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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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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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.

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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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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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Should I Use My Savings To Pay Off my Mortgage?

Should I Use My Savings To Pay Off My Mortgage?

This question is from Karen. She asks, “With interest rates so low, we aren’t earning anything on our savings. I’m also worried about another significant drop in the stock market. Should I take money from my savings to pay off my mortgage?”

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There are two parts to this. One is eliminating debt. The other is what is the better use of your money?

Paying off debt is never a bad thing, especially as you get closer to retirement. According to the Employee Benefits Research Institute, the largest annual expenditure for people 50 and older is housing. If you can pay off your mortgage before you retire, it can help you have a more successful retirement.

There is also a huge psychological boost to being debt-free. What happens if the economy shuts down again and you get laid off? Not having a mortgage payment can reduce your stress. It’s less stressful knowing you don’t have to come up with $1,000 each month when you’re not working. We cannot underestimate the value of being debt-free.

What is the best way to do this? Here are some factors to consider. These apply whether you’re using a lump sum or paying extra on your principal. 

Compare interest rates

The first thing is to compare your current interest rate to what you earn on your savings and investments. If your mortgage interest rate is high, 4% or more, and you’re earning 0.75% (or less) on your savings, this decision is easy. The difference in the cost of your money compared to what you’re earning is significant. Using your savings to pay down or pay off your mortgage makes a lot of sense. If your interest rate is closer to 3%, and you’re invested in something that has a potential to earn 8%, the math changes.

Your age

The second factor is your age. For someone under 40, the value of compounded returns from investing can be better for your future. If you are closer to retirement, the benefit to paying off that mortgage is more valuable.

use savings pay off mortgage
use savings pay off mortgage

How long will you live there?

Are you planning to stay in your house for a long period of time? If you’re planning to remain there for several years, paying off the mortgage makes more sense. If you’re planning to sell your home in the next 36 months, I’m not sure the answer is as clear. You may not want to pay off your mortgage if you plan to sell it in the very near future.

Tax costs

What are the potential tax costs to raise the funds to pay off your mortgage? Does that come from an IRA or a 401k? If it does, then the entire distribution can be taxable.

Here is an example. If you need $100,000 to pay off your mortgage, you may need to withdraw $133,000 from an IRA. The extra amount will cover the taxes. That is a very expensive way to pay off your mortgage.

Selling stock to pay off your mortgage can also result in a significant tax cost. Your sales proceeds are $100,000. You paid $50,000 for those shares. You will incur $7,500 in capital gains taxes and some additional state income tax. That is also an expensive way to pay off your mortgage.

If the money is in a savings account, there is no tax cost to use it for your mortgage.

Paying off debt is rarely a bad choice, but you need to look at it from all angles and make an intelligent choice.

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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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Is Doing Nothing The Right Thing To Do?

Is Doing Nothing the Right Thing to Do?

During a Bear Market, many investors are tempted to sell their stocks and move to cash.  Many financial advisors will tell them to sit tight, and ride out the storm.  Is “doing nothing” the right thing to do?  Today we’ll share some interesting data that shows that in the last market, doing nothing was better than panicking.

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We’ve already been through a lot this year. And we’re still dealing with a lot. We have an election coming up in a few weeks. The Coronavirus is still part of our lives. There are questions about another major shutdown. And there are some concerns with all the government help that there is going to be hyperinflation. There are a lot of things that could cause another bear market.

Doing nothing

When we have major turmoil, people want to do something to protect their nest egg. In every bear market, we’ve had people call and ask if they should go to cash. Our answer has always been no. Sit tight right through any storm we encounter.

We believe you will be better off if you don’t make an emotional decision. Doing nothing is hard to do. In fact, it’s the second hardest thing to do as an investor.

Inevitably, we will have someone who can’t take it anymore and bail out. During the “dot com” bust and the Great Recession, we had clients who sold their stocks within a week of the market bottom after the damage was done.

Cash panickers

Is doing nothing the right choice? Recently, Vanguard did a study during the bear market this spring. They looked at over 31,700 accounts, both retirement plans, like 401(k)’s, and retail accounts. They found that 0.5% of those accounts panicked and moved to cash between the market high on February 19 and the end of May.

They looked at two things. They looked at the actual returns of those clients at three different points: March 31, April 30th, and May 31. And they compared those to the returns those clients would have realized if they had done nothing. Here’s what they found.

By the end of March, 56% of those clients who went to cash were in a better place than if they had done nothing. This means they had a higher balance than if they stayed invested.

The stock market rebounded very quickly. By the end of April, only one third of those clients were in a better place.

By the end of May, only 15% of those clients had a higher balance by going to cash. 85% of those clients who panicked would have had better results if they did nothing.

85% of those clients who panicked would have had better results if they did nothing.

Selling low...

Why is that? Most of them didn’t guess the correct time to move to cash. You have to make that decision very early in the process, so you don’t take part in the downturn. A good number of them went to cash after a significant amount of the damage was done.

When the market turned around and moved higher, they missed a great buying opportunity. They didn’t participate in the rebound. Essentially what they did was sell low and bought at higher prices. This is the exact opposite of what you’re supposed to do.

Is doing nothing the right thing
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is doing nothing the right thing

The cost of being wrong

If you sell now thinking things are going to get bad, you have to be aware that they may not get as bad as you think. For example, let’s take the 2016 election. I woke up that morning and saw that Donald Trump won the election and immediately turned to CNBC. The futures that morning showed that the Dow Jones Industrial Average was in for a rough day. When I got to work I had two calls before the market opened. These clients were extremely concerned about what was going to happen in the stock market. They thought it was going to be ugly.

By the time the market opened, futures were positive. Over the next several months, we saw the stock market race higher. Had those clients gone to cash, they would have missed that rally.

If things do get as bad as you believe, you might be right for a while— just like the folks in the Vanguard study. But will you have the confidence to buy at lower prices?

Most people think things are going to get worse before they get better. Stocks are forward looking. The stock market will turn around long before the economy turns around. Stocks will begin to increase long before people believe things will get better. If doing nothing is the second hardest thing to do, then buying stocks in the middle of a bear market is the hardest.

Vanguard found only 9% of those 31,000 accounts bought more stocks during the bear market.

If you have to...

If you’re convinced you need to go to cash, do it early. Do it before things get worse. We’ve already seen a minor pullback. Don’t wait until things are down 20% or more to sell. And you need to have a plan to buy at lower prices. You must have courage to buy when things look like they’re going to get much worse.

If you can’t make the decision to do both of those things, then do nothing. Sit tight and ride out the storm.

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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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Should I Use The Roth 401k?

Should I Use the Roth 401(k)?

Our next question is from Mike. He asks, “My employer recently announced they’re offering a Roth 401k option. Should I be using the Roth 401k? Also, I’ve been putting money in the Lifecycle 2035 fund. Is that a good idea?”

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Should I use the Roth 401(k) or not?

Traditional 401k deferrals are done on a pre-tax basis. This means you get a current tax benefit, a tax deduction. Your money grows tax-deferred. When you get to retirement and you take it out, you pay taxes on your distributions.

Roth deferrals offer no current tax benefits. It’s an after tax contribution. The money in your account grows tax free. When you take it out, you will pay no taxes on the growth or the contributions.

The Roth option has a lot of benefits. There are some questions that you need to ask yourself to make this decision.

Will Your Taxes be higher today or in retirement?

If your tax rate is going to be the same or higher in retirement then doing the Roth makes a lot of sense. If you’re a higher income earner today, that tax benefit may be far more valuable than when you do retire.

Are you addicted to your tax deduction?

I make pre-tax deferrals in my 401k to reduce my tax bill. It’s very difficult for me to start sending the government more money. I’m addicted to my tax deduction.

Next year, I’ll be able to do the over 50 catch-up contributions. I plan to use the Roth 401k for these because I’m not used to that tax deduction.

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How long until you retire?

The longer you have, the better the Roth 401k is. If you can let this compound for 20, 30, or 40 years, then the Roth makes a whole lot more sense than the pr- tax deferrals.

How much have you saved in pre-tax accounts?

If you have a large balance in a traditional IRA or 401k funded with pre-tax contributions, you may want to use the Roth option. This can help with tax planning for your retirement income. Distributions from traditional IRA’s get taxed as ordinary income. Having assets in other types of accounts allow for tax planning in retirement.

In general terms, I like the Roth options. The longer you have, the better. If you’re under 40, you should absolutely be doing the Roth if you can. Taxes do matter, and it needs to be a factor in your decision. But the longer-term benefits are huge.

If you’re 50 or older, you may not benefit as much from the Roth. It does allow you that flexibility to plan going forward.

Target Date Funds

Lifecycle and Target Date funds are designed to be a one-size-fits-most option. The date in the fund is to help you identify which year is closest to the year you want to retire. The asset allocation of those funds depends on the length of time from now until the year in the name of the fund.

Here’s an example. Vanguard has lifecycle funds. Their longest one right now is 2060 or 40 years away. The 2060 Fund has 88% of its assets in stocks. Vanguard’s 2035 Fund looks at a retirement 15 years from now. It only has 72% of its assets in stocks. The 2025 fund has 58% of its assets in stocks. Each year the fund family will adjust that allocation as you get closer to that target date.

Does it make sense to use one of these? As long as you’re doing it, right, yes. Remember, just pick one and keep it simple. We see mistakes with this. Some people will put some in the 2060 fund, some in the 2035 fund, and some in the 2025 fund. That’s not how they’re designed to work.

If you want to control your allocation, use a combination of the other funds that are available. Otherwise, use one target-date fund.  

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Financial Planning

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 I Max My Roth and My 401k?

Can I Max My Roth IRA and My 401k?

Sandy wants to know if she can max her Roth IRA and her 401k contributions.  Let’s dig into the rules.

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This question is from Sandy. She asks, “Can you contribute the maximum amount to a Roth IRA and the Roth account in the government’s Thrift Savings Plan?”

The answer is yes—if you qualify to make a Roth IRA contribution.

Here are the contribution limits for 2020. For retirement plans whether it’s the Thrift Savings Plan, a 403b plan at the hospital or a school, or a 401k plan, you can contribute $19,500. If you’re over 50, there’s a catch-up contribution. That amount is $6,500. You can contribute $6,000 to a Roth IRA. If you’re 50 or older, you can contribute an additional $1,000.

If you wanted to maximize both, and you’re under age 50, that’s $25,500. If you’re 50 or older, that’s $33,000 total per person. If you’re married, you can do both, and your spouse can do both. If you have that much extra income, that’s phenomenal!

There are income limits for Roth IRA contributions. You can make the maximium Roth IRA contribution if your modified adjusted gross income (MAGI) is below these limits. For married couples filing a joint return, the limit is $196,000. If you’re single, that limit is $124,000. If you’re married and you file separate returns, the income limit is $10,000.

If your MAGI is over those limits, your eligibility to make those Roth IRA contributions changes. You may be able to do a partial contribution or none at all.

The Married Filing Separately Tax Trap

The married filing separately thing is an interesting little trap. A lot of people will file separate returns to try to save on state income taxes. But it has a hidden impact on things like your IRA contributions. It impacts deductions for traditional IRAs, Roth IRA contributions and Roth conversions.

If you’re married filing a separate return and your income is over $10,000, a lot of those things disappear. You want to be very careful with that. You don’t want to get a surprise later on.

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September 2020 Client Letter

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Financial Planning

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 Do I Use My Savings To Create Income?

How Do I Use My Savings To Create Income?

Tim asks,”How do I use my savings to create income in retirement?”

In this episode, we’ll talk about:

  • Immediate Annuities
  • Bonds
  • Dividend Paying Stocks
  • Systematic Withdrawals

Listen now: How Do I Use My Savings to Create Income?

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We answer:

Transcript: How Do I Use My Savings To Create Income?

1. Immediate Annuity

This is an insurance contract that creates an income stream for the rest of your life. You can add survivor benefits to this so it will be the rest of you and your spouse’s life. It’s guaranteed by the insurance company and their ability to pay.

Advantages

Eliminates market value risk

This eliminates any market value risk. There are no worries about the stock market going up or down.

Better payouts

You usually will get a higher payout than using the 4% rule. Immediate annuities typically pay out a greater percentage.

Income you can’t outlive

It will pay as long as you or you and your spouse are alive.

Disadvantages

Lose control of your principal

You lose all control of your principal. So if you need more income or a lump sum in the future, you likely won’t have access to the principal for those needs.

Fixed Income

The payout is typically a fixed amount. There are a few contracts out there that will provide some inflation adjustments. But those contracts will reduce the initial income benefit to account for the annual increase.

No Legacy

When you and your spouse have passed, there is no money to leave to your heirs. If you buy the contract, and two months later something tragic happens, that money is gone. There are a few policies that have refund provisions. But, that provision could reduce your monthly income.

Low Interest Rates

Low interest rates mean smaller payments. When interest rates increase, this will be a more attractive option.

This may be a reasonable choice for part of your savings. I wouldn’t recommend anyone put all their savings in one of these contracts.

What we often find is most people don’t like giving up control of their principal. And we believe there are better ways.

2. Income Producing Investments

You can also use income-producing investments. This means bonds and dividend paying stocks.

Bonds

Bonds pay an interest payment. Unfortunately, bonds are not a great choice right now. You might be able to find good interest payments on some bonds, but you have to pay a high premium for them. This means when the bond matures, you’ll get less than what you paid to buy the bond. Newer bonds won’t have good interest rate payments. This limits your income stream. Bonds also offer little or no appreciation potential.

Dividend Paying Stocks

Dividend paying stocks make sense. Over time, dividends tend to increase. There is also potential to see your principal grow

Constructing a portfolio that can generate a 3% yield or higher can be a challenge. You want to buy good dividend payers. This means companies that reliably pay their dividend and increase their dividends.

You can do it, but you introduce other variables. There’s risk for concentrating too much in a particular stock. Dividend cuts can create problems. This isn’t a risk-free strategy.

The last thing to consider is most people don’t want to be 100% invested in stocks. So that can limit your income as well.

Systematic Withdrawals

The third way is to use systematic withdrawals. This is one of the better inventions by the mutual fund industry. Over time, you sell shares of your investments to create income. It’s a very simple process.

You don’t have to use mutual funds to do this either. It can be done with exchange traded funds or individual stocks. You sell shares to produce your income.

You can combine this with a dividend strategy too. If you own a company that doesn’t pay a dividend, you could sell shares to supplement the dividends you get.

Here is something to remember when you’re looking at producing income. Snow or rain, it’s all water. If the “snow” represents dividends and the rain is “capital appreciation”, it all benefits you. It doesn’t matter if your income is from dividends or from selling shares.

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3. Managing Taxes

You also want to think about your taxes. If you have many sources of retirement funds, you have that ability. Distributions from Roth IRAs, for example, are tax free. Income from a personal or joint account may be more tax friendly. Distributions from IRAs and pre tax 401k plans are taxed as ordinary income. Most of the time, 100% of those distributions are going to be taxable. When you have separate sources of savings, you can manage your tax liability to some degree.

Unfortunately, for many people, their only asset for retirement income is their 401k. This limits your ability to manage your tax bill.

It can help to talk to an advisor about your situation. They can help you with a strategy that makes sense for you.

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Financial Planning

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 Will the 2020 Presidential Election Affect the Stock Market?

How Will the 2020 Presidential Election Affect the Stock Market?

How will the 2020 presidential election affect the stock market? That’s a big question on the minds of many. Today, we’ll dig into some numbers. We’ll show you what happened to the stock market in the three months before and after previous presidential elections.

Watch Now: How will the 2020 Presidential Election Affect the Stock Market?

2020 Election Affect the Stock Market

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2020 election affect the stock market

This year is off to a crazy start. It started with the Coronavirus. That caused the stock market to drop by about 34%. From the bottom of the bear market to today, we’re now close to all-time highs. The stock market has increased by almost 50%.

The virus is still a factor in our lives. Now we get to add a presidential election to the mix. How will the campaign season influence the market?

Elections and the Stock Market: Historical Data

We are focusing on the three months before a presidential election. This means August, September and October. And we are looking at the three months after. This includes November, December, and January. We have nine election years going back to 1980.

The 3 Months Before

The average gain of the stock market for the three months before an election was about 0.75%. Stocks improved six out of the nine years.

The 3 Months After

For the three months after an election, the stocks gained 2.36%, on average. It was positive in seven of the nine years.

The Outlier: 2008

There was an outlier. 2008 was a really bad year. From August to October 2008, the stock market dropped by about 23%. Following the election, the stock market continued to decline. It fell another 22.5%.

If you remove this outlier from the data set, the results look much different. 

Leading up to the election, the gain improves to about 3.5%. After the election, if you take out this outlier, the stock market improved 5%.

Will this year be more like 2008?

The election didn’t have the type of impact on the stock market that one might think. But you might be wondering right now, “Will this year be more like 2008?”

But there are also reasons to expect this rally to continue. Some data points to better things ahead.

Vaccine Progress

Companies are making progress on a vaccine. A lot of the optimism in the stock market relates to the optimism of a vaccine coming to market sometime next year. There are a number of companies now entering second and third stage trials.

The Big Question: Do Your Long Term Plans Depend on the 2020 Election?

It is hard to make big allocation decisions based on short term events. Most of the historical data points to the election not being a significant factor to stock market performance.

Your long term plans aren’t likely to change based on the outcome of this election. This makes it very difficult to make a decision based on that outcome.  .

The election concerns many people. There’s a very big divide between the two sides. It’s very contentious and very emotional. This creates a desire do something. Some think if “Candidate A” wins, things are going to go downhill. And if “Candidate B” wins, things are going to be great. But we don’t know what that outcome will be.

Making big decisions based on short-term events, creates more chances to make mistakes. That’s not a real good way to do things.

You need to base your asset allocation decisions on your long term plans. You shouldn’t base them on what happens in a presidential election.

Have Questions?

If you have questions about your situation or would like to discuss how the pandemic and bear market have affected you, click the button to arrange a call.

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Financial Planning

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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10 Years From Retirement: What Should I Be Doing?

10 Years Away From Retirement: What Should We Be Doing?

Heidi asks: “We’re 10 years away from retirement.  What should we be doing to prepare? Should we pay off our mortgage before we retire?”

Please note:  This is a highlight from our July Ask a CFP Pro show.

Listen Now: 10 Years Away From Retirement: What Should We be Doing?

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This is a highlight from our Ask a CFP® Pro show that aired on July 6.  If you missed it and would like to listen to the complete episode, click on the button below.  

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Transcript: 10 years from retirement: What should we be doing?

We want to retire in about 10 years. What’s the best way to prepare for that? And is it best pay off our house before retiring?

Still in growth mode

If you’re 10 years away from retirement, you still should be in growth mode. This means you’re more heavily invested in stocks. You’re looking to pursue higher returns.

Over the next decade, bonds aren’t going to help you a whole lot. You’re looking at 1% to 2% returns going forward based on current yields.

If there is a major downturn in the stock market, you have some time to recover from that. Even though we’re not out of this bear market yet, there could be another one in the future. You’re still going to be able to recover. If we do have that downturn again, it becomes a great buying opportunity. You may never find prices that low again.

Volatility shouldn’t be a significant concern at this point. As you get closer, when you’re five years away, that story may change. But, right now, you still have the ability to enjoy those compounded returns. If you can save and invest for higher returns, it should pay off for you in the long term.

I wouldn’t have any problems being 100% invested in stocks for the next four or five years, if I were you. I think the benefits will outweigh the long term risk. It could be tough to do. When you have those volatile times, nobody likes to see their balances go down. But again, I think the growth will be significant for you.

Eliminate debt

Should you pay off your house before you retire? If you can do so in a reasonable fashion, absolutely—yes! In fact, you should try to have all your debts paid off by the time you retire. That means car payments, your mortgage, and credit card debts. The fewer expenses you have, the better your retirement is going to be.

Retirement is all about cash flow. In our experience, the biggest reason people run out of money is because they spend too much. And debt payments are a form of spending. So the more you spend to pay debts, the less you have to do other things. Or it could mean you have to take more money from your nest egg than you should.

Eliminating debt can be a huge boost to your retirement plans as a whole.

Here are some other things that you want to do

Know your Social Security numbers…

Get your Social Security earnings record and benefit estimates. This is going to be a key component in helping you plan for retirement. It will help you make good decisions about when to start your Social Security benefits. And for most of us, it’s still a key part of our income.

Get organized

Get things organized. Understand where all your accounts are and how they’re invested. This allows you to create a better plan.

What does retirement look like?

It’s too soon to do detailed budgeting. But at the same time, you can start thinking about what your retirement is going to look like. You can think about what you want to do in retirement. Then you can see how much it will cost.

Health insurance

Have a good idea of what your health insurance is going to be if you’re going to retire before age 65. This is huge. If you have to go out and buy your own health insurance, that’s a big expense that you’re going to incur. You want to know what that’s going to be because it will have an impact on the numbers.

Work on your current cash flow

The last thing I would suggest is get your current cash flow situation in order. Know where your money’s going. Know how you’re spending it. If you can rearrange things to focus more on saving and eliminating debt, you’ll be glad you did. You have to make those things a priority. When you do that, you’ll have some flexibility and freedom in your retirement.

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Financial Planning

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.

Our Most Recent Videos And Posts