adam

About Adam Sommers

Adam Sommers has been investing on behalf of clients since 1996. As the founder of Sommers Financial, Adam’s goal was — and remains today — to manage investments responsibly and with integrity, for the benefit of each client.

August 2017

Want to reduce or eliminate capital gains taxes on investment property?

By |August 12th, 2017|

We have a lot of clients that own real estate investments as another way to provide investment income and grow their net worth. I can appreciate the tax advantages and diversification of owning investment property; in fact, my wife and I have acquired a few income properties over the past ten years.

With real estate values nearing all-time highs again, many of our clients have unrealized capital gains in their real estate portfolios. Unrealized capital gains are not taxed; but if you want to sell your appreciated property, you have two choices:

a) Pay capital gains tax (currently up to 20%, plus a 25% tax on any accumulated depreciation that you must recapture).

b) Perform a 1031 Exchange, thereby deferring the tax, and transferring your cost basis to another investment property of equal or higher value.

What if I told you I have a strategy that can stretch your capital gains tax over multiple years, with the goal of remaining in a low tax bracket each year? What if I had a plan that would completely eliminate capital gains taxes on your investment property gains all together? Yes, we can help you avoid capital gains tax on millions of dollars in gains, potentially saving you hundreds of thousands of dollars.

First, the easiest way to stretch out your capital gains for tax purposes is to sell your investment property on contract to a buyer. A portion of each payment received from the contract is considered your basis, so you only pay tax on a portion of payments received each year. If you want to stretch it out over 10 years, draft a 10-year sale contract with a large (i.e. amount of tax) prepayment penalty.

Another way to stretch out the capital gains tax would be to perform a 1031 exchange and use the proceeds to purchase multiple like properties. So you could turn your 12-plex into five condos or single-family homes tax-free, using the 1031 exchange rules. Then, you could sell one or two units per year to stretch out your taxes and try to remain in a lower tax-bracket, to be taxed at only 15% – or even 0% (if you’re in the 15% tax bracket or lower)!

Now for the best part: The way to completely avoid capital gains tax takes the 1031 exchange into multiple properties one step further. Let’s assume you bought five condos as in the last example. 1031 exchange rules state that you can convert an investment property into a personal residence after three years of ownership. So let’s say three years from now, you move into one of the condos. You only have to live there two years to be able to sell it tax-free. So within five years, you’re realizing tax-free gains from your original investment property. Then every two years, you simply move to the next property, and put one up for sale. Within a decade, you will have realized huge gains without paying one cent of capital gains tax (from selling three of the five properties in the first nine years – at years 5, 7, and 9).

This strategy may seem like a bit of a logistical nightmare, but for savings of a few hundred thousand dollars, it may just be worth it!

(PS – For our advisory clients, we have an additional bonus in regard to this strategy, making it even easier and more profitable – just call our office and ask to speak with Adam about the specifics.)

May 2017

We’ve officially launched a me-too “Robo”

By |May 25th, 2017|

We’ve been excited about the movement toward automated, fiduciary investment advice, sometimes called robo-advice, since we saw what WealthFront.com had to offer more than five years ago. I remember looking over Joyce’s shoulder as I walked her through their site, with her jaw dropping to desktop. Now, the likes of Vanguard and Charles Schwab are taking the lead from those first-to-market robos, including Betterment and Wealthfront.

In February of last year, we launched our own robo-advisory service we call Sustainable Income Portfolios. We aimed for a niche market that the others haven’t targeted: baby boomers looking to turn their 401ks and IRAs into retirement income. We purposefully kept our fees on the low-end (a vendor said yesterday, “those are some slim margins!”), far under-pricing Personal Capital, which charges 0.75% per year, with our flat fee of 0.36% per year. While WealthFront, Schwab and Betterment all come in around the 0.25% per year fee schedule, we think we’re worth the extra 0.11%.

Why? Because we’re not robots. We are real people, with over 20 years of investing and client service experience who have survived two huge bear markets both in 2000-2002, and 2008-2009. We know how our clients react to market swings. We understand how volatility affects the psyche. We also understand the value of ETFs designed with rock-bottom fees and broad market exposure.

We feel we’ve blended the best of both human advice, and automated investment allocation.

As of February 2017, we added growth portfolios to our automated investment management service, so folks have over a dozen portfolios to choose from, based on their return objectives and tolerance for volatility.

Sustainable Income Portfolios have had a terrific first year. Now, they exist alongside portfolios targeting growth, socially-conscious investing, and closed-end fund arbitrage. You can invest in any of our models, from Risk Number 25 all the way to Risk Number 82 – at SIPincome.com.

January 2017

2016 SFM Returns, while not spectacular, were comparatively good!

By |January 5th, 2017|

I just completed a review of how each of our Model Portfolios performed in 2016, the first full year in which we’ve used them with a majority of our clients. As some background, we use Riskalyze to determine our client’s tolerance for volatility, balanced against their desire for high returns. Once clients are assigned a Risk Number between 1 and 100, we can then match each client to one of our Model Portfolios with a similar Risk Number.

We break down our portfolios into Income vs. Growth, Conservative vs. Aggressive vs. Moderate, and Low-Cost vs. Optimal. Our low-cost models all utilize commission-free ETFs and mutual funds, with below average expense ratios. The holdings in our Income Models have above average yields. Our Aggressive Models exclude the most conservative of funds, while our Conservative Models exclude the most aggressive ETFs and mutual funds.

In 2016, the 21 model portfolios that we use in client accounts averaged 7.9%, after-fees (coincidentally, 7.9% was also the 2016 return of the Naked Alpha Fund). Our best performing portfolio out-performed its benchmark by 4.5% when adjusted for risk. Our worst performer was our “Conservative Growth” portfolio (+1.8%), which under-performed the S&P Conservative Index (+5.6%) by 5.9%, after adjusting for risk. We use benchmarks that are well-matched, and well-diversified: indices like the S&P Conservative and Moderate Indexes, and the iShares Aggressive Allocation. For our “all-stock” and hedge fund portfolios, we use the Russell 3000 and the SGI Wise Long/Short Index, respectively. Our “Ultra-Conservative” model (+4.0%) was a pleasant surprise in 2016, out-performing the 1-3 Year Treasury Portfolio (+0.8%) by over 2.5% when adjusted for risk.

In order to determine which Portfolio and benchmark is right for you, we suggest that you update your Risk Number annually. Here’s hoping 2017 provides similar out-performance, only with more spectacular total returns!

August 2016

High returns with no risk, trading options? Sign me up …

By |August 12th, 2016|

… to test how much they spin the truth.

Over the past year, I’ve had a very aggressive investor ask me to help him find the “investing silver bullet,” that will make a lot of money with little risk. In fact, I’ve had many clients ask for this over the years – just none as headstrong as this one. He is convinced that there is a way to make a lot of money – likely trading options – without risk of losing principal. He was so convinced that early in the year, he gave me $500 to subscribe to a weekly options advisory that sends 2-3 daily emails with trade recommendations. The website boasted of 546% gains in a month.

I signed up for the service, and we set up a “paper-trading” account at OptionsXpress. I followed every email’s recommended buys and sells, and after 30 days, we were down 6%. However, on the website, the operator bragged of a 174% gain the last 30 days. He lied. Hi likely still lies on his website (I just checked and he says he’s banked a 2,062% gain since inception). There are many problems with his method of calculating returns, but the most egregious is the flat out lie about the performance in the 30 days I traded alongside him. I had to break the news to my client that this, unfortunately, wasn’t the investing silver bullet he was looking for.

A couple of months later, my still unconvinced client brought me another possible path to riches: an options training course that promised 95% winners. It only cost $99, so he gave me a one hundred dollar bill after I agreed to take the course. Keep in mind, when I tracked my Naked Alpha Fund options trades from 2007 – 2009, I had a 92% success rate on my options trades; so I wasn’t discounting this advertised 95% success rate.

After reading through the book (and before watching the video), I determined that this instructor was simply using historical statistics to push my 92% success rate to 95%. He also advised considering accepting a lesser 90% success rate, as the availability of potential trades and return increases. There is nothing wrong with his approach; in fact, I even incorporated his statistical analysis into my Naked Alpha Fund options trading to ensure at least 90% success. However, this 90-95% success rate comes with a trade-off: the returns are “boring”. With his “recommended hedged” strategy, we can expect about 0.25% per month after costs – or 3.0% per year – nothing to write home about. Of course if you leverage it three times, it becomes 9% per year, but the risk increases three-fold along with your return.

As much as I’d like to find that high return, low risk sure-thing investment, returns are normally commensurate with risk. There are very few opportunities that I’ve found over my 20 years of managing money where we can make a healthy return without taking on risk. One is the 90% certainty credit spread option trades that I execute in the Naked Alpha Fund. The other is my newest strategy, Closed-End Fund Arbitrage. In both, we hedge our exposure to the markets at a cost, but our success rate has been able to generate around 10% annually after-costs, with less than 50% of the volatility (risk) of the stock and bond markets.

Please keep bringing me ideas, and I’ll research and vet them in order to learn how to better invest for all of my clients. I’m not afraid to say I don’t know everything; but I’m also not gullible enough to think that paying anyone for investment advice will bring me great riches with no risk. You shouldn’t be either.

July 2016

Outperforming Math Wizards? No problem!

By |July 5th, 2016|

A few weeks back, I attended a due diligence forum in Denver, Colorado with 361 Capital, an alternative asset manager fairly new to the mutual fund space. They currently manage five funds across three strategies: long/short, counter-trend managed futures, and “macro opportunity”. In looking over the offerings, the macro opportunity fund has been a dismal failure since launching two years ago, and was not even mentioned at the forum. That’s okay – I wasn’t planning any diligence on it given its performance history.

The global long/short equity strategy is their clear leader, and the strategy they focused half of the presentations around. The fund began trading 30 months ago, has a clearly defined process, executed by a brilliant investment team. Funny thing is, it’s sub-advised by Analytic Investors, and 361 Capital has no control of portfolio selection or trading. Though 361 Capital has their own investment team and traders, they’re simply the marketing arm for Analytic Investors’ historically successful strategy with this particular fund.

I happen to be “one of those guys” that asks a lot of questions. At a “due diligence forum”, fortunately it is welcomed and encouraged. As I listened to the smart folks from Analytic Investors walk us through their investment process, I came up with my own idea of how to “test” if Analytic Investors and 361 Capital really add value to the investment research that exists (though they create and publish much of it). I asked a pointed question at the forum trying make them squirm, but it was answered politically, rather than directly. You know how that is given the constant election cycle media circus that dances in front of us.

I give them the benefit of the doubt for sidestepping my question, as it would have been nearly impossible to respond on the fly to my challenge. When I got back to the office and discussed with Joyce my experience at the forum, I walked her through my challenge, only to discover that I was right. Looking back at the fund’s results since inception, we could basically replicate how they invest using only two ETFs. So the question was now if I could replicate the results of their investment process at a lesser cost than they charge inside the mutual fund.

Investment theory is easy to research, and test. On the flip side, practical investments take real money, and need real markets (supply and demand). Capital is not free. So when we “sell short” investments, we must pay margin interest to “borrow” the shares that we sell. Using the tools we have at the office to back test investment strategies, I can – in a vacuum – replicate their investment results. In fact, my results even outperformed the mutual fund by nearly 1% in every 12 month period. However, given the ease of trading in and out of a mutual fund, and the ability to avoid margin interest costs, I plan to continue utilizing the 361 Global Long/Short Equity Fund – because we can’t invest in a vacuum, and we will incur cost drag in our replication strategy.

While I’m convinced their investment process is solid (if not brilliant given the academic research that supports it), after seeing what’s behind the curtain, it took me all of five minutes to replicate it using inexpensive ETFs. We live in a great time to be investing. ETFs have revolutionized the investment landscape, and made it possible for investors like us to keep up with highly paid math wizards at a ridiculously low cost.

June 2016

Accounting changes for the 21st century

By |June 14th, 2016|

I’ll admit to geeking out a bit this weekend while reading Barron’s, but I really did have an “aha moment”.  In the 20 years I’ve been investing on behalf of clients, I’ve done as much reading as I can on how to identify great investments. Most of my research has been on fundamental analysis, in the vein of Warren Buffett and Benjamin Graham – search for “value”. I’m an accountant by training, so I really enjoy looking at financial statements and finding bargains and great values.

The downside to fundamental, financial statement analysis is that I’ve often disregarded great up and coming companies over the past 20 years. Facebook, Amazon, Tesla, Google, Netflix, etc. I have always thought it crazy that investors are willing to pay 200 times the same dollar of earnings that I can get with Ford or Chevron for 10 times. A P/E ratio above the anticipated growth rate of earnings didn’t seem like a value to me.

But I watched the stocks of Amazon, Google, Tesla, et al climb into the stratosphere over the past few years. “They don’t even pay a dividend!” “Amazon doesn’t even make a profit!” I shouted to myself. What the stodgy old accountant in me was missing was the value in these companies that can’t be expressed on the financial statements. I knew they were great companies, with great products, but I said they weren’t great stocks.

Now I get to find out why I have been wrong all these years, thanks to a new book about “The End of Accounting, and the Path Forward for Investors and Managers”. I have in my mind a few of the reasons I’ve missed out on growth stocks.

  1. Branding is not carried on the balance sheet as an asset unless it is purchased in an acquisition. So companies that develop a strong brand from the ground up don’t look to be the same “accounting value” as a serial acquirer. I need to adjust for that.
  2. In the past, most of the assets of businesses were property, plant, equipment, and inventory. Think about today’s great 21st century companies. Many of them don’t have those old-school assets. They have technology. They have networks. They have brands. They have human capital. Those items are hard to value on a balance sheet, when payroll and R&D are expensed, rather than additions to company assets.

I’ve put the book on my wish list at Amazon, and I’m looking forward to calculating quantitatively the value of Research and Development spending, as well as brand value.

Think about Donald Trump. When he boasted of a net worth of $10 billion, many people scoffed. His real estate holdings aren’t worth but $x billion.

But wait. What’s in a name? Specifically, what’s the value of the Trump name, or brand. Think about  a water bottle. You’d pay more if it had a Nike swoosh on it. Same for Trump’s real estate. His brand is worth something.

These innovative authors – accounting nerds – think they’ve come up with a way to calculate the value.

This stodgy old accounting nerd is looking forward to reading it.

https://www.amazon.com/Accounting-Forward-Investors-Managers-Finance/dp/1119191092

“Out of the Box” Investment Strategies

By |June 3rd, 2016|

Not only are we the only independent, fee-only registered investment advisor in Columbia County (i.e. required to act in our clients’ best interest AT ALL TIMES), but we implement some unique investment strategies that our clients appreciate.

We don’t simply place your money into loaded mutual funds and tell you to ride out the market swings.

Aside from a typical, well-balanced portfolio utilizing ETFs, mutual funds, stocks and bonds, here are some of our more unique strategies that we currently offer:

  1. Closed-End Fund Arbitrage. We go long/short using high payout, heavily discounted closed-end fund shares and offset the holdings exposure via index ETFs.
  1. Private Real Estate Notes. We work with three separate builders/real estate developers that build spec homes, purchase for their rental portfolio, or fix and flip. They pay an average of 10-12% interest for first position with LTVs from 50% – 100%.
  1. The Naked Alpha Fund. This is a hedge fund, managed by Adam Sommers, that employs an option strategy that uses vertical put spreads, real estate, costless collars, and layers that over our Closed-End Fund arbitrage strategy and aims for 10-20% per year.
  1. Sustainable Income Portfolios. We have five SIPs that are built for ultraconservative to aggressive investors. One is a bond ladder using ETFs, One is long-only, IRA-eligible Closed-End Fund Arbitrage strategy, and the other three are ETF portfolios made up of three buckets of income-producing assets: Stocks/Bonds/Alternatives. SIPs are less active than the first three items, thus we only charge 3bps per month. We do re-balance them strategically and tactically quarterly. These portfolios provide good returns over the business cycle, but are subject to market movements. The focus of these portfolios is the regular income they produce. it allows for clients to use the consistent income, and let the portfolio ride market cycles.

We’d love to discuss any and every one of these options with you as you look to invest your hard-earned wealth responsibly, and with integrity.

May 2016

How the Naked Alpha Fund will fare during future market crashes

By |May 25th, 2016|

In 2015, our “pooled investment vehicle” (aka hedge fund) The Naked Alpha Fund had its worst performance yet – even worse than 2008. Last fall, we set out to determine why, after the fund’s unit value had fallen 16.9% from the final week of June through September.

We discovered that our mechanism for hedging our stock exposure wasn’t as effective as we’d planned. As just a few of our holdings were plummeting, the indexes that we had purchased insurance against dropping were holding up rather well, comparatively. Our original premise had been that if we sell puts on enough stocks, our portfolio should resemble the S&P 500; hence, buying insurance using S&P 500 Index puts should work.

2015 proved we were wrong in our assumptions. We normally sell puts on 20-30 stocks at a time, giving us a representative sampling of the S&P 500 – that in 2015 proved NOT to mimic moves of the S&P 500 as a whole. Last year, the largest and most influential stocks held up well (see FANG stocks) while a few of our holdings (see TWTR, MU, SNDK, QCOM) crashed as much or more than 50%.

So, in October of 2015, we decided to change the way that we hedge our short put positions. Instead of buying puts on the index, we buy puts on the same stocks that we’re selling puts on. It’s called a “vertical put spread” in the options-trading world. This way, if we sell puts on a stock that plummets, our downside is limited in each and every case.

Where we are today is far more comfortable than 2015 and prior, knowing the downside of each of our positions. We still, however, also initiate cost-less collars for next January, creating additional UN-HEDGED exposure in our portfolio. These collars have on average 18% protection built-in, so it’s fairly benign risk at this point. The benefit of these un-hedged collars is that we participate in much of the upside if the stocks we’re exposed to have a good run between now and January.

What this has all culminated in is the ability for us to predict how the Naked Alpha Fund will react to down markets in the next 30-60 days. We now have a pretty good estimate of what the NAF return will look like if stock markets begin to drop. Here is a snapshot of our estimations for the portfolio as of 5/25/2016:

Stocks down 5% – NAF eeks out approximately +0.8% positive return

Stocks down 10% – NAF will drop approximately 4.5%

Stocks down 15% – NAF will drop approximately 8.6%

Stocks down 20% – NAF will drop approximately 11.5%

Stocks down 25% – NAF will drop approximately 14.4%

This gives not only our clients peace of mind knowing the most undesirable outcomes possible, but due to our hedging methodology change, our manager can better gauge the inherent risk of the portfolio.

Generating Sustainable Income

By |May 2nd, 2016|

We’ve been working for the past year or so on developing a simple, cost-effective way to generate income for clients in retirement. In years past, you could simply ladder investment grade corporate or U.S. Treasury bonds, and earn a nice 5-7% yield on your portfolio with very little risk.

However, since 2008, the Federal Reserve, in its attempt to keep the economy growing, has set it’s overnight lending rate to banks at zero percent. This key interest rate has influenced interest rates the world over. And while you can now borrow to purchase at house at sub-4%, the losers in a low-interest rate environment are retirees attempting to live off the income generated by their savings.

Enter Sustainable Income Portfolios, or what we call SIPs. We have developed 8 optimized SIPs ranging from ultra-conservative to aggressive, that aim to provide investors inflation-adjusted income, indefinitely. The more aggressive you go on the scale, the more principal fluctuation you are likely to endure. However, as in any investment, the lower the risk, the lower the potential reward.

Currently (as of 5/2/2016), all of our SIPs generate income between 2.9% and 6.5% in annual distributed income. There is potential for price appreciation in all but the most conservative SIP.

The ultra-conservative SIP that provides the 2.9% yield is best suited to those investors looking to protect principal, but yearning for more yield than a bank will provide. The other seven SIPs should all be able to keep up with inflation as asset prices rise, in addition to the monthly income they provide. The most aggressive SIP has the potential for a total annual return of up to 11%, based on past returns and volatility.

You can learn more at www.SIPIncome.com.

April 2016

Our 4 favorite ETFs at the moment

By |April 29th, 2016|

The following 4 ETFs are favorites of ours at the moment, and are included in at least 5 of our Model Portfolios:

  • (8) VYM – Vanguard High Dividend ETF. Yield: 3.10%. Expense ratio: .09%
  • (8) VNQ – Vanguard U.S. Real Estate ETF. Yield: 4.28%. Expense ratio: .12%
  • (7) IVV – iShares S&P 500 Index ETF. Yield: 2.28%. Expense ratio: .07%
  • (5) IGHG – ProShares Interest-Rate Hedged Corp. Bond ETF. Yield: 3.64%. Expense ratio: .30%