To be blunt, there is deception all around us. The primary presidential elections are a perfect example – whether it is Republicans debating with Republicans, Democrats questioning other Democrats, or Republicans and Democrats fighting each other, there is so many half-facts and conflicting information that it is impossible for everything said to be true.
There is an equal amount of deception in the financial service industry. Whether you are watching CNBC, reading Forbes Magazine, or listening to a local salesperson promote his financial product, it is hard to believe we are ever getting the complete story from an unbiased perspective regarding any personal finance issue.
Deception is frequently used to strengthen one’s agenda. An agenda can be supported by drawing attention to specific facts, or reinforced by drawing attention away from less desirable facts.
Hiding Good News in Deceit
The reality is there are always some parties that don’t want us to know the good news happening around us. For example, financial television mediums are dependent on constant viewers in order for their business plan to succeed. Frankly, they can’t go on the air and tell viewers that there is nothing to worry about and that their time would be better spent outside on a bike or with friends and family. Instead, they must consistently remind viewers of all possible downsides to insert a fear that at any moment something could happen that would restrict our ability to meet our financial goals. This is an example of utilizing deceit to take attention away from the good news that is more reflective of our environment.
Another example of using excessive information to conceal good news is the emergence of ultra-responsive investment strategies. Study after study has concluded that the best way to make money investing in the market is to buy and hold long-term positions. That is great news because it is fairly simple and can potentially be accomplished by anyone (at least in principle). However, this great news is frequently concealed by investment institutions who offer a responsive solution to every possible market scenario. Even though research suggests that an investor is better off not reacting to variables impacting the daily market, some financial institutions still promote such a strategy so they can charge higher fees due to a more frequent level of involvement.
Hiding Bad News in Deceit
In some situations, some parties may hide the bad news within their agenda amongst an abundance of less relevant information. As you might have noticed, most annuities are overly complex and not easily understood. The contracts accompanying these products are commonly the size of a book and written in such a manner that even the most experienced financial planners have a hard time comprehending. Meanwhile, the excessive fees and outlandish surrender periods of these products are something that are frequently not discussed by the advisor promoting the product. This is an example of using BS to make something overly complicated to conceal their negative features.
A second example of burying bad news in deceit is the way non-publicly traded REITs (real estate investment trusts) are sold. As millions of investors have learned over the last 20 years, non-publicly traded REITs are not a liquid investment, and if an investor wants to quickly sell their holding they frequently need to do so at a steep discount (commonly less than 50% of the purchase price). Clearly, this is bad news. However, the financial salespeople offering these investments claim that not listing the product on a public exchange enables the product to endure less volatility because investors can never get online and see their investment’s value go down. Of course, just because investors can’t see the daily fluctuations in their investment’s value doesn’t mean that the price of the investment will be stable when the investor wants to sell, and most owners of non-publicly traded REITs ultimately eat their shirts.
The Best Solution Available
In all aspects of life, it is useful to question one’s agenda and examine the use of deception to achieve that agenda. This is as true in the financial service industry as it is anywhere else. Simply looking for scenarios where the use of excessive or non-relevant information might be used to conceal facts that are either good or bad for you is likely to sharpen your decision making skills.
Further, I’d suggest that working with a fee-only financial advisor is likely to minimize situations where someone else’s agenda might conflict with what is in your best interest. Fee-only financial planners are restricted from recommending financial products that reward them for doing so. Further, fee-only financial planners are held to a fiduciary standard, which means they are required by law to make recommendations that are in your best interest. These two factors are likely to limit the amount of deceit you’ll need to sort through.
Monday, November 23, 2015
Wednesday, November 11, 2015
Why Constantly Updating Retirement Projections is Vital
New retirement projections should consistently be created to reflect changing circumstances. While short-term fluctuations in retirement plan outcomes should be anticipated and not cause an over-reaction, long-term implications should receive attention and be addressed.
Base Scenario
Consider a 65-year old retiree who would like to withdraw the inflation-adjusted equivalent of $20,000 of after-tax dollars per year from his investment account until age 90. This individual’s nest egg consists of a $500,000 IRA, and his financial plan estimates an average annual investment return of 6%, an effective tax rate of 18%, and an inflation rate of 3%. According to these assumptions, the individual’s financial plan indicates a high probability of success. A Monte Carlo analysis, which accounts for varying sequences of returns (because a flat 6% return isn’t achieved every year but rather achieved on average over time), calculates a success rate of 85%.
Impact of the 2000’s
Now, consider this same individual with one adjustment – that it is the year 2000 and we are about to enter what is now looked at as the “Lost Decade.” During the next 10 years, the S&P 500 averaged an annual return of less than 1%. Let’s assume the investor had a diversified portfolio, which would have generated superior returns to a 100% large cap stock portfolio, and achieved an average annual return of 2% during the decade. Of course, the individual would have still been withdrawing the inflation-adjusted equivalent of $20,000 of after-tax dollars per year during this time period.
At the end of the decade and when the investor is 75 years of age, his nest egg would have been depleted to $301,784. By contrast, if the investor had achieved the anticipated annual return of 6%, his nest egg actually would have increased in value over this time period, ending the decade at a value of $521,185. Unfortunately, the unexpected lower rate of return has severally reduced the success rate of the individual’s retirement plan to an unacceptable 39%.
Note that in this situation, the investor didn’t do anything wrong. With the benefit of retrospect, we can see that an extended period of essentially no growth in the stock market was unavoidable. This illustrates the importance of paying more attention to variables that we can impact (such as spending) and less attention to factors that are out of our control (such as short-term market returns).
Benefit of Plan Updates
Without adjustments, this individual now has a high probability of outliving his money – the ultimate failure of retirement planning. For this reason, updates need to be made to the individual’s financial plan so these issues can be identified and addressed. An analysis of the investor’s new circumstance at age 75 can discover that if annual portfolio withdrawals are reduced to an inflation-adjusted equivalent of $17,700 of after-tax dollars, the financial plan’s success rate bounces back up to 85%. While spending less than the investor’s goal is not ideal, it is certainly better than running out of money.
It is also worth noting that the 6% long-term investment return anticipated by the investor’s financial plan at age 65 may still very well come to fruition, even after enduring a 10-year period with such a low growth rate. Just as it was possible for returns to be unusually low for the “Lost Decade,” it is equally possible that returns will be above average for an extended period of time in the future. In fact, this scenario has actually played out as the S&P 500 is already up over 100% since 2010. Consequently, it is possible that our hypothetical investor would have only needed to reduce spending for a short period of time and that the quick market recovery would have enabled him to return to his previous withdrawal goals relatively quickly. Of course, frequently retirement plan updates would identify when the individual would be able to return to his more comfortable level of spending.
Frequent Updates are Preferable
Lastly, it is important to note that even a quick market recovery can’t save an investment plan if there is no money left in the portfolio to experience the bounce. For this reason, it would be better if our hypothetical investor actually reduced spending during the period of slow market growth as opposed to after the extended period of lackluster returns. This is exactly why I’d recommend updating your financial plan at least annually – so issues can be identified quickly and adjustments can be made efficiently and when they have the most impact.
Unanticipated factors that affect retirement planning occur frequently. These variables range from market declines, to higher inflation rates, to changes in the tax structure, to surprise healthcare expenses, to new rules involving Social Security. Frequently updating your financial plan will help identify some of these issues – which are frequently out of our control – and allow us to address shortcomings by focusing on factors that we can adjust.
Base Scenario
Consider a 65-year old retiree who would like to withdraw the inflation-adjusted equivalent of $20,000 of after-tax dollars per year from his investment account until age 90. This individual’s nest egg consists of a $500,000 IRA, and his financial plan estimates an average annual investment return of 6%, an effective tax rate of 18%, and an inflation rate of 3%. According to these assumptions, the individual’s financial plan indicates a high probability of success. A Monte Carlo analysis, which accounts for varying sequences of returns (because a flat 6% return isn’t achieved every year but rather achieved on average over time), calculates a success rate of 85%.
Impact of the 2000’s
Now, consider this same individual with one adjustment – that it is the year 2000 and we are about to enter what is now looked at as the “Lost Decade.” During the next 10 years, the S&P 500 averaged an annual return of less than 1%. Let’s assume the investor had a diversified portfolio, which would have generated superior returns to a 100% large cap stock portfolio, and achieved an average annual return of 2% during the decade. Of course, the individual would have still been withdrawing the inflation-adjusted equivalent of $20,000 of after-tax dollars per year during this time period.
At the end of the decade and when the investor is 75 years of age, his nest egg would have been depleted to $301,784. By contrast, if the investor had achieved the anticipated annual return of 6%, his nest egg actually would have increased in value over this time period, ending the decade at a value of $521,185. Unfortunately, the unexpected lower rate of return has severally reduced the success rate of the individual’s retirement plan to an unacceptable 39%.
Note that in this situation, the investor didn’t do anything wrong. With the benefit of retrospect, we can see that an extended period of essentially no growth in the stock market was unavoidable. This illustrates the importance of paying more attention to variables that we can impact (such as spending) and less attention to factors that are out of our control (such as short-term market returns).
Benefit of Plan Updates
Without adjustments, this individual now has a high probability of outliving his money – the ultimate failure of retirement planning. For this reason, updates need to be made to the individual’s financial plan so these issues can be identified and addressed. An analysis of the investor’s new circumstance at age 75 can discover that if annual portfolio withdrawals are reduced to an inflation-adjusted equivalent of $17,700 of after-tax dollars, the financial plan’s success rate bounces back up to 85%. While spending less than the investor’s goal is not ideal, it is certainly better than running out of money.
It is also worth noting that the 6% long-term investment return anticipated by the investor’s financial plan at age 65 may still very well come to fruition, even after enduring a 10-year period with such a low growth rate. Just as it was possible for returns to be unusually low for the “Lost Decade,” it is equally possible that returns will be above average for an extended period of time in the future. In fact, this scenario has actually played out as the S&P 500 is already up over 100% since 2010. Consequently, it is possible that our hypothetical investor would have only needed to reduce spending for a short period of time and that the quick market recovery would have enabled him to return to his previous withdrawal goals relatively quickly. Of course, frequently retirement plan updates would identify when the individual would be able to return to his more comfortable level of spending.
Frequent Updates are Preferable
Lastly, it is important to note that even a quick market recovery can’t save an investment plan if there is no money left in the portfolio to experience the bounce. For this reason, it would be better if our hypothetical investor actually reduced spending during the period of slow market growth as opposed to after the extended period of lackluster returns. This is exactly why I’d recommend updating your financial plan at least annually – so issues can be identified quickly and adjustments can be made efficiently and when they have the most impact.
Unanticipated factors that affect retirement planning occur frequently. These variables range from market declines, to higher inflation rates, to changes in the tax structure, to surprise healthcare expenses, to new rules involving Social Security. Frequently updating your financial plan will help identify some of these issues – which are frequently out of our control – and allow us to address shortcomings by focusing on factors that we can adjust.
Monday, November 2, 2015
Major Changes to Social Security Filing Strategies (Updated!)
After the market crash of 2000, Congress passed the Senior Citizens
Freedom to Work Act. This law was intended to enable people who had
previously retired and claimed their Social Security benefit to stop
receiving their monthly check while they returned to work and continued
earning retirement credits. Doing so would enable the worker to earn
more income from employment while increasing their future Social
Security benefit.
An unintended consequence of this adjustment was that it enabled U.S. citizens to explore and take advantage of various strategies to maximize their Social Security benefits that were outside the intentions of the law. These strategies became known as the “file and suspend” strategy and the “restricted application” strategy. This morning President Obama and Congress passed the Bipartisan Budget Act of 2015, which is intended to prohibit people from utilizing these strategies going forward.
Let’s dive into the differences between the “file and suspend” and the “restricted application” strategies as well as the steps you may need to take if currently utilizing one of these strategies.
File and Suspend
The file and suspend strategy is when Spouse 1 files for Social Security and then immediately suspends the benefit. This can be beneficial because it could possibly enable Spouse 2 to begin collecting a spousal benefit based on Spouse 1’s work history. Further, it would enable Spouse 1 to collect delayed retirement credits until age 70, getting an 8% per year raise in monthly Social Security payments.
The U.S. government has concluded that this strategy is abusive of the Social Security system in that it is essentially double dipping, as it allows a couple to begin collecting a benefit based on one spouse’s work history while at the same time collecting delayed retirement credits on the same work history.
At this time, it appears this strategy will no longer be allowed after April 30, 2016 -- six months from the signing of the law. However, couples who have begun this strategy within the six-month deadline will be allowed to complete the process. By comparison, after April 30, 2016, couples will no longer be allowed to start collecting a spousal benefit for Spouse 2 unless Spouse 1 is also collecting a benefit.
Steps to Take If This is You
Suppose your spouse is currently collecting a spousal benefit based on your work history, although you are not currently collecting your own Social Security benefit. This would be a scenario resulting from the use of the file and suspend strategy.
If this is reflective of your current situation, you will likely be grandfathered into the program and be allowed to complete the process. Alternatively, if this situation is representative of the Social Security strategy you intend to utilize in the future, you will no longer be allowed to execute this approach unless you start the process by April 30, 2016. Since you must be at least full retirement age to suspend benefits, this option is only available to people who will reach age 66 on or before April 30, 2016. If age 66 is obtained after April 30, 2016, you will either need to start claiming your own benefit in order for your spouse to receive their spousal benefit, or your spouse will not be allowed to collect a spousal benefit until you file to receive your own benefit.
On the other hand, some people who intend to take advantage of the “file and suspend” approach can actually accelerate their implementation of the strategy in order to begin the process before the six-month deadline arrives.
Restricted Application
The restricted application strategy is slightly different from the file and suspend strategy in that Spouse 1 files for his own benefits and never stops collecting that benefit. However, this may allow Spouse 2 the opportunity to begin collecting a spousal benefit immediately while delaying her own benefit until she reaches age 70. Again, this can be beneficial in that it allows Spouse 2 to collect one form of Social Security (the spousal benefit) as soon as Spouse 1 files but also allows the same spouse to continue collecting delayed retirement credits on her own work history. Upon reaching age 70, Spouse 2 can then switch from collecting the spousal benefit, which was based on Spouse 1’s work history, to collecting their own Social Security benefit which has been building delayed retirement credits even during the years when a spousal benefit was being collected.
Again, with a file and suspend strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1 immediately suspended his benefit and is currently collecting delayed retirement credits. With the restricted application strategy, Spouse 1 never needs to suspend the collection of his own benefit and Spouse 2 still gets to collect a spousal benefit while earning delayed retirement credits on her own work history. Going forward, the U.S. government would like to ensure that each spouse is either collecting a benefit (either their own or a spousal benefit) or earning delaying retirement credits, but not both.
However, the restricted application strategy is being phased out over a different time span than the file and suspend strategy. Quite simply, as long as an individual reaches ages 62 before the end of 2015, they will be allowed to utilize the restricted application strategy at any point in the future. Conversely, people who will not reach age 62 before the end of the year will have no opportunity to take advantage of the restricted application strategy.
Steps to Take If This is You
As long as both spouses are at least age 62 before the year ends, then your strategy will likely not be interrupted. However, if one spouse isn’t age 62 before year-end, then your strategy will likely need to be reconsidered.
Speak to Your Financial Planner
If you have any questions regarding how these changes will impact your Social Security benefit, please speak to your financial advisor.
During every financial plan review over the next six months, I will be examining your situation and determining whether these changes affect you. If this law impacts you, I will be exploring any adjustments that need to be made. In the meantime, please don’t hesitate to reach out to me if you have any questions.
An unintended consequence of this adjustment was that it enabled U.S. citizens to explore and take advantage of various strategies to maximize their Social Security benefits that were outside the intentions of the law. These strategies became known as the “file and suspend” strategy and the “restricted application” strategy. This morning President Obama and Congress passed the Bipartisan Budget Act of 2015, which is intended to prohibit people from utilizing these strategies going forward.
Let’s dive into the differences between the “file and suspend” and the “restricted application” strategies as well as the steps you may need to take if currently utilizing one of these strategies.
File and Suspend
The file and suspend strategy is when Spouse 1 files for Social Security and then immediately suspends the benefit. This can be beneficial because it could possibly enable Spouse 2 to begin collecting a spousal benefit based on Spouse 1’s work history. Further, it would enable Spouse 1 to collect delayed retirement credits until age 70, getting an 8% per year raise in monthly Social Security payments.
The U.S. government has concluded that this strategy is abusive of the Social Security system in that it is essentially double dipping, as it allows a couple to begin collecting a benefit based on one spouse’s work history while at the same time collecting delayed retirement credits on the same work history.
At this time, it appears this strategy will no longer be allowed after April 30, 2016 -- six months from the signing of the law. However, couples who have begun this strategy within the six-month deadline will be allowed to complete the process. By comparison, after April 30, 2016, couples will no longer be allowed to start collecting a spousal benefit for Spouse 2 unless Spouse 1 is also collecting a benefit.
Steps to Take If This is You
Suppose your spouse is currently collecting a spousal benefit based on your work history, although you are not currently collecting your own Social Security benefit. This would be a scenario resulting from the use of the file and suspend strategy.
If this is reflective of your current situation, you will likely be grandfathered into the program and be allowed to complete the process. Alternatively, if this situation is representative of the Social Security strategy you intend to utilize in the future, you will no longer be allowed to execute this approach unless you start the process by April 30, 2016. Since you must be at least full retirement age to suspend benefits, this option is only available to people who will reach age 66 on or before April 30, 2016. If age 66 is obtained after April 30, 2016, you will either need to start claiming your own benefit in order for your spouse to receive their spousal benefit, or your spouse will not be allowed to collect a spousal benefit until you file to receive your own benefit.
On the other hand, some people who intend to take advantage of the “file and suspend” approach can actually accelerate their implementation of the strategy in order to begin the process before the six-month deadline arrives.
Restricted Application
The restricted application strategy is slightly different from the file and suspend strategy in that Spouse 1 files for his own benefits and never stops collecting that benefit. However, this may allow Spouse 2 the opportunity to begin collecting a spousal benefit immediately while delaying her own benefit until she reaches age 70. Again, this can be beneficial in that it allows Spouse 2 to collect one form of Social Security (the spousal benefit) as soon as Spouse 1 files but also allows the same spouse to continue collecting delayed retirement credits on her own work history. Upon reaching age 70, Spouse 2 can then switch from collecting the spousal benefit, which was based on Spouse 1’s work history, to collecting their own Social Security benefit which has been building delayed retirement credits even during the years when a spousal benefit was being collected.
Again, with a file and suspend strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1 immediately suspended his benefit and is currently collecting delayed retirement credits. With the restricted application strategy, Spouse 1 never needs to suspend the collection of his own benefit and Spouse 2 still gets to collect a spousal benefit while earning delayed retirement credits on her own work history. Going forward, the U.S. government would like to ensure that each spouse is either collecting a benefit (either their own or a spousal benefit) or earning delaying retirement credits, but not both.
However, the restricted application strategy is being phased out over a different time span than the file and suspend strategy. Quite simply, as long as an individual reaches ages 62 before the end of 2015, they will be allowed to utilize the restricted application strategy at any point in the future. Conversely, people who will not reach age 62 before the end of the year will have no opportunity to take advantage of the restricted application strategy.
Steps to Take If This is You
As long as both spouses are at least age 62 before the year ends, then your strategy will likely not be interrupted. However, if one spouse isn’t age 62 before year-end, then your strategy will likely need to be reconsidered.
Speak to Your Financial Planner
If you have any questions regarding how these changes will impact your Social Security benefit, please speak to your financial advisor.
During every financial plan review over the next six months, I will be examining your situation and determining whether these changes affect you. If this law impacts you, I will be exploring any adjustments that need to be made. In the meantime, please don’t hesitate to reach out to me if you have any questions.
Friday, October 30, 2015
Breaking News: Major Changes Coming to Social Security Filing Strategies
After the market crash of 2000, Congress passed the Senior Citizens Freedom to Work Act. This law was intended to enable people who had previously retired and claimed their Social Security benefit to stop receiving their monthly check while they returned to work and continued earning retirement credits. Doing so would enable the worker to earn more income while increasing their future Social Security benefit.
An unintended consequence of this adjustment was that it enabled U.S. citizens to explore and take advantage of various strategies to maximize their Social Security benefits that were outside the intentions of the law. These strategies became known as the “file and suspend” strategy, and the “restricted application” strategy.
As part of the 2016 budget, President Obama and Congress intend to prohibit people from utilizing these strategies going forward. At the time of this publication, these proposed changes are not yet law. Although both the House of Representatives and the executive branch have signed off on these bills, they still need to be approved by the Senate before the laws go into effect. However, this is expected to occur with minimal modifications within the first week of November.
Let’s dive into the differences between the “file and suspend” and the “restricted application” strategies as well as the steps you may need to take if currently utilizing one of these strategies.
File and Suspend
The file and suspend strategy is when Spouse 1 files for Social Security and then immediately suspends the benefit. This can be beneficial because it could possibly enable the individual’s spouse to begin collecting a spousal benefit based on Spouse 1’s work history. Further, it would enable Spouse 1 to collect delayed retirement credits until age 70, getting an 8% per year raise in monthly Social Security payments.
The U.S. government has concluded that this strategy is abusive of the Social Security system in that it is essentially double dipping as it allows a couple to begin collecting a benefit based on one spouse’s work history while at the same time collecting delayed retirement credits on the same work history.
At this time, it appears that this strategy will no longer be allowed beginning six-months from the date the law is passed. Further, it is currently unclear what action will be taken against those who have already utilized this strategy. It currently appears possible that couples who have already started this strategy will be allowed to complete the process. Alternatively, it is possible that couples who have started this process will no longer be entitled to the spousal benefit they are currently receiving until Spouse 1 begins claiming his Social Security benefit, at which time the spousal benefit for Spouse 2 would continue. In a worse-case scenario, it is possible that the U.S. government may attempt to recollect any benefits that are no longer allowed from couples who have already taken advantage of this strategy. (I believe this is the least likely result, as it would be hard to take money away from people who have already collected it.)
Steps to Take If This is You
Suppose your spouse is currently collecting a spousal benefit based on your work history, although you are not currently collecting your own Social Security benefit. This would be a scenario resulting from the use of the file and suspend strategy.
If this is reflective of your situation, then significant adjustments might need to be made as this law becomes more concrete. It is possible that you will either need to start claiming your own benefit in order for your spouse to continue receiving their spousal benefit, or your spouse will need to stop collecting any benefit until you file to receive your own benefit. Again, these kind of adjustments will likely be implemented six months after the bill is finalized.
Alternatively, and depending on how the law is agreed upon, it is possible that some people who intend to take advantage of the “file and suspend” approach actually accelerate their implementation of the strategy in order to begin the process before the six-month deadline arrives.
Restricted Application
The restricted application strategy is slightly different from the file and suspend strategy in that Spouse 1 files for his own benefits and never stops collecting that benefit. However, this may still be beneficial in that it allows Spouse 2 the opportunity to begin collecting a spousal benefit immediately while delaying her own benefit until she reaches age 70. Again, this can be beneficial in that it allows Spouse 2 to collect one form of Social Security (the spousal benefit) as soon as Spouse 1 files but also allows the same spouse to continue collecting delayed retirement credits on her own work history. Upon reaching age 70, Spouse 2 can then switch from collecting the spousal benefit, which was based on Spouse 1’s work history, to collecting their own Social Security benefit which has been building delayed retirement credits even during the years when a spousal benefit was being collected.
Again, with a file and suspend strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1 immediately suspended his benefit and is currently collecting delayed retirement credits. With the restricted application strategy, Spouse 1 never needs to suspend the collection of his own benefit and Spouse 2 still gets to collect a spousal benefit while earning delayed retirement credits on her own work history. Going forward, the U.S. government would like to ensure that each spouse is either collecting a benefit (either their own or a spousal benefit) or earning delaying retirement credits, but not both.
However, the restricted application strategy is being phased out over a different time span than the file and suspend strategy. Quite simply, as long as an individual reaches ages 62 before the end of 2015, they will be allowed to utilize the restricted application strategy. Conversely, people who will not reach age 62 before the end of the year will have no opportunity to take advantage of the restricted application strategy.
Steps to Take If This is You
As long as both spouses are at least age 62 before the year ends, then your strategy will likely not be interrupted. However, if one spouse isn’t age 62 before year-end, then your strategy will likely need to be reconsidered.
Speak to Your Financial Planner
If you have any questions regarding how these changes will impact your Social Security benefit, please speak to your financial advisor.
During every financial plan review over the next six months, I will be examining your situation and determining whether these changes affect you and exploring any adjustments that need to be made. In the meantime, please don’t hesitate to reach out to me if you have any questions.
An unintended consequence of this adjustment was that it enabled U.S. citizens to explore and take advantage of various strategies to maximize their Social Security benefits that were outside the intentions of the law. These strategies became known as the “file and suspend” strategy, and the “restricted application” strategy.
As part of the 2016 budget, President Obama and Congress intend to prohibit people from utilizing these strategies going forward. At the time of this publication, these proposed changes are not yet law. Although both the House of Representatives and the executive branch have signed off on these bills, they still need to be approved by the Senate before the laws go into effect. However, this is expected to occur with minimal modifications within the first week of November.
Let’s dive into the differences between the “file and suspend” and the “restricted application” strategies as well as the steps you may need to take if currently utilizing one of these strategies.
File and Suspend
The file and suspend strategy is when Spouse 1 files for Social Security and then immediately suspends the benefit. This can be beneficial because it could possibly enable the individual’s spouse to begin collecting a spousal benefit based on Spouse 1’s work history. Further, it would enable Spouse 1 to collect delayed retirement credits until age 70, getting an 8% per year raise in monthly Social Security payments.
The U.S. government has concluded that this strategy is abusive of the Social Security system in that it is essentially double dipping as it allows a couple to begin collecting a benefit based on one spouse’s work history while at the same time collecting delayed retirement credits on the same work history.
At this time, it appears that this strategy will no longer be allowed beginning six-months from the date the law is passed. Further, it is currently unclear what action will be taken against those who have already utilized this strategy. It currently appears possible that couples who have already started this strategy will be allowed to complete the process. Alternatively, it is possible that couples who have started this process will no longer be entitled to the spousal benefit they are currently receiving until Spouse 1 begins claiming his Social Security benefit, at which time the spousal benefit for Spouse 2 would continue. In a worse-case scenario, it is possible that the U.S. government may attempt to recollect any benefits that are no longer allowed from couples who have already taken advantage of this strategy. (I believe this is the least likely result, as it would be hard to take money away from people who have already collected it.)
Steps to Take If This is You
Suppose your spouse is currently collecting a spousal benefit based on your work history, although you are not currently collecting your own Social Security benefit. This would be a scenario resulting from the use of the file and suspend strategy.
If this is reflective of your situation, then significant adjustments might need to be made as this law becomes more concrete. It is possible that you will either need to start claiming your own benefit in order for your spouse to continue receiving their spousal benefit, or your spouse will need to stop collecting any benefit until you file to receive your own benefit. Again, these kind of adjustments will likely be implemented six months after the bill is finalized.
Alternatively, and depending on how the law is agreed upon, it is possible that some people who intend to take advantage of the “file and suspend” approach actually accelerate their implementation of the strategy in order to begin the process before the six-month deadline arrives.
Restricted Application
The restricted application strategy is slightly different from the file and suspend strategy in that Spouse 1 files for his own benefits and never stops collecting that benefit. However, this may still be beneficial in that it allows Spouse 2 the opportunity to begin collecting a spousal benefit immediately while delaying her own benefit until she reaches age 70. Again, this can be beneficial in that it allows Spouse 2 to collect one form of Social Security (the spousal benefit) as soon as Spouse 1 files but also allows the same spouse to continue collecting delayed retirement credits on her own work history. Upon reaching age 70, Spouse 2 can then switch from collecting the spousal benefit, which was based on Spouse 1’s work history, to collecting their own Social Security benefit which has been building delayed retirement credits even during the years when a spousal benefit was being collected.
Again, with a file and suspend strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1 immediately suspended his benefit and is currently collecting delayed retirement credits. With the restricted application strategy, Spouse 1 never needs to suspend the collection of his own benefit and Spouse 2 still gets to collect a spousal benefit while earning delayed retirement credits on her own work history. Going forward, the U.S. government would like to ensure that each spouse is either collecting a benefit (either their own or a spousal benefit) or earning delaying retirement credits, but not both.
However, the restricted application strategy is being phased out over a different time span than the file and suspend strategy. Quite simply, as long as an individual reaches ages 62 before the end of 2015, they will be allowed to utilize the restricted application strategy. Conversely, people who will not reach age 62 before the end of the year will have no opportunity to take advantage of the restricted application strategy.
Steps to Take If This is You
As long as both spouses are at least age 62 before the year ends, then your strategy will likely not be interrupted. However, if one spouse isn’t age 62 before year-end, then your strategy will likely need to be reconsidered.
Speak to Your Financial Planner
If you have any questions regarding how these changes will impact your Social Security benefit, please speak to your financial advisor.
During every financial plan review over the next six months, I will be examining your situation and determining whether these changes affect you and exploring any adjustments that need to be made. In the meantime, please don’t hesitate to reach out to me if you have any questions.
Tuesday, October 27, 2015
Who Are the Best Predictors of Stock Market Performance?
Every day CNBC airs dozens of “financial professionals” making market forecasts. Similarly, every financial publication has multiple pieces regarding the future of the stock market. With so much information, how is it possible to determine who is worth listening to and what information to incorporate into your investment strategy?
Without dropping any names, I’d suggest that the more confident a market pundit is about his or her prediction, the more you should question their advice.
People who make strong, unwavering forecasts are interesting to watch and appear as intelligent, appealing leaders whose advice is worth following. Meanwhile, people who frequently say phrases such as “it depends,” “maybe,” or even “I don’t know” don’t seem to be adding much value and don’t appear to be any more knowledgeable than the average investor. Yet, I’d suggest you tune out the stanch forecaster pounding his fist on the table as he speaks and rather listen closely to the individual who is less willing to make firm predictions.
Stock market performance is clearly not a result of any singular factor such as whether or not companies will generate more profits than expected. If this was the case, making market predictions would be easy – one could simply guess the answer to be yes or no and have a 50% chance of being correct. Rather, hitting profit targets is only point A on a long list of factors impacting stock market performance.
Point B may be whether or not the Federal Reserve will raise interest rates during their next meeting. Again, our market forecaster could guess yes or no to this question and have a 50% chance of being correct. However, when considering both factors A and B, now our market forecaster has to be right twice on two issues where there is only a 50% probability of being correct on each. Simple math tells us there is only a 25% chance that this will occur (50% x 50% = 25%).
Point C may be whether the republicans or the democrats win the 2016 election. Again, there is a 50% chance of either possibility. Now there are three factors in play, each with a 50% probability, so the probability that the market pundit will get all three factors correct is 12.5% (50% x 50% x 50% = 12.5%).
Point D may be whether the US dollars strengthens or weakens when compared to other currencies. Again, there is a 50% chance of getting this right, so when we consider all four factors, there is now a 6.25% chance of getting it right (50% x 50% x 50% x 50% = 6.25%).
There are hundreds of factors that go into this equation. Will Greece have another economic crisis? Will the price of oil go up or down? Will a war breakout with Russia? This is exactly why forecasting market performance is so difficult!
For this reason, the people who make the best forecasters are people who say phrases such as “perhaps,” “however,” and “on the other hand” a lot. Doing so illustrates that the individual has looked at the situation from a lot of different perspectives and realizes that everything may not go according to plan. These types of people also tend to admit when they are wrong more willingly and update their analysis utilizing the latest information available, even if the new information doesn’t reflect what they previously anticipated. Their thought process is likely: “I got point A wrong, so I need to adjust my thinking on point B, which will have an impact on point C, so how does this change my perspective on point D.” We’ll call this a point-A-to-point-B-to-point-C-to-point-D mentality.
By comparison, the forecaster who makes the strong prediction while staring into the camera likely utilizes more of a point-A-to-point-D mentality. They are less likely to admit that there are more factors affecting market performance than can be managed, and less likely to incorporate new information that doesn’t coincide with his previous prediction when making forward-looking forecasts. Their thought process is likely: “I may have gotten point A wrong, but that doesn’t matter. All that matters is point D and I believe I got that right when making my prediction.” This approach is obviously less logic-based than the approach taken by the forecaster who knows there are too many factors to enable an individual to make a confident prediction.
While people who make confident predictions regarding market performance are entertaining to watch and provide advice that is simple to follow (he said buy, so I’ll buy), their advice is not likely to be any more accurate than other market pundits. In fact, if they are unwilling to admit when they get any potential factor concerning market performance wrong, their advice may be more damaging then useful. By comparison, market forecasters who utilize phrases such as “however,” “it is hard to say,” and “I’m not sure” provide advice that may come off as unhelpful or impossible to follow, but it is these people who provide logic-based nuggets of information that are likely to benefit your investment portfolio.
Without dropping any names, I’d suggest that the more confident a market pundit is about his or her prediction, the more you should question their advice.
People who make strong, unwavering forecasts are interesting to watch and appear as intelligent, appealing leaders whose advice is worth following. Meanwhile, people who frequently say phrases such as “it depends,” “maybe,” or even “I don’t know” don’t seem to be adding much value and don’t appear to be any more knowledgeable than the average investor. Yet, I’d suggest you tune out the stanch forecaster pounding his fist on the table as he speaks and rather listen closely to the individual who is less willing to make firm predictions.
Stock market performance is clearly not a result of any singular factor such as whether or not companies will generate more profits than expected. If this was the case, making market predictions would be easy – one could simply guess the answer to be yes or no and have a 50% chance of being correct. Rather, hitting profit targets is only point A on a long list of factors impacting stock market performance.
Point B may be whether or not the Federal Reserve will raise interest rates during their next meeting. Again, our market forecaster could guess yes or no to this question and have a 50% chance of being correct. However, when considering both factors A and B, now our market forecaster has to be right twice on two issues where there is only a 50% probability of being correct on each. Simple math tells us there is only a 25% chance that this will occur (50% x 50% = 25%).
Point C may be whether the republicans or the democrats win the 2016 election. Again, there is a 50% chance of either possibility. Now there are three factors in play, each with a 50% probability, so the probability that the market pundit will get all three factors correct is 12.5% (50% x 50% x 50% = 12.5%).
Point D may be whether the US dollars strengthens or weakens when compared to other currencies. Again, there is a 50% chance of getting this right, so when we consider all four factors, there is now a 6.25% chance of getting it right (50% x 50% x 50% x 50% = 6.25%).
There are hundreds of factors that go into this equation. Will Greece have another economic crisis? Will the price of oil go up or down? Will a war breakout with Russia? This is exactly why forecasting market performance is so difficult!
For this reason, the people who make the best forecasters are people who say phrases such as “perhaps,” “however,” and “on the other hand” a lot. Doing so illustrates that the individual has looked at the situation from a lot of different perspectives and realizes that everything may not go according to plan. These types of people also tend to admit when they are wrong more willingly and update their analysis utilizing the latest information available, even if the new information doesn’t reflect what they previously anticipated. Their thought process is likely: “I got point A wrong, so I need to adjust my thinking on point B, which will have an impact on point C, so how does this change my perspective on point D.” We’ll call this a point-A-to-point-B-to-point-C-to-point-D mentality.
By comparison, the forecaster who makes the strong prediction while staring into the camera likely utilizes more of a point-A-to-point-D mentality. They are less likely to admit that there are more factors affecting market performance than can be managed, and less likely to incorporate new information that doesn’t coincide with his previous prediction when making forward-looking forecasts. Their thought process is likely: “I may have gotten point A wrong, but that doesn’t matter. All that matters is point D and I believe I got that right when making my prediction.” This approach is obviously less logic-based than the approach taken by the forecaster who knows there are too many factors to enable an individual to make a confident prediction.
While people who make confident predictions regarding market performance are entertaining to watch and provide advice that is simple to follow (he said buy, so I’ll buy), their advice is not likely to be any more accurate than other market pundits. In fact, if they are unwilling to admit when they get any potential factor concerning market performance wrong, their advice may be more damaging then useful. By comparison, market forecasters who utilize phrases such as “however,” “it is hard to say,” and “I’m not sure” provide advice that may come off as unhelpful or impossible to follow, but it is these people who provide logic-based nuggets of information that are likely to benefit your investment portfolio.
Monday, September 21, 2015
Rethinking Diversification
As a financial planner, one of my favorite words is
“diversification.” Diversifying a portfolio essentially ensures that we don’t
have all of our investment eggs in the same basket. A properly diversified
portfolio should experience fewer losses than a non-diversified portfolio as
well as benefit from a reduced downside when the market decreases in value. I
have a chart that I draw for clients in steps that help me illustrate the
purpose and benefits of diversification.
Step one of the chart is to communicate that given enough
time, the market has always produced positive returns. (The phrase “enough
time” is subjective and fluctuates, but the fact that the market is worth more
now than when you were born proves the point.)
Thus, given enough time, the market will eventually move from point A to
point B:
Armed with this information, what two investments would make
up the most consistently performing portfolio? Two assets that ebbed and flowed
in a perfectly opposite manner while they ultimately trend upward:
A portfolio of only these two perfectly inversely correlated
assets would lead to an incredibly stable and predictable rate of return with
virtually no volatility:
Unfortunately, these exact investments don’t exist. However,
certain asset categories sometimes (not always!) exhibit this characteristic.
For instance, when stocks experience a decline, bonds often benefit as
investors sell their equities while their prices are low and buy bonds in what
is called a flight to quality. The increased demand for bonds causes the price
of the asset to also increase. Thus, an investor who had half his money invested
in stocks and half in bonds would likely experience a decrease in the value of
the stock portion of his portfolio but an increase in the value of his bond
holdings. This would lead to a less dramatic loss when stocks go through a
rough patch. Similar relationships can also exist between other asset classes:
Obviously, the more inverse relationships that exist within
a portfolio, the less volatility it is likely to experience. This is the true
value of diversification.
However, there is a factor that we must return to – that the
market and a diversified portfolio only make money when given sufficient time.
What happens to a diversified portfolio over shorter periods of time? Does
diversification still add value?
One of the implied assumptions in the charts above is that the
better performing asset makes more than the worst performing asset loses during
any given cycle. For instance, the best performing asset might make +15% while
the worst performing category might lose -5%. If this was the case, the
portfolio would average a +5% overall return. If this wasn’t the case and the
best category returned +10% while the worst asset lost -10%, the portfolio’s
performance as a whole would be flat (a return of 0%). Fortunately, investments
tend to both make money more frequently than lose money and also make more during
the years when they achieve a positive return then they lose during years when
they experience a loss.*
Unfortunately, over short periods of time, this is not always
the case. In fact, the relationship could be the opposite – the worst
performing asset category may lose -15% while the best performing category may
only make +5%, resulting in an overall portfolio loss of -5%. As the above
charts assume a sufficient amount of time for the market to work, these
temporary period of market declines aren’t reflected in the diagrams.
A chart consisting of only the potential disappointing
short-term returns of +5% for the best investment and -15% for the worst
investment would look something like this:
While the negative short-term results aren’t particularly
exciting, the above chart illustrates that diversification adds value even
during a bear market. If we had a non-diversified portfolio during a market
correction (which would be represented by either the blue or the green line),
then there are periods when our portfolio would decrease in value at a much
more dramatic pace than our diversified portfolio (represented by the red line).
As this series of charts illustrates, while diversification
doesn’t prevent a portfolio from avoiding losses over short periods of time, it
does add value to a portfolio during environments of both increasing and
decreasing market values. Further, a diversified portfolio is likely to endure
both fewer and less drastic periods of short-term losses. All things
considered, a diversified portfolio is very likely to produce superior returns
over a non-diversified portfolio over an extended time frame.
Subscribe to:
Posts (Atom)