Recent Musings

1. When building a portfolio, you basically have two choices.

With the availability of index funds, it’s not difficult to build a portfolio. The question is, what kind of portfolio do you want to build? Or, to put it another way, what are you trying to accomplish?

Do you want to trail the market when it’s going up or when it’s going down?

You can structure your portfolio to be more aggressive than the overall stock market. That will help you when the market is going up but hurt you in down markets. Alternatively, you can structure things to be more conservative than the market, in which case you’ll trail in up markets but lose less when the market is going down. The takeaway being you can’t have it both ways.

Investment returns (in the realm of normal) are within our control. Many people worry about the stock market. It doesn’t need to be that way. If you don’t want to lose sleep worrying about the market, you don’t have to. It’s all about the asset allocation choices you make.

2. When it comes to investments, there’s no such thing as perfect.

No investment is going to be perfect, and we shouldn’t expect it to be. In traditional finance textbooks, investment decisions are presented as a tradeoff between risk and return. If you want more return, you must take more risk. But if you want less risk, you must be content with lower returns.

That is a bit over-simplistic so when evaluating investments, investors should think things through much more carefully. In addition to risk and return, consider an investment’s fees, complexity, liquidity, tax treatment and the overall level of economic certainty or uncertainty.

3. When warranted, be willing to pay more.

It’s worth paying more if you’re getting extra value. Most investors are sensitive to fees and taxes—and they should be—but this comment is a good reminder not to take this too far.

Similarly, if you own an overpriced, underperforming fund, should you hang on forever just because you would have to pay some taxes if you sold?  Of course not. Do the math and don’t be afraid of costs if you think it will pay off in the long run.

4. Don’t fall in love with an investment.

Just as there’s no perfect investment, there is no investment that you should expect to remain perfect for all time. I see this as particularly applicable to thinking about index funds—an investment that appears awfully close to perfect right now.

I believe that low-cost index and factor funds are the best way to invest—and there’s plenty of supporting data. But we should never be too comfortable. Currently, indexing works exceptionally well. But it may not work forever. Markets are dynamic. Indexing might begin to work less well or other forms of investing might begin to work better. Anything can happen, so be careful. When it comes to your investments, you don’t want to be blindsided.

CBlakely, CFP®, CTFA

Market Corrections

The stock market got “interesting” again this week. Volatility is back after having disappeared for the last year and a half. Volatility in the markets is normal and over the long-term, a 10 percent decline in the U.S. stock market happens once a year – on average.

This week I’ve been watching the financial media try to whip this up into something it’s likely not. I’m guessing it’s good for ratings as financial shows have seen a dramatic viewership decline in the last several years. Now, it’s way too early to start calling for bear markets, but you would think we are in the middle of one if you watch the financial news. And interestingly, each barking head has a different reason for what is happening, how can that be?…. but I digress. 

The market is down a little over 10% from its all-time highs, after running up over 100% cumulatively, the last five years – with dividends reinvested. But I do understand the pain we feel from investment losses is twice the joy we get from gains.

So what should we do when the market goes down?

#1. Stick to your plan and remain focused on your long-term objectives.

If you do anything, it may be a good time to rebalance your portfolio back to your targeted asset allocation percentages.

#2. Don’t pay heed to the pundits, they are looking to stir controversy or sell something or both and don’t obsess about the market value of your investments.

We are inherently irrational when it comes to investments, it may be wise to talk to your financial advisor or planner to discuss or revisit short and long-term expectations.

No one knows whether this correction will be short-lived or turn into a long, drawn-out affair. No one can predict how investors will react given the hundreds of variables that shape global market returns daily. But if you have a plan of attack or have put one in place working with your advisor, you sidestep the emotional flight response and hopefully will look back on this another behavioral vulnerability overcome. 

CBlakely, CFP®, CTFA                            02-2018

Its Never Too Late to Start Investing for Retirement

Michael Kitces, director of wealth management Pinnacle Advisory Group, sees it regularly in his financial planning practice: clients who are close to retirement but haven’t saved. “They fall into two groups — either they don’t focus on it, or they are despondent,” says Mr. Kitces. “They think their retirement is doomed — it’s a real lose-lose scenario.”

His clients are not alone. Among workers age 55 or higher and nearing retirement, almost half have saved less than $100,000, according to the Employee Benefit Research Institute. A third have less than $25,000.

The savings shortfall means many Americans face the prospect of retiring solely on Social Security, which replaces just 39 percent of pre-retirement income for the average worker retiring at 65, according to the Center for Retirement Research at Boston College.

But near-retirees do have some opportunities to improve their financial scenario in retirement. Which is not to give up on saving. Therefore, rule number one is to save more. If you don't live below your means, financial freedom is not within your reach.

If you start saving 25 percent of a $100,000 salary at age 50 could potentially have about $650,000 at 65 or about $1,000,000 at 70 (assuming a 7.5 percent investment rate).

So to start, create a household budget to reallocate spending to retirement saving - it is more challenging until your children are out of the house. But if possible, maximize contributions in your 401(k) account and open an IRA. Over the age of 50, you benefit from higher “catch-up” limits on tax-deferred savings, for 401(k) accounts it's $24,000; for I.R.A.s, it's $6,500.

The contribution limit for 401(k)'s and 403(b)'s increased to $18,500 in 2018. Take advantage of the additional pre-tax savings and future tax-deferred growth. The catch-up contribution limit for employees age 50 and over will remain at $6,000.

If you or your spouse has access to a workplace retirement plan such as a 401(k), you may not be able to additionally make a tax-deductible contribution to an IRA if you earn too much. The IRA tax deduction is phased out for high earners. The IRA contribution limit is $5,500, with an additional $1,000 catch-up contribution allowed for those age 50 and over. That’s potentially a total of $31,000 that can be invested in tax-deductible tax-deferred vehicles.

Also, waiting to file for Social Security offers another opportunity to increase retirement income. Social Security benefits, which are adjusted annually to account for inflation, can be claimed as early as age 62, but monthly benefits rise 8 percent for every year that you wait up to age 70, increasing your benefit by over 60 percent.

When investing be wary of high-cost funds, academics agree, generally the lower the cost of the fund, the more you keep – this translates to a larger balance at retirement.

As always, you should seek out a credentialed professional that is fee transparent and offers holistic, evidence-based advice.

CBlakely, CFP®, CTFA              01-2018

Sources: The New York Times, Center for Retirement Research at Boston College,  Employee Benefit Research Institute

Why Low-Cost Investing Likely Results in Above Average Returns

Several studies found that only the top 2 to 3 percent of active-fund managers have enough skill to cover their costs. It’s hard enough to save for a house or retirement. So why pay big fees for subpar investment returns? Maybe think about low-cost investing, with an eye toward index investing.

To quote Nobel Prize winning economist Eugene Fama on active managers: “You’re charging people for stuff you can’t deliver.”

We are in the early stages of a move toward low-cost investing as huge sums of money have been flowing out of actively managed mutual funds and into index funds. According to Barry Ritholtz, “we are in the middle of the Copernican Revolution about the proper way to invest or at least the rational way to invest.”

It’s easy to think — by seeing the ads and reading newspaper articles — that if you’re just clever enough, you’re going to win. The delusion comes in the form of how the stock markets actually work.  We don’t understand the negative-sum nature of active investing. Whatever you win, I lose. Whatever I win, you lose, and we both pay to play that game. So the negative-sum nature of investing is one problem that’s often overlooked.

And then there is the second problem, which is, most people suffer from overconfidence, particularly in noisy environments where the feedback is weak. That describes the stock market. It’s incredibly noisy and it’s really easy to misinterpret what the return on your portfolio means.

Simple, perhaps, but elusive. In part because the alternative — the gamble of picking stocks — is so seductive. Which may explain why it took so long for index funds to really catch on. The index fund is more predictable, and boring — which, as Jack Bogle sees things, is its virtue. “It diversifies away the risk of individual investments. It diversifies away the risk of picking a hot manager and diversifies away the idea that you can pick market sectors like healthcare, technology, or whatever it might be.”

And then there’s the cost comparison. According to Vanguard founder Jack Bogle, “They charge a lot for this service. We estimate the average expense ratio is almost one percent for an actively managed fund. Then these active funds, all of them have sales loads. The index funds do not. The active funds further turn over their portfolios at a very high rate and that’s costly. You add that all up and the cost of owning a mutual fund on average is two percent. You can buy an index fund of, an S&P 500 Index Fund, let’s say, for as little as four basis points, four one-hundredths of one percent. In a 7 percent market, you’re going to get 6.96 percent.”

That difference — two percent versus four one-hundredths of one percent — may not sound like a lot. But over time, those numbers are compounded by what Bogle calls the “relentless rules of humble arithmetic.”

Again according to Jack Bogle, “if the market return is 7 percent and the active manager gives you 5 after that two percent cost, and the index fund gives you 6.96 after that four basis point cost — you don’t appreciate it much in a year — but over 50 years, believe it or not, a dollar invested at 7 percent grows to around $32 and a dollar invested at five percent grows to about $10. Think what an investor thinks about when he looks at that number. He says, “Wait a minute! I put up 100 percent of the capital. I took 100 percent of the risk and I got 33 percent of the return.” Well, anybody that thinks that’s a good deal, I’ve got a bridge I want to sell them.”

To paraphrase Bogle, here’s the reality of the actively-managed mutual fund business, you get precisely what you don’t pay for. So, if you pay nothingⁱ, you get everything!

Now there are those who can and some people have and have for long periods of time. Look no further than Warren Buffett. The challenge is being able to identify in advance who will outperform the market, for them to beat the market consistently year over year, and then to do it in excess of costs, fees, taxes, commissions. How can an investor tell when it is luck or skill? 

The bottom line is most people are better off with low-cost indexing for most of their invested money. Active investment management may have a role in asset allocation and portfolio construction, but only when it’s low cost, adds diversification and is not used to exacerbate behaviors detrimental to accumulating wealth.

C. Blakely CFP®, CTFA                        10/2017

ⁱ - by nothing, I mean almost nothing.

Sources: Bloomberg View - Ritholtz, Freakonomics – Bogle interview, Fama Interview 

Working Past 65 - Considerations for Social Security and Medicare

Living Longer

If you are nearing or at 65 you know there are many decisions you will need to make that will be very important in determining your financial well-being after you stop working. One big consideration that I believe many of us may get wrong is estimating our longevity – we tend to underestimate it.

Case in point, my grandfather lived to be seventy, my father died at seventy two. If I couple that data with the conventional wisdom often cited that states men live into their late 70’s, (and women into their early 80’s) I might expect to make it to my mid 70’s. However, this is mistaken thinking, actual life expectancy is quite a bit longer – the upside! - and it can lead to serious financial consequences – the downside.

The Social Security Administration’s most recent analysis of expected longevity if you’re 50 years old, is 83 years for a woman, and 80 years for a man. This average can be misleading because some will not live to retirement and some will live 30 years in retirement.

In fact, as noted in a recent Wall Street Journal article, 56 percent of all 50-year-old women are expected to live longer than their life expectancy of 83 years and 55 percent of all men are expected to outlive their expectancy of 80 years, according to the Social Security table. This is because the distribution of ages when people are expected to die is a bit skewed with more people living longer than dying early.

So plan to live longer and fine-tune your retirement strategy. This may mean saving more, or for those nearing retirement, reconsidering whether you should work for a few more years and continue growing your retirement accounts.

If you are considering working past 65 there are several very important considerations, although I am only going to touch on two for this post.

When to take Social Security

If you are not planning to live long in retirement then start taking Social Security at age 62. But, if you plan on living into your eighties, consider this, if you defer taking social security until you are 70 ½, the increase in the payout over those eight years is 76 percent – inflation protected! That is a big move up and may make a big difference if you have not been able to save enough for retirement.

What about Medicare

You’re eligible for Medicare at age 65 but what if your desire or need is to continue to work? Hopefully there is someone at work to help navigate this but in many cases you can't rely on your employer for Medicare guidance. Employers frequently provide wrong or confusing advice about when employees should enroll in Medicare.

If you work for a company with fewer than 20 employees, be sure to enroll in Part B during your initial enrollment period. Medicare automatically becomes your primary payer, and your employer's plan is unlikely to pay for any expenses that could be covered by Medicare - even if you forgot to enroll in the government program.

Typically, the insurer will notify you that it will not pay a claim because it should have been submitted to Medicare. If an insurer pays several claims then realizes you are eligible for Medicare -they seek repayment from you. As long as you're still employed, you can enroll in Part B without penalty - and you should do so immediately.

If your employer has 20 or more employees there are different rules. You do not have to enroll in Part B while you're still working. You should** enroll in Part A because it's free for most people, and Part A will be secondary to your employer plan. A spouse who is 65 or older can stay on your company plan and delay Part B until you leave.

If you’re happy with your employee coverage and don’t want to get Part B but are receiving Social Security benefits and automatically received a Medicare card, you can send it back and ask for it to be reissued just for Part A. (You can’t delay signing up for Part A if you are already on Social Security.)

It could make sense to drop your employer coverage if your benefits are inadequate and your premiums, deductibles and other out-of-pocket costs are high. You should compare the benefits and costs of your employer plan with the costs of Medicare, plus Part D and a Medigap policy.

A self-employed person who has an individual insurance policy should enroll in Medicare during the initial enrollment period. Otherwise a policy can coordinate with phantom Part B, meaning that it will pay secondary to Medicare, even if you haven't enrolled.

Once you leave your job, you can enroll in Part B without penalty during an eight-month "special enrollment period," which begins the month after you stop working. To avoid a gap in coverage, be sure to enroll in Medicare a month or two before you leave your job. If you miss this enrollment period, you will need to wait until the next general enrollment period.

**You may run into a bit of a roadblock if you have a tax-free health savings account tied to your employer's high-deductible health plan. Whether you should delay enrollment in Medicare so you can continue contributing to your HSA depends on your circumstances. Employer health care coverage pays primary before Medicare so you effectively don’t need to have Medicare in order to pay your health expenses. This means that as long as you are currently working and you wish to decline Medicare Part B, you can do so and enroll in Part B later when you lose your coverage. However, you cannot decline Medicare Part A, unless, you’re not accepting Social Security benefits. As long as you are not accepting Social Security benefits, you can choose to decline Part A also, which preserves your HSA tax benefit! As soon as you want to stop contributing to the HSA (and if you are still currently working) you can enroll in Part A and get six months of retroactive coverage.

Once you enroll in any part of Medicare, you won’t be able to contribute to your HSA, it’s the law. If you would like to continue making contributions to your HSA, you can delay both Part A and Part B until you stop working or lose coverage from your employer. You will NOT pay a penalty for delaying Medicare, as long as you enroll within 8 months of losing your coverage or stopping work (whichever happens first).

Finding out More

Medicare is a complex service and this post serves only to make you aware of the basics. For more information and help, your state likely offers a free health insurance counseling program (APPRISE in Pennsylvania) designed to help you navigate Medicare. An excellent resource for more information is the Medicare Rights Center's online Medicare Interactive service (www.medicareinteractive.org), which answers many common enrollment questions. Or you can call the State Health Insurance Assistance Program (find your state SHIP at www.shiptacenter.org).

CBlakely, CFP®, CTFA                           02/2017

Sources: SocialSecurity.gov, Medicare.gov, Wall Street Journal

How to Add a Half a Million to Your Retirement Account by Cutting not Adding

I’ve been trying to come up with a scenario that fairly represents the difference one percent makes over our investing lifespan using as an example, two employees who systematically put the same amount of money away for retirement and then spend down those assets during about two decades of retirement.

The Scenario

It starts with two 30 year old employees who work until their full retirement age of 67. The first 20 years they invest in an 80/20 portfolio of stocks to bonds, starting with nothing and adding $750 a month (1/2 of the current contribution limit). At 50 years old, the mix is changed to 50/50 and again using 1/2 of the current contribution limit plus the catchup provision, which totals $1,000 a month. Finally, our representatives live another 18 years in retirement, so at 67 the portfolio allocation is again changed, this time to 20/80 stocks to bonds. It is also assumed during retirement they each receive monthly cash distributions from the portfolio. The return figures used are historical averages (see notes for detail) and inflation was taken into account using a 2 percent annual increase.

There is one key difference in the two portfolios, one was charged 27 basis points (0.27%) in fees using a passive funds strategy and the other was charged 1.27 percent for an actively managed funds portfolio. Effectively a one percent difference over the 55 years our investors were invested.

The Results

Over the first twenty years, from ages 30 to 50 the portfolios grew to $374,506 for the passive portfolio and $332,515 for the active portfolio, remember the only difference affecting return is the fee. Over the next 17 years leading to retirement, the passive portfolio ends up with an inflation adjusted $1.27 million while the active portfolio maxes out at $1.01 million. Again the difference is only due to fees. At 67 our retirees begin taking monthly withdrawals, the passive investor takes $6,500 a month for life and dies at 85 with about $430,000 left for heirs, charity or her dog. The active investor cannot take as much or the portfolio would be depleted prior to age 85 and instead takes $5,788 a month so that the portfolio is worth zero at death.

The one percent cost difference to an investor under this scenario over a 55 year period is well over $500,000. Over the 37 years of employment that little one percent fee difference accounts for a 30 percent difference in the amount of capital growth in the portfolios. During retirement the difference in fees is the difference between taking $78,000 out each year and having some capital assets left – comfy with some breathing room - or taking $69,450 out each year with nothing left at the end – live past 85 and its Social Security.

These results are only one of near infinite scenarios depending on when you start investing, how long you work, how much you put away, etc. The important takeaway is that lower fees mean better return probabilities for investors, irrespective of your age or dollar amount of your assets. In other words the less you pay the more you keep. This post does not even take into account that active fund managers have underperformed passive funds across most fund categories over longer-term time periods (10-15 years), making the case for low-cost passive investing even more compelling.* Although in theory the case for active management seems intuitive, the actual track record of most actively managed funds is underwhelming.

As always, seek the help of an accredited professional when it comes to your financial future.

CBlakely CFP®, CTFA          04/2015   

Notes: Inflation assumption - 2 percent per year. Historical returns: 80/20 portfolio 8.92% annually, 50/50 portfolio 7.71% annually and 20/80 portfolio 5.72% annually. Time value calculations used monthly compounding, and retirement calculations used sequential cash flows all with the same value (annuity).

Although the author (me) believes in the veracity of the formulas and results, these numbers have not been subjected to review and may contain errors.

Source: *The Case for Index Investing – Vanguard White Paper March 2015