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Top takeaways from 10 articles on asset allocation.

By Posted on In Investment Strategies, Rule of Thumb, Uncategorized

I’ve been doing a lot of reading on Asset Allocation this morning and here are a few key takeaways that I think might be helpful to investors:

  • Static allocations assume the relationships between the various asset classes stay the same.  Dynamic allocations assume that the relationships are constantly changing.  Look back over the past five years and you can see how the relationships are in constant state of fluctuation.
  • Dynamic asset allocation can be accomplished with frequent reviews, opportunistic components, and flexible strategies.  It’s more active than static, and requires more effort and time.
  • Leveraging a portfolio (borrowing money to buy more of a certain asset class) to create risk parity across each asset class can reduce the overall risk of the portfolio while providing acceptable returns. This can be complicated to do on your own and comes with its own set of risks and higher costs (cost to borrow money).
  • Marcus Schlumerich, author of The Efficient Frontier in Modern Portfolio Theory, got it right when he stated that “a portfolio is efficient if no other portfolio has the same expected return with lower volatility.”
  • A growing trend in asset allocation goes beyond the standard 60/40 split between stocks and bonds.  New research suggests a broader and deeper use of asset classes can help to reduce risk.
  • Due diligence is becoming increasingly important as new asset classes in the alternative space emerge.
  • Asset classes are cyclical and respond based on economic environments. Changing economic environments cannot be predicted. Portfolios need to be designed with that in mind.

It’s nice to see new research supporting strategies that  have already been implemented in our client portfolios. If you’re interested in putting the Asset Allocation approach to work in your own investment portfolio, please feel free to contact us.

Talk about the magic of compounding interest!

By Posted on In Investment Strategies, Rule of Thumb, Saving, Uncategorized

I just stumbled upon this interesting nugget.  All things being equal, a 19 year old who contributes $2,000 per year for JUST 7 years will have more money at age 65 than a 26 year old who made $2,000 contributions each year until age 65.

Talk about the magic of compounding interest.  Too bad, most 20-somethings won’t realize this until it’s too late.

For details, read: Investment Advice for Gen Y

Four Strategies to Determine Your Asset Allocation.

By Posted on In Investment Behavior, Investment Strategies, Retirement, Rule of Thumb, Uncategorized

Asset allocation is an important component to any portfolio.  It deals with the ratio between various asset classes such as stocks and bonds.  Many investors don’t know where to start or how to determine if their asset allocation is appropriate based on their objectives or risk tolerance. Below are four strategies to determine an appropriate asset allocation.  Each one with pros and cons.

  • Rule-of-thumb Formulas are useful for quick planning purposes.  For an investor, this should be a starting point to see if their current allocation is in the ballpark.
  • Risk Tolerance. Investors can complete questionnaires which can identify how comfortable they feel about volatility in their portfolio.  The questions identify how the investor would feel if they were to see their account value decline by X% over various time frames.  Based on their answers, a portfolio is designed around their risk profile.  This is an objective data-driven solution, which many find appealing. But an investor’s risk profile is not static. It changes day to day, depending on their experiences, the news, and a variety of other factors.  When the economy has a negative outlook, an investor’s appetite for risk is usually much lower than when the economy is bullish.
  • Stage of Life.  Age based asset allocations that adjust over time have grown in popularity.  The premise is simple: as an investor gets closer to retirement, his allocation shifts to more conservative asset classes.  This can help reduce the risk of extreme market volatility right before they enter retirement.  The downside, this approach does not factor in personal considerations such as risk tolerance, longevity or financial goals.
  • Goal based. At times, we have built portfolios around a client’s financial goal, such as having $500,000 in assets by the time they retire.  We can show the client the risk factors he/she would take on to try to reach that goal.  This often sparks a conversation with the client about other factors that should be explored, such as increasing the savings rate or adjusting the goal.

If you’re looking to get started, begin with this popular rule of thumb: subtract your age from 110 to determine your stock percentage, put 10% in cash, and the remainder in bonds. From there, you can edge the portfolio to be more aggressive by increasing your stock holdings or more conservative by increasing cash or bonds.

This is starting point, although you should seek professional guidance in determining an asset allocation that will meet your objectives.

What to do if you forgot your RMD

By Posted on In Retirement, Rule of Thumb, Uncategorized

While there are a couple of exceptions, you’re required to take distributions from an IRA or a 401k under two circumstances. These are known as the Required Minimum Distributions, or “RMDs”, and they generally apply to:

a. Your own IRA, in the year you’ve reached age 70-1/2; and

b. An IRA you inherited, from someone other than your spouse, in the year following that person’s death.

Failure to take the RMD results in one of the most severe penalties you can imagine: the penalty is 50% of the missed distribution amount. So if your IRA is worth $100,000, and the RMD calculation is, say, $4500, the penalty for not taking that distribution is $2250. Ouch!

Luckily that penalty can be waived if you have a good excuse and you correct your oversight. The details are in the IRS guide to IRAs, Publication 590. But Boston area attorney Natalie Choate, a specialist in retirement distribution planning, summarized the process for me when I attended a seminar sponsored by the Boston Tax Institute a couple of weeks ago.

It appears that the IRS will generally waive the penalty when there is both a “reasonable cause” and “remedial action”. Reasonable cause can be an error by the IRA custodian, or bad advice from an advisor, or your illness, military service, or, surprisingly, your incarceration! The remedial action is usually your making up for the distributions that you had previously missed.

You also have to file IRS Form 5329 as follows:

·On line 50, enter the amount of the RMD that you missed

·On line 51, enter the amount of the RMD that you took, usually $0

·On line 52, enter the difference as $0, and mark “RC” in the margin to indicate “reasonable cause”

·Attach a statement on the “reasonable cause”, and provide evidence of the remedy or corrective action.

Form 5329 can be filed as a stand-alone form for the tax year in question, and no amendment of your prior return is needed.

If you find yourself in this situation, you should contact a tax accountant to guide you through the process.

If you have specific questions about your RMDs, please email me at ron@ol-advisors.com

 

Our Take on the “4% Rule” for Retirement Withdrawal

By Posted on In Investment Strategies, Retirement, Rule of Thumb, Uncategorized

Many advisors tell their clients, as a rule of thumb, a client can withdraw about 4% of their portfolio each year, without it affecting the principal. We have been telling our clients this for years. In fact, this rule of thumb dates back a few decades and was determined after a lot of research.

And then a few weeks ago, an article written in the WSJ called into question the validity of the rule of thumb. Its premise is quite simple: if you retire and then your portfolio drops like it did in 2008, then a withdrawal rate of 4% of the original balance would most likely not be able to sustain you through retirement. You would then need to reduce your withdrawal rate. In the investment and financial community, this was quite a statement to make and has caused many individuals to question their current withdrawal rate.

It’s important to consider a few points that the article touches upon, but are overlooked:

1) The “4% Rule” is a rule of thumb, a guide, a rough figure to help investors determine how much they can withdraw from their portfolio in retirement.

2) A client should only take what they need from their portfolios. They should keep as much invested as possible, so their assets can continue to appreciate. An extra $1,000 sitting in a checking account earning next to nothing, should probably stay in invested where it can generate a decent return.

3) The “4% Rule” does account for some of the long tail risks. When this rule of thumb was calculated in the 90’s, it did use data points going back to the depression. Of course, there are scenarios where the “4% Rule” will not work, but these are the outlier scenarios. They are economic situations that happen every 75 years or so. Fortunately, we are recovering from one of them right now.

The most important point to take away from this post and the article is to remember that the “4% Rule” should be renamed “4% Rule of Thumb”. Maybe then investors will understand that withdrawals will have to fluctuate depending on market conditions and their needs.

If you’re interested in some additional information on this topic, Vanguard has a few interesting pieces on the topic.