Someone once said “It takes a great deal of boldness and a great deal of caution to make a great fortune and when you have got it, it requires ten times as much wit to keep it.” Although exactly who said it is unclear, the message is definitely clear. Many of you have been building your retirement savings for years, even decades. No matter how much you have saved, you definitely don’t want to lose some of it by making an avoidable mistake.
While the market volatility can be a major threat to some retirement plans, Uncle Sam is an unavoidable reality for most of us. And unless you have a Roth IRA, if you take a withdrawal from a Traditional IRA, or comparable tax-deferred account, you are inevitably going to pay taxes. No way to avoid it, but you may be able to minimize the amount of taxes and/or penalties by paying attention to some key areas.
Here are five pointers that may help you avoid penalties and/or reduce your tax liability.
IRA and Roth IRA Income Limitations
If you make improper contributions to your IRA or Roth IRA, penalties can apply. There are no income limits to contribute to a conventional/traditional IRA, but some of the contributions you make to your IRA, thinking they will reduce your taxable liability, might not be allowed and could be disqualified in the future. Taxes and penalties may be assessed in arrears. Specifically, if you are active in a company-sponsored retirement plan, income limits apply to how much of your contribution will be tax-deductible. The deduction starts to phase out if your Modified Adjusted Gross Income (MAGI) is $98,000 for married/joint filing ($61,000 for single) and is entirely phased out if your MAGI is greater than $118,000 for married/joint ($71,000 for single).
If you are married and are not active in a company-sponsored retirement plan, but your spouse is, then the deduction phases out from $184,000 to $194,000 MAGI for your contribution. The rules above apply separately to your spouse’s potential contribution.
If you don’t take the Required Minimum Distribution (RMD) from your tax-deferred plan(s), such as IRA, 401(k), 403(b), etc., which are required in the year in which you turn age 70 ½, you may have to pay a major penalty. You can defer the first year’s distribution to the second year, but then you have to take two RMDs in the second year. Except for the first year, you have to follow the rules every year to avoid the penalty. And the penalty is a stiff one! It’s 50% of the RMD – and you still have to pay the income tax as well. For example, if the RMD is $2,500 and you are in the 25% marginal federal income tax bracket, the penalty would be $1,250 (paid to the IRS), along with the $625 income tax on the full $2,500, leaving you with $625! You definitely want to avoid this penalty.
Here is one of the more common ways to make a mistake in this area. You remember to take the RMD from your primary IRA, but you forget that you have other IRA accounts. In order to fully satisfy the IRS, you have to withdraw the RMD based on ALL of your tax-deferred accounts, including any annuities that you may own in an IRA. Your total RMD for any given tax year is calculated by taking the current value of all of your tax-deferred accounts as of December 31st of the prior year, and dividing it by the government’s uniform life expectancy table, giving you the minimum amount that must be distributed from your tax-deferred accounts. The penalty applies to the amount that you are short. It’s also important to know that you don’t have to take withdrawals from each separate account. Strategically, it might make sense for you to take the entire RMD from one account, or two accounts; it’s up to you. The IRS doesn’t care where it comes from they just require you to take the total RMD each year. Make sure you follow this requirement and avoid the costly penalty!
Inherited IRAs – Spousal Beneficiary
It is common for a spousal beneficiary to roll an inherited IRA into their existing IRA. That’s okay if the surviving spouse is over 59 ½. However, if the spouse is under 59 ½, it is important for that spouse to keep it separate as an inherited IRA in order to preserve the right to withdraw funds without the 10% early withdrawal penalty, which is waived for this type of account. On the other hand, if the spouse beneficiary is over 59 ½, an inherited IRA can be combined with another IRA.
Another key difference for a spousal beneficiary is that they do not have to immediately begin taking an RMD unless the original owner had reached 70 ½ and had started taking the RMD. If the original owner had started taking an RMD, then the spouse has to continue to take the RMD based on the spouse’s life expectancy after the year in which the original owner died.
Inherited IRAs (and Roth IRAs) – Non-Spousal Beneficiary
Non-spousal beneficiaries of any age who want to “stretch” the IRA withdrawals over their life expectancy must start the RMD in the year following the death of the original owner, regardless of whether that owner had reached age 70 ½ or not. They also want to keep an inherited IRA separate in order to preserve the ability to withdraw funds without the 10% early withdrawal penalty. Once they reach age 59 ½, they can combine it with another IRA, though they may want to keep it separate if they are utilizing the “stretch” option.
Note that Roth IRA owners are not required to take an RMD, but non-spouse beneficiaries are required to take an RMD from an inherited Roth IRA (spouses are exempt from this requirement). If they do not, the 50% penalty will apply, even though withdrawals from any Roth IRA are tax-free.
Inherited IRAs – Wrong Beneficiary
This pointer won’t produce any tax savings, but it may keep a tragedy from occurring. Unfortunately, people don’t always pay enough attention to who they have named as beneficiaries. There are many stories following a divorce, death or remarriage where owners forget to update their beneficiaries.
Beneficiaries should be reviewed after every major life event to ensure that the information is properly updated on the account. A basic will does not apply to any tax-deferred account, unless the individual’s estate is the named beneficiary. And this is typically not a recommended strategy as it robs the potential beneficiaries of the opportunity to “stretch” IRA withdrawals over their lifetime.
As you can see, IRAs can have quite an effect upon an individual’s tax situation. IRA accounts continue to grow in popularity, as more and more businesses move away from providing traditional defined pension plans and workers are expected to take on a more significant role in funding their own retirement. Not surprisingly, the rules and regulations surrounding IRAs are very complex and often confusing. The same can also be said to our Tax Code. Thus, if you are seeking some assistance with gaining more clarity about IRAs and the role they can play within your own retirement planning, give me a call and we can talk about doing so.
One of the things that I hear most often when having my first consultation meeting with a new client is their fear of running out of money. In fact, this is the number one concern, even more so since the Great Recession, per Gallup’s April 2016 Economy and Personal Finance survey.
Here is one example of the many conversations that I have had regarding potential threats to my client’s financial success. Recently, a retired couple shared the fact that they are facing an issue, which could derail their “Plan A” – dementia. Their concern is that potential escalating healthcare costs for the spouse who has received an early diagnosis may end up depleting the sizable nest egg they had painstakingly built over their working years, leaving the remaining spouse with very little. How quickly the funds are depleted depends on how fast the disease progresses, and how long the affected individual lives with the disease.
It’s very difficult to be completely prepared for this type of situation. However, there are options that may help to reduce the financial and emotional pain associated with the high cost of extended care for a family member suffering from a disabling disease.
The total cost of healthcare is rising, faster than inflation, and it does not appear that this trend will be reversed anytime soon. This is precisely why it’s so important to discuss healthcare-related situations, and why it is also critical that when helping new clients prepare a plan, we not only address their financial goals, but also their deepest concerns. One of the key aspects of my commitment as a financial advisor is to help provide clients peace of mind as part of the planning process.
Estate planning is not easy. It isn’t just about having a will and naming beneficiaries on your IRA and 401(k). There are other considerations. Unfortunately, we don’t know our future and it could be complex. Some pre-planning in this area can be helpful vs. waiting until the situation occurs, especially when it comes to helping make sure that you don’t deplete your entire nest egg.
Each person presents a different challenge, has a different set of goals and a different set of assets to help support those goals. They may have different health issues or different ideas when it comes to the transfer of wealth to the next generation or they may not even have another generation to pass their wealth on to. I always start off planning for the ideal situation, “Plan A” if you will. But life has many twists and turns, so it is critical that a plan anticipates some changes.
You may never be able to be totally prepared, mentally and financially, for every possible change that you might face over the (hopefully) many years of retirement, but it is valuable to have previously discussed how you might handle some of these scenarios.
One of the ways that we help our clients address these challenges is through educational workshops.
For example, last Fall, I invited estate planning attorney Albert Hehr from Meyers, Roman, Friedberg & Lewis to my 2016 Economic Update. During those sessions, Al reviewed all of the basic estate planning documents in detail, including why each one was needed and the ramifications for not having them. As part of that discussion, he specifically highlighted the dramatic financial impact that an extended illness can have on a couple’s financial status. He explained that while it can wipe out the financial assets of a single person, it can be extremely disastrous for a couple. It’s not uncommon for a healthy caregiving spouse, who did everything they could to care for their partner, to not only end up emotionally and physically exhausted, but to also end up financially ruined because they depleted their entire retirement savings.
Al and I have met with several of my clients regarding the importance of having proper and current estate planning documents in place well before a serious illness, divorce, or death of a loved one takes place. The true value of proper estate planning, is that it anticipates many situations, including those mentioned above, and outlines steps to take should one of them occur.
It is important not to put off sitting down with a financial advisor who can help create a plan that addresses your financial goals. As an expert, they can incorporate investment strategies that help ensure you and your family have enough money to support your long-term financial goals, thereby increasing your probability of success.
My mission as an advisor, is to help reduce or eliminate surprises and the concern with running out of money. If you need a plan, would like a second opinion or just have questions, don’t hesitate to contact me. I’m here to help.
Now that we know the results of the election, what should you do with your investments? In my opinion, if you were positioned appropriately before the election, it makes sense to retain that same strategy during the transition into the new administration.
On the other hand, this change may also be a good time to step back and review your overall financial picture. Have your long-term goals changed? Are your investment returns meeting expectations? Reasonable goals, combined with sound planning, can pay dividends regardless of market conditions. According to FINRA (Financial Industry Regulatory Authority), the following 5 steps can help steady your pulse during market downturns and elevate your financial security.
1. Revisit your financial goals.
Set clear, prioritized goals. Good financial goals, tied to a sound long-term financial plan, typically will survive short-term market ups and downs. It is critical that you have a plan that includes annual savings as well as a diversified portfolio based on reasonable returns for the market risk that is appropriate for you.
2. Focus on asset concentration.
Do you have a large position in a particular stock or mutual fund? Significant market movement in that position can illuminate concentration risk, the risk of amplified gains or losses that may occur from having a large portion of your holdings in a particular investment, asset class or market segment relative to your overall portfolio. It’s important to diversify across, and within, the major asset classes to reduce the potential of a significant loss.
3. Focus on your financial security.
Take advantage of day-to-day opportunities to help build your finances for the long term, such as paying your credit-card debt on time and in full, if possible, to avoid paying high interest rates (which are cancerous to your long-term savings plan), and setting aside funds for the unexpected (car repair) or the specific (vacation in Hawaii). If possible, set up automatic contributions; to 401(k) plans, savings accounts and a Roth IRA if you qualify.
4. Understand the impact of higher interest rates.
Yes, the Fed finally started to raise the federal funds rate and might do so again. That will have a positive impact on your savings accounts, but it will likely have a negative impact on your current bond holdings. When interest rates rise, bond prices generally fall. New bonds will have higher interest rates, so it will be better long-term, but you might see a short-term negative impact on the bond portion of your portfolio. Stick with the plan!
5. Protect your money.
Fraud is a growing threat and financial scammers operate in all market conditions. In times of high market volatility, investors may be particularly vulnerable to pitches touting guarantees of “risk-free” returns. Combining a guarantee with a specific amount of money you will make—”this is a safe investment that will earn you $6,000 every quarter”—is a highly effective tactic known as phantom riches. You can avoid fraud by working only with registered investment professionals—use FINRA BrokerCheck (brokercheck.finra.org) to find out if a person is registered to sell securities—and by sticking to your pre-determined financial plan.
These steps are just some of the right things to do when it comes to financial matters. Unfortunately, no one can predict what will happen in the various markets. That is what makes it all work. If we knew what was going to happen, we could devise the perfect plan. So, as an alternative, I suggest you define your goals, develop a plan based on reasonable expectations, maintain a diversified portfolio, periodically monitor it and stick to the plan. Let us know if you would like to have your plan reviewed or, if you don’t have one, we can help you develop something that fits your unique goals and expectations.
Have you ever taken a vacation, without first planning where you want to go, what you want to see, how you are going to get there and how much it will cost?
Waiting to the last minute to decide on a vacation usually doesn’t end well. For example, it would be silly to get in your car and just start driving to England from Cleveland, wouldn’t it? But for many Americans, that is how they are approaching their retirement—with no real plan.
We all want to have a fun and memorable vacation. And we know that good planning can help to make that happen.
We have friends with two small children who recently returned from a trip to Walt Disney World in Florida. Having never been there before, they wisely consulted with a travel agent who was an expert in all things Disney, well over a year before they visited. The agent talked to them about their goals for the trip, which would allow them to experience all of the magical things that were important to both the kids and the parents. They settled on a budget, which they knew, based on the advice from the agent and their situation, would allow them to have their dream vacation. Because they started early, they were able to save plenty of money to meet their goals for the vacation without much sacrifice related to their daily living. Since they have returned home, they cannot stop talking about what a great time they had and how this was one of their best family vacations ever!
Not unlike how travel agents can help to determine your goals and budget for a vacation, working with a financial planner can also help you to be strategic and plan effectively for your retirement. These days, with improved healthcare and technology, retirement can last 20 – 30 years.
One of the biggest concerns people have when they begin their retirement is running out of money.
With interest rates at record lows, it’s even more critical to plan. You wouldn’t want to take an extended vacation without putting together a plan, so why would you retire without doing so?
Here are the top 10 reasons why you should have a strong financial plan, according to a recent study by Forbes. It will:
- Help you define your financial goals
- Help you see whether your goals are realistic, especially for your timeline
- Help you see how you can bring your spending in line with your goals
- Show you what money mistakes you are currently making
- Allow you to measure progress toward your goals
- Help you find new ways to maximize your money
- Help you identify risks that you hadn’t thought of
- Make you more confident with your money
- Help you build wealth
- Help you live more comfortably
The reality is that most Americans should plan for their retirement, yet it is easy to procrastinate because we may feel like it is far away or it’s too overwhelming. Vacations have a definite beginning and an end, which is easier to view as a project. However, the time frame for retirement is unknown and the end, well, most of us don’t want to think about that yet. Even so, we should understand that Plan A may not work out and we should have a Plan B in case of emergencies, illness, downturn in the economy, or any other unexpected situation. Being aware of the possibilities puts us into a better position to handle life’s challenges.
I receive many inquiries from people in their 50’s and 60’s who have done little to prepare financially for retirement. I believe it is never too late to start planning. If this resonates with you, and you would like to begin a discussion on where you are in regards to retirement, why not get that conversation started today?
Many Americans depend solely on Social Security for their retirement lifestyle. Unfortunately, too many people are under the false assumption that Social Security will be enough to cover all their expenses. The following statement is taken directly from the front page of the Social Security statements prepared
by the Social Security Administration.
“Social Security is the largest source of income for most elderly Americans today, but Social Security was never intended to be your only source of income when you retire. You also will need other savings, investments, pensions or retirement accounts to make sure you have enough money to live comfortably when you retire.”
While one needs to consider all of the other retirement income sources, given the flexibility in the starting date of Social Security benefits, the biggest issue for most individuals and couples as they approach retirement is when to start taking the benefits. This is especially true for married couples. When is the ideal time to begin drawing on your Social Security benefits? The best answer is that it depends. It depends on a lot of factors. You can begin to receive Social Security benefits as early as age 62, which is considered early retirement. In some cases, this might make a lot of sense. In other cases, it may be better to wait until age 70, which is the latest you can begin to take Social Security to maximize your benefits.
Here are two examples from our book, Money Talks: Life Lessons to Help You Plan Now, Save Wisely, and Retire Well of how making the decision as to when to begin drawing Social Security is not always as simple and straight forward as it would seem. Gary and Liz are retired. Gary chose not to retire until age 70 so he could maximize his Social Security benefits. He was healthy, didn’t smoke, and expected to live for a long time. Together, they had done an excellent job of saving for retirement. So, when Gary retired at 70 and started his Social Security payments, Liz was at her full retirement age of 66, so it made sense to start her benefits at the same time.
At age 71, exactly one year after retiring, Gary discovered that he had pancreatic cancer and died a year later. Liz was devastated emotionally after losing Gary, but she was very upset when she thought about how they had planned their retirement, maximizing Gary’s Social Security benefit to support their long-term plan. However, once Liz reviewed her financial situation, she was relieved when she found that they had in fact done the right thing after all. After Gary died, Liz learned that she inherited his Social Security benefit, but lost hers, as Gary’s was the greater of the two. Since Gary had worked until age 70, she was receiving the highest benefit possible.
The same cannot be said for Joseph and Sally. Joe planned to work until age 65, but when an early retirement package was offered; he took it at age 61. Sally was 61 as well, still working and carrying the family health insurance through her employer. Between his pension and her income, they were living a comfortable lifestyle. A year after retirement, Joe picked up some old hobbies, including golf and wood-working and his expenses started to increase. When he turned 62, he started his Social Security benefits to supplement his pension and her income. Sally worked three more years to age 65, and then retired when they both were eligible for Medicare. Sally’s Social Security benefits were significantly lower than Joe’s, even though she had waited until age 65, so she was pleasantly surprised when she qualified for spousal benefits and received more money. Spousal benefits are typically 50% of the other spouse’s income (amount may be reduced, depending on the age of the spouse when the benefit is initiated). Check with the Social Security Administration for specific details regarding the calculation of these benefits.
Joe expected to live a long time. After all, when he retired at age 61, both of his parents were still alive in their 80’s. So, when Joe chose his pension, he picked the highest amount, based on his single life. That meant that he would receive the highest payment amount for as long as he was alive. However, there was no provision for Sally after his death. Since he had taken the highest pension amount and he expected to live a long time, he felt that taking the lower Social Security benefit, starting at age 62, made sense. The extra money allowed Joe and Sally to live very comfortably in retirement.
Unfortunately, Joe was playing golf one day and had a heart attack on the golf course and passed away shortly thereafter. He was only 67 years old. Sally was distraught, but what really shocked her was when she found out that she lost Joe‘s pension and her Social Security benefits immediately upon his death, leaving her with only one income source, Joe’s Social Security benefits. Once a spouse dies, Social Security only continues to pay out one benefit, whichever is the higher of the two payments. And although Joe’s benefit was the larger of the two, since he had started his Social Security benefit early at age 62, his benefit had been reduced about 25% from the amount that he would have received at his full retirement age of 66. That left Sally with about 40% of the income that she and Joe had been living on before his untimely death.
These are just two examples of why knowing when the right time to begin taking Social Security benefits can be a tough decision. The beauty of life is that we never know what lies ahead of us. If we did, it would be all too predictable. However, not knowing what lies ahead makes planning for the future that much more difficult. As a result, the decision when it might be best to start Social Security benefits is not easy.
As financial advisors, we often recommend that you plan for the worst and hope for the best. Good planning anticipates potential catastrophes and develops a strategy that can address them if they actually occur. Retirement can be a long-term proposition, though it can also be cut short. Since no one individual knows which it will be, we have to anticipate both scenarios and balance them in order to help our clients achieve an enjoyable retirement lifestyle.
Don’t hesitate to contact us, if you have questions regarding when to begin taking your Social Security benefits.
Spring break comes up once a year and, as the parent of a college freshman, I realize that my wife and I finally have the freedom to schedule a vacation when we want to!
That may not seem like much, but after having four children, the oldest of which is going to be 30 years old next month; it has been a long time since we actually had that opportunity.
As a financial planner, I work with a lot of individuals and couples. Many of them take annual vacations and I bet they would have trouble disagreeing with me on the following point:
Most people spend more time planning their next vacation than their eventual retirement!
Retirement planning is my specialty. I know that each individual and couple with whom I meet has different lifestyle goals, challenges, assets, risk-tolerances, and health. Because of these differences, I believe that each of these individuals and couples can benefit from a unique retirement plan, tailored to all of the variables mentioned. In order to properly prepare a successful retirement plan, it takes time and a lot of planning.
According to the 2012 Retirement Confidence Survey conducted by the Employee Benefit Research Institute (EBRI), only 42% of Americans have actually calculated how much money they will need to save for retirement.
Here are some key issues to consider before making a decision:
1. Can I afford to retire? No matter how old you are, it’s almost always a good idea to take inventory of your financial assets before one decides to retire. Add up all of the assets you have, including those not targeted for retirement, and then subtract any outstanding debts to give you a rough idea of your total net worth. This list should include your home, car(s), clothes, jewelry, collections, etc. This should be good news and help you realize what resources are available to you if you decide to meet with an advisor to help you prepare a customized plan. Developing a projection of your retirement income stream will help you decide whether or not you can afford to retire.
2. What is your projected retirement lifestyle budget? Think about what you plan to do in retirement. Take the time to identify where you are spending your money today. Then, ask yourself how that is going to change, if at all, after you retire. Do you plan to do more travel? Do you plan to pay off some debt? Once you have a projected retirement budget, then you can use that figure in the retirement analysis. If you don’t do the analysis yourself, there are free online tools available or you can contact a financial advisor to help you project how those expenses will be affected by inflation and taxes.
3. When should you begin drawing Social Security? That depends on how much you have saved, what your retirement budget looks like, and how much risk you want to take in the market. These are some of the items that you can control. Unfortunately, there are a whole bunch of other factors that you can’t control. For example, we have no control of interest rates, the stock market, the bond market, regulations, weather, health, war, terrorism, etc. So, you need to focus on those factors that you can control.
4. How much income can you generate from your retirement assets? Portfolios can be structured to accomplish many different objectives, including defensive (avoid loss of principal), income (focus on interest and dividend income) or growth (ignore short-term volatility). Each of these has a place in a retirement plan, depending on several factors, including your retirement savings, projected retirement budget, risk tolerance, health, and legacy goals. While 4% is a common distribution rule of thumb, you may need more or less, and you may or may not be able to afford this distribution, depending on the factors mentioned. It is best to have a professional perform an analysis of your needs in order to provide you with a distribution rate that best protects your assets and supports your long-term retirement goals.
5. How much risk should you be taking? Typically, I have found that clients are unsure of how much risk they need to take. In some cases, they don’t even understand how that relates to a targeted portfolio return. Most clients relate their returns to the S&P 500 or the Dow Jones Industrial Average (DJIA), as opposed to a specific long-term goal. They look at whether they are better or worse than the individual markets. The S&P 500 tracks the price of the 500 largest US corporations and the DJIA tracks the 30 largest US corporations. In most cases, these indexes have little or no correlation to a client’s portfolio. One of the key outcomes of my retirement analysis is to show clients the minimal targeted return on their retirement assets that will support their desired retirement lifestyle. This is a very important piece of knowledge. Once my clients know that percentage return, they can better select an allocation that minimizes the amount of risk they need to take in order to be financially successful in retirement.
6. What are the most appropriate investment strategies for your retirement assets? Investment strategy ought to be born from risk management. While there have been many studies that support the belief that portfolio returns are more dependent on asset allocation (percentage of portfolio in stock vs. bond vs. other investments) than on individual holdings, including the Determinants of Portfolio Performance by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, there have been even more white papers published that disagree with that belief, including The Asset Allocation Hoax By William Jahnke. No matter which side you are on, it is clear that the balance between stock, bond and other is an important consideration, as is the specific investment vehicle(s) used to make the investment. So, whether you are a do-it-yourselfer or you work with a financial advisor, I believe that it is critical that you start with the risk profile that model. One advantage of working with an advisor is being able to have them help you identify how much risk you need to be exposed in order to accomplish your long-term investment goals.
7. What will you do in retirement? Some people are so focused on their daily jobs working up to retirement, they literally run right up to the point of making the retirement decision before they realize that they have not really thought about what they are going to do in retirement. This can be a real problem. Active people become restless or frustrated when they don’t have anything to do. I strongly suggest looking—well before a desired retirement date—into volunteer work, part-time jobs, and consulting are common choices. From my perspective, I have found those that do the best in retirement have a plan to stay active, physically as well as intellectually. Spending time doing what you want to do can be very healthy. Whether it is a new hobby or volunteering for a cause in which you feel very passionate, having a reason to get up in the morning is critical to long-term health and satisfaction in retirement. According to a recent Employee Benefit Research Institute (EBRI) study, it appears that the link between people that die shortly after retirement may be linked to inactivity. Your body and mind need to be active. Don’t turn them off just because you have retired.
According to the Employee Benefit Research Institute (EBRI) study, it showed that people who calculate how much savings they will need are more confident about their ability to retire.
As with other aspects of your life, like your vacation, doing proper planning significantly increases satisfaction with the outcome. If you haven’t spent the time you should have on your financial plan, contact Szarka Financial to set up an appointment to discuss your long-term financial needs.
During these past few months, we are basically seeing more of what we have already seen this year.
- Volatility is back.
- Interest rates are at record lows, in the U.S. and across the world.
- U.S. economic growth is slow, but steady.
- International economic growth is flat to negative.
- Commodity prices continue to fall.
Looking forward, it appears that the above conditions will be with us for some time. Stock market volatility has increased in most stock, bond and commodity markets. The uncertainty of the global economic markets appears to have unnerved the investment community. As a result, the greed that has been ruling investor behavior has given way to fear.
In my opinion, China was the tipping point. Until their meltdown a few weeks ago, the investment community was feeling cautiously optimistic, afraid to be left out of any further gains from the stock markets. The U.S. stock market, as measured by the S&P 500, had continued to set record high water marks earlier in the year, closing at 2131 on 5/21/15, after rising over 200% from the 3/9/09 low of 676. International stock markets, while having lagged the U.S. stock market, showed signs of life, responding to the European Central Bank’s version of a Quantitative Easing program initiated in March 2015. While commodity prices had been stagnant, there was a belief that the consumer would spend the extra money, saved from lower energy prices (gasoline, electricity, and natural gas), on goods.
Then the Shanghai stock market started to drop in June 2015, falling more than 30% in a three week period. In August 2015, The Chinese government cut the interest rate, the Peoples Bank of China devalued their currency, the renminbi, and other stern measures were taken in hopes of stemming the market retraction. It didn’t work, further unnerving an already nervous investment community which took the move as confirmation of the softening economic environment in China. If China was slowing down, it was projected that the ripples were going to be felt worldwide and the investment community reacted.
The U.S. stock market, as measured by the S&P 500, retracted to October 2014 levels, noteworthy as this marked when the Federal Reserve officially ended QE3, the latest version of the U.S. quantitative easing which had begun tapering in January 2014. The international equity markets reversed their most recent gains and pulled back in response. Commodity markets moved somewhat lower, with oil prices dropping even further. The only good news, though not dramatic, was that there was economic data supporting the belief that the U.S. consumer was now spending some of the money they saved in energy costs on consumer goods.
So, what does this mean to investors? It means it’s going to be even harder to find the kind of returns that have been achieved over the past six years, since the S&P 500 low on March 9, 2009. The forecast is for a “new neutral”, a term coined by PIMCO, a global investment management firm, in May 2014. The belief is that interest rates will continue to be at relatively low levels, the stock market will see very moderate growth over the near term, and inflation will remain in check. The evidence so far supports this belief. Furthermore, no one can accurately predict when these conditions will change.
So, how do you position your investments in this environment? Typically, investors do not like uncertainty and there is a lot right now. It means the investment community has had to recalibrate their expectations. So reviewing investment portfolios and adjusting them to these market conditions becomes even more critical. How much risk should you take? With the risk-free return equal to around 1.0% and inflation running around 2%, how do you protect your purchasing power? If you are a client of mine, you know that I define the risk you need to take based on what target return you need in order to accomplish your long-term goals.
Reacting to short-term stock market volatility can give you gray hair and an ulcer. These conditions can test your investing discipline, but I strongly recommend that you refer to your long-term plan, assuming that you have one. If you don’t have one, get one. You have a lot of planners and investment advisors to choose from, but my investment recommendations are based on risk parameters that are consistent with a long-term plan. I would be happy to help you update your existing plan or define a new plan for you in order to help reduce your short-term anxiety and increase the probability of your long-term plan success.
In the midst of a six-year market rally, more than half of Americans don’t own any stock investments at all, potentially missing out on a big investing opportunity to build retirement savings and overall wealth, according to a new Bankrate Money Pulse survey.
It’s often said that a rising tide lifts all boats. “But a rising tide isn’t much help if you don’t have a boat”, according to Claes Bell, CFA and Mobile Editor at Bankrate.com.
Bell cites six factors contributing to this behavior:
- Sitting on the sidelines
- Lost years for millennials
- Why we’re not taking stock
- Failed financial education
- Mistrust of the markets
- Many not paying attention to retirement
From my perspective, three of these points are especially critical to the financial planning success of my clients; MANY NOT PAYING ATTENTION TO RETIREMENT, SITTING ON THE SIDELINES and MISTRUST OF THE MARKETS.
Many not paying attention to retirement
Planning for retirement takes time. I specialize in retirement planning, so it’s not surprising that I believe that this is one of the most important factors.
Actual planning for retirement can be done reasonably quickly, but implementing an effective plan usually takes years, even decades for those that are early planners. The interesting thing is that it is so much easier the earlier you get started. I have four children and I have always told them, “The hardest part of any project is getting started.” And like any successful project, the more you pay attention, the better the results. Consider two couples, thinking about retirement, but at very different points in their lives.
George and Pauline Smith, a 60 year-old couple, are thinking very seriously about retiring in five years. They have never met with a financial planner before, but now that they are approaching retirement, they feel it may be useful to get some input on their plan. They meet with a financial planner and find that they need to save an additional $200,000, over and above their current retirement savings plan, to support their planned lifestyle for retirement in five years. That means they need to save an additional $2,941 per month, assuming that they earn 5% over the next five years, to have $200,000 added to their retirement savings.
In contrast, Fred and Jane Jones, a 40 year-old couple, just met with a financial planner for the first time. They learn that that they need to save an additional $200,000 over the next 25 years, in addition to their current retirement savings plan. However, they only need to save an additional $336 per month, assuming that they earn 5% over the next 25 years, to have $200,000 added to their retirement savings.
Which couple is going to have the better chance of success? That’s pretty obvious, right?
Having a plan which specifies a disciplined savings plan and an appropriate investment allocation is critical. However, it is also very important to monitor progress toward intermediate goals and adjust the plan, if necessary, to achieve the longer-term results.
Sitting on the sidelines
The Bankrate Money Pulse survey found that 52% of Americans report not owning any stock-based investments. Robert Stammers, CFA and director of investor education for the Chartered Financial Analyst Institute, is not surprised. He states that many Americans “see themselves as savers and they worry about capital preservation and don’t take the risk necessary to achieve the returns that they need to fulfill their long-term investment goals. The average person has less than $25,000 saved for retirement. So people certainly aren’t prepared, and that’s just making them less prepared.”
Reflecting back to the Smith and Jones families, the additional savings required for their retirement may not be their biggest challenge. Achieving a 5% annual return in the current environment may be the bigger challenge, especially for the Smith’s. Interest rates are at historical lows, making it more difficult to meet that goal over the next five years. Having a retirement plan and saving early is critical, but the addition of some exposure to equity-based investments can help investors achieve portfolio returns that exceed inflation, potentially increasing their personal wealth over time.
Without the higher returns realized from some exposure to the equity markets, the longer-term issue for these couples may be their purchasing power. Inflation increases the cost of living, thereby reducing purchasing power by an average of 3% over time. Since that rate currently exceeds the interest rate on any type of guaranteed savings account, individuals are forced to take more risk in order to beat inflation. The low interest rate environment is likely to stay for some time, longer than most “savers” would like to see. So, some exposure to the equity markets may be required for many in retirement.
Mistrust of the markets
With two major (+45%) corrections in the stock markets since 2000, coupled with illegal trading, high-speed trading, inside information, and fraudulent brokers and advisors, it’s no wonder that the general public mistrusts the markets. Many of those that lost a material amount of their savings in the stock markets have not forgotten, and are reluctant to put what they have left back in those same markets. Regrettably, the media has helped prolong their memory. “It’s funny because most of the people who stayed in the market actually did OK,” Stammer says. Unfortunately, fear sells more in the media, so the major financial networks tend to focus on that instead of how well portfolios may have recovered.
We can learn a lot from both the Smiths and the Jones. Starting a disciplined savings plan early in life, with an appropriate investment allocation is vital. But that is not enough. Monitoring the progress of your plan periodically is also just as important. These essential steps toward sound financial management might make the difference between you just surviving in retirement vs. enjoying your desired retirement lifestyle. Don’t wait until tomorrow to develop your plan. And, if you already have a plan, why not consider getting a second opinion to make sure you are still on the right track?
USA Today recently published a study, which found that while many Americans with significant savings fear going broke in retirement, they are not willing to cut back on their current lifestyle to save for the future.
About 55% of respondents say that they fear not having enough money in retirement, more than they fear losing their job (37%) or gaining weight (25%), according to the 2014 Bank of America’s Merrill Edge report, which is released twice a year.
These results are based on a national survey of 1,000 people defined as emerging affluent because they have $50,000 to $250,000 in total household investments, including cash, savings, mutual funds, IRAs, stocks, bonds and other investments. About 90% of respondents have retirement savings, and they began saving at the age of 33.
Despite their fear of going broke, 33% are not willing to cut back on entertainment to save more, 30% won’t reduce eating out, and 28% are not willing to forego vacations, the survey found. More respondents (63%) say having money to live “here and now” is more of a priority than those that said saving for the future (48%) is a priority.
So, why the seemingly short-sighted view? Is this a problem?
One might expect that a plan would help. Even a short-term plan, like a budget, would be helpful, right? Well, 89% of the respondents said that they have a household budget, but yet 66% say that they can’t live within it! More women (59%) than men (51%) are worried about outliving their money. Men will likely be surprised to know that women are more apt to cut back on eating out and shopping for clothes! By the way, more divorced individuals (68%) are worried about outliving their money than their single, married or widowed counterparts.
In my opinion, this is a problem. When I work with an individual or couple, one of the first steps I take is to develop a long-term financial retirement projection. It’s a model and there are a lot of factors that can affect it, now and in the future. But, having that starting point is very enlightening for my clients. It takes away the guessing, the supposing, the wishing and the hoping! Remember, hope is not a plan. The model reflects the client’s assumptions and delivers an objective view of the future. It can be updated at any time and rerun to identify progress toward the retirement goals or opportunities to make adjustments. We can and do measure the progress against those assumptions over time.
Whenever I perform this analysis, I lump the outcome into three major categories; well prepared for retirement, borderline prepared for retirement, or not prepared for retirement. Knowing this information allows my clients to take steps to react to the analysis.
Those that are well prepared for retirement may be ironically too conservative in their lifestyle and can consider doing more than they thought they might do in retirement. If they have lived a conservative lifestyle, which is why they are so well prepared for retirement, they may have an estate issue. What are they going to do with all of the money if they don’t spend it?
Those that are borderline prepared may want to take a slightly more conservative posture in their current lifestyle. It is amazing how easy a small change is–if you have time for that change to take effect. Imagine a ship that leaves the shore and the direction is off slightly. If it’s a short trip, it may not make a difference. But, if the ship is heading to a destination 1,000 miles away, a few degrees off course can mean that ship will miss the destination by hundreds of miles. The more time you have, the less sacrifice you have to make in order to improve your future financial success.
For those that are not prepared for retirement, the outcome of this analysis can be very devastating. However, depending on how long the client(s) have to react to the information, the personnel involved can take steps to reduce the gap in their retirement plan. Again, the more time they have, and the greater the current sacrifice, the more progress can be made. In these situations, clients also may choose to adjust their retirement goals. Maybe they were too optimistic about what they could do or maybe they just didn’t know.
I am a great believer in knowing where you stand. Once you are armed with that information, you can react to it. My recommendation is that you focus on your plan. If you have one, update it and follow it. If you don’t have one, now is the time to put one in place.
Finally, the investment strategy for retirement assets ought to be coordinated. They need to work together, in terms of the overall risk. Savings accounts are not earning much right now, but if they are targeted for retirement, they are part of your allocation. They need to be offset by the assets that are exposed to the market. The amount of risk your portfolio is exposed to in the various markets, including US and International stock markets, US and International bond markets, real estate, commodities, etc., is something you can control.
Once you retire, portfolio risk and expenses are really the only things that you have direct control of in your retirement plan. Before you retire, you can also control the amount you save. If you have control of these factors, you can feel free to enjoy the here and now! If you don’t have control or you aren’t sure, you owe it to yourself to find out how well prepared you are for retirement. Give me a call and let’s start this important discussion. It could make the difference between you being well prepared for retirement or potentially hundreds of miles off course.
Although it was only a few weeks ago that we were celebrating the holidays, and an overall good performance in the markets for 2014, what we have seen thus far in the U.S. and International stock AND bond markets may be glimpse of what we can expect in 2015.
If so, it’s likely to be a rough ride. Volatility seems to be back and investors are not very excited about it.
We know that fear and greed can drive market behavior, right? Volatility is a key driver of fear, and the media all too often seems to feel compelled to spread it, thus investors need to be able to separate reality from negative hype and over-reaction. Oddly, YTD, through 1/20/15, the S&P 500 was down only 33.46 points, or 1.6%, while the U.S. bond market, as measured by the iShares Core U.S. Aggregate Bond ETF, was actually up 1.3% over the same period. This news surprises most people because the media’s attention seems overly focused on volatility.
Globally, record low interest rates across the world have left many countries with negative interest rate yields, and the currency market has recently been whipsawed by the latest moves by the Swiss central bankers. Slow-to-negative economic growth and lower government spending in foreign countries is threatening to offset U.S. gains and lower overall global growth projections.
So, what’s going on? What is causing this to happen?
Americans are spending less. The U.S. consumer represents 65% of the U.S. Gross Domestic Product, or GDP. So, as the American consumer goes, so goes the U.S. economy. We are a service-oriented economy, so the basic philosophy is that we all need to do our part and spend money in order to keep the economic engine running. And a healthy U.S. economy supports growth in the job market. While recent quarterly data indicates that the retail sales have increased over the past two quarters, the holiday season was a little disappointing. How the consumer reacts to the news of a global slowdown will likely tell us how the U.S. stock market will perform in 2015.
The global economy is weakening. While the United States continues on a slow, but steady economic recovery, the rest of the world appears to be moving in the opposite direction. China has just reported the lowest growth experienced over the last several years and Japan continues its economic struggles. The European Central Bank just announced an economic stimulus plan, similar to the one that the United States just exited. How the global economies and investment markets react to this stimulus will be determined in the future. On top of that, the trickle-down effect of the significant drop in oil prices is also yet to be determined.
Commodity prices continue to fall. Overall, commodity prices have been basically flat to down over the past year as global demand for them has diminished. Energy prices are down dramatically, with crude oil leading the way as prices recently dropped below $45 per barrel, which was the first time since April 2009. Copper has plummeted recently as well. In contrast, gold and silver prices are up year-to-date (probably as a flight to safety in light of the increase in volatility), but are still trading at levels below their value two years ago. Given that most global economies have slowed down, many of which are basically flat compared to one year ago, commodities are not expected to recover any time soon.
What does all of this mean and what should you do about it? Many Wall Street analysts talk about how volatility provides buying opportunities. Well, that depends on how you manage your portfolio. If you are a frequent trader, it may give you a place to invest your cash. But, if you are a more typical investor, your funds are likely fully invested in a balanced portfolio. For those with a long-term perspective, staying the course may be the best strategy to ride out this storm.
If your portfolio is making you seasick, it may be time to have more than just a quick chat with your financial advisor. You may want to schedule some time to revisit your goals and objectives with your advisor to see if you have the right plan.
Give me a call, and let’s talk about your short and long-term financial goals.
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