George Financial Advisors - Wealthscape Advisors€¦ · George Financial Advisors Ted George, CFP®, MSFP Financial Advisor 1414 Soquel Ave, Suite 220 Santa Cruz, CA 95062 831-438-6000

George Financial AdvisorsTed George, CFP®, MSFPFinancial Advisor1414 Soquel Ave, Suite 220Santa Cruz, CA [email protected]

October 14, 2014

Estate Planning is a critical part of a Financial Plan. Regardless of your current financial situation, the desire to continue helping your family after you are gone is fairly universal. The best way to achieve this is with solid estate planning. After reading this month's lead article, consult the Estate Planning checklist to make sure you have all your bases covered.

We continue our mini-series on Tax Planning with an article on Tax Planning for Income.

This month's final article (click here to read) discusses Active vs Passive Investment Strategies. Each approach has its own merits. Read it and decide which strategy best fits your needs. Please let us know if you have any questions regarding this controversial topic.

Financial Insights for Living Well - October 2014Documents in this presentation:

Introduction to Estate PlanningEstate Planning ChecklistTax Planning for Income

Introduction to Estate Planning

What is estate planning?Simply stated, estate planning is a method for determining how to distribute your property during your life and at your death. It is the process of developing and implementing a master plan that facilitates the distribution of your property after your death and according to your goals and objectives.

At your death, you leave behind the people that you love and all your worldly goods. Without advance planning, you have no say about who gets what, and more of your property may go to others, like the federal government, instead of your loved ones. If you care about (1) how and to whom your property is distributed, and (2) ensuring that your property is preserved for your loved ones, you need to know more about estate planning.

As a process, estate planning requires a little effort on your part. First, you'll want to come to terms with dying, at least to a degree that you can deal with the necessary planning. Understandably, your death can be a very uncomfortable subject, but unfortunately, the discussions in this area are full of references to your death, so it really can't be avoided. Some statements may seem too businesslike and unfeeling, but tiptoeing around the subject of dying will only make the planning process more difficult. You will understand the process more easily and implement a more successful master plan if you approach it in a straightforward manner.

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Who needs estate planning?

Not just for the wealthy

Estate planning may be important to individuals with a wide range of financial situations. In fact, it may be more important if you have a smaller estate because the final expenses will have a much greater impact on your estate. Wasting even a single asset may cause your loved ones to suffer from a lack of financial resources.

Your master plan can consist of strategies that are simple and inexpensive to implement (e.g., a will or life insurance). If your estate is larger, the estate planning process can be more complex and expensive.

Implementing most strategies will probably require you to hire professional help of some kind, an attorney, an accountant, a trust officer, or an insurance agent, for example. If your estate is large or complex, you should consult with an estate planning expert such as a tax attorney or financial planner for advice before the implementation stage.

In deciding on your course of action, you should always consider whether the benefit of the strategy outweighs the cost of its implementation.

May be especially needed under certain circumstances

You may need to plan your estate especially if:

Your estate is valued at more than the federal gift and estate tax applicable exclusion amount or your state's death tax exclusion amountYour income tax bracket is in excess of 10 percentYou have children who are minors or who have special needsYour spouse is uncomfortable with or incapable of handling financial mattersYou're a business ownerYou have property in more than one stateYou intend to contribute to charityYou have special property, such as artwork or collectiblesYou have strong feelings about health-care decisions You have privacy concerns or want to avoid probate

How to do itDesigning a plan is a process that is unique to each estate owner. Don't be intimidated or overwhelmed at the prospect. Even the most complex plan can be achieved if you proceed step by step. Remember, the peace of mind that comes with developing a successful estate plan is worth the time, trouble, and expense.

Understand your particular circumstances

Begin the estate planning process by understanding your particular circumstances, such as your age, health, wealth, etc.

Understand the factors that will affect your estate

You will also need to have some understanding of the factors that may affect the distribution of your estate, such as taxes, probate, liquidity, and incapacity.

Clarify your goals and objectives

When your particular circumstances and the factors that may affect your estate are clear, your goals and objectives should come into focus.

Understand the strategies that are available

With these goals and objectives now clear, you can begin to consider the different estate planning strategies that are available to you.

Seek professional help

Seeking professional help (an attorney or financial advisor) will help you understand the strategies that are available and formulate and implement your master plan.

Formulate and implement a plan

Finally, after following these steps, you can formulate and implement a plan that works for you. Here are a few basic tips: (1) make sure you understand your plan, (2) rely on people you trust, and (3) keep your documents and information organized and within easy reach.



Perform periodic reviews

When you have implemented your master plan, be sure to perform a periodic review and, if necessary, make revisions that reflect any changing circumstances and tax laws.

How do you begin?There are many estate planning strategies, including some that are implemented inter vivos (during life), such as making gifts, and others post-mortem (after death), such as disclaimers. Before you choose which strategies are right for you, you need to understand your particular circumstances.

Gather and analyze the facts

Understanding your particular circumstances results from gathering and analyzing the facts. The following questions may help you to accomplish this. If they are not easy to answer, you may have to make some estimates based on reasonable assumptions and expectations.

Information regarding your financial condition

What is your current income?What is your income likely to be in the future?How much do you spend each year?What are your expenses likely to be in the future?What are your current assets and debts?Are your assets currently owned solely or jointly?What estate planning strategies have you already implemented?

Family information

Who are the family members you intend to benefit?What are the needs of each family member?

What other factors need to be considered?Decide what your goals and objectives are in light of your particular circumstances and in light of the factors that may affect your estate. The primary factors that may affect your estate are your beneficiaries, taxes, probate, liquidity, and incapacity.

Taxes

One of the largest potential expenses your estate may have to pay is taxes, which may include federal transfer taxes, state death taxes, and federal income taxes.

Federal transfer taxes--The federal transfer taxes include (1) the federal gift tax and estate tax and (2) the federal generation-skipping transfer tax (GSTT).

Federal gift tax--Gift tax is imposed on property you transfer to others while you are living. You need a basic understanding of how the gift tax system works to minimize gift tax liability. Under the gift tax system, in 2014 you are allowed a $5,340,000 lifetime applicable exclusion amount that reduces your gift and estate tax liability (any (basic) applicable exclusion amount you use during life effectively reduces the amount that will be available at your death). Also, you are currently allowed to give $14,000 per donee gift tax free under the annual gift tax exclusion (the annual gift tax exclusion is indexed for inflation, so this amount may change in future years). Further, certain other types of transfers can be made gift tax free. You need to understand what these types of transfer are and how they work to take full advantage of them.Federal estate tax--Generally speaking, estate tax is imposed on property you transfer to others at the time of your death. You need a basic understanding of how the estate tax system works for several reasons:

Saving your property for your beneficiaries--Estate tax rates could reach as high as 40 percent in 2014, which means that a large chunk of your estate may go to the federal government instead of your beneficiaries. If you want to preserve your estate for your beneficiaries, you'll need to know how to minimize estate tax with respect to your property.Reducing estate tax liability--Under the estate tax system, you are allowed an applicable exclusion amount that reduces your estate tax liability. Also, there are exclusions, deductions, and other credits available that allow you to pass a certain amount of your estate tax free. You need to understand what these exclusions, deductions, and credits are and how they work to take full advantage of them.Providing for the payment of estate tax--Generally, estate tax must be paid within nine months after your death. To avoid depriving your beneficiaries of what you intend for them to receive, you should provide that specific and sufficient assets be set aside and used for this purpose. In addition, these assets should be sufficiently liquid to pay these expenses when they are due.



Planning for estate tax expense--Although calculating estate tax can be complex, you should estimate what the amount of your estate tax may be (if any), so that you can arrange to replace that wealth.

GSTT--Another federal transfer you need to understand is the federal generation-skipping transfer tax (GSTT). The GSTT is imposed on property you transfer to an individual who is two or more generations below you (e.g., a grandchild or great-nephew). Not surprisingly, the IRS wants to levy a tax on property as it is passed from generation to generation at each and every level. The purpose of the GSTT is to keep individuals from avoiding estate tax by skipping an intermediate generation. A flat tax rate equal to the highest estate tax then in effect is imposed on every generation-skipping transfer you make over a certain amount. Currently, some states also impose their own GSTT. Check with an attorney or your state to find out what may be subject to your state's GSTT, and how and when to file a state GSTT return.

State death taxes--States also impose their own death taxes. You should be aware of what the death tax laws are in your state and how they may affect your estate. There are three types of state death taxes: (1) estate tax, (2) inheritance tax, and (3) credit estate tax (also called a sponge tax or pickup tax). Some states also impose their own gift tax and/or generation skipping transfer tax.

Estate tax--State estate tax is imposed on property you transfer to others at your death, much like federal estate tax. The state estate tax calculation for most states is similar to the federal calculation.Inheritance tax--Unlike estate tax, the inheritance tax is imposed on your beneficiary's right to receive your property. Tax is due on each beneficiary's share of your estate. Beneficiaries are grouped into classes (generally based upon their familial relationship to you) and are taxed accordingly. Although inheritance tax is due on each heir's share of your estate, it's your personal representative who writes the check from your estate to pay it.Credit estate tax--Some states impose a credit estate tax (also referred to as a sponge tax or pickup tax).

Most states that imposed a credit estate tax have "decoupled" from the federal system (i.e., they're imposing some form of stand-alone estate tax.)

The federal system allows a deduction for state death taxes for the estates of persons dying in 2005 and later. Prior to 2005, a credit was available.

Federal income taxes--In the estate planning context, you should be aware of three federal income tax considerations:

1. Income taxation of trusts --If your estate plan includes the use of a trust, you need to know that a trust may be an income tax-paying entity. The trustee may be required to file an annual return and pay income taxes on trust income.

2. Decedent's final income tax return --Your personal representative or surviving spouse has the duty of filing your last income tax return that covers the tax year ending on the date of your death.

3. Income taxation of your estate --Your estate is considered a separate income taxpaying entity. Your personal representative must file and pay income taxes on any income your estate receives (e.g., interest from bonds, or dividends from stock).

Probate

Probate is the court-supervised process of proving, allowing, and administering your will. The probate process can be time-consuming, expensive, and open to public scrutiny. Avoiding probate may be one of your most important goals. To develop a successful avoidance strategy, you'll need to understand how the probate process works, how to estimate probate costs, and what is subject to probate.

Liquidity

Estate liquidity refers to the ability of your estate to pay taxes and other costs that arise after your death from cash and cash alternatives. If your property is mostly nonliquid (e.g., real estate, business interests), your estate may be forced to sell assets to meet its obligations as they become due. This could result in an economic loss, or your family selling assets that you intended for them to keep. Therefore, planning for estate liquidity should be one of your most important estate planning objectives.

Incapacity

Planning for incapacity is a vital yet often overlooked aspect of estate planning. Who will manage your property and make health-care decisions for you when you can no longer handle these responsibilities? You need to ask and answer this question because the consequences of being unprepared may have a devastating effect on your estate and loved ones. You should include plans for incapacity as a part of your overall estate plan.

What are your goals and objectives?Your goals and objectives are personal, but you can't formulate a successful plan without a clear and precise understanding of what they are. They can be based on your particular circumstances and the factors that may affect your estate, as discussed earlier, but your feelings and desires are just as important. The following are some goals and objectives you might consider:



Provide financial security for your familyEnsure that your property is preserved and passed on to your beneficiariesAvoid disputes among family members, business owners, or with third parties (such as the IRS)Provide for your children's or grandchildren's educationProvide for your favorite charityMaintain control over or ensure the competent management of your property in case of incapacityMinimize estate taxes and other costsAvoid probateProvide adequate liquidity for the settlement of your estateTransfer ownership of your business to your beneficiaries

What are estate planning strategies?An estate planning strategy is any method that facilitates the distribution of your assets and the settlement of your estate according to your wishes. There are several estate planning strategies available to you.

Intestate succession

Intestate succession is a strategy by default and is a means of transferring your property to your heirs if you have failed to make other plans such as a will or trust. State law controls how and to whom your property is distributed, who administers your estate, and who takes care of your minor children. Without directions, your opinions and feelings are not considered. Indeed, one of your primary goals in planning your estate may be to avoid intestate succession.

Last will and testament

A will is a legal document that lets you state how you want your property distributed after you die, who shall administer your estate, and who will care for your minor children. This is probably the most important tool available to you. Anyone with property or minor children should have a will.

Will substitutes

A will substitute, for example, Totten Trust and payable on death bank accounts, allows you to designate a beneficiary of certain property that will automatically pass to that beneficiary after you die and avoids passing through probate.

Trusts

A trust is a separate legal entity that holds your assets that are then used for the benefit of one or more people (e.g., you, your spouse, or your children). There are different types of trusts, each serving a different purpose, and include marital trusts and charitable trusts. You will need an attorney to create a trust.

Joint ownership

Joint ownership is holding property in concert with one or more persons or entities. There are different types of joint ownership, such as tenancy in common and community property, each with different legal definitions, requirements, and consequences.

Life insurance

Life insurance is a contract under which proceeds are paid to a designated beneficiary at your death. Life insurance plays a part in most estate plans.

Gifts

A gift is a transfer of property, not a bona fide sale, that you make during your life to family, friends, or charity. Making gifts can be personally gratifying as well as an effective estate planning tool.

Tax exclusions, deductions, and credits

There are several important estate planning tools you can use that are offered by the federal government. These include the annual gift tax exclusion, the applicable exclusion amount, the unlimited marital deduction, split gifts, and the charitable deduction.

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IMPORTANT DISCLOSURES

Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered



investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See www.GeorgeFA.com for more information.

The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

The receipt of this document shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than the state of California or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of California and certain other states.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Copyright © 2014 George Financial Advisors LLC All Rights Reserved

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October 14, 2014






Estate Planning Checklist

General informationYes No N/A

1. Has relevant personal information been gathered?

Personal detailsFamily detailsCurrent advisory teamGoals and expectations

2. Has financial situation been assessed?

AssetsLiabilitiesLife insurance policies



Other insurance coverageIncomeExpenses

3. Have current documents been reviewed?

WillTrust documentsPower of attorneysMedical directivesInsurance policiesBuy-sell agreementsDeeds, leases, mortgages, and land contractsGuardian nominationsSeparation/divorce agreementsTax returns

4. Have funeral arrangements been made?

Notes:

Basics Yes No N/A

1. Is there currently a valid will?

2. If yes, does will reflect current goals and objectives?

3. Does choice of executor remain appropriate?

4. Has durable power of attorney been executed?

5. Have medical directives been executed?

6. Have beneficiary designations for retirement plans and life insurance policies been reviewed?

7. Has impact of probate been considered?

Notes:

Trusts Yes No N/A

1. Is the use of a living trust appropriate?

2. Is the use of a testamentary trust appropriate?

3. Is the use of an irrevocable life insurance trust appropriate?

4. Do existing trusts, if any, continue to meet overall objectives?



Notes:

Estate tax Yes No N/A

1. Has estate plan been reviewed due to changing tax laws?

2. Has impact of estate tax been evaluated?

3. Have options to minimize estate tax been explored?

Lifetime giftingFull use of basic (applicable) exclusion amount and marital deductionQualified terminable interest property (QTIP) electionsQualified domestic trust (QDT) for noncitizen spouseCharitable givingGrantor retained trustsFamily limited partnership (FLP)/limited liability company (LLC)

Notes:

Lifetime gifting Yes No N/A

1. Have gifts been made?

2. Has a lifetime gifting strategy been implemented?

3. Are gift tax consequences understood?

4. Has consideration been given to types of property suitable for gifting?

5. Is valuation discount planning understood?

Notes:

Charitable intentions Yes No N/A

1. Have charitable gifts or bequests been planned?

2. Is a charitable trust appropriate?

Charitable lead trustCharitable remainder trustPooled income fundPrivate foundationDonor-advised fund

3. Is a charitable gift annuity appropriate?

4. Is the charitable gift of a remainder interest in a home or farm appropriate?



Notes:

Life insurance issues Yes No N/A

1. Have liquidity needs of estate at death been evaluated?

2. Is current life insurance coverage appropriate?

3. Have steps been taken to keep life insurance proceeds out of taxable estate?

Policy ownershipIrrevocable life insurance trust

4. Have beneficiary choices been evaluated in light of overall estate plan?

Notes:

Business interests Yes No N/A

1. Have provisions been made to transfer business interest?

Buy-sell agreement and necessary fundingSell businessTransfer business with lifetime giftsKey person buyout

2. Is liquidation an option?

Notes:



Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See www.GeorgeFA.com for more information.











October 14, 2014






Tax Planning for Income

What is tax planning for income?Tax planning for income usually involves strategies for minimizing your taxable income. In particular, the timing and the method by which your income is reported become paramount. Effective planning begins with an understanding of the various types of income. Next, you'll want to consider tools for creating tax-free income, methods of sheltering earned income from taxes, strategies to defer taxes (and other tax-advantaged strategies), and vehicles for shifting income and tax. For older taxpayers, it's also useful to know how to minimize taxation of your Social Security benefits.

Why is it important for you to understand the concept of income?As a general rule, you are required to pay tax on your income from whatever source derived, unless a statutory exception applies. Therefore, it's important for you to know which items are included and excluded from the IRS's definition of gross income. Additionally, income can be taxed at different rates, depending on whether the income is ordinary or derived from the sale or exchange of certain classes of property held for certain minimum time periods. Because losses can sometimes be used to offset income, it's also important to understand the concept of active versus passive income.



Why is it important to know how to generate tax-free income?Although income is usually taxable, there are a number of vehicles that can produce tax-free or nontaxable income. You may be able to enjoy some portion of your income, tax free, by switching some of your investment money to these vehicles. Vehicles to consider include Roth IRAs and tax-exempt bonds.

How can you shelter earned income from taxes?Sheltering your earned income involves employing one or more tools to generate losses, deductions or credits that will reduce the current federal tax burden on your earned income. Typically, your desired result is income deferral. Several methods exist to shelter earned income from taxes, including traditional deductible IRAs and employer-sponsored retirement plans.

Why should you be aware of strategies to defer taxes?There are several reasons why deferring the taxation of income is generally desirable. First, deferring taxes will provide you with more money right now to fund various financial plans. Moreover, certain qualified retirement plans allow you not only to defer some of your current taxable income, but also let your retirement savings grow tax-free until a distribution is taken.

As a general rule, when tax rates are stable, it's wise for you to defer the recognition of as much income as possible to a later year and accelerate deductions. This will allow you to minimize your current income tax liability. As a consequence, you will be able to invest money that would otherwise have been used to pay income taxes, keeping that money working for you. When you eventually recognize the income, it's possible that you'll be in a lower tax bracket.

What are some other tax-advantaged strategies?Many other tax-advantaged strategies exist. For instance, you should be aware of tax shelters and tools for creating passive income in order to take advantage of passive losses. Additional strategies that may help you reduce your overall income tax burden include taking advantage of the tax benefits of generating capital gains, investing in real estate, receiving annuitized payments, and engaging in year-end tax planning.

How can you shift income and tax to others?Income shifting refers to dividing income among two or more taxpayers in a way that lowers overall taxes. Typically, income is shifted from higher bracket taxpayers to lower ones. If you're interested in income shifting, you should be aware of a number of topics, including the kiddie tax, the tax treatment of below-market and interest-free loans, and the benefits of making gifts of income producing property and employing family members.

What about Social Security benefits?If you're an older taxpayer, you should probably be concerned with minimizing the taxation of your Social Security retirement benefits. Certain techniques exist to limit the taxation of such benefits, including filing your income tax return jointly and employing tools to reduce your modified adjusted gross income.



Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See www.GeorgeFA.com for more information.










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Active vs Passive Investment StrategiesOne of the longest-standing debates in investing is over the relative merits of active portfolio management versus passive management. With an actively managed portfolio, a manager tries to beat the performance of a given benchmark index by using his or her judgment in selecting individual securities and deciding when to buy and sell them. A passively managed portfolio attempts to match that benchmark performance, and in the process, minimize expenses that can reduce an investor’s net return.

Each camp has strong advocates who argue that the advantages of its approach outweigh those for the opposite side.

Active investing: attempting to add valueProponents of active management believe that by picking the right investments, taking advantage of market trends, and attempting to manage risk, a skilled investment manager can generate returns that outperform a benchmark index. For example, an active manager whose benchmark is the Standard & Poor’s 500 Index (S&P 500) might attempt to earn better-than-market returns by overweighting certain industries or individual securities, allocating more to those sectors than the index does. Or a manager might try to control a portfolio’s overall risk by temporarily increasing the percentage devoted to more conservative investments, such as cash alternatives.

An actively managed individual portfolio also permits its manager to take tax considerations into account. For example, a separately managed account can harvest capital losses to offset any capital gains realized by its owner, or time a sale to minimize any capital gains. An actively managed mutual fund can do the same on behalf of its collective shareholders.

However, an actively managed mutual fund’s investment objective will put some limits on its manager’s flexibility; for example, a fund may be required to maintain a certain percentage of its assets in a particular type of security. A fund’s prospectus will outline any such provisions, and you should read it before investing.

Passive investing: focusing on costsAdvocates of unmanaged, passive investing–sometimes referred to as indexing–have long argued that the best way to capture overall market returns is to use low-cost market-tracking index investments. This approach is based on the concept of the efficient market, which states that because all investors have access to all the necessary information about a company and its securities, it’s difficult if not impossible to gain an advantage over any other investor. As new information becomes available, market prices adjust in response to reflect a security’s true value. That market efficiency, proponents say, means that reducing investment costs is the key to improving net returns.

Indexing does create certain cost efficiencies. Because the investment simply reflects an index, no research is required for securities selection. Also, because trading is relatively infrequent–passively managed portfolios typically buy or sell securities only when the index itself changes–trading costs often are lower. Also, infrequent trading typically generates fewer capital gains distributions, which means relative tax efficiency.

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Note: Before investing in either an active or passive fund, carefully consider the investment objectives, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing. And remember that indexing–investing in a security based on a certain index–is not the same thing as investing directly in an index, which cannot be done.

Blending approaches with asset allocationThe core/satellite approach represents one way to employ both approaches. It is essentially an asset allocation model that seeks to resolve the debate about indexing versus active portfolio management. Instead of following one investment approach or the other, the core/satellite approach blends the two. The bulk, or “core,” of your investment dollars are kept in cost-efficient passive investments designed to capture market returns by tracking a specific benchmark. The balance of the portfolio is then invested in a series of “satellite” investments, in many cases actively managed, which typically have the potential to boost returns and lower overall portfolio risk.

Caution: Bear in mind that no investment strategy can assure a profit or protect against losses.

Controlling investment costsDevoting a portion rather than the majority of your portfolio to actively managed investments can allow you to minimize investment costs that may reduce returns.

For example, consider a hypothetical $400,000 portfolio that is 100% invested in actively managed mutual funds with an average expense level of 1.5%, which results in annual expenses of $6,000. If 70% of the portfolio were invested instead in a low-cost index fund or ETF with an average expense level of 0.25%, annual expenses on that portion of the portfolio would run $700 per year. If a series of satellite investments with expense ratios of 2% were used for the remaining 30% of the portfolio, annual expenses on the satellites would be $2,400. Total annual fees for both core and satellites would total $3,100, producing savings of $2,900 per year. Reinvested in the portfolio, that amount could increase its potential long-term growth. (This hypothetical portfolio is intended only as an illustration of the math involved rather than the results of any specific investment, of course.)

Popular core investments often track broad benchmarks such as the S&P 500, the Russell 2000® Index, the NASDAQ 100, and various international and bond indices. Other popular core investments may track specific style or market-capitalization benchmarks in order to provide a value versus growth bias or a market capitalization tilt.

While core holdings generally are chosen for their low-cost ability to closely track a specific benchmark, satellites are generally selected for their potential to add value, either by enhancing returns or by reducing portfolio risk. Here, too, you have many options. Good candidates for satellite investments include less efficient asset classes where the potential for active management to add value is increased. That is especially true for asset classes whose returns are not closely correlated with the core or with other satellite investments. Since it’s not uncommon for satellite investments to be more volatile than the core, it’s important to always view them within the context of the overall portfolio.

Tactical vs. strategic asset allocationThe idea behind the core-and-satellite approach to investing is somewhat similar to practicing both tactical and strategic asset allocation.

Strategic asset allocation is essentially a long-term approach. It takes into account your financial goals, your time horizon, your risk tolerance, and the historic returns for various asset classes in determining how your portfolio should be diversified among multiple asset classes. That allocation may shift gradually as your goals, financial situation, and time frame change, and you may refine it from time to time. However, periodic rebalancing tends to keep it relatively stable in the short term.

Tactical asset allocation, by contrast, tends to be more opportunistic. It attempts to take advantage of shifting market conditions by increasing the level of investment in asset classes that are expected to



outperform in the shorter term, or in those the manager believes will reduce risk. Tactical asset allocation tends to be more responsive to immediate market movements and anticipated trends.

Though either strategic or tactical asset allocation can be used with an entire portfolio, some money managers like to establish a strategic allocation for the core of a portfolio, and practice tactical asset allocation with a smaller percentage.


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