Author: Staff

By Steven Dudash

November 22, 2016

Full Article 

As a wealth manager, more than a few things keep me up at night, including what the election of Donald Trump means for the markets, the country’s economy and how Brexit will ultimately unfold. Perhaps my biggest worry continues to be that investors – both on the retail and institutional side – have not adjusted their expectations in today’s interest-rate and equity market environment.

To illustrate, consider a meeting I had recently with a $250 million university endowment fund. Each year, it uses 5.25% of its assets to award scholarships and at the same time expects to keep pace with a long-term inflation projection of 2.5%. To meet these assumptions and keep the principal intact, basic math says the fund needs to generate returns of just under 8%.

Given that the next 30 years will not be anything like the last 30 years, when investors could rely on a 50/50 portfolio of stocks and bonds to produce that kind of return, that’s pretty implausible. This is not a fun message to deliver to a roomful of stern-face endowment board members. It’s equally unpleasant to have to look a retiree or pre-retiree in the eye and tell them that may be facing a future income shortfall. Nevertheless, it’s the truth. A big reason why can be found in two significant events that occurred over the course of the last three decades – the scale of which are not likely to repeat themselves anytime soon.

The first was the rise of the PC and the Internet during the 1980s and 1990s, which caused productivity to spike, breeding higher corporate profits and boosting stocks. But as technology has permeated more and more areas of the labor market, productivity growth has slowed in recent years, crimping earnings. While equities have hardly suffered, that’s a bit of mirage, having been propped up by an aggressive Federal Reserve.

The second has been the steady decline in bond rates. The U.S. ten-year bond yield hit an all-time high of nearly 16% in September 1981. Earlier this summer, it was 1.36%, and despite a rise in recent since the presidential election, yields are not expected to ramp up meaningfully in the coming years, thanks to interest rates that are all but guaranteed to remain below historical norms for an extended stretch.

Therefore, we now have a stock market that is fully valued and unlikely to repeat past performance (even if corporate tax rates decline under Mr. Trump), combined with a bond market that is depressed, and unlikely repeat past performance. So what should investors do?

Assuming that, unlike an endowment, you can’t adjust your income needs, think about upsizing your level of risk. A 50/50 portfolio simply won’t be enough anymore, period. So my advice, at least in the near term, would be to lower U.S. government bond exposure and look to European equities.

Granted, it will likely be a bumpy ride, riddled with stomach-churning ups and downs. But as the United States seems likely to begin gradually raising interest rates in the coming months, much of Europe is essentially in the middle of QE infinity, still injecting massive amounts of capital into their economies in an attempt to jumpstart lagging growth. Take advantage of this phenomenon.

Cynically, whether those efforts are successful isn’t the concern over the long haul. The more important point is that mainland Europe, for all its issues, is in many ways valued much more favorably than the U.S. market, and there as some opportunities to go bargain hunting. PE ratios aside, Euro markets are likely to appreciate, if for no other reason than the governments are willing to mortgage their futures to make that happen.

Skeptics will point to looming concerns over Brexit. But England was never fully integrated with the rest of Europe in the first place, and as we have seen in the wake of that vote earlier this year, the divorce may not be the nightmare many predicted. What’s almost certain, though, is that the rest of the European Union will remain intact.

The bottom line is that investors need to be realistic about what the next 30 years may hold. This is a case where the past is unlikely to repeat itself, which means you may need to change your outlook and be willing to venture into areas that may not be so popular in the present but offer the opportunity to achieve larger upside potential.

 

 

 

 

New Labor Department rule is pushing brokers to decide whether to continue use of commissions

By: MICHAEL WURSTHORN

Commissions are at the center of a new brokerage battle.

Stockbrokers for years have been moving away from commissions—payments per trade—as a way to charge their customers. Instead, they have been pushing fee-based accounts, where they charge a percentage of assets regardless of the amounts of trading.

For investors who rarely traded, though, commissions remained the more cost-effective approach.

Now a new rule from the Labor Department concerning retirement accounts is pushing brokers to decide whether to continue, or nix, the use of commissions.

Known as the fiduciary rule, the policy is aimed at eliminating incentives that might cause brokers to give conflicted advice—an inherent problem with commission-based retirement accounts that can have varying sales costs depending on the types of investment products. But a move away from commission accounts could mean investors may now end up paying more in fee-based accounts.

So far, brokerages are breaking into two broad camps: those that plan to offer some level of commission-based options and those that would rather avoid the thorny issues of trying to make commission accounts comply with the new rule, which begins to take effect in April.

“There’s definitely going to be a percentage of people hurt by these conversions,” said Steven Dudash, head of Chicago-based IHT Wealth Management. “Old-school, traditional investors who have nothing but bonds because they want ultrasafe security [and] your buy-and-hold investors are going to get hurt if they go to more costly fee-based accounts.”

The new order is being illustrated by two Wall Street bellwethers that have taken opposing views on the best approach under the new rule, with Bank of America Corp.’s Merrill Lynch effectively eliminating commission-based individual retirement accounts and Morgan Stanley attempting to retain such accounts.

Moving an IRA to a fee-based structure from commissions could mean higher costs for some investors, especially those who trade stocks occasionally or have portfolios consisting mostly of bonds, experts say.

Fee-based IRA accounts are typically charged a fee of around 1% annually. So a theoretical $1 million fee-based account would cost about $10,000 a year, brokers say. That doesn’t include other fees, such as embedded costs in exchange-traded funds and mutual funds, although those expenses are typically small, says Matthew Papazian, a financial adviser with Denver-based Cardan Capital Partner.

The costs associated with a commission-based IRA can vary more broadly depending on the frequency of trading, the investment products purchased and the fees that come with them.

If that theoretical $1 million was in a commission-based IRA at a brokerage, and the client did about 10 stock trades over a year, the cost could be around $3,000 or less, according to brokers. Those fees would be pushed higher if the client bought other products, such as structured notes, which can carry upfront charges of 2%

But an investor who trades more frequently or buys higher-cost products would incur higher costs. If that same investor executed 30 significant trades of a specific stock in a year, their costs could be as much as $13,000.

For bondholders, the cost difference between a commission-based IRA and one that charges fees is even greater, says Mr. Dudash.

Moving clients to a fee-based structure is a simpler step toward complying with the rule, as well as part of a broader industry shift over the last decade, observers say. Brokers say those costs are justified because they have to provide a higher level of service by spending more time understanding a client’s full financial situation.

“Some brokerages are seeing [commissions] not being offered at all as a competitive advantage,” says Bharat Sawhney, a managing director focused on wealth and investment management at consulting firm Gartland & Mellina Group in New York. “There could be an asset play here where firms like Morgan Stanley choose to offer commissions as others pull away.”

However, brokerages will have to justify such conversions to avoid violating the rule. A broker who recommends a fee-based account to a commission-paying retirement saver who trades little or doesn’t need close monitoring would be an “abusive practice,” according to guidance released by the Labor Department on Thursday.

Retirement savers also have the option of moving their account away from full-service brokerages like Merrill and Morgan Stanley to self-directed IRAs or an automated robo adviser that relies on an algorithm to provide advice, both of which aren’t significantly affected by the Labor Department’s rule.

Those options, especially a self-directed account, would mean investors no longer have access to advice.

“Unfortunately some of the fallout on some investors will be choosing between no longer receiving advice or paying higher fees for it,” Mr. Dudash said.

 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Bonds investing involves risks. Bonds are subject to market and interest rate risk if sold prior to maturity.

 

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By Jane Bennett Clark,

You wouldn’t dream of running a marathon without undergoing months of training. Or heading into the wilderness without making sure you have adequate provisions. Or betting your life savings on a business venture you haven’t thoroughly researched.

But when it comes to entering retirement—when a failure to plan can have devastating consequences—a surprising number of people are unprepared. More than half of workers older than 55 haven’t developed a plan for paying themselves in retirement, according to a recent study by Ameriprise, and almost two-thirds haven’t identified which investments they’ll tap first. Many wait until they’ve set their retirement date to put together any kind of plan at all.

Planning late is better than never planning, but your chances of a secure retirement will improve if you start making decisions and checking items off your to-do list at least a year out. Take a look at seven big issues you’ll face as you transition into retirement.

Sign Up for Medicare

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You can’t ignore signing up for Medicare. You’re eligible at age 65, and you can sign up without penalty anytime from three months before until three months after the month of your 65th birthday. Medicare Part A covers hospitalization and is premium-free, so there’s generally no reason not to sign up as soon as you’re eligible. One exception: You can’t contribute to a health savings account if you enroll in Medicare. If you have an HSA and want to keep fueling it, don’t sign up for Medicare until you retire. (To enroll, go to www.ssa.gov.)

Part B covers outpatient care, including doctors’ visits. It costs $121.80 a month for singles with an adjusted gross income (plus tax-exempt interest) of $85,000 or less ($170,000 for couples) who sign up in 2016. Above those income levels, you’ll have to pay $170.50 to $389.80 per month. You’ll also have to pay a surcharge of $12.70 to $72.90 a month on top of the premium for Part D prescription drug coverage.

If you don’t sign up for Part B during the seven-month window around turning 65, and you do not have coverage through your current employer, you may have to pay at least a 10% penalty on premiums permanently when you do sign up. If you work for a company with fewer than 20 employees, your group coverage generally becomes secondary to Medicare at age 65, so you should sign up for both Part A and Part B—otherwise, you may not be covered at all.

Employees of larger companies can choose to keep group coverage while still working and hold off on signing up for Part B. But you must sign up for this coverage within eight months of leaving your job or, once you do enroll, you’ll pay at least a 10% penalty on premiums for the rest of your life.

Make a Retirement Budget

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Aside from signing up for Medicare, matching your future costs to income is the most important step in the run-up to retirement. Start by identifying fixed expenses—say, for food, housing, insurance and taxes—along with more-flexible expenses, such as for clothing and gifts. Don’t ignore big, occasional costs, says Lauren Klein, a certified financial planner (CFP) in Newport Beach, Calif. “Eventually, you’re going to need a new roof or you’ll have to replace your car,” she says. “Those costs shouldn’t come as a surprise.”

In a separate column, list discretionary expenses, for costs such as travel, entertaining and dining out. Note that some expenses will go down or disappear when you’re no longer working—you won’t be paying payroll taxes or saving for retirement, and your wardrobe will cost less when every day is casual Friday. But some expenses, such as for travel and health care, could also go up.

Once you’ve identified your fixed, essential expenses, match them to your resources. Ideally, guaranteed income—Social Security and maybe a pension or an annuity—will cover the basics. If not, you’ll have to use your retirement savings to close the gap, as well as to cover the nonessentials.

If your nest egg seems too skimpy to go the distance, better to know that before you leave your job, says Joe Tomlinson, a CFP in Greenville, Maine. “You don’t want to think later, I wish I’d worked another three years.” Working longer not only lets you continue to save for retirement but also means you have fewer years in retirement to finance, and it helps you delay taking Social Security.

Make a Retirement Budget

Maximize Social Security

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You can sign up for benefits as early as age 62 (full retirement age is 66 for people born between 1943 and 1954). But by claiming early, your benefits will be reduced by about 25% to 30% of the amount you’d get at full retirement age. For every year you postpone taking benefits after full retirement age until you hit age 70, you get an 8% boost.

If you think you have a less-than-average life expectancy (83 for 65-year-old men; 85 for 65-year-old women), or if you know you’ll need the income to make ends meet, you’ll probably take the money when you reach full retirement age, if not before. But if you have reason to think you’ll live into your nineties or beyond and that your savings could fall short, “draw down your IRAs, keep working—do whatever you have to do to get that 8% increase,” says Klein.

Although the government recently axed two lucrative claiming strategies that mainly benefited married couples, couples still have more options than singles. But their decision is also more complicated. You can take your own benefit as early as age 62, or you can claim a benefit equal to at least 50% of your spouse’s benefit if it’s higher and your spouse has already claimed. Either way, you’ll get a lower benefit if you claim before full retirement age. If you’re divorced or widowed, you may also have access to benefits based on your spouse’s earnings, which may be a better deal than your own.

 

Review Your Portfolio

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For years, you’ve concentrated on accumulating savings. Now the goal is to preserve your nest egg. You’ll still need to invest for growth to beat inflation and maintain spending, but you don’t want to risk losing a big chunk of your savings. A portfolio with 55% stocks, 40% bonds and 5% cash is a reasonable mix for near-retirees and retirees. More-aggressive investors might adjust the mix to 60% stocks and 40% bonds and cash; conservative investors could do the reverse.

If you’re like many investors, you have some or all of your retirement money in a target-date fund, which starts almost entirely invested in stocks when you’re several decades away from retirement and grows more conservative as you near the target date (theoretically, about the time you retire). Now’s the time to take a look at the fund, if you haven’t already, to see if you’re comfortable with its risk level. Each fund arrives at its definition of conservative a little differently. Fidelity’s 2015 Freedom Fund, for instance, currently puts you at 57% stocks and 42% bonds and cash; Vanguard’s 2015 target-date fund sets the mix at 50% stocks and 50% bonds. Both funds continue to grow more conservative over the next several years.

Review Your Portfolio

Set Your Withdrawal Plan

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Consider how you want to draw down your savings once you have retired. One long-standing strategy is to use the 4% rule: You withdraw 4% in the first year of retirement and the same dollar amount, adjusted for inflation, every year thereafter. The percentage-plus-inflation-adjustment strategy provides a reasonable assurance that your money will last 30 years or so, based on historical returns, but it lacks flexibility. You could do irreparable harm to your retirement stash by following the rule during a bear market, especially if the markets tank at the start of retirement.

A second approach is to take 4% of your portfolio and skip the inflation adjustment. This strategy technically ensures that you’ll never run out of money, but it’s “highly sensitive to the market,” says Colleen Jaconetti, senior analyst of the investment strategy group at the Vanguard Group. If the market goes south in a given year, so does your payout. Vanguard proposes a hybrid strategy in which you take a base percentage each year but set a ceiling on increases and a floor on decreases over the previous year to keep spending relatively smooth.

A third approach, the bucket strategy, represents a different tactic altogether. In the first bucket you put enough cash, CDs and other short-term investments to cover one to three years of living expenses, after factoring in guaranteed income. You fill the second bucket with slightly riskier investments, such as intermediate-term bond funds and a few diversified stock funds. The third bucket, for long-term growth, is devoted entirely to diversified stock and bond funds. As you spend down the first bucket, you eventually refill it with money from the second, and the second with money from the third. The purpose of this strategy is to avoid being forced to sell investments in a down market to fund living expenses.

Setting up a bucket system takes careful planning. If you decide to go this route, start positioning your assets now (or better yet, a few years ahead of retiring). Target-date funds don’t lend themselves to the bucket approach because each withdrawal represents a piece of the whole pie.

SEE ALSO: 8 Things No One Tells You About Retirement

Set Your Withdrawal Plan

Weigh Pension Choices

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If you’re lucky enough to be eligible for a pension, you’ll probably be offered the choice between a lump sum and guaranteed lifetime payments. With the guaranteed payments, you’ll have the security of knowing they will last as long as you do. With a lump sum, you can invest the money yourself and potentially end up with more than you’d draw from a pension over your lifetime. Plus, you have access to the entire amount from the get-go, and whatever remains in the account when you die goes to your heirs. On the downside, your investment won’t necessarily do better than the total amount of the payouts, especially if the market performs worse than you anticipate or you live longer than you expect.

To estimate which choice offers you the biggest potential payout, you’ll have to figure out the returns you’ll need from the lump sum to re-create the pension’s stream of income over your expected life span, says Michael Kitces, a CFP who’s a partner and director of wealth management at Pinnacle Advisory Group. If you think you can reap the same paycheck by investing the money at a doable 4% over 25 years, taking the lump sum would be a reasonable choice—unless you expect to live beyond those 25 years (maybe your parents and grandparents all lived to be 100), in which case “the pension looks like a pretty good deal,” says Kitces. The same goes if you’d need to earn 8% on your money to create the same income stream.

Married couples who choose lifetime payouts face another decision: whether to take the single-life option or the joint-life option, which has lower payouts to reflect the longer time over which the pension is likely to be paid out before the surviving spouse dies. Most couples choose joint life, which is the default option; you both must sign off if you choose single life. The minimum payout for joint life is 50%, although some plans let you choose a higher percentage—say, 75%—for a commensurately lower payout from the beginning. No matter who dies first, the reduced benefit usually kicks in for the survivor.

Weigh Pension Choices

Consider an Annuity

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You could use a chunk of your own savings to buy yourself a pension, in the form of an immediate or deferred-income annuity. These products also guarantee lifetime income, but the key word is lifetime: Unless you buy a costly rider, the payouts stop when you die, even if it’s the month after you start getting the paycheck. Plus, buying an annuity means giving up liquidity. Don’t put all your retirement assets in this basket. One approach, says Tomlinson, is to invest enough so that the payout combined with Social Security and any other guaranteed income will cover your fixed expenses.

Annuities come in myriad forms, some so complicated they can make your head hurt. Not so a single-premium immediate annuity: “It’s ridiculously simple,” says Tomlinson. “You pay x dollars up front, and the annuity pays you y dollars for the rest of your life.” With interest rates practically flatlining, however, you won’t get much for your money: A 66-year-old man who pays $100,000 for an immediate annuity would get $543 a month. (For quotes based on your situation, see www.immediateannuities.com.)

To beef up the payout, you could ladder your annuity purchases, with the expectation that interest rates will rise over time (even if they don’t, the older you are when you buy the annuity, the bigger the payout). Or spring for a deferred-income annuity now and collect the payout 10 to 20 years down the road. In exchange for your patience, the insurer will fork out much more—in the case of the 66-year-old man, about $1,300 a month if he collects 10 years out.

You can use up to $125,000 or 25% of your IRA or 401(k) account balance, whichever is less, to purchase a deferred-income annuity called a QLAC. And you won’t have to take required minimum distributions at age 70½ on what you paid for it.

Your Money

By RON LIEBER

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Here’s how to get better returns in your retirement account: Pay as little attention to it as possible.

That was the conclusion of a study by the investment giant Fidelity, according to a 2014 article on Business Insider. The article relayed the transcript of a Bloomberg program in which the well-known money manager Jim O’Shaughnessy said that people who had forgotten that they had accounts outperformed everyone else.

Fidelity, which has received inquiries about the study ever since, without knowing why, told me this week that it had never produced such a study.

How disappointing, given how tantalizingly counterintuitive the supposed conclusion was: Perhaps chasing headlines and darting in and out of stocks and bonds as hedge fund managers do wasn’t necessary after all.

But when the Standard & Poor’s 500-stock index hits a record high, as it did on Friday, we ought to be reminding ourselves of the near certainty of stock market declines that will test us just as the ones that began in 2000 and 2007 did. The apocryphal Fidelity study still suggests two questions that we should all be asking ourselves: How often should we look? And if we do check the performance of our investments, how often should we make any changes?

Michaela Pagel, an assistant professor in the division of economics and finance at Columbia Business School, answers the first question as the phantom Fidelity researcher might: Check your account statements as seldom as possible, especially when markets are falling.

We humans tend to experience pain from losses much more acutely than whatever joy we might experience from an equal-size gain. “If you’re watching as the markets go down, you are twice as unhappy as you would be happy if they went up by the same amount,” Professor Pagel said. “So looking at the market is, on average, painful.”

So stop looking so much. Consider turning off paper statements and email notifications for retirement accounts that you won’t need to draw on for several years. Most people’s accounts fall into that category — even those on the brink of what will hopefully be a multidecade retirement. The less we look, the less tempted we’ll be to act to try to alleviate that pain.

But many of us will look anyway. We are rubberneckers, masochists, cravers of information. We convince ourselves that since the facts are different this time, then perhaps our behavior should be, too.

So should we touch our investments the next time markets take a prolonged dive? This is something Fidelity actually has studied. After the stock market collapse in 2008 and early 2009, the company noticed that 61,200 401(k) account holders had sold all of their stock. So the company started tracking them to see whether that move would pay off.

Since then, 16,900 had not bought stocks in their retirement accounts through the end of 2015. About 13,000 of them are under 60, so they probably didn’t just cash out and take early retirement either. Through the end of 2015, their account balances rose by 27.2 percent, including new contributions.

People who had at least some stock exposure, however, saw their accounts jump 157.7 percent. That left them with an average balance of $176,500, $82,000 more than the people who got rid of all their stock. Now imagine that $82,000 difference compounding over 20 or 30 more years, and think hard about whether you want to touch the stocks in your retirement fund the next time the markets fall far.

This is an extreme example but an important one, given that plenty of smart people capitulate when faced with the pain of looking too hard at fast-falling balances. Even when market moves aren’t quite as severe, people still tend to fiddle with their holdings. In the second quarter of this year, 13 percent of Fidelity 401(k) account holders did so.

One group is not counted in those numbers, though: the people who keep all their retirement money in target-date funds. These funds are designed not to be touched, since they maintain a prescribed mix of investments that shifts slowly over the years as you age and need to take fewer risks. In other words, they buy and sell only when they are supposed to, according to the investment mix that corresponds to your age. And sure enough, only 1 percent of the Fidelity account holders in those funds made any moves during the second quarter. If this sort of investing is attractive to you, automated investing firms like Betterment and Wealthfront work in similar ways.

Left to our own devices, picking and choosing among a variety of funds, we’re likely to change our minds often and flit in and out of things. According to Morningstar data examining 1,930 stock mutual funds over 15 years ending in June, the difference between what the funds would have delivered to steadfast investors and what the average investor (who did not hang around for that long) actually earned was 0.99 percentage points. That doesn’t seem like much, but a one percentage point difference in returns can mean missing out on many hundreds of thousands of dollars in returns over the decades.

So why do we keep touching? It may be because it’s so easy to fall under the influence of people who seem to know what they are talking about. In the “Seers and Seer Suckers” chapter of his new investing guidebook, “Heads I Win, Tails I Win,” Spencer Jakab explains in fine and uproarious detail how consistently most of them fail to predict the future.

He should know, as he used to be one. A former top-rated stock analyst in what he describes as the “fortunetelling business,” Mr. Jakab reveals in the book that he actually had no idea how his stock picks performed against any kind of market average, and still doesn’t. No one at his firm kept track, and neither did he. He’s now doing more honest work in the Wall Street Journal newsroom. He also keeps a shelf of books at home filled with what he believes is bad investment advice — just to remind himself how hard it is to achieve any kind of genius.

While Mr. Jakab did not repeat the legend of the Fidelity study in his book, it did show up on a Columbia University webpage promoting Professor Pagel’s research. She hadn’t known its origins either. (Turns out Mr. Shaughnessy first heard about it from a now former employee, who has not returned emails about where he heard of it, according to a spokeswoman.)

But when I told Professor Pagel that Mr. Shaughnessy’s interviewer, Barry Ritholtz, had wondered whether the punch line to the study might be that the most successful Fidelity account holders were the dead ones, she thought he might be onto something. “Even if it’s not true, it’s actually true,” she said. “Dead people can’t get upset from seeing the market go down.”

Bank of England action means we’re in quantitative easing infinity, expert says

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The world is in quantitative easing infinity now, after the Bank of England cut interest rates for the first time in over seven years.

While many economists had predicted that the U.K.’s central bank would lower rates, the actions the BOE announced Thursday were slightly more aggressive than expected.

“I think we’re in QE infinity now and now they’re coming up with new ways of making QE because they can’t cut rates anymore than they already have,” Steven Dudash, president of IHT Wealth Management, said on CNBC’s “Power Lunch.” He added, however, that he doesn’t “see how that helps banks.”

“It’s hard to see how that’s going to help the bank world and I’d probably be avoiding them right now at least for the foreseeable future,” Dudash said.

But Robert Pavlik, chief market strategist at Boston Private Wealth, said banks could potentially benefit from this economic backdrop because they’re involved in trading bonds and issuing new bonds for corporations. He explained that the financial sector reaps an investment banking fee from these kinds of activities.

“I am at least somewhat more favorable on the banks because I think with this cut in interest rates and the additional bond purchases by the Bank of England, it’s going to help some of these international banks like JPMorgan, like Citigroup and so I think there is some favorable impact,” Pavlik said.

Pavlik said he is interested in financial stocks like Bank of America, JPMorgan Chase, Citigroup and BlackRock. “Lower interest rates means positive things for these companies going forward,” he said.

 

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