A look at how variable rates of return do (and do not) impact investors over time.
What exactly is the “sequence of returns”? The phrase simply describes the yearly variation in an investment portfolio’s rate of return. Across 20 or 30 years of saving and investing for the future, what kind of impact do these deviations from the average return have on a portfolio’s final value?
The answer: no impact at all.
Once an investor retires, however, these ups and downs can have a major effect on portfolio value – and retirement income.
Why are investors and economists getting nervous about Treasury yields?
What is the yield curve, and why is the financial media writing about it? Here is a brief explanation, starting with a clarification.
A yield curve is really an X-Y graph projecting expected rates of return for equivalent-quality bonds with different maturity dates. But it is not just any yield curve that matters. When investors, commentators, and economists talk about “the yield curve,” they are talking about the graph plotting the interest rates of Treasuries: 3-month, 2-year, 5-year, 10-year, and 30-year notes. The “curve” is the line connecting their projected future yields. This Treasury yields snapshot is authoritatively referred to as: “the yield curve.”1,2
The Federal Reserve has hiked the benchmark interest rate twice this year, and it expects to make two more hikes before 2019 arrives. It projects the federal funds rate will approach 3.5% by 2020.1
What could these rate hikes mean for you?
Why you should periodically review beneficiary designations.
Your beneficiary choices may need to change with the times. When did you open your first IRA? When did you buy your life insurance policy? Are you still living in the same home and working at the same job as you did back then? Have your priorities changed a bit – perhaps more than a bit?
While your beneficiary choices may seem obvious and rock solid when you initially make them, time has a way of altering things. In a stretch of five or ten years, some major changes can occur in your life – and they may warrant changes in your beneficiary decisions. In fact, you might want to review them annually.
Beneficiary designations commonly override bequests made in a will or living trust. Many people do not realize this. When assets have designated beneficiaries, they can usually avoid probate and transfer directly to that person.1,2
A move that high earners can make in pursuit of tax-free retirement income
Does your high income stop you from contributing to a Roth IRA? It does not necessarily prohibit you from having one. You may be able to create a backdoor Roth IRA and give yourself the potential for a tax-free income stream in retirement.
If you think you will be in a high tax bracket when you retire, a tax-free income stream is just what you want. The backdoor Roth IRA is a maneuver you can make in pursuit of that goal – a perfectly legal workaround, its legitimacy further affirmed by language in the Tax Cuts & Jobs Act of 2017.1
You establish a backdoor Roth IRA in two steps. The first step: make a non-deductible contribution to a traditional IRA. (In other words, you contribute after-tax dollars to it, as you would to a Roth retirement account.)1
A tax-advantaged option too many families overlook
At first glance, a Roth IRA might seem an unusual college savings vehicle. Upon further examination, it may look like a particularly smart choice.
A Roth IRA allows you to save for college without the constraints of a college fund. This is an important distinction, because you cannot predict everything about your child’s educational future. What if you contribute to a 529 plan or a Coverdell ESA and then your child decides not to go to college? Or, what if you save for years through one of these plans with the goal of paying tuition at an elite school and then a great university steps forward to offer your child a major scholarship or a full ride?
If you take funds out of a Coverdell ESA or 529 college savings plan and use them for anything but qualified education expenses, an income tax bill will result, plus a 10% Internal Revenue Service penalty on account earnings. (The 10% penalty is waived for 529 plan beneficiaries who get scholarships.)1,2
Comparing the old rules with the new.
The Tax Cuts and Jobs Act made dramatic changes to federal tax law. It is worth reviewing some of these changes as 2019 approaches and households and businesses refine their income tax strategies.
Income tax brackets have changed. The old 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% brackets have been restructured to 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These new percentages are slated to apply through 2025. Here are the thresholds for these brackets in 2018.(1,2)
How much attention do you pay to this factor?
Will you pay higher taxes in retirement? Do you have a lot of money in a 401(k) or a traditional IRA? If so, you may receive significant retirement income. Those income distributions, however, will be taxed at the usual rate. If you have saved and invested well, you may end up retiring at your current marginal tax rate or even a higher one. The jump in income alone resulting from a Required Minimum Distribution could push you into a higher tax bracket.
While retirees with lower incomes may rely on Social Security as their prime income source, they may pay comparatively less income tax than you will in retirement – because up to half of their Social Security benefits won’t be counted as taxable income.1
Given these possibilities, affluent investors might do well to study the tax efficiency of their portfolios; not all investments will prove to be tax-efficient. Both pre-tax and after-tax investments have potential advantages.
Constructing a portfolio this way may help you ride through a bear market in retirement
Stocks sometimes retreat. That reality can be overlooked in a long bull market. Bear markets do appear, and a deep downturn could force you to sell securities in retirement, so you can pay for necessary expenses.
Right now, you might have too much money in stocks. Years of steady gains may have unbalanced your portfolio and heightened your risk exposure. If you are 60 or older, that constitutes a warning sign, especially given this bull market’s age. What would a downturn do to your retirement fund and your retirement income?
If you are wondering how to respond to this risk, consider the bucket approach to retirement income planning.
The bucket approach may help you through different market cycles in retirement. This investing strategy
A calm investor may realize better long-term returns than an overly concerned one.
Investors are people, and people are often impatient. No one likes to wait in line or wait longer than they have to for something, especially today when so much is just a click or two away.
This impatience also manifests itself in the equities markets. When the S&P 500, Dow, or Nasdaq take a tumble, some investors grow uneasy. Their impulse is to sell, get out, and get back in later. If they give into that impulse, they may effectively pay a price.1
Across the twenty years ending in 2015, the annual return of the S&P 500 averaged 9.85%. During this same period, the average retail investor realized a yearly return of just 5.19%. (These numbers come from Dalbar, a respected investment analytics firm.) Why the difference? It could partly stem from impatience.1
Daniel Shub, AIF®, RFC®
Wealth Advisor & Founder.
OCTO Capital Wealth Management
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