Financial planners often work with averages. But the reality is that each bear market will be different from the norm. At the time that I write this, the depth of this particular drawdown does not even rank with the worst in history. Sure, it may still get worse, but that’s where we are today.
We may not want to hear about how things will get better, because the situation with the Covid-19 pandemic and its resulting prescription of social isolation and market downdrafts is scary. But, eventually, things will get better.
Keep in mind that things may get worse before they get better. The count of people with the virus will almost certainly increase. If you don’t have a source yet, you can keep up with it over here. But eventually, the Coronavirus epidemic will run out of steam. We will get back to our places of work. Kids will go back to school. Financial markets will right themselves out. We will revert to standard toilet paper buying habits. We will start going out to eat again. Life will become normal again.
Financially, the question is not just how bad will things get, but how long it will take for our nest eggs to rebuild, so we can put our lives back on tr
Hence, it could take us a while before we make it back to the previous market peak. However, we may want to look at the data differently. This graph shows that, historically, we have needed to achieve a return of 46.9% to recover from a bear market . According to Franklin Templeton calculations, these numbers can look daunting. However, they have been achieved and exceeded after every past downturn. While there is no guarantee, these numbers suggest that there will be strong returns once we have reached the bottom of the market. I like to think of this as an opportunity.
With the time that it takes for investments to grow and get your money back, there is time to take advantage of higher expected returns. For those who have resources available, this means that there is time to deploy your money at lower prices than has been possible in recent months.
Those of us who have diversified portfolios and are not in a position to make new investments, the opportunity is to rebalance to benefit from a faster upswing.
We know from history that every US stock market downturn was followed by new peaks at some point following.
Could this time be different?
Of course, that too is possible.
I like to think that the future will be better. We will still wake up in the morning looking to improve ourselves, make our lives better, and achieve our goals. We are still going to invent new technologies, fight global warming, and struggle for a more equitable society.
We are living through difficult times right now. Losses in our brokerage and retirement accounts are not helping. But we will get through this. Please reach out to me if you have specific questions or concerns.
Roth IRA accounts are well known for providing tax-free growth and retirement income within specific parameters. The catch is that contributions must be made with earned income that has been taxed already. In other words, Roth accounts aren’t exactly tax-free, they are merely taxed differently.
On the other hand, Traditional IRA retirement accounts are funded with pretax dollars, thereby reducing taxable income in the year of contribution. Then, distributions from Traditional IRA retirement accounts are taxed as income.
The Roth IRA is not tax-free, it is merely taxed differently
However, the tax benefit remains the most prominent factor in the Roth vs. Traditional IRA decision. To make the decision that helps you pay fewer lifetime taxes requires an analysis of current vs. future taxes. That will usually require you to enlist professional help. After all, you would not want to choose to contribute to a Roth to pay fewer taxes and end up paying more taxes instead!
As everyone’s circumstances will be different, it would be beneficial to check with a Certified Financial Planner® or a tax professional to plan a strategy that will minimize lifetime taxes, taking into account future income and projected taxes.
Check out our other posts on Retirement Accounts issues:
The SECURE Act makes several changes to the Internal Revenue Code (IRC) as well as the Employee Retirement Income Security Act (ERISA) that are intended to expand retirement plan coverage for workers and increase savings opportunities. The SECURE Act also radically changes several techniques used for retirement and tax planning.
Some of the key provisions affecting employer retirement plans, individual retirement accounts (IRAs), and Section 529 Plans included in the SECURE Act are as follows.
This RMD provision is part of the good news in the SECURE Act. It will allow retirees more time to reach their retirement income goals. For many, it will enable better lifetime tax planning as well.
End of the “Stretch” IRA
Prior to the SECURE Act, the distributions on an inherited IRA could be “stretched” over the expected lifetime of the inheritor. That was a staple tool of estate and tax planning.
No more. With a few exceptions, such as for the spouse, the “stretch” is now effectively crunched into ten years. Accounts inherited as of 12/31/2019 are now expected to be distributed over ten years, without a specific annual requirement.
The new law allows a penalty-free distribution of up to $5,000 from an IRA or employer plan for a “Qualified Birth or Adoption Distribution.” For a qualified distribution, the owner of the account must take the distribution for a one-year period starting on (1) the date of birth of the child or (2) the date when the adoption becomes final (individual must be under age 18). The law permits the IRA owner who took the distribution to pay it back to the plan or IRA at a later date. However, these distributions remain subject to income taxes.
Generally speaking, we at Insight Financial Strategists think that people in this situation should avoid availing themselves of this new wrinkle in the law. In our experience, a distribution from retirement accounts before retirement can have profound impacts on retirement income security.
It may sound off-topic, but it is not. The SECURE Act also addresses 529 plans. For students and their parents, the SECURE ACT allows tax-free 529 plans to pay for apprenticeship programs if they are registered and certified by the Department of Labor.
This provision will be helpful for those people who have children headed to vocational track programs.
Given how students and parents scramble to meet the challenge of the cost of higher education, I do not forecast that most 529 plans have much left over to pay off loans!
Business Retirement Plans
(Part-Time) Employee Eligibility for 401(k) Plans – In most 401(k) plans, participation by part-time employees is limited. The SECURE Act enables long-time part-time workers to participate in 401(k) plans if they have worked for at least 500 hours in each of three consecutive 12-month periods. Long-term part-time employees who become eligible under this provision may still be excluded from eligibility for contributions by employers.
Delayed Adoption of Employer Funded Qualified Retirement Plan– Beginning in 2020, a new plan would be treated as effective for the prior tax year if it is established later than the due date of the previous year’s tax return. Notably, this provision would only apply to plans that are entirely employer-funded (i.e., profit-sharing, pension, and stock bonus plans).
403(b) Custodial Accounts under Terminated Plans are allowed to be Distributed in Kind – Subject to US Treasury Department guidance, the SECURE Act allows an individual 403(b) custodial account in a terminating plan to be distributed “in-kind” to the participant. The account distributed in this way would retain its tax-deferred status as a 403(b).
Establish Open Multiple Employer Plans (MEPs) – Employers may now join together to create an “open” MEPs, referred to in the legislation as “Pooled Plans.” This will allow small employers to join together and share the costs of retirement planning for their employees, such as through a local Chamber of Commerce or other organization, to start a retirement plan for their employees.
Increased Tax Credits – The tax credit for small employers who start a new retirement planwill increase from $500 to $5,000. In addition, small employers that add automatic enrollment to their plans also may qualify for an additional $500 annual tax credit for up to three years.
There are many more provisions in the SECURE Act. While some of them are useful for taxpayers, it is worth noting the observation by Ed Slott, a tax expert and sometimes wag: “whatever Congress names a tax law, it does the opposite .” This is worth keeping in mind as you mull the implications of this law. With the SECURE Act now the law, it may be time to check in with your fiduciary financial planner and revise your retirement income and estate plans.
A key item of the TCJA is that it increased the standard deduction, reducing the impact of the elimination of State and Local Taxes (SALT) under $10,000 and the elimination of personal deductions. As a result, about 84% of taxpayers claim the standard deduction and do not itemize. By comparison, about 56% of taxpayers itemized before the enactment of the TCJA. The vast majority of taxpayers are no longer subject to the Alternative Minimum Tax (AMT), since two of its key drivers, the deductibility of state and local taxes and personal deductions, are no longer a practical issue for most people. And in 2018, only 1,700 estates were subject to the federal estate and gift tax. So for most people, the TCJA has made taxes simpler to deal with. What’s there not to like about a simpler tax return ?
Source: Congressional Budget Office
Impact of the TCJA on the Federal Deficit
As predicted, the TCJA worsened the federal deficit bringing it to nearly a trillion dollars in fiscal year 2019. That was in spite of an increase in tax revenue due to the continuing improvement in the economic climate. Of course, the federal deficit continues to be driven by federal spending on the sacred cows of modern US politics: Defense, Social Security, and Medicare. Interest on the federal debt is also a major budget item that needs to be paid. While our continuing regime of low interest rates is helping control the interest on the debt, it is clear that the future may change that.
What will happen to tax rates?
Tax rates are lower now than they have been since the 1970s and 80s. Hence, industry insiders tend to think that tax rates have nowhere to go but up. That is also what’s is predicted by the TCJA, which is largely designed to sunset in 2025. Should the American people turn on Republicans at the 2020 election, it’s possible that the TCJA will see a premature end. However, it seems that the possibility that the American people might elect a progressive in 2020 is largely discounted when it comes to tax rate forecasting: most people assume that tax rates will increase.
Political forecasting aside, there are still things that we can do to lower our taxes . It should be noted that many of the techniques in this article are not limited to the year-end. Furthermore, we all have different situations that may or may not be appropriate for these techniques.
Tax Loss Harvesting
Even though we have had a pretty good year overall, many of us may still have positions in which we have paper losses. Tax-loss harvesting consists of selling these positions to realize the losses. This becomes valuable when you sell the equivalent amount of shares in which you have gains. So if you sell some shares with $10,000 in losses, and some with $10,000 in gains, you have effectively canceled out the taxes on the gains.
You then have to reinvest the shares sold into another investment. Be careful not to buy back the exact same shares that you sold. That would disallow the tax loss harvesting!
At the same time, it makes sense to review your portfolio and see if there are other changes that you would like to make. We are not fans of frequent changes for its own sake. However, periodically our needs change, the markets change, and we need to adapt.
Income Tax Planning
While tax loss harvesting is mostly about managing Capital Gains taxes, it is also important to keep an eye on income tax planning . This is a good time of year to estimate your income and your taxes for the year. When comparing your estimated Adjusted Gross Income with the tax tables, you will see if you might be creeping up into the next tax bracket. For instance, if you are single and your estimated AGI is $169,501 (and you have no other complexity), you are right at the 32% tax bracket (after you remove the $12,000 standard deduction). In this example, that means that for every dollar above that amount you would owe 32 cents in federal income tax, and a little bit more for state income tax, if that applies to you.
If your income is from a business, you may possibly defer some of that income to next year. If your income comes from wages, another way to manage this is to plan an additional contribution to a retirement account. In the best of cases your $1,000 contribution would reduce your taxes by $320, and a little bit more for state taxes.
In some cases, you might have a significant dip in income. Perhaps if you have a business, you reported some large purchases, or you booked a loss or just had a bad year for income. It may make sense at this point to take advantage of your temporarily low tax rate to do a Roth conversion. Check with your wealth manager or tax preparer.
One way around that situation is to bundle or lump charitable gifts. Instead of giving every year, you can give 2, 3 or more years worth of donations at one time. That would allow your charity to receive the contribution, and, potentially, for you to take a tax deduction.
Pushing the bundling concept further, you could give even more to a Donor Advised Fund (DAF). With that option, you could take a tax deduction, and give every year from the DAF. That allows you to control your donations, reduce your income in the year that you donate, and potentially reduce income taxes and Medicare premiums. Consult your wealth strategist to ensure that taxes, income, and donations are optimized.
First, it is important to review Required Minimum Distribution (RMDs). Anyone who is 70 ½ years of age or older is subject to RMDs. Please make sure to connect with your financial advisor to make sure that the RMD is properly withdrawn before the year-end.
The RMD is a perennial subject of irritation for people . Obviously, if your retirement income plan includes the use of RMDs, it’s not so much of an issue. However, if it is not required, it can be irritating. That is because RMD distributions are subject to income taxes that may even push you into the next tax bracket or increase your Medicare premium. There are, however, some ways that you can deal with that.
For instance, if you take a Qualified Charitable Distribution (QCD) from your IRA and have the distribution given directly to a charity, the distribution will not be income to you. Hence you won’t pay income taxes on that distribution, and it will not be counted toward the income used to calculate your Medicare premium. However, it will fulfill your RMD, thus taking care of that pesky issue.
Generally, we advocate planning for lifetime taxes rather than for any one given year. Lifetime financial planning has the potential to result in even more benefits. It should be noted that many of the possibilities outlined in this article can be used throughout the year, not just at year-end. We encourage you to have that conversation with your wealth management team to plan for the long term!
Ready & ABLE: 529A, a New Planning Tool for Disabled Family Members
In the week leading to the Christmas holiday, the US congress passed the ABLE Act of 2014 as part of the Tax Increase Prevention Act of 2014. ABLE stands for Achieving a Better Life Experience. The Act creates the new 529A plan. It is a significant change to the financial planning landscape for special needs beneficiaries.
The 529A plan is modeled after the Section 529 College Savings Plans, which are widely used for college planning. The 529A is meant to help people with disabilities as defined under Social Security rules and will allow tax advantaged distributions for certain expenses for the disabled beneficiary including housing, transportation, health and wellness, education and more without disqualifying the disabled individual from Federal and State aid.
As with the current 529 plans, for funds not used for qualifying expenses, any investment growth would be taxed as ordinary income plus a 10% penalty. Additionally, the funds can be rolled over tax-free from one ABLE account to another and the designated beneficiary can be changed from one disabled person in a family to another in the same family.
In theory the 529A will be limited to the same maximums that apply to 529 plans in their respective state. However, in practice the maximum amount that can be held in a 529A will be limited to $100,000. Above that amount, the beneficiary may lose his or her qualification for Medicaid coverage. In addition, a maximum of $14,000 can be contributed annually to a 529A.
There are other differences between the 529A and the current 529 plans. For example, it appears that the 529A will only be able to be used in the beneficiary’s resident home state. Hence, if the beneficiary moved, it may require rolling over the 529A from one state plan to another. That is different from the college 529, for which families can use the best state plan that they can find, including out of state plans.
The 529A is a great new tool to add to the panoply available to help disabled people. It will allow more middle-income families to plan support for their disabled family members with an easy to use framework that should be relatively low cost. The 529A comes with built-in advantages such as lower costs and tax advantages. On the other hand, there are restrictions for annual and maximum contributions to the 529A. On balance, the new plan should be very attractive to many middle class families.
It will take some time for 529A rules to be finalized and for states to roll out the plans. Hopefully, Massachusetts will be at the vanguard!
(an earlier version of this article also appeared in the Boston Globe)
At a Symposium on Impact Investing held at the Vatican during the third week of June, Pope Francis appealed to sustainable investors to support social justice through their actions. According to the Pope: “It is important that ethics once again play its due part in the world of finance and that markets serve the interests of peoples and the common good of humanity.”
Changing ourselves as individuals is merely the first step. The second more imperative question to ask is: how can we make the companies and organizations around us behave and act in a systematically conscious manner for the advancement of society? As individuals some of us may feel overwhelmed by the scale of such a question. The answer was highlighted by Pope Francis during the symposium: we should make our investments count .
Impact investing or Socially Responsible Investing is when you not only invest in a corporation but also in the message they spread. For instance:
Starbucks is one of the most powerful coffee chains in the world. While they brew their signature coffee blends, they simultaneously aim to keep the underlying coffee bean environmentally equitable by using “Green Coffee” or fair trade coffee.
Ben and Jerry’s make wholesome dairy products and they also donate more than 7.5% of their pre-tax profit to various charities around the world.
Dell supports 4,615 charities around the world. In addition the Dell Social Innovation Challenge aims to mentor and nurture social entrepreneurs who have potentially socially consequential ideas.
Whole Foods may be our local grocer; internationally the organization supports 40,000 impoverished female micro-entrepreneurs.
The list goes on. It may be worthwhile to note that while these companies have achieved paramount corporate Socially Responsible Investing standards, they are also highly profitable enterprises. Socially Responsible Investing does not mean forfeiting gains, just choosing how to obtain them.
The inevitable question arises: do these organizations use their socially conscious efforts to mask their corporate greed?
None of these organizations are not 100% socially responsible in their actions. Yet they have taken stride to mitigate their harmful activities as well as promoting social causes. It is precisely this trend that we as social investors should campaign for.
There are a wide array of Socially Responsible Investing funds available offered by several well established fund managers as well as specialized advisers. These funds screen companies based on their ESG (Environmental, Social and Governance) standards. They simultaneously attempt to retain a diversified portfolio to mitigate the underlying risk.
The Calvert Social Index Fund is an index fund benchmarked on the Calvert Social Index® established to measure the performance of US-based sustainable and responsible companies. It has a diversified 699 issues in its current portfolio and a four star rating from Morningstar. The average return annually over a ten year period ranging from 4/01/04 to 3/31/14 for the A-shares is 6.15%, while the return of the Calvert Social Index during this period is 7.21%.
Another notable one is the Parnassus Fund which is benchmarked against the S&P 500. The average return of the A shares (post tax and excluding distribution fees) over a ten year period (01/01/04 to 12/31/2013) is 6.99% .The return of the S&P 500 by comparison for this period is 7.39%.
The iShares MSCI KLD 400 Social ETFis indexed to the MSCI KLD 400 Social Index (a free floating adjusted capitalization weighted index consisting of companies which comply with strict ESG standards). The fund’s performance since inception (11/14/06 to 12/31/13) has been 6.11%. The Index by contrast had a 6.65% annual average return over the same period.
The Green Century Balanced Fund contains a diversified portfolio of stocks and bonds. It is benchmarked against the S&P 500 Its return over the last ten year period has been 4.97% (04/01/04 to 3/31/14), compared with 8.34% for the S&P 500 over the same period.
These choices are not exhaustive. However, they demonstrate that there are Socially Responsible Investing choices that are valid from an investment standpoint. These Socially Responsible Investing options are diversified and varied. They are constructed in such a way that you need not sacrifice on returns in order to be socially conscious.
If you are interested in Socially Responsible Investing, take some time to research the possibilities and consult your Financial Planner regarding the investment options available and how they may fit in with your goals and your portfolio.
This blog post is contributed by Harshita Mira Venkatesh, a student at the University of Rochester majoring in Financial Economics and Applied Mathematics. Harshita is also a summer intern at Insight Financial Strategists LLC for the Summer of 2014. She intends to pursue a career in equity research analysis.
Note: All content provided on this blog post is for informational purposes only. We make no representation as to the accuracy or completeness of any information on this site or any information found by following any link on this site. The information is general in nature and may not be applicable or suitable to an individual’s specific circumstances or needs. Application to an individual situation may require considerations of other matters. The investments featured in this blog post are for illustration purposes only. No representation is made as to their suitability for any individual’s portfolio. If you have questions about the mutual funds described, please contact your investment professional.
How to choose a financial planner is a question that vexes many people looking for one, even as a number of online resources address the topic. For instance, theFinancial Planning Association as well as a number of online resources in the financial and popular media offer advice on that.
I was prompted to think about this issue by a question I received recently
“Currently I am pulling about 4% on my trading accounts. These are probably below what is going on in the market, but that’s one of the reasons I am seriously looking at a financial adviser.
Do you have any empirical data (history) on what returns I could expect. I am a numbers type so that would definitely help me in my decision making process. “
It is a great question! Clients want results, and Financial Planners want results. The difficulty with using results to measure effectiveness, and as a benchmark on how to choose a financial planner, is that there are so many moving variables that using historical results to choose a financial planner is not effective. As the saying goes, there are lies, damn lies and then there are statistics.
Hence my answer:
Before answering the question “…we would need to work a little more on your objectives and your comfort with risk. An investment portfolio would have to reflect both. For instance, if you have a short term goal, you would want the money allocated to that goal to be in a lower risk investment allocation. If you have a long term goal, you would want the opposite. Then, could you compare the performance of the two? They would be like apples and oranges, so probably not.
Now if you and I had the same long term goal, should we be invested in the same way? Only if we have the same attitudes toward risk, ie how we feel when the market goes down. Depending on our respective comfort with risk, you and I would have different asset allocations. Could you compare the performance of our two asset allocations? It would be like comparing a red delicious with a granny apple. Sort of the same thing, but not quite.
With regard to your results, I assume that they are year to date. Compared to a S&P 500 return of 19.33% year to date on 9/23/2013, a 4% return year to date would be reflective of a fairly conservative asset allocation with relatively little risk. In a stock trading situation, your 4% probably came with taking substantial risk.
My job as a financial planner is to understand your goals and your comfort with risk. Then I can propose an investment allocation and investments that efficiently help you reach your goals with the appropriate amount of risk.
In summary, I could provide you with numbers, but they would not be meaningful without the underlying context of where they came from. Chances are they will be better than some other financial planners’, and worse than some others. In and of itself that would not be meaningful, and, in my opinion, you should not rely on those numbers to decide how to choose a financial planner.”
Chances are your retirement plan offers one or more stock funds to choose from. If it is consistent with your investment objectives and your investment risk tolerance, you may want to consider investing a portion of your plan in an aggressive growth fund.
Risks and Rewards
Aggressive growth funds, as the name indicates, are stock funds that are growth-oriented. Included in aggressive growth funds are several options like “small-cap” funds, “emerging market” funds, as well as various kinds of international funds. Aggressive growth funds tend to invest in smaller, fast-moving companies in developing sectors with the potential for rapid growth (hence the name), such as high-tech or biotechnology. They may also invest in equities that have fallen out of favor on Wall Street, but appear ready for a comeback.
Because they invest in companies that are often less known and not as established as the companies that make up the Dow Jones Industrial Average (DJIA), aggressive growth funds tend to exhibit volatile behavior. For instance, when the market goes down, an aggressive growth fund may go down more than the DJIA. Conversely, when the market goes up, aggressive growth funds often go up more. The goal of aggressive growth funds is to achieve higher returns than other stock funds.
Aggressive growth funds are best suited for long-term investors with the intestinal fortitude to bear the market’s worst downturns while seeking the strongest returns. For example, an investor may want to allocate some of his or her portfolio to aggressive growth funds to potentially accumulate as much as possible over a long time horizon. These funds may be especially suitable for younger investors with 25, 30, or 35 years until retirement.
Don’t Forget Diversification
Regardless of how aggressively you would like to invest, keep in mind the crucial benefits of allocating your money across investments that behave differently.
If you invest in an aggressive growth fund, you may want to balance its inherent risk with investments that have different risk characteristics such as growth and income funds, bond funds, and money market funds.
A financial planner can help you determine the investment allocation that’s best suited for you and your goals.
Tactical asset allocation can enhance a long term strategy
Strategic asset allocation, the practice of maintaining a strategic mix of stocks, bonds, and cash, has guided many investors in creating portfolios that suit their risk profile and long-term investing goals. This widely used strategy is a long-term, relatively static tool and is not intended to take advantage of short-term market opportunities.
Proponents of tactical asset allocation, in contrast, take a shorter-term view. Tactical asset allocation is the practice of shifting an asset allocation by relatively small amounts (typically 5% or 10%) to capitalize on economic or market conditions that may offer near-term opportunities. Tactical asset allocation differs from re-balancing, which involves periodic adjustments to your strategic allocation as a result of portfolio drift or a change in personal circumstances. With tactical asset allocation, you maintain a strategic allocation target, but fine tune the exact mix based on expectations of what you believe will happen in the financial markets.
Tactical asset allocation also can involve shifting allocations within an asset class. For example, an equity portion of a portfolio may be shifted to include more small-cap stocks, more large-cap stocks, or other areas where an investor perceives a short-term opportunity.Note that mutual funds that invest in these areas may impose restrictions on short-term trading, and it is important to understand these restrictions before making an investment.
A tactical approach involves making a judgment call on where you think the economy and the financial markets may be headed. Accordingly, a tactical asset allocation strategy can increase portfolio risk, especially if tactical allocations emphasize riskier asset classes. This is why it may be a good idea to set percentage limits on asset allocation shifts and time limits on how long you want to keep these shifts in place.
In addition, when evaluating investment gains that are short-term in nature, such as those on investments held for one year or less, it is important to understand taxes on short-term capital gains. Currently, short-term capital gains are taxed as ordinary income, where the highest marginal tax rate is 39.6%. In contrast, long-term capital gains on investments held for more than one year are taxed at 15% for most investors, 20% for joint filers earning more than $450,000.
This week I wrote the following short piece for the Boston Globe:
Many people have trouble putting together an emergency fund. After all, there is always something else to spend money on! These are often small items, small fees and small purchases that go unnoticed. However, they add up. What if you could limit your purchasing of these small items, and put your extra cash into a rainy day fund instead?
Here are some ideas:
1. Consider giving up your daily Dunkin’ Donuts or Starbucks habit. At $3.05, a cappuccino may not seem like a lot, but one every 251 working days in the year adds to $765. What small expenses do you incur every day that adds up?
2. AT&T and Verizon will charge you $199.99 for the new iPhone5 or the newer Samsung Galaxy 4 with a two year contract. The truth is most of us want the new hot phones and their fancy features. How long will these phones stay “hot”?
3. Pack your lunch: a sandwich or a salad at Panera will set you back $9 a day, or $2,259 a year.
4. Carpooling is great. Biking to work is better: It will not just save you gas, it will make you healthy too. Have you tried Boston Bikes yet?