Investing

  • WHAT SHOULD I DO WITH MY 401K RIGHT NOW?

    The swift drop in the stock market from all-time highs into a bear market has left investor’s heads spinning. Almost before anyone had time to fully process the fall, the market started to rebound. Down 30%+ from the peak, the stock market started to recover and as of the beginning of May was only around 15% below the all-time high in February.

    Good and bad headlines continue to alternate in the news. Historic unemployment numbers, better than expected results due to people socially isolating, infection hot spots popping up due to delayed action, and general unease and uncertainty about how long it will take for things to return to normal.

    So, what should investors expect for the future and more importantly what should they do about it? With regards to both the coronavirus and its impact on the economy and the stock market: Is the worst behind us or are we in store for more bad news before we start to turn the corner? I can’t answer these questions, but I can provide some advice for how to prepare your finances for the future.

    Take stock of your personal finances

    First things first, do what you can to make sure your day to day and month to month expenses are covered. If you are lucky enough to have a stable income coming in at this time, now is the time to review your emergency savings and make sure it is adequate. Most financial advisors recommend between 3-6 months of expenses, but the ultimate number is whatever allows you to sleep soundly at night. If your employment situation is shaky or uncertain no one is going to razz you for having 9 months’ worth of cash in a savings account right now.

    If you are in an industry that has been hit hard by the effects of the coronavirus shutdown and you have or are in danger of losing your income, now is the time to prepare. The stimulus and increased unemployment benefits from the recently passed CARES act can help build a savings buffer, and federal student loan deferred payments may help some as well. If you are worried about missing payments for rent, your mortgage, or other essential services, reach out to your landlord, bank, or creditor before you’ve missed a payment to understand what options you may have for credits or deferral.

    If you feel secure about managing your cash flow then you can move onto the next level and consider what to do about your retirement investments.

    Continue your 401k contributions

    If your personal finances are locked down, you are able to continue working, and have an income coming in, then the right answer for almost everyone is to continue making your contributions as normal. No one can predict with any certainty if March was the low point for the stock market this year or if the worst is yet to come. During these times of market stress, our fight or flight instincts start to kick in and it can feel like you have to do something. But reacting based on your gut is rarely the right move and you should instead listen to Richard Bogle: “Don’t do something. Just stand there!”

    If you are in the early or middle stage of your career and still have a while to go before retirement then this is likely not the last time you will experience a market drop of 30% or more. This is just another example of the volatility you will need to live with to enjoy the returns that come with owning stocks, as well as an opportunity to buy them at a lower price than you could just two months ago. It’s better to focus on your time in the market rather than timing the market.

    If your company has cut matching 401k contributions because of worries about the economy you might want to review the available investments in your 401k and if they are high fee or otherwise don’t meet your needs you could shift your contributions to an IRA or Roth IRA. Just set a reminder to turn your 401k contributions back on when your company begins offering a match again.

    If you are able to increase your contribution, now is probably a good time to do it. Market crashes hurt while they are happening, but they do increase the forecast for future stock returns.

    Create a Financial Plan

    If you have a financial plan in place, now is the time to review it and reassess some of your original assumptions. Were you optimistic or pessimistic regarding your emergency fund, too conservative or aggressive in your asset allocation and risk tolerance, were you focusing on the right goals?

    The steady upward market climb during the past decade had the effect of lulling investors into a false sense of security, where every time the market dropped a few points investors started to scream “BTD!” (that’s “buy the dip!” for those of you who aren’t a part of fintwit). We haven’t seen it for a while, but the market can remain lower and decide not to hit new all time highs for a lot longer than we’ve experienced recently.

    If you don’t have a financial plan now is the time to put one together. As the saying goes, the best time to plant a tree was 30 years ago, the second-best time is today. The same sentiment applies to financial plans. The best time to put together a plan was in the middle of the 10-year bull market we just experienced, the second-best time is today.

    Consider your risk tolerance and asset allocation. If you were invested 100% in stocks or in an 80/20 stock/bond portfolio, how do you feel? If you were comfortable with the volatility and the drop in your portfolio’s value then that’s probably the right allocation for you. If, however you had some sleepless nights, it might be a good time to reconsider the level of volatility you can live with. The stock market will probably not be as rosy as the period from 2009-2019, so you need to make sure you can handle volatility when it comes. Some of the worst financial decisions happen when investors’ emotions get the better of them.

    Another option is to get some help from a financial advisor as you put together your financial plan. One of the biggest benefits from working with an advisor is having an experienced person to talk to and help guide you toward what the right decision is for your specific situation and then help you stick with it.

    With social distancing and stay-at-home orders in effect, many advisors are adding the ability to meet virtually with clients, while some have been working virtually with clients for years 😉

    Have questions about your specific situation?

  • A late Christmas gift from Uncle Sam! Higher IRA and 401k contribution limits for 2019

    With all of the hubbub around the holiday season you probably missed a nice gift you received from Uncle Sam. And, like the forgetful uncle that he is, he forgot to give it to you until January, but as they say, it’s the thought that counts.

    So, what present am I talking about? Why, the $500 increase in IRA and 401k contribution limits of course!

    Contribution Limits for 2019

    For 2019 the maximum you can contribute to an IRA has increased to $6,000, up from $5,500 last year ($7,000 for individuals 50 or older). And for a 401k the maximum employer contribution increased to $19,000 up from $18,500 (this also applies to 403b, most 457 plans and the governments Thrift Savings Plan). Individuals 50 or older contributing to these plans (401k, 403b, 457, TSP) can still contribute an additional $6,000.

    What also increased were the income limits for the phaseout of when you can and can’t contribute to IRAs and Roths. You can find the full rundown of the changes on the IRS’s website here: IRA increases contribution limits for 2019.

    But don’t forget about 2018

    You also still have the option to contribute to your IRA or Roth for 2018. You can contribute right up to April 15. So, if you haven’t yet contributed this year you still have time to sock away up to $5,500 ($6,500 if your 50 or older) into your IRA and count it against 2018’s taxes.

    If your income is above the Roth contribution limits, you are unfortunately too late to enact a backdoor Roth contribution for 2018 since you had to complete those by Dec 31 2018. Maybe a financial planner could have helped make sure your financial tasks were completed on time wink, wink?

    What is the impact of that extra $500?

    You may yawn and think, “big whoop, an extra $500, what will that get me?” Well I’m glad you asked. Even though it might not seem like much, given it’s only an extra $41.67 a month. Depending on your investing time frame that $500 could add up to a serious bump in your portfolio over time.

    If We assume 7% growth within a tax advantaged account, after 10 years you would have an additional $6973. After 20 years it would be $20,624 and after 30 that would grow to $47,479. All from contributing just an extra $500 a year.

    Upping your contribution

    Now is the perfect time to increase your contribution for 2019 or make one for 2018. If you’re a W-2 employee you should receive your copy in the mail any day now.  By comparing your earned income in box 1 of your W-2 to the income limits at the link mentioned above you can figure out if you qualify to contribute to an IRA, Roth, or both. And if you plan to earn the same amount for 2019 this will help you decide where to contribute for the coming year as well.

    Another decision to make is when to make your 2019 contributions: in one $6,000 chunk or by dollar cost averaging with an automatic monthly contribution.

    The upside with automatic monthly investments is that you don’t have the worry about contributing $6,000 in one chunk then watching the market drop the next day. The downside is if the market decides to move steadily upward throughout the year, the impact of your monthly contribution is reduced each month.

    Historically the stock market finishes the year higher than where it started about ¾ of the time. Given this info you are likely better off making the lump sum contribution at the start of the year. But if it helps you to sleep at night by making the monthly contributions then go that route. We humans tend to feel the pain of loss much more acutely than the joy from a gain.If you are in Boise or beyond and would like to talk with a fee-only advisor about your IRA or 401k funding questions, or anything other questions you might have, give us a call. We are happy to help.

  • MILLENNIALS HAVE HOW MUCH IN THEIR 401(K)?!

    A recent article in Investor’s Business Daily got a lot of attention online. The subject of the article was how much the average 401(k) balance has increased over the past 10 years split out by generations. Millennials had an average balance of $137k in 2019 up from $10,500 in 2009. While Boomers had an average of $366k up from $98k 10 years ago.

    It seemed that most people responding to the article on social media had a similar reaction along the lines of, “that’s crazy, there’s no way that’s true”. And turns out they were mostly right. The data was taken from a fidelity survey of their 401k plan participants, but what wasn’t stated in the article was that these numbers only considered those individuals that had their same 401k account open for the past 10 years. Once you hear this detail the numbers start to make a bit more sense.

    The majority of millennials are still in the early stage of their careers which is typically a time where people take the opportunity to jump around between jobs, companies, and different places to live and see what fits them best. This is especially true for this generation as we have pushed marriage and home buying later either because of preferences, opportunities or both. It makes sense that those that have had a stable job with the same 401k for the past 10 years would have a much higher balance than the overall average. It’s probably a pretty limited set of the millennial cohort included in this data set, but I think there are a few points we can take away from this info, even if the article seems to have been constructed in a way to get people worked up and share it purely from a “would you look at this *#$&?!” angle.

    Just stick with it

    The accounts included in this group have been open for at least 10 years, which illustrates the amazing effect you can have by continuing to do the little things right month after month and compound them over time. Continuing to contribute to your 401k plan, paycheck after paycheck, is a great first step towards building up your retirement savings. Especially given the benefits that a 401k typically provides vs an IRA: employer matching, higher contribution limits, additional after-tax contributions if available.  

    It can be tempting when moving from one job to another to cash out your 401k rather than roll it over into a new 401k or IRA. There are a few times where cashing it out makes sense from a financial planning perspective, such as in the case of extreme hardships, but it’s typically a much better option to roll it into another plan and continue making your contributions and grow your funds for the future.

    The benefits of having a 401k 

    If your employer didn’t offer a 401k and you only had access to investing within an IRA (with contribution limits below $7k/year for the past decade) you would be hard pressed to grow your account in the same way without maxing out your IRA contribution every year over the past 10. However, with a 401k you could contribute up to $16,500 yourself and $49k total between you and your employer in 2009, and those numbers increased over the decade to $19,000 and $56k respectively. It’s obvious with a 401k that you could contribute much more, especially as your income grows, than with only an IRA, not to mention the benefits of receiving employer match contributions.

    If you don’t have access to a 401k consider asking your employer to offer one. Many small businesses do not offer a 401k because of concerns about cost and matching contributions, but in recent years 401k plan administration costs for small businesses have decreased and companies do not need to offer a full or even any match if they don’t want to. 401k plans have been shown to be great for retention of employees and I’m sure the individuals in the fidelity study are glad that they had the opportunity to invest in theirs over the past decade.

    What else can you do

    So, what can you do if you don’t have a 401k and it doesn’t look like you will get access to one anytime soon?

    • If you are a 1099 employee consider setting up a SEP-IRA. With a SEP you can contribute up to 25% of your earnings or $57k, whichever is lower, for 2020. This can be a way to goose your contribution above the traditional IRA limit of $6k. If you are not a 1099 employee but are considering it make sure to consult with a tax professional whether or not it makes sense to switch from a W-2 to self-employed because there are additional tax consequences to consider.
    • If you can, contribute to an HSA. Stack that on top of your IRA adds an additional $3,550 ($7,100 if you are married) that you can contribute to tax advantaged accounts. HSAs are also one of my favorite stealth retirement accounts because they are triple tax efficient if used correctly. You can contribute tax-free, the funds grow tax-free inside the account, and the funds can be withdrawn tax-free if used for qualifying medical expenses.

    So, there are steps you can take if your 401k or other retirement savings accounts aren’t at the level of those in the article, or otherwise where you’d like them to be. And if you’d like someone to help you put together a plan to boost your 401k or IRA contributions consider reaching out to a fee-only financial planner today.

  • POLITICS AND INVESTING

    With all of the ups and downs in the stock market lately, and the multitude of different news headlines you see trying to explain it away – tariffs, potential interest rate cuts, rising or falling inflation, etc. You would be forgiven for worrying how the decisions or tweets made by those in the government will affect the stock market and your investments.

    Maybe you think that having Republicans in charge leads to stability so that businesses can plan and make investments for the future, and that’s better for the stock market than when Democrats are in power. While your neighbor is sure that the complete opposite is true because of the economic stimulus that flows from all of the liberal spending projects. I have heard both types of comments over the years, and I’m betting you have heard them or know someone who has blind faith in one party or the other as well.

    In 2010 I had a co-worker who was sure that the decisions congress and the federal reserve were making after the financial crisis were going to lead to runaway inflation, a recession, and another stock market crash, and was invested based on these outcomes.  Unluckily for them and their portfolio, but luckily for the rest of us none of those situations has come to pass and the S&P 500 has almost tripled from then till now.

    I’ve also heard people during the market drawdown at the end of 2018 say that they sold out of the stock market and wouldn’t invest again until “that bozo” was out of the white house. Right now, it is too soon to tell but the stock market did recover at the end of 2018 and has posted great performance through the first 2.5 years of this presidential term.

    While it may feel like the government has a big effect on the economy and the performance of the stock market, I’m here today to tell you that it’s hard to see much of a difference based on who is in charge. And there are many other things you should be focusing on instead.

    Democrats – Running up a deficit and that’s bad for the country and the markets… right?

    People tend to believe that since Democrats want to increase spending and expand social programs like Medicare for all that the US spends more money when they are in charge. Depending on who you talk to, experts will say that the spending is good because it can help stimulate the economy, while others will say that the increased spending is bad because it generates more debt we will have to pay back later.

    But either way, since the 1980s when Ronald Reagan was president the yearly budget deficit has tended to increase under Republican presidents and decrease under Democratic Presidents. So, maybe it’s Republicans who are spending and propping up the economy/saddling us with debt? Not exactly what you’d expect based on the stereotypes huh?

    Republicans – The party of business… or not?

    Experts also argue that the economy and the stock market both do better with a Republican president. After all, the GOP is considered the party of big business, which definitely leads to certainty and stability and a stronger economic outlook for the future. Except that’s not the case either.

    Looking at the economic data starting after WWII, America’s GDP has grown 4.4% per year when Democratic presidents were in office versus 2.5% per year for Republicans. While the stock market has performed similarly returning 9.7% annually for D’s versus 6.7% annually for R’s during roughly the same time period.

    And if certainty and stability from a business point of view is what you expect from a Republican president, you’d have a hard time making a successful argument that there is anything remotely stable about the decision making going on in the current White House. But, even with that all of that instability and the corresponding inability for America’s CEOs to make accurate plans for the future, the S&P 500 is still up over 30% from Jan 2017 to September 2019.

    What you should actually focus on, instead of which political party is in charge.

    Rather than pulling your money out of the stock market based on what happens next November, or any other gut related feeling you might have, focus on these three things that you can control.

    1. Maximize your cash flow (Income – Expenses = Savings). Spending less than you earn is step number one towards successfully saving for the future. Maybe you can predict the stock market’s moves based on the daily political moves, but if you don’t have any savings to put to work as your investments then you still won’t get very far.

    2. Build a plan. What are you saving and investing for? How much do you want to have in savings for emergencies, how much do you need each month to pay for your mortgage and student loans, how much do you need for retirement? Think about these questions and put a plan in place. It is much easier to achieve a goal when you have a realistic expectation of the money/time/effort it will take to reach it.

    3. Understand your appetite for risk. Investing in the stock market has been the best strategy to achieve those long-term goals, but the stock market has good and bad days and everyone’s temperament is different. Having an idea of how you will react to stocks losing 20, 30 or 40% before recovering will help you build a plan that you can stick with for the long haul and see to completion.

    By focusing on these aspects of your financial life, instead of the day to day movements of the stock market or the election by election movements of the government, you put your focus on things that you can control, rather than worrying about things in life that no one can predict.

    If you’d like some assistance building a financial plan or understanding your risk tolerance and the decisions you should make to achieve your financial goals contact a financial planner today. At Steady Climb Financial Planning we have openings to bring on new clients in the fall. Schedule your free initial consultation today!

  • WHAT ARE ESG AND SRI FUNDS?

    Every generation has their different stereotypes informed by their attitudes and behaviors. This is caused by many different factors: the economic, political and social environment when they were growing up; changes in the media, communications, and travel options that occur over time; different education, family and lifestyle priorities.

    Digging into exactly why different generations prioritize different things isn’t the point of this post. We know the great depression or the baby boom era shaped those generations just as those of us today have been influenced by the great financial crisis and other recent events.

    What I find interesting are the ways in which these generational attitudes change and how the companies that want to receive their purchasing and investing dollars change to accommodate them.

    Younger Generational Values

    Taking a look at the younger generations: Millennials, the tail end of Gen X, upcoming Xennials, you hear some common themes that have shifted compared to past generations. They tend to value experiences over things, they are more concerned about the environment, they want to know the companies they purchase from and work for are good actors in the world.

    Corporations as Do-Gooders

    Companies have embraced some of these themes and have tried to earn their customers trust in different ways. Some by focusing on what they call their triple bottom line: social, environmental, and financial impact; rather than only worrying about their profits. Other companies can now be classified as B Corporations, which means they must balance their decisions between purpose and profit. And some companies, such as Patagonia, tout the work they do organizing and working to impact climate change.

    Individuals are interested in this not only from a consumer standpoint, but from an investing standpoint as well. Investors want to invest with companies they believe are operating in accordance with their values. This can be because investors believe it is the right thing to do, and also because they believe that companies that care about the same things they do – the environment, social issues, their community – will prosper and do better as a result.

    Similar to the early days of investing to track an index, investing in socially responsible or environmentally responsible companies in the past has been challenging. But as with most other things in capitalism, where there is a demand, a product will be created to meet it. Enter the SRI and ESG funds into the mutual fund and ETF landscape.

    People tend to use the two terms interchangeably but there is a big difference. Using the term ESG, means in addition to traditional valuation metrics like sales, cashflow, and debt; you are also considering the environmental, social, and governance practices when evaluating a company.

    ESG – Environmental, Social, Governance

    Environmental: Climate Change, Pollution, Renewable Energy Use, Protection of Natural Resources

    Social: Human Rights, Community Engagement, Employee Relations, Health and Safety, Child and Forced Labor

    Governance: Transparency, Quality of Governance, Conflicts of Interest, Independent of the Board of Directors, Ethical Conduct, Executive Compensation

    SRI – Socially Responsible Investments

    SRI goes a step further, when you use a set of values to screen companies based on their ESG metrics.

    Examples:

    • Investing in companies that increase transparency in their supply chain and manufacturing methods to improve worker health, safety and working conditions.
    • Not investing in companies that contribute to climate change, or ignore their effects on natural resources.
    • Investing in companies that support the use of renewable energy.
    • Not investing in firearms manufacturers.

    Due to the growing interest in investing in these types of companies, index companies have built SRI and ESG indices and funds to track them. Most of these funds are designed starting with an index like the S&P 500 and then removing or reducing the amount of companies with lower ESG scores.

    But rather than tracking an objective metric like company size or location, evaluating and scoring companies based on their SRI and ESG metrics is a subjective measure. Fund and index companies will weight things differently and you must do your due diligence when purchasing these funds to understand which companies are included.

    As this story from marketwatch illustrates depending on your views and what you deem to be socially responsible you might be surprised to learn that your SRI fund owns sugary soda companies or chemical manufacturers.

    The Future for SRI Funds

    As the younger generations move into their prime working and investing years I wouldn’t be surprised to see the demand for these types of funds increase. Since the Forum for Sustainable and Responsible Investment first began tracking them in 1995 the amount of assets invested in these funds has grown from $639 Billion to over $11 Trillion.

    If you are interested in aligning your investments with your values make sure you do your homework on the companies involved. If you have questions it would be a good idea to talk to a financial advisor, who could help you understand the differences and risks involved with different funds.

  • HOW DO FINANCIAL ADVISORS GET PAID?

    sometimes you gotta channel your inner jerry maguire : show me the money!

    Maybe you’ve heard the terms Fee-only, commissions, or Fee-based when it comes to investment advice. But, most people don’t really understand how their financial advisors get paid or even how much they are paying for financial advice. This is due in large part to the number of different ways “financial advisors” are compensated, and the fact there is set rule on who can and can’t use the term “advisor”.

    In this post I’ll describe three of the main ways that advisors are paid and the benefits and drawbacks of each. Then I’ll define a few terms I think you should know that can help you find the right type of advisor for you. Advisors can use pieces from all three of these fee structures, so be sure to ask any advisor to explain exactly how they are paid.

    I will state up front that I am  biased against the commission-based structure. It is unfortunately designed to introduce conflict between the broker and their clients, and push people into products and portfolios that are not right for them.

    The three main fee structures are

    1) Commission based

    2) Assets Under Management (AUM)

    3) Flat fee – usually charged hourly, monthly, or quarterly

    1) Commissions.

    Pros: ?

    Cons: No fiduciary duty, incentives not aligned, higher likelihood of conflicts of interest

    In this model a client works with a stock broker or insurance broker, but they can also call themselves an advisor. When you buy your stocks, bonds, mutual funds, annuities, or insurance policies from this person they earn a commission from the company that provided it. Their client, you, doesn’t pay them anything directly, but you could be losing because of the misaligned incentives in the system.

    One of the main problems with this model are that the broker probably earns a higher commission from some products than others, which means they are incentivized to sell you those products more than others that pay them a lower commission. As a broker they are not legally bound to look out for your best interest. They just have to provide you with advice or products that are “suitable”. Consider this example:

    You want to purchase $100k of a balanced stock mutual fund for your retirement and they have 2 funds with similar performance to choose from. Fund A costs you, the client, 2% expenses annually, but Fund B only costs you 0.05% expenses annually. You would probably choose Fund B for yourself, right? But Fund A gives the broker a 5% commission and Fund B only gives them 1%. The broker will only make $1,000 by selling you Fund B instead of $5,000 if they sell you Fund A. If you were the broker which choice would you make?

    By having the fund companies and insurance companies pay your advisor instead of paying them yourself, you may feel like you are paying less for advice, but you might be paying more in ways you don’t realize or be pushed into buying products that aren’t right for you.

    2) Assets Under Management (AUM)

    Pros: Incentives aligned, easy to understand fee, fee isn’t a concern for monthly cashflow

    Cons: Fees can drag on investment performance, does value increase along with the fee increase, clients can forget what they are actually paying for advice, clients need to have adequate AUM to work with advisor

    In this model the advisor charges a fee based on the value of your portfolio that they advise you on, your assets that they manage. Typically, the fee is somewhere between 1%-2% and gets smaller as your portfolio gets larger, so 1.5% for $1M, 1% for $1M – $1.5M etc. But this is can vary greatly between different advisors, so make sure you ask before signing on the line that is dotted.

    This can be a good way for an advisor to structure their fees, and if they are only charging AUM then they would qualify as a fee-only advisor. In this structure the advisor and client’s incentives are aligned, as the advisor’s fee increases along with the growth in the value of the portfolio.

    These fees are typically paid out of the portfolio as well, rather than out of a client’s monthly cashflow. This can be nice for a client because they do not have to budget for monthly or quarterly payments to the advisor, but it also puts a 1% or greater, drag on the growth of the portfolio. Paying monthly or quarterly, the same as with your other recurring expenses could help improve your returns and judge the value you receive from your advisor for the fee you are paying. Another question a client should ask as their investments grow is if the value they receive from an advisor managing a $2M portfolio is twice as much as when they were managing a $1M portfolio.

    Another downside for the AUM model is that it is designed to work for a client that has an account for the advisor to manage. Such as a brokerage account, IRA, Roth, etc. For younger clients who are still in their prime working years, their largest accounts are probably their 401k’s. These reside with the 401k plan where they work, and cannot be managed by an Advisor unless rolled over into an IRA, which is likely not be the best option for most people.

    3) Flat fee – usually charged hourly, monthly, or quarterly

    Pros: Easiest fee structure to understand, doesn’t drag on investment performance, easy to judge value for fee, can work with clients without large AUM

    Cons: Usually have to pay out of monthly cashflow

    An advisor charging a flat fee looks like most of the transactions that we are used to, the advisor provides a service and the client pays them for it. This makes the flat fee model one of the easiest to understand one of the reasons why it is growing in popularity for advisors and clients alike.

    With this model an advisor can charge for specific work on an hourly or project basis, much like an attorney. Or an advisor can work with clients on an ongoing basis where clients pay a standard monthly or quarterly fee. This level of flexibility allows clients to pay for as much or as little service as they need.

    The fee charged for advisory or planning services can vary based on the needs of the client and the specialization of the advisor. An advisor may charge a higher fee to individuals with small businesses and rental property than to a younger single professional. Or an advisor might charge a higher fee to a client to prepare a retirement plan versus a client just needing investment management advice. Clients can find advisors charging from $150-$1000 per hour for different projects, and from $150-$500 or more per month for ongoing financial planning or financial advising relationships.

    The flat fee model allows an advisor to work with individuals who might not be a fit for an advisor that charges on AUM, while also helping prevent the conflicts of interest that can occur with the commission model.

    Helpful Terms To Understand

    Fee-only:

    When you see the term fee-only it is used to describe a registered investment advisor that has a fiduciary duty to serve their client’s best interest.

    Fee-based:

    The term fee-based was created by commission-based agents and brokers to muddy the waters and confuse consumers. As a term it means advisors charge a fee in addition to collecting commissions.

    Registered Investment Advisor

    A registered investment advisor is an advisor that has registered with the SEC to provide advice to their clients, they have a specific fiduciary duty to their clients to act in their client’s best interest.

    Certified Financial Planner (CFP®)

    The CFP® is a professional designation awarded by the CFP board. Someone holding the CFP® must have a bachelor degree, 6,000 hours of financial planning experience, complete the CFP® educational program and pass the final examination.

    Where you see someone using the terms fee-only, registered investment advisor, and CFP® you can be reasonably certain they are using an AUM fee structure, flat fee structure, or a combination of the two, but always do your due diligence and ask how they are compensated to be certain before entering into any agreement.

    At Steady Climb Financial Planning we are a fee-only, registered investment advisor located in Upper Arlington, Ohio, and I have earned the CFP®. You can learn more about the services we offer here: Planning, Investing, and more or about our firm here: About Us, or answer some general questions here: FAQ.

    If you are looking for a financial planner or are curious about how we can help, or just have some general questions, please contact us today.

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  • WHAT EXACTLY IS AN INDEX FUND

    An index fund is simply a security that seeks to track the movement of a particular index. In plain English that means it’s like a stock whose price goes up and down the same as the index it follows. An index can be pretty much anything. The Dow Jones Index is an index made up of 30 companies picked by the Dow Jones company. The S&P 500 is an index made up of the 500 largest public companies in the US. The Russell 2000 is an index of 2000 smaller public companies in the US. So, if an index is just a basket of companies what makes an index fund so special and why should you choose to invest in them versus anything else that’s out there? 

    The Stock Market Generally Trends Up

    Investing in stocks is seen as the best way for most people to invest for retirement because it offers the best possibility for the higher returns needed. Money invested in savings accounts will work hard just to beat inflation. Money invested in bonds will grow slowly, generally in the range of 3% – 5%. While the returns on the US stock market have generally been around 8% annually, depending on what date range you look at. Why has the stock market continued to climb? New ideas, new products, more productivity, more efficient ways of doing things, more people entering the workforce, more people entering the consumer pool, and on and on. Will the stock market continue to go up? I tend to think so, and of course we will continue to experience economic setbacks like in 1929, 1987, 2000 and 2008, but nothing in life is certain. I think Warren Buffett said it best in this quote from 2016:

    “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs. America’s social security promises will be honored and perhaps made more generous. And, yes, America’s kids will live far better than their parents did.”

    So, if we believe that the value of the stock market will continue to increase and investing in stocks is the best way to grow our wealth to prepare for the future, why are index funds the best way to do that? Shouldn’t we just find the next Amazon or Google and invest with them?

    Picking the hot stock

    The problem with finding the next hot stock is finding the next hot stock. There are many very smart people who spend a ton of time and money trying to find the next Apple or guess when the next recession will hit. You’ve no doubt heard of some of the most famous investors like Warren Buffett or Benjamin Graham. That’s because it is incredible hard to pick successful stocks, or “beat the market” year in and year out. The people that can do this are justifiable famous in their field.

    The Benefits of Diversification

    If you have the skill to pick the best performing stocks and only buy those, that is definitely the way to go. The problem is that the vast majority of us are just as likely to pick the next pets.com as we are to find the next Amazon. The solution is to purchase a basket of different stocks like in an index fund. By diversifying among a large number of stocks we decrease the chance that we’ll go bust and lose our entire investment. We choose to own the entire market, rather than trying to beat it.

    WITH A DIVERSIFIED PORTFOLIO WE SETTLE FOR THE OPPORTUNITY FOR DECENT RETURN, RATHER THAN RISK AN ALL OR NOTHING BET ON ONE SINGLE STOCK.

    Active Funds vs Index Funds

    Since there are smart people out there who know how to beat the market why don’t we pay them to beat the market for us? It turns out you can try to do this by buying “active” funds. These are mutual funds or ETFs made up of stocks that a manager chooses because he/she thinks they will do well and outperform the market. Just as with index funds there are many varieties to choose from as well. There are funds and managers that specialize in certain countries or certain industries or types of companies and on and on. The problem is that just as with picking a quality individual stock, it is very hard to pick a quality active fund.

     Maybe an active fund will outperform its benchmark for one year, but it’s very difficult for it to do better year after year. The S&P Dow Jones Indices releases their SPIVA® (S&P Indices Versus Active) reports each year. According to their year-end 2017 report over 80% of US Equity funds did worse than the market. Source: https://www.aei.org/publication/more-evidence-that-its-very-hard-to-beat-the-market-over-time-95-of-financial-professionals-cant-do-it/

    It is just as hard for someone to select which active funds will outperform in a certain year as it is to select which stocks will do the same. So, if we can’t really pick which of the active funds will do well, why do we choose index funds instead? The answer comes down to the one thing that we can control in the situation. Cost.

    It Turns Out You Don’t Get What You Pay For

    When comparing an index fund that seeks to track the S&P 500 (the largest 500 US companies, remember) and an active fund that seeks to select the best performing large US companies, we cannot predict which one will come out on top. We can look at the past performance of both funds and see which has done better over the past 3, 5, or 10 years. But as we discussed above, that gives us no indication of how they will do in the future.

    The one thing we can contrast between the two and be certain of is their respective costs. With the index fund there is a cost associated with bundling the basket of stocks together and selling you a slice. An active fund has additional costs for the fund manager, research and more. Because you don’t have to pay the additional “active” costs with an index fund it will typically be the cheaper option.

    The average expense ratio for an active equity fund in 2018 was 0.76% and the average for an index equity fund was 0.20%. source: https://www.napa-net.org/news-info/daily-news/mutual-fund-expense-ratios-continue-descent

    That 0.56% difference in fees between an index and active fund may not seem like a lot, but it definitely adds up over time. On a $500,000 portfolio earning 6% annually, by paying an extra 0.56% in fees you would lose out on additional $421,938 over a period of 30 years. Looking at it this way you can understand how much of an effect fund fees have on your portfolio’s performance.

    Cheaper than the Alternative and Just as Good

    All of these reasons: diversification, lower fees, the difficulty of picking winners are why index funds are the right choice for most investors. These benefits have led to a rise in popularity of index funds whereas before you could only find funds that tracked the largest stock markets, today you can find an index fund for almost anything.If you are interested in learning more about how to put together a portfolio of index funds that is right for you, I recommend talking to a fee-only financial planner. They can take the time to understand your goals and time horizon and put together a financial plan that fits your situation. And if you would like to speak to us at Steady Climb Financial Planning reach out today, we have open availability to take on new clients.

  • MARKET CORRECTIONS ARE HEALTHY AND NECESSARY

    Looks like we’re in bear territory now!

    With the stock market’s historic growth that began after the recession in early 2009, many experts believe a 10% pullback would be a healthy sign for the markets going forward. This sort of drop is not horribly painful, especially by historical standards, and in order for the stock market to keep advancing there must be at least a risk of decline.

    Why is a market correction healthy and beneficial? After all, most people are counting on continued gains to be able to meet their goals. The main reason is that it prevents a stock bubble from forming. Bubbles occur when stock prices rise so far that they are clearly out of line with the earnings potential, and value, of the underlying companies. We saw the consequence of that in the awful 2000-02 and 2008-09 market wipeouts, when some people lost half their wealth or more.

    Certainly, market corrections never feel healthy when they occur. It seems people only think it’s a healthy correction when it is other investor’s holdings that are affected. People get fearful as the market declines, the media fan the flames by giving investors reason after reason to be afraid, and worries that this is the beginning of the next crash begin to develop.

    While many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10%. That’s what customarily constitutes a correction. In the most recent sell-off, at the beginning of this year from January 26th to February 8th of 2018, the S&P 500 index fell 10.2%. The market barley crept into correction territory, but then rebounded and went on to have several days of all-time highs later in the year.

    In a great post at awealthofcommonsense.com, Ben Carlson looked at the S&P data going back to 1950, and found 28 time periods when stocks fell by 10% or more. So, on average, the market has experienced an official correction every 2.25 years.

    S&P Losses of 10% or More Since 1950

    • Total Occurrences: 28 Times
    • Average Loss: -21.6%
    • Median Loss: -16.5%
    • Average Length: 7.8 Months
    • Greater Than 20% Loss: 9 Times
    • Greater Than 30% Loss: 5 Times

    As you can see, the average post-1950 market correction lasted just under eight months and the median total loss was 16.5%. But what about steeper declines?

    Out of the 28 times the S&P 500 decreased by 10%, the market went on to decline by 20% – the standard definition of a bear market – only nine times (32% of the time), and a loss greater than 30% only five times (18%). The data confirm that, although these types of large losses do occur, they really are the exception.

    Here are the past 12 corrections in the S&P 500 Index, according to Standard & Poor’s:

    Can you Stomach a Correction?

    Are you thinking: “I don’t think I can stomach a drop of 16.5%.” Then that’s where the wisdom of diversification and having a financial plan becomes apparent. Remember that the data above represents the historical performance of the S&P 500, an index composed of 100% stocks.

    Working with a capable financial advisor can help ensure you have an asset allocation mix of stocks, bonds and cash that reflects your tolerance for risk. A riskier portfolio tilted more heavily towards stocks will perform worse than a conservatively balanced one if you panic and sell when the market declines.

    Even for a younger investor, your portfolio likely shouldn’t consist of 100% stocks. The appropriate allocation for an average investor in their 30s or 40s might be closer to 80% stocks. This means that your portfolio should suffer a drop of around 13.2% during the median market downturn. If that number still makes you queasy, consider having a conversation with your advisor about the amount of volatility you are comfortable enduring within your portfolio.

    By making adjustments to your plan: boosting savings, changing goals, or altering time horizons; you should be able to construct an asset allocation that allows you to rest easier during these periods of market turbulence.

    Although the recent market pullback might create anxiety, media headlines and possibly fear, remember this: we’ve been here before.-source for market data included in this article: “When Stocks Fell 10%…” Ben Carlson. https://awealthofcommonsense.com/2018/10/when-stocks-fell-10/

  • IS THE HSA THE BEST RETIREMENT ACCOUNT?

    As we head into the last quarter of the year, many of us are coming up on the time to re-enroll in our employer benefit programs. This leads nicely into a discussion of one of the best retirement accounts available. A secret retirement account, that wasn’t designed as for retirement savings in the first place. The Health Savings Account.

    Where did the HSA come from?

    The Health Savings Account (HSA) was created in 2003 as a way to help those with high deductible health insurance plans save for future healthcare costs. These plans were created for people that didn’t expect to need as much health insurance throughout the year. The health insurance company offers a less expensive plan, but the catch, is there is a higher deductible if you do get sick and need to get healthcare. The HSA is an account for someone with this type of plan to save money to use for future healthcare expenses in a tax-advantaged account.

    Retirement accounts are designed to save you on taxes, but you do have to pay them at some point. With a traditional IRA or 401(k) you get to contribute pre-tax dollars, but the withdrawals are taxed as ordinary income in retirement. With a Roth IRA or 401(k) the reverse is true, you pay taxes now and can withdraw the funds tax-free in retirement. So why is the HSA one of the best retirement accounts available?

    The beauty of the HSA is that you get to deposit pre-tax dollars into your account and as long as you have qualifying medical expenses, you can withdraw your money tax-free. This is the only account where you can both contribute and withdraw tax-free. 

    HSA basics

    • 2018 Individual Contribution limit: $3,450
    • 2018 Family Contribution limit: $6,900
    • Contributions are made with pre-tax money, and can be made by you and your employer.
    • Contribution limits apply to the money contributed by you and your employer.
    • You can open an HSA if you have a high deductible plan at any time in the year.
    • If you switch to a high deductible plan during the year, you get a prorated contribution limit. So, if you’re single and switched to a high deductible plan in September, and have it through the end of the year, your contribution limit would be $1,150 (4/12 x $3,450).
    • Money can be withdrawn tax free when used for qualifying medical expenses.
    • After the age of 59 ½ money can be withdrawn for any purpose and is taxed at ordinary income tax rates; essentially the HSA can function the same as a traditional IRA.

    How to use an HSA as a retirement account

    If the HSA was created for healthcare expenses how do you use it as a retirement account? The key lies in a little bit of planning ahead. With an HSA you are allowed to withdraw money from the account to pay for qualifying healthcare expenses. You can withdraw the money any time after the expense occurs and you don’t have to withdraw it in the same calendar year or within a period of time after the expense occurs.

    You can allow the money in your HSA to grow by paying for healthcare expenses with after-tax dollars today, and reimbursing yourself from the HSA in the future.

    By paying out of pocket, you allow your HSA contributions to continue to grow tax-free until you withdraw them. That could be another 30-40 years of tax free growth! 

    Example

    Let’s say I have a high deductible health plan for my family. That means I can contribute $6,900 into an HSA for the year. I estimate that my healthcare expenses that aren’t covered by insurance are around $500 per year. I can pay those costs with after-tax dollars and keep that $500 in my HSA to keep growing tax free. I just have to keep track of my healthcare expense receipts to withdraw the money at a later date.

    If you happen to lead an exceptionally healthy life and don’t need to spend much on medical expenses, your HSA turns into a quasi-IRA after you turn 59 ½. You can withdraw your money tax-free for healthcare expenses as before, or you can withdraw it and pay income tax as you would with a traditional IRA. 

    Your HSA always belongs to you, not your employer. Even if you decide to switch away from a high deductible plan, you can still use your HSA for medical expenses and the money you contributed can continue to grow.

    Don’t forget!

    There are a few things to keep in mind when researching your HSA. More employers are starting to contribute to employee HSA’s so take that into consideration when deciding whether and how much to contribute. Most HSA’s require you have a certain balance in the account before you can allocate funds to investments. The amount varies, but is typically around $1,000.  Some HSA providers don’t offer the option of investing in low-cost index or mutual funds, so do your research on the available investments before opening an account. The fees vary between HSA’s and some employers will cover the cost. If you leave an employer or they decide to switch to a new HSA provider be sure to check on the fees, it may make sense to open an account with another provider.

    What do you think? Is the HSA is the best retirement account available?

  • BACK TO SCHOOL WITH THE 529 PLAN

    The summer is over and the kids are back in school. While this is a happy time for parents, it can also cause some anxiety by reminding you that life after grade school is fast approaching. Depending on how old your kids are you may be helping them with their A B C’s, in the thick of college planning, or still looking forward to elementary school when you can finish paying for daycare.

    When thinking about their children’s future after high school most parents’ minds quickly turn to the thought of college and how to pay for it. One of the defining features of gen X and millennials entering the workforce has been the presence of student loan debt. If you plan for your kids to go to college, you may be wondering if there is a way to help them reduce or even eliminate the need for loans to obtain their degree.

    College tuition expenses have outpaced inflation over the past 20 years. A year of tuition and fees at a public school, a public school for out-of-state students, or at a private school will run you $9,528, $21,632, or $34,699 respectively. These figures only account for tuition and don’t include the cost of room & board. Even if the price rise slows and only keeps pace with inflation, that can be a hefty chunk of change 5, 10 or 18 years down the road. By starting saving as early as you can, the power of compounding can help grow your college savings and make the eventual bill a bit easier to swallow.

    Types of education savings plans

    529 Plan: The most popular type of account when it comes to saving for college are 529 plans. The 529 plan is most popular and tends to be the best choice for most people because of a few attributes: tax free growth and withdrawal for qualified use, state income tax deductions for certain states, and higher contribution limits than other plans.

    There are other types of accounts available where you can save for your child or dependent if you have problems with the restrictions on the 529 plan.

    Coverdell Education Savings Accounts (ESA): These allow you to invest in almost any type of security vs the 529 plan’s more limited menu of funds. A downside is that the contribution limit is capped at $2,000 annually and balances must be withdrawn by the time the beneficiary reaches 30. A former benefit was the ability to use funds in the ESA for elementary and primary school as well as higher education. This benefit is lessened by the changes included in the Tax Cuts and Jobs Act of 2017 which gave the same options to holders of 529 plans.

    The Uniform Gift to Minors Account (UGMA) and Uniform Transfer to Minors Account (UTMA): These are a good option for those that are unsure if their children will be attending college. These accounts don’t benefit from the favorable tax treatment that the 529 plan does, but withdrawals are taxed at the typically much lower tax bracket of the child. These are also counted as assets when calculating student aid while 529 plan values are not, which can negatively affect financial aid availability.

     529 plan benefits

    The attributes that make a 529 plan great are the tax advantages: deductions on contributions, tax free growth, and tax-free withdrawals. 34 states allow you to take a deduction on your state income taxes for at least some of your contributions, and no matter where you reside your contributions grow tax free and withdrawals aren’t taxed as long as they are used for covered expenses. So even if you live in a state such as Washington, which doesn’t have a state income tax, you can still benefit from the tax-free growth.

    Because the 529 plans are administered by the states, they can vary in subtle ways but most are pretty similar. The two state 529 plans I am most familiar with are Idaho’s and Ohio’s and offer a good example of the different ways states can structure their plans. Both States offer a tax deduction for contributions, but Idaho offers $6,000 individual/$12,000 joint deduction, while Ohio offers a $4,000 deduction for each beneficiary. In Ohio’s plan you may pay a different fee based on the funds you select, in Idaho’s every fund charges the same 0.5% fee.

    Remember that for most States, you must use that State’s plan to qualify for the tax deduction. If you live in a non-state income tax State, or one that doesn’t offer a deduction you can shop around and choose any state plan that offers the funds or fees that you like best.

    Contributions to a 529 plan are considered a gift for tax purposes, so if you contribute over $15,000 to one beneficiary you will have to list the amount over $15,000 as a gift on your federal tax return. However, you can take advantage of “accelerated gifting” by giving a lump sum of 5 years’ worth ($75,000) of gifts at once without incurring gift taxes. Most people do not have the means to make this large of a donation, but if you have relatives who are looking for ways to reduce the value of their estate they can take advantage of this process as well and the $75,000 applies per beneficiary. Anyone can contribute to a beneficiary’s plan, not just their parents.

    A new 529 benefit I mentioned above is the ability to withdraw 529 proceeds to pay for elementary or primary school education as well as secondary schooling. While this is a nice benefit for those looking to use a 529 plan to help pay for private school tuition, it arguably hinders the largest benefit of the plan, the tax-free growth that occurs inside the account. By withdrawing the funds early to use to pay for a private elementary school you are robbing the account of the later compounding and growth that would occur.

    The 529 plan sounds like the winner, now what?

    Before diving into starting up a 529 plan for your kids I recommend taking a step back to take stock of your own financial situation first. I give the same advice flight attendants give in their pre-flight safety briefing, put your own oxygen mask on first before helping those around you. Saving for your children’s education is important and it’s something you can do along with saving for your retirement and other goals, but I recommend making sure you are hitting a few benchmarks beforehand.

    • Do you have a safety fund of 3-6 months expenses built up in the case of emergency?
    • Are you contributing enough to your employer’s 401(k) to receive the full match amount?
    • If you have some high interest debt, do you have a plan in place to pay it off before opening a 529 plan for your child?
    • If you have student loans are you on track to pay them off in a reasonable time frame?

    If you can answer yes to these questions and feel comfortable with your savings and investing goals, then forge ahead!

    Ok, I’m ready, what do I do next?

    As I mentioned above, you can’t purchase individual stocks within a 529 plan account. Each State’s plan includes a set of funds to choose from. These range from a conservative option like a savings account to an aggressive option invested in growth stocks. The fund options available to investors is an area where most states are doing a great job. Both Idaho’s and Ohio’s plans are full of the type of funds that I use and recommend: low-cost, passively managed index funds.

    The goal for a passive index funds is to mirror the returns of the index it is benchmarking, such as the S&P 500. I use and recommend passive funds over active funds because studies have shown that active managers can’t reliably outperform the market year in year out, so investors are better off going with the low fee passive fund rather than the more expensive active fund.

    A few things to take in mind when selecting the fund are your risk tolerance and your time horizon (e.g. how long until junior heads to college). If you are lucky enough to get started when your children are very young you can probably afford to take more risk and invest in the aggressive funds more heavily weighted to stocks. Whereas if you only have a few years until college you might want to be more conservative and divide your investments among stock funds, bond funds and savings accounts.

    As always you need to take your own behavior and risk tolerance into account. If you have 15 years until you need to use the money for college then you have time to weather the ups and downs in a stock fund in order to get more growth, but if you know that your stomach can’t stand a 20%-40% drop in the value of your account without panicking then you may want to invest more conservatively. A financial planner can help advise you on the funds you should choose, as well as provide support and guidance when the markets get rocky, as they surely will. Some plans also offer the ability to work with a financial advisor as a service for an additional fee.

    Ohio’s plan has another option that can take some of the guesswork out of selecting which fund to choose: target-date funds. These funds work in the same way as target-date retirement funds. You select a fund based on the year your child will graduate. In the early years the fund will be invested mostly or all in stocks, and as graduation approaches the fund gradually and automatically shifts into a more conservative posture of bonds and cash. This reduces the chances of a large drawdown just as you would need to use the money.

    If you are planning to choose the funds and manage the account on your own, you should have a plan in place to revisit them regularly (quarterly, half yearly, annually), just as you would your other investments. If you are manually managing your funds you will want to adjust the portfolio to lean more conservative (and less likely to go down in value) as your child gets closer to college age. If you invest in target date funds these check-ins should not require much work other than checking on the account balance and that your deposits are still going into the account as they should.

    To sum up, if you are looking to save for your children’s college education:

    • Open a 529 plan for a beneficiary (your kid), probably the one offered by your State so you can take advantage of the income tax deduction.
    • Deposit into the account, or better yet set up a monthly auto-deposit.
    • Decide if you are going to pick the investment funds inside the plan yourself, or work with an advisor to help you.
    • Feel confident about the steps you’ve taken to prepare for your children’s future!

    Bonus Step: If relatives have asked about helping out with your children’s education, then let them know they can contribute to the account as well.If you have more questions about 529 plans or are curious about other education savings options you can reach me at chris@steadyclimbfp.com or by phone or text at 208-996-0375. I look forward to hearing from you!