Category Archives for "Financial Planning"

Feb 16

Rolling Over Your 401(k) to an IRA

By Jim Wood | Financial Planning , Investment Planning , Retirement Planning

Rolling Over Your 401(k) to an IRA

 

401(k) rolloverChanging jobs or retiring are two life events that provide opportunities to roll over your 401(k) to an IRA . If retiring, many 401(k) plan sponsors allow you to keep your 401(k) savings in their company plan. However, there are good reasons to consider a roll over of 401(k) assets to an IRA .

The first is to gain better control over your investment portfolio, once the assets are within the IRA. Company sponsored 401(k) plans may have limited investment options and restrictive trading and exchange policies. IRAs generally provide a broader range of investment options and more flexibility.

The second reason is the potential to obtain better guidance in adjusting the asset allocation to a more appropriate level that takes into account your own individual goals and risk tolerance. Although 401(k) plans may offer appropriate investments and some educational information about those options, 401k plan sponsors do not usually make available truly personalized advice to plan participants.

Regardless, there are mistakes that you need to avoid in the process of rolling over your 401(k). To avoid those mistakes, it is important to be able to recognize them. (Click here to receive the Top Mistakes in 401(k) Rollovers fact sheet.)

What are your 401(k) rollover options?

If you are changing jobs, you may have the option to roll over your existing 401(k) into your new employer’s 401(k) plan – be sure to verify that your new employer plan accepts rollovers. Regardless, you always have the option to roll over to an IRA that you can manage. And for the reasons noted above, rolling over to your own IRA may provide you with a better result .

It should be noted that one reason to keep your retirement assets in your 401(k) plan is that costs are often, but not always, lower in 401(k)s.  However, without an appropriate investment plan, lower costs may not bear fruit.

In general it is a good idea to get advice from a Financial Planner who is a fiduciary. You may think that your financial advisor is obligated to do what is best for you, the client. However, not all are not obligated to act in your best interest (whereas a fiduciary would be), and may advise higher fee products, or proprietary products sold by the firm he or she represents or products that do the job.

In April 2016 the Department of Labor rolled out a new regulation that is to take effect in 2017 mandating that all investment professionals working with retirement plan participants and IRA owners shall adhere to a fiduciary standard for all retirement accounts for which they provide investment advice. For purposes of the DOL rule, retirement accounts include 401(k)s, IRAs, and Roth IRAs among others.  The Department of Labor estimates that the investing public would save $4 billion a year with the new fiduciary rule. As you might expect, the fiduciary rule is opposed by affected Wall Street interests that are seeking to water it down or eliminate it entirely.

The Trump administration issued an executive order on February 3, 2017 to review the rule. While the Trump administration would like to roll it back, the industry is moving ahead with implementation, potentially regardless of possible regulatory about faces. Hence the future of the rule is unclear at this time.

you always have the option to roll over to an IRA that you can manage

Of course, whether or not this regulation takes effect in 2017, you can still benefit from working with a fiduciary advisor. If the advisor you are working with is not working to a fiduciary standard – i.e., with your best interests in mind, seek out someone who is. It’s important: after all you are dealing with your money and your future standard of living in retirement.

In the current regulatory environment, fee-only Financial Planners at Registered Investment Advisor firms usually serve as fiduciaries, and are required to always act in your best interests – they must avoid conflicts of interest, and cannot steer plans and IRA owners to investments based on their own, rather than their clients’ financial interests.  In contrast, brokers, insurance agents and certain other investment professionals only have a responsibility to recommend securities that are “suitable.”

Making sure that the investment professional you are working with is acting in your best interest may help you invest your retirement funds more appropriately. Note that the Securities and Exchange Commission (SEC) has not promulgated similar regulations for non-retirement investment accounts so if you are not dealing with a fiduciary advisor, you run the same risk of potentially higher costs or merely suitable investments. In fact if you have an IRA and a brokerage account with your financial advisor, he or she may end up being a fiduciary on one account and not a fiduciary on the other account.  How is that for confusing?

 

A previous version of this post has appeared in the Colonial Times.

Feb 07

5th Annual Symposium

By Chris Chen CFP | Financial Planning

5th Annual Symposium

Oakley CCThe 5th Annual Symposium on Divorce Financial Issues will be held on Friday March 24, 2017 at the Oakley Country Club in Watertown, MA. The Symposium provides a full day devoted to Financial Issues for Divorce Professionals such as therapists, coaches, mediators and lawyers.

This year, the Symposium is a fundraiser in support of the Community Dispute Settlement Center (CDSC), a 501(c)(3) not for profit mediation and training center dedicated to providing an alternative and affordable forum for resolving conflict. Part of the registration fee will be donated to CDSC.

The Symposium is offered by Insight Financial Strategists LLC, a Registered Investment Advisor with a focus and expertise in Divorce Financial Planning , in conjunction with the speakers and their respective firms.

This year’s presenters include

Ross Grifkin, a banker in Waltham, MA: buying out a small business in a divorce.

Kim Whelan a mediator in Newton, MA: tricks and traps of the middle income divorce.

David Kellem a lawyer and mediator in Hingham, MA: the post divorce budget and how it impacts divorce settlements and negotiation

Bill Coyne, a lawyer in Newton, MA: divorce as your last estate plan

Chris Chen, a financial planner in Waltham: divorce and disability insurance

The Symposium will be held at the Oakley Country Club in Watertown, MA on Friday March 24 from 8:30 to 4:30. Continental breakfast and a buffet lunch will be served. The cost of the Symposium is $195. Use code EARLY75 for a $75 early bird discount valid until March 5, 2017. Please register here

We look forward to see you there!

 

 

Jan 30

Politics and Economics

By Chris Chen CFP | Financial Planning , Retirement Planning

Politics and Economics

 

Frankfurt am Main, Skulptur "Bulle & Bär"We started the year in the middle of a correction, as the S&P500 lost 13.3% between November 4, 2015 and February 11, 2016.

However, supported by a slow but continuing economic recovery, rising corporate profits and low interest rates, 2016 ended up being a pretty good year for the financial markets with the S&P500 rising 11.96%.

Concerns over China, falling oil prices, surging junk bond yields, recession fears, the rising dollar, Brexit, a four-quarter profit recession, a contentious U.S. election, weakness in U.S. manufacturing, and eurozone banking worries all conspired against bullish sentiment during various times of the year.

While the pundits credited a solid market prior to the election to the expectation that Clinton would win, we were surprised by the reaction to Trump’s win and the consequent exuberant market rally. Most of the year’s gains happened in the fourth quarter after the election.

So what about 2017?

Trump and the Republican Congress have made many promises, some of which appear to help sustain the financial markets.  In particular the move to tax reform and limit regulations will probably be implemented and  is viewed very positively by the business community.

Some proposals such as rebuilding infrastructure have the Congress and Trump at odds. Historically, infrastructure has not been a strong Republican concern. It remains to be seen whether a significant bill can pass Congress.

Some other initiatives are more problematic and could have consequences that have not yet been factored in the financial markets.  The move to limit legal immigration and the intent to expel millions of undocumented immigrants could have a ripple effect throughout the economy, including Silicon Valley and the agriculture industry.

Talking about altering trade patterns, starting with the elimination of the TPP and various noises about import tariffs goes counter to decades of bipartisan free trade efforts.  It is not clear what the net impact of these policies, which have not yet been fully defined, will have on the economy. However, restricting free trade is not a positive.

Last but not least, Republicans have a political imperative to deal with health care. Will they show the intestinal fortitude to go through with a full repeal of Obamacare, as has been talked about? A full “repeal now and replace later” could create chaos for States, employers, insurance companies, the healthcare industry, and the public. We’ll have to wait and see to evaluate the net effect.

The financial markets are demonstrating optimism in the midst of all this political turmoil, although we don’t know if the clouds on the horizon carry rain or not. Regardless the US economy is strong and resilient; it will survive our dysfunctional politics.

 

This post is extracted from our January 2017 newsletter.  Please write to let us know that you would like a copy

Jan 17

Five Common Questions About Divorce

By Chris Chen CFP | Divorce Planning , Financial Planning , Retirement Planning

divorcing-swansdivorcing-swans5 Common Questions About Retirement and Divorce

divorce and retirementRetirement accounts are often one of the major assets of divorcing couples. Analyzing and dividing retirement accounts can be fairly complex . Some of the major questions that I come across include the following:

1. Is My Retirement Account Separate Property?

People will often feel very proprietary about their retirement accounts. They will reason that because the account is in their name only, as opposed to the house which is usually in both their names, they should be able to keep those accounts. Most of the time, this is flawed reasoning. The general rule is that assets that are accumulated during marriage are considered marital assets regardless of the titling.

However, there are cases when part of a retirement plan can be considered separate. This often depends on state law, so it is best to check with a specialist before getting your hopes up.

2. Can I Divide a Retirement Account Without Triggering Taxes?

Most of us know that taking money out of a retirement account will usually trigger taxes and sometimes penalties. However, dividing retirement accounts in divorce provides an exception to that rule. You can divide most retirement accounts in divorce tax-free through a Qualified Domestic Relations Order  (QDRO). As a result of the QDRO, both spouses will now have a separate retirement account.

QDROs are used for 401(k)s, defined benefit pension plans, and other accounts that are “qualified” under ERISA . Many accounts that are not “qualified” such as 403(b)s use a “DRO” instead. The federal government uses its own procedure known as a “COAP”. Some accounts such as IRAs and Roth IRAs can be divided with a divorce agreement without requiring a QDRO.

Since there are so many different retirement accounts, the rules to divide them vary widely. Plan administrators will often recommend their own “model” QDRO. It usually makes sense to have a QDRO specialist verify that the document conforms to your interests.

3. Can I Take Money out Without Penalty?

In general, you cannot take money out of retirement accounts before 59½ years of age without triggering income taxes and a 10% penalty . It makes taking money out of retirement accounts a very expensive proposition as you may only get 60 to 70 cents for every dollar that you withdraw, depending on your tax bracket and the State that you live in.

In addition, that money that was set aside for retirement will no longer be there for that purpose. Although you might tell yourself that you will replace that money when you can, that rarely ever happens.

However, if you have no other choice, it so happens that divorce is one of the few exceptions to the penalty rule. A beneficiary of a QDRO (but not the original owner) can, pursuant to a divorce, take money out of a 401(k) without having to pay penalties. However, you will still have to pay income tax on your withdrawal. Note that this only applies to 401(k)s. It does not apply to IRAs.

4. How Do I Compare Retirement Accounts with Non-Retirement Accounts?

Most retirement accounts contain tax-deferred money. This means that when you get a distribution, it will be taxable as ordinary income. At the other end of the spectrum, if you have a cash account, it is usually all after-tax money. In between you may have annuity accounts where the gains are taxed as income, and the basis is not taxed; you may have a brokerage account where your gains may be taxed at long-term capital gains rate; or you may have employee Restricted Stock which is taxed as ordinary income. All of these accounts can be confusing.

In order to get an accurate comparable value of your various assets, you will want to adjust their value to make sure that it takes the built-in tax liability into account. Many divorce lawyers will use rules of thumb to equalize pre-tax and after-tax accounts. Rules of thumbs can be useful for back-of-the-envelopes calculations , but should not be used for divorce settlement calculations, as they are rarely correct.

What is the harm you might ask? Rules of thumb are like the time on a broken clock – occasionally correct, but usually wrong . In the best of cases, they may favor you. In the worst cases they will short change you. If the rule of thumb is suggested by your spouse’s lawyer, it will have a good chance of being the latter.

Because these calculations are not usually within a lawyer’s skill set, many lawyers and clients will use the services of a Divorce Financial Planner to get accurate calculations that can form a solid basis for negotiation and decision making. It is usually better to know than to guess .

5. Should I Request a QDRO of My Spouse’s Defined Benefit Pension?

Defined Benefit pension plans provide a right to a stream of income at retirement . Unlike 401(k)s and IRAs they are not individual accounts. They do not provide an individual statement with a balance that can be divided.

As a result, many lawyers take the path of least resistance and will want to QDRO the pension. It is usually painful to the pension beneficiary who will often feel very emotional about his or her pension. And it is not necessarily in the spouse’s interest to QDRO the pension .

A better approach is to consider the value of the defined benefit pension compared to the other retirement assets. With a pension valuation, you can judge the value of the pension relative to other assets and make better decisions on whether and how to divide it. A pension valuation will allow each party to make an informed decision and eventually provide informed consent when agreeing to a division of retirement assets.

Another key consideration is that defined benefit plans are complex. Although they have common features, they are each different from one another, and each come with specific rules. You will be well advised to read the “plan document” or have a Divorce Financial Planner read it and let you know the key provisions.

A common provision is that the benefit for the alternate payee can only start when the plan participant starts receiving benefits and must stop when the plan participant passes away. It is all good for the plan participant. But what if as a result of that, the alternate payee ends up losing his or her pension benefits too early?

Hence a key issue of valuing defined benefit plans is that a true valuation is more than just numbers. It also involves a qualitative discussion of the value of the plan, especially for the alternate payee. Some Divorce Financial Planners can handle the valuation of interests in a defined benefit plan easily and the discussion of the plan. Others will refer you to a specialist.

The Bottom Line

Retirement plans are more complex than most divorcing couples expect . Unlike cash accounts they do not lend themselves to a quick asset division decision.  The short and long-term consequences of a sub-optimal decision can be far reaching. It will be worth your while to do a thorough analysis before accepting any retirement asset division.

 

 

A previous version of this post was published in Investopedia

Aug 25

Is Your Portfolio Diversified?

By Chris Chen CFP | Financial Planning , Investment Planning

Is Your Portfolio Really Diversified?

Diversification is simple to understand. In the context of managing your portfolio, diversification is (simply) about investing in diverse securities so as to lower the risk of the portfolio. Ever since markowitzNobel Prize winner Harry Markowitz wrote his seminal paper “Portfolio Selection” in 1952, finance professionals (and increasingly lay people) have understood that the true risk of an asset is its contribution to the risk of a portfolio.

In a recent survey run by Insight Financial Strategists, according to 41% of respondents a single mutual fund is sufficient diversification . After all, even the most concentrated mutual fund typically has several dozen stocks. However, many mutual funds diversify within a single asset class in a single country, such as, large-company stocks in the U.S.

Others will concentrate their portfolio on a few securities, sometimes with very unfortunate results. For instance, between September 1, 2015, until November 17, 2015, the Sequoia fund (symbol SEQUX) lost 26.3% of its value largely due to its high concentration in a single stock, Valeant (VRX). Looking at the price evolution of VRX below (source: Google), and knowing that SEQUX had more than 30% invested in VRX, it is not surprising that the mutual fund tumbled.

Stock price of VRX from 9/1/2015 to 12/1/2015

Price of VRX from 9/1/2015 12/31/2015

In practice, diversification is hard to implement. There are many levels of diversification. Some of them are:

  • by individual securities
  • by asset manager;
  • by asset class; and
  • by geography.

Ideally, an investor will want to diversify so that the various investments are not correlated with one another, have low correlation or even have negative correlation. For instance, according to data from portfolio analytics firm Kwanti, Goldman Sachs (GS) and JP Morgan (JPM) have an 89% correlation based on monthly returns. In other words, buying GS and JPM in the same portfolio only provides a low diversification value.

diversification is about investing in diverse securities so as to lower the risk of the portfolio

In another example, based on monthly returns, JPM and Walmart have a negative correlation of -0.14%, according to data from Kwanti . I don’t know that I would necessarily want to buy either JPM or WMT. However, this pair provides good diversification from one another.

Most of us end up investing in mutual funds and exchange-traded funds, not in individual securities. The same principle applies there. Having a single large cap mutual fund that tracks Standard & Poor’s 500-stock index may not be sufficient diversification.

Sure, the S&P 500 ETF provides more than one security and is, therefore, diversified. But in general, most of the securities within a single asset class will be highly correlated with one another (such as with JPM and GS). With that, you would be protecting yourself against the risk inherent in any given company in the portfolio, but not against risks inherent to the asset class or other factors.

Ideally, you would want to be diversified across asset classes, across regions of the world and across asset managers. The following jelly bean chart from Schwab demonstrates the benefits of a wide diversification program: the ranking of the assets by performance changes seemingly randomly from year to year. A fully diversified portfolio (the orange boxes in the chart) is intended to avoid the peaks and valleys of individuals asset classes while providing a more middle-of-the-road return experience.

Jelly Bean chart

Is your portfolio diversified? A detailed analysis from a fee-only Certified Financial Planner can give you the full scoop on your portfolio and provide suggestions to mitigate the risks that you are exposed to. Like any other sound advice, apply it now, not later.

 

A previous version of this post was published in Kiplinger.

Jul 19

Getting Help When You Need It Most

By Chris Chen CFP | Divorce Planning , Financial Planning

Getting help when you need it most

chess pieces divorcingWhen “Lindy” was trying to figure out the implications of the latest divorce settlement offer that she received from her soon-to-be ex-husband “Ted,” she panicked. She would have asked her lawyer for
guidance, as 79% of divorcing individuals end up doing, but she was not sure that her divorce lawyer could give her the guidance she needed .

The previous offer had come two days before their last court appearance. There was just not enough time to understand the implications of the various components of the offer and assess whether it was an equitable division of marital assets. Lindy was just too nervous to make the decision “on the steps of the courthouse”, so she said no.

Even Lindy’s lawyer was happy with the process

Clearly, there is something wrong with a process in which the financial outcome is so critical to both parties but people like Lindy and Ted get no professional financial support despite spending substantial sums of money litigating a divorce. Yet it is not surprising. The financial issues of divorce have become terribly complex ranging from shorter-term tax issues to longer-term financial planning issues.  Divorce lawyers have enough on their hands with the legal issues of divorce. Increasingly, divorce lawyers are unable to counsel their clients in depth on the financial implications of divorce , which inevitably have a lasting impact on their quality of life and stability long after the divorce itself is finalized.

According to a recent survey conducted by the Institute of Divorce Financial Analysts, 75% of respondents believe that a divorce financial specialist would have been helpful in the preparation, negotiation or recovery phases of their divorces . According to this same survey, 45% of people litigating their divorces felt unprepared to enter financial negotiations and 40% of those mediating their divorces feel the same way.

No wonder divorce financial planning has risen as a specialty. Professionals dedicated to meeting the needs of divorcing individuals can help people such as Lindy and Ted understand the financial issues of divorce, negotiate settlements and recover into a financially stable post-divorce life.

In Lindy’s case, she was fortunate to be referred to a Divorce Financial Planner by a divorce coach. Divorce Financial Planners build on financial expertise often acquired by Certified Financial Planners (CFP®) or Certified Public Accountants (CPAs). They also often hold the Certified Divorce Financial Analyst (CDFA®) designation. They excel in their ability to simplify the complex financial issues of divorce so that people like Lindy and Ted can understand the consequences of their decisions and plan accordingly for their separate futures. In addition, Divorce Financial Planners bring to the table an understanding of tax issues in divorce, employee stock options, retirement plans, pension plans, Social Security, real estate and long-term financial planning.

They help assess potential outcomes of strategies such as trading home equity for ownership of retirement accounts—is that a good idea for you for the long term?

In Lindy’s case, the new offer seemed to address her needs better. Ted offered to give Lindy more of the 401(k) in exchange for keeping his pension. In addition, Ted offered more alimony.

However, Ted’s offer was still not clear about his employee stock options, as he did not know how to value them. In addition, the offer did not address the issue of college funding for their 13 year old daughter.

Lindy’s Divorce Financial Planner carefully reviewed the settlement offer in light of her individual circumstances, explained the various issues and made recommendations for her lawyer. After some more negotiations, Lindy and Ted were able to come to an agreement and avoid a costly trial. Even Lindy’s lawyer was happy with the process , as it helped him to focus on his area of expertise: writing the agreement and managing the legal process.

A previous version of this post was published in Kiplinger

Jun 13

Alimony…not far from Acrimony

By Thomas Seder | Divorce Planning , Financial Planning

Alimony...not far from Acrimony

Alimony issuesA major issue between divorcing and divorced spouses is that of spousal support, or alimony.  The issue is freighted with significant financial and emotional ramifications.  The aim of spousal support is to provide needed economic support to the lower-earning spouse.  It takes into account a variety of factors, including length of the marriage, ages and health of the parties, earning capacity, assets of the parties, needs of the recipient, and the payor’s ability to pay.

In 2011 the alimony laws in Massachusetts underwent significant reform .  Prior to this enactment of alimony reform, alimony was “forever”, even for short-term marriages.  Under the old laws, retirement of the payor didn’t necessarily provide relief from the payor’s having to continue support payments indefinitely.  You can get a summary of the new law here.

Not surprisingly, there are countless horror stories regarding alimony and how it has contributed to financial and emotional ruin.  The Alimony Reform Act of 2011, which took effect in March 2012, was intended  to bring more fairness to the alimony calculation and is highlighted by the following:

(1) it ends payments for life;

(2) it ties the duration for paying alimony to the length of the marriage;

(3) for long term marriages (more than 20 years), alimony ends at Full Retirement Age , as defined by Social Security (though the judge has discretion in awarding indefinite alimony in long-term marriages); and

(4) alimony may be terminated, reduced, or suspended when the recipient spouse lives with another person for at least three months (the “cohabitation” issue).  

To get your comprehensive summary of the Massachusetts Alimony Reform Law click here.

One conclusion gleaned from the legislation’s focus on limiting the duration of alimony is that it becomes more critical for the lower-earning spouse to find employment, in order to be self-sufficient when alimony ends.  

Child support in many ways is tied to alimony .  For example, in cases where the combined incomes of divorcing spouses is above $250,000, there may be no alimony granted…the only form of support may be child support.  Also, depending on the respective tax brackets of the divorcing parties, it may sometimes be beneficial to both to consider using “Unallocated Support”, which is essentially re-characterizing child support as alimony.

While Alimony Reform does much to clarify certain issues, there still remains room for interpretation, and different judges may adopt very different positions on the same fact patterns…one should bear in mind that nothing is etched in stone.  Nonetheless, familiarity with these guidelines should help to point you in the right direction on the subject of alimony.  The issues are complicated and intertwined and should be reviewed with an attorney, or divorce financial planner.  However, to start our handy reference may suffice!

Feb 12

4th Annual Symposium on Divorce Financial Issues

By Audrey Siciliano | Divorce Planning , Financial Planning

 

Fourth Annual Symposium

We are pleased to announce our Fourth Annual Symposium on Divorce Financial Issues on Friday March 18 from 8:30 to 4:30 .  It will consist of a full day devoted to Financial Issues for Divorce Professionals such as therapists, coaches, mediators and lawyers.  Please register here.

This year the Symposium is a fundraiser in support of The Divorce Center, a 501(c)(3) not-for-profit organization with a vision is to “Improve the Divorce Process and Its Impact on the Family” .  Part of the registration fee will be donated to The Divorce Center‘s newly established Parent Education Fund. This fund will provide Positive Parenting Programs to single parents, couples wanting to co-parent, and nontraditional families before, during, and  after divorce and after the Court-Mandated Parents Apart Program.

The 4th Symposium is offered by Insight Financial Strategists LLC, a Registered Investment Advisor with a focus and expertise in Divorce Financial Planning , in conjunction with the speakers and their respective firms.

Our distinguished speakers include:

William M. Levine, principal of Levine Dispute Resolution, will address self modifying agreements in divorce.

Laurence Kotlikoff, Economics Professor at Boston University, expert on Social Security and developer of ESP a financial planning software who will address economic issues in divorce.

Neal Winston, Principal of Winston Law Group a law firm specializing in Elder Law, Special Needs, and Estate Planning, will discuss estate planning and special needs issues within the context of divorce.

Brian Flood, a leading national risk management expert and author of “Wealth Exposed” will focus on often-overlooked property and casualty insurance issues in the divorces of high net worth couples.

The Fourth Symposium will be held at the Oakley Country Club in Watertown, MA on Friday March 18 from 8:30 to 4:30 . Continental breakfast and a buffet lunch will be served.

The cost for the Symposium is $195. Use code EARLY80 for an $80 early bird discount valid until February 28, 2016, for a net cost of $115.  Please register here.

We look forward to see you there!

Jan 04

PORTFOLIO RISK MANAGEMENT or Can you sleep at night?

By Jim Wood | Financial Planning , Investment Planning , Retirement Planning

Can You Sleep At Night?

Shy moon

When choosing an investment or an investment advisor we pay great attention to investment results. We all want the highest possible return on our investments . Most of us understand that the more risk we take the more gain we may make, but also the more we may lose. It is a wonderful thought to consider how much we might make, but it is very prudent and wise to consider how much we might lose if things go bad. What can YOU afford to lose? Does the risk in YOUR portfolio match your needs?

The average gain of the S&P 500 from the start of 2010 to the end of 2014 was 15.45% . Quite a nice average gain and one that most professionals believe cannot be expected to continue in the long term.

In the bear market of the recent Great Recession, the S&P 500 lost over 54.9% of its value from October 9, 2007 to March 9, 2009 . If you had stayed invested in the S&P500 throughout the same period, you would have needed an estimated 122% return for your investment to return to its pre-recession level.

If instead in the same period you had been invested 50% in the S&P 500 and 50% in the Barclays US Aggregate Bond Index, you would have lost approximately 23.84%. You would have then needed a return of only 31.35% for your investment to return to its pre-recession level.

Obviously, this example is hypothetical. There are many other factors that weigh into portfolio design. Although real life portfolios will often contain many more components, this simple example illustrates the benefits of diversification, and the importance of managing risk in a portfolio.

It is up to you and your financial planner to judge the risk that you can afford, and up to your financial planner to help you implement a portfolio that reflects that risk.

Jim Wood Graph

Percentage Gains Needed to Offset Losses

The bar chart to the left will allow you to estimate the amount of gain required to offset any loss that you might have experienced.

How did 2015 do for you? At the end of November 2015 the S&P 500 was up 3.01% for the year . Many investors with all stock , and therefore, high risk portfolios, are still down for the year, and perhaps still not sleeping well.

What to do? After a financial planner has assessed your risk capacity, he/she will be able to recommend a fully diversified portfolio that includes all relevant asset classes to match your financial objectives.

Note: The above hypothetical example is based on historical performance of the S&P 500 and Barclays US Aggregate Bond Index using Morningstar data. You cannot invest in indices. Trading and management fees are not computed in the example. This is not investment advice, which can only be given individually based on your risk tolerance and circumstances.

 

A previous version of this post appeared in the Colonial Times

Dec 23

Interest Rates, the Economy and You

By Chris Chen CFP | Financial Planning

Interest Rates, the Economy and You

Janet Yellen official portrait

Janet Yellen, Chair of the Federal Reserve

The Federal Reserve recently announced on December 16 that it would increase the Federal Funds rates by 0.25%.  It has been 3,457 days since the Fed increased rates, with the last rate increase in 2006, or almost 9.5 years.  The Fed’s policy of ultra low rates was initiated during the Great Recession and was intended to help stimulate an economy that was reeling from the sub-prime mortgage crisi. Evidently, the Fed believes that the economy is strong enough to withstand a return to a more normal rate environment.

Most observers believe that the Federal Reserve will continue to raise rates through 2016 and 2017. Some believe that the Fed will increase rates three or four times in 2016. According to Brian Wesbury, Chief Economist at First Trust, on December 17, the federal funds future market is priced to anticipate two rate hikes next year.

Here is a guide to what it means for the rest of us:

Mortgage borrowers may consider that now may be the time to refinance , especially if you are on an Adjustable Rate Mortgage (ARM). The December 16 increase is not likely to have a very strong impact on long term interest rates, which tend to follow the 10 year Treasury rate. However future fed funds rate increases will most likely push the yield curve up, leading to more costly refinancing down the road.

the very modest increase in the Fed Funds rate will not yet trigger an increase in bank and CD rates sufficient to cause a stampede from mattresses to CDs

On the other hand, short term mortgage rates will be affected immediately thus leading to an immediate increase in ARM payments. As noted above, conventional wisdom is that rates will continue to increase , and will eventually have a substantial upward impact on traditional long term mortgage rates. Get yours while you can!

Borrowers with Home Equity Lines of Credit (HELOC) will be impacted directly by the fed funds increase with increased monthly payments which will become more painful as the Fed continues to step up rates over the next few years. If you have the income, the credit score, and the debt ratio, you may want to refinance your HELOC into a long term fixed rate mortgage. If not, make efforts to pay down your balance to keep your payments manageable!

Credit card borrowers are likely to see an increase in interest rates and payments, even though credit card interest rates are already sky high. If you can pay those credit cards down, do so . For those who use 0% credit cards to roll balances from one period to another, expect that the 0% interest rate period will shorten over time: you will have to roll over balances more often.

From an income standpoint, long suffering fixed income investors are not out of the woods yet. As the Boston Globe reported me saying in October, the very modest increase in the Fed Funds rate will not yet trigger an increase in bank and CD rates sufficient to cause a stampede from mattresses to CDs. However it is a marginal improvement, and perhaps savers will be rewarded with increased returns as rate hikes continue over the next few months and the next few years.

Investors saw the stock market close up on the day of the Fed’s announcement, with the S&P 500 closing at 2,073.07. Clearly, the market was not spooked by the modest .25% increase , or the prospect of more increases next year. This may be an opportunity to do a portfolio check and ensure that you maintain a well diversified portfolio that is adapted to your needs, risk tolerance and time horizon. In particular you will want to understand the impact that your bond allocation will have on your portfolio.
If you have not done so already, schedule a review on your debt and investment strategies with your CERTIFIED FINANCIAL PLANNER™ Professional.

 

A previous version of this post appeared in the Boston Globe’s Managing Your Money blog

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