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Should I Invest in Private Equity?

Should I Invest in Private Equity?

In recent years, the private equity sector has attracted a lot of attention, especially from high net worth investors asking, “Should I invest in private equity?” These investments are in private, non-publicly traded companies, so many investors in mutual funds and stocks don’t necessarily have access to this sector. Private equity firms you’ve probably heard of include The Blackstone Group and The Carlyle Group.

 

Mechanics of investing in private equity

 

Typically, private equity investors are investing for ownership in mature businesses. Ordinarily, they claim to invest to maximize the company’s value and then sell it at a profit. In this, they’re similar to venture capitalists (VCs). 

However, unlike VCs, they usually purchase a majority ownership stake of 50% or more in the target company. Private equity firms own several businesses, known as portfolio companies, at the same time. It’s diversification in action, avoiding putting all their eggs in one company’s basket.

The strategy for private equity firms is to raise money from limited partners (LPs) to form a private equity fund. Once the capital goal has been reached, the fund closes. It then invests in the portfolio companies they’ve targeted. The firm’s team begins the work of turning around the portfolio companies and bringing them to profitability. 

The ideal candidate for private equity investment is a company that’s either stagnant or in some trouble but, with some capital and management oversight, has the potential for good growth. It does take time to turn troubled companies around, and the lifespan of a private equity fund is typically ten years. It’s not a fast cash strategy.

When the fund successfully sells a portfolio company, profits are returned to the LPs after fees. On occasion, the company goes public instead.

 

Who can invest in private equity?

 

It’s been a somewhat exclusive club for a long time because many investments are only available to accredited investors. The SEC doesn’t regulate Private companies that don’t trade on a public exchange. 

Therefore, accredited investors must have a net worth of at least $1 million and an income of $200,000 or more ($300,000 for married couples) over the past two years. These investors have to have more investing experience and therefore are up to doing their research and making decisions about private firms.

The buy-in for traditional private equity is usually pretty significant as well. Though some funds allow a minimum contribution of $250,000, others require millions.

There are some other ways to invest for those who don’t meet the accreditation minimums. Equity crowdfunding allows you to buy an ownership stake for as little as $2,000, depending on income. As a bonus, the SEC regulates these platforms.

Or you can buy shares of private equity ETFs (exchange-traded funds). They’re publicly traded, like all ETFs, but invest in private companies.

 

Types of private equity to invest in

 

Often the deal is done via leveraged buyout or LBO. The purchase involves both equity and plenty of debt (hence the “leveraged”), which the company eventually must repay. Once the company regains and improves its profitability, the debt becomes less of a burden.

Another type of private equity investing is “distressed funding,” which involves companies filed for Chapter 11 bankruptcy. Sometimes the goal of the fund is to restructure the firm and turn it around to sell at a profit. Other times it’s to strip the business for spare parts and gain on the assets, which is why some private equity firms have a bad reputation.

Venture capital is a type of private equity investing. Unlike other private equity funds, however, VCs usually don’t buy an ownership stake. They go after promising new businesses to take to profitability and sell instead of mature ones.

Finally, there are specialized LPs, which often invest in real estate. Most of their investments are in commercial or multifamily real estate. Specialized LPs may also take on infrastructure projects like bridges and roads.

 

Advantages of private equity investing

 

 

Potentially high reward

Because these are private companies, the information publicly available is minimal. Good private equity funds have a substantial investment team that picks great candidates for turnaround. The potential profit from rescuing a portfolio of troubled businesses and turning them around is massive.

 

Passive income

As a limited partner, you’ll just be sitting back and letting the money flow. The fund’s investment team are the general partners (GPs) doing all the work.

 

Disadvantages of private equity investing

 

Illiquid assets

Unlike public investments that trade on an exchange, you can’t just sell your stake in the fund any old time you feel like it. Investors are usually required to keep their money invested for a minimum of three to five years.

That allows the GPs to work their magic, but it also means that money is not available to you if you need it.

 

High fees

Think mutual fund fees are high? If so, you might get blown away by the payment structure of private equity, which is similar to hedge funds. They’re allowed to charge an unlimited amount of fees because SEC doesn’t regulate them, unlike mutual fund managers.

Performance bonuses are standard for the GPs in a private equity fund. The fee structure is usually the “2 and 20” approach. The annual fee is 2% AUM (assets under management) with a 20% performance bonus on the profits.

 

Potentially high risk

As you know, there’s no free lunch in investing! The high potential upside comes along with a high potential downside. Even a talented team isn’t guaranteed to turn every company around, and you could very quickly lose money in this investment.

 

Reporting issues

With publicly traded stocks on an exchange, it’s tough to fudge prices or performance. However, private equity firms typically use IRR (Internal Rate of Return) to demonstrate performance. However, that number isn’t realized until the business is sold. 

Therefore, over the life of the fund, they’re reporting interim, estimated IRRs. They can pick and choose comparable businesses to generate a number that looks better than the ultimate return.

 

Ways to invest intelligently in private equity

 

Skip the funds and their high fees

Investing directly into a firm allows you to avoid all the layers of the management structure. If you still prefer a more passive investment, use private equity ETFs.

 

Commit capital to specific deals

Instead of investing in one fund, you can agree to buy in deal-by-deal. This way, the management fees don’t start ticking until the money is invested. Not only that, you decide which deals you want to be a part of.

 

Diversification across GPs

Just as you diversify your stock investments in different companies and funds, do the same for your private equity investments. Research the fund managers and make sure you’re comfortable with their style.

 

Are you interested in further diversifying your portfolio? Please feel free to give us a call at 619.255.9554 or email us to set up an appointment.

 

 

 

Are you on track for retirement?

Making sure you will be ready for retirement can be overwhelming. Funding your retirement accounts over the years is a critical part of your journey to the retirement of your dreams. An experienced Financial Advisor can help you navigate the complexities of investment management. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Messenger RNA Technology a Silver Lining

Messenger RNA Technology a Silver Lining

Many of us have been in lockdown for more than a year. We’ve canceled vacations, restaurant visits, and in-person schooling. More than 500,000 of our loved ones across the country have passed away.

Is there a COVID pandemic silver lining?

It turns out there is. The messenger RNA immunization technology developed for the Moderna and Pfizer coronavirus vaccines has the potential to revolutionize the way we treat—and prevent—a wide variety of other diseases and illnesses. Scientists are sequencing HIV, seasonal flu viruses, and certain cancers. They are identifying snippets of RNA that could teach the body to fight them off before they can run rampant through the body.

The vaccine approach to the coronavirus uses lipid nanoparticles—essentially fat bubbles—to deliver bits of a disease’s genetic material into the body, helping the immune system spot the spike proteins they use to enter human cells. At the moment, Moderna is working on two HIV vaccine candidates: mRNA-1644 and mRNA-1574.

The vaccine has been tested successfully in macaque monkeys, which developed neutralizing antibodies that bind to the proteins that HIV uses to enter cells, neutralizing the disease before it can spread. Another mRNA test protects mice against HIV infection.

 

Messenger RNA for the Flu?

 

Meanwhile, phase 1 clinical trials for more effective seasonal flu vaccines will start this year. Companies are developing additional RNA vaccines for mononucleosis, types of lymphoma, and nasal cancer. Other experimental cancer vaccines will require doctors to extract tumor samples from the patient, sequence the genome, and create a specific RNA therapy that will teach the immune system to destroy the cancer cells—and only the cancer cells. Six of 10 patients in an early trial responded positively to the treatment; in two, the cancer was destroyed, while four others stabilized and had no further cancer progression.

The newly-developed therapies also offer promise in fighting several autoimmune diseases, including multiple sclerosis. A recent mRNA experiment suggests that mRNA treatment can promote the development of blood vessels. An injection might improve outcomes in people undergoing coronary artery bypass surgery.

Some of these therapies might have happened eventually without the crash COVID vaccine projects, but almost certainly, they would not have been in clinical trials this quickly. We mourn the millions of people lost to the pandemic here and abroad, but there may be fewer deaths, and diseases, in our future.

 

 

 

Are you on track for retirement?

Making sure you will be ready for retirement can be overwhelming. Funding your retirement accounts over the years is a critical part of your journey to the retirement of your dreams. An experienced Financial Advisor can help you navigate the complexities of investment management. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Kids Need to Understand Taxes

Kids Need to Understand Taxes

Raising children who understand the value of money gives them an advantage. So, that means your kids need to know about taxes. Of course, receiving a check at their first job for much less than the $15 per hour stated on the employment agreement is one way to find out. 

 

Instead of believing that they’ve been robbed by their employer (or the government), by learning early on why taxes are deducted from their checks, they’ll understand that some of the taxes taken out pay for Social Security and Medicare when they’re no longer able to work. 

 

They’ll also find out that federal and state taxes pay for things like the police and fire departments in the town where your family lives, as well as roads and bridges in addition to national defense and parks. Maybe even more important to many kids today, the fiber optic infrastructure that allows them to stay online all day!

 

As a taxpayer, of course, you well know that taxes can be complicated. While you know that you don’t need to burden your five-year-old with the difference between marginal income tax rates and capital gains rates, you might not be sure what your kids need to know and when. 

 

As always, you know your children best, and you might want to let them in on some of these topics earlier or later than suggested, depending on personalities and experience. The ranges are pretty broad, though. Take the opportunity to make sure they’re clear on the foundations before you start teaching them more advanced topics.

 

Children ages 5-10 need to understand tax basics

Even in elementary school, your kids can absorb some fundamental and easy lessons about taxes. It’s probably easiest to start while you’re shopping at the grocery or toy store. Find an item whose price is easy to understand, like $1 or $5 or $10. (Good luck in some of the stores, which for behavioral finance reasons, charge $4.99 or $9.99 instead! But that’s a lesson for later.) 

 

Run the item(s) through checkout separately, so it’s clear on the receipt how much tax you paid. Point out that while the price was $5, the amount that came out of your pocket was slightly more than that. 

 

They’ll want to know where the money goes. At this age, there’s no need to get very specific. Your kids only need a high-level overview; that money goes to the government to fund things like parks, police, and schools. No need to get political here either; just the basic facts will do.

 

Middle school/junior high, ages 11-13 need to understand taxes in relation to their paycheck

At this point, your kids will be familiar with sales taxes, having seen you shop. Maybe they’ve been able to shop themselves.

 

They’re old enough to begin learning about other taxes, such as income tax, property tax, and Social Security/FICA. Show them your pay stub and discuss the various amounts that have been deducted and why. If you have Social Security statements, you can demonstrate where the money goes later on in life.

 

Let them know what the deductions for Medicare and Social Security pay for. You can also explain the federal, state, and potentially local taxes. They should have a basic understanding of the US government from school and know that the federal government is in charge of some things, and state and local governments run others. Taxes at every level support all these different branches of government.

 

Although you’ll explain the deductions from your paycheck to them in some detail, that’s not the central concept they need to know. The big lesson here is that the money they earned according to the stated pay rate is not what shows up in the paycheck. 

 

Show them the difference between the stated rate and what gets deposited into your account. Of course, not all deductions will be taxes since you likely have health care and retirement contributions taken out as well. Talk to them about the importance of budgeting with the net amount after taxes and other deductions, not the gross income.

 

Show them your property tax bill as well. Property owners fund local improvements and projects, so they need to understand where the money goes.

 

Teens 14 and over need to understand how to file their taxes

At this age, your kids are probably paying taxes in some shape or form already. They’re paying sales tax when they shop, and if they have jobs, they’ll also be paying income tax. They know the reality of paying taxes, especially if you’ve been educating them along the way.

 

If they do have part-time (or other) jobs, show them how to keep their documents organized for tax time. Let your kids know about the importance of W-2s and why they need to keep track. They should do their income taxes (with your guidance, of course) during this time. 

 

There are plenty of online software applications to use, which makes it easy. My dad made me do my taxes when I was in high school, and back then, we had to use paper forms and read the instructions. 

 

Doing their taxes each year helps your children understand the basic calculations and the importance of tax deductions. They’ll also be in the habit of doing their taxes annually, so they won’t need to worry about IRS fines and fees later on.

 

If they don’t have their own jobs, they can sit with you while you do your taxes online or go to the CPA with you. 

 

When your kids start asking why so much money goes to taxes, discuss how Congress sets the rates. You can also show them that income tax rates change over time. For example, income tax rates on high earners are currently significantly lower than when the government built the interstate highway network across America and other big infrastructure projects in the middle of the last century.

 

If they’ve been investing, or you’ve been investing on their behalf, introduce capital gains tax. Explain how they only pay it when investments are sold. Let them know about capital losses, which can reduce the amount of capital gains they’ll need to pay taxes on.

 

Understanding income and capital gains taxes is an excellent segue into the importance of tax-deferred accounts. You know your children will need a significant amount of assets in the future and the need to start saving early to take advantage of compound returns. Show them what a difference not paying income and capital gains taxes on the money they accumulate in these accounts makes down the road.

 

If you’ve been saving for their future in college 529 accounts, you have another chance to showcase the importance of deferred or tax-free (for qualified expenses) money. Depending on when you started funding the accounts, you can also demonstrate the power of compounding over time. 

 

There are many opportunities to teach your kids about taxes in an age-appropriate way. It’s critical for them to understand the difference between gross and after-tax income to know how to budget appropriately. Tax season is an excellent time to demonstrate to your older kids why they need to understand IRS rules and regs.

 

If you’d like to talk to us about investments for your kids, please feel free to give us a call at 619.255.9554 or email us to set up an appointment.

 

Are you on track for retirement?

Making sure you will be ready for retirement can be overwhelming. Funding your retirement accounts over the years is a critical part of your journey to the retirement of your dreams. An experienced Financial Advisor can help you navigate the complexities of investment management. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Why you should be tax-loss harvesting

Why you should be tax-loss harvesting

Tax losses can be constructive when it comes time to add up what you owe Uncle Sam. Especially when you’re in a high tax bracket and especially in years where you have gains that you’d like to offset.

Losses need to be realized before the end of the year, December 31, to qualify for that tax year. There are a few other things that you need to know to take full advantage of them.

 

What is tax-loss harvesting?

If you have an investment that’s lost value compared to its basis, selling it at a tax loss allows you to offset other capital gains in your portfolio. You can even use some losses against your income. If you have more losses than gains, you can use an additional $3,000 more tax loss to offset your income. Carry the remainder forward into future tax years, known as a carry-forward loss.

After freeing up cash in the portfolio from the sale, you can buy another similar security. Or use the money available to rebalance your portfolio back to its intended allocation.
Tax-loss harvesting doesn’t work for your tax-deferred accounts, so only your taxable brokerage account provides you this opportunity.

 

Beware the wash-sale rule when tax-loss harvesting

The IRS doesn’t let investors take a capital loss of one security against the same security gain. The wash-sale rule prevents you from buying a substantially similar investment (or even an option to do so) within 30 days of the date the loss was realized by selling the security.

It’s critical to remember that the 30-day period applies before the sale in addition to after the fact. If you’re planning to buy a similar investment, you’ll need to do so more than a month before you sell the one for a capital loss.

Even if you don’t want to reallocate your portfolio, you can still purchase a security that’s like the original investment but not substantially similar to avoid falling afoul of the wash-sale rule. Investors often buy a mutual fund or ETF in the same sector as the stock they sold to maintain the same allocation.

 

Costs of tax-loss harvesting

If you’re planning to harvest losses every time the market drops, tax prep will be much more difficult. Remember that you probably have shares at different cost bases within your investment because you bought them at different times.

You’ll need to have records of the basis of every share so that you can sell the correct shares to generate the loss. This is why tax-loss harvesting can be very costly in terms of actually carrying out the program!

Given the costs of trading, make sure that the loss you’re going to harvest is of greater value than the expense. If you want tax-loss harvesting to be a part of your plan, you should do it more than once a year in December before the deadline.

Instead, consider rebalancing more than once a year. As you identify securities that you need to sell to rebalance back to your allocation, you may spot some opportunities to take losses.

 

Harvesting losses for improving your portfolio

Taking capital losses is especially important if you end up realizing short-term gains. The short-term capital tax rate is the same as your ordinary-income rate, so it’s best to avoid them whenever possible. The long-term capital gains tax ranges from 0 to 20%, depending on your income. Selling a purchase within twelve months of buying is considered short-term, and 12 months plus is long-term.

When it comes to the mechanics of your tax return, like-losses are applied against like-gains first. Long-term losses offset the long-term gains, and then short-term losses offset short-term gains. If you have more losses in one category and gains in another, the remaining loss offsets the gains.

For example, suppose you have $20,000 in capital losses, half short-term and half long-term, to offset $15,000 in capital gains, also half-and-half. The long-term $10,000 loss offsets the $7,500 long-term gain, with an excess of $2,500 in losses. The short-term $10,000 offsets the $7,500 short-term gain, again with an excess of $2,500, so you now have $5,000 of losses.

If you’re married filing jointly, you can take up to $3,000 of these losses this year on your income tax. (For singles and filing separately, it’s $1,500.) That means you have $2,000 to carry forward into the next tax year.

 

Tax-loss harvesting when you don’t have capital gains to offset

You still reduce your taxes by taking capital losses because up to $3,000 can be used against your income tax every year. By reinvesting your “harvest savings” back into the portfolio, you can accumulate a bit more to compound for the next few years.

Suppose you’re in the 30% tax bracket, and you have $3,000 of capital losses you could take. The immediate savings is $3,000* 30%, which is how much you’d otherwise pay in tax, or $900. Reinvesting that amount every year for the next twenty years, assuming a reasonable average rate of return of 6%, would result in an accumulation of about $35,000.

 

Other tax-loss harvesting considerations

Be careful when considering capital losses against gains on mutual funds. At the end of the year, most funds pay out capital gains distributions, in addition to making others throughout the year.

While you can use capital gains to offset long-term realized gains on mutual funds, they can’t be used against short-term distributions. Those are treated as ordinary dividends, and the mutual fund company will identify which is which.

You’ve probably already figured out that this strategy works best in high marginal tax brackets. If you take a year off with no income, that’s not likely to be the right time to wield this particular tool. Younger investors who are not in the high tax brackets yet may not see much benefit.

If you’ve invested your whole portfolio in index funds, you’re not going to squeeze many tax reductions out of your tax-loss harvesting. Because these funds are not actively managed, most of the securities are held for the whole year (or longer), with very few sales to generate either a gain or a loss.

However, if you invest in actively managed funds or ETFs, or stocks, you may find more opportunities to decrease your tax burden. Turnover in actively managed funds tends to be high, and all the buying and selling generates the potential for capital gains and losses.

Note that you don’t have much control over the gains that mutual funds distribute because an equal share is portioned to every owner of shares. You also generate gains or losses when you sell the fund yourself. By contrast, stocks are entirely within your control.

Are you interested in learning more about tax-loss harvesting for your portfolio? Please feel free to give us a call at 619.255.9554 or email us to set up an appointment.

 

 

 

Are you interested in tax savings by tax-loss harvesting?

It might be time to check and see if your investments are exposed to excessive taxes. An experienced Financial Advisor can help you navigate the complexities of investment management, advantage opportunities and avoid costly mistakes. Talk to a Financial Advisor>

Dream. Plan. Do.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

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