Stop, Drop, But Don't Roll: Keep The Backdoor Roth Open

Stop, Drop, But Don't Roll:  Keep The Backdoor Roth Open

Quit, Leave, & Roll

The common mantra of financial advice is to roll the 401(k), 403(b), or other employer sponsored retirement plan into an IRA after quitting and leaving a former employer.  However, rolling a retirement plan into an IRA does have its drawbacks, especially for high-earners.  Rolling a 401(k) plan into an IRA can close the door on Backdoor Roth IRA, which could substantially increase the tax liability on a Traditional IRA that is predominately funded with non-deductible contributions.

The Backdoor Roth IRA is the term used to describe the process of making a non-deductible contribution into a Traditional IRA and immediately converting to a Roth IRA.  The purpose of the Backdoor Roth IRA is to avoid taxes on the growth of post-tax contributions.  If an individual earns more than $72,000 (>$119,000 married filing jointly), the contribution into an IRA is non-deductible.  The Backdoor Roth immediately converts these post-tax monies to a Roth IRA to avoid taxes on the growth.  If the non-deductible contribution remains in a Traditional IRA, the growth on this money is subject to income tax when it is withdrawn.

Our paper, Stop, Drop, But Don't Roll:  Keep The Backdoor Roth Open, covers the merits of keeping money in a 401(k) plan and not rolling into an IRA to maximize after-tax returns.

If you have questions on Backdoor Roth IRAs or on your employer retirement plan, please feel free to reach out to us.



Increasing Interest Rates & Bond Portfolio

The Key To Duration:  Portfolio Sensitivity To Changing Interest Rates

The market believes that the Fed will increase interest rates with ~99% probability based upon trading in the futures market.  With the Federal Reserve set to announce their targeted Federal Funds Rate on June 14th, we believe that this is a proper time to reevaluate the risks of fixed income as well as the metrics used to evaluate interest rate risk.

Bond prices move inversely to yields.  If yields increase, the price of a bond goes down and vice versa.  The price of a used car is analogous to bond prices in a rising rate environment. For example, an auto enthusiast is trying to sell a two year old car with 30,000 miles and squeaky brakes. A new car with the latest safety features, better performance, and zero miles can be purchased for $35,000. In order for our auto enthusiast to sell his used car, it would have to be priced less than $35,000. Much in the same way a bond that pays $40 a year would have to be priced lower to entice a buyer if new bonds pay $50 a year.  In the auto market, Manheim Market Reports can be utilized to estimate the depreciation of a vehicle. Fixed income enthusiasts utilize duration to gauge the price change of a bond due to a change in yields.

While we do believe that Janet Yellen will proclaim higher rates, we do not believe it is time to panic and take action driven by emotion.   Rather, the time prior to the eight scheduled meetings of the Fed is a good time to evaluate the risk exposure of a fixed income portfolio and reconcile this with required returns and tolerance for risk.



Invest or Pay Off Debt?

Pay or Save:  The Decision To Invest or Pay Off Debt

In this paper, Peak Capital explores the optimality of investing versus paying off debt.  We hope to provide assistance in the decision making process through our analysis; however, there is ultimately no 100% correct answer.  The answer will be dependent upon each person's unique situation and aversion to risk.  The answer to "Pay or Save" should not be limited to a binary outcome.

The optimal choice to invest or pay off debt cannot be determined by comparing expected returns and financing costs in isolation.  A holistic approach should be incorporated in the decision which includes consideration of volatility of investments, risk tolerance, need for future cash flows, and tax implications.

Be cautious when using "Invest vs Pay Off Debt" calculators.  It is critical that the outputs are questioned and given their due diligence.  One of the primary limitations of these calculators is the assumption of static rates of return without consideration of investment volatility.

At the most fundamental level, the decision to pay off debt or invest comes down to one simple question:  Is it worth the risk?

Investment Expense

Investor's Alpha:  Investment Expense

The sixth part of our Investor's Alpha series focuses on the importance of reducing or eliminating common fees investor incur in the management of their portfolio.  A majority of these fees can be avoided almost entirely or lowered through investor action.

  • Account Service Fees
  • Brokerage Commissions
  • Expense Ratios
  • Advisor Fees

Reducing investment management expenses is a simple, easy method to improve portfolio performance.  In investment management, the less you pay, the more you keep.  Reducing investment expenses by $1,000 annually combined with a 3% rate of return is ~$49,000 after thirty years.

Investors through their own actions have the ability to control the outcome of their portfolios compensating for the inability to control the markets.  Managing the cost of investing is one of the investor controlled inputs that drives the wealth equation:

Wealth = Factors You Control + Investment Return

Proper Asset Location

Investor's Alpha:  Proper Asset Location

The fifth part of our Investor's Alpha series illustrates the extra return an investor can harvest by properly locating their investments among taxable and retirement accounts.  An investor can enhance their long-term returns by reducing taxes by placing investments that are subject to high taxes inside of retirement accounts to minimize tax drag.  In addition to properly locating assets, an investor can also increase portfolio longevity in retirement by withdrawing assets strategically from a combination of taxable accounts, Traditional IRA, and Roth IRA accounts.

Proper asset location is an investor driven controlled input that can enhance returns with a low amount of time and effort.  As in real-estate, location can help increase portfolio returns during the accumulation phase and increase longevity during the distribution phase.

  Wealth = Factors You Control + Investment Returns

Tax Management

Investor's Alpha:  Tax Management

The fourth part of our Investor's Alpha series highlights the importance of minimizing taxes to enhance long-term returns.  Tax management is a process and not just a RonCo product that one can "set it and forget it".  The goal is to avoid taxes to keep more income from both wages and investments to enhance portfolio outcomes.  Investor's should take every advantage of every opportunity that the IRS provides to avoid, reduce, and defer the amount of taxes paid.

Tax management at its most basic level is a dynamic, optimization function.  Those fancy math words basically mean that investors should follow these 3 easy steps:

  1. Be aware of the basic tax laws
  2. How do these laws impact my income and investments?
  3. What actions can an investor take to reduce their tax burden?

The following inputs should drive a review of the portfolio to evaluate if changes should be made:

  • Change in year
  • Major new tax laws
  • Change in employment (hired, fired, retired)
  • Change in Family (kids, marriage, divorce, death)
  • Move out of state

Almost every major life even will trigger a change in a person's tax situation.  The most important part of the tax management process is to have awareness that if your life changes, your taxes will likely change as well.

Tax management is an investor controlled input into the wealth equation:

Wealth = Factors You Control + Investment Returns

Proper Asset Allocation

Investor's Alpha:  Proper Asset Allocation

The third part of our Investor's Alpha series focuses on the importance on the proper asset allocation of an investor's portfolio.  Asset allocation is a continuous, dynamic process and not just the results of a haphazard collection of stocks, bonds, and cash.  Asset allocation should be driven by the investor and not headlines or a top mutual funds list.  Asset allocation is a process that aligns the risk of the portfolio with the tolerance of the investor. 

The key drivers of asset allocation are:

  • Return Objectives
  • Risk Tolerance
  • Time Horizon
  • Tax Situation
  • Liquidity Needs
  • Legal / Regulatory Constraints
  • Unique Circumstances

A change in asset allocation should be driven by changes in the seven inputs above and not the performance of the stock market.

Properly allocating a portfolio is an investor controlled input into the wealth equation:

Wealth = Factors You Control + Investment Returns

Systematic Portfolio Rebalancing

Investor's Alpha:  Systematic Portfolio Rebalancing

The second part of our Investor's Alpha series focuses on the importance of having a plan in place to systematically rebalance a portfolio.  Having a set of rules to guide the construction and maintenance of a portfolio can enhance returns.  It is also important to note that rebalancing is not a return maximization strategy; rather, it is a risk realignment strategy.

Portfolio Rebalancing is an investor controlled input into the wealth equation:

  Wealth = Factors You Control + Investment Returns

Peak Capital Research & Management believes that in a low return environment, investor controlled inputs will be an important factor in enhancing returns in a low return environment.

10 Dollars A Day

Investor's Alpha:  10 Dollars A Day

Peak Capital Research & Management is proud to present the first part of our Investor's Alpha series.  This series will focus on investor controlled inputs into the investment process that will enhance portfolio outcomes.  Investor driven inputs will be an important factor in enhancing returns in a low return environment.

Wealth = Factors You Control + Investment Returns

  • Savings Rate & Spending Rate
  • Systematic Portfolio Rebalancing
  • Proper Asset Allocation
  • Tax Management
  • Proper Asset Location
  • Investment Expenses

The first part of our series, "10 Dollars A Day", examines the importance of savings rate in creating wealth.  Wealth accumulation begins with saving and investing on a regular basis.  Even a small amount of savings, give time and modest returns, can build into a large amount of wealth.  Saving and investing $10 a day and earning a return of 3% becomes ~$174,000 after 30 years.  A little change, both figuratively and literally, makes a significant impact on wealth.