Texas Estate Planning

What Will Happen if There’s a Market Crash During Retirement?

Let’s use the market crash of 1987 as an example for this discussion on “What are the odds the market will crash during your retirement years?” from Market Watch. It’s not as famous as the deep dives of the 2008 markets, but it was actually the worst in U.S. stock market history. While some people believe it was not that significant, and that government safeguards would have prevented the crash if it was really that bad, those arguments may not be right.

A study released from Harvard and Boston University came up with a formula that predicts the frequency of stock market crashes over extended periods of time, “Institutional Investors and Stock Market Volatility.” If these extremely learned sources are correct, then we should all understand that market crashes are events that will continue to occur, regardless of any other factors.

For this analysis, imagine a person retiring at age 65, with a generous life expectancy of 30 years. Let’s look at the scientists’ formula for the chances of a market crash during that person’s retirement. Note that the bigger the size of the crash, the lower the probability of one occurring. However, the odds of a huge crash are still high enough that we should expect one, and perhaps more than one, during any given person’s retirement.

Consider first a 15% daily drop, which would be a decline of around 4,000 points in the Dow Jones Industrial Average. There’s a 67% chance that this will happen at some point during a 30-year retirement. Note that the formula does not mean that crashes of this size happen like clockwork every so many years. The formula predicts what the average frequency of crashes will be over an extended period of time. You may never see a 15% crash—but your planning is on shaky ground, if you have set your retirement investments up with no consideration for a big crash.

What would such a drop do to retirement finances? The answer is different for everyone, depending on how their equity portfolios are structured, how much cash on hand you have and if you are able to dramatically change your spending when your portfolio loses value.

However, a bigger impact could be the psychological response to the drop that many people, unfortunately, are quick to make in the face of a crash. Going to all cash is the worst thing that anyone could do, and yet people do it, time and time again.

According to the professor’s formula, we should expect as many as 18 daily drops of at least 5% in the years during our retirement. Over the last thirty years, there actually have been 15 such daily drops. It is slightly slower than the prediction but still, remarkably close.

What can you do to prepare for these inevitable events? Be aware that one or more stock crashes will likely occur during the course of your retirement. Don’t panic when they occur, and depending upon on your risk aversion, do what you need to in order to position your portfolio, so you can sleep at night.

Reference: Market Watch (October 31, 2019) “What are the odds the market will crash during your retirement years?”

Let’s use the market crash of 1987 as an example for this discussion on “What are the odds the market will crash during your retirement years?” from Market Watch. It’s not as famous as the deep dives of the 2008 markets, but it was actually the worst in U.S. stock market history. While some people believe it was not that significant, and that government safeguards would have prevented the crash if it was really that bad, those arguments may not be right.

A study released from Harvard and Boston University came up with a formula that predicts the frequency of stock market crashes over extended periods of time, “Institutional Investors and Stock Market Volatility.” If these extremely learned sources are correct, then we should all understand that market crashes are events that will continue to occur, regardless of any other factors.

For this analysis, imagine a person retiring at age 65, with a generous life expectancy of 30 years. Let’s look at the scientists’ formula for the chances of a market crash during that person’s retirement. Note that the bigger the size of the crash, the lower the probability of one occurring. However, the odds of a huge crash are still high enough that we should expect one, and perhaps more than one, during any given person’s retirement.

Consider first a 15% daily drop, which would be a decline of around 4,000 points in the Dow Jones Industrial Average. There’s a 67% chance that this will happen at some point during a 30-year retirement. Note that the formula does not mean that crashes of this size happen like clockwork every so many years. The formula predicts what the average frequency of crashes will be over an extended period of time. You may never see a 15% crash—but your planning is on shaky ground, if you have set your retirement investments up with no consideration for a big crash.

What would such a drop do to retirement finances? The answer is different for everyone, depending on how their equity portfolios are structured, how much cash on hand you have and if you are able to dramatically change your spending when your portfolio loses value.

However, a bigger impact could be the psychological response to the drop that many people, unfortunately, are quick to make in the face of a crash. Going to all cash is the worst thing that anyone could do, and yet people do it, time and time again.

According to the professor’s formula, we should expect as many as 18 daily drops of at least 5% in the years during our retirement. Over the last thirty years, there actually have been 15 such daily drops. It is slightly slower than the prediction but still, remarkably close.

What can you do to prepare for these inevitable events? Be aware that one or more stock crashes will likely occur during the course of your retirement. Don’t panic when they occur, and depending upon on your risk aversion, do what you need to in order to position your portfolio, so you can sleep at night.

Reference: Market Watch (October 31, 2019) “What are the odds the market will crash during your retirement years?”

Retirement Planning Tips For the Coming Year

On average, American men today will live to 84.3 years, says the U.S. Department of Social Security. That means you can expect to enjoy at least 20 years of retirement or muddle through two decades of financial worry, depending on your level of preparation.

Consider that the average monthly income for a couple receiving Social Security benefits is $2,176. That’s about $26,000 a year, says Farm Journal’s Ag Pro in the article “5 Retirement Investment Tips.” If that’s an average benefit, then farm couples should expect to receive less than that. Why? Because farmers are very good at avoiding taxes, said David Marrison, Ohio State University Extension specialist. Even if they receive the average amount, he asks, where’s the rest of the household income?

When it comes to retirement income, about $26,000 is just not enough. To allow for a comfortable retirement and limit negative impact on the family farm, or any family business for that matter, planning must be done in advance. Here are a few tips that are simple, direct and can make a difference for your retirement.

When are you going to retire? Many people retire at 65.  However, the decision often needs to be made from a financial perspective and not based on age. If you can work a little longer, that may give you a better chance of building up enough finances to retire comfortably.

What’s your budget? This is where so many people fail. How much money are you going to need when you retire, starts with knowing how much money you are spending now. For farm and business owning families, some expenses can get co-mingled, such as fuel or utilities. Get into the details and make sure you are not missing any expenses.

Inflation. Recent years have seen a very low impact of inflation but that may be changing. Once you’ve identified your target savings goal, build in inflation. Here’s one way to do it: take the number 72 and divide it by an interest-rate factor. Many experts use 4%, which is the average inflation rate for the last five decades. Using this rule, you can expect your living expenses to double what they are today because of inflation. Sounds scary? That’s why planning is so important.

Make a plan for savings. View retirement as both a means to an end and a way to reduce tax liability. For farmers, good times used to translate into mitigating taxes, by purchasing equipment. However, it’s likely that putting away money in a 401(k) may have been a better idea.

Start saving today. Even if all you are doing is setting aside 10% for the future, if you are young enough that can be a good start.

Add to these tips getting your estate plan done or updating your estate plan. Your estate plan is a critical piece for farm families, who want to pass the farm down to the next generation. In addition to a will, you also need Power of Attorney for your finances and documents for health care. Make an appointment with a local estate planning attorney to get this done.

Reference: Farm Journal’s Ag Pro (Dec. 24, 2018) “5 Retirement Investment Tips”

Forget That 4% Withdrawal Rule and Instead, Focus on Flexibility

Scratch that rule, advisors are now saying, because there are too many other factors to consider. The old 4% rule, reports Forbes in the article “Here’s How to Refresh Your Retirement: The 4% Rule of Thumb,” doesn’t work anymore, in light of increasingly high healthcare costs, jobs that can be done well into one’s later years and a longer life expectancy.

It is now thought that the 4% rule is a decent base line.  However, you’ll need to go deeper into the details to plan for your retirement. Your spending also has a lot to do with what you expect from retirement and how expensive a lifestyle you choose.

One key factor today is tax-deferred investing. The importance of being taxed at the highest rate versus paying a lower tax rate can be misleading. Many people defer taxes on their investments, because they don’t want to pay 30% to 40% income taxes when they could defer to a higher bracket, if tax laws change. 

Some are considering investment in single family rental properties. If you buy a rental house with a small capital investment, the house will ideally appreciate over time on a tax-deferred basis. Owners benefit by depreciating expenses on their tax returns. The single-family rental home can be paid off in 15 years to 20 years and create income for the owner—predictable income that could also increase from year to year.

Another strategy is to create an investment portfolio that combines diversified stocks and high-quality fixed annuities, paired with a systematic withdrawal plan and a built-in buffer strategy to reduce risk in the case of severe stock market swings.

One advisor noted that if a retiree today relies on a traditional 60/40 stock/bond portfolio, they could be looking at a financial disaster. The yields on bonds are at historic lows and a 4% withdrawal is just asking for trouble.

An effective tax reduction strategy has the potential to raise a retiree’s safe withdrawal rate even higher.

The best advice is to have a plan in place that works for the lifestyle that you and your spouse want and being prepared to adjust, if necessary. Your plan may include working, until you both reach full retirement age, working part time during retirement, moving to a location that is more affordable or aging in place.

Your plan should include putting your estate plan in place, by working with an experienced estate planning attorney. At the very least, you’ll need a will, power of attorney and a medical directive. Depending upon your situation, you may need more complex planning tools.

Reference: Forbes (Aug. 7, 2018) “Here’s How to Refresh Your Retirement: The 4% Rule of Thumb”

Is Your 401(k) Completely Bulletproof?

There’s a lot of bad press about workplace retirement plans and particularly about the fees.  However, to be perfectly blunt, 401(k) plans have been a great help to millions of working Americans. In total, 55 million of us own $5.3 trillion in these accounts, according to industry data. Put simply, 401(k)s work—they get people to save for retirement.

That’s the good news, according to an article from MarketWatch, “All the ways you can mess up your 401(k)—even if you max out your contributions.” The bad news? People who are diligent and organized, still make mistakes with their 401(k)s. They often leave money on the table. That includes good savers, who are making the maximum contributions.

If you care about making the most out of your 401(k) plan, here are some points to watch for:

Not Investing. Even with automatic enrollment in place, would you believe as many as 80-90% of those participating in a 401(k) leave their contributions in cash? True. The problem? Cash is subject to inflation and steadily loses value. Stocks and bonds may go up and down.  However, they traditionally will grow more than inflation.

Turning down free money. Many companies incentivize savings, by offering to match contributions by a percentage of their employee’s salary match or a specific amount. Not making the most of that match is saying “No, thanks” to free money. 

Missing company matches by front-loading contributions. This is more commonly seen in aggressive savers, who try to max out their contributions as quickly as possible every year.  However, zero contributions in later pay periods risks not getting all the possible contributions. Ask your employer how you might spread out payments over the course of the year. Talk with your HR department to be clear  about your company’s match plan details.

Paying high fees. Most companies watch the fees, before signing up with a 401(k) provider.  However, you can advocate for yourself, if your company’s choice seems to have high fees. Choose low-cost index funds over expensive active mutual funds. According to BrightScope, almost all plans have access to index funds.  However, only about a third of total plan assets are invested in low-cost funds. 

Timing the market. Here’s what typically happens: people ignore their accounts for years at a time and then one day they open their statement to find there’s a LOT of money in their accounts! It’s more a result of the power of time, known as compounding in investment circles, than of their investing skills. The problem is, the method that worked—a risk-adjusted portfolio over time—makes them think it’s time to micromanage their accounts. Stick with what’s worked and let the power of compounding do its job.  You will find that you will do better.

Abandoning accounts. Leaving one job and opening up a new 401(k), results in many people forgetting to move their old 401(k). Fees can take their toll over time and a once robust account can be depleted.

When you have too many accounts, it can be difficult to manage them wisely. You end up with a  many accounts, with funds in the wrong kinds of investments. What was appropriate in your thirties, is wrong for your early 60s. Roll those old balances into a single IRA and you’ll be able to have a clearer vision of how your portfolio is balanced or how it isn’t.

No matter what stage of life you’re in, it is wise to make time to keep an eye on how your money is managed. When retirement comes around, you’ll be glad that you did.

Reference: MarketWatch (May 5, 2018) “All the ways you can mess up your 401(k)—even if you max out your contributions.”

Complicated Estate Planning

When some people think about investments they think about traditional assets. The kind of assets in which you invest depends on the hoped for return you expect (and the risks you are willing to assume). Securities and real estate are two common assets familiar to most people.

However, there are other people who also think in terms of "tangible items of personal property" when thinking about investments. For example, these people invest in art, wine, collectible toys, vintage cars and much more. In the sense that these things can be sold later for profit, they can be seen as investments.

On the other hand, there is almost always more involved when people make uncommon investments, which is why they are sometimes referred to as "passion assets." Those who invest in these assets have an emotional attachment to the objects themselves beyond their pure investment value.

Investopedia, in a recent article entitled "How to Handle Passion Assets in an Estate Plan," discussed how planning for these passion assets can be problematic. One key problem is determining whether heirs want to keep the items or want them to be sold. The answer to that question can make different ways of holding the assets better than others. For example, if heirs want to sell a passion asset, then holding it in an irrevocable trust can create a substantial capital gains tax liability. Alternatively, holding title directly can avoid capital gains taxes but can create estate tax issues if heirs do not also inherit enough liquid assets to pay the tax.

If you have invested in any passion assets, it is important that you consult with an estate planning attorney about the impact on your estate plan.

Reference: Investopedia (Dec. 17, 2015) "How to Handle Passion Assets in an Estate Plan"

 

Getting Younger Heirs to Invest

Much has been written about the millennial generation, those people born between 1980 and 2000. Their work ethic, tastes and even general politeness have been questioned by older adults. 

One thing that some believe is different about millennials is that they do not just get financial advice from professionals. They also get advice from friends, social media and online gurus. 

This is seen as a problem for Wall Street firms who are in the business of selling financial advice and getting people to use their services to invest. Since estimates speculate that millennials will inherit $30 Trillion from their parents and grandparents, it is paramount for Wall Street to attract the attention of these young heirs.

As Bloomberg reports in an article titled "Wall Street Has Its Eyes on Millennials $30 Trillion Inheritance," Wall Street has taken an unusual strategy to attract the attention of millennials, using animation and cartoon like graphics. 

Click over to read the original article and see some examples of the cartoon graphics Wall Street firms are using.

One takeaway: if you are planning on leaving a millennial a large inheritance, it might be a good idea to have an estate plan that takes the choice of investing away from them and giving it to a professional. 

A trust, for example, could be used instead of leaving the inheritance outright with a professional trustee to help protect the inheritance from and for your millennial loved ones. 

If Wall Street is concerned that millennials will not invest their inheritance prudently, perhaps it would be wise for you to be concerned as well.

Reference: Bloomberg (March 3, 2015) "Wall Street Has Its Eyes on Millennials $30 Trillion Inheritance"