Next on the Agenda- Income Tax

Washington is moving on to tax reform. Earlier this week, the Senate Republicans made it clear that they want to focus on tax overhaul and critical fiscal legislation.  Republicans and Democrats have already outlined their plans.  Income taxes have always been a very important and often contentious subject. Before we review the key issues, let’s step back and review tax policy generally.

I remember my first tax class in Champaign, Illinois over 50 years ago.  We learned that income tax policy was more than simply raising money.  Taxes have always been an instrument of economic and social policy for the government, as well.

Income taxes became a permanent part of life in America with the passage of the 16th Amendment in 1913.  The first tax amount was 1% on net personal incomes above $3,000 with a surtax of 6% on incomes above $500,000 (that’s about $9 million of income in today’s dollars).  By 1918, at the end of WWI, the top rate was 77% (for incomes over $1 million).  During the Great Depression, the top marginal tax rate was 63% and rose to 94% during WWII.  The top rate was lowered to 50% in 1982 and eventually 28% in 1988.  It slowly increased to 40% in 2000, was reduced again from 2003 to 2012 and now is back at 40%. Corporate tax rates are 35% nominally, though the effective rate for corporations is between 20% and 25%.

Changes in the tax structure can influence economic activity.  For example, take the deduction for home mortgage interest.  If that deduction were eliminated, the housing market would most likely feel a big hit and economic growth, at least temporarily, would likely decline.  In addition, an argument is often made that tax cuts raise growth.  Evidence shows it’s not that simple.  Tax cuts can improve incentives to work, save and invest for workers, however, they may subsidize old capital that may undermine incentives for new activity and growth.  And, if tax cuts are not accompanied by spending cuts or increased economic growth, then the result is larger federal budget deficits.

Our income tax system is a “progressive” system.  That means that the tax rate goes up as the taxable amount increases.  It is based on a household’s ability to pay.  It is, in part, a redistribution of wealth as it increases the tax burden on higher income families and reduces it on lower income families.  In theory, a progressive tax promotes the greater social good and more overall happiness.  Critics would say that those who earn more are penalized by a progressive tax.

So, with that background, let’s look at some of the key issues.

The Republicans and the White House outlined their principles last Thursday:

  • Make taxes simpler, fairer, and lower for American families
  • Reduce tax rates for all American businesses
  • Encourage companies to bring back profits held abroad
  • Allow “unprecedented” capital expensing
  • Tax cuts would be short-term and expire in 10 years (and could be passed through “reconciliation” procedures by a simple majority)
  • The earlier proposed border adjustment tax on imports has been removed

Also this week, Senate Democrats indicated an interest in working with Republicans if three key conditions are met:

  • No cuts for the top 1% of households
  • No deficit-financed tax cuts
  • No use of fast-track procedures known as reconciliation

The last big tax reform was 1986.  It was a bipartisan bill with sweeping changes.  Its goals were to simplify the tax code, broaden the tax base and eliminate many tax shelters.  It was designed to be tax-revenue neutral.  The tax cuts for individuals were offset by eliminating $60 billion annually in tax loopholes and shifting $24 billion of the tax burden from individuals to corporations.  It needed bipartisan support because these were permanent changes requiring a 60% majority vote.

With all that in mind, sit back, relax and follow what comes out of Washington in the next few months. It will be interesting to watch how everything plays out for tax reform, the next very important piece of proposed legislation.

Some Cures for Procrastination

While most of us are having a super summer, maybe traveling a little bit, maybe kicking back a little, 60 psychologists were in Chicago last week attending the 10th Procrastination Conference. Their goal:  to better understand who procrastinates and discuss how the dreaded loop of perpetual delay can be altered.

Amazing.  20% of people are true procrastinators.  It seems of all countries surveyed, including the U.S., to Poland, Britain, Germany, Japan, Saudi Arabia, Turkey, and Peru, all have about 1 in 5 residents who are chronic procrastinators, or “procs.”  They delay in completing a task to the point of experiencing subjective discomfort, such as anxiety or discomfort.  A proc is usually consistent; procrastinating in multiple areas of her or his life- work, personal, financial and social.  Procs often lose jobs, have broken marriages, suffer deflated dreams, have self-esteem issues and are in financial disarray. Procrastination can be a real problem.

Hopefully, though, we have none or only few chronic procs in our readership.  However, for those who are in the other 80% who “on occasion” delay making decisions until it is too late, find themselves saying “I’ll do it tomorrow,” putting things off until the last minute or simply neglecting important items, here are some ideas on ways to get more things done.

  • Begin by forgiving yourself for being a part-time procrastinator.
  • Break down tasks into smaller pieces. For example, “select your blog topic,” as opposed to “write the blog.”
  • Consider using the Pomodoro technique. Plan your day in 25 minute intervals with a 5 minute break after each.  Complete small tasks throughout the day which will produce a huge cumulative effect and a wonderful feeling of accomplishment.
  • Adopt the “Seven Minute Rule.” If you have a task that requires seven minutes or less, just get it done now.  No need to put it on a to-do list or waste energy thinking about it over and over again, just knock it out.
  • Minimize distractions. One key area is emails.  Consider being email free for 15-25 minutes at a stretch to be able to concentrate and complete a project rather than getting sidetracked every other minute.
  • Deal with problems now. Remember the following saying:  “If you have to swallow a toad, it’s best not to look at it too long.”
  • Seek external help for your goals.

It’s no surprise that many people procrastinate on getting their financial matters in order.  Making decisions for what happens to your estate when you die isn’t all that much fun.  Reviewing insurance coverage for when your house is destroyed or your dog bites your neighbor isn’t extremely enjoyable.  Income tax planning isn’t a bowl of cherries.  Planning for retirement and making choices about needs, wants and wishes is not like having a birthday party.  Trying to make investment decisions by yourself with so much information available and so many  conflicting, self-proclaimed “experts” is difficult and frustrating.

However, all of these items are very important and do need to be put in order. Wealth management is one of those key areas where seeking external help can break your procrastination and help you reach your goals.  Consider working with a full-service fee-only fiduciary like DWM.  Not only will you get an experienced, competent team to guide you and provide information and choices so you can make decisions on all aspects of your finances.  In addition, with firms like DWM, who have a proprietary and prudent process in place, you receive regular, consistent follow-up on all investment, financial planning, insurance, income taxes and estate planning matters for years to come.

So, don’t procrastinate.  Consider some of these ideas for getting more things done. And, if you need external help on your finances in order, please give us a call.

Tick, Tock… Is it Time for your Required Minimum Distribution (RMD)?

“Time flies” was a recent quote that I heard from a client.  Remember a long time ago…putting money aside in your retirement accounts, perhaps at work in a qualified traditional 401(k) or to an individual retirement account (IRA)?  It’s easy to ‘forget’ about it because, it was after all, meant to be used many years down the road.  It would be nice to keep your retirement funds indefinitely; unfortunately, that can’t happen, as the government wants to eventually collect the tax revenue from years of tax deferred contributions and growth.

In general, once you reach the age of 70 ½, per the IRS, many of those qualified accounts are subject to a minimum required distribution (RMD) and you must begin withdrawing that minimum amount of money by April 1 of the year following the year that you turn 70 1/2.  Of course, there are a few exceptions with regards to qualified accounts, but as a rule, when you reach 70 ½, you must begin taking money from those accounts per IRS guidelines if you own a traditional 401(k), profit sharing, 403(b) or other defined contribution plan, traditional IRA, Simple IRA, SEP IRA or Inherited IRA.  (Roth IRAs are not required to take withdrawals until the death of the owner and his or her wife.)  Inherited IRAs are more complicated and handled with a few options available to the beneficiary, either by taking lifetime distributions or over a 5 year period.  The importance here, is to be aware that a distribution is needed.  Another word of caution…In some cases, your defined contribution plan may or may not allow you to wait until the year you retire before taking the first distribution, so review of the terms of the plan is necessary.  In contrary, if you are more than a 5% owner of the business sponsoring the plan, you are not exempt from delaying the first distribution; you must take the withdrawal beginning at age 70 1/2, regardless if you are still working.

The formula for determining the amount that must be taken is calculated using several factors.  Basically, your age and account value determine the amount you must withdraw.  As such, the December 31 prior year value of the account must be known and, second, the IRS Tables in Publication 590-B, which provides a life expectancy factor for either single life expectancy or joint life and last survivor expectancy, needs to be referenced.  The Uniform Lifetime expectancy table would be referenced for unmarried owners and the Joint Life and Last Survivor expectancy table would be used for owners who have spouses that are more than 10 years younger and are sole beneficiaries.  It comes down to a simple equation: The account value as of December 31 of the prior year is divided by your life expectancy.  For most of us, your first RMD amount will be roughly 4% of the account value and will increase in % terms as you get older.

It all begins with the first distribution, which will be triggered in the year in which an individual owning a qualified account turns 70 ½.  For example, John Doe, who has an IRA, and has a birthdate of May 1, 1947, will turn 70 ½ this year in 2017 on November 1.  A distribution will need to be made then after November 1, because he will have needed to attain the age of 70 ½ first.  Therefore, the distribution can be taken after November 1 (for 2017), and up until April 1 of the following year in 2018.

Once the first distribution is withdrawn, subsequent annual RMDs need to be taken for life, and are due by December 31.  In this case, John Doe will need to next take his 2018 distribution, using the same formula that determined his first distribution.  This will become a regular obligation of John’s each year.

So, we’ve talked about who, what, why and when, now let’s talk about the where.  Once the distribution amount is calculated, an individual can then choose where he or she would like that money to go.  Depending on circumstances, if the money is not needed for living expenses, it is advised to keep the money invested within one of your other non-qualified accounts such as a Trust or Individual account, i.e. you can elect to make an internal journal to one of your other brokerage accounts.  Alternatively, if you have another thought for the money, you can have it moved to a personal bank account or mailed to your home.  Keep in mind that these distributions, like any distribution from a traditional IRA, are taxed as ordinary income, thus, depending on your income situation, you may wish to have federal or state taxes withheld from the distribution.  At DWM, we can help our clients determine if, and what amount, to be withheld.

Another idea for the money could be a qualified charitable distribution (QCD).  Instead of the money going into one of your accounts, a direct transfer of funds would be payable to a qualified charity.  There are certain requirements to determine whether you can make a QCD.  For starters, the charity must be a 501 (c)(3) and eligible to receive tax-deductible contributions, and, in order for a QCD to count towards your current year’s RMD, the funds must come out of your IRA by the December 31 deadline.  The real beauty about this strategy is that the QCD amount is not taxed as ordinary income.

It may be pretty scary to know how quickly time flies, but with DWM by your side, we can take the scare out of the situation!

DWM 2Q17 Market Commentary

“Let the Good Times Roll!” Yes, the 1979 song by Ric Ocasek and the Cars may describe the market’s attitude in the first half of 2017. “You Might Think” the markets are “Magic” or “All Mixed Up” – other classic Cars songs – but, nonetheless, investors should be pleased to see their mid-term results.

With the trading year half-way complete now, “It’s All I Can Do” to give you the major market stories in 2017:

  1. 1.All three major non-cash asset classes (equities, fixed income, and alternatives) are positive to start the year.
  2. 2.Large-cap equities have significantly outperformed small-cap equities, the largest outperformance to start the year in almost 20 years. Large caps, as represented by the S&P500, were up 3.1% for 2Q17 and up 9.3% Year-to-date (“YTD”) through June 30th. Small caps, as represented by the Russell 2000, were up 2.5% and 5.0%,
  3. 3.Growth is significantly outperforming value. In fact, it’s the biggest outperformance to start a year ever besides 2009. The S&P500 Growth Index was up 4.4% 2Q17 & 13.3% 1H17 vs the S&P500 Value Index, up 1.5% and 4.9%, respectively!
  4. 4.International stocks are outperforming domestic stocks. The last several years have seen the opposite, but now international is outperforming domestic in what may be a tidal change. The MSCI EAFE Index was up 6.4% for the second quarter and now 13.8% YTD!
  5. 5.Minimal volatility – Despite political noise and other headlines around the world, the equity market continues to move forward with little whipsaw. The CBOE Volatility Index, Wall Street’s so-called “fear gauge”, saw its lowest level in over two decades!

Let’s drill down into the various asset classes.

Equities: Obviously, we can see from above that returns in ‘equity land’ were quite decent. In general, stocks rallied on strengthening corporate earnings, improving economies both here and abroad, and continued support from central banks. Earnings from S&P500 companies increased 14%, the best growth since 2011.

Fixed Income: The Barclays US Aggregate Bond Index gained 1.5% in the second quarter and is now up 2.3% for the year. The Barclays Global Aggregate Bond Index produced even better returns, +2.6% 2Q17 and +4.4% YTD, thanks to stronger results overseas. Many bond investors, including DWM, have been surprised at the falling US government bond yields. The 10-year Treasury Note started the year at 2.45, peaked in March at 2.61, only to close the quarter at 2.30. Why aren’t rates going up? Much of it has to do with skepticism about the passage of Trump’s fiscal agenda. Amongst other things, there has not been the promised major tax reduction nor a flood of fiscal spending yet. As such, inflation expectations weakened in June. However, hawkish comments in the last several days from major central banks, including our US Fed indicating a strong chance that they will announce in September a decision to start shrinking its balance sheet, has caused a reversal in bond yields to start the third quarter. We see the Fed continuing to unwind the past years of stimulus via rate hikes or balance sheet reductions in a well-announced, controlled fashion.

Alternatives:  The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 0.4% for the second quarter and 1.1% YTD. This benchmark gives one a good feel for what alternatives did in general. Of course, there are many flavors of alternatives so drilling down into the category can reveal very different results. Furthermore, alternatives can take the form of either alternative assets and/or alternative strategies. “Traditional” alternative assets like gold* and real estate** fared well through the first half, up 7.8% and 3.2%, respectively. However, another “traditional” alternative in oil (a commodity) suffered, falling back into bear territory. US fracking companies continue to pump at lower prices frustrating OPEC’s goal of price stability via OPEC member supply cuts. A couple of alternative strategies fared differently: managed futures*** have shown losses in the first half, down -5.6%; whereas merger arbitrage**** has had a decent gain of 2.2%. These examples show how alternatives behave independently, thereby providing the ability to reduce the volatility of one’s overall portfolio.

It has been a solid first half for most balanced investors. Looking forward, it’s hard to say what path the markets will take. They could continue this nice trajectory upward – did you know that US stocks were up in January, February, March, April, and May? This is significant because, historically, when US stocks are up in the first 5 months of the calendar year, the average return for US stocks for the full calendar year was +28.8%! This first-five-months-up event has only happened 12 times and in all 12 times, the year ended up in double digits!

However, domestic stocks are getting expensive. The S&P500 now trades at 18x projected earnings over the next 12 months, its highest level in 13 years. Overseas stocks are still a relative bargain compared to the US and one of the reasons for their recent and expected-to-continue outperformance. Furthermore, where the US has raised short-term interest rates four times since the end of 2015, international central banks have been and will remain relatively more accommodative for the near future.

The other scary thing is that the equity and bond markets are sending mixed signals. If bond yields stay down, that would tell us that the bond market sees tepid economic growth, which could be true if all of the pro-growth Trump agenda plans do not come to fruition. For now, the equity markets are signaling otherwise – that this bull market has legs based upon strong corporate results and improving fundamentals. No, Mr. Ocasek, the signals from the bond market and equity market are not “Moving In Stereo.” Only time will tell to see what market is signaling correctly. In the meantime, the goal is to have a portfolio in place that can weather any storm. At DWM, we think our clients’ portfolios are well-positioned for what the markets will throw at us. We look forward to the journey. In fact, and finishing with one last Cars’ classic, “Let’s Go!”

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*represented by the iShares Gold Trust

**represented by the SPDR Dow Jones Global Real Estate ETF

***represented by the AQR Managed Futures Strategy Fund

****represented by the Vivaldi Merger Arbitrage Fund

Happy Fourth of July!

We must be free not because we claim freedom, but because we practice it. ~William Faulkner

Those who won our independence believed liberty to be the secret of happiness and courage to be the secret of liberty. ~Louis D. Brandeis

From the entire DWM team, we would like to wish you a safe & fun Independence Day!

Now’s the time to plan your 529!

Summmerrrtttime!  Every day in the summer at our office here in Charleston, we are regaled with the carriage tour drivers’ versions of this famous song from Porgy & Bess.  We end up having that song stuck in our head a lot of the time!  Already the ads for back to school sales are appearing and it reminds us that, while the “livin’ is easy” right now, the hustle of getting kids ready to head back to school isn’t far away.  We hate to interrupt your summer fun, but it is a good idea to get ready for college tuition payments no matter what age those students are!

We wanted to highlight the particular advantages of using 529 plans for funding your education purposes, as it is the most cost-effective way to manage the expenses of higher education.  Enacted in 1996, Section 529 of the Internal Revenue Service Code allows an account owner to establish a plan to pay for a beneficiary’s qualified higher education expenses using two types of plans – a pre-paid tuition program or the more popular, state-administered college savings plan.  The beneficiary can be a family member or friend or an owner can set up a 529 account for their own benefit.  Anyone can then donate to the account, regardless of the owner or beneficiary.  Funds can be deposited and used almost immediately (need to wait 10 days) or can be invested and grown until needed.  Surprisingly, according to a Wall Street Journal article recently, only 14% of Americans plan to use 529s to pay for college.

Although there is no allowable federal tax deduction for 529 contributions, the income and gain in the account are not taxable, as long as they are used for qualified education expenses.  These qualified expenses include tuition, room & board, books and, in a 2015 legislative change, payments for many technological expenses like a computer, printer or internet access, even if not specifically required by the educational institution.  The costs for off-campus housing can also qualify, as long as the amount used matches the average cost of resident-living at your university.  Many states, like SC and IL, also allow a tax deduction for 529 contributions to in-state plans.  Another recent legislative change allows for an increase from one to two annual investment selection changes per year, unless there is a rollover and then a change can be made at that time.  This gives the 529 owner a little more benefit, flexibility and control over their accounts.

When funding 529 accounts, we recommend that our clients not fund more than 50% of the total cost of estimated expenses for the education of their student before the student selects and starts college.  One nice feature about 529 plans is that they are transferrable to a sibling or other close family member, if a student doesn’t use or exhaust their entire 529 account.    However, you don’t want to overfund an account and then have some leftover.  Only the gains in the account are taxed, but there is a 10% penalty on the account if the funds are withdrawn and not used for qualified education expenses.  Another reason for not overfunding is that there are many scholarships available – you may have an accomplished science whiz or an amazing athlete that earns scholarship money.  Once final amounts of tuition requirements are determined, 529 account owners can make necessary additional contributions to take advantage of tax benefits.

There are many scholarship opportunities available for those who take the time to look and apply.  Checking with the high school guidance counselor, local civic groups or community organizations about scholarships or awards opportunities can give your high school student some hands on involvement in paying for their own education!  All high school seniors should also fill out the annual FAFSA (Free Application for Federal Student Aid).  There are many opportunities for earning money for college and nothing should be ruled out.

We know that using 529 accounts is the least expensive way to pay for college.  Research shows that the most expensive way to pay is by taking out student loans or paying out of pocket as the student needs it.  At DWM, we want to help you strategize how to save for and pay for any education expenses that you may have before you, no matter when those costs are expected.  We can help you evaluate the various state plans and the investment options in the 529s and calculate an appropriate annual or lump sum amount of savings.  We will be glad to help make your summertime livin’ easy and carefree!  Okay, now back to summer fun…already in progress!

“American Spirit and Values”

David McCullough, Pulitzer Prize winning historian has a new book.  “The American Spirit,” is a compilation of speeches Mr. McCullough has made over the last 25 years.  His hope is to “remind us, in this time of uncertainty and contention, of just who we are and what we stand for, of the high aspirations of our founders and of our enduring values.”   Our country has always stood for opportunity, vitality and creative energy, fundamental decency, insistence on truth, and good-heartedness to one another.

However, much of what we read in the papers these days belies our American values.  Today, let’s look at two key areas- corporate America and Washington- that require substantial improvement.

First, let’s talk about today’s problem of big business focusing solely on “maximizing shareholder value.”  The result has been an almost Dickens-like atmosphere for consumers and employees. Turning airplanes into cattle cars is a good example.  We all saw the United passenger dragged off the flight in April.  United used to have a bonus program for executives based on on-time arrivals, consumer satisfaction and profit.  It doesn’t now- it’s only based on pretax income and cost savings.  Same thing for American Airlines.  After years in Chapter 11, AAL came out of bankruptcy by merging with US Airways in 2013.  Earlier this year, after finally making a profit, management awarded its long underpaid flight attendants and pilots with a raise to bring them to industry levels of compensation. Wall Street “freaked out” that some potential shareholders earnings were being diverted and AAL’s stock price tanked.

Wal-Mart doesn’t want that to happen to them. Seven Walton family members (with a net worth of $130 billion) own ½ of WMT.  In 2015, WMT made $14.7 billion and shareholders got $10.4 billion in dividends and stock repurchases. WMT’s “low, low prices” are in part made possible by low, low wages for its 1.5 million employees. Many full-time WMT employees live in poverty, without enough money to pay for an apartment, buy food, or get basic health care. And, each year, we taxpayers pay $153 billion to pay for food stamps and other welfare programs for low paid employees, with WMT employees receiving about $7 billion of it.  WMT’s CEO made $21.8 million last year. The median annual pay for CEOs of the S&P 500 companies is now $11.7 million.

The real issue with low wages is the impact on the overall economy.  One company’s workers are another company’s customers.  Profitable companies could pay workers more and shareholders less, leading to more spending on products and services from other companies. This is turn could increase the revenue and profits of the overall economy.  Treating employees more fairly, giving them more opportunity and training is good for America and the economic growth and happiness of our country.  Focusing on making super products and providing excellent customer service are great.   Those aspects of capitalism are good for American.  The greed and selfishness parts are not.

Which brings us to Washington.  In less than five months, President Trump has transformed us from leaders of the free world to whiny bullies.  He pulled us out of the Trans-Pacific Partnership, refused to reaffirm the mutual defense commitment to NATO and abandoned the voluntary Paris climate accord.  Here’s how Mr. Trump’s national security adviser, Lt. Gen. H.R. McMaster described the President’s world view:  “The world is not a ‘global community’ but an arena where nations, nongovernmental actors and businesses engage and compete for advantage.”

Really?  Is it all about self-interest? What happened to the more cooperative, rules-based vision that motivated America and its allies since WWII?  Our leadership was good for the world and has been good for our country.  A world of cutthroat competition and zero-sum outcomes is not.

On the domestic side, the House passed the Financial Choice Act (FCA) last week.  Very disappointing.   This legislation would replace the post 2008 financial crisis Dodd-Frank regulations, designed to protect Americans.   FCA would repeal the “Volker Rule,” which restricts banks from certain types of trading, and would strip the Consumer Financial Protection Bureau of its power to write rules and supervise investment firms (particularly regarding deceptive practices and consumer complaints.)  This, like the Health Care Choice Act and proposed tax reform, is just another Congressional attempt to give Wall Street and the top 1% unfair advantages so they can keep making more money at the expense of most Americans.

History can be a strength and an inspiration- it reminds us who we are and what we stand for.  Certainly, let’s make America Great, but let’s do it the right way- working together and providing opportunities for all 321 million Americans to reach their full potential. Let’s move away from the toxic polarization, greed and selfishness we see every day and get back to the high aspirations of our founders; cooperation, vitality, energy, basic truth and decency.  And, yes, let’s “Make Our Planet Great Again” and work with almost 200 countries worldwide to mitigate global warming.  We 7.5 billion citizens of the world are all in this together, hopefully for centuries and centuries to come.  Finally, let’s remember and promote our American Spirit and Values.

Successful Investing Strategies for Millennials

We have all heard how important it is to start saving for retirement at a young age; but what exactly does that mean? A lot of young working people will sock money away in a savings account and think they are doing the right thing. While having cash for a rainy day/unexpected life event is very important, it is not at all how to save for retirement or save for a big purchase (i.e. down payment on a mortgage/new car). The secret behind it all is something called “compounding interest”. Compounding interest is something that happens over the course of many years and is hands down the best strategy to obtaining financial freedom.

For starters, it is important to understand what kind of account you are funding. Ideally, funding both a qualified account and non-qualified account is important. Qualified accounts are tax-advantaged retirement accounts such as Traditional IRAs, Roth IRAs, and 401ks. The beauty about these accounts is that they can grow either tax-deferred (such as a Traditional IRA) or tax-exempt (i.e. Roth IRA), however they cannot be tapped until a later age without penalty. Qualified accounts also come with contribution limits so one cannot put in an indefinite amount. Although you will pay tax on earnings upon sale of investments within non-qualified accounts, the good news is that the funds are available for withdrawal at any time with no age restriction.

We understand young workers may not be able to fund both kinds of accounts early in their careers, therefore, we recommend funding the qualified accounts (retirement) first, followed by the taxable, non-retirement accounts.

Click here to learn a little more about Roth and Traditional IRA’s (qualified/retirement accounts).

The next step is to determine what kind of asset allocation aligns with your ‘Risk Tolerance Level’. We recommend consulting an investment expert, like DWM, to help determine your risk level profile (e.g. defensive, conservative, balanced, moderate, or aggressive) and the funds you should be invested in. Assuming your risk tolerance lands you in a “balanced” portfolio, you should expect a targeted long term rate of return of 6 to 8% per year. This may not sound like an enormous annual rate of return, but after compounding interest over a long investment time horizon, one is capable of achieving impressive portfolio numbers.

Now for the magic of compounding interest, what it can mean for your future, and why it is so important to start early for young workers. The best way to explain this is through an example:

If you contribute $5,500 to a Roth IRA (the max a Roth allows each year) starting at 22 years old and average 7% return per year until retirement at age 65, the $236,500 total contribution will turn into $1,566,121.

Compare that to socking away $5,500 into the same type of account, invested in the same exact funds, starting at age 40: Your account will grow to $372,220. This is still great and much better than not investing at all, but it would be a lot nicer to grow an account to over 1.5 million dollars versus less than 0.4 million dollars going into retirement.

An accepted estimate in the financial planning world is something called “The Rule of 72”. This is a quick and simple math equation that estimates how many years it will take to double an investment, given a certain annual rate of return. If we assume a 7% rate of return, we would divide 72 by 7 to come to a final answer of 10.24. So, with an annual return of 7%, it will take you a little over 10 years to double an investment. Therefore, a 25 year-old has the potential to double his/her invested money every 10 or so years from your early 20’s until retirement (4x over).

This means one would need to more than quintuple your annual income if you wait until age 40 vs. starting at 22 to make up for not putting away the $5,500 the 18 years prior (~$1.25 million) you technically missed out on.

Click here to see what amount you can achieve if you started putting $5,500 away today.

Another big misconception with saving young is “maxing out a 401(k)”. Many young workers will say they are maxing out their 401(k). However, simply putting away the 3-4% a company matches is not at all maxing out a 401(k), in fact, it is barely scratching the surface. As of 2017, the maximum employee contribution, per year to a 401(k), is $18,000- this is maxing out a 401(k). Let’s say a 25 year old makes $50,000 per year and is contributing 4% to his/her 401(k) that the company is matching. This 4% is only $2,000 per year and the match only becomes yours after it vests. It is important to understand your companies vesting schedule because in some cases it can take six years or more for that to actually be considered your money.

Another important step to saving/investing correctly is analyzing the investment menu within your 401(k). This involves studying the funds offered within a 401(k) and identifying an appropriate asset allocation target for yourself in-line with your risk tolerance. It is also important to look at the underlying fees within the funds of the 401(k). If you are in a large cap equity fund charging 70 basis points but there is another large cap fund that charges only 9 basis points, it can make a big difference over 20-30 years. Here at DWM, we do a 401(k) analysis for all clients because we understand the importance a few basis points can have on an individual and their family over the course of a lifetime.

We have all heard our millennial generation and future generations will never be able to retire because of different theories on social security and how rare pensions are today. This could not be further from the truth. We simply need to take our savings just as seriously as our expenses and we may be capable of not only retiring, but comfortably retiring and being able to leave a legacy for future generations. While a lot of millennials believe they are going to invent the next pet rock and become overnight millionaires, it might be a good idea to start saving the correct way because slow and steady does indeed win the race. 

SC Business Review Interviews Les Detterbeck: “Consider Alternatives!”

Press Release:  Tomorrow morning, May 23, at 7:50 a.m. ET on NPR/WSCI Radio (89.3) Mike Switzer will conduct his SC Business Review.  I will be his guest. The 6 minute segment was taped three weeks ago. The topic is “Liquid Alternatives.”  Please tune-in if you can.

Mike Switzer:  Hello and welcome to SC Business Review.  This is Mike Switzer.  As stocks continue their long-term upward trend, many are concerned about what will happen to their portfolios when the bull market ends.  Today, we are talking with Les Detterbeck, a wealth manager with Detterbeck Wealth Management.  Les is one of the few professionals in the country who has attained a CPA certificate, is a CFA charter holder and a Certified Financial Planner professional.  Welcome, Les.

Les Detterbeck:  Good morning, Mike.  It’s a pleasure to be with you this morning.

MS:  Les, the markets keep going up.  What happens when the bull market ends?

LD:  Mike, of course, no one can predict the future.  We will have a pullback, correction or crash sometime in the future. We just don’t when and how much.  Right now, we’re in the midst of the second longest bull market in history- 8 yrs and counting.  There is still optimism about tax reform, deregulation and infrastructure additions boosting the economy and the markets.

MS:  Yes, Les, but what are some of the concerns?

LD:  Mike, there’s been a recent ramping up of potential global conflicts, there is significant political risk both here and abroad, and stock valuations are at an elevated level, just to name some of the major ones.

Let’s remember what happened in 2008 when the financial crisis turned a bull market to a bear.  Equities were down 40-50%.  Most investors lost a major part of their portfolio.  However, prepared investors stayed invested and only lost 5-8%.  And, they didn’t have to climb out of a big hole when markets reversed in March 2009.  Many of these investors who did well owe their results to alternative investments, designed to participate in up markets and protect in down markets.

MS:  Les, what do you mean by an alternative?

LD:  Basically, these are not traditional equity or fixed income investments.  Alternatives provide diversification and therefore reduce risk and volatility.  They are not correlated to the equity market and therefore can provide a return even when stocks are not doing well.  For those investors whose primary focus is protection and secondary is growth, alternatives are a great addition to a portfolio.

MS:  Could you give us some examples?

LD:  Certainly.  Gold and real estate are alternatives.  They are not part of the traditional asset class of equities or fixed income.  Other examples are non-traditional strategies, such as market-neutral funds, arbitrage funds, and managed futures funds.  All designed to perform in both up and down markets.  New alternatives come to the marketplace regularly.  Recently we have reviewed and added to our client portfolios alternative assets investing in the global reinsurance industry and online consumer lending.

MS:  Les, tell us why and how alternatives work?

LD:  First, they provide increased diversification.  We all have heard “don’t put all your eggs in one basket.”  Second, lower correlation.  They don’t perform in lock step with stocks.  Harry Markowitz won a Nobel Prize by showing that combining assets which do not exhibit a high correlation with one another gives investors an opportunity to reduce risk without sacrificing return.  Studies, including those by the CFA, show that inclusion of at least 15% of alternatives can reduce the volatility and increase the returns of portfolios.  As a result, clients can get comfortable with their allocation and stay fully invested.  No need to try to time the markets-which is a loser’s game.

MS:  How did you get into alternatives and how are they used?

LD:  My son Brett and I started our business in 2000, the year of the dot.com bubble burst.  Stocks lost 15% and our clients did slightly better than that.  We didn’t take any solace in beating the S&P 500- our clients had lost money.  In 2001, the stock markets were again down and again, our clients lost money.  We realized we needed to find an answer- how do we protect our clients’ money and grow it as well?

We researched, reviewed and investigated everything we could find on alternatives. And, bought them ourselves so we could “test drive” them.  In early 2008, at a time somewhat like now, when valuations were high and there were concerns that the bull market might be ending, we knew it was time to prepare our clients for the end of the bull market.

We compiled and issued a report to them in January 2008 entitled “The Bubble Bust” which outlined our concerns about the coming end of the bull market and how alternatives could protect their portfolio.  We met with our clients and, in general, reduced equity allocations and substituted alternatives.  When the crisis came that fall, our clients were prepared.  Their overall portfolio losses were minimized.   Today, virtually all of our clients use three assets classes; equities, fixed income and alternatives.  Asset allocations vary by client and alternatives compose 15%-40% of a typical client portfolio.

MS:  Any final thoughts, Les?

LD:  If your focus is on protecting and growing your portfolio, consider adding liquid alternatives; designed to participate in up markets and protect in down markets.  In times like this, they can really reduce risk, increase returns and provide great peace of mind.

MS:  Les, thank you so much for visiting us today.  We hope you will join us again.

LD:  Mike, I will look forward to that.

Ask DWM: “Please Explain how Investment Returns are Calculated”

Excellent question from a valued client and an extremely important one.  You need to know how your investments are performing.  Are you on track to meet your goals?  Are any changes needed?

To start, focus on your “total return.” In simplest terms, this is the total increase in your portfolio for the period. Let’s say you had $100,000 in one account at the beginning of the year and you didn’t add money or subtract any money during the year. At the end of the year, this account has grown to $111,820.  Your total return is $11,820 ($111,820 ending value minus $100,000 beginning value).  This is an 11.82% total return ($11,820 divided by $100,000).

Next, let’s drill down a little further.   The total return is composed primarily of two parts; the change in market value during the period plus dividends and/or interest earned.  Let’s assume, for simplicity sake, that this $100,000 portfolio only had one investment on January 1, 2016 and it was invested entirely in the Schwab S&P 500 Index Fund (SWPPX).  Those shares were valued at $31.56 per share at the beginning of that year- 3,168 shares with a total value of $100,000 (3,168 times $31.56).   Here is what actually happened with those shares in 2016:  Their value went up to $34.42. The $2.86 per share increase ($34.42-$31.56) amounted to a $9,062 increase in value.  And, in December, dividends were paid totaling 87 cents per share, a total of $2,758.  So, the account increased by a total of $11,820, of which there was a $9,062 price increase (9.1%) and a $2,758 (2.7%) dividend return.  Overall, an 11.82% total return for 2016.

Dividends and interest are the income received for holding the security and are called the “yield.”   Some investors focus on a high yield and ignore the potential impact of market increases or decreases.  We believe that is a mistake.  Historically, there are times, such as periods of low inflation, when dividend-paying stocks have outperformed.   And, there are times, such as the 1990s, when tech stocks with limited earnings and no dividends outpaced dividend payers by nearly 5% per annum.  Focus on total return (and, of course, diversification).

Now, let’s look at the situation where money is added or subtracted from the investment portfolio during the year.  When this happens, the performance results are generally calculated and shown as “time-weighted returns” which eliminates the impact of money coming in or going out and focuses on daily returns. Our DWM/Orion reporting system calculates the daily return for each holding and multiplies the daily returns geometrically to determine the time-weighted return.

The DWM/Orion reports show gross total returns for all holdings and asset classes and deduct management fees in calculating the time-weighted return.  Furthermore, reports covering a period of less than a year are not annualized.  For example, if the time-weighted return for the first three months is 2%, the report shows 2% and does not annualize that number (assuming the next three quarters will be similar results) and show an 8% annualized return.  However, on reports covering a period of more than one year, the overall results are reduced to annual amounts.  For example, if a performance report covering a three-year period shows a time-weighted return of 6%, then the overall return for that total period is approximately 18%.

The CFA Institute, the global association of vetted investment professionals, including Brett and me, which sets the standard for professional excellence and integrity identifies clear, trustworthy investment reporting as the most valuable tool for communicating investment information.  Early on, we at DWM determined that we and our clients needed a robust reporting system to calculate, help monitor and report on your investments.  Schwab as custodian provides regular statements for each account showing balances and activity during a given period. However, the statements don’t show performance vs. benchmarks on a percentage basis.  It also only shows one account at a time. Our DWM/Orion reporting system can show you performance at various levels: asset, asset class, account and household for a more complete, holistic review.

In today’s world, when there is so much data and so much news and much is either fake or biased, it’s important to know that your investment returns with DWM are calculated in an objective basis and compared to benchmarks for any time period.  This allows proper monitoring and facilitates modifications, when needed.

Thanks again for the question and let us know if there are any follow-up questions.