What is 450 you ask?

It is a name that finds it’s inspiration in the lives of savers and investors. In essence the name is “for the fifty.” But each of us must ask ourselves “which fifty am I?” or “which fifty do I want to be?”

Are you at risk of becoming...

You see, 450 is most of us. 

We’re either hoping Social Security will help us out or hoping our modest savings will miraculously stretch across 20-30 years of retirement.

The good news is it’s never too late to start.

There is always hope and opportunity to put a little away now so that you can live the life you want to live when work is no longer an option and retirement is upon you. Our publishing company, which is focused on and created “for the fifty” will deliver topics that are easy to read and always written with you in mind. Our goal is to educate and equip savers every step of the way.

As our friends at Charles Schwab post their 2018 Modern Wealth Index data[1], their research findings are eye-opening:   

1. Sixty percent of Americans live paycheck to paycheck

2. Only twenty-five percent have a written financial plan.

Ultimately, the Schwab findings point to a challenging financial future for most American.  About one-half of all American households with residents age 55 and older have no savings such as a 401(k) plan or IRA.  The latest GAO report findings make sense given the number of workers living paycheck to paycheck.

Money isn’t something a whole lot of people enjoy talking about, but at some point, the tone should change so that we can put these glaring facts on the table and work towards a flexible solution.  It seems the findings are explicit (at least with the 2018 Modern Wealth Index): if you have a written plan, you’ll be in the top decile of financial performers.  In other words, you’ll put yourself in an optimal position to have both financial peace and wellness.

[1] www.aboutschwab.come/modern-wealth-index-2018

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Image credit: Amol Tyagi

Over the last nine months since my daughter was born, I have learned to hear and translate her grunts, squeals, cries, and even noises that sound very similar to what a pterodactyl probably sounded like. The other night I woke to a cry that was not familiar. In her sleep she had stuck her foot through the slats in the side of the crib, but when she turned to pull her foot out, she could not; her foot was stuck. Putting her foot in the space between slats was easy, pulling it out…well, that was a different story.

This experience can be similar to that of an investor who has saved well for retirement but may have difficulties withdrawing dollars due to Sequence Risk. Sequence Risk, also known as sequence of return risk, is the risk assumed by an investor taking withdrawals from an investment account when receiving lower or negative investment returns. Specifically, this becomes serious early on in someone’s withdrawal timeline, as the investor/retiree ends up withdrawing a larger portion of their total portfolio than planned. Knowing what Sequence Risk is and how to plan for it is instrumental to a successful long-term financial plan. To illustrate Sequence Risk and its impact, let’s first look at the 20-year experience of two investors who are not taking withdrawals (Scenario 1) compared to the experience of the same two investors who are withdrawing from their accounts during that same 20-year period (Scenario 2).

A Scenario of Two Markets

Investor A deposits a lump sum of $400,000 in the S&P 500 (500 biggest companies in the US) on January 1, 1998. Investor A does not touch her investments for 20 years and now her balance is over $1,600,000, despite both the Dotcom Crash and the 2008 Financial Crisis. A great reward for the disciplined long-term investor.

With Investor B we see a similar scenario. She deposits a lump sum of $400,000 in the S&P 500 and doesn’t touch it for 20 years. Except this time the annual returns of the S&P 500, while staying the same, are randomized in their order and weighted for an early market downturn of two consecutive years of negative returns (-37% and -22.1%). After 20 years Investor B arrives at the same balance of over $1,600,000.

Scenario 1:

For the long-term investor, the sequence of returns does not seem to influence the investor’s portfolio if he or she is not withdrawing from their investments. Both Investor A and Investor B, while having very different market experiences, arrive at the same place. A great case for the long-term investor to not balk at market volatility.

The Sequence Risk for a Retiree

Where the order of returns does impact the investor (i.e., a retiree) is when they begin withdrawing from their investments in a down market. To see the impact Sequence Risk has on an investor, we will look at the same investment returns experienced by Investor A and Investor B. In this scenario the difference is each investor will begin taking annual withdrawals of $20,000 (5% of beginning balance) at the end of each year.

With Investor A, we see after the market experience of the S&P 500 from 1998 to 2017, she would expect to have $618k after 20 years of retirement.

As for Investor B, when the market experience begins with a downturn for the investor, the retiree’s balance would be significantly less, only $193k. A difference in the order of returns can mean a difference of almost $425k, or a 1/3 of the portfolio size, after 20 years.

Scenario 2:

Why does it matter?

Two retirees with identical wealth can have entirely different financial outcomes, depending on the state of the market when they start retirement and begin taking withdrawals, even if the long-term market averages are the same.

What do you need to do?

While you cannot control what the sequence of future returns is, there are things you can do to impact the success of your financial plan. If you are a long-term investor, make sure you have a plan, revisit the plan annually, and stay disciplined. If you are already in or are entering retirement, it is important for you and your advisor to plan accordingly:

Assess your risk. Appropriately assess your risk as you are entering retirement years. Assuming more risk than necessary paired with a down market can make you greatly susceptible to Sequence Risk.

Lower retirement expenses. Pay off any debt (including mortgage payments) before entering into retirement. Having fewer expenses in retirement provides flexibility for when the markets get rocky and withdrawing less is prudent (based on what was just laid out about Sequence Risk).

Have a short-term strategy be a part of your long-term financial plan. Hold assets that allow for flexible spending without having to veer from your long-term strategy. Holding cash or fixed income investments can provide short-term income sources, helping you avoid withdrawing a large portion of your total portfolio in a down market.

Continue working. If entering into a market experiencing low or negative returns, keep your job. What no retiree wants to hear after a long career of hard work! However, continuing to save and to delay retirement withdrawals by even a few years has the potential to yield long-term exponential growth.

While my daughter had no issue putting her foot in the space between slats, the issue was pulling her foot out. Dad was able to save the day. Realizing the most efficient angle, I was able to help her pull her foot out. With investors, sometimes it takes someone to come alongside and help strategize the most efficient strategy to withdraw dollars, no matter what is going on in the market. If you are planning on retiring soon and want help building a tailored financial plan and assessing the risk on your retirement accounts, let us know. Human Investing is here to help.   

*Scenarios are used for illustration purposes only. Past performance is not an indicator of future outcomes.

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A recent theme in our client conversations has been around the timing of investing. On a regular basis we hear the question, “when is the right time to invest?” especially when times are uncertain. It’s a great question, one that is worth considering, but before answering this question let me state: We at Human Investing are long-term investors. Don’t mistake that for “buy and hold,” but rather “buy and assess.” Additionally, we believe financial planning is the key to investment success. While planning does not guarantee success, it does improve the odds of a successful outcome. In our advisory practice, the financial plan informs the investment decision.

Once the plan is in place and we’ve made the decision to invest, the timing of investing may not always mean we push a button to invest one hundred percent of someone’s capital in that moment. What it does mean is that we have a thoughtful discussion on the different strategies we might utilize to put the money to work, choosing the right option based on the client’s plan and their input.

Let’s walk through an example. The chart below is a hypothetical client who invests $500 per month ($6k/year) over an eleven year period starting January 2007 and ending December 2017. For this exercise we simulated investing the $500/month into a simple total stock market index exchange-traded fund with the symbol ITOT. The total invested capital in 2007 was $66,000 with net proceeds of $136,809 on the last day of 2017. Pretty incredible results considering the eleven year time frame included small gain and loss years of 2007, 2011, and 2015 and a large loss of 39.42% in 2008.

This is a great example of a strategy called dollar-cost averaging. Dollar-cost averaging is an investment strategy with the goal of reducing the impact of volatility on large purchases by adding small amounts of the intended purchase into the market over a specified period of time. Technically speaking, taking a lump sum and immediately investing the funds for an extended period of time is the best option. The challenge with the lump sum method is that many investors struggle to invest 100% of their money right away due to factors like willpower and emotion. With the dollar-cost averaging approach the investor puts his money to work bit-by-bit, which for many, feels good emotionally and prevents money ear-marked for investing from staying in cash too long. For these reasons and others, the methodical dollar-cost averaging approach has become the most successful way to invest capital for the long-run.

My intent is not to vilify a cash investment as bad. For many investors cash has a place and a purpose within their overall portfolio. I’m looking to highlight an effective approach/strategy for when a client’s financial plan requires a greater return than 1%.  

If you’ve asked the question, “What is this money for?” and the timeline is long-term, consider the total sum you are looking to invest, divide that sum into a reasonable time period and make a commitment to dollar-cost average those funds into the market. In doing so you won’t find that you’ve kept the funds in cash for any longer than is necessary, and you will be well on your way to your stated long-term savings and investment goal.

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Investor Principles for Success

Investors big and small, sophisticated and simple, struggle to get the investment returns they desire. DALBAR and Associates and others have documented the performance shortfall for years, but few tangible solutions exist to close the gap between actual returns and expected returns. From what I’ve observed, I believe the core of investors and their advisor’s failure is in not asking the question, “What is the investment for? What is the savings goal?” prior to making investment decisions.

* DALBAR; Blackrock

By consequence investors have failed to keep up with the performance of even the most passive investment. As mentioned, the success or failure of the individual investor is well documented by DALBAR and Associates. In the ten years leading up to 2016, investor returns (for asset allocation funds) were 1.89% per year. This return is far less than what a bond index (e.g. Barclays Agg.) would have yielded at 4.51%. The moral of the story? Individual investor behavior is a major contributing factor to under-performance. 

ASK THE QUESTION

Both advisors and individual investors must ask the question, “What is this investment for?” In other words, what are you trying to accomplish by foregoing spending right now and instead saving those dollars? Answering this question will create a goal/objective for the savings and will lead to investments that optimally align with the stated goal.

Consider for example Jane, a 25 year old investor with two different saving goals: 1) save for a house; and 2) save for retirement. It is fine if Jane thinks, “I’d like to be aggressive because I’m an aggressive person,” but that posture aligns much better with the retirement account that has 35-45 years before it is needed than it does for the house savings account with a 3-5 year saving and investing timeline. Because aligning investments with both the goal and the timeline is crucial when investing, ask the question, “Why am I saving. What is this for?”

BE DISCIPLINED

After you’ve answered the question for yourself and made the corresponding investments to align with your stated goal and timeline, it’s all about discipline. If like Jane you have a three to five year savings goal, then the objective would be a stable portfolio. But what if, during that time, Jane thought to herself, “The stock market is doing so well and my friend has made so much money investing in XYZ stock, maybe I’ll try and make a little more too.” While that is a fine thought, in the context of the goal and timeline, to act on it would be undisciplined. If the goal is to buy a house and it’s a short-term goal, the action for Jane is to maintain a stable job, budget her income, and stay disciplined to her investment plan since these will be key drivers in her ability to save for and purchase a house...not the stock her friend bought.

A lack of investment discipline may also impact the long-term investor. What if Jane made some aggressive choices for her VERY long-term retirement account? One day, the same friend who bought XYZ stock tells Jane, “I sold my stock. It was getting crushed. The market is crashing.” Jane may very easily feel that she made the wrong decision by investing “aggressively” in her retirement account and in reaction, sell. Being disciplined is about sticking to a prudent investment strategy based on your needs and timeline. For Jane, discipline may look like HOLDING these more volatile higher-earning investments not based on the short-term return but rather her long-term goals.

If the stated saving goals were aligned with the right investments, then there would be minimal volatility in the short-term house savings account. Similarly, with a longer-term goal (retirement) in place, Jane would expect to see more volatility with higher long-term returns than with the more stable investments she made for the house.

BE PATIENT

Whether you are an advisor or an individual investor, if you’ve asked the right questions and you have an investment plan to accomplish your goals, then be patient and wait for that plan to play itself out. If you’ve done the work upfront, then your probability for success will be much higher than if you failed to ask the question and go through the process.

Looking at the poor performance of the individual investor leads me to conclude two things: 1) too many investors have not asked the right question upfront to make an investment plan to meet their specific goals; and 2) those who may have started out by asking the right question have failed to stay disciplined to their objectives.

In summary,

1.       Ask the questions: “What is the purpose of these funds? What is the point of saving instead of spending?”

2.       Be disciplined

3.       Be patient

Sources: *BlackRock; Bloomberg; Informa Investment Solutions; Dalbar. Past performance is no guarantee of future results. It is not possible to directly invest in an index. Oil is represented by the change in price of the NYMEX Light Sweet Crude Future contract. Contract size is 1,000 barrels with a contract price quoted in U.S. Dollars and Cents per barrel. Delivery dates take place every month of the year. Gold is represented by the change in the spot price of gold in USD per ounce. Homes are represented by the National Association of Realtors’ (NAR) Existing One Family Home Sales Median Price Index. Stocks are represented by the S&P 500 Index, an unmanaged index that consists of the common stocks of 500 large- capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Bonds are represented by the BBG Barclay U.S. Aggregate Bond Index, an unmanaged market-weighted index that consists of investment-grade corporate bonds (rated BBB or better), mortgages and U.S. Treasury and government agency issues with at least 1 year to maturity. International Stocks are represented by the MSCI EAFE Index, a broad-based measure of international stock performance. Inflation is represented by the Consumer Price Index. Average Investor is represented by Dalbar’s average asset allocation investor return, which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/16 to match Dalbar’s most recent analysis.

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It’s the most wonderful time of the year. No not Christmas; one of the biggest sporting competitions of the year is underway – the NCAA March Madness! For the next few weeks NCAA Men & Women’s Basketball teams will complete against one another to see who will make it to the ‘big dance’ and who will go home crying. Tough competition, major upsets and bragging rights are experienced by both basketball teams and fans alike. Across the world numerous individuals have filled out brackets, making a guess on who will win/lose in the tournament. For every person who is competing there are just as many strategies in choosing their winners. Here are a few used in Human Investing’s office:

• Choosing the better ranked team (Each team is seeded 1-16, with 1 as the strongest team in their region.)

• If mascots were to fight who would win

• Consider a team’s (average margin of victory) x (Conference RPI)

• Let colors be your guide – pick your favorite team colors

• Flip a coin

• Ask your kids to help

• Following the crowd

• Google isn’t a bad strategy either

At the end of the day there are upsets and sometimes the most absurd strategy comes out ahead. When it comes to investing, left to their own devices most people have a similar experience with picking an investment strategy as they do with filing out a march madness bracket. Unfortunately for investors, the verdict is out: they aren’t doing a very good job. By the end of 2016, the S&P 500 had a 20yr annualized return of 7.68%. For the same time period, the average investor had an annualized return of only 2.29%, trailing the S&P significantly by 5.39%.*

*Dalbar; Blackrock

See the effects of the annualized return of stock and bonds on $10,000 over 20 years, compared to the “Average Investor.” A gap of over $33,000, jaw dropping. 

*Dalbar; Blackrock

The decisions investors make about how to diversify, the time they choose to get into or out of the market, fees they pay or underperforming funds they choose cause them to generate returns far lower than the overall market.

Don’t leave your retirement savings to chance. Have a process:

1.     Build an investment strategy that is tailored to your goals and time line:

• Start by answering the “Why.” Why are you investing? Is it to cover the cost of living at retirement so that you can continue to provide for you and your family? Or is it something else?

• Only after the “Why” should you figure out the “How.” Do you feel comfortable managing your investments yourself? If you don’t, get help.

  • Invest in a Target Date Date fund, built for an investment timeline that matches your date of need to utilize your investment dollars.

  • Hire an advisor to customize and implement an investment strategy based on your “Why.” Human Investing can help, come talk to us.

2.     Know yourself, know your risk: 

• Be aware and understand how your investments perform and react in different markets. Make sure you are comfortable with the risks associated with your investment strategy. If you are not, its time to go back and reassess the “How” of your financial plan.

• Having a plan and understanding how your investments work can help you stay the course and block out the noise which may hinder the decision-making process. A plan can help us approach our important financial decisions rationally rather than defaulting to impulse.

3.     Maintain & Monitor:

• Keep tabs of your account. Check in but avoid making frequent changes.

• Rebalance: Take a moment to rebalance your portfolio. As investments perform differently in different markets, ratios of investments in your portfolio will naturally change overtime. Bringing your portfolio back to the intentional investment ratios by rebalancing annually is a great habit. Automate this process if possible.

• Update your investment plan as life changes.

Don’t leave your retirement to the flip of a coin or by following what everyone else is doing. Whether you need help building a strategy to save for retirement or want pointers on how to fill out your March Madness Bracket, let us know. Human Investing is here to help.

Further Reading: Identifying your investment Risk 

Sources: *BlackRock; Bloomberg; Informa Investment Solutions; Dalbar. Past performance is no guarantee of future results. It is not possible to directly invest in an index. Oil is represented by the change in price of the NYMEX Light Sweet Crude Future contract. Contract size is 1,000 barrels with a contract price quoted in U.S. Dollars and Cents per barrel. Delivery dates take place every month of the year. Gold is represented by the change in the spot price of gold in USD per ounce. Homes are represented by the National Association of Realtors’ (NAR) Existing One Family Home Sales Median Price Index. Stocks are represented by the S&P 500 Index, an unmanaged index that consists of the common stocks of 500 large- capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Bonds are represented by the BBG Barclay U.S. Aggregate Bond Index, an unmanaged market-weighted index that consists of investment-grade corporate bonds (rated BBB or better), mortgages and U.S. Treasury and government agency issues with at least 1 year to maturity. International Stocks are represented by the MSCI EAFE Index, a broad-based measure of international stock performance. Inflation is represented by the Consumer Price Index. Average Investor is represented by Dalbar’s average asset allocation investor return, which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/16 to match Dalbar’s most recent analysis. 

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Highway 212 by Matt Duncan

While working with employees at retirement plans over the years, one thing I’ve realized is that being disciplined to save for retirement is challenging and there are many obstacles to doing it successfully. For those living the northwest, saving for retirement can be particularly hard due to the average wage vs. the cost of housing.

Income vs cost of living

When thinking about specific clients that truly save well, regardless of income, a theme that I see is all of these people have a specific mindset towards saving and understand how to achieve short term and long term goals. Over the past month I’ve had a few things cross my life about perspective and goal setting that I wanted to pass along:

First order vs. Second order consequences

A book that I’m in the middle of listening to is by a famous investor Ray Dalio who is the founder of Bridgewater Investments, the largest hedge fund in the world at 160 billion. Dalio, is one of the most successful investors of our time and has some truly unique ways of managing his team and thinking through problems. One passage that really stuck out to me is:

“I’ve come to see that people who overweight the first order consequence of their decisions and ignore the effects of second-and-subsequent-order consequences rarely reach their goals. This is because first-order consequences often have opposite desirability’s from second order consequences resulting in big mistakes in decision making. For example, the first order consequence from an exercise plan (pain and time spent) are commonly considered undesirable, while the second-order consequences (better health and more attractive appearance) are desirable.”

This principle holds true for investing towards retirement as well. By saving a $100/month for their future, a person is giving up something today (coffee, vacation, entertainment) in order to have a more desirable retirement. In other words, this is a first-order consequence and second order consequence type of decision. While this concept is not a unique one, I’d never heard it explained this way and it resonated with how I view decision making.

What’s your “This” in order to get “That”

A friend of mine made the comment a few weeks back “Has your company done the whole let’s set goals for 2018 and never check back in on them again movement?” Unfortunately, corporate goal setting has that stereotype. Often, because it’s true. Luckily our company has Jill, a mother of four and a low tolerance for time wasting activities. She recently implemented a quarterly system for goal setting and tracking. Our team has high hopes for this new system and we’ll ultimately see how it goes. My big takeaway from our time talking about goals was the video she presented by Dr. Henry Cloud called “Start Small”. In this video he speaks to how we all want to get to the big goal but have a hard time setting and sticking to smaller goals.

For some of the guys in our office this meant going on the TB12 diet plan to prepare for our upcoming middle aged athletic endeavors (for me my city league basketball team starting in late January. Wish me luck!).

For you, similar to the Dalio piece, maybe this means looking at what your long term goals is (i.e. having X amount of money at retirement) and shrinking that down to what do I need to do this month/this week in order to get a little closer to that goal.

At the end of the day, the phrases “mindset” and “goal setting” can sound really cheesy, and when done poorly can lead to nothing. However, when we look at our collective social circles and see people who have reached their goals (whether those be physical, business or relationships) often times they are using mindsets like the ones Dalio and Cloud are talking about. Hopefully these can be somewhat inspirational when it comes to putting away additional funds towards your savings goal.

If you have questions or would like to have a conversation about your retirement plan, please don’t hesitate to email or call our team!

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Happy New Year from your Advisors at Human Investing! Now that 2018 is in full swing we wanted to check in to make sure you are staying up with your New Year's resolution of saving appropriately. You may already know but the 2018 limits of how much you can save may differ from 2017 amounts. See below for your 2018 contribution limits. Want help making sure you are maximizing your retirement savings, we're here to help. Call our office at 503-905-3100 with any questions. Click here to be directed to the IRS website for further information.

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He’s making his list and checking it twice. Are you?

Make this year-end check list a gift to yourself.

Tax Overhaul – What you can do in 2017:

In light of the latest tax overhaul, millions of Americans will change the way they calculate deductions when filing taxes. With state and local tax deductions being capped at $10,000 and an increase in the standard deduction ($12,000 for single filers and $24,000 for married couples filing jointly), affected tax payers will not get value in itemizing deductions. Considering these changes, here are a few ways to be proactive with your tax bill in 2017:

• Accelerate Donations: Make charitable contributions in 2017 that you won’t be able to itemize in 2018.

• Bunch Future Donations: This is for those who plan to make charitable contributions in 2018 and beyond. If your donation will not increase your deduction above the standard deduction, save your donations for a year in which your donations will allow you to deduct more than that of the standard deduction.

• Utilize a Donor-Advised Funds: An investment account for the sole purpose of contributing to charitable organizations you care about. You can contribute cash, securities or other assets (such as bitcoin) into a Donor-Advised Fund and grow your donation tax free before contributing to the 501(c)(3) of your choice. In most cases this would allow you to take an immediate tax deduction.

• Gift Your Stock: Considering recent market growth, donate appreciated investments such as appreciated shares of stock. The donor is able to immediately deduct the full market value (up to certain limits) without paying capital-gains tax on growth.

• Make your Mortgage Payment in 2017: If you will have a mortgage payment due January 1, 2018, pay it by December 31 for 2017 deduction purposes. This is in light of the future $10,000 per return cap on state and local tax deductions (SALT).

Save:

A qualified retirement account like a 401k allows you to save large sums of money on a tax deferred basis. For the year 2017 an individual can save up to $18,000, with an additional catch up contribution of $6,000 for those 50yr or older. Saving today is the most impactful means for you to grow your retirement savings, as a bonus you are able take advantage of the tax benefits that come with contributions. See the impact of saving using our Retirement Calculator

Rebalance your portfolio:

Avoid unnecessary risk, take a moment to rebalance your retirement accounts and reassess your investment allocation. With stocks1 up 15.46% and bonds2 up 2.02% annualized over the last 5 years (see graph), you could be taking on some additional risk with an out of balance retirement account. Taking the time to rebalance your portfolio can help disperse some of this risk.

This graph shows $10,000 invested in both Vanguard Total Stock Market Index Fund Admiral (VTSAX)1 and Vanguard Total Bond Market Index Fund Admiral (VBTLX)2 in December 2012. $10,000 invested in stocks would have grown to over $20,000 while bonds would have grown to just over $11,000.

Unsure about your investment portfolio? Want to make sure that it aligns with your goals and timeline? Human Investing has tools to help.

Contribute to your Health Savings Account (HSA):

For those in high-deductible health insurance plans you can save $3,400 pre-tax dollars to your HSA. Have a family? You can save $6,750. Age 55 or older? Save an additional $1,000. To learn more about the cost of health care at retirement and the advantage of the triple tax benefit of a Health Savings Account see our blog post about healthcare at retirement.

Contribute to a 529:

Such contributions must be made before the end of the year to take advantage of any state-income-tax benefits or to be eligible for the federal gift-tax exclusion. Starting in 2018 per the tax overhaul, 529 accounts can be used not just for college education but also K-12 expenses.

Call Human Investing:

Let’s Talk. Human Investing is here to help. 503.905.3100

Source: WSJ.com, Laura Sanders.

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This past week I went on what has turned into a weekly running date with a buddy of mine. In addition to discussing our anticipation for the 2nd season of Stranger Things and who was going to binge the show fastest, my friend brought up an article he saw in The Wall Street Journal a few weeks ago. Knowing that I work at Human Investing, he asked: “I read something about how Morningstar Fund Rating are kind of bogus. Have you heard anything about that?”

Oh I had heard about it and I had many thoughts. Selecting a fund for investors has turned into murky waters over the past few years as it seems like many organizations are pushing their own agendas - explaining why their fund or fund process is best. In response to my friend and to the Wall Street Journal’s Article on Morningstar’s fund rating process

"https://www.wsj.com/articles/the-morningstar-mirage-1508946687"  I wanted to do a quick Q&A on a prudent process for selecting a fund or funds that fit into your portfolio.

These are the types of questions that are essential to ask yourself when selecting a fund:

Q: I haven’t read the WSJ article about Morningstar and it’s very long, can you summarize it for me?

A: Sure! In short multiple reporters did a yearlong investigation asking the question, “Is the Morningstar rating system a good guide for investors when looking to invest capital?” Their takeaway was that it is not and in my estimation they are somewhat right.

Q: Did Morningstar Respond to the article?

A: Yes. Morningstar took this article very seriously and gave multiple responses including this one  http://news.morningstar.com/articlenet/article.aspx?id=831740. I really enjoyed this paragraph and believe that it represents how investors should use Morningstar ratings:

“The star rating system has been a useful starting point for research that tilts the odds of success in investors favor.”

Q: In a nutshell should I use the star rating as my only means for choosing a fund?

A: No

Q: Okay so if star ratings aren’t the best way to judge a fund, then what should I do?

A: Now you are asking the right questions! As a fiduciary (someone who by law must act in the best interest of another) for many 401k plans here are a few bullet points that our firm typically recommends when selecting a fund:

• Regression to the Mean: Just because a fund or an asset class has recently outperformed its peers it doesn’t mean that trend will continue. More times than not it means the opposite is more likely. If you are currently selecting your funds based on short-term past performance, it might have worked out recently but you are playing a losing game in the long term.

• Passive over Active: By selecting a passive (index fund) over an active manager you are often accomplishing two things.

  • First you are reducing your overall investment costs which is an immediate savings to you.

  • Second you are subscribing to the idea that indexes historically outperform active managers. Historically this has been a true statement. The chart below speaks to indexes beating active managers in their respective asset classes 85% of the time over a 15-year period!!!! There are active managers who have outperformed their benchmark, however the deck is stacked against investors when trying to determine who that manager is.

• Behavior Management: You can do everything right when investing in a fund, but if an investor panics and sells out of an investment at the wrong time all of their good decisions are immediately lost by their behavior. Understanding the rocky road of long term investing is essential to selecting a fund(s) that fits your needs

• Risk Management: In line with behavior management is also understanding your risk and the risk of the fund you are investing in. If you knew there was the potential of your fund losing half its value how would that affect your decision to invest in the fund?

Solution

Whether you’re investing through your employer’s retirement plan or outside that plan, often a great solution is to use an age based target date fund or a risk based constant risk model (i.e. aggressive, moderate or conservative allocation fund). Both fund types look to take holistic approach to diversify risk and create an allocation either based on your age or risk profile. It’s important to check if these options use index funds as the component parts to ensure you are aligning with the aforementioned investment strategy.

Our team recognizes that tracking your investments may not be your full-time job. If this blog post or the WSJ article sparks any questions, please don’t hesitate to reach out as we would welcome talking through your investment selection process and make sure you are maximizing your investable dollars!

  #1: Know Where You Stand Financially

Whether because of singleness, divorce or death of a spouse over 90% of women will be managing their money alone at some point in their future. Because women tend to save less and live longer, it is critical that women start looking out for themselves financially!  The good news is there is always time for course correction. Below are a few tips to help you know where you stand financially.

1. Get involved in your household finances. Don’t be afraid to have the hard conversation with your significant other - your future may depend on it. Some couples find it helpful to set up a financial date night. Set some guidelines for the conversation. It can be an emotional topic so try and keep it light and educational.

2. Make sure you and your significant other are fully maximizing employee benefits, especially any employee match to a retirement plan, life insurance, and disability benefits.

3. If eligible contribute to IRAs; learn about and take advantage of the spousal IRA.

4. Have jointly owned as well as individual bank and credit card accounts. Speak with your trusted advisor about how you can protect one another in the event of a death or disability - you want to have access to accounts if you need them.

5. Most importantly, know where all the money is and keep log-in credentials for all accounts stored safely.

#2: Have a Plan

Envision retirement! Whether it is around the corner or 30 years away it is important to envision what you would like your future to look like and then plan for it. Whatever your income may be, it is never too early or too late to create a plan.  In our experience clients that have gone through the planning process tend to have more contentment, assurance of their future and unity with their partners.

A financial plan can help answer questions such as:

1. Are you saving enough?

2. Are your assets allocated properly?

3. Are you properly insured?

4. What will happen to your assets when you die?

5. How will you know if you have saved enough and can retire?

#3: Don’t Forget to Budget!

In our experience clients that budget tend to have a high rate of success at reaching their financial goals. When we take stock of what we are spending it is amazing to discover how trivial things may be eroding our wealth accumulation day by day. And you don’t need to re-create the wheel: there are some great budgeting tools out there that can help. One tool we like to refer clients to is YNAB (You Need a Budget). You can do research and find all kinds of tools and apps.  Many are quite user friendly and have apps that you and your significant other can both use.

#4: Put Your Money to Work and Ask for More!

1. Part of any good investing strategy is putting your money to work for you. If you are afraid to invest talk to your financial advisor about your fears and how you feel about taking risk. There are many different strategies to accomplish your goals. By expressing your fears, exploring the options and educating yourself you will be equipped to face your fears and overcome them or at least minimize them. The sooner you address your fears around investing the quicker you can put your money to work.

2. Ask for a raise! Although the gender pay gap is closing there are still many women that are not making as much as their male counterparts. One reason for this is that women are less likely to ask for a raise and advocate for themselves. Equip yourselves by working to achieve job goals, deepen your level of expertise and research what others are making in similar positions. At your next review present your findings and then be prepared to ask for that raise. You might be pleasantly surprised by the response you receive. Commit a portion of those new dollars towards your long-term goals and get them invested.

#5: Consult with Your Trusted Advisor

Having an advisor to assist and guide you on your journey can be a game changer.  Don’t be afraid to ask your advisor the simple and complex questions so you can be involved in the conversation.  If your advisor is not a good fit, look for someone you feel comfortable with, can trust and can easily talk with.  An advisor can provide you with accountability, a roadmap for retirement, counsel in turbulent times and help with financial discipline.  They can also be a huge asset in the event of a death or family emergency.  We have helped many families navigate these difficult situations as an added support.

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Do you participate in an employer’s retirement plan in which you own your employer’s stock? Before selling shares or rolling your account over to an IRA, you should consider a special election that could save you significant tax dollars. For taxpayers with employer stock held inside a qualified employer plan, the IRS allows a special election to distribute those shares at their cost basis and recognize the appreciated gain at preferential capital gain tax rates (avoiding “ordinary” income tax rates). This strategy is known as “Net Unrealized Appreciation” and is outlined in IRS code section 402(e)(4). The net unrealized appreciation is referring to the excess fair market value (FMV) of your employer shares over their cost basis. The election creates an immediate income tax liability on the cost basis of the distributed shares, but allows for continued deferral and favorable tax rates on the embedded and future gain.

There are three requirements to qualifying for and executing an “NUA” election strategy. First, the stock must be distributed out of your employer plan “in kind.” Transferring stock “in kind” means you take distribution of the stock itself, not its liquidated cash value. Second, the NUA election must be made as part of a lump sum distribution in a single tax year. You can make the NUA election on all or a portion of your employer stock and make a tax-free rollover with the rest of your account. The rules only stipulate that the entire account must be distributed/rolled over in a single tax year. Lastly, the lump sum distribution must transpire from one of four situations: death, attaining age 59 ½, leaving the company, or disability.

Below is a chart that outlines the tax treatment of employer stock distributed in an NUA election (www.kitces.com)

For example, let’s say you were a Nike employee and inside your 401(k) you hold 150k of Nike stock. Those shares have been purchased inside your 401(k) over a 20-year career and have an average cost basis of 50k. You retired last month and are looking to roll over your 401(k) assets into an Individual Retirement Account (IRA). Before making the rollover, you decide to make the NUA election on all your Nike stock. The distribution of those shares at their cost basis is immediately taxable at your ordinary income tax rates (i.e. 33% * 50k = $16,500). Those assets are now outside a qualified plan and all embedded and future appreciation can be realized at capital gain rates. Let’s say you then held those Nike shares until they were worth 200k. That 150k gain (200k FMV – 50k basis) would be taxable at 15%, or $22,500. So, in total with an NUA election, you paid $39,000 in Federal income tax. In contrast, by not making the NUA election, and rolling the entire 401(k) into your IRA there is no immediate income tax bill on the rollover, but all embedded and future gains are taxed at ordinary income tax rates. So, using the $200,000 fair market value assumption, and a lower 25% Fed tax rate, your tax bill would be $50,000 when drawn out of the rollover IRA account. The NUA election would have saved $11,000 in Federal income taxes.

Because there is a tradeoff between recognizing income immediately on an “in kind” stock distribution (NUA election) and a full retirement plan rollover, the cost basis in those employer shares is a significant consideration. The lower the cost basis in the shares, the better. Studies have shown unless your cost basis is 50% or less of the stock’s FMV at the date of distribution it is hard to make a case for the NUA election, and a full rollover to an IRA likely makes the most sense (www. kitces.com).

That said, everyone’s situation is different and there are varying factors that may lead to one recommendation over another. Even your desire for charitable giving may weigh in on the decision. For example, let’s say you were to make the NUA election and receive 100 shares with a cost basis of $40 and a FMV of $100; this would create 40k of gross income in the year of distribution. But, if you were to donate 40 of those 100 shares to a charitable organization or donor advised fund, you could create an offsetting 40k charitable contribution deduction. This offsetting deduction could mute the immediate income tax impact and leave you with 60 shares (60k value) that can appreciate at preferential tax rates outside of a retirement account.

There are a multitude of taxpayer specific situations and profiles that may or may not support making the NUA election. So, if you hold employer stock in a qualifying retirement plan and are getting close to retirement, looking to rebalance the account, or sell out of any of those employer shares, please reach out to us and see if an NUA election strategy makes sense for you.

If you would like to talk with one of our advisors please call Jill Novak at 503-905-3100.

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