.

We spoke with tax experts in Germany, France and Britain about how much tax they would expect a citizen of their countries to pay on an income similar to Mr. Romney’s. The short answer is, millions more.

None of our tax advisers, all of whom deal with wealthy clients, wanted to be identified, and they cautioned that there was no way to give more than a ballpark estimate without studying Mr. Romney’s tax forms in more detail themselves.

But for the sake of a simple comparison, let’s start with France, which has a top income tax rate of 48 percent, and a capital gains tax rate of 19 percent. (All income is also subject to a 13.5 percent social security tax that helps to pay for things like pensions, unemployment insurance and health care; in the United States, by comparison, the top ordinary income rate is 35 percent and the capital gains rate is 15 percent. Only the relatively small Medicare tax is applied to all earned income, while in 2010 and 2011 Social Security tax applied to only the first $106,800 of wage and salary income.)

In Paris, the hypothetical M. Romney’s effective tax rate would probably have been in the neighborhood of 35 to 40 percent, including the social security tax. While much of his income derived from capital gains, his dividends, interest and income from his private-equity holdings would mostly be taxed at ordinary income rates. At 40 percent, his bill would have been about $8.6 million. (France also gives generous tax credits for large families, but M. Romney’s five children are all adults now, so that would not be of much use.)

In the United States, Mr. Romney paid $3 million in income taxes on his 2010 income of $21.6 million, for an effective rate of 13.9 percent. His Social Security and Medicare tax bills would have been trivial by comparison.

In Britain, income tax rates top out at 50 percent. But most likely, a top London tax lawyer told us, the effective rate would be significantly lower, since Mr. Romney’s income from capital gains would have been taxed at 18 percent to 28 percent.

So, he said, an educated guess would produce an effective tax rate for Mr. Romney of ‘‘probably 30s rather than 40s.’’ At 35 percent, the tax on Sir Mitt’s $21.6 million would add up to about $7.6 million.

In Germany, high-earning workers pay individual income tax rates of up to 45 percent, though our adviser — a lawyer in Frankfurt with a top international firm — noted that an additional ‘‘solidarity surcharge’’ is tacked on top of that for an effective top rate of 47 percent. Mr. Romney, however, would benefit from the lower rate applied to private capital investments: 25 percent, with the solidarity surcharge bringing it up to about 26.4 percent. With most, but not all, of his income treated as capital gains, Herr Romney would probably pay about 30 percent, or $6.5 million.

As for Mr. Gingrich, who paid 32 percent in federal income tax on his $3.14 million in income, he would face mostly ordinary income tax rates in Europe, so he would probably have to fork over about 40 percent of his income if he lived in one of the major European countries.

Of course, many wealthy people find ways to avoid the tax collector (legally and illegally), even in the dreaded European welfare states. Just ask officials in Greece and Italy.

In fact, Mr. Romney may even have competition: Liliane Bettencourt, heiress to the L’Oréal fortune and the richest person in France, made headlines last year with reports that she paid only about 4 percent in taxes on an income of nearly 250 million euros, or $324 million.

After the uproar, Ms. Bettencourt and some other members of the French wealthy elite took a page from Warren Buffett’s book, and asked the government to raise their taxes.

This post has been revised to reflect the following correction:

Correction: January 25, 2012

An earlier version of this post misstated Liliane Bettencourt’s reported annual income. It was in the hundreds of millions of euros, not hundreds of billions.

Article source: http://feeds.nytimes.com/click.phdo?i=8940c13c2558deebf294fc83d58d6252

Filed Under: Economy News Tagged With: , ,