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ACap Asset Management
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Get a pulse on your financial position

May 2012: ACap ReCap

1. What is a hedge fund, and should I invest in one?

A hedge fund is an investment vehicle similar to a mutual fund, but with some key differences. Hedge funds have a larger investment minimum (typically $100,000+) than mutual funds; they are primarily used by endowments, pension plans, and accredited investors (an accredited investor is someone with $1 million in net worth, excluding their home); and unlike mutual funds, which can be cashed out at any time, hedge fund investors can withdraw funds only at set intervals. A hedge fund is paid in two ways: an annual management fee (usually between 1-2%) and a performance fee (usually 20%). The performance fee includes a high watermark which prevents the manager from earning the same fee twice. For example, if the fund started off at $100 and rises to $110, the fund manager would earn 20 percent on the $10 growth, but if the fund subsequently declined in value to $90 and increased again to $109 (a 21% rise), the fund manager would not earn a performance fee until the value went above $110. This is why most hedge funds that significantly decline in value rarely stay in business because it is very difficult to beat the “high” watermark. Hedge funds are good diversifiers for portfolios because their returns are not correlated with the market, but their high investment minimums and illiquidity make them suitable to a select few.

2. I hear taxes are going up next year, is that true?

The Bush tax cuts are set to expire at the end of 2012, and their impact will affect all investors, large and small. If left to expire as expected, the marginal tax rates will increase; but much more importantly, the long term capital gains tax rate will increase dramatically – see chart below. The chart shows only long term capital gains tax rates because short term capital gain rates mirror ordinary income tax rates. If you have appreciated assets, you may want to consider harvesting your gains this year while the tax rate is still low. Harvesting gains entails selling and repurchasing an appreciated asset to lock in the gain, increase the cost basis, and in this case lower your effective tax. Or if you are planning on selling a particular asset next year anyway, you may want to accelerate the sell to this year and keep the proceeds in cash or another equivalent asset. There are various strategies you can take to best prepare for the change in tax rates, but first plan out a strategy by carefully reviewing your entire tax situation before making any decisions. For example, if you already have large tax loss carry forwards from prior years, then a different tactic may be more appropriate. Bottom line: Take a holistic approach rather than an individual asset approach.

2012

2013 & Beyond

Ordinary Income Rates Long-Term Capital Gain Rate Ordinary Income Rates Long-Term Capital Gain Rate

10%

0

15%

10%

15%

0

25%

15%

28%

20%

28%

15%

31%

20%

33%

15%

36%

20%

35%

15%

39.6%

20%

Source: Wikipedia

3. Should I pay off my student loans before I start to invest?

This is probably the number one question I’m asked when speaking with clients and prospects, and the answer is never a simple one. Each person and situation is different, and unfortunately, emotions play a huge part. If you have very low interest rate loans that are fixed, the financially prudent choice would be to pay your minimum payments for the duration of your loan and invest the difference towards retirement. For example, there are many people with fixed interest rate loans below 6 percent for 25 years. If inflation eventually picks up to its historical average of 3 percent, your effective interest rate is 3 percent or lower. But, if you invested the difference toward retirement and are earning more than 6 percent, you will come out ahead. However, if you are debt averse, you will be emotionally better off by making larger monthly payments to reduce your student loans as quickly as possible; this will give you peace of mind regardless of what the financially prudent thing to do is.

4. How can I prevent identity theft?

Unfortunately, there is no way to entirely protect yourself from identity theft, but there are several easy things you can do that will drastically minimize your risk. The first thing you should do every month is reconcile your credit cards and bank statements; notify your financial institution immediately if you see any questionable charges. Second, check your credit annually using the only free site sponsored by the Federal Trade Commission; go to FTC.gov and follow the instructions. Carefully look at your report to identify any unknown accounts and report them immediately. Limit the number of credit cards you use, and segregate certain cards for online purchases only. Don’t respond to emails, even from friends, seeking financial assistance. Fraudulent emails are more prevalent now than ever, and they are sometimes disguised as having come from friends/relatives. When in doubt, call the person who sent you the email and ask if they did indeed send the email. Lastly, do not share your Social Security number and date of birth in an email, text or any other form of public communication.

5. What is the Medicare surtax, and will I be affected?

While this was not the most frequently asked question of the month, the general public’s unfamiliarity with it and its significance warrants mention in this month’s ACap ReCap. In order to help pay for the recently passed health care reform, the Unearned Income Medicare Contribution section of the Patient Protection and Affordable Care Act will impose a 3.8 percent surtax on certain types of income for individuals, estates, and trust. If your modified adjusted gross income exceeds certain thresholds: single ($200,000), married filing jointly ($250,000), and married filing separately ($125,000), you will be required to pay the 3.8% surtax on the following types of income: interest, dividends, rents, royalties, and some other forms of non-wage income. Note that this tax is in addition to the current Medicare tax paid by all employees on wages. The recently passed health care bill is still being debated in courts over its constitutionality, but it is important to be cognizant of the tax and prepare for it in the event the health care bill is upheld in the courts. There are many minor provisions to this new tax which can be found at www.healthcare.gov, but you can also stay tuned for an upcoming in depth article on this surtax as well as steps you can take to prepare for and minimize the surtax.

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