What if Congress passed a law to help investors, and it actually did? About a decade ago these pages covered a pressing problem with participant-directed 401(k) retirement plans. A lot of those participants weren’t showing much interest in self-directing their investments. At the same time, employers and plan trustees didn’t want the liability of automatically steering those accounts into anything but the most conservative alternative, often a money market fund. Letting retirement savings idle away the decades at short-term interest rates seemed a dubious strategy. Enter the Pension Protection Act of 2006. One provision of that huge legislation laid out guidelines for something called a Qualified Default Investment Alternative (QDIA). Plans could automatically direct participant contributions into investments meeting those guidelines and be substantially insulated from liability. Investment companies responded with a proliferation of target-date retirement funds, the most familiar type of QDIA. As these pages have previously discussed, target-date funds are broadly diversified allocations designed to gradually shift their holdings as the targeted date draws nearer. Such funds now hold more than $755 billion in assets, up ten-fold in less than a decade. Of course, popularity is not always predictive of great investment results, and investors are notoriously poor timers. Over the years a host of studies have indicated that the actual returns experienced by mutual fund investors typically fall short of the performance of the funds they hold. But the popularity of target-date funds is not a case of chasing hot market sectors or stocks. Mutual fund researcher Morningstar studied investor experience across the dozen fund companies that had target-date offerings for the full decade ended December 31, 2014. Morningstar found that, on average, those investors experienced somewhat better returns than the funds themselves. On an asset-weighted basis, their average annualized return was pegged at 6.13% compared to [...]
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Some call it the “fragile decade,” that first 10 years of retirement when market movements can have a profound effect on a portfolio’s ability to sustain income and financial security for the years ahead. It has a lot to do with the sequencing of returns. In the years leading up to retirement, many investors have discretionary income to make meaningful contributions to retirement savings, and they’re not yet drawing from those nest eggs. If markets are down, they’re buying in at lower prices with better upside prospects ahead. But once that employment income must be replaced, at least in part, by withdrawals from retirement savings, the impact of a significant market downturn can be magnified. Suppose one starts retirement with a diversified, million-dollar portfolio and initiates 4% annual withdrawals. If in the first year of retirement the portfolio suffers a 10% market-driven decline, and then a 5% decline in year two, those withdrawals will trim that $1,000,000 portfolio down to about $780,000. At that level, $40,000 represents a more aggressive 5.1% withdrawal rate. Even a 15% bounce-back performance for the underlying investment holdings in year three will only restore the portfolio to about $850,000 net of those ongoing withdrawals. Sustainability of Income For a Portfolio Diversified as Follows: At a withdrawal rates of: 24% U.S. Stocks 3% 4% 5% 6% 24% Internat’l Stocks Chances of sustaining 24% U.S. Bonds income for 30+ years is... 20% Global Bonds 95% 95% 92% 69% 5% Cash Asset class indexes: Cash: 90-Day U.S. Treasury; U.S. Stocks: S&P 500 Index; U.S. Bonds: Ibboston U.S. Long-Term Corp. Bond Index; Internat’l [...]
A plunge in oil prices is feeding consumer pocketbooks and reshuffling the economic and strategic cards across the globe. OPEC’s recent decision to sustain current production levels looks like a high stakes game of chicken. These countries produce 40% of global oil but failed to anticipate the magnitude of the U.S. production surge – up 80% in six years. That increase is greater than the output of every OPEC country except Saudi Arabia. And it has coincided with recovering production in some previous trouble spots just as economic activity appears to have stalled in some key corners of the world. This is a decidedly different dynamic from the well-worn story of tight oil supplies and rising demand from China and other emerging economies. Now exporters strategize to hold market share and see who’ll be able to keep the crude flowing if prices slip lower. Current levels may curtail some higher-cost production, but the U.S. surge is proving resilient, and technology moves on. The International Energy Agency (IEA) estimates that just 4% of U.S. wells need oil above $80 per barrel to be profitable. Some sources believe most shale oil and Canada’s tar sands can be economic even if oil approaches $50 per barrel. Meanwhile, some key OPEC members – notably Venezuela and Iran – are stressed. Russia is not in OPEC, but oil generates 40% of its state budget. The ruble has tumbled along with oil, boosting the cost of Russia’s heavy dependence on imported food and consumer goods. Regions that are heavy oil importers are getting a welcome break. This includes much of the Eurozone and Japan, both of which have been flirting with recession. There are a number of beneficiaries across Asia, including China and especially India, which imports about 85% of its oil. Lower prices are a [...]
Analysis released last year by the Internal Revenue Service shows younger investors are choosing Roth IRAs over the traditional variety in large numbers. Fund manager T. Rowe Price confirms that as of year-end 2013, investors under 34 have eight times more money in Roth IRAs than in traditional IRAs. There’s logic to that, assuming young investors are looking at currently low marginal tax rates, lots of years to enjoy tax-deferred growth, and easier access to a portion of their Roth assets if a need arises a few years down the road. But as those same workers edge into higher marginal tax brackets the argument gets a little more nuanced. The main lure of the Roth IRA is the promise of tax-free income in retirement. But is a young worker’s biggest worry the tax burden she’ll carry in retirement? Or is it the challenge of saving enough to support a comfortable retirement? There are always plenty of competing demands for the dollars we might otherwise set aside for the future. One’s tax rate in retirement, 30-35 years down the road, can be a tenuous rationale for forgoing the deduction one might capture with a traditional IRA contribution today. After all, that deduction lowers the out-of-pocket cost of the IRA contribution which facilitates more savings. And that’s a certainty now rather than a possibility in the distant future. Even if a young investor has the funds to maximize an IRA contribution – Roth or traditional – there are other tax-deferred vehicles in which to invest the tax savings from a traditional IRA contribution. And that brings us to one of the most basic financial planning precepts: Try to control as much capital as you can for as long as you can. Paying income taxes at a high rate in one’s golden years [...]
I recently set up a SIMPLE IRA plan for a business in Corvallis. Their goal was to help their employees save for retirement while not spending a small fortune on administrative costs. If this is the case for your business, you may want to take a look at a SIMPLE IRA plan. Who is eligible: Businesses with less than 100 employees, tax-exempt organizations, and government entities. Who must be covered: Any employee earning $5,000 during any two preceding years. Required Employer Contribution: Dollar-for-dollar match up to 3% of pay OR 2% of gross pay up to $245,000 for all eligible participants who earn at least $5,000. Maximum Contribution: $12,000 deferral plus a $12,000 maximum match. Those over the age of 50 may make an additional catch-up contribution of $2,500. Advantages: - Minimal paperwork and expense - Minimal tax filing - Participant deferral of current income taxes Note: When participants take before-tax contributions out of their retirement plans, that money is subject to ordinary income tax and, if withdrawn before age 59 ½ , may be subject to an additional 10% federal tax penalty (25% penalty if withdrawn from a SIMPLE IRA within the first two years). Those are the basics, but please give us a call if a SIMPLE plan seems like it may be appropriate for your business.
For the better part of two decades some market sages have warned that stocks could face a stiff, steady headwind as retiring baby boomers trim their equity holdings in favor of more conservative allocations and start spending their nest eggs. It’s the flipside of the view that the great bull market of the 1980s and ‘90s was partly fueled by the boomers surging into the prime earning and saving phase of their lives. Demographics certainly can influence markets, but it’s probably more of an indirect effect tied to the relative dynamism of the national economy. Recent studies question the idea that retiring boomers will tank stocks. Several years ago the U.S. Government Accountability Office determined that demographic variables account for less than 6% of the stock market’s variability of returns. A more recent study by the Vanguard mutual fund company cited several key factors that counter the boomer-sell-off scenario. Yes, the boomer generation is large: 76 million U.S. births from 1946 through ‘64. But the rate at which they retire and the manner of doing so will vary widely. Besides, there were 50 million Gen-Xers born from 1965 through ’76, and 70 million Gen-Yers born 1977-2002. The supply of workers/savers/investors doesn’t exactly end with the boomers. In fact the U.S. has one of the better profiles among large nations with respect to the growth of the 15-64-year-old population. Yes, as of 2010 boomers owned nearly 47% of U.S. equities. But that’s not statistically different from the share their parents’ generation held 20 years earlier. Older folks generally own more financial assets than younger folks. Nothing new about that. And in trying to gauge the selling pressure that might come to bear, it’s worth noting that the wealthiest 20% of boomers hold 96% of the equities held by their age cohort, [...]
If you own individual bonds or bonds within mutual funds, you may want to start taking a more cautious approach to your bond investing. Although bonds are typically considered a relatively safe investment, we may be entering a period where bond prices could be volatile. We are seeing signs that interest rates could be moving up in the near future. Rising interest rates are not a good thing for bond investors as bonds generally lose value when rates rise. For example, if you own a bond that matures in 10 years, or own a bond fund with an average maturity of ten years, a 1% rise in interest rates could cause your bond investment to decrease in value by as much as 10%. There are ways to protect, or at least mitigate potential loss in this type of a scenario. Give us a call if you’d like to discuss this in more detail.
Let’s explore some of the differences between a traditional IRA and a Roth IRA. With a traditional IRA, your contributions may be tax-deductible and can grow tax-deferred. In retirement, traditional IRA distributions are taxable as ordinary income. With a Roth IRA, your contributions are non-deductible, but have the opportunity to grow tax free. At retirement age, distributions from a Roth IRA are tax free. Here is a list of some of the primary differences: Traditional IRA Roth IRA Tax Treatment of Contributions: Tax-deductible Non-deductible Tax Treatment of Distributions: Taxable as ordinary income Tax free Mandatory Distributions: Mandatory at age 70.5 No mandatory distributions Early Withdrawal Penalty: 10% on entire amount 10% only on earnings Although the above table highlights some of the major differences between a traditional IRA and a Roth IRA, there are a number of other nuances not reflected. Please feel free to contact us to discuss which makes the most sense for your financial situation.
In the last post, we talked about our first core investing belief, that asset allocation is the most important decision in investment management. This post introduces our second core investing belief, that changing financial markets require continuous monitoring and tactical flexibility. This philosophy is contrary to the typical buy-and-hold approach that investors have been persuaded to embrace. Many people are convinced the proper way to invest is to simply leave their money in the market and hope for a decent return. We believe there is a better way! We feel investors should emulate the large, institutional investors by taking a more sophisticated, tactical approach to investing. At Willamette Investment Advisors, we maintain a forward-looking investment process that is focused on long-term trends in the financial markets. So, depending on what is taking place in the financial markets, we adjust our clients’ mix of investments to both mitigate risk and take advantage of investment opportunities. With record low interest rates and extreme stock market volatility, how are your investments positioned for what lies ahead? Give us a call; we’d love to discuss it with you.
We have 2 primary investment beliefs: 1) That asset allocation is the most important decision in investment management. 2) That changing financial markets require continuous monitoring and tactical flexibility. This post focuses on asset allocation and we’ll address the second core belief in the next post. Asset Allocation is simply the term we use in the financial industry to describe how your money is invested in all of the various investment options available, and in what proportion. For example, if you have a financial advisor making the asset allocation decisions for you, they are deciding how much you should be investing in US Large company stocks, how much in bonds, international stocks, etc. An important study by two Nobel Prize winning researchers highlights the importance of asset allocation in investment returns. They found that over 90% of the variance in an investment portfolio is determined by how the assets are allocated. Other factors such as stock selection and timing, while still important to consider, only represent a small portion of an investor’s return. For example, back in 1999 when the stock market was up over 50%, it didn’t matter if you owned Microsoft, General Electric, or IBM, you still made a lot of money. But, in the crash of 2000/2001, owners of those investments lost money while even a mediocre bond fund had a positive return. So, rather than spending the majority of your time deciding between two similar stock investments, it is much more important to figure out whether you should invest 30% or 60% of your portfolio in stocks (or any stocks at all for that matter). We help our clients with these important asset allocation decisions and closely monitor and adjust their asset allocation as the financial markets change.