A combination of recent tax cuts, swelling government debt and changing political winds have many concerned about increases in future tax rates.  This has created a growing interest in strategies that can lower and mitigate future income taxes. One such strategy is available and often missed by many Nike employees within their 401(k) plan, known as “Mega Backdoor Roth 401(k) contributions”. While the name often elicits laughter at first, it can in fact be a serious and tangible way to save on future income taxes. 

What is the Nike Mega Backdoor Roth 401(k)?

The Mega Backdoor Roth 401(k) provides the ability to make additional tax-advantaged contributions to the Nike 401(k) plan above and beyond the typical employee limits of $19,500, plus catch-up contributions of $6,500 for ages 50+ (2020).  The additional contributions are in the form of “after-tax” contributions of up to 3% of income.  This applies to base salary and any PSP bonus. The total contribution amount will have a cap based on annual IRS limitations: $8,550 for 2020 and $8,700 for 2021.  The after-tax contributions can then be converted to Roth dollars within the plan, which allow them to grow tax-free and be distributed tax-free* in the future. 

How to Execute the Strategy

The process starts by electing to make after-tax contributions within the Nike 401(k) plan of up to 3%.  Once the after-tax contributions have been made, it is important to then convert these contributions into tax-free Roth funds* by periodically electing to do an “In-Plan Roth Conversion”.  To complete the In-Plan Roth Conversion, the employee will need to call the Nike 401(k) phone line and make the request verbally.  Be prepared to spend 10-15 minutes on the phone for the conversion process to be completed.     

The In-Plan Roth Conversion is important because the growth of the after-tax contributions will become taxable as ordinary income upon distribution if the conversion is never completed. However, if you convert those funds into Roth dollars, then the future growth and distributions will be tax-free*. We recommend that the In-Plan Roth conversion be completed on a periodic basis to make sure that the funds are converted before any significant growth occurs.  Any growth of the after-tax contributions at the time of this conversion will be taxable income, but if completed regularly, the growth and subsequent tax is typically minimal.  Ideally the conversion would be completed after every payroll or monthly, but practically speaking, one to two times per year should be sufficient to effectively execute the strategy.

Is this Strategy Right for You?

Nike’s robust benefit options can leave many unsure of which savings plan is best for them.  Whether it is 401(k) contributions, ESPP, Deferred Comp or Mega Backdoor 401(k) contributions, there are only so many dollars available out of a paycheck.  The order of priority is different for each person based on their personal tax situation, time frame at Nike, and plans for the future.  We believe that the best way to determine the priority of one plan over another is through financial planning projections. Through the financial planning process, we take your financial considerations today and project them into the future. While this does not predict the future, it does allow you to measure the impact of each savings option and find the optimal course of action.

Solution to Cash-Flow Problem

A potential solution to the cash-flow challenge of participating in the Mega Backdoor Roth 401(k) contributions is to repurpose other funds.  Available options that we have identified include existing after-tax accounts like Individual, Joint or Trust investment accounts, extra cash in the bank, or cash that you have from selling and diversifying out of Nike RSUs, ESPP, or Stock Options.  You can use these accounts to supplement your cash flow while the Mega Backdoor Roth contributions are coming out of your paycheck. 

Lower Your Tax Burden

While this strategy may not make sense for every Nike employee, it is a unique opportunity to get significant dollars into a Roth account that might not otherwise be available.  Whether or not income taxes actually do increase in the future, the Nike Mega Backdoor Roth 401(k) is a very effective way to lower your long-term tax burden and should be considered as part of your financial plan.

If you want to know more about how to take advantage of the Nike Mega Backdoor 401(k), please get in touch.

You can schedule time with me on Calendly, e-mail me at marc@humanvesting.com, or call or text me at (503) 608-2968.

*Assumes first Roth contribution made at least 5 years before withdrawal and withdrawals occur after age 59½.

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In March, we were inundated with updates about the coronavirus and the unknown ramifications to follow. In the same month that the NBA was postponed, children were sent home from school, toilet paper fled the grocery store shelves, the US stock market had three of the worst days in US history.

Behind the scenes

Unlike the year 2020, your 401(k) account is routine and emotionless. If there is no user interference (yes, that is you), your account will continue to invest in the stock market every paycheck. A 401(k) account can help alleviate market-timing decisions by adopting an investment strategy called dollar-cost averaging. Instead of waking up in the morning and deciding “is today a good day to buy some stock?”, your 401(k) systematically makes those timing decisions for you.

To review the ease of these timing decisions, I wanted to show investors what happened if you made a $50.00 contribution to your 401(k) account every paycheck during 2020. In this scenario, we assume employees were paid every two-weeks (starting on January 3, 2020) and invested in the Vanguard Target Retirement 2055 (VVFVX) fund.

Slowly building a foundation

These dollars represent the trading value of the Vanguard Target Retirement 2055 (VVFVX) on specific days. In this exercise, the lowest trading price was $31.16 on March 20th, and the highest trading price was $48.55 on November 27th.

Thank you, automation.

As you can see, the best time to invest in the stock market this year (March) was also arguably the most uncertain and scary time to be an individual investor. From a February 21st paycheck to a March 6th paycheck, the price of this target date fund dropped 9%. From a March 6th paycheck to a March 20th paycheck, the price dropped 21%.

When prices were falling, your 401(k) account bought shares at a lower price without panicking, consulting the news, or making impulsive decisions. For that reason, we should give 401(k) accounts a standing ovation for being a reliable, unemotional investment vehicle this year.

Let 2020 be a reminder that if your boxes are checked, outsourcing and automating your account is one way to ease your emotions.

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Perhaps now more than ever, it makes sense to increase your deferral to the SERPLUS deferred compensation plan. The following chart compares current tax rates to the proposed tax rates by the new administration.

Though we are uncertain when the tax changes will be implemented, we do know that tax rates will increase. If taxes increase, your deferred compensation benefits may become even more important for your tax planning.

TAP INTO Significant Tax and Income Benefits

Deferred compensation plans provide an opportunity to receive less income today in order to pay less taxes on that income when received in the future. When making annual deferred compensation elections, you have the choice of a 5-year, 10-year, or lump sum payment at retirement (when employment with Intel ends). If you plan to retire at 62, you could elect to receive distributions for 10 years from your SERPLUS plan to stretch out your income and realize it in a lower tax bracket until age 72. With this plan, you have deferred compensation income providing for your first 10 years of retirement. In your early 70’s, social security and required IRA distributions will supplement your steady income stream, and eventually replace your deferred compensation income.  

Spreading deferred compensation income out over 10 years allows you to take it in a lower tax bracket, like 21% for Federal and State combined or 24% combined after 2025. This tax deferral would provide for a tax reduction between 23% and 35%. In a hypothetical scenario, $50,000 contributed per year over 15 years would total $750,000 (without earnings computed). The income deferral could provide $172,500 in tax savings in a conservative example and $262,500 in savings in a more generous example. That is real money in your pocket rather than in the Federal and State governments. 

In the peak earning years of your life, with your 401k maxed out and not providing enough tax deferral and future income, the SERPLUS deferred compensation plan is a great tool to help increase both.

Cash Flow Considerations AND SOLUTIONS

If you do participate in the plan, your current take-home pay will decrease.  If cash flow becomes tight, there are opportunities within your employee benefits that could help provide the needed funds. It may be advisable to sell some company stock (ESPP, RSUs) to supplement your monthly income so that you can participate in the plan and defer income. Keep in mind, your election made in 2020 on salary is for the 2021 income year, whereas the bonus election is for the bonus paid in 2022. A portion of the bonus could be especially important to defer in 2022 considering the proposed tax changes. 

Questions ABOUT YOUR INTEL BENEFITS?

If you have questions about making deferred compensation elections, please schedule a call.

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Recently I received a note from a longtime Human Investing client. He was following up on a discussion we had back in March, where he, like others, was concerned about where the market was headed. Here is a mostly intact version of what he said:

I just wanted to thank you and acknowledge your sound advice eight months ago when everything was running off the edge. Since then, we are up more than $250K (17%) and above where we were then. The reality is that had I pulled out, I would not have gotten back in before missing most of the bounce back. Hindsight can be wonderful when you do not make the wrong decision!  My friend, who sold out in March, is still hanging onto the belief that we are headed down again. Who knows the future.

A Discussion Goes a Long Way

The purpose of this note is not to take a victory lap for the advice we dispensed. Instead, it highlights how a discussion can help put investing in perspective in a tense market moment. This client has 50% of their portfolio in safe investments, like high-credit quality bonds and cash. The remaining portion is in broadly diversified equities. Despite having enough cash and bonds on hand to live a decade without having to touch their equities, they had a concern. The discussion with this client revolved around whether they needed more than ten years of cash and bonds to live and focused less on market timing. In the end, it was the client who decided to hold tight, not me. I was the one who removed myself from the emotion of the situation and was there to ask the right questions. 

Throughout my career, my role in the client’s life has evolved. In the mid-90s, we were providing stock recommendations and picking money managers. Today, we rely on trading algorithms from Morningstar and low-cost index funds from Vanguard and Barclay’s. The quantitative work has shifted from money management to financial planning and tax planning/compliance. This work is done by my colleagues at Human Investing: Andrew Gladhill, CFA, Marc Kadomatsu, CFP, Amber Jones, CPA, and Luke Schultz, CPA. On the flip side of the quantitative work is qualitative research, which involves non-numerical data. Qualitative research comes from our interaction with clients and hearing about their feelings, emotions, and opinions. These qualitative insights are paramount to a successful retirement plan. Some might argue that emotion and opinion can derail the best of financial plans. This is at the heart of the above quote. Quantitatively, the client was in great shape, but their “in the moment emotions” almost derailed a great retirement plan. 

Dalbar Inc. provides performance information on the “average investor”. Figure 1 is a chart I have tracked for years. One of the many reasons why the “average investor” does so poorly versus the returns of various asset classes and stock/bond mixes is due to their emotions. Having someone to talk to about these thoughts and feelings can be helpful.  If the plan permits and valid concerns arise from the discussion, then changes can be made.  However, if the change is not rooted in probability and the financial plan, there is the potential that the decision being made can be harmful.

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Figure 1

Investing over the long run

It is interesting to see the S&P 500, dating back to the year I started in the financial services profession. Figure 2 depicts much relevant information. Most notably is the long term upward trending line during my career. If we went back to the early 1900s, the chart would look similar—lots of ups and downs with a trend line that moves up over time. 

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Figure 2

Sometimes, the drops in the market happen gradually—as do their recoveries (as was the case in 2000). Other times, market volatility stems from “counterparty risk,” which was the case in 2007 when the housing market and credit created uncertainty. In the most recent case, the severe volatility was brought upon by fear from a pandemic and an uncertain future. Regardless of the reason, volatility is a natural part of investing in the stock market. My observation is that volatility is permanent. Surprises (both up and down) are common. The financial plan, which is a quantitative document developed by credentialed experts, can be worth its weight in gold. It can act as a financial roadmap when you feel lost—and provide an advisor like me the data-points to dispense proper advice during anxious moments.

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On a recent financial planning call with colleague Amber Jones and a new client of our firm, we had a chance to discuss college savings for their daughter. It is always interesting to hear how families view college for their children and grandchildren. Some consider college a necessary expense, while others view college as an investment. Regardless of your college position, I thought it would be helpful to look at unemployment levels by education and income, based on the type of education an individual achieves. The numbers paint an incredible picture. Figure 1 underscores the importance of going to college. Not only are those with college degrees employed more consistently, but their annual earnings are nearly double those with a high school degree.

  Figure 1. Employment and income by education attainment

In short, Figure 1 makes a good case for encouraging your children (and grandchildren) to go to college. Yes, there are dozens of college alternatives, including starting a business or going to trade school. We all know successful individuals who never stepped foot in college or tried a university and decided it was not for them. I hope this article is taken in the way it was intended—that is, if college is an option, it is an excellent investment worth the sacrifice. 

Maybe you are a grandparent trying to think of a gift for your granddaughter—fund a college savings account. Maybe you are a parent wondering if college is a good investment—the answer is yes, fund a college savings account. Or possibly you are a teenager considering going to college—do what you can to make it happen. College is a sacrifice for families and for the one that is bold enough to attend.  Nevertheless, the payoff can be significant. As far as an investment goes, I can think of no better. 

If you have questions about college, funding a college savings account, or if you just want to have a thinking partner on the topic, call us; we would love to hear from you. College comes in many shapes and sizes. For example, a four-year degree, split between community college and Portland State University, averages less than $8,000 per year. Even if loans are required to meet tuition demands, the potential return on investment is immediate and over a lifetime, sizeable.

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On September 1st, my beautiful wife and I welcomed our new son into the world. His arrival has brought our family much joy during this season. Like all newborns, he has also brought sleepless nights, an abundance of comfort food, and disruption to our schedules and disciplines. As a result, I am here to tell you from personal experience the “dad bod” is real (find out if you have a dad bod here).

As I begin the journey to get back in shape, exercise and clean eating seem more difficult than ever before. Had I maintained my regimented sleep, diet, and exercise schedule throughout the entire pregnancy, returning to my baseline wouldn’t be as challenging. In physics, we call this inertia. In finance, we call this the compounding effect.  

Like most things in life, there is a compounding effect on our actions. 

• Consistency in showing up to work → proficiency at your job. 

• Consistency in showing up in the lives of loved ones → richer relationships. 

• Consistency with a sustainable diet and exercise plan → greater physical health. 

• Consistency in following a prudent investment strategy → increased net worth. 

Consistency is integral to the compounding effect

The inverse is also true. Disruption is a detriment to the compounding effect, a truth for our fitness as well as our investment accounts. To quote Charlie Munger, Warren Buffet's partner at Berkshire Hathaway —“The first rule of compounding is to never interrupt it unnecessarily”.

I would argue that someone’s consistency often has a greater impact than their effort and resources. Take the following example of two investors: 

• Investor A - saves $2K/year from age 26-65.  

• Investor B - saves $2K/year from age 19-26 and stops there.  

• Both achieve a 10% annual return.*  

At age 65, who ends up with more money?  

• Investor A: $883,185  

• Investor B: $941,054 

By saving and investing $2,000 at the beginning of each year from age 26 to 65 (39 total years), Investor A can expect to have a final balance of $883,185. Investor B only saves for 8 years but starts to save earlier in life than Investor A. Investor B benefits by taking advantage of 46 years of compounding growth, finishing with a balance of $941,054.

What Investor B lacks in consistency of contributions, they make up for in consistency of not interrupting the compounding effect on their investment account. I know you are probably curious, what would happen if Investor B did not stop contributing at age 26? Investor B’s account balance would be $1,902,309. Once again consistency wins out.

Start now and stick with it

• There are no shortcuts to saving for retirement and fighting the "dad bod". Starting can be difficult and sometimes painfully slow, however, the long-term results can be powerful. 

• The easiest advice to give is “never get off track.” However, like your sleep schedule with a newborn, there are some things you cannot control. It is important to know how to reassess and get back to work.  

• Building anything valuable and defensible takes time, effort, and energy. Build a plan today.  

If you want to compare notes on raising a newborn, see baby photos, or discuss the impact of consistency when building a prudent financial plan, please reach out. We are here for you.

*This is for illustrative and discussion purposes only. Investment results will vary.

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A lot has changed in 2020, but contributions limits will remain relatively consistent going forward. The IRS recently announced the 2021 contribution limits. The most notable change specific to retirement plans is that the annual deferred contribution limit will increase from $57,000 in 2020 to $58,000 in 2021.

Here are the applicable updates for the coming year.

Please let us know if you have any questions. We look forward to working with you in 2021. Take good care.

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A week ago, I came across a chart that does a nice job representing the call volume we have been experiencing at Human Investing in 2020. While the amount of calls we receive does not equal the amount of times people search for CNBC, the two data points are certainly correlated.

The image is titled, “When Markets Fall, We Search”, and ultimately shows that individuals have been more likely to seek out CNBC (market related news) any time the market has fallen over the last 15 years.

I’d argue that you could replace ‘search’ with ‘speculate’ and both the phrase and the chart would remain true, “when markets fall, we speculate”. Given the state of current affairs and the upcoming presidential election, individuals are worrying about their retirement accounts. A growing number of conversations our team has with individuals inside of retirement plans sound something like this:

Caller: “I’m fearful of (X) candidate winning the election because I’m affiliated with (Y) political party (both sides are saying this). Additionally, there is uncertainty around COVID, and I don’t feel comfortable staying invested during these unpredictable times. I’d like you (Human Investing) to help provide me with a more conservative investment recommendation.”

Before I respond with market research, I want to reiterate that you aren’t alone with your concerns and fear. We hear you. At the same time, before making any decisions related to your portfolio, take the time to think through all the angles of your decision. The rest of this post will hopefully provide some anecdotes in your process. Here are few thoughts about what it looks like to plan for the end of 2020 and into 2021. Remember, it is better to plan than to speculate.

The correlation between your Politics and Your Portfolio

Generally speaking, there is low correlation between political parties and the stock market. However, that statement is easy to say and difficult to live out in practice. Tread lightly when reading articles that try to align which stock/sectors to own with the political party that takes office. This article from 2016 couldn’t have been more wrong prognosticating that energy companies (specifically Exxon Mobile) would be top performers for the proceeding four years. It goes without saying this was a massive miss.

The bigger influence: Are you a speculator or planner?

If you think like a speculator, you will make rash decisions around your investment accounts and have no plan for re-entering the market if you move your dollars to cash or to a conservative investment.  

If you think like a planner, you will use both quantitative and qualitative measurements to evaluate your decision. For example:

• If you have a long-term horizon (greater than 15-20 years), political changes should not impact your investment decisions.

• Irrespective of the political environment, review if your account is too aggressive or too conservative for your financial landscape.

• Have a clear understanding of both candidate’s tax policies. Changes to the federal tax code should be a factor in your financial planning for the remainder of 2020 and into the future. If you are working with a CPA and/or Financial Advisor, make sure they are staying abreast with any impactful tax code changes.

  • Biden Tax Proposal

  • Trump Second Term Tax Ideas
    

Ditching The Market

Trying to time the market when negative news arises (or the anticipation of negative news) is a dangerous game to play. Luckily, we have a recent case study of how dangerous it can be. From January 1st to March 23rd, the stock market fell 30%. Since then, the market has recovered all losses and then some. If you were thinking like a spectator, it would have been easy to create a narrative around mid-March to pull your money out of the market and wait for greener pastures. If an investor did so, most likely that investor is still waiting for the market to dip and has missed out on the recent recovery as indicated by the second chart.

If you think like a planner when the market is more volatile, sometimes taking some form of action itches a behavioral scratch. Here are some ways to take action while not compromising your account:

• Raise your contribution in your retirement account to take advantage of a decreasing market (buying more shares at discounted prices).

• Open a small “fun money” account to track if your predictions are correct.

• If the market does significantly drop, look at converting pre-tax dollars to ROTH.

The concept of thinking like a speculator vs. thinking like a planner represents the cultural moment we are living in right now.

Speculating = headlines, fast moving social media, and the potential for instant gratification.

Planning = well thought out strategies that take time and often require no action.

As we head into this season of elections and COVID uncertainty, I hope this post provides some perspective on how to approach your portfolio. As always feel free to reach out to our team to talk through your thought process. We are happy to help!

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“Am I okay?” Fear ripe in my voice. 

We just heard what no climber ever wants to hear: one loud scream, three thuds, then nothing.

At that moment, I was sixty feet in the air doing the routine work of cleaning the anchor, removing all the gear that protected us as we climbed up the route and re-setting the rope to be lowered and move on to the next climb when we heard it.

That sound? It was someone falling. Hard. We didn’t know how far or how badly, but we knew that climb was higher than mine: about eighty feet top to earth.

“I got you!” He called back. “Take a deep breath. Tell me what you’re doing.”

I did. I called out every single step I was taking to clean the anchor and secure the rope back to my harness –triple checked for safety – and he held the rope. Eventually, my feet and wobbling legs arrived safely back on earth.

When you rock climb, there is obvious risk involved. Risk that you accept as the price of admission for moving higher than twenty feet – the height where, if you fall, you most likely will not be fatally injured. 

Confidence matters. Confidence in your gear, skill, weather, and your risk tolerance. Yet there is a confidence that is as important – if not more important – than all the confidence inside you: that is confidence in your belay partner.

Your partner is the one on the other end of the rope, your safety line, whose responsibility it is to pay attention, catch you when you fall, and lower you safely from sky to earth. A good belay partner must not only know the mechanics of climbing and safety but must also know you. They communicate clearly and are always paying attention – often mitigating the risks that are out of your control when you chose to leave the earth and head toward the open blue.

At no point after hearing those falling sounds did anything feel ok. My imagination was a wild hostage situation, forcing in front of my focus nightmares of gear failing and my body hurling through space.

But in reality, I was okay. I was safely anchored.  We had a plan and practice in place for climbing safely. My belay partner was paying attention, “I got you”. He heard the sounds too, but he did not take his focus off the rope and my safety.

Investing in the stock market can be a lot like rock climbing

There is risk involved in climbing your portfolio value higher than a modest, though acceptable, goal of beating inflation.

When the market takes a dive and the media heads are talking about total economic fall-out, it sure doesn’t feel okay. Do you have a good partner? A good advisor is a good partner. 

Are they paying attention? When you hear the rumble and scary sounds of the market moving and you call out, “Am I okay?”, how does your advisor respond?

At Human Investing, we are your partner on the other end of the rope

• Our climbing anchor is the fiduciary standard. Every trade, conversation, and piece of back-office work is done to mitigate unnecessary risk as your portfolio climbs, and it is all done with YOUR best interest in mind.

• Our figure-eight is clean and tight.  Your financial plan is like tying the climbing rope in to your harness – it is your safety line that serves to mitigate risk by informing how your dollars are invested to avoid and securely catch any falls. When the market crashes, we are on the other end of the line. 

• Our GriGri is loaded and locked.  We have the highest standard in investment tools.  We know our tools and we use them well, monitoring the “weather patterns” of the market, watching your portfolio as it climbs and responding as appropriate.

• “On Belay? Belay on! Climbing? Climb on!”  Before you climb you say to your partner:  Are you ready and paying attention?  We are paying attention and ready to serve you. There is more than one set of eyes on your accounts – you are more than dollars and stock holdings to us.  We will not be distracted by the noise around us.

• “I got you!”  As with any good partner: We know you.  We will respond to fear or a fall.  Your time with us is invested in discussing your goals, your values, and your reactions when your portfolio climbs or lurches.  We answer when you call, and sometimes we call you first because we also hear the sounds of the news and peers, and it may be scary. But in the end, we “got you.” We will not allow a fall-fear to inflict avoidable loss.

If you would like to talk to an advisor about how to climb your portfolio the Human Investing way, give us a call or send us an email.  It would be our pleasure to partner with you.

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Health Savings Accounts (HSA) made the roster of tax-deferred accounts. For this reason, these accounts can be a favorable component in a financial plan both today and in the future (65+ years old). HSA accounts were first introduced in 2003, and since then, their utilization among employees and employers has grown meaningfully. In order to be eligible to participate in an HSA – an employee must be covered by a High-Deductible Health Plan (HDHP) and not be enrolled in Medicare or other health coverage. Like an employer-sponsored retirement plan, a Health Savings Account offers benefits for both employees and employers. As such, their increased popularity is hardly surprising.

While there are many benefits of HSA accounts, we must also recognize that switching from a PPO plan to an HSA often results in more out-of-pocket medical expenses during the year. Yes, we agree that sounds unappealing. However, there is always more to the story.  

Benefits of HSA accounts to Employees

• The account is portable. Contributions to HSA need not be used in the tax year they are made. Additionally, if an employee changes jobs, the account is still accessible.  

• Health Savings Accounts do not impose income limitations. Unlike IRAs, highly compensated individuals are still eligible to participate in these tax-deferred accounts.

• Health Savings Accounts provide a trifecta of tax savings:

  • Employee contributions are federal-tax deductible.

  • Federal tax on investment earnings is deferred until withdrawal.

  • All withdrawals (including earnings) used to pay for qualified healthcare costs are free from federal taxes regardless of when they are made.

• Dollars contributed to an HSA are both literally and psychologically compartmentalized for medical expenses.

Benefits of HSA accounts to Employers

• The time and money employees spend on healthcare is often more efficient with an HSA. This seems intuitive because unlike an FSA, employees have ‘skin in the game’.

• Employer contributions to their employees’ HSA accounts are exempt from FICA taxes. In 2020, the combined FICA rate is 7.65% which is not insignificant.

• Offering an HSA plan further diversifies the benefit offerings for their employees.

Hierarchy of Retirement Savings

For those with an employer-sponsored retirement plan and an HSA account, there is a hierarchy for where to best save one’s dollars. This hierarchy assumes the employee does not have significant debt and has also created an emergency savings fund.

• First Priority: Take full advantage of the 401k employer match. Free money!

• Second Priority: Maximize your HSA contributes and invest your dollars for the future.

• Final Priority: If you have extra earnings, contribute the maximum to a 401k plan or a Roth IRA.

Here is an example scenario of the three-step hierarchy above:

• Sophia’s employer matches 50% up to 6%. Melissa should contribute 6% to her 401k plan, and her employer will contribute 3%. Free money – check.

• Next, Sophia should maximize her annual HSA contribution. Trifecta of tax savings – check!

• Finally, Sophia can contribute additional funds to her 401k plan to maximize her annual contribution and/or contribute to a Roth IRA.

Withdrawal Rules

There are early withdrawal restrictions for Health Savings Accounts to ensure individuals are using their account for the intended purpose: paying for medical expenses. Specifically, HSA’s incur a 20% penalty and income tax on any amount withdrawn before age 65 that is not used for medical expenses. That said, an HSA account should be opened with the pure objective of saving and paying for inevitable health expenses throughout one’s life.

When you have your inevitable health care expenses, you can also pay out-of-pocket and keep the receipts for tracking your deductible. From a long-term growth and tax perspective, this may be advantageous if you have extra savings in your bank account.  

Investment Strategy

Most HSA accounts have a minimum cash balance required. Once you have saved the minimum cash balance, the additional dollars can be invested. The investment strategy within your HSA account will vary depending on your financial landscape, but often the investment strategy is aligned with your other retirement accounts – like a 401k or an IRA.

Prioritize your health

It is absolutely imperative to acknowledge that HSA dollars should be spent on health and wellbeing as needed. As exciting and opportunistic it is to imagine a future tax-deferred balance, health today must be prioritized. We do not work in the health sector, but at Human Investing we have a team of financial advisors who are committed to ensuring your medical costs are accounted for in a strategic manner.  

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What a season it has been.  I hope and pray that each individual and family member receiving this note is healthy and safe.  My goal over the coming months is to increase the volume of written communication.  These notes will not replace our regular scheduled tax, planning, or portfolio updates.  Instead, they will supplement those conversations and provide a financial perspective that can be communicated efficiently in writing.  The purpose of this note is to discuss our position on market timing and portfolio rebalancing.

Portfolio Rebalancing

We believe that the financial plan is the seminal document for investors seeking to accomplish long term goals. Each financial plan is prescriptive in the amount of saving and portfolio return that is required to accomplish the goals outlined in the plan.  The asset allocation decision is an important one—given it considers risk tolerance, time horizon, and financial goals[1].

The goal of rebalancing is to minimize risk and recalibrate, rather than to maximize return.  The process of rebalancing takes the imbalance that is created by certain asset classes over time and recalibrates those asset classes.  It takes the asset allocation that was originally prescribed by the financial plan and reorients the portfolio to its intended mix of stocks, bonds, and cash.

For most portfolios, recalibration should occur a few times a year.  This is particularly true in retirement accounts, given there is no tax liability for creating gains.  In trust accounts as well as individual and joint accounts, there is a sensitivity to tax gains as a possible consequence of rebalancing.  Every effort is taken to minimize tax liability in those types of accounts.  However, it can be hazardous to let the concern over taxes negate the discipline of regularly rebalancing.  I can think of too many instances where a client avoided rebalancing their account out of concerns for taxes—only to have the market go down. The tax liability for rebalancing was ultimately dwarfed by the loss of principle due to the market decline.  In short, it is rarely advisable to let the tax tail wag the investment dog.

Market Timing

The most common question I receive is, “when should we sell out?”  My typical response is never.  If an investor has a financial plan, which accounts for planning-based return expectations and subsequent asset allocation, the portfolio should always be properly positioned for risk and return.  If the goal of “selling out” is to reduce risk, the action of selling implies the original allocation was incorrect. 

In the past, there have been a few occasions where dramatically reducing risk by selling equities and raising cash makes sense.  Or, to sell a portion of the stock investment and place the proceeds in bonds.  But those reasons have to do with new information about the client situation, which prompt a change in the asset allocation. As an example, years ago, we had a client let us know that their business was struggling, resulting in the potential that their retirement account would need to be tapped for an emergency.  Liquidating equities in their account was a response to a change of plans and circumstances—this is a plan modification and not market timing. 

There is ample research dating back to the 1980s which suggests timing the market[2] or being able to predict the direction of the market is challenging at best[3].  Therefore, we believe in rebalancing “to recapture the portfolio’s original risk-and-return characteristics”[4], and we rely on the financial plan as the authoritative document to prescribe the proper mix of stocks and bonds for each client we serve.

Sources

[1] Zilbering, Y., Jaconetti, C. M., & Kinniry Jr, F. M. (2015). Best practices for portfolio rebalancing. Valley Forge, Pa.: The Vanguard Group. Vanguard Research PO Box, 2600, 19482-2600.

[2] Brinson, G. P., Hood, L. R., & Beebower, G. L. (1986). Determinants of portfolio performance. Financial Analysts Journal, 42(4), 39-44.

[3] Butler, A. W., Grullon, G., & Weston, J. P. (2005). Can managers forecast aggregate market returns?. The Journal of Finance, 60(2), 963-986. 

[4] Zilbering, Y., Jaconetti, C. M., & Kinniry Jr, F. M. (2015). Best practices for portfolio rebalancing. Valley Forge, Pa.: The Vanguard Group. Vanguard Research PO Box, 2600, 19482-2600.

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A credit score can be a helpful tool for your overall financial wellness. Unfortunately, rules and regulations surrounding credit scores can be complex and unclear. Read on to learn the importance of a good credit score, its components, and how to use a credit score to impact your financial health.

WHAT IS THE PURPOSE OF A CREDIT SCORE?

Put simply, a credit score is your financial report card. It allows lenders to assess your trustworthiness as a borrower. A good credit score not only grants you easier access to lower interest rates on loans, but it can also help you rent an apartment, finance a car, or pay down a mortgage. In short, your credit score helps you navigate the lending side of the financial world, and even gain greater financial success.

WHAT ARE THE COMPONENTS THAT MAKE UP A CREDIT SCORE?

Your payment history: Do you have a record of paying your bills, in full and on time? Doing so will boost your credit score. Paying bills on an inconsistent basis (or ignoring them completely) will lower your score. FYI, paying the minimum monthly payment is not paying your bills in full. Paying only the monthly minimum will negatively impact your credit score. Don’t be tricked by that sneaky number. Live within your means and pay your bills on time. Pro tip: Utilize due dates in your calendar, or use the reminders app on your phone, to remind you to pay your bills.

The amount you owe: Do you approach or reach your credit limit each month? The ratio of the amount you spend and the limit on your credit card is called credit utilization. It is best to keep this ratio high (i.e. 1:10 not 1:1). Leaving room between the amount you spend in any given month and the limit on your credit card will boost your credit score, while closely approaching your credit limit each month (or reaching it) will lower your credit score.

The length of your credit history: How long have you had a credit score? The longer the better! If you do not currently have a credit card, make sure you are responsible enough to own one before rushing to get one. Remember, it is better to be a responsible borrower for a shorter period of time than an irresponsible borrower for a longer period of time.

Your credit mix and new accounts: How many accounts do you have? Utilizing a variety of different borrowing options (i.e. a combination of a mortgage, an auto loan, and student loans) isn’t bad if necessary. In fact, it can actually be helpful! Try to keep open accounts to a minimum, even if you only use some accounts sparingly. Opening multiple accounts can cause lenders to be more suspicious, which in turn can lower your score. So, yes, you heard me. You might need to cancel that Hawaiian Airlines card, even if you save $150 every 2 years for your biannual Hawaii trip.

Aside from these factors, lenders may also look at your salary, occupation and job title, and employment history. These additional factors will not actually change your credit score, but they can be used in addition to your credit score to assess your trustworthiness.

WHAT IS A GOOD CREDIT SCORE?

By assessing each of these components, a three digit credit score is generated, ranging from 300-850. Any score over 700 is considered a good score.

SO, WHAT DOES IT LOOK LIKE TO BE A RESPONSIBLE CREDIT CARD HOLDER?

Sure, this information can be helpful, but how can it be applied to everyday life? Let’s look at an example.

Sophia is a recent college graduate.

She just received her first full-time job and is looking to build her credit score. She applies for a credit card that has a low credit limit and only uses it for her regular monthly payments: gas, Netflix, and her gym membership. She lives within her means, knowing she has other payments to consider, such as her student loans and auto loan.

Sophia gets used to living off of a budget.

Every month, Sophia remembers to pay her credit card bill, and pay it in full. As a young lender, it is important for her to stay on top of her monthly payments.

As Sophia ages, she solidifies her good spending habits.

She opens another credit card account that has a larger spending limit, and uses it conveniently for groceries, bills, and other expenses—still living within her means and paying her bills on time.

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All her daily money habits pay off.

Her credit score has deemed her a trust-worthy lender, and she is able to lock-in favorable rates for the mortgage of her first home!