Tuesday, April 10, 2007

Happy with $200 K tax bill

I've entered in all of my major numbers from 2006 into Turbo Tax. My tax bill for 2006, including federal and state, will be roughly $200 K. This is a huge number, but I am absolutely thrilled.

I was mentally expecting a $600 - 700 K tax bill, due to the gross proceeds totals on my 1099's. I was saved by the AMT cost basis on my sales of company ISOs. Because of the AMT cost basis, my effective tax rate this year will be relatively tiny - I already paid a lot of the taxes due on these shares several years ago in the form of AMT.

I do not owe any penalties, because I met the safe harbor requirements for 2006. As I mentioned in an earlier post, it's better to owe without penalty than to get a refund. 2006 was a great year for investment returns of all types, so it's a good year to owe the IRS.

My sister's family owes over $30K this year, due to withdrawal from a deferred compensation plan. Apparently this was an unexpected bill. I'm thinking of offering to help review their budgeting, but it's a sensitive topic...

Sunday, April 01, 2007

Asset correlation

I've commented a few times about how correlation between asset classes (international vs domestic market, commodities vs overall market) has risen in recent years. I see a couple of decent articles on this topic:


There is good data in this article, but I'm not sure I agree with all of the author's conclusions:

"International diversification works. Over the past 30 years, portfolios comprising both U.S. and non-U.S. equities have experienced higher returns and lower levels of overall risk. Risk reduction was the dominant effect for those who invested internationally during the past decade.
While the realized correlation of returns between US equities and non-US equities has risen in recent years, there is little evidence that changes in underlying cashflows have become more correlated across countries. While the changes in valuation ratios across countries have become more correlated, we question the extent to which elevated 'valuation correlation' can persist in the face of fundamental cashflow growth diversification. Although we are hesitant to endorse international equities from a relative return standpoint, we believe that capitalization, realized return and valuation data suggest that international equities are at least as attractive as US equities - if not more so.
While correlations have increased over the past several years, these levels are not expected to persist and are most likely associated with the recent negative market environment and the technology/telecom/internet bubble. Nonetheless, the long-term average correlation between U.S. and non-U.S. markets may have risen from 0.5 to a new level of between 0.6 and 0.65 reflecting increasing economic integration and globalization. Despite this increase, a 5-10% improvement in the risk-adjusted excess return (as measured by Sharpe Ratio improvement) of a U.S. equity portfolio can still be realized by adding non-US assets to the mix."

I think correlations have increased because people have diversified their assets into international equities, and that high correlation may continue indefinitely.

Another article comments on diversifying into gold:


"The Economist article cited at the start of this discussion points out that the low correlation that made gold so attractive a few years ago has increased to the point that gold provides far less diversification value. Aside from correlation, the volatility of an asset is crucial in determining its attractiveness—and gold is, and has always been, very volatile. There are a number of broad asset classes that provide low correlation and far lower volatility. Broad natural resource funds like IGE and utilities funds such as IDU exhibit low correlation to the broader markets with a manageable level of volatility. An asset class with a very high risk/return level, such as precious metals, is harder to manage around because of the enormous swings that are possible.
The second key point from looking at the correlation matrices is that an investor ultimately needs to look at correlations to the overall portfolio rather than correlations between individual asset classes."

I'd supply the Economist links, but you need a paid subscription to access.

For my own portfolio, I am not going to diversify further into precious metals. Instead, I will be increasing bond holdings (international and corporate, I already have a lot of munis) and international equity.

Friday, March 30, 2007

Search for financial advisor kicking into high gear

Remember when I started looking for an advisor many months ago before I got buried in my job? I kicked my search back into high gear today by making appts with financial advisors over the next couple of weeks. For kicks, I'm throwing in a couple of interviews with high net-worth advisors highlighted in Barrons' most recent Top 100 list. I'll have a little fun with this, and see for myself if a "Top 100" advisor is really much better than any other advisor. I know all the questions to ask now, and expect to be fairly knowledgeable about evaluating advisors after this process.

I was initially impressed by one of the advisors in that she was actually suspicious of my cold call. She thought I was putting her on (thought I was trying to recruit her or obtain some competitive information), so didn't divulge much information about her accounts or sound very friendly at all until she verified me by Googling me. Someone careful handling my money, I like that.

She said she was suspicious because I sounded too familiar with the drill.

Feel free to leave comments on any burning questions you may have for a financial advisor. I blogged a while back about some questions I asked, will provide an update on the question list (it's longer now) and how each advisor answered.

Reviewed my uncle's finances

I spent an afternoon last week reviewing my uncle's finances. He is about to retire in a couple of years. I had gifted him some stock a few years ago which we finally sold last year, so I wanted to make sure everything was in order for his tax filing.

The cost basis of the gift stock was essentially zero, but I found that he didn't have to pay any capital gains tax at all because he had substantial loss carryforwards. Very awesome, that was really good use of gifted appreciated stock (saved several thousand in taxes). I'm too curious for my own good, so I wanted to trace the history of all those losses to make sure someone didn't screw up somewhere. I ended up reviewing all his tax returns back to year 2000. Ah yes, the year 2000 when everyone had huge losses, and probably lots of people forgot to offset their losses.

I found a $2000 error his tax accountant made in favor of the IRS. The warning lights came on when I saw that he paid AMT in year 2000. AMT at his income level? It turns out that there was an error made in the TMT calculation which flowed through all the way to the bottom line. I left instructions for his accountant to ammend my uncle's tax return (and heard today that the accountant was quite embarrassed about the mistake). We are beyond the 3 yr limit for ammendments, but there is some hope that the IRS will refund him the $2000 because the IRS agent didn't catch the error either!

Hopefully the knowledge I have about taxes pays off here. It really helps to understand the big picture and not get lost in the maze of numbers, which apparently happened to his accountant. His accountant should have known that my uncle's income level should not have triggered AMT.

I spent a couple of hours reviewing his investments. It appears that he gets little to no advice on his substantial account. Beyond the initial funding, he has added to his holdings only a couple of times in the past 5 years. There does not appear to be any major annual rebalancing. The holdings in the account are mutual funds that are available at any discount brokerage. The portfolio is approximately 60% fixed income, 40% stocks. The stock holdings are well diversified, including international, growth/value, and all cap sizes. The shocker is that in addition to the mutual fund fees, there is a 1% annual advisor fee, which for his portfolio amounts to $4000. A 1% fee for a mostly-fixed-income portfolio, ouch! So next month, we will transfer all his holdings over to a discount brokerage. No need to sell anything for a couple of years, the allocation looks decent. He will have a nice pension, so we don't need to get ultra-conservative.

Altogether, we saved several thousand on this year's taxes, possibly $2000 on a prior year's taxes (keeping fingers crossed that the ammendment is accepted), and another $4000 in annual advisor fees. Not bad for an afternoon's work!

Thursday, March 29, 2007

Covered half my shorts

I don't mean to turn this blog into a trading diary, but I just covered half my short positions. We're not oversold yet, but after putting out a sizeable short position last week and watching the market trend down for 5 days, I didn't want to be greedy.

We will probably be in oversold territory next week.

I see some comments I haven't responded to. Will get to them later today, I'm late for basketball now.

Tuesday, March 27, 2007

A trip to the bank

I had a 100K 6.45% CD mature today, so I took a trip to my bank to deposit the proceeds. Since I do all of my regular banking transactions on-line, whenever I go into a branch office, it is invariably for a transaction involving a large dollar amount. I get the same predictable comments every single time. For withdrawals or wire transfers:

"Congratulations, buying a home?"

For deposits:

"Getting ready for a down payment on a home?"


"Do you have a financial advisor?"

I think I have gotten one of these three questions in my last 10 trips to the bank.

The last time I didn't get one of these three questions was when I made a deposit of a 500K+ check from the IRS. She had a lot of questions for me, but I most remember the first comment:

"Wow, you must be really happy." I was happy to finally get my money back, but I didn't explain to her that the only reason I got such a large check back was because I hideously overpaid my estimated taxes (see http://rags2richesfinancial.blogspot.com/2007/03/financial-decision-history.html). Getting an IRS refund check is not a good thing - hitting safe harbor in a big tax year is!

Every asset is a bubble

I read a blog entry today by Cramer that I couldn't agree with more. It's the reason that in my earlier blog entries, I couldn't find safe yield for my cash. He writes:

"Everything's a bubble. Mortgages? Bubble. Private equity? Bubble. Buybacks that lever companies? Bubble. Copper? Bubble. Corn? Bubble. Farm land? Bubble. Ethanol? Bubble. Solar? Bubble. Tech without earnings? Bubble. Office real estate? Bubble. Brokerage trading profits? Bubble. Hedge fund creation? Bubble. Derivative creation? Bubble. ETF explosion? Bubble. China stock market? Bubble. Blackstone? Bubble. "

To this, I'd add lots of other assets, including gold and residential real estate. When I searched for non-bubble categories last year, the only ones I came up with were German and Japanese residential real estate, which there are no investment vehicles for. Owning your own business is also not a bubble.

I can vouch for the fact that private equity is a bubble. I am coming across lots of private equity offerings now. This was a true wealth generator for the rich the last 8-10 years, generating 30% annual returns, available only to those with over 10-20 million of investable assets. Wall Street is now packaging them and marketing them to the next tier down.

I totally agree with Cramer. Bubbles have been around for many YEARS now. Will they pop? Probably. But when they pop, we will be too scared to invest in them. I only know of two people who timed the 2002 market low perfectly.

It seems to me most retail investors are invested somewhat in gold or hoarding a huge amount of cash (which many have borrowed against their home). But if you're afraid of bubbles, you would have missed out on the entire stock market bull run from 1981. Or like me, you would have waited 12 years to buy a house before throwing in the towel. When I bought my house, I was 100% sure I bought at the top. Years later, my home's unleveraged value is up 25-30%.

What can we do? Keeping cash under the mattress is guaranteed to make us poor in 20 years. We have no choice but to play the bubbles and limit the downside. Use protection.

Life is short. If your family needs more space than in your apartment, don't avoid buying the house if you can afford it. Get a predictable fixed mortgage, follow the conventional mortgage rules instead of what the loan officer sells you. You've already saved a bundle with the housing correction. You could wait until the market bottoms next year, or the year after, or in 5 years. But you and your children will also be a year, or two years, or 5 years older. Builders are welcoming low-ball offers these days.

Monday, March 26, 2007

A word about charity

So far, I haven't written anything about charity since I view it to be a very personal issue. But since this blog is anonymous and nobody reads it anyway, I'll talk about charity and what I think about it. I think charity is important, but it's up to all of us to make our own personal choices about charity.

I remember my first experience with charity, my school was collecting donations to feed the hungry. I was only 7 or 8 at the time and had a 25 cent or 50 cent weekly allowance (it wasn't much even at that time - I'm not that old!), or a couple of bucks left over from washing cars. Well I put everything I had into the donation, and I remember being yelled at by my mom that we needed that money ourselves. I don't blame her at all, my dad had passed away already and my mom was already battling cancer on her own while trying to raise three kids. She did eventually come around and tell me that she was proud of me.

I think charity is important because no matter how crummy a condition we find ourselves in, there is always someone worse off who needs food more.

The largest amounts that I've donated have gone to my alma maters, towards scholarships and improving classrooms, and rebuilding a burned down school. I strongly believe in the power of education, and empowering youth to excel.

I donated to Red Cross for Tsunami Relief and Katrina, and generally donate openly to charities sponsored by friends under the assumption that they've done their research already. I donate to Catholic Charities knowing that a good amount of that money gets to the people who need it. Cancer research funding is important to me. I also believe in charity for war veterans.

I've donated to Second Harvest, which got some negative press recently:


Kinda makes me want to give up pork...

I used to be selective about giving money to the homeless, but when I turned 30, I started giving money to anyone who asked for it, thinking that it's not my place to judge what they did with it. After being accused of being an enabler multiple times, I came up with these ad-hoc rules: 1) Give to anyone who looks over the age of 60. 2) Give to anyone missing a limb or an eye or obviously disabled in any way 3) Give to any female. 4) Give to any child - not sure about this one in countries where adults are obviously running some operation feeding off of sympathy towards children; the adults take all the money anyway. 5) Give to any leper (I've seen a lot of them in foreign countries). 6) When in doubt, always err towards the side of compassion and trust in the decency of people.

If you are male, look between the ages of 20 and 50, obviously have no problem walking car to car holding out your hands all day every day, and appear to have most of your mental capacity intact, don't look for sympathy from me anymore.

I believe in what Bill Gates and Warren Buffett did. I will save the bulk of my donations for later in life, because I feel those who have the ability to grow their money will maximize their contributions by keeping the money longer when they are young and giving more of it away as they get older.

Amazing luck streak continues

OK, I'm sure I've doomed myself by claiming a luck streak, but how amazing is that? One trading day after raising the highest % of cash in years in my brokerage account, and shorting DIA/QQQQ, we get a down 100+ day so far.

I'm not really into day-trading, so I don't plan on covering anything yet. Will wait patiently for bigger gains. At least till the 10-day average oscillator swings back into oversold territory.

Financial decision history

I've been meaning to post a history of critical decisions in my financial life. I saw Frugal Zeitgeist's history at http://frugalzeitgeist.blogspot.com/2007/03/stupid-things-i-have-done.html and decided to follow the same format.

Age 12: Orphaned as a child, I had to start working at age 12 to support myself. I learned about minimum wage, sweatshops, and standing on your own two feet. Didn't learn about child labor laws. I had my own checking account, I think I even had a credit card. I worked every year ever since that first job.

Age 14: I remember a freshman class assignment to state our financial goals for the next 5-10 yrs. I remember writing that I expected to make $35K a year after graduating from college, and being laughed at by classmates for having such outrageous expectations. I have no idea where I pulled that number out of.

Age 17: After graduating from high school, I had the choice of going to UC Berkeley or MIT. I made my choice purely on tuition cost. Although I had a scholarship for MIT, it wouldn't have been enough to pay for half the first year's tuition, much less room and board. Even at that age, I didn't want to take on any debt. I'm not sure how my life would have been different if I had chosen MIT, but I don't think I could have done any better financially. I probably would have turned out geekier.
I remember during my MIT interview, the interviewer suggested I apply for Harvard pre-med. I'm glad I didn't, I don't think I would have made a good doctor. My sis is a doctor, you have to really love the field to dedicate your life to it.

Age 21: I worked lots of odd jobs all through college to pay for it, but into my senior year I decided to do an engineering internship for 8 months at Chevron. It paid $25K annually, which to me was a ridiculous amount of money at the time. It enabled me to graduate from college with no debt, and $10K in the bank.

Age 22: Started first full time job, making - you guessed it - exactly $35K. I consciously made a choice between grad school and work - my childhood pretty much dictated my decision again. Not sure where I would have wound up if I followed the grad school route.

I made several financial mistakes in my job selection. First, being a pretty immature dude, I was too lazy to interview. So I pretty much stopped interviewing after getting two offers - one from Bell Labs in NJ, and one from a semiconductor company in Silicon Valley. I chose friends + weather over Bell Labs. If I was on the ball, I would have tried to get an interview at a company like Sun Microsystems or Cisco, and been set for life from the start.

Second, what sold me on my first job was that it involved travel, lots of travel. Being an adventurous young man, I found travelling for free really appealing. I spent 3 months in Scotland and UK, and another 3 months in Penang, Malaysia, and took ample vacation after both overseas assignments to tour the surrounding countries. I remember putting 5000 miles on my rental car in Scotland, with all the castle-hopping weekend trips I took. The decision was both good and bad for me financially. While I managed to have awesome travel adventures on company money, and room and board fully paid for while banking 100% of all my paychecks, saving that little money probably cost me big money. In order to get the travel experiences, I chose a product engineering career rather than a much more lucrative design engineering career. It took me almost 4 years to get back on the design engineering career path.

Age 23: I bought my first non-junker car, a Honda Accord. Still second-hand, but only 11,000 miles on it. I kept this car for 14 years and 250,000 miles. It was still running fine when I donated it. I remember when I went into the Mercedes dealer while shopping for my next car. They didn't take me seriously after asking what I was currently driving... :)

Age 26: After getting a little exposure to design engineering at a previous position, I decided to fully dedicate myself to design by switching companies and taking a pretty substantial pay cut (since most of my experience was in the other career path). Of course, in the long run, this was the second best decision of my financial history.

Age 28: After getting two full years of intensive experience in chip design, I decided to take a big risk for a big payoff going to a startup company. I had learned from my coming-out-of-college interviews, and this time around, I wasn't lazy. I interviewed at many companies, made sure I spoke with most of their staff, previewed and evaluated their products. I made the best financial decision of my life from this detailed evaluation, hitting a grand-slam home run on my first start-up selection. I spoke with the director from my previous position, and he strongly advised me against my decision: he had tried 10 startups during his career, and none of them had made it big. I had quite a lot of respect for him professionally, given that he had BSEE and MSEE from Stanford, and was quite strong technically, but thankfully I went against his advice.

In hindsight, I made a mistake in negotiating for a higher salary rather than more stock options (this ended up costing me millions, but it's impossible to know that at the time).

Age 31: I made the brain-dead mistake of not early exercising all my stock options before the company went public. I made this mistake because it cost real money to do the exercise (thousands or tens of thousands), but it would have saved me hundreds of thousands, possibly millions, in taxes later on. A case of being penny wise, pound foolish.

Age 33: I made my first million, 1.5 million to be exact. I made the mistake of thinking that this amount was a lot, listened to the advice of numerous financial advisers, and started diversifying out of my company stock and into a bunch of "safe" stock in big companies (think S&P 500). It's hard to say exactly, but this diversification probably cost me in the neighborhood of 15-20 million pre-tax dollars.

Age 34: Made my second and third (and fourth?) million. Bought my first home, paid for in cash. I guess in hindsight, it was a mistake not to buy my first home right out of school, I certainly could have afforded to with my first salary. But 12 years earlier, I already thought housing was a bubble and it would crash any day - haha. Instead, it more than tripled in those 12 years. Another mistake is my debt-averse thinking. I have hated and feared debt all my life, probably because I grew up so poor (relative to those around me). The concept of good debt is something that is very difficult for me to grasp, even to this day.
The same year, I made the huge mistake of not offsetting capital gains by realizing capital losses. So I ended up with a huge tax bill that could have been a lot smaller. I ended up taking the losses in the next tax year, and then it took a couple of years to finally recoup the capital loss carryforward.
Things could have been a lot worse. Many people got hammered by AMT bills that year on option exercises of stock that eventually became worthless stock. I think the IRS is finally providing some relief to them years after the fact. I don't know how the IRS can deal with the situation fairly to everyone involved.
The subject of financial mistakes you can make in purchasing and owning a home is a whole other story on its own.

Age 35: My accountant made a mistake in my estimated taxes. I didn't double-check and based my entire year tax planning off of my accountant's numbers. This mistake cost me another million. Ever since then, I have made sure I personally understand my tax situation, and I even go so far as to do my own taxes. I've found that it really helped me understand consequences of financial decisions (when to buy assets, when to sell assets, the timing of tax payments, tax implications for different assets, how to stay out of AMT or how to get it back once you've paid it, etc). And how screwed up our tax system is.

Current: Took over my investments in the past few years. I understand them to the point now that I am comfortable to hand over the control again to a third party. Because now I know exactly what to expect from them.

Thursday, March 22, 2007

Finished housecleaning

The market didn't tumble from profit-taking today. I felt strangely out of sync with the market as I sold off anything that wasn't bolted down today. I'm up to 25-30% cash from 10% in my diversified stock portfolio (I was at 15-20% cash before buying into the market ~3 wks ago). This is my highest cash position in years in this account. What's everyone else doing? It doesn't seem like there are many sellers today.

When I finished selling, I opened short positions in DIA and QQQQ equivalent to 8% of the portfolio. This is a trading position only. I am still hugely net long due to holdings in my company in other accounts.

For an opinion on why DIA isn't cracking, check out this analysis on each individual component:


I'm not an acolyte of Jim Cramer, I don't even watch Mad Money (no CNBC), but I do find his insight helpful.