How to Save For Retirement

Next Tuesday is the deadline for making IRA contributions for 2016. Last year’s Accountable Update on the same subject, Allergies and April 18, explored the “cost” of skipping a contribution. That message is still timely if you have the means to make a contribution beforehand. 

The fact is, however, that "nearly half of families have no retirement account savings at all," the Economic Policy Institute (EPI) reported last year. EPI went on to show that the median retirement savings for all families in the US is less than the maximum IRA contribution for 2016 ($5,500).

While it is a sad reality that some folks just have too much month leftover after the money runs out to put something away, for many it is more about the choices we make. So, this year, let’s look at how making different choices can quickly get you on the right track.

Give A Hand Up

This first tip is for parents and grandparents that have the means to make a gift to your kids and grandkids. While the tax laws require earned income to qualify for making an IRA contribution, there is no restriction on where the funding for the IRA comes from.

For example, my 17-year-old had a summer job last year that earned him about $1,200. For 2016, the rules regarding funding an IRA limit contributions to $5,500 or your taxable compensation for the year, if your compensation was less than $5,500. Thus, my son can contribute up to $1,200 to an IRA for last year.

The problem? He has already spent about half of what he earned. But, I’m willing to match him dollar for dollar if he’ll invest it in a Roth IRA. I have taken time to explain to him the value of investing at such a young age. Showing him a compound interest calculator, like the one on the SEC’s website, allowed him to easily see the benefits of regular savings over time.

We've also discussed that he can expect similar matching "gifts" going forward. I hope this results in an early appreciation for the value of saving and investing by improving his understanding that the real payoff is down the road.

While annual gifting does have limitations ($14,000 per donee in 2016-17), it can also provide a very efficient way to transfer wealth, especially if you anticipate your estate will be above the estate tax thresholds.

Spend What’s Left

Have you ever noticed that no matter how much money you make, it never seems to be enough? Perhaps you are seeing the effects of the psychological phenomenon known as “present bias”. This predisposition to opt for the immediate gratification of making a purchase today ultimately comes at the expense of saving for tomorrow. But knowing that we may have that tendency can allow us to effectively plan to overcome it.

Take for example, tax refunds. In 2015, about 70% of tax returns resulted in a tax refund that averaged nearly $3,000. That would fund over half of an IRA contribution for those taxpayers! Some may suggest paying off debt with your refund, but since retirement contributions are "use or lose" opportunities, I favor paying yourself first while you still can.

In households with < $61,500 Adjusted Gross Income, there is also a tax credit available for up to $1,000 if an IRA or other retirement account contribution is made. The credit is referred to as the Retirement Savings Contributions Credit, and while it may only apply to those with relatively modest incomes, it is a pretty sweet incentive for those that qualify. 

I’ve also previously discussed cash back credit cards and “snowballing” debt payments by paying off your highest interest debt first and then applying those payments to the next highest until the debt is paid off. Taking cash back rewards or extinguished debt payments and putting those into your retirement account can really help in making the shift to saving first and spending what is left. 

Small Changes Add Up

While having Mom & Dad helping foot the bill or getting some cash back from Uncle Sam are great, for most of us the reality is that we have to make occasional hard choices when it comes to saving or spending. Before getting into how a few small changes might add up to significant retirement savings, let’s be honest. Budgets, like diets, get blown by rationalizing. Telling yourself that this “one cookie” won’t hurt anything is probably true, until your “one” turns into several. Suddenly those hundred or so calories are now 400-500 and you're left staring at the scale wondering why those pounds won't come off.

The same thing happens when we grab a bottled water, coffee shop latté, or take-out meal. Not only may some of those add inches to our waist, they all take bites out of our wallets. If we just partake in these indulgences on rare occasion, it’s no big deal. But if we aren’t honest with ourselves and allow them to become habit, they can quickly eat up our potential to save more.

Some ideas of places to look for some savings include:

• Limiting withdrawals at your bank’s ATM to once per month instead of hitting any ATM (especially out of network) every time you need $20. 
• Cook your own dinner or bring lunch instead of eating out.
• Drinking tap water.
• Making your own coffee.
• Dropping that premium cable subscription, or cable altogether.
• Stop paying for gym memberships you aren’t using.
• Keep that old phone a while longer and drop the replacement insurance plan.
• Arrange a work carpool.

As you can see below, these can really add up.

ATM Fees[i]	$4	x4 per month	= $16/month
Eating Out[ii]	$10	x5 per week	= $200/month
Bottled H2O[iii]	$1	x1 per day	= $30/month
Coffee[iv]	$2	x1 per day	= $60/month
Reduce Cable	$50	x1 per month	= $50/month
Cut Gym	$25	x1 per month	= $25/month
Reduce Phone	$25	x1 per month	= $25/month
Carpool [v]	$13	x2 per week	= $54/month
			= $460/month

Everyone’s personal situation will vary, but by employing one or more of the ideas we’ve touched on today, you’ll be well on your way to being one of the good statistics. Get in touch if you have any questions.

[i] http://www.bankrate.com/banking/checking/2016-bankrate-checking-account-survey-atm-fees-stay-on-record-setting-streak/

[ii] http://www.thesimpledollar.com/dont-eat-out-as-often-188365/

[iii] http://www.businessinsider.com/bottled-water-costs-2000x-more-than-tap-2013-7

[iv] http://www.fastfoodmenuprices.com/starbucks-prices/

[v] Based on average commute distance of 12.6 miles each way and IRS mileage rate of $.535 per mile

Q1 2017 Market Review

The US stock markets posted impressive gains in Q1 2017 as the “Trump Rally” that began the day after his surprise victory in November of last year showed few signs of losing steam. Expectations of lower taxes, less regulation, and increased infrastructure spending have continued to provide the fuel to propel stocks higher.

The Federal Reserve raised its benchmark interest rate a quarter of a point to 1%, the second increase in three months, with indications of further rate hikes to come. Rising rates are generally an impediment to growth and rising stock prices, but the increase also signals improving confidence in the economy. It also was largely in-line with expectations. If anything, the fear has been that the Fed would raise rates even higher or more often.

International markets, both developed and emerging, posted even stronger gains while commodities, REITs, and bonds lagged. In the fixed income space, domestic bonds outpaced foreign, and municipals did slightly better than government or corporate bonds.

US Large cap stocks and value stocks outperformed small and growth segments.

If you weren’t paying close attention, you may have missed the significant rally in emerging markets stocks. This is just another example of an out of favor asset class turning when you may have least expected it, given the protectionist tenor and anti-globalist rhetoric coming from Washington DC. Believe it or not, the Mexican Peso was the top performing global currency versus the US Dollar!

This is another reminder of why we practice disciplined asset allocation based on your goals, risk tolerance, and risk capacity instead of trying to outguess the markets. It also serves to illustrate that there is a world of opportunity out there, and staying too close to home can cause us to miss out.

The Q1 2017 Market Review features world capital market performance and a timeline of events for the past quarter. It begins with a global overview, then features the returns of stock and bond asset classes in the US and international markets.

As always, if current markets have you concerned about your portfolio, please get in touch for a free review.

Should You Own International Investments?

“Why should we own ANY international investments,” asked one of my clients while discussing their portfolio recently? Then he followed up, "With globalization, don't we get the benefits of investing internationally by just sticking with the largest US companies that do business worldwide?"

For the past several years, strong performance in the domestic stock markets has led to more of these types of questions being asked. It’s not surprising really, since domestic stocks have significantly outperformed international stock markets since 2010.

That recent outperformance can lead investors to underweight, or completely avoid, many investments that are headquartered in other countries. Too much “Home Bias”, however, can mean lost opportunities to share in the success of thousands of companies representing about half of the world's investment dollars, as seen in Exhibit 1. Many of those companies do a lot of business in the USA. Companies such as Nestle, Shell, Toyota, Anheuser-Busch InBev, Michelin, Honda, and Bayer, are just a few examples of household names that would be excluded from a portfolio comprised solely of US stocks.

Exhibit 1

For some, the question may be more about the current political and/or economic atmosphere than anything else. Keep in mind that just as trying to time the ups and downs of local stock markets is virtually impossible, determining beforehand when domestic stocks will outperform international is a guessing game, at best. As seen in Exhibits 2 and 3, there are few (if any) patterns to the performance of developed or emerging stock markets over the past 20 years.

Exhibit 2

Exhibit 3

The recent outperformance of domestic markets may also be leading to memory loss for some of us that invested during “The Lost Decade” of 2000-2009. As a reminder, that was the S&P 500®’s worst 10 year period ever, losing an average of .95% per year. World markets outside the US did considerably better. For example, the MSCI World ex USA Index averaged 1.62%, and the MSCI Emerging Markets Index had a 9.78% annualized return over that same period.

Being diversified doesn't insure against losses. It actually does guarantee that we don’t have a large percentage of our portfolios in whatever stock, industry, or country that is the big winner, or loser, in a given year. But it can lead to better outcomes overall than trying to guess those winners or losers in advance.

Looking back to 1970, the S&P 500® outperformed a globally diversified portfolio in 18 years, while underperforming 29 times. That’s not to say that we'll see a repeat of that pattern, but by investing in a globally diversified portfolio (domestic + international) such as the Dimensional Equity Balanced Strategy[1] , you may smooth out performance and avoid the extremes of attempting to pick the winner or loser.

Exhibit 4

In fact, over that same timeframe, investing in a global portfolio would have beaten the domestic portfolio over 85% of the time.

Exhibit 5

As markets gyrate, it can be tempting to try and guess what foot will be next to rise or fall. But recent events such as Brexit and the US Presidential Election have shown us that markets can, and often do, act contrary to what the conventional wisdom seems to suggest. Keep that in mind if recent news items or random opinions have you second guessing why diversification matters.

Maybe Dartmouth College’s Ken French put it best, “Diversification is about the closest thing to a free lunch in capital markets, so you may as well get a huge helping of it.”

If you’re concerned about your level of diversification, get in touch for free portfolio review. I'll even throw in lunch.

[1] Rebalanced monthly. The Dimensional Equity Balanced Strategy Index is comprised of commercial and Dimensional indices, 70% US equity indices, and 30% non-US indices.  US: S&P 500, large cap value, small cap, small cap value, Dow Jones REIT; non-US: international value, international small cap and small cap value, emerging markets, and emerging markets value and small cap.  Additional index information is available upon request.