Obama’s MyRA: A Short Recap

myRAIn his recent State of the Union speech, President Obama introduced a new program of retirement saving for the 50% of Americans that do not currently have employer-funded retirement plans. This MyRA, as it is called for “My IRA”, allows workers to contribute up to $15,000 in a starter-saving plan that exclusively uses government Treasury Bonds. The accounts offer guaranteed principal, tax-free withdrawals of principal and no fees. Couples with an adjusted income of $191,000 or less and individuals with $129,000 or less may contribute after-tax a maximum per-year of $5,500 or $6,500, if older than 50. Once the account reaches $15,000, principal can be transferred to a traditional IRA or withdrawn without penalty for other uses. Any growth earned in the account will face a 10% withdrawal penalty if taken before age 59.5. Self-employed workers are not candidates for these accounts.

As a way to encourage saving for those workers who currently are not offered another vehicle, the rates of return on the bonds are running at an average of 3.6%, which is superior to standard bank savings accounts or CD’s. Other incentives for using the MyRA as a short-term saving plan include the fact that the principal is guaranteed, there are no fees and no withdrawal penalties on principal. This could  encourage workers to get in the habit of automatically deducting contributions directly from a paycheck for savings or used as a potential way to accrue a home down-payment or emergency fund. It requires little to get started – $25 initial minimum, and then allows deductions of as little as $5 per paycheck. Also, because the Treasury Bonds are the only investment, there is no education or decision-making required. Workers can easily transfer their account from employer to employer, either for full-time or part-time jobs.

The detractors maintain that this is simply a new market for buying Government bonds to fund overspending and to unload the Treasury Bonds purchased under the Obama administration’s recent policy of “quantitative easing”,  where the Fed  has purchased large amounts of Treasury bonds to help contain interest rates and encourage growth. Also, rising interest rates would have a major negative effect on the value of 30 year bonds. Others point out that this program is inadequate to overcome the estimated $6-8 trillion in retirement saving shortfalls and that concentration should instead be on fixing Social Security. There are no tax deductions for these contributions and the government gets to use your money and keep it from being invested in higher-earning choices. Also, employers are not required to offer this plan and it is unclear how the program will launch at its predicted start-date at the end of 2014.

There appear to be some benefits to using this as a short-term savings plan and it may act as an incentive to encourage personal savings, but it falls far short of the intended fix for under-funded retirement accounts and is an unlikely fit for most DWM clients. It provides little tax benefits and the only investment option, long-term treasury bonds, is not a good one. Further, it can certainly be argued that the spotlight should be on fixing the other government-sponsored and non-voluntary retirement savings program – Social Security.

Welcoming Ginny Wilson

Ginny1Ginny Wilson has joined Detterbeck Wealth Management as an account associate working in the Charleston office with Les Detterbeck to help coordinate and direct client services.

Ginny’s background has focused on bookkeeping and business management for several small businesses in healthcare, manufacturing and insurance.  She also worked as a congressional analyst for the UN in Washington, D.C.

Ginny is an enthusiastic fan of the Michigan State Spartans and any team or sport for which her three teenagers play.  She and her family love to get out and enjoy the South Carolina weather and lifestyle.

Please join us in welcoming her!

Why “Smart Beta Indices” can be Smart for your Portfolio

Core and Satellite pie chart
(Click above for full size image)

Most of our clients are very familiar with our core and satellite investment approach where we see the investing world in primarily three investment classes: equities, fixed income, and alternatives. Furthermore, they have heard us preach that we like to use low-cost, generally passive vehicles for the traditional asset classes (equities and fixed income) and active vehicles for the non-traditional alternative asset class. What they may not realize is that we also utilize something that falls somewhere in between truly passive and truly active, something known as “smart beta” or “enhanced” indexing. 

We’ve always been proponents of low cost. Active management brings higher expenses to the table as those management companies need to pay for overhead (such as talent, rent for bigger buildings, marketing, etc) that passive shops do not. This generally leads to higher expenses, higher transaction costs, and more tax ramifications for the investor which explain the empirical studies that show that over time active management funds underperform their benchmark. If one believes in relatively efficient markets, then these active/higher fee funds don’t make much sense when there are passive vehicles that follow an index with much lower fees. In fact, as of August 2012, actively managed mutual funds had a weighted average OER (Operating Expense Ratio) of 0.88% whereas passively managed mutual funds had a weighted average OER of 0.13%.* By going passive instead of active, that difference of 75 basis points goes straight to one’s bottom line, all else being equal.

However, as great as low cost index securities seem, they are not perfect. 

Let me explain: traditional indices are capitalization-weighted. Which mean cap-weighted index funds overweight the biggest companies and underweight the smallest ones. For example, using cap-weighted methodology, an S&P500 Index fund’s biggest holding currently would be Apple at about 3% and its smallest holding would be Graham Holdings at just 0.02%. Apple’s weighting is 150 times Graham’s holdings! Should we be taking a 150x bet on Apple versus Graham? Maybe, maybe not. What we do know is that empirical studies show that there is a small size and value premium. Hence, cap-weighted equity index funds tend to overweight overvalued securities and underweight undervalued ones, creating a 2% return drag in developed markets and more in less efficient ones, according to Rob Arnott at Research Affiliates.

So if smart beta indices aren’t weighted by capitalization, then what are they weighted/created by? One of the first methods to come about, and one of the simplest ones, is equal-weighting. For example, an S&P500 equal-weighted smart beta index would have 0.20% of every one of the 500 companies within the S&P. Another example would be fundamentals-weighting which is where weights of the portfolio are determined by fundamentals like earnings, dividends, and cash flow. (FYI, DWM utilizes this method within its Core Equity model via the Schwab Fundamental US Large Company Index [symbol: SFLNX]). Other smart beta indices weight the index to low volatility or upward price momentum. The one thing they all have in common is that size does not matter. And, because of that, we’ve seen outperformance. 

Smart beta utilizing non-price-weighted indices can be quite attractive. Smart beta indices retain the benefits of traditional cap-weighted indices, such as broad market exposure, diversification, liquidity, transparency, and low cost access to markets, while at the same time they offer the opportunity to achieve enhanced performance over the cap-weighted benchmark. 

Smart beta strategies are pretty exciting yet also can be pretty complicated to many. One really needs to “look under the hood” to get a good understanding of exactly how these work. Be sure to use an investment professional like DWM to filter through all the different choices when investing.

*Mutual fund expense ratios as of August 21, 2012. Asset weighting based on net assets as of July 31, 2012. Data provided by Morningstar, Inc. Passive funds are those coded by Morningstar as Index Funds.

Call to Action: Safeguard Your Important Information

call_to_actionA few weeks ago, we wrote about identity theft. Today, we’d like to expand on one key element: storing and safeguarding your important documents and contacts.

Stuff happens. Our nephew and his wife had their apartment in Washington, Illinois completely wiped out in November. With the exception of the clothes on their backs and one cell phone, they lost everything, including social security cards, birth certificates, marriage certificates and much more. Yes, ultimately, they were able reclaim their identities. But, if they had secured their records in a secure, safe spot, the process would have been much easier and less stressful. We’ve had other clients who were victims of floods and other disasters as well, which destroyed their records. 

In addition, sometimes the issue is not natural disasters, but rather lack of attention to getting things in order. We have new prospects who come to us after a death in the family looking for help. They are dealing not only with the grief of losing a loved one, but also the fact that the records they need for the estate are in horrible shape or non-existent. They first need help in collecting the information for the estate. Then, they need help managing the information and the assets.

We suggest now is a great time to get all your important information in order. And, then, to scan it into the cloud as a backup for your “hard copy.” Think of it, electronic copies of all of your important documents and contacts in one safe, secure place.

Here are some of the documents that should be included:

·  Estate planning documents including trusts, wills, powers of attorney, etc.

·  Business papers covering partnership agreements, corporation papers, and employment agreements

·  Tax records including returns and supporting data

·  Banking records

·  Real estate records including deeds, title insurance, notes, and rental property records

·  Insurance policies

·  Titles to autos, trucks, boats, planes

·  Personal papers including birth certificates, social security cards, marriage certificate, military papers, citizenship papers, divorce judgments, etc.

·  List of key advisors’ contact information including financial adviser, CPA, attorney, clergy, doctors, insurance agents, employer, landlord/real estate salesperson, successor trustees, etc.

·  List of relatives and close friends to be contacted in case of an emergency or death

The above list may seem daunting. But, trust me (as someone who actually did this process a few months ago), it really isn’t. You probably have most of the information (somewhere). And, the pieces you don’t have, you can get. Once you have everything assembled, you need to scan in everything and then put the electronic copies in a safe place-presumably in the cloud. DWM clients often give us their originals for a few days, and we upload everything for them.

Our DWM/Orion client portal includes a safe, secure document vault. The Orion “cloud” can be accessed by us or our clients, 24/7, from anywhere in the world. Because the Orion cloud is a small, privately owned enterprise, we like the fact that our client information is stored here and not a mega-cloud like Dropbox, Sharefile or Amazon.

With winter still outside for most of the U.S., now is a great time to get your important documents assembled, scanned and stored electronically in a safe place. Here is a checklist of documents and contacts. Let us know if we can help.

How Much Stock Should You Own?

asset allocation dog
(Click above for full size image)

The Wall Street Journal directed that question to retirees Monday. It’s really a good question not just for retirees, but investors of all ages. Research shows that asset allocation accounts for more than 90% of investment returns.

Let’s start with retirees. The old “wisdom” was that you subtracted your age from 100 and that was how much of your portfolio should be allocated to stocks. The balance was suggested to be in fixed income. So, this rule of thumb would conclude that most investors age 70 would have 30% allocated to stocks and 70% allocated to fixed income. That’s likely the wrong allocation today for three reasons:

  1. The equity allocation may be high or low.
  2. The fixed income allocation is likely too high these days.
  3. There are no alternatives in the allocation.

For retirees and investors of all ages, the answer lies not in the age of the investor but their risk profile. Our regular readers know that risk has three components:

  • Risk Tolerance – Are you a risk taker? This is typically reviewed through use of a questionnaire.
  • Risk Capacity – How much money can you afford to lose? This is typically reviewed by estimation of worst case outcomes in relation to your net worth.
  • Risk Perception – This is a subjective judgment people make about a given risk at a point in time.

Every investor has their own unique characteristics as far as goals, income, expenses, net worth, legacy wishes, expected longevity and risk profile. We have clients in their 60s, 70s and 80s with a “growth” or “aggressive” risk profile. They may or may not be working, don’t withdraw a large percentage annually from their portfolio, are comfortable with risk overall, have enough net worth where they can afford to lose an expected given portion of their assets and they have a low perception of danger of a given risk. Hence, based upon their unique characteristics, their asset allocation might be 60% equity, 20% fixed income, and 20% liquid alternatives. A far cry from 30% equity and 70% fixed income based on their age alone.

Conversely, we have some young clients who don’t like risk and have a “defensive” or “conservative” risk profile. Their asset allocation could be 30% equity, 35% fixed income and 35% alternatives. Everyone is different.

Another rule of thumb that needs review is the 60/40 portfolio. The traditional “balanced risk” portfolio is 60% stocks and 40% bonds. Some financial advisers recommend this 60/40 portfolio to their clients of all ages and all risk profiles. To them, the mix is what Goldilocks would say is “just right.” They recommend you “set it at 60/40 and forget it.” Unfortunately, it hasn’t worked well since 2000. Many of their clients should have had less allocated to stocks and more to bonds through 2011. And, now with the bond bull market seemingly over, they face the prospect of reducing the bond allocation but don’t want more in equity.

These first five weeks in 2014 remind us that the stock market doesn’t always go straight up and diversification is key. It’s no surprise that we continue to see more and more industry literature suggesting investors and advisers consider liquid alternatives for a portion of their portfolio – something we’ve been doing for ourselves and our clients for over seven years. Instead of a 60/40 portfolio, the DWM allocation for an investor with a balanced risk profile these days might be 50% stocks, 25% bonds and 25% alternatives.

Lastly, risk profiles change over time. Many risk profiles are different today than they were in early 2008. We live in a different world today than six years ago and it’s always changing. That’s why we are continually monitoring and managing the investment environment and meeting with our clients to help them with their financial goals and review their risk profiles. That’s what we call Total Wealth Management or “TWM.”

Beware of advisers that rely on antiquated rules of thumb (such as using your age for your asset allocation) or suggesting a 60/40 set-it-and-forget-it portfolio. Identifying and maintaining the appropriate asset allocation requires a lot more work. It requires a robust financial planning and investment management process like DWM’s TWM. If you’d like more information please give us a call.