Stop Trying to Pick the Best Fund

Posted On July 30, 2017 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

So much attention is paid to picking “the right fund” or “the best fund” by investors, but in my experience, this question has little bearing on whether or not an investor is successful in achieving their goals. In fact, I don’t even think fund selection is in the top 5 factors for financial success. There are so many more important things to consider first!

1) How much you save. If you contribute $500 a month to your company 401(k) and your colleague contributes $1,000 a month, I would bet that they will have twice as much money as you after 10 years, regardless of your fund selection process. Hot funds turn cold, so most investors just average out over time. Figuring out how to save and invest more each month will get you to the goal line faster than spending your hours trying to find a better fund.

2) Sticking with the plan. Your behavior can have a greater impact than your fund selection. Many investors sold in 2009, incurring heavy losses and then missing out on the rebound in the second half of the year. Trying to time the market is so difficult that investors are better served by staying the course rather than trying to get in and out of the market.

I know that people think they are being rational about their investments, but what usually happens is that we form an opinion emotionally and then find evidence which corroborates our point of view. This is called confirmation bias. Better to remain humble and recognize that we don’t have the ability to determine what the future holds. Buy and Hold works, but only when we don’t screw it up!

3) Starting with an Asset Allocation. People may spend a vast amount of time picking a US large cap fund, but then miss out on the benefits of diversification. Other categories may outperform US large cap stocks. I recently opened an account for a new client, whose previous advisor had him invested in 180 positions – all of which were US large cap and investment grade bonds. No small cap, no international equities, no emerging markets, no floating rate bonds, no municipal bonds, etc.

The most important determinant of your portfolio return is the overall asset allocation, not which fund you chose! Our process begins with you, your goals, timeline, and risk tolerance to first determine a financial plan, including an appropriate asset allocation. The asset allocation is really the portfolio and then the last step is to just plug in funds to each category. Funds in each category perform similarly. If it’s a horrible year, like 2008, in US large cap, that fact is more significant than which large cap fund you chose.

A famous, and controversial, 1995 Study found that 95% of the variability of returns between pension funds was explained by their asset allocation.

4) Not chasing performance. The problem with trying to pick the best fund is that you are always looking through today’s rearview mirror. There will always be one fund that has the best 5, 10, or 15 year returns. There are always funds which are doing better than your fund this year. But if you buy that new fund, you may quickly become disappointed when the subsequent returns fail to match its “perfect” track record.

So then you switch to another new fund. And like a financial Don Juan, the performance chaser is quick to fall in love, but just as quick to move on, creating a tragic, endless cycle of hope and failure. If you are investing for the next 30 years, changing funds 30 times does not improve your chances of success! By the way, if you exclude sector funds, single country funds, and other niche categories from your portfolio, you will be well on your way to avoiding this pitfall.

5) Setting Goals. If you have a goal or large project at work, you probably create a plan which breaks that goals down into a series of smaller steps and objectives. Unfortunately, very few people apply the same kind of discipline, planning, and deliberate process to their finances as they do to their career and other goals. When you begin with the goal in mind, your next steps – how much to save, how to invest, what to do – become clear.

Bonus, 6) Doing what works. Why reinvent the wheel or take on unnecessary risk? We know that 80% or more of actively managed funds lag their benchmarks over five years and longer. With 4 to 1 odds against you choosing a fund that outperforms, why take that risk at all? Even if you get it right once, do you realize how small the possibility is that your choice will outperform for another five years? Better to stick with Index Funds and ETFs. Besides the better chance of performing well, you will also start with very low expenses and excellent tax efficiency. When you use Index funds, it frees up your mind, time, and energy to focus instead on numbers 1-5.

Choose your funds carefully and deliberately because you should plan to live with those funds for many, many years. There are genuinely good reasons for changing investments sometimes and we won’t hesitate to make those trades when necessary. But on the whole, investors trade way too much for their own good. The grass is not always greener in another fund!

Reducing Sequence of Returns Risk

Posted On July 23, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

The possibility of outliving your money can depend not only on the average return of the stock market, but on the order of those returns. It doesn’t matter if the long-term return is 8%, if your first three years of retirement have a 50% drop like we had going into March of 2009, your original income strategy probably isn’t going to work. Taking an annual withdrawal of $40,000 is feasible on a $1 million portfolio, but not if your principal quickly plummets to $500,000.

We evaluate these scenarios in our financial planning software and can estimate how long your money may last, using Monte Carlo analysis that calculates the probability of success. For most people retiring in their 60’s, we plan for a 30 year horizon, or maybe a little longer. And while this analysis can give us a rough idea of how sound a retirement plan is, no one knows how the market will actually perform in the next 30 years.

What we do know from this process is that the vast majority of the “failures” occur when there are large drops in the market in the early years of retirement. When these losses occur later on, the portfolio has typically grown significantly and the losses are more manageable. This problem of early losses is called Sequence of Returns Risk, and often identifies a critical decade around the retirement date, where losses may have the biggest impact on your ability to fund your retirement.

There are ways to mitigate or even eliminate Sequence of Returns Risk, although, ultimately I think most people will want to embrace some of this risk when they consider the following alternatives. Sequence of Returns risk is unique to investing in Stocks; if you are funding your retirement through a Pension, Social Security, Annuity, or even Bonds, you have none of this risk.

1) Annuitize your principal. By purchasing an Immediate Annuity, you are receiving an income stream that is guaranteed for life. However, you are generally giving up access to your principal, forgoing any remainder for your heirs, and most annuities do not increase payouts for inflation. While there is some possibility that the 4% rule could fail, it is important to remember that the rule applies inflation adjustments to withdrawals, which double your annual withdrawals over the 30 year period. And even with these annual increases, in 90% of past 30-year periods, a retiree would have finished with more money than they started. The potential for further growth and even increased income is what you give up with an annuity.

2) Flexible withdrawals. The practical way to address Sequence of Returns Risk is to recognize upfront that you may need to adjust your withdrawals if the market drops in the first decade. You aren’t going to just increase your spending every year until the portfolio goes to zero, but that’s the assumption of Monte Carlo Analysis. We can do this many ways:

Not automatically increase spending for inflation each year.
Use a fixed percentage withdrawal (say 4%) so that spending adjusts on market returns (instead of a fixed dollar withdrawal).
Reduce withdrawals when the withdrawal rate exceeds a pre-determined ceiling.

It is easier to have flexibility if withdrawals are used for discretionary expenses like travel or entertainment and your primary living expenses are covered by guaranteed sources of income like Social Security.

3) Asset Allocation. If we enter retirement with a conservative allocation, with a higher percentage in bonds, we could spend down bonds first until we reach our target long-term allocation. Although this might hamper growth in the early years, it could significantly reduce the possibility of failure if the first years have poor performance. This is called a Rising Equity Glidepath.

Other allocation methods include not withdrawing from stocks following a down year or keeping 1-3 years of cash available and then replenishing cash during “up” years.

4) Don’t touch your principal. This is old way of conservative investing. You invest in a Balanced Portfolio, maybe 50% stocks and 50% bonds, and only withdraw your interest and dividends, never selling shares of stocks or bonds. In the old days, we could get 5% tax-free munis, and 3% in stock dividends and end up with 4% income, plus rising equity prices. Since you never sell your stocks, there is no sequence of returns risk. This strategy is a little tougher to implement today with such low bond yields.

Investing for income can create added risks, especially if you are reaching for yield into lower quality stocks and bonds. That’s why most professionals and academics favor a total return process over a high income approach.

5) Laddered TIPS. Buy TIPS that mature each year for the next 30 years. Each year, you will get interest from the bonds (fairly small) and your principal from the bonds that mature that year. Since TIPS adjust for inflation, your income and principal will rise with CPI. It is an elegant and secure solution, with a 3 1/3% withdrawal rate that adjusts for inflation.

The only problem is that if you live past 30 years, you will no money left for year 31 and beyond! So I would never recommend that someone put all their money into this strategy. But if you could live by putting 80% of your money into TIPS and put the other 20% into stocks that you wouldn’t touch for 30 years, that may be feasible.

Except you’d still likely have more income and more terminal wealth by investing in a Balanced Allocation and applying the 4% rule. However, that is a perhaps 90% likelihood of success, whereas TIPS being guaranteed by the US Government, TIPS have a 100% chance of success. (Note that 30 year TIPS have not been issued in all years, so there are gaps in years that available TIPS mature.)

If the market fell 30% next year, would your retirement be okay? How would you respond? What can you do today about that possibility? If you worry about these types of questions, we can help address your concerns about risk, market volatility, and Sequence of Returns.

What we want to do for each investor is to thoroughly consider your situation and look at your risk tolerance, risk capacity, other sources of retirement income, and find the right balance of growth and safety. Although the ideal risk would be zero, you may need substantially more assets to fund a safety-first approach compared to having some assets invested. And that means that for how much money you do have, the highest standard of living may come from accepting some of the Sequence of Returns Risk that accompanies stock investing.

When a 2% COLA Equals $0

Posted On July 16, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

Social Security provides Cost of Living Adjustments (COLAs) annually to recipients, based on changes to the Consumer Price Index. According to an article in Reuters this week, the Social Security COLA for 2018 should be around 2%. Social Security participants may be feeling like breaking out the Champagne and party hats, following a 0.3% raise for 2017 and a 0% COLA for 2016.

Unfortunately, and I hate to rain on your parade, the average Social Security participant will not see any of the 2% COLA in 2018. Why not? Because of increases in premiums for Medicare Part B. Most Social Security recipients begin Part B at age 65, and those premiums are automatically withheld from your Social Security payments.

Social Security has a nice benefit, called the “Hold Harmless” rule, which says that your Social Security payment can not drop because of an increase in Medicare costs. In 2016 and 2017 when Medicare costs went up, but Social Security payments did not, recipients did not see a decrease in their benefit amounts. Now, that’s going to catch up with them in 2018.

In 2015, Medicare Part B was $105/month and today premiums are $134. For a typical Social Security benefit of $1,300 a month, a 2% COLA (an increase of $26 a month) will be less than the increase for Part B, so recipients at this level and below will likely see no increase their net payments in 2018. While many didn’t have to pay the increases in Part B over the past two years, their 2018 COLA will be applied first to the changes in Medicare premiums.

I should add that the “Hold Harmless” rule does not apply if you are subject to Medicare’s Income Related Monthly Adjustment Amount. If your income was above $85,000 single, or $170,000 married (two years ago), you would already pay higher premiums for Medicare and would be ineligible for the “Hold Harmless” provision. And if you had worked outside of Social Security, as a Teacher in Texas, for example, you were also ineligible for “Hold Harmless”.

The cost, length, and complexity of retirement has gone up considerably in the past generation. Not sure where to begin? Give me a call, we can help. Preparation begins with planning.

How to Be a World Traveler

Posted On July 7, 2017 By Scott Stratton, CFP(R), CFA In The Good Life /

When asked to describe The Good Life, many of us include a desire to travel and see the world, often in our top three or four goals. Yet, often we find reasons why it seems impractical or impossible to do so today. My college roommate, Marty Regan, travels more than anyone I know, and I have always found it fascinating to talk with Marty about how he does it. Here’s my interview with Marty.

SS: We met up in Taos in May and now you are in Tokyo for the summer. Give us a rundown of where you’ve been in the last 12 months.

MR: Last year I was conducting research in Cambridge, UK, and during the summer I traveled to Ireland, Italy, and Iceland. I returned to the USA in late August and have since taken domestic trips to Maine, New York, California, and New Mexico. Over Christmas and New Year’s I traveled in New Zealand for five weeks.

To be a world traveler, a lot of people think you have to be very wealthy. Did you win the lottery or inherit a family fortune? This is all from your college professor salary?

Yes, it is. However, I am single with no children, have no debt and lead a simple lifestyle in an area with a relatively low cost of living, so I have dispensable income to spend as I wish.

What do you enjoy most about travel? What have you learned from other cultures?

As a composer, I have always been fascinated with the relationship between life experiences (including travel!) and artistic expression. If a writer, artist, or composer experiences a cathartic moment when doing something significant like cycling through the Netherlands when the tulips are in full bloom or witnessing an architectural masterpiece like the Pantheon in Rome, how are those experiences manifested when they begin their next work? For writers and visual artists, it seems to me that the relationship is often quite direct. For example, a writer could attempt in prose to capture the details of a particular scene or space, while an artist could be inspired to render the scene realistically or perhaps more abstractly in a painting. In either case, one could argue that the resultant work was directly inspired by the experience. For a composer however, this relationship is a bit more slippery. For me, musical “inspiration” often involves finding myself in a new and unfamiliar environments and allowing myself to be stimulated by the experiences that await me.

I strongly suggest reading Pico Iyer’s article Why We Travel.

I think many people – myselfincluded – could work from anywhere in the world, as long as we have internet. How has travel impacted your work?

As long as I have my computer or iPad with me, I can conduct most of my work remotely. Travel has not negatively impacted my work in anyway.

You’ve obviously figured out how to travel on a budget, because you spend weeks or months in some of the most expensive cities in the world. I imagine that hotels in these cities can cost $500 a night and up. How do you make this work?

Well, I am very lucky in that I have a network friends and colleagues all over the world. I sometimes plan trips where friends of mine reside, not for the promise of free accommodation, but because of the companionship and benefit of having a local teach you about their city. If I travel to a place where I do no know anyone, then I find other ways to keep costs low by living like a local. I rarely stay in hotels.

Let’s talk more about lodging. Where do you stay? How do you find places?

When I stay in a place for a long period of time, Airbnb is my preferred accommodation option. VRBO is also dependable. Some cities I have used Airbnb for extended visits include London, Rome, Paris, Prague, Helsinki, Shanghai, and Seoul, among others.

Outside of lodging, any advice for saving money on transportation, food, and entertainment while you are travelling?

I don’t purchase plane tickets until I have spent time exploring the market for a while and I am confident that I am getting a fair price. I try to stick to the Star Alliance network and pay with my United Chase Plus credit card because purchases add up really quickly that can redeemed for free flights. I always try to stay somewhere with access to a basic kitchen so that I can buy food at local groceries to save on meal expenses. As far as entertainment is concerned, I rarely book in advance but rather show up the day of the performance (symphony orchestra concerts, ballet, theater, etc.) and inquire about last minute rush tickets. Often I am given tickets for free by patrons who can’t use them and have left them at the box office. This happened recently for a performance of Götterdämmerung at the Houston Grand Opera. I was prepared to pay $150+ for a good seat!

You rent your house in College Station through Airbnb. How has that helped you with your travel?

I started renting my house on Airbnb in 2011. Basically, I use the rental income that I receive from Airbnb to pay for expenses that I incur when I travel. At the moment, I am currently residing in Tokyo for 2+ months, but rental income from my home covers my rental expenses here. Here is a link to my home.

Who is a good candidate for Airbnb? If someone is thinking of making their house available, what should they know?

A good candidate for Airbnb would include a person who can appreciate the unique quirks that you might encounter when living in someone’s home. If you are hoping for a cookie-cutter Hyatt or Hilton experience, then Airbnb is not for you. If you are thinking of making your house available, be aware that fielding questions from guests can sometimes take a lot of time! Create a profile in which answers to the most commonly-asked questions are available. Have a system in which guests can check in and check out without you being there, such as having a lock box on the door or installing a keyless entry system. Consider providing amenities that will make their stay memorable. In my case, I usually leave a snack and fruit basket along with fresh-squeezed orange juice. I also leave a hand-written welcome letter as well as a guest book where I request that guests leave their comments.

Do you set a daily or weekly budget for when you travel?

I have never planned daily or weekly budgets!

Favorite travel memory?

Taking a snowmobile tour in Iceland to the top of a glacier in August for my birthday to view a filming location for the Secret Life of Walter Mitty.

Best place to visit that has a surprising value?

Czech Republic.

Many thanks, Marty, and safe travels! See you in Texas in the Fall.

Originally from Long Island, New York, Marty Regan is an Associate Professor at Texas A&M University and lives in Bryan-College Station. He is a composer who specializes in composing music for traditional Japanese instruments. Marty graduated from Oberlin College, lived in Tokyo for 6+ years, and received a Ph.D. from the University of Hawaii, Manoa.
martyregan.com

Mid-Year Report: The Return of Irrational Exuberance?

Posted On July 2, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /

We’ve passed the mid-year point and the market has had a strong performance in the first half of 2017. Investors should be very pleased with the results of the past six months, although I believe there are reasons to be guarded going forward. Our portfolio models all notched positive returns, but our value oriented approach held back returns relative to our benchmarks.

Looking first at stocks, our global equity benchmark, the MSCI All Country World Index (iShares ticker ACWI) produced a total return of 11.92%. That would be a great return for the whole year, and it’s only July 1 as I write this. US Stocks, such as the Russell 1000 Index (iShares ticker IWB) were up 9.15% in the first half.

Across the board, international stocks were well ahead of US Stocks, with both Developed and Emerging Markets producing 15% returns for the first half. Our International and Emerging small caps did even better, over 17%. Our positions in foreign equities were strong contributors to our portfolio returns. If you are just investing in domestic stocks, you really missed out so far in 2017. And International stocks remain less expensive than US stocks by most measures.

Our holdings in US Value stocks lagged, gaining only 2-4% versus the 9% of the overall market. Last year, Value outperformed both Growth and Core by a wide margin. For 2017, a handful of technology companies are dominating returns, specifically the so-called FAANG stocks: Facebook, Apple, Amazon, Netflix, and Google (now called Alphabet).

While these companies continue to post exciting growth, the price of these stocks is now incomprehensible to me. It feels like 1999 all over again, when there was no price too high for growing tech leaders. While I think that today’s top stocks are bonafide companies with genuine earnings, I still can’t justify the price of the shares.

It smells like a bubble to me, although limited to this small number of stocks. Now that doesn’t mean that we are necessarily on the verge of a collapse. Indices could continue to go higher from here, and even if a few high flyers do get clipped, that doesn’t mean that the rest of the economy will be in trouble.

Our investment process favors patience. We focus our portfolios towards the cheaper segments of the market which have lagged. We look for reversion to the mean, investing as contrarians, rather than chasing momentum. Our value funds and REIT ETF had positive returns, but were detractors from performance, as was our allocation to Alternatives. However, I remain committed to these positions because they are relatively cheap. While they did not beat the market over the past 6 months, our rationale for holding them has only grown more compelling.

In fixed income, the US Aggregate Bond Index (iShares ticker AGG) was up 2.40% year to date. Our fixed income allocations were ahead of AGG by 30 to 80 bps, with higher yields and lower duration. Our position in Emerging Market bonds was a standout performer for the half. I continue to keep a close watch on high yield bonds, but overall think we are well positioned for today’s economy and potential future rate hikes.

I write about the markets twice a year, and not more frequently, to not distract us from sticking to a long-term allocation. We focus on what we know works over time: diversification, keeping costs low, using index funds for core positions, and tilting towards value. Our discipline means that we don’t let short-term events pull us away from our strategy.

Looking at the first half, our fixed income and international equity holdings did quite well. Our value and alternatives holdings have not yet had their day in the sun. However, if the market does eventually realize that the US tech stocks have gotten “irrationally exuberant”, I think we will be glad we have our more defensive positions.

Can You Reduce Required Minimum Distributions? (Updated for 2026)

Posted On June 25, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies / 1 Comment

Required Minimum Distributions (RMDs) are withdrawals the IRS mandates from most traditional retirement accounts once you reach a certain age — and those ages are changing under current law. This article explains when RMDs begin in 2026, how they are calculated, and practical ways to reduce the tax impact of RMDs as part of a broader retirement income plan.

What Are RMDs and When Do They Begin in 2026?

An RMD is the minimum amount the IRS requires you to withdraw from eligible retirement accounts each year once you reach a specified age. These withdrawals are generally taxable as ordinary income.

Under current law:

Age 73: You must begin RMDs if you are born between 1951 and 1959.
Age 75: You will begin RMDs if you are born in 1960 or later, with this rule in effect starting in 2033.

The first RMD is due by April 1 of the year after you reach the applicable age. After that, all RMDs must be taken by December 31 each year. However, I recommend you do not delay your first RMD until the following year as it will require to take two (taxable) distributions in the same tax year.

Important Notes

RMDs apply to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and other defined contribution plans.
You can withdraw more than the minimum in any year.
Roth IRAs do not require RMDs during the account owner’s lifetime, though beneficiaries must take distributions after the owner’s death.

Required Minimum Distributions often force income at inconvenient times, which is why they should be addressed within a comprehensive retirement income planning strategy rather than reactively each year.

Can You Avoid RMDs?

No — once you reach the age where RMDs begin, you generally must take them. However, there are a handful of legitimate strategies to reduce their impact on your taxes and retirement planning. Reducing future RMDs often requires coordinated Roth conversion planning.

Reducing RMDs is rarely about a single tactic. It requires coordinated decisions around Roth conversions, charitable giving, and income timing as part of an overall tax planning for retirees approach.

Strategy 1: Use Qualified Charitable Distributions (QCDs)

Qualified Charitable Distributions (QCDs) allow you to give up to $105,000 per year directly from your IRA to a qualified charity, and the donated amount counts toward your RMD without adding to taxable income.

This means:

Your RMD requirement is satisfied
Your taxable income is lower
You remain in potentially lower tax brackets

QCDs are especially useful for retirees who are charitably inclined and want to lower adjusted gross income (AGI) for Medicare, taxation of Social Security benefits, or subsidy eligibility such as ACA planning. (See also: Using the ACA to Retire Early) You do not have to itemize your tax return to benefit from a QCD.

Strategy 2: Roth Conversions Before RMD Age

A Roth conversion means paying tax now to move money from a traditional IRA to a Roth IRA — and Roth IRAs do not have RMDs during your lifetime.

Benefits:

Decreases future RMD amounts
Reduces future taxable income
Provides tax-free income later

Roth conversions work best in years when your taxable income is lower than usual or before RMDs begin. This strategy is one core reason many retirees coordinate Roth conversions with Social Security timing and other planning moves. (See: Roth Conversions After 60) Converting assets during a Bear Market, when their value may be temporarily lower, is a very effective strategy.

Strategy 3: Qualified Longevity Annuity Contracts (QLACs)

A QLAC is a deferred annuity that allows you to remove a portion of your traditional IRA from RMD calculations while deferring income until a later age (as late as 85).

Key points:

The amount invested in a QLAC is excluded from your IRA balance when calculating RMDs.
Payouts begin at a future date you choose.
QLACs can be effective for mitigating large RMDs during certain years.

Strategy 4: Still Working Exception With Employer Plans

If you are over the RMD age but still working, and not a 5% owner of the business, you might be able to delay RMDs from your current employer’s retirement plan (e.g., 401(k)), though this exception does not apply to IRAs.

This can provide additional flexibility in managing your income and taxable distributions. Ask your 401(k) if they can allow you to roll your IRA into your 401(k).

Strategy 5: Asset Location

Placing bonds in your IRA will also benefit because it will keep your IRA from having high growth. Otherwise, if your IRA grows by 20%, your RMDs will grow by 20%.

It is more tax efficient to keep growth stocks and ETFs in a taxable account and your bonds in an IRA. This allows you to receive favorable long-term capital gains treatment (0%, 15%, or 20%) for stocks, a tax benefit which is lost in an IRA. Lastly, if you hold the stocks for life, your heirs may receive a step-up in basis, which they will not in an IRA.

How RMDs Are Calculated

The IRS calculates RMDs using your retirement account balance at the end of the prior year divided by a life expectancy factor from the IRS tables. IRS

If you have multiple traditional IRA accounts, the IRS lets you aggregate your RMDs — calculate each separately, then take the total from any one or combination of traditional IRAs. However, RMDs from 401(k)s generally cannot be aggregated with IRAs.

What Happens if You Miss an RMD

If you fail to take your RMD or do not take enough, the IRS may impose a penalty. Previous penalties were 50% of the amount not withdrawn, but under later interpretation and relief provisions, a 25% excise tax may apply, reduced to 10% if corrected within two years using Form 5329. IRS

Recent IRS reminders underline the importance of meeting deadlines and taking RMDs accurately to avoid costly penalties.

How RMD Planning Fits Into Retirement Income Strategy

RMDs are just one piece of a larger retirement income plan. Thoughtful planning should consider:

Social Security timing (See: Social Security: It Pays to Wait)
Roth conversions before RMD age, especially if you are in the 12% tax bracket.
Qualified Charitable Distributions
Tax bracket management and Medicare IRMAA
Sequence of returns risk and withdrawal sequencing

For many retirees with $500,000–$5 million in investable assets, reducing the tax impact of RMDs can meaningfully improve their retirement cash flow and legacy goals. This topic is often part of a broader retirement or tax planning conversation. If you’d like help applying these ideas to your own situation, you can request an introductory conversation here.

Frequently Asked Questions

What age do RMDs start in 2026?
Most people are required to begin RMDs at age 73 if born in 1951–1959. For individuals born in 1960 or later, the RMD age will rise to 75 starting in 2033. Congress.gov

Can I avoid RMDs entirely?
No, you cannot avoid RMDs once you reach the required age, but strategies like Roth conversions, QCDs, QLACs, and delaying employer plan RMDs while working can reduce the tax impact.

Do Roth IRAs have RMDs?
No — Roth IRAs do not require RMDs during the account owner’s lifetime, making conversions a valuable planning tool.

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.