Broadview Articles

As a financial advisor, I spend a great deal of time reading, collecting, and developing perspectives that I use to help people achieve their financial goals. I share the best of what I read and enjoy sharing this useful information with clients, friends, and colleagues so that everyone can benefit.

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The Case for Diversification in a Single Picture

Winning By Not Losing – Helpful Tax Planning Strategies

The Importance of Staying Invested

The Advantage of After-Tax 401K Offerings and Contributions

Market Volatility is Your Friend

Wealth Creation and Tax Advantages from Life Insurance

The Roth IRA – How to Maximize Its Benefits 

The Ordinariness of Market Corrections

The Case for Diversification in a Single Picture

This chart is one of my favorites.  It’s affectionately called “the periodic table” since its appearance is similar to the more well-known Periodic Table of Elements.

It highlights the performance of each of the major asset classes over the past 20 years and the annualized returns of those asset classes during that period.  Pictures often speak a thousand words, but this one illuminates an important investment truth in just three:   

Diversification is Essential

Today’s asset class “stars” can (and will) be tomorrow’s laggards and no one knows for sure which stars will shine brightest when.  Diversification helps ensure that you always hold the stars when they are shining.

The data also strongly suggest that diversification helps ensure that the road to investment returns are far less volatile than they would be had you been overly concentrated in a small handful of investments that encountered hard time…as they all do at some point.

The best way to achieve maximum wealth creation for the least amount of risk or volatility is to diversify.

The Importance of Staying Invested

We have been enjoying one of the longest bull markets in history.  It is now nearly 10 years strong, with the S&P 500 increasing nearly over 300% since its low point in 2009.  Hopefully, it has plenty more room to run, but there will come a time when the bears have their day for a while (as they always do).    

One can’t predict when this will happen but one can prepare for it by developing a strategy for how they will approach it when it does.  They can also see to it that their strategy is in place before rather than after the bear takes over.  

An important part of developing a strategy is to understand the history of what happened during and after previous bear markets.  There have been 13 bear markets (as defined by a 19%+ drop in the S&P 500) since World War II.  Some of these bears have been relatively modest (around 20% from top to bottom), while others have been more extreme (exceeding 50% from peak to trough).  The average drop has been 31% and they have occurred about one year out of every 5.  

Each of the bear markets have been painful for investors.  However, without fail, the overall market recovered after each bear to achieve new all-time highs (note the 300%+ increase for the S&P 500 since its 2009 bottom).  It often took time to happen (eg years), but history shows it always has.    

With this in mind, I find the following chart to be a powerful piece of this story.  It shows how much wealth creation investors would have missed out on if they had been on the sidelines during the best daily market returns for the S&P 500 from 1993 - 2013.  Imagine missing the best 10 days during this 20-year period and sacrificing 40% of your wealth creation.  Worse, imaging missing the best 20 days and missing out on 67% of your wealth creation!  

Many of the best daily returns came in bunches following the bottoms of painful bear markets.  Since it’s impossible to effectively time when these events will happen – just like it’s impossible to effectively time market highs and lows — it’s vital for people to have a financial plan and investment strategy that enables them to:  

Stay Invested In The Market and Buy Into The Market When It’s “On Sale”  

It can be difficult to do this when things are going south and the financial press is calling the latest Armageddon different from all others before it.  But history (and the market) has greatly rewarded those who were able to do it. Having a strategy in place that keeps this history in mind can help people better weather the tough times and maximize wealth creation when opportunity knocks.

Market Volatility Is Your Friend

Given the market’s strength over the past several years, many will not recall that there have been several periods when things didn’t feel very strong.  The most recent ones were: 1) earlier this year (2018) when the S&P 500 pulled back more than 10% and 2) two periods in 2016 (January/February and June) when the S&P 500 fell by more than 10% and many international markets fell by more than 20%.

A better word for these periods is volatile.  Volatility naturally causes worry or anxiety for many as it makes investment and retirement portfolios look either healthy or no so.   It’s during these times I like to remind myself that volatility over the long run is a friend rather than an enemy.  

Here is a great example that is often used to illustrate why volatility should be considered more friend than foe for the long-term investor:   

There are two doors you can walk through.   

Door #1 – you spend 15 years putting $1000 into an investment every month over that timespan, with the possibility of seeing that investment get cut in half twice during two major market downturns.  

Door #2 – you spend 15 years putting $1000 into an investment every month over that timespan, with the same annual performance of what’s behind door number one, but no drawdowns.  

Which would you choose? On the surface, you’d choose Door #2. Of course, who wouldn’t?  But it’s the wrong choice. The trick here is to remember that you’re adding to the investment in a disciplined way, at a rate of $1000 per month.  

That’s when you realize that Door #1, with its twin 50% crashes, is the better option.  It’s the harder choice to live with, of course, but that’s what the new money’s for.  

Had you opted for Door #1 over the disappointing 15 year period for stock returns between 2000 and 2014, you would have lots of money to show for your troubles. Much more money than had you opted for the steadier Door #2.  

Eric Nelson at Servo Wealth explains how this is possible, by looking at an investor who chose to buy $1,000 worth of the S&P 500 each month over the 15-year period (2000 through 2014) versus the investor who chose to buy the more stable Vanguard Short Term Bond Index.  

In both options, the investor invested $180,000 cumulatively.  For Door #1, the total ending portfolio value was $352,202.  This is nearly twice as much as you saved and is the equivalent of a +8.5% per year return on your contributions!  

How can this be? The S&P 500 only averaged +4.1% annualized returns during that time. But not all of your savings averaged 4.1%. Some money went in after 2001 and 2002 and 2008 and 2011 when shares were extremely depressed and subsequently earned returns of +12%, +15% and +20% or more…  

We can see the opposite effect when we observe the outco4e of dollar-cost-averaging the same amount into the low-risk bond fund. Remember, it had the same annual compound return over the 15-year period. But the amount of accumulated wealth was only $228,294, almost $130,000 less than what you netted from the S&P 500.  

The magical part is that the two investment choices both netted around 4.1% annually on average. But by taking advantage of the short-term declines – in a discipline, systematic way (which is the key) – investors can learn to embrace the volatility that ends up punishing some, but rewarding others with higher than average returns.  

Conditioning yourself to love drawdowns is not easy – and the more money you have at risk, the harder it is. Younger people with 401(k) plans and newer brokerage accounts can use the power of DCA (dollar cost-averaging) – this is one critical advantage they have over their parents and grandparents. If they take advantage of it, the magic of compounding doesn’t take very long to appear.  

Don’t flee from volatility, understand how it helps you and think of it as a very good friend.

The Roth IRA – How to Maximize Its Benefits

I get lots of questions about how people should think about Roth IRAs as part of retirement and/or legacy planning.  

 Some of the most common are:  “Should I make regular or Roth contributions in my 401K?”, “When should I make Roth contributions outside of my 401K or traditional IRA”, and “What good is a Roth IRA in relationship to my other tax-deferred accounts (eg 401K and traditional IRA)?”   

Roth IRA’s play an important role in retirement and legacy planning because they:  1) enable after-tax earnings grow tax-free for the rest of your life; 2) help minimize tax exposure before and during retirement; and 3) give you the option to pass on Roth IRA accounts to heirs in tax efficient manner.  

Here is a checklist I’ve put together to help people better understand how to maximize the opportunity from Roth IRAs:    

  • When to Contribute to a Roth IRA – It’s generally a good idea to make regular annual contributions to a Roth IRA.  This enables you to build a solid Roth IRA in time to take advantage of it in retirement.  The contribution limits for 2018 and 2019 are $5,500/yr per individual with an extra $1,000/yr allowed for individuals 50 years and older.  For Roth IRA accounts established by December 31, 2018, you have until April 15th, 2019 to contribute for the 2018 tax year. 
  • What are the Important Income and Other Limitations — There are income limit restrictions on Roth IRA contributions ($120,000 – $135,000 for individual income tax filers and $189,000 – $199,000 for married couples filing jointly in 2018).  However, people who exceed those income levels can contribute to a Roth through something called a back-door Roth IRA (see that item in the checklist below).  The other limitation to consider is the $5,500 and $6,500 contribution limits apply to all IRA (Roth and Traditional) contributions to all accounts in a given year.  Therefore, if you max out your Roth IRA contribution you can’t make a traditional IRA contribution (either pre-tax or after-tax contribution) that same year.  This limitation doesn’t apply to 401K contributions, so you can max out a 401K contribution and also max out a Roth IRA contribution.   
  • Can I Make a Regular or Roth Contribution Inside my 401K — Many 401K plans (although not all) give people the opportunity to make both regular and Roth IRA contributions within a 401K.  The IRS allows up to an $18.5K tax deferred contribution inside of a 401K in 2018 and 2019.  This increases to $24.5K for people 50 years and older.  The $18.K and $24.5K limitations apply to any combination of regular and/or Roth contributions (note that Roth contributions inside of a 401K can only go up to the $5,500 and $6,500 limits mentioned above).   
  • Should I Make a Roth Contribution Instead of a Regular 401K or IRA Contribution — The key thing to think about when deciding between making a regular or Roth contribution inside a 401K is how you think your current federal income tax bracket will compare to the bracket when you are retired.  If you think your current tax bracket is lower than where you will be in retirement then it makes sense to max out your Roth IRA contribution either inside or outside a 401K.  This is because you trade off paying a lower marginal tax on the contribution today rather than in the future.  Conversely, if you think your tax bracket is higher today than it will be in retirement then it doesn’t make sense to do it as you’ll pay more in taxes today than in the future.  If you think your current tax bracket will be about the same in the future then chat with your advisor or accountant about what makes most sense depending on your overall income and tax situation. 
  • Can I Maximize My 401K Contribution and Still Contribute to a Separate Roth IRA — Yes.  If you do not exceed the Roth IRA income contribution limits then it’s as simple as making a direct contribution to a Roth IRA account.  If you do exceed the Roth IRA contribution limits then you can pursue the Back-Door Roth contribution strategy highlighted below. 
  • When Should I consider a Roth IRA Conversion – Roth IRA conversions are very good to think about when you have years in which you have taxable income but will be in a lower tax bracket than you’re likely to be in in retirement.  A couple of popular scenarios are when you are building a new business and/or when you have moved into semi-retirement and are working part time.  These are optimal times to convert traditional IRA money into a Roth IRA as the tax advantage can be significant. 
  • How Do I Do a Back-Door Roth IRA Contribution – The back-door Roth IRA is for investors who earn too much to contribute to a Roth IRA outright.  With this kind of Roth IRA contribution you start by making an “after-tax” contribution to a traditional IRA.  Once that contribution has been made you convert it to a Roth IRA shortly thereafter.  There aren’t income limitations on “after-tax” traditional IRA contributions or on converting those to a Roth IRA.  The one thing that can complicate things is if you have a lot of traditional IRA assets, for reasons discussed here.  There are often ways to work through this, but you’ll want to talk through them with a financial advisor or tax planner. 
  • Can a Roth IRA Help Me in Legacy Planning – Yes it can.  Since Roth IRA’s don’t  have required minimum distributions during your lifetime, the beneficiaries of the Roth funds, assuming the account is titled and structured properly, can stretch the tax-free distributions over the beneficiaries’ lifetimes. This is somewhat complicated and should be done in conjunction with a financial advisor and/or tax specialist.

Winning by Not Losing – Helpful Tax Planning Strategies

As we approach the holidays we all have plenty on our minds.  One thing that may not be top of mind but is important to be on top of are strategies to minimize your tax burden in 2018 and get you set up for tax success in 2019.

There are a number of tax-saving opportunities for individuals, families and business owners that are worth checking out to ensure you’re taking advantage of the ones that apply to you.

I’ve teed up a handful of strategies I think are most important to consider for individuals and families.    

  • Maximize Retirement Plan Contributions:  This one is the most obvious and one everyone is likely aware of.  That said, it’s common that people with plenty of financial flexibility aren’t doing this.  Bottom line…if you haven’t maxed out contributions to your 401(k) or 403(b) retirement plan, consider doing so before year-end to lower your taxable income.  The maximum allowable contribution in 2015 is $18.5K prior to age 50 and $24.5K once you reach age 50.  At a minimum, if you work for an employer who matches some of your contributions, make sure you contribute enough to get the full match the company offers as it’s ”free money”.
     
  • Tax Loss Harvesting:  It has been an interesting market dynamic in 2018.  The US stock market is up quite a bit, but international developed and emerging markets are down.  Many fixed-income assets are also down some in 2017.  If you have investments in taxable accounts whose value is currently lower than when you made the investment, you should consider selling those assets and lock in capital losses that can be used against current or future capital gains.  There can be significant tax savings from doing this since you can write off up to $3K per year of capital losses and any additional capital losses can be carried over to future years.  Importantly, if you sell mutual funds with losses it’s often a good idea to purchase similar funds so you don’t miss out on future growth opportunities from the asset class those funds are designed to cover in your portfolio.
     
  • Avoiding Capital Gains Distributions:  Each year, mutual funds companies are required by law to distribute the vast majority of a fund’s capital gains to shareholders.  A fund’s capital gains are generated by fund managers’ buying and selling securities within the fund during the year.  Most companies distribute these gains in mid-to-late December.  For people with mutual funds in taxable accounts, this often means you’ll incur capital gains taxes before the end of the year.  It can pay to check if the capital gains the fund distributes exceed gains you may have garnered in those funds.  If so, a tax saving option is to sell out of the funds before the distribution date and purchase similar funds that do not have substantial capital gains distributions.
     
  • Accelerating Key Deductions:  There are a number of opportunities that fall into this category.  They include things like pre-gifting charitable donations, bundling medical expenses and others.  However, my favorite is to accelerate your January 2019 mortgage payment into December.  Assuming you have less than $1M in home loans (primary and secondary), this will allow you to write off a 13th month’s mortgage interest in 2018.  Unless you think you’ll be in a lower tax bracket in 2019 this is a nice, easy way to reduce taxes this year.    

For those of you who aren’t sure whether you’re maximizing near-term tax-saving opportunities or set up for future tax success, it can really pay to develop a plan for this.  Your financial advisor should be able to help or feel free to reach out if you think I can help.

The Advantage of After-Tax 401K Offerings and Contributions

Several years ago the IRS made a ruling change that has prompted many large companies (although far from all) to allow for “after tax 401K” retirement plan contributions.  According to Bankrate.com, some 48% of employers now offer employees the ability to contribute after-tax dollars into their 401K plan.  So, you may have this benefit and now even know it.  If you’re not sure, I encourage you to find out and to take a look at these reasons why.   

 What Is The “After Tax 401K Contribution” Benefit?  

 This benefit allows employees to contribute “after tax” income into a 401K account each year.  The “after tax 401K” contribution is in addition to the “pre-tax” 401K and “after tax” Roth IRA contributions that have been standard options for most 401K plans for years.  In my former employer Microsoft’s case, the plan allows a maximum after-tax contribution of $20,000 per year.  For reasons too complicated to get into here, it’s likely that is about as high as most of these offerings will go if you have one.    

 Why Is This An Important Benefit?  

It Increases Investment Returns Through Tax Deferred Growth:  The “after tax 401K” significantly increases the amount of money employees can contribute to tax-deferred retirement accounts.  As most know, the major benefit of tax-deferred retirement accounts is that investments made in those accounts grow tax-free (eg you don’t pay Uncle Sam for dividend income and/or capital gains) until you begin taking distributions later in life.  The more money people can get into tax-deferred accounts the more their money will be able to grow before retirement.  Here is a simple example:  

An employee invests $10,000 in the “after-tax 401K” plan.  The $10,000 is invested in a diversified portfolio in the company’s 401K mutual fund offerings which grows an average of 7% per year.  If all dividends and capital gains are reinvested, this $10,000 grows to about $76,100 at the end of 30 years.  On the other hand, if that same $10,000 were invested in a traditional taxable investment account over the same timeframe, was invested in the same mutual funds growing at 7% per year, produced typical 2% annual dividend income and generated 1% taxable capital gains distributions the $10,000 would grow to about $63,400.  The “after tax 401K” option generates nearly 20% more investment returns all else being equal.   And this is just for a single $10,000 that someone invests.  

 It’s A Great Way to Create A Meaningful Roth IRA:  The other big opportunity from this benefit is that contributions made to the “after tax 401K” account can be rolled over to a Roth IRA on a quarterly basis.  Roth IRAs are powerful retirement savings tools because they enable retirement savings to grow tax free (like 401ks and Traditional IRAs) but unlike 401Ks and Traditional IRAs, they also: 1) DON’T get taxed on any gains within the account when distributions are taken (note: for this to be the case you need to be 59 1/2 and have had the Roth IRA for 5 years or more); and 2) owners are NOT REQUIRED to take any distributions from the account if they don’t wish to…ever.  Because you don’t pay any taxes on money taken from a Roth in retirement, many people use Roth distributions to help lower their tax bracket in retirement.   

The key, however, is to be disciplined and convert the “after tax 401K” contributions to a Roth IRA on a quarterly basis.  This is because if money in the “after tax 401K” account is invested and increases in value during the quarter there will be some tax implications when the money is converted to the Roth IRA.  If, however the employee chooses to keep the initial contribution in cash until they convert it to the Roth IRA they shouldn’t have to pay any tax on the conversion and the money can get invested quickly after the conversation and begin growing for retirement.   

Should I Contribute to a Regular Pre-Tax 401K or an “After-Tax 401K”?  

It is still a good idea to max out your pre-tax 401K contribution before taking advantage of the “after tax 401K”.  There is for two reasons:  1) pre-tax 401K contributions often get some kind of employer matching contribution which accelerates the impact of the pre-tax contribution.  Employee matching funds are effectively “free money” so you want to capture as much of that as you can.   2) pre-tax contributions lower the employee’s taxable income so are generating tax savings that can range anywhere from 10%-40%+ depending on a person’s marginal income tax rate.  Once an employee has maxed out their allowable pre-tax 401K contribution it is then a good idea to put as much “after tax 401K” as they can (up to the maximum allowable by the plan, of course).

Conclusions  

There are a number of advantages to after-tax 401K contributions that make them worth serious consideration if your employer offers one.  If you aren’t sure whether you have one it would be worth checking into it. Finally, managing the conversion process is one of the many things we do for clients to ensure they are maximizing this benefit.  If it’s something you’d like to discuss further, please do not hesitate to contact us.

Wealth Creation and Tax Advantages from Life Insurance

If you’d asked me several months ago whether I’d be writing about life insurance in a Blog post I would have said “no”.    Frankly, I didn’t know much about life insurance.  I knew I had some through my employer but didn’t think more about it.  However, once I left my employer I had to secure a new policy to protect my family.  At the same time, as a Financial Advisor I wanted to learn more about the pros and cons of different insurance options so I could effectively advise people on how to utilize insurance as both a tool for protection and a tool for wealth creation.    

My first learning reinforced what I already knew – term life insurance as a protection strategy is not only worthwhile, but absolutely necessary for most people.

My second learning really surprised me – life insurance can be much more than a protection strategy.  In fact, there are several very effective ways to use life insurance to enhance wealth creation and more efficiently transfer wealth to your heirs.

While insurance can be complicated and the details best suited for face to face discussion, as it pertains to wealth creation three great things to know are:

First, individuals who accumulate wealth in taxable investment accounts (think accounts other than 401Ks and IRAs) can significantly enhance wealth creation by investing instead within the structure of an insurance policy.   This is possible because investments made within life insurance policies grow tax free, can produce income that is distributable tax free and can be passed on to heirs tax free.

Second, there is considerable choice in what you can invest in.  This includes plenty of high quality, diversified, low cost mutual funds, that enable people to create the kind of investment portfolios they would have created within a taxable account.

Third, there is enough value in the tax efficiency to make it worth investigating for people who currently have life insurance through their work or other means.

It’s worth noting that I don’t sell or in any way benefit from life insurance products.  As an investment advisor, I am responsible for doing what’s in my client’s best interests. It’s within this context that I share these learnings so that people who are interested can learn more about it.

Your financial advisor should be able to provide you with more details if you are interested. I’m also be happy to chat with you if you think I could be of help.

The Ordinariness of Market Corrections

In February and March of 2018 the US equities market (S&P 500) entered “correction” territory.  A correction is defined as a drop of 10% or more from a previous market high.

It has been since June and January of 2016 that the S&P had experienced a correction.  Before January, 2106 it has been over 1,400 calendar days since the last correction, the third longest such run in 50 years.  Given these gaps, it’s easy to forget that corrections do happen.  In fact, they happen quite often.  According to JP Morgan (see chart), the S&P 500 has averaged at least 1 correction per year since 1928.

What’s more, according to separate S&P data, the average intra-year decline has been 14.9% since 1980.   

Given the frequency of corrections, the question then is not what it’s like to experience them but rather how we respond to them.  Anytime the markets correct (let alone turn into Bear Market drops of over 20%) it’s easy to get jittery about what will happen next and what, if anything, we should do.  

 At times like these, it’s important to remember that corrections are natural, frequent and positive for investors long-term returns (since they allow new investments and dividends on current ones to come in at cheaper prices).  Conversely, responding to corrections by modifying or abandoning disciplined, long-term wealth creation strategies is likely to end up causing portfolios to underperform what those strategies were created to achieve.   

It can be difficult to ignore the noise that follows corrections, but if we recognize that they happen frequently then hopefully we can ignore them and remain true to our longer-term investment objectives.