Chapter 15 Financial Investments: How Do We Divide the Portfolio Pie?

• Library: Divorce & Money (Nolo) (2020 Ed.)

CHAPTER 15: Financial Investments: How Do We Divide the Portfolio Pie?

Concepts to Consider

An Investment From Marriage May Make Little Sense When You're Single

Don't Take an Investment You Can't Live With

Use Your Divorce to Cut Your Losses

No Investment Is Risk Free

Asset Options: Sell Now, Keep It Forever, or Take It for a Loss

Balance Security, Income, and Growth

If You Don't Know the Tax Basis, the Tax Bill May Shock You

Beware of Inflation and Inflated Claims

Look to Total Return, Not Yield

Steps to a Settlement

Step 1: What Investments Do You and Your Spouse Hold?

Step 2: Who Owns Each Investment?

Step 3: What Is the Legal (Equity) Value of Each Investment?

Step 4: What Is the Financial (After-Tax/After-Sale) Value of Each Investment?

Step 5: Which Assets Should You Keep?

Step 6: How Will You and Your Spouse Divide the Investments?

When you divide the investments you and your spouse made during marriage, it's doubtful you'll get exactly what you want. But you should get what you need.

SKIP AHEAD

If neither you nor your spouse has investments, skip ahead to Chapter 16.

The first step in dealing with financial investments is to analyze your portfolio objectively—that is, the stocks, bonds, mutual funds, real estate investments, gold, collectibles, and the like that make up your investment holdings. Then work to get the assets that can put you in the best position to build toward your future after divorce.

How do you know which investments will serve you best?

Ask a dozen financial planners and you'll get the same answer: "That depends."

Choosing the investments that will serve you best depends on several factors—your future plans, current age, risk tolerance, income needs, and investment experience. You should aim for investments that meet your individual needs, allow you to sleep at night, and keep your taxes to a minimum.

As you read this chapter and evaluate your investments, keep in mind the following two questions:

• Is the investment performing well?
• Is the investment appropriate for me?

Whether you are a novice or veteran investor, use the formulas and tips in this chapter to select the investments that will best support you after the divorce. Even if you are completely unfamiliar with the investments you and your spouse share, you need not be intimidated—if you do your homework.

In some instances, you may need to consult with financial experts before making decisions, because certain investments can carry complications due to tax laws or illiquidity (not being able to sell an investment at a reasonable price). Tax advisers, stockbrokers, and financial planners may be particularly useful. Whether you get help from experts or not, you can save time and money by doing some groundwork and gathering information.

Concepts to Consider

To get started, here are a few basic investment concepts to help you.

An Investment From Marriage May Make Little Sense When You're Single

While married, the two of you may have chosen certain investments because they met your shared goals—such as a mutual fund to help save for the down payment on a house or an annuity to increase the retirement kitty. Once you divorce, however, your goals, tax bracket, and ability to withstand losses may change. Perhaps as a couple you could afford to hold on to a stock with great potential, even when its value fell. As a single person, however, such a stock may be totally unsuitable if you're looking for stable income. Similarly, a spouse in a high-income tax bracket may not want to keep an investment that generates substantial taxable interest.

Don't Take an Investment You Can't Live With

Does the mere mention of Wall Street give you the jitters? Can you bear to sit by and watch what happens to the bond market? Do you have the time, energy, and interest to keep up with the performance of your investments? Think about these questions carefully as you look at each asset. Like a spouse, you should only keep an investment if you can stand living with it. Don't take an asset if you don't understand its risks.

Use Your Divorce to Cut Your Losses

When it comes to investments, no one likes to admit to making a bad call or a poor decision—especially if your spouse warned you not to buy the loser in the first place. But you wouldn't fight to keep the awful picture Aunt Lucille gave you for a wedding present, would you? Why hold on to investments that are not doing well? Because of the emotional distress of divorce—or simple "investment inertia"—some people hang on to investments they ought to sell. Divorce is the perfect time to review all of your investments and unload those that drain your portfolio value or don't meet your long-term financial goals.

No Investment Is Risk Free

Even in a booming economy, no capital investment comes with a 100% guarantee of success. Whether you're working with banks, hedge funds, brokerage firms, or investment companies or buying U.S. government-issued bonds, everything carries risk.

The booms, busts, and investment scandals and swindles of the last two decades should be enough to bury the notion of a "risk free" investment. Yet, this great illusion of the American marketplace lives on. You should not be taken in, no matter how persuasive an argument seems. The fact is, regardless of what you might see, hear, or want to believe, every investment carries risk. (Even what were once the most trusted places for money—banks, savings and loans, and insurance companies—have shown this to be true.) Ignoring risk is common among today's investors who have been hit by a virtual avalanche of new financial products, each promising rewards that may or may not materialize. Take time to ask questions about the downside of any investment you plan to keep as part of your settlement. Keep in mind one general rule: The greater the potential for gain, the greater the risk.

Never keep an investment that carries a greater risk than you can afford. Doing so increases the risk of loss, because you will probably sell the investment when its value drops rather than ride out its ups and downs.

EXAMPLE: In the property settlement, Cheryl received 300 shares of WOW Mutual Fund, a fund investing in small-capitalization computer companies. The fund had a high return of 22% in the prior year. Her husband, Jim, convinced her that with the $14,000 worth of WOW shares, she would make more money than with the lower-return Treasury bonds he was taking as part of the settlement. Cheryl quickly learned, however, that the greater the potential for gain, the greater the risk; her $14,000 investment dropped to $8,700 the next year.

Who Do You Trust to Handle Your Investments?

It's common for people to seek help and financial advice in their community and social networks. But as the Madoff case and many other investment scandals made clear, financial fraud often hinges on the victims' trust and vulnerability. When you're in crisis—such as during a divorce—it's easy to put your faith in someone who seems wise and caring, but may not be.

For your protection and peace of mind, you should engage a third-party financial adviser to help handle your investments. If you house your investments with a third-party custodian—and you should—it's easier to monitor the health of the investment and access advice from a reliable source. Check with your local bank or an established investment management firm to see how you might work with a financial adviser.

Trust, but verify, is a sound approach when you're allowing someone else to handle your investments.

Asset Options: Sell Now, Keep It Forever, or Take It for a Loss

"Assume sale." Those two words sum up the best advice you can follow when deciding what to do with assets at divorce. So often, cherished investments you thought you would keep forever end up on the auction block after divorce. Ideally, you should keep only those investments that financially fit your goals and needs—and you should sell or transfer to your spouse those that do not. If you sell the investment at divorce, you share the selling costs and potential tax bite with your soon-to-be ex-spouse. Waiting until after the divorce to unload assets means you incur all those expenses yourself.

Too often, divorcing couples overlook the simple fact that an asset they are eventually planning to sell can be sold prior to the divorce. They get caught up in making trade-offs to reach a quick or supposedly fair property settlement and accept assets they don't want or intend to keep. If, however, you assume sale, you're forced to consider taxation and other costs. Then your negotiations can be based on the real cost of keeping the asset and not an illusory value. And if you do keep the asset, you know what it's truly worth.

Losers Can Be Winners

When you incur a capital loss at sale, remember that this loss can offset capital gains. If your capital loss exceeds $3,000, you can carry over the excess losses until they are used up, either by offsetting capital gains or taking the maximum $3,000 deduction from your gross income.

Gains and losses on jointly owned or community property are generally divided equally between spouses upon the divorce judgment or settlement. This is important, since a loss greater than $3,000 will have tax implications in years after you and your spouse divorce. If one spouse has a greater need to declare such losses, then they become an item of value in negotiation, and an agreement for their division should always be included in the final divorce settlement or judgment.

An investment asset may provide you with a tax loss when you sell it. If it would, and if you have another asset on which you expect a gain, it may make financial sense to take the loss-producing asset in the settlement. Then you can sell the "loser" after the divorce to offset the tax gain from the sale of the other asset, and reduce your overall tax liability. It pays to know which stocks, bonds, or mutual funds carry a tax loss with them. For example, limited...