Investing in 2018: Defensive Funds

As the previous article suggests, 2018 might be a difficult year for stock market investing. Yes, a 9-year bull market could stretch to 10 years. However, the longer the bulls keep running, the greater the chance that they’ll have to pause for breath, and an exhausted equities market will sag. Risk reduction can be just as important as profit potential at current stock values.

One approach to risk reduction is to sell stocks and put the proceeds into cash. That may turn out to be a good move now, but it’s also possible that you’ll miss another good year in the market while earning virtually nothing in cash.

Another way to play defense is to review your asset allocation. If your investment plan is to have a 60/40 portfolio, stocks to bonds, equity gains might have moved that ratio to 70/30, for example. Trimming stocks and increasing bonds to get back to 60/40 probably would make your portfolio less volatile.

Safety in numbers

One additional defensive tactic could be to reduce your holdings of individual stocks, then shift some assets into mutual funds and ETFs. A fund with 50 holdings is not as likely to be decimated as a portfolio with only 2 or 3 stocks. Funds often are managed by experienced professionals, backed by analysts who spend considerable time seeking desirable issues.

That said, there are many thousands of stock funds from which to choose. There is no certain way to predict results of a given fund, but some strategies might boost the likelihood of finding one that can provide some cushion in a down market.

Crafty capturing

One possible approach is to use “capture ratios” to evaluate funds that you’re considering. There are two types of ratios: downside capture and upside capture. The downside capture ratio shows a fund’s losses in relation to a relevant market benchmark during downturns. The upside capture ratio shows a fund’s gains in relation to a relevant market benchmark during upturns. This information can be found online on

Example 1: XYZ Fund’s 10-year downside capture ratio shows that it held losses to about 80% of its benchmark’s decline during market drops, while its 10-year upside capture ratio reports that it’s returning about 90% of the market’s gains during upward moves. This positive spread indicates the fund has held down losses while delivering largely positive results.

Comparing capture ratios can be useful but it’s not a guarantee of success. If it were, everyone would simply look up capture ratios online, invest in the funds with the best positive spread, and mint money.

Nevertheless, the idea of comparing upside with downside performance can be useful. A fund that has done relatively well—that is, limiting losses—during the bear markets of 2000-2002 and 2008-2009 may be a fund that could do the same in the bear market of 2018 or 2019, or whenever the Ursidae family comes out of hibernation. If a fund that has done well defensively also has registered strong growth in rising markets, it may be a fund worth further evaluation.

Winning the numbers game

Underlying the approach of investing defensively is some basic math that investors may overlook.

Example 2: John Lucas holds $100,000 in XYZ Fund. The market drops 25% in the next year, but XYZ only falls by 20% to $80,000.

At the same time, John’s cousin Linda James holds $100,000 of ZYX Fund, which drops the full 25% to $75,000.

Going forward, John needs a 25% gain to get back to $100,000, and Linda needs a 33.3% gain to recoup her losses. It’s certainly possible that Linda’s fund will outperform John’s in the recovery, but it has significantly more ground to make up.

Carrying this example further, investors need a return over 40% to recover from a 30% loss, a 67% return after a 40% loss, and so on. Holding down losses can put you in a better position to build wealth when market cycles turn bullish, as you’ll have more assets left to participate in future growth.

Stress reduction, too

Defensive funds may have non-mathematical attributes as well. Historically, bear markets have proven to be buying opportunities. Stock prices are “on sale,” after steep declines. Yet, many investors sell during downturns and subsequently are late to get back in, forgoing potential profits. This sort of selling may be less likely after, say, a 10% decline in asset values than with a 20% drop.

If you decide to seek a fund with a good record of playing defense, see if the manager or managers who held down losses during bear markets are still in place. Read the fund’s materials to find out if its investment philosophy meshes with yours, or discuss the fund’s approach with your investment adviser. When stock market records are falling regularly, patience and prudence can pay off.

2018 May Be A Difficult Year for Investors

As of this writing, it appears that 2018 may be a difficult year for investors. Yields on bonds, bank accounts, money market funds, and other savings vehicles are extremely low, with questionable prospects for substantial increases. Stock market indexes, on the other hand, are at or near record levels.

In essence, relatively low-risk places to put your money this year appear to offer scant returns. Equity markets have been rising since early 2009, so the chance of a pullback may be just as great as the possibility of solid gains.

Given this environment, where might investors go for opportunities for respectable returns with some protection against a steep decline? One possibility is in the stock market.

Paying dividends

Equity markets are notoriously difficult to predict. Nevertheless, dividend paying stocks might tilt the risk-reward odds in your favor. During recent bear markets, dividend payers generally fared better than those that didn’t pay dividends.

This seems reasonable because dividend paying companies may be enterprises that generate ample cash flow—enough to distribute some profits to investors. Companies in strong financial condition could be favored by investors in stormy economic weather, and the prospect of ongoing dividend payouts might stem panicked selling.

Floor and ceiling 

Whereas dividend paying stocks may offer some protection during down markets, they also might deliver solid returns. The yield on the benchmark Standard & Poor’s 500 Index currently is nearly 2%. That’s the yield for the broad index, so some of the large companies included in the index have dividend yields of 3% or more. When an investment starts with such a payout, it’s less likely to fall into negative territory and is already on the way to possible robust returns.

Dividends can grow, too. Indeed, many public companies have long histories of raising their payouts.

Example: Nancy King is a widow who depends on investment income for her lifestyle. She invests $50,000 in shares of GHI Corp., currently paying a 4% dividend, or $2,000 a year. If GHI raises its annual dividend to $2,500 over the next few years, Nancy will collect a 5% return on her initial investment.

In addition, qualified dividends receive favorable tax treatment. Nancy, in a low tax bracket in our example, could owe 0% on qualified dividends. Other taxpayers owe 15% or, for those in the highest ordinary tax bracket, 20%. These rates are lower than ordinary income tax rates.

Go with a pro

It’s true that dividend paying stocks can offer many advantages. However, investing in equities carries risks; even the most established company, with excellent management, can see its share price tumble in a broad selloff. Selecting individual dividend paying stocks can require thorough research and portfolio monitoring.

Therefore, many investors prefer to invest in mutual funds or ETFs that focus on dividend stocks. There are dozens of such funds available, with portfolio managers who are responsible for stock selection. Other funds track a custom index of dividend paying stocks. Dividend stock funds tend to fall into two broad categories:

  • High payout. Some funds are designed to pay higher yields than the S&P 500, perhaps 3% or 4%. They may use “dividend capture” strategies, buying funds just before a dividend payout. High dividends may be appealing, but a robust payout can indicate a relatively low share price due to concerns about the company’s growth prospects.
  • Dividend growth. These funds may have yields similar to the S&P 500 or lower. However, the stocks they hold are chosen because the companies have enjoyed growing earnings along with rising dividends and are considered likely to continue such profitability.

Quality counts

Dividend oriented investors may hold individual stocks, specialized funds, or a combination. They aim to own successful, profitable companies that will provide a steady stream of cash flow, bull market or bad. There’s no magic about dividend paying stocks and there have been instances in which a dividend cut has been followed by a plunging stock price. Still, buying successful companies that pay appealing dividends is one way to approach equity investing this year, with current prices at lofty levels.

Qualified Dividends

  • Most stock dividends paid to U.S. investors are qualified dividends that are subject to the low 0%, 15%, and 20% tax rates.
  • To be qualified dividends, the dividends must be paid by a domestic corporation or a foreign corporation that meets certain requirements (a qualified foreign corporation).
  • To get the low rates, investors must hold onto a stock for more than 60 days during the 121‑day period, which begins 60 days before the ex‑dividend date.
  • The ex-dividend date is the first day of trading when the buyer of a stock is no longer entitled to the most recently announced dividend payment. If the ex-dividend date is December 12, a December 11 buyer would receive the latest dividend, but a December 12 buyer would not receive it.

2017 Year-End Tax Planning Strategies In Light of the Tax Reform


Today, President Trump signed the Tax Cuts and Jobs Act into a law which means there will be significant changes for millions of taxpayers effective January 1, 2018. In light of these changes, there are some things you can do before the end of 2017 that can benefit your tax situation this year and next.    See our list below and, as always, please let us know if you have any questions.

  1. Accelerate Tax Deductions and Defer Income.  The Act includes a decrease in tax rates.  Individuals will have a maximum tax rate of 37% and corporations will have a maximum rate of 21%.  With this decrease in tax rates, it may be beneficial to accelerate deductions for 2017 and defer income to 2018 and later, to the extent allowable.
  2. Pay State, Local, and Real Estate Taxes. The new law will limit combined deductions for state, local and real estate taxes to $10,000.  Taxpayers that currently itemize and are not subject to AMT, who also expect to owe additional state and local income taxes for 2017, should consider paying before year-end. Even if you are subject to AMT, you still will get the state income tax deduction for any state and local taxes, so in many cases it still makes sense to go ahead and pay the tax by year-end. The Act does limit prepaying the 2018 state income tax, particularly when paying as an estimate at the end of 2017.
  3. Accelerate Buying Business Assets. The new law provides incentives for businesses to make capital investments.  Businesses can write off 100% of the cost of certain qualified property placed in service after September 27, 2017 through bonus depreciation.  The 100% rate applies to most personal property, such as equipment, furniture and computers, but the new law expands the definition to include used property where the old law only included new assets.
  4. Accelerate Charitable Contributions. Under the new Act, the standard deduction is doubled and many taxpayers will no longer benefit from itemizing their deductions. If you will not be itemizing your deductions in 2018, consider making your planned 2018 charitable contributions in 2017 to ensure you get the tax benefit of your contribution.
  5. Pay off Home Equity Lines of Credit. The Act repeals the deduction for interest paid on home equity lines of credit.  If you are paying interest on home equity lines of credit, consider paying it off or down.  Beginning in 2018, the interest will no longer be deductible. On existing regular mortgage loans, the new law preserves the deduction for mortgage interest on up to $1 million of loan principal. Under the Act, for new mortgages taken out on or after December 15, 2017 interest will only deductible on the first $750,000 of mortgage debt.
  6. Carry Back of Net Operating Losses. Under the old law, taxpayers that have net operating losses were able to carry back losses to offset taxable income for the prior two years or carry forward those losses for up to twenty years.  Under the new Act, taxpayers will not be able to carry back losses. Net operating losses carried forward will only be able to offset 80% of taxable income.  Businesses that are in a loss situation for 2017 or close to break-even may want to consider accelerating deductions into 2017 to maximize the current year loss.  2017 losses can still be carried back two years.
  7. Review Your Estate. The Act did not repeal the gift and estate tax as we had all hoped.  It did, however, increase the amount you can transfer without incurring any gift or estate tax to $10 million for an individual ($20 million for married couples).  Keep in mind that this provision only applies to tax years 2018-2025, so it is important to consult with your legal counsel and tax advisors to see how these changes will impact your estate plan.  The current gift tax exclusion is $14,000 per donee and can still be utilized before December 31, 2017.

This information is general in nature. As every situation is different, please contact us before taking any specific action. 

Tax Cuts and Jobs Act – Final Version: BUSINESSES

Corporate Taxes
The Conference Committee version of H.R. 1 calls for a 21-percent corporate tax rate beginning in 2018. The Conference bill makes the new rate permanent. The maximum corporate tax rate currently tops out at 35 percent.

Bonus Depreciation
The Conference bill increases the 50-percent “bonus depreciation” allowance to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft). A 20-percent phase-down schedule would then kick in. It also removes the requirement that the original use of qualified property must commence with the taxpayer, thus allowing bonus depreciation on the purchase of used property.

The bonus depreciation rate has fluctuated wildly over the last 15 years, from as low as zero percent to as high as 100 percent. It is often seen as a means to incentivize business growth and job creation.

Vehicle Depreciation
The Conference bill would raise the cap placed on depreciation write-offs of business-use vehicles. The new caps would be $10,000 for the first year a vehicle is placed in service (up from a current level of $3,160); $16,000 for the second year (up from $5,100); $9,600 for the third year (up from $3,050); and $5,760 for each subsequent year (up from $1,875) until costs are fully recovered. The new, higher limits apply to vehicles placed in service after December 31, 2017, and for which additional first-year depreciation under Code Sec. 168(k) is not claimed.

Section 179 Expensing
The Conference bill would also enhance Code Sec. 179 expensing. The Conference bill sets the Code Sec. 179 dollar limitation at $1 million and the investment limitation at $2.5 million.

Deductions and Credits
Numerous business tax preferences would be eliminated under the Conference version of H.R. 1. These include the Code Sec. 199 domestic production activities deduction, non-real property like-kind exchanges, and more. Additionally, the rules for business meals would be revised, as would the rules for the rehabilitation credit.

The Conference bill leaves the research and development credit in place, but requires five-year amortization of research and development expenditures. The Conference bill also creates a temporary credit for employers paying employees who are on family and medical leave.

Interest Deductions
The Conference bill generally caps the deduction for net interest expenses at 30 percent of adjusted taxable income, among other criteria. Exceptions would exist for small businesses, including an exemption for businesses with average gross receipts of $25 million or less.

Pass-Through Businesses
Currently, owners of partnerships, S corporations, and sole proprietorships – as “pass-through” entities – pay tax at the individual rates, with the highest rate at 39.6 percent. The House bill proposed a 25-percent tax rate for certain pass-through income after 2017, with a nine-percent rate for certain small businesses. The Senate bill generally would have allowed a temporary deduction in an amount equal to 23 percent of qualified income of pass-through entities, subject to a number of limitations and qualifications.

The Conference bill generally follows the Senate’s approach to the tax treatment of pass-through income, but with some changes, including a reduction in the percentage of the deduction allowable under the provision to 20 percent (not 23 percent), a reduction in the threshold amount above which both the limitation on specified service businesses and the wage limit are phased in, and a modification in the wage limit applicable to taxpayers with taxable income above certain threshold amounts.

Net Operating Losses
The Conference Committee version of H.R. 1 modifies current rules for net operating losses (NOLs). Generally, NOLs would be limited to 80 percent of taxable income for losses arising in tax years beginning after December 31, 2017. The Conference bill also denies the carryback for NOLs in most cases while providing for an indefinite carryforward, subject to the percentage limitation.

The House bill called for repealing many current energy tax incentives, including the credit for plug-in electric vehicles. Other energy tax preferences, such as the residential energy efficient property credit, would have been modified. The Conference bill retains the credit for plug-in electric vehicles and did not adopt any of the other repeals of or modifications to energy credits from the House bill.

The Conference bill does not modify or repeal the so-called “Johnson amendment.” This provision generally restricts Code Sec. 501(c)(3) organizations from political campaign activity.

The Conference bill would extend from nine months to two years the period for bringing a civil action for wrongful levy. The Conference bill does not prohibit increases in IRS user fees, as proposed by the Senate bill.

The Conference Committee version of H.R. 1 follows the lead of both the House and Senate bills in moving the United States to a territorial system. The Conference bill would create a dividend-exemption system for taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed. The foreign tax credit rules would be modified, as would the Subpart F rules. The look-through rule for related controlled foreign corporations would be made permanent, among other changes.

A portion of deferred overseas-held earnings and profits (E&P) of subsidiaries would be taxed at a reduced rate of 15.5 percent for cash assets and 8 percent for illiquid assets. Foreign tax credit carryforwards would be fully available and foreign tax credits triggered by the deemed repatriation would be partially available to offset the U.S. tax.

Tax Cuts and Jobs Act – Final Version: INDIVIDUALS


The House and Senate Tax Cuts and Jobs Act Conference Committee unveiled its tax reform package on December 15. The Committee, after a week of intense negotiations, blended the House and Senate versions of the Tax Cuts and Jobs Act (H.R. 1) into one legislative package. GOP leaders predict that Congress will pass this final version of H.R. 1 before lawmakers leave for their holiday recess. The Conference agreement generally tracks the overall framework for tax reform released by the GOP earlier this year and the House and Senate versions of H.R. 1. This final bill carries a January 1, 2018, effective date for most provisions.

The Conference bill would impact virtually every individual and business on a level not seen in over 30 years. As with any tax bill, however, there will be “winners” and “losers.” The bill calls for lowering the individual and corporate tax rates, repealing countless tax credits and deductions, enhancing the child tax credit, boosting business expensing, and more. The bill also impacts the Affordable Care Act (ACA), effectively repealing the individual shared responsibility requirement.

President Trump has signaled his support for tax legislation before year-end. Few possible roadblocks to ultimately getting a bill to the President’s desk before year-end remain. Prior Senate hold-outs have now signaled their support of the Conference bill, while support in the House appears to be holding steady Nevertheless, some still-hidden parliamentary hurdle or sudden public concern should not be discounted until all the votes are in.

Tax Rates
The Conference Committee version of H.R. 1 proposes temporary tax rates of 10, 12, 22, 24, 32, 35, and 37 percent after 2017. Under current law, individual income tax rates are 10, 15, 25, 28, 33, 35, and 39.6 percent.

Conference Agreement Brackets

RateJoint ReturnIndividual Return
10%$0 - $19,050$0 - $9,525
12%$19,050 - $77,400$9,525 - $38,700
22%$77,400 - $165,000$38,700 - $82,500
24%$165,000 - $315,000$82,500 - $157,500
32%$315,000 - $400,000$157,500 - $200,000
35%$400,000 - $600,000$200,000 - $500,000
37%Over $600,000Over $500,000

Under the Conference bill, income levels would be indexed for inflation for a “chained CPI” instead of CPI. Both the original House bill and the Senate bill called for a chained CPI. In general, this change would result in a smaller annual rise in rate brackets, which the Joint Committee of Taxation estimates, when combined with using the chained CPI for all other inflation-adjusted tax amount, would bring $128 billion more into the U.S. Treasury over the next ten-year period. The chained CPI is permanently applied to almost all amounts subject to annual inflation adjustment, even the permanent amounts that would apply if provisions are allowed to expire after 2025.

Standard Deduction
The Conference bill calls for a near doubling of the standard deduction. It increases the standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other individuals, indexed for inflation (using chained CPI) for tax years beginning after 2018. All increases are temporary and would end after December 31, 2025. Under current law, the standard deduction for 2018 had been set at $13,000 for joint filers, $9,550 for heads of households, and $6,500 for all other filers. The additional standard deduction for the elderly and the blind ($1,300 for married taxpayers, $1,600 for single taxpayers) is retained.

Deductions and Credits
The Conference bill makes significant changes to some popular individual credits and deductions. Many of the changes, however, are temporary, generally ending after 2025, in order to keep overall revenue costs for the bill within budgetary constraints.

Mortgage interest deduction. The Conference bill limits the mortgage interest deduction to interest on $750,000 of acquisition indebtedness ($375,000 in the case of married taxpayers filing separately), in the case of tax years beginning after December 31, 2017, and beginning before January 1, 2026. For acquisition indebtedness incurred before December 15, 2017, the Conference bill allows current homeowners to keep the current limitation of $1 million ($500,000 in the case of married taxpayers filing separately).

The Conference agreement also allows taxpayers to continue to include mortgage interest on second homes, but within those lower dollar caps. However, no interest deduction will be allowed for interest on home equity indebtedness.

Some homeowners dodged a bullet when the Conference bill rejected the additional limitation in both the House and Senate bills to increase the holding period for the homeowners’ capital gain exclusion to a five-out-of-eight year principal-residence test.

State and Local Taxes.
The Conference bill limits annual itemized deductions for all nonbusiness state and local taxes deductions, including property taxes, to $10,000 ($5,000 for married taxpayer filing a separate return). Sales taxes may be included as an alternative to claiming state and local income taxes.

Miscellaneous Itemized Deductions
The Conference bill repeals all miscellaneous itemized deductions that are subject to the two-percent floor under current law.

Medical Expenses
The Conference bill follows the Senate bill in not only retaining the medical expense deduction, but also temporarily enhancing it. The Conference bill lowers the threshold for the deduction to 7.5 percent of adjusted gross income (AGI) for tax years 2017 and 2018.

Family Incentives
The Conference bill temporarily increases the current child tax credit from $1,000 to $2,000 per qualifying child. Up to $1,400 of that amount would be refundable. The Conference bill also raises the adjusted gross income phaseout thresholds, starting at adjusted gross income of $400,000 for joint filers ($200,000 for all others).
The child tax credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children.

The Conference agreement retains the student loan interest deduction, as proposed in the Senate bill. It also modifies section 529 plans and ABLE accounts. The Conference bill does not overhaul the American Opportunity Tax Credit, as proposed in the House bill. The Conference bill also does not repeal the exclusion for interest on U.S. savings bonds used for higher education, as proposed in the House bill.

The Conference bill repeals the deduction for alimony payments and their inclusion in the income of the recipient.

The Conference Committee version of H.R. 1 generally retains the current rules for 401(k) and other retirement plans. However, the Conference bill would repeal the rule allowing taxpayers to recharacterize Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion. Rules for hardship distributions would be modified, among other changes.

Federal Estate Tax
The Conference bill follows the Senate bill in not repealing the estate tax, but rather doubling the estate and gift tax exclusion amount for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The generation-skipping transfer (GST) tax exemption is also doubled.

Alternative Minimum Tax
The Conference Committee version of the bill retains the alternative minimum tax (AMT) for individuals with modifications. The Conference bill would temporarily increase (through 2025) the exemption amount to $109,400 for joint filers ($70,300 for others, except trusts and estates). It would also raise the exemption phase-out levels so that the AMT would apply to an income level of $1 million for joint filers ($500,000 for others). These amounts are all subject to annual inflation adjustment.

Affordable Care Act
The Conference bill repeals the Affordable Care Act (ACA) individual shared responsibility requirement, making the payment amount $0. This change would be effective for penalties assessed after 2018.

Carried Interest
Under the Conference bill, the holding period for longterm capital gains is increased to three years with respect to certain partnership interests transferred in connection with the performance of services.

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