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The Right Things to do in a Volatile Market

February 11, 2016

“Don’t panic.”
“Don’t sell at the bottom.”
“Don’t try to time the market.”

You’re used to being told what you shouldn’t do when the market is falling.  Today I’d like to talk about the right things to do in a volatile market.

The Market is Cyclical:  Expect ups and downs

Before we discuss the right things to do in a falling market, a quick reminder that the market is cyclical.  That means it will go up AND down.  As much as we would all love the market to go up all the time, that’s just not realistic.

So what is realistic?  Market history shows that declines of 5% occur in 19 out of every 20 years.  Declines of 10% or more occur more than every other year, declines of 20% or more occur one in five years, declines of 30% or more occur one in twelve years and declines of 40% or more occur one in fifty years.

Market Declines

Based on this data, declines in the market are not only possible, they should be expected.  So instead of panicking every time the market goes down, why not take advantage of it?

Risk Tolerance and Asset Allocation

The first thing you should do when the market is falling is to review your portfolio to make sure it matches your risk tolerance, time frame and goals.  If it doesn’t, then some rebalancing may be in order.

Most people have a pretty good idea of whether they are an aggressive or conservative investor.  However, if you’d like some help with this, there are many risk tolerance forms online such as Vanguard’s tool at https://personal.vanguard.com/us/FundsInvQuestionnaire.

At times like this it’s not unusual for people to want to take their money out of the stock market and park it in CDs or money markets or even under their mattress.  However, it’s important to remember that you need some growth in your portfolio in order to stay ahead of inflation (especially since most savings and money market accounts are paying less than 1% these days); however, you can take less risk in your portfolio and still earn moderate returns over the long run.

Here’s a chart of various portfolios (based on the percentage of stocks vs. bonds) for the period ending December 31, 2014.  As you can see someone who had 40% stocks and 60% bonds earned the same amount as someone who had 80% stocks and 20% bonds over the 10-year average period.  Sure the more conservative investor made less during the raging bull market of 2009-2014, but the long-term growth of your portfolio is what matters, not what you made last month or last year.

Return 100% Stocks / 0% Bonds 80% Stocks / 20% Bonds 60% Stocks / 40% Bonds 40% Stocks / 60% Bonds 20% Stocks / 80% Bonds
1-year 1% 2% 1% 1% 1%
3-yr ave 15% 11% 9% 6% 4%
5-yr ave 12% 9% 8% 7% 5%
10-yr ave 7% 6% 6% 6% 5%
Worst 1-yr -37% -32% -19% -10% -3%

Another benefit is that the more conservative investor lost much less than the more aggressive investor.  From the table you can see that the person who had 80% stocks lost 32% in the worst 1-year period (2008), while the person who had 40% stocks only lost 10% during that same time period.

Time the Market

Yes, you read that right.  I said “time the market”.  But we’re going to do it the right way, not the wrong way.  The wrong way is selling at the bottom and then jumping back in after the market has already recovered.  Studies show that people who try to time the market lose an average of 50% more than people who stick with their investment plan.

Having said that, what if you need to rebalance your portfolio because it doesn’t match your goals?  Or what if you are retired and need to raise cash for next year’s living expenses?  You may need to make some changes when the market is down, whether you want to or not.

However, you can be strategic about when you make those changes.  As you can see from the following chart, the market is very volatile right now.  Much like the weather in Missouri, if you don’t like it, wait a few days and it will change.  With large swings in the market, you should try to time any selling on the up days rather than selling on a large down day.  While it’s not as ideal as waiting for the market to recover from its current correction, its far better than selling at the bottom and locking in large losses.

On the flip side, if you’re young and have a long way to go until you retire, you should take advantage of the down market to buy more stock (see Buy Low, Sell High below).  So instead of timing the market in a bad way (and locking in losses), you can take advantage of the low market to increase your portfolio over the long run.

SPX 2 hour chart

Buy Low, Sell High

If you are still many years away from retirement, you should be glad the stock market is down!  Remember, when the stock market is down stocks are on sale.  Which would you rather pay… $100 for a new pair of shoes or wait until they are marked down to $50?  $50 of course!  That’s exactly the same mindset you should have when it comes to the stock market.

If you are investing regularly in a 401K, you are already doing this (it’s called dollar cost averaging and it basically means that you are buying more stocks when the market is down and less when the market is up).  However, you could be more proactive and invest even more in the market when it is down by increasing your 401K contributions, investing in a Roth IRA or just by buying a stock mutual fund.

Raise Cash

People who are already retired or close to retirement should aim to have the next 12-24 months of living expenses in cash.  This is to help keep you from having to sell when the market is down.  If you have a large pension or your Social Security benefits cover most of your living expenses then you may not need as much cash, but in general retirees should try to maintain 1-2 years of living expenses in cash.

The best way to do this is to save any current surplus (if you are still working or if your monthly income exceeds your expenses).  However, if you need to raise cash to meet this rule of thumb, remember to do it strategically as described above.

Tax Planning

A downturn in the market could be an opportunity to reduce your taxes.  If you have investments outside of retirement accounts, consider taking losses for tax purposes.  This is especially helpful if you have a large holding in one stock or one mutual fund that you’ve been meaning to reduce.

Just remember to avoid the wash sale rules, which state that losses will be disallowed if you sell a security and immediately purchase a substantially identical security.  For example, if you sell 100 shares of Walmart stock to take the loss for tax purposes you must wait at least 30 days to purchase new shares of Walmart stock.  However, you can invest in a different company or a large cap stock mutual fund without triggering the wash sale rule.

Also, this works best when you have capital gains to offset.  Remember that you can only deduct up to $3,000 of capital losses against ordinary income (wages, pensions, Social Security, etc.) so the benefits of tax loss selling can be limited.

Another way to take advantage of a lower market is to do Roth IRA conversions.  When you convert money from a traditional IRA to a Roth IRA you have to pay taxes on the entire amount converted.  So if you have a $10,000 IRA that you’ve been wanting to convert and the value of that IRA has gone down to $8,000, converting at the lower value will reduce your taxable income by the decline in value of the IRA.

Reduce Your Investment Costs

There are many different types of investment costs.  Mutual funds have an annual operating expense, you may pay transaction fees when you buy and sell investments, or you may pay a monthly or quarterly fee to an investment manager.

These fees may not seem like a big deal when the market is going up, but when you are losing money you may want to rethink the investment fees you pay.  High fees can have a large impact on your portfolio over the long run, so you should minimize your fees whether the market is going up or down.

Annual operating expenses on mutual funds can range anywhere from 0.08% all the way up to 2.5%.  While some actively managed funds (with higher fees) actually earn those fees, it’s hard to outperform the market over a long-term consistent basis.  With that in mind, consider investing in low-cost index funds or exchange traded funds (ETFs).

If you are working with an investment manager, you could be paying anywhere from 0.5% up to 1.5% annually to that manager.  Again, some investment managers do a great job and are earning that fee, but many others aren’t even keeping up with the market.  You should review the fees you are paying and determine if you would be better off investing on your own or working with a fee-only financial planner (who charges by the hour or project instead of based on your asset value).

Defer Major Purchases and Prioritize Investments

“Many investors don’t realize that a large percentage of their long-term investing gains are made during a bear market. A bear market is the time to be pouring money into the market, buying low, rather than taking it out. Thus, it is a great time to defer some of your major purchases. This is not the time to buy a new car, purchase that boat you’ve had your eye on, remodel the kitchen, or take that dream trip to Tahiti. This is the time to fund your Backdoor Roth IRAs, accelerate your 401(k) contributions, start that taxable investing account “.  This is an expert from Physician’s Money Digest’s article 6 Things to Do in a Bear Market

This advice can apply to both retirees and people who are still in the accumulation phase.  If you are retired, you should try to avoid taking large withdrawals when the market is down.  If you had a family vacation, home improvement or other large purchase planned and the market declined right before you needed that money you should try to delay the purchase until the market has recovered.  I know this is easier said than done, but it could make the difference between running out of money during your lifetime or not.

Okay, so that was really a “don’t” not a “do”.  So here’s the thing to “do” part: If you’re in the accumulation phase, consider using funds that were designated for large purchases for investing instead.  I realize that investing when the market is down isn’t nearly as fun as taking a beach vacation or buying a new car, but it can boost your long-term returns significantly.

Remember the Long Term Trend is Up

Above we talked about how often the market can experience corrections.  While it’s important to understand that the market moves in cycles and it won’t always be going up, it’s also important to remember that even with market corrections, the overall long-term trend of the market is up.  To put the market into perspective, consider the following (source: Horsesmouth.com):

  • The average intra-year drop since 1980 has been 14.2%, yet annual returns have been positive in 27 of those 36 years.
  • Over a 10-year period, an average investor in the S&P 500 index would have experienced positive returns 95.1% of the time.
  • A review of all 20-year periods from 1950-2015 showed an average annual return of 8.9% per year for a 50/50 portfolio, with 5% as the lowest annual return for that time period. If you consider that the US economy experienced a major recession during this period, this return becomes even more impressive.

So while we may be in a correction right now, it’s the long-term that matters not what the market does today or this week or even this month.

Resources:

I hope shifting your focus from what you shouldn’t do in a down market to what you should be doing has been helpful.  For more information on dealing with market volatility, here are some articles for you to read:

Market Volatility: What Investors Should Know
A Rocky Market Action Plan for Retirees
6 Things to Do in a Bear Market

Also, many of the points I made in August – when the market first started going down – are still relevant, so please revisit that article here: http://www.beacon-advisor.com/2015/08/stock-market-update-dont-panic/

And finally, if you have any questions or would like to review your portfolio, please don’t hesitate to contact me.

Congress Extends Tax Breaks for 2015 and Beyond

December 29, 2015

tax_refund_336x280In what has become an annual ritual, Congress recently passed a last minute bill to extend tax laws that expired at the end of 2014. The good news is that some of these extenders are now permanent, which will eliminate the need to extend them in future years. Other provisions were extended just through 2016 and others were extended through 2019.

The Protecting American from Tax Hikes (PATH) Act of 2015 was signed into law on December 18. Here is a summary of the most popular provisions that were extended or made permanent.

Extenders that are now permanent include:

Tax free distributions from IRAs to charities: The PATH Act permanently extends the provisions allowing tax-free distributions by individuals age 70½ or older directly from their IRAs to qualified charities. The annual limit is $100,000 per taxpayer.

American Opportunity Tax Credit: The PATH Act makes permanent an enhanced AOTC, with a maximum deduction of $2,500 and phaseout thresholds of $80,000 for single filers and $160,000 for joint filers. 

Deduction for state and local sales taxes: Taxpayers may elect to deduct state and local sales taxes in lieu of deducting state and local income taxes. This optional deduction, which is especially valuable to residents of states without a state income tax and purchasers of certain big-ticket items, is now permanent.

Child Tax Credit: The enhanced child credit, which allows for a refundable portion with a reduced income threshold, is made permanent. This provision was scheduled to expire after 2017.

Earned Income Credit: The PATH Act makes permanent certain enhancements in the EITC for lower-income taxpayers. Previously, the enhancements were only available though 2017.

Deductions for teacher’s expenses: The deduction for up to $250 of out-of-pocket eligible educator expenses is now permanent. It will be indexed for inflation beginning with 2016 tax returns. You claim this deduction “above the line,” meaning it’s available even if you don’t itemize. If you do itemize, you can also generally claim qualified expenses above $250 as a deduction subject to a 2% of adjusted gross income limit.

Section 529 plans: The PATH Act permanently extends the rule allowing computers and related equipment to be treated as qualified expenses.

Section 179 expensing: The PATH ACT permanently restores the maximum expensing deduction of $500,000 for qualified business property with a phaseout threshold of $2 million. (It was scheduled to drop to $25,000 with a $200,000 phaseout threshold.) It will be indexed for inflation for 2016 and thereafter.

The following provisions were extended through 2016

Tuition and fees deduction: If you or a family member is an eligible student, you may be able to claim a tuition and fees above-the-line deduction for qualified higher education expenses for 2015 and 2016. For 2015 tax returns, the maximum deduction is $4,000 when your adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers). The maximum deduction is $2,000 when your AGI is less than $80,000 ($160,000 for joint filers).

Residential energy credit: The latest version of the residential energy credit, which provides a lifetime credit of up to $500 for 10% of qualified expenses, is extended through 2016.

Mortgage debt exclusion: The tax exclusion for mortgage forgiveness on up to $2 million of debt on a principal residence is extended, with certain modifications through 2016.

Deductibility of mortgage insurance premiums: This provision allows taxpayers to deduct mortgage insurance premiums subject to a phaseout beginning at $100,000 of AGI. The deduction is extended through 2016.

50% bonus depreciation (extended through 2019): Although 50% bonus depreciation for qualified business property is retroactively extended to 2015, it will be reduced to 40% for 2018 and then 30% for 2019. Bonus depreciation will completely expire after 2019 unless it is extended again.

These are just a few of the tax extenders included in the 231 page PATH Act passed last week.  For a more detailed list of the tax provisions that were extended please see  “SECTION-BY-SECTION SUMMARY OF THE PROPOSED PROTECTING AMERICANS FROM TAX HIKES ACT OF 2015”

Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Budget Deal Eliminates Important Social Security Filing Strategies

November 5, 2015

social security strategies eliminated Earlier this week President Obama signed the 2016 budget deal which included several surprise provisions for Social Security.

The two biggest changes will be to the “file and suspend” strategy and the ability to file a “restricted application”. The loss of these two strategies will affect many Americans’ retirement plans as they were relying on these strategies to boost their retirement income. People who were relying on the additional income from these strategies will need to re-evaluate their retirement plan to determine if they can still retire at their goal date or if they will have to work longer to replace the lost income.

File and Suspend

The biggest change is to the “file and suspend” strategy.

First a little background on the strategy… In order for spouses to collect the spousal benefit, the other spouse must have already filed for benefits. Often times the higher earning spouse is not yet ready to receive benefits though, so in the past he got around this by filing for benefits and then immediately suspending them. This allowed his spouse to start receiving spousal benefits while he delayed his own benefit (usually to age 70). The benefit of this strategy was that the higher earner could continue to earn accrued benefits (at a rate of 8% per year) on his own benefit while allowing his spouse to start receiving a spousal benefit on his earnings record.

Under the new law, spousal benefits are no longer payable while the other spouse’s benefits are under suspension. In other words, spousal benefits can only be collected if the other spouse is actually receiving his benefits. The husband can no longer file and suspend his benefits; he must actually be receiving them for his spouse to collect spousal benefits.

In previous versions of the budget deal, anyone receiving spousal benefits based on a suspended benefit would have had their benefits terminated within six months if the other spouse didn’t reinstate his benefits. Thankfully the bill was changed so that people already receiving spousal benefits on a suspended benefit will not lose their benefits; however, this strategy will not be available going forward.

Another benefit of suspending benefits was the ability to request a retroactive lump sum for the amount that the person would have received if he/she had not suspended her benefits. This benefit has also been eliminated under the new budget deal.

In effect, the only reason to do a voluntary suspension under the new law is if you take Social Security benefits early and you later decide that you made a mistake and want to delay your benefits. In that case, you will still be able to suspend your benefits, but only after you have reached your full retirement age, and your spouse and other dependents will not be able to claim benefits while your benefit is under suspension.

Restricted Application

The other strategy that has been eliminated is the ability to file a restricted application for spousal benefits only.

Under the old law a spouse who was eligible for both a spousal benefit and her own benefit could choose to receive the spousal benefit only (at her full retirement age) and delay her own benefit to age 70. This was the best of both worlds as it allowed her to delay her own benefit to the maximum amount while still collecting a benefit at her full retirement age (the spousal benefit, which is half of her spouse’s primary insurance amount). This strategy was called the restricted application.

Unfortunately, under the new law this will no longer be allowed. If you apply for benefits you will be considered to have “deemed” to have filed for your own benefits. The only way you would receive the spousal benefit instead of your own is if the spousal benefit is higher than the benefit you would receive based on your own earnings record.

The impact of this change is that spouses will either have to start claiming their own benefits early or they will delay to age 70 but they won’t be able to receive a spousal benefit between full retirement age and age 70.

Widow’s Benefits

The changes above apply to retirement and spousal benefits only, they do not apply to survivor benefits. Widows who choose to receive survivor benefits can still elect to delay their own benefits to full retirement age or later to receive the delayed credits.

Time-Line: When Will the Changes Take Place

File and Suspend:

The key date for the file and suspend strategy is May 1, 2016.

If you have already filed and suspended, this bill will not affect you. Your spouse can still collect spousal benefits even though your own benefits are suspended.

If you have not yet filed and suspended benefits (but are eligible to do so), you can still file and suspend before May 1, 2016 and your spouse will still be able to collect spousal benefits.

If you turn age 66 within six months after the law is enacted (the law was officially signed on Monday 11/2/15 so you must reach age 66 by May 1, 2016), you can still file and suspend benefits allowing your spouse and dependents to receive benefits on your earnings record.

After May 1, 2016 no one will be able to collect benefits on another person’s earnings record unless they are actually receiving benefits. If someone has filed and suspended their benefits, then no other benefits will be paid on that account.

The only reason someone will want to file and suspend benefits after May 1, 2016 is to correct a mistake. For example, if you retired at 64 and immediately started receiving Social Security but then decided that may not have been the best idea, you can still suspend your benefits once you reach your full retirement age. However, no one will be able to receive benefits on your earnings record while your own benefits are suspended.

Restricted Application:

The key age/date for the restricted application is people who will be age 62 or older by the end of 2015. Basically, people born before January 1, 1954 will be grandfathered in for the restricted application strategy.

Here is the time-line for the restricted application elimination: If you are already receiving spousal benefits then you can continue to receive those benefits, they will not be taken away from you.

If you will be age 62 by the end of 2015, then you may still file a restricted application to claim spousal benefits only when you reach age 66. However, the person who’s earnings you are claiming benefits on must either be collecting benefits when you apply or they must have filed and suspended their benefits within the time-line above. Divorced spouses who are age 62 by the end of 2015 can collect spousal benefits at age 66 even if their ex-spouse is not yet claiming benefits (as long as they are at least age 62).

Anyone younger than age 62 at the end of 2015 will not be allowed to claim spousal benefits only going forward. This will primarily affect people who have benefits based on their own earnings record that are higher than the spousal benefit would be. In the past, you could elect to take the spousal benefit only, even if it was lower than your own benefit, and delay your own benefit until age 70. Now when you apply for benefits, you will only be awarded the spousal benefit if the amount is greater than your own benefit would be.

Conclusion and What to Do Now

The purpose of the changes above was to “close several loopholes in Social Security’s rules about deemed filing, dual entitlement and benefit suspension in order to prevent individuals from obtaining larger benefits than Congress intended.”

Unfortunately this reform will affect more than the top 1% that Congress was supposedly targeting. Millions of middle income Americans use these strategies to improve their qualify of life during retirement, including divorced women who will likely be hit the hardest.

Reform measures of this magnitude usually take years to happen. These changes took place over just a few days and will be implemented quickly, leaving very little planning time for the people who will be impacted.

If you are already retired or are close to retirement and were planning on taking advantage of the file and suspend or restricted application strategies, please contact me for a review.  We will need to re-evaluate when you will start receiving Social Security as well as how that will impact your overall plan.

Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

The SSA Announces: No Social Security Increase in 2016

October 16, 2015

social security increase

One of the best features of Social Security is the annual cost of living adjustment or COLA.

The COLA was created to help seniors keep up with rising costs. This is especially helpful to retirees who depend on Social Security for the majority of their income (note: according to the Social Security Administration, retirement benefits make up at least half the income for approximately two-thirds of the people collecting Social Security, and 90 percent of the income for at least one third of Americans receiving benefits).

The COLA has averaged 2.65% since 1990.

Here are the COLAs received from 1975-2015:

July 1975 — 8.0%
July 1976 — 6.4%
July 1977 — 5.9%
July 1978 — 6.5%
July 1979 — 9.9%
July 1980 — 14.3%
July 1981 — 11.2%
July 1982 — 7.4%
January 1984 — 3.5%
January 1985 — 3.5%
January 1986 — 3.1%
January 1987 — 1.3%
January 1988 — 4.2%
January 1989 — 4.0%
January 1990 — 4.7%
January 1991 — 5.4%
January 1992 — 3.7%
January 1993 — 3.0%
January 1994 — 2.6%
January 1995 — 2.8%
January 1996 — 2.6%
January 1997 — 2.9%
January 1998 — 2.1%
January 1999 — 1.3%
January 2000 — 2.5%
January 2001 — 3.5%
January 2002 — 2.6%
January 2003 — 1.4%
January 2004 — 2.1%
January 2005 — 2.7%
January 2006 — 4.1%
January 2007 — 3.3%
January 2008 — 2.3%
January 2009 — 5.8%
January 2010 — 0.0%
January 2011 — 0.0%
January 2012 — 3.6%
January 2013 — 1.7%
January 2014 — 1.5%
January 2015 — 1.7%

Unfortunately, the SSA recently announced that there will not be an increase in benefits in 2016. This is only the third time in 40 years that there has not been a COLA.

You may be wondering how there can be no COLA when the cost of food, housing and medical care (the top expenses for retirees) keeps going up. The COLA is based on the CPI-W, which is a measure of a basket of goods consumed by workers. One of the top expenses in this measure is the cost of transportation. Since the cost of oil was down in 2015, the overall index was down in the third quarter – the quarter used to determine the COLA for the next year. Many argue that the CPI-W is not an adequate measure of retirees expenses (after all, transportation costs generally go down significantly once you retire) and should not be used to calculate annual cost of living increases for Social Security benefits. While this may be true, unfortunately, it’s the measure that is required under current law.

To make matters worse, the SSA is warning to expect large increases in Medicare premiums (up to 52% higher) unless Congress acts soon.

The only silver lining is that people who are already receiving Social Security cannot have their benefits reduced by rising Medicare premiums. This is known as the hold harmless rule.

The inflation protection that Social Security provides to seniors is very valuable. Unless you are a teacher or government employee, there is no other benefit that increases as your living expenses increase. For this reason, I generally encourage people to maximize their benefits as much as possible. This typically means delaying your benefits as long as possible and implementing spousal and other filing strategies as appropriate.

However, if you are planning on applying for Social Security in the next few months, it might make sense to apply for benefits now so that you will be considered an enrollee for Medicare before premiums go up. Your goal should be to maximize your Social Security as much as possible, so please don’t apply early just to avoid the Medicare premium increase, but if you were planning on starting Social Security in early 2016 anyway, applying a few months early could save you up to $600 in Medicare premiums in 2016.

You can read the full announcement regarding the 2016 COLA at http://ssa.gov/news/press/releases/#/post/10-2015-1

 

Kansas Residents May be Entitled to Refund of KC Earnings Tax Paid

August 24, 2015

Thanks to a recent ruling from Topeka, Kansas residents who work in Kansas City (and pay KC earnings tax) may be eligible for a refund of the KC taxes paid.

I am reviewing the recent ruling and will contact any clients who I believe may benefit from it. However, if you are a current tax client and you believe you will benefit from this rule, you are welcome to contact me and get your name on the list of amended tax returns to be completed.

Here is an article describing the new ruling:
http://www.kansascity.com/…/government…/article31669076.html


Kristine McKinley is a fee only financial planner in Kansas City, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

Stock Market Update: Don’t Panic!

August 24, 2015

I sent out an email to my clients today telling them why they shouldn’t panic in face of the recent stock market volatility.  I”m sure many people are nervous after three large down days in a row, so I thought I’d post a copy of the email I sent out below:

Hello,

 

I just wanted to check in with you.  If you’ve been around me for a while, you know I tell people not to watch the market on a daily basis.  However, I know its human nature to do so anyway, so you have probably seen the news that US stocks fell sharply lower last week with the Dow losing 800+ points on Thursday and Friday.  While it never feels good to see stocks tumble into the red, it is by no means time to panic.  Here’s why:

 

  • The market moves in cycles.  While we all would like to see our portfolios go up all the time that just isn’t how the market works (nor is it realistic!).  Having said that, it’s important to note that since 1900 there have been 35 declines of 10% or more in the S&P 500.  Of those 35 corrections, the index recovered fully within an average of 10 months.
  • The S&P 500’s average annual total return over the past 50 years is 10%.  This is even with large corrections such as those that occurred after 9/11 and during the 2008 economic recession.  As you know, I use a pretty conservative rate of return in your retirement projection (6-7%), so your plan should still be solid even with the current market volatility.
  • We’ve been in a very strong bull market the last five years or so.  The S&P 500 more than doubled in value from March 2009 through 2013 with annualized returns of more than 20% through the end of 2014.  Knowing that, I have been telling clients that a correction is overdue, if for no other reason than to bring market values back down to “normal” levels.  So a correction this year was certainly not unexpected.
  • However, the volatility of the past few days has been greater than expected for a “reversion to the mean” type of correction.  This has been due to a combination of events including China’s devalued currency, speculation over the Fed’s plans for US interest rates, declining oil prices, ongoing uncertainty in Greece, and so on…  Each of these factors on its own can have an effect on the market; combined, their impact has been more dramatic.  Even so, none of this news was entirely unexpected.
  • Key US economic factors (manufacturing orders, housing starts, auto sales, P/E ratios, etc.) remain strong, which is why most analysts are viewing this week’s activity as a correction rather than a bear market.  This means from an investment perspective, this may be a great buying opportunity rather than a time to sell.
  • If economics and history repeat themselves – and to date they haven’t failed in this regard – the market will rebound, and long-term investments will continue to provide value.
So what should you be doing now?

 

  • Make sure you have a portfolio that matches your risk tolerance, time frame and goals.  This has always been my highest priority, so if you’ve been in for a review recently, your portfolio should already match these goals.
  • Rebalance your portfolio annually.  This ensures that you don’t become over-weighted in any one asset class, thus putting your portfolio at greater risk during a decline.
  • Keep adequate liquid funds to cover living expenses (if retired) or emergencies (if still working).  A good rule of thumb is to have 3-6 months of living expenses set aside if you are still working, and 12-24 months of living expenses set aside if you are retired or close to retirement.
  • And finally, don’t panic.  People who try to time the market lose on average 50% more than people who stay the course.  This is because when you sell after a large decline you are locking in your losses with no way to recover them.
If anything shifts to change my thinking, I will let you know right away.  But for now, I urge you to sit back, relax and enjoy the rest of this beautiful day.  If you are too concerned about the immediate days ahead, please send me a note and I’ll be happy to address your concerns individually.
In the meantime, turn off the TV and don’t listen to the talking heads screaming doom and gloom headlines (remember, they are emphasizing the negative in order to keep people watching).  Practice patience and assess your own comfort level in weathering what may be some choppy days ahead.

 

All the best,
Kristine

 

P.S.  Here is one of my favorite graphs regarding stock market volatility:
As you can see from this graph, market declines are normal with a 94% chance that a 5% decline will happen in any given year, a 59% chance of a 10% correction every other year, a 21% chance of a 20% decline every five years, etc.  Based on these probabilities and the unprecedented returns we have seen in the S&P 500 over the last five years or so, we are actually long overdue for a correction.  While that may not be very comforting, it’s important to put historical market corrections into perspective and to understand that corrections are a normal part of the stock market.

 

A Guide to Withdrawing Retirement Assets

June 12, 2015

financialA lot is being written about how much money Americans can withdraw from their investments to fund their retirement years. Now, a new research institute launched by Fidelity Investments has outlined the order in which money should be withdrawn from various tax-deferred and taxable investment accounts. Described as the ‘withdrawal hierarchy,’ the Fidelity Research Institute suggests the order, with modifications made courtesy of other financial planning experts.

1. Take your minimum required distributions (MRDs) from qualified accounts and IRAs. If you are age 70½ or older, make sure you know which of your accounts require such distributions and how large those distributions need to be, and then meet the requirements and deadlines, avoiding the application of the 50 percent income tax penalty that will be assessed if you fail to make timely withdrawals of required distributions.

2. Liquidate loss positions in taxable accounts. Some investments in your taxable accounts may be worth less than their tax basis. In addition to offsetting realized losses against realized gains, at the federal level you can usually use up to $3,000 ($1,500 for married couples filing separately) of net losses each year to offset ordinary income including interest, salaries, and wages. Unused losses can be carried forward for use in future years.

3. Sell assets in taxable accounts that will generate neither capital gains nor capital losses. Such assets generally include cash and cash-equivalent investments as well as capital assets which have not increased in value. If your withdrawals from this tier in the hierarchy largely come from cash-equivalent investments, sufficient liquid assets holdings should remain intact in order to cover short-term financial emergencies. And be especially mindful of portfolio rebalancing issues.

4. Withdraw money from taxable accounts in relative order of basis, and then qualified accounts or tax-deferred saving vehicles funded with at least some nondeductible (or after-tax) contributions, such as variable annuities and Traditional IRAs that contain non-deductible contributions. The choice depends on the circumstances, and in some cases it might make more sense to tap the tax-deferred vehicle first, but for most retirees, capital gains rates are lower than ordinary income tax rates and generally liquidating capital assets first would be beneficial.

Assuming there is a significant difference in the basis-to-value ratio of the assets to be liquidated in two accounts, the better tactic for choosing between these two types of withdrawals may be to liquidate the assets with the higher ratio. That is, the assets that have generated the smallest gain or the largest loss as a percentage of their basis. If the basis-to-value ratio of the assets to be liquidated in each account is relatively low due to significant investment gains, it often will be preferable to liquidate the assets in the taxable account.

Conversely, if the basis-to-value ratio of the assets to be liquidated in each account is relatively high, it may be preferable to liquidate assets in the tax-deferred account if portfolio demands require it. Note that IRAs are generally subject to certain aggregation requirements when allocating basis. When liquidating gain positions in taxable accounts, it usually makes sense to sell assets with long-term capital gains first, since they should be taxed at lower rates than short-term gains.

5. Withdraw money from tax-deferred accounts funded with deductible (or pre-tax) contributions such as 401(k)s and Traditional IRAs, or tax-exempt accounts such as Roth IRAs. It may not make much difference which account you tap first within this category since all withdrawals from any tax-deferred accounts funded with fully deductible (or pre-tax) contributions are taxed at the same rate. When withdrawing money from tax-deferred accounts funded with fully deductible (or pre-tax) contributions, you may wish to request that taxes be withheld.

If you believe that the withdrawals you make may be subject to different tax rates over the course of your retirement (whether due to changes in tax law or to varying tax brackets as a result of fluctuations in income) you may be better off liquidating one type of account within all of these guidelines before another. For example, it may make more sense to leave your Roth account intact if you thought your ordinary income tax rate was likely to rise in later years, increasing the value of the Roth’s tax exemption.

Estate planning considerations may also significantly impact the entire hierarchy. Generally, qualified and tax-deferred assets may be given a higher order within the withdrawal hierarchy in the case of larger estates expected to hold “excess” assets which will pass to heirs or be subject to estate taxes. Capital assets receive a step-up in basis at death, while qualified and tax deferred assets are considered to contain “income in respect of a decedent” and do not receive a step-up. A number of other issues may also have an effect on the recommended order of withdrawal, like if the retiree’s income approaches the threshold of paying taxes on Social Security income.

This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Kristine McKinley, CFP, CPA, a local member of FPA.

The Importance of an Annual Financial Checkup

September 7, 2014

It’s one of the six steps of the financial planning process. But, oftentimes, it’s the one step that gets overlooked. It’s the sixth step – the annual financial check-up.

The annual financial check-up is indeed the most important of the financial planning steps. And yet, financial planners and clients sometimes downplay its significance.

What is the annual review and why is it so important? In short, the annual review is the opportunity to measure a client’s progress against their plan of action. It’s also the one time when planners and clients can examine the many changes that typically occur any given 12-month period – the birth of a child, the death of a loved one, the loss of a job, a major purchase – and then readjust the client’s financial plan, charting a new course if need be or further affirming the client’s progress towards their personal financial goal achievement.

Indeed, lives are seldom static and that’s why financial plans are not necessarily set-and-forget documents. But what exactly should financial planners and clients examine in their annual meetings? And when should they conduct their annual meetings.

Typically, financial planners will collect a client’s data, prioritize their goals, examine their resources, make recommendations, and implement a plan as part of the financial planning process. In an annual review, the financial planner will do much of the same and then some. They will first typically examine a client’s progress against the plan time frames. This sort of monitoring benefits both planners and their clients. Clients get an opportunity to step back from their busy lives and review their goals and confirm that their priorities remain the same Planners have a chance to reconnect with their clients to affirm their positive actions towards goal achievement or to help refocus them so that they don’t get too far off track. And planners get a chance to enhance the relationship and trust.

In some cases, planners and clients will want to establish a regular appointment, meeting on an annual basis, and in some cases on a quarterly or semi-annual basis. Typically, the planner and client will review in these meetings short-term goals, examining what if anything may have changed. In some cases, the planner will make changes to a client’s investment portfolio in light of tactical or strategic asset allocation models in place. In other cases, a planner will suggest changes based on certain life events. The birth of a child or grandchild may require a discussion about 529 plans. A divorce may require changing beneficiary designations on retirement accounts and life insurance policies.

In addition a planner may want to review with their clients new research that has become available in the interim to either confirm rationale or provide a basis to alter a client’s short-term or long-term strategies. For instance, new research that shows the escalating costs of nursing homes or health care in retirement wouldn’t change the goal of “secure long-term retirement,” but it would change the strategy to achieve that goal.

Besides reviewing family developments, planners would also address in an annual review regulatory and other changes that could affect adversely or positively a client’s financial plan. The new Medicare Part D plan or the introduction of the Roth 401(k) could prove useful to some clients. In other cases, the annual review is a chance to review potential changes, changes in the federal estate tax laws, for instance, and devise possible plans of actions.

Planners and clients will often want to measure the “performance” of the investment portfolio as part of the annual review. Typically, performance should be measured against several benchmarks, the most important of which is the client’s own personal goals. For instance, if the planner and the client established that a portfolio should grow by 5 percent per year before taxes then the performance should be measured against that yard stick. To be sure, it’s important that portfolios be measured against standard benchmarks. But only as a point of reference. Meeting personal investment goals is far more important that over performing or underperforming the Dow Jones industrial average. By and large, it’s imprudent for planners and clients to make wholesale changes to a portfolio bases solely on one quarter as well as one year of performance.

In summary, annual reviews provide a chance for planners to examine a client’s long-term goals. These reviews can establish whether the client is generally on course to meet their goals. It’s also a chance to review changes that have occurred and begin to anticipate changes that may occur. It’s a chance to implement any new plan of action that has been developed in light of changing goals or changing performance. And then last, the annual review provides the perfect opportunity to establish future review meetings.

One of the most important worksheets to review is a balance sheet or net worth statement. If reaching all of the client’s goals will require a net worth of $1 million at some point in the future, it is the balance sheet that will demonstrate movement toward or away from that goal. It is a road map. When going out of town, a map is almost always consulted before and during the trip. Progress toward your ultimate destination is noted by each passing town or landmark. It is easy to see when you move off track and what corrections should be made to get you back on the correct path in the least amount of time or distance. The balance sheet measures your progress toward your monetary goal in a finite manner. What the numbers show from year-to-year are not as important as what they show after several years looked at as a whole.

This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Kristine McKinley, a local member of FPA.  Kristine is a fee only financial planner serving the greater Kansas City area.

Common Social Security Retirement Questions

June 23, 2014

social security questionsAs Baby Boomers are getting closer and closer to retirement, they have many questions about Social Security, such as…

Will Social Security be there for me when it’s my time to collect benefits?

For a long time the media has been telling us that Social Security is going bust. Millions of Americans depend on Social Security to fund all or part of their retirement, so this is a huge concern in our country. So do we really need to worry about Social Security going under before we start collecting our retirement benefits?

The 2009 Social Security Trustees Report anticipates that Social Security benefits paid to retirees will exceed Social Security taxes paid in by workers (and earnings on the funds in the trust) beginning in 2016.  In addition, the trust fund could be exhausted by 2037.  Once the trust fund is gone, benefits will still be paid out, but the taxes collected from people still working will only be enough to cover 76% of the benefits promised.

Read more

Got Retirement Questions? Chat with an Expert for Free on Feb 7 and Feb 12

January 27, 2013

Kiplinger magazine and the National Association of Personal Financial Advisors (NAPFA) are teaming up for the annual Jump-Start Your Retirement Plan Days to bring you free one-on-one personal finance advice.

NAPFA members (including me!) from across the U.S. will be standing by to answer your questions from 9:00 a.m. to 5:00 p.m. ET on Thursday, February 7 AND Tuesday, February 12, 2013.

This year, Jump-Start Days will feature four separate chat rooms, each hosted by expert financial advisors:

Chat Room #1: Taxes and Retirement

Chat Room #2: Saving for Retirement

Chat Room #3: Income in Retirement

Chat Room #4: Other Financial Challenges

The chat rooms will be open a week in advance so you can get your questions in early.  To submit a question, simply follow the link above that best fits your question.  Advisors will answer questions in the order they come in.  

I will be in the Taxes and Retirement chat room from 11-1 on February 7.  I look forward to answering your questions!

Read more at http://www.kiplinger.com/article/retirement/T047-C000-S001-jump-start-your-retirement-plan-days.html#D3iXVK9A45kfobIk.99

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Beacon Financial Advisors, LLC, is a fee-only financial planning and Registered Investment Advisory firm headquartered in Lee’s Summit, Missouri and serving the greater Kansas City area. The firm offers comprehensive financial planning services. Beacon advisors work solely for their clients. Continue reading about our Services

About Us

Kristine McKinley, CFP®, CPA, is the founding principal of Beacon Financial Advisors, LLC, an independent, fee-only financial planning firm serving the greater Kansas City area. Kristine focuses on providing fee-only financial planning, investment advice, and tax preparation to individuals and families from all income levels. Continue reading About Us

In the News

Kiplinger Magazine/NAPFA (February 2013) – Kristine McKinley answered reader’s tax questions during the 2013 Jump Start Your Retirement Plan Days sponsored by Kiplinger magazine and the NAPFA Consumer Education Foundation. Click here for more News...