Roth Conversions are a Big Deal

It is no secret 2020 took the world by surprise and will be the year we all remember. It also seems investors have learned there are many things we certainly cannot control. However, when it comes to financial planning, and in particular tax and retirement planning, there are significant opportunities we all should consider now since they may not be available for long. If you haven't considered Roth conversions before, 2020 may be the year.

Why 2020? It's because we have historically low tax rates and some have suggested they could rise in the near term. Taxes could also rise due to the increasing budget deficit, increased stimulus spending and highest deficit since World War II. For those whose employment has been impacted by the Covid-19 pandemic, this may present planning opportunities. And the obvious may be that higher tax rates put tax-deferred retirement savings at risk; so some of us may want to pay off the "debt" at the lowest possible tax rates.

KEY CONSIDERATIONS:

Assess overall market conditions and factors to determine if a Roth IRA conversion makes sense.

Determine which group of assets and/or asset class to convert.

Work with Advisor or CPA to determine the amount to convert.

Determine how you will pay the income tax on the conversion.

Compare other viable long-term tax planning strategies.

NEXT STEPS

Evaluate your need for a 2020 tax conversion. One option is to perform a series of smaller annual conversions over time. This fills up the lower tax brackets each year and manages the tax liability. Also, be sure funds are available to pay the taxes.

A second option is to convert larger amounts in 2020. By now, you should have a reliable estimate of 2020 income. If the pandemic caused business losses, a job status change from retirement or unemployment, or a large change to income, this year may allow for a larger conversion.

This popular planning strategy can allow you to pay lower tax rates today and allow the funds in your Roth IRA to grow tax-free. It can also allow for the potential for 100% tax-free withdrawal from your Roth in the future.

While a Roth IRA conversion can remove some risk of uncertainty to your planning process, keep in mind your Roth is not subject to required minimum distributions (RMDs). Smaller RMDs can reduce tax liability and increase sustainable lifetime income.

The benefits can be significant, but this strategy is not for everyone.

As always we are here to help.

Best,

CAM Investor Solutions

Source: AICPA; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

History and Presidential Elections

What History Tells Us About US Presidential Elections and the Market

It’s natural for investors to look for a connection between who wins the White House and which way stocks will go. But as nearly a century of returns shows, stocks have trended upward across administrations from both parties.

Stocks have rewarded disciplined investors for decades, through Democratic and Republican presidencies. It’s an important lesson on the benefits of a long-term investment approach.

Shareholders are investing in companies, not a political party. And companies focus on serving their customers and growing their businesses, regardless of who is in the White House.

US presidents may have an impact on market returns, but so do hundreds, if not thousands, of other factors—the actions of foreign leaders, a global pandemic, interest rate changes, rising and falling oil prices, and technological advances, just to name a few.

The anticipation building up to elections often brings with it questions about how financial markets will respond. But the outcome of an election is only one of many inputs to the market. Below is a link to an interactive exhibit that examines market and economic data for nearly 100 years of US presidential terms and shows a consistent upward march for US equities regardless of the administration in place. This is an important lesson on the benefits of a long-term investment approach.

Follow this link to learn more about each presidency:   Interactive Exhibit - Markets Under Each Presidency

As always, we are here to help.

Best,

CAM Investor Solutions

Source: In US dollars. Stock returns represented by Fama/French Total US Market Research Index, provided by Ken French and available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html; US Government Presidential and Congressional data obtained from the History, Art & Archives of the United States House of Representatives. US Senate data is from the Art & History records of the United States Senate; Federal surplus or deficit as a percentage of gross domestic product, inflation, and unemployment data from Federal Reserve Bank of St. Louis (FRED). GDP Growth is annual real GDP Growth, using constant 2012 dollars, as provided by the US Bureau of Economic Analysis. Unemployment data not reported prior to April 1929; Dimensional Fund Advisors; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

The Impact of Low Rates

Last week, we saw market movements that signaled a low-yield environment. Since then, rates have continued to fall.  Currently the 10-year treasury is trading close to 50bps and the entire yield curve is pricing at below 1% for the first time in history.

Although these unprecedented movements may reflect more short-term fears, we believe they should motivate a revaluation of traditional notions of risk and reward.  As we look to ensure one's financial planning strategies remain sound, below we highlight some key considerations that may impact all of us:

Over the past couple of weeks, coronavirus fears and the rapid drop in oil prices have gripped global markets. 

In the US, the S&P 500 recently experienced its worst week since the global financial crisis as investors piled out of risk assets, and yields on safe haven assets have collapsed.

In particular, the yield on the 10 year Treasury breached the 1% mark - and is currently the lowest it has been in modern record (back to 1962).

Although the bond market rally may have benefited many traditional fixed income investors in recent weeks, we view the level of current yields as the most relevant measure of investors' experience to come. And we believe these yields may predict a prolonged period of challenging performance by traditional fixed income portfolios.

While this may concern some, it really means that everyone should review all of their current bond and fixed income strategies to ensure they still meet one's financial planning and retirement income needs.

In contrast, there are some strategies that still invest and currently offer higher yields above current fixed income solutions – far more than the 1-2% yields currently offered by traditional fixed income.

In addition, some of these strategies have established a track record of delivering consistent returns which have been relatively robust to market instability, due to their structure and near-zero correlation to equities and bonds. While we invest in these strategies for some clients, they are not a one size fits all and require additional consideration and due diligence.

Whatever developments may unfold over the next few weeks and months in financial markets or global economies, we believe smart financial planning will continue to serve as a ballast in investors’ portfolios.

Over the past few years, we've discussed the impact of a low interest rate environment on investors' financial planning goals and investment returns. While some argue rates may one day rise again closer to long-term averages, this is very hard to predict.

Of course, low rates can be great for so many things such as:

Lower mortgage payments

Smaller borrowing costs

Increased stimulus and economic growth

Greater business valuation

Global trade benefits

However, as we've discussed prior, low rates and in particular a low risk-free rate can have consequences on our investment returns, our financial planning assumptions, and the ability to generate sustainable lifetime income. Therefore, it is important to be proactive and understand these implications in order to create a smoother path both during the working years and well into retirement.

For reference, academia has documented the fact that higher portfolio volatility can subject investors and retirees to significant sequencing risk. It can also result in a lower level of gross accumulation of wealth. In contrast, there may be better planning and investment strategies that can be measured with greater precision, with less volatility, and where the sequencing risk works in investors favor.

With all this in mind, we want to remind investors that during a time of economic changes like the ones we are experiencing now, it is important to evaluate and trust the financial plans you have put in place and avoid the temptation to let emotions make your financial decisions. Your financial plan is there to guide you through times like this.

As always we are here to help.

Best,
CAM Investor Solutions

Source: Bloomberg; Stone Ridge Asset Management; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

How Much Income is Enough

Everyone has a different value of a dollar. Regardless of how we view our investments, manage our liabilities, claim our social security benefit, and many other financial decisions, the illusion of wealth is real.

If given the choice of receiving $100,000 at the start of your retirement or $500 per month for the duration of your retirement, which would you choose? What about $200,000 versus $1,000 per month? Which option seems more adequate—the lump sum or monthly amount?

In reality, purchasing an annuity for $100,000 would result in a guaranteed lifetime income of approximately $500 per month, while buying one for $200,000 would yield roughly $1,000 per month. So, these lump sums and annuitized streams are economically equivalent. But are they psychologically equivalent? (Note: As a fee-only fiduciary, CAM earns no fees from any annuity or insurance recommendations).

Perceptions of Wealth: Lump Sum Versus Monthly Income

Behavioral science researchers Hal Hershfield, Dan Goldstein, and Shlomo Benartzi have investigated this question in several studies involving thousands of middle-aged adults (approximate ages 40-60) with varying incomes, educational levels, and ethnicities. In one study, for example, they asked a group of people if they thought $100,000, $200,000, $1 million or $2 million would be adequate to fund their retirement years. To keep things well controlled, they told them to imagine that each sum represented the total amount of money they would have to spend in retirement. The researchers then asked a separate research group how adequate these same amounts would be as monthly income of $500, $1,000, $2,000 and $4,000.

Not surprisingly, as the following figure shows, a lump sum of $100,000 didn’t rate very high on perceived adequacy. Their research participants gave it roughly a 2.25 on a 1-7 scale (where 7 represented “totally adequate”). But participants didn’t think about $500 per month in the same way. That amount garnered roughly a 1.75 on our seven-point scale. And the same was true for the $200,000 lump sum (which averaged a 2.5 rating) and the annuity of $1,000 per month (which rated a 2).

Perceived Adequacy (Between Subjects) of Amounts of Money in 401(k) Plan

Source: Goldstein, Hershfield and Benartzi, 2016.

Annuity Income May Boost Saving Intentions

Although lump sums and their equivalent monthly amounts are financially the same, they are not psychologically equivalent. At times, lump sums may seem like they are worth more than their resulting annuitized streams. This matters for more than just simple perceptions of adequacy. When offered a $200,000 lump sum versus an equivalent $1,000 monthly annuity, research participants in another study were more motivated to increase their retirement savings (in a hypothetical context) when seeing the annuity compared to the lump sum. In other words, the $1,000 monthly annuity seemed less adequate and therefore boosted savings intentions.

But the story isn’t quite so simple. Yes, lump sums may sometimes seem more adequate than their annuitized streams. But look what happens when we asked people about the adequacy of a $2 million lump sum versus an annuity of $4,000 per month—the annuity seemed more adequate than the lump sum.

Annuities Become More Attractive When Amounts Are Larger

What’s going on here? When people think about how much money they’ll have for the future, more money will always seem better. But the mode of distribution—a lump sum or a monthly amount—will change perceptions of that wealth. From mortgages to car payments to credit card statements, we typically have more experience dealing with monthly amounts of money and whether a given amount will cover our expenses on a monthly basis.

As a result, it appears that people are more sensitive to changes in wealth expressed in monthly terms. This sensitivity can set up an interesting situation in which people perceive monthly amounts as less attractive than lump sums at lower levels of wealth (e.g., $100,000 lump sum versus $500 monthly). At lower levels of wealth, people can more accurately judge just how little a given amount would get them. We call this situation the “illusion of wealth.” Yet, people see monthly sums as more attractive at higher levels of wealth (e.g., $2 million lump sum versus $4,000 monthly income) where people can more accurately judge just how much a higher amount would buy them, or the reversal of the illusion of wealth.

These illusions can affect other financial decisions as well. Claiming Social Security benefits early, for example, results in slightly lower monthly payments over the course of retirement. When the earliest claiming age was 62, workers would forego $119 per month if they claimed benefits at 62 compared to 63. Over time, however, that same amount in lump-sum form would be equal to about $21,492. The illusion of wealth would suggest that the $21,492 lump sum seems larger and therefore a more painful amount to give up compared to the $119 monthly payment.

But it’s not just large decisions like retirement claiming age that are relevant. Consider the case of liabilities. Focusing on small monthly payments spread out over time can have detrimental effects on overall financial well-being if we simultaneously ignore the effects of compounding interest.

Numbers in Isolation Probably Don’t Provide Enough Information

Taken together, we might be better served to question the format that we use when we consider a variety of important financial decisions. Each number—whether it is a monthly amount or a lump sum—is probably not sufficient to use as the basis for a well-informed decision. Rather, when making saving, spending, and investment decisions, we are likely better served by having an understanding of both the sum and its broken-out parts.

Because these decisions can have such a significant impact on one's current financial planning or longevity planning assumptions, we believe a greater understanding for investors is deserved in order to maximize their well-being for the future.

As always we are here to help.

Best,
Marc

Source: Hal Hershfield, Ph.D., Associate Professor of Marketing and Behavioral Decision Making in the Anderson School of Management at the University of California, Los Angeles; Avantis Investors; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Will I Have Enough

Many investors in retirement have certain goals in common: more money rather than less, minimal wealth volatility, and enough financial cushion to cover the extra costs of, hopefully, living a very long life.

Retirees have generally tried to meet those goals with a simple rule of thumb: hold a balanced stock/bond portfolio and withdraw at a sustainable rate. Historically this worked in large part because risk-free rates averaged 5.9% the last 65 years. Risk-free rates form the foundation of expected total return to every risky asset, i.e.:

Expected total return = risk-fee rate + expected risk premium

So, total returns to stocks and bonds were sufficiently high to meet investor needs. After all, if you followed the rule of thumb, withdrawing 4% of your portfolio in retirement when risk-free rates were 5%+, you didn't need to worry much about running out of money, and you probably ended up having plenty to pass on to your heirs. It was all pretty easy.

Unfortunately, the days of adequate and reliable expected total returns on a traditional stock/bond balanced portfolio could look different. Risk-free rates are near zero or negative in all developed markets, and global yield curves appear to forecast persistently low or negative rates for some time to come. Low or negative risk-free rates can pull down the expected total returns on all investments, stocks and bonds alike.

What about volatility? Volatility is driven by the non-risk-free portion of returns, so it doesn't decline just because expected total returns are lower. Given the potential new combination of lower expected total return and not lower volatility, simple math tells us that the probability of a low or negative cumulative return over any future period may now be (much) higher in some asset classes. Recent research calls this "The New Arithmetic of Financial Planning" and it represents a direct challenge to traditional retirement analysis.

So risk-free rates have collapsed vs. historical averages, but what about risk premiums? Risk premiums are unknowable in advance, of course, but what's not unknowable is just how tenuous realized risk premiums on traditional asset classes can be. For example, in Japan the equity risk premium has been negative for the last three decades, and counting. In the U.S., stocks have experienced a worst-case drawdown of 865. And while investors don't need to be reminded of the 55% drop in their equity portfolios ten years ago, what some may find surprising is that in just the last 12 months, the average small stock in the U.S. is down 9%, and the average international stock is down 1%. Investors are not entitled to the equity risk premium - certainly over shorter periods (10-20 years) and even over periods that many investors typically consider very long term (30 years+).

As we look ahead to the future, it is also interesting to note several of the following which may impact one's financial planning assumptions going forward:

Historically, the equity risk premium has been reliant on the outsized performance of a small number of companies.

Over the last 93 years, 4% of stocks have driven 100% of U.S. stock market wealth creation. The other 96% are a push.

About 25 stocks (out of about 26,000 ever to exist) have driven 30% of all stock market wealth creation. 

Some may ask, where is the next Microsoft and Amazon? Here are a few more thoughts to keep in mind for planning purposes:

Something perhaps not well known to most investors is that companies are staying private longer.

Sarbines-Oxley may be forcing some of this reaction by company executives.

The significant growth in available private market capital is also a reason since an IPO may not be needed.

How can investors capture the hyper-performance in their early few post-IPO years?

Microsoft and Amazon went public with much lower valuations than companies today such as Uber, Peloton and Lyft just to name a few.

While there is a significant amount of data and evidence on this topic, most agree that future expected returns could be lower going forward in some areas of the market. To be clear, lower does not mean negative nor does it imply a forecast for a recession or a stock market crash. However, it may mean that one's current financial planning or longevity planning assumptions are affected. What this evidence does make pretty clear is the case for smart diversification, risk management, and holistic financial planning.

As always we are here to help.

Best,
Marc

Source: U.S. Treasury 10-year constant maturity rates; Morningstar; Bloomberg; Thomson Reuters; Stone Ridge Asset Management; Oliver Wyman: Longevity Risk Premium October 2019; Bessembinder, Hendrik, et al., "Do Stocks Outperform Treasury Bills?" Journal of Financial Economics, forthcoming; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Has a Global Recession Arrived

Some claim that a global recession has begun following a lot of the recent economic data. Others might argue that major problems only exist overseas, and signs of any recession is not present in the United States.

Regardless of who is right, we expect a recession won't be confirmed until twelve months or longer after the fact. This is similar to what we've seen in the past and is usually confirmed by the National Bureau of Economic Research (NBER) as well as other sources. The challenge is that predicting a recession is harder than you think.

INTEREST RATES

A lot of this debate and investor concern has been fueled by the recent steep decline in interest rates and does deserve further attention. Many of you may be wondering what happens if we experience zero or negative interest rates in the future? To be blunt, nobody knows with certainty what will happen because we've never experienced such an environment in the United States. It's also expected many "experts" will pretend they know what will happen and we recommend investors use caution around those who provide this kind of advice. Just remember, interest rates can increase too which many seem to forget.

As many of you know, our firm uses facts, logic, and an evidence-based approach to financial planning and investing. Instead of trying to forecast or "guess" future events, we look to focus on what we know to be true as well as seek to provide our clients with a higher probability of success. In our recent blog A Stock Market Cycle and Investor Discipline, we highlighted interest rate yields and inflation expectations are at generational lows. Given this current environment, we address several investor questions below that relate to the possibility of zero (or negative) interest rates including considerations for the next recession:

If we anticipate a recession is coming, should we get out of the stock market and go to cash and bonds? No. If you have a good financial plan in place that is properly managing investment risk and liquidity, then you should have been planning for market volatility (or you would have been 100% in the stock market). Also, some bond strategies may carry more risk than you think even though they are deemed to be safe.

Aren't my treasury bills (T-bills) safe in a recession or low-rate environment? Yes, the principal value for individual issues is guaranteed, however, T-bills are not immune to inflation. There are other solutions to accomplish this.

Should we continue to expect low inflation? By traditional measurements, inflation is at generational lows in the United States. However, if you look closer it is present in the economic data and in the goods and services we buy every day. Should tariffs continue, this is expected to also push up inflation pressures.

Should I sell all my fixed income if rates go to zero? Probably not all, but yes, it's possible some of the longer duration or higher risk bond funds may no longer offer appropriate compensation for risk. Fixed income has had a historic bull market given declining rates. At these levels it seems reasonable to expect most fixed income will produce lower returns going forward and some of these strategies may also bear greater risk if rates reverse course and increase. Hence, some holdings may warrant selling and rebalancing into higher quality, short-term duration funds which should still provide ample liquidity, but be less sensitive to interest rate fluctuations. In terms of individual bonds, their yield to maturity or yield to worst should not be impacted.

Given the risk of recession and interest rate fluctuations, will this hurt my real estate investments? Not necessarily as it depends on what sector of real estate (public vs. private; residential vs. commercial, etc.). Also, if short-term interest rates began to rise, it doesn't mean this will be bad for the sector.

Are there any fixed income strategies to consider that are not tied to interest rate fluctuations? Yes, some exist such as alternative lending, private debt, and inflation protection strategies. However, it is important to evaluate if these are appropriate in the context of one's risk tolerance and asset allocation.

Should I still hold as much cash if rates keep dropping? Any good financial plan will always retain a healthy amount of cash for emergency reserves, essential living expenses, and other needs. This level of liquidity avoids having to sell or realize losses in a down market or tough recessionary environment.

Given recession risks, should I reallocate into alternative investments? While some alternatives may offer diversification benefits for certain investors, many of these solutions will still feel the pain and impact of weak economic activity and recessionary periods. In particular, many private alternatives don't price each day or will experience a lag in reporting. Lack of liquidity is often an issue too for many private alternatives during a period of distress.

Should I own individual bonds or bond mutual funds? Potentially both, especially if rates continue to fall further.

How long should we expect low interest rates? There is a lot of research that suggests the best predictor of future rates are today's interest rates. So, it's possible low rates may continue for some time.

What is the impact of a long-term, low rate environment? Its positive for those looking to borrow, refinance, structure businesses, debt, and many other common financial needs. For income investors, it may present a challenge to generate enough income due to lower yields. It also seems reasonable to expect that traditional fixed income returns will be lower in the future compared to the past twenty or thirty years. This will impact financial planning and retirement income expectations for some. A low-rate world may also decrease future stock market returns which was a critical discussion that we covered earlier this year in The 60/40 Investment Debate.

For investors who have a sound financial plan in place and are properly managing risk, most of this discussion should have no impact on you. However, a second opinion never hurts.

As always, we appreciate our relationship with you, and we are here to help.

Best,
Marc

Source:  J.P. Morgan; Federal Reserve Bank of St. Louis; Dimensional Fund Advisors; Bloomberg; Stone Ridge Asset Management. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

A Stock Market Cycle and Investor Discipline

Every point in a stock market cycle brings its own emotional challenges for long-term investors. When volatility spikes, as it did in 2018, investors need to muster their intestinal fortitude and avoid the temptation to flee to cash. In times of extended market doldrums, as we saw in 2015-16 when stocks mostly moved sideways, investors must avoid the temptation to go looking for higher returns in risky investments that can lead to big losses.

Then there is the environment we currently find ourselves in – with most major market indices at or near all-time highs. When stocks push into record territory, no one other than short sellers are unhappy. Real Estate continues to look unstoppable as well. It is also worthy to note that interest rate yields and inflation expectations are at generational lows.

Source: Federal Reserve Bank of St. Louis, FRED Economic Data Period: January 1, 1964 to March 31, 2018; Source: Illuminating the Path Forward, Ross Stevens, Joshua Zwick, Randolph Cohen, February 2017, p 5.

But the enthusiasm is often tempered with anxiety about stocks being overvalued and poised for a fall. These fears are only enhanced by the endless stream of stories in the financial media highlighting analysts’ predictions of a looming downturn. These stories are often accompanied by suggestions that investors should “take some winnings off the table” and pare back their stock exposure. We even discussed some related concerns in a recent blog The 60/40 Investment Debate.

To better understand how long-term investors should view the future direction of the stock market, it’s helpful to revisit the past. A look back at some of the major milestones the Dow Jones Industrial Average has achieved through the years is insightful.

The Dow first closed above the 1,000 threshold in 1972. It cleared 2,000 in 1987, closed above 5,000 in 1995 and hit 10,000 for the first time in 1999. Several times along this journey, the Dow failed to hold its ground when it reached a milestone and pulled back. Stocks entered a long bear market in 1973 and struggled to emerge from it for the rest of the decade. The Dow also spent much of the 2000s trying to hold the 10,000 level, only to fall back during the bear markets of 2001-02 and 2008-09. But the Dow also frequently blew through other milestones without looking back, notably during the mid and late 1990s, as well as in recent years. The below chart for the period from 1995 to 2017 highlights the journey to new milestones for the Dow:

Source: CBS Marketwatch research

The bottom line is that stocks hitting record highs and major milestones is not a clear indicator that a downturn is looming. Stocks can, and often do, keep soaring well after the conventional wisdom has decided equities are overvalued. And even if a downturn occurs, they are often temporary and shouldn’t dissuade long-term investors from putting money to work in the stock market. Of course, trying to predict market events in advance with long-term success is impossible. However, we do understand the importance of proper risk management and believe everyone should have a custom financial plan in place that is aligned with their investment strategy. This not only helps achieve one's goals, but can provide a better way to protect their financial health for both their current and future needs. 

As usual, the Oracle of Omaha, Warren Buffet, had some keen insight on this topic. At a Forbes magazine conference in 2017, Buffet scoffed at those who are bearish about the future performance of the U.S. stock market. “Being short America has been a loser’s game, and I predict to you it will continue to be a loser’s game,” he said. He then made a prediction that the Dow would reach the 1,000,000 level within a century.

At first glance that seems incredibly bullish on Mr. Buffet’s part, but it’s worth noting that it would only require a 4% average annual gain in the Dow to reach the 1,000,000 milestone in a hundred years. And that’s really the whole point we are making: stocks are always plowing ahead, though rarely on a straight line. But the climb through record highs and major milestones is an inevitable part of the stock market’s nature, and those investors who let fears of stocks being “too high” are the ones who won’t be along to enjoy the ride.

A bit of esoteric-but-still-interesting research crossed our desk this quarter. The research firm TS Lombard conducted a study in which they separated out the returns generated in the S&P 500 from domestic (U.S. based) investors vs. the returns generated by overseas investors. The study covered the period from January 1, 2017 to April 24, 2019, and the results were striking.

The study found that nearly all of the 30% gain in the S&P 500 during that time period came outside of U.S. hours. When the U.S. exchanges were open, the S&P gained a mere 2%, with the rest of the gain coming after U.S. exchanges had closed. The spread was especially striking since the beginning of 2018, with the S&P 500 actually experiencing a 5.4% decline during U.S. trading hours, yet still posting a 9% gain for the period thanks to the bullishness of overseas investors.

So what can we glean from this research study? To us, it seems clear that overseas investors in U.S. stocks are focused much more on long-term fundamentals than they are on the short-term news cycle. Stocks in the U.S. tend to be more volatile while the U.S. exchanges are open because American investors are immersed in all the short-term noise surrounding the markets. How often have we seen the Dow plunge 100 points or more over a news report that momentarily panics the market, only to fully recover the next moment when the report proves false or less dire than initially believed?

While news about the U.S. certainly doesn’t end at our borders, it’s logical to assume that overseas investors aren’t as obsessed with every iota of new information that comes out during the U.S. trading day and are instead focused on finding the best investments for their money. And U.S. stocks have proven, time and again, to be an outstanding long-term investment.

Something to keep in mind the next time irrational anxiety grips the market and sends investors scurrying to hit the panic button.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

Source:  Forbes; J.P. Morgan; Federal Reserve Bank of St. Louis; Bloomberg; Stone Ridge Asset Management. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Creating My Own Longevity Strategy

To be blunt, as part of their financial planning process, many more people should establish a longevity strategy. As we discussed in a recent blog Longevity Planning vs. The 4% Retirement Rule, there are many considerations when making these decisions. However, two primary characteristics determine which pre-retirees and retirees will benefit most:

INITIAL FINANCIAL CONDITION: Retirees with “modest-sized” nest eggs relative to expected expenses in retirement need a longevity strategy more. Retirees with large nest eggs relative to expected expenses in retirement require little income protection, as their strong financial position allows them to weather market fluctuations and unexpected longevity. Retirees with small nest eggs relative to expected expenses should focus on accumulating assets before pursuing income protection.

INDIVIDUAL RISK TOLERANCE: Retirees with low risk tolerance – either to market conditions or to individual longevity – should pursue income protection for piece of mind.

In addition to these primary factors, the investor should consider his or her current age when deciding whether to create a custom investment portfolio or purchase longevity insurance right now. Still, additional considerations and scenarios exist when considering which solution is best for investors. For example, though a longevity insurance policy becomes more appealing as one ages, every year of delay in purchasing it creates an opportunity cost. The premium increases as the time between the purchase date and the income start date decreases. In selecting the optimal age of purchase, the investor must compare:

The return on each dollar of investible assets used to purchase the longevity insurance policy. This is how fast the premium increases for a longevity insurance policy with a specific income start date;

The return on that same dollar if it were instead invested in an alternative risky portfolio.

Though no precise wealth level corresponds to each of the rows above (as it will vary with a retiree’s goals and income needs, among other characteristics), those whose net worth is likely to be greater than $10 million to $15 million+ at retirement may want to consider self-insuring; whereas those who are likely to retire with less than $1 million, may want to focus on accumulating assets. That leaves a very large “sweet spot” in between.

THE PAYOFF

So including a longevity strategy (custom investment portfolio or longevity insurance) in a holistic lifetime financial plan has significant payoffs:

Improve your odds of meeting your goals: By including a longevity strategy in the portfolio, the retiree may be able to guarantee funding for his or her retirement needs after age 85. As a result, the retiree might bear investment risk for a shorter time. Even with a potentially lower expected portfolio return (say due to low interest rates), the retiree can still improve the ability to meet all of their retirement expenses.

Spend and leave behind more for small upfront investment: A longevity strategy can empower retirees to use their savings, as well as increase their bequest to their heirs. By allowing an investor to build a financial plan that addresses the risk of outliving their assets, establishing one’s own longevity solution can provide an investor with the same financial security with higher living standards; the same financial security with less initial principal required; and higher expected asset accumulation with the same financial security.

Enjoy the peace of mind of knowing you’re protected: In addition to financial benefits, longevity strategies can create the income stream that provides peace of mind. In general, financial planning improves investors’ sense of control, happiness, and life satisfaction. By removing the contingency around living past one’s life expectancy, longevity insurance can further increase that sense of well-being, allowing people to stop worrying and enjoy their retirement.

This sense of confidence can itself lead to a longer life. Studies have shown that financial worry leads to depression, anxiety, sleepnessness, sickness, and poor relationships. The right longevity strategy can initiate a virtuous cycle, in which financial security creates well-being, which extends life while protecting retirees against the costs of those extra years.

SHOULD WE BE PLANNING FOR MANY MORE TOMORROWS

Making the right planning decisions today has never been more important.

Human ingenuity has dramatically extended our lifespans, and these advances may even be accelerating. That is the good news. The bad news is that living longer, with fewer reliable sources of retirement income, exposes us to the frightening prospect of outliving our assets. But investors don’t have to take this unnecessary risk. A longevity strategy is a targeted, purpose-built solution to this problem. It is the missing element required to transform a financial plan focused on getting investors to retirement, to a lifetime plan that gets them all the way through it and beyond.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

How much Retirement Income is right for you

Source:  Harvard Business School; Irving, Kym. "The Financial Life Well-Lived"; Bartholomae/Fox. "Coping with Economic Stress." Journal of Financial Therapy, 2017. Oliver Wyman; Stone Ridge. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Longevity Planning vs. The 4% Retirement Rule

Last month, in our blog The 60/40 Investment Debate, we discussed a few key considerations when it comes to longevity risk. As our focus continues in a pursuit to solve this very important issue, we realize longevity planning is often confused with traditional planning for one’s future retirement.

For most, today’s retirement planning only focuses on planning “to” retirement rather than “through” retirement. Financial planners generally do a good job of putting focus on the accumulation years before retirement; sometimes using rules of thumb for the subsequent post retirement years. One popular example is the well-known 4% Retirement Rule, which was first stated by William Bengen’s 1994 paper. This framework used historical data to determine “safe” rates of withdrawal from a portfolio. How many times have we heard, "Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4%, followed by inflation-adjusted withdrawals in subsequent years, should be safe."

What’s the biggest assumption underlying the 4% rule?

It is neither investment returns, nor the longevity of the retiree. It is the presumption that the retiree won’t withdraw more than 4% of the initial asset balance each year. To be sure, investors could always withdrawal less than 4% and cut back on essentials in the case of poor investment performance. But without knowing how much they’ll need later in life; the decision is filled with uncertainty. Regardless, it seems retirees may not even adhere to the 4% rule when you consider actual behavior. While the 4% rule may not be realistic, many scholars and marketers quickly adapted Bengen’s research. In years that followed, its simple approach made it popular. Since nobody knows how long they will live, planning decumulation around actuarial averages results in a retirement income strategy that may lack precision.

But investors ideally need a roadmap that considers all phases of life. Predicting the length of the journey may be difficult, but one can still plan for all possibilities, matching the inflow and outflow of assets over the totality of retirement. Conventional financial wisdom reveals the path to retirement, but the road through it still needs to be made. Since nobody knows their exact retirement income needs, investors need to build a conservative margin in their household balance sheet to fund any unexpected expenses from longevity. This may come from their investment portfolio or through a custom insurance solution to share in the risk.

Source: One-Year Treasury Constant Maturity (DGSI) from FRED website 11/1/2018. Past results are no guarantee of future results.

How Much Risk Are You Willing to Accept?

Since the size of the cushion has profound implications for the retiree’s financial well-being, it should depend on how averse the investor is to longevity risk. Those who save too little, risk hardship or forced dependence, whereas those who save too much may experience unnecessary deprivation. If you factor in sequence of returns risk as well as a low interest rate world (as highlighted in the chart above) , this will require additional consideration for most investors as they look to create wealth, generate income, and manage portfolio risk at retirement.

Can any asset allocation address longevity risk? By building a cushion, the investor may be able to reduce the investment risk portion of the income risk, but no traditional asset has the capability of insuring against longevity risk. Hence, the investor can tweak asset allocations forever to arrive at an “efficient” portfolio from an investment risk perspective, but the exclusive use of traditional assets leaves an entire source of risk unaddressed. The investor unnecessarily hinders his or her portfolio efficiency. Put bluntly it is impossible to have an optimal income efficient portfolio if the underlying assets’ investment strategy cannot address all the risk.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

How much Retirement Income is right for you

Source:  J.P. Morgan; Dimensional Fund Advisors; Vert Asset Management; Morningstar, Inc.; Federal Reserve Bank of St. Louis; Bloomberg; FRED; McKinsey; SIFMA; Morgan Stanley; BIS; Deloitte; Stone Ridge Asset Management. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.