@alecbennett95

Looking to go on a “once and a lifetime” vacation to Fiji? Renovate your kitchen? Upgrade your car? Did you know you may be able to utilize your 401k or other retirement plan to take a loan to help finance this big expense? Here are the details, the dangerous reality, and things to consider when taking a 401k loan:

The Details:

If your plan document permits, a 401k loan can help you access up to $50k of likely your biggest pool of assets, avoid creditors, pay interest back to yourself (typically prime rate + 1%) and there is no need for good credit to qualify. You wouldn’t be the only one taking advantage of this opportunity; according to the National Bureau of Economic Research, about 1 in 5 active participants have a 401k loan.

NBER Working Paper No. 21102

The Dangerous Reality:

Does all of this sound too good to be true? Well, it just might be. A 401k loan can come at the cost of hundreds of thousands of dollars in future retirement income (see graph below). So, whether you have a loan or are planning to take a loan, it is important to know some of the dangers of borrowing against your future self:

Forfeit the tax advantage of your retirement plan dollars - When you are paying back your loan, interest payments are done so after tax. This forfeits the tax advantage of these retirement dollars as taxes are paid when you contribute and later withdraw.

Leaving your employer? Think again - If you leave employment at your company, whether by your choice or your employer’s, you will find yourself in a sticky situation. The remaining balance of the loan will need to be paid back by the time you file taxes for the current year. Defaulting on your 401k loan comes at a great cost. The remaining loan balance will be considered taxable income. If you are under age 59 ½, a 10% early withdrawal penalty will be tacked on as well.

Abandon free money – If your 401k has an employer match you may miss out on free money if you cannot afford to continue contributing to your 401k while paying back the loan.

Miss out on market growth - Your dollars are not fully invested while you have an outstanding loan balance. This means a portion of your portfolio would miss out on opportunity for growth, specifically when market returns are greater than the interest rate paid to yourself.

Detrimental impact on retirement income - A 401k loan can have a detrimental impact on your retirement savings and your potential income in retirement. The below graph shows the effects on an individual’s retirement savings and monthly retirement income. Three scenarios shown are 1) take a 401k loan and push pause on contributions; 2) take a 401k loan while continuing to save; and 3) don’t take a loan.

This graph is for illustration purposes only. It highlights the impact a loan has on an individual’s retirement balance and monthly retirement income after 30 years of investment growth during working years (assuming 7% annual market return and annual contributions of $7,500) and 30 years of income through retirement (assuming 4% rate of return). In this example an individual takes a $15k 401(k) loan from a $50k balance to pay down some bills and a finance a vacation.

The “once in a lifetime trip to Fiji” can ultimately cost more than $1,400 per month in retirement income.

That’s $515k over 30 years of retirement!

Options to consider:

For some, a 401k loan can be a helpful tool when “life happens,” allowing participants of retirement plans the ability to access a pool of assets intended for retirement. However, while this can be an attractive tool for some, borrowing from your future self can have its drawbacks. Either way, here are issues worth thinking about:

• Want to go on a once in a life time trip to Fiji, or finance some other big expense that isn’t worth putting your retirement income in risk? Budget for future big expenses, plan and start saving today.

• Building an emergency reserve (3-6month’s income) to keep you on track financially and avoid a last resort 401k loan when an unexpected expense comes up.

• Are you in a pinch and need to take a loan or have already taken a loan? Continue saving in to your retirement account so as to not miss out on valuable retirement savings and possible employer match.

• Want to take a 401k loan? Check with your HR representative or 401k advisor to see what options are available to you.

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Many of the blogs that we post reference strategies on how to save for retirement and how many Americans need to save more than they currently are (or else you might end up like this.)

However, in addition to saving, many of us will be a recipient of a retirement account via a loved one or acquaintance passing away. Will Kellar and I had the idea to consolidate some good resources online and provide a road map for beneficiaries as they look to navigate best practices when they are on the receiving end for one of these accounts. In a season of loss, remember we are here to help navigate this difficult time.

You are listed as a beneficiary, are you the SPOUSE or OTHER?

You are a spouse listed as a beneficiary

 

Traditional, SEP IRA, or SIMPLE IRA

Option 1: Transfer the assets to your own IRA

Benefits

• Dollars can continue to grow tax-deferred.

• Designate your own beneficiaries.

Next steps

• This option is only available if you are the sole beneficiary.

• All that’s needed is to roll the funds into your existing IRA or open a new IRA to roll the funds into.

When is the money available?

• You can access funds at any time, but a penalty will apply to distributions made before 59 ½.

• After 70 ½ your account will be subject to normal required minimum distributions.

This might make sense when

• If you are over age 59 ½ this option often can make sense because it provides flexibility on beneficiaries you can designate, you have the full ability to access funds. Additionally, if you are between 59 ½ and 70 ½ you might be taking yourself out of a Required Minimum Distribution (RMD) scenario.

Option 2: Transfer the assets to an Inherited IRA

Benefits

• Dollars can continue to grow tax-deferred.

• You will not have to pay a 10% early withdrawal penalty.

• You can designate your own beneficiaries.

Next steps

• You can transfer assets into Inherited IRA in your name.

• If there are multiple beneficiaries you must establish a separate account by December 31st following the year of death in order to use your own life expectancy. If you miss this deadline RMD’s will based off of oldest beneficiary.

When is the money available?

• You can access funds at any time.

• Your life expectancy may be used to calculate RMD’s.

If the original account holder was under 70

• RMD must begin by the later of:

  • December 31 following the year of the original account.

  • December 31 of the year in which the original account holder would have reached 70 ½.

• If the original account holder was 70 ½ or older:

  • RMD’s must start by December 31st of the year after death.

  • If the original account holder did not take RMD for the year in which he or she died, you must take at least that amount as a distribution by the end of the current year.

This might make sense when

• If you are under 59 ½. By transferring to an Inherited IRA you provide yourself flexibility in three ways:

1. You have the option to withdrawal funds penalty free based on your life expectancy. So if you would like the money over time this is a great choice.

2. You also have the choice to start RMD’s based on when your deceased spouse would have turned 70 ½.

3. If you are hoping to use all of the funds in the next 5 years there is a provision called the “5-year method” that allows for distribution of all funds without paying penalties over the first 5 years of the account being open.

Option 3: Lump Sum Distribution

Benefits

• No 10% early withdrawal penalty (think of this as following the 5-year rule).

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• All at once.

• Taxable portion of the distribution will be considered taxable income.

This might make sense when

• You have an immediate need for the funds.

Qualified Retirement Plan (401(k), 403(b), etc.)

Option 1: Leave it in Plan (this is dependent upon plan rules)

Benefits

• Dollars can continue to grow tax-deferred.

• You will not have to pay a 10% early withdrawal penalty.

• You can designate your own beneficiaries.

Next steps

• You can transfer assets into Inherited IRA in your name.

• If there are multiple beneficiaries you must establish a separate account by December 31st following the year of death in order to use your own life expectancy. If you miss this deadline RMD’s will based off of oldest beneficiary.

When is the money available?

• You can access funds at any time.

• Your life expectancy may be used to calculate RMD’s.

If the original account holder was under 70

• RMD must begin by the later of:

  • December 31 following the year of the original account.

  • December 31 of the year in which the original account holder would have reached 70 ½.

• If the original account holder was 70 ½ or older:

  • RMD’s must start by December 31st of the year after death.

  • If the original account holder did not take RMD for the year in which he or she died, you must take at least that amount as a distribution by the end of the current year..

This might make sense when

• You are needing to by some time and do not have trusted place to open an IRA this is a great option. Ultimately, in our opinion having these dollars end up either in an IRA in your name or an inherited IRA often providing additional flexibility.

Option 2: Transfer the assets to your own IRA

Benefits

• Dollars can continue to grow tax-deferred.

• Designate your own beneficiaries.

Next steps

• This option is only available if you are the sole beneficiary.

• All that’s needed is to roll the funds into your existing IRA or open a new IRA to roll the funds into.

When is the money available?

• You can access funds at any time, but a penalty will apply to distributions made before 59 ½.

• After 70 ½ your account will be subject to normal required minimum distributions.

This might make sense when

• If you are over age 59 ½ this option often can make sense because it provides flexibility on beneficiaries you can designate, you have the full ability to access funds. Additionally, if you are between 59 ½ and 70 ½ you might be taking yourself out of a Required Minimum Distribution (RMD) scenario.

Option 3: Lump Sum Distribution

Benefits

• No 10% early withdrawal penalty (think of this as following the 5-year rule).

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• All at once.

• Taxable portion of the distribution will be considered taxable income.

This might make sense when

• You have an immediate need for the funds.

ROTH IRA

Option 1: Transfer the assets to your own IRA

Benefits

• Dollars can continue to grow tax-deferred.

Next steps

• If you are the sole beneficiary you can transfer funds into your existing or new ROTH IRA.

• If you are one of multiple beneficiaries, you must take your share as a distribution and roll into a ROTH IRA within 60 days.

When is the money available?

• You can access funds at any time.

• Distributions are generally tax and penalty free if you are over 59 ½ or qualify for a penalty free exception and have met the five-year holding period. Schwab provides guidance if you are looking for what rules apply to you if you are looking to distribute funds.

This might make sense when

• You plan to take distributions based on when you turn 59 ½ not the beneficiary.

Option 2: Transfer the assets to an Inherited ROTH IRA

Benefits

• You bypass the 10% early withdrawal penalty.

Next steps

• Transfer assets into Inherited ROTH IRA held in your name.

• If there are multiple beneficiaries, separate accounts must be established by December 31st following the year of death in order to use your own life expectancy; otherwise RMDs will be based on the life expectancy of the oldest beneficiary.

When is the money available?

• You can access funds at any time.

• Any earnings are generally tax free if the five-year holding period has been met.

• Your life expectancy may be used to calculate RMDs.

Annual distribution (RMDs) must begin by the later of:

• December 31 following the year the original account owner died or

• December 31 of the year when the original account holder would have reached 70 ½

You may also follow the five-year rule under which the account must be fully distributed by December 31 of the fifth year following the year of death.

Option 3: Take a lump sum distribution

Benefits

• No 10% early withdrawal penalty.

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• All at once.

• Distributions are generally tax and penalty free if you are over 59 ½ or qualify for a penalty free exception and have met the five-year holding period.

This might make sense when

• You have an immediate need for the funds.

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You are listed as a beneficiary, not a spouse

 

Traditional, SEP IRA, or SIMPLE IRA

Cannot roll over to your own IRA

Option 1: Transfer assets to an Inherited IRA

Benefits

• Dollars can continue to grow tax-deferred.

• No 10% early withdrawal penalty for distributions.

• Designate your own beneficiaries.

Next steps

• Transfer dollars to Inherited IRA, under your name.

• If there are multiple beneficiaries you must establish a separate account by 12/31 to use your own life expectancy for Required Minimum Distributions (RMDs). Otherwise RMDs will be based off the life expectancy of the oldest beneficiary.

When is the money available?

• Able to access dollars at any point. Dollars withdrawn will be considered taxable income. Here are some distribution options:

  • Cash out the IRA in 5 years, by Dec 31st of the fifth year since the retirement account owner’s death.

  • Take distributions over your life expectancy.

  • Take distributions over life expectancy of original owner.

  • Take Out Required Minimum Distributions Over the Oldest Beneficiary's Life Expectancy.

• RMDs must start by 12/31 of the year after death.

• If account holder was younger than 70 ½ and original account owner did not take an RMD for year of death, you must take this RMD amount for current year.

• Notably, the requirement for a non-spouse beneficiary to take out a minimum distribution is only a minimum requirement the beneficiary may take out more, anytime he wishes.

This might make sense when

• The non-spouse beneficiary would like to stretch inherited dollars, taking distributions over their life expectancy while allowing dollars to continue to grow tax deferred.

• The non-spouse beneficiary is older than the original owner (who was not 70 ½ at death), it’s more appealing to use the decedent’s longer life expectancy.

Option 2: Lump Sum Distribution

Benefits

• No 10% early withdrawal penalty.

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• Dollars available at once.

• Taxable portion of the distribution will be considered taxable income.

This might make sense when

• You have an immediate need for the funds. Note that by taking funds out all at once there is the potential to move into a higher tax bracket.

ROTH IRA

Cannot roll over to your own IRA

Option 1: Transfer assets to an Inherited Roth IRA

Benefits

• Dollars can continue to grow tax free.

• No 10% early withdrawal penalty for distributions.

• Designate your own beneficiaries.

Next steps

• Transfer dollars to Inherited Roth IRA, under your name.

• If there are multiple beneficiaries you must establish a separate account by 12/31 in order to use your own life expectancy for Required Minimum Distributions (RMDs). Otherwise RMDs will be based off the life expectancy of the oldest beneficiary.

When is the money available?

• Able to access dollars at any point, any earnings are generally tax-free if the five-year holding period has been met. Here are some distribution options:

  • Distribute the Roth IRA in 5 years, by Dec 31st of the fifth year since the retirement account owner’s death.

  • Take distributions over your life expectancy.

  • Take distributions over life expectancy of original owner.

  • Take Out Required Minimum Distributions Over the Oldest Beneficiary's Life Expectancy.

• RMDs must start by 12/31 of the year after death.

• Notably, the requirement for a non-spouse beneficiary to take out a minimum distribution is only a minimum requirement the beneficiary may take out more, anytime he wishes.

This might make sense when

• The non-spouse beneficiary would like to stretch inherited dollars, taking distributions over their life expectancy allowing for dollars to continue to grow tax deferred.

• The non-spouse beneficiary is older than the original owner (who was not 70 ½ at death), it’s more appealing to use the decedent’s longer life expectancy.

Option 2: Lump Sum Distribution

Benefits

• No 10% early withdrawal penalty.

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• Dollars available at once.

• Any earnings are generally tax-free if the five-year holding period has been met.

This might make sense when

• You have an immediate need for the funds.

Qualified Retirement Plan (401(k), 403(b), etc.)

Option 1: Transfer assets to an Inherited IRA

Benefits

• Dollars can continue to grow tax-deferred.

• No 10% early withdrawal penalty for distributions.

• Designate your own beneficiaries.

Next steps

• Transfer dollars to Inherited IRA, under your name. This must be done so as trustee-to-trustee transfer, where the distribution check is made payable directly to the new inherited IRA account; if the beneficiary takes possession of money, it is permanently and irrevocably distributed and ineligible for rollover.

• If there are multiple beneficiaries you must establish a separate account by 12/31 in order to use your own life expectancy for Required Minimum Distributions (RMDs). Otherwise RMDs will be based off the life expectancy of the oldest beneficiary.

When is the money available?

• Able to access dollars at any point dollars withdrawn will be considered taxable income. Here are some distribution options:

  • Distribute the Roth IRA in 5 years, by Dec 31st of the fifth year since the retirement account owner’s death.

  • Take distributions over your life expectancy.

  • Take distributions over life expectancy of original owner.

  • Take Out Required Minimum Distributions Over the Oldest Beneficiary's Life Expectancy.

  • RMDs must start by 12/31 of the year after death.

  • Notably, the requirement for a non-spouse beneficiary to take out a minimum distribution is only a minimum requirement the beneficiary may take out more, anytime he wishes.

This might make sense when

• The non-spouse beneficiary wants more flexible distribution options than in the Qualified Retirement account.

• The non-spouse beneficiary would like to stretch inherited dollars, taking distributions over their life expectancy allowing for dollars to continue to grow tax deferred.

• The non-spouse beneficiary is older than the original owner (who was not 70 ½ at death), it’s more appealing to use the decedent’s longer life expectancy.

Option 2: Lump Sum Distribution

Benefits

• No 10% early withdrawal penalty.

Next steps

• Transfer assets to bank account or brokerage account.

When is the money available?

• Dollars available at once.

• Taxable portion of the distribution will be considered taxable income.

• The distribution will be subject to a mandatory 20% Federal Tax withholding (possible additional state tax will be withheld).

This might make sense when

• You have an immediate need for the funds.

 

In a season of loss, remember Human Investing is here to help navigate this difficult time.

Sources: www.irs.gov www.schwab.com

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This article was originally published on Forbes.

Shutterstock

The Employee Retirement Income Security Act (ERISA) was established in 1974 to give employees retirement income security. Why, then, after 40-plus years, are Americans so underprepared for retirement?

According to a 2015 study from the Government Accountability Office, "About half of households age 55 and older have no retirement savings (such as in a 401(k) plan or an IRA)." Even those who have saved have saved poorly. Among those households of residents ages 55 to 64 with some retirement savings, the median amount saved is $104,000. For those 65 to 74, the amount is roughly $148,000 per household. And, with 70% of the civilian population having access to a retirement plan and 91% access for government employees, it’s a wonder there is such a lack of retirement readiness.

There is no shortage of financial and intellectual capital being spent on a solution for retirement readiness. But most solutions have fallen short of narrowing the gap between the retirement haves and have-nots. So, what is the solution? My thoughts follow:

Government Plus Employer Plus Employee

First, the government is already involved in the regulation of retirement plans, as well as allowing for employers to deduct the expenses of having a plan, so why not go all in? Why not tell employers, “If you are going to get the deduction, you need to meet certain requirements that are great for employees, great for your business and great for our country”?

Those requirements could include auto-enrollment (as this has been a home-run for participation), auto-increase (as individuals get raises, they add a little more to their retirement) and an eligible age-based default option (eligibility for a great default option would be low-cost and diversified as you get from the likes of popular mutual fund providers with their index retirement glide path funds).

In order to qualify for a business deduction or incentive from the government, an employer would be required to match a certain amount. I’d propose 5%, with the employee required to commit 5% to get that amount. Why these amounts? Because if someone has a job for 40 years and invests in a basket of mutual funds growing at or around 8%, with both the employee and employer contributing at 5% each, they end up a millionaire (assuming a $36,000 annual salary, or $300 per month contributions, compounded monthly for 40 years.)

The Industry

In a recent Society for Human Resource Management (SHRM) study, more than 70% of HR professionals surveyed emphasized the importance a retirement savings plan. So, at a minimum, employees are aware of the need to save and desire to do so. While there is definitely a need amongst employees to save for retirement, there are several barriers that impact participants interest and willingness to save. First, trust among advisors is low. Second, many plans have a dizzying array of options, which negatively impacts deferral rates. Finally, not all employers offer to match contributions, which minimizes the incentive for employees to contribute to the 401(k) versus less automated choices, like an IRA.

So, what can the industry do to partner with employers and their workforce? There are two things in my view:

1. Understand the heart of ERISA. Advisors and their firms are to put the interests of the employee and their income security at the center of everything they are doing. If, somehow, the advice we are giving in any way conflicts with the employee and their security, then we should reassess what we are doing and meet the stated purpose of ERISA -- it doesn’t need to be any more complex.

2. In order to minimize the potential for anything but the fiduciary standard, any firm operating in the retirement space should be required to be a fiduciary and have no ability to be dually registered or receive commissions, kickbacks, trips or any other super-secret benefit.

Join the small percentage of firms that are truly fee-only and have no way of receiving any form of compensation other than from the client. Disclosing away conflicts is not the answer for the clients, as few read the disclosures they are provided. If we are going to serve clients well, eliminating the ability for the conflict to exist is the only reasonable route to go.

In conclusion, the government is already involved in both rule-making and incentives for companies and their employees to offer and invest in retirement plans. A model for offering a retirement plan that meets certain criteria in order to fully receive the incentive should be outlined and adhered to by companies and their employees. In partnership with the government, employers and employees, the financial services community should be held to a higher standard to eliminate the conflicts that keep retirement plans for becoming all they could be, which is for employee retirement income security.

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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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