Volatile Market Good Time for Retirement Savings

Jane Young, CFP, EA

Jane Young, CFP, EA

This is a great time to maximize your retirement contributions.  Not only will you save money on taxes but you can buy stock mutual funds on sale.  The one year return on the S&P 500 is down about 8% and market volatility is likely to continue throughout the year.

Dollar cost averaging is a great way to invest during a volatile market and it is well suited for contributing to your retirement plans.  With dollar cost averaging you invest a set amount every month or quarter up to your annual contribution limit.  When the stock market is low you buy more shares and when the market is high you buy fewer shares.  You can take advantage of dips in the market and avoid buying too much at, inopportune times when the market is high.

Ideally, the goal is to maximize contributions to your tax advantaged retirement plans however, this isn’t always possible.  Prioritize by contributing to your employer’s 401k plan up to the match, if your employer matches your contributions.   Your next priority is usually to maximize contributions to your Roth and then resume contributions to your 401k, 403b, 457 or self-employment plan.   Contributions to traditional employer plans are made with before tax dollars and taxable at regular income tax rates when withdrawn.  Roth contributions are made with after tax dollars and are tax free when withdrawn in retirement.   Some employers have begun to offer a Roth option with their 401k or 403b plans.

For 2015 and 2016 the maximum you can contribute to an IRA is $5,500 plus a catch-up provision of $1,000, if you were 50 or older by the last day of the year.  You have until the due date of your return, not including extensions, to make a contribution – which is April 18 for 2015. There are income limits on who can contribute to a Roth IRA.  In 2015, eligibility to contribute to a Roth IRA phases out at a Modified Adjusted Income (MAGI) of $116,000 to $131,000 for single filers and $183,000 to $193,000 for joint filers.  In 2016 the phase out is $117,000 to $132,000 for single filers and $184,000 to $194,000 for joint filers.

Your 401k contribution limits for both 2015 and 2016 are $18,000 plus a catch-up provision of $6,000, if you were 50 or over by the end of the year.  If you are employed by a non-profit organization, contact your benefits office for contribution limits on your plan.

If you are self-employed maximize your Simple (Savings Investment Match Plan for Employees) or SEP (Simplified Employee Pension Plan) and if you don’t already have a plan consider starting one to help defer taxes until retirement.

Regardless of your situation take advantage of retirement plans to defer or reduce income taxes on your retirement savings.  Current market volatility may provide some good opportunities to help boost your retirement nest egg.

Investing in a Volatile Market

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Here are some things you should keep in mind when investing in the stock market; the market will fluctuate, there will be years with negative returns, the stock market is for long term investing, and the media and prognosticators will greatly exaggerate negative information to create news and get attention.  If you keep this in mind, you can dramatically improve your long term investment returns and sleep better at night.  Based on numerous studies conducted by DALBAR, the average investor earns several percentage points below the market average due to market timing and emotional reactions to market fluctuations.  It’s how we are wired.  When the market goes up, we feel good and we want don’t want to miss out on the opportunity to make money.  As a result, we buy stock when the market is at its peak.  On the flip side, when the market drops we worry about losing money, and sell when the market is at the bottom.  It’s hard to make money in this cycle of buying high and selling low.  When investing in the stock market, try to avoid overreacting to the inevitable short term fluctuations in the market.

Other factors that can help you ride out dramatic fluctuations in the market include establishing a solid financial foundation and maintaining an asset allocation that meets your investment timeframe.  Establish a solid financial foundation by living within your means, minimizing the use of credit, and maintaining an emergency fund of 3 to 6 months of expenses.  A strong foundation helps you avoid pulling money out of the stock market at inopportune times should an emergency arise. 

Once you have established a strong financial foundation you can start investing in the stock market.  One key to success with stock market investing is establishing an asset allocation that’s in line with the timeframe in which you will need money.  Money that is needed in the short term should not be invested it the stock market.  As a general rule, do not invest any money needed within the next five years in the stock market.  Over long periods of time the stock market has trended upward, but in the short term there have been periods with substantial drops.  Give yourself time to ride out the natural fluctuations in the market.  

Additionally, it is important to diversify your money across a wide variety of investments.  You can reduce the amount of risk you take by diversifying across different companies, municipalities, industries, and countries.  When one type of investment is doing poorly, another may be doing well.  This helps to buffer the losses you may experience in your portfolio.  An excellent way to diversify is through the use of a variety of different types of mutual funds.  Mutual funds pool your money with money from others to invest in a large number of companies or government entities based on a predefined investment objective.

Selling Home May be Better Option Than Renting

 

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Jane M. Young CFP, EA

 

It’s time to move but you hate to sell your house when the market is down.  Maybe you should rent your house for a few years? Or, on second thought, maybe not.

There are many factors to consider before deciding to rent your home.  Do you have the temperament and the time to be a landlord?  Are you comfortable with the idea of having someone else living in your home?  Do you want to manage the rental yourself or do you plan to hire a property manager?  If you manage the property yourself do you have time to learn about fair housing laws, code requirements, lease agreements, escrow requirements and eviction procedures?  Who will take care of repairs and maintenance and are you ready for tenant calls in the middle of the night?  If this sounds a bit daunting, a property manager may be your best option.  A property manager will cost you about 10% of the rent.  Be sure to include this in your cash flow analysis.

Before renting your home do a realistic cash flow analysis.   Add up your projected expenses and deduct them from your projected rental income to see if renting will result in a profit or a loss.  If you project a loss, does your projected appreciation on the home while it’s rented compensate you for the time and money it will cost you? Do you have funds to cover a negative cash flow?  Your expenses may include your mortgage payment, property taxes, insurance, home owner’s association dues, maintenance and repairs, legal and accounting fees and property management fees.  A rule of thumb for maintenance and repairs is about 1 – 2% of the market value of your home, depending on the home’s condition.   You may need to spend money up front to attract good quality tenants.

When calculating your rental income, you need to decrease your projected rental income by about 8% to allow for vacancies.  In Colorado the average rental vacancy rate has been around 7-9 percent over the last five years, based on U.S. Census data.  When a renter moves or is evicted it can take several months to get a new renter in place.

If you rent you can take a tax deduction for depreciation against your rental income.  To calculate your annual depreciation, take the value of your home, on the date you begin renting, less the value of land and divide it by 27.5.  Unfortunately, this is just a temporary gift from the IRS.  When your home is sold you must recapture all of the depreciation at 25%.

Other potential drawbacks to renting your home include the possibility of major damage inflicted by a tenant, drawn out eviction processes, negligence or safety lawsuits and costly maintenance issues.

An additional consideration, if you have a capital gain on your home, is the loss of the capital gain exemption of $250,000 for individuals and $500,000 for a couple if you haven’t lived in your home for 2 or the last 5 years.

Stock Can Be a Good Option in Retirement

 

 

 

 

 

 

Jane M. Young

As we approach retirement, there is a common misconception that we need to abruptly transition our portfolios completely out of the stock market to be fully invested in fixed income investments.   One reason to avoid a sudden shift to fixed income is that retirement is fluid; it is not a permanent decision. Most people will and should gradually transition into retirement.  Traditional retirement is becoming less common because life expectancies are increasing and fewer people are receiving pensions. Most people will go in and out of retirement several times.  After many years we may leave a traditional career field for some well-deserved rest and relaxation.  However, after a few years of leisure we may miss the sense of purpose, accomplishment, and identity gained from working.  As a result, we may return to work in a new career field, do some consulting in an area where we had past experience or work part-time in a coffee shop.

Another problem with a drastic shift to fixed income is that we don’t need our entire retirement nest egg on the day we reach retirement.   The typical retirement age is around 65, based on current Social Security data, the average retiree will live for another twenty years. A small portion of our portfolio may be needed upon reaching retirement but a large percentage won’t be needed for many years.   It is important to keep long term money in a diversified portfolio, including stock mutual funds, to provide growth and inflation protection.   A reasonable rate of growth in our portfolio is usually needed to meet our goals. Inflation can take a huge bite out of the purchasing power of our portfolios over twenty years or more.   Historically, fixed income investments have just barely kept up with inflation while stock market investments have provided a nice hedge against inflation.

We need to think in terms of segregating our portfolios into imaginary buckets based on the timeframes in which money will be needed.  Money that is needed in the next few years should be safe and readily available.  Money that isn’t needed for many years can stay in a diversified portfolio based on personal risk tolerance.  Portfolios should be rebalanced on an annual basis to be sure there is easy access to money needed in the short term.

A final myth with regard to investing in retirement is that money needed to cover your retirement expenses must come from interest earning investments.  Sure, money needed in the short term needs to be kept in safe, fixed income investments to avoid selling stock when the market is down.  However, this doesn’t mean that we have to cover all of our retirement income needs with interest earning investments.  There may be several good reasons to cover retirement expenses by selling stock.   When the stock market is up it may be wise to harvest some gains or do some rebalancing.  At other times there may be tax benefits to selling stock.

 

Are Your Bonds Safe?

 

 

 

 

 

 

Jane M. Young

Let’s compare some differences between stocks and bonds.  When you buy a bond you are essentially lending money to a corporation or government entity for a set period of time in exchange for a specified rate of interest.  When you invest in the stock market you assume an ownership position in the company whose stock you are purchasing.  As a result, the value of your investment will fluctuate based on the profit or loss of the underlying company.  With the purchase of a bond the value of your investment hould not fluctuate based on the financial performance of the issuer, assuming it remains solvent.  You will continue to receive interest payments according to the original terms of the agreement until the bond matures.  Upon maturity the amount of your original investment (principal) will be returned to you along with any interest that is due.   As a general rule, stocks are inherently more risky than bonds, therefore investors expect to receive a higher return.

Bonds may appear to be safe but they are not without risk. Currently, there is some risk associated with low interest rates that may not keep up with inflation.  This is especially true with many government bonds. Two additional risks typically associated with bonds include default risk and interest rate risk.

Default risk is the risk that the issuer goes bankrupt and is unable to return your principal.  Most bond issuers are assigned a rating to help investors assess the potential default risk of a bond.   Generally, investors are compensated with higher interest rates when taking a risk on lower rated bonds and receive lower interest rates on higher rated bonds.

Interest rate risk is based on the inverse relationship between interest rates and the value of a bond.  When interest rates increase the value of a bond will decrease and when interest rates decrease the value of a bond will increase. If you hold an individual bond until maturity your entire principal should be returned to you.  You have the control to keep the bond until maturity and avoid a loss.  However, if you need to sell before maturity you may lose some principal. The loss of principal is greater for longer term bonds.  This needs to be weighed against the benefit of a higher interest rate paid on longer term bonds.

Bond mutual funds can provide diversification and reduced default risk because your money is pooled with hundreds of other investors and invested in bonds from a large number of different entities.  If one or two entities within the mutual fund go bankrupt there will be minimal impact on each individual investor.  However, with mutual funds you have less control over interest rate risk.  When interest rates increase, bond fund managers often experience a high rate of withdrawals forcing them to sell bonds at an inopportune time.  This usually results in a loss of principal, the severity of which is greater for longer term bond funds.

Stay The Course! Ten Steps to Help You Through Uncertain Financial Times

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Jane M. Young, CFP, EA

1. Don’t react emotionally! This will result in a constant cycle of buying high and selling low. Once you sell, you lock in your losses. Stay the course and focus on what you can control.

2. Make sure you have an emergency fund of three to six months of expenses.

3. Evaluate your asset allocation to be sure it is consistent with the timeframe in which you need to withdraw money. The stock market is a long term investment; you should never have short term money in the stock market. Make adjustments to your allocation based on your long term goals and need for liquidity not on fear.

4. Maintain a well diversified portfolio.

5. Pay-off credit cards and high interest consumer debt. Be wary of variable rate loans, lines of credit and mortgages. The downgrade in the U.S. credit rating could hasten an increase in interest rates.

6. Get your personal finances in order. It’s always a good idea to understand your spending and keep expenses in line with your income and financial goals. This is a good time to tighten your belt to be prepared for unexpected emergencies.

7. Use dollar cost averaging to invest new money into the stock market. Volatility in the stock market creates great buying opportunities.

8. Don’t get caught up in the media hype. They are in the business to sell newspapers, magazines and television commercials. Avoid the new hot asset class they are trying to promote this week. Sound investment advice is boring and doesn’t sell newspapers.

9. Take steps to secure or improve your income stream. Are you performing up to speed at work? Are you getting along with co-workers? Should you take some classes to keep your skills current? Are you underemployed or under paid for your education and experience? Consider a second job to pay down excess debt.

10. Stay calm, be patient and focus on making sure your financial plan meets your long term goals and objectives. Stay the course, this too shall pass.

Solve the Deficit Problem by Cutting Government Spending – You Don’t Stop the Spending by Refusing to Increase the Debt Ceiling

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Jane M. Young, CFP, EA

A few clients and friends have asked me if they should be making changes to their investment allocations based on the uncertainty around raising the debt ceiling. While we don’t want to bury our heads in the sand we should not over react to something that probably won’t come to pass. In my opinion the political stakes are way too high for all parties concerned to allow the U.S. to default on its obligations. At the moment everyone is playing chicken but at the end of the day, neither party can afford the political fallout that would result in a failure to raise the debt ceiling. This does present a great opportunity for the media to get attention with sensationalistic, doomsday headlines to help them sell newspapers or television spots. This is also a great opportunity for political posturing on the part of both Democrats and Republicans. It is my projection that on August 2nd we will still have a huge deficit problem and a higher debt ceiling.

The debt ceiling is an indication of a much bigger problem with federal government spending. The problem is not solved by changing the debt ceiling; the problem was created when congress approved spending resulting in the need to raise the debt ceiling. Failure to raise the debt ceiling is like trying to close the barn door after the horse has gotten out. Refusing to raise the debt ceiling is a meaningless gesture, with regard to our deficit. However, it carries a catastrophic impact on the perceived safety of U.S. debt which would ripple down through all aspects of our financial lives. This is clearly not an acceptable course of action. The real issue is getting a handle on government spending and the deficit which will require major reforms to Social Security and Medicare. Our economy and prosperity are being held back by a looming black cloud caused by fear and uncertainty with regard government spending and the federal deficit.

New Normal

By Bert Whitehead, MBA, JD

A number of clients have expressed alarm at the recent clamor of commentators who have been predicting a cataclysmic economic change worldwide. These pundits claim that we are facing an economic “New Normal” and express concern that the ‘old’ economic rules on which we rely no longer operate.

Their conclusions? Drastic changes are needed in our lives and investments to accommodate the “New Normal!”

Usually they question the viability of the U.S. dollar and offer the possibility that China, or perhaps a block of other nations, are somehow positioned to ‘take over’ the U.S. because they hold so many U.S. bonds. Another variation of this calamity centers on the recent collapse of the real estate market, the precipitous drop in the stock market, and extraordinarily low interest rates. Taken together, these developments presage the end of American prosperity for our children and ourselves.

Of course these apocalyptic pronouncements are more effective if they are tied to some political viewpoint, the more extreme the better. More often than not, far right political viewpoints proclaim that doomsday is the certain result of left-wing politics. Leftist views generally emphasize the inevitable revolution that suppression of the masses will cause.

(Note to “Investment Advice” file: Never let your politics drive your investments!)

It’s time to confront these ridiculous assertions. Yes, it is true that the investment and economic travails of the past decade have been severe and have impacted many people worldwide. Some of these changes have not occurred before during many of our lifetimes. It is enticing to point the finger of blame and shame at our financial, economic, investment and political leadership. But that is not the whole story
The power of momentum in democratic economies is easily underestimated. Although dramatic from time to time, the impact of severe financial shifts must be kept in proportion and viewed within a broader historical perspective. We need to recognize that most extreme economic shifts are self-correcting.

Even with unemployment at over 9%, over 90% of our citizens are employed. Real estate crashes, weather-related disasters, stock market crashes, low interest rates, etc. have all happened before. Indeed the damage done by seismic economic shifts during the Great Depression, the severe stagflation in the 1970’s, and the collapse of S. & L.’s in the 1980’s were all worse than we have seen today…and all of these are relatively minor when compared to the disruption of the financial markets in the 19th century. And whatever happened to the “New Economy” theory that gave rise to the ‘dot-com’ frenzy of the 1990’s?

It is folly to fret about how much of our debt is owned by the China (interestingly, Japan owns nearly as much U.S. debt as China, even though that fact is not usually noted). What can the Chinese do with our debt? They can’t dump it on the White House lawn and demand to be paid off with gold. They can’t go on the world markets and exchange dollars for Euros or Yen, or even buy gold. Any of these moves would be self-defeating because dumping huge amounts of money in any market would decrease the value of their remaining dollars. Actually, their only realistic option is to spend it in the U.S.!

There is a concern that the U.S. dollar is at a “tipping point” and will soon lose its status as the world’s reserve currency. But no other currency is in a position to take its place. The Euro’s stability is much too questionable. The Yuan doesn’t have a long enough history to be relied upon, especially when a dictatorial government can arbitrarily determine its value. Neither these nor other ‘respectable’ currencies such as the Yen, the British Pound, the Swiss Franc, etc. have enough depth to support a global economy.

Those who espouse extreme economic outcomes are invariably selling something. Usually it is their newsletter or book, or some strategy to beat the market, or gold itself. The most eminent economists in the world have never been able to predict any economic cycle with a meaningful consensus. Why should you believe the extreme voices of charlatans who use their advanced marketing techniques to dupe the fearful?

What can you do? I suggest that you sit back and follow sensible advice. The Functional Asset Allocation model, which is used by nearly 200 fee-only members of ACA (Alliance of Cambridge Advisors), focuses on the basics.

Consider this…there are only three possible economic scenarios: we can have inflation, deflation, or prosperity. It is a waste of time to try to determine which is coming next. The prudent approach is to be prepared for all three possibilities. As the ancient wisdom of the Torah exhorts: “Invest a third in land, a third in business, and a third in reserves!”

Today, that translates into a balanced portfolio of real estate, equities (i.e. stocks in companies), and cash and bond reserves. Trying to market-time and pick the next ‘hot investment’ is foolhardy. If you allow the vagaries of global economics, i.e. exogenous factors, to be the focus of your attention, you risk making decisions based on emotion rather than rational thought. In truth, it is the ‘endogenous factors’ in your life that determine your financial future.

As Pogo once said, “We have met the enemy, and he is us!” Instead of dithering about what will happen in the Mideast, or where interest rates are headed, or when will real estate level off, look at the things in your life that make a difference. Are you saving at least 10% of your gross income? Are you living within your means? Do you have enough liquidity to ride out a financial setback? Do you have a long-term fixed rate mortgage to protect you from inflation? Do you have government bonds to weather another bout of deflation.

Obsessing about the various complexities and possible outcomes in today’s global economy inevitably leads to rash and unwise leaps. Keep an eye on the issues within your reach! It is the key to a confident journey and a serene financial future.

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.

Does the Stimulus Make Gold Shine? (part II) – How to Buy Gold

If you decide to buy gold as a hedge against inflation there are several options. One can invest in gold through mutual funds, exchange traded funds (ETF), gold bullion, gold coins, gold mining stock and gold futures. In selecting an investment vehicle keep in mind your reason for purchasing gold – it’s a doomsday investment. If the entire financial world is crumbling around you, your gold needs to be secure. If you buy gold, consider investment in gold coins. Some options include the American Eagle, the Vienna Philharmonic or the Canadian Maple Leaf. With gold coins you have possession, they come in commonly accepted denominations and they are portable.

An exchange traded fund (ETF) may seem like a convenient way to buy gold. However, when you purchase an ETF, you own shares in the ETF, you don’t have physical possession of the gold. If you decide to purchase a gold ETF make sure the company has gold reserves to cover 100% of the investor deposits. Some of the largest ETFs have recently come under scrutiny for this issue. Finally, be cautious with investments in gold mutual funds, gold mining shares and ETFs that may become inaccessible in times of extreme market distress or collapse.

Does the Stimulus Make Gold Shine? (Part I)

Jane M. Young CFP, EA, CDFA

I have frequently been asked about the wisdom of investing in gold to hedge against inflation. Generally gold is not a great investment, it is commonly thought of as a doomsday investment. Gold is very risky and exceptionally volatile. The value of gold is based on what people are willing to pay. The market value of gold can be highly dependent on irrational emotions. Over long periods of time the return on gold has mirrored that of inflation resulting in a real return close to zero. The current price of gold is exceptionally high; it increased almost 60% over the three years ending in 2008. Additionally, the cost to acquire and sell gold can be prohibitive.

Recent increases in government spending make inflation a greater threat. A threat of inflation makes gold more appealing. Gold usually holds its value at times when other assets are losing their value. The demand for gold generally spikes in times of economic instability and inflation. If the government becomes unable to sell treasuries to cover significant increases in government spending it will resort to printing money. This will result in inflation. Historically, inflation has lead to higher gold prices.

If you decide to reinforce your portfolio with gold to guard against inflation or economic instability it should only represent a small percentage of your portfolio – generally 5% and no more than 15%.

Finding Peace of Mind in Turbulent Times

 Jane M. Young, CFP, EA

 

                                         

1. Don’t lose sight of your investment timeframe.  You’ve heard it time and time again but stock is a long term investment.  So, don’t let the current drop in the stock market cause you to make drastic changes to money you won’t need for 10, 15 or 20 years.   If you don’t need your money for 5 to 10 years stop worrying about it, the market will recover.   If you are in or approaching retirement, you should have put aside the money you will need in the short term.   Use this for your immediate needs.   Down the road in 5 or 10 years when you need to tap into your stock mutual funds they should be back to reasonable levels.   Don’t lose sleep about the level of your investments 10 years from now.

 

2. Every financial crisis feels like the end of the world while we are in it.  If you were to look at the headlines during any one of the past financial downturns you couldn’t differentiate them from today.   Every time we go through a financial crisis whether it’s the savings and loan crisis in the 80’s or the dot.com crisis the message is the same.  This time it’s different, things will never be the same, the sky is falling and so forth.   Everything isn’t rosy, but we will recover from this.  We need to avoid making decisions based on emotion and fear.  The media is in the business to sell papers or increase viewers.  They are going to sensationalize our economic situation.  Good news does not provide high ratings.    Take a deep breath, hug your kids, walk your dog, live your life and stay the course with your portfolio – this too shall pass.

 

3. Don’t pass up a once in a lifetime opportunity to invest in stock at exceptionally low values.  Sure it has been exceptionally painful to watch the stock portion of our portfolios drop by 40% but what a great opportunity we have.   If you have a long time horizon now is a great time to invest in the stock market.  I encourage you to invest a set amount of money into a diversified set of stock mutual funds every month (dollar cost averaging).   Investing in your company 401k or a Roth IRA is a great way to make systematic investments.   Now is the time to invest, not to sit on the sidelines.  It is always darkest before the dawn.  Remember, the stock market is counterintuitive – you feel like selling when you should be buying and you feel like buying when you should be selling.  Therefore, right now we should be buying!!!   When you feel it is safe to buy again it will be too late.

 

4.  Choose your battles and focus on what you can control.  You can’t control the fluctuations in the stock market or where the market is headed.  However, you can better prepare yourself for a weak economy.  Maybe now is the time to cut your personal spending and build up your emergency fund.  Evaluate how to reduce your expenses and pay off debt. Make sure your skills are current and relevant.  Build and strengthen your network now before you really need it.  If you are approaching retirement, and the market has set you back, evaluate alternatives and contingency plans.   Take advantage of opportunities available to you – buy stock mutual funds at low values,  re-finance your home at a low interest rate, convert your traditional IRA to a Roth and sell those especially weak stocks to harvest tax losses.