Should I worry if my 401k savings are down?

Contributed by: Robert Ingram, CFP®

It can be scary when financial markets are volatile and selloffs happen. Understandably, many are concerned about how COVID-19 will impact the economy, our health, and our financial security. These fears and the volatile markets that follow can temp retirement savers to make drastic changes to their investment portfolios; some may even cease investing entirely. For example, if you watch your 401(k) continue to lose value, you may want to stop contributing. However, I’ll explain why you should stick with your current long-term savings and investment plan.

Why Its Beneficial to Keep Contributing

Contributing to a retirement plan like a 401(k) or 403(b) is still one of the best ways for most Americans to save and build wealth for retirement, particularly in times of economic uncertainty. 

• Tax Benefits 

  Contributions to most 401(k) plans are made pre-tax, meaning these amounts are excluded from your taxable income in the year they are made. This reduces your current income taxes. It also allows those savings to grow tax-deferred year-after-year until they are withdrawn.

  Employer plans that offer a Roth designated account (i.e. a Roth 401(k) or Roth 403(b)) can present a great opportunity for investing. Roth contributions are made after-tax, so those amounts do not reduce your taxable income like the 401(k) does. However, those savings grow tax-deferred. The withdrawals and earnings are tax-exempt, provided you are at least age 59 ½ and have held the account for at least 5 years. This tax-free growth can be a powerful tool, especially for individuals that may be in a higher income tax bracket in the future.

• Opportunity To Buy Low

  For investors that are still contributing to their plans, a downturn in markets actually presents an opportunity to invest new savings into funds at lower prices. This allows the same amount of contributions to buy more shares. As markets and economic conditions rebound, you will have accumulated more shares of investments that could grow in value.

• Matching Contributions

  Need another incentive to keep those contributions going? Don’t forget about opportunities to receive employer matching with retirement plans. If your employer offers a 401(k) match, you would receive additional savings on top of your own contributions. Let’s say your employer matches 50% on contributions you make up to 6% of your salary. By putting 6% of your income into your 401(k), your employer would contribute an extra 3%. That’s like earning a 50% return on your invested contributions immediately. Those extra contributions can then buy additional shares which can also compound over time. 

Should I Ever Consider Stopping Contributions?

Even in a booming economy and during the strongest bull market, it’s important to have a strong financial foundation in place before deciding to invest over the long-term. Having key elements of your day-day-finances as stable as possible is necessary as we navigate the incredible challenges created by COVID-19. A few examples include:

• Control Over Your Cash Flow

  Do you know exactly how much money you earn and spend? Understanding where your income exceeds your expenses gives you the fuel to power your savings. How secure is your employment? Are you in an industry directly or indirectly impacted by the economic shutdowns due to COVID-19? What would happen to your cash flow if you had a reduced income? If there are other expenses you could cut in order to maintain your contributions, you should still try to contribute. However, if you need every dollar possible to pay your bills, you would have no choice but to suspend your 401(k) contributions.

• Cash For Any Short-Term Needs

  Having cash reserves is a critical part of a sound financial plan. If an unexpected expense occurs or you had a loss of income, be sure to have cash savings to draw from rather than being forced to sell investments that may less valuable or to use credit cards with high-interest debt. If your savings is less than a month’s worth of normal expenses, you should consider focusing your efforts on reinforcing your cash reserve rather than on your retirement plan. Then, ideally, you should work towards building 3 to 6 months’ expenses for your emergency fund as you continue to save for retirement or other goals.

• Tackling Your Debt

  If you have high-interest rate debt that you are working to pay off and are unable to find additional savings in your budget to increase your payment amounts, it could make sense to redirect your retirement plan contributions to pay the debt down first. On the other hand, if your employer offers a company match, you should still consider contributing at least enough to get the full amount of matching dollars (remember that free money could see a return of 50% or more). You could then redirect any amounts you are contributing above that maximum match percentage.

Your situation and needs are unique to you. It’s important to work closely with a financial advisor when making decisions, especially in these incredibly difficult times.

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.

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Keep in mind that investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results.

Using the Bucket Strategy to Meet Retirement Cash Needs

Contributed by: Josh Bitel, CFP®

If you are in or close to retirement, you are probably concerned about the recent market uncertainty. You may be wondering how your investment portfolio can be structured to provide the income you need, without putting the portfolio in a vulnerable position. 

The Bucket Strategy (not to be confused with the “Bucket List”) describes a cash distribution method to provide you with income from your portfolio during any kind of market cycle. 

Consider that we have four buckets, and that every investment within your portfolio fits into one of these buckets. This strategy can provide cash needed in retirement, even if equity markets drop or stay low for extended periods of time. 

Bucket 1:

The first bucket is designated for cash needs of one year or less. This bucket contains cash and short-term securities that mature in less than one year to support your needs for the next 12 months. 

Bucket 2:

The second bucket starts generating cash flow in the 13-36 month range, or years two and three. This bucket contains short-term bonds and fixed-income type securities that have a small amount of volatility, but are primarily designed for preservation of capital. The holdings in this bucket will pass on interest income that ultimately flows into the first bucket. 

Bucket 3:

The third bucket is structured to generate cash flow needs in years four and five, and primarily contains strategic income and higher yielding bonds (lower quality, longer maturing and international type bonds). However, they do pass on interest income that flows into the first bucket, much like bucket #2. 

Bucket 4:

The fourth, and last, bucket is made up of equities (stock investments) and other assets that have higher volatility like gold, real estate, commodities, etc. Many of these assets will produce dividends to help replenish the first bucket, if the dividends are set to pay in cash and not reinvest. Ideally, when the market is volatile, as we’ve been seeing lately, this bucket is left alone to ride out the market cycle and replenish as we recover.

The Bucket Strategy is designed to provide enough cash flow to get through roughly a 6- or 7-year period without needing to liquidate the stock portion of the portfolio. This should provide you with the confidence (and more importantly, cash) needed to enjoy your retirement and start working on your Bucket List! 

Talk to your financial planner to see how the Bucket Strategy might work for you.

Josh Bitel, CFP® is an Associate Financial Planner at Center for Financial Planning, Inc.® He conducts financial planning analysis for clients and has a special interest in retirement income analysis.

Is the Diversified Portfolio Back?

Contributed by: Robert Ingram

(Repurpose of the 2014 blog: ‘Why I Didn’t Like My Diversified Portfolio’)

As our team finished 2018 and began reviewing the 2019 investment landscape, I couldn’t help but to think of a Money Centered blog written by our Managing Partner, Tim Wyman. As Tim shared:

“I was reminded of the power of headlines recently as I was reviewing my personal financial planning; reflecting on the progress I have made toward goals such as retirement, estate, tax, life insurance, and investments. And, after reviewing my personal 401k plan, and witnessing single digit growth, my immediate reaction was probably similar to many other investors that utilize a prudent asset allocation strategy (40% fixed income and 60% equities). I’d be less than candid if I didn’t share that my immediate thought was, “I dislike my diversified portfolio”.

The headlines suggest it should have been a better year. However, knowing that the substance is below the headlines, and 140 characters can’t convey the whole story, my diversified portfolio performed just as it is supposed to in 20xx.”

This may have been a familiar thought throughout 2018. Interestingly though, Tim’s blog post was actually from 2015. He was describing 2014.

THE FINANCIAL HEADLINES – Same Old, Same Old?

The financial news about investment markets today still focuses primarily on three major market indices: the DJIA, the S&P 500, and the NASDAQ. All three are measures for large company stocks in the United States; they provide no relevance for other assets in a diversified portfolio, such as international stocks, small and medium size stocks, and bonds of all types. As in 2014, the large U.S. stock indices were at or near all-time highs throughout much of 2018. Also in that year, many other major asset classes gained no ground or were even negative for the year. These included core intermediate bonds, high yield junk bonds, small cap stocks, commodities, international stocks, and emerging markets.

Looking Beyond the Headlines

Here at The Center, our team continues to apply a variety of resources in developing our economic outlook and asset allocation strategies. We take into account research from well-respected firms such as Russell Investments, J.P.Morgan Asset Management, and Raymond James. Review the “Asset Class Returns” graphic below, which shows how a variety of asset classes have performed since 2003.

This chart shows the historical performance of different asset classes through November of 2018, as well as an asset allocation portfolio (35% fixed and 65% diversified equities). The asset allocation portfolio incorporates the various asset classes shown in the chart.

If you “see” a pattern in asset class returns over time, please look again. There is no determinable pattern. Because asset class returns are cyclical, it’s difficult to predict which asset class will outperform in any given year. A portfolio with a mix of asset classes, on average, should smooth the ride by lowering risks that any one asset class presents over a full market and cycle. If there is any pattern to see, it would be that a diversified portfolio should provide a less volatile investment experience than any single asset class. A diversified portfolio is unlikely to be worse than the lowest performing asset class in any given year. And on the flip side, it is unlikely to be better than the best performing asset class. Just what you would expect!

STAYING FOCUSED & DISCIPLINED

As during other times when we have experienced strong U.S. stock markets and periods of accelerated market volatility, some folks may be willing to abandon discipline because of increased greed or increased fear. As important as it is to not panic out of an asset class after a large decline, it remains equally important to not panic into an asset class. In the case of the S&P 500’s outperformance of many other asset classes, for example, many have wondered why they should invest in anything else. That’s an understandable question. If you find yourself in that position, you might consider the following:

• As in the five years leading up to 2015, the S&P 500 Index (even with the recent pullback in stock prices) has had tremendous performance over the last five years. However, it’s difficult to predict which asset class will outperform from year to year. A portfolio with a mix of asset classes, on average, should smooth the ride by lowering risk over a full market cycle.

• Fundamentally, prices of U.S. companies relative to their expected earnings are hovering around the long-term average. International equities, particularly the emerging markets, are still well below their normal estimates and may have con­siderable room for improvement. This point was particularly relevant in 2018 and continues to be as we begin 2019.

• Through 2018, U.S. large caps, as defined by the S&P 500 Index, have outperformed international equities (MSCI EAFE) in six of the last eight years. The last time the S&P outperformed for a significant time, 1996-2001, the MSCI outperformed in the subsequent six years.

• What’s the potential impact on a portfolio concentrated in a particular asset class, if that asset class experiences a period of loss? Remember, an investment that experienced a loss requires an even greater percentage return to get back to its original value. For example, an investment worth $100,000 that loses 50% (down to $50,000) would actually require a 100% return from $50,000 to get back to $100,000.

MANAGING RISK

Benjamin Graham, known as the “father of value investing,” dedicated much of his book, The Intelligent Investor, to risk. In one of his many timeless quotes, he says, “The essence of investment management is the management of risks, not the management of returns.” This statement may seem counterintuitive to many investors. Rather than raising an alarm, risk may provide a healthy dose of reality in all investment environments. That’s important in how we meet financial goals. Diversification is about avoiding the big setbacks along the way. It doesn’t protect against losses – it helps manage risk.

Often, during times of more volatile financial markets like those we have experienced during the last couple of months, the benefits of diversification become apparent. If you have felt the way Tim did back in 2015 about your portfolio, we hope that after review and reflection, you might also change your perspective from “I dislike my diversified portfolio” to “My diversified portfolio – just what I would expect.”

As always, if you’d like to schedule some time to review anything contained in this writing, or your personal circumstances, please let me know. Lastly, our investment committee has been hard at work for several weeks and will be sharing 2019 comments in the near future. Make it a great 2019!

Robert Ingram is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.®

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Any opinions are those of Bob Ingram, CFP® and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI is an index of stocks compiled by Morgan Stanley Capital International. The index consists of more than 1,000 companies in 22 developed markets. Investments can not be made directly in an index.