A common financial planning question we get is “Should I have a living trust?” Not everyone needs one—here’s how to determine if you do.
In this week’s reader, we cover homeowner’s insurance and hurricanes, IRA beneficiaries and minors, and financial conversations with aging parents.
You can’t tell it by looking at the calendar, unless you know what you are looking for, but we are getting ready to head into one of the most important times of the year. No, I’m not talking about the holiday season, although I’m sure we will be hearing Christmas songs sometime soon. It’s a particularly important time of year if you, or a loved one, are covered by Medicare. It’s the Medicare open enrollment period, the time when Medicare beneficiaries can make changes to their plan and pick one that works best for them. In effect, each year you get a “do-over” on choosing your plan. The open enrollment period starts on October 15 and ends on December 7.
Open enrollment is a big deal, but unfortunately, most people don’t take advantage of it. Make sure that you do not let December 7 slip by without at least reviewing your Medicare options. Don’t assume that the plan that was best for you in 2017 will be the best for you in 2018. Plans change every year, and the open enrollment period is your chance to trade in your old plan for one that fits you better.
Are you satisfied with your current Medicare plan? Has it changed? Have premiums or out-of-pocket costs gone up? Has your health changed? Do you anticipate any change in medical care or treatment? Is the drug coverage you have still appropriate? These are all important questions to ask yourself because during open enrollment, you can switch from Original Medicare to a Medicare Advantage plan, or from a Medicare Advantage plan to Original Medicare; you can change from one Medicare Advantage plan to another; you can enroll in a Medicare prescription drug plan (Part D) or switch from one Part D plan to another.
Speaking of prescription drug coverage, one of the big changes that occur every year is a plan’s formulary, the plan’s list of medicines that are covered and how they are covered. Drug makers can raise or lower their prices, which will have an effect on your plan. Maybe a cheaper, generic version of a drug you need has become available. A plan’s formulary is one of the things you must review when evaluating Part D coverages. What good is a plan if it doesn’t cover the drugs you need?
So, where do you start? First, you should receive a notice from your current plan about any changes that will occur in 2018. They are required to send the notice to you for review. And while it’s a bit of a long document, it’s not difficult to work through if you know what you are looking for. Here are some of the things you should be reviewing: monthly premiums—and any change from last year; deductibles—they generally change a bit each year, and some plans will absorb some of the cost increases; copays and coinsurance—and any changes in amounts or requirements; drug tiers—to see if any drugs that you take moving from one pricing tier to another; out-of-pocket-maximums—you may have two caps to review, one for health coverage and one for drug coverage; provider networks—to see if your doctor and hospital choices have changed; drug formularies—for the reasons mentioned above.
There are also two sites I would recommend that you spend a little time on. The first is Medicare.gov, which can help answer a lot of your questions. The second is Medicare Plan Finder, which will help you get specific information on the plans that are available to you.
Open enrollment is also important because it gives you, as a consumer, a big say in what plans are offered. The best plans available are rewarded with new business as consumers exercise their right to choose. The plans that consumers don’t like will have to either change or disappear. But while open enrollment is good in theory, most people typically stay with what they have, even despite evidence that they would be much better off by changing to another plan.
Don’t be most people. By spending a few hours each year reviewing the changes in your plan, and the other plans that are out there, you can become a savvy Medicare shopper. Many articles have been written about what health care costs will be in your retirement years. Here is one way that you can work to control those costs.
It’s so obvious that you may not have even noticed it. It’s the paragraph that is part of the paperwork for every investment account that you open with an advisor, brokerage firm, bank, or insurance company. It makes so much sense that you acknowledge it and move on, barely giving it a thought. It’s obviously important because sometimes it’s in ALL CAPS. I’m referring to the part of the contract that says, “Past performance is not a guarantee of future results.”
We inherently understand this and know that it’s true. We know that the markets change every year. We know that last year’s best-performing investment may be this year’s laggard. Some years, stocks provide a better return than bonds; sometimes bonds do better than stocks. Large company stocks can outperform one year, and small company stocks lead the way the next. International stocks are this year’s star and next year’s dud.
We know that investments work this way, yet when it comes to managing our portfolio, lots of folks seem to come up with a bad case of amnesia. When selecting investments, too many of us make the decision on whether to add an investment to our portfolio by looking at the recent performance. This seems to be the case whether it’s a stock, a mutual fund, an exchange-traded fund (ETF), or another type of investment vehicle. If it has done well recently, we’ll add it to our portfolio mix. If it hasn’t done well, we tend to avoid it.
This behavior is known in the industry as “Chasing the hot dot.” We know that last year’s winners are often this year’s losers, but many of us seem unable to transfer this knowledge to action when selecting our investments. I see this most often when people are choosing the investment mix for their 401(k) plans at work. They’ll look at the menu of funds available to them in the plan and choose the ones that have the best performance numbers over the last six months or a year. This is not how to choose your investments.
I have a chart I like to use when explaining our investment strategy to clients. I call it my “Skittles chart” because it’s very colorful. It assigns a bright color to all the asset classes that we use when building our model portfolios. For example, U.S. stocks might be a shade of blue, international stocks might be yellow, emerging markets might be red, and short-term bonds might be green. The chart then ranks the asset classes based upon their performance each year. The result is a quilt-like pattern of bright colors, reflecting how each asset class has done each year relative to the others.
When discussing the chart, I’ll point to 2007, which shows that emerging markets were the top-performing asset class, returning 39.4% for the year. I’ll explain that many people would look at that return and make the decision to add it to their portfolio because it was doing so well. Of course, in 2008, emerging markets were the worst-performing asset class, losing 53.3%. The poor investor who bought the fund at the beginning of the year gets to the next year and says, “Well, that didn’t work out.” So, the fund is sold. And of course, in 2009 emerging markets returned to the top of the performance list with a gain of over 78%. So now the investor, who bought when the price was high after 2007 and sold when it was at a low in 2008, has another chance to buy high. Buying high and selling low is not how to win at the investing game.
A better approach is to make sure your portfolio is diversified across the major asset classes. If you owned emerging markets in 2007 and you enjoyed a 39% gain, you would rebalance your portfolio and sell a bit of it (but not all) when the price was high. Then, after the asset class lost 53% in 2008, you would rebalance again and buy when the price was low. Buying low, selling high—that’s how you are supposed to invest.
When it comes to building your portfolio, just remember that funds that have outperformed in the past do not always keep on winning. Past performance provides little insight about how that fund will perform in the future. That’s why that paragraph is in every investment agreement. It’s so obvious.
What to do about health care is one of the major decisions that everyone faces when getting close to retirement. A lot of people delay retirement until they reach age 65 because they don’t want to lose their employer-sponsored health plan. Even if they are financially able to retire, they will often continue to work until they are eligible for Medicare. With the uncertainty that is the state of our health care system right now, it’s hard to blame them.
But what do you do once you turn 65 years old and are eligible for Medicare? In the first part of this series on Medicare planning, I discussed the importance of timing your Medicare enrollment (Medicare Enrollment—Not As Easy As It Sounds). The second part of the series (Medicare—Which Path Is Right for You?) was a discussion on the differences between Original Medicare and Medicare Advantage. In this post, I will discuss the types of Medicare Advantage plans that are available.
As a refresher, Medicare Advantage plans are sold and administered by private insurance companies. Original Medicare is administered by the federal government. Medicare Advantage plans must provide, at a minimum, the same coverage as Original Medicare Parts A and B. The plans often include prescription drug coverage and additional coverages like vision and dental, and some come with other benefits, like a gym membership. With Original Medicare, you can visit almost any doctor in the country. With a Medicare Advantage plan, you generally get care from within the provider’s network of medical professionals. Most people choose Original Medicare, but about 30% of enrollees select Medicare Advantage.
For this post, I am going to assume you have decided that a Medicare Advantage plan would be the right path for you. If that’s the case, it’s important that you understand the types of plans you will choose from. The most common Medicare Advantage plans are health maintenance organizations (HMOs), preferred provider organizations (PPOs), and private fee-for-service (PFFS) plans. Lesser-known plans under the Medicare Advantage umbrella include special needs plans (SNPs) and medical savings account (MSA) plans. We’ll take a closer look at each type and highlight the differences.
Health maintenance organization: With this type of plan, you select a primary doctor from the insurer’s network, and that doctor manages your health care. If you need to see a specialist, you usually will need a referral from your primary doctor, and you are typically not covered for services provided outside of the network, although there are exceptions. The rules of this type of plan may be the most restrictive, but it will generally offer the lowest plan costs.
Preferred provider organization: Under a PPO, you generally can go to any doctor or hospital, but you will pay more if you use a provider outside of the insurer’s network. If you need to see a specialist, you generally won’t need a referral, but if you select a provider outside of network, you will pay more. This type of plan is more flexible, but it usually comes with a higher premium.
Private fee-for-service plan: This plan was once the fastest-growing type of Medicare Advantage plan. It was popular because you didn’t have to choose a primary care doctor and usually didn’t need a referral to see a specialist. You had to be careful with this plan, however, because not all Medicare providers accepted it. The popularity of this type of plan has declined because of some changes in the Medicare laws. It’s important to make sure you understand the details of how the plan works if you opt for it.
Special needs plan: As the name implies, this type of plan is available for Medicare enrollees who have some type of special need. The plan will offer custom benefits designed to meet the specific needs of the plan member. You could be eligible for this type of plan if you have a severe and/or chronic condition like diabetes, end-stage renal disease, chronic heart failure, or dementia. Living in a nursing home is another example of a condition that would be eligible for this type of plan.
Medicare savings account: This type of plan is not as popular as the other types of plans. It combines a high-deductible health plan with a bank account in your name. When you select this type of plan, Medicare will make deposits into your bank account that you can use to pay for medical expenses. This type of plan is really only appropriate for you if you don’t need a lot of care, because the amount deposited into your MSA is often less than the deductible.
As I wrote in the first part of this series on Medicare, getting the coverage that is best for you is not a simple process. You don’t just show up at age 65 and sign up. You need to make sure you understand your options and make the best choices based upon your individual needs. Don’t pick a plan because a friend or family member picked it. Make sure that it’s right for you.
Picture this: Through your hard work and discipline, you have accumulated a relatively significant amount of savings outside of your retirement accounts. You have more than enough cash set aside in your emergency fund, which is your safety net, and you are thinking about whether you should use some of your excess savings to pay off the mortgage that is left on your home. So, should you?
Just like most financial questions, there is no easy answer. The right answer could be different for you than it is for your friends or family members. The best you can do is to try to understand the pros and cons of both sides of the issue so that you can make the best decision for you and your family. This article will attempt to help you understand the pros and cons of this tricky question.
In the financial planning community, there are two schools of thought on whether you should pay off your mortgage. Many advisors think that you should do everything you can to eliminate all debt, including your mortgage. Other advisors believe that there is a difference between good debt and bad debt and that a mortgage is considered good debt. (A couple of examples of bad debt would be credit cards and auto and boat loans.)
So, what are the benefits of paying off your mortgage? Obviously, there’s the fact that you will no longer have a monthly mortgage payment. Not having that monthly obligation will free up cash flow that you can use to pay for other things that are important to you. There’s also the peace of mind factor. There’s no way to put a value on the warm and fuzzy feeling that comes from laying your head on your pillow each night knowing that, no matter what happens in the financial world, you own your home and nobody can take it away. There are studies that say that the happiest and most successful retirees are the ones who own their homes free and clear.
Are there any cons of paying off your mortgage? The most obvious is the opportunity cost on the money you used to pay off your mortgage. Opportunity cost is the benefit you would have received if you had made a different decision. If you still had those funds, you would most likely have them invested. The return you could have earned on those funds is the opportunity cost of paying off your mortgage. And therein lies the rub. Because of the fluctuations in the investment world, you don’t know what kind of gains, or losses, you might get on those invested dollars.
What are the benefits of not paying off the mortgage? One answer is the opposite of the opportunity cost discussed in the previous paragraph. Depending upon the interest rate you are paying on your mortgage, you may be able to invest the funds and get a better return. In today’s low interest rate environment, that’s not a very high bar. If you have a mortgage in the 4% range and can get more than 4% on your investment portfolio, you are ahead of the game. Of course, most investments are not guaranteed. The way that I typically explain this concept is like this: If you have a 4% mortgage and you pay it off, you are, in effect, getting a 4% guaranteed return on those dollars. If you do not pay off the mortgage and invest instead, you will do better if your portfolio earns more than 4%, worse if it earns less or loses money.
Remember that mortgage interest is also a tax-deductible expense. So, if you are still able to itemize your deductions, you will pay a lower “net” interest rate on your mortgage. To illustrate, let’s assume you are in the 25% tax bracket and have a 4% mortgage. By deducting your mortgage from your taxable income, you are effectively paying a net rate of 3%. That’s pretty cheap money.
I fall into the camp that believes that, in most cases, a mortgage is good debt, especially in today’s interest rate environment. When interest rates finally move higher, I will undoubtedly re-evaluate my position. But for now, I consider the historically low interest rates we have available as incredibly cheap money.
Many of you know that my wife and I are building a new home. As we were going through the mortgage process to secure the funding for our home, we reviewed the 15- and 30-year options. Fifteen-year mortgages are at extremely low rates, but we opted for the slightly higher 30-year option because it gives us the flexibility to lock in a very low rate for a very long time. We can certainly make additional principal payments if we want, which could pay off the mortgage in 15 years, but having the 30-year option in place gives us flexibility on paying the mortgage down in a way that is comfortable for us over the years. In the meantime, we can keep our investment portfolio intact, hopefully growing our portfolio by more than the cost of our borrowed funds.
But it’s important to remember what I mentioned earlier. Just because it might be the right decision for me not to pay off my mortgage doesn’t mean that it’s necessarily the best option for you.
When we look at the performance of the investment markets so far in 2017, something seems to be missing. We know that it’s there. We can feel it. But we just haven’t seen it in a while. Our monthly and quarterly statements look pretty good, and most of the asset classes we own are doing well. So, what’s missing? We know that risk and reward are basic principles of investing. So far this year, we’ve seen reward, but risk seems to be missing.
When most people think about risk, they are thinking about market risk—the risk that their investments will lose value. Most of us still remember the harrowing years of the financial crisis that occurred a decade ago. We saw the U.S. stock markets drop more than 50% from 2007 to 2009. It was a long, painful decline, and it was a devastating example of market risk.
But risk comes in several flavors. While market risk is the boogeyman that seems to scare folks the most, it’s hardly the only risk we face as investors. One of the main reasons that we invest is to help offset inflation risk. When the prices of milk, eggs, and other living expenses go higher, it takes more money to maintain our standard of living. This flavor of risk is particularly dangerous for retirees. When you are no longer working and are living off your savings, inflation eats away at your purchasing power. The increasing costs of health care as we age are becoming a huge risk for a lot of people. What can we do? We can invest. If we can grow our investments more than the inflation rate that eats away at our purchasing power, we can stay ahead of the game. So, we end up taking on some market risk to help offset our inflation risk.
Longevity risk is the risk that we will outlive our savings. It’s another form of risk that is particularly dangerous for retirees. Thanks to the wonders of modern medicine and improvements in living conditions, we are living longer. This means that we are spending more money and putting more stress on our savings. Longevity risk is bad enough, but when it’s combined with inflation risk, it’s a double-whammy to retirees. Again, we try to mitigate these risks by taking on market risk. If we can grow our savings by investing wisely, we can help offset some of the risk of running out of money in our later years.
There are other risks that we face when investing. Concentration risk is the flavor of risk that comes from having too many of our investment eggs in one basket. If our portfolio is heavily concentrated in one type of investment, an individual stock, a bond, or even an asset class, we risk losing money if that investment does poorly. We can reduce this risk by diversifying our portfolio across many investments, industries, and countries.
Credit risk is the risk we take when we buy a bond or other type of fixed-income investment. When we buy a bond, we are basically lending our money to a company or a government. Credit risk comes from the chance that we don’t get paid back when the bond matures. Once again, this risk can be lessened by owning a diversified portfolio of bonds, or by owning a bond fund.
We can’t avoid risk, because it is everywhere in one form or another. The key to being successful financially is to balance the types of risk. That balance is different for everyone. We accept some of one type of risk to help offset another type. We all have different goals, and we all deal with the different types of risk in different ways. It’s important to find the balance that is right for each of us.
Enrolling in Medicare is not a simple process. As you approach age 65, there are several decisions that need to be made. Making a wrong decision, based on your circumstances, can have a big impact on your finances and your health insurance coverage. In the first part of this series on Medicare (Medicare Enrollment—Not As Easy As It Sounds), I discussed the importance of the timing of your enrollment. In this article, I will try to help you understand the different paths that you must choose from when it’s time for you to enroll.
It’s important to understand that you have two paths to choose from when enrolling in Medicare. You can select either Original Medicare or Medicare Advantage. Both paths have advantages and disadvantages, and what might be the best path for you may not necessarily be the best path for friends or family members.
The first step in choosing the right path is understanding the difference between the paths. Original Medicare is administered by the federal government and consists of a few different parts. Part A is the coverage that pays for expenses incurred during inpatient hospital visits and for those in a skilled nursing facility. It also pays for some expenses related to home health care and hospice services. Medicare Part B pays for medically necessary services, like lab tests and doctor visits, to diagnose and treat your health issues.
When you choose Original Medicare, you start with Parts A and B, and then you can add optional coverages. Part D is an optional coverage that pays for prescription drug expenses. The other optional coverage is a Medigap policy. Medigap policies are administered by private insurance companies and offer a variety of coverages for co-pays and deductibles. It is important to note that not all health care providers accept Medicare patients, but most do, so you can choose from a wide variety of doctors and specialists.
Medicare Advantage plans offer an alternative path for Medicare enrollees. These plans are administered by private companies. They are required to offer the same coverages as Original Medicare, and they often offer more, like vision, dental, or hearing coverage. Most of them offer drug coverage. They work with a network of providers and therefore have more rules when it comes to getting a referral to a specialist. The premiums are typically significantly lower than Original Medicare, and some plans are offered with zero premium. But zero premium does not mean zero cost. There are out-of-pocket expenses, usually with each service provided under the plan.
Which Path Should You Pick?
So, which path should you choose? Like most financial questions, the answer is … it depends. If your doctor is not in a Medicare Advantage network, you’ll need to find a new doc or go with Original Medicare. If you plan to travel extensively, you might also want to consider Original Medicare because you are not limited to doctors within a network. If your health is good and you don’t incur a lot of medical expenses, a Medicare Advantage plan can probably save you some money.
Of course, that leads to the question that many ask: “Why not sign up for Medicare Advantage while healthy and switch to Original Medicare and a Medigap plan when we need more services?” That would be nice, but it doesn’t work that way. Once you’ve decided which path is right for you, it’s not easy to change. There are certain times each year when you can apply for a change, and there are some rules you have to follow.
It’s relatively easy to switch from Original Medicare to a Medicare Advantage plan. But if you want to go from a Medicare Advantage plan to Original Medicare, it can get complicated. After spending an amount of time in a Medicare Advantage plan, you can lose the guarantee to get a Medigap plan. The Medigap insurance companies can put you through medical underwriting. That means if you have a pre-existing chronic condition, you can be denied coverage. And having Original Medicare without a Medigap policy can become cost prohibitive, especially if you have a chronic condition.
Remember, I said it isn’t easy. But the key to making any decision is to gather as much information and knowledge about the subject as you can. You can then weigh the pros and cons of each choice as they apply to your situation. The Medicare website (www.Medicare.gov) is a great resource and can help make sure you are on the right path.
If you have a little less hair now than you’ve had in the past, or if the hair you do have is some variation of the color of silver, you might recognize the title of this post. It’s a line from the Herman’s Hermits’ 1965 hit version of the song “I’m Henry the Eighth, I Am.” The song was originally popular as a 1910 British music hall tune, and it became the second-fastest-selling song in history (up to that point) when the Hermits released their version. It was the British band’s second No. 1 hit on the Billboard 100. It was also a pretty simple song. In the Hermits’ version, it was the same chorus sung three times. Between the first and second chorus, Herman (Peter Noone) called out, “Second verse, same as the first.” It became an iconic phrase.
What does a line from a mid-1960s pop song have to do with either financial planning or investing? Well, quite frankly, not a lot. But it is what went through my head as I spent some time this weekend reviewing the most recent performance of the markets. I guess I’m really showing my age!
I’m writing this article during the Fourth of July holiday weekend, and that means we just ended the second quarter of the year. The end of a quarter is a good time to check the score and see how the asset classes that we use to build our clients’ portfolios are performing. It’s the first step in deciding whether, and how, we will need to rebalance those portfolios.
The first quarter of the year, ending in March, was a very good one for investors. All the asset classes that we use in our portfolios were higher. Stocks led the way. Emerging market stocks were the big gainers in the quarter, followed by international developed country stocks and, finally, U.S. stocks. All three of those asset classes enjoyed big gains. Real estate enjoyed modest gains, and even bonds were higher for the quarter, although not by much.
Second verse, same as the first. Or, I should say, second quarter, nearly the same as the first. The gains weren’t quite as big in the second quarter, but stocks led the way again. The international developed country stocks swapped the top spot with emerging markets, but both were nicely higher. U.S. stocks once again showed nice gains, but trailed their international counterparts. Real estate gained slightly again, and bonds managed to eke out some more small gains, except for the Treasury Inflation-Protected bonds, which finished fractionally lower for the quarter.
So, what does this mean to you? It means that unless you are rebalancing your portfolio regularly, you might have more exposure than you think to stocks, particularly international stocks. If that’s the case, then you are taking on more risk than you normally would. It might be time to bring your portfolio back into balance by selling off some of the stocks that have enjoyed big gains this year and using the proceeds to bring your bond allocation back up to where it’s supposed to be.
Remember, rebalancing doesn’t mean you are selling the entire asset class. It simply means that you sell enough to capture the gains that you’ve benefited from over the last two quarters. Buying low, selling high—that’s the way we are supposed to play this game of investing.
You may have heard some news in the financial press about the so-called “Fiduciary Rule.” It is a new rule that is supposed to make sure that financial advisors always act in the best interest of their clients when providing financial advice. It might be surprising to you that we needed such a rule. I think that most people would expect that their advisor is acting in their best interest—but that isn’t always the case.
Basically, there are two types of financial advisors. There are the advisors who work for a bank, a brokerage firm, or an insurance company. These advisors have not been held to a fiduciary standard in the past, which means that they have only been required to make sure that their investment advice is “suitable” for their clients—in other words, they can put their interests before those of their clients. These advisors are often compensated by commissions on the financial products that you purchase through them.
On the other hand, there are the independent financial advisors who only work for their clients. Those advisors have always been held to a fiduciary standard, meaning that they must always act in their clients’ best interest.
New Rule Limited in Scope
The “Fiduciary Rule” was originally put forth by the Department of Labor under former President Obama. Initially, it was scheduled to be phased in from April 10, 2017, to January 1, 2018. However, after President Trump was elected, the implementation was delayed. For a while, it looked like the rule would not be implemented at all. However, the new administration ultimately allowed the rule to go into effect on June 9.
While the rule is a step in the right direction, it’s limited in its scope, and it may be changed or revoked. At this point, the rule requires all advisors to provide fiduciary guidance for retirement accounts. This means that some advisors will be acting as fiduciaries in some situations but not in others.
We wanted to assure you that Rall Capital Management is, and always has been, a fiduciary advisor. We act in our clients’ best interest 100% of the time. We’ve always have been a fiduciary advisor—and not just because it’s required for independent advisors. We do it because it’s the right thing to do.
When (and if) it finally happens, you won’t be able to say you weren’t warned. The media has certainly been warning you. There isn’t a day that goes by that I don’t see a headline from a newspaper, a television show, or some website about the upcoming crash, correction, or bursting bubble that is coming soon in the stock market.
I can’t say that I disagree that we are due for some kind of pullback. We’ve enjoyed an eight-year bull market since the financial crisis of 2007–2009. All three of the major stock market indexes are at record highs. In fact, the current rally, at 98 months long, is the second-longest bull run since World War II. While it hasn’t been a straight run to the upside, it has been a steady upward trend since the market lows hit in March 2009.
But in the short run, since the election of Donald Trump as President of the United States, it’s been mostly a straight move higher for stocks. On Election Day last year, the Dow Jones Industrial Average, which is the most widely used measuring stick of the overall market, closed at 18,332. As I write this post, the Dow is at 21,384. That’s a gain of 3,052, or 16.6%, in seven months. Whenever we see the price of anything run up that far and that fast, we expect the price to eventually pull back a bit. Trying to predict when and how it’s going to happen is when we get into trouble.
The fact that the markets have moved higher since the election hasn’t been surprising. After all, President Trump was viewed as more pro-business than President Obama. If things are going well for businesses, profits increase, and that usually means higher stock prices. So a rally after the election wasn’t all that surprising. What has been surprising is the magnitude and velocity of the rally.
It’s especially surprising when we look at the economic reports. We seem to be in a period of slow economic growth and low productivity growth, and stocks are expensive based upon historical price-to-earnings measures. The main initiatives of the new administration—like tax reform, revamping our health insurance system, and reducing regulations—seem to be stuck in Washington’s gridlock. All things considered, it’s no wonder that the “experts” are calling for a reversal.
So, as investors, what should we be doing to protect ourselves?
The first thing we should do is review our risk tolerance. How much risk are you comfortable with? Keep in mind that most people have a higher tolerance for risk when the market is moving higher. It’s not that the tolerance for risk is actually higher—it’s that the markets seem less risky when they are moving higher. And the portfolio-damaging emotion of greed creeps in to make you think you are more risk tolerant that you really are.
We should also remember that it works the same way when stock prices are falling. When the headlines in the newspapers, on television, or on the internet are screaming about how much stocks have fallen, the other portfolio-damaging emotion—fear—creeps in, and suddenly you are not as risk tolerant as you thought. Many people learned this the hard way during the 2007–09 crisis.
You should also remember that you are about 10 years older now, and 10 years closer to the time when you will need your investment dollars. Most likely, the value of your portfolio is also substantially higher now, so you have more at risk.
Next, you should make sure that your portfolio is well-diversified by being spread across several asset classes. The Dow Jones Industrial Average and the S&P 500 are not representative of what your portfolio looks like. These indexes are made up of the stocks of large U.S. companies. A properly diversified portfolio will also include stocks of small and medium-sized companies, and a good helping of stocks from other countries. You should also hold a mix of bonds. The bond side of the portfolio should be spread across different maturities, governments, and corporations. The proper mix for you should be based on how you answer the risk tolerance question.
Remember that diversifying your portfolio will mean that you won’t enjoy the same returns as the “hot” asset class, like U.S. stocks right now. But it also means that when that hot asset class suddenly turns cold, you won’t suffer the same damage.
Finally, you need to stay disciplined. Whether things are going very well for a particular asset class, or very badly, you need to stick with your investment strategy. Don’t let the headlines, good or bad, affect the way you manage your portfolio.
OK, you’ve been warned. Sometime in the future, the markets will go down. We don’t know when, and we don’t know by how much. But whether you want to call it a crash, a correction, or a bubble bursting, now you know how to deal with it.
When I was a teenager, one of my favorite musicians was Mac Davis, a crossover country and pop star whose hits included “Baby, Don’t Get Hooked on Me” and “One Hell of a Woman.” I still remember one summer, when I was about 15 or 16 and working at the Ohio State Fair. He was performing at the fair, and I was lucky enough to meet him. That memory resurfaced this weekend, when I found myself thinking of another one of his hits while I was enjoying a weekend in New York City with my wife, Gina.
A couple of weeks ago, I posted “Are You Living Too Frugally?” It was a discussion about the tendency of a large number of retirees to spend well beneath their ability. They have become so accustomed to saving money and watching their expenses that they find themselves sitting on a big pile of money late in life that they are hesitant to spend. In the article, I tried to convey that while it is important to keep funds available in the event of a financial or health emergency, it’s also important to experience life. We want to make sure that we cross off our bucket list items before it’s too late.
This weekend, I thought about how important it is to live life before retirement as well. The other hit song from Mac Davis that I alluded to earlier was “Stop and Smell the Roses.” The lyrics of that song convey the message about how important it is to make sure you have a balance between your work and your personal life. Taking it one step further, it’s important to get that work/life balance in order throughout your life, not just in retirement. “Before you went to work this morning in the city, did you spend some time with your family?”
While Gina and I both enjoy our work, we sometimes find ourselves wrapped up in the daily tasks of running our respective businesses. We don’t work physically hard, but we do work hard and often spend the majority of our waking hours inside our business. We are both in the client service industry, so it’s important to make sure that we take care of the things that our clients expect from us. But it’s just as important for us to step away at times so that we can refresh ourselves and recharge our batteries. We are not going to do our clients any good if we end up burned out and not giving our all when we are working.
Plan for the Future, but Take Care of the Present
It’s important to make sure you take time for you and your loved ones. Life is about more than the work we do. As a financial advisor, I’m always emphasizing how important it is to save and invest for our future selves, but it’s just as important to take care of our present selves. We all hear way too many stories about someone we know who passes away at far too young of an age. We get only one shot at this life, and we need to make sure that we are making the best of it. As the saying goes, “I’ve never met someone on their deathbed who wishes they had spent more time at the office.”
This weekend, Gina and I stepped away to focus on our work/life balance. I was attending a conference in New York City, which ended on Friday. On Friday afternoon, Gina flew up to join me. We spent the weekend in Manhattan, sampling the city life. We ate at some nice restaurants, did a couple of runs through Central Park, attended a couple of Broadway shows, and toured the 9-11 Memorial in the Financial District. We didn’t do any work for the entire weekend, which is unusual for us.
We spent quality time with each other and had fun. That’s what’s really important, isn’t it? As I write this, we are on the plane heading home. It’s back to work tomorrow. And while we may be a little tired and might still be recovering from our weekend in the Big Apple, we both feel refreshed, relaxed, and ready to work.
Yes, it’s important to plan for your future and make sure you are prepared for the days when you are no longer working. Save. Invest. Make sure you and your family are protected and that your financial house is in order. Work hard and do the best you can at whatever career you have chosen. But it’s equally important to “Stop and Smell the Roses” along the way.
The lady on the television screen seemed very smart. She had an impressive educational background and lots of experience as an analyst for a Wall Street investment firm. She was also very persuasive as she stated her case to the CNBC host that, based on her analysis of the data, the stock price of the company they were discussing was primed for a big increase.
The gentleman on the screen also seemed to be very smart. He had an equally impressive educational background and similar experience as an analyst for a different Wall Street investment firm. And he was equally persuasive as he told the same CNBC host that, based on his interpretation of the data, he was convinced the stock price of the same company would decline.
Both analysts gave their opinions within the same segment of a CNBC morning show. Both were likable and seemed to be honest and well-intentioned. And, based upon the way they presented their argument, they certainly believed in their interpretation of the data. But they obviously both could not be correct.
This scenario plays out almost every day in the world of investing. Whether the analysts are discussing a company, a sector of the economy, an asset class, or the overall market, there are always differing opinions. So, as an investor, what should you do?
Our advice? Don’t watch. If you must watch, make sure you do so for entertainment purposes only.
In Part One of our series that explains How We Invest, and Why, we discussed the efficiency of the markets and how the first step in our process is to acknowledge that we don’t know more than “the market.” When a Wall Street investment firm, or an investment manager, makes a prediction about the price of a security, an asset class, or the market, they are making a claim that they know more.
We don’t believe that they do, and we believe that their directional calls are nothing more than guesses.
This leads to the second building block in our investment process: Don’t try to outguess the market. The pricing power of the market works against investment managers who try to outsmart other market participants through stock picking or market timing. Over the 15 years ending December 2016, 82% of all U.S. mutual funds trailed their respective benchmark. An investor is better off owning the benchmark, via a low-cost index fund, and not paying the high cost of having a manager trying to pick stocks or time the market.
It’s not easy holding this view. Wall Street wants you to think that the millions of dollars that they spend on fund managers and research departments can give you an edge if you invest with their firm. And they spend millions more on advertising that tries to convince you of that “fact.” But remember, every time you, or your fund manager, makes an investment move based on their research (i.e., guesses), you face transaction costs and possible tax consequences that can negatively affect the return of your investment portfolio.
We believe, and the evidence confirms, that a much better and less costly way to invest is to own a globally diversified portfolio using asset-class-based mutual funds or exchange-traded funds (ETFs). Don’t try to guess which company is going to be better than another. Own them all. Don’t try to guess which country around the world will be the next “winner.” Own them all. By owning them all through diversified funds, you can take the guesswork out of the investment process. And you will also reduce your portfolio risk in the process.
If you think that saving for retirement is hard, wait until it comes time to spend it. When you are working and making contributions to a retirement plan, it’s pretty easy. You open a retirement account, contribute to it regularly, and off you go. If you are lucky enough to have a company-sponsored plan, you make your deposits into the account via payroll deduction.
Oh sure, you will have to actually sign up for the retirement plan. And you will have to make decisions about a few things, but it’s pretty easy. When you open the account, you will name a beneficiary who will inherit the assets if something happens to you. Next, you’ll have to decide how much to contribute to the account. I would suggest that you shoot for at least 10% of your gross pay, but anything is better than nothing. If you are really lucky, your company will match your contribution—that’s free money! Make sure you are contributing at least enough to get the full company match. Finally, you’ll need to make decisions about how your account is invested. Often, when just starting out, a target retirement date fund is a good choice.
That’s it! Pretty simple. During your working years, you’ll hardly notice the retirement account. But boy, do you start paying attention to it when it comes to start spending it. Going from living on a regular paycheck to living off of your retirement funds is often more difficult than saving is! In last week’s post, Are You Living Too Frugally, I discussed how we are seeing a trend of older clients holding on to a big pile of money and underspending in their retirement years. I believe the perfect retirement plan ends with a bounced check to the funeral service. Just kidding. Sort of.
When you look to replace your paycheck, you must consider your resources and start to develop a plan of action. Usually there will be Social Security income and maybe a pension. The rest of the cash flow that you need to fund your lifestyle will have to come from your savings. Hopefully, you’ll have some after-tax savings—maybe cash you received when you downsized and sold your longtime home. You might have an IRA or a 401(k) or 403(b) from your working years. Maybe you have a Roth IRA. More and more people do.
The question then becomes “What’s the best way to take money out of my accounts?” The answer, like most answers in the financial planning world, is “It depends.” In the above scenario, our fictitious retired couple has three buckets of money to choose from. They have their after-tax money from the sale of the house. This money has already been taxed at some point, and any cash flow that comes from this bucket is not taxable again, except for the interest, dividends, and capital gains the investments generate. Our couple also has a bucket of tax-deferred money, which comes from their IRA, 401(k), or other retirement accounts. Any cash flow coming out of these accounts will be taxed as ordinary income. Finally, they have a couple of Roth IRA accounts that they funded in the years leading up to retirement. This gives them a bucket of tax-free money.
By managing which bucket you take money out of to fund your cash flow needs, you can, to some degree, control the tax consequences of your retirement income. For example, you might want to take distributions from your post-tax bucket first. Any cash taken from this account is not taxable, except for tax that may be due on the interest, dividends, and capital gains. But that’s generally OK because capital gains tax rates are lower than ordinary income tax rates. And, depending upon your tax bracket, they may be tax-free.
If you are taking distributions from your retirement account, those funds are considered ordinary income. Monitor how much you are taking, and if you are getting close to moving into a higher tax bracket and still need cash flow, you can take some distributions from the tax-free pile, your Roth accounts.
Please remember, the example above is just that—an example. It is not a recommendation. We do, however, recommend that everyone review their individual situation by doing some tax planning. Having a distribution plan in place can help you get the cash flow that you need while lessening the tax bite on those treasured retirement dollars.
Meeting with our clients is one of the best parts of my job. Many of our clients have been with us for several years, and our meetings are like conversations with old friends. While we spend a good amount of time in our meetings reviewing portfolios and discussing financial issues that are affecting them, most of our time is spent catching up on what has occurred in their lives since our last meeting and making sure we are all prepared for whatever might happen in their future.
Every client is different and therefore every conversation is different, but there are also a number of similarities. A couple of meetings I had last week demonstrate how similar our conversations can be at times. In two separate meetings, with two separate, longtime clients, I had the same piece of advice. “Go spend some money” was my message to both.
That advice might sound funny coming from someone who makes a living by trying to get clients to save and invest for their future. But in these two cases, the advice was certainly appropriate. And, based upon the research paper I read this weekend, it’s probably appropriate for a lot more people (more on the paper in a bit).
Both meetings I am referring to involved at least one spouse who is more than 80 years old. They are both still healthy, although both admit to starting to slow down a bit. The other thing that they have in common is that both couples were very good savers through their working years and are very comfortable financially. Not rich, but comfortable. Both couples have nice-sized IRA accounts that we manage for them. And both are taking just enough from each to barely satisfy their required minimum distributions.
My advice to go spend some money is based on my philosophy that because we get to go around only once in this life, we should limit the “I wish we would have …” thoughts before it’s too late. We use a financial life planning approach with our clients that aims to limit the regrets they may have at the end of life. “I wish we would have taken more family vacations,” “I wish we would have traveled more,” “I wish we would have given more” are all examples of regrets we try to help them avoid.
Plan Wisely, but Don’t Miss Out on Life
I certainly understand the desire to keep a healthy level of funds available in the event of a long-term-care need. In fact, I support it. I often say that the time bomb ticking inside of anyone’s financial plan is the potential for a long stay in a nursing home. So I’m not advocating that they go on some wild spending spree. But I don’t want them so concerned about a potential need that they miss out on what life has to offer.
The research report I mentioned earlier confirms that my clients are not unique in this regard. The report, Living Too Frugally? Economic Sentiment & Spending Among Older Americans, by Mark Fellowes, CEO of United Income, suggests that retirees are not spending enough in retirement to live out their life-long dreams. The report indicates that, for a lot of seniors, a lack of confidence in future economic growth and their own financial well-being keeps them sitting on large portfolios.
A study done by the University of Michigan for the Social Security Administration and the U.S. Commerce Department found that adults become less optimistic about future economic growth and financial health as they age. So they are less likely to spend their nest egg. The study also found that wealth and investments generally grow as people age—so they are leaving behind large amounts of wealth when they pass away.
While leaving behind some wealth for your heirs is certainly not a bad thing, I would guess (or at least hope) that most kids would prefer to see mom and dad live life in such a way as to have few regrets. So our advice is to do some long-term-care planning and make sure you will be able to afford whatever care you may need as you grow older. Then go spend some money!
It’s the end of another school year. This is the time when the kids start planning their summer break, their summer jobs, and for those graduating, their next step toward adulthood. The younger kids will look forward to swimming, playing, and maybe going to a summer camp. Those who are graduating will start planning for their freshman year of college or getting started in their first real job. Those in the middle will look forward to enjoying a summer of relaxation, maybe training for an upcoming sports season, or landing a summer job.
I’ve always assumed that the motivation for a young person to find that summer job is simply to have some spending cash. I thought that they want to work so that they can put gas in their car, maybe pay for a date, add some of the latest fashions to their wardrobe, or just have a little cash in their pocket. Money earned at a summer job provides a young person with independence, and I applaud the resourcefulness and responsibility of those who take this path.
I applaud louder and longer for those who want to do more with the money they earn at their summer job. I was pleasantly surprised by my nephew at a recent family gathering celebrating Mother’s Day. He’s been lucky enough to land what looks like a pretty good summer job. He’ll have work, a paycheck, and enough flexibility to train for the upcoming football season. He surprised me when he asked how he should invest part of his paycheck. He said that he wants to set some money aside and have his money earn money, instead of just sitting in a bank or spending it all. Kudos to him!
So what should a young person do when they want to set aside a little of their current cash flow to start building a better future for themselves? My nephew will turn 18 at the end of this summer. He obviously has a lot of life and life’s transitions in front of him. He’ll want to go to college. He’ll want to buy a car. He’ll probably eventually want to marry, buy a home, have kids, and all the normal things that are part of adulthood.
What investment vehicle would allow him to save for his future but be flexible enough to allow him access to his funds if he needs them for that car, that education, or that house? There are a few choices that could work for him, but the one I recommended was the multipurpose Roth IRA.
Why would I recommend a retirement account to an 18-year-old young man? A Roth IRA sounds like it’s a long-term investment plan, designed to be used in retirement. It is. But the Roth IRA is also a very flexible vehicle that can help him when other needs come up.
First, let’s cover the basics of the Roth. There are income eligibility limits. So if you make too much money, you can’t contribute. But that’s certainly not the case for most 18-year-old young people. For 2017, you can contribute 100% of your earned income, or $5,500, whichever is less. (Note: If you are over 50, you can contribute $6,500.)
While the main idea behind the Roth is to save for retirement, the account is very flexible. You can withdraw your contributions at any time without a penalty. This means that if my nephew wants to buy that car, pay for that college, or buy that house, he can access the money he has invested. It’s important to note that there are restrictions on withdrawing earnings. Typically, you need to have had the Roth IRA account for five years and be at least 59½ years old to withdraw the tax-free earnings from the account. However, there are exceptions. You can withdraw up to $10,000 to buy a first home, tax-free and penalty-free. And you can withdraw earnings with no penalty, but not tax-free, if you use the funds to pay for higher education expenses for you or a family member.
For those reasons, I think the Roth IRA is a great choice for my nephew, and for most people. It’s important to remember that the Roth IRA is just a type of account. To make it work most effectively, you must invest it properly. As I’ve discussed in previous posts, you should focus on building a globally diversified, asset class–based portfolio using low-cost index mutual funds or ETFs.
So if you know of a young person who is interested in doing something more with their summer job money than just spending it, the Roth IRA is a choice that can work out very well for them.
It sounds so easy and uncomplicated: Reach age 65, sign up for Medicare, and your health insurance is taken care of for the rest of your life. But seldom are things as easy as they sound. That is certainly the case with Medicare, the health insurance system in place for more than 55 million Americans. While signing up for Medicare sounds relatively simple, there are a lot of moving parts that require decisions that will impact your pocketbook and your insurance coverage.
As important as Medicare is in the life of our senior and disabled citizens, there are very few resources that provide proper guidance on working your way through the Medicare maze—and it’s certainly not a set-it-and-forget-it kind of decision. This post, and upcoming posts that we will make on this subject, will attempt to clear up some of the confusion and misinformation surrounding this very important topic.
Our first piece of advice on this topic is that you must be proactive in dealing with this complicated program. The book Get What’s Yours for Medicare (Phillip Moeller, 2016) points out that “No One Told Me” is a scary cautionary Medicare tale. Prepare yourself so that you don’t have to ever say that no one told you.
Before we get into how the enrollment process works, it would be good to go over the Medicare basics. Medicare has three parts: Part A provides insurance for expenses incurred at hospitals and is generally premium-free. Part B provides coverage for doctors, as well as outpatient and medical equipment expenses. And Part D is prescription drug coverage. We know—what happened to Part C? We’ll cover that in a future post.
We recommend six steps when going through the Medicare enrollment process:
Check your timing.
Choose your Medicare path.
Select your specific plans.
Enroll in Medicare (note that this is the fourth step, not the first!).
Enroll in your specific plan(s).
Review your coverage annually.
There are some decent resources that can help with steps three through six. But there aren’t many that will help with the first two steps. Yet it’s steps one and two where 90% of Medicare mistakes are made. We should not take those mistakes lightly because just one mistake can cost you thousands of dollars and may not be able to be undone. This post will offer guidance on the first step, and future posts will address the rest.
Check Your Timing
To get started, we must first determine the best time for you to enroll in Medicare. At age 65, if you are a U.S. citizen, you are eligible to begin Medicare—but being eligible doesn’t mean that you have to sign up right then. If you are already receiving Social Security when you turn 65 (which is another topic we will discuss in a future post), you should be automatically enrolled in Medicare Parts A and B—but, again, this doesn’t necessarily mean that you have to accept, and pay for, Part B. By receiving Social Security benefits, you are automatically enrolled in Part A. Your decision to sign up for Part B is going to be determined by whether you have coverage through an employer group health insurance policy. This is the case whether you are receiving Social Security benefits or not.
So if you are turning 65 and are not covered by a group health policy through an employer, you’ll want to sign up during your initial enrollment period, which is the seven-month window surrounding your birth month (the window includes the three months before your birth month, your birth month, and the three months after). If you are covered by a group health insurance policy, you’ll need to enroll during a special enrollment period. For Parts A and B, this means that you can enroll at any time while you are still covered, or within eight months after coverage or employment ends (whichever is first). For Part D, you’ll have 63 days after the coverage or employment ends (again, whichever is first).
Of course, there is always an exception to make things more complicated. If you are covered by an employer group plan with fewer than 20 employees, then you must sign up during your initial enrollment period. This is because, for small employers, the group plan will stop being the “primary” payer of claims and will become “secondary” to Medicare.
If you make a mistake in this phase of your enrollment, you could end up paying late enrollment penalties. And these are not small, slap-on-the-wrist kinds of penalties. In most cases, if you don’t sign up when you are first eligible, your premium can go up 10% for each 12-month period that you would have had coverage. And those increases don’t go away after a year or two. They follow you for life. Or you could end up with a more costly coverage that you cannot switch out of. You could face long delays in enrollment of up to a year and a half without coverage. And finally, you could end up having to pay back health care costs that you thought were covered.
It’s obvious that the basic step of signing up for Medicare is anything but basic. And that’s just signing up. Deciding which path and which plans are best for you isn’t exactly a picnic either. We’ll discuss those in future posts.
The investing world can be a scary place. It can also be exciting. At times, it can seem like there’s nothing to it, and at times it can seem like the most complicated thing you’ve ever done. All of the thoughts and emotions that are part of investing are enhanced because, after all, you are putting your money and your financial future at risk.
Risk and reward go hand in hand when you invest. You can be very conservative and not subject your investments to much risk, but then you are not going to get much in the way of return on your investment dollars. Or you can take a lot of risk, looking for the proverbial home run. That approach can lead to stellar returns, or it can lead to distressing losses.
So what is your strategy when it comes to investing your portfolio? Are you actively looking for that one piece of information that will give you the edge you need to catch the next wave of increasing prices of your favorite tech stock? Or maybe you suffer from “paralysis by analysis,” overwhelmed by the information flow and its potential impact on your portfolio?
There is no shortage of investment strategies that you can follow. In fact, just this morning, we learned of a new strategy. A financial podcast that we listen to discussed a strategy that will buy or sell a company’s stock based on the tweets from our Tweeter-in-Chief, President Donald Trump. If he tweets a positive comment about a company, they will buy the stock. If it’s a negative tweet, they will sell it. Sounds crazy, right? But there are thousands of money managers in the investment world, and thousands of different strategies that they use to try to get their edge.
When it comes to investing for the financial future for our clients, we can’t, and won’t, play games like that. We follow a very disciplined approach to investing, based on a Nobel Prize-winning academic strategy that focuses on controlling what we can control. And we are smart enough to know that we can’t control the markets. This article is the first in a series that will explain our approach and the science behind it.
The First Step: Humility
The first building block in the science behind our investment philosophy is the need to embrace market pricing. While that sounds a little complicated, it’s really not at all. It simply means that the financial markets are very efficient and that all of the information available on a particular stock, bond, or other investment is reflected in the current price. Millions of investors around the world buy and sell investments every day, and the information that they bring to the markets helps to set prices. When some new information affecting an investment comes out, it is immediately factored into the price of that investment.
We like to use the price of Apple stock as an example. If Apple is coming out with a new iPhone soon, you know about it, we know about it, and millions of people around the world know about it. There is no way to profit from any kind of information edge that you might think exists, even if it is only temporary. That’s why it’s not a good idea to run out and buy Apple stock when you hear the news. Years ago, there may have been some pieces of information that took time to work through the markets, but with today’s technology, that time gap has disappeared. Many of us have alerts on our smartphones that let us know in real time when some important news has been released.
So the first step in putting our “evidence based” strategy into action involves being humble enough to know that we don’t know more than “the market.” There are several more pieces that we use to fully build out our strategy. We’ll cover those in future posts.