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.

The Value of an Advisor

Vanguard has recently published an update to their Advisor's Alpha series:

Putting A Value On Your Value:  Quantifying Vanguard Advisor's Alpha

In this research paper, Vanguard believes that an advisor can add approximately 3% in net returns by utilizing their framework.  The table below outlines investment-oriented as well as relationship-oriented strategies that add value to the client.  It is important to note, the 3% increase in net returns should not be expected to be realized every year.  The actual realization of returns from the value-add of best practices will be intermittent.  The actual value to each client will, as always, depend on everyone's unique situation: time horizon, financial goals, portfolio composition, tax bracket, etc . . .

 

At Peak Capital Research & Management, we believe that our firm is positioned to help our clients maximize their opportunity to gain this added return.  Peak Capital Research & Management has strategies to try and maximize the return from each Alpha Strategy.  Our focus is on putting our client's in the best position possible for success; however, this does not always guarantee an optimal outcome.  Our focus is placed on the things that our firm and our client's can change: savings/spending rate, costs, asset location, etc.   

Utilizing a sports metaphor to outline how the driver's (low costs, asset location, etc) does not necessarily guarantee a certain output (returns):  Michael Jordan has missed 26 game winning shots.  Jordan was famously known for being extremely prepared for games by doing extra strength training, conditioning, and taking extra shots after practice.  Jordan did everything that he could to put himself in the best position to succeed, but he still missed game winning shots.  Peak Capital Research & Management will help our client's put themselves in the best position for success by:

Suitable Asset Allocation

Our firm utilizes broad based index funds and ETFs to give our clients diversified exposure to a wide range of asset classes.

Cost-Effective Implementation

Our firm utilizes low cost funds and ETFs from Vanguard and iShares in our client's portfolios.  Combined with our low AUM fee (0.5%) and the cost of the underlying funds and ETFs in a typical portfolio (0.15% to 0.20%), a typical portfolio's all in cost is approximately 0.70%.

Rebalancing

Our firm rebalances client portfolios annually or when an asset class deviates from its target allocation by more than the allowable range for that asset class.

Behavioral Coaching

Our firm provides coaching and education to our client's to maintain their investment strategy, especially during periods of market turbulence.

Asset Location

Our firm will position client's investments in an efficient manner to minimize the impact of taxes on the portfolio.  For example, typically fixed income investments will be located inside of retirement accounts, because interest is taxed at a higher rate than dividends from a stock.  Asset location also includes strategies for saving for college and health savings accounts.

Spending & Saving Strategy

Our firm will design a withdrawal strategy that focuses on minimizing the taxes on the portfolio.  This will include strategically withdrawing monies from taxable accounts, IRAs, and Roths.  In the years preceding the draw-down period of the portfolio, our firm will examine the use of strategic Roth conversions to reduce the required minimum distributions from pre-tax retirement accounts.

Total Return vs Income Investing

Our firm believes in a total return approach, which considers both components of return: income and capital appreciation.  The total-return approach typically has a lower risk, improved tax-efficiency, and potentially longer lifespan of the portfolio. 

For additional information or if you have any questions, please free to reach out to us here at Peak Capital Research & Management.  

Hire A CFA

Why Our CFA Credential Matters

Today’s financial markets demonstrate the importance of having reliable evidence of your financial adviser’s integrity, experience, and commitment. Among the credentials that financial professionals may hold, none are more highly regarded than or as rigorously focused
on investment knowledge as the Chartered Financial Analyst® designation. 

 Ethics

Ethics are a core component of the curriculum that leads to the CFA designation. Every CFA charterholder is required to annually sign a statement declaring adherence to the CFA Institute Code of Ethics and Standards of Professional Conduct.

 Knowledge and Experience

Every CFA charterholder has at least four years of industry experience and has passed 18 hours of rigorous examinations on subjects that include investment tools, asset valuation, portfolio management, and the application of ethical and professional standards.

 Global Relevance

The CFA charter has become the global professional investment credential. There are CFA charterholders in more than 130 countries, with increasing demand worldwide for the CFA program.

 Recognition

Respect for the program’s professional standards has made the CFA designation the mark of distinction for investment professionals worldwide.

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