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 [...]
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.
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.
There's been much debate in investing circles over the last year about whether inflation or deflation represents a more likely threat to the future of the U.S. economy. With a recovery that's still tentative compared to previous recessions, measures designed to stimulate the economy or cut spending to rein in the budget deficit provoke warnings about their potential to create one or the other. The case for inflation As the economy has begun to recover, worries about the potential for future inflation have become widespread. The Fed has undertaken extraordinary measures to make sure there is plenty of money in circulation, but some experts worry that the increased money supply will eventually cut the dollar's purchasing power, especially if interest rates are kept at historically low levels for too long. They cite the easy availability of money as contributing to the late-1990s tech bubble and the mid-2000s housing bubble, and fear that another could be on the way. The Federal Reserve Board's monetary policy committee maintains that inflation currently is too weak to support normal economic growth, let alone launch an inflationary spiral. However, those who see inflation in our future watch for warning signs such as increased Treasury yields, particularly on longer-term bonds. Higher yields when bonds are auctioned suggest that investors are increasingly wary of tying up their money for long periods at a fixed interest rate if they feel that inflation is going to erode the buying power of those fixed payments over time. Wholesale prices also are watched closely; higher prices at the wholesale level can be a precursor of higher prices at retail (that is, if retailers are able to pass those costs along to buyers, which is not always the case). The case for deflation At first blush, the falling prices that characterize deflation [...]
Everyone knows the stock market has its ups and downs, but just what’s involved in recovering from a serious down? If you lose 10% one year but your portfolio returns 10% the next year, are you even again? The short answer: no. The math of recovering from a loss isn’t quite that symmetrical. You have to gain more than you lost to recoup all your losses. To understand why, let’s look at a hypothetical example. Say you have a $100,000 portfolio. In Year 1, you suffer a 10% loss and are down $10,000. That leaves your portfolio worth only $90,000. In Year 2, the market rebounds and your portfolio rises by 10%. However, that 10% increase is based on a $90,000 portfolio, not $100,000. That means a 10% return adds only $9,000 to your portfolio not $10,000, leaving you still down $1,000 from where you started. You would actually have to earn a return of a little over 11% to get back to your original $100,000. The bigger the loss, the bigger that rebound needs to be to get you even. For example, if that $100,000 portfolio had taken a 40% hit, as many did in 2008, you’d need almost a 67% increase to offset that $40,000 loss. That could take several years even if stocks perform well. The challenge is compounded by investor psychology. Adjusting your asset allocation to aim for a higher return is one way to try to recoup losses faster. However, many investors find it difficult to take on additional risk after having watched their investments take a hit. And there’s no guarantee that more risk will necessarily produce the desired result—at least not within the desired time frame. The lopsided nature of recovery from market losses underscores why risk management is such a key component [...]
Assets in a Traditional IRA or 401(k) grow tax-deferred and distributions are taxable at ordinary income tax rates. A Roth IRA grows tax deferred and distributions are tax free. By converting your assets to a Roth IRA, you'll be paying your tax liability now - at a potentially lower rate-in exchange for tax-free growth and tax-free distributions in the future. If you make the conversion in 2010 you can spread the tax bill out equally over two years (your 2011 and 2012 tax returns). This special two-year provision is only available to conversions made in 2010. Unlike a traditional IRA, the government does not mandate you take required distributions from a Roth account. Therefore, you can let the entire account grow tax-deferred for as long as you wish. If you have enough wealth to be concerned about estate taxes, converting to a Roth may provide an additional benefit to you. There are other issues to consider before deciding if converting is right for you. A good place to start the conversation is to talk with your financial advisor. If you do not have an advisor or are thinking about hiring a new one, I’d love the opportunity to visit with you.