What Are Today’s Projected Returns?

Posted On June 18, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /

One of the reasons I selected the financial planning software we use, MoneyGuidePro, is because it offers the ability to make projections based on historical OR projected returns. Most programs only use historical returns in their calculations, which I think is a grave error today. Historical returns were outstanding, but I fear that portfolio returns going forward will be lower for several reasons, including:

Above-average equity valuations today. Lower dividend yields than in the past.
Slower growth of GDP, labor supply, inflation, and other measures of economic development.
Higher levels of government debt in developed economies will crowd out spending.
Very low interest rates on bonds and cash mean lower returns from those segments.

By using projected returns, we are considering these factors in our financial plans. While no one has a crystal ball to predict the future, we can at least use all available information to try to make a smarter estimate. The projected returns used by MoneyGuidePro were calculated by Harold Evensky, a highly respected financial planner and faculty member at Texas Tech University.

We are going to compare historical and projected returns by asset class and then look at what those differences mean for portfolio returns. Keep in mind that projected returns are still long-term estimates, and not a belief of what will happen in 2017 or any given year. Rather, projected returns are a calculation of average returns that we think might occur over a period of very many years.

Asset Class	Historical Returns	Projected Returns
Cash	4.84%	2.50%
Intermediate Bonds	7.25%	3.50%
Large Cap Value	10.12%	7.20%
Small Cap	12.58%	7.70%
International	9.27%	8.00%
Emerging Markets	8.85%	9.30%

You will notice that most of the expected returns are much lower than historical, with the sole exception of Emerging Markets. For cash and bonds, the projected returns are about half of what was achieved since 1970, and even that reduced cash return of 2.50% is not possible as of 2017.

In order to estimate portfolio returns, we want two other pieces of data: the standard deviation of each asset class (its volatility) and the correlation between each asset class. In those areas, we are seeing that the trend of recent decades has been worse for portfolio construction: volatility is projected to be higher and assets are more correlated. It used to be that International Stocks behaved differently that US Stocks, but in today’s global economy, that difference is shrinking.

This means that our projected portfolios not only have lower returns, but also higher volatility, and that diversification is less beneficial as a defense than it used to be. Let’s consider the historical returns and risks of two portfolios, a Balanced Allocation (54% equities, 46% fixed income), and a Total Return Allocation (72% equities, 28% fixed income)

Portfolio	Historical Return	Standard Deviation	Projected Return	Standard Deviation
Balanced	8.53%	9.34%	5.46%	10.59%
Total Return	9.18%	12.20%	6.27%	14.23%

That’s pretty sobering. If you are planning for a 30-year retirement under the assumption that you will achieve historical returns, but only obtain these projected returns, it is certainly going to have a big impact on your ability to meet your retirement withdrawal needs. This calculation is something we don’t want to get wrong and figure out 10 years into retirement that we have been spending too much and are now projected to run out of money.

As an investor, what can you do in light of lower projected returns? Here are five thoughts:

Use projected returns rather than historical if you want to be conservative in your retirement planning.
Emerging Markets are cheap today and are projected to have the highest total returns going forward. We feel strongly that they belong in a diversified portfolio.
We can invest in bonds for stability, but bonds will not provide the level of return going forward that they achieved in recent decades. It is very unrealistic to assume historical returns for bond holdings today!
Investors focused on long-term growth may want more equities than they needed in the past.
Although projected returns are lower than historical, there may be one bright spot. Inflation is also quite low today. So, achieving a 6% return while inflation is 2% is roughly comparable in preserving your purchasing power as getting an 8% return under 4% inflation. Inflation adjusted returns are called Real Returns, and may not be as dire as the projected returns suggest.

Applying The Rule of 72

Posted On June 11, 2017 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

The Rule of 72 is a very simple financial short-cut: divide your rate of return into 72 and you have (approximately) the number of years it takes for your money to double.

Double Your Money
2% = 36 years
4% = 18 years
6% = 12 years
8% = 9 years
etc.

This gives you an idea of the importance of compounding. But aside from being a way to impress children and small animals with your math prowess, is there a practical application of the rule of 72? Yes, there are a number of ways that thinking about The Rule of 72 can improve our behavior and give us better financial outcomes with our investing. For example:

1) Think Long-Term. Think in terms of “doubling periods”. If you are targeting a 7% rate of return, your doubling period would be 10 years. If you have 20 years until retirement, you would expect your money to double twice. If you have $200,000 today, you should have $800,000 in 20 years, in this hypothetical scenario. And that is without any additional saving!

2) Start Early. You want to double your money as many times as you can, but let’s face it, a life expectancy of 85 years can only contains so many periods of 9 or 12 years. To maximize your wealth, you have to start as early as possible.

Let’s consider two investors: Smart Sally and Late Larry. Sally starts investing $500 a month at age 22, while Larry waits until he is 32. He’s still young, right? He also invests $500 a month and they both earn an 8% return until retirement at age 62. At age 62, here’s where they stand:

Smart Sally has $1,745,503. Late Larry has $745,179. Sally has a million dollars more because she started 10 years earlier! Not saving in your 20’s could mean you have a million dollars less for retirement. Don’t miss out on getting that extra doubling period.

3) Invest for Doubling. I see people with money markets in their retirement accounts even though they aren’t going to retire for decades. Nobody knows what the market is going to do tomorrow or this year, but if you are investing for 20 years, recognize that a 2% return will take 36 years to double and a 1% return will take 72 years. What does your money market pay in 2017? Less than 1%? At that rate, even your great-grandchildren won’t live long enough to see that double.

Stop thinking that a lack of volatility equals safety. Investing at a low rate of return basically guarantees that your money isn’t going to grow significantly. In that regards, cash is a riskier investment to your goals than stocks.

Use the rule of 72 to choose diversified investments that are in line with your goal of doubling your money. If you have the time and risk tolerance, you need to be invested in a way that will generate long-term returns of 6%, 8%, or more. The S&P 500 Index returned 12% annually from 1926 to 2010. Although our expected returns are lower today for stocks, they are also lower for cash, bonds, and inflation.

Let’s say that you are 41 and plan to retire at age 65, in 24 years. You have $250,000 today. if you are investing in a high quality bond fund that returns 3%, you will double your money once in 24 years, to $500,000. Invest in a balanced allocation at 6% expected return, and you will double every 12 years, bringing you to $1,000,000. But if you can invest aggressively, and achieve a 9% return, you could doubles your money three times, once every 8 years. That would bring you to $2 million at age 65.

If you understand the Rule of 72, you can focus on long-term results, starting early, and investing for growth. There will be volatility along the way; there will be down years and bear markets. But if you are in the accumulation phase of your life, your focus should be to strive for long-term returns that will double your money. And with retirement often lasting 20 to 30 years, age 65 is not the end, or a finish line, but just the start of a new phase of investing. You still need growth even in retirement!

Replacing Retirement With Work/Life Balance

Posted On June 4, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

72% of workers over the age of 50 plan to keep working in retirement, according to a 2014 Study. It seems to me we need a new word for “retirement”, because it no longer has the same meaning as it did 50 years or even 20 years ago. And then when we talk about Retirement Planning, people think it doesn’t apply to them.

Today’s workers are redefining how we think about work, life, money, and prosperity. The idea of achieving The Good Life varies from person to person, but there is a rising recognition that our sense of satisfaction and well being comes from a work/life balance and not simply having more money.

The traditional Retirement of working full-time to age 65, collecting your pension, and never working again, is disappearing. This change doesn’t just affect people in their sixties. Workers in their thirties, forties, and fifties are saying “Why should I work 50 hours a week during the prime of my life and not enjoy myself?”

And older adults don’t want to be thrown on the trash heap of obsolescence. They still have much to contribute, enjoy the challenge of work, and want to know that they can make a difference in the world.

The revolution is in how we think about work. People are no longer content to sacrifice their life for a company, career, or 401(k) account. Some call this The New Retirement, and while it does replace our old ideas about Retirement, these approaches have nothing to do with age. You could be 65 or 35 and embracing a whole different approach to work and retirement.

Below are 8 ways people are working and living differently today. Which are you? Which do you want to be? Where is your ideal work/life balance?

1) The Encore Career. Leave behind your practical first career and embark on something that fills you with joy. For some it may be working in the non-profit sector, or on a hobby, or passion. For others, it may be volunteer work if they do not need an income.

2) The Frugals. Many Americans will have to work forever to afford a huge house, new cars, and luxury lifestyle. More people today are rejecting consumerism with the belief that working to try to “Keep up with Joneses” is actually preventing you from enjoying your life. The Frugals are self-reliant and happy to find what they need used, on sale, or go without!

3) The Minimalists. They may live in a tiny house, have a very small wardrobe, or just hate clutter. It is surprising to me how many Minimalists used to have a lot of debt (student loans, car payments, credit cards. mortgages), and made a 180-degree turn to believing that less is more. Simplicity is happiness. Like the Frugals, Minimalists recognize that if you cut your annual expenses from $50,000 to $25,000, you only need half the assets or income to support your needs. That changes your reasons for work.

4) The Part-Timer. Also called the Phased Retirement, it’s a move from working full-time to less than full-time. Many part-timers work just enough to cover their bills. While that sounds spartan, if you are not touching your IRA or 401(k) for years, you are still letting those assets grow! Some companies are happy to have their veteran employees continue part-time, bringing their wealth of experience and knowledge to projects. And for many people, working 10-20 hours a week is the perfect amount to be enjoyable and rewarding, without being exhausting or too stressful.

5) The Retirement Entrepreneurs. Leave behind the 9-5 gig and start your own business as a consultant or by providing a good or service where you have some expertise. Be your own boss, have flexible hours, and work as much or as little as you need. Coupled with a pension, Social Security, or planned withdrawals, and you can still generate plenty of income. Or better yet, “retire” at 50 and use the business to bridge the years until you can tap into those real retirement income sources. In the past, many new businesses were very capital intensive, took long hours (50 hours or more per week), and had high rates of failure. Today’s lifestyle entrepreneurs want the 4-Hour Work Week, to not be an hourly slave, but to make money without huge risks or time commitments. And in the internet age, it can be done!

6) Multiple Income Streams. Many of the most financially secure people I know do not just have one job, they have multiple sources of income. Maybe one job is their main gig, and they also do consulting work, are a Reservist, own real estate, or have a weekend business. This gives you options. If one income stream takes off, you can drop the others and work part-time. In the mean time, you can save aggressively to become independent sooner.

7) The Traveler. Many people want to be able to see the world and spend more time with family. Today, with a laptop and a cell phone, more and more jobs are no longer tied to a desk. Smart people are looking for those positions – or creating them – so that they can work from anywhere. What if you could do your work from the Beach in the winter and the mountains in the summer?

8) The Contract Worker. In many fields, there are needs for short-term positions that may last 1-9 months. Some people will take a contract for 6 months, work hard, and then take off the next 6, 12, or 18 months. They can wait until they find another contract opportunity that interests them.

Francis Bacon said that Money makes a good servant but a bad master. Today more workers are asking how work can support their life and dreams, and not the other way around. They don’t want to be working forever and risk missing out on life. So, let’s put together your budget, look at the numbers, and start making plans. Financial Planning today is no longer just Retirement Planning – it’s helping you achieve your own path to independence, however you want to define it.

Resources for Helping an Aging Parent

Posted On May 28, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

Many Americans are helping to care for an aging parent or relative. Even if you’re not today, you may well find yourself in that situation in 5, 10, or 15 years from now. Sometimes that care is directly assisting with daily living, but often that care may be helping someone navigate the challenges of maintaining their independence for as long as possible.

Below are links to resources which can help. Organization and planning are key, and these are areas where a CFP professional like myself can help in ways that go way beyond just managing investments. We’ve organized this into three categories: Planning, Health, and Financial.

PLANNING

The Retirement Problem: What Will You Do With All That Time? From Knowledge@Wharton

Can We Talk? A Financial Guide for Baby Boomers Assisting Their Elderly Parents (book)

10 Tips for Holding a Family Meeting from Psychology Today

HEALTH

Getting Started With Medicare from Medicare.gov

NCQA Health Insurance Plan Ratings for comparing Medicaid Supplement Policies available in your state.

Long Term Care: Costs, How to Pay, Staying in Your Home, from the US Department of Health and Human Services

10 Early Signs and Symptoms of Alzheimer’s from the Alzheimer’s Association

Advance Care Planning from the National Institute on Aging

FINANCIAL

Social Security Retirement Planner

10 Things You Can Do to Avoid Fraud from the FTC

Getting Your Affairs in Order from the National Institute on Aging

Estate Planning for Second Marriages from the American Bar Association

Working with a financial planner is a way to bring a third party to help facilitate important discussions. There are so many vital questions to consider: Where would you like to live as you age? What health issues may impact this decision? Do you have a plan for care or extra help? Who will manage your assets and pay your bills? How will you communicate decisions and wishes to your family?

Planning for health issues, financial objectives, and family communication means parent’s wishes can be honored if or when a crisis occurs. Aging can be very stressful on family members, not to mention potentially a significant financial obligation. I think a lot of us would rather not think about our parents or relatives as aging, but we are doing everyone a disservice if we don’t talk about this and plan ahead.

Extracted from: Planning Concerns for the Aging Population, Susan Korngay, Journal of Financial Planning, April 2017, pp. 27-30.

What is the Best Way to Take Retirement Withdrawals?

Posted On May 21, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning / 1 Comment

If you are looking to retire in the near future or are recently retired, you may be interested to learn that how you take withdrawals from your portfolio may have a dramatic impact on the success of your retirement plan. Here’s a summary of a recent article in the Journal of Financial Planning.

Researchers considered a 60/40 portfolio with 4% withdrawals for retirement to examine different withdrawal strategies. They used historical equity returns since 1970, an assumed 2% rate of return for bonds, 1% in fees, 3% annual inflation increases, and a 30 year retirement horizon. They tested four different ways of withdrawing funds from a $1 million portfolio and calculated the percentage of success of each approach as well as the median portfolio value that was left over at the end of 30 years.

Strategy	Success Percent	Median Ending Value
Spend Stocks First	72%	$912,593
Annual Rebalancing	80%	$730,302
Simple Guardrail	94%	$1,390,418
Spend Bonds First	97%	$4,222,468

Most advisors suggest annual rebalancing. This approach keeps your portfolio pegged at a 60/40 allocation even as 4% annual withdrawals are taken. Note the success rate here was 80%, which means that in 1 out of 5 trials, the strategy failed to provide 30 years of inflation adjusted withdrawals. Annual Rebalancing also had the lowest Median Ending Value, which is important for a cushion if you or your spouse should live longer than 30 years, or if you would like to leave assets to heirs or charity.

The best result was obtained by Spending Bonds First. That means that a retiree would not touch their stocks at all while they spent down their entire 40% in bonds. At 4% withdrawals, it would take about 11 years until you had depleted your bonds and for the following 19 years, you would have a 100% equity portfolio. This type of strategy is sometimes called a “Rising Equity Glidepath” by Michael Kitces and other researchers.

Spending Bonds First might provide the best return because it begins with more than a decade of stock growth, with no withdrawals, which in most periods would have been a significant rate of return. However, this approach is controversial, because most practitioners (and regulators) believe that the typical retiree in their seventies or eighties does not have the risk tolerance to be 100% in equities. But, if you did have the stomach for this type of approach, there is evidence from this article and several others that validates the potential benefits of spending bonds first.

The Simple Guardrail may be easier for most retirees to tolerate and for advisors to adopt because it does not require moving to a 100% equity portfolio. The guardrail is simply this: no withdrawals are taken from stocks following a down year to give them a chance to rebound. The portfolio is also rebalanced back to 60/40 annually. While it doesn’t have the dramatically higher median ending value of Spending Bonds First, the guardrail still offers a noticeable improvement in success versus standard rebalancing, from 80% to 94%.

While Spending Bonds First may offer the best hypothetical results, it may be too aggressive for most retirees. The Simple Guardrail improves results on a more basic premise of giving equities an opportunity to rebound after a down year. In our next down year in equities, we will be talking with clients who are taking distributions about this idea.

The study is interesting, but it assumes one account and does not consider the real world complexities of taxes, multiple types of accounts, or Required Minimum Distributions. We look very thoroughly at each client’s withdrawal strategy to fulfill their income needs in the most efficient manner possible.

Source: Determinants of Retirement Portfolio Sustainability and Their Relative Impacts, DeJong and Robinson, Journal of Financial Planning, April 2017, pp. 54-62.

The Future of Social Security

Posted On May 14, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

It seems like the Internet Age has helped create a culture of instant gratification, short attention spans, and sound bites. There is less interest and patience for detailed discussions, long-form journalism, or acknowledging the complex trade-offs of decisions. We have moved into a post-factual world where the truth gets less airplay than spin. Politically, everything is black and white, right or wrong.

Frequently, I see people posting political comments or memes on Facebook about Social Security. These posts are meant to make the other party look like villains, but are often factually incorrect, incomplete, and short-sighted. I avoid getting sucked into these unproductive conversations, but many people could use a better understanding of the numbers and reality of our situation.

We should be having a real, adult conversation about Social Security. It is the future of not only retirement planning, but of our country’s prosperity and debt. I hope this primer below will make the case for why we need to reform Social Security and the challenges we face.

First, it is a myth that Social Security saves your contributions. Social Security is and always has been an entitlement program, like Welfare or Food Stamps. Current taxes are used to pay current benefits. The Social Security taxes you paid in 2015 were paid out to Social Security Beneficiaries in 2015. None of that money was saved for you.

Because of post-WWII demographics, there was for a very long time, a Social Security surplus. They took in more payroll taxes than they paid out in benefits. That annual surplus was invested in the Social Security Trust Fund, to pay a portion of future benefits. It was never the intent or expectation that the Trust Fund would cover all future expenses.

For decades, the Trust Fund saved this surplus. However, in the 1970’s politicians looked for a way to close the budget gap and decided to spend the Trust Fund and replace those assets with IOU’s in the form of Treasury Bonds.

Several years ago, the annual Social Security surplus disappeared and became negative. Today, there is a short-fall where current OASDI taxes are insufficient to cover benefits paid. The short-fall is presently being covered by the Trust Fund through cashing in their Treasury Bonds. This is where all the Facebookers get things wrong – Social Security does have an impact on the deficit. Benefits which are paid from the Trust Fund are now part of our national debt, as new bonds are issued to replace those cashed by the Trust Fund.

Once the Trust Fund reaches zero, the Social Security Administration will be able to cover only 77% of their promised benefits. Every year, the Social Security trustees project when this will occur, presently thought to be 2035. This is the date that Social Security will be insolvent, or “bankrupt”.

People say, But I paid into Social Security, I am OWED those benefits! Unfortunately, the Social Security System is broken and the numbers are simply not going to work. When the program began, there were 16 workers for every retiree. Today, there are 3 workers for every retiree, and that ratio is expected to continue to fall to 2 to 1, before the mid-century.

There are a couple of reasons why this has happened. Demographically, the Baby Boomer generation is enormous and there are thousands of people who are starting benefits every day for the next two decades. When Social Security began, the life expectancy at birth was only 65. Today, if you are already 65, the typical beneficiary will probably live another two decades. The retirement period being funded by Social Security has swelled from a couple of years to 20, 30, or more years because of our increasing longevity.

What originally worked in 1935 isn’t possible with today’s population. Every year, the Trustees tell Congress exactly how to fix Social Security. There are only two options: increase taxes or decrease benefits. There is no magic unicorn of preserving promised benefits and not raising taxes. That’s not how Math works. So when a politician promises that they will not lower benefits, they are either in favor of higher taxes or they are just blowing smoke. If they ignore the issue for long enough, it will become their successor’s problem.

Seniors vote and turn out better than any other age group. Politicians and candidates know this. The easiest attack in politics is to say that your opponent wants to “take away your Social Security check”. Up to this point, that war cry has silenced every politician who has proposed Social Security reform, including the bi-partisan Simpson-Bowles commission which came up with comprehensive solutions.

The present approach from politicians is the worst for America: kick the can down the road and let someone else fix it. Parties are too concerned with maintaining their seats over the next two years (or taking them back), to be willing to think longer-term than the next election cycle. The longer we wait to address the short-fall, the more drastic steps will be required.

Simpson-Bowles proposed increasing the Full Retirement Age from 67 to 69 over several decades. This would have had zero impact on current retirees and gave 20 years notice to future retirees. But even this small change brought the full opposition of the AARP, and ultimately none of the commission’s proposals were ever enacted.

Presently, workers and employers pay OASDI taxes on the first $127,200 of earnings (2017). Raising the income ceiling on Social Security taxes will not be sufficient to fully fund benefits, even if we were to eliminate it entirely. There will probably need to be some reduction in benefits if we are to avoid increasing taxes significantly on all workers. But that doesn’t mean that everyone will see their benefits plummet. Ways to reduce benefits include:

Increasing the Full Retirement Age gradually from 67 to 70
Changing how SS calculates cost of living adjustments (COLAs)
Means-testing benefits
Creating a cap on benefits, say to the first $75,000 in income
Adjusting mortality calculations for today’s increased longevity
Lowering the payout formulas and tying them to future increases in longevity

By the way, increasing immigration and the population of younger people would help retirement programs like Social Security. Look at a country like Japan, which has an even higher percentage of retirees than the US, to see the challenges of financially supporting a large segment of the population. The money that is spent on retirement programs, or to finance the debt of those programs, crowds out other government spending which might be better for economic development.

There is no quick fix or easy solution to save Social Security, but it’s time we expect more from our politicians. Fixing Social Security and Medicare will not be easy or painless, but we need to be thinking now about how we can preserve these programs and ensure their viability for younger workers and future generations. Become an informed voter and be on the lookout for when politicians are using issues as ammunition to lob at their opponents, rather than looking at solutions for America. Likes is the one of the most important reactions that a TikTok creator can get for their videos. You feel much more appreciated, when you notice a dramatic growth of the number of free TikTok likes you get. Obviously, TikTokers of all levels are looking for the opportunities to increase the number of likes they get. In this article we will share this information! Here are some tips: Catchy description; Follow the trends; Post videos daily and Paid Promotion. Paid promotion is one of the most effective ways to get more TikTok likes. However, choose the trusted providers wisely, such as tiktoknito.com.

My Used Car Adventure, Part II

Posted On May 6, 2017 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

Some people in Dallas pour more money into new cars than they do their investments and financial future. They get a new luxury car every three years, but tell me they cannot afford to put $5,000 into an IRA. I think their priorities are backwards! To sink our hard-earned cash into a depreciating asset will keep us poor and stressed, rather than allowing us to enjoy the peace of mind of financial independence.

Last night, a friend was asking me whether he should fix up his 10-year old Toyota (facing a $400 expense) or buy a new car. Previously, I have written in this blog about my real costs of buying a high-mile used car. Three years ago, I purchased a 2002 Toyota 4Runner with 179,000 miles for $4,500. Seems like an invitation to disaster and disappointment, right? Well, here’s how things turned out…

I sold the 4Runner last fall, after two years of ownership, with 197,000 miles on the odometer. During my ownership, it never broke down and always started on the first try. It was completely dependable and there were no unexpected repairs, only routine and preventative maintenance. I sold it for $4,150, my full asking price on a (free) Craigslist ad, to the first person who looked at it.

That means that over the two years, my total depreciation was $350. I cleaned the car meticulously before selling, and you truly can polish money into a car. If it looks great and you can show detailed maintenance history, you will do well.

While my depreciation was very low, I had maintenance expenses over the two years. The biggest expense was a set of four new tires, $744.84. (Those are some big tires, 265’s!) The rest of the work I performed myself and included: four oil changes, replacing the rusty radiator, hoses, and thermostat, changing the differential oil, steering fluid, and brake fluid, wipers, air filter, PCV valve, two indicator bulbs, and one headlamp. Sounds like a lot, but most of those are 5-minute jobs. My total spend on maintenance over two years was $574.33.

The average car on the road is over 11 years old, but many of us still hate older cars. It is definitely a headache when a car breaks down and leaves you stranded, but that can happen even in a new car. From a behavioral perspective, the inconsistency in our thinking is that we have such a strong aversion to paying for unexpected repairs but are so willing to accept the known and inevitable loss of depreciation.

Why is spending $1,000 on a repair so much more painful than losing $4,000 in depreciation over a year? Depreciation is the bigger expense. Almost every new car will lose 50% of its value in 5 years. By 10 years, you will have an 80 to 90 percent loss.

The reality is that today’s cars are more dependable than ever. When you trade in your 8 year old car with 100,000 miles, chances are that someone else is going to drive that vehicle for another 8 years and another 100,000 miles. But you will have paid 80% of the depreciation!

Now, I realize that a sample of one (my experience with one 4Runner) does not prove a statistical case that all used car purchases are going to be effortless and inexpensive. It is entirely possible that I was just lucky. The car could have blown up the day after I bought it and I’d have lost my $4,500 investment. Fortunately, it did not, but that is a gamble I can afford to take.

My advice remains that the least costly course of action is to keep your current vehicle for as long as possible so that you can spend years on the flat end of the depreciation curve. Maintenance costs should not be unexpected, even though the timing and amounts are always unknown. The key is to remember that your repair costs are still likely to be a fraction of the depreciation costs of a new car. When you have to get a new vehicle, consider a used car and let someone else pay the steep depreciation of the first 3, 5, or even 10 years of the car’s life.

I know rationally that keeping cars for 10+ years is the best option, but truthfully, I get bored with cars. If you are fine with the same vehicle for a decade, that is fantastic. You are undoubtedly being very smart to keep one vehicle for 10 years. But I’d rather get a different vehicle every couple of years, a habit which could get very, very expensive. Luckily for me, I don’t really care if a car is new or used, just that it is new to me.

When I sold the 4Runner, everything still worked and I could have kept on driving it. But I just wanted something different. I purchased a 2006 Mercedes E350 sedan with 123,000 miles for $5,300. Now I am not only flouting the conventional wisdom of avoiding older, high mileage cars, I am doubling down by going from a dependable Toyota with cheap parts, to a luxury car with very expensive German parts.

I’ve had the Merc for a few months and have already put on 5,000 miles, with zero issues. The engine seems quite strong and everything on the car feels very well made. Fingers crossed that it holds up! We’ve had a number of BMWs in the past and I always wanted a Mercedes. I’ve gotten a number of compliments on it, but I think people would be very surprised if they knew how little I paid for it! I expect that, unlike the Toyota, I will not do all the work myself and that my maintenance costs will be higher. I will continue to keep a spreadsheet and report back to you, my readers, and let you know how it turns out – good, bad, or ugly!

Social Security Planning: Marriage, Divorce, and Survivors

Posted On April 29, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

The Social Security Statement you receive is often incomplete if you are married, were married, or are a widow or widower. Your statement shows your own earnings history and a projection of your individual benefits, but never shows your eligible benefits as a spouse, ex-spouse, or survivor.

In general, when someone is eligible for more than one type of Social Security benefit, they will receive the larger benefit, not both. But how are you supposed to know if the spousal benefit is the larger option? Social Security is helpful with applying for benefits, but they don’t exactly go out of their way to let you know in advance about what benefits you might receive or when you should file for these benefits.

The rules for claiming spousal benefits, divorced spouse benefits, and survivor benefits are poorly understood by the public. And unfortunately, many financial advisors don’t understand these rules either, even though Social Security is the cornerstone of retirement planning for most Americans. Today we are giving you the basics of what you need to know. With this information, you may want to delay or accelerate benefits. The timing of when you take Social Security is a big decision, one which has a major impact on the total lifetime benefits you will receive.

1) Spousal Benefits. If you are married, you are eligible for a benefit based on your spouse’s earnings, once your spouse has filed to receive those benefits. If you are at Full Retirement Age (FRA) of 66 or 67, your spousal benefit is equal to 50% of your spouse’s Primary Insurance Amount (PIA). If you start benefits before your FRA, the benefit is reduced. You could start as early as age 62, which would provide a benefit of 32.5% of your spouse’s PIA. Calculate your benefit reduction here.

If your own benefit is already more than 50% of your spouse’s benefit, you would not receive an additional the spousal benefit. When you file for Social Security benefits, the administration will automatically calculate your eligibility for a spousal benefit and pay you whichever amount is higher. A quick check is to compare both spouse’s Social Security statements; if one of your benefits is more than double the other person’s benefit, you are a potential candidate for spousal benefits.

If your spouse is receiving benefits and you have a qualifying child under age 16 or who receives Social Security disability benefits, your spousal benefit is not reduced from the 50% level regardless of age.

Please note that spousal benefits are based on PIA and do not receive increases for Deferred Retirement Credits (DRCs), which occur after FRA until age 70. While the higher-earning spouse will receive DRCs for delaying his or her benefits past FRA, the spousal benefit does not increase. Furthermore, the spousal benefit does not increase after the spouse’s FRA; it is never more than one-half of the PIA. If you are going to receive a spousal benefit, do not wait past your age 66, doing so will not increase your benefit!

2) Divorced Spouse Benefits. If you were married for at least 10 years, you are eligible for a spousal benefit based on your ex-spouse’s earnings. You are eligible for this benefit if you are age 62 or older, unmarried, and your own benefit is less than the spousal benefit. A lot of divorced women, who may have spent years out of the workforce raising a family, are unaware of this benefit.

Unlike regular spousal benefits, your ex-spouse does not have to start receiving Social Security benefits for you to be eligible for a benefit as an ex-spouse, as long as you have been divorced for at least two years.The ex-spouse benefit has no impact on the former spouse or on their subsequent spouses. See Social Security: If You Are Divorced.

If you remarry, you are no longer eligible for a benefit from your first marriage, unless your second marriage also ends by divorce, death, or annulment.

A couple of hypothetical scenarios, below. Please note that the gender in these examples is irrelevant. It could be reversed. The same rules also apply for same-sex marriages now.

a) A man is married four times. The first marriage lasted 11 years, the second lasted 10 years, the third lasted 8 years, and his current (fourth) marriage started three years ago. The current spouse is eligible for a spousal benefit. The first two spouses are eligible for an ex-spouse benefit, but the third is not because that marriage lasted less than 10 years. A person can have multiple ex-spouses, and all marriages which lasted 10+ years qualify for an ex-spouse benefit!

b) A woman was married for 27 years to a high-wage earner, and they divorced years ago. She did not work outside of the home and does not have an earnings record to qualify for her own benefit. She is 66 and unmarried, so she would qualify for a benefit based on her ex-spouse’s record.

However, if she were to marry her current partner, she would no longer be eligible for her ex-spousal benefits. If the new spouse was not receiving benefits, she could not claim spousal benefits until he or she filed for benefits. Additionally, if the new partner is not a high wage earner, her “old” benefit based on the ex-spouse may be higher! Some retirees today are actually not remarrying because of the complexity it adds to their retirement and estate planning. And in some cases, there is an actual reduction in benefits by remarrying.

3) Survivor Benefits. If a spouse has already started their Social Security benefits and then passes away, the surviving spouse may continue to receive that amount or their own, whichever is higher. The survivor’s benefit can never be more than what they would receive if the spouse was still alive.

If the deceased spouse had not yet started benefits, the widow or widower can start survivor benefits as early as age 60, but this amount is reduced based on their age (See Chart). Widows or widowers who remarry after they reach age 60 do not have their survivorship eligibility withdrawn or reduced.

One way to look at the survivorship benefit: which ever spouse has the higher earnings history, that benefit will apply for both spouse’s lifetimes. The higher benefit is essentially a joint benefit. For this reason, it may make sense for the higher earner to delay until age 70 to maximize their benefit. If their spouse is younger, is in terrific health, and has a family history of substantial longevity, it may be profitable to think of the benefit in terms of joint lifetimes.

Additionally, Social Security offers a one-time $255 death benefit and also has benefits for survivors who are disabled or have children under age 16 or who are disabled.

The challenge for planning is that none of these three benefits – spousal, ex-spouse, or survivor – are indicated on your Social Security statement. So it is very easy to make a mistake and not apply for a benefit. I like for my clients to send me a copy of their Social Security statements, and I have to say that more than half of the clients I have met don’t understand how these benefits work, even if they are aware that they are eligible.

Social Security Administration: it’s time to fix your statements. You can do better.

Does Rebalancing Improve Returns?

Posted On April 22, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /

Like flossing, we’re told that we need to rebalance because it’s good for us. But does rebalancing improve returns? Like many financial questions, the unsatisfying answer is “it depends”. Today we are going to take a deeper dive into rebalancing, when it works, when it doesn’t, and why it is still a good idea.

You might choose a 60/40 allocation (60% stocks, 40% bonds) because that portfolio has certain risk and return characteristics which fit your needs. Over time, as the market moves, your portfolio is likely to diverge from its original allocation; rebalancing is placing the trades to restore your original 60/40 allocation.

If we assume that stocks grow at 8% and bonds at 3%, what would happen if you did not rebalance? With a higher return, the stocks would become a bigger portion of the portfolio. In fact, after 30 years, your allocation would have shifted from 60/40 to 86/14. It should be noted right at the outset that under the straight-line assumption of stocks outperforming bonds, your performance would be higher by never rebalancing. Selling stocks to maintain a 40% weighting in bonds would slow your growth.

However, if you wanted an aggressive portfolio, you wouldn’t have started with a 60/40 allocation. We should recognize from the outset that the primary goal of rebalancing is not to enhance returns but to maintain a target allocation.

But since the stock market does not move in a straight line and give us exactly 8% returns every year, rebalancing may have a benefit in taking advantage of temporary price disruptions. If the the market tumbles, rebalancing will buy stocks at those low prices. And when the market runs up and is high, rebalancing can sell overvalued stocks and add to the safety of bonds.

What is key to rebalancing, but poorly understood by investors, is that the frequency of rebalancing is a crucial consideration. There’s not just one way to rebalance. Let’s consider a couple of scenarios.

1) In a trending market, where stocks move in one direction for a long time, the more frequently you rebalance, the worse return you create.

For example, let’s imagine a Bull Market where stocks grow by 10% each quarter, and bonds only gain 0.75% per quarter. If you started with $100,000 in a 60/40 portfolio, and did nothing, you would have $129,059 at the end of one year. But if you rebalanced each quarter, your return would be $127,682. Here, rebalancing quarterly would have reduced your returns by $1,376.

But you thought rebalancing was supposed to enhance returns? When a market trend continues for a long period, you would be better off sticking with the trend, rather than rebalancing against the trend.

2) Interestingly, rebalancing also makes returns worse in prolonged bear markets, too.

Same situation: 60/40 portfolio with $100,000. Now let’s imagine a one-year Bear Market where stocks fall by 10% per quarter and bonds gain 0.75% per quarter. Without rebalancing, your portfolio would fall from $100,000 to $80.579. If you rebalanced each quarter, you would have made things even worse, with a drop from $100,000 to $79,076. Rebalancing would have extended your losses by $1,503, or 1.87%.

By rebalancing in a prolonged Bear Market, you were adding to stocks, even as they continued to lose value.

3) While rebalancing hurts returns in directional markets, it can improve returns in markets which are fluctuating. In this third example (still $100,000 in a 60/40 allocation), we assume that bonds return 0.75% per quarter, but that stocks go down 10%, then up 10%, then down 10% and then up 10%.

After one year, with no rebalancing, you’d have $100,019. If you rebalanced quarterly, you would have $100,482. That’s a nice difference in a basically flat market. While rebalancing hurts returns if there is a steady trend, it can improve returns when markets vacillate between positive and negative periods.

So what do we do? Not rebalancing (ever) is not a good choice because you will diverge from your risk preferences. We try to strike a balance in our rebalance frequency by doing it only once a year, and only when a position deviates by more than 5% from target levels.

By rebalancing annually, we allow for longer trends, since Bull or Bear markets can certainly last for at least 12 months. So if you see other firms that brag about rebalancing monthly or quarterly, please understand that more frequent rebalancing is not necessarily better or any guarantee that it will increase returns. As we have shown, there are reasons why more frequent rebalancing could actually make things worse in a Bear Market, which is right when you would want the most defense.

Additionally, we need to consider the costs of rebalancing. Besides transaction costs, in a taxable account, short-term gains are taxed as ordinary income. We hold our positions for at least 12 months before rebalancing to get preferential long-term rates. More frequent rebalancing could be creating an unnecessary tax bill.

With extremely low yields today, it may make sense for some young, aggressive investors to consider being 100% in stocks. Then rather than focusing on rebalancing, you can take advantage of market drops by dollar cost averaging with new purchases. However, even in a 100% stock portfolio, you still have target weights in categories such as Large Cap, Small Cap, International, Emerging Markets, Real Estate, etc. And often it still makes sense to rebalance when one of those categories has a large move up or down.

Once you have accumulated some wealth, whether that is $300,000 or $3 million, you really have to think about how you would feel if the market fell by 50%. From a behavioral perspective, having a target allocation and a rebalancing process means that you have created a framework, a discipline, for how you will respond to the inevitable Bull and Bear market cycles. And the process of rebalancing – to buy low and sell high – is definitely preferable to our innate response, which is often to buy when there is euphoria and to throw in the towel when the market plunges.

Hopefully, you now understand that rebalancing is not a guarantee to enhance returns. In fluctuating markets, it can help you buy low and sell high. But in long-trending markets, the more frequently you rebalance, the more you will reduce your returns, whether it is a Bull Market or a Bear Market. So we can’t blindly just say that rebalancing is good, we have to use it intelligently.

Declutter Your Space, Declutter Your Mind

Posted On April 15, 2017 By Scott Stratton, CFP(R), CFA In Behavioral Finance / 1 Comment

There are remarkable benefits to tackling clutter, whether that clutter is physical, mental, or financial. Clutter creates added stress and tends to freeze people from taking action and doing what is important and in their best interest. Some of the key benefits of working with a financial planner include getting organized, consolidating accounts, and having a coherent strategy for your financial life. It’s not rocket science, yet somehow, it can be so difficult for people to do what they know they should do. We aim for simplicity in everything we do.

We all can benefit from decluttering. But where to start? It can be a daunting task. It’s so daunting in fact, that most people don’t even want to bother. But clutter can represent fear, self-doubt, fatigue, and guilt. If you’re a perfectionist, clutter is a reminder of your failures and lack of control.

Do we need all this stuff? Many of us have hoarding tendencies, a love of material items, and a feeling that we “need” more things to be happy. We were raised this way. Our grandparents lived through the Great Depression, and they learned to never throw anything away in case they needed it later. That scarcity mentality is fear-based and was passed down from generation to generation. We have to unlearn that more is always better.

When you are able to reduce clutter, it feels wonderful. How can you get started?

1) Start small. Just fill one box or one trash bag with stuff you can get rid of. Maybe this will be easy for you. But for many of us it’s tough to decide that you don’t need something. Ask your self these questions:

– When was the last time I needed this, used this item, or wore this clothing? Was it this month, or was it years ago?
– What would happen if I did not have this item? Would I miss it? Would I need it? If it’s rarely used, could I borrow one from a friend?
– Would I buy this again today?

2) Give with a purpose. Maybe there is someone else who would benefit from your unneeded item, who would appreciate it, and give it a new life. Why keep it in your closet, if it could be helping someone else?

There are many local charities that will accept your used items. Since I foster for Operation Kindness, let me share this: You can donate your unwanted clothes, shoes, books, toys, and small appliances to Operation Kindness. They will even pick up your items at your house! Just schedule a pick-up at www.DonateForKindness.org. And be sure to keep a list of your items for tax time, so you can take a deduction for a non-cash charitable donation.

Or donate to another charity of your choice. Or sell your stuff on Craigslist, or on eBay, or at your neighborhood yard sale, and make a few bucks. Some people have made thousands selling extra things in their house.

3) Set a timer for 30 minutes. When confronted with a large and unpleasant task, it’s easy to feel overwhelmed. Who knows how long it will take? This causes us to procrastinate getting started.

Here’s what I do: just set a timer for 30 minutes and GO. You don’t have to have a plan, just attack whatever seems to be the area of greatest need and keep moving for 30 minutes. I often find that I actually clean the room or rooms in less than 30 minutes. When the bell rings, I stop and move on with my day.

You can do anything for 30 minutes, and psychologically, it is easier to say “I am going to clean for 30 minutes” than to leave it open-ended, “I am going to clean this clutter.” Even when I don’t finish in 30 minutes, I have often made a significant dent – 50%, 75%, even 90% complete. Don’t let Great be the enemy of Good. If we can just spend 30 minutes, we may find that we achieved the result we needed, and often that is good enough.

The next day, you can always go for another 30 minutes. You don’t have to declutter all at once. We only have so much time, attention span, and energy. Give yourself permission to take small bites. It’s okay – you are moving in the right direction.

4) Stop digging. As the saying goes, if you are in a hole, the first step is to stop digging. Step back a figure out why you are accumulating so much stuff. Is shopping a hobby? Do you buy stuff when you are bored, or stressed, or tired? Do you buy things you regret, that you don’t need?

Become more aware of your feelings about things. Acknowledge those feelings, those triggers, and find an alternative action. Take up a new hobby, go to the gym, find something else to fill those feelings other than shopping.

5) Outsource. Hire a personal assistant or a housekeeper or someone to do the work you hate doing. No need to feel guilty, there are only so many hours in the week. And if you hate doing some type of work, why do it? You can spend your time more productively elsewhere.

Decluttering creates a feeling of empowerment. I am in charge. I am organized. I am ready to make decisions and remove any obstacles in my way. Getting rid of clutter is like taking a weight off your shoulders. You aren’t even aware of how much it is a burden until you get rid of it.

There are benefits to your house, to your stress levels, and even to your relationship with your spouse and children. Decluttering is not just about stuff, it’s about your mindset.

If you can tackle decluttering your house, you can apply many of the same steps to your financial clutter:
1) Start small, just do one thing.
2) Set aside 30 minutes to organize your finances tonight. Don’t keep putting it off!
3) Change behavior that isn’t in line with your goals.
4) Outsource to a professional, to a Certified Financial Planner professional like me.