As was the case when I wrote about strategies that are overhyped to consumers, I received several suggestions for more strategies overhyped to financial planners. So this month, I’ll share a few with you.

As a reminder, for these purposes, my definition of “overhyped” is something that gets a lot of attention but probably doesn’t have as big a positive impact as is touted, is likely to have a negative impact, or for which there are very few advisors who can or will attempt to execute the strategy or use the product.

Qualified Opportunity Funds

These are a double whammy. Few people will use them and most that do won’t do well financially, at least among retail investors.

Qualified opportunity funds (QOF) are a wonderful idea. They give investors a way out of appreciated holdings without a big immediate tax bill and an incentive to invest in QOFs that will fund business and tangible property within “qualified opportunity zones.” These zones are low-income census tracts nominated by the state, district or U.S. territory in which they are located. These areas are in greater need for economic development.

Unfortunately, few people will utilize these funds.

First, the initial tax breaks are simply not that attractive. There is some deferral and some reduction of gains, but neither is big enough to be enticing. The tax benefits must be bigger than what Congress has put together to justify the risk on the back end.

Look at most articles touting these funds. There is an assumption that the investments the funds will make in the struggling areas will be profitable. I am highly skeptical about that being the case. I have no doubt some QOFs will work well for both investors and residents of these zones. That will be a beautiful thing.

However, the rush to put together funds, exacerbated by the short time frame for some of the tax breaks, makes me highly skeptical of most management groups and the investments they will make. Think about it. If you were going to start one of these funds and could show you were a good bet, you should be able to raise money from very wealthy families foundations, endowments and the like pretty easily. That would certainly be preferable to hiring salespeople to hound brokers and advisors for the relatively small amounts most of the solicitations I receive are requesting.

Further fueling my skepticism is the emphasis on the deferral of gains and basis increases. The crux of the pitch is all about tax breaks and there is little to nothing about what the management teams will do with my client’s funds. If the projects that my client’s funds are put in work out well, the future tax break can be significant, yet the results on the back end are not a big part of the pitch. If the projects are just OK or fail, the tax benefits could be paltry

Further, most of the materials I have seen fail to mention there is no step up in basis at the death of the owner, making these even less attractive for many potential investors. The offers I have seen remind me of the real estate limited partnerships, tax credit deals and non-traded REIT messes I have seen over the last 30 years.

I like the concept generally but hope Congress can offer stronger initial incentives, a longer time fame for people to obtain those benefits, and a longer time frame for sponsors to organize themselves. Until then, I also hope most financial planners will better serve their clients by letting their fiduciary instincts kick in and rather than biting at the lure of an intriguing but modest tax break, will choose to look at other ways to manage capital gains tax exposure.  

Bunching Deductions To A Donor Advised Fund

This is the second December that it seems like every financial-focused consumer and trade publication has an article with someone touting bunching deductions and donating to a donor advised fund.

Understand, both bunching deductions and using donor advised funds have been perfectly legitimate strategies for years. I label this overhyped because I only need one hand to count the number of people I have seen do this during the last two years.

The first cause of the low adoption rate is the larger standard deduction. For non-itemizers, combining deductible expenses for more than one year into an expense in a single year can be a fine technique. Of the deductible expenses, charitable donations are the most controllable. This makes them attractive for bunching purposes.

However, because the standard deduction is so high, there are fewer deductions allowed and some deductions are more limited, the gap between the amount of the standard deduction and the total of itemized deductible expenses is larger than ever. This means taxpayers must bunch larger amounts to attain a deduction greater than what they would have received without bunching. The gap makes the payoff more modest and the technique less appealing.

For many taxpayers, the payoff is not attainable. They simply don’t have the means to make a large enough donation to get any extra deductibility. We see this often with retirees who have owned their home a long time (low property taxes), have no mortgage (no interest deduction), and are relatively healthy or have good insurance (no medical expense deduction). Due to age, many get an even larger standard deduction than younger couples, making the gap larger.

Further narrowing the number of people that will execute this strategy is the nature of donor advised funds (DAF). While a DAF can be a pretty cool vehicle, there is nothing special about a DAF as a recipient of a donation from a tax standpoint. It is an easy way for people to create a pot for doling out funds to multiple charities or over multiple years, but many people seem to have their favorite causes. The same tax effect would be received if the bunched donations were given to one of these favored non-profits outright, whether it be the Red Cross, a church, an alma mater or the Foundation for Financial Planning.

Model Marketplaces

These things have proliferated over the last couple of years. I don’t think they are harmful by any means, but we don’t find them particularly valuable.

Model marketplaces lie somewhere between a Turnkey Asset Management Program (TAMP) and managing assets entirely in house. Regardless of which route you take, certain elements need to be completed. You need a strategy, you need to implement and you need to monitor. Model marketplaces help address that first step of establishing a portfolio strategy without delegating latter steps as you would with a TAMP. Instead of building a model yourself, you select a model from the marketplace.

Nothing wrong with that, per se’. From a big picture perspective, it strikes me as a decent addition to the landscape. But, with good systems and people to support sound processes, we haven’t found any of the steps to be difficult. Moreover, of all the steps in the process, developing a strategy might be the easiest.  

‘Alternative’ Investments

Our clients are not endowment funds at major universities. Their goals, temperament and resources have little, if any, resemblance to such funds. 

Low correlation does not, of itself, present a diversification benefit. You can get low correlation from a mattress or a jar buried in the back yard too. There needs to be a sound economic underpinning to the investment in order to expect a return. In many cases, what you get instead of diversification is de-worsification—higher costs, greater dependency on management’s crystal ball, less transparency, lower tax efficiency and control, and often, limited or no access to the funds.

I can make the case that many clients need stocks to have a reasonable chance they will reach their financial goals. I can further argue many clients need the stability of high-quality fixed income products to have a reasonable chance they will reach their financial goals. I’ve yet to meet a client that needs a hedge fund, managed futures programs or other alternative product to reach their goals. I do not believe that any client will fail financially because they omitted alts from their portfolio. The drag on results that a significant majority of alts have delivered, however, can put strain on a household’s finances.

The better approach is the one good financial planners take instead of trying to squeeze a little more out of a portfolio. They make decisions in context of the client’s total financial situation and work with clients to focus on factors they can control like spending, tax management and behavioral coaching.

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager and Worth magazines. He practices in Melbourne, Fla. You can reach him at [email protected].