Albion Financial Group is proud to announce and celebrate the firm’s newest Certified Financial Planner®. Financial Planners are engaged in the detailed aspects of the financial advising relationship. Their efforts make it possible for our clients to seamlessly envision and plan for a variety of prospective scenarios. Their contribution to the team is essential as we work to guide clients toward making a lifetime of good financial decisions.
Bitcoin, and more broadly cryptocurrencies, are seeing increasing news coverage. This has left many wondering: “What is bitcoin and how does it work?” For those trying to better understand bitcoin and cryptocurrencies, here’s our understanding on a handful of frequently asked questions:
What is bitcoin?
Bitcoin is a digital “currency” that can be used to purchase goods and services (only at select locations, for now), or held as a store of speculative value. There are many differences between bitcoin and traditional currency, but the principal difference is that bitcoin is not issued by a government or regulated by a government entity.
Where did bitcoin come from?
This is where it gets a bit mysterious. Bitcoin was created by “Satoshi Nakamoto”, an unknown individual or group of individuals. Under this pseudonym a white paper was circulated in 2008 that first described the concept for a transparent, visible peer-to-peer payment system authenticated by a vast network that does not require the presence of a third party middleman – such as banks or other financial institutions. By combining cryptography and unique software protocols, Satoshi Nakamoto originated a payment system that allowed participants to transact directly with one another.
How is it possible to make currency transactions without banks?
Bitcoin transactions have been made possible with the encryption technology underpinning cryptocurrencies known as “blockchain.” Blockchain is a global Internet-wide distributed network that is at its core a decentralized accounting ledger recording every bitcoin transaction. The blockchain ledger is shared by way of an extensive network and the information therein is validated by network “miners” every ten minutes by solving mathematical puzzles using very fast computers and high amounts of electricity. This network validated ledger is crucial as it ascribes proof of ownership to digital assets like bitcoin. If the ledger proves ownership, participants can have trust when making transactions.
Tying together the concept of bitcoin and blockchain, think of it this way – the bitcoin “coins” themselves are simply seats within the aforementioned blockchain ledger. Anyone can buy into or sell out of this ledger at any time – with no prior consent, and with little-to-no fees. Therefore, when buying a bitcoin you are essentially acquiring one of a number of fixed slots within this ledger. You leave the ledger by selling your bitcoin to someone else who wishes to buy in.
If I want to buy bitcoin, how would I make a purchase? Do I need to buy a whole coin?
There are many exchanges out there that allow participants to deposit US dollars (or other widely accepted global currencies) directly from traditional bank accounts in exchange for bitcoin. Some cryptocurrency exchanges also have mobile apps allowing participants to buy bitcoin anytime, anywhere.
Additionally, participants need not buy a whole bitcoin to participate. The smallest unit of bitcoin, a “satoshi”, is the size of one hundred millionth of a single bitcoin (0.00000001 BTC).
What are the risks to purchasing and holding bitcoin? The current price seems high!
It depends on the type of risk one is referring to. Let’s start with general cybersecurity threats. Cryptocurrency exchanges, including those which trade bitcoin, have been hacked before, and will likely be hacked again. Perhaps the most notable example was in 2014 when “Mt. Gox”, the largest bitcoin exchange at the time, failed as a direct result of hackers and vast bitcoin theft. Security surrounding cryptocurrency exchanges have notably improved since Mt. Gox’s failure. Individuals can use bitcoin digital wallets and vaults that are encrypted with a secure network key which dramatically reduces the possibility of being hacked.
Another key risk worth touching on is the possibility of loss of capital for those speculating on its price. Bitcoin has experienced a monumental run as of late. There are a variety of opinions and market variables as to why this has occurred. Will this price rally continue, or crash? Nobody knows for sure. However one way to think about it is, by design, bitcoin was given a finite supply – determined at inception to be 21,000,000 bitcoins – and we are now seeing growing awareness leading to rising demand. This basic supply / demand dynamic may help describe, at least at some level, recent price moves in bitcoin. That being said, just because more cryptocurrency enthusiasts are now entering the market seemingly pushing up prices does not mean everyone should take a position. With a greater understanding of bitcoin – both its potential opportunities and risks – paired with careful holistic wealth advice, more educated decision making can be made on potential bitcoin / cryptocurrency participation.
We hope that this FAQ provides a helpful introduction to bitcoin / cryptocurrencies, and perhaps even sparks your desire to want to learn more. The investment team at Albion Financial Group is well versed in bitcoin / cryptocurrencies and blockchain technology. Please reach out to us at 801-487-3700 or firstname.lastname@example.org if we can answer your bitcoin, investment, or financial planning questions.
Disclaimer: Information provided is for educational purposes only. This is not a recommendation to buy or sell any security or cryptocurrency. There are significant risks associated with cryptocurrency that are unique and must not be taken lightly. It is critical that you perform your own due diligence prior to engaging in any buy or sell transaction. The value of bitcoin, or any cryptocurrency can, and may, ultimately go to zero.
A quick reference for tax rates, savings and retirement contributions, college savings strategies, as well as Social Security and Medicare information.
Everyone’s financial situation is unique – the information found in the 2021 Planning Guide should only be used as a foundation for discussing your individual circumstances with a CERTIFIED FINANCIAL PLANNER™ practitioner, legal or tax professional.
The wealth advising team at Albion Financial Group understands the complexities of the current wealth management environment and would be honored to discuss your financial situation and strategies that may help you reach your personal financial goals.
Please give us a call at (801) 487-3700 or email email@example.com.
We wish you a prosperous 2021.
Devin Pope, CFP®, MBA
Senior Wealth Advisor
Albion Financial Group
Listen back to Albion’s November conference call.
- 00:00 John Bird, President & CEO – Introduction
- 03:27 Jason Ware, CIO – Markets & Economy
- 11:54 Doug Wells, Partner – Planning Strategies
- 26:09 Q & A
- 27:28 How is potential regulation of “Big Tech” affecting our investments?
- 33:23 What should I be doing to protect my portfolio in the context of so much ambiguity?
- 41:21 Who can I talk to if I am anxious about my portfolio for any reason?
- 43:18 With the ongoing pandemic and a potential change of president, are there investment changes I should make?
- 48:48 Conclusion
You’ve worked hard for your employer for several years and been rewarded with options on the company stock. Now stock options make up a large share of your wealth and you’re thinking it’s time to pay more attention. But what are these options worth and how should they be handled? As employers have grown more creative with compensation, questions like these no longer apply only to the executive suite. In many companies options are now available to employees of all levels and for some represent a substantial portion of their total compensation package. Understanding how stock options work, and determining how to maximize their value can be complicated. While employee stock options can be great wealth creation vehicles, understanding what they are and how they work will greatly increase the odds of a positive outcome.
Stock options grant the holder the right to purchase shares in a company at a specified price (exercise price) for a specified period of time (expiration). The aim of granting options is to incentivize employees; aligning their interest with that of the company. By doing so the company hopes to increase operational performance and thus profitability. There are two types of options awarded; incentive stock options (ISOs) and nonqualified stock options (NQSOs). The key difference between the two is how they are treated for tax purposes.
Incentive Stock Options (ISOs)
ISOs offer more favorable tax treatment than NQSO’s, taxing the gain on the sale of the underlying shares at long-term capital gains rates if the holding rules are correctly followed. There are two important holding periods to meet the holding rule requirement. The first holding period begins with the grant date of the option. The option holder must wait at least two years from the grant date prior to selling the underlying shares in order to have the gain taxed at long-term capital gains rates. The second period begins when the stock is transferred to the employee. In order to receive long-term capital gains treatment the shares must be held for at least one year following the date the stock was transferred. If the two holding periods are met then the gain will be considered long-term. Be aware that ISO’s are an alternative minimum tax (AMT) preference item and in certain circumstances can trigger AMT.
Nonqualified Stock Options (NQSOs)
NQSOs are less tax favorable, but are more commonly used as they are not subject to the same restrictions on issuance as ISO’s. When a NQSO is exercised tax is due at ordinary income rates on the difference between the exercise price and the value of the stock at the time of exercise. The exercise price becomes the cost basis for the position going forward. When the shares are eventually sold they will be subject to short-term or long-term capital gains based on the length of the holding period from the time of exercise.
Stock options are a great way to build wealth and over time may come to represent a large share of one’s net worth. However there are risks. First and foremost is concentration. Not only does the employee rely on the company for income but he also depends on the ongoing success of the company if his net worth is to be maintained. A failure of the company is a double whammy; the income is gone and the stock option assets on his personal balance sheet have greatly diminished in value. It is important to sensibly diversify the balance sheet from time to time to avoid having all eggs in one basket.
The method used to exercise options can also have unintended consequences. In the late 1990’s many technology and internet based companies experienced substantial stock price appreciation. Employees of these companies were suddenly wealthy and exercised their stock options. Given the strength of the companies in the market many employees chose to hold the shares for further appreciation. When the bottom fell out and the share prices dropped these same employees discovered that their tax bill, based on market price at exercise, was greater than the now depressed value of the shares. There were many variations on this theme but the net result was the same; when the share prices plummeted the option value disappeared and the option owner found himself with liabilities but no assets left to cover them.
An idea often considered is to hedge the exercised shares by purchasing a corresponding put option while waiting for twelve months to pass in order to receive long-term gains treatment. Unfortunately this does not work. Such a strategy suspends the holding period in the eyes of the IRS and the holding period for capital gains purposes remains suspended as long as the put is in place. Fortunately all is not lost. With proper planning and a clear vision of what employee stock options can and cannot do an investor can design a strategy to protect against catastrophic downside loss while allowing participation in the ongoing success of the company. With a clear-eyed hard headed analysis the option owner can greatly increase the probability of meeting their long-term financial objectives.
Imagine; you invest $100,000 in a stock. Six months later you put another $100,000 into the same stock. Six months after that you sell all your shares for $300,000. After a few rounds of self- congratulation on your stock picking prowess you decide to calculate your return. You know you invested $200,000 and had gains of $100,000. Since your gain of $100,000 is 50% of the $200,000 invested your gain is 50%. While this is a straightforward calculation something doesn’t feel quite right. Should the fact that only half the money was invested initially with the other half invested midway through the time period cause you to adjust your calculation? In search of answers you go online and find two rate of return calculators. You enter your data and click to the answer. One says you earned 66%, even better than your own calculation had indicated. But the other says your rate of return was… Zero. Yes, zero. Something must be wrong. You recheck your data and determine that both answers are correct. Welcome to the exciting world of dollar-weighted versus time-weighted returns!
Ever since assets have appreciated people have worked hard to come up with methods to quantify their profit. At its simplest, the appreciation calculation is straightforward. Just divide the amount the investment appreciated by the initial value of the investment as in the example above where the $100,000 gain was divided by the $200,000 investment showing a rate of return of 50%.
However it starts getting a bit more complicated if during the period the performance is being measured money is added to or taken from the investment account. Dollar-weighted and time weighted return calculations are the two methods that account for cash inflows and outflows during the performance measurement period.
Let’s look at dollar-weighted returns first. While the calculation is straightforward the details are challenging. All you have to do is divide the gain by the average capital base. Gain is the amount left over after subtracting all the money put into the investment. Average capital base is a bit trickier; it is the sum of the initial investment plus or minus any funds added to or removed from the investment after the start date, adjusted for the time period the funds were in the account.
That’s a tough sentence; here is an example:
Suppose we start our investment account with $100. Six months later we add another $100. Six months after that we want to measure the performance for the previous 12 months. What is the average capital base? It is the initial $100 plus half of the second $100 added to the account, for a total of $150. Only half of the second $100 is included because it was only invested for half the period. If instead of adding funds, $50 had been removed from the account halfway through the performance period, the average capital base would have been $75; the initial $100 minus half of the $50 that was removed.
The advantage to the dollar weighted calculation compared to the basic calculation where gain is divided by the amount invested with no adjustment for cash inflows and outflows is that the dollar weighted calculation modifies the performance to reflect the gain relative to the funds actually available for investment.
Time weighted return takes dollar weighted returns one step further. In calculating time weighted returns, first you divide the performance period into smaller time periods; quarters, months, weeks and days are typical. Then for each of these smaller time periods a dollar weighted return is calculated. Finally, these smaller period returns are compounded to generate the time weighted return for the whole performance period.
Using time weighted returns further diminishes the impact of cash inflows and outflows on the actual return of the assets in the portfolio. A bit of math clarification is in order. When compounding multiple periods of return you must add 1 to each percentage number and then subtract 1 from your final result. Here is why. Suppose you are compounding quarterly and for three quarters in a row you earn 5% per quarter. Mathematically 5% is 0.05 so if we multiply 0.05 * 0.05 * 0.05 we get .0001, or one tenth of one percent. Whenever you multiply any number by a number less than 1 the product will be less than the initial number.
So here is what to do; add 1 to each percentage to be multiplied then subtract 1 from your answer:
1.05 * 1.05 * 1.05 = 1.16
1.16 – 1 = .16 = 16%.
5% per quarter compounds to a 16% total return after three quarters.
So which return calculation makes the most sense? It depends. The basic “gain divided by amount invested” calculation which does not take into account cash inflows and outflows provides the most clarity when you are trying to figure out how many more (or less) dollars you have than you did before investing. But it does not capture the impact of cash moving in and out of the investment account.
Dollar weighted returns capture more than just the return of the assets in the portfolio. They also give you a better idea of the returns earned on the money you had at risk. If your advisor helps you determine when to add funds to the account, or when it makes sense to pull money out, the dollar weighted return is more likely to highlight the impact of that advice. More typically, cash flows into or out of an account are driven by the client and are based on cash flow needs, savings strategy and other life events.
If you want to hone in exclusively on the impact of the investment decisions made within the portfolio then time weighted returns are likely the better measure. However most investors will find that investment portfolios experiencing large inflows and outflows will have time weighted performance that differs from managed portfolios that do not have such contributions and withdraws.
Of course if there are no cash inflows and outflows after the initial investment then all three performance calculation methods; gain divided by amount invested, dollar weighted, and time weighted, will show the same investment return. (great point …. Correct but not intuitively obvious).
Back to that opening problem; why did one performance method show a 66% return while the other showed a 0% return? Here are more details on the twelve months of investing. During the 12 month period the $100,000 investment lost half its value, to $50,000, in the first six months at which point an additional $100,000 was added. In the second six months the investment doubled in value so the $150,000 grew to $300,000.
First we’ll calculate the dollar weighted return which is the gain divided by the average capital base. The gain is $300,000 less the $200,000 that was invested, or $100,000. Next comes the average capital base. We had $100,000 for the full period and $100,000 for half the period for an average capital base of $150,000. $100,000 gain divided by the $150,000 average capital base is .666, or a 66.6% return. Not bad.
Next we’ll calculate the time weighted return and we’ll do it by calculating the dollar weighted return for two time periods and then compounding them. For the first six months the stock declined by $50,000 and the average capital base was $100,000 for a return of -50%. For the second six months the stock appreciated by $150,000 on an average capital base of $150,000 for a return of 100%. To compound these two periods we add 1 to each return and multiply them together:
First, add 1 to each period return;
1 – 50% = .5
1 + 100% = 2
Then multiply the adjusted return numbers together;
2 * 0.5 = 1
Finally, subtract the 1 from your result;
1 – 1 = 0 which equals 0.0%
Performance measurement should be a detailed and accurate exercise following prescribed performance calculation standards. Yet even when the calculations adhere to a standard the results can vary significantly depending on which performance calculation method is used. Next time you’re quoted an investment return you’ll know to ask a few follow-up questions to ascertain what the investment in question might have actually done for you.
John Bird, MBA, CFA, CFP / President
Albion Financial Group
Disaster Waiting to Happen or Disaster Averted; You Choose
Headline: “Earthquake Strikes Salt Lake City. Buildings Destroyed: Utilities Down for a Month”
What comes to mind when we think about disasters are cataclysmic events; floods, earthquakes, fires and the like. And while it is essential to plan for these dramatic possibilities there are far less newsworthy yet much more likely “disasters” that can impact us in adverse ways. So prior to confronting the daunting task of planning for an unlikely large scale disaster spend some time planning for the more likely, and far more mundane, inconveniences that could rock your world. A side benefit to this planning is that your efforts can be used as building blocks when creating a large‐scale disaster recovery plan. Disaster mitigation strategies cover a broad range of topics from planning places for your family to meet in case of an emergency to maintaining adequate supplies of food and water. While the full range of disaster mitigation topics is essential to review, this piece will be limited in scope to essential preparations you should make to avoid crippling problems with your financial affairs.
Have you ever had your purse or wallet lost or stolen?
If so you know well those moments of concern as you attempt to recall exactly what was in it and what damage the thief might do before you are able to take mitigating steps. Having your mail stolen brings the same response with the additional uncertainty of not knowing what exactly was in the mailbox that day. What about that sinking feeling when due to business volatility bank balances are too low at the end of the month to meet your living expenses? Do you have adequate liquidity outside your company if the problem persists? What about your health? Do you have a mechanism in place in the event you are unable to conduct your own affairs due to a temporary disability? Who can you turn to for help in the event of an emergency? Let’s categorize and address these issues.
Checking and Organizing your Financial Information
Begin by organizing your financial data, recording the relevant account information, and storing it in a safe place. Know where your deeds, titles, and insurance policies are located and have them stored securely in a place where you can quickly grab them on your way out the door. Document the possessions in your house; walk through your home with a video camera recording images and describing the contents of each room. If possible have copies of the relevant documents, the video of your home, and account information secured off site and accessible by a trusted friend or advisor who you can reach on short notice. This will prove invaluable should your home be damaged or destroyed and also very useful if putting a hold on your assets or cancelling credit cards or debit cards becomes necessary, particularly if you are out of town and unable to access the information on your own.
Make sure your planning documents are current. This allows for someone you trust to make decisions on your behalf should you be unable to do so. Many of the tools to do this are relatively simple to execute but may have complex repercussions. Be careful to whom you grant these powers. Make sure your health care powers accurately reflect your wishes and are properly executed. Review your estate planning documents whenever you experience a significant life change. Keep copies of critical documents (Social Security, Passport and Driver’s License).
These documents are not very useful if they are not available when needed. Be sure someone you trust knows how to access the documents in case of an emergency. This trusted individual might need to get an executed copy of your health care directive to the hospital should you be unable to do so yourself.
At least annually obtain a credit report from each of the three reporting bureaus. There are also services available that, for a fee, can keep you apprised of any credit activity under your Social Security number on a daily basis.
Maintaining Accessible Rainy Day Funds
The other day when driving to work I pulled into a gas station to fill up. As we all now do, I got out, slid my credit card through the reader, and placed the nozzle in the filler tube. When the pump then told me my card could not be accepted I went inside and was informed that their link was down, they could not accept credit cards, and if I wanted to buy gas I’d have to use cash. Fortunately I had cash that day so was able to fill my tank but while I was doing so a half dozen cashless potential customers were turned away.
We are dependent on our financial system to function each day and the example above indicates how ingrained it has become in the fabric of our lives. While we don’t advocate basing disaster mitigation exclusively around the notion that our financial system will cease functioning it is likely that there could be temporary interruptions to your ability to access funds. This could be a result of a temporary system failure as mentioned above or the result of a failure of the tools in which your funds are invested. To protect against a temporary inability to access funds or credit lines keep several days of cash on hand. These are funds that would tide you over until the financial network in your area is up and running again. It is important to separate this cash from “walking around” cash you may normally carry in your wallet. While it is not the focus of this piece you should also have adequate food and water stored at home to tide you through a temporary period of time in the event you are unable to purchase basic supplies.
Far more likely than a systemic financial failure is an event specific to you or your region of the country that interrupts your usual cash flows from employment. Have a cash reserve set up to carry you and your family through three to six months of lean times. Keep these cash reserves as safe and liquid as possible. FDIC insured bank deposits and high quality money market funds are the best options. Yes, the yields on these tools are nonexistent right now but the purpose of this piece of your financial puzzle is safety and liquidity, not return.
Be careful of investment tools that are “similar” to money market funds but may offer a slightly higher current yield. While many of these tools may function as advertised for years, failure is most likely to occur in a time of crisis; just when you need it most. Auction rate securities, for example, were very popular as a cash management tool several years ago. By trading daily liquidity for weekly liquidity investors received a higher interest rate on their money. Unfortunately many investors in these tools did not understand that these were not money market funds. In 2008 when buyers for auction rate securities dried up holders were unable to sell their positions for much needed cash.
Check your insurance coverage. A good disability policy can make a big difference for you and your family should you be rendered unable to work for a period of time. Good health insurance (and yes, we recognize this is a hot button issue) can make the difference between a health issue being a minor setback or a road to bankruptcy. As CEO you are likely the primary breadwinner in your household. What happens to your family if you pass away? Life insurance, properly used, can really help your family meet their objectives should you be unable to provide for them.
The last point about liquidity is to review whether your financial assets are adequately diversified. It is very common for CEO’s, business owners, and senior executives to have the majority of their net worth tied up in their company. While wealth is often best created through concentration it is best retained through diversification. When your paycheck, your career path, much of your net worth, and in many cases your reputation is tied to a single company it is prudent to diversify a portion of your balance sheet away from that company. There are many tangible benefits to building a substantial portion of your net worth outside your company. These include the flexibility to raise funds without impacting your firm and the ability to maintain your family should the company fall on rough times and be unable to meet your cash flow needs. It also provides a lifeboat should the unthinkable happen and the company fail.
The Benefits of a Good Team
You likely already work with an accountant, an attorney and a financial advisor. When creating your disaster mitigation plan do not hesitate to take advantage of their expertise. A solid team watching your back can not only ease the process of creating your plan but can certainly prove invaluable help should the plan ever be called into use.
Your attorney can help you correctly create legal documents, specific to you, that provide essential guidance and a framework for action in the event of a variety of disasters. He can work through asset titling issues to ensure that your assets are held in such a way that they provide the most benefit to you and your family in a variety of prospective circumstances. Your attorney can review your full slate of documents from trusts and wills to medical and financial powers to make sure they meet your current requirements and do not have conflicting passages that could cause problems in the future.
Additionally, your attorney will usually keep a copy of all documents they create giving you the benefit of off‐site storage for these critical items should your originals become lost, stolen or destroyed. In addition to advice on how best to navigate the tax and regulatory environment in which your business operates your accountant is an excellent backup location for your specific financial information. Should your financial information be lost, stolen, or destroyed your CPA will have records that can provide essential guidance as the data is reconstructed. Often your CPA firm will know your corporate information as well as your personal information and can be an excellent source of aid in the event a disaster befalls your firm.
Most CEO’s of closely held businesses keep close tabs on most if not all of the financial relationships of their company and some choose to forego an accounting relationship altogether, preferring to handle these functions on their own. While this can be effective for the individual CEO it quickly becomes a problem if the CEO is no longer able to function. It can be extremely disruptive to the business, to say nothing of the family members charged with picking up the pieces, to recreate this knowledge base in the absence of a quality, previously involved, CPA.
Often communications with your financial advisor occur with far more frequency than with the other professionals on the team. It is in your best interest to use that relationship to its fullest. Your financial advisor can serve as a trusted backstop if they know you, the pieces of your financial puzzle, and how you’d like the pieces to fall together in the coming years. They can be an excellent place to keep backup copies of your data, and if they adhere to a fiduciary standard, can give you the security of knowing there is a team out there that has a duty to look out for your best interests first. Your financial advisor can provide guidance regarding tools and techniques that are best suited to your individual circumstances whether it be a place to park an emergency reserve fund or the appropriate investment policy for financial assets with a longer time horizon. In the event of an emergency they are in a position to quickly help you implement steps to mitigate the damage to your financial situation.
Disaster recovery planning can be a daunting project but like so many endeavors it can be accomplished if divided into smaller more manageable tasks. The items outlined here are some of the steps that serve as building blocks to a comprehensive disaster mitigation plan. There are scores of resources available to help you design and build your own disaster recovery strategy. One of the most comprehensive sources is the Federal Emergency Management Agency. They have extensive guidance available online at http://www.fema.gov/plan/index.shtm. May you create an excellent plan and never have to use it.
Devin Pope, MBA, CFP
Senior Wealth Advisor
Albion Financial Group