Category: Retirement

A common mistake investors make is to continue to contribute to their Roth IRA even though they are no longer eligible. Most people will start a Roth IRA when there income is lower and mistakenly think that they can continue to make annual contributions; but unfortunately, the IRS limits Roth contributions at higher income levels. Luckily, there are ways to continue to build these accounts, regardless of income. Here is what you need to consider if you want to increase your investments to Roth accounts.

First off, what is a Roth?

A Roth account is a great way to save on your tax bill to Uncle Sam. Roth accounts are unique in that they are only taxed once. When you contribute to the account you are adding after-tax dollars, the money then grows tax-free, and it is not taxed when it is withdrawn. (Earnings may be taxed and or penalized if they are taken prior to 59 ½ or within 5 years of the first contribution to the account.)

Why should I invest in a Roth?

A Roth account is particularly valuable when contributions are made when your tax bracket is relatively low, and you have a long time for the money to grow. For example, let’s say you start to contribute to a Roth IRA at age 20 and contribute $5,000 a year until age 30. Even if you do not contribute to it at all after age 30, your balance, assuming a rate of return of 8%, at age 65 would be roughly $1,070,900. You only paid taxes on the $50,000 of contributions and will never pay taxes on over $1M worth of growth. That is the power of tax-free compounding.

Who can contribute?

Generally, you can contribute to a Roth IRA if you have taxable compensation, are less than 70 ½ years of age, and your Modified Adjusted Gross Income is less than:

  • $191,000 for married filing jointly
  • $129,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and
  • $10,000 for married filing separately and you lived with your spouse at any time during the year.

The maximum contribution is the lessor of $5,500 ($6,500 if you are age 50 or older), or your taxable compensation.

If you have income over these amounts, you are disqualified from adding to your Roth account. (In addition, you will also be over the limit for a deductible traditional IRA.)

If my income disqualifies me from contributing to my Roth IRA, do I have any other options?

Yes. You have three options a Roth conversion, Roth 401K, or backdoor Roth conversion.

Roth Conversion

Even though you are unable to contribute to a Roth, there are no income limits to Roth conversions, so you may decide to convert your traditional IRAs to Roth IRAs and take advantage of your investment growing tax-free with no future required minimum distributions. A conversion would make sense if you expect your tax rate to be higher in the future and are willing to pay the taxes on the conversion with funds outside of the IRA account.

Roth 401K

Another way to build some tax-free investment growth via a Roth is to sign up for your Roth 401K if your workplace offers the option. Unlike the Roth IRA, the Roth 401K has no income limitations for eligibility. Since we prefer income that will be taxed at relatively low rates to fund a Roth, it may make sense to contribute after-tax payroll deductions to the Roth 401K up to point where your taxable income puts you in the top of the 25% income tax bracket, after which point, any additional contributions could be made to the traditional 401K, so as to keep you in the 25% marginal tax bracket. This not only helps diversify the taxability of your investments but also provides added flexibility for your withdraws in retirement.

Note that you will likely want to roll over the Roth 401K at retirement and or prior to age 70, as the Roth 401K does require that you take annual RMDs (Required Minimum Distributions) during your lifetime, whereas the Roth IRA does not.

Back door Roth conversion

Another way to add funds to your Roth IRA is through a “backdoor” Roth conversion. Here is how it works. You make a non-deductible contribution (after-tax dollars) to a traditional IRA and then, convert the IRA to a Roth IRA. If done correctly, this conversion will result in minimal taxation.

Ex: Tony and Tina make over $225K a year. They are in their 40s and want to build some tax-free funds into a Roth for their retirement. They each make a $5,500 contribution to a traditional IRA in January which has a zero balance, as they have already converted all of their traditional IRA accounts. Six months later, they convert the funds to their Roth account. The tax impact of the conversion will be based on the difference in the value of the account at conversion and the original $5,500 contribution.

When would you not want to do a backdoor conversion?

  • If you have substantial traditional IRA assets which have been deductible, the back door conversion becomes tougher as the pro rata rule comes into play. The pro rata rule aggregates all of the existing IRA balances and taxes the conversion based on the ratio of deductible funds to the total. For example, say that Lars has $94,500 in several traditional IRAs in which he contributed deductible pre-tax money. He makes a contribution of $5,500 to a non-deductible IRA this year and then converts the $5,500 account using the backdoor strategy. If he did not have any existing IRAs, the conversion would likely not be a huge taxable event (depending on the account value when he converted that year). However, since the total IRAs are now $100,000 and his conversion amount is $5,500, 94.5% of his IRAs are deductible, so $5,198 of his conversion would be taxable.
  • If you are going to need the funds within 5 years, this strategy will not be optimal, because a backdoor Roth is considered a conversion and not a contribution. Converted funds will incur a 10 percent penalty if withdrawn within five years unless you are age 59 ½ or older.
  • As always with a Roth, if you are in a higher tax bracket now then you expect to be in retirement, you may want to keep the money in the traditional IRA.
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With a crying baby or a two-year-old throwing a tantrum you may feel ready to retire on some days! You may also have a hard time conceptualizing the relaxing vision of your “Retirement.” Alas, the day will come when our little ones have grown up, and we will all be enjoying a new kind of independence—-one that will hopefully last a long time! The question is, “Will you be ready?”

While “ready” can come with many emotional factors such as the empty nest and exiting the social network of the workplace, as a financial planner, I will focus on the financial aspects of “ready.”

First, let me define retirement. You may immediately think of the outdated images of older people sitting in Adirondack chairs reading books and wistfully gazing at the sea. We’ve all seen this picture in any number of advertisements targeted to retirees. Ahhh….how peaceful.

In reality, though, as we consider our generation, we have had our children later, we are living longer, and we will likely want to lead very active lives as we continue to age. When I talk about retirement, I really just mean that time when you are going to rely upon — and draw upon —- your accrued savings whether that is from a 401K, your IRAs, or just money from a brokerage or savings account that you have invested.

To know if you are “ready,” you have work to do before you get to the money part. Do you know what you want from this time that society calls retirement? Have you painted this picture in your mind? I challenge you to ponder what you might want for your future. If you have read my column in the past, you know that I am a strong proponent of creating a vision —- that is, really setting aside time in a serene place to feel and envision what you want to create. I recommend that you and your spouse do this separately — and then compare your answers about what your retirement will look like. It makes for very lively date night conversation!!

Once you know from a lifestyle perspective what you want to do, feel, and “have,” the next part of being “ready” is to attach costs to this vision. The purpose of doing this exercise is ultimately to answer the question, “How much money will I need for retirement?”

This question alone keeps many financial planners in business since the art of calculating this need is not easy. And, the resulting numbers are astronomical (think Millions). The list of factors and considerations that impact the amount is long. A few questions you will need to be able to answer before any planner can help you are:

What age to you anticipate you want to retire? Do you have a goal of retiring at age 50 or do expect to keep working through until your mid-sixties or beyond? Again, this is the age where you would start to rely on your assets accumulated.

How much income do you want? This is hard to get your head around, so start with your income today. Are you comfortable? I will guess that you will want at least as much as you make now, if not more. While you may reduce your expenses in retirement (home costs may be eliminated, you may relocate to a less expensive area, you no longer have to save for your children), you will have much higher health insurance costs, and you will probably want to travel or do other exciting activities that require cash.

Will you have additional income? What is your confidence level in the existence of a social security system? Do you envision yourself working part-time or starting a business? Do you have cash flow from other investments such as real estate? Are you fortunate enough to have a pension? Are you confident it will still be available when you retire?

As you can see, getting “ready” to retire is a process you can start right now. While your idea of retirement will probably change many times as you have more birthdays, the practice of creating the vision, assigning value and ensuring you are contributing enough money toward your goal is one that will serve you well in any area of your financial plan. Make sure you get ready now.

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Many studies show that Americans are woefully behind on their savings for retirement.  In fact, according to the 2018 EBRI annual survey, roughly 60% of all workers surveyed have less than $25,000 saved for retirement. But things might not be as bad as they seem. 

A recent study by risk management firm Towers Watson attempts to debunk the magnitude of the retirement crisis in America.   The authors suggest that most retirees will be better off than predicted, since they don’t require as high a replacement ratio of preretirement income, as what is commonly recommended. They argue that the often quoted rule of thumb that retirees will need to fund 85% of pre-retirement income annually, may be too high.  In reality, retirement cash flow needs change over time.  As retirees age they move through the “go-go” years, the “slow-go” years, and then the “no-go” years.  We spend far less than we anticipate at the end of our lifecycle, due to diminished mobility and health.

In addition, the savings cycle is variable.  People will forgo savings early in their career, but ramp savings up substantially in the latter stage of their working years to make up for lost time.

I was recently asked to comment on the Towers Watson study by reporter Mandi Woodruff for an article in Yahoo Finance.  My instant reaction to this story was that individual investors have to take these rule-of-thumb numbers with a grain of salt.  The data on annual retirement savings is flawed (as the Towers Watson report points out).  For example, it does not include the value of pensions, real estate, or closely held businesses.  It also does not include the value of transfer payments and other governmental programs, so the resulting data set is incomplete. We cannot draw conclusions based solely on this data.

Gauging retirement readiness should be done on an individual basis.  More importantly, as a financial planner who specializes in retirement planning, I know that simple tools or rules of thumb are crude at best.  They are like applying blunt machetes in a surgical procedure.  They are not going to result in the precision that is needed for each individual’s situation.

The best way to approach retirement planning is to work from the bottom up and determine the clients’ specific personal cash needs and requirements over the balance of their lives.  Quick on line calculators and rules such as multiple of final income or spending as a ratio of income can’t possibly apply to everyone.   These repeatedly quoted prescriptions for success insinuate that the planning process is static and deterministic, when in fact, it is a dynamic process based on many fluid assumptions and variables.  The ever changing-nature of a client’s personal life, tax laws, financial markets, etc. require that the plan is periodically updated.

Instead of a rules based approach, each client should be evaluated in a highly customized and holistic way.  That is the essence of true financial planning.  It’s not just about investments anymore. It is about how a person will fulfill their dreams and what money can do for them during their lifetime.  It is about career planning, lifestyle planning, legacy planning, tax planning, and cash flow planning.  More importantly, it also encompasses the “x factor” of a client’s behavior towards and attitudes about money in his or her life.

While many in the field of finance are touting the trend and threat of robo-advisors, holistic retirement planning lends itself far more to the human touch. Since many Baby Boomers are entering the distribution phase of their financial life, customized financial planning is becoming more important than ever.

Proper financial planning starts with an in-depth conversation with a client to better understand what makes him or her tick.  It requires listening, attentiveness, and is done best when there is an ongoing relationship with that client.  It is not a one and done event.

A detailed retirement plan projection often requires the client answering the following questions:

  • What are you needs, wants, and bucket list items in retirement?
  • When would you like to retire and how will you phase into the new lifestyle? Will you still want to engage in part time work once you quit your job?
  • How will you spend your free time?  What might a typical day look like?
  • How often will you be travelling and where will you go?
  • How often will you be connecting with friends and family?
  • Do you want to leave money to heirs or a favorite charity? How will gifts to kids and your charities change upon retirement?
  • How healthy are you and do you have a history of longevity in your family?
  • How much are you willing to save in order to achieve an early retirement?  And conversely, how much are you willing to cut spending before and after retirement, in order to retire early?
  • What are your plans for your home? Will you relocate?  Will you keep your second home?  Will you need any major improvements done? Will you downsize?
  • How often will you buy cars and other vehicles?  How much will you spend on each vehicle?

These questions not only help to determine annual and overall cash flow needs, they also can help assess behavior around money as well as risk tolerance.

I often use the metaphor of a jigsaw puzzle.  Each client walks into my office and figuratively drops the pieces of their life puzzle on my table.  Each puzzle picture is uniquely different.  It is up to the client and me to put these pieces together to develop a vibrant picture of their future retirement years.

While I think these rules of thumb to assess retirement readiness are not adequate, there are some principles that are highly correlative to retirement readiness.

I suggest that if clients are serious about wealth-building they should save at least 15% of their salary throughout your career and that should limit wealth in personal real estate to no more than 25% of your total assets.

These principles encourage strong savings mentality, keep debt to a minimum, and reduce exposure to a low return asset class (personal real estate).  Living below one’s means is a successful way to build wealth and a good lifelong habit.  A strong savings rate helps protect against longevity and poor investment returns, as well as having to heavily tilt retirement savings to the back end of a career–which makes the investor more susceptible to market corrections in the years just prior to retirement.

Finally, the personalized, holistic approach to retirement planning addresses the significant challenges that savers have with regard to retirement planning.  Having a planner that fully understands these risks and properly accounts for them will help the client feel more confident about his or her prospects for retirement.  For example, if the planner assumes conservative investment return assumptions, accounts for higher healthcare cost inflation, adjusts Social Security benefits to account for some reform, assumes a relatively long life span, and the clients still have a high chance of success, they will feel more confident about their upcoming retirement.  The peace of mind that is achieved through the financial planning process is something that a rule of thumb or quick on line calculator won’t necessarily provide.

While the savings statistics for Americans suggest significant shortfalls in retirement, working with a planner to determine how to maximize financial opportunities like Social Security and pension maximization, tax reduction strategies, and maximization of their human capital, is essential to preparing for a successful retirement.  Ideally, the process is started as early as possible to improve a retiree’s chance of success and ensure that their unique vision of  retirement is realized.

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If you are like most workers in South Carolina, you probably have procrastinated saving for retirement. Now that you have put your retirement planning on the front burner, you realize that you’ll have to aggressively ramp up your savings rate. You wonder if you can make up for lost time by being more aggressive with your investments. Unfortunately, that may not help you as much as you thought. Retirement planning is all about math, and to help illustrate the math equation, I like to use the metaphor of a garden to explain the lifecycle of retirement savings and distributions. Here are four basic questions that will help you assess your ability to retire. Reflecting on each of these questions will enable you to better understand where you need assistance and also what you are doing well.

Questions One: The Retirement Garden- How Big is Your Plot?

The amount of income you make during your career is your “human capital.” You potential capital is greatest when you are just entering the work force. Whether you work for decades with a low to modest income or you retire early and get a golden parachute worth multiple millions, think of that total income (years worked x income per year) as the land you have available to plant the seeds of your retirement savings. One way to maximize your land is to retire later or invest in your career development. It is also imperative that you protect your “land” with proper insurance such as life and disability.

Questions Two: Planting Seeds for Future Growth- What is Your Savings Rate?

It is how you cultivate your land that counts. In order to have an abundant garden, you need to plant a lot of seeds and seedlings. For example, you may have a high income for many years, but if you are not systematically saving a portion of your income (at least 10%, if not 15%) your land will not bear enough fruit in the future. Your land will be barren. Even investors with modest plots (income) who have diligently sowed the seeds of savings over the years may have more plentiful income in retirement than their profligate neighbors. This is why most financial planners recommend starting early and putting retirement savings on autopilot. To sow more seeds for retirement savings, increase your savings rate into your 401K or other retirement plan and cut back on spending to save additional amounts outside your retirement plan, if you are already at the maximum limit.

Question Three: Weeding, Feeding, and Pruning for Optimal Growth- Do You Have a Sound Investment Plan?

A well thought out investment strategy helps you maximize the growth of your “retirement garden,” but most of the heavy lifting needs to be done by acquiring land (income) as well as planting seeds and seedlings (consistent and/or significant savings). Many people think of their investments like fertilizer, and rationalize that if they increase the aggressiveness of their portfolio, they can make up for lost time. But you can’t rely solely on fertilizer for the output of your garden. Just like fertilizer, too much of a good thing, (say holding a concentrated position of one stock, maintaining too high an exposure to equities, or skewing your portfolio to highly volatile sectors like emerging markets) could undermine your progress, especially if you have limited time left to build up your retirement silo.

Proper asset allocation among low-cost, diversified asset classes such as domestic and international stocks, real estate, commodities, and high quality bonds can provide adequate growth while helping to mitigate potential losses. Just like we plant various crops to hedge our bets, we invest in various asset classes to create an all-weather portfolio. Planting a variety of crops will protect us from a variety of risks and ensure some of our harvest survives no matter what Mother Nature (or the markets) throw at us. Ideally, some investments will perform well when others underperform, and vice versa. The overall performance will be unpredictable and change as often as the weather. Consistently pruning your portfolio through periodic re-balancing of these asset classes, possibly as infrequently as once a year, will help maximize the long run return or yield of your garden.

Questions Four: Providing For Your Future Harvest- Should You Consult an Experienced Gardener?

Retirement planning and investment management need not be (complex or expensive). It is all about how investors behave within the retirement planning cycle. In order to help motivate and guide your master plan for retirement, you may want to consider seeking out the expertise of a fee-only CERTIFIED FINANCIAL PLANNER Professional. He or she will help you determine how much you need to save based on your unique goals and design a low cost investment portfolio to help build and maintain wealth as well as minimize drawdown during your distribution phase. Probably the most important benefit of a professional advisor is that he or she will keep your invested through thick and thin instead of bailing when times get tough. Some investors try to time the market by buying into the market during upswings and selling during declines. This could reduce the overall yield of their crop, just like harvesting a crop before its peak might. Instead, you will need to plant often and consistently (through dollar cost averaging).

I hope that the retirement garden serves as an inspiration for you to focus on maximizing the abundance of your retirement garden. By planting, harvesting, and consuming the fruits of your labor in a prudent manner, you will reap the rewards in the form of a satisfying retirement lifestyle.

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Over Memorial Day weekend my company was an exhibitor at the San Francisco Birth & Baby Fair. As usual, many expectant and new parents wondered by my table, and when I asked them about their financial plan, they hesitated, “Well, we’re going to get a 529 Plan….right??”

Not so fast, I caution you. College funding is often detrimentally the primary focus of new parents’ financial plans. With the birth of a child, parents suddenly feel a need to start saving for college. Before their child can eat solids — let alone order out a late night pizza —parents feel the stress of the tuition bill. This is not surprising. The cost of college is increasing at a rate that is almost double inflation, and it does not appear to be changing any time soon. If you have had a baby recently, you are looking at shelling out approximately $250,000-$450,000 (depending on cost and investment assumptions) if you decide you want to pay for your sweet baby’s college. This means you have to save $500-$1000 a month for 18 years (more or less, again depending on assumptions) to fund a college education fully. Yikes!

You may think it is almost blasphemous to say that parents should not save for college yet. I shock many parents when I don’t jump in and quickly answer their question, “Should we get a 529 Plan?” They may expect that I start listing the states’ plans which I would select, but I truly do not know how to answer that question. It’s like my son’s favorite Animal Rescuer. Once his trusty camera locates the crying wolf pup, she has to “zoom out” to see more of the picture. That is what I have to do before I can answer the inevitable 529 question.

What is your Big Picture? How is your retirement savings? Are you on target to have enough saved for your later years (probably not—that’ll be a different article)? Have you switched from two incomes to one? Do you plan to move into a more expensive home soon? What are your values? What are your priorities? And the list goes on …

Let’s say you’ve met with your financial planner and/or you’ve had a focused exploration of all areas of your financial situation in another manner. You’ve decided you do have college savings as a top priority, and you are ready to contribute some cash. Should you have a 529 Plan?

The answer is a very clear “maybe.”

While there are many vehicles for college savings, I will focus on the common dilemma I address with most parents, “Should we fund a 529 Plan or just put our savings in a tax-deductible account (a regular brokerage account)?”

If you are not familiar, a 529 Plan is a college savings account into which you make after-tax contributions and invest in funds as offered by your selected state’s plan. As long as you use the funds in the account for qualified education expenses (tuition, room, board, etc.) for the named beneficiary, you will not have to pay tax on the investment gains. This tax advantage makes these accounts very exciting!

However, 529 Plans may have limited investment choices, narrowing your options and potentially limiting your ability for maximum gain or adequate diversity. Finally, non-qualified distributions will be taxed at ordinary income tax rates and assessed a 10% penalty, so if you do not use the money for education and you do not transfer it to someone else, you pay the price.

You do not have to take advantage of any of the college savings vehicles to pay for college—-or use them exclusively. Many people choose to invest in a regular brokerage account, paying capital gains (15% in many cases) on the sale of assets when it is time to pay for college. This route opens up the potential use of the funds (rather than limiting it to education and the rules of the education accounts) and gives ultimate flexibility in investment choices.

How do you decide which vehicle to choose? Take a look at your situation and your habits:

1. Check in on your total financial picture, especially your retirement goals. Do you know how much money you will need when you retire (it’s a higher number than you think!)? Are you on track? Most couples I meet with get my “oxygen mask” speech, “Secure your mask before putting on your child’s…..” In other words, save first for your retirement, then focus on education, especially if dollars are limited. You can borrow for college, but not for your retirement. And who would have to step in to care for you if you run out of money? Your children.

As you look at where to put your investment dollars, remember that IRAs have special rules for using funds for education expenses, and taxable investment accounts can be used for retirement or education. The tax argument for using a 529 may be a moot point when you finally want to use that money —- it depends on the investments available, the rates of return, fees charged, capital gains tax rates, and cost of borrowing if you need other funds to name a few factors. If you want to leave your options open for use of your savings, then a 529 Plan probably does not work best for you.

2. Do you have parents/grandparents who want to contribute money for your son’s or daughter’s education? Do they care what kind of account the money goes to? Often times, grandparents like to be assured that their money will go to pay for college and not your next vacation. This is where a 529 Plan comes in handy. 529 Plans give family members the comfort of knowing their contributions are earmarked for education. Plus, you may encourage ongoing giving by having an account in place into which anyone can contribute.

3. What are your savings habits? Would you be too tempted by an accessible brokerage account? Will having a specific education account for which you’d be penalized if you withdraw money for other uses be the most assured way you will save for children’s college? Do you just like the idea of having money set aside in an account specifically labeled for college? If yes, then a 529 Plan could work well for you since it would separate these savings from other funds.

When it comes to college savings, you will probably want to utilize a few different vehicles. Which one(s) are best for your situation — and whether or not you should even save for college right now— should only be answered after looking at your total financial picture. Before you jump right into making a large contribution to a 529 Plan, make sure you “zoom out” to see more of the picture first.

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I recently read an article about families who were celebrating Spring break by indulging in $100,000 family vacations. Although I enjoy traveling, I have to admit that I would have terrible buyer’s remorse over spending such a hefty sum for a vacation. Don’t get me wrong; I celebrated a big birthday last year with a trip to Italy. I budgeted and planned for years for that vacation, as it was always a dream of mine. I enjoyed the trip but was also glad to be home. It made me wonder if long, expensive travel excursions were just not my thing.

This year, I want to plan a staycation in order to enjoy my local area. I find that I take for granted all of the fun and amazing activities that Columbia, SC has to offer. I am often too busy with work to spend quality time on Lake Murray, where I live, or partake in the events that are happening in and around my area.

I think it would be great to “unplug” from the computer (even lock it away in the safe so I know I won’t be tempted to do work) and pretend that I am on a 7-day vacation in my home city. Here is my partial “to do” list for my staycation:

  • Eat out at 3 new restaurants around town.
  • Go to the Riverbanks Zoo and take a long walk in the botanical garden and also try the new zip-line.
  • Travel to the new farmers market (I have never been) and buy fresh veggies and fruit.
  • Go to the shooting range and become more proficient in my target shooting.
  • Take a 2-hour hike or bike ride in the Harbison State Forest.
  • Go kayaking in the lake—although I live on the lake, I never seem to have time for it.
  • Read a great book on my book list that is not about finance.
  • Take a long boat ride up the lake with friends and have a picnic on board.
  • Spend some quality time in my garden.
  • Spend a day volunteering for a local charity.

I think lists like these are helpful for us to understand better what makes us tick and what types of hobbies and activities we will tend to enjoy in retirement when we do have more time at our disposal. When you think of it, retirement is like an extended stay-cation.

In order to better prepare for retirement, I ask my clients to put together a list of a perfect day in retirement. What will they do? With whom will they spend time? How much exercise will they partake in? How much will they connect with others? All of these factors help us “test drive” our retirement plan. So how about you? Have you ever done a stay-cation, and if so, what was your favorite activity? It is likely that this memory will provide you with insight regarding how you will spend your time in retirement.

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We are now experiencing the fifth most powerful bull market in stocks since 1900. The Federal Reserve, through its quantitative easing program, has lowered interest rates to near zero, thereby forcing investors to search for income in nontraditional places. In response, dividend yielding stocks and high yield “junk” bonds have soared in price. If you review the trajectory of the S&P 500 over the past year, it appears that the market is advancing without any significant corrections.

The market continues to shrug off risks. Despite poor economic data, decelerating growth in China, still unresolved European debt woes, and increasing tensions between Russia and her neighbors, the market continues on its march upward. The only data the market seems to respond to are signals from the Federal Reserve that they may increase interest rates. For now, the stock market assumes that new Federal Reserve Chair Jerome Powell “has its back.” The dovish Powell appears to be an advocate of an accommodative policy through 2018.

Investors can become complacent believing that this pattern will last indefinitely. To wit, the flow of money into stock funds reached an all-time high in 2013-2017 as memories of the crisis of 2008 faded. The belief that market gains can be achieved consistently with no apparent risk of correction is not only naive, but dangerous. Investors in Bernie Madoff’s fund were likewise transfixed by the steady, impressive returns that seemed to move with no correlation to the financial markets. Sometime when things seem to be too good to be true…..
We only need to look back to the more recent examples of complacency and calls of “this time it’s different,” to remind ourselves of the dangers that can result from this mentality.

In the 2000 tech implosion, the market finally came to the reality that stocks with non-existent earnings and lofty prices were not necessarily a good buy. We were told that “earnings did not matter” and that this was “the new paradigm.”

In 2007, when everyone was buying second homes, flipping “spec” homes, and loading up on a McMansions they could not afford, the party line was that, “housing is an investment that never goes down in value.”  The financial crisis was created in part due to this mentality, and we are still feeling the painful repercussions.  In this article , Peter Schiff discusses the implications of the massive debt the US has incurred post 2008.  He states,

America is trying to borrow its way out of recession. We are creating debt now in order to push up prices and create the illusion of prosperity.

He opines further that:

 “The red flags contained in the national and global headlines that have come out thus far in 2014 should have spooked investors and economic forecasters. Instead the markets have barely noticed. It seems that the majority opinion on Wall Street and Washington is that we have entered an era of good fortune made possible by the benevolent hand of the Federal Reserve. Ben Bernanke and now Janet Yellen have apparently removed all the economic rough edges that would normally draw blood. As a result of this monetary “baby-proofing,” a strong economy is no longer considered necessary for rising stock and real estate prices.”

It is important for investors to remind themselves of the following:

Markets are cyclical

Corrections are normal consequence of business cycles:  We can’t predict when they will occur, but we should prepare mentally for their eventuality.

Market timing is extremely difficult.

Who would have predicted that in 2013 the S&P 500 would increase over 30%?  This occurred despite the debt ceiling and budget showdowns, sluggish economic growth, and other geopolitical events.  Few if any analysts, predicted this incredible performance, giving further credence to the notion that the so called “experts” are not particularly prescient.

Chasing performance can lead to pain

Investors have a tendency to pile into segments of the market that have recently performed well , buying more of the recent winners and eschewing the “dogs” that underperformed.  But short term performance is not indicative of longer term returns.  Overexposure to one asset class, say large-cap US stocks, will reduce your portfolios diversification, thereby increasing the overall volatility of your investment mix. Discipline in the form of rebalancing would be a better tactic. In this related article, Craig Israelsen discusses this behavioral tendency and how it can be avoided through proper diversification.

Looking at traditional measures of valuation, the current stock market is overvalued.  According to John Hussman, current valuations suggest that equities are poised to deliver paltry returns of roughly 2.3% before inflation over the next 10 years.  Even the Fed’s own Richard Fisher, president of the Federal Reserve Bank of Dallas, recently said he was concerned about “eye-popping levels” of some stock market metrics warning that the Fed must monitor the signs carefully to ensure bubbles were not forming.

In irrational times like this, it is important to maintain perspective; we don’t know exactly what the stock market will do in the short run.  We can’t control inflation, taxes, political turmoil, the weather, our health or major geopolitical events.  We must instead focus on the things we can control like the following:

Our emotions– It is essential that we have a portfolio of investments that we can stick with through thick and thin.

Review your investment policy statement that was prepared as part of you plan; and specifically; revisit the potential decline for your investments based on your target allocation to the stock market to see if it is still palatable

Rebalancing –After a large market advance, it is important to prune our winners and reinvest proceeds in losing asset classes.

Most recently, that would mean selling stocks and buying bonds. While this is counter to our  behavioral instincts, it is a powerful way to maximize long-range investment returns.

Costs–Given that future stock market returns are likely to be lower, costs becomes especially important.

Employing no-load, passive, low-cost funds and ETF’s will help maximize your gains.  The money you save due to low fees will compound for you over time.  This has an exponential effect on the growth of your portfolio.  Costs are reflected in your funds’  expense ratios.  Low cost investment advice helps to further reduce the overall cost of your investment management.

Diversification–resist the urge to follow performance and load up on yesterday’s star asset classes

Just because US stocks have been stellar performers doesn’t mean that this will continue. We never know in advance which portion of the portfolio will be the star performer. As this periodic table of asset class performance indicates, the stars of one year can easily turn to dogs the next. It is also important to remember that cash, CDs, and high-quality bonds, while they possess frustratingly low yields, are still an essential component of your portfolio, as they act as shock absorbers in periods of market turmoil.

Risk– if you’re planning to retire in the next five years or recent retiree, you may want to adjust your portfolio to position yourself more conservatively.

Recent studies suggest that minimizing your exposure to stocks, five years before and five years after retirement  and then increasing your stocks allocation slowly over time, may be a prudent way to maximize spending in retirement as well as avoid outliving your funds.

In summary, the market over the past few years may convince you that risk will be rewarded with little chance of loss. But remember, what goes up must go down, and invariably, a tipping point emerges that changes the course of the market.  History does repeat itself.  Be realistic and stick to a prudent plan so you are well equipped to weather any market storm.

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In the early 1980s, I started doing the occasional talkback radio segment on Sydney radio station 2BL. Retirement was something many callers wanted to discuss. It seems to me that at that time, people planned to retire at 65. Most financial planning was fairly haphazard and tended to take place after the date of retirement.

Today, almost two decades later, we have changed. People plan to retire much earlier and better health means we are living much longer. It has now got to the point where some people will spend more time in retirement than in the work force.

This makes retirement a serious business. A 55-year-old male will now live for another 23.8 years, on average, and a 55-year-old female 28.2 years. On top of this, our expectations for retirement have changed. We do not expect to stay at home all day minding the grandchildren. We hope to be healthy, active and doing those things that we did not have time to do in our working lives, such as travel – and in my case, play more golf!

Now, the bad news here is that an active lifestyle tends to cost more. Travel can be done cost effectively, but it still requires money. You will want to run a car, be able to eat out occasionally, and not have to worry about the cost of a meal with friends.

Don’t get me wrong. You don’t need a fortune to live well. In fact, most people don’t have a fortune to retire on and, today, around 74% of 65- to 69-year-olds are on an age pension.

A retired couple I know live on a public service pension, plus an investment portfolio of around $150,000. They own a modest but comfortable home. Sure, they are well set up, but not dissimilar to many other retired. Between the income from their portfolio and the pension, their annual income is around $25,000. Due to a few of the simple tax strategies like income splitting and franked dividends, they pay very little tax – which help a lot.

What fascinates me about this couple is that they lead a truly global lifestyle. In retirement they decided they wanted to learn the languages and culture of other countries, so they live four months a year in Australia, four months a year in Italy and the other four months in France – all on $25,000 a year. Sounds ridiculous doesn’t it? But they are able to do it, and this is how:

  1. They rent their home for at least six of the eight months they are away. Yes, this is a hassle because they have to store all their personal possessions with their family, but they rent it out fully furnished for a bit below market rent and do very careful reference checks on the people moving in.
  2. The eight months they are away each year, in France and Italy, they take a small apartment well away from the tourist haunts and they find that they can live more cheaply than in Australia. Remember, they can now speak both languages fluently so they mix and eat with the locals at local, not tourist, prices.
  3. They book and pay for their airfares well in advance to get the best deals.

Even if the last thing you want to do is live overseas, my point is that your retirement should be, and can be, a time when you reap the rewards of your working life.

Okay, so these days you need to start planning your retirement early. If you are getting close to retirement, you need to start thinking about a number of other things as well:

  1. What are your plans for your retirement? What do you want to do and what will it cost?
  2. Will your assets provide the income you need to live comfortably? Can you top this up with a pension?
  3. Where will you live? How will this impact on your lifestyle and your family?
  4. What are your views on estate planning? Does your will reflect your wishes?
  5. Investment will become very important. Do you need an adviser, and if so how do you choose one?
  6. What plan do you have to ensure your retirement is a stimulating time in your life?

My best tip on retirement is, of course, to plan early. For younger readers of this article, or those of you who can influence younger readers, please do think about it and encourage people to plan for retirement from the day they start work. An 18-year-old only needs to put aside about 12% Of her salary into super and she can retire on 75% of her final salary, linked to inflation. This would provide quite a decent standard of living. At 35 years of age the requisite contribution increases to around 30%, at 45 around 49% and at 55 you’d need to save 108% of you salary to retire on 75% of your final salary. Now I know some good savers, but putting aside 108% of your salary would not be easy!

Please don’t feel depressed if you are retired or close to retirement and have saved very little. After all, the importance of saving has only been made clear in the last few years. Fortunately, we do have a reasonable age pension system. I know it isn’t generous, but it does provide a minimum standard of living and is certainly better than nothing.

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Raise the topic of superannuation next time you have a few friends around for a barbecue and you’ll get a range of reactions. Some people will look at their watches and ask “Is that the time?“, some will pour themselves extremely large drinks, some will slip into a type of coma, others will become completely absorbed by a spoon or salt shaker, and a few will say “I think super is okay because people keep telling me it is, but I’m not really sure why.” The majority will tell you that it is confusing, keeps changing and is all too hard.

Well, I’m one of those people who keeps saying super is okay, and what I am going to try to do here is explain why. And I hope as you read this your mind won’t drift off to a palm-fringed beach on a tropical island. Bring it back here if it does, because, confusing as super may be, it’s worth knowing about. Indeed, if you play your superannuation cards properly, you will actually be able to accompany your mind to that tropical paradise when you retire, as well as doing many other things you have only dream about during your working life.

What is superannuation?

Basically, superannuation is designed to provide for us financially in retirement. It’s built up over our working lives from contributions made by our employers and, hopefully, topped up out of our own pockets. It’s also taxed lightly – both to encourage our active contribution towards it and to increase the size of its pay-out at the end.

That’s the good news. The bad news is that it’s confusing, your money is locked away for a very long time, and the Federal Government continually fiddles with the rules. While this may bring us no joy, the fact is, we need super.

Consider this: in 2001 we have around six people in the work force for every person in retirement. That’s a large pool of taxpayers from which to fund the aged pension. But, because we are having longer and having fewer children, by 2030 there will be only there people working for every retired person.

Let’s look at it another way. Today we have around 8.267% aged 65 or more populations. In 19 years’ time, when I reach 65 there will be just under 10% of us! Already pensions are a major funding burden, accounting for more than 30% of the Federal Budget, so can you imagine what it’s going to be like then? Either taxpayers in  the future will have to be taxed to within an inch of their lives if the aged pension is to remain at its present (modest) real level, or (far more likely) the pension will fall.

But “What about the value of the family home?“, I hear you say. Who cares about a pension if you’re sitting on good real estate? Okay, but do you really want to find yourself at retirement with no option but to sell the home you’re perfectly happy living in and don’t wish to leave? And after you’ve sold and put aside sufficient proceeds to live off comfortably for the rest of your life, you will be faced with taking a very substantial downgrading in the type of housing or the location you can afford. No, relying on the value of your home is not the way to plan for your retirement.

A comfortable retirement can only be funded by a separate next egg of investments, which has been built up for that purpose during your working life. And your success in building up a suitably sized nest egg will depend on your success as a saver. The reason is very clear. If you don’t save, you don’t invest, and if you don’t invest you will have nothing (apart from your home) to retire on.

The problem is, however, that we are not good savers. Certainly earlier generation who lived through tougher times were much better at it than we are. That’s why, I am sure, the Government has decided to force us to save, and the way they have chosen to implement this is through compulsory superannuation.

The key word here is compulsory. If there was only voluntary superannuation there’s little chance we’d contribute enough for it to do what it supposed to do – provide for a comfortable retirement and head off a society increasingly burdened by taxation to pay for the aged.

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