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.

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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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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.

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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Is Gold a Better Investment than Stocks?

Is Gold A Better Investment Than Stocks?

Is gold a better investment than stocks?  Wendy asks, “I keep hearing ads advising us to sell our stocks and buy gold or silver. For an older investor, is this a valid point?” 

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Gold Better iNvestment than stocks

Is gold a better investment than stocks?  

Gold is one of the ultimate fear assets. When things go haywire in the markets, people tend to turn to gold because it’s a tangible asset, and it has value everywhere.

We’re dealing with the possibility of hyperinflation. If that happens, gold could do very well. Another shutdown could increase the fear level of investors. Gold could also do well in that case. There are periods of time, like early 2020, where gold really shined.

Fact or Myth? Gold is safer than stocks

You have a gold bar locked in the safe. You paid $1,500 dollars for it. Unless you pay attention to gold prices, you know you have a gold bar and it has value. You may not know how much it’s worth, but it’s going to be worth something to somebody.

If you pulled it out earlier this year and thought to yourself, “I wonder how much this is worth?”, you discovered it was worth $2,000. Then, you put it back in the safe until next year. The next time you think about the bar, it could be worth $1,500. It could be worth $1,200.

Gold has extreme fluctuations in value, just like stocks. Let’s look at the last 13 years.

  • 2013 -28%
  • 2014 -2%
  • 2015 -10%
  • 2018 -2%.

Over the same timeframe, stocks were down

  • 2008 -37%
  • 2018 -4%.

Over 13 years, gold lost money four times, and stocks were down twice.

If you look at the last 48 calendar years, gold experienced declines 18 times. Stocks fell 11 times.

Gold is not a “safer asset” than stocks.

Is gold better than stocks?

Here is a link to a good article called, Gold’s Romantic Delusion. There’s a graph in that article which shows $10,000 invested in gold in 1980 versus $10,000 invested in stocks. On July 31 2020, the gold would have been worth about $36,000. Stocks would have been worth $761,000.

Is Gold Better Than Stocks

Source: Gold’s Romantic Delusion by Andrew Hallam.  Click here for the full article

Is it a better asset than stocks for older clients, or any client for that matter? In our opinion, no. The numbers say the opposite. Gold isn’t a bad investment, but I wouldn’t own gold instead of stocks.

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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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Should I Start Social Security at 62?

Should I Start My Social Security At 62?

This question is from Lloyd. He asks, “I’m planning to retire in the spring when I turn 62. Should I start taking my Social Security or should I wait?”

This is a big decision. The only decision we have when we’re looking at social security is when to file for our benefits.

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The impact of retiring early

The year you were born determines your normal retirement age. When you start Social Security before your normal retirement age, your benefits are reduced. If you’re married, the spousal benefit is also discounted. It also means a lower survivor benefit. The dollar amount of your cost of living adjustments will also be smaller. The percentage will be the same, but the dollar amount of the increase will be smaller.

A lot of people still signed up for social security early.

  • 31% of men and 27% of women sign up for their social security benefits at age 62
  • 6% applied at age 63
  • 7% filed at age 64
  • 10% applied for social security at age 65
  • 33% filed for their benefits at normal retirement age
  • 6% waited until age 70 to maximize their benefits

A little more than half of the recipients file for their benefits early.

A look at some numbers

You can do a lot of calculations to help determine when to start your benefits. Delaying your retirement can lead to thousands of dollars of additional benefits over your lifetime. But, you must live long enough to make it work. Generally speaking, you have to live until you are in your early 80s.

Here is how this can impact Lloyd. Let’s say his full retirement benefit is $2,300 per month. If he starts Social Security at 62, his benefit shrinks to $1,640.

At his full retirement age, his wife’s spousal benefit, if he’s married, would be half of the $2,300 or $1,150. At age 62, the spousal benefit will be, at most, $820. The combined benefits are nearly $1,000 less each month.

If Lloyd waits to start his Social Security, his discount isn’t as big.

  • By waiting a full year to apply for benefits, his amount grows by 7%
  • If he waits two full years, his benefit grows by over 14%
  • Should he wait until age 65, three years later, his benefit grows by 24%

A big decision

Should Lloyd take his Social Security benefits at 62?

It depends. Is he healthy? Is he married? Can he afford to retire without taking his benefits and not to put too much stress on his savings? There are a lot of factors, and it’s hard to say yes or no.

Here is what we typically see. People start their social security when they retire—regardless of their age. Most of the time, it’s because they need the money. The ones who retire and delay their Social Security have been good savers and have low expenses.

You need to consider your entire situation. You can’t make the decision about Social Security in a vacuum. There are many other factors involved in this process.

If you are unsure what to do, talk to a financial advisor before you make a costly mistake.

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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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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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is doing nothing the right thing

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
is doing nothing the right thing
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.

is doing nothing the right thing
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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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?”

Listen Now: Should I Use the Roth 401(k)?

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Do you want to hear the full show?

The full episode is over 25 minutes long.  And we’ve found that not everyone wants to spend that much time listening to things.  But if you want to listen to the entire episode, it is below.

We answer:

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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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