Should I Participate in a Deferred Compensation Plan?

Contributed by: Robert Ingram, CFP®

Many executive compensation packages offer types of deferred compensation plans. If you have one available, it can be a powerful tool to accumulate additional retirement savings. But is it right for you?

While this can be an effective way to reduce current income and build another savings asset, there are many factors to consider before participating. Plans can be complex, often less flexible than other savings vehicles, and dependent on the financial strength and commitment of the employer.

How Do Non-Qualified Deferred Compensation Plans Work?

By participating, you generally defer a portion of your income into a plan with the promise that the employer will pay the balance to you in the future, plus any growth and earnings on those assets. The amount you defer each year does not count towards your income in that year, thereby reducing your taxable income (at least for now). When the deferred income pays out to you in the future, it counts toward your taxable income at that time. These accumulated funds within the plan can also grow tax-deferred through different investment options, depending on how the plan is set up. This sounds a lot like contributions to a 401(k) plan in that contributions are not taxed in the year contributed, and earnings can grow tax-deferred.

However, unlike a qualified plan such as a 401(k) or pension plan, a non-qualified deferred compensation plan is not covered under ERISA, and there are no mandated income caps and annual contribution limits, like the annual maximum on a 401(k) (in 2024 $23,000 plus an additional $7,500 “catch up”  for those age 50 and above). For high-income employees, having this ability to defer an even larger portion of income in addition to qualified plan contributions (and subsequently the taxes on that income) can be a significant advantage. 

Because the plan is not under ERISA, it is also not a protected asset from creditors. The plan’s security depends on the financial strength of the employer and whether the employer has established certain funding arrangements. 

The deferred compensation agreement also establishes when and how you can withdraw funds. Typically, the plan defines certain triggers for it to pay out, such as at a retirement date/age or at separation from service, for example. The plan can also have several different ways to allow for withdrawing (paying out) funds. Different options can include a lump sum distribution or set withdrawals spread out over a number of years (e.g., a schedule over three years, five years, or even as many as 15 years). Some plans may allow payouts to begin during your working years, while others may not. You may not have any other early withdrawal choices for hardships, plan loans, etc. There are no IRS-imposed required minimum distributions for qualified retirement plans (beginning at age 73 in 2023). However, you may also have less control over your withdrawals from a deferred compensation plan. 

Advantages of a Deferred Compensation Plan 

• The plan allows you to defer current income or additional compensation today and claim it in the future. Doing this can lower your income, which is subject to income taxes in the current year, and help keep you in a lower tax bracket. 

• It can allow you to build tax-deferred additional assets for future needs (typically an additional retirement savings vehicle).

• The plan is not subject to the ERISA requirements and the annual contribution limits of qualified retirement plans such as a 401(k) (unless otherwise set by the employer plan).

• It can be customized for an employee or groups of employees.

Disadvantages of a Deferred Compensation Plan

• These plans are not protected under ERISA, so you may risk losing your promised income and potential earnings if the employer company goes bankrupt or does not properly fund the plan.

• The plan language may impose rules where you lose the money if you leave the employer.

• The ability to withdraw funds is typically set on a predetermined schedule in the plan, such as at retirement, at termination, and either as a lump sum or spread over several years. This can limit some control and flexibility over when you have access to the money and how much income you will claim from the plan in a given year.

• Deferring income today means having to claim that income in the future.  If your income is higher in the future or if tax rates increase, deferring more income today could be less attractive.

Planning Considerations for Using Your Deferred Compensation Arrangement

• Financial strength of the employer. 
  Since the dollars in the deferred compensation plan are not yours until they are paid out to you, the employer must be in a strong enough financial position to make good on its promise to pay. 

• Are you maximizing your contributions to your employer retirement plan?
  If you’re not contributing up to the annual maximum to your 401(k), for example, doing that first makes more sense. The dollars you contribute are your own, not the employers’ and generally are more flexible for when and how you can take distributions.  

• What is your timeframe for needing the funds?
  Ideally, the funds in your deferred compensation should be used in retirement. That is a benefit of deferring taxable income during your working years.

• What is the right payout schedule? 
  There may be options for a single lump sum or a series of installment payments, such as an equal amount distributed over five or seven years, for example. Spreading out your payment may help limit the taxable income in a given year. However, when taking installment payments, you need to be comfortable remaining tied to the plan until the full balance is distributed.

These are some examples of the considerations for contributing to this deferred compensation plan. As with other types of employer compensation and retirement plans, deferred compensation plans can impact your financial situation in different ways, both in the current year and in future years. That’s why it’s critical that you work with your financial and tax advisors when making these kinds of planning decisions. So please don’t hesitate to reach out if we can be a resource.

Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Center for Financial Planning, Inc. Center for Financial Planning, Inc. is not a registered broker/dealer and is independent of Raymond James Financial Services.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Bob Ingram, CFP® and are not necessarily those of RJFS or Raymond James. Raymond James Financial Services, Inc. and its advisors do not provide advice on tax issues, these matters should be discussed with the appropriate professional.

Social Security Cost of Living Adjustment & Wage Base for 2021

Contributed by: Kali Hassinger, CFP®, CDFA®

It has recently been announced that Social Security benefits for millions of Americans will increase by 5.9% beginning January 2022. This is the largest cost of living adjustment in 40 years! The increase is calculated based on data from the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, from October 1st, 2020 through September 30th, 2021. Inflation has been a point of concern and received a great deal of media attention this year, so this increase comes as welcome news for Social Security recipients who have received minimal or no benefit increase in recent years.

The Social Security taxable wage base will also increase in 2022 from $142,800 to $147,000. This means that employees will pay 6.2% of Social Security tax on the first $147,000 earned, which translates to $9,114 of Social Security tax. Employers match the employee amount with an equal contribution. The Medicare tax remains at 1.45% on all income, with an additional .9% surtax for individuals earning over $200,000 and married couples filing jointly who earn over $250,000.

For many, Social Security is one of the only forms of guaranteed fixed income that will rise over the course of retirement. However, the Senior Citizens League estimates that Social Security benefits have lost approximately 33% of their buying power since the year 2000. This is why, when working to run retirement spending and safety projections, we factor an erosion of Social Security’s purchasing power into our clients’ financial plans.

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

Finding Meaningful Ways to Spend When Your Financial Plan Allows

Contributed by: Sandra Adams, CFP®

Several months ago, I wrote about clients who had developed such great savings habits to retire that they were shocked they could spend more in retirement than they had been spending in pre-retirement (“Can You Change Your Spending Habits in Retirement”). Of course, by the time this happens, most clients realize that it is very difficult, if not impossible, to change their spending habits or their lifestyle in general. Ultimately, they have trouble spending the money they have available to them.

I continue to have discussions in financial planning reviews with these clients when their retirement spending continues to be well below what is possible for their long-term financial success. Often this generates meaningful conversations regarding what might be possible with the excess funds, for the clients to make their lives more enjoyable and valuable, and for their families and communities.

Here are just some of the ideas that have come out of these discussions:

• Annual gifting to children — in cash or specifically for the individual needs for the children and/or their families.

• Assisting with grandchildren’s education.

• Taking a memorable trip(s) that the client has always dreamed of taking.

• Creating or contributing to a scholarship program at the client’s former school/university.

• Making a significant donation to a charity that has special meaning to the client.

• Investing in a hobby that has significant meaning/value to the client.

• Helping a family member that is struggling financially.

While spending more than what is necessary is still not easy for most of these clients, they begin to find that it makes more sense and is easier to do when the spending is meaningful for them, their families, or their community. And with the help of a financial advisor along the way to make sure that the spending is still in line with their plan, even if they do those things that are meaningful (and sometimes fun), they can move forward with confidence and find new ways to be creative with their spending.

Sandra Adams, CFP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® and holds a CeFT™ designation. She specializes in Elder Care Financial Planning and serves as a trusted source for national publications, including The Wall Street Journal, Research Magazine, and Journal of Financial Planning.

How To Manage Your Finances After A Divorce

Contributed by: Kali Hassinger, CFP®, CDFA®

Divorce isn’t easy.  Determining a settlement, attending court hearings, and dealing with competing attorneys can weigh heavily on all parties involved. In addition to the emotional impact, divorce is logistically complicated.  Paperwork needs to be filed, processed, submitted, and resubmitted.  Assets need to be split, income needs to be protected, and more paperwork needs to be submitted!  With all of these pieces in motion, it can be difficult to truly understand how your financial position will be impacted.  Now, more than ever, you need to be sure that your finances are on the right track.  Although every circumstance is unique, there are few steps that are helpful in most (if not all) situations.

Assess your current financial situation

Following a divorce, you’ll need to get a handle on your budget. You may be responsible for paying expenses that you were once able to share with your former spouse.  What are your current monthly expenses and income?  Regarding expenses, you’ll want to focus on dividing them into two categories: fixed and discretionary.  Fixed expenses include things like housing, food, transportation, taxes, debt payments, and insurance.  Discretionary expenses include things like entertainment and vacations.

Reevaluate your financial goals

Now that your divorce is finalized, you have the opportunity to reflect on your needs and wants separate from anyone else.  If kids are involved, of course their needs will be considered, but now is a time to reprioritize and focus on your needs, too.  Make a list of things you would like to achieve, and allow yourself to think both short and long-term.  Is saving enough to build a cash cushion important to you?  Is retirement savings a focus?  Are you interested in going back to school?  Is investing your settlement funds in a way that reflects your values important to you?

Review your insurance needs

Typically, insurance coverage for one or both spouses is negotiated as part of a divorce settlement, however, there is often still a need to make future adjustments to coverage.  When it comes to health insurance, having adequate coverage is a priority.  You’ll also want to make sure that your disability or life insurance matches your current needs.  Property insurance should also be updated to reflect any property ownership changes resulting from divorce.

Review your beneficiary designations & estate plan

After a divorce, you’ll want to change the beneficiary designations on any life insurance policies, retirement accounts, and bank or credit union accounts. This is also a good time to update or establish your estate plan.

Consider tax implications

Post-divorce your tax filing status will change.  Filing status is determined as of the last day of the year.  So even if your divorce is finalized on December 31st, for tax purposes, you would be considered divorced for that entire year. Be sure to update your payroll withholding as soon as possible.

You may also have new sources of income, deductions, and tax credits could be affected. 

Stay on top of your settlement action items

Splitting assets is no small task, and it is often time consuming.  The sooner you have accounts in your name only, the sooner you will feel a sense of organization and control.  Diligently following up on QDROs, transfers, and rollovers is important to make sure nothing is missed and the process is moving forward as quickly and efficiently as possible.  Working with a financial professional during this process can help to ensure that accounts are moved, invested, and utilized to best fit your needs.

When your current financial picture is clear, it becomes easier to envision your financial future.  Similarly, having a team of financial professionals on your side can create a feeling of security and support, even as you embrace your new found independence.

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

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This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional.

How The Historically High Cost Of Retirement Income Affects Your Financial Plan

Contributed by: Nick Defenthaler, CFP®, RICP®

Now more than ever, we find ourselves reminiscing. And if you’re like me, it’s usually about the simple things in life that were so easy to take for granted. Like going out to eat with a large group of friends, having a surprise birthday party for a loved one, or attending a sporting event or concert with a packed arena filled with 30,000 fans having a great time. COVID has caused this reminiscing to occur and it has also played a role in reminiscing of a world where investors used to receive a reasonable yield on portfolios for a relatively low level of risk.

Interest rates have been on a steady decline for several decades now, so COVID certainly isn’t the only culprit to blame here. That said, reductions in interest rates by the Federal Reserve when the pandemic occurred in spring 2020, certainly did not help. As an advisor who typically works with clients who are within 5 years of retirement or currently retired, it’s common to hear comments like, “When we’re drawing funds from our accounts, we can just live off of the interest which should be at least 4% - 5%!”. Given historical dividend and bond yield averages and the fact that if we go back to the late 90s, an investor could purchase a 10 year US treasury bond yielding roughly 7% (essentially risk-free being that the debt was backed by the US government), I can absolutely see why those who lived through this time frame and likely saw their parents living off this level of interest would make these sort of comments. The sad reality is this – the good old days of living off portfolio interest and yield are pretty much dead right now (unless of course, you have a very low portfolio withdrawal rate) and it will likely remain this way for an extended period.

One way to look at this is that the average, historical “cost” to generate $1,000 of annual income from a 50% stock, 50% bond balanced portfolio has been approximately $25,000 (translates into an average yield of 4%). Today, an investor utilizing the same balanced portfolio must invest $80,000 to achieve the $1,000 annual income goal. This is a 320% increase in the “cost” of creating portfolio income!  

It’s worth noting that this is not an issue unique to the United States. The rising cost of portfolio income is a global conundrum as many countries are currently navigating negative interest rate environments (ex. Switzerland, Denmark and Japan). Click here to learn more about what this actually means and how negative interest rates affect investors. Below is a chart showing the history of the 10-year US government bond and US large cap equities from 1870 to 2020.

Source: Robert Shiller http://www.econ.yale.edu/~shiller/

The chart is a powerful visual and highlights how yields on financial assets have taken a nosedive, especially since the 1980s. The average bond yield over 150 years has been 4.5% and the average dividend yield has been 4.1%. As of December 2020, bond yields were at 0.9% and dividend yields stood at 1.6% - quite the difference from the historical average!

So why this dramatic reduction in yields? It’s a phenomenon likely caused by several factors that we could spend several hours talking about. Some experts suggest that companies have increasingly used stock repurchases to return money to shareholders which coupled with high equity valuations have decreased dividend yields globally. Bond yields have plummeted, in part from a flight to safety following the onset of the pandemic as well as the Federal Reserve’s asset purchasing program and reduction of rates that has been a decade-long trend.

The good news is that a low-interest rate environment has been favorable for stocks as many investors (especially large institutional endowments and hedge funds) are realizing that bonds yields and returns will not satisfy the return requirements for their clients which has led to more capital flowing into the equity markets, therefore, creating a tailwind for equities.

Investors must be cautious when “stretching for yield”, especially retirees in distribution mode. Lower quality, high yield bonds offer the yields they do for a reason – they carry significantly more risk than government and high quality corporate and mortgage-backed bonds. In fact, many “junk bonds” that offer much higher yields, typically have a very similar correlation to stocks which means that these bonds will not offer anywhere near the downside protection that high quality bonds will during bear markets and times of volatility. In 2020, it was not uncommon to see many well-respected high yield bond mutual funds down close to 25% amid the brief bear market we experienced. That said, many of these positions ended the year in positive territory but the ride along the way was a very bumpy one, especially for a bond holding!

The reality is simple – investors who wish to generate historical average yields in their portfolio must take on significantly more risk to do so. It’s also important to note that higher yields do not necessarily translate into higher returns. US large cap value stocks are a perfect example of this. Value stocks, which historically have outperformed growth stocks dating back to the 1920s, have underperformed growth stocks in a meaningful way over the last 5 years. This underperformance is actually part of a longer trend that has extended nearly 20 years. Value companies (think Warren Buffet style of investing) will pay dividends, but if stock price appreciation is muted, the total return for the stock will suffer. Some would argue that the underperformance has been partially caused by investors seeking yield thus causing many dividend-paying value companies to become overbought. In many cases, the risk to reward of “stretching for yield” just isn’t there right now for investors, especially for those in the distribution phase. It simply would not be prudent to meaningfully increase the risk of a client’s allocation for a slight increase in income generated from the portfolio.

As we’ve had to do so much over the past year with COVID, it’s important for investors, especially retirees, to shift their expectations and mindset when it comes to portfolio income. Viewing one’s principal as untouchable and believing yield and income will be sufficient in most cases to support spending in retirement is a mistake, in my opinion. Maximizing total return (price appreciation and income) with an appropriate level of risk will be even more critical in our new normal of low rates that, unfortunately, has no sign of leaving anytime soon.

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

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Views expressed are not necessarily those of Raymond James and are subject to change without notice. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.

The Key To Financial Planning Is Sticking to the Basics!

Contributed by: Sandra Adams, CFP®

A colleague of mine and I were recently presenting a session on Savings for Junior Achievement for a Detroit High School class as part of The Center’s Financial Literacy initiatives. As part of our presentation, we both shared personal stories about how the fundamentals of budgeting and savings had personally impacted us during our earlier years. Why am I sharing this with you?

First, it was a good reminder that our perspective about money certainly changes over time. Thinking back, I now realize that how I think about money now is certainly different than how I thought about money in my teens and twenties. This is important especially when we are talking to our children and grandchildren about handling money.

Second, it was a good reminder that our experience teaches us good lessons. The things we have been through over our lifetimes, especially with money, sticks in our minds either positively or negatively. Positive experiences and behaviors we will tend to repeat and negative experiences and behaviors we hopefully will learn from and NOT repeat. Although some people take longer to learn than others.

Third, and most importantly, I was reminded with my own story that sticking to the financial planning basics works.

The Basics Are:

• Paying yourself first. (Building savings to yourself right into your budget!)

• Living within your means (spending first for needs and then for wants; spending for wants only if there is money in the budget).

• Building a savings reserve for emergencies.

• Building savings in advance for short-term goals.

• Not accumulating debt that is not needed and paying off any credit in the money that it is accumulated.

• And once you can do all that, building long-term savings for long-term goals like buying a house and retirement.

At one point in my life, I was in a real financial hole, but by sticking to the basics and having a lot of patience, I slowly dug myself out. And I sit here today being able to say that by following the fundamentals, you can be financially successful.  Sticking to the basics works!

Sandra Adams, CFP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® and holds a CeFT™ designation. She specializes in Elder Care Financial Planning and serves as a trusted source for national publications, including The Wall Street Journal, Research Magazine, and Journal of Financial Planning.

Am I Spending Enough Or Saving Too Much?

Contributed by: Kali Hassinger, CFP®, CDFA®

No you didn’t read that title incorrectly.  After decades of consistent and focused saving, how do you change your mentality to feel comfortable spending what you’ve worked so hard to accumulate?  Good savers spend decades developing the discipline to save, plan, and minimize debt, all for the ultimate goal of reaching financial independence and freedom.  However, when it comes time to use those hard-earned funds to support your retirement lifestyle, it can be a difficult transition.

The Center defines financial planning as a coordinated and comprehensive approach to reaching your financial goals.  It necessitates an appropriate balance between spending now and investing for the future.  That is a difficult balance to maintain, and without truly understanding your current resources and future needs, it is easy to miss the mark.  Without professional analysis and review, many either spend too much now and jeopardize future goals or have save too aggressively and end up unnecessarily sacrificing current quality of life. 

In planning, we can quantify what it takes to meet future financial goals, and make sure that we are doing what is needed to help reach those objectives.  In some cases, that knowledge can provide the freedom to actually reduce savings.  Beyond just allowing increased spending, this can also provide the opportunity to pursue passions as opposed to income.

When finally reaching that retirement finish line, however, turning your savings into income can be a daunting task.  Pulling from a balance that you’ve worked years to accumulate and build up can be uncomfortable, especially if you don’t know how much you can safely withdrawal without jeopardizing your long term financial security.  If you’re like many of our clients, it isn’t uncommon to react to this discomfort by under-spending and unintentionally accumulating money throughout retirement. 

Life is all about balance.  In this example, it’s about protecting your financial future while also enjoying life now.  If you’re in the enviable position of having more than you need for retirement, making a meaningful plan for the excess can help to ease the reluctance to spend.  Whether it is gifting, creating a financial legacy, or granting yourself permission to indulge a bit, if it brings you joy, it is worth considering.  Of course we would not recommend spending money frivolously, but, the ultimate goal is to pursue areas of interest because they are meaningful and important to you - unconstrained by financial concerns.  Isn’t that true financial freedom?  

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

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Opinions expressed are not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss.

How Much Guaranteed Income Should You Have In Retirement?

Contributed by: Nick Defenthaler, CFP®, RICP®

How much guaranteed income (we’re talking Social Security, pension, and annuity income) should you have in retirement? I am frequently asked this by clients who are nearing or entering retirement AND are seeking our guidance on how to create not only a tax-efficient but well-diversified retirement paycheck. 

“The 50% Rule”

Although every situation is unique, in most cases, we want to see roughly 50% or more of a retiree’s spending need satisfied by fixed income. For example, if your goal is to spend $140,000 before-tax (gross) in retirement, ideally, we’d want to see roughly $70,000 or more come from a combination of Social Security, pension, or an annuity income stream. Reason being, this generally means less reliance on the portfolio for your spending needs. Of course, the withdrawal rate on your portfolio will also come into play when determining if your spending goal would be sustainable throughout retirement. To learn more about our thoughts on the “4% rule” and sequence of return risk, click here.  

Below is an illustration we use frequently with clients to help show where their retirement paycheck will be coming from. The chart also displays the portfolio withdrawal rate to give clients an idea if their desired spending level is realistic or not over the long-term.

Cash Targets

Once we have an idea of what is required to come from your actual portfolio to supplement your spending goal, we’ll typically leave 6 – 12 months (or more depending of course on someone’s risk tolerance) of cash on the “sidelines” to ensure the safety of your short-term cash needs. Believe it or not, since 1980, the average intra-year market decline for the S&P 500 has been 13.8%. Over those 40 years, however, 30 (75% of the time) have ended the year in positive territory:

Market declines are imminent and we want to plan ahead to help mitigate their potential impact. By having cash available at all times for your spending needs, it allows you to still receive income from your portfolio while giving it time to “heal” and recover – something that typically occurs within a 12-month time frame.

A real-world example of this is a client situation that occurred in late March 2020 when the market was going through its bottoming process due to COVID. I received a phone call from a couple who had an unforeseen long-term care event occur which required a one-time distribution that was close to 8% of their entire portfolio. At the time, the stock portion of their accounts was down north of 30% but thankfully, due to their 50% weighting in bonds, their total portfolio was down roughly 17% (still very painful considering the conservative allocation, however). We collectively decided to draw the income need entirely from several of the bond funds that were actually in positive territory at the time. While this did skew their overall allocation a bit and positioned them closer to 58% stock, 42% bond, we did not want to sell any of the equity funds that had been beaten up so badly. This proved to be a winning strategy as the equity funds we held off on selling ended the year up over 15%.  

As you begin the home stretch of your working career, it’s very important to begin dialing in on what you’re actually spending now, compared to what you’d like to spend in retirement.  Sometimes the numbers are very close and oftentimes, they are quite different.  As clients approach retirement, we work together to help determine this magic number and provide analysis on whether or not the spending goal is sustainable over the long-term.  From there, it’s our job to help re-create a retirement paycheck for you that meets your own unique goals.  Don’t hesitate to reach out if we can ever offer a first or second opinion on the best way to create your own retirement paycheck.

Nick Defenthaler, CFP®, RICP® is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

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Opinions expressed are those of the author but not necessarily those of Raymond James, and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Charts in this article are for illustration purposes only.

Should Some Of Your Money Be In Bonds?

Contributed by: Angela Palacios, CFP®, AIF®

The Center's Director of Investments Angela Palacios, CFP®, AIF® explains 3 reasons why you should own bonds.

Through thoughtful financial planning, The Center wants to make sure that you achieve your goals regardless of what markets are doing for short periods of time.  We are often asked why we would want to own bonds in a portfolio (especially now with interest rates at all-time lows!). While equity markets generally provide positive returns, there are still periods when they do not.

By their nature, stocks are better than bonds at providing investment returns as there is more risk involved in investing.  There is no promise to repay your principal or interest along the way.  However, while stocks might be better at providing total returns, bonds can provide returns more consistently because of these “promises”.  If we were only focused on investment return, our portfolio would reflect 100% stocks. However, for most investors it still makes sense to continue holding bonds…here are a few reasons why!

Reason #1: To support a withdrawal strategy

One of the worst-case scenarios could have been retiring right before the Great Recession (late 2007).  What if you had retired right before this scenario and needed to withdraw money from your portfolio even as markets corrected?  Owning bonds during times of stress means there is a bucket within your portfolio that you can live on – perhaps for extended periods of time if needed – without having to touch stock positions that are down (they can even provide funds to deploy into equities opportunistically or through routine rebalancing).  Using bonds as your source of income during this time (both the interest and selling bond positions) allows the equity positions a chance to rebound (which usually happens as we have experienced in the past). 

Reason #2: Less Downside Capture

If you capture less of the downside it usually won’t take you nearly as long to get back to your “break-even” or back to where your portfolio value started before equity markets correct.  The below chart does a great job of showing how this looked after the Great Recession.  It shows the dark blue line [a portfolio mix of 60% stock(S&P 500) and 40% bonds (Barclays US aggregate bond index)] recovered nearly a year and a half earlier than a portfolio holding just stock.

JP Morgan Guide to the Markets

Reason #3: Better Investor Behavior

Never underestimate the shock of opening a statement and seeing a swift downturn in your nest egg!  An allocation to bonds can potentially really assist your portfolio in this aspect as shown by the chart above.  If you look at the February ’09 point on the chart and cover up everything to the right of that, ask yourself “Is the “green line” experience something you could shrug off and continue holding or even invest more at this point?”.  Now it is clear that you should have held on to your stock positions but in those moments back in 2009, we didn’t have the benefit of “hindsight” to lean on.

Current Events: What Do Bonds Have Going For Them Now?

JP Morgan Guide to the Markets

All that being said, bonds are in a unique position right now (although similar to where we stood 5 years ago before rates started to rise).  So what do bonds have going for them other than just how they behave as part of your overall return experience?  There are a few tailwinds out there for bonds.  For U.S.-based bonds, while interest rates are low in the U.S., they are still better than other countries with the exception of emerging markets and below investment grade issues.  This steadily attracts buyers of our debt supporting prices even at these low-interest rates.

Another point is that we are still in the midst of a pandemic, there could continue to be unanticipated economic impacts that affect markets unexpectedly.  The economy is pretty vulnerable right now and when we are vulnerable an unexpected shock (black swan event) could have a larger than expected impact on markets if it were to occur.  Remember these are events no one could see coming (like the pandemic itself!).  Right now it is a far easier decision to sell stock positions and rebalance into bonds while calmer markets are prevailing than in the midst of a downturn.  These markets are pricing everything to perfection, rates staying low, Federal reserve continuing with their bond-buying strategies, vaccine dosages being deployed without a hiccup, no more widespread shutdowns, another government stimulus package, etc.  Things don’t always go to plan so adding to bonds helps to insulate you against events that are out of our control.

Another caveat to this is the lower interest rates are, the fewer bonds tend to correlate with stocks.  Meaning when rates are lower the assistance they provide during equity market downturns should be improved.

The chart below provides the historical basis for this view. It shows for each month since 1926 the stock-bond correlation over the subsequent 120 months (orange line). The chart also plots for each month where the 10-year Treasury yield stood (blue line). Notice that the two data series tend to rise and fall in unison, with higher Treasury yields associated with higher stock-bond correlations over the subsequent decade.  It also shows that while the 10-year treasury rate stays below 4% their performance remains uncorrelated or negatively correlated which is exactly what we are hoping for in the event of equity market volatility.

What If The Markets’ Worst Fears Are Realized And Rates Increase Causing Bonds To Lose Value?

A bad year of performance for bonds is far different than for equities.  This decade has had some tough years for bond positions.  The Bloomberg Barclays US Aggregate bond index has experienced a negative performance calendar year in 2013 (-1.98%) and two years where returns were essentially flat (2015 up .48% and 2018 up .1%).  While it is hard to predict the path of interest rates over the coming year diversification within your bond portfolio will be important.  For example, shortening the duration of the bond portion of your portfolio may help alleviate some of the risks of interest rates rising (remember when interest rates rise bond prices tend to fall).

I hope this helps your understanding as to why we are interested in still owning bonds as a portion of your investment portfolio!  Please don’t hesitate to reach out with any questions you may have!

Angela Palacios, CFP®, AIF® is a Partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.

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This material is being provided for information purposes only. Past performance doesn't guarantee future results. Investing involves risk regardless of the strategy selected, including diversification and asset allocation. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market. You cannot invest directly in any index. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.

COVID-19 and Your Money: Know These 4 Easy Financial Tips

Contributed by: Sandra Adams, CFP®

The coronavirus pandemic has taken us by storm. The virus has been devastating both financially and psychologically for many across the world. It has changed the way we will likely live our lives forever and forced us to slow down and think about things differently. Here are the top financial lessons that COVID-19 has helped us to see a little clearer...lessons that may be worth holding onto even after the pandemic is behind us.

1. Stick To A Budget

   It is easy for budgeting to take a backseat when times are good. We may find ourselves spending money on unnecessary items because we aren’t paying attention. The pandemic forced many to take a hard look at their expenses due to loss of income and free time. Many cut back on those “extras” they didn’t need, didn’t want, or weren’t using. They found ways to be more frugal without impacting the quality of life. Also a major plus: family time at home didn’t cost anything.

2. Have An Emergency Reserve Fund

   As in any financial crisis or economic slowdown, having emergency reserves can save you if hours are cut or a job is lost. While you can collect unemployment, there is often a gap in it getting paid out. Having emergency reserves, enough to get you through several months’ worth of expenses can be a lifesaver in these situations. The truth is, the majority of the U.S. population does not have this. If you do not have an emergency reserve fund…make this your goal before the next crisis!

3. Update Your Estate Plan

   People of all ages suddenly realized it might not be too soon to make sure their estate planning documents are in order. Durable Powers of Attorney and Wills (and potentially a Trust if applicable) used to put off most younger folks until they started to have families or until they felt like they had accumulated “enough” in assets. The sudden threat of a virus that could take your life at any age suddenly made these documents more important. Even more so with anyone over the age of 18 needs to have their Durable Powers of Attorney as their parents are no longer able to make legal, financial, or medical decisions on their behalf. Many COVID-19 patients were taken to facilities alone and not allowed to have a family member accompany them.

4. Get Life Insurance

   The pandemic caused a surge of folks to wonder if they were sufficiently covered from a life insurance standpoint. Many were younger families who had not yet accumulated sufficient assets to support their spouses and children long-term. While less common, COVID-19 deaths have appeared in the young adult group. If those families did not have sufficient life insurance, their surviving members were left in a devastating financial situation. It’s extremely important to make sure one always has sufficient life insurance coverage until they have the time to accumulate assets to support their families later in life. More young folks need to get life insurance; middle-age clients need it if asset accumulation is behind schedule. 

While COVID-19 has greatly impacted our lives, we can certainly learn from it. Consider implementing these 4 lessons. We are certain to learn more lessons from COVID-19, but this is a good place to start!

Sandra Adams, CFP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® and holds a CeFT™ designation. She specializes in Elder Care Financial Planning and serves as a trusted source for national publications, including The Wall Street Journal, Research Magazine, and Journal of Financial Planning.