Have stocks risen too fast?

Have Stocks Risen Too Fast?

Posted On July 19, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /  

Many investors today are asking, Have stocks risen too fast? We’ve had a terrific rebound off the lows of March and US stock indices are largely back in positive territory for the year. It has been quite a roller-coaster ride.

Unfortunately, uncertainty about Coronavirus remains high. We have neither a cure nor do we have the contagion under control in the US. The economic fallout from unemployment, consumer spending, and falling corporate profits remains unknown. It’s easy to make a case that the stock market has gotten ahead of itself and is being too optimistic.

That could be the case. But we shouldn’t be surprised that stocks are up. The stock market is a leading economic indicator. Traders are betting on things that they expect to happen, not waiting to respond to things that have already happened. Yes, the market is pricing in things improving. And if the market is wrong, stocks could respond negatively.

What should investors do? Run for cover? Buy gold and guns? No, I don’t think we should attempt to time the market. Trades based on what we think might happen in the next 12 or 24 months are not likely to add any value, in my opinion.

While our approach is focused on long-term results, I do not think investors should be complacent today. There are steps we are taking, without trying to bet on the short-term direction of stocks. Here are six strategies:

Stock Strategies for Today

  1. Rebalance. When there’s a big move in the market, up or down, rebalance to your original allocation. This creates a process to buy low and sell high.
  2. Re-examine your risk profile. Did the March collapse make you realize that your portfolio is too aggressive? If so, let’s take a closer look at your overall risk profile. This shouldn’t be guesswork. We use FinaMetrica, a leading Psychometric evaluation tool, to measure each client’s risk tolerance. If you should be less aggressive, now is a good time to make trades. Not when there is panic like March.
  3. Consider your return requirement. Two people could have the same risk tolerance. But if one has $100,000 and the other has $2 million, it is possible that they need different returns to meet their goals. One might need growth and the other might favor more stability and income. You only need to get rich once.
  4. Add alternative sources of return. The more we can diversify your portfolio, the better. Investments that have a lower correlation to stocks and less volatility can help create a smoother overall performance. That’s why we have taken the time to educate our clients about investments such as Preferred Stocks and Convertible Bonds.
  5. Look to lagging parts of the stock market. US Large Cap Growth is leading the rebound since March. Other areas are not yet back to even. For example, international stocks, or US Mid Cap Value. Today, some parts of the market are more expensive than others. If all you are doing is buying the best recent performers, you are looking in the rear view mirror. Instead, look at the fundamentals. Which stocks are less expensive today and a better relative value going forward?
  6. Lower your expense ratio. If your expected return on stocks is less today, a lower expense ratio will help you keep more of the market’s returns. That’s a big advantage of Index Funds. But we also like actively managed funds from companies like Vanguard, who recognize the importance of low costs.

Fixed Income

As you are worrying if stocks have risen too fast, don’t neglect your fixed income. Yields are way down in 2020. The good news is that the price of bonds has risen, which has helped your portfolio. Now, the problem is that people aren’t looking at the current yields. Money markets are yielding 0.01%. The five year Treasury Bond was at 0.22% this week. Your Investment Grade bond fund may be at 1.25% or less.

What worked in fixed income over the last 1-2 years is unlikely to produce much return going forward. We have ideas to upgrade the yields on your fixed income – from cash to intermediate bonds – while maintaining your credit quality and risk. That won’t have any impact on what stocks do, but your fixed income can create safety and income that gives you a smoother portfolio result.

The fact is that no one knows if stocks have risen too fast. It’s unknowable. We should resist the temptation to try to time the market today. We prefer to focus on what we can control: our asset allocation, good diversification, implementing portfolio alternatives, and keeping expenses and taxes low.

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2020 RMDs

2020 RMDs Fixed

Posted On June 27, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

At the end of March, the CARES Act waived 2020 RMDs (Required Minimum Distributions) from retirement accounts. This will help people who do not need to take distributions. They can leave their IRAs alone and not be forced to take a taxable withdrawal while the market is down.

Unfortunately, this change created a couple of problems. People could have started their 2020 RMDs as early as January 1, but the waiver didn’t occur until late March. Some people set up monthly distributions from their IRA, but can only put back one, due to the rules regarding 60-Day Rollovers. Later, the IRS said that if you took a withdrawal between February 1 and May 15, you could put it back before July 31. But that left out people who took RMDs in January.

This week, the IRS corrected both of those situations with IRS Notice 2020-51. The ruling will provide relief for anyone who wants to put back their RMDs taken after January 1. You have until August 31 to roll them back into your IRA. Also, if you took multiple withdrawals, you can put them all back. That’s because this one-time rollover is not going to be considered a 60-Day Rollover. (You con only do ONE 60-day rollover in a 365 day period.)

Also, Inherited IRAs (Stretch or Beneficiary IRAs) were never allowed to do 60-day rollovers. Under this week’s ruling, if you had taken your RMD from an Inherited IRA, you can put now return the money to the account through August 31. Unprecedented!

As a reminder, the age for RMDs increased to 72, from 70 1/2, last year. It’s good that the IRS has provided relief from the quagmire Congress created with CARES Act changes in March. So, if you don’t want to take an RMD, you don’t have to. And now you can reverse your RMDs if you had already started.

Planning Opportunities

Currently, tax rates are low, but the Federal rates are supposed to sunset after 2025. So, if you have a choice between paying some taxes now at 12% or 22% that might be better than paying 15%, 25%, or more down the road. Also, if you anticipate needing to take more than your RMD next year, you might be better off spreading that amount over 2020 and 2021, if it will keep you in a lower marginal tax bracket.

Another opportunity afforded by the 2020 RMD waiver is to do a Roth Conversion. If you had planned to pay the taxes on a $50,000 RMD, you could do a $50,000 Roth Conversion instead. Once in the Roth, your $50,000 is growing tax-free with no future RMDs. You paid some taxes at today’s lower rates, and reduced your future RMDs by doing a conversion in 2020.

A Roth Conversion does not count towards your RMD amount. So for people over 72, most never want to do a conversion because they are already paying a lot in taxes on their RMD. It’s best to do conversions after you retire – and are in a low bracket – but before you start RMDs. For people who missed that window, 2020 is the year to do a Roth Conversion.

Retirement Income Expertise

Creating tax-efficient retirement income is our mission and passion. If you want professional advice on establishing your retirement income plan, we can help. Here’s how:

  • We stay informed. Rules regarding your IRAs and 401(k) accounts have actually seen significant changes in the past couple of years.
  • Tools, not guesses. We analyze the likelihood of success of your retirement income plan through MoneyGuidePro. You will create a baseline scenario, which we will monitor and adjust based on market changes.
  • Asset location. Improving tax-efficiency through placing investments which generate ordinary income into tax-deferred accounts, and keeping long-term capital gains and qualified dividends in taxable accounts. Research and select more tax-efficient investment vehicles.
  • Sequence of Withdrawals. Determine the optimal order of withdrawals by account type and asset. Evaluate when you begin Pension payments and Social Security.

I suspect that there are not a lot of my readers who need to put back RMDs from January and are impacted by Notice 2020-51. But, I do have clients in this exact situation, and this type of detailed work is how I can add value to your financial life. Whether you are already retired, soon to be retired, or it’s just a dream at this point, we can create a plan to take you through the steps you need to feel comfortable about retirement.

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Investing During Coronavirus

Investing During Coronavirus

Posted On June 21, 2020 By Scott Stratton, CFP(R), CFA In Behavioral Finance, Portfolio Management /  

Investing during Coronavirus has exposed many flaws in portfolios, investor behavior, and advisor services. There’s a saying that everyone is a genius in bull market. Unfortunately, the previous 10 glorious years in the stock market masked a lot of risks for investors.

Since the March stock market crash, investors are discovering these problems and realizing that their portfolios may need a tune-up. Here are 9 investment pitfalls which were exposed by the Coronavirus.

9 Investment Pitfalls

  1. No Risk Analysis. Don’t wait until a Bear Market to assess what level of risk is appropriate for you and your goals.
  2. No target asset allocation. You can not rebalance if you do not begin with an objective such as a 60/40 or 70/30 allocation.
  3. Not diversified. Being concentrated in individual stocks or sectors can create wildly different results than the overall market. Diversification is valuable.
  4. Changing Direction. In March, investors wanted to sell at the low. However, in hindsight, they should have been buying. Stick with your plan and resist the temptation to time the market.
  5. Performance Chasing. We want to believe that the best strategies in the recent years will remain winners. Evidence, however, suggests that top active funds are unlikely to continue to outperform.
  6. Not using Index Funds. Everytime there is a crisis, I hear the argument that active fund managers can be more defensive than an index fund. However, when I look at industry data, such as SPIVA, the majority of active funds still have worse long-term results than their benchmark.
  7. Ignoring expenses and taxes. We can often create significant savings in expenses and taxes with good planning.
  8. Only focusing on investment returns. Investing is important, but your financial plan should address more. What about your savings rate, debt management, emergency fund, employee benefits, life insurance, estate planning, or college savings goals?
  9. Bad service from an advisor. Are you getting rebalancing, monitoring, and adjustments to your portfolio? Are you receiving timely financial planning advice? Is your advisor available to meet and able to add value?

Financial Planning Process

What investors need to understand about investing during Coronavirus are the benefits of a financial planning process. There is a science to financial planning and portfolio management. That is to say, there are best practices and important steps which individual investors often miss on their own. We can’t avoid market volatility, but having a disciplined process can make sure you are well prepared to avoid these nine problems.

Read more: Good Life Wealth Management Financial Planning Process

Why Good Life Wealth Management?

  • Fiduciary: our obligation is to place client interests first.
  • Fees, not commissions. Transparent costs means you know exactly what and how we are paid. As a result, we think this better aligns our interests, reduces conflicts of interest, and benefits clients with independent ideas.
  • CFP(R) Professional. Only about 25% of advisors in the industry hold the Certified Financial Planner designation. For more than 30 years, CERTIFIED FINANCIAL PLANNERâ„¢ certification has been the standard of excellence for financial planners. CFP® professionals have met extensive training and experience requirements, and commit to CFP Board’s ethical standards that require them to put their clients’ interests first. That’s why partnering with a CFP® professional gives consumers confidence today and a more secure tomorrow.
  • CFA, Chartered Financial Analyst. The CFA Program provides a strong foundation in advanced investment analysis and real-world portfolio management skills. CFA charterholders occupy a range of investment decision-making roles, typically as a research analyst or portfolio manager. 

When you have an important need, you seek professional advice. Our process is designed to help you achieve your financial goals and avoid the pitfalls that are often not seen until a crisis occurs. Did March reveal some problems with your portfolio and your financial plan? If so, give me a call and we can help you get back on track.

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Become a Wealth Builder

Become A Wealth Builder

Posted On June 15, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning /  

Is this a terrible time to become a wealth builder? With market uncertainty from the Coronavirus, and the very real destruction of jobs and income, it’s easy to dispair. But you shouldn’t and here’s why.

There remains a unique opportunity in America to become financially independent. Building wealth is a slow process that requires patience, discipline, and smart decisions. But once that process has begun, it is simple. And by simple, I mean not complex. That’s not to say it is easy! Like running a marathon, it’s a long haul, but it is also just one step at a time.

You can begin those steps today. We offer two programs at Good Life Wealth Management. Our Premier Wealth Management program provides holistic financial planning and tactical asset management for investors with assets over $250,000. The Wealth Builder Program is designed for investors who are starting out and have less than $250,000 to invest. In fact, many of my clients in the program start with zero dollars to invest with me.

You can read more about the Wealth Builder Program here. Today, I want to share three reasons why now is a great time to start the process.

Long-term Expected Returns

Investing should be a 30+ year process, but people are so focused on the month to month volatility. Don’t! It’s noise that will distract from your goals. The Vanguard Capital Markets Model, projects the following expected annualized returns for the next 10 years (as of June 3, 2020):

  • US Large Cap 5.4% to 7.4%
  • US Small Cap 6.2% to 8.2%
  • International Equity 8.5% to 10.5%

That’s not bad. Will Vanguard be right? No one knows. But I do know that leaving your money in a bank account earning 0% won’t grow. If you have more than 10 years until retirement, history suggests you are likely to be wise to invest. And if the market does drop, that is often a great buying opportunity for investors in Index Funds. Stick with diversified funds, and Dollar Cost Average with monthly automatic contributions.

Consider Inflation

Right now, there is no inflation and the concern in the near months is deflation. However, globally, governments are expanding the supply of money and taking on new debt at an unbelievable pace. How will economies be able to repay all this debt?

There are a couple of possible scenarios. Some smaller countries will default and not repay their debt. Some will introduce austerity measures, slash spending, and raise taxes. This will be very unpopular. I think the preferred way for many developed economies will be to try to gradually inflate out of debt. That is to say, it is easier to repay a fixed dollar amount of debt as the GDP and taxes of a country grows. So, some inflation will be good and very welcome.

Inflation does not help consumers, as the cost of living increases. We also have very low interest rates today, which penalizes savers. But if the eventual scenario is modest inflation, it will benefit borrowers like the government. People who hold cash – nominal dollars – will see their purchasing power decline with inflation. Wealth Builders investing in stocks and real assets are more likely to see their net worth grow in times of inflation.

Positive Wealth Building Habits

Over the past 16 years as a Financial Advisor, I’ve met many people who are financially independent and observed their personal characteristics. Successful investors are not necessarily smarter than everyone else, but they usually are optimistically committed to good savings habits.

We’ve certainly had bad times in the past 20 years. It hasn’t been an easy road. We had the Tech bubble, followed by 9/11, and struggled with an unprecedented three down years in a row. The Death of Equities? No. We had the housing bubble and crash in 2008-2009. Was that the end of investing? No.

There are times when you have big drops and it’s ugly. Today, people may be thinking that the world is going to hell in a handbasket and that investing now would be pointless. But that is exactly what investors over the past 20 years faced, and it turned out fine. That’s why I think it’s important to educate yourself on history and think positive. Create wealth building habits now without worrying about what is going to happen in the rest of 2020.

  • Make automatic contributions to your accounts like a 401(k) or IRA. Dollar Cost Average and keep investing.
  • Diversify. Consider Index Funds as core holdings. Evidence shows that a majority of active funds underperform their benchmark over 5 or more years.
  • Don’t get greedy. Chasing performance can hurt returns. Avoid speculating on individual stocks, sectors, or countries.
  • You cannot control what the market does. Your goal should be to be a participant in the market, not to try to get in and out of the market.
  • Focus on what you can control: your mix of investments (asset allocation), and keeping taxes and expenses low. Rebalance.
  • Live beneath your means. Keep your housing and car expenses down and create the room in your budget to save. Increase your savings rate over the years, not your lifestyle expenses.

Conclusion

In spite of today’s uncertainty, there are reasons why young people need a plan to become a wealth builder. Long-term equity expected returns are still attractive, especially relative to cash and 10-year bonds. If you anticipate inflation picking up over the next several decades. you want to be invested for growth. Good savings and investing habits can create wealth over time. The more years you have, the earlier you start, the more chance to compound your returns. Eventually, your money will work for you.

In our Wealth Builder Program, we begin with a Balance Sheet to quantify all your assets and liabilities. For many young professionals, this often starts as a negative number. We will track your net worth and create a plan to save, invest, and grow your wealth. We will address risks to you and your family and develop a plan that’s unique to your situation.

Yes, you can always wait for tomorrow. A decade ago, we had just come out of a crash. As of May 31, 2020 the 10-year annualized return of an S&P 500 fund (SPY) is 13%. Were people wildly optimistic 10 years ago about the opportunity to invest? No. There’s never that degree of confidence and certainty. You just have to get started and commit to making it work. Ready to become a wealth builder? Email me for information.

Past performance is no guarantee of future results. Investing involves risk of loss of capital. Dollar cost averaging cannot guarantee against a loss.

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Unplanned Retirement

Unplanned Retirement

Posted On May 31, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

With job losses this year reaching 40 million, many Americans are being forced into an unplanned retirement. Maybe they wanted to work until age 65 or later and find themselves out of work at age 60 or 62. Job losses due to Coronavirus layoffs may be the most common reason today. However, many people also enter early retirement due to their health or to care for a spouse or parent.

Each year, the Employee Benefits Research Institute publishes a Retirement Confidence Survey Report. Here are some findings from their 2020 report published in April:

  • 48% of current retirees retired earlier than they had planned. Only 6% retired later than they originally planned.
  • Less than one-half of workers have tried to calculate how much money they will need to live comfortably in retirement.
  • Of workers who reported their employment status would be negatively effected by the Coronavirus, only 39% felt confident that they will have enough money to last their entire life.

Half of all retirees retired at a younger age then they had planned. That statistic has remained very consistent over the years. In the 1991 report, it was 51%. This is a reality that more people should be preparing for. If you want to retire at 65, 70, or “never”, will you be prepared if you end up retiring at 64, 60, or 55? Certainly, if you enjoy your work, keep on working! But sometimes, the choice is not ours and people find themselves in an early, unplanned retirement.

If you have lost your job or just want to be better prepared should that happen, you need to plan your retirement income carefully.

Unplanned Retirement Steps

  1. You should begin with a thorough and accurate calculation of your spending needs. Not what you want to spend but what you actually spend. Determine your health insurance costs until age 65 and for Medicare after age 65, including Part B premiums, and Medicare Advantage or Medigap coverage, and Part D prescription drug coverage. Read more: Using the ACA to Retire Early.
  2. Reduce your expenses. This will require setting priorities and determining where you can do better. Still, there may be some low hanging fruit where you can save money with little or no change in your lifestyle. Read more: Cut Expenses, Retire Sooner
  3. Calculate your sources of retirement income. Read more: When Can I Retire?
  4. Be careful of starting Social Security at age 62. This is very difficult for people to not access “free money”, everyone wants to do it. Be sure to consider longevity risk and the possible benefits of spending investments first and delaying Social Security for a higher payout later. Read more: Social Security, It Pays to Wait
  5. Consider going back to work, even part-time, to avoid starting retirement withdrawals. The more you delay your retirement, the more likely you will not run out of money later. Here’s the math on why: Stop Retiring Early, People!

Be Prepared for the Unexpected

I think the best way to survive an unplanned retirement is to achieve financial independence at an early age. If you could retire at 50, plan to work until 65, and end up retiring at 60, it’s no problem. This requires saving aggressively and investing prudently from an early age. And that’s why retirement planning isn’t just for people who are 64. Retirement planning should also be for people who are 54, or 44, or even 34. Plan well, and an early retirement could be a good thing. It’s your chance to begin a new adventure!

If – surprise! – you do happen to be facing an unplanned retirement, let’s talk. We can help you evaluate your options for retirement income and establish a process and budget. Our retirement planning software can help you make better informed decisions, including when to start benefits, how much you can withdraw, and if you have enough money to last your lifetime.

It certainly is a shock to people when they end up retiring earlier than they had originally planned. However, it is very common and about half of all retirees are in the same situation. Unfortunately, not everyone who has an unplanned retirement will be having the comfortable years they had hoped. Basing your retirement on the assumption that you will work until age 70 or later may not be realistic. It could even set you up for failure if you end up needing to retire early. Whatever your age, retirement planning is too important to not seek professional help.

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Adding Convertible Bonds

Adding Convertible Bonds

Posted On May 24, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

This week, we are adding Convertible Bonds to our Premiere Wealth Management portfolios. This will shift 2-6 percent of portfolios from equities to our Alternative Investments sleeve. What are convertible bonds and why now?

Convertible bonds and are unique in that they have an option to convert from a bond into shares of stock of a company. Why would you want to do that? Let’s say a $1,000 bond has an option to convert it into 20 shares of stock. That would give a convert price of $50 a share. If the stock price stays at $40 a share, you would just let the bond mature and get back your $1,000 in principal. But if the stock price rises to $60 a share, you could convert your $1,000 bond into 20 shares. Then you could sell the shares for $60 a share, or $1,200. And while you wait, the bond pays interest.

Benefits of Convertible Bonds

Why do companies offer convertible bonds? There are a couple of benefits to the company:

  • Convertible bonds typically pay lower interest rates since there is also potential upside for investors. This saves the company on interest costs versus issuing regular bonds.
  • If the bonds do convert to stock, the company issues new shares and does not have to use cash to pay back the loan. Imagine borrowing $100 million and then paying it off by issuing stock!
  • Compared to issuing new shares right away, a convertible bond delays diluting existing shareholders for several years. The interest expense is deductible for the company, whereas paying a stock dividend would not.

Here are the benefits for investors of convertible bonds:

Other Considerations

What are the risks of convertible bonds?

  • Companies who issue convertible bonds can be lower credit quality, and more than half do not carry a credit rating. Some of these bonds will default.
  • The volatility of convertibles can be closer to stocks than it is to high quality bonds like Treasury Bonds. Once the stock price is above the convert price, the price of the bond will be about as volatile as the stock.

How to invest in Convertible Bonds?

Because Convertible Bonds are closely related to equities, I consider them more of a substitute for stocks rather than fixed income. For this reason, we reduced equities to purchase a Convertible Bond Fund. I would recommend buying a fund rather than individual bonds. The fund can research the credit quality of unrated issuers and will diversify into a large number of bonds.

The fund we are adding has a 27-year track record and a five-star rating from Morningstar. Here is the most recent quarterly fact sheet on the fund. We will invest in the Institutional Share class, which has a lower expense ratio. Typically, investors would need $1 million to buy the institutional shares, but I can buy shares for my clients as a Registered Investment Advisor.

Why now?

We have had a very strong rebound in stocks markets since the lows of March. While there are a lot of reasons for optimism, the economic recovery from the Coronavirus seems to be priced into stocks. Bond yields are near zero, and offer little return potential compared to stocks. In this environment, I would like to add alternative investments that might offer returns better than bonds, but with less downside risk than stocks.

Currently, we have 10% allocated to Alternatives, using Preferred Stocks and a Hedge Fund replication strategy. Adding Convertible Bonds, our target weighting in Alternatives will be to 12-16 percent. No one can predict what markets will do in the near future. What we can do is to diversify our sources of return and risk. We can evaluate which investments have offered effective risk-adjusted returns historically and how they might work today. If you have questions about investing during the Coronavirus, please send me a message.

Past performance is no guarantee of future results. Investing in convertible bonds carries risk of loss.

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Safe Investing During Deflation

Safe Investing During Deflation

Posted On May 17, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

How do you begin to think about safe investing during deflation? Last week, the US Bureau of Labor Statistics reported that the CPI-U fell 0.8% in April. The Consumer Price Index is a basic measure of inflation and has almost always been positive throughout US History. Deflation is not a good environment for building wealth.

While this could be a temporary blip due to falling energy prices in April, we certainly are not out of the woods from the economic damage of the Coronavirus. With 20.5 million people filing for Unemployment in the last two months, there could be an extended reduction in consumer demand. And we know from Econ 101 that when demand shifts down, there becomes an oversupply of goods, and prices fall. That’s deflation.

I think that any deflation will be temporary and that the global economy will recover. But the amount of time this takes could be anywhere from months to years. And while I am studying projections of the depth and duration of this likely recession, my readers know what I think about expert predictions. They are wildly inaccurate. Trying to time the market based on economic predictions is likely to do worse than staying the course.

Deflation Is Anti-Growth

What might deflation mean for investors? Historically, stocks do poorly during deflationary periods. Commodities and Real Assets also can lose value. If millions of people lose their jobs and income, how are they going to afford a mortgage and buy a house? We know from 2008 that house prices can go down when people cannot buy houses.

No one has a crystal ball to know what will happen next. But, I think investors can and will want to make small adjustments to their investment portfolios because of the possibility of deflation. With the market rebounding incredibly well from the March lows, the upside versus downside potential in the near term has worsened.

It is okay to want to have some of your investments in a safe asset. The challenge that we discussed in the previous blog is that we are near zero percent interest rates today on cash, CDs, and Treasury Bills. While this would technically preserve purchasing power in a deflationary environment, we can do better and should be looking to grow.

Fixed Annuities For Capital Preservation

My suggestion for a safe yield today: fixed annuities. This week, I had a client purchase a 5-year annuity at 2.9%. That is 2.6% higher than a 5-year Treasury bond today (0.307%). Both are guaranteed, yet the annuity gets a bad rap. Sometimes, an annuity is the right tool for the job. Sometimes, it is not. Unfortunately, because some unscrupulous salespeople sold annuities which were unsuitable for the buyers, investors have negative perceptions.

I keep bringing them up because they are an objectively effective fixed income solution that many savers would appreciate. Because I want every investor to make informed decisions, here is what you need to know about Fixed Annuities.

Annuity Basics

  1. An annuity is issued by an insurance company and is a contract between the company and you. There are many flavors of annuities, but the kind I am discussing today are Fixed Annuities, specifically Multi-Year Guaranteed Annuities (MYGAs).
  2. A MYGA has a set term (3, 5, 7, or 10 years commonly) and a fixed rate of return. In this aspect, it behaves similarly to a CD.
  3. An Annuity is a tax-deferred retirement vehicle. You will not pay any taxes on the gains from the annuity, until you withdraw the money. At the end of the term, you can roll into a new annuity and continue to defer the gains. This is called a 1035 Exchange. There are no income restrictions or contribution limits to annuities.
  4. If you withdraw from an Annuity before age 59 1/2, there is a 10% penalty on the gains. Annuities are most popular with investors over 55, but younger people who know they are not going to need the money until retirement can also use a MYGA towards retirement saving. You can invest IRA money (Traditional, Roth, etc.) into an Annuity, too.
  5. There are often large penalties if you withdraw money from an annuity before its term is complete. For this reason, it is very important to have other sources of liquid assets. That way you can remain in the annuity for the full term.
  6. What happens if an Insurance Company fails? Annuities are insured at the State level by a mandatory Guaranty Association. In Texas, all insurers pay premiums to the Texas Guaranty Association, which protects annuity holders up to $250,000. This information is for educational purposes only and is not an inducement to buy insurance. If you have more than $250,000 to invest, spread your money over several insurance companies to stay under the covered limit.

How to Use MYGAs

A MYGA is a good substitute for a bond or bond fund. They offer safety and capital preservation, but with a higher rate of return than cash, CDs, or T-Bills available today. While there are some corporate and municipal bonds with higher yields, they are generally not guaranteed and carry risk that the issuer could default and be unable to pay. That’s especially a problem during deflation, as bankruptcies could increase significantly, causing losses to bondholders.

The main trade-off with MYGAs is the lack of liquidity. We want to keep annuity purchases to a reasonable size. I also recommend creating a 5-year ladder, where you divide your total investment into 5 pieces which will mature in 1,2,3,4, and 5 years. Then in each subsequent year, you will have access to 20% of your investment, should you need it. And what you don’t need, you can reinvest into a new 5-year annuity at the top of the ladder.

Lastly, for transparency, Annuities pay a commission. If someone purchases a MYGA from me, the insurance company will pay me a commission on the sale. I generally view commissions as a conflict of interests. However, I’d point out that a 2.9% yield on a MYGA is the net return to the investor.

There are no investment advisory fees for Annuities. For some reason, I don’t hear very many Investment Advisors mentioning that to their clients when they bash Annuities! I want what is going to be best for you. If that’s an annuity, fine, and if not, that’s fine too. echo The minimum investment on most annuities is $10,000, but if you have a smaller amount, let me know.

Stay Diversified, Increase Safer Positions

Safe investing during deflation can be a challenge. Low interest rates aren’t helping investors. I will continue to recommend diversified portfolios which may have 50% or more in stocks for long-term investors. Still, there is a role for safe investments for most portfolios, and many people may want to have more safe investments. They offer ballast against the risk of stocks and the diversification can give a smoother trajectory to your overall return.

Given the strong rebound we have had from the March 2020 crash, this may not be a bad time to reevaluate your risk profile. If that thought process has you wondering about safe investing during deflation, lets talk about MYGAs. I am an independent agent and can offer annuities from many different companies to find you the best features and rate for your needs.

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Retirement Income at Zero Percent

Retirement Income at Zero Percent

Posted On May 3, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

With interest rates crushed around the world, how do you create retirement income at zero percent? Fifteen years ago, conservative investors could buy a portfolio of A-rated municipal bonds with 5 percent yields. Invest a million dollars and they used to get $50,000 a year in tax-free income.

Not so today! Treasury bonds set the risk-free rate which influences all other interest rates. Currently, the rate on a 10-year Treasury is at 0.618 percent. One million dollars in 10-year Treasuries will generate only $6,180 in interest a year. You can’t live off that.

You can do a little better with municipal bonds today, maybe 2-3 percent. Unfortunately, the credit quality of municipal bonds is much worse today than it was 15 years ago. A lot of bonds are tied to revenue from toll roads, arenas, or other facilities and are seeing their revenue fall to zero this quarter due to the Coronavirus. How are they going to repay their lenders?

Debt levels have risen in many states and municipalities. Pension obligations are a huge problem. The budget issues in Detroit, Puerto Rico, Illinois, and elsewhere are well known. Shockingly, Senator McConnell last week suggested that states maybe should be allowed to go bankrupt. That would break the promise to Municipal Bond holders to repay their debts. This is an appalling option because it would cause all states to have to pay much higher interest rates to offset the possibility of default. And unlike Treasury bonds which are owned by institutions and foreign governments, Municipal Bonds are primarily owned by American families.

With Treasuries yielding so little and Municipal Bonds’ elevated risks, how do you plan for retirement income today? We can help you create a customized retirement income plan. Here are three parts of our philosophy.

1. Don’t Invest For Income

We invest for Total Return. In Modern Portfolio Theory, we want a broadly diversified portfolio which has an efficient risk-return profile, the least amount of risk for the best level of return. We focus on taking withdrawals from a diversified portfolio, even if it means selling shares.

Why not seek out high dividend yields and then you don’t have to touch your principal? Wouldn’t this be safer? No, research suggests that a heavy focus on high yields can create additional risks and reduce long-term returns. Think of it this way: Company A pays a 5% yield and the stock grows at zero percent; Company B pays no yield but grows at 8%. Clearly you’d be better off with the higher growth rate.

When you try to create a portfolio of high yield stocks, you end up with a less diversified portfolio. The portfolio may be heavily concentrated in just a few sectors. Those sectors are often low growth (think telecom or utilities), or in distressed areas such as oil stocks today. The distressed names have both a higher possibility of dividend cuts, as well as significant business challenges and high debt.

The poster child for not paying dividends is Warren Buffett and his company, Berkshire Hathaway. He’s never paid a dividend to shareholders in over fifty years. Instead, he invests cash flow into new acquisitions of well-run businesses or he buys stocks of other companies. Over the years, the share price of BRK.A has soared to $273,975 a share today. If investors need money, they can sell their shares. This is more tax-efficient, because dividend income is double taxed. The corporation has to pay income taxes on the earnings and then the investor has to pay taxes again on the dividend. When a company grows, the investor only pays long-term capital gains when they decide to sell. And the company can write off the money it reinvests into its businesses.

2. Create a Cash Buffer

Where a total return approach can get you into trouble is when you have to sell stocks in a down market. If you need $2,000 a month and the price of your mutual fund is $10/share, you sell 200 shares. But in a Bear Market when it’s down 20%, you’d have to sell 250 shares (at $8/share) to produce the same $2,000 distribution. When you sell more shares, you have fewer shares left to participate in any subsequent recovery.

This is most problematic in the early years of retirement, a fact which is called the Sequence of Returns Risk. If you have a Bear Market in the first couple of years of retirement, it is more likely to be devastating than if you have the same Bear Market in your 20th year of retirement.

To help avoid the need to sell into a temporary drop, I suggest keeping 6-12 months in cash or short-term bonds so you do not have to sell shares. Additionally, I prefer to set dividends to pay out in cash. If we are receiving 2% stock dividends and 2% bond interest, and need 4% a year, we would have to sell just two percent of holdings. This just gives us more flexibility to not sell.

Also, I like to buy individual bonds and ladder the maturities to meet cash flow needs. If your RMD is $10,000 a year, owning bonds that mature at $10,000 for each of the next five years means that we will not have to touch stocks for at least five years. This approach of selling bonds first is known as a Rising Equity Glidepath and appears to be a promising addition to the 4% Rule.

3. Guaranteed Income

The best retirement income is guaranteed income, a payment for life. This could be Social Security, a government or company Pension, or an Annuity. The more you have guaranteed income, the less you will need in withdrawals from your investment portfolio. We have to be fairly conservative in withdrawal rates from a portfolio, because we don’t know future returns or longevity. With guaranteed income, you don’t have to fear either.

We know that Guaranteed Income improves Retirement Satisfaction, yet most investors prefer to retain control of their assets. But if having control of your assets and the ability to leave an inheritance means lower lifetime income and higher risk of failure, is it really worth it?

I think that investors make a mistake by thinking of this as a binary decision of 100% for or against guaranteed income. The more sophisticated approach is to examine the intersection of all your retirement income options, including when to start Social Security, comparing lump sum versus pension options, and even annuitizing a portion of your nest egg.

Consider, for example, if you need an additional $1,000 a month above your Social Security. For a 66-year old male, we could purchase a Single Premium Immediate Annuity for $176,678 that would pay you $1,000 a month for life. If you instead wanted to set up an investment portfolio and take 4% withdrawals to equal $1,000 a month, you would need to start with $300,000. So what if instead of investing the $300,000, you took $176,678 and put that into the annuity? Now you have guaranteed yourself the $1,000 a month in income you need, and you still have $123,322 that you could invest for growth. And maybe you can even invest that money aggressively, because you have the guaranteed annuity income.

Conclusion

It’s a challenge to create retirement income at zero percent interest rates. Unless you have an incredibly vast amount of money, you aren’t going to get enough income from AAA bonds or CDs today to replace your income. We want to focus on a total return approach and not think that high dividend stocks or high yield bonds are an easy fix. High Yield introduces additional risks and could make long-term returns worse than a diversified portfolio.

Instead, we want to create a cash buffer to avoid selling in months like March 2020. We own bonds with maturities over five years to cover our distribution or RMD needs. Beyond portfolio management, a holistic approach to retirement income evaluates all your potential sources of income. Guaranteed income through Social Security, Pensions, or Annuities, can both reduce market risk and reduce your stress and fear of running out of money. The key is that these decisions should be made rationally with an open mind, based on a well-educated understanding and actual testing and analysis of outcomes.

These are challenging times. If you are recently retired, or have plans to retire in the next five years, you need a retirement income plan. We had quite a drop in March, but recovered substantially in April. The economy is not out of the woods from Coronavirus. I think global interest rates are likely to remain low for years. If you are not well positioned for retirement income, make changes soon, using the strength in today’s market to reposition.

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Coronavirus Market

Coronavirus Market Update

Posted On April 26, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning /  

As we enter the seventh week of shut-downs, we are going to share our Coronavirus Market Update. Let’s look at the numbers and talk about stocks, unemployment, interest rates, oil prices, and government assistance programs.

1. Market rebound

From a low of 2237 on the S&P 500 Index on March 23, we are up 27% to 2836 as of Friday’s close. This is a remarkable bounce. Now the market is down only 12% year to date. I have a couple of thoughts on this:

  • The rebalancing trades I placed in March consisted of selling bonds and buying stocks. Overall, those trades have been profitable and beneficial for clients. At the time, it did not feel good to buy stocks in the midst of such carnage. Rebalancing is usually a contrarian action; we buy when markets are down and sell when markets are up.
  • If you thought the best move in March was to bail out and increase cash, it didn’t work. The market bottom will often be significantly ahead of an economic bottom. The market is a leading indicator. You won’t get an All-Clear to come back into the market.
  • Was that THE bottom? Will we retest lows? I don’t know and it is not predictable. We have up come very far, very fast and as I will discuss below, we are only seeing the tip of the iceberg of the economic fallout. The market has had a 26% move in a month and I am going to rebalance again. Because we made deliberate trades in March, some portfolios may now be overweighted in stocks after this quick rebound. Those trades will happen this week.

2. Unemployment

There have been 26 million unemployment claims since the start of the Coronavirus. Approximately one out of six workers have been laid off and this number excludes most independent contractors. A report from the Federal Reserve Bank of Boston projects that 18% of homeowners and 36% of renters in New England will be unable to make their housing payments.

These levels of unemployment have not been seen since the Great Depression, when unemployment reached 24% in 1933. This will have a ripple effect on consumer spending, defaults on loans, mortgages, and credit cards, the auto industry, real estate prices, and so on. For the economy, this will likely have an impact for at least 12-18 months.

Markets go up when there are more buyers than sellers. That’s it. So, the action over the past month tells you that there is money on the sidelines, in spite of rising unemployment. The wealthy are less wealthy, but they are rebalancing and looking for profits in a strong market. They are also bargain shopping for great companies which may have been trading at multi-year lows in the past month.

3. Oil prices

This week, massive options selling coupled with no buyers caused the May futures contracts for Crude Oil to sink into negative prices. With people not travelling, demand for oil has plummeted. A few countries have flooded the market with oil and current daily production exceeds demand by 20 million barrels a day. Luckily, Texas is more diversified today than just oil companies, but oil companies are taking a hit.

Oil Companies which have borrowed a lot of money for expansion or acquisition are in trouble and may fail. This is creating fear in the bond market, where the spreads on corporate bonds have widened significantly. At the beginning of the year, corporate bonds were trading at yields very close to Treasuries. Not so today, and that creates opportunity to buy bonds of companies with strong balance sheets.

4. Interest Rates

Treasury bill interest rates fell to zero last month, to match zero rates in Europe and Japan. Today, those levels have increased slightly, but remain around 0.13% to 0.20% for maturities of two years or less. Take aways:

  • You can’t fund your retirement with Treasury bonds today – the returns are too low. These rates are way below historical inflation, and even if we are in deflation for the next year, the returns just don’t work with most people’s required rate of return in their retirement projections.
  • You can move from Treasuries to CDs to Fixed Annuities to increase your yield while maintaining a guaranteed, safe return. Treasury rates are being manipulated by Central Banks. As governments take on trillions of new debt, they somehow become a safer credit and their interest rate falls to zero? This is not what a free-market looks like and it is penalizing the heck out of savers and retirees.
  • Individual investors will choose not to own Treasuries. The Fed wants to push investors out of risk-free assets and into risky assets like stocks or real estate.

5. Government Programs

Individuals have been receiving their $1200 stimulus checks. Many small businesses who applied for the Paycheck Protection Program have been shut out as demand for those loans greatly exceeded the $349 Billion allocated. I’ve heard that only companies who applied on the very first day received funds. Apparently, the Treasury favored community banks and therefore you were actually less likely to receive the loan if you applied through one of the large national banks. However, if you have an application pending, Congress is going to fund further loans. Thank you to everyone who reached out to me to discuss their PPP application.

The SBA also offered the Emergency Income Disaster Loans (EIDL). They announced a week ago that they were no longer accepting applications. I applied for this program about 18 days ago and still have not received a reply. They originally said applicants would receive the money in three days. I sent an email about my application and received back a form letter saying they were still processing applications in the order received. Hopefully, this will work! If you applied for any government assistance for your business, please shoot me an email and let me know where things stand for you.

Final Thoughts

The market has had a great rebound in April and it is a big relief. Losses have been cut by 2/3 and many investors have been buying. From my perspective, investors seem less panicked this year than they were in 2000 or 2008. As a result, most have understood that they need to ride things out and that this will pass.

We rebalanced in March and that worked well. It is part of our discipline and we will look at rebalancing again now that we have recovered 26%. This will be done on a portfolio by portfolio basis and will include a careful examination of the tax implications of any trades. Most of the March trades harvested losses, so we can now realize short-term gains up to those levels.

The economy clearly isn’t out of the woods. Unemployment will probably increase in May. These numbers will grow and many families are going to have to tighten their belts. There is a tremendous amount of government support being directed at impacted industries and small businesses. Hopefully, those funds will start to reach companies soon. Investors need to be patient and have a disciplined plan. We will continue to focus on your long-term success and look at ways to reduce unnecessary risk.

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Stimulus Payments to Business Owners

Stimulus Payments to Business Owners

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

As part of the $2 Trillion CARES Act, there are three programs to provide Stimulus payments to business owners. Unlike the 2008 crisis, this time the government is not bailing out the big banks and Wall Street. Instead, Washington is sending cash to self-employed people and small business owners. They are shoveling money out the door to help you pay your bills, keep your workers paid, and still have a business when we eventually emerge from the Coronavirus shutdown. The scale of this is unprecedented and you should make sure to get your share.

We are going to look at three specific programs and give you links to find more information and apply. The three stimulus payments to business owners include: the Paycheck Protection Program, Employee Retention Tax Credit, and the SBA Disaster Grant. You may be eligible for some or all of these programs.

What if you are self-employed or an Independent Contractor, but not a corporation, LLC, or other entity? You are still a business even if you are the only employee. If you file a Schedule C, you have a business. If you have questions, here’s my contact info.

Paycheck Protection Program

The Paycheck Protection Program is providing $349 Billion in loans to small businesses. These loans are designed to keep employees on the payroll and off unemployment. The loans are forgivable. The government doesn’t want you to pay them back, as long as you spend the money to pay employee salaries and benefits in the next eight weeks.

The PPP is available to businesses from 1 to 500 employees. The Small Business Administration (SBA) guarantees the loans, which will be provided through 1700 Banks and Credit Unions. Your bank is probably already an SBA lender. Technically, the PPP is a 2-year loan at 0.50% interest. Payments are not required for six months. If you spend the loan on allowable expenses within 8 weeks, then the loan will be forgiven. You also have to keep the same number of employees and not reduce payroll during this period. The loan forgiveness will be non-taxable. Steps:

  1. Apply for the loan at your bank using Model Application (link below).
  2. Spend the loan in the following eight weeks on payroll, benefits, and rent.
  3. Apply for loan forgiveness and document that the funds were spent as intended.

You must state on the application that your business was impacted by the Coronavirus and you need this money to meet payroll and expenses. This is easy. Most businesses are “non-essential” and were required to close in your area due to the shelter in place rules. Even if you stayed open, you may have had supply disruptions, or other negative impacts to you business.

Loan Amount and Application

The application provides instructions to calculate your loan amount. You are eligible to borrow two and one-half months of payroll, up to $10 million. Payroll includes gross pay plus taxes. Salary eligible for loan forgiveness is capped to $100,000 per person annually.

Then over the next eight weeks, you can spend the loan on payroll, payroll taxes, employee benefits, including health insurance premiums, retirement plan contributions, and sick leave or vacation. You can also spend the money on rent or mortgage interest for your business property (if you have a store or office, for example). Non-payroll expenses cannot exceed 25% of the total.

Eligible businesses includes corporations and LLCs, but also includes non-profit organizations, sole proprietors, and those who are self-employed or independent contractors. Many businesses can apply for the loan starting on April 3, 2020, and Independent Contractors can apply starting April 10. The program will close once the $349 Billion is gone. Don’t delay!

Here is the required application for the Paycheck Protection Program. Your bank should accept this paperwork for the loan. The SBA is paying all the application or service fees for the loan, so it costs you nothing. If you have a business account at Chase, apply here to get in their queue.

Employee Retention Credit

If you own a business with multiple employees, such you should also know about the Employee Retention Tax Credit. It’s another part of the CARES Act. To qualify, you must have either been temporarily closed down due to local regulations or have your gross receipts fall by 50% this quarter versus last year. For business owners with lower income or part time workers, it may be better to use the Employee Retention Credit rather than the PPP. You have to choose one or the other: if you take the PPP you are ineligible for the Employee Retention Credit.

The Employee Retention Credit is for 50% of income per employee up to $10,000 a year. So the maximum tax credit is $5,000 per employee for 2020. Now if your employees will make less than $5,000 in 2.5 months but more than $10,000 for the rest of the year, you would be better off with the ERC versus the PPP. The ERC is not available to self-employed individuals and will apply to income from March 12, 2020 to the end of the year. Full details and eligiblity here on the IRS Website.

In general, I think the PPP is the better option for most businesses, but it would not hurt to run the numbers. Calculate if the Employee Retention Credit would provide you with more funds. Of course, you won’t get the tax credit until you file your 2020 taxes next year. If you need the funds to meet payroll now, then you need the PPP. The ERC is not available to self-employed or sole proprietors.

SBA $10,000 Disaster Grant

The third of the stimulus payments to business owners from the CARES Act is the SBA Disaster Loan program. The full name is the COVID-19 Economic Injury Disaster Loan Application. They have expanded the eligibility to all businesses. You are technically applying for a loan. As part of the loan application, they will advance your business $10,000 of the loan. This is not called a “grant” on the SBA application, even though the CARES Act calls it a grant, so it can be confusing. They will direct deposit the funds into your business account within a week. The $10,000 Grant does not have to be repaid, but if you borrow more than the $10,000, the rest would have to be repaid. You’re not going to believe this, but even if the SBA does not approve your loan, you still get to keep the $10,000.

You can apply online at the SBA website here; it should take less than 20 minutes. On page one, they ask questions about your business eligibility for the Economic Injury Disaster Loan Program. Most will check the first line: “Applicant is a business with not more then 500 employees.” That qualifies you for the grant, even if you are the only employee.

Next, you will certify that you are not in a disqualifying business (i.e. porn). Third, you will give information about your business, including EIN, gross revenues and cost of goods sold for the 12 months to January 31, 2020. Fourth, information about the owner and the bank information for the deposit. Towards the end of the application, there is a box to check if you want to be considered for a $10,000 advance on the loan. CHECK THIS BOX. This advance is the $10,000 grant under the CARES Act. After you submit, it will give you an application number. Print this page or write it down. You do not receive an email confirmation, but you will be notified of the decision by email.

Which to Choose?

Technically, you can apply for both the SBA disaster grant and the PPP. However, they will subtract the disaster grant from your PPP forgiveness amount. The primary reason to do the disaster grant instead of the PPP is if your PPP would be under $10,000. If you need additional loans beyond the PPP’s two months of funding, do both applications. Also, you can apply for the Disaster Grant right now online whereas most banks are struggling to get ready for the PPP application.

Don’t delay in applying for stimulus payments for business owners. There are limited funds in place and some of these programs are first come, first served. I’ve spoken with some clients who are reluctant to take a bailout of their business and are prepared to tough it out. With everyone going to shelter in place, the economy is grinding to a halt. And when you have a service economy, that’s a catastrophic problem. So, please take the money and use it. Pay your employees. Keep buying stuff. Keep funding your retirement accounts. And of course, replenish your emergency fund or increase it. If you don’t need the money, make a donation to your favorite local charity, because they are also hurting from the shutdown.

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