Video: 5 Best Practices for Limiting Your Tax Burden in Retirement
Tax implications and in particular, limiting your tax burden during retirement, is often one of the top concerns for our clients whether they are retired or approaching retirement. It’s a topic that must be addressed in any thorough retirement plan. We found this video from Morningstar. We wanted to share it with you because it discusses several of the strategies we implement with clients on the regular basis.
“A flexible withdrawal strategy, diversification across account types, and targeted Roth conversions can limit the tax drag for retirees,” says Morningstar’s Christine Benz. Click to image below to watch the video.
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If you would like to talk to us about how these strategies might fit into your financial plan, click here.
When we do a benchmark analysis on a 401k plan, we are always looking for factors that create excess drag on the performance of the plan. There are several factors that can impede the growth of a 401k plan including the mix of funds each participant chooses and how much they are deferring into the plan. In fact, those factors have the largest effect on the growth of the plan; however, those factors are not directly controllable by the plan sponsor. Parasitic drag as we see it is anything that causes the growth of the plan to suffer regardless of the choices that participants make.
There are two main potential sources of drag on performance at the plan level:administrative expenses and investment expenses. Administrative expenses are related to the actual operation of the plan. This includes the TPA, record-keeper, financial advisor, custodian, sales broker etc. Investment expenses are those built into the investment choices themselves, usually expressed in terms of an expense ratio.
Part of the problem is often that the true costs associated with each of these are buried in complex disclosure documents. To further confuse the issue – some of the fees collected in one area are shared with service providers in another (a practice called “revenue sharing”.)
Drag from various expenses can not be 100% eliminated, however, knowing what is reasonable for a plan similar in size to yours so that you can compare what you are paying to that benchmark is a good place to start.
abc News featured one small business owner’s discovery of the drag in their plan back in September of 2013. You can watch their report by clicking on the abc News logo to the right.
The Department of Labor over the past few years has also recognized the issue and begun to implement regulations to help plan sponsors make more informed choices with regards to expenses. They even produced a video for sponsors to illustrate why expenses can be such a big issue. You can see the video by clicking the video to the right.
So far, 2015 is the year of the yawn as far as the markets go. Record low volatility and a very narrow trading range in the US stock markets make it pretty quiet on the portfolio front. So how does an investor know what is a good idea to own vs. what is not so hot?
If you are a client of ours, or have ever come to one of our workshops, you have heard us use the term Relative Strength. Relative Strength is an indicator that we use that measures how an investment / sector / market is performing relative to others over time. Because the comparison is on a relative basis, it allows for the comparison of dissimilarly priced investments.
An easy example would be comparing two stocks – one starting at $10 per share, the other starting at $100 per share. Over a given period, the $10 stock increases to $20 per share, while the $100 stock increases to $150 per share. In relative terms the one that went to $20 is ranked higher than the one that went to $150, because on a percentage basis, it had a larger increase over the same period of time.
Although the analysis over time of a Relative Strength ranking chart can be somewhat complex, the basic theory is not hard to understand:
It is generally better to own things that are ranked highly against their peers.
Relative Strength rankings are helpful to show which markets or sectors are doing better than others, and then can be used to rank investments within those markets or sectors to see which specific securities are outpacing the competition.
Learn more about Relative Strength on Investopedia here:
What is your advisor or broker’s investment style?
For many people, the answer is “I don’t know, but as long as it makes me money, I’m good.” This is not a horrible answer. However, one problem with not knowing is the element of SURPRISE. People do not like surprises when it comes to their portfolios. You may be surprised at what does (or does not) happen in your portfolio during certain market conditions if you do not have a basic understanding of the investment style the person you entrust with your money uses.
Investment style and portfolio management strategy can be a complex subject and not one you are likely interested in spending years learning. After all, that’s why you hire an advisor. Let’s look at a typical bear market pull-back. We all know they happen, remember 2008 and 2001? If you are using a passive style and the market drops 30% over 6 months…SURPRISE!
Your portfolio value drops too and depending on your allocation, the drop may be pretty significant. You may be a bit upset because your advisor didn’t “do anything” about it. However, since the investment style is passive and based on a buy and hold mentality, you really should not have expectedmuch activity. If your advisor’s style was more active, you may have been able to expect a different set of actions.
Our investment style is often referred to as “momentum investing”, which is an active management style. The actions we would take in a portfolio during that same bear market event may be very different than the passive example above. This is not to say that an active investment style is always better, but statistics show that momentum investing can provide consistent results when compared against other styles or a passive index like the S&P 500.
The bottom line is: if you understand a little bit about the investment style of your advisor or broker, you are more likely to have your expectations met rather than… SURPRISE!
If you would like to learn more about our firm’s active investment strategy, consider coming to one of our monthlyworkshops or simply contact us for a consultation. We would be happy to discuss it with you.
The general rule of thumb with bonds is prices tend to go down as interest rates rise. Of course with any theory there are exceptions, however, the reasoning behind it is reasonably straight forward. It helps to understand some bond basics.
A bond is essentially a loan you make to an entity like a government or corporation in return for interest. You can sell a bond, like any other security. How much you can sell your bond for is determined by how desirable the interest rate of it is compared to others on the market.
For example:
If you own a bond that is paying 5% and new bonds being issued with the same term are paying 6%, then your old bond may be worth less to investors than the new ones and thus their price goes down.
Longer term bonds tend to feel the effects of interest rates before shorter term bonds. Bond investors often choose to buy shorter term bonds instead of longer term bonds as pressure from rising interest rates affects the bond market.
How are bonds doing now?
Over the past couple of weeks, long term bond prices have fallen a bit, likely due to rising interest rates. As a result, in a few of our models we have shifted to some shorter bond positions. So far theory and reality are relatively close on this one. But remember, the inverse relationship between bond prices and interest rates is a rule of thumb and not an absolute.
Read more on Investopedia about bonds and interest rates: Here
Last Friday was May 1st. For many, this date signifies the real beginning of spring, welcoming “May flowers” and the holiday May Day. In the investing world, it is the trigger point for some investors of an old stock market adage “Sell in May and go away.” This seasonality based risk management theory, is rooted in the idea that the market is softest from May to November for equity investors. Theoretically, you could sell your equities in May, buy in November and be better off than if you held them for the entire year.
Is seasonality real or just stock market lore?
According to the Stock Trader’s Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period.
So, is it real?
Well, our feeling is yes (and no). The problem with any hard-and-fast rule for investing is that it does not always work. In 2011, the seasonal theory might have had you looking brilliant, but in 2012, 2013 and 2014 – not so much.
Is just ignoring it the best policy?
Ignoring long term, statistical, unbiased data is rarely a good plan. We do utilize seasonality as a factor when we are making a change to our equity holdings in a portfolio. Is it the sole factor? No.
How about a simple sports analogy:
A football coach is calling a play that includes a pass. It is raining out and the ball is slippery. A good coach would most likely take these conditions into account when determining if a pass is worth the risk. The rain is a factor in the coach’s decision making process. Rain is not a deal-breaker every time for a pass – clearly, quarterbacks pass in the rain all the time. However, it is an additional risk that has to be considered and may change the call from the coach in some situations.
Would it be a great play to sell all your equities simply because it is May 1st? Maybe, but it would just be a guess. Seasonality data is real and it should be an added factor in upcoming portfolio decisions.
Over the past couple of weeks we have mentioned the international equity sector gaining momentum and potential portfolio changes as a result. This idea of making portfolio changes based on the change in leadership or ranking is all part of a strategy we utilize called Sector Rotation.
Sectors are specific sub-categories of a market. For example, the broad stock market can be broken down into 10 sectors such as technology, utilities, healthcare etc. . If you look at the returns for each sector over time you notice that the returns can be dramatically different from sector to sector; often having as much as an 80% difference between the top and the bottom year to year. Here is a link to Morningstar’s Sector Returns page.
The term Sector Rotation strategy in non-market-jargon could simply be “category change” strategy. By ranking the various sectors (or categories) in any given market and monitoring it over time, you can clearly see those that are the leaders, those that are rising and those that are falling. By employing Sector Rotation strategy we can own more of the categories that are performing well and less of those performing poorly. As the leadership changes we look to replace the categories that are falling in ranking with ones that are rising.
The theory is not too complex. Having the time, expertise and data to put it into practice is a bit more involved and not something the average investor is likely to engage on their own. As portfolio managers, employing strategies such as sector rotation is a big part of what we do for our clients.
Here are links to Investopedia’s definition of Sector Rotation.
“Patience” Making a move AFTER buy sell indicators change
In last Monday’s Weekly Wire, we talked about the rise in ranking of the international equity sector. Over the past week, we saw that momentum continue. Whether this is due to the quantitative easing overseas that we mentioned last Monday or other factors, the beauty of relative strength indicators is that the “why” something is happening is not nearly as important as the fact that it “is” happening.
Speculating on the “why”, although sometimes interesting to debate, can unfortunately lead investors into decisions based on plain old guessing. The problematic assumption with a guess is that whatever the investor is attributing the momentum to is – a) correct and b) will continue.
We follow a less emotional or gut-based decision making process, focusing on what actually has happened as the inflection point for changes to any portfolio. The key is – patience. Our indicators have to actually move from buy to sell or vice versa for us to make a change. It’s not enough to just guess that an indicator move may happen, guessing is not part of a repeatable process.
So for now, we wait. Would we be surprised if our international equity indicators move to buy signals in some portfolios? No. Are we making portfolio changes early based on a hunch? Also no, but stay tuned!
“International” Quantitative Easing having an effect overseas ?
For the past few years the US stock markets have been the consistent front-runners for growth investing. That said, we are seeing early signs of strength from the international markets.
In Europe, quantitative easing was announced last year, much like the US government’s quantitative easing from a several years prior which helped boost the US stock markets. The latest numbers may indicate that this action has begun to have a similar positive effect overseas.
On a relative strength basis, we are still seeing the US stock markets as the leaders with US fixed income coming in second. However, international equity markets are now third and gaining momentum. Not enough movement for any wholesale change in strategy, but another indicator that is a ping on the RADAR that we are watching closely.
This is the first of our new Weekly Wire series. Our clients often ask us for our take on recent events or market conditions. Weekly Wire’s are short and sweet, but we hope they will give you some insight into our thought process and spark some great questions. Let us know what you think, we always like to hear from you!
“Exhale” Signals from an overbought market
Last week the US equity markets pulled back a little. The Dow Jones Industrial Average and the Standard & Poor’s 500 Index each fell every day last week before edging higher on Friday. Our short-term indicators predictably switched to sell; however, medium and long term indicators remained substantially unchanged. Our collective take on the week was that it represented a bit of a collective exhale from an overbought market, which is not too surprising.
What this means to our clients is that the recent pullback is part of the normal ups and downs of the capital markets. Our short term indicators are not used to “time” the market with existing accounts. Rather these indicators work well in deciding when to use a dollar cost average strategy when committing new cash to invest.
All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
