Investing

Understanding Risk Tolerance: A Strategic Imperative for Corporate Professionals

By David C. D’Albero II

Understanding and managing risk tolerance is crucial, particularly for corporate professionals who navigate complex financial landscapes. Risk tolerance refers to the degree of variability in investment returns you’re willing to withstand—essentially, how much potential loss you’re prepared to accept in your portfolio in exchange for the possibility of higher returns. For executives managing significant assets, aligning your risk tolerance with your investment strategy is not just important—it’s a strategic imperative.

The Role of Risk Tolerance in Professionals’ Investment Strategies

As a corporate professional, especially in dynamic areas like the NYC metro and New Jersey, your financial decisions are often more complex than those of the average investor. Risk tolerance isn’t just a personal preference; it’s a vital component of your overall financial strategy. Executives with lower risk tolerance might prefer a portfolio that leans heavily on conservative assets like cash equivalents, bonds, or other fixed income investments. These options offer stability but typically come with lower returns.

On the other hand, if you have a higher risk tolerance, your portfolio might be more heavily weighted in stocks and other higher-risk assets. This approach can yield higher returns but also exposes you to greater volatility. For highly compensated professionals, the key is to invest according to your specific risk tolerance and broader financial objectives. For instance, if you prefer to minimize risk, you might allocate only 35% of your portfolio to stocks, with the remaining balance in bonds, fixed income, or alternatives like commodities, hedge funds, or real estate. These alternative investments can help mitigate volatility, offering a diversified approach that aligns with your risk profile.

Avoiding the Pitfalls of Misjudging Risk Tolerance

Corporate professionals often have a higher appetite for risk due to their professional experiences and successes. However, it’s easy to misjudge risk tolerance, especially when basing it on periods of strong market performance. During bull markets, even seasoned professionals can fall into the trap of overconfidence, assuming that the market will continue to perform well indefinitely. This mindset can lead to a misalignment between your actual risk tolerance and your investment strategy.

Risk tolerance isn’t about gauging how comfortable you feel during good times. It’s about assessing your ability to withstand downturns or significant market volatility—much like what we saw during the 2008 financial crisis or in more recent market disruptions. If your portfolio is too aggressive for your true risk tolerance, you may find yourself making impulsive decisions, like selling off investments at a low point, which can severely impact your long-term financial goals.

Assessing Your True Risk Tolerance

For highly compensated corporate professionals, understanding your true risk tolerance is essential. Begin by reflecting on how you felt during the most recent market downturn. Did it cause you significant anxiety? Were you tempted to make quick, emotion-driven decisions? If so, this might indicate that your current investment strategy is too aggressive.

Another effective way to assess your risk tolerance is by using a structured risk tolerance questionnaire. This tool can help you evaluate your financial goals, time horizon, and comfort level with risk, offering a more accurate picture of your risk profile. Honest answers to these questions will provide crucial insights that can guide your investment decisions and ensure they align with your financial objectives.

Time Horizon: A Key Factor in Risk Management

As an executive, your time horizon—the length of time you expect to hold an investment before needing to access it—is another critical factor in managing risk. Typically, the longer your time horizon, the more risk you can afford to take on, as you have more time to recover from potential market downturns.

There are two primary types of time horizons to consider: income cash flow time horizons and lump sum time horizons. For example, if you’re planning for retirement, your strategy will likely focus on generating long-term income, rather than liquidating assets immediately upon retirement. In contrast, if you’re saving for a large purchase, such as a vacation home or a significant business investment, your strategy will involve liquidating your portfolio at a predetermined future date.

Understanding and planning around your time horizon is crucial because it influences how you allocate your investments. Mismanagement in this area can lead to significant setbacks, especially when timing is critical to achieving your financial goals.

Strategic Management of Risk Tolerance

Mismanaging your risk tolerance can have significant consequences, particularly for corporate executives with complex financial portfolios. If you’re too aggressive with short-term investments, you could incur substantial losses with insufficient time to recover. Conversely, being overly conservative with long-term goals could result in underperformance, leaving you short of your financial targets when your time horizon ends.

To avoid these pitfalls, it’s essential to consider the specific purpose of your investments. Most professionals have multiple financial goals, each with different time horizons and risk tolerances. For example, the strategy for a short-term investment goal, such as funding a child’s college education, will differ significantly from your long-term retirement strategy.

Working with a financial advisor who understands the unique challenges and opportunities faced by corporate executives is key. Together, you can complete a cash flow analysis to determine how much you need to save and invest to meet your goals. By starting early and leveraging market growth, you can optimize your investment strategy and minimize the financial burden on your capital.

For corporate professionals, understanding and managing risk tolerance is not just a financial necessity; it’s a strategic advantage. Regularly reviewing your risk tolerance and time horizon ensures that your investment strategy remains aligned with your evolving goals and the market landscape. By taking a proactive approach, you can navigate the complexities of the financial markets with confidence and achieve your long-term objectives.

Strata Capital is a wealth management firm serving corporate executives, professionals, and entrepreneurs in the New York Tri-State Area, focusing on corporate benefits and executive compensation. Co-founded by David D’Albero and Carmine Coppola, the firm specializes in making the complex simple to ensure clients feel confident in their financial decisions. They can be reached by phone at (212) 367-2855, via email at carmine@stratacapital.co, or by visiting their website at stratacapital.co.

Cornerstone Planning Group, Inc., (“CSPG”) is an SEC registered investment advisory firm. The information contained herein should not be construed as personalized investment advice and should not be considered as a solicitation for investment advisory service. The information (e.g., tax ) provided is believed to be accurate however CSPG does not guarantee or otherwise warrant such information. For more information regarding CSPG you can refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov) and review our Form ADV Brochure and other disclosures.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Leveraging Deferred Compensation Plans for Strategic Financial Growth

By Carmine Coppola

Deferred compensation allows you to delay receiving a portion of your income until a later date, which can be particularly advantageous if your taxable income is expected to be lower in the future. For many, this strategy mirrors the familiar 401(k) plan, a qualified deferred compensation plan protected by the Employee Retirement Income Security Act of 1974 (ERISA). While 401(k) plans have their benefits, particularly for the average employee, they come with restrictions that can limit their utility for high earners. This is where non-qualified deferred compensation (NQDC) plans step in, offering far greater flexibility and potential benefits.

What Are Non-Qualified Deferred Compensation Plans?

Non-qualified deferred compensation plans, often referred to as elective deferral plans or supplemental executive retirement plans (SERPs), provide a powerful tool for high-income earners to manage their income and tax liabilities strategically. Unlike qualified plans like 401(k)s, NQDC plans do not have the same contribution limits, age restrictions on withdrawals, or required minimum distributions (RMDs). This means you can defer a significant portion of your income, reducing your taxable income for the current year while allowing the deferred amount to grow tax-deferred until you choose to withdraw it.

Moreover, many NQDC plans allow you to select your investments and may even include a company match—essentially a raise that can further enhance your financial growth. These plans are sometimes called “golden handcuffs” because they can be used by employers to incentivize retention among their most valuable employees. The more you earn and defer, the more you stand to benefit from the tax advantages, making NQDC plans an attractive option for those planning to stay with their employer long-term.

Strategic Considerations for NQDC Plans

Participation in an NQDC plan requires careful planning and decision-making. Typically, you’ll need to enroll during a designated period and establish a written agreement with your employer. This agreement outlines critical details, such as the amount of income you’ll defer, the deferral period or distribution schedule, and your investment choices. Once these elections are made, they can be challenging, if not impossible, to change, so it’s essential to approach this decision with a clear understanding of your financial goals and the potential long-term impact.

To simplify the process, it’s helpful to break down your strategy into three main components:

1. Purpose: What specific goals do you want to achieve with your deferred compensation? Are you saving for retirement, a child’s education, or a major purchase like a vacation home?

2. Amount: How much of your salary or bonus will you defer each year? This decision will depend on your current financial needs and your future goals.

3. Timing: When do you want to start receiving distributions, and how long do you want them to last? Your timing will affect your tax liabilities and your ability to meet your financial goals.

Practical Examples of NQDC Plan Utilization

To illustrate how NQDC plans can be strategically leveraged, consider the case of Gianna, a highly compensated employee with a salary and bonus totaling $550,000 per year. Gianna also receives $50,000 annually in restricted stock units (RSUs) and is withdrawing $25,000 per year from an inherited IRA. This puts her total income at $625,000, placing her in the highest federal tax bracket with an effective tax rate of 30.7%. Gianna doesn’t need the additional $75,000 in income from the RSUs and IRA, so she decides to defer $75,000 of her bonus each year into her NQDC plan. By doing this, she reduces her taxable income to $550,000, dropping her just below the threshold for the highest tax bracket and saving her approximately $27,000 in federal taxes annually. Over ten years, this strategy could add $750,000 to her retirement savings, not including investment growth, while maintaining her current lifestyle.

Another example involves Bill and Laura, a couple with ambitious financial goals. They plan to cover their children’s college expenses and purchase a dream vacation home. Bill, who has an NQDC plan through his job, decides to defer $50,000 per year into three different accounts within the plan, each aligned with a specific goal. One account will cover their son’s college expenses, another their daughter’s college expenses, and the third will be used for the down payment on the vacation home. By carefully structuring their deferrals and distributions, Bill and Laura can achieve these goals without disrupting their cash flow or lifestyle.

Addressing Income Gaps and Retirement Planning

NQDC plans can also be a valuable tool for addressing income gaps in retirement. For example, John and Sarah plan to retire at 62 but want to delay taking Social Security until they turn 67. This creates a five-year income gap. By deferring a portion of her bonus each year, Sarah can use the distributions from her NQDC plan to fill this gap, allowing their retirement and investment assets to continue growing. This strategy also gives them the flexibility to maximize their Social Security benefits by delaying them until age 70.

Mitigating Risks and Planning for the Unexpected

It’s essential to recognize that while NQDC plans offer significant benefits, they also come with risks. For instance, if your company undergoes layoffs or restructuring, you could face financial uncertainty. However, if you’ve been deferring a portion of your income into an NQDC plan, you may have a financial cushion to fall back on. Consider the case of Mike, a 55-year-old vice president who began deferring part of his bonus each year. With a current plan value of $350,000, Mike has the flexibility to manage his income if he’s laid off, retires early, or decides to work for a lower salary. His NQDC plan allows him to supplement his income, cover health insurance costs, and delay taking Social Security until it’s more advantageous.

Non-qualified deferred compensation plans are a potent tool for high-income earners looking to strategically manage their income, reduce tax liabilities, and achieve long-term financial goals. However, these plans are complex and require careful planning and ongoing management. Before making any decisions, it’s crucial to collaborate with a seasoned financial professional who can help you navigate the options and ensure your deferred compensation plan is intricately woven into your broader financial and retirement strategy. By taking a thoughtful approach, you can leverage your NQDC plan to secure a more flexible and financially stable future.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Ultimate Guide to Cash Balance Pensions After Leaving Your Job

Wondering what to do with that retirement account from your previous employer? If you’ve worked in Corporate America, there’s a good chance this account is a cash balance pension plan. Unlike traditional pensions, these plans often provide more options when you leave a company.

What is a Cash Balance Pension Plan?

A cash balance pension plan is a retirement plan where the company contributes on behalf of its employees. Unlike a 401(k), employees do not contribute to these plans. Think of it as an additional 401(k) match from your employer. The company deposits funds into the plan based on your compensation, and rather than being invested, the balance typically grows at a crediting rate based on interest rates.

When you leave the company, your plan balance usually continues to earn interest credits, but the company stops making contributions.

What to Do with Your Plan After Leaving the Company

If you’ve left your job and are wondering what to do with your old cash balance pension plan, the answer will depend on your unique situation. Generally, these plans offer four different options, which can vary based on your former employer.

Option 1: Annuitize the cash balance pension, turning it into a monthly income stream. This works similarly to creating your own “traditional pension.”

Option 2: Roll the balance over into an IRA. This will allow you to continue investing the funds how you’d like.

Option 3: Leave the money in the plan. Some companies allow this, and some do not. Most companies have an age at which you MUST initiate another option, usually 65.

Option 4: Take a lump sum distribution. It’s important to note the entire balance would be taxed as ordinary income.

Taking a lump sum distribution is rarely the best choice unless your plan balance is relatively small. Therefore, we’ll focus only on the other options for the rest of this article.

We’ll walk you through each option and the scenarios in which it might make sense. This will give you a complete understanding to help guide your decision-making process. Finally, we’ll provide a list of steps to determine which option may be most favorable for your situation.

Option 1: Annuitizing the Plan to Create an Income Stream

Think of this option as trading in the balance of your cash balance plan for a “traditional pension.” Company plans typically offer multiple payout options, such as single or joint life.

If your goal is to create additional income in retirement, this may be the right option for you, especially if you are retiring now and need the income immediately. However, this option is not ideal if you prefer flexibility, liquidity, and control of your assets. It may also be less appealing if you are still working and are far from retirement.

What are the advantages of annuitizing my cash balance pension?

It allows you to generate an income stream to supplement your other retirement income sources.
The joint payout option ensures the income stream lasts for both your and your spouse’s lives, hedging against longevity and premature death risks.
The investment risk is transferred to the company, meaning you do not have to manage the assets; you just receive the income.

What are the disadvantages of annuitizing my cash balance pension?

You’re trading an asset for an income stream. You lose liquidity, so if you need the cash sooner, you can’t access it.
The income stream ends with you (or your spouse if they outlive you and you’ve chosen the joint option). It will not be passed along to your heirs or be part of your estate.
There is the potential opportunity cost of not being able to invest the balance elsewhere.

Important Note: If you determine that you want more guaranteed income and are planning on annuitizing your cash balance pension, it’s always advisable to price out other income-producing investments (such as outside annuities) to compare income amounts. You might find a higher income rate at another insurance company.

Option 2: Rolling Over Your Cash Balance Pension to an IRA

Just like you can roll over your 401(k), you can also roll over your cash balance pension into an IRA. You can transfer it to an existing IRA or set up a new one.

What are the advantages of rolling over my cash balance pension?

You have complete control over how funds are invested, allowing you to align your investment strategy with your overall financial plan.
You maintain the asset, which can now be passed down to your heirs and your estate.
If you decide you prefer a guaranteed income stream later, you can always purchase an annuity in the future.
Distributions are easier. Most cash balance plans do not permit partial distributions, but rolling over to an IRA gives you full control over distributions, making it easier to receive your money (e.g., direct deposit vs. a mailed check).
This option offers the most flexibility.

What are the disadvantages of rolling over my cash balance pension?

You bear the investment risk, so if the investment decreases in value, so does your asset.
You no longer receive the interest credit you would have if you left the money in the plan.
You can no longer annuitize through your company’s plan (see Option 1). However, you still have the option to annuitize through another insurance company at a later date if you choose to do so.

Option 3: Leave the Money in the Cash Balance Plan

Most companies allow you to leave the money inside the cash balance plan even after you’ve left the firm. However, there is usually an age limit by which you must choose another option, typically age 65.

If you leave the money in the plan, you will continue to earn interest credits. The crediting rate is usually based on a treasury or corporate bond rate published by the IRS. Be sure to check your plan’s Summary Plan Description for more details.

What are the advantages of leaving money inside my cash balance pension plan?

Ideal for conservative investors who do not need additional income right now.
Beneficial if you are satisfied with the interest rate it’s paying, especially if it’s higher than what you could get elsewhere.
If you’re close to retirement, it keeps the annuitized income option available for later use.

What are the disadvantages of leaving my money inside my cash balance pension plan?

Potential opportunity cost for aggressive investors or those far from retirement who might benefit from investing in riskier assets.
There is a time limit on how long you can keep the funds in the plan.
Facing limited liquidity compared to other investments, making it harder to access funds quickly.
Many plans do not allow for partial distributions.

Steps to Evaluate What Cash Balance Pension Option is Best for You

This decision should not be made in isolation. It’s crucial to assess how your choice integrates with your overall financial plan. Since the decision is permanent, be thorough in your evaluation. Here are the steps you can take to start the process:

Step 1: Determine Your Retirement Status

The first step is to consider whether you are retiring soon or planning to continue working. If you’re retiring, you’ll need immediate income; if you’re still working, you have more time before requiring retirement income. This distinction will also impact the Internal Rate of Return (IRR) calculations in later steps.

Step 2: Assess Your Guaranteed Income Sources

Identify your sources of guaranteed income in retirement, such as Social Security, pensions, and annuities.

Step 3: Estimate Your Retirement Expenses

Calculate your anticipated expenses in retirement. Focus on essential needs like housing and food before considering discretionary spending like vacations and entertainment.

Step 4: Identify Any Income Gaps

Compare your estimated expenses with your guaranteed income sources to identify any shortfalls. If there is a gap, consider whether annuitizing the cash balance pension can fill it. If there isn’t a gap, annuitizing might not be necessary.

Step 5: Calculate the Internal Rate of Return (IRR)

Use the IRR formula in Excel or have your financial advisor run the analysis for you. The IRR will give you a number to compare against alternative investment strategies. (Tip: If your advisor can’t run this analysis, it might be time to find a new one!)

Step 6: Compare IRR to Investment Strategies

Always compare your cash balance pension annuitization IRR with other investment options. Annuitizing the pension might provide a steady income stream, but it’s essential to evaluate whether it’s the best choice compared to other investment strategies.

Step 7: Run Financial Forecasts for Each Option

This step is crucial. Run separate financial forecasts for each option to see how they affect your long-term financial future. Compare these scenarios to understand the impact on your overall financial health and legacy planning.

By following these steps, you’ll gain a better understanding of which option makes the most sense for your unique situation. Always run scenarios against your overarching financial plan to ensure you make the best decision for your financial future.

Final Thoughts on Managing Your Cash Balance Pension

Deciding what to do with your old cash balance pension plan is a significant choice that can impact your financial future. It’s essential to consider how each option fits into your overall financial strategy and long-term goals. Whether you choose to annuitize, roll over into an IRA, or leave the funds in the plan, understanding the advantages and disadvantages of each option is crucial.

By thoroughly evaluating your situation and running detailed forecasts, you can make an informed decision that aligns with your retirement goals and financial needs. Remember, this decision is permanent, so take the time to explore all your options carefully.

If you’d like assistance exploring the best option for your old cash balance pension plan, we’re here to help. Schedule a free consultation with us today. Together, we’ll analyze your unique situation and guide you toward making an informed decision tailored to your needs.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

ESG Investing – For the Socially Responsible Portfolio

Our society has become increasingly aware of how our individual actions influence the world around us. Now more than ever, Americans are making an effort to “go green,” speak out for the underrepresented, and make the world a better place to live. With that, consumers and investors have become increasingly adamant about contributing to worthy causes—not only do buyers want to shop local and support the small business owner, but they want to invest in companies that reflect their personal values.

In short, people want to put their money where their mouth is.

When it comes to investment strategies, the term “ESG investing” has gained a lot of traction. Most people define ESG investments as ones that improve the environment or benefit society in a positive way, but the true definition is a little more complex.

In this blog, our team at Strata Capital will tell you everything you need to know about this financial buzzword and how it applies to your plan.

What exactly is ESG investing?

ESG stands for environmental, social, and governance, and it refers to a ranking system that uses these three categories to classify companies as sustainable investment opportunities. (The term “sustainable” is used broadly here to refer not only to environmental longevity, but a positive impact in each category.) The rank (or score) a company receives helps investors determine whether the company is worthy to be included in a portfolio of sustainable investments.

A company’s environmental ranking considers how the company contributes to the conservation of the natural world.
A company’s social score reflects the treatment of people inside and outside the company.
Governance considers a company’s operations from an ethical perspective.

Here are some of the specific factors that determine a company’s ESG score:

ENVIRONMENTAL	SOCIAL	GOVERNANCE
Energy Sources	Company-Employee Relationship	Executive Pay
Waste Management	Sexual Harassment Policies	Political Contributions
Pollution Control	Fair Employee Pay	Honest Accounting Practices
Climate Change	Employee Diversity	Board Member Diversity
Raw Material Sourcing	Offering Similar Benefits Among Peers	Company Corruption
Carbon Emissions	Human Rights Issues	Executive’s Acting as Fiduciaries
Green Energy Initiatives	Does the Company’s Mission Benefit Society	Lawsuits
Deforestation	Positive Relationship with Community	Lobbying

In general, the higher the ESG score, the more sustainable the company (and therefore the investment).

Is ESG different than SRI (socially responsible investing)?

Yes and no—ESG is the grading system used to measure companies in these categories, while SRI refers to the act of using an ESG-based grading system to choose companies or funds to include in portfolios. So if you’re investing in companies that have a high ESG score, you’re probably partaking in what you would consider socially responsible investing.

That said, socially responsible investing is a general term that encompasses environmentally sustainable investing, impact investing, or ethical investing. SRI investing can differ depending on the investor’s definition of what is “socially responsible.”

Some investors (or wealth managers helping choose investment accounts) use an exclusionaryonly approach. This strategy, rather than seeking value-driven investments, simply avoids investments that don’t align with an investor’s values—like companies that produce tobacco, alcohol, or firearms.

So while you might define socially responsible investing as avoiding tobacco investments, others might take a more comprehensive approach.

How is a company’s ESG score determined?

Each company is compared to others in its industry, so there’s no numerical threshold for what qualifies a company as an ESG investment. Companies are generally considered part of a sustainable investment strategy when they have a higher ESG score than their peers in the three qualifying categories. Depending on who is ranking the company, the precise score or ranking can vary, and most analysts use a percentile system rather than a specific score.

Who determines a company’s ESG score?

ESG scores aren’t regulated by one particular authority, so there are lots of companies that use their own grading systems to measure a company’s ESG qualification. MSCI is one of the largest independent providers of ESG ratings, and they create sub-categories within the three main categories (environmental, social and governance) that each carry their own weight to determine a company’s final percentile ranking.

How can I find out a company’s ESG score?

Unfortunately, it’s not always easy to find a company’s ESG score, since much of the research and data is sold to institutional firms, rather than distributed for public consumption. There are a few websites like Sustainalytics where you can search for companies’ scores, but they typically don’t disclose why the score is high or low or where the company ranks in individual categories. However, most publicly traded companies have an ESG section on their website where consumers can investigate their ranking.

Should I consider ESG scores when shaping my investment strategy?

There are pros and cons to focusing solely on companies with high ESG scores. The main benefit, of course, is that you’re supporting companies with values similar to yours (assuming you agree with the standards of the ESG scoring system). And because this is increasingly important to many investors, it can also benefit your portfolio from an economic standpoint. Investments into ESG funds have increased dramatically in recent years, which has caused them to outperform lower-scoring companies—which in turn makes them a more viable investment.

But just because a company has a low ESG score, that doesn’t mean it’s a bad company or a bad investment. By excluding low-scoring companies, you could miss opportunities to invest in lucrative companies that could benefit your portfolio.

If it’s important to you to invest sustainably, the most important thing to understand is your definition of “sustainable” and how it compares to an ESG score. Your values may not align with an analyst’s definition of sustainable, so if you’re relying heavily on an ESG score to influence your decisions, make sure you do as much research as possible.

What’s next?

At the end of the day, different investments suit different people, and part of our job is helping clients determine which strategies best align with their values and goals. If you’re interested in maximizing your portfolio for socially responsible investing, we’d love to help. We’ve learned a thing or two about ESG investing (and by that, we mean quite a lot), and we’re here to help in any way we can. To talk with one of our advisors, just give Carmine a call!