The Risks Of Employer Stock

November 15, 2021

One of the biggest risks lurking in people’s investments is having too much in a current or former employer’s company stock. What’s too much?

Rule of thumb

You should generally have no more than 10-15% of your investment portfolio in any single stock. It’s worth noting that an investment adviser can lose their license for recommending more than that.

More than just a stock when it’s your job

So why is this such a bad idea? What if your company stock is doing really well? Well, remember Enron, anyone? While it’s practically impossible for a well-diversified mutual fund to go to zero, that could easily happen with an individual stock. In that case, you could simultaneously be out of a job and a good bulk of your nest egg.

Now, I’m not saying your company is the next Enron. It could be perfectly managed and still run into trouble. That’s because you never know what effect a new technology, law, or competitor can have, regardless of how good a company it is.

Nor does the company have to go bankrupt to hurt your finances. Too much in an underperforming stock can drag down your overall returns, and even a well-performing stock can plummet in value just before you retire. As volatile as the stock market is as a whole, it’s nothing compared to that of an individual stock.

Why do we over-invest in our own companies?

So why do people have so much in company stock? There are two main reasons. Sometimes, it’s inadvertent and happens because you receive company stock or options as compensation. For example, your employer may use them to match your contributions to a sponsored retirement plan. Other times, it’s because people may feel more comfortable investing in the company they work for and know rather than a more diversified mutual fund they may know little about.

A general guideline is to minimize your ownership of employer stock. After all, the expected return is about the same as stocks as a whole (everyone has an argument about why their particular company will do better, just like every parent thinks their child is above average). Still, as mentioned before, the risks are more significant. That being said, there are some situations where it can make sense to have stock in your company:

When it might make sense to keep more than usual in company stock

1) You have no choice. For example, you may have restricted shares that you’re not allowed to sell. In that case, you may want to see if you can use options to hedge the risk. This can be complicated, so consider consulting with a professional investment adviser.

2) You can purchase employer stock at a discount. If you can get a 10% discount on buying your employer’s stock, that’s like getting an instant 10% return on your money. If so, you might want to take advantage of it but sell the shares as soon as possible and ensure they don’t exceed 10-15% of your portfolio.

3) Selling the stock will cause a considerable tax burden. Don’t hold on to a stock just because you don’t want to pay taxes on the sale, but if you have a particularly large position, you may want to gift it away or sell it over time. If you do the latter, you can use the same hedging strategies as above.

4) You have employer stock in a retirement account. This is a similar tax situation because if you sell the shares, you’ll pay ordinary income tax when you eventually withdraw it. However, if you keep the shares and later transfer them out in kind to a brokerage firm, you can pay a lower capital gains tax on the “net unrealized appreciation.” (You can estimate the tax benefit of doing so here.) In that case, you may want to keep some of the shares, but I’d still limit it to no more than 10-15% of your total portfolio.

5) You have a really good reason to think it’s a particularly good investment. For example, you work at a start-up that could be the proverbial next Google. It may be too small of a company for analysts to cover, so it may genuinely be a yet-to-be-discovered opportunity. In that case, go ahead and get some shares. You may strike it rich. But remember that high potential returns come with high risk so ensure you’ll still be financially okay if things don’t pan out as hoped.

The ups and downs of the stock market typically get all the media and attention. But your greatest investment risk may come from just one stock. So don’t put all your eggs in it.

Three Ways to Skin the Asset Allocation Cat

December 02, 2019

Over the past several weeks, you’ve heard me talk a lot about investing and for good reason. Investing is one of the most important parts of any financial goal or wealth accumulation strategy. The problem, like with most things, is that there is no one perfect way to do it. You probably know the basics—diversify, re-balance, dollar-cost average—but did you realize that there are at least three forms of asset allocation? Knowing what they are, how they are different, and which one may be right for you could make you a better investor over time.

Strategic asset allocation

Strategic asset allocation is the one you are probably most familiar with and the one most often used by financial advisors and professionals. The objective of strategic asset allocation is to find an optimal portfolio that offers the highest potential return for any given level of risk. It usually starts with a risk tolerance assessment, followed by a recommendation of how you should split up your assets between stocks, bonds and cash.

Rather than being a typical buy-and-hold strategy, strategic asset allocation requires ongoing attention as certain asset classes perform differently at different times. As such, rebalancing is a key component of strategic asset allocation. Since rebalancing causes investors to sell out of asset classes that are outperforming in order to buy into asset classes that are underperforming, it forces the investor to buy low and sell high. For this reason, some might consider it a contrarian approach to investing.

Buying low and selling high is one potential advantage of strategic asset allocation. Another is reduced volatility. By keeping the ratio of stocks to bonds within a targeted range, potential returns are also expected to stay within a certain range. Investors can implement a strategic asset allocation strategy in a number of ways, including following the guidance of a financial advisor, using an online financial advisory service, or by investing in a target-date fund.

Tactical asset allocation

Ironically, what a lot of investors may think they are getting when they hire a financial professional is tactical asset allocation. The objective of tactical asset allocation is to improve portfolio returns by periodically changing the investment mix to reflect changes in the market. It may seem logical to move assets into fixed income when interest rates are high and away from fixed income when interest rates are low, but tactical asset allocation involves security selection and market timing—two things that are often considered taboo in the investment universe.

Tactical asset allocation can be as simple as sector rotation, such as moving assets away from the best performing sector to the worst performing sector, or as sophisticated as using charts and graphs to try and predict market movements. Style preference (growth v. value) can also be important when using a tactical asset allocation strategy. Investors should exercise caution when using a tactical asset allocation approach as market trends can sometimes last longer or shorter than expected.

Since the goal of tactical asset allocation is to try and increase performance by timing the market and moving money around, it would be appropriate for an investor with a high tolerance for risk, a low sensitivity to taxes, and an ability to devote time to developing and monitoring buy and sell indicators. Investors that wish to utilize a tactical asset allocation strategy should decide whether they will use actively-managed mutual funds, passively-managed index funds or ETFs, or individual securities. Investors may be able to implement this strategy with a financial advisor or on their own through a self-directed brokerage account.

Core/satellite asset allocation

If you are not sure which approach to take, why not take both? The objective of core/satellite asset allocation is to enhance performance by investing in two portfolios. The larger of the two (i.e., the core) typically represents 60-80% of the total portfolio and uses strategic asset allocation for determining its holdings. The remaining share (i.e., the satellite) uses tactical asset allocation to take advantage of market opportunities as they arise. For the core component, you may want to use low-cost index or exchange traded funds (ETFs) and rebalance periodically. For the satellite portion, you can use any combination of funds, individual securities, real estate (e.g. REIT), commodities, options, etc., based on where you see market opportunity.

The benefit of this approach is that it gives you a disciplined investment strategy via the core while still allowing you to “play” the market with the satellite portion. If you make some good investment decisions with the satellite, you enhance your return. If your investment instincts are not so great, you still have the core working for you.

The core/satellite approach may be appropriate for investors that want to test their knowledge of investing against the market by comparing the performance of the satellite to that of the core. It would also be appropriate for investors that want to get more involved in investing but not all at once. Because there is a tactical component, investors will need to consider how much time they can devote to managing the portfolio before taking this approach.

As you can see, there are several ways to build an investment portfolio. Choose the one that is right for you based on your objective and level of involvement. And don’t forget to get help when needed.

The Real Reason Your Stock Picks Are Wrong

July 13, 2017

It’s common knowledge that in the long run, stocks outperform treasury bills, which are short term loans to the federal government that can be considered a relatively risk-free form of cash. But according to a new study by Hendrik Bessembinder of Arizona State University, a majority of stocks in the CSRP database underperform treasury bills over both one-month and lifetime returns from 1926-2015. In fact, almost all the returns of the stock market come from just the top 4% of stocks! So what does this mean for you?

  1. Picking individual stocks is basically gambling. The odds are simply heavily stacked against you. If you want to “invest” a small amount of money in individual stocks in the hope of outsized returns, go for it. (I actually do this myself.) Just make sure it’s money you can afford to lose and not your retirement nest egg or college fund.
  2. Put your eggs in lots of baskets. It’s not just to avoid the big losers. It’s also to make sure you get the big winners too. For most people, this means investing in mutual funds or ETFs since it’s generally more difficult and expensive to buy enough individual stocks to be adequately diversified.
  3. Be careful of active management. Considering how slim the odds are of picking that 4% of stocks, it’s no wonder that the vast majority of active money managers underperform. They either have to take the risk of missing that 4% and drastically underperforming the market (hence putting their careers in jeopardy) or more likely, they create “closet index funds” that mostly buy the entire market but still end up underperforming (albeit less drastically) due to fees and transaction costs. You can avoid these problems by simply investing in a diversified portfolio of low cost index funds. This way, you know you’ll have that 4%.

None of this means you should abandon stocks for treasury bills. Let’s not lose sight of the big picture here. A dollar invested in US stocks in 1926 was worth $448 in real inflation-adjusted dollars at the end of last year while a dollar in treasury bills was only worth $1.53, barely staying ahead of inflation. If you want your money to grow (and you probably need some growth to hit your long term investing goals), stocks are still where the action is. We just don’t know which ones yet.

 

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Use This Hack to Figure Out How to Invest

June 07, 2017

If I could wave a magic wand and impart knowledge to anyone who thinks they have to be an investing expert in order to make money in the stock market, I would make sure that everyone knows that you don’t have to even be interested in investing in order to do it well. People who want to talk stock tips are often disappointed when they bring that subject up with me – I have relatively zero interest in the market. Yes, I’m a CFP® and no, I don’t like to choose investments.

I understand how to do it quite well, and really enjoy helping others learn what they need to know, but I don’t waste my time worrying about whether the next bear market will happen this year or next. I am quite certain there will be quite a few bear markets between now and retirement, but as a long-term investor, I don’t particularly care when they’ll happen or how long they’ll last, and neither should you. To me, a bear market is like the semi-annual sale at Athleta – a great time to stock up!

An easy investing hack

If you’re like me, and really just want to make sure you’re taking advantage of the overall long-term growth potential that investing in the stock market offers without having to analyze mutual fund ratings, asset allocation models or stock charts (nothing against those who do – more power to you and I wish you much investing success!), then this hack is for you.

Stocks and bonds and asset allocation, oh my

One of the most confusing parts about investing is figuring out what percentage to invest in stocks versus bonds, not to mention dividing the stock portion up among different market segments like large cap, mid cap, international, etc. (JARGON ALERT!)  When I first got into financial planning, I was totally stumped about how to do this. Was there some magic formula that only really smart market gurus could come up with? I knew that there were financial advisors who very confidently presented custom mixes to clients, but where did they get this information? Did I have to work for one of the big investment banks in order to have access to this information for my clients?

Then one day, I discovered the answer. It’s not some secret formula and it isn’t rocket science. You don’t have to know the first thing about what the market is going to do tomorrow or even worry if it’s up or down or going sideways. All you have to do is copy the mix of a Target Date Fund (also sometimes called Target Retirement Funds or Freedom Funds, depending on the investment company that runs them) with the date closest to your retirement year.

How it works

The easiest way to find the mix of a Target Date Fund is to look at the information for the fund, which is often found on the Fund Fact Sheet or you can just look one up on the website of companies like Fidelity, Charles Schwab, Vanguard, etc. You can typically find a pie chart that tells you the percentage of the fund that’s invested in different parts of the market, and then literally copy that percentage using index funds into your own account.

Imitation = flattery = easy investing

The advantage over using the Target Date Fund itself

Why not just buy the Target Date Fund itself, you may be wondering? One of the common criticisms of Target Date Funds is cost – because they require a little more attention than a standard index fund, they typically cost a little more. So, it’s mostly just to save money on fees, although this strategy would also work for someone who has a 401(k) that doesn’t offer Target Date Funds (admittedly, this is becoming less and less common, but check those fees!). It’s kind of like going to a craft show to scope out the cute DIY goods then going home and copying everything you saw that you liked, rather than buying the finished product at the marked-up price.

This hack is also perfect for someone who wants to be a little bit more hands-on, but is still learning the ins and outs of investing. Finding that perfect asset allocation is a bit of the holy grail in the investing world, so save yourself the search and take advantage of the work already done by the experts.

Things to watch out for

  • Rebalancing. If you decide to use this hack, then you also have to be sure you’re rebalancing periodically — at least once a year, you need to check in to make sure your percentages haven’t gotten too far out of whack. If you’re lucky, your account will allow you to automatically rebalance instead of having to do the math, but either way, this is how you take advantage of buying low and selling high.
  • Taxes. If you’re using this hack in a non-retirement account, then any time you do rebalance, you’ll likely be incurring capital gains and/or losses. Not to discourage rebalancing, but just be aware of the potential tax consequences if you’re making big shifts.
  • Adjusting for risk. One of the benefits of just choosing a Target Date Fund is that it automatically shifts the investments toward a more conservative mix as your retirement date draws nearer, so you’ll be on the hook for that with this strategy. Every five years or so, check back with the mix of your original fund to see what changes you need to make when you rebalance.

Why is an Index Important in Investing?

May 22, 2017

Everywhere you turn, you hear or read personal finance experts advocating the use of index funds in your portfolio. Employees often call our Financial Helpline asking if their 401(k) funds are index funds or wondering what exactly an index fund is and how to pick the right one for them. They also ask how they can know if their mutual fund is performing well. The key to both is understanding indexes.

An index is a statistic

An index is a statistic measure of change in the prices of major groups of stocks or bonds which represent an area of the overall market. In investing, indexes are used as a guide to constructing portfolios, and to set a starting point (benchmark) and measure portfolio performance over time. Indexes are usually capitalization-weighted, meaning that the largest companies have the most influence on the index. Common indexes like this include:

  • The S&P 500®, which includes 500 large companies in a market capitalization weighting, and is widely viewed as a benchmark for the U.S. stock market. If you’ve got a “large company growth fund” in your retirement account, it’s likely its performance will be compared to the S&P 500. You can track the index by entering symbol SPX.
  • The NASDAQ Composite Index includes all the stocks which trade on the NASDAQ market. It includes a lot of technology companies, but isn’t limited to them. You can track this by entering symbol IXIC.
  • The Russell 2000 Index includes 2,000 small companies in the U.S. You can track this by entering symbol RUT. If you’ve got a “small company” or “small cap” fund in your retirement account, it’s likely that its performance will be compared to the Russell 2000.
  • The Bloomberg Barclays U.S. Aggregate Bond Index tracks a range of types of fixed income securities to represent the types of bonds in the bond market. If you have a “total U.S. corporate bond” fund in your retirement account, it is likely its performance will be compared to the Bloomberg Barclay’s U.S. Aggregate Bond Index. Bloomberg Barclays has many common bond indexes and you can find and track yours here.

Another well-known index that is frequently reported as an indicator of the total U.S. economy, the Dow Jones Industrial Average, is a measure of 30 U.S. blue chip stocks from all industries except transportation and utilities. It is a price-weighted average, which means that the most expensive stocks influence the index the most. You can track this by entering symbol DJIA.

An index fund mimics the index

An index fund is a type of mutual fund with a portfolio designed either to match directly or track the performance of an index. For example, an S&P 500 index fund would hold stocks of the companies in the S&P 500 index in direct proportion to how they are represented in the index. When you choose an index fund, you’re choosing a passive method of managing your investments. You won’t outperform the index, but should closely track the performance of the index, with slight underperformance due to trading costs and fees. Index funds are a great way to minimize the fees in your retirement plan or other investment portfolio, which can really add up over a long period of time. Not all index funds are created equally, however, so make sure you read the fund fact sheet and prospectus before you invest. Not sure about how to choose the right funds for you in your retirement account? Start here with an easy to read post from fellow planner Kelley Long on how investing is like choosing a pizza.

An index gives you a way to compare how you’re doing

Comparing your mutual fund to an index that contains similar stocks or bonds is an excellent way to measure how your fund is doing over time. A fund will generally disclose its benchmark, the index against which the fund management measures its performance. For a passive index fund strategy, the comparison is simple. An actively managed fund, which is designed to try to beat an index (although most don’t), may have a composite benchmark (made up of several indexes in pre-set proportions).

The upshot: do a review of your retirement accounts and other investments. Do you own index funds, and if so, what indexes do they track? Do you have a diversified portfolio of funds which track different indexes? Do you have actively managed funds, and if so, what indexes are they measured against? How did they do? If you’re not sure about where to start, call your Financial Helpline or call your financial coach if you have one.

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

How Should You Invest in an HSA?

May 18, 2017

I’ve written about how to invest in a Roth IRA, your employer’s retirement plan, and a taxable account, but a new type of tax-sheltered account that’s growing in popularity is a health savings account or HSA. (If the new health care bill passes, HSAs could become even more important as the contribution limits would be doubled.) Like a health care FSA, HSA contributions are tax-free and can be used tax-free for qualified health care expenses, but unlike FSAs, you can leave the money in the account to be used for future health care expenses (and for any purpose without penalty after age 65). For this reason, many plans allow you to invest money in the account. Before investing your HSA, here are some things to consider:

When might you use the money?

Anything you might spend in the next few years shouldn’t be invested at all. That’s because a downturn in the market could force you to sell investments at a loss and even leave you without enough money in the account to cover your health care costs. If you use the account for current expenses, you might want to leave at least enough in cash to cover your deductible for the next year or two. On the other hand, if you plan to cover any current health care costs with other savings and not touch the HSA, you can invest as much as the plan will allow you (many require you to keep a minimum amount in cash) to grow as much as possible tax-free for future medical expenses.

How should you invest it?

You can either look at your HSA as a standalone account or as part of your overall retirement portfolio. In the former case, you can invest it in a fully diversified asset allocation fund or a balanced portfolio based on your risk tolerance and time frame. In the latter case, you can use it for investments that may not be available in your employer’s retirement plan.

Where should you have your HSA?

Unlike with your employer’s retirement plan, you don’t have to wait until you leave or turn age 59 ½ to transfer your HSA to a different provider. If you want to invest in something not available from your current provider, you may want to consider other options. Just be aware that your contributions from your payroll and your employer will likely continue being deposited in your current HSA so you’ll have to keep transferring the balance periodically.

Not sure what to do? Consider consulting with an unbiased financial planner to discuss your options in more detail. In the meantime, don’t let analysis paralysis stop you from contributing to an HSA at all. You can always leave it in cash until you make your decision.

Retirement Planning Step 3: Choose Your Investments

May 17, 2017

When it comes to choosing how to invest the money you deposit into your 401k and/or your IRA, it’s easy to get overwhelmed, but don’t let information overload stop you. It’s true that investing can get complicated and involved, but there are also things out there that make it pretty easy.

First thing though, is knowing whether you are a conservative, moderate or aggressive investor. The younger you are, the more aggressive you MAY be, but just to be sure, take this quiz to find out. Once you know what your investing personality is, the best way to narrow your options is by declaring yourself either a hands-off or hands-on investor.

What’s the difference?

Typical things a hands-off investor might say:

“I wish someone would just do this for me.”

“Words like ‘allocation’ and ‘portfolio’ are foreign to me.”

“I want to set it and forget it.”

“I rarely review my account and prefer a pre-mixed solution.”

The good news is that the investing industry recognizes that there are plenty of people out there who want the benefits of investing but who don’t have the knowledge, interest or even just the time to do it well, so they have created solutions that can be really great. If that sounds like you, then you don’t need to worry about how to pick a stock or watch channels like CNBC or Bloomberg TV – that’s more for the hands-on folks.

If you’re a hands-off investor, look for Target Date Funds in your 401k or IRA – the easiest way to spot them is that they have a year, like 2050, in their name. Target Date Funds are great because they choose the mix of stocks and bonds for you, in a mix according to the year you choose, and they typically charge lower fees than more actively managed options. Moderate investors typically choose the fund with the year closest to when they turn 65, while conservative investors may look for a year that’s closer to today and aggressive people often choose the one closer to the year they’ll turn 70 or 75.

When Target Date Funds aren’t available, then hands-off investors may opt to hire an investment manager to help them pick or they use the suggested investment mixes that can be found on the last page of the Risk Tolerance Profile and Asset Allocation Worksheet to help them put together a mix of the funds available in their 401k.

Typical things a hands-on investor might say:

“I enjoy researching mutual funds and their objectives.”

“I love my Jim Cramer bobblehead.”

“I log into my account regularly to check in on things.”

“Investing is interesting and I enjoy learning about it.”

If you’re a hands-on investor, chances are you probably have a pretty good handle on what you want to do with your money, but here are a few resources to check out to keep your knowledge and skills top notch:

How to Invest in Your Employer’s Retirement Plan

Should You Care About a Mutual Fund’s Past Performance?

How Investing is Like Eating Pizza

 

What Tesla and United Can Teach Us About Investing

May 05, 2017

In another of my “grumpy old man” rants here, I’m absolutely mystified by investors and the car company Tesla. Sure, they make cool cars. Sure, they are selling directly to consumers and bypassing the traditional dealership model. Sure, every time I see one I give it a long look and think “that’s pretty awesome.” But in the midst of all of all of that, I just don’t understand how their stock price can be so high.

Tesla passed General Motors as the #1 US car company recently. Last year, Tesla sold about 76,000 cars. GM sold about 10,000,000. GM made over $9 BILLION in profits last year, while Tesla has had 2 profitable quarters…EVER! It is perhaps due to the “cool factor” that Tesla is now the #1 car company in the U.S. based on market capitalization. (Market capitalization is simply the number of shares outstanding times stock price.)

Clearly, the stock market is rewarding more than just financial results. As someone who has all but stopped using Facebook, never liked Twitter and is not a fan of social media in general, it seems that the stock market is moving away from rewarding the old school “logic and reason” of profitable companies seeing their stock price rise and companies who have yet to hit their stride from a profitability standpoint not getting much traction in the market. There are a lot of future expectations built into stock prices. This makes it hard to be an investor.

Heck, one video was able to move the stock price of United Airlines. This is a company with $9.1 billion in revenue in just the 4th quarter of 2016 and the stock price moved because of one cell phone video. This age of social media definitely has ripple effects in the investment markets. No one could have predicted in advance that United would have been hit by a wave of negativity after a cellphone video went viral or that an unprofitable car company would be worth more than General Motors.    

Picking individual stocks and outperforming the market is HARD! Most professional managers struggle to beat their respective index. If you bought Apple very early on, you’re probably a pretty happy investor. If you bought Enron or MCI WorldCom, probably not so much. All of those companies had spectacular performance at some point in their history, but only one is still in business.

That’s why it’s becoming increasingly more important to diversify your portfolio. Having a mix of stocks – small, mid-sized, large, international, emerging markets – and bonds and cash can help you avoid devastating losses like many investors experienced in 2008. Check out my blog from last week and get to know who you are as an investor and build a low cost, non-emotionally driven portfolio.

Since I started with a grumpy old man rant, I’ll end with an old phrase that we’ve all heard countless times in our lives. Don’t put all your eggs in one basket! In the investment world, it simply makes sense.

What’s the Market Going to Do Next?

April 28, 2017

One of the questions I’ve been getting asked A LOT recently is what I think the stock market is going to do. My usual answer is that it’s going to go up, and it’s going to go down. The only thing I don’t know is how much it will go in either direction or when the tide will turn. In essence, I’m useless when it comes to predicting the future movements of the stock market. That usually leads to a conversation around their retirement timeline, their ability/willingness to absorb losses in the stock market and their opinions about the future.

It was right after one of these calls that I read this story about a hedge fund manager who is giving back $1.25 BILLION in cash to the investors in his fund! That’s astounding, primarily because that’s over a billion dollars that the fund will no longer get paid a fee to manage. Even a small fee on over a billion dollars is a pretty big amount of money to give up.

Why is he doing this? He’s concerned that the stock market is overvalued and that he can’t find the right investments to buy in order to give his investors the type of returns he would like to provide. Now, let’s not shed any tears for him. He’s still got over $16 billion invested, and I’m pretty sure that’s enough to keep the lights on and food on the table.

But it is tangible evidence of someone believing that the stock market might be a bit overpriced right now. There are also managers who believe that the market, because of economic growth, job growth and corporate earnings – is poised to move upward for quite some time. (I’m still solidly in the camp of “I don’t know which way the market is going.”)

But whether the market goes up or down or sideways in the next few months to the next 3-5 years shouldn’t prompt you to take any action. The key to long term wealth building (and that’s why we all invest) is to pick a strategy and stick to it in good and bad markets. Investors who did nothing in response to the market collapse of 2008 were better off within a few years than the day before the crash. Those who moved everything out of stocks as the market tanked or after the market tanked may still not be whole.

The first thing you can do is to understand who you are as an investor. Here’s a quick investment risk quiz that can help you figure this out and gives you some hypothetical portfolios that might be appropriate for your particular risk tolerance. When your overall risk level changes due to changing time horizons, retirement goals, age, family circumstances, etc, it’s time to reallocate your long term investments.

When pressed for time, I ask a one question risk tolerance quiz. “On a scale from 1 to 10, where 1 is the most conservative investor in the world (money in the mattress) and 10 is the most aggressive (willing to put all of your money on a couple stocks and see what happens) – what number would you give yourself?” If someone answers 3 or 4 then 30-40% of their long term investment portfolio could be allocated toward high growth/high risk investments like stocks.

It’s by no means a comprehensive approach, but it has a very consistent answer with the other quiz above as well as other similar quizzes. In a former role, I had about a dozen clients take 5 or 6 different risk profile quizzes. They all came out with roughly the same answer and it was pretty darn close to the one question risk quiz.

So in spite of the fact that a hedge fund manager is giving back a big chunk of money to investors because he thinks the market is overvalued and other managers are incredibly optimistic about the markets moving forward, your goal as an investor is to understand who you are, get to an asset allocation that is consistent with your time lines and goals, and don’t get too high when things are good or too low when things are bad. From my experience, emotions are the enemy of good decision making and this applies to investing as well. Markets, like many things in life, are cyclical and if you’re patient and consistent, good things usually happen.

 

How to Invest in Your Employer’s Retirement Plan

April 27, 2017

Last week, I wrote about how to invest in a Roth IRA but how about your employer’s retirement plan like a 401(k) or 403(b)? After all, that’s where most people have the bulk of their retirement savings. Here are some options:

Keep it simple…real simple. If you have a target date retirement fund in your plan, this is the simplest option. In fact, it’s probably the default so you may not need to do anything at all.

The idea is to pick the fund with the target date closes to when you think you’ll retire. Each fund is fully-diversified to be a one-stop shop that automatically becomes more conservative as you get closer to retirement so you can set it and forget it. It doesn’t get much easier than that.

There are a couple of downsides though. First, you may not even have this option in your plan. Second, your plan’s target date funds may have high fees. Finally, you don’t have the ability to customize the mix of investments to match your particular risk tolerance (although you can pick an earlier date if you want to be more conservative or a later date if you want to be more aggressive) or to complement any outside investments you may have.

Target a particular risk level. If you don’t have a target date fund or want something more tailored to your particular risk tolerance, see if your plan has a target risk fund or an advice program. A target risk fund is fully diversified to be a one-stop shop, but it stays at a particular risk level so you may want to switch to something more conservative as you get closer to retirement.

An online advice program can recommend a particular mix of investments based on your risk tolerance. Many programs will even use the lowest cost options in your plan and/or factor in any outside assets you may have. For example, if you have a lot of stocks in a Roth IRA, the program may reduce your stock holdings in your plan accordingly. However, it will need to be periodically updated as your situation changes and some programs charge additional fees.

Create your own mix. If the above options aren’t available to you or if you prefer to have more control, you may have to create your own mix of investments. You can take a risk tolerance quiz like this one and use the suggested allocations as guidelines.

Just be sure to look for low cost fund options to implement your portfolio. You may want to use your plan for those assets in which you have low cost fund options and use outside accounts for the rest. (That’s why I invest mine all in a low cost S&P 500 index fund.) Don’t forget that taxes are another cost. If you have investments in taxable accounts, you may want to prioritize the most tax-inefficient investments like taxable bonds, commodities, real estate investment trusts, and funds with high dividends and turnover for your tax-sheltered retirement account since more of their earnings will otherwise be lost to Uncle Sam.

Consider a small amount in company stock. If company stock is an option, you might want to keep a small amount there to benefit from potentially lower taxes on the gains when you eventually withdraw it from the plan. Just don’t have more than 10-15% there because having too much in any one stock is too risky, no matter how great the company is. This is especially true with employer stock because if something happens to your company, you could be out of a job at the same time as your portfolio is decimated.

Not sure what to do? Don’t let analysis paralysis prevent you from investing at all. You can start with a simple option like a target date or target risk fund for now and adjust later. You don’t want to make the perfect investment plan the enemy of the good.

 

Does a Money Market Fund Make Sense for You?

April 24, 2017

Are you looking for a stable value investment with easy access to your cash when you need it but a higher return than leaving your money in a checking or savings account? A money market fund could be a good fit. Here are some things to consider.

What is a Money Market Fund?

While a money market fund is often referred to as a “cash equivalent” because of its low risk profile, a money market fund is not cash. It’s actually a mutual fund which invests in very short term, low risk debt securities such as treasury bills, the debt of various government agencies, and “commercial paper” (short-term corporate IOUs). The investment objective of a money market fund is to earn interest for its shareholders while maintaining a stable net asset value (NAV) of $1 per share. The value of these short-term investments rarely fluctuates, which is why they’re considered almost as good as cash. But since they’re not cash, money market mutual funds yield a slightly higher return than savings accounts or money market accounts.

When to Use a Money Market Fund

The benefits of money market mutual funds — safety, liquidity and a higher yield on “cash-equivalent” savings — make them attractive to many savers with differing goals. Here are some common uses for money market funds:

  • For an emergency fund – A money market fund can be a low risk place to keep 3-6 months of expenses. Make sure you choose one that doesn’t have a penalty for redeeming shares.
  • For cash management – Many financial institutions offer money market accounts with cash management privileges, where unused cash balances are swept into a linked money market fund and shares are redeemed to pay a check, debit card or ATM withdrawal.
  • To save for short term goals like a home down payment – Money you know you will need relatively soon shouldn’t be subject to the volatility of the stock or bond markets.
  • As a parking place between investments – If you sell an investment, you can park the proceeds from the sale in a money market fund while you research other investment options.
  • To balance the asset allocation of your portfolio – Many investment strategists recommend that a portion of any investor’s portfolio remain in “cash,” available to take advantage of opportunities that come up in the stock and bond markets.

When Not to Use a Money Market Fund

A money market fund is considered a short term, cash-type investment. That’s great for your emergency fund but may not be the best place for retirement savings that you don’t plan to access for decades. If you’re not sure what the mix of stocks, bonds and cash (such as money market funds) should be in your portfolio, download this Risk Tolerance and Asset Allocation Worksheet.

Types of Money Market Funds

There are differences among money market funds that make for variations in taxation, safety and yield. Savers with different goals will choose different funds. Money market funds, depending on their objective, can offer a taxable return or a full or partially tax-free yield, depending on what type of debt securities they hold in the fund..

What to Know Before Investing

Money market funds are not federally insured. However, most people consider the amount of extra risk in money market funds to be so minimal as to be easily offset by the slightly higher interest they earn. Fees on money market funds can vary, so do some research before you invest, including reading the fund’s prospectus.

 

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

 

How Should You Invest In Your Roth IRA?

April 20, 2017

If you’re like many people I’ve talked to recently, you may have decided to contribute to a Roth IRA before the deadline on Tue. However, it’s not enough to open an account and fund it. After all, a Roth IRA is simply a tax-sheltered account, not an investment. You still have to decide how to invest the money. Here are some options to consider:

Use it as an emergency fund. If you don’t have enough emergency savings somewhere else, you can use a Roth IRA as part or all of your emergency fund since you can withdraw your contributions tax and penalty-free at any time and for any purpose. (Earnings are subject to taxes and a 10% early withdrawal penalty before 5 years and age 59 ½ but the contributions all come out first.) In this case, you’ll want to keep it someplace safe and accessible like a savings account or money market fund. Once you accumulate enough emergency savings elsewhere, you can invest it more aggressively for retirement.

Save for a short term goal. A Roth IRA can also be used penalty-free for a first-time home purchase (up to $10k) or education expenses. If you intend to use your Roth IRA for either goal in the next few years, you’ll probably want to keep it in savings.

Choose investments that complement your other retirement accounts. For example, you may want to use your Roth IRA for investments that may not be available in your employer’s plan like real estate, gold, commodities, emerging markets, international bonds, and microcap stocks. They can help diversify a more traditional mix of bonds and large and small cap US and international stocks.

Choose a more conservative mix for early retirement. If you’re planning to retire before becoming eligible for Medicare at age 65 and are planning to purchase health insurance through the Affordable Care Act (assuming it hasn’t been repealed and replaced), a tax-free Roth IRA can help reduce your insurance costs because the insurance subsidies are based on your taxable income. Since a large percentage of the account may be coming out over a relatively short period of time, you may want to invest it more conservatively than your other retirement investments.

Choose more aggressive investments for long term tax-free growth. If you’re not planning to withdraw your Roth IRA early, you may want to take the opposite approach and use it for the most aggressive parts of your portfolio. That’s because the account is growing tax-free and may be the last to be touched. (It helps that Roth IRAs aren’t subject to required minimum distributions.) Some examples of more aggressive investments would be emerging market and small and micro cap stocks.

Keep it simple. If this all sounds confusing and you want to just keep your investing as simple as possible, you can look at each account separately. For example, you might choose a target date retirement fund for your Roth IRA since it’s a fully diversified one stop shop that automatically becomes more conservative as you get closer to the retirement date. All you need to do is pick the one with the date closest to when you think you’ll retire and set it and forget it. If you want something more customized, you can also use a robo-advisor or design your own portfolio based on your particular risk tolerance.

Like all financial decisions, your choice begins with your goal. Are you trying to save for emergencies? Do you plan to use the account early or late in your retirement? Or do you just want to keep things as simple as possible?

 

 

 

Should You Invest in an Equity-Indexed Annuity?

April 17, 2017

Should you consider investing in an annuity linked to stock market returns but with less risk than the stock market? I recently had a coaching session with an employee who had invested a lump sum distribution from a retirement account into an equity-indexed annuity. Did she make the right decision, she wondered, and should she add more to the annuity or diversify into something else?

Remind Me What an Annuity Is, Please!

An annuity is a contract between you and an insurance company in which the insurance company agrees to make periodic payments to you, starting immediately or at some future time, in return for payment from you, either in a lump sum now or over flexible installments over time. With a “fixed annuity,” the insurance company agrees to a fixed return and a fixed payment. With a “variable annuity,” the rate of return and the payment vary depending on the investment choices within the contract.

So What is an Equity-Indexed Annuity?

An equity indexed annuity is the lovechild of a fixed and a variable annuity. With an equity-indexed annuity (EIA), the insurance company will pay an interest rate linked to a stock market index if the market index is up, with a guaranteed minimum rate if the market is down. In the case of the employee I spoke with, she would earn an annual rate of return linked to the performance of the S&P 500 during the accumulation phase of the annuity, capped at 6%. If the S&P 500 index went down, her return would be 0% for that year.

Who is a Good Candidate for an Equity-Indexed Annuity?

The primary financial planning purpose of an annuity is to turn a sum of money into a stream of income you cannot outlive. An equity-indexed annuity makes the most sense for an investor who is a) looking to create a future fixed income in retirement and b) who is not comfortable with direct stock market risk but would like to participate partially in potential stock market returns. In the case of this employee, she was willing to accept a cap on returns of 6% in return for no loss of her investment if the market declined.

She was also within 10 years of retirement and much more concerned about maintaining the value of her savings than she was in generating out-sized returns. It’s important to have both fixed and flexible sources of income in retirement so ideally an investor would refrain from putting all their retirement savings into an annuity. I encouraged this employee to keep some of her retirement funds in her 401(k) and IRA so she would have a source of income to meet flexible expenses in retirement such as a big vacation, dental work or an unexpected home repair.

Who is Not a Good Candidate for an Equity-Indexed Annuity?

A more aggressive investor would not be comfortable capping returns at 6% – especially in a year when the S&P 500 index went up 20%. Plus annuities generally have high fees which can eat into investment performance. EIAs typically have high surrender charges during the first 8-10 years of the contract so once purchased, you’ve got a strong incentive to stay put.

The moderately aggressive to aggressive investor could consider accumulating savings in a diversified portfolio of low fee index funds. That investor could potentially build a larger nest egg and then purchase an immediate annuity at retirement with some of those savings if interested in turning them into a stream of income. Because of the higher fees, younger investors are also generally not good candidates for equity indexed annuities. Finally, an investor who doesn’t ever plan to turn their savings into retirement income is not a good candidate for an annuity.

Was it a Fit for Her?

Was an equity-indexed annuity a good fit for this employee? After weighing the pros and cons, her conclusion was “yes.” She was willing to trade upside potential in order to eliminate the risk of losing money.

She was planning to annuitize within ten years – turning her annuity into a stream of payments in retirement. Moreover, she had chosen a reputable insurance company with an A+ rating from A.M.Best. Although she was excited about the annuity return/risk profile, she decided it would be best to continue to keep some of her retirement money in her employer plan so she’d have some flexible sources of income to meet unexpected retirement expenses.

Do Your Homework

Annuities are very complex investments. Before signing on the dotted line, make sure you’ve read and understand all the provisions in the contract. If you are considering an equity-indexed annuity, start with this fact sheet from FINRA. Check out the financial strength of the issuing insurance company and make sure it has a high rating for its financial position. If possible, get an unbiased second opinion from a financial planner in your workplace financial wellness program or a fee-only CFP® professional.

 

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

 

Why You Should Love Investing

April 13, 2017

When a lot of people think of financial planning, they think of investing…with dread. It sounds complicated, time consuming, and risky. But for me, investing is actually my favorite part of financial planning. Let me tell you why…

In most areas of life, we generally get what we put in, whether that’s in terms of the price we pay or the amount of time and hard work we expend. In other words, you get what you pay for. However, investing is the one area of life where you get rewarded for being both cheap and lazy.

Let’s start with the first step, which is diversification. As you’ve probably heard, you don’t want to put all your eggs in one basket, but you still have to decide how many of your “eggs” or money to put in each “basket” or asset class: stocks, bonds, cash, and real assets. What makes this confusing is that there’s a ton of conflicting views on this so investment expert Meb Faber decided to compare 9 of the top recommended asset allocation strategies by various other investment experts and see how they performed since the 1970s. What he found is that the difference between the best and the worst performing strategy was only 1.6% and if you removed the worst performing portfolio (which is an outlier since it only has 25% in stocks), the difference was only 1%. When he compared the models of the major financial institutions, he found that the difference was only about half a percent.

However, just because they ended up in similar places doesn’t mean that they performed similarly from year to year. Each of the models had many years in which they outperformed and many in which they under-performed. If you chose a model based on which was the top performing over the previous decade, you would actually have done much worse. Whether you use a one-stop shop asset allocation fund, a robo-advisor, one of the model portfolios listed in one of Faber’s blog posts above, or a financial advisor’s recommendation, which portfolio you pick is less important than that you pick one (to make sure you’re reasonably diversified) and stick with it through thick and thin. (Everyone, even Warren Buffett, has periods of under-performance.)

There’s one other way you can sabotage your returns: costs. It’s been estimated that the average mutual fund costs .9% a year in expenses and 1.44% a year in transaction costs. (This doesn’t even include any loads or commissions you may pay to purchase the fund.) That 2.34% would be enough to turn the best performing strategy into the worst.

It’s not like you’re getting anything for those costs either. In fact, a recent Morningstar study called low fund fees “the most proven predictor of future fund returns.” Warren Buffett has said the same thing. So as you choose which funds to use in your portfolio, look for ones with low fees (called the expense ratio) and low turnover (which leads to lower transaction costs). If index funds are available, they tend to have the lowest costs and hence tend to outperform more expensive actively managed funds over long periods of time.

The moral of the story is that investment success boils down to three simple rules:

  1. Be diversified. Pick a reasonably diversified portfolio. Don’t be a greedy pig (bet on individual stocks) or a fearful chicken (keep all your money in bonds and cash). After all, both pigs and chickens get slaughtered.
  2. Be cheap. Use low cost funds to implement your asset allocation strategy. In this case, you get what you don’t pay for.
  3. Be lazy. Once you have your portfolio, stick with it. Don’t try to time the market or otherwise, mess with it other than to rebalance it periodically back to the original allocation or to switch to lower cost funds as they become available.

Think about it. Where else are you most rewarded for being both cheap and lazy? Now do you love investing? If so, the first step is to save so you have something to invest, but that’s another story…

 

Which Retirement Plan Benefits Are You Missing Out On?

April 06, 2017

This week, we’re recognizing Employee Benefits Day on April 3rd by writing about ways to appreciate and “benefit from your benefits.” One of the most common benefits that is often underappreciated and underutilized is your employer’s retirement plan. In particular, here are some features that you may not be taking full advantage of if you’re fortunate enough to have them in your plan:

Employer’s match. According to our research, 92% of employees are contributing to their plan but almost a quarter aren’t contributing enough to get the full match from their employer. At the very least, make sure you’re contributing enough to not leaving any of this free money on the table.

Contribution rate escalator. If you can’t afford to save enough to hit your goal, try slowly increasing your contributions by one percentage point each year. This tends to be less than cost of living adjustments so people generally don’t even notice the difference in their paychecks, but after just a few years, they may be saving more than they ever thought they could. A contribution rate escalator can do this for you automatically.

Roth contributions. Unlike pre-tax contributions, you get no tax benefit now, but Roth contributions can grow to be tax-free after 5 years and age 59 ½. This is especially useful if you’re worried about paying higher tax rates in retirement or if you’re planning to retire early since tax-free Roth distributions won’t count against you in calculating the subsidies you would be eligible for if you purchase health insurance through the Affordable Care Act (assuming the subsides are still in place) before becoming eligible for Medicare at age 65. Roth contributions are also more valuable if you max out your contributions since $18k tax-free is more valuable than $18k that’s taxable. (Yes, you could technically invest the tax savings from making pre-tax contributions, but then you’d still have to pay a tax on those earnings too.)

After-tax contributions. If you max out your normal pre-tax and/or Roth contributions, you may be able to make additional after-tax contributions. These aren’t as advantageous since the money goes in after-tax and the earnings are taxed at distribution, but you can convert them into a Roth account to grow tax-free, either while you’re still at your job if the plan allows it or by rolling it into a Roth IRA after you leave. You can also generally withdraw after-tax money while still working at your job (subject to taxes and a 10% penalty on earnings before age 59 1/2).

Asset allocation funds. To simplify your investing, retirement plans will often provide you with fully-diversified asset allocation funds that can be a one-stop shop. Some, called target date funds, even automatically become more conservative as you get closer to the target date so you can simply “set it and forget it.”

Online retirement and investing advice. Some plans provide access to a free online retirement planning and investment tool that can tell you whether you’re on track for retirement and make specific investment recommendations based on your particular risk tolerance and time frame, typically using the lowest cost funds in your plan.

Brokerage window. If you’re looking for an investment not otherwise available in your plan, see if you have a brokerage option that will give you access to thousands of other funds and in some cases, even individual stocks.

Employer stock. While you don’t want to put too much in any one stock (no more than 10-15% of your overall), especially your employer’s, there can be a tax benefit for doing so when you eventually cash out the account. If you transfer the employer stock directly to a brokerage firm in-kind, you can pay a lower capital gains tax on the growth instead of the higher ordinary income tax rate that you would normally owe on distributions.

Retirement plan loans. If you need a loan, borrowing from your retirement plan doesn’t require a credit check and the interest goes back into your own account. However, you miss out on any earnings that money would have received and if you leave your employer, you may owe taxes plus possibly a 10% penalty (if you’re under age 59 ½) on any outstanding balance after 60 days. (Some plans do allow you to continue making loan payments though.) Also, be aware that retirement plan loans are paid back from your paycheck so there’s no possibility of default and you can’t discharge them through bankruptcy.

Financial wellness. Some plans offer free, unbiased financial wellness coaching to help you plan, save and invest for your retirement. This is an important benefit since it can help you take advantage of all the others.

Which of those benefits are you not taking advantage of? See which ones are offered by your plan and start utilizing them. Your future self will thank you.

 

 

 

Should You Follow Senator Elizabeth Warren’s Investment Advice?

March 23, 2017

Last week, I wrote about some of her money management tips as described in an article titled “You, Too, Can Invest Like Elizabeth Warren!” Overall, I found them a bit too simplistic. Now let’s take a look at the investing side:

1. Visualize. Specifically, “take a moment to savor your dream.” It’s hard to argue with this. If visualizing your retirement or other goals helps motivate you to save and invest, go for it. Just remember that the dream probably won’t become reality unless you wake up and take action, which brings us to…

2. Create a retirement fund. Warren suggests contributing 10% of your income to a 401(k) or IRA. This isn’t a bad idea on its face but lacks detail. Why just 10%? The consensus seems to be that the average American household needs to save about 15% of their income for retirement so 10% is probably too low.

Even better, you should run a retirement calculator to get a more personalized number. That’s because the percentage you should be saving depends on your age, your current retirement savings, how aggressively you invest, when you want to retire, how much retirement income you need, and how much you can expect to get from Social Security and other income sources. In other words, you may need to save a lot more or a lot less, depending on your particular goals and situation.

It also matters whether you choose a 401(k) or an IRA. While they can have similar tax benefits, you’ll want to contribute at least enough to your 401(k) to get your employer’s full match. After that, your choice depends on a variety of factors like the investment options in each account and whether you prefer the convenience and simplicity of having everything in your 401(k) or the freedom and flexibility of an IRA. Don’t forget that you can also do both.

3. Invest prudently in the stock market. Warren also recommends investing another 5% (or 10% if you’ve paid off your mortgage) in an indexed mutual fund. Her own non-retirement account portfolio is largely invested in fixed and variable annuities with some money in stock, real estate, and bond funds.

Again, why 5%? The amount you save should depend on how much you’re willing to put away to reach your goals. If your goal is retirement, you’ll probably want to max out your 401(k) and IRA before investing in a taxable account. If your goal is education funding, consider tax-advantaged education accounts like a Coverdell account or 529 plan.

The index fund recommendation makes sense since compared to actively managed funds, they generally have lower costs, outperform over the long run, and generate less in taxes since they don’t trade as much. However, Warren seems to be using deferred annuities instead to shield her personal money from taxes. There are a couple of downsides to this strategy. One is that variable annuities tend to have high fees. Another is that the earnings are withdrawn first and are taxed at ordinary income tax rates.

In addition, her heirs will also have to pay taxes on the earnings they inherit after she passes away. In contrast, long term (over one year) capital gains on stocks and funds are taxed at lower tax rates and won’t be taxed at all when passed on to heirs. Her real estate and bond funds also generate a lot of taxes.

A better strategy for Warren would be to prioritize the bonds and real estate investments in her 401(k) and IRA and use the taxable accounts for the remaining stock funds. This is because stocks are more tax-efficient and their higher volatility would allow her to use losses to offset other taxes. By sticking to index funds, she could save even more in taxes and other costs.

4. Oh, and avoid investing in these: gold, prepaid funerals, and collectibles. I’m not sure I’d call prepaid funerals an investment at all, but collectibles can be a fun way for someone to speculate as long as they’re not counting on them for anything. A small amount in gold is used by many investors as a hedge against rising inflation and other types of instability and can help diversify a portfolio since it typically moves differently than stocks and bonds.

As with her money management advice, you could do a lot worse than funding a retirement account, investing in an index fund, and avoiding speculative investments. But Warren’s investment advice is a bit too oversimplified as well. Instead, find out what retirement and investing strategy makes the most sense for your particular needs or work with an unbiased financial planner who can help you. After all, we don’t all have a senator’s pension to bail us out of any mistakes.

 

Where Should You Have Your HSA?

February 16, 2017

Do you have a health savings account (HSA)? If so, you probably got it through your employer and have it at an administrator chosen by them. What you may not realize is that you can choose to transfer your account to a different provider.

This recently came to my attention when Financial Finesse changed HSA providers. Rather than transfer my account into the new administrator, I decided to consider my other options. If you’re shopping around for a new home for your HSA, here are some things to consider:

What do you want to invest the account in? If you’re looking to use it to cover immediate expenses, you’ll want to keep your HSA someplace safe like a savings account. In that case, you can just compare the interest rates they’re paying.

On the other hand, if you’re planning to invest the account to grow for the future as I am, you’ll want to see what the investment options are. Many providers don’t even let you invest outside of a cash account at all. Others give you a limited number of choices (including sometimes funds that may be difficult to access otherwise). Some allow you to invest in thousands of mutual funds and even individual stocks through a brokerage account. To maximize my investment options, I focused my search on the latter.

Do you need to keep a certain amount in a cash account? For someone planning to invest most or all of their account, having to keep money in cash can be a drag on returns. In fact, my main motivation for switching providers was that my current HSA administrator requires me to keep $5k in the cash account or be charged a $3 monthly fee that can’t be deducted from the brokerage account, forcing me to leave money in the cash account to cover the fees. It may not sound like much, but if that extra $5k was invested and earned a 10% average annualized return (I invest my HSA pretty aggressively) over the next 30 years, it would end up becoming an additional $82k that I could use tax-free for future medical expenses. That’s not a bad payoff for a few minutes of paperwork.

What are the fees? Fees are another thing that can eat into your returns, especially if you have a small balance. Make sure to include any additional costs that you may be charged for using the investment option, including both administrative and transaction fees. However, keep in mind that extra investment earnings can more than compensate for an additional fee. For example, it’s worth me investing that $5k in my current HSA because the investments would have to earn just .72% more than the cash account to make up for the $36 in additional fees each year.

You don’t hear much about HSA transfers, probably because HSAs are still relatively new and haven’t acquired enough assets to make providers aggressively compete for them yet. But as these accounts continue to become more common, I expect this will be a growing area of interest. For now, at least be aware that you have a choice and depending on how you plan to use your HSA, it could be a consequential one.

 

 

 

 

Should You Be In an Asset Allocation Fund?

February 09, 2017

One of the most common questions we get on the Financial Helpline is how to choose investments in your employer’s retirement plan. Investing can be complex and intimidating so it doesn’t surprise me that people are looking for help with their decision. What does surprise me is how few of them understand and use an option that was created to help simplify their decision.

Depending on your plan, you may have a target date or a target risk fund available to you. Both are “asset allocation funds” that are designed to be fully-diversified “one stop shops.” All you need to do is pick one fund that most closely matches your target retirement date or your risk level. (Target date funds can also be “set it and forget it” because the funds automatically become more conservative as you get closer to the target retirement date.)

If you think of investing as getting you from point A to point B, asset allocation funds are like the commercial jets of investing. They’re much cheaper than a private jet (a financial advisor) and much simpler than piloting your own plane (picking your own investments). That’s why when I first heard about these funds early in my financial career, I assumed they would take over much of the mutual fund industry and even replace the need for a lot of financial advisors. While they have seen a meteoric rise, especially as the default option in retirement plans, they still aren’t utilized as much as I thought they would be. I think there are 3 main myths responsible for this:

1. Putting everything in one asset allocation fund is having all my eggs in one basket. What you don’t see is that an asset allocation fund is actually a basket of baskets. Each fund is composed of several other funds. In fact, one asset allocation fund is usually more diversified then the typical mix of funds that I see people in.

So why not have other funds in addition to it? Isn’t that making your portfolio even more diversified? The problem here is that these funds were professionally designed to hold a certain proportion of investments so adding others will throw the balance off. It’s like adding extra ingredients to a chef-prepared meal. Only do it if you really know what you’re doing (in which case, you probably don’t need an asset allocation fund anyway).

2. I can probably do better on my own. Remember that these funds were put together by professional money managers who’ve been trained in investment management and do this for a living. What’s the chance that you’ll create a better portfolio? One study of 401(k) participants showed that investors who chose their own funds did worse on average than those who just went with a target date fund.

Part of that is due to lack of knowledge. However, a lot is also likely due to the temptation to buy investments that are performing well and then sell them when they eventually underperform, which is a recipe for buying high and selling low. If nothing else, asset allocation funds provide discipline… assuming you don’t trade these funds too of course.

3. Asset allocation funds are always more expensive. You would think that this professional management would come at a steep price. After all, paying for investment management typically costs .5-1% of your portfolio. However, asset allocation funds are generally only slightly more expensive than other funds and if they’re composed of index funds, they can actually cost much less than most actively managed funds. Check the fund’s expense ratio before making assumptions as to their cost.

That all being said, there are reasons not to use an asset allocation fund. You may not have one available in your plan or the one you have may be too expensive. Sophisticated investors or those with an advisor may want to create a more personalized portfolio that better matches their risk level or complements outside investments to maximize tax-efficiency. But if those situations don’t apply to you, consider an asset allocation fund. Flying commercial may not be a perfect experience, but it’s better than the alternatives for most people.