You May Need to Take Some Risk to Meet Your Goals

Jane Young, CFP, EA

Jane Young, CFP, EA

Before you start investing, it is important to understand the relationship between risk and return and as well as what level of risk you are comfortable taking.  Generally, an investment with a higher return will involve taking on more risk.    If all investment opportunities provided the same return, everyone would select the least risky choice.  As a result, a more risky investment must provide a higher return to attract investors.  At the most basic level, an investment is where one party needs money and another party has money to lend or invest.  The investor does not want to lose his money, so he demands an increasing level of return as the risk increases.

There are many different kinds of risk.  One of the most common is market risk, or the risk of losing money in the stock market when the price of stock falls.  This can be caused by a change in the overall economic situation, impacting the entire market, or by a change within a specific company.  A commonly accepted practice for decreasing this type of risk is diversification into many companies in different industries and different geographical locations. 

When investing in fixed income or interest earning investments, such as bonds and CDs, the most common risks are default risk and interest rate risk.  Default risk is the risk that the bond issuer will become financially insolvent or bankrupt.  Bond issuers are rated based on their stability to help investors gauge how much risk they are taking.  Interest rate risk is the risk that interest rates will increase after you have purchased a bond or CD, resulting in a drop in the current market value. This is of greatest concern if you own a bond fund or don’t hold an individual bond to maturity.

Two additional risks that many investors fail to consider include opportunity loss and inflationary risk.  If you try to avoid risk by avoiding the stock market, you may hurt your chances to earn a decent return.  With current interest rates on CDs and Treasury Bonds so low, conservative investors may be unable to keep up with inflation and build their retirement plans to desired levels.   Volatility in the stock market can be very scary, but over long periods of time it has outperformed most other investments.  By avoiding the stock market you take the risk of missing out on the higher returns provided with a more balanced portfolio.  You may even lose money, if inflation exceeds the interest rate on your CDs.

Moderation is the key.  Investing your entire portfolio in the stock market is far too risky, but investing your entire portfolio in fixed income is also risky.  You risk losing the opportunity to earn a reasonable rate of return, to keep up with inflation and to meet your investment goals.  The best plan is a diversified portfolio that meets your investment timeframe and long-term goals.

Understanding Social Security Survivors Benefits is Worth the Effort

Jane Young, CFP, EA

Jane Young, CFP, EA

There are a myriad of different Social Security options available to widows and widowers.  If you have lost a spouse, it is worthwhile to take the time required to fully understand your Social Security benefits. As a widow or widower, you have the choice of taking Social Security based on your own work record, or Social Security based on the work record of your spouse (survivor benefits).  You are eligible for 100% of your deceased spouse’s basic benefit, at full retirement age.  Reduced benefits are available as early as age 60, and if you are disabled, benefits can begin at 50.  The full retirement age is 66 if you were born between 1945 and 1956, and gradually increases up to 67 if you were born between 1957 and 1960.  The normal retirement age for everyone born after 1960 is 67.

If you started taking Social Security on your own record, before the loss of your spouse, call Social Security to see if you can receive more in the form of survivor benefits.  One nice feature of Social Security survivor’s benefits is the option to begin taking benefits based on your own earnings record, and later switch to survivors benefits.  Conversely, you can begin taking survivor’s benefits and later switch to benefits based on your own work record.   Unlike standard spousal benefits, you can switch even if you started taking benefits prior to reaching full retirement age.

Generally, you cannot get survivor’s benefits if you remarry before age 60.  After age 60, remarriage does not impact your benefits.  Additionally, at age 62 you are eligible to get benefits based on your new spouses benefits.  You may have the choice between benefits based on your own work record, benefits based on the work record of your deceased spouse, or benefits based on the work record of your current spouse.  Unfortunately, you have to choose from one of these options.  If other family members are entitled to survivor’s benefits, there is a limit to the total amount that can be paid to a family.

 If you receive a pension from a federal, state, or local government job where you did not pay Social Security, your survivor’s benefits may be reduced.    Your Social Security benefits will be reduced by two thirds of your government pension.  Additionally, if you collect Social Security based on your own work record, and you receive a pension from a job where you did not pay Social Security, your benefit may be reduced due to the Windfall Elimination Provision. Be sure to discuss this with your Social Security representative before you file for benefits.

Social Security survivor’s benefit can be very complex; please take the time to fully understand your options.  Before filing for Social Security, research the options available to you at www.socialsecurity.gov and meet with a Social Security representative to fully understand your choices.

Are Bond Funds Safe as Interest Rate Rise?

 

Jane Young, CFP, EA

Jane Young, CFP, EA

A key tenant in properly managing your investments is to maintain a well diversified portfolio.  A well diversified portfolio usually contains a mix of stock or stock mutual funds and fixed income investments.  Stock mutual funds are long term investments that can provide you with growth over a long period of time. Fixed income investments can provide you with short term liquidity, income, and a buffer against stock market volatility.  Bond funds have long been a staple in most fixed income portfolios.  However, with the threat of rising interest rates, many bond funds may no longer provide the stability you are seeking in the fixed income sleeve of your portfolio.

Interest rates, after dropping close to all time lows, have begun to increase.  The bond market had experienced what is commonly referred to as a 30 year bull market. Until recently, interest rates had been steadily dropping since the 1981.  As interest rates fell, bond owners experienced a corresponding increase in the value of their bonds.  Generally, when you buy a bond and interest rates decrease, the market value of the bond will rise. On the other hand, if interest rates increase, the market value of the bond will drop.  If you hold an individual bond to maturity, assuming the issuer does not default, your entire principal will be returned, regardless of the prevailing interest rate. 

Many investors prefer bond mutual funds over individual bonds because they provide greater diversification, liquidity and professional management.  However, recently bond funds have experienced decreasing yields.  As bonds within mutual funds mature, they are replaced with lower earning bonds.  In an environment of increasing interest rates, another major concern is the potential loss of principal.  If many investors decide to sell their bond funds, the fund managers may be forced to sell individual bonds at an inopportune time.  The manager may be forced to sell bonds before maturity, at less than the face value.

The duration of a bond fund is a measure of it’s sensitivity to changes in interest rates or interest rate risk.  For example, if the duration of a bond fund is 5 years, and interest rates decrease by 1%, the value of the bond fund should rise by about 5%.  If interest rates increases by 1%, the value of the bond fund should drop by 5%.  Short term bonds have a lower duration and long term bonds have a higher duration.  You can find the duration of most bond funds at Morningstar.com.

With the threat of higher U.S. interest rates, consider moving your longer term bond funds into short term bond funds or international bond funds.   For greater security of principal, move your bond funds into an FDIC insured CD ladder or equity indexed CD.   Bond funds usually represent the safe portion of your portfolio,  and some of your principal may be at risk as interest rates rise.

Are You Ready for the Unexpected?

 

Jane Young, CFP, EA

Jane Young, CFP, EA

The recent fires remind us how crucial it is to plan for unexpected financial misfortunes.  An important part of financial planning is ensuring you are adequately protected from life’s calamities.  You can’t control what life throws at you, but you can ease the blow by being prepared and keeping your financial life in order.

This may seem obvious, but we have a tendency to procrastinate when it comes to insurance and other precautionary measures.   You should always maintain an emergency fund of three to six months of expenses.  Even with good insurance, it may take time for the insurance company to reimburse you for a loss.   You should review your insurance coverage on a regular basis.  While most of us have home and auto insurance, things change and you may need some adjustments.  I encourage you to meet with your insurance agent at least once every three years or when there is a major change in your life.  Even if you are adequately insured, it is advisable to periodically get quotes from several reputable insurance companies. This can lead to considerable savings as your life circumstances change.

Make sure that you have adequate insurance to cover the current replacement value of your home and your personal property.  This is especially important if you’ve made significant home improvements.  You also need adequate insurance to pay for a place to live until you can buy or build a new home.   You may need a rider or additional coverage if you do business out of your home or you have collectibles, jewelry, art, or firearms.  It is prudent for most to have an umbrella liability policy equal to one to two times your net worth.  A good insurance agent can help you assess the risks that are unique to your situation and ensure you are adequately covered.

In addition to insurance you need an emergency plan to help you react quickly, should a disaster strike.  I recommend keeping all of your important documents in a safe deposit box.  Be sure to back-up important computer files at an off-site location.  Document all of your personal belongings and special features of your home with a video or pictures; this should also be kept in safe deposit box.

You also need to be prepared should something happen to you.  If others are dependent on your income, consider term life insurance to help them get by without your assistance.  If you are a primary wage earner, consider long term disability insurance to provide income if you are unable to work.  You should have a current will and health power of attorney.   When reviewing your will, be sure to review beneficiary designations for your retirement plans, annuities, and life insurance policies.

Generally, if you live within your means, stay out of debt and save 10–15% of your income, you will be better prepared to handle financial disasters that may arise.