15 Costly retirement mistakes

15 Costly retirement mistakes

15 Costly retirement mistakes… Retirement is a major milestone for many Americans. Retiring marks the end of your working life and the beginning of a new chapter. As a financial advisor, my job is to help my clients avoid mistakes and retire with confidence and peace of mind.  Together we build a solid roadmap to retirement and a gameplan to achieve your financial goals. My role as a financial advisor is to provide an objective and comprehensive view of my clients’ finances.  As part of my process, I look for any blind spots that can put my clients’ plans at risk.  Here is a list of the major retirement mistakes and how to avoid them.

1. Not planning ahead for retirement

Not planning ahead for retirement can cost you a lot in the long run. Delaying to make key decisions is a huge retirement mistake that can jeopardize your financial security during retirement. Comprehensive financial planners are more likely to save for retirement and feel more confident about achieving their financial goals.  Studies have shown that only 32% of non-planners are likely to have enough saved for retirement versus 91% of comprehensive planners.

Reviewing your retirement plan periodically will help you address any warning signs in your retirement plan. Recent life changes, economic and market downturns or change in the tax law could all have a material impact on your retirement plans. Be proactive and will never get caught off guard.

2. Not asking the right questions

Another big retirement mistake is the fear of asking the right question. Avoiding these

Here are some of the questions that my clients are asking –

  • “Do I have enough savings to retire?”
  •  “Am I on the right track?”.
  • “Can I achieve my financial goals?”
  • “Can I retire if the stock market crashes?”.
  • “Are you fiduciary advisor working in my best interest?” (Yes, I am fiduciary)

Asking those tough questions will prepare you for a successful retirement journey. Addressing your concerns proactively will take you on the right track of meeting your priorities and achieving your personal goals

3. Not paying off debt

Paying off debt can be an enormous burden during retirement. High-interest rate loans can put a heavy toll on your finances and financial freedom. As your wages get replaced by pension and social security benefits, your expenses will remain the same. If you are still paying off loans, come up with a plan on how to lower your debt and interest cost. Being debt-free will reduce the stress out of losing viable income.

4. Not setting goals

Having goals is a way to visualize your ideal future. Not having goals is a retirement mistake that can jeopardize your financial independence during retirement. Without specific goals, your retirement planning could be much harder and painful. With specific goals, you have clarity of what you want and what you want to achieve. You can make financial decisions and choose investment products and services that align with your objectives and priorities. Setting goals will put you on a successful track to enjoy what matters most to you.

5. Not saving enough

An alarming 22% of Americans have less than $5,000 in retirement savings. The average 401k balance according to Fidelity is $103,700. These figures are scary. It means that most Americans are not financially ready for retirement. With ultra-low interest rates combined with constantly rising costs of health care,  future retirees will find it difficult to replace their working-age income once they retire. Fortunately, many employers now offer some type of workplace retirement savings plans such as 401k, 403b, 457, TSP or SEP IRA. If your employer doesn’t offer any of those, you can still save in Traditional IRA, Roth IRA, investment account or the old fashioned savings account.

6. Relying on one source for retirement income

Many future retirees are entirely dependent on a single source for their retirement income such as social security or pension.  Unfortunately. with social security running out of money and many pension plans shutting down or running a huge deficit, the burden will be on ourselves to provide reliable income during our retirement years. If you want to be financially independent, make sure that your retirement income comes from multiple sources.

7. Lack of diversification

Diversification is the only free lunch you can get in investing and will help decrease the overall risk of your portfolio. Adding uncorrelated asset classes such as small-cap, international and emerging market stocks, bonds, and commodities will reduce the volatility of your investments without sacrificing much of the expected return in the long run.

A common mistake among retirees is the lack of diversification. Many of their investment portfolios are heavily invested in stocks, a target retirement fund or a single index fund.

Furthermore, owning too much of one stock or a fund can cause significant issues to your retirement savings. Just ask the folks who worked for Enron or Lehman Brothers who had their employer’s stocks in their retirement plans. Their lifetime savings were wiped out overnight when these companies filed for bankruptcy.

8. Not rebalancing your investment portfolio

Regular rebalancing ensures that your portfolio stays within your desired risk level. While tempting to keep a stock or an asset class that has been on the rise, not rebalancing to your original target allocation can significantly increase the risk of your investments.

9. Paying high fees

Paying high fees for mutual funds and high commission insurance products can eat up a lot of your return. It is crucial to invest in low-cost investment managers that can produce superior returns over time. If you own a fund that has consistently underperformed its benchmark,  maybe it’s time to revisit your options.

Many insurance products like annuities and life insurance while good on paper, come with high upfront commissions, high annual fees, and surrender charges and restrictions.  Before signing a contract or buying a product, make sure you are comfortable with what you are going to pay.

10. No budgeting

Adhering to a budget before and during retirement is critical for your confidence and financial success. When balancing your budget, you can live within your means and make well-informed and timed decisions. Having a budget will ensure that you can reach your financial goals.

11. No tax planning

Not planning your taxes can be a costly retirement mistake. Your pension and social security are taxable. So are your distributions from 401k and IRAs. Long-term investing will produce gains, and many of these gains will be taxable. As you grow our retirement saving the complexity of assets will increase. And therefore the tax impact of using your investment portfolio for retirement income can be substantial. Building a long-term strategy with a focus on taxes can optimize your after-tax returns when you manage your investments.

12. No estate planning

Many people want to leave some legacy behind them. Building a robust estate plan will make that happen. Whether you want to leave something to your children or grandchildren or make a large contribution to your favorite foundation, estate, and financial planning is important to secure your best interests and maximize the benefits for yourself and your beneficiaries.

13. Not having an exit planning

Sound exit planning is crucial for business owners. Often times entrepreneurs rely on selling their business to fund their retirement. Unlike liquid investments in stocks and bonds, corporations and real estate are a lot harder to divest.  Seling your business may have serious tax and legal consequences. Having a solid exit plan will ensure the smooth transition of ownership, business continuity, and optimized tax impact.

14. Not seeing the big picture

Between our family life, friends, personal interests, causes, job, real estate properties, retirement portfolio, insurance and so on, our lives become a web of interconnected relationships. Above all is you as the primary driver of your fortune. Any change of this structure can positively or adversely impact the other pieces. Putting all elements together and building a comprehensive picture of your financial life will help you manage these relationships in the best possible way.

15. Not getting help

Some people are very self-driven and do very well by planning for their own retirement. Others who are occupied with their career or family may not have the time or ability to deal with the complexities of financial planning. Seeking help from a fiduciary financial planner can help you avoid retirement mistakes. A fiduciary advisor will watch for your blind spots and help you find clarity when making crucial financial decisions.

Your Retirement Checklist

Retirement checklist

A happy and financially secure retirement is a primary goal for many working Americans. I created a retirement checklist that will help you navigate through the complex path of retirement planning. For my readers who are serious about their retirement planning, follow these 12 steps to organize and simplify your planning process. My 12-step retirement checklist can be a practical roadmap regardless of the age you want to retire. Following these steps will ensure that you have reviewed all aspects of your life and how they can impact your decisions before and during your retirement. Here is the crucial retirement checklist of all the things you need to do in preparation for the next chapter of your life.

1. Know what you own

You have worked very hard for this moment. You have earned and saved during your entire career. Now it’s time to benefit from your hard work. The first step of your retirement checklist is understanding what you own. Don’t guess. Don’t assume. You need to thoroughly evaluate all your assets, real estate, businesses, and retirement savings. Everything that you have accumulated during your working years can play a pivotal role in your successful retirement.

2. Gather all your financial documents

On the second step of your retirement checklist, you need to collect all relevant documents that show your asset ownership – financial statements, trust documents, wills, property deeds. This will be an excellent opportunity to gather all your plan statements from old 401k and retirement plans. If you own a real estate, make sure you have all your deeds in place. If you are beneficiary of a trust, collect all trust documents. Check all your bank, saving accounts and social security statements. Make sure that you build a complete picture of your financial life.

3. Pay of off your debt

One of your main pre-retirement goals is to become debt-free. If you are still paying off your mortgage, student loans, personal loans or credit card debt, now it’s a great time to review your finances and come up with a payment plan that will help you pay off your debts and improve your retirement prospects.

4. Build an emergency fund

The emergency fund is your rainy-day money. It’s the money that covers unexpected expenses. So, you don’t have to dip in your regular monthly budget. It’s the money that will help you if you unexpectedly lose your job or otherwise unable to earn money. I recommend keeping at least six months’ worth of living expenses in a separate savings account. Ideally, you should have built your emergency fund long before you decided to retire. If you haven’t started yet, it’s never too late to create one. You can set aside a certain percentage of your monthly income to fill the emergency fund until you reach a comfortable level.

5. Learn your employee benefits

Sometimes employers offer generous retirement benefits to attract and retain top talent. Many companies and public institutions provide 401k contribution matching, profit sharing or a pension. Some employers may even offer certain retirement health care benefits. If you are lucky to work for these companies and public organizations, learn your benefits package. Ensure that you are taking full advantage of your employee benefits. Don’t leave any free money on the table.

6. Secure health insurance

A retired couple will spend, on average, $285,000 for healthcare-related expenses during their retirement. This cost is only going higher at a faster rate than regular inflation. Even if you are in good health, healthcare will be one of your highest expenses after you retire.

Medicare part A and part B cover only part of your healthcare cost including impatient and hospital care. They do not include long-term care, dental care, eye exams, dentures, cosmetic surgery, acupuncture, hearing aids and exams, routine foot care. You will be responsible for paying for Medicare parts D out of pocket through your private Medicare Advantage insurance. Medicare Advantage is a "bundled" plan that includes Medicare Part A (Hospital Insurance) and Medicare Part B (Medical Insurance), and usually Medicare prescription drug (Part D).

7. Maximize your savings

Unless you have a generous pension, you will have to rely on your retirement savings to support yourself during retirement. Your 401k and IRA will likely be your primary retirement income source. So even if you have championed your retirement savings, now it’s a great time to calculate if your accumulated savings can support you during retirement. To boost your confidence, maximize your retirement contributions to 401k plans, IRA and even taxable investment accounts. Once you reach 50, the 401k and IRA plans will allow making additional catch up contributions.

There is another compelling reason to save in tax-deferred retirement accounts. If you are in the prime period of your earnings, you are probably in a very high tax bracket. Maximizing your tax-deferred retirement contributions will lower your tax bill for the year. You can withdraw your money

8. Prepare your estate plan

Estate planning is the process of assigning trustees and beneficiaries, writing a will, giving power of attorney, and health directives. The estate plan will guarantee that your wishes are fulfilled, and your loved ones are taken care of if you die or become incapacitated. Creating a trust will ensure that your beneficiaries will avoid lengthy, expensive and public probate. Update your beneficiaries in all your retirement accounts.

Estate planning is never a pleasant topic or an ice-breaking conversation. The sooner you get it done the sooner will go on with your life.

9. Set your budget

Budgeting is a critical step in your retirement checklist. Once you retire, you may no longer earn a wage, but you will still have monthly expenses. Retirement will give you a chance to do things for which you haven’t had time before that. Some people like to travel. Some may pick up a hobby or follow a charitable cause. Others may decide to help with grandchildren. You may choose to buy a house and live closer to your kids. Whatever lifestyle you choose, you need to ensure that your budget can support it.

10. Create social security and retirement income strategy

The most crucial step in your retirement checklist is creating your income strategy. This is the part where you might need the help of a financial planner so you can get the most out of your retirement savings and social security benefits. Your retirement income strategy should be tailored to your specific needs, lifestyle, type of savings and the variety of your assets.

11. Craft a tax strategy

Even though you are retired, you still have to pay taxes. Up to 85% of your social security benefits can be taxable. All your distributions from your 401k plan and Traditional IRA will be subject to federal and state tax. All your dividends and interest in your investment and savings accounts are taxable as well.

Only, the distributions from Roth IRA are not taxable. As long as you have your Roth IRA open for more than five years and you are 59 ½ or older, your withdrawals from the Roth IRA will be tax-free.

Ask your financial advisor to craft a tax strategy that minimizes your tax payments over the long run. Find out if Roth Conversion makes sense to you.

12. Set your retirement goals

Retirement opens another chapter in your life. The people who enjoy their retirement the most are those who have retirement goals. Find out what makes you happy and follow your passions. Your retirement will give you a chance to do everything that you have missed while you were pursuing your career.

Final words

Navigating through your retirement checklist will be a reflection of your life, career, assets, and family. No one’s retirement plan is the same. Everybody’s situation is unique and different. Follow these simple 12 steps so you can enjoy and better prepare for your retirement. Be proactive. Don’t wait until the last minute for crucial financial decisions. Make well-informed choices so you can be ahead of life events and enjoy your retirement to the fullest.

Early retirement for physicians

Early retirement for physicians

Early retirement for physicians….As someone married to a physician and surrounded by many friends in the medical field, I know that early retirement is on the minds of many physicians. If you are reading this article, you have probably put some serious thoughts about it as well.

Retiring early is a very personal decision. And it is not an easy decision to make. It would be best if you considered many financial and personal factors before you make the final call. Retirement will change your lifestyle dramatically. Your salary and healthcare benefits will be different. You might experience an unexpected change of pace. You may lose touch with colleagues and friends. On the bright side, you can travel and do things that matter most to you. Your stress level will go down, and you will spend more time with your family and loved ones.

Physician Burnout

Many physicians decide to leave the profession due to physical and emotional stress. A 2019 study by the AMA, the Mayo Clinic and Stanford University School of Medicine found that 44% of U.S. physicians presented at least one symptom of burnout. For comparison, the overall burnout among US workers is 28%.

Among the specialties with the highest burnout rate are Urology (54%), Neurology (53%), Physical Medicine and Rehabilitation (52%), Internal Medicine (49%), and Emergency Medicine (48%).

The peer pressure for early retirement

Be prepared to encounter some resistance from colleagues and patients when you announce your early retirement. There is this unspoken public “belief” that doctors owe the society their skills and knowledge. Many patients don’t want to look for another doctor. And some of your colleagues may feel that you are abandoning the profession. You need to ignore the noise and focus on your personal goals.

I compiled a list of suggestions that will help you prepare on your journey to early retirement. Don’t wait until the last moment. Get ahead of the curve so that you can take the financial stress out of your retirement plans.

Study your benefits

The first step to early retirement for physicians is to know your employee benefits in full detail. Most public and private healthcare systems offer competitive benefits packages with a wide range of perks including pension, 401k match, profit sharing, healthcare coverage, life insurance, disability insurance, and loan repayment. Many employers even offer an early retirement option at 55.

These benefit packages vary significantly from one employer to the next. Take some time to learn and understand your options. If your goal is to retire early, consider an employer that will give you the highest chance to achieve this goal.

Become debt-free

The US student debt has skyrocketed to $1.6 trillion. Seventy-five percent of medical students graduated in their class of 2018 with student debt. The average loan per student is $196,520. Furthermore, many medical students graduate with more than $300,000 in debt. It’s not uncommon that some physician couples owe over half a million dollars in student debt.

A crucial step in your journey to early retirement for physicians is paying off ALL YOUR DEBT including student loans, credit cards, and mortgage. It might seem like an uphill battle, but it’s not impossible.

There are several options you can consider when tackling your student loans – loan forgiveness, refinancing with low-interest rates and income-driven repayment.

Maximize your retirement savings

When you retire early, assuming before the age of 66, you will not have full access to your social security benefits, pension, and Medicare benefits. In many cases, you may want to delay taking your pension and social security to maximize the amount you will receive annually.

One way to cover the gap while you are waiting is through your personal retirement savings. Most employers nowadays offer either a 401k, a 403b, or a 457-retirement plan. When you join your employer retirement plan, you can save up to $19,000 per year as of 2019. If you are 50 or older, you can save an additional $6,000 for a total of $25,000 per year. An additional benefit to you is that these contributions are tax-deductible and will lower your tax bill. Many employers also offer a match that can further boost your retirement savings. For more information about how to increase your 401k savings, read my article about “The Secret to becoming a 401k millionaire.

Save outside your retirement plan

if you plan to retire early, you need to make additional savings outside of your retirement plan.

First, you need an emergency fund. It would help if you had at least six months’ worth of living expenses in cash or a savings account. This emergency fund will serve you as a buffer in case of sudden and unexpected expenses.

Second, save in a taxable investment account. The main benefit of using an investment account is liquidity. You can access these funds at any point in time without any restrictions.

If you retire in your 40s or 50s, you may not be able to access your retirement accounts before reaching 59 ½. There are some legal exemptions, including poor health, disability and economic hardship that allow withdrawing your retirement savings without a penalty. However, these exceptions may not apply to you. And ideally, you should let your tax-deferred retirement savings grow for as long as possible.

Investing outside of your retirement accounts does not provide immediate tax benefits. All investments will be after-taxes. You may also incur taxes on dividends and capital gains. To make the most out of your investment account, make sure to use low cost, tax-efficient ETFs, and index funds.

Have an exit strategy if you own a medical practice

If you own a medical practice and want to retire early, you will need a sound exit and succession plan. You will have to find a suitable buyer or someone who will manage the day-to-operations on your behalf. Many business owners have a significant portion of their wealth, locked-in their business. If selling your practice is the primary source of your retirement income, then you will need to consider tax implications from any potential realized capital gains.

Consider moving to a low-cost location

If you currently work and live in an expensive area like San Francisco or New York City, you may want to consider retiring in a different state or even another country. The cost of living differential between Mississippi or Arkansas versus New York and California could make a big difference in your retirement lifestyle, especially if you are working on a tight budget.

Look for healthcare coverage

One of the main challenges, when you plan for early retirement for physicians, will be healthcare coverage. Depending on your employer, some doctors have excellent medical and dental benefits. In some cases, these benefits are completely free or heavily subsidized by your employer.  Some hospitals that offer an early retirement option could have healthcare benefits included. In other cases, when you retire early, you could lose these perks. Since you won’t have access to Medicare until you reach 65, you will need to find a reasonably priced healthcare insurance policy.

Do not underestimate healthcare costs. According to Fidelity, a 65-year old couple retiring in 2019 can expect to spend $285,000 in health care and medical expenses throughout retirement. For single retirees, the health care cost could reach $150,000 for women and $135,000 for men.

Consider working per diem

If you are short of retirement savings or bored of staying at home, you may consider working per diem or locum tenens. You can work on an hourly basis at your own pace. The extra work will boost your early retirement income and will keep your knowledge up to date.

Stick to a budget

You must adhere to a budget before and after your retirement. Before retirement, you need to pay off your debt and save for retirement aggressively. Depending on your income, these payments can cut through your family budget. You may have to make some tough choices to avoid or delay large purchases and curb discretionary spending.

Once you retire, your income may go down. True, you don’t have to drive to work, but some of your expenses might still be the same.

Here are some ideas about how to save money. Cook instead of going to a restaurant. Make your own coffee. Drive your old car instead of buying a new one. Travel off-season.

Have a plan

A happy retirement comes with a good plan. It may require some self-discovery but ultimately will lead to finding a purpose and fulfilling your life dreams. You can travel and volunteer. Write a book. Teach. Learn a new hobby or language. Find out what makes you happy outside of your daily routine and make the most out of your free time.

The bottom line on early retirement

Early retirement for physicians is not an illusion. It’s an achievable mission that requires a great deal of planning and some personal sacrifice. If you want to retire early, you need to start planning now. Some hospital systems offer early retirement packages. Unfortunately, your guaranteed retirement income or pension will be a lot less than what you would get if you retire ten years later.

Your family can be a big influencer for or against your decision to retire early.  You might have a partner who wants to stay active. Perhaps, you have children who are going to college soon. Every family is different, and every situation is unique. Do the number crunching and see what makes the most sense to you.

10 Behavioral biases that can ruin your investments

10 Behavioral biases that can ruin your investments

As a financial advisor, I often speak with my clients about behavioral biases. Our emotions can put a heavy load on our investment decisions. In this article, I would like to discuss ten behavioral biases that I encounter every day. It’s not a complete list, but it’s a good starting point to understand your behavioral biases and how to deal with them.

We have to make choices every day. Often our decisions are based on limited information or constrained by time. We want to make the right call every single time. But sometimes we are wrong. Sometimes we can be our worst enemy. Stress, distraction, media, and market craziness could get the worst of us.

Behavioral finance

In 2018 Richard Thaler won the Nobel prize for his work in behavioral economics. In his 2009 book “Nudge” and later on in his 2015 book “Misbehaving: The Making of Behavioral Economics,” Thaler reveals the architecture of the human decision-making process. He talks about behavioral biases, anomalies, and impulses that drive our daily choices.

In another study about the value of the financial advisor or the advisor alpha, Vanguard concluded that clients using a financial advisor have the potential to add 1.5% of additional annual returns as a result of behavioral coaching. Further on, Vanguard concludes that because investing evokes emotion, advisors need to help their clients maintain a long-term perspective and a disciplined approach.

 

Afraid to start investing 

Social Security is going into deficit by 2035. And most employers moving toward Defined Contribution Plans (401k, 403b, SEP-IRA). It will be up to you and me to secure our retirement by increasing our savings and investments. However, not everybody is in tune. For many people, investing is hard. It’s too complicated. Not all employers provide adequate training about retirement and investment options. And I don’t blame anyone. As much as I try to educate my blog readers, as well as many colleagues, we are outnumbered by the media and all kinds of financial gurus without proper training and credentials. If you are on the boat and want to start investing, talk to a fiduciary financial advisor, or ask your employer for educational and training literature. Don’t be afraid to ask hard questions and educate yourself.

“This time is different.”

How many times have you heard “This time is different” from a family member or the next financial guru, who is trying to sell you something? Very likely, it’s not going to be any different. As a matter, it could be worse. As humans, we tend to repeat our mistake over and over. It’s not that we don’t learn from our mistakes. But sometimes it’s just more comforting staying on your turf, not trying something new, and hoping that things will change. So, when you hear “This time is different,” you should be on high alert. Try to read between the lines and assess all your options.

Falling for “guaranteed income” or “can’t lose money” sales pitch

As many people are falling behind their retirement savings, they get tempted to a wide range of “guaranteed income” and “can’t lose money” financial products. The long list includes but not limited to annuities, life insurance products, private real estate, cryptocurrency, and reverse mortgage. Many of these products come with sky-high commissions and less than transparent fees, costly riders, and complex restrictions and high breakup fees. The sales pitch is often at an expensive steakhouse or a golf club following a meeting in the salesperson’s office where the deals are closed. If someone is offering you a free steak dinner to buy a financial product that you do not fully understand, please trust me on it – you will be the one picking the tab in the end.

Selling after a market crash

One of the most prominent behavioral biases people make in investing is selling their investments after a market crash. As painful as it could be, it’s one of the worst decisions you could make. Yes, markets are volatile. Yes, markets crash sometimes. But nobody has made any money panicking. You need to control your impulses to sell at the bottom. I know it’s not easy because I have been there myself. What really helps is thinking long-term. You can ask yourself, do you need this money right away. If you are going to retire in another 10 or 20 years, you don’t need to touch your portfolio, period. Market swings are an essential part of the economic cycle. Recessions help clean up the bad companies with a poor business model and ineffective management and let the winners take over.

You may remember that the rise of Apple coincided with the biggest recession in our lifetime, 2008 – 2009. Does anyone still remember Blackberry, Nokia, or Motorola, who were the pioneers of mobile phones?

Keeping your investments in cash

Another common behavioral bias is keeping your investments in cash…..indefinitely. People who keep their 401k or IRA in cash almost always miss the market recovery. At that point, they either have to chase the rally or must wait for a market correction and try to get in again. As a financial advisor, I would like to tell you that it is impossible to time exactly any market rally. By the time you realize it. It’s already too late.

To understand why timing the markets and avoiding risk by keeping cash can be harmful, see what happens if an investor misses the biggest up days in the market. The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis.

10 Behavioral biases that can ruin your investments - Keeping Cash

As you can see, missing the ten best days over between 1998 and 2018 meant earning nearly 2.5% less on an annual basis and leaving half of the potential absolute gains on the table. Here’s the kicker: Six of the 10 “best days” in the market were within weeks of the worst days in the market. In other words, some of the best days often happen as “v-shaped” bounces off the worst days. Going to cash on a big negative day means increasing the risk of missing a big positive day which, as can be seen from the table above, can have a substantial impact on your returns over time.

Chasing hot investments

One of the most common behavioral biases is chasing hot investments. People generally like to be with the winners. It feels good. It pumps your ego. There is a whole theory of momentum investing based on findings that investors buy recent winners and continue to buy their stock for another 6 to 12 months. We have seen it time and time again – from the tech bubble in 2000, through the mortgage-backed securities in 2008, to cryptocurrency and cannabis stocks in 2018. People like highflyers. Some prior hot stocks like Apple, Google, and Amazon dominate the stock markets today. Others like Motorola, Nokia, and GE dwindle in obscureness. If an investment had a considerable run, sometimes it’s better to let it go. Don’t chase it.

Holding your losers too long

“The most important thing to do if you find yourself in a hole is to stop digging.” – Warren Buffett.

In a research conducted in the 1990s by professor Terrance Odean, he concluded that investors tend to hold to their losers a lot longer than their winners. A result of this approach, those investors continue to incur losses in the near future. Professor Odean offers a few explanations for his findings. One reason is that investors rationally or irrationally believe that their current losers will outperform. A second explanation comes from the Prospect Theory by Kahneman and Tversky (1979). According to them, investors become risk-averse about their winners and risk-seeking to their losers.

When it comes to losing bets, they are willing to take a higher gamble and seek to recover their original purchase price. A third theory that I support and observed is based on emotions. The pain from selling your losers is twice as high as the joy from selling your winners. We don’t like to be wrong. We want to hold on to the hope that we made the right decision. After all, it is a gamble, and the odds will be against you. At some point, we just need to make peace with your losses and move on. It’s not easy, but it’s the right thing to do.

Holding your winners too long

There is a quote by the famous financier Bernard Baruch – “I made my money by selling too soon.” Many people, however, often hold on to their winners for very long. Psychologically, it’s comforting to see your winners and feel great about your investment choices. There is nothing wrong with being a winner. But at some point, you must ask yourself, is it worth it. How long this run can go for and should you cash in some of your profits. What if your winners are making up a large part of your investment portfolio? Wouldn’t this put your entire retirement savings at risk if something were to happen to that investment?

There is no one-size-fits-all answer when it comes to selling your winners. Furthermore, there could be tax implications if you realize the gains in your brokerage account. However, it’s prudent to have an exit strategy. As much as it hurts (stops the joy) to sell the winners, it could lower the risk of your portfolio and allow you to diversify amongst other investments and asset classes.

Checking your portfolio every day

The stock market is volatile. Your investments will change every day. There will be large swings in both directions. So, checking your portfolio every single day can only drive crazy and will not move the needle. It could lead to irrational and emotional decisions that could have serious long-term repercussions. Be patient, disciplined, and follow your long-term plan.

Not seeking advice

Seeking advice from a complete stranger can be scary. You must reveal some of your biggest secrets to a person you never met before. It’s s big step. I wish the media spends more time talking about the thousands of fiduciary advisors out there who honestly and trustworthy look for your best interest.

My financial advisory service is based on trust between you as a client and me as the advisor . So, do not be afraid to seek advice, but you also need to do your homework. Find an advisor who will represent you and your family and will care about your personal goal and financial priorities. Don’t be afraid to interview several advisors before you find the best match for you.

Final words

“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” – Warren Buffet.

Investing is an emotional act. We put our chips on the table and wish for a great outcome. We win, or we lose. Understanding your emotions and behavioral biases will help you become a better investor. It doesn’t mean that we will always make the right decisions. It doesn’t mean that we will never make a mistake again. We are humans, not robots. Behavioral biases are part of our system. Knowing how we feel and why feel a certain way, can help us when the markets are volatile, when things get ugly or the “next big thing” is offered to us. Look at the big picture. Know your goals and financial priorities. Try to block the noise and keep a long-term view.

Reach out

If you have questions about your investments and retirement savings, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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The biggest risks for your retirement savings

Biggest risks to your retirement savings

Whether you are just starting your career or about to retire, you need to understand the risks you are facing when you plan for your future retirement.

Most experts recommend that you should aim to replace about 80% of work income during your retirement. Part of your retirement income will come from Social Security. Other sources could be a public pension, IRAs, 401k, rental income, sale of real estate or business, royalties, or a part-time job. However, the 80% is not a definite number. The amount you need in retirement could vary substantially depending on your lifestyle, family size, number of dependents, health issues, and so on.

Social Security benefits

The maximum Social Security benefit in 2019:

  • $3,770 for someone who files at age 70.
  • $2,861 for someone at a full retirement age of 66
  • $2,209 for someone aged 62

For reference, very few people reach these upper limits. The average Social Security retirement benefit in 2019 is $1,461 a month. The average disability benefit is $1,234.

Unfortunately, the Social Security trust is already running a deficit. Currently, the Social Security is paying more benefits than all the proceed its receiving from the payroll taxes. Its reserve will be depleted by 2035. After that point, social security recipients will have to receive only a portion of their actual benefit. The current estimate is around 75%.

Pension Shortfall

Similarly to Social Security, most of the public and private pension plans nationwide have an enormous shortfall between assets and their future liabilities. According to a recent study by Pew Charitable Trust and Pension Tracker, US public pension shortfall is over $1 trillion. States like Alaska, California, Illinois, Ohio, Hawaii, and New Jersey have one of the highest pension burdens in the nation. Even after ten years of economic recovery and bull market, most state pension plans are not prepared to face another downturn. Policymakers must take urgent measures to close the pension funding gap, which remains at historically high levels as a share of GDP.

Low savings rate

With social security benefits expected to shrink, I advise my clients that they need to increase their savings in order to supplement their income in the future. Retirement savings in IRA, 401k and even a brokerage account will provide you with the necessary income during your retirement years.

Unfortunately, not everyone is forward-looking. The average 401k balance, according to Fidelity, is $106,000 in 2019, while the average IRA is $110,000. The sad reality is that most Americans do not save enough for retirement and we are facing a retirement crisis.

Not saving enough for retirement is the highest risk of enjoying your retirement years.

Relying on a single source

Many people make the mistake of relying on a single source of income for their retirement.  

Imagine that you were planning to retire in 2009 upon selling a piece of real estate. Or you had all your retirement savings in a 401k plan and the market just crashed 50%.  Many of these folks had to delay their retirement for several years to make up for the lost income. Similarly, selling your business can be risky too. With technology advancements, many businesses are becoming obsolete. You may not always be able to find buyers or get the highest price for your business.

We always recommend to our clients to have a diversified stream of retirement income. Diversifying your source will create a natural safety net and potentially could increase the predictability of your income in retirement.

Market risk

We all would like to retire when the market is up and our retirement account balance is high. However, the income from these retirement accounts like IRA, Roth IRA and 401k are not guaranteed. As more people relying on them for retirement, their savings become subject to market turbulence and the wellbeing of the economy.  Today, prospective retirees must confront with high equity valuations, volatile markets, and ultra-low and even negative yields.

In my practice, I use my clients’ risk tolerance as an indicator of their comfort level during market volatility. With market risk in mind, I craft well-diversified individual retirement strategies based on my clients’ risk tolerance and long-term and short-term financial goals.

Sequence of returns

The sequence of returns is the order of how your portfolio returns happen over time. If you are in your accumulation phase, the sequence of return doesn’t impact your final outcome. You will end up with the same amount regardless of the order of your annual returns.  

However, if you are in your withdrawal phase, the sequence of returns can have a dramatic impact on your retirement income. Most retires with a 401k or IRAs have to periodically sell a portion of their portfolios to supplement their income. Most financial planning software uses an average annual return rate to project future account balance. However, these average estimates become meaningless if you experience a large loss at the start of your retirement.

Our retirement strategies take the sequence of returns very seriously. Some of the tools we use involve maintaining cash buffers, building bond ladders and keeping a flexible budget.

Taxes

Your IRA balance might be comforting but not all of it is yours. You will owe income taxes on every dollar you take out of any tax-deferred account (IRA, 401k, 403b). You will pay capital gain taxes on all realized gains in your brokerage accounts. Even Social Security is taxable.

With skyrocketing deficits in the treasury budget, social security and public pensions will guarantee one thing – higher taxes. There is no doubt that someone will have to pick up the check. And that someone is the US taxpayer – me and you.

Managing your taxes is a core function of our wealth management practice. Obviously, we all must pay taxes. And we can not predict what politicians will decide in the future. However, managing your investments in a tax-efficient manner will ensure that you keep more money in your pocket.

Inflation risk

Most retirees have a significant portion of their portfolios in fixed income. Modern portfolio managers use fixed income instruments to reduce investment risk for their clients. At the time of this article, we are seeing negative and near-zero interest rates around the world. However, with inflation going at around 2% a year, the income from fixed-income investments will not cover the cost of living adjustments. Retirees will effectively lose purchasing power on their dollars.

Interest risk

Bonds lose value when interest rates go up and make gains when interest rates go down. For over a decade, we have seen rock bottom interest rates. We had a small blip in 2018 when the Fed raised rates 4 times and 1 year’s CDs reached 2.5%. At that point in time, many investors were worried that higher interest rates will hurt bond investors, consumers and even companies who use a lot of debt to finance their business. Even though these fears are subdued for now, interest rates remain a viable threat. Negative interest rates are as bad for fixed income investors as the high rates are. Unfortunately, traditional bond portfolios may not be sufficient to provide income and protect investors for market swings. Investors will need to seek alternatives or take higher risks to generate income.

Unexpected expenses

Most financial planning software will lay out a financial plan including your projected costs during retirement. While most financial planning software these days is quite sophisticated, the plan remains a plan. We can not predict the unexpected. In my practice, I regularly see clients withdrawing large sums from their retirement savings to finance a new home, renovation, a new car, college fees, legal fees, unexpectedly high taxes and so on. Reducing your retirement savings can be a bad idea on many levels. I typically recommend building an emergency fund worth at least 6 months of living expenses to cover any unexpected expenses that may occur. That way, you don’t have to touch your retirement savings.

Healthcare cost

The average health care cost of a retired couple is $260,000. This estimate could vary significantly depending on your health. Unless you have full health insurance from your previous employer, you will need to budget a portion of your retirement savings to cover health-related expenses. Keep in mind that Medicare part A covers only part of your health cost. The remaining, parts B, C, and D, will be paid out of pocket or through private insurance.

Furthermore, as CNBC reported, the cost of long-term care insurance has gone up by more than 60% between 2013 and 2018 and continues to go higher. The annual national median cost of a private room in a nursing home was $100,375 in 2018.

For future retirees, even those in good shape, healthcare costs will be one of the largest expenses during retirement. In my practice, I take this risk very seriously and work with my clients to cover all bases of their health care coverage during retirement.

Longevity

Longevity risk is the risk of running out of money during retirement. Running out of money depends on an array of factors including your health, lifestyle, family support and the size and sources of retirement income.  My goal as a financial advisor is to ensure that your money lasts you through the rest of your life.

Legacy risk

For many of my clients leaving a legacy is an important part of their personal goal. Whether funding college expenses, taking care of loved ones or donating to a charitable cause, legacy planning is a cornerstone of our financial plan. Having a robust estate plan will reduce the risks to your assets when you are gone or incapacitated to make decisions.

Liquidity Risk

Liquidity risk is the risk that you will not be able to find buyers for your investments and other assets that you are ready to sell. Often times, during an economic downturn, the liquidity shrinks. There will be more sellers than buyers. The banks are not willing to extend loans to finance riskier deals. In many cases, the sellers will have to sell their assets at a significant discount to facilitate the transaction.

Behavioral risk

Typically, investors are willing to take more risk when the economy is good and the equity markets are high. Investors become more conservative and risk-averse when markets drop significantly. As humans, we have behavioral biases, Sometimes, we let our emotions get the worst of us. We spend frivolously. We chase hot stocks. Or keep all investments in cash. Or sell after a market crash. Working with a fiduciary advisor will help you understand these biases. Together, we can find a way to make unbiased decisions looking after your top financial priorities.

Final Words

Preparing for retirement is a long process. It involves a wide range of obstacles. With proper long-term planning, you can avoid or minimize some of these risks. You can focus on reaching your financial goals and enjoying what matters most to you.

Reach out

If you need help growing your retirement savings, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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Why negative interest rates are bad for your portfolio

Why negative interest rates are bad for your portfolio

Quantitative Easing

Ever since the financial crisis of 2008-2009, central banks around the world have been using lower interest rates and Quantitative Easing (QE) to combat to slow growth and recession fears. In the aftermath of the Great Recession, all major central banks cut their funding interest rate to nearly zero.

The QE policy led to the longest US economic expansion in history. As the US economy improved, the Federal Reserve started hiking rates in late 2015 and continued hiking until December of 2018. The Fen fund rate reached 2.4% in the early months of 2019. In the meantime, the European and Japan Central Banks hovered their interest rates near zero. In 2016, for the first time, we registered negative interest rates in Europe and Japan.

The trade wars

Escalating fears for slowing global growth and trade war threats had forced the Fed to announce its first rate cut since the financial crisis. While widely expected, the rate cut triggered a chain of events. First, President Trump imposed an additional 10% import tax on $300 billion of Chinese good. In return, the Chinese central bank lowered the target exchange rate between US dollars and yuan to 7.0039, the lowest level since April 2008. Losing confidence for a quick trade resolution the equity markets sold off by 3%. The 10-year Treasury fell to 1.7%, one of the lowest levels since the financial crisis.

Negative interest rates

Fearing that the intensifying trade war between the US and China could adversely impact the global economy, many Central banks around the world cut their funding rates to zero or even negative levels. Most recently the Reserve Bank of New Zealand lowered its rate from 1.5% to 1%. Furthermore, the New Zealand Governor said, “It’s easily within the realms of possibility that we might have to use negative interest rates,”

In Germany, the 30-year government bond turned negative for the first time last week. In Japan, the 10-year government bond yields -0.2%.

As we stand today, there is $15 trillion in government bonds that offer negative interest rates, according to Deutsche Bank. In short, European investors are paying to own EU government bonds. 

In addition, there are 14 European below investment grade bond issuers trading at negatives rates. Conventionally, the junk bonds are issued by risky borrowers with weaker balance sheets that may struggle to pay back their loans. The typical junk-bond offers a higher income to compensate investors for taking the higher risk of not getting paid at all.

So why negative interest rates are bad for your portfolio

Traditionally, retired and conservative investors have used government bonds as a safe-haven investment. Historically, US treasuries have had a negative correlation with stocks. When the equity markets are volatile, many investors move to US government bonds to wait out the storm. Therefore, many portfolio managers around the world use government bonds as a diversification to lower the risk of your investment portfolio.

So, let’s imagine a conservative investor whose portfolio is invested in about 40% in Equities and 60% in Fixed Income. This person has a low-risk tolerance and would like to use some the extra income to supplement her social security benefits and pension. With ultra-low or negative interest rates, 60% of the portfolio is practically earning nothing and potentially losing money. Let’s break it down.

Lending free money

Investors in negative-yielding bonds are effectively giving the government free money and receiving nothing in return. With $15 trillion worth of negative-yielding bonds, many institutional investors might be willing to take the “deal” since they have legal restrictions on a target amount of fixed income instruments they must own.

No risk-reward premium

The interest rate is the risk-reward premium that the lender is willing to take to provide a loan to a borrower. The higher the risk, the higher the interest rate. Simple. If the risk-reward relationship is broken, many creditors will choose not to lend any money and have the risk of going out of business. Why would a bank give you a negative interest mortgage on your home?

Can’t supplement income

Going back to our imaginary investor with 60% in negative-yielding bonds. This portfolio will not be able to provide additional income that she will need to supplement their pension or social security benefits. What if our investors could not rely on guaranteed benefits, and her portfolio was the sole generator of income? In that case, she will have to spend down the portfolio over time. She would have to adjust her lifestyle and lower her cost so she can stretch the portfolio as long as she could.

Need to take more risk to generate higher income

What if our investor wants to protect her principal? To generate higher income, our conservative investor will ultimately have to consider higher-risk investments that offer a higher positive yield. She will have to be willing to take more risk to receive a higher income from her portfolio.    

Subject to inflation risk

The inflation risk is the risk of lower purchasing power of your money due to rising prices. In a simple example, if you own $100 today and the annual inflation is 2%, the real value of your money will be $98 in a year. You are essentially losing money.

With the US inflation rate at around 1.6% as of June of 2019 and Eurozone inflation rate hovering about 1.2%, there is a real risk that the ultra-low and negative rates will reduce the real value of your investments. Investments in negative-yielding bonds will end up with lower purchasing power over time 

Subject to interest rate risk

In the fixed-income world, rising interest rates lead to a lower value of your bonds. The reason is that older bonds will have to sell at a lower price to match the yield of the newly issued bonds with a higher interest. Just about a year ago when the Fed was hiking rates by 0.25% every quarter, fixed income investors were rightly worried that their bond holdings would lose value. Many bonds funds ended up in the negative in 2018. Even with lower or negative interests, this risk is looming out there.

Promote frivolous spending and cheap debt

It’s not a secret that lower interest rates allow more individuals, corporations, and governments alike to borrow cheap credit. While everybody’s situation is unique, cheap credit often leads to frivolous and irresponsible spending. With US consumer debt reaching $13.51 trillion, total US corporate debt at $15.5 trillion, and Federal debt pushing above $22 trillion, the last thing we need is banks and politicians writing blank checks.

Create asset bubbles

Cheap credit leads to asset bubbles. Artificially low interests allow phantom companies with negative earnings and weak balance sheet to borrow cheap credit and stay afloat. 

The financial crisis of 2008 – 2009 was caused by lower interest rates, which increased the value of US real estate. Many borrowers who otherwise couldn’t afford a mortgage took on cheap loans to buy properties around the country. This led to a real estate bubble which burst soon after the Fed started hiking the interest rates.

One bright spot

The lower interest rate will allow millions of Americans to refinance their mortgage, student debt, or personal loan. If you have borrowed money in the last three year, you might be eligible for refinancing. Be diligent, talk to your banker, and assess all options before taking the next step.

Reach out

If you need help with your investment portfolio or have questions about generating income from your investments, reach out to me at stoyan@babylonwealth.com or 925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

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The Secret to becoming a 401k millionaire

401k millionaire

How to become a 401k millionaire? Today, 401k plans are one of the most popular employee benefits. Companies use 401k plans to attract top talent. 401k plan is a powerful vehicle to save for retirement and become financially independent. According to Fidelity, there are 180,000 Fidelity 401(k) plans with a balance of $1 million or more. Congratulations to you If you are one of them. There are still many helpful tips that can get you to reach your financial goals while keeping your investments safe.

You hear stories about people with a million dollars in their 401k plan. Then you look at your 401k balance, and it doesn’t look as high as you would like it to be.

The path to becoming a 401k millionaire

I hope this article will guide you on your path to become a 401k millionaire.

There are many variables that can impact your 401k account – age, salary, debt, tax rate, risk tolerance, plan fees, employee match.

Becoming a 401k millionaire is not as hard as it might seem. However, you need to follow a few simple rules that can get you on the right path.

“The best time to plant a tree was 20 years ago. The second-best time is now.”

Start saving early in your 401k

Saving early in your 401k will guarantee you the highest chance to become a 401k millionaire at the lowest cost.

I did the math for how much you need to contribute if you start fresh at any age. These numbers are based on assumptions for continuous monthly 401k contributions until reaching 65 with a 7% average annual market return for a 60/40 portfolio and 2% annual inflation.  Keep in mind that these assumptions are just assumptions and only for illustration purposes.  Your situation could be unique and could change the math dramatically.

401k Contributions by Age if you start fresh

 

Age|Monthly
Contribution
|Yearly
Contribution
|Lifetime
Contribution
25$387$4,644$190,404
30$560$6,720$241,920
35$820$9,840$305,040
40$1,220$14,640$380,640
45$1,860$22,320$468,720
50$3,000$36,000$576,000
55$5,300$63,600$699,600

 

What drives the growth of your 401k is the power of compounding. It’s the snowball effect of accumulating earning generating more earnings over time. The longer you wait, the larger the amount you will need to contribute to reaching your 1-million goal.

If you are 25-years old and just starting your career, you need to save approximately $390 per month or $4,644 annually to reach the $1-million goal by the age of 65. Your lifetime contribution between the age of 25 and 65 will be $190,000.

When you start saving in your 30s this target number goes to $560 per month. Your lifetime contribution between the age of 30 and 65 will be $241,920.

Your saving rate goes up to 1,220 per month if you start saving actively in your 40s and increases to $5,330 at the age off 55.

Take advantage of your employer match

If my recommended monthly contribution looks like an uphill battle, don’t forget about your employer match. Many employers offer a 401k match to attract and keep top talent. The match could be a percentage of your salary, one-to-one match or an absolute dollar amount. If your employer offers a 4% match, at a minimum you should contribute 4% to your 401k plan. Take full advantage of this opportunity to get free money.

Max out your 401k

In 2020, you can make up to $19,500 contribution to your 401k plan. If you can afford it, always try to max out your contributions.

Catch-up contributions when 50 and older

If you are 50 years or older, you can make an additional $6,500 contribution to your plan. Combined with the $19,500 limit, that is a maximum of $26,000 in 2020.

Save aggressively

Obviously, owning $1 million is a big accomplishment. However, it may not be enough to sustain your lifestyle during retirement.  As a financial advisor, I recommend to my clients replacing at least 80% of their income before retirement. If you are a high earner or plan to retire early, you need to save more aggressively to reach your goals.

Be consistent

An important part of the formula of becoming a 401k millionaire is consistency.  Saving every month and every year is a critical part of achieving your financial goals. On the contrary, large gaps could hurt your chances of reaching your financial goals.

Don’t panic during market turbulence

The market can be volatile. Don’t let your emotions get the worst of you. Nobody has made any money panicking. During the financial crisis of 2008-2009, many people stopped contributing to their 401k plans or moved their investments into cash. These folks never participated in the market recovery and the longest bull market in history. Stay invested. And think of this way. If the market goes down, your plan will invest your automatic monthly contributions at the lower prices. You are already getting a deal.

Watch your fees

Higher fees can erode your returns and slow down the pursuit of your financial goals. I recently advised a 401k plan, where the average fund’s fees were 1.5%. In the age of ETFs and index investing it is mind-blowing that some 401k plan still charges exuberantly high fees. If your 401k plan charges high fees, talk to your manager or HR representative and demand lower fee options.

Be mindful of your taxes

Taxes play a big role in 401k planning. Most 401k contributions are tax-deferred. Meaning that your contributions will reduce your current taxable income. Your investments will grow tax-free until you reach retirement age. You start paying taxes on your withdrawals. There are a couple of strategies you can implement to make your withdrawals to make more tax-efficient. You can reach out to me if you have any questions on that topic as every situation is unique and could require a unique solution.

Roth 401k

Currently, some employers offer a Roth 401k contribution as an additional option to their plan. Unlike the tax-deferred option, Roth 401k contributions are made on an after-tax basis. Roth 401k contributions don’t have an immediate financial impact. However, if planned well, Roth contributions could help you immensely to reach your financial goals. For example, let’s assume that you are in a low tax bracket and your employers offer both tax-deferred and Roth 401k contributions. The tax-deferred option is usually the default. But if you are in a low tax bracket, your tax benefit will be minimal. In that case, maybe it’s worth selecting the Roth 401k.

Don’t take a loan

Under no circumstances, you should take a loan from your 401k plan. No matter how dire the situation is, try to find an alternative.  Taking a loan from your 401k can set you back many years in achieving your financial goal of becoming a 401k millionaire. Obviously, all rules have exceptions, but before you take a loan from your 401k, talk to your financial advisor first for alternatives.

Keep a long-term view

Life happens. Markets go up and down. You can lose your job or change employers. You need to pay off a big loan. Your car breaks down. You need money for a down payment on your first house. Something always happens. Circumstances change. Whatever happens, keep a long-term view. Your 401k plan could be the answer to your financial independence. Don’t make rash decisions.

Reach out

If you need help growing your 401k savings, or learn how to manage your 401k investments, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

The Smart Way to Manage Your Sudden Wealth

The Smart Way to Manage Your Sudden Wealth

Getting rich is the dream of many people. When your sudden wealth becomes a reality, you need to be ready for the new responsibilities and challenges. As someone experienced in helping my clients manage their sudden wealth, I want to share some of my experience.

Wealth sources

Your sudden windfall can come from many different sources – receiving an Inheritance, winning the lottery, selling your business or a real estate property, signing a new sport or music contract, royalties from a bestselling book or a hit song, or selling shares after your company finally goes public. Whatever the source is, your life is about to change. Being rich brings a unique level of issues.  Your new wealth can have a variety of financial, legal and core repercussions to your life.

Avoid making any immediate changes to your life

Don’t make big and hasty changes to your lifestyle. I recommend that you wait at least six months. Let the big news sink in your mind.  Let things settle down before quitting your job, moving to another city or making a large purchase. Keep it quiet. The next six month will give you a chance to reassess your life, control your emotions and set your priorities.

Figure out what you own

This is the moment you have been waiting for all your life. You are probably very excited, and you deserve it. There are tons of things you want to do with your money. But before you do anything.  Take a deep breath. Figure out exactly what you own. Gather all necessary information about your assets. Maybe your sudden windfall is in cash. However, your new wealth could be in real estate, land, stocks, art, gold, rare wines, luxury cars and so on. Not always your new fortunate can easily be converted into cash. Each wealth source is unique on its own and has specific legal and financial rules.

Build your team

Your financial life is about to become a lot more complicated. You will need a team of trusted experts who will help you navigate through these changes. Your financial team can help you understand your wealth.   They watch your back and flag any blind spots. Talk to your team and figure what are your options.

Hire a CPA

You are rich. And that’s a great news for the IRS and your state. There is a very good chance you will pay more taxes that you ever imagined. Start assembling your financial team by hiring a reputable CPA who understands your situation and can steer you through the complex world of taxes.  Each source of wealth has unique tax rules. Find out what rules apply to you.

Hire a financial advisor

Look for a trusted fiduciary financial advisor with experience managing sudden wealth. A fiduciary advisor will look after your best interest and guide you in your new journey. Talk to your new advisors about your personal and financial goals and how to reach them with the help of your new wealth.

Have a financial plan

Ask your advisor to craft a financial plan that is tailored to your unique situation, specific needs and financial objectives. Figure out how your sudden wealth can help you reach your goals – retire early, send your kids to college, buy a new house, become self-employed. The list is endless. Talk to your advisor about your risk tolerance. Many of my clients who earned a windfall have a low risk appetite. An important part of our conversation is how to reach their goals without taking on too much risk.

Protect your new wealth

You need to take steps to protect your sudden windfall.  For a starter, try to keep

If your new money is sitting in your checking account, make sure you allocate it among several different banks and account types. Remember that FDIC insurance covers up to 250k per person per bank in each account category.

If you inherited real estate or art or some other type of physical property make sure to have solid Insurance to protect you from unexpected events.  

In case you received stocks or other investments, speak to your financial advisor how to hedge them from market volatility and losing value.

Have an estate plan

No matter how well you plan, life can be unpredictable. Getting a windfall is a great opportunity to update your estate plan or craft a new one. The estate plan will protect your loved ones and ensure your legacy in the face of the unknown. If something happens to you, your fortune will be used and divided per your own wish. The alternative is going through a lengthy and expensive probate process that may not have the same outcome.

Pay off your debts

If you owe money, you have a chance to pay off your debts.  Credit cards debts and any personal loans with high interest should be your priority. Your new wealth can help your live a debt-free life. This is one area where working with a financial advisor will make a big difference in your life.  

Beware that many people who receive sudden windfall end up borrowing more money and sometimes filing for bankruptcy.  Don’t be that person. You still need to live within your means.

Plan your taxes

Depending on the source of sudden wealth you may owe taxes to the IRS and your state either immediately or sometime in the near future. Don’t underestimate your tax bill. Your CPA and financial advisor should help you understand and prepare for your current and future tax bills.

Don’t overspend

Many lottery winners and former athletes file for bankruptcy due to poor spending habits, lending money to family and friends and money mismanagement. The fact that you are rich doesn’t mean that you can’t lose your money. You need to be responsible. Talk to your advisor about your monthly budget and what you can afford.  

Be philanthropic

Making a donation is an excellent way to give back to the society and leave a legacy.  If you have a charitable cause close to your heart, you make a difference. Often time, charitable contributions can be tax-deductible and lower your tax bill. Talk to your CPA and financial advisors how you can achieve that.

Conclusion

Sudden Wealth can come in all shapes and forms – cash, real estate, land, ongoing business, royalties, stocks, and many others. Even though it might not be completely unexpected, the way you feel about after the fact might be shocking to you. Don’t let your emotions get the worst of you. Getting windfall is a great life accomplishment. And you should make the best out of it.  Work with your team of trusted professionals and build a long-term plan with milestones and objectives.

Reach out

If you are expecting a windfall or recently received a sudden wealth, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

Subscribe to get our new Insights delivered right to your inbox

5 things you need to know about your Target Retirement Fund

5 things you need to know about your Target Retirement Fund

Target Retirement Funds have become a popular investment option in many workplace retirement plans such as 401k, 403b and SEP IRA. They offer a relatively simple way to invest your retirement savings as their investment approach is based on the individual target retirement dates. In this post, I will discuss the 5 things you need to know about your target retirement fund.

Nowadays, almost all investment companies offer target retirement funds – from Fidelity to Vanguard, American Funds, Blackrock, and Schwab. Although plan administrators and advisors have a choice amongst several fund families, they will typically select one of them for their plan. Multiple target fund families are readily available in individual brokerage accounts or self-directed IRAs.

Learn more about our Private Client Services

Workplace plan participants typically have to choose one fund from a single family with target retirement dates in 5-year increments – 2025, 2030, 2035, 2040, 2045, and 2050. Often, plans with auto-enrollment features will automatically assign a target retirement fund based on the estimated year of retirement. Manual enrollment programs will have the fund series in their fund line-up, which could consist of a mix of index, actively managed and target retirement funds.

The base assumption of the target retirement funds is that younger investors have a long investment horizon and higher risk tolerance, therefore, they should have their target retirement assets in more risky investments such as stocks. Inversely, older investors will have a shorter investment horizon and lower risk tolerance. Therefore, the majority of their target retirement money will be in more low-risk investments such as bonds.

Despite their growing popularity, target retirement funds have some limitations and are not identical.  They have substantial differences that may not always appeal to everybody. In this post, I would like to explain some of those nuances.

Style

Target funds utilize two main investment styles – passive indexing and active management. Passive Target Retirement Funds like Vanguard and BlackRock LifePath primarily invest in a mix of index funds. The second groups including T. Rowe Price, Fidelity, American Century, and American Funds pursue an active strategy where investments are allocated in a mix of active mutual funds typically managed by the same firm.

Fees

The fund investment style will often impact the management fees charged by each fund. Passive funds tend to charge lower fees, usually around 0.15% – 0.20%. On the other hand, active funds typically range between 0.40% – 1%.

NameTickerMorningstar RatingMorningstar Analyst RatingAUMExpense
Vanguard Target Retirement 2045VTIVX4-starGold$18.1 bil0.16%
T. Rowe Price Retirement 2045TRRKX5-StarSilver$10.2 bil0.76%
American Funds 2045 Trgt Date Retire R6RFHTX5-StarSilver$4.8 bil0.43%
Fidelity Freedom® 2045FFFGX3-StarSilver$3.5 bil0.77%
American Century One Choice 2045AROIX4-starBronze$1.7 bil0.97%

If you have any doubts about how much you pay for your fund, double check with your plan administrator or Human Resource. Not to sound alarming but I recently read about a case where a 401k plan contained a fund listed as “Vngd Tgt Retrmt 2045 Fund.” whose sole investment was Vanguard Target Retirement 2045 Fund. However, instead of charging an expense ratio of 0.16%, the fund was taking a whopping 0.92%.  The only purpose of this sham is to deceive participants into believing they are investing in the real Vanguard fund and marking up the expense ratio exponentially.

Asset allocation

The asset allocation is the most critical factor for investment performance. According to numerous studies, it contributes to more than 90% of the portfolio return.  As a factor of such significance, it is essential to understand the asset allocation of your target retirement fund.

While comparing five of the largest target retirement families, we see some considerable variations between them. Vanguard has the highest allocation to Foreign Equity, while T. Rowe has the largest investment in US Equity. Fidelity has the highest allocation to Cash and Cash Equivalents while American Century has the biggest exposure to Bonds. And lastly, American Funds has the largest distribution to Other, which includes Preferred Stocks and Convertible Bonds.

 

2045 Series 

NameTickerCashUS StockNon-US StockBondOther
Vanguard Target Retirement 2045VTIVX 1.11 52.98 34.91 9.77 1.23
T. Rowe Price Retirement 2045TRRKX 2.87 58.98 28.48 9.05 0.62
American Funds 2045 Trgt Date Retire R6RFHTX 3.66 53.21 29.02 9.77 4.34
Fidelity Freedom® 2045FFFGX 5.79 57.58 32.07 3.93 0.63
American Century One Choice 2045AROIX 2.04 55.38 20.32 21.36 0.90

It is also important to understand how the target asset allocation changes over time as investors approach retirement. This change is known as the glide path. In the below table you can see the asset allocation of 2025 target fund series. All of them have a higher allocation to Bonds, Cash and Cash Equivalents and a lower allocation of US and Foreign Equity.

2025 Series

NameTickerCashUS StockNon-US StockBondOther
Vanguard Target Retirement 2025VTIVX 1.44 38.05 25.09 34.30 1.12
T. Rowe Price Retirement 2025 FundTRRHX 3.35 45.64 22.06 28.23 0.72
American Funds 2025 Trgt Date Retire R6RFDTX 4.12 39.60 19.36 33.65 3.27
Fidelity Freedom® 2025FFTWX 8.99 41.70 24.31 24.46 0.54
American Century One Choice 2025ARWIX 7.18 40.01 11.88 40.01 0.92

 

 Keep in mind that the target Asset Allocation is not static. Moreover, the fund managers can change the fund allocation according to their view of the market and economic conditions.

Performance

After all said and done, the performance is what matters for most investors and retirees. However, comparing performance between different target funds can be a little tricky. As you saw in the previous paragraph, they are not the same.

So let’s first look at a comparison between different target-date funds from the same family. The return figures represent a net-of-fees performance for 3, 5 and 10 years. Standard Deviation (St. Dev) measures the volatility (risk) of returns.  As expected, the long-dated funds posted higher returns over the near-dated funds. However, the long-dated funds come with higher volatility due to their higher allocation to equities.

 

Target Date Performance Comparison by Target Year

ReturnStandard Deviation
NameTicker3-Year5-Year10-Year3-Year5-Year10-Year
American Funds 2025 Trgt Date Retire R6RFDTX 5.71 9.36 5.88 6.78 7.48 12.83
American Funds 2035 Trgt Date Retire R6RFFTX 6.73 10.43 6.44 8.70 8.84 13.81
American Funds 2045 Trgt Date Retire R6RFHTX 6.99 10.67 6.56 9.09 9.10 13.96
American Funds 2055 Trgt Date Retire R6RFKTX 7.33 11.32 9.13 9.15

 

The comparison between different fund families also reveals significant variations in performance. The majority of these differences can be attributed to their asset allocation, investment selection, and management fees.

Target Date Performance Comparison by Fund Family

Return  Standard Deviation
NameTicker3-Year5-Year10-Year3-Year5-Year10-Year
Vanguard Target Retirement 2045VTIVX 6.24 9.50 5.70 9.42 9.51 14.63
T. Rowe Price Retirement 2045TRRKX 6.54 9.92 6.20 9.68 9.80 15.80
American Funds 2045 Trgt Date Retire R6RFHTX 6.99 10.67 6.56 9.09 9.10 13.96
Fidelity Freedom® 2045FFFGX 6.50 8.95 4.82 9.83 9.64 15.25
American Century One Choice 2045AROIX 5.79 8.63 5.73 8.38 8.41 13.50

How they fit with your financial goals

How the target retirement fund fit within your financial goals is an important nuance that often gets underestimated by many. Target retirement funds assume the investors’ risk tolerance based on their age and the estimated year of retirement. Older investors will automatically be assigned as conservative while they could be quite aggressive if this is a part of their inter-generational estate planning. Further, young investors default to an aggressive allocation while they could be more conservative due to significant short-term financial goals. So keep in mind that the extra layer of personal financial planning is not a factor in target retirement funds.

 

Final words

Target retirement funds come with many benefits. They offer an easy way to invest for retirement without the need for in-depth financial knowledge. Target funds come in different shapes and forms and bring certain caveats which may appeal to some investors and not to others. If you plan to invest in a target retirements fund, the five questions above will help you decide if this is the right investment for you.

 

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs) and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,  Copyright: <a href=’https://www.123rf.com/profile_pogonici’>pogonici / 123RF Stock Photo</a>

6 Essential steps to diversify your portfolio

6 Essential steps to diversify your portfolio

Diversification is often considered the only free lunch in investing. In one of my earlier blog posts, I talked about the practical benefits of diversification. I explained the concept of investing in uncorrelated asset classes and how it reduces the overall risk of the investments.  In this article, I will walk you through 6 essential steps to diversify your portfolio.

 

1. Know your risk tolerance

Risk tolerance is a measure of your emotional appetite to take on risk. It is the ability to endure volatility in the marketplace without making any emotional and spur of the moment investment decisions. Individual risk tolerance is often influenced by factors like age, investment experience, and various life circumstances.

Undoubtedly, your risk tolerance can change over time. Certain life events can affect your ability to bear market volatility. You should promptly reflect these changes in your portfolio risk profile as they happen.

 

2. Understand your risk capacity

Often your willingness and actual capacity to take on risk can be in conflict with each other. You may want to take more risk than you can afford. And inversely, you could be away too conservative while you need to be a bit more aggressive.

Factors like the size of savings and investment assets, investment horizon, and financial goals will determine the individual risk capacity

 

3. Set a target asset allocation

Achieving the right balance between your financial goals and risk tolerance will determine the target investment mix of your portfolio. Typically, investors with higher risk tolerance will invest in assets with a higher risk-return profile.

These asset classes often include small-cap, deep value, and emerging market stocks, high-yield bonds, REITs, commodities and various hedge fund and private equity strategies. Investors will lower risk tolerance will look for safer investments like government and corporate bonds, dividends and low volatility stocks.

In order to achieve the highest benefit from diversification, investors must allocate a portion of their portfolio to uncorrelated asset classes. These investments have a historical low dependence on each other’s returns.

The US Large Cap stocks and US Treasury Bonds are the classic examples of uncorrelated assets. Historically, they have a negative correlation of -0.21. Therefore, the pairs tend to move in opposite direction over time. US Treasuries are considered a safe haven during bear markets, while large cap stocks are the investors’ favorite during strong bull markets.

See the table below for correlation examples between various asset classes.

Asset Correlation Chart
Source: Portfoliovisualizer.com

4. Reduce your concentrated positions

There is a high chance that you already have an established investment portfolio, either in an employer-sponsored retirement plan, self-directed IRA or a brokerage account.

If you own a security that represents more than 5% of your entire portfolio, then you have a concentrated position. Regularly, individuals and families may acquire these positions through employer 401k plan matching, stock awards, stock options, inheritance, gifts or just personal investing.

The risk of having a concentrated position is that it can drag your portfolio down significantly if the investment has a bad year or the company has a broken business model. Consequently, you can lose a substantial portion of your investments and retirement savings.

Managing concentrated positions can be complicated. Often, they have restrictions on insider trading. And other times, they sit on significant capital gains that can trigger large tax dues to IRS if sold.

 

5. Rebalance regularly

Portfolio rebalancing is the process of bringing your portfolio back to the original target allocation. As your investments grow at a different rate, they will start to deviate from their original target allocation. This is very normal. Sometimes certain investments can have a long run until they become significantly overweight in your portfolio. Other times an asset class might have a bad year, lose a lot of its value and become underweight.

Adjusting to your target mix will ensure that your portfolio fits your risk tolerance, investment horizon, and financial goals. Not adjusting it may lead to increasing the overall investment risk and exposure to certain asset classes.

 

6. Focus on your long-term goals

When managing a client portfolio, I apply a balanced, disciplined, long-term approach that focuses on the client’s long-term financial goals.

Sometimes we all get tempted to invest in the newest “hot” stock or the “best” investment strategy ignoring the fact that they may not fit with our financial goals and risk tolerance.

If you are about to retire, you probably don’t want to put all your investments in a new biotech company or tech startup. While these stocks offer great potential returns, they come with an extra level of volatility that your portfolio may not bear. And so regularly, taking a risk outside of your comfort zone is a recipe for disaster. Even if you are right the first time, there is no guarantee you will be right the second time.

Keeping your portfolio well diversified will let you endure through turbulent times and help your investments grow over time by reducing the overall risk of your investments.

 

 

About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

 

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing, Copyright: www.123rf.com