Decision Frameworks
IN THE SUMMER of 1966, author John McPhee spent two weeks lying on a picnic table in his backyard. Why?
McPhee was suffering from writer’s block. As he described it, “I had assembled enough material to fill a silo, and now I had no idea what to do with it.”
Investors find themselves in a similar situation today. There’s no shortage of financial information around us. But that doesn’t make it easier to know what to do with it.
When it comes to financial decision-making, there is, of course, one fundamental problem: None of us can see around corners. But that doesn’t leave us completely empty-handed. Whenever possible, I suggest employing decision frameworks. They can help us to do the best we can in the absence of complete information.
Here are four such frameworks you might consider as you look ahead to the new year.
Trading decisions
Suppose you’re lukewarm on an investment and thinking of selling it. How should you think through this decision?
To start, you might evaluate the investment’s merits. If it’s an individual stock, you could examine its valuation and study the company’s financials. If it’s a fund, you could look at its track record and management fees. And if it’s held in a taxable account, you could also check its tax efficiency.
Against those factors, you would then assess the tax impact of selling your shares. But how should you weight each factor in your decision? A fund might be tax-inefficient, for example, but have a good track record. When making decisions like this, the framework I suggest is to evaluate three factors: risk, growth potential and tax impact. And I would consider them in that order.
Estate taxes
The federal estate tax can be punitive for those with assets over the lifetime exclusion. Under current law, that’s $15 million per person, but it’s a political football and could easily change down the road. Many states also impose their own estate taxes, with much lower exclusions. For those with assets even in the neighborhood of the applicable exclusion, it might seem like an obvious decision to pursue estate tax strategies.
Indeed, many families conclude that it’s worth virtually any amount of time, effort and cost to limit their exposure to these steep taxes. That’s a logical conclusion, but it’s not the only way.
Other families take a different view. They reason that if their estates will be subject to tax, then, by definition, their children will be receiving substantial sums. Since that’s the case, they don’t see the need for acrobatics to leave their children even more, especially since those strategies usually introduce cost and complexity.
The most typical estate tax strategy, for example, is an irrevocable trust. In addition to the legal work required to set one up, these trusts require third-party trustees, and trustees typically ask to be compensated. This kind of trust also requires a separate tax return each year. Also, assets in trusts like this don’t benefit from a cost basis step-up at death, making the tax benefit a little more uncertain.
Estate tax strategies, in other words, might make sense, but they aren’t the obvious “right” answer in all cases. That’s why, as you think through this question for your own family, you might employ this simple framework: Start by asking yourself which objective is more important: to keep taxes to an absolute minimum or, on the other hand, to keep complexity to a minimum. Let that be your guide.
Portfolio construction
How much effort should you put into your portfolio? Author Mike Piper draws an apt analogy. Building a portfolio, he said, is like making a fruit salad. Here’s how he explained it:
“If you choose to have just 3-4 ingredients in your fruit salad instead of 7, that’s fine…There’s no one single recipe that beats the others…And you don’t have to be super precise about it—a little more or less of something than you had intended is not a disaster.”
It’s an important point. Because there are so many available investment options, and because there is so much information and commentary around us, it can sometimes feel like we need to do more to optimize our investments. The reality, though, is that this is a choice.
Just as with estate tax strategies, you might yield a benefit by fine tuning your portfolio, but you shouldn’t feel compelled to. The most important thing is that it be reasonable. As long as you aren’t taking inordinate risk, it’s a choice whether you choose to have five, 10 or 500 holdings in your portfolio. As Piper points out, you won’t necessarily go wrong with whichever path you choose, so choose the path that suits you.
A 360-degree view
Earlier in my career, I worked as an investment analyst at a firm where we were responsible for picking stocks. In discussing an idea with a colleague one day, it occurred to us that if you knew enough about any given stock, you could easily make an argument either for or against that stock. It was in the eye of the beholder.
Consider a stock like Nvidia. On the one hand, it’s the dominant player in a fast-growing market and has enviable profit margins. But those margins are inviting competition, and there are concerns that the market is becoming saturated.
Which set of arguments is correct? As with all financial decisions, we can’t know without the benefit of hindsight. That’s why I suggest what I call the “five minds” approach. Instead of taking a single position on a given question, try to look at it from all sides, balancing the viewpoints of an optimist a pessimist, an analyst, a psychologist and an economist.
How would this work in practice? If there’s an idea that looks like it makes sense, pause and ask what the opposing argument might be. If you’re looking at a question through a quantitative lens, pause and ask what the qualitative factors might be.
And always consider the broader context. Suppose, for example, you’re considering a Roth conversion. A key element in that equation is whether future tax rates will be higher or lower than they are today. To help answer this question, we could consult history as a guide, looking at historical tax rates and government debt levels.
No one has a crystal ball. But since that’s the case, frameworks like this can help us manage through decisions with incomplete information.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
McPhee was suffering from writer’s block. As he described it, “I had assembled enough material to fill a silo, and now I had no idea what to do with it.”
Investors find themselves in a similar situation today. There’s no shortage of financial information around us. But that doesn’t make it easier to know what to do with it.
When it comes to financial decision-making, there is, of course, one fundamental problem: None of us can see around corners. But that doesn’t leave us completely empty-handed. Whenever possible, I suggest employing decision frameworks. They can help us to do the best we can in the absence of complete information.
Here are four such frameworks you might consider as you look ahead to the new year.
Trading decisions
Suppose you’re lukewarm on an investment and thinking of selling it. How should you think through this decision?
To start, you might evaluate the investment’s merits. If it’s an individual stock, you could examine its valuation and study the company’s financials. If it’s a fund, you could look at its track record and management fees. And if it’s held in a taxable account, you could also check its tax efficiency.
Against those factors, you would then assess the tax impact of selling your shares. But how should you weight each factor in your decision? A fund might be tax-inefficient, for example, but have a good track record. When making decisions like this, the framework I suggest is to evaluate three factors: risk, growth potential and tax impact. And I would consider them in that order.
Estate taxes
The federal estate tax can be punitive for those with assets over the lifetime exclusion. Under current law, that’s $15 million per person, but it’s a political football and could easily change down the road. Many states also impose their own estate taxes, with much lower exclusions. For those with assets even in the neighborhood of the applicable exclusion, it might seem like an obvious decision to pursue estate tax strategies.
Indeed, many families conclude that it’s worth virtually any amount of time, effort and cost to limit their exposure to these steep taxes. That’s a logical conclusion, but it’s not the only way.
Other families take a different view. They reason that if their estates will be subject to tax, then, by definition, their children will be receiving substantial sums. Since that’s the case, they don’t see the need for acrobatics to leave their children even more, especially since those strategies usually introduce cost and complexity.
The most typical estate tax strategy, for example, is an irrevocable trust. In addition to the legal work required to set one up, these trusts require third-party trustees, and trustees typically ask to be compensated. This kind of trust also requires a separate tax return each year. Also, assets in trusts like this don’t benefit from a cost basis step-up at death, making the tax benefit a little more uncertain.
Estate tax strategies, in other words, might make sense, but they aren’t the obvious “right” answer in all cases. That’s why, as you think through this question for your own family, you might employ this simple framework: Start by asking yourself which objective is more important: to keep taxes to an absolute minimum or, on the other hand, to keep complexity to a minimum. Let that be your guide.
Portfolio construction
How much effort should you put into your portfolio? Author Mike Piper draws an apt analogy. Building a portfolio, he said, is like making a fruit salad. Here’s how he explained it:
“If you choose to have just 3-4 ingredients in your fruit salad instead of 7, that’s fine…There’s no one single recipe that beats the others…And you don’t have to be super precise about it—a little more or less of something than you had intended is not a disaster.”
It’s an important point. Because there are so many available investment options, and because there is so much information and commentary around us, it can sometimes feel like we need to do more to optimize our investments. The reality, though, is that this is a choice.
Just as with estate tax strategies, you might yield a benefit by fine tuning your portfolio, but you shouldn’t feel compelled to. The most important thing is that it be reasonable. As long as you aren’t taking inordinate risk, it’s a choice whether you choose to have five, 10 or 500 holdings in your portfolio. As Piper points out, you won’t necessarily go wrong with whichever path you choose, so choose the path that suits you.
A 360-degree view
Earlier in my career, I worked as an investment analyst at a firm where we were responsible for picking stocks. In discussing an idea with a colleague one day, it occurred to us that if you knew enough about any given stock, you could easily make an argument either for or against that stock. It was in the eye of the beholder.
Consider a stock like Nvidia. On the one hand, it’s the dominant player in a fast-growing market and has enviable profit margins. But those margins are inviting competition, and there are concerns that the market is becoming saturated.
Which set of arguments is correct? As with all financial decisions, we can’t know without the benefit of hindsight. That’s why I suggest what I call the “five minds” approach. Instead of taking a single position on a given question, try to look at it from all sides, balancing the viewpoints of an optimist a pessimist, an analyst, a psychologist and an economist.
How would this work in practice? If there’s an idea that looks like it makes sense, pause and ask what the opposing argument might be. If you’re looking at a question through a quantitative lens, pause and ask what the qualitative factors might be.
And always consider the broader context. Suppose, for example, you’re considering a Roth conversion. A key element in that equation is whether future tax rates will be higher or lower than they are today. To help answer this question, we could consult history as a guide, looking at historical tax rates and government debt levels.
No one has a crystal ball. But since that’s the case, frameworks like this can help us manage through decisions with incomplete information.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.The post Decision Frameworks appeared first on HumbleDollar.
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