Market Commentary | March 2024

'It’s not what you earn that makes you wealthy, it’s what you keep.'

This adage is what I heard repeatedly from my father as he was describing his investment process that is now called the Freedom4 quadrant. Part of the reason why I implemented the machine learning and algorithms for investment management was the repeatability of the technology even in the ever-changing markets. The principle behind them is to mitigate risk and move to cash in times of peril. History has shown its ability to perform admirably in volatile times. Hence the reason for my desire to continue to rely on it and look to provide additional solutions for my clients.

Two areas of focus that is centered around keeping what you earn, is what I would like to briefly focus on. The Freedom4 quadrant has a box titled ‘Alternative Investments’ and I have been doing due diligence for the investment offerings in that space. Pensions and endowment funds have long been invested in alternative investments with allocations up to 40-50% of their assets. For example, I have highlighted the Yale endowment below.

• Over the past 30 years, Yale significantly reduced its reliance on domestic marketable securities (U.S. stocks, bonds, and cash). Today, domestic marketable securities constitute less than one-tenth of the portfolio. Instead, Yale allocates over nine-tenths of the Endowment to non-traditional asset classes, including:
  
  
• Foreign equity
• Private equity
• Absolute return strategies
• Real assets
• These alternative assets offer higher expected returns and lower volatility compared to the 1985 portfolio.
• Yale’s long-time horizon allows it to exploit illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.

Private markets have historically generated attractive risk-adjusted returns relative to their public market equivalents. Private equity can enhance returns while private debt can increase income. A 50/50 blend of private equity and private debt has provided ~20% higher risk-adjusted returns than holding either on its own. In addition to the risk mitigation and return potential, there are certain alternatives that also provide tax reduction benefits such as oil and gas and real estate.

Oil and gas drilling projects are an example of an alternative investment opportunity that allows the investor to partake of Intangible Drilling Cost and depletion expenses to reduce gross income thereby reducing taxable income. These tax benefits are a large benefit and impacts the appeal of investing in oil and gas projects. Investing in oil and gas also has an income component which typically distributes income the year after investment from the production of the wells drilled and may last up to 10 years.  

Another option when investing in alternatives, is the ability to convert an IRA to a Roth using the J-curve of the project. The J-curve is a trendline that shows an initial loss in year one immediately followed by a gain in year two. The use of this J-curve could prove hugely beneficial by converting an IRA to a Roth saving roughly 30-40% on the value of the conversion. There are certainly some risks associated with every investment that should be carefully considered.

The last area of emphasis is tax planning. In my opinion there isn’t a more efficient way to ‘keep what you have earned’ by utilizing the tax breaks within the IRS code to save money on your taxes. The tax planning knowledge we have and the tax software Foxstone Financial and Retirement Planning Resources utilizes allows us to analyze our clients current tax situation and offer everything from simple to elaborate strategies to reduce taxes. Some of these strategies could be as simple as funding a HSA account, maximizing IRA and 401k contributions, funding a 529 plan, etc. to more intricate strategies such as historical building easements, land donation fee simple strategies, purchasing green energy tax credits, to oil and gas as mentioned above, and the depreciation and cost segregation of any real estate asset.

With tax season upon us, I am happy to discuss proper asset allocation using the Freedom4 quadrant, alternative investments, and strategies to effectively reduce taxes so you can ‘keep more of what you earn’!

Note: This fund is only accessible to accredited investors. 

If you have any questions about the fund and its potential benefits for your portfolio, please schedule a call with me below.