How to Pick Investments for Your 401k

How to Pick Investments for Your 401k

Today we discuss how to pick investments for your 401k.  Do the performance statistics matter?  What about expenses? What are the most important things you can do to pick the right funds?

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How to pick investments for your 401k

Today we have a question from Randy. He writes, “I’m trying to choose investments for my 401k. How important are the three-year and five-year returns when picking the funds? What should I be focusing on to choose the right investments?”

401k plans are wonderful savings vehicles. But oftentimes, you get very little guidance about how to select the investments. Some plans have hundreds of options. Other plans may only have a dozen. It is hard to know which ones to pick to help you achieve your goals.

Information Overload

Plan sponsors provide a lot of data about the fund in your plan. It includes the type of fund it is. You will see common terms like growth, growth and income, or capital preservation. It may tell you how the fund invests. It may own stocks, bonds, or real estate. And it will show you what the internal expenses are.

You also get a lot of information about the funds’ past performance. Many people will focus on these numbers.

Everyone Loves a Winner

We all like winners. It is easy to spot the funds which have big numbers. Who doesn’t want that fund with a five-year track record of 15% per year?

Is picking funds really that simple? Unfortunately, the answer is no. There have been studies that show past performance is not good at predicting the future. The most popular one is the Standard and Poor’s Persistence Scorecard. The report shows how many funds were top performers in the past that stayed that way in the future.

We looked at their most recent data (2019), and here are some interesting findings:

  • Only 3.84% of funds that were top half performers in 2015 remained top half performers over the next four years.
  • Only 21% of the funds that were in the top tier for five-year periods ending in 2014 remained top tier performers by 2019

Using past results has shown to be a very unreliable tool to pick your funds.

How to Pick Investments for Your 401k

Your primary focus should be on your asset allocation. This is the mix you have between stocks and bonds and other assets. Owning more stocks gives you greater opportunities for future growth. But it also means you will experience more short-term declines in your account values.

Bonds can reduce volatility, but they will not offer as much potential for growth.

As a general guideline, the younger you are, the more you should have in stocks.

  • If your retirement is 20 years or more from now, it is reasonable to have between 80 and 100% stocks in your account.
  • If your retirement is 15 years away, you may want to scale that back to between 70 and 90% stocks.
  • If you are 10 years from retirement, you may want to be 60 to 75% stock.
  • If your retirement is five years or sooner, you may only want to be 50 to 60% stock.

Costs Matter

Focus on low-cost funds. These are likely going to be funds that track a specific index like the S&P 500. You also may want to diversify by using large-cap, mid-cap, and small-cap stocks. Each of those will behave a little differently. International stock funds are also a good choice. Sometimes they do better than the US companies.

The same thing applies to bond funds. Use the lower-cost funds. Right now, you may want to avoid anything that has “long-term” in the name.

Keep it Simple

You can have too many funds, you should be able to build a good allocation with six or fewer funds. Some will even suggest only using four. In some situations, you can create a good allocation with only two funds.

If you would like to receive a second opinion about your 401k, choose a time on the calendar below.

Talk to a Certified Financial Planner™ Professional

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Obstacles To Your Retirement

Obstacles To Your Retirement

What are the biggest obstacles to retiring when you want to? Whether you are two years from retirement or 20 years, we all face similar obstacles. Today, we discuss the three biggest obstacles to your retirement.

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Obstacle 1: Health Insurance

Many people would like to retire at 62 or younger. But there is a big problem. Health insurance at that age can be very expensive. Depending on where you live, premiums for health insurance can cost between $1,200 and $1,800 per month, per person. That means $2,400 to $3,600 for a couple. You can also expect those premiums to increase a significant amount each year.

The coverage may also not be as good as what you currently have. Many policies have high deductibles and limited options for providers and hospitals. You also may not have prescription coverage.

What can you do to overcome this obstacle?

Delay Retirement

The most obvious answer is to wait until 65 to retire. At that point, you are eligible for Medicare, which is a lot less expensive.

Dedicated Savings

If delaying retirement is not an option, maybe you want to consider saving more. Consider creating a dedicated account designed to cover your health insurance premiums. If you already have a health savings account, that may be a way to help. But you want to be careful using your HSA. You cannot use your HSA to pay for health insurance premiums if you deduct or claim a tax credit for those costs on your return.

Take More Income from Savings

The other thing you can do is to take more income from savings early in retirement. Doing this can add risk to your nest egg. If your investments struggle, a higher withdrawal rate could create problems.

Obstacles to Your Retirement
Obstacles to Your Retirement

Obstacle 2: Mortgage Debt

The second major obstacle is mortgage debt. It tends to be one of the larger items in your budget. According to the Employee Benefit Research Institute, people between the ages of 65 and 75 spend on average $21,000 per year on housing costs. More people are retiring with mortgages than they did 10 years ago. A mortgage can be a significant part of that annual total. How can you overcome this?

Prioritize Paying Off Your Mortgage

If you have a few years until you retire, make paying off your mortgage a higher priority. Saving is important , but eliminating this debt will improve your retirement cash flow.

Many people earn more on their savings than what they pay in interest. But the impact of compounding returns over five or ten years isn’t as significant. Paying off the mortgage can have more long-term value to you when thinking about your retirement.

Refinance Your Loan

You may want to consider refinancing your house, especially right now. Mortgage rates in 2020 are as low as they have ever been. Refinancing can reduce your interest rate and spread the payments over more years. This can reduce your payments. It is not ideal, but it’s better than putting too much strain on your nest egg.

Downsize

Consider downsizing. Sell your house and use the equity to buy something smaller where you may not have the debt. You may not need all that space anyhow. Downsizing could also lower your insurance premiums and property taxes.

Obstacle 3: Inadequate Savings

Most people will struggle to retire on their terms because they did not save enough. How can you overcome this?

Save More

If you have a few years before you want to retire, make saving a higher priority. Re-examine what expenses are critical to enjoying life and cut those that are not.

Pursue Growth

Be more growth oriented. Pursuing higher returns can help you accumulate more. This works better if you have a longer timeframe. Remember, there could be some rough periods where things could be very difficult.

Delay Retirement

The third thing you can do is delay your retirement date. Waiting to retire gives you more time to save. It also reduces the discounts to Social Security or pensions.

Consider Working Part-Time

You can also consider other ways to supplement your income such as part-time lower stress work.

Simplify Your Life

Consider simplifying and minimizing your lifestyle. You may have to scale back on some things and reduce expenses to make retirement work.

Your retirement decision is about balancing risks. Increasing the income from your savings increases the risk of running out of money. But, waiting to retire means you have less time to enjoy your golden years.

There are no one-size-fits-all rules. You need to make the right decision for you and your family. And you need to make the best decision you can with all the information available. If you would like help going through the numbers, talk to a financial planner.

Talk To a Financial Planner

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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Offered Early Retirement? Start Here.

Offered Early Retirement? Start Here

A listener was offered early retirement.  There is a lot to consider before making your decision to retire—even if you weren’t offered an incentive.  If you’re thinking about retiring soon, and don’t know where to begin, start here.

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Offered early Retirement start here

This week we have a question from David. He writes, “I’ll be 62 in the spring. My employer has offered early retirement. How do I know if I can make it work?

This is an excellent question. Let’s cover some of the basics.

Know Your Numbers!

This means your income and your expenses.

Your Savings

How much have you saved? And how much income can your nest egg provide? This is an important thing to determine. The more you withdraw from your nest egg, the greater the risk of running out of money during your lifetime.

You want to get as much as you can without putting too much stress on that account.

Pension

Are you going to get a pension? If so, how much will it be? Should you consider a lump sum payout if it is available? This is an important decision to make. For some people taking the monthly payments makes the most sense. For others, taking a lump sum is a better choice. You will want to work through the numbers and determine what is right for you.

Social Security

You need to make a decision about your Social Security. You are eligible to start your Social Security at 62. But that comes with big discounts. Can you wait to take your Social Security until age 65 or your normal retirement age? Waiting to start your benefits reduces the discount. This can result in thousands of dollars of additional benefits over your lifetime. But it does not always make sense to wait. Sometimes it makes sense to start it at 62 if you need to. Please look at this decision very carefully.

Early Retirement Incentive Payment

If you are getting an incentive to retire, how will that impact your cash flow? Does the payment mean you will not have to take income from your 401k? Does it provide enough income so you can delay your Social Security?

If you can use that money to pay your expenses, you can reduce stress on your savings or improve your Social Security benefits.

Expenses

Knowing your expenses is very important. Look at what you are spending now and how it will change when you retire. Certain things in your budget are going away. You are not going to be driving to work every day. You won’t be buying clothes for work and you may spend less on meals, too.

Some expenses might increase. You may play golf more often. You may have other hobbies that cost money. That means you might be spending more on some things.

If things are tight, is there anything that you can cut from your budget? Are there lower priority expenses that you can drop to help make things work for a few years.

Spending is a major component of your long-term financial success. In fact, overspending can be one of the biggest reasons people run out of money.

Debt

Do you have a lot of debt? Loan payments can be a significant expense, especially car payments and mortgage payments. Can you can use your early incentive payment to eliminate some of those debts? That could have a big impact on your cash flow. You need to work through the numbers to see if this is worth considering.

You may want to consider refinancing your mortgage. This isn’t an ideal strategy. The ideal situation would be to be debt free when you retire. Refinancing your mortgage could lower your monthly payment and help your budget.

Early Retirement Offer Start Here
early retirement offer start here

The Big Issue: Health Insurance

Because you are only 62, one of the biggest things that you will face is buying health insurance. Recently, we have heard quotes for coverage between $2,000 and $3,500 a month. This is a very significant expense. You can expect the premiums to increase each year until you are eligible for Medicare.

Most of those policies are going to have big deductibles, and the coverage may not be ideal. You may also have to change doctors, and you may not be able to go to your preferred hospital.

The health insurance marketplace in our area is very difficult right now. But, if you can figure this out, you have a real chance to make early retirement work.

Your Spouse

Is your spouse going to retire or continue working? If they are going to keep working, how will they adjust to you being home all day when they have to get up and go to work? Maybe they are retiring too, and you both will have to adjust to both of you being home all day.

Practical and Objective Advice

You want to make the right decision for your family.  Consider talking to a fiduciary financial advisor to help you work through the numbers.
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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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How Could Your Taxes Change in 2021?

How Could Your Taxes Change in 2021?

How could your income taxes change in 2021? We’re still waiting on election results. But we can look ahead to the potential changes to your taxes if Joe Biden wins the election.

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Here’s what we know about Mr. Biden’s tax plan.

Improving and Adding Certain Tax Credits

He wants to improve and add tax credits.  His plan calls for:

  • increasing the Child and Dependent Care tax credit. (this is for daycare costs)
  • expanding the earned income tax credit for people over 65.
  • renewable energy credits for electric vehicles and solar panels.
  • restoring the first-time homebuyers tax credit.
  • for 2021—and as long as economic conditions dictate—increasing the child tax credit.

Tax Credits for Retirement Savings

His plan also wants to equalize the tax benefits of retirement plan contributions. Right now, people get a deduction for some of those retirement plan contributions. He wants to change this to a tax credit.

What is the difference between a tax deduction and a tax credit? Which is better?

 
A Tax Deduction is something which reduces your income. If you earned $1,000, and have a $200 deduction, your adjusted income is $800. You compute your tax using the reduced amount. If your tax rate is 15%, your $200 deduction will lower your taxes by $30.
 
A Tax Credit is a direct reduction of your income tax liability. If your tax liability is $1,000, and you have a $200 credit, your tax bill is $800.
 
In most cases tax credits are better than tax deductions.

Tax Increases for High Earners and Corporations

Mr. Biden also wants to increase taxes for those people who make a lot of money. If you make over $400,000, you can expect a significant tax increase.

  • your social security taxes will go up.
  • The maximum tax rate that you pay on your income will also increase.
  • If you are a business owner, you will lose the qualified business deduction.
  • It will also tax capital gains and qualified dividends as ordinary income for those making over $1 million.
  • It will also limit the benefits of itemized deductions.

He also wants to increase the taxes on businesses. The corporate tax rate under Mr. Biden’s proposal goes from 21% to 28%.

Lastly, he wants to restore federal estate taxes back to 2009 levels.

The Most Concerning Tax Change

There is something in Mr. Biden’s tax plan that will impact a lot of people. It involves how your cost basis is treated at a person’s death.

What is cost basis? 

Your “cost basis” is what you pay for an asset. Whether you buy a house, a stock, a rental property or a bond, whatever you pay for that asset is your cost basis. If you add money to it, it increases your cost basis.

The cost basis is important when you sell that asset. You pay capital gains tax on the difference between the sale price and your cost basis. Let’s look at an example. Let’s say you buy a stock for $10,000. After several years, the value has grown to $50,000. If you sell that stock, you pay capital gains on the difference between the sale proceeds of $50,000 and your cost basis ($10,000). You would owe taxes on $40,000.

How Could Your Taxes Change in 2021

If you had reinvested the dividends from that stock, your cost basis increased. Let’s say you reinvested $5,000 of dividends, the cost basis increases to $15,000. If you sell the stock, you pay capital gains taxes on the difference between the $50,000 and $15,000.

Current Law vs What Could Change

Under current law, your cost basis steps up or steps down when you die. What Mr. Biden wants to do is eliminate the step-up in basis. Consider this. You paid $10,000 for your stock. It’s worth $50,000 at your death. Under current law, your heirs have a cost basis of $50,000.

Likewise, let’s say your parents bought a house several years ago for $50,000. When they die, the house is worth $200,000. Under current law, the basis increases to $200,000.

Under Mr. Biden’s proposal, there would be no step-up in basis.  This means you would have a capital gain of $150,000 when you sold your parents house.

The other disturbing thing about Mr. Biden’s tax plan is the deemed sale at death. This means the tax code would treat a person’s assets as being sold at the date of death (rather than sold when the heirs want to sell them). It would make that capital gains tax due immediately.

Right now, most of those assets pass to others with little to no tax bill. Eliminating the step-up in basis will hit the wallets of many Americans.

Don't Worry Yet

None of this has happened yet. We still do not know who the President-elect is, and we do not know who is going to control the Senate or the House. But this is something to monitor. If you have a question about how any of this could impact you, talk to a financial advisor or a tax professional.
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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Can You Still Do Qualified Charitable Distribution in 2020?

Can You Still Do a Qualified Charitable Distribution in 2020?

Can you still do the Qualified Charitable Distribution in 2020? This is a question we received from a listener. We’ll tell you what a QCD is, who qualifies, how you do it, and offer a few tips.

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Today we have a question from Charlie. He asks, “I saw where we don’t have to take our required minimum distributions this year. Can we still do the charitable distribution from our IRA?”

The CARES Act suspended the need for required minimum distributions in 2020. But what Charlie is referring to is the qualified charitable distribution. This allows people who are at least 70½ to send a distribution from their IRA directly to a charity. There is a benefit to this, you don’t have to report it as income.

Tax benefits of a Qualified Charitable Distribution

Today, the standard deduction is much higher. Most people aren’t able to itemize their deductions. This means many people lost the tax benefits from charitable donations.

By not having to report them as income, you do get the tax benefit. And the benefit is even better. You don’t pay federal or state income taxes on the qualified charitable distributions. Itemized deductions don’t help you on your state income taxes.

How do you make a Qualified Charitable Distribution?

Here is what you need to know about Qualified Charitable Distributions:

  1. You have to be at least age 70½.
  2. Because the funds are not going to the account owner, most custodians are going to require a signed form. You’ll need the name and address of the charity.
  3. The custodian will then send the funds directly to the charity.

This distribution is going to show up on your 1099R as a normal distribution. You need to tell your tax preparer that this is a qualified charitable distribution. They will be able to handle it properly for your return.

Something to consider...

Even though you aren’t required to take money from your IRA this year, you can still do the qualified charitable distribution. But, keep something in mind. We are close enough to the end of the year to consider waiting until January to complete this. It will count towards your 2021 required minimum distribution. We’re not trying to discourage you from supporting those organizations now. But, if you wait a couple months, it will give you the biggest bang for your buck.

A tip for 2021 (and beyond)

Let’s say you go to church every week and you put $20 in the collection basket. Use the qualified charitable distribution and send them $1,000 from your IRA, instead. The church gets the same amount and you’ll get the tax benefits you didn’t receive before. If you have questions about how this could help you, talk to a financial advisor.
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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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