Zynergy

Retirement Planning

A New Year Means a Fresh Start for Your Finances

risk tolerance

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It is that time of year again…time to work on your New Year’s resolutions and start fresh with your finances. While many think about their resolutions in terms of eating better, exercising, reading more, etc., not many people think about it in terms of their finances.  The beginning of the new year is a great time to think about how you can improve your finances so that you can achieve your goals.  Whether it includes buying a home, saving more for retirement, putting away money for a child’s college education, creating a budget, paying down debt; having a financial plan and a strategy for the year ahead can be a great way to reduce stress and put you in control of your financial life.  If you want 2022 to be a better year for your money, consider incorporating some of the items below into your New Year’s resolutions:

  • Create a budget – I will be the first to admit that budgeting is not a fun exercise.  However, a solid financial plan starts with a well-thought-out budget.  A spending plan can not only help you make progress towards your financial goals but can also help reduce stress throughout the year.  Consider tracking your expenses via a software program to get a good understanding of where your money is going.
  • Build an emergency fund – An emergency fund is a cornerstone of a financial plan. It is a great way to ensure that you are covered should you need cash to cover an emergency.  This way you do not have to rely on a credit card or dip into your long-term investments to get the cash you need.  While the textbooks say that you should have three to six months of your living expenses in an emergency fund, this could be an overwhelming number for some to achieve in the short term.  For those who do not have an emergency fund at this time, I would suggest that you commit to saving at least $1,000 in your emergency fund.  Once there, you can add to the fund over the course of the year should you find yourself with excess cash flow.  Better yet, choose a time frame in which you would like to target for a fully-funded emergency fund.  This way you can add the monthly amount going into your emergency fund to your budget.
  • Pay down debt – If you have outstanding credit card balances or other debt with a high-interest rate, then now is a good time to commit to eliminating your debts for good.  Perhaps it would make sense for you to refinance your debt into a lower interest rate.  Refinancing your debt may provide you with a lower monthly payment, which will improve your monthly cash flow.  These extra dollars can be applied to extra principal payments on your debt, redirected into your emergency fund, or put aside and invested for other long-term goals.
  • Make sure you get your free money – Do you have access to a retirement plan (401k, 403b, TSA) at work?  If so, do you know if your company offers a matching contribution?  Contributing to a retirement plan is an excellent way to save for retirement in a tax-efficient manner.  Most companies that have a retirement plan, but not all, will match an employee’s contributions, up to a certain amount.  This is virtually free money! If your company has a matching program in place then I would suggest that you take full advantage of the match, or at least as much as your budget will allow.  Do not leave free money on the table.
  • Review risk tolerance – If you experienced a life change over the past year or if you are expecting a change in the new year, then now is a good time to take a fresh look at your risk tolerance.  Understanding how you respond to market risk can have a positive, or negative, impact on your ability to achieve your goals.  If you are taking on too much risk than you can handle and we find ourselves in the middle of a bear market, how will you respond? If you are like most investors, you will most likely sell at the bottom and not be around for the recovery.  This can have a devastating impact on your long-term financial security.  Have an honest conversation with yourself about your risk tolerance.  Ask yourself: if the market drops 30% or 40%, how is that going to make me feel?  Will that cause me to abandon my long-term investment plan? If so, you may want to think about reallocating your portfolio so that it is in line with your risk tolerance.
  • Rebalance portfolio –Rebalancing your portfolio involves shifting your investments among different asset classes to keep your portfolio in line with your target allocation.  Not only does this approach ensure that you are buying low and selling high but can also eliminate the temptation to time the market.  Since we cannot consistently predict what a particular asset class will do in the future, it is impossible to know the optimum time to sell an asset to maximize profits.  But by rebalancing your asset allocation at least once a year, you will be taking advantage of the market.  You will also be keeping your portfolio in line with your risk tolerance so that you can achieve your long-term goals.
  • Review insurance – Reviewing your various insurance policies is a great way to not only to know how much you are paying for these policies but, more importantly, to determine if you have too much insurance – in which case you can probably save some premium dollars by reducing the coverage – or not a sufficient amount of insurance – in which case you may need to increase your coverage in certain areas.  Creating an inventory of your insurance policies (life, disability, auto, homeowners, renters, etc.) is a great first step in understanding the cost and coverage of your policies.
  • Estate planning documents – I know that it is never easy to talk about estate planning.  However, it is extremely important that you have the basic estate planning documents in place.  These include a Last Will and Testament, Power of Attorney, and Medical Directive.  Not only will these documents name your beneficiaries but will also allow you to name a trusted person, or persons, who you would like to take your place should you not be in the position to make financial or medical decisions for yourself.  If you already have these documents, it is still important to review them from time to time to ensure that they are consistent with your current estate planning goals.

Take control of your finances, and start fresh this new year with a plan for how you are going to handle your cash! We are here to help, so if you have any questions, feel free to contact Zynergy Retirement today.

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Are you planning on taking the leap into retirement in the New Year?  Choosing to retire is a big step, and you want to be sure that you are setting yourself up well for a secure retirement.  If you haven’t already, now is a good time to get your financial house in order so that you are fully prepared for the exciting journey ahead of you.  Getting your financial house in order involves preparing your retirement budget, knowing your sources of retirement income, understanding where your investment accounts are located, and how they are invested.  In addition, this is also a good time to think about how you are going to spend your time in retirement.  Now that you do not have to deal with the daily commute and a busy work schedule, how are you going to fill the hours of your day in retirement? Below you will find five important tasks you should complete over the next few months as you head into retirement.

  1. Prepare your retirement budget – Setting a budget is one of the most important things you can do leading up to and in retirement.  When reviewing your budget, it is important to separate your expenses into two categories: (1) essential expenses and (2) discretionary expenses.  Essential expenses are those that must be paid.  These include things like rent, mortgage, utilities, and groceries.  Discretionary expenses represent voluntary spending.  These are items that you would like to purchase, but they are not mandatory.  Discretionary spending is drawn from the money that is left over after paying your essential expenses.  
  1. Understand your retirement income – Once you have completed your budget, you will then want to understand where your income is going to come from.  The main source of retirement income for many Americans is Social Security, but it could also include a monthly pension payment or a stream of income from an annuity.  Once you know your income sources, you will then want to compare them to your expenses.  If you are like most people, once you retire, your expenses will likely be higher than your income.  In this situation, you will need to supplement your income from your savings and investments. Understanding how much income your portfolio needs to provide will help in determining how your portfolio should be invested.  
  1. Review your risk tolerance and asset allocation – When you retire, you will be transitioning from the accumulation stage of life to the decumulation stage.  The accumulation stage involves saving as much as you can and investing those savings at a level of risk you are willing to accept.  However, upon retirement, you will begin to draw from your portfolio to help supplement your income.  Therefore, the way you invest in retirement is very different than how you invest prior to retirement.  By reviewing your risk tolerance and asset allocation before heading into retirement, you can assure that your portfolio is positioned in such a way that it can provide the income you need, and reduce volatility.  
  1. Contemplate where you want to live – Have you given any consideration to where you would like to live in retirement?  Some of the reasons people move in retirement include: to be in a more favorable climate, to be closer to other family members, to be closer to people their own age, or to reduce their cost of living.  Whatever the reason, moving can have a significant impact on your finances and your quality of life.  If you are thinking about moving and you have narrowed down your search to a few areas, it may be a good idea to spend a few weeks or even a few months in each location.  This way you can get a feel of the local community and activities that are available. 
  1. Maintain an active and social lifestyle – Upon retirement, many people lose their sense of self-worth and often feel isolated.  Since they are no longer working, they feel like they are no longer contributing to society.  In addition, they lose the daily interactions with colleagues and co-workers that they have become accustomed to.  As a result, it is not uncommon for new retirees to slip into depression.  Studies have shown that an active retirement lifestyle leads to better mental and physical health.  Therefore, you should start thinking about how you will stay active in retirement.  Perhaps you can join a gym, a social club, find a hobby, or work part-time.  All of these will go a long way to ensure a long and happy retirement.  

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Do You Know Where to Go from Here?

By Bill Gallagher, CFP®, MPAS®

“Would you tell me, please, which way I ought to go from here?”

“That depends a good deal on where you want to get to”, said the Cat.  

“I don’t much care where”, said Alice.

“Then it doesn’t matter which way you go”, said the Cat. 

“-so as long as I get somewhere”, Alice added as an explanation. 

“Oh, you’re sure to do that”, said the Cat, “if you only walk long enough.”

I was watching Alice in Wonderland with my daughter recently, and as a financial planner, I couldn’t help but relate the above dialog between Alice and the Cheshire Cat to financial planning and investment management.  To me, this dialog represents why it is so important for individuals to take time to define their life goals and objectives within the context of a comprehensive financial plan and an investment policy statement.  

While the underlying message in the dialog above is true, if you don’t know where you’re going, any road will get you there – it does not get to the heart of the issue as it relates to someone who is trying to plan for their future.  Yes, any road will get you there, but “there” may not be where you want or need to be. 

Those who have gone through the process of designing a roadmap for their goals will most likely achieve those goals more effectively and efficiently than those who do not have a plan.  The road may not always be smooth, and there will be many detours along the way, but with a personal guide in your hands you will be able to navigate around and through those detours to get back on track more quickly than if you did not have a course of action. 

Whether you are in the accumulation stage of saving for a goal (e.g. retirement, education, new home, vacation home, etc.) or are in retirement, and drawing income from your portfolio, it is extremely important that you establish your goals and objectives within the context of a comprehensive financial plan, thereby creating your personal roadmap.  It is also important to ensure that your assets are invested appropriately given your goals, objectives, and risk tolerance.  Investments are tools we use to get from where we are to where we want to be, and to get there efficiently, your investment portfolio should be governed by an investment policy statement (IPS).  

What Is An IPS?

While the financial plan serves as a strategic guide for your life goals, an IPS is a process of implementing your investment program.  Properly aligning your risk tolerance with your goals and objectives will help you deal with any surprises down the road.  I like to think of an IPS as a framework for a well-diversified portfolio through which you can expect to generate acceptable long-term returns, at the level of risk you are willing to accept.  It is within this framework that you consider and define your risk tolerance as an investor.  The importance of fully exploring and understanding your risk tolerance cannot be overstated, as your risk tolerance will specify your overall target asset allocation and will help in establishing the investment guidelines relating to the selection of your portfolio assets.  

What is Included in the Investment Policy Statement?

The principal reason for developing an IPS is to establish a course of action that will be followed through different market cycles.  This includes periods of market volatility when emotional or instinctive responses might otherwise prompt less than prudent actions.  Without such guidelines, research has shown that investors often make investment decisions that may be inconsistent with prudent investment management principles, their financial objectives, and their risk tolerance.  All too often, during extended bull market rallies and severe bear markets, investors take a short-term view of a long-term investment strategy and end up making decisions that can cause irreparable harm to their financial situation.  Having a financial plan and IPS to reference in times of market volatility may help bring your goals and objectives back into focus and remind you of the long-term nature of your investment portfolio. 

Risk & Return

By now many people understand the relationship between risk and return.  In general, for an investor to achieve above-average investment returns, he or she must be willing to accept a higher degree of risk.  While this relationship between risk and return exists, for most investors, “risk” has more to do with the potential for the loss rather than for the potential of investment gains.  Too much loss triggers a fear response that often causes the investor to abandon their investment strategy, in some cases doing irreparable harm to their financial situation.  One measure of risk tolerance, then, is the investor’s emotional capacity to accept market volatility and their subsequent response to it. 

An equally important, but often less considered measure of risk tolerance is an investor’s financial capacity for a loss of capital.  Financial risk capacity is determined to be the amount of loss a person can sustain before compromising his or her ability to achieve their financial goals and objectives.  Financial capacity can often only be determined through the completion of a comprehensive financial plan or analysis.  

In some cases, one’s emotional capacity may exceed their financial capacity for loss.  Even though the investor may truly be able to hold through a significant market decline, their individual circumstances, and the timing of the decline – and any recovery from it – may put financial goals in jeopardy.  Like a scale, risk needs to be balanced between the fear response and the need for returns to achieve the investment goals.  Understanding the relationship between emotional and financial risk influences how aggressively or conservatively a portfolio might be invested.  

The use of a financial plan and IPS is considered best practice.  Developing a solid financial plan and IPS is not a typical exercise for most investors.  It requires a significant understanding of one’s goals and tolerance for risk, and provides support for following a well-conceived, long-term investment plan – especially during turbulent or exuberant times; a plan which, as the Cat said, “depends a good deal on where you want to get to.”

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Q: I am hearing a lot about inflation. Is this something that could impact my investments and should I be concerned?

Let’s start with a brief explanation of what inflation is and how it works. Inflation, by definition, is the general rise of prices for goods and services in the economy. To see the impact of inflation, look no further than the cost of a gallon of milk over the past 40+ years. In 1975 a gallon of milk cost $1.32 and in 2020 this cost increased to $3.32 (this represents a 2% average annual increase of the cost of milk). While there is not much we can do about inflation, the Federal Reserve (the Fed) was created in 1913 with the objective of maintaining a stable and secure economy. The Fed’s two main goals are to keep prices stable and maximize sustainable employment. The Fed has several tools at their disposal to help achieve these goals. These tools allow the Fed to regulate the supply of money in the economy by adjusting extremely short-term interest rates. For example, when the economy is showing signs of slowing, the Fed will begin to reduce short-term interest rates in an effort to bring down borrowing costs and spur economic activity. The reverse is also true. When the economy is heating up, the Fed will increase interest rates to help cool down the economy in an effort to avoid a spike in inflation.

Inflation can actually be good for stocks, up to a certain point. As I mentioned above, it is common for the Fed to gradually increase interest rates during an economic expansion. These periods of economic expansion are often associated with rising employment, leading to increased consumer spending, which translates into higher corporate profits. Higher corporate profits will most likely result in a higher demand for the company’s stock, which will translate into rising stock prices. When the economy gets too hot, the Fed will most likely speed up the increase in interest rates to help avoid a spike in inflation. When this occurs, corporations will start to feel the squeeze, ultimately leading to reduced profits. This in turn will cause investors to sell stocks, leading to a decline in stock prices.

On the other hand, we see the opposite effect of inflation on bonds. Rising interest rates have a negative impact on bondholders. As interest rates increase, the value of the bonds they own will decrease. As we saw above, stocks can do well (at least for a period of time) in an inflationary environment, however bonds will not have the same fate. In addition, if the bond an investor owns pays a fixed rate of interest and with the cost of goods increasing, the interest payments he receives may not be enough to keep up with the rise in prices. This may cause the investor to sell a portion of his holdings, when the value of his portfolio is down, just to keep up with the increase in the goods he needs to purchase. This problem is exacerbated over time. The longer duration the bond, the larger the impact inflation will have on its value.

Is there a way I can hedge my portfolio against inflation?

One of the main ways to hedge against inflation is by investing in real estate and/or commodities (i.e., gold, oil, copper, lumber, etc.) Think of a commodity as the inputs needed to create a particular good or service. For example, think about the materials you need to build a house. One of the most important materials is lumber. Lumber in this example would be considered a commodity. Unlike bonds, and to some extent stocks, commodities tend to increase in value during inflationary periods. As the demand for goods and services increases, the price of those goods will increase, which will increase the prices of the commodities it takes to produce those goods and services. So, if an investor’s goal is to make sure their portfolio keeps pace with inflation it may be a good idea to add some commodities into the mix.

Inflation is a natural force in the economy and will ebb and flow over time. There will be periods of high inflation, experienced during the 1970s, and periods of time with low inflation, which we have experienced over the past 20 years. Unfortunately, no one has a crystal ball that can forecast the future, including the ability to predict the rate of inflation nor the performance of the financial markets. When it comes to investing, it is important to understand your risk tolerance and focus on diversification. Knowing your risk tolerance is the first step because it will help you understand how you are wired as an investor. Are you one who likes the thrill of riding a rollercoaster? Or would you prefer floating down the lazy river in a tube? Once known, you can begin to develop your asset allocation (i.e., how much should be in stocks, bonds, real estate, and commodities). From there, you want to make sure you diversify your holdings within each asset class by investing in low-cost ETFs or mutual funds.

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FAQ: Why is the market going higher with Covid still such a big risk to the economy?

Answer: This is a question that has perplexed many since mid-April. In an attempt to clearly explain, I will give you a short answer and a long answer.

Short answer: The short-term moves of the market are extremely humbling to those who try to predict them. It is impossible and even folly to do so. All of your investment decisions should be based on your age, risk tolerance, and long-term goals. Occasionally, we even suggest long-term valuation may drive allocation decisions (the value of this asset class is very low on a historical basis, so I will hold a larger allocation than usual). They should never be based on your idea of what will likely happen in the future. You, like everyone else who tries to predict the future, will get humbled very quickly. As they say in the Navy seals; “Be humble or get humbled”. I can’t think of a better slogan for investors who try to predict the short-term.

Long-answer: There are many factors that play into the market direction, specifically in the short-term, but probably the biggest and most overlooked factor from the average investor is the price (or value). There is an adage in investing that the greatest cure for low prices is low prices.

In February and March when the serious health and economic effects of Covid became apparent, the market was caught off guard by its severity and began a steep and aggressive selloff. Selloffs of this speed and magnitude are scary to the most logical and hardened of investors and money managers. Essentially, the downward draft begins to lose all appearance of logic and becomes emotional as risk managers, money managers, and average investors begin to panic and decide getting out before they lose any more money (regardless of valuation) will stop the pain and allow them to sleep at night. Notice the words chosen in the previous sentence, emotional words driving decision making; nothing logical. While investors are looking to sell to stop the pain of watching their account balances dwindle, company share prices border on absurd. An example I used in March to describe the illogical market movement was The Walt Disney Company. This is a brand name we all know that runs a diverse entertainment empire. Obviously, Covid would have a serious impact on their parks, sports business (they own ESPN), and film production business. However, these are all short-term disruptions, and their foray into digital entertainment and streaming through their Disney+ service is likely to thrive. The stock traded around $150 in January pre-Covid. During the doldrums of the March selloff, the stock had cratered almost 50% to hit a low of around $79/shr. This begs the question of whether a short-term disruption in a part of this company’s business which is almost certain to thrive again in a post-Covid world justify a 50% cut in the valuation of the company. The assertion is ridiculous, and the price was obviously based on fear and panic…not logic. Five months later DIS trades at $130/shr.

This is one small example of what was obvious throughout the stock market. This is also similar to what has happened during past panics, 1929, 1987, 2008, etc. When prices overcorrect on the downside, no amount of bad news can be worse than the fear that the market projected. In fact, when everyone is expecting bad news, bad news tends not to move markets…. but good news will be completely unexpected and drive things much higher. Just like the saying it is darkest before the dawn when investors get what they expect, the low prices are already reflecting that which means the only potential for surprise is on the upside.

Once markets did bottom out in late March the federal reserve and the federal government began to step in and provide support to the economy through fiscal and monetary stimulus. This began to grease the gears of an economy that was screeching to a halt. Although the magnitude of the stimulus is not sustainable for the long term, it is a way to prime the short-term pump of the economy while we figure out the next steps in the fight against the virus.

The combination of low stock prices (intense fear already baked in) and federal stimulus created an environment where the market was compelled to move higher….and move higher it did. Most indexes gained back everything they lost to achieve break-even returns on the year by July (a rally of about 50% depending on the index) and the Nasdaq has achieved a 20% year-to-date gain in this wacky environment.

Now, we stand at a place where valuations, at least for technology, seem irrational on the upside. Large-cap technology continues to climb with almost reckless abandon conjuring shades of a tech bubble in a world still fraught with pandemic risks. Logic has again detached from the market in the short term.

The only advice I can offer during times like this is to be careful of being in a position where your portfolio is aligned with the prevailing sentiment. If everyone thinks the same thing will happen in the future (i.e. the market will fall and stay down for a year or two as happened in March), the opposite is almost certain to happen based purely on valuations. As of today, my fear is the prevailing sentiment that technology can do no wrong. I have had several of our members request we purchase Apple, Facebook, Tesla, Amazon, etc. simply because they have gone up lately and are doing well in a Covid world. This is dangerous thinking. Investments should not be purchased because they have done well in the past and you think the future will bring good things for them. They should be purchased on the merit of their valuation (what am I paying today for future earnings).

Don’t try to predict. Allocate. Adjust your allocation based on your age, risk tolerance, goals, and maybe valuations during times when they become extreme and leave the soothsaying to the fortune-tellers and weathermen.

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FAQ: Now that the market has corrected and is down, should I be doing anything different with my retirement investments?

Answer: This is an excellent question that we have been getting often since mid-March.

As the COVID-19 crisis continues to engulf our world in uncertainty, that lack of clarity has translated through to the manic-depressive stock market. The market selloff in mid-March was historic, with the S&P 500 bottoming out about 37% below its all-time high just a few weeks prior.

In addition to a panicky stock market, the traditional safe investments, like treasury bonds were hitting historic highs with the 10-year treasury offering record low yields (in the bond world, yield and price are negatively correlated, so when one goes up, the other falls) of .5% or less. Essentially, valuations of equities, especially when compared with bonds, seemed compelling.

However, the disparity was short-lived as the market remained at or near its lows for only a few days and immediately turned upwards, recovering more than half its losses.

Now, with exceedingly low yields on bonds (do I really want to lend the government money for 10 years and get less than 1% interest each year?) and a recovering stock market, should you change your allocation?

The answer depends on the traditional metrics of financial planning such as age, risk tolerance, time frame, and goals. If you are retired and drawing from your portfolio to provide your retirement income, you may not have the ability to take risks with that money. Volatility can be deadly to money you need to live off of for the next 3-5 years.

However, for those of you who are younger, have more than 5 years to retirement, and have a relatively high-risk tolerance, this may be an excellent time to move your portfolio to a more aggressive posture to take advantage of cheap valuations in equities and sell bonds at historically high prices.

Be smart, make your allocation decision based on your circumstances, and if you have the ability to weather the COVID-19 storm, take advantage of the opportunity presented. However, the stock market is not a casino. Do not gamble money you need in the near future on a hunch.

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FAQ: Now that the market is at all-time highs, how should I change my investments strategy?

Answer: This is an excellent question that we get from our members whenever the market makes new highs (which has been often, lately).

The answer is that a new high should have little relevance on your asset allocation. The economy is supposed to grow, businesses are supposed to work to become more efficient, and thus, the stock market is supposed to make new highs over time. In 1924, people were concerned when the Dow crossed over 100, in 1982, they were concerned when it crossed over 1,000, in 2011 they were concerned when it broke 10,000, and in 2016 when it broke 20,000. As I write this, the Dow Jones Industrial Average sits just shy of 29,000. Over that time, the growth has been compelling.

This is not to say that the market has not experienced financial challenges and lost decades along the way. We’ve had depressions, recessions, financial crisis, bursting bubbles, wars, and terror attacks. All of these periods are scary and can lead to dramatic declines. However, the one thing they all have in common is they were temporary. In time, the market recovered to make fresh highs, often leading to period of decades of fresh highs.

A better question may be related to market valuation. Are the investments I have in the market today (even at fresh highs), valued at or below historically average valuations? In today’s environment, the answer is yes. During periods right before major financial collapses such as the late 1920’s or the late 1990’s, valuations had no correlation with reality. A correction was inevitable, if not long overdue when it came.

Focus on an allocation based on your age and risk tolerance and ignore the rollercoaster ride the market will surely offer. Come retirement, you will be much more comfortable with this long-term approach.

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