Preparing For A Potential Deflationary Scenario [View article]
I fail to understand this article. Common sense (for me, at least, and for all other inflation/deflation related articles I've read in my life) would suggest that in a long-term deflationary scenario, long-term highly rated bonds would do best, while all real assets would suffer in the long term (all other parameters and short-term speculation set aside). That is the definition of (asset) deflation. The article suggests buying 4 assets that are usually considered inflation hedges. The author comments: " in a scenario where currencies are crumbling AFTER a bout of high inflation"... sorry, in my understanding: currencies crumbling = real assets doing good = high inflation; currencies doing good vs. real assets = deflation. It's impossible for an asset to be an inflation AND a deflation hedge.
The result in the tax-deferred investment scenario (MLP or similar outside IRA) is actually $48,000 - ($42,000 * 0.3) = ca. $35,500 of consumable wealth, as $6,000 would be the basis for the capital gains or deferred distributions. Doesn't change the argument just exacerbates it :) The system doesn't allow me to correct the typo.
(6) from a portfolio-theoretic point of view, the suitability of any investment vehicle is the same for trad vs. Roth IRA. Only adjust your position sizing to reflect your expected marginal tax rate, e.g. $1,000 of stock ABC in your trad IRA is equivalent to $600 in your Roth. In either case, the exponential growth on the $600 portion ("bucket") will never be taxed.
The above exercise is generic. Applied to the case of KMR or other MLP, and looking at the above results ($48,000 vs. $36,500 of consumable wealth), it seems it can make a whole lot of sense to put KMR in an IRA. This would apply even more to most of the other MLPs, given that the basis will be depleted sooner or later which will put and end to the tax deferral in the taxable account. I haven't done the math yet as to whether a typical stock with 2.5% dividend or an MLP with 7% dividend should have preference in IRA space if IRA space is limited. My guess would be they come close. As I said, only when one expects applicable tax laws to never change in one's lifetime, no taxable corporate events of any kind, AND confident to never withdraw but rather inherit, AND confident to be able to keep the tax basis from depleting for a long enough time, then surely MLP should be in a taxable account.
Sorry for the long analysis, but given the dramatic differences in consumable wealth, I think it's worth using pencial and paper and doing some elementary calcs rather than relying on statements like "putting a tax-deferred security in a tax shelter wastes the shelter’s tax benefits"; "there is no need to put the deferred income KMR in a IRA"; "a Roth might be a better deal, if you can live with the decreased liquidity (??)"
as I've been following your thorough and very helpful analysis of the complex issues with MLPs in IRAs, I'm sure you have the analytical skill to understand my posting and will agree to every statement, if you read it very carefully and in context. Notice I used the words "effectively" or "essentially" several times. Another way to understand the utility of trad vs Roth IRAs is to get a pencil and paper - no PhD in Math needed, just simple multiplications. Since a few years ago, almost everybody can do a Roth conversion of their IRAs at any time regardless of income. The same principle applies to Roth 401(k) vs tax-deferred 401(k) for salary deferrals. Maybe some numbers help. For simplicity, I only treat the cases where the initial salary is invested in a trad IRA (i.e. the salary is tax-deferred) and withdrawn (or converted to Roth & subsequently withdrawn) after 30 years, vs in a Roth vehicle at the beginnin when the salary is paid. Say your personal marginal income tax rate is 40% and you have $10,000 in a trad IRA, which you funded from untaxed salary. Also assume you expect to achieve investment returns of 7% p.a., combined fed/state tax on investment income is 30%, and you expect to retire in ca. 30 years at which time you intend to withdraw your money for consumption. All of these numbers can be modified and none changes the essence of the argument, nor does the fact that tax rates may vary, or that in case of Roth conversion tax can be paid from external funds, which can provide further optimization but is unrelated to the essence of this argument. Under the aforementioned assumptions, in 30 years, the $10,000 will have grown to ca. $80,000, that is ca. 8 times your initial investment. At time of distribution you have to pay your tax, and you will be left with ca. $10,000 * 8 * 0.6 = $48,000 for personal consumption. Had you converted it to a Roth at the beginning of the 30 year time period, you would have paid your personal income tax rate at the beginning (i.e. when you receive the salary or convert to Roth), your start capital would have been $10,000 * 0.6 = $6,000 as $4,000 would have gone to the government. After 30 years, the $6,000 would have grown to ca. $6,000 * 8 = $48,000, which you could then withdraw tax-free and consume. In either case, you have the same $48,000 for consumption at the end. In either case, you pay your personal income tax rate of 40% of your then current value of your investment at some point in time. Another way to say it is, you pay 40% of your initial earned income plus 100% of any accumulated investment returns on those 40% (remember those 40% would have never been yours from the beginning, and could have never generated investment income, had you taxed your initial salary); but in either case, the 60% that are yours, will grow tax-free and any investment income on it will never be taxed, regardless of IRA type. Think of your trad IRA to be divided into two buckets at all times: 60% yours forever tax-free and 40% the government's, and any earnings stay in the two different buckets.
This situation is fundamentally different from a [investment income-]tax-deferred vehicle. Had you bought a tax-deferred investment (like KMR) from your salary instead of investing in an IRA, it would have deferred taxes on your investment income, but not on your initial contribution from salary. Therefore, it would have grown to $10,000 * 0.6 * 8 = $48,000, and after paying tax on the deferred income it would have provided $48,000 - ($38,000 * 0.7) = ca. $36,500 for consumption after 30 years. Not as good as an IRA, but better than a "regular" taxable investment, which would not achieve deferral of income tax on the initial salary, and compound only at 7% * 0.7 = ca. 4.9% yearly, to provide only ca. $25,000 after 30 years for consumption.
In summary, it becomes clear that (1) The personal wealth at retirement depends hugely on understanding the effect of taxation on the various account types, and how the account and investment types *effectively* behave ("effectively" means applying the literal verbiage to the correct entry variables, and looking at the formula for final consumable wealth); (2) tax-deferred investments are much better than regular taxable investment over long time horizons; but, (3) tax-deferred investments are far inferior to any investments in tax-deferred *accounts* (trad or Roth IRA or equivalent), because they defer different things (see next point); (4) the root cause for the latter is that tax-deferred investments just defer tax on the investment income, but eventually taxes on the investment income has to be paid (luckily with inflated dollars). By contrast, any IRA (both trad or Roth) effectively makes investment income on "your" portion of the initial salary investment tax-free. As the bucket analogy shows, the trad IRA achieves this by deferring the tax on the initial salary, i.e. deferral of tax on initial salary is essentially equivalent to tax-free investment income (tax-free growth of the investment after paying tax on salary); therefore, (5) setting aside speculation on tax rates and other tricks which don't change the essence of this analysis, trad and Roth IRA achieve the same end result which is far better than tax-deferred investments outside an IRA. Mathematically speaking, the 30% rate (or 0.7 factor factor) in our example numbers above are never applied in case of either IRA type.
Roth IRAs and traditional IRAs are essentially the same as far as suitability for any investments is concerned. What many, including the previous commenter, don't understand, is that investment income is effectively tax-free (not only tax-deferred or tax-"sheltered") in EITHER case. The only difference is that in case of traditional IRA, the percentage of **personal income tax** on the original contribution (and the associated investment gains that wouldn't have been accrued in the first place in an after-tax e.g. Roth scenario) is effectively deferred. Again, investment income on the (1 - (your tax rate)) ratio portion of the funds will accrue tax-free (not tax deferred) for your 30 or what not years until retirement and will be withdrawn tax-free in both a traditional or Roth IRA. That is the beauty of IRAs. All those questions "what shall I put in my Roth" vs. "what shall I put in my trad IRA" are meaningless from a portfolio-theoretic point of view. The only thing to consider is your stake in your non-Roth funds are essentially only (1 - (your personal tax rate)) times what you see on your account statements, where tax rate is your expected tax rate at retirement, which means your Roth funds are by that factor more valuable and should be valued higher in your asset allocation. That means of any asset, you can put x dollar of it in your Roth of x / (1 - (your personal tax rate)) of it in your trad IRA, and it will have the same effect in your total asset allocation. Having that said, KMR can make a whole lot of sense in an IRA because all the investment income over the years is tax-free. In a taxable account, it would be taxed at time of redemption. Admittedly, for those who expect to hold it until death and have heirs, and expect the tax laws to not change and the company to survive in the current form over a lifetime without potentially taxable corporate events, takeovers, mergers, change of corporate structure, ..., KMR should probably be held in a taxable account.
I'm not sure if most of the author's investment criteria are relevant. I thought the most reliable predictor of future returns are the current valuations. Those are almost entirely omitted in the article.
Hi, can we get a definite answer on this? I think this would dramatically impact the long-term strategy for some of us. The basis of units is typically depleted after ca. 10 years. My assumption was that the MLP can be kept forever tax-free (until sale) if the distributions are always reinvested or additional shares otherwise purchased. Am I understanding your thesis would defeat this? Also, how are purchases on multiple dates treated on the K-1's? Does anyone have an example? Is there space on the K-1 to list the basis of each lot separately?
thanks for your explanation. I was more referring to the general undertone in the comments. I have experienced plenty of examples in Europe and the U.S. of "dilution" and ripoffs of minority shareholders etc., So I'm wondering which country is worse. Can you please comment on my second remark refering to the fact that India supposedly opened the markets for direct trading to foreign individuals at the beginning of 2012? I would like to buy the stocks directly to save the ADR and/or index fund fees (ca. 0.75% yearly), but I have yet to find a U.S. broker to actually provide direct access to Indian markets. There is a discussion thread on Interactive Brokers regarding this, though. Any help would be appreciated.
Interesting article, but I have concerns about the objectivity of the article and the comments. 1. "foreign investors will make no money" - so when Nifty 50 companies pay out their dividends which they have been doing for decades - how does it work? are there many cases where the payouts to foreigners have been confiscated while those to Indians not? So how can it be that foreigners who invest passively in a broad selection of index companies cannot make money, while Indians or insiders can make money? 2. google "India opens stock market to foreign individuals". How dated is the information of this article; or has the opening of the Indian stock market been secretely repealed?
Berkshire Hathaway Is Loaded For Long-Term Appreciation [View article]
Thanks for your reply. But I still beg to differ on the second part. Eventually, all investments need to be valued on either current or anticipated future cashflow or earnings. Both cash flow or earnings, are naturally discounted by whatever tax overhead the corporate structure brings about, in perpetuity unless the holding company is expected to split up. I don't see how that would be different for Berkshire or any company, for both operating subsidiaries or the investment portfolio.
Berkshire Hathaway Is Loaded For Long-Term Appreciation [View article]
I have two concerns. First, conglomerates usually are valued at a substantial discount to the sum of the parts. Birkshire trades at a ca. 15-20% premium. So Birkshire trades more than 50% higher (using this valuation method) than many of its peers. Given the muted growth prospects that Warren Buffet himself admits, is this premium justified? Can the historic outperformance be repeated by that large a margin to compensate for this overvaluation? Second, from a discounted cashflow model perspective: I assume Birkshire pays ca. 35% corporate taxes on its earnings. 35% less after-tax earnings in perpetuity because of double taxation at the shareholder level, would - all other things being equal - justify a 35% lower value on a DCF basis as compared to the sum of its parts, correct? Add that to the premium to book value, and we arrive again at a huge overvaluation (using this metric). Caveat: I'm not an accountant and didn't read Birkshire's statements, so feel free to correct me.
3 High Yielding MLPs Offering Growth For 2013 And Beyond [View article]
This article does not offer any fair valuation target. It also does not offer any rationale as to why the common laws of economics would not apply to MLPs: that high margins usually attract competing capital, eventually margins will compress, pricing will reflect marginal cost of production, and yields will eventually reflect current market real rate of returns and risk. The article kind of implies that the future will be an extrapolation of the past. The pipeline industry cannot grow faster than the rest of the economy forever. There are many competing big pipeline operators; how will that affect pricing power? There are many big pipelines e.g. from Canada to the Northeast U.S. for which utilization and demand has dramatically declined because of local shale gas discoveries. What will happen to these capital investments? How would it affect MLPs that own them?
Master Limited Partnerships And Your IRA [View article]
teamwar, Correct, but your argument would defeat any fair value analysis and make any discussion moot. The fundamental analysis will determine your actual future cash flow from the investment, and should normally be the first approximation for valuating long-term investments and making decisions, as the market will eventually follow the actual cash flow and even if it doesn't, if you invest long term your cash flow matters and not the price others trade it for on an exchange. Unless you want to do some short-term speculation on irrational investors behavior, which can deviate either direction. Having that said, I think we're off-topic. LNCO appears to be trading at some discount, as expected.
Master Limited Partnerships And Your IRA [View article]
@GD: LNCO's current dividend is probably higher because it's trading at a discount with respect to LINE. @teamware: Your thinking is wrong. financial markets trade the expected (discounted) future, not the current cash flow. The current discount may or may not reflect the fair discount in expectation of the corp tax expense and lower after-tax returns in the future, and the adjustment may happen at any time.
Preparing For A Potential Deflationary Scenario [View article]
The author comments: " in a scenario where currencies are crumbling AFTER a bout of high inflation"... sorry, in my understanding: currencies crumbling = real assets doing good = high inflation; currencies doing good vs. real assets = deflation. It's impossible for an asset to be an inflation AND a deflation hedge.
Hello Taxes... Goodbye MLPs [View article]
Hello Taxes... Goodbye MLPs [View article]
The above exercise is generic. Applied to the case of KMR or other MLP, and looking at the above results ($48,000 vs. $36,500 of consumable wealth), it seems it can make a whole lot of sense to put KMR in an IRA. This would apply even more to most of the other MLPs, given that the basis will be depleted sooner or later which will put and end to the tax deferral in the taxable account. I haven't done the math yet as to whether a typical stock with 2.5% dividend or an MLP with 7% dividend should have preference in IRA space if IRA space is limited. My guess would be they come close. As I said, only when one expects applicable tax laws to never change in one's lifetime, no taxable corporate events of any kind, AND confident to never withdraw but rather inherit, AND confident to be able to keep the tax basis from depleting for a long enough time, then surely MLP should be in a taxable account.
Sorry for the long analysis, but given the dramatic differences in consumable wealth, I think it's worth using pencial and paper and doing some elementary calcs rather than relying on statements like "putting a tax-deferred security in a tax shelter wastes the shelter’s tax benefits"; "there is no need to put the deferred income KMR in a IRA"; "a Roth might be a better deal, if you can live with the decreased liquidity (??)"
Hello Taxes... Goodbye MLPs [View article]
as I've been following your thorough and very helpful analysis of the complex issues with MLPs in IRAs, I'm sure you have the analytical skill to understand my posting and will agree to every statement, if you read it very carefully and in context. Notice I used the words "effectively" or "essentially" several times. Another way to understand the utility of trad vs Roth IRAs is to get a pencil and paper - no PhD in Math needed, just simple multiplications. Since a few years ago, almost everybody can do a Roth conversion of their IRAs at any time regardless of income. The same principle applies to Roth 401(k) vs tax-deferred 401(k) for salary deferrals. Maybe some numbers help. For simplicity, I only treat the cases where the initial salary is invested in a trad IRA (i.e. the salary is tax-deferred) and withdrawn (or converted to Roth & subsequently withdrawn) after 30 years, vs in a Roth vehicle at the beginnin when the salary is paid. Say your personal marginal income tax rate is 40% and you have $10,000 in a trad IRA, which you funded from untaxed salary. Also assume you expect to achieve investment returns of 7% p.a., combined fed/state tax on investment income is 30%, and you expect to retire in ca. 30 years at which time you intend to withdraw your money for consumption. All of these numbers can be modified and none changes the essence of the argument, nor does the fact that tax rates may vary, or that in case of Roth conversion tax can be paid from external funds, which can provide further optimization but is unrelated to the essence of this argument. Under the aforementioned assumptions, in 30 years, the $10,000 will have grown to ca. $80,000, that is ca. 8 times your initial investment. At time of distribution you have to pay your tax, and you will be left with ca. $10,000 * 8 * 0.6 = $48,000 for personal consumption. Had you converted it to a Roth at the beginning of the 30 year time period, you would have paid your personal income tax rate at the beginning (i.e. when you receive the salary or convert to Roth), your start capital would have been $10,000 * 0.6 = $6,000 as $4,000 would have gone to the government. After 30 years, the $6,000 would have grown to ca. $6,000 * 8 = $48,000, which you could then withdraw tax-free and consume. In either case, you have the same $48,000 for consumption at the end. In either case, you pay your personal income tax rate of 40% of your then current value of your investment at some point in time. Another way to say it is, you pay 40% of your initial earned income plus 100% of any accumulated investment returns on those 40% (remember those 40% would have never been yours from the beginning, and could have never generated investment income, had you taxed your initial salary); but in either case, the 60% that are yours, will grow tax-free and any investment income on it will never be taxed, regardless of IRA type. Think of your trad IRA to be divided into two buckets at all times: 60% yours forever tax-free and 40% the government's, and any earnings stay in the two different buckets.
This situation is fundamentally different from a [investment income-]tax-deferred vehicle. Had you bought a tax-deferred investment (like KMR) from your salary instead of investing in an IRA, it would have deferred taxes on your investment income, but not on your initial contribution from salary. Therefore, it would have grown to $10,000 * 0.6 * 8 = $48,000, and after paying tax on the deferred income it would have provided $48,000 - ($38,000 * 0.7) = ca. $36,500 for consumption after 30 years. Not as good as an IRA, but better than a "regular" taxable investment, which would not achieve deferral of income tax on the initial salary, and compound only at 7% * 0.7 = ca. 4.9% yearly, to provide only ca. $25,000 after 30 years for consumption.
In summary, it becomes clear that (1) The personal wealth at retirement depends hugely on understanding the effect of taxation on the various account types, and how the account and investment types *effectively* behave ("effectively" means applying the literal verbiage to the correct entry variables, and looking at the formula for final consumable wealth); (2) tax-deferred investments are much better than regular taxable investment over long time horizons; but, (3) tax-deferred investments are far inferior to any investments in tax-deferred *accounts* (trad or Roth IRA or equivalent), because they defer different things (see next point); (4) the root cause for the latter is that tax-deferred investments just defer tax on the investment income, but eventually taxes on the investment income has to be paid (luckily with inflated dollars). By contrast, any IRA (both trad or Roth) effectively makes investment income on "your" portion of the initial salary investment tax-free. As the bucket analogy shows, the trad IRA achieves this by deferring the tax on the initial salary, i.e. deferral of tax on initial salary is essentially equivalent to tax-free investment income (tax-free growth of the investment after paying tax on salary); therefore, (5) setting aside speculation on tax rates and other tricks which don't change the essence of this analysis, trad and Roth IRA achieve the same end result which is far better than tax-deferred investments outside an IRA. Mathematically speaking, the 30% rate (or 0.7 factor factor) in our example numbers above are never applied in case of either IRA type.
Hello Taxes... Goodbye MLPs [View article]
Having that said, KMR can make a whole lot of sense in an IRA because all the investment income over the years is tax-free. In a taxable account, it would be taxed at time of redemption. Admittedly, for those who expect to hold it until death and have heirs, and expect the tax laws to not change and the company to survive in the current form over a lifetime without potentially taxable corporate events, takeovers, mergers, change of corporate structure, ..., KMR should probably be held in a taxable account.
Master Limited Partnerships And Your IRA [View article]
8 Best International ETFs For 2013 [View article]
Hello Taxes... Goodbye MLPs [View article]
Caveat Emptor: Investing In India [View article]
Caveat Emptor: Investing In India [View article]
1. "foreign investors will make no money" - so when Nifty 50 companies pay out their dividends which they have been doing for decades - how does it work? are there many cases where the payouts to foreigners have been confiscated while those to Indians not? So how can it be that foreigners who invest passively in a broad selection of index companies cannot make money, while Indians or insiders can make money?
2. google "India opens stock market to foreign individuals". How dated is the information of this article; or has the opening of the Indian stock market been secretely repealed?
Berkshire Hathaway Is Loaded For Long-Term Appreciation [View article]
Berkshire Hathaway Is Loaded For Long-Term Appreciation [View article]
Second, from a discounted cashflow model perspective: I assume Birkshire pays ca. 35% corporate taxes on its earnings. 35% less after-tax earnings in perpetuity because of double taxation at the shareholder level, would - all other things being equal - justify a 35% lower value on a DCF basis as compared to the sum of its parts, correct? Add that to the premium to book value, and we arrive again at a huge overvaluation (using this metric). Caveat: I'm not an accountant and didn't read Birkshire's statements, so feel free to correct me.
3 High Yielding MLPs Offering Growth For 2013 And Beyond [View article]
Master Limited Partnerships And Your IRA [View article]
Master Limited Partnerships And Your IRA [View article]
@teamware: Your thinking is wrong. financial markets trade the expected (discounted) future, not the current cash flow. The current discount may or may not reflect the fair discount in expectation of the corp tax expense and lower after-tax returns in the future, and the adjustment may happen at any time.