Bonds at a Discount: CEFs on Sale

Posted On November 21, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Since the election, bond yields have risen and prices have fallen in anticipation of increased government spending and an uptick in inflation. The yield on the 10-year Treasury was 2.33% on Friday, almost a full percent higher than the all-time low, set only a few months ago in July. When bond prices fall, many investors will sell their funds at the end of the year to harvest losses and redeploy their capital into other bond funds.

The annual tax-loss harvesting creates a unique opportunity for investors to look at Closed End Funds. Closed End Funds (CEFs) are an alternative to bond mutual funds. They are similar to mutual funds in that they are diversified, professionally managed baskets of stocks or bonds. In a regular mutual fund, you buy and sell shares directly from the fund company, whereas with a CEF, you buy or sell shares on a stock exchange with other buyers or sellers. There are a fixed number of shares, so a CEF manager can focus on managing their portfolio without the impact of money flowing in or out of the fund.

This works very well for bond strategies, and indeed many CEFs have an income focus and pay dividends monthly or quarterly. Today, there are many CEFs that pay 4-6% tax-free, or 5-10% taxable. They range from high investment grade credit ratings to junk bonds. Some have been around for decades.

Here is a comparison of Closed End Funds with Mutual Funds:

Closed End Funds Mutual Funds “open end”
Professionally managed basket of stocks, bonds, etc. Professionally managed basket of stocks, bonds, etc.
Fixed number of shares Unlimited number of shares
Buy/sell on an exchange Buy/sell from the fund company
Price may be at a premium or discount to NAV Price equals net asset value (NAV)
Manager does not need to buy or sell securities; fixed pool of money Manager must buy or sell to meet inflow or outflow of cash
May use leverage Typically not leveraged

Many people have not heard of CEFs because they generally don’t advertise. The managers cannot raise new money, and their management fee is fixed, usually around 1% of assets. The fund manager has no incentive to advertise, so CEFs remain a secret of the investment community. When these CEFs trade at a discount to the underlying value of the assets, you may be able to buy the equivalent of $1,000 of bonds for $950 or $900 dollars. And that is what is happening right now – tax-loss harvesting is widening the discounts of many bond CEFs.

We generally don’t use CEFs in our portfolio models because they tend to have more price fluctuation than mutual funds. Besides the change in NAV, the discount or premium can change by as much as 10% or more in any year. But when that discount widens to 10% plus, that is often a good entry point for investors who are willing to hold the funds for long-term and who don’t mind a bit of additional volatility.

However, not all CEFs are created equal! There are many different strategies, and they have many more moving parts than mutual funds. We have an in depth process for choosing our CEFs and have been investing in these for more than a decade. If you are looking to increase your portfolio income, let’s talk about if Closed End Funds might be a good fit for you.

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Four Investment Themes for 2017

Posted On November 14, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /   2 Comments

Each November and December, I undertake a complete review of our Premier Wealth Management Portfolio Models and make tactical adjustments for the year ahead. We have five risk levels: Conservative (roughly 35% equities / 65% fixed income), Balanced (50/50), Moderate (60/40), Growth (70/30), and Aggressive (85/15).

Our investment process is tactical and contrarian. Each year we look for those market opportunities which have attractive and low valuations, and increase our weighting to those segments, while decreasing those categories which appear more expensive. We include Core positions, which offer broad diversification and are the essential and permanent foundation of our portfolios. And we purchase Satellite positions which we feel offer a compelling current opportunity in a more narrow or niche investment category. Typically, there are 12-15 positions in total, consisting of Exchange Traded Funds (ETFs) and Mutual Funds.

While we are not afraid to make changes to our models, we believe that when it comes to trading, less is more. We want to minimize taxable sales and especially to avoid short-term capital gains. That’s why we only change the models once a year, although we also believe that more frequent trading would be likely to be detrimental rather than return enhancing.

For 2017, our portfolio changes will be based on three considerations:
1) Relative valuations (reducing expensive stocks and adding to the inexpensive segments).
2) Replacing our holdings in a few categories, where another fund appears to offers a better risk/return profile.
3) Our world view of the markets in 2017, which is more focused on identifying risk than trying to predict the top performing investments. No matter what, diversification remains more valuable than our opinions about investment opportunities.

Here then are our four investment themes for 2017:

1) Low for Longer
Although interest rates may have bottomed in 2016, it does not appear that there will be a V-shaped recovery. We think interest rates, inflation, Domestic and Global GDP will all remain quite low for 2017.

2) Full Valuations
US Equities are no longer cheap. Years of central banks holding interest rates near zero (or actually negative in some countries this year) has forced investors into risk assets. This has driven up PE multiples. And while I would not call this a bubble, you can’t say that the US market is cheap today. That means that equity growth going forward is likely to be tepid.

Low bond yields pushed investors into dividend stocks, specifically to consumer staples and utilities, which are perhaps the most “bond-like”. These categories seem to be especially bloated and could underperform.

Turning to bonds, the yield on the 10-Year Treasury has increased from 1.6% to 2% in the past three months. Time will tell, but could this summer have been the peak of the 30-year bull market in bonds? I don’t know, but when yields are this low, prices on long-term bonds can move dramatically. We invest in bonds for income and stability and to balance out the equity risk in our portfolios. We’re not interested in using bonds to speculate on the direction of interest rates.

While there may not be an equity level of risk in bonds, it is safe to say that the price of bonds globally is higher in 2016 than it has ever been before. Bonds are much less attractive than five years ago, although we find some pockets that interest us and may at least give us a chance of exceeding inflation and earning a positive real return on our money.

3) Leadership Rotation
I believe we are going to see a very gradual shift in three areas:

A) From Growth to Value. Since 2009, growth stocks have dominated value stocks. This tends to be cyclical, but over the long-term, value has outperformed. We see a widening valuation gap between popular growth stocks, some of which are trading at PEs of 100 or higher, and out of favor value companies. Value is showing signs of life in 2016, and we think that there will be mean reversion at some point that favors value.

B) From Domestic to Emerging. Over the past 5 years, US stocks have reigned. Boosted by a strong dollar and a global flight to quality, US stocks have outperformed others and become more expensive than international stocks. Emerging markets have languished and are now trading at a big discount to developed markets. But emerging economies have higher growth rates and overall, have less debt and more favorable demographics than developed markets. While volatility will be higher, Emerging markets could greatly outperform if you are looking out 10 or 20 years from now.

C) From Bonds to Commodities. In 2016 we have already seen a rebound in oil, gold, and other commodity prices. After years of commodity prices falling, have we put in a bottom? We don’t have commodities in our models currently, but when inflation and interest rates start to pick up, I expect to see commodities gain and bonds suffer. That’s why the bull market in bonds may well end at the same time as the bear market in commodities. 2017 may be a good year to start diversifying for long-term investors.

4) High Risk, Low Return
With full valuations in equities and very low interest rates in bonds, expected returns for a Balanced or Moderate allocation are likely to be noticeably lower than historical returns. While volatility has been actually very mild for the past several years, investors should not be lulled into thinking that their portfolios will continue to grind higher without the possibility of a 10% or 20% correction.

Unfortunately, in today’s global economy, it seems less likely that a traditional diversification, for example, adding small cap and international stocks, will provide any sort of defense in the next bear market. We are expanding our investment universe to look for alternative strategies which can offer a true low correlation to equities. When the market is booming or even just recovering (like 2009), equities are often the top performers. But in a high risk, low return environment, we want some positions that offer the potential for positive returns with lower, different, or uncorrelated risks. If you want to explore these in greater detail, see our new Defensive Managers Select portfolio model.

These four investment themes are important considerations for how we position for 2017. You can get investments anywhere and they are becoming a low-cost commodity. However, what you cannot get anywhere is insight, personal service, and a custom-tailored individual financial plan. Investments are interesting, but we view them as a means to an end. Investments should accomplish your financial goals with the absolute least amount of risk necessary. The more interesting angle is how we can use investments to fulfill your plan just for you.

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How to Invest if Income Taxes Increase

Posted On September 26, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Is there really any doubt that income taxes will be going up at some point in the future? Deficits are growing ($590 Billion for 2016 alone) and there is no interest in Washington in reducing expenditures. Given the magnitude of Federal spending, even if a balanced budget were possible, the reduction in cash flow would crush the economy and send unemployment through the roof. We’re addicted to our spending.

Politicians have realized that even the faintest hint of “raising taxes” would be career suicide. This means that increasing marginal tax rates (except on those making over $250,000) is impossible. But raising tax revenue by “closing loopholes for the rich” is considered a heroic undertaking. There are a lot of proposals out there right now to increase tax revenue, and you don’t have to be Bill Gates or Warren Buffet to be impacted.

Many of these “loopholes for the rich” benefit middle class professionals. Chances are that if you are reading this, you’re going to be paying higher taxes in the years ahead. Even if your marginal tax bracket remains the same, your effective tax rate – the total amount of taxes you pay – could rise with these proposals:

  • Eliminate the Stretch IRA for beneficiaries who inherit an IRA.
  • Close the Roth conversion process which allows the “back-door Roth IRA”.
  • Create Required Minimum Distributions for Roth IRAs.
  • Cut the estate tax exemption from $5.45 million to $3.5 million and increase the rate from 40% to a range of 45% to 65%.
  • Eliminate the step-up in cost basis on inherited assets.
  • Add a 4% surtax on income over $5 million.
  • Cap itemized deductions to 28% of your income.
  • Create a capital gains schedule that requires an asset be held for 6 years to qualify for the lowest long-term capital gains rate of 20%. Increase capital gains taxes on assets held less than 6 years.
  • Increase the Social Security payroll tax from 12.4% to 15.2%.
  • Increase the payroll tax ceiling from $118,500 (2016) to $250,000. Or eliminate the cap altogether.
  • Apply the payroll tax to passive income, so business owners are taxed the same on distributions and dividends as they would be on salary.
  • A proposal in July from Ohio congressman James Renacci would lower the corporate income tax and add a consumption tax, or European-style VAT.
  • Limit the mortgage interest deduction, which disproportionately benefits wealthier home owners because it requires itemized deductions. One proposal is to replace the deduction with a smaller tax credit.
  • Place a cap on tax-deferred accounts. For example a 62-year old with $3.2 million in tax-deferred accounts would be ineligible to make further contributions. Other proposals suggest caps as low as $500,000.

Although this is an election year, I do not view this as a political issue. Whoever is elected to the Presidency and to Congress will have to deal with reducing deficits. While some candidates propose to cut taxes, this would dramatically increase the debt, which already stands at $19 Trillion. When interest rates eventually rise, a significant portion of our annual tax revenue could be needed solely for paying interest on our debt. So, I view tax cuts as not only unrealistic, but dangerously inflating a problem our children will ultimately have to bear.

If effective tax rates are going higher, what can you do to keep more of your investment return?

1) Tax efficiency will be more valuable. Using low-turnover ETFs, asset location, and tax loss harvesting can lower your tax liability. Reduce tax drag and keep gross income under $250,000, if possible. See: 6 Steps to Save on Investment Taxes.
2) Tax-free may be more preferable than tax-deferred. If you think your tax rate in retirement will be the same or higher than today, there is less benefit to investing in a Traditional 401(k) or IRA. Preference goes to the Roth 401(k) or Roth IRA. See: To Roth or Not to Roth.
3) Tax-free municipal bonds will be even more attractive when compared to taxable bonds.
4) Rather than allowing capital gains to accumulate for years and become an enormous tax bill in the future, it may be wise to harvest gains in years when you are in a lower tax bracket, up to the threshold of your current tax rate.
5) Don’t negate reduced tax rates for qualified dividends and long-term capital gains by placing those investments into an IRA or Annuity where the distributions will be taxed as ordinary income.

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Do You Receive Mutual Fund Capital Gains Distributions?

Posted On August 8, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

I always ask prospective clients to bring a copy of their most recent tax return and often learn a wealth of information reviewing their taxes. In doing such a review last week, I noticed that in the previous year, a prospective client had to pay taxes on $13,875 in taxable capital gains distributions from their mutual funds.

If your mutual fund is inside of a 401(k) or IRA, capital gains distributions don’t matter. However, when a mutual fund is held in a taxable account, you end up paying taxes on capital gains distributions even though you didn’t sell the position. Instead, you are paying taxes for trading the fund manager does inside the portfolio, or worse, to provide liquidity to other shareholders, who sold before December and left you holding the bag to pay for their capital gains.

Luckily, there is a better way. In my previous position working with high net worth families, the majority of assets were held in taxable portfolios. We had a number of families with $10 million to over $100 million in investments with our firm. Needless to day, I spent considerable time in looking at ways to reduce taxes, and became very effective at the process of Portfolio Tax Optimization. I offer this same approach and benefits to my clients today.

Vanguard studied the value advisors bring through planning skills like tax optimixation. They estimate that “Advisor’s Alpha” can add as much as 3% a year to your net returns.
Link: Quantifying Vanguard Advisor’s Alpha

If you have significant assets in taxable accounts, I can help you. Here are five ways we can lower your taxes and allow you to keep more of your hard earned principal:

1) Use ETFs. The prospective client with $13,875 in capital gains distributions, had approximately $600,000 in mutual funds. I created a spreadsheet that calculated capital gains if they had been invested $600,000 in my 60/40 portfolio instead. Most of my holdings are Exchange Traded Funds (ETFs), which due to their unique structure, are much more tax efficient than mutual funds. In fact, my nine ETF holdings had total distributions of zero in the same year .

In the 60/40 model, we also had five mutual funds in categories where there are not equivalent ETFs. My calculation of capital gains distributions: $2,167. So, if we had been investing for this client, their capital gains distributions could have been reduced from approximately $14,000 to $2,000. The investment vehicles we choose matter!

I should note that this is just looking at capital gains distributions. Both ETFs and mutual funds also pay interest and dividends, which are taxable. There is more to managing taxes than just picking ETFs.

2) Asset Location. We could have further reduced taxes by choosing where to place each holding. Some funds generate interest, which is taxed as ordinary income, where as other funds generate qualified dividends, which is taxed at a lower rate of 15-20%. We place the funds with the greatest tax liability into your IRA or other qualified account, to reduce your overall tax burden. Funds that have little or no distributions are ideal for taxable accounts.

3) Avoid short-term capital gains. If you sell an investment within a year, those short-term gains are taxed as ordinary income, your highest tax rate. After 12 months, sales are treated as long-term capital gains, at a lower rate of 15-20%. We do not sell or rebalance funds before one year to avoid short-term gains. Unfortunately, many mutual fund managers don’t have any such tax mandate, so oftentimes, a significant portion of fund’s capital gains distributions are short-term.

4) Tax Loss Harvesting. At the end of each year, we review taxable portfolios for positions which have declined. We harvest those losses and immediately replace each position with a different fund in the same category (large cap, international, etc.). This fund swap allows us to use those losses to offset other gains or income, while maintaining our target asset allocation. If realized losses exceed gains, you can use $3,000 of losses to reduce ordinary income. Remaining losses are carried forward to future years.

5) Municipal Bonds. For investors in a higher tax bracket, your after-tax return may be better on tax-free municipal bonds than on taxable bond funds. However, an advisor will not know this without looking at your tax return and determining your tax bracket. That’s why we make planning our first priority, before making any investment recommendations. (Would you really trust anyone making investment recommendations without knowing your full situation? Are those recommendations designed to profit them or you?)

We take a disciplined approach to managing portfolios to minimize taxes, and it is a valuable benefit to be able to customize our approach for each individual client.

On this same client’s tax return, I realized that they did not deduct their Investment Management fees, a $6,000 miscellaneous deduction.
Link: Are Investment Advisory Fees Tax Deductible?

If you have taxable investments, we may be able to save you thousands, too. Let’s schedule a call today. You deserve a more sophisticated and efficient approach to managing your wealth.

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2016 Market Update

Posted On July 11, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

While the Brexit turmoil in June roiled markets, stocks, bonds, and our portfolio models finished in positive territory for the half-year through June 30. I am happy to provide periodic updates on market performance, but I would be remiss if I did not include my customary remarks that we really should not dwell on short-term performance, let alone mistakenly believe that this type of data should form the basis of our portfolio management or trading decisions.

Looking globally at equities, the iShares All-Country World ETF, ticker ACWI, was up 2.06% through June 30. Our US Large Cap ETF (IWB) tracks the Russell 1000 Index and was up 3.68%. Not surprisingly, international developed stocks were down slightly, with our ETF, VEA, down 1.93%. Strong performances were contributed by Emerging Markets (EEMV), which was up 7.36%, and top honors go to Real Estate Investment Trusts (VNQ) at 13.48%. All considered, not bad, and even the categories which were down – and received a great deal of news coverage – were in fact only down a couple of percent.

We may be starting to see a shift which I have been anticipating for several quarters. Value lagged growth for years, but that seems to be reversing in 2016. Same for Emerging Markets Equities: after years of trailing US stocks, their valuations have become too cheap to ignore and EM outperformed over the past six months. Our process is based on contrarian investing. We overweight the segments which are the cheapest and often, have performed the worst in recent years. “Buy low and sell high” means buying segments that are temporarily out of favor.

While stocks were up in the first half of the year, bonds were actually up more, thanks to interest rates’ steady decline. As fear picked up in the second quarter, investors fled to the safety of bonds, pushing prices up and yields down. As of last Friday, the 10-year US Treasury bond had a yield of 1.37% and the 30-year bond of 2.11%. It is absolutely unbelievable to see US bonds at these levels, except that the yields are even lower in Germany, Japan, and a handful of other developed countries. Through June 30, the US Aggregate Bond ETF (AGG) was up 5.30% and we saw even greater gains in our high yield and emerging markets debt funds.

Looking ahead to the second half of the year, I have modest expectations for stocks. The S&P 500 Index is currently over 2100, and it seems to stall each time we reach this level. I think the market needs to see significantly better than expected earnings to finally catapult the index over 2200. We should be prepared for increased volatility, like we saw in June. I would not hesitate to put money to work on any drops in equities.

If bonds were overvalued six months ago, they have only become more so today. However, that doesn’t guarantee that yields are poised to rip higher this year. There seems to be an increasing belief that these shockingly low yields are not a temporary phenomenon, but a new reality caused by the high debt, slow growth, zero inflation backdrop that seems to be spreading throughout the world. We will continue to emphasize short duration in our fixed income holdings. The quest for yield has become very expensive, and some investors may not realize the potentially high risks that accompany many 3, 4, and 5% yields.

We will not be making any changes to our model portfolios for the second half of 2016. We focus on low-cost index strategies that are diversified, tax efficient, liquid, and transparent. It’s a recipe for success for the patient investor. I am pleased that we are up this year, even if it just in the low single digits.

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Keep Calm and Carry On

Posted On June 24, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

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I’m posting today in response to the vote in Britain to leave the European Union, which surprisingly passed 51-49 yesterday. This action has roiled global markets today and I wanted to reach out with some thoughts.

Looking at foreign equities, the Vanguard Developed Markets ETF (ticker: VEA) is down 7% this morning. It is undoubtedly a significant and painful drop. The ETF is recently trading at $34.35 a share. To put this in context, the same shares traded as low as $34.02 on June 16. So all we have done today is give up the past eight days of gains. It is not the devastating loss that news channels would like to have you believe.

I do however anticipate further volatility next week, especially on Monday morning, after more panic sets in over the weekend. As an investor, we accept the reality that corrections of 10% or more are a common occurrence, and in fact, swings of 10% or more occur in a majority of years. In the long run, events like the Brexit are nothing more than noise which unfortunately distracts investors from staying focused their long-term goals.

If you have cash on the sidelines, I’d suggest placing orders to add to a diversified asset allocation in line with your goals and overall risk tolerance. That’s what I’ve been doing this morning: placing limit orders to add to our existing ETF positions for clients who have cash in their portfolios. We have not sold any positions and discourage investors from selling based on today’s news. While the Brexit vote increases uncertainty in Europe, the actual implications for the drivers of investment growth – corporate earnings and balance sheets, economic fundamentals, and credit conditions – remain largely unchanged.

Our investment philosophy is based on the significant evidence of the importance of asset allocation and diversification. While we are strategic in our model portfolios, we can and do adjust the weightings of asset classes in a contrarian manner. We want to buy (or “overweight”) those assets which are the cheapest and typically, have performed the worst recently. If European stocks weakens further, we will actually consider increasing our allocation.

Even without changing our Portfolio Model targets, our discipline is to rebalance portfolios if the categories move more than 10% away from our target weightings. To actually profit from volatility, you have to view events like today as an opportunity. That is easy to do in hindsight, but difficult to do in the present, unless you have a rigorous and systematic approach.

I am happy to report that my phone is not ringing off the hook this morning. Hopefully, the consistent message of the reasons and benefits of sticking with your plan are being heard. If you want to talk about your portfolio, have a question, or just want to catch up, please don’t hesitate to give me a call or send me a note. Otherwise, keep calm and carry on!

P.S. If you aren’t currently a client of Good Life Wealth Management, I’d like to share with you the benefits of having your own financial plan. Investing should be tailored to your needs, which only happens after you have an individual plan! Call me at 214-478-3398 or reply to this email.

Link: The Good Life Financial Planning Process

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The Safest Way to Beat Inflation

Posted On March 21, 2016 By Admin In Portfolio Management /  

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With interest rates so low today, investors wonder where they can keep their money safe both in terms of their principal and purchasing power. We recently discussed Fixed Annuities as one substitute for CDs or bonds, with the conclusion that Annuities are best for investors over 59 1/2 who don’t need liquidity for at least five years. For others, one often overlooked option is Inflation-linked Savings bonds, officially known as Series I Bonds.

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Five Things To Do When The Market Is Down

Posted On February 15, 2016 By Admin In Behavioral Finance, Portfolio Management /  

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When the market is down, it hurts to look at your portfolio and see your account values dropping. And when we experience pain, we feel the need to do something. Unfortunately, the knee-jerk reaction to sell everything almost always ends up being the wrong move, a fact which although obvious in hindsight, is nevertheless a very tempting idea when we feel panicked.

Even when we know that market cycles are an inevitable part of being a long-term investor, it is still frustrating to just sit there and not do anything when we have a drop. What should you do when the market is down? Most of the time, the best answer is to do nothing. However, if you are looking for ways to capitalize on the current downturn, here are five things you can do today.

1) Put cash to work. The market is on sale, so if you have cash on the sidelines, I wouldn’t hesitate to make some purchases. Stick with high quality, low-cost ETFs or mutual funds, and avoid taking a flyer on individual stocks. If you’ve been waiting to fund your IRA contributions for 2015 or 2016, do it now. Continue to dollar cost average in your 401k or other automatic investment account.

2) If you are fully invested, rebalance now; sell some of your fixed income and use the proceeds to buy more stocks to get back to your target asset allocation. Of course, most investors who do it themselves don’t have a target allocation, which is their first mistake. If you don’t have a pre-determined asset allocation, now is a good time to diversify.

3) Harvest losses. In your taxable account, look for positions with losses and exchange those for a different ETF in the same category. For example, if you have a loss on a small cap mutual fund, you could sell it to harvest the loss, and immediately replace it with a different small cap ETF or fund.

By doing an immediate swap, you maintain your overall allocation and remain invested for any subsequent rally. The loss you generate can be used to offset any capital gains distributions that may occur later in the year. If the realized losses exceed your gains for the year, you can apply $3,000 of the losses against ordinary income, and the remaining unused losses will carry forward to future years indefinitely. My favorite thing about harvesting losses: being able to use long-term losses (taxed at 15%) to offset short-term gains (taxed as ordinary income, which could be as high as 43.4%).

4) Trade your under-performing, high expense mutual funds for a low cost ETF. This is a great time to clean up your portfolio. I often see individual investors who have 8, 10, or more different mutual funds, but when we look at them, they’re all US large cap funds. That’s not diversification, that’s being a fund collector! While you are getting rid of the dogs in your portfolio, make sure you are going into a truly diversified, global allocation.

5) Roth Conversion. If positions in your IRA are down significantly, and you plan to hold on to them, consider converting those assets to a Roth IRA. That means paying tax on the conversion amount today, but once in the Roth, all future growth and distributions will be tax-free. For example, if you had $10,000 invested in a stock, and it has dropped to $6,000, you could convert the IRA position to a Roth, pay taxes on the $6,000, and then it will be in a tax-free account.

Before making a Roth Conversion, talk with your financial planner and CPA to make sure you understand all the tax ramifications that will apply to your individual situation. I am not necessarily recommending everyone do a Roth Conversion, but if you want to do one, the best time is when the market is down.

What many investors say to me is that they don’t want to do anything right now, because if they hold on, those positions might come back. If they don’t sell, the loss isn’t real. This is a cognitive trap, called “loss aversion”. Investors are much more willing to sell stocks that have a gain than stocks that are at a loss. And unfortunately, this mindset can prevent investors from efficiently managing their assets.

Hopefully, now, you will realize that there are ways to help your portfolio when the market is down, through putting cash to work, rebalancing, harvesting losses for tax purposes, upgrading your funds to low-cost ETFs, or doing a Roth Conversion. Remember that market volatility creates opportunities. It may be painful to see losses today, but experiencing the ups and downs of the market cycle is an inevitable part of being a long-term investor.

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What To Do With Your CD Money

Posted On February 1, 2016 By Admin In Portfolio Management /   1 Comment

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If you’ve had CDs mature over the past several years, you’ve faced the unfortunate reality of having to choose between reinvesting into a new CD that pays a miniscule rate, or moving your money into riskier assets and giving up your guaranteed rate of return and safety. Although you can earn a higher coupon with corporate bonds than CDs, those investments are volatile and definitely not guaranteed. I understand the desire for many investors to keep a portion of their money invested very conservatively in ultra-safe choices. So, I checked Bankrate.com this week for current CD rates on a 5-year Jumbo CD and here is what is offered by the largest banks in our area:

Bank of America 0.15%
JPMorgan Chase 0.25%
Wells Fargo 0.35%
Citibank 0.50%
BBVA Compass 0.50%

While there are higher rates available from some local and internet banks, it is surprising how many investors automatically renew and do not search for a better return. Others have parked their CD money in short-term products or cash, hoping that the Fed’s intention of raising rates in 2016 will soon bring the return of higher CD rates.

Unfortunately, it’s not a given that the economic conditions will be strong enough for the Fed to continue to raise rates in 2016 as planned. This week, the 10-year Treasury yield dropped below 2%, which is not strong endorsement of the likelihood of CD rates having a major rebound in 2016.

This is the new normal of low interest rates and slow growth. While rates could be nominally higher in 12 months, it seems very unlikely that we will see 4% or 5% yields on CDs anytime in the immediate future. Waiting out in cash is a sure-fire way to not keep up with inflation and lose purchasing power.

What do I suggest? You can keep your money safe – and earn a guaranteed rate of return – with a Fixed Annuity. I only recommend Fixed Annuities with a multi-year guaranteed rate. Like a CD, these have a fixed interest rate and set term. At the end of the term, you can take your investment and walk away.

Today, we can purchase a 5-year annuity with a rate of 2.9% to 3.1%, depending on your needs. I know that’s not a huge return, but it’s better than CDs, savings accounts, Treasury bonds, or any other guaranteed investment that I have found. Since an annuity is illiquid, I suggest investors set up a five year ladder, where each year 20% (one-fifth) of their money matures. When each annuity matures, you can keep out whatever money you need, and then reinvest the remainder into a new 5-year annuity.

The beauty of a laddered approach is that it gives you access to some of your money each year and it will allow your portfolio to reset to new interest rates gradually as annuities mature and are reinvested at hopefully higher rates. In the mean time, we can earn a better return to keep up with inflation and keep your principal guaranteed.

Issued by insurance companies, Annuities have a number of differences from CDs. Here are the main points to know:

  • Annuities typically have steep penalties if you withdraw your money early. It’s important to always have other sources of cash reserves for emergencies. Consider an annuity as illiquid, and only invest long-term holdings.
  • If you take money out of an annuity before age 59 1/2, there is a 10% premature distribution penalty, just like a retirement account. A 5-year annuity may be best for someone 55 or older.
  • Money in annuity grows tax-deferred until withdrawn. If you rollover one annuity to another, the money remains tax-deferred. Most annuities will allow you to withdraw earnings without penalty and take Required Minimum Distributions (RMDs) from IRAs. Always confirm these features on an annuity before purchase.
  • While CDs are insured by the FDIC, annuities are guaranteed at the state level. In Texas, every annuity company pays into the Texas Guaranty Association, which protects investors up to $250,000. If you have more than this amount to invest, I would spread it to multiple issuers, to stay under the limit with each company.

If you have CDs maturing and would like to learn more about Fixed Annuities, please contact me for more information.

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