Invest $1000 a month

Where to Invest $1,000 a Month

Posted On February 1, 2021 By Scott Stratton, CFP(R), CFA In Financial Planning /  

Many investors wonder where they should invest $1,000 a month. Maybe they’re starting out from scratch. Or maybe they have been doing a 401(k) for years and have additional cash they want to invest.

You’ve paid off your credit cards and have an emergency fund with three to six months of expenses. You’ve got a good paycheck, but it all seems to disappear. Unfortunately, many Americans remain on this paycheck to paycheck treadmill, even if they have a decent income. What breaks this cycle is establishing monthly automatic contributions. Make investing automatic and you will adjust your other spending. And then when you do get a raise, aim to increase your saving, not your spending.

Let’s consider a few ways to invest $1,000 a month. I’ll go into some detail in this first scenario and then give a few variations.

Married with Children

With many couples, one has a good retirement plan at work, but the other spouse does not. For example, maybe they’re self-employed, work part-time, or are a stay at home parent. They’ve got two kids and want to make sure their kids can go to college some day, too.

  1. $500 a month into a Roth IRA. The annual contribution limit is $6,000, which is $500 a month. At an 8% hypothetical return, you would have $745,179 in this Roth IRA after 30 years. And that would be available tax-free! If you had this same amount in a 401(k) and had to pay 22% income tax, you’d be facing a $163,939 tax bill. That’s the amazing tax savings of a Roth IRA.
  2. $450 into 529 College Savings Plans. Put in $225 a month for each kid for college. Like a Roth IRA, a 529 Plan offers tax-free growth, provided the money is used on qualified higher education expenses. At an 8% hypothetical return, you would accumulate $41,162 for your 8-year old to go to college in 10 years. And you’d have $77,858 in 15 years for your 3-year old. (What if one kid doesn’t go to college? Switch the beneficiary to the other child. 529 Details here.)
  3. $50 a month into a 20-year term life insurance policy. For most young families, some life insurance is important and I believe term life is a great solution. For a 38-year old male, we can get a $1 million Term policy for as low as $42 a month if they are in excellent health. Contact me for details.

With their $1,000 a month, this family is on their way to potentially having:

  • $745,000 in tax-free money for retirement in 30 years
  • $119,000 towards their kids’ college
  • A $1 million life insurance policy if something should happen to Dad

Double Income No Kids

  1. $500 a month to two Roth IRAs. Don’t need a 529 Plan or life insurance? You can both do Roth IRAs at $500 a month each. Roth eligibility rules are based on joint income, so if one spouse can contribute, both can. After 30 years at our hypothetical 8%, you’d have almost $1.5 million in two Roth IRAs. That’s the incredible power of compound interest! (Make too much for a Roth IRA? Consider the Backdoor Roth Contribution.)

Self-Employed

  1. $500 a month into a Traditional IRA. Get a tax-deduction for this contribution. However, if you or your spouse are eligible for a retirement plan at work, income limits apply.
  2. $500 into a SEP-IRA. This is also tax-deductible for self-employed individuals. You can do both a SEP and a Traditional or Roth IRA. Since the SEP has much higher contribution limits than a Traditional IRA, why not just put the $1,000 a month into the SEP? The SEP may reduce your QBI Deduction for the Self-Employed.

Invest $1,000 a Month

There are lots of smart ways to invest $1,000 a month. We can help you sort through your options and get started. The Roth IRA offers tax-free growth, whereas the Traditional IRA or SEP-IRA offers an upfront tax deduction. For many parents, you may want to invest some of your $1,000 a month in a 529 College Savings Plan. Term Life Insurance could be a piece of the pie, too.

Another option would be to contribute to a Health Savings Account, or HSA. For 2021, you can contribute up to $300 a month ($3,600 a year) into your HSA, if eligible. This is a tax-deductible contribution and can be withdrawn tax-free for qualified medical expenses in the future. If you have family coverage, the HSA contribution limit doubles to $7,200 a year ($600 a month).

Most people don’t feel like they have an “extra” $1,000 every month. That’s okay. You can start with less, even just $50 a month. Most importantly, just get started. Then, you can gradually increase your monthly contributions over time. Once you get to $1,000 a month, you can go up from there! The more you save and invest, the faster you can reach your financial goals.

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Investment Themes for 2021

Investment Themes for 2021

Posted On January 10, 2021 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Today we are going to discuss our top Investment Themes for 2021. I’ve stated that predictions are generally worthless, and 2020 certainly proved this point. 12 months ago, no one anticipated the massive impact of the Coronavirus. And the lightning speed of the stock market recovery remains shocking.

From its highs in February, US Stocks fell 35% to March 23. The recovery saw a 65% rally, with the S&P 500 Index ending the year up 17.6%. It was a mind-boggling year for investors, but I think we can count our blessings. This was the fastest Bear Market and recovery in history. Compared to the previous two Crashes, investors felt compelled to stay the course this year. And this proved wise.

(Here’s what I wrote to investors on March 21: Stock Crash Pattern.)

So, where do we go from here? Will 2021 unwind all the gains of 2020? My philosophy remains that we do not need to predict market movements or time the market to be successful. As a long-term investor, my approach to tactical investing is based on over-rebalancing. Think of rebalancing – trimming categories which rose (and became expensive) and adding to what became cheap. We overweight the assets which are cheaper.

We remain fully invested in our target allocation, but the weighting of funds can change from year to year. In some years, we own assets which lag other categories. That’s okay. That’s part of being a diversified investor. We want to avoid chasing performance.

Trades for 2021

  1. US large cap growth has become very expensive. For 2021, we are shifting some of our large cap growth to a mid cap growth fund. The valuations there are not as elevated.
  2. US small cap appears to have turned. Q4 of 2020 was the best quarter for small cap in 30 years. We added to small cap in our Growth and Aggressive models.
  3. Emerging Markets have a high expected long-term return. We remain overweight in EM.
  4. Value stocks lagged growth names again in 2020. (Growth stocks performance was highly concentrated in a small number of tech stocks such as Facebook, Amazon, Alphabet, and Tesla.) We are committed to our Value Funds and believe that they are compelling today.
  5. Bond yields fell in 2020 to all-time lows. The US Aggregate Bond Index had a return of 7.4%, but most of that was from prices increasing. Less than 2% came from yield. So, we finished 2020 with terrible yields – less than 1% on a 10-year Treasury bond.
  6. Yields were up in the first week of 2021, and bond investors are seeing falling prices. We are positioned towards the short-end of the yield curve and want to avoid chasing high yield today.
  7. Fixed Annuities remain a good substitute for CDs and Bonds for investors who don’t need liquidity. We can get a 5-year annuity at 3.0%.
  8. There are relative values within municipal bonds and Emerging Markets debt. Other than that, we expect very low returns from bonds. Own them for diversification. They provide ballast if your stocks are down and give you the ability to rebalance.
  9. We trimmed some short-term bonds and added to Preferred Stocks. Although many are priced at par today, we can get yields of 4-6%. This is an attractive middle ground between the volatility of stocks and the 0-1% yields of bonds.
  10. Both stocks and bonds are at all-time highs right now, and that makes alternatives compelling. In addition to Preferred Stocks, we have positions in Convertible Bonds and a Hedge Fund Strategy mutual fund.

Adding Value

We certainly hope markets will rise in 2021, but there’s no guarantee that will happen. I can say that we added value in 2020 in three other ways:

  • In March, we harvested losses in taxable accounts. For example, we sold one large cap ETF and immediately replaced it with a different large cap ETF. Losses will offset capital gains distributions and will carry forward indefinitely.
  • We rebalanced in March, trimming bonds and buying stock ETFs which were down. These trades proved profitable, although they didn’t feel so good when the market was crashing.
  • We stayed the course throughout the year. Selling during a panic like March would have been disastrous. We believe that planning and behavior are fundamental to success.

Our investment themes for 2021 are not predictions. We can’t control what the market will do. Our focus is to think long-term, stay diversified, and keep costs and taxes down. Still, our portfolio models are not static. We make changes to the weightings of our Core positions based on their relative valuations. And we add or remove Satellite positions that are attractive for the current environment.

Investments are a tool to grow your wealth and achieve your financial and life goals. While I enjoy discussing investments, more of my conversations with clients are around their objectives and making sure they are on track. And that’s how it should be.

Behind the scenes, a lot of research, thought, and analysis goes into our investment management decisions. If you’d like to ask about your portfolio and how we invest, please give me a call.

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COVID Relief Bill

COVID Relief Bill Passes

Posted On December 23, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning /  

A new bi-partisan COVID Relief bill passed Congress this week and will impact almost every American in a positive way. This stimulus legislation creates additional income and tax benefits to offset the economic damage of Coronavirus. The $900 Billion bill includes another stimulus payment to most Americans, an extension of unemployment benefits, and seven tax breaks. As of this morning, President Trump has not yet signed the bill.

$600 Stimulus Payment

The CARES Act provided many families with stimulus checks this summer. Those checks were for up to $1,200 per person and $500 per child. There will be a second stimulus check now, for $600 per person. Parents will receive an additional $600 for each dependent child they have under 17. Adult dependents are not eligible for a check.

Like the first round of checks, eligibility is based on your income. Single tax payers making under $75,000 are eligible for the full amount. Married tax payers need to make under $150,000. There is a phaseout for income above these thresholds.

Payments will be distributed via direct deposit, if your bank information is on file with the IRS. If not, like before, you will be mailed a pre-paid debit card. This payment will not be counted as taxable income. Payments should start in a week and are expected to be delivered much faster than the two months it took this summer.

These $600 payments are again based on your 2019 income, but will be considered an advanced tax credit on your 2020 income. What if your 2019 income was above $75,000, but your 2020 income was below? If you qualify on your 2020 income, the IRS will provide the $600 credit on your tax return in April. If they send you the $600 based on your 2019 income and your 2020 income is higher, you do not have to repay the tax credit. This is a slightly different process than the first round of checks, and will benefit people whose income fell in 2020.

Unemployment Benefits

The CARES Act provided $600 a week in Federal Unemployment Benefits, on top of State Unemployment Benefits. This amount was set to run out on December 26. The new COVID Relief Bill provides an 11-week extension with a $300/week Federal payment. Now, unemployed workers will have access to up to 50 weeks of benefits, through March 14. Unfortunately, because of how late the legislation was passed, states may be unable to process the new money in time. So, there may be a gap of a few weeks before benefits resume.

Seven Other Tax Benefits

  1. Child Tax Credit and Earned Income Tax Credit. Under the new legislation, tax payers can choose between using their 2019 or 2020 income to select whichever provides the larger tax credit.
  2. Payroll Tax Deferral. For companies who offered a deferral in payroll taxes in Q4, the repayment of those amounts was extended from April to December 31, 2021.
  3. Charitable Donations. The CARES Act allows for a $300 above-the-line deduction for a 2020 cash charitable contribution. (Typically, you have to itemize to claim charitable deductions.) The new act extends this to 2021 and doubles the amount to $600 for married couples.
  4. Flexible Spending Accounts (FSAs). Usually, any unused amount in an FSA would expire at the end of the year. The stimulus package will allow you to rollover your unused 2020 FSA into 2021 and your 2021 FSA into 2022.
  5. Medical Expense Deduction. In the past, medical expenses had to exceed 10% of adjusted gross income to be deductible. Going forward, the threshold will be 7.5% of AGI. This will help people with very large medical bills.
  6. Student Loans. Under the CARES Act, an employer could repay up to $5,250 of your student loans and this would not be counted as taxable income for 2020. This benefit will be extended through 2025.
  7. Lifetime Learning Credit (LLC). The LLC was increased and the deduction for qualified tuition and related expenses was cancelled. This will simplify taxes for most people, rather than having to choose one.

Read more: Tax Strategies Under Biden

Summary

The new COVID Relief Bill will benefit almost everyone and will certainly help the economy continue its recovery. For many Americans, the stimulus payments and continued unemployment benefits will be a vital lifeline. Certainly 2020 has taught all of us the importance of the financial planning. Having an emergency fund, living below your means, and sticking with your investment strategy have all been incredibly helpful in 2020.

Read more: 10 Questions to Ask a Financial Advisor

If you are thinking there’s room for improvement in your finances for 2021, it might be time for us to meet. Regardless of what the government or the economy does in 2021, your choices will be the most important factor in determining your long-term success. We will inevitably have ups and downs. The question is: When we fall, are we an egg, an apple, or a rubber ball? Do we break, bruise, or bounce back? Planning creates resilience.

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retirement buckets

Retirement Buckets

Posted On December 11, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Our fifth and final installment of our series on retirement income will cover the strategy of five-year retirement buckets. It is a very simple approach: you maintain two buckets within your portfolio. Bucket 1 consists of cash and bonds sufficient for five years of income needs. Bucket 2 is a long-term growth portfolio (stocks).

We could start with up to a 5% withdrawal rate. Let’s consider an example. On a $1 million portfolio, we would place $250,000 in Bucket 1. That is enough to cover $50,000 in withdrawals for five years. Bucket 1 would be kept in cash and bonds, for safety and income. Each year, you would take withdrawals from Bucket 1.

Bucket 2, with $750,000, is your stock portfolio. The goal is to let this money grow so that it can refill Bucket 1 over time. In years when Bucket 2 is up, we can refill Bucket 1 and bring it back up to five years worth of money. At $750,000, a 6 2/3% annual return would provide the $50,000 a year needed to refill Bucket 1.

Addressing Market Volatility

When the market is flat or down, we do not take a withdrawal from Bucket 2. This addresses the big risk of retirement income, having to sell your stocks when they are down. Instead, by having five years of cash in Bucket 1, we can wait until the market recovers before having to sell stocks. That way, you are not selling stocks during a time like March of 2020, or March of 2009! Instead, we hold on and wait for better times to sell.

Historically, most Bear Markets are just for a year or two, and then the market begins to recover. Sometimes, like this year, the recovery is quite fast. The goal with our Retirement Buckets is to never have to sell during a down year. And while it is always possible that the stock market could be down five years in a row, that has never happened historically.

Retirement Buckets is different from our other withdrawal strategies, such as the 4% rule or the Guardrails strategy. Those strategies tend to have a fixed asset allocation and rebalance annually. The Retirement Buckets Strategy starts with a 75/25 allocation, but that allocation will change over time. Our goal is not to maintain exactly 25% in the cash/bonds bucket, but rather to target the fixed amount of $250,000. If the market is down for two years, we may spend Bucket 1 down to $150,000.

Stocks for Growth

For most people, having five years of cash and bonds in reserve should be sufficiently comfortable. However, if you wanted to increase this to 7 years, a 65/35 initial allocation, that would also work. But, I would suggest starting with at least a 60% allocation to stocks. That’s because when Bucket 2 is smaller, you need an even higher return to refill the $50,000 a year. If you started with 60/40 ($600,000 in Bucket 2), for example, you’d need a return of 8 1/3%.

Retirement Buckets can work because you are creating flexibility around when you are going to sell stocks. When you maintain any fixed allocation, you run into the problem of selling stocks when they are down. Rebalancing is good when you are in accumulation – it means you are buying stocks when they are low. But for retirement income strategies, selling stocks when they are down is likely going to be a bad idea.

Selling Bonds First

Somewhat related to a Buckets Strategy is another income strategy, the Rising Equity Glidepath. In this approach, you sell your bonds first. So, if you started with a 60/40 allocation at retirement and withdraw 4% a year, your bonds would last you 10 years (actually a little longer, with interest). If you avoid touching your stocks for 10 years, they are likely to have doubled in value, historically, with just a 7% annual return. I see the Rising Equity Glidepath as being related to the buckets strategy because both approaches focus on not selling stocks. This reduces the Sequence of Returns risk that market losses impact your initial retirement years.

However, most investors become more conservative as they age, so they aren’t going to like the Rising Equity Glidepath. If they retire at 65, that puts them on track to be at 100% equities at age 75. That’s not what most want. So, even though the strategy looks good in theory, it’s not going to make sense in practice.

What’s Your Plan?

The Retirement Buckets approach can provide a strategy that is logical and easily understood by investors. We maintain five years of cash and bonds, and can replenish the cash bucket when the market is up. This gives you a flexible process for how you are going to fund your retirement and respond to market volatility.

I hope you’ve enjoyed our series on retirement income approaches. It is so important to understand how to create sustainable withdrawals from your portfolio. Whether you are already retired or have many years to go, we are here to help you find the right strategy for you.

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guardrails withdrawal strategy

Guardrails Withdrawal Strategy

Posted On December 1, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

After looking at Bengen’s 4% Withdrawal Rule last week, today we turn to the Guardrails Withdrawal Strategy created by Guyton and Klinger in 2006. Bengen’s 4% Rule is a static withdrawal strategy – he tested various fixed withdrawal rates over 30-year periods to calculate a safe withdrawal rate for retirement income. This is a static approach because he did not attempt to adjust withdrawals based on market performance.

As a result, one criticism of the 4% Rule is that it is too conservative and is based on the historical worst case scenario. In many scenarios, retirees could have taken much more income than 4%. Or they could have retired years earlier! In bad market scenarios, it also seems unlikely that a retiree would continue to increase their withdrawals every year for inflation if it risked depleting their assets.

A Dynamic Withdrawal Strategy is one which adjusts retirement income up or down based on market performance. Guyton’s Guardrail approach establishes a framework for retirees to adjust their income if necessary. The benefit is that you could increase your withdrawals if performance is above average. It also means you may need to reduce withdrawals during a bad stretch. A dynamic approach means you could start with a much higher withdrawal than just 4%. The guardrails creates an ongoing process to know if your withdrawal rate is in the safe zone or needs to change.

Guyton’s Guardrail Rules

Like Bengen’s framwork, Guyton looked at historical market performance over a 30-year retirement. Here are the main points of his Guardrails Withdrawal Strategy:

  • Your initial withdrawal rate could be 5.4%.
  • You increase withdrawals for inflation annually, EXCEPT in years when the portfolio has fallen in value, OR if your withdrawal percentage exceeds the original rate of 5.4%. In those years, you keep the same withdrawal amount as the previous year.
  • If a market drop causes your current withdrawal rate to exceed 6.48%, then you need to cut your withdrawal dollars by 10%.
  • If market gains cause your withdrawal rate to fall below 4.32%, then you can increase your withdrawal dollars by 10%.
  • This strategy worked with allocations of 65/35 and 80/20. With a 50/50 portfolio, the safe withdrawal rate drops from 5.4% to 4.6%.
  • After a year when stocks were down, withdrawals should only come from cash or bonds. On years when the market is up, he would trim stocks and add to cash to meet future withdrawals.

On a $1 million portfolio, the Guardrails approach suggests you could safely withdraw $54,000 in year 1. That’s significantly higher than the $40,000 under Bengen’s static 4% rule. And while you might forgo annual inflation increases if the market does poorly, you were already starting at a much higher income level. Even if you had a 10% cut in income, from $54,000 to $48,600, you are still getting more income than if you were using the 4% Rule.

Dynamic Withdrawal Range

The Guardrails approach establishes an ongoing withdrawal range of 4.32% to 6.48%. That is a 20% buffer from your original 5.4%. If your withdrawal rate goes outside of this range, you should decrease (or can increase) your withdrawals. The static 4% rule only focused on your initial withdrawal rate and then just assumes you make no changes regardless of whether your future withdrawals are high or low. The 4% rule is an interesting study of market history, but I think retirees want to have a more strategic approach to managing market risk.

The benefit to a retiree for implementing a Guardrails approach is significant. If you need $40,000 a year, you would only need an initial nest egg of $740,740 with the guardrails, versus $1 million under the 4% rule. And you now have a clear process each year to evaluate the sustainability of your current withdrawals. You are responding to markets to aim for an effective retirement strategy.

Calculating a sustainable withdrawal rate for retirement income will always be an unknown. We’ve talked about the challenges of sequence of returns risk, inflation, and longevity. While we can’t predict the future, having a dynamic approach to retirement withdrawals is appealing and intuitive. Is a Guardrails Withdrawal Strategy right for you? Along with portfolio management, our retirement planning process can offer great peace of mind that you are taking a prudent, well-thought approach to managing your wealth.

You only get one retirement. If you are retired or will be retiring within three years, you need a retirement income plan. Find out more:

Schedule a Free Call.
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The 4% Withdrawal Rule

The 4% Withdrawal Rule

Posted On November 20, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Many retirement income projections are based on the work of William Bengen, a financial advisor who created the 4% withdrawal rule. Today, in part three of our five-part series on creating retirement income, we look at Bengen’s 4% Rule and what it can mean for your retirement.

Bengen’s Research

Twenty-five years ago, there had been little research done on how to create retirement income from a portfolio. Thankfully, most people had pensions which guaranteed their payments. However, with the rise of 401(k) plans, the responsibility for retirement income shifted from the employer to the employee and their investment portfolio. We needed a more rigorous framework for retirement planning.

Bengen looked back at the history of the stock and bond returns and considered a 30-year retirement period. Since inflation increases your cost of living, he assumed that retirees would need to increase their retirement withdrawals annually. He then calculated, for every period, the maximum withdrawal rate that would have lasted for the full 30 years, adjusting for inflation.

He examined this for every 30 year period with available data. For example, 1930-1960, and then 1931-1961, 1932-1962, etc. all the way up to the present. In the all 30-year periods, retirees were able to withdraw at least 4% of their initial sum. In the worst case scenario, retirees with a $1 million portfolio could withdraw $40,000 in year 1, and increase it every year with inflation. This is the Safe Withdrawal Rate, or SAFEMAX as Bengen called it.

Interestingly, Bengen did not name this the 4% Rule. In interviews with reporters, they started calling it the 4% Rule and the name stuck.

Portfolio Implications

Bengen originally used a simple two asset portfolio using one-half US Large Cap Stocks and one-half US Intermediate Treasury Bonds. He assumed annual rebalancing, which helped with stock market volatility. He found that the 4% Rule would work with about one-half to three-quarters invested in stocks. With higher allocations to stocks, the portfolio became more likely to implode during bear markets. And with higher allocations to bonds, the portfolio could not keep up with the inflation-adjusted withdrawals. So, the sweet spot for a retirement allocation seemed to be from 50/50 to 75/25.

In the majority of 30-year periods, the potential withdrawal rate was much higher than 4%. In a few periods, it even exceeded 10%. The 4% rate was the worst case scenario. 4% worked for all of the 51 different 30-year periods starting in 1926 that Bengen considered in his original paper. At a 4% withdrawal rate, your money actually grew in most of the periods. If you started with a $1 million portfolio and took 4% withdrawals, your portfolio would have actually exceeded $1 million, 30 years later, in the majority of cases.

Later, Bengen added Small Cap stocks to the mix, with a portfolio of 30% large cap, 20% small cap, and 50% bonds. With this portfolio mix, he found that the safe withdrawal rate increased to 4.5%. Bengen considers this work to replace his initial 4% Rule. Unfortunately, the name had already caught on and Bengen will forever be known as the creator of “The 4% Rule”, but he would rather it was called “The 4.5% Rule”.

There is definitely room for higher withdrawals than 4%. The problem is that we don’t know what future returns will be and we don’t know the sequence of returns. So, the safest bet remains to start at only a 4% withdrawal. For people who retire before age 65, we may want to plan for a longer potential horizon than Bengen’s 30 year assumption. A longer retirement might require a lower rate than 4%.

Summary

The 4% Withdrawal Rule is a good rule of thumb for retirement income. When we use other analytical tools, such as a Monte Carlo evaluation, it often generates results similar to Bengen’s rule. If you want to use a 4% rate, your nest egg needs to be 25-times your annual needs. This is a very high hurdle for most people. It’s incredibly challenging for most Americans to save 25 times their annual expenses during their working years.

So while it is a conservative way to calculate retirement income, the 4% rule may make people over-prepared in most periods. As a result, people could have spent more money in retirement. Or they could have retired years earlier, but waited to accumulate enough assets to meet the 4% Rule. That’s a flaw with the 4% Rule.

The other weakness is that it is based on history. Just because it worked in the past century is no guarantee that it will work in the future. For example, if we have very low bond yields, poor stock returns, or higher inflation, it’s possible that a 4% withdrawal fails. One researcher, Wade Pfau, tried to apply the 4% Rule to investors in other countries. He found that it didn’t work for every country. We have had a really good stock market, and low inflation, here in the US and that’s why it worked historically.

Bottom line: the 4% Withdrawal Rule is a good starting place to understand retirement income. But we can do better by having a more dynamic process. We can adjust withdrawals based on market performance. Or you can delay or reduce inflation adjustments. We can avoid selling stocks in down years. All of these strategies can enhance the 4% rule and potentially enable you to start with a higher withdrawal rate. We will consider two such strategies in the next articles, considering Guardrails and a 5-year Bucket Approach.

Bengen is retired now, but still writing and continuing his research. He realized that his initial research left a lot of money on the table for retirees. Two months ago, he produced a new article looking at stock market valuations and inflation to refine the initial withdrawal rate. If you are retiring when stocks are expensive, future returns are likely to be lower, and you should start with a lower withdrawal rate. If stocks are cheap, you might be able to start with a higher withdrawals than 4%. Bengen believes this new process could calculate a safe-withdrawal rate of 4.5% to 13%. (The present calculation using his new method is 5.0%.) Time will tell if his new research gains wider acceptance, but for now, he will be best known as the father of the 4% withdrawal rule.

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Guaranteed Retirement Income

Guaranteed Retirement Income

Posted On November 12, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Guaranteed Retirement Income increases satisfaction. When you receive Social Security, a Pension, or other monthly payment, you don’t have to worry about market volatility or if you will run out of money. You’re guaranteed to receive the payment for as long as you live. That is peace of mind.

Research shows that people prefer pension payments versus taking withdrawals from an investment portfolio. When you were working, you had a paycheck show up every month and you didn’t feel bad about spending it. There would be another paycheck next month. Unfortunately, with an investment portfolio, retirees dislike spending that money. There is “range anxiety” that their 401(k) or IRA will run out of money. There is fear that a market drop will ruin their plans. After spending 40 years building up an account and it’s not easy to reverse course and start to spend that nest egg and see it go down.

Corporate and Municipal pensions have been in decline for decades. As a result, most of us have only a Social Security benefit as guaranteed income. That’s too bad. 401(k) plans are a poor substitute for a good pension. You need to accumulate a million bucks just to get $40,000 a year at a 4% withdrawal rate. It places all the responsibility on American workers to fund their own retirement, and this has led to wildly disparate retirement readiness between people. Even those who accumulate significant retirement accounts still have the worries about running out of money. Sequence of Returns, poor performance or mismanagement, cognitive decline, or longevity are all risks.

The solution to create guaranteed lifetime income is a Single Premium Immediate Annuity, or SPIA. A SPIA is a contract with a life insurance company in which you trade a lump sum in exchange for a monthly payment for life. For as long as you live, you will get that monthly check, just like a Pension or Social Security. When you pass away, the payments stop. For married couples, we can establish a Survivor’s Benefit that will continue the payout (sometimes reduced at 50% or 75%) for the rest of the survivor’s life, if the owner should pass away.

How much would it cost? For a 65-year old man, a $100,000 premium would establish a $537/month payment for life. That is $6,444 a year, or a 6.4% rate on your premium. For a 65-year old woman, it would be $487, a month, or $5,844 a year (5.8%) For a couple, if the wife was also 65, that same premium would offer $425/month for both lives (100% survivors benefit). That’s $5,100 a year, or 5.1%. The greater the expected longevity, the lower the monthly payment.

There are some fairly obvious advantages and disadvantages of a SPIA.

Pros

  • Lifetime income, fixed, predictable, and guaranteed
  • No stock market risk, no performance concerns, no Sequence of Returns risk

Cons

  • Permanent decision – cannot reverse later
  • Some people will not live for very long and will get only a handful or payments back
  • No money leftover for your heirs
  • No inflation protection – monthly payout is fixed

I’ve been a financial advisor since 2004 and I have yet to have a client who wants to buy a SPIA. For some, the thought of spending a big chunk of money and the risk that they die in a year or two, is unbearable. However, the payout is fair, because some people will live for much longer than the average. The way insurance works is by The Law of Large Numbers. An insurance company is willing to take the risk that someone will live for 40 or 50 years because they know that if they sell thousands of annuities, it will work out to an average lifespan across the group. Some people live longer than average and some live less than average.

Two Ways to Use a SPIA

Although they remain unpopular, SPIAs deserve a closer look. Let’s immediately throw away the idea that you should put all your money into a SPIA. But there are two ways that a SPIA might make sense as part of your retirement income plan.

  1. Use a SPIA to cover your basic expenses. Look at your monthly budget. Assume you need $3,000 a month to cover all your expenses. If you have $2,200 in Social Security benefits, buy a SPIA that would cover the remaining $800 shortfall. For the 65-year old couple above, this $800/month joint SPIA would cost $188,235. Now you have $3,000 a month in guaranteed lifetime income to cover 100% of your basic expenses. Hopefully, you still have a large investment portfolio that can grow and supplement your income if needed.

The nice thing about this approach is that it takes a bit less cash than if you follow the 4% rule. If you needed $800 a month ($9,600 a year), a 4% withdrawal rate would require you have a portfolio of $240,000. The SPIA only requires $188,235.

Let’s say you have a $1 million portfolio. You could (a) put it all in the portfolio and start a 4% withdrawal rate, or (b) put $188,235 into the SPIA and keep the remainder in the portfolio. Here’s what that would look like for year one:

  • a. $1 million at 4% = $40,000 potential income
  • b. $188,235 SPIA = $9,600, PLUS $811,765 portfolio at 4% = $32,470. The combined income from the SPIA and portfolio is now $42,070

You have increased your income by $2,070 a year and you have established enough guaranteed income to cover 100% of your monthly needs. Then, you are not dependent on the market to cover your basic expenses each month.

2. The second way to think of a SPIA is as a Bond replacement for your portfolio. Instead of buying Treasury Bonds and worrying if you will outlive them, you can buy a SPIA, and the insurance company will buy very safe bonds. The insurance company then assumes your Longevity risk.

Back to our example above, let’s say your $1 million portfolio is invested in a 60/40 allocation (60% stocks, 40% bonds). Just consider the SPIA as part of your fixed income sleeve. If you had a target of $400,000 in bonds, rather than letting them sit in 10-year Treasuries earning 0.7% today, go ahead and put $188,235 in the SPIA and keep $211,765 in bonds. Your $600,000 in stocks remains the same. Now, on your SPIA, you are getting a withdrawal rate of 5.1% to 6.4%. And although you are eating your principal with a SPIA, you have no longevity risk, it’s a guaranteed check. You have reduced the withdrawal requirement from your equities and can better weather the ups and downs of the stock market.

Is a SPIA Right For You?

A SPIA isn’t going to be for everyone. But if you want lifetime guaranteed retirement income a SPIA is a solid, conservative choice. Used in conjunction with the other pieces of your income plan (Social Security and Investment portfolio), a SPIA can help you sleep well at night. Especially for investors who are in great health and with a family history of longevity, it may be worth putting some money into a SPIA and turning on that monthly check. It can help offset the stock market risks that could derail your plans.

I know many parents think putting money into a SPIA will reduce money for their kids to inherit. That might be true. Of course, if you live a long time and run out of money, you won’t be leaving any money to your kids either. Our goal with any retirement income solution is to make sure you don’t outlive your money, which hopefully also means you are able to leave some money to your heirs.

What if the insurance company goes under? Isn’t that a risk? It is. Thankfully, most states protect SPIA policy holders up to $250,000. If you are planning to put more than $250,000 into a SPIA, I would seriously consider dividing your funds between several companies to stay under the limits. Read more: The Texas Guaranty Association. (Note that this information is provided solely for educational purposes and is not an inducement to a sale.)

In the next three articles in this five-part series, we will look at different withdrawal strategies for your investment portfolio. These approaches include the 4% rule, a Guardrails approach, and 5-year Buckets. All of these will help you manage the risks of funding retirement from stocks. But before we get to those, I wanted you to realize that you don’t have to put all your money into stocks to create retirement income. These withdrawal approaches are likely to work, and we know they worked in history. But if you want to buy your own pension and have a guaranteed retirement income, a SPIA could be the right tool for the job.

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Creating Retirement Income

Creating Retirement Income

Posted On November 5, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Today, we are starting a five-part series to look at creating retirement income. There are various different approaches you can take when it is time to retire and shift from accumulation to taking withdrawals from your 401(k), IRA, or other investment accounts. It is important to know the Pros and Cons of different approaches and to understand, especially, how they are designed to weather market volatility.

In upcoming posts, we will evaluate SPIAs, the 4% rule, a Guardrails Approach, and 5-Year Buckets. Before you retire, I want to discuss these with you and set up an income plan that is going to make the most sense for you. Today, let’s start with defining the challenges of creating retirement income.

Sequence of Returns Risk

During accumulation, market volatility is not such a bad thing. If you are contributing regularly to a 401(k) and the market has a temporary Bear Market, it is okay. All that matters is your long-term average return. If you invest over 30-40 years, you have historically averaged a return of 8-10 percent in the market. Through Dollar Cost Averaging, you know that you are buying shares of your funds at a more attractive price during a drop.

Unfortunately, market volatility is a big problem when you are retired and taking money out of a portfolio. You calculated your needs and planned to take a fixed amount of money out of your portfolio. If the market averages 8% returns, can you withdraw 8%? That should work, right?

Let’s look at an example. You have a $1 million portfolio, you want to take $80,000 a year in withdrawals. Imagine you retired in 2000, having reached your goal of having $1 million! Here’s what your first three years of retirement might have looked like, with $80,000 annual withdrawals:

  • Start at $1,000,000, 9% market loss = $830,000 ending value
  • Year 2: start at $830,000, 12% market loss = $650,400 ending value
  • Year 3: start at $650,400, 22% market loss = $427,312 ending value

This would blow up your portfolio and now, your $80,000 withdrawal would be almost 20% of your remaining funds. This is Sequence of Returns Risk: the order of returns matters when you are taking income. If you had retired 10 years before these three bad years, you might have been okay, because your portfolio would have grown for a number of years.

Because a retiree does not know the short-term performance of the stock market, we have to take much smaller withdrawals than the historical averages. It’s not just the long-term average which matters. Losses early in your retirement can wreck your income plan.

Longevity Risk

The next big risk for retirement income is longevity. We don’t know how long to plan for. Some people will have a short retirement of less than 10 years. Others will retire at 60 and live for another 40 years. If we take out too much, too early, we risk running out of funds at the worst possible time. There is tremendous poverty in Americans over the age of 80. They didn’t have enough assets and ran out of money. Then they end up having to spend down all their assets to qualify for Medicaid. It’s not a pretty picture.

And for you macho men who intend to die with your boots on – Great. You may wipe out all your money with your final expenses and leave your spouse impoverished. She will probably outlive you by 5-10 years. That’s why 80% of the residents in nursing homes are women. You need to plan better – not for you, but for her.

Read more: 7 Ways for Women to Not Outlive Their Money

We plan for a retirement of 30 years for couples. There’s a good chance that one or both of you will live for 25-30 years if you are retiring by age 65. There are different approaches to dealing with longevity risk, and we will be talking about this more in the upcoming articles.

Inflation Risk

Longevity brings up a related problem, Inflation Risk. At 3% inflation, your cost of living will double in 24 years. If you need $50,000 a year now, you might need $100,000 later, to maintain the same standard of living.

A good retirement income plan will address inflation, as this is a reality. Luckily, we have not had much inflation in recent decades, so retirees have not been feeling much pressure. In fact, most of my clients who start a monthly withdrawal plan, have not increased their payments even after 5 or 10 years. They get used to their budget and make it work. Retirement spending often follows a “smile” pattern. It starts high at the beginning of retirement, as you finally have time for the travel and hobbies you’ve always wanted. Spending typically slows in your later seventies and into your eighties, but increases towards the end of retirement with increased health care and assistance costs.

When we talk about a 4% Real Rate, that means that you would start at 4% but then increase it every year for inflation. A first year withdrawal of $40,000 would step up to $41,200 in year two, with 3% inflation. After 30 years (at 3% inflation), your withdrawal rate would be over $94,000. So, when we talk about a 4% withdrawal rate, realize that it is not as conservative as it sounds. Even at a low 3% inflation rate, that works out to $1,903,016 in withdrawals over 30 years. It’s a lot more than if you just were thinking $40,000 times 30 years ($1.2 million).

Periods with high inflation require starting with a lower withdrawal rate. Periods with low inflation enable retirees to take a higher initial withdrawal amount. Since we don’t know future inflation, most safe withdrawal approaches are built based on the worst historical case.

Invest for Total Return

There is one thing which all of our retirement income approaches agree upon: Invest for Total Return, not Income. This is counter-intuitive for many retirees. They want to find high yielding bonds, stocks, and funds. Then, they can generate withdrawal income and avoid selling shares.

It sounds like it would be a rational approach. If you want a 5% withdrawal rate, just buy stocks, bonds, and funds that have a 5% or higher dividend yield. Unfortunately, this often doesn’t work as planned or hoped!

Over the years, I’ve invested in everything high yield: dividend stocks, preferred stocks, high yield bonds, Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), Closed End Funds, etc. They can have a small place in a portfolio, but they are no magic bullet.

Problems with Income Investing

  • Value Trap. Some stocks have high yields because they have no growth. Then if they cut their dividends, shares plummet. Buy the highest dividend payouts and your overall return is often less than the yield and the share price goes no where. (Ask me about the AT&T shares I’ve held since 2009 and are down 14%.)
  • Default risk. Many high yield investments are from highly levered companies with substantial risk of bankruptcy. Having 5% upside and 100% downside on a high yield bond or preferred stock is a lousy scenario. When you do have the occasional loss, it will be greater than many years of your income.
  • Poor diversification. High yield investments are not equally present in all sectors of the economy. Often, an income portfolio ends up looking like a bunch of the worst banks, energy companies, and odd-ball entities. These are often very low quality investments.

Instead of getting the steady paycheck you wanted, an income portfolio often does poorly. When your income portfolio is down in a year when the S&P is up 10-20%, believe me, you will be ready to throw in the towel on this approach. Save yourself this agony and invest for total return. Total return means you want capital gains (price appreciation) and income.

For investors in retirement accounts, there is no tax difference between taking a distribution from dividends versus selling your shares. So, stop thinking that you need to only take income from your portfolio. What you want is to have a diversified portfolio and a good long-term rate of return. Then, just make sure you are able to weather market volatility along the way.

Read more: Avoiding The High Yield Trap

Ahead in the Series

Each of the retirement income approaches we will discuss have their own Pros and Cons. We will address each through looking at how they address the risks facing retirees: Sequence of Returns Risk, Longevity Risk, and Inflation Risk. And I’ll have recommendations for which may make the most sense for you. In the next four posts, I’ll be explaining SPIAs, the 4% Rule, a Guardrail Approach, and 5-Year Buckets.

Even if you aren’t near retirement, I think it’s vitally important to understand creating retirement income. Retirement income establishes your finish line and therefore your savings goals. If you are planning on a 4% withdrawal rate, you need $1 million for every $40,000 a year in retirement spending. Looking at your monthly budget, you can calculate how much you will need in your nest egg. Then we can have a concrete plan for how much to invest and how we will get there. Thanks for reading!

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maximize FAFSA financial aid

Maximize FAFSA Financial Aid

Posted On October 25, 2020 By Scott Stratton, CFP(R), CFA In College Savings /  

We are going to discuss three specific strategies:

  • Moving Assets from reportable sources to non-reportable locations
  • Reducing cash by paying down debt
  • Avoiding assets in the child’s name

Before we get to the details, a few caveats. First, some of the expected family contribution is based on the parent’s income. If you have a high income, your reported assets may not make a big difference in financial aid. Second, it’s possible that the college’s solution to your financial need will be to offer more loans, rather than a scholarship. We want to be careful about taking large loans for college, as these are increasingly becoming a significant burden for students and parents. Some schools have a generous amount of need-based financial aid available and at those schools, these strategies may increase the scholarships your student receives.

Non-Reportable Assets on the FAFSA

Non-reportable assets include:

  • All Qualified Retirement Accounts, such as 401(k), 403(b), IRA, Roth, SEP, and SIMPLE plans
  • Your home
  • Small businesses
  • Household items and personal possessions

If you are planning on a child going to college in a few years, you may want to put as much as you can into your non-reportable assets, such as retirement accounts, and not into a savings account or taxable investment account. If you have a lot of cash, look at maximizing your 401(k) and IRAs to shift your investments into retirement accounts.

Paying Down Debt

If you have credit cards, car loans, or a home mortgage, that debt does not get considered on the FAFSA. Your cash, however, will be counted towards your expected Family Contribution. If you want to maximize your eligibility for student aid, you could pay down debt. This will reduce the cash you have as a reportable asset. And your home, cars, and personal assets are not considered on the FAFSA.

Obviously, you want to make any changes well in advance of applying for financial aid and make sure you keep enough cash for your emergency fund.

Avoid Assets in the Child’s Name

Assets of the child will have an expected contribution of 20% a year, whereas an asset of the parent has a maximum contribution of 5.64%. Having a lot of money in the name of a college kid will reduce their financial aid eligibility. This is a problem with the UGMA account for minors – colleges expect that this account will be fully available for tuition and expenses.

If your pre-college student has earned income, it may be preferable to put their assets into a Roth IRA than into a savings account. In the year of the FAFSA application, a retirement contribution is typically counted as eligible income, but not as a reportable asset. The assets in a Roth IRA accumulated before college are not a reported asset. This way, the money your child earns before college can start to grow for them and not get sucked into college expenses.

College funding is an important part of financial planning. A lot of people think college planning means getting a 529 plan. There is more to it than just 529 plans. By managing your reportable assets, you can maximize your FAFSA financial aid.

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Questions to Ask a Financial Advisor

Questions To Ask A Financial Advisor

Posted On October 20, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning /  

I recently saw an article on 10 Questions to Ask a Financial Advisor, as a way to interview prospective advisors. The article is on point, and I hope that future clients will ask me these questions. Doing so will enable them to understand my process and recognize the value I can provide. Let me save you the time by providing my answers here.

1. Are you a Fiduciary?

Yes, I am a Fiduciary. I am legally required to place client interests ahead of my own. As an independent Registered Investment Advisor, I am not tied to any single company or product. My goal is to do the best I can to help every client.

2. How do you get paid?

On portfolios above $250,000, the asset fee is 1% a year. This is charged at the beginning of each quarter, at 0.25%. For clients who just want a financial planning engagement (without $250,000 in investments), the quarterly cost is $2500. My clients know exactly how much they pay me and have the right to leave at any time if they are unsatisfied. By charging an annual fee on the value of your portfolio, our incentives are aligned. If your account goes up, I get paid a bit more. And if your account goes down, I make less. I think this is mutually beneficial and creates accountability. My goal is to have a long-term relationship with each client.

Read more: The Price of Financial Advice

3. What are my all-in costs?

Aside from the fee described above, I do not charge any other fees, planning charges, or receive investment commissions. The core of our portfolios are low-cost funds from companies like Vanguard, iShares, and SPDRs. We build portfolio models in-house, so you will never be charged an outside management fee or “wrap” fee. Some other firms will charge you $2,000 for an initial plan, followed by a 1 to 1.5% management fee, and then outsource your portfolio to someone else who will ding you another 1% to manage your investments! Our focus is on keeping your investment costs low.

4. What are your qualifications?

I hold the Certified Financial Planner (CFP) and Chartered Financial Analyst (CFA) designations. I received a Certificate in Financial Planning from Boston University. Since 2004, I have been a full-time financial advisor. Before that, I taught at several colleges and approach my practice as an educator. My academic background includes a Bachelors degree from Oberlin College, and a Masters degree and Doctorate in music from the University of Rochester.

You should also look up an advisor on the SEC’s Investment Advisor Public Disclosure website to check if they have any disciplinary record, bankruptcies, or legal settlements. I do not.

5. How will our relationship work?

Planning comes first. A financial plan can help you see your goals clearly and develop concrete steps to achieve them. Investment policy is the product of financial planning so it has to be second. I work with a small group of families so I can do my best work and provide a high level of service. Financial planning is a long-term process, not a once and done event.

We begin with an in-depth Discovery Meeting to learn both the quantitative details about your financial situation as well as the qualitative goals, needs, and preferences you have for your money and your life. We will gather statements, tax returns, and other documents to analyze. All clients will complete a Finametrica Risk Profile and we will go over the results together. Based on your objectives, we use a modular planning process to address the areas which are most important and relevant to your situation.

In the first year, we have a lot of work to do in establishing your plan. Starting in year two, we will meet twice a year for monitoring and ongoing planning. I encourage clients to reach out to me whenever they have questions about financial topics or if their situation changes.

6. What’s your investment philosophy?

Investors are best served by a passive, long-term investment strategy. Our role is to manage a diversified, target asset allocation for buy and hold investors. We create and manage a series of Portfolio Models to meet the differing needs and risk preferences of our clients.

Within each Portfolio Model, we employ a Core + Satellite investment strategy. Core holdings are low-cost Exchange Traded Funds, in primary categories such as US Large Cap Stocks, US Small Cap Stocks, International Developed Equities, Investment Grade Bonds, and Cash. Satellite holdings are more tactical and may vary from year to year depending on their relative value and attractiveness. Satellite positions may include ETFs, mutual funds, or alternative investments, such as Emerging Markets, Real Estate, Commodities, Preferred Stocks, Convertible Bonds, Floating Rate Income, or other categories or strategies.

We do not believe that we can add value through market timing, picking individual stocks, sector rotation, or speculative strategies. We see little evidence that such strategies are beneficial for investors, especially when we consider the additional risks associated with them.

7. What asset allocation will you use?

Our models include the target allocations below, to be determined by your situation. Each model typically has 10-15 Exchange Traded Funds or Mutual Funds and is diversified across thousands of securities.  

  • Ultra-Equity: 100% Equity / 0% Fixed Income
  • Aggressive: 85% Equity / 15% Fixed Income
  • Growth: 70% Equity / 30% Fixed Income
  • Moderate: 60% Equity / 40% Fixed Income
  • Balanced: 50% Equity / 50% Fixed Income
  • Conservative: 35% Equity / 65% Fixed Income

8. What investment benchmarks do you use?

We use two benchmarks: for stocks, the MSCI World Index Total Return, and for fixed income, the Barclays US Aggregate Bond Index.

Read more: How a Benchmark Can Reduce Home Bias

9. Who is your custodian?

Charles Schwab & Co. will hold your accounts. We think it is a beneficial arrangement where you can work with an independent fiduciary advisor, and also have the strength, low-cost, and technology from one of the largest financial institutions in the world.

10. What tax hit do I face if I invest with you?

We will look at your individual situation and carefully consider taxes in our transfers, trades, and investment strategy. Working with high-net worth families, we aim for tax‐efficiency through the implementation of asset location, low‐turnover funds, tax loss harvesting, and tax‐favorable investment vehicles. We rebalance portfolios typically once a year, to avoid creating short-term capital gains.

Read More: 9 Ways to Manage Capital Gains

Have other questions for me? Drop me a note! I’m happy to chat.

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