Getting Ready for a Fresh Start

Despite the potential long-term benefits of reviewing personal finances on an annual basis, it seems that many Americans still don’t make it a priority to do so.

Have you already taken steps to give yourself a fresh financial start next year? It’s still not too late to begin.

Aim Higher for Retirement

Today, workers are eligible to contribute more money than ever to their employer-sponsored retirement plans. For most workers, the maximum annual pre-tax contribution is $18,000 in 2015. If you’re at least 50 years old, you may also make additional contributions — known as catch-up contributions — of up to $6,000. That amounts to a $24,000 overall contribution limit this year.

Search for Savings

Even if you can’t contribute the maximum, a reality for many given life’s various financial challenges, seek out opportunities to set aside more money for retirement whenever possible.

Consider creating a comprehensive household budget that allows you to plan and track spending on an ongoing basis and includes among your listed expenses a commitment to “pay yourself” in the form of retirement savings. More than likely you’ll find some “fat” in your budget, even just a little, that can be trimmed to free up savings dollars.

Defeat Debt

The U.S. savings rate recently hit its lowest level in almost half a century, due in part to higher rates of borrowing and credit card debt. If debt is getting in the way of your long-term goals, consider strategies for chipping away at it:

  • Transferring high-interest debt to a credit card with a lower rate.
  • Trying to pay at least twice the minimum required payment.
  • Using a tax-refund to pay off outstanding loans.

For more ideas on how to get a fresh start or to discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Understanding Bond Investing: It’s a Matter of Balance

It’s a common misconception to think of bonds as “plain vanilla” investments that are appropriate only for certain types of people, such as financially conservative retirees. But in reality, bond investments may have the potential to add stability to a portfolio and help reduce overall investment risk — regardless of your age or financial outlook.

What Is a Bond?

Bonds are investment securities issued by corporations or governments to raise money for a particular purpose. Basically, bonds are the “IOUs” of the business world. There are different types of bond funds, each with varying levels of risk and return potential. Generally speaking, the higher the risk, the better the return potential. For example:

  • Government bond funds invest in bonds issued by the U.S. Treasury. Historically, they have been among the strongest types of bond investments. However, they typically offer lower returns than other bonds.
  • Corporate bond funds invest in bonds issued by private companies. They can range from “investment grade” (safer, lower return potential) to “below investment grade” (riskier, higher return potential).

Know the Risks

Bond funds are subject to several types of investment risk, including:

  • Market risk — Like stock prices, bond prices move up and down. However, such fluctuations tend to be less severe in the bond market.
  • Interest rate risk — When interest rates rise, bond prices may fall, and vice versa.
  • Inflation risk — If the return on a bond fund does not outpace the rising cost of living, the purchasing power of your investment could decline over time.

Managing Risk

Despite these risks, investors of all ages may potentially benefit from putting some money in bond funds. Because bond funds tend to respond to market influences differently than stock funds, they may help balance out the risks associated with stock investing.

In addition, lower-risk bond funds, such as government and investment-grade corporate bond funds, may help protect some of your money from losses during turbulent times.

If you would like to review bond investments in your current portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

About that Social Security Insolvency

Social Security’s future solvency has become one of the most commonly-discussed issues in retirement planning—and for good reason.  Gallup polls show that an estimated 57% of retirees rely on Social Security as a major source of retirement income—a number that has held steady since the early 2000s.  But when Generation X and Y individuals plan for their future retirement, they’ll often ask their advisor to assume that Social Security won’t be there for them 20 or 30 years down the road.

However, if you look closely at the numbers, you see a very different story.  Up until 2011, the Social Security system actually collected more revenues from workers’ FICA payments than it paid out in benefits—and that has been generally true since the 1940’s.  Most of the Social Security benefits that people receive today are simply a transfer; that is, the money is collected from worker paychecks (and, of course, employer matches), spends a few days at the U.S. Treasury and then is paid out to recipients.  The surplus has been used to pay government operating expenses, and for seven decades, the government issued “special issue federal securities” (essentially fancy IOUs that pay interest) to the Social Security trust fund.

In 2011, the program crossed that threshold where benefit payments slightly exceeded the amount collected.  Why?  Because the number of beneficiaries, compared to the number of workers, has steadily increased.  In 1955, there were more than eight workers paying into Social Security for every beneficiary.  Today, that number is closer to three workers for every beneficiary, and by 2031, if current estimates are correct, that ratio will fall to just over two workers supporting every retired beneficiary.

When Social Security Administration actuaries crunch the numbers, they have to take into account the shifting demographics, and then make estimates of fertility and immigration rates, longevity, labor force participation rates, the growth of real wages and growth of the economy every year between now and 2078.  After adding in the value of the government IOUs, they estimate that if nothing is done to fix the system, the trust fund IOUs will run out in the year 2033.  At that time, only the FICA money collected from workers would be available to pay Social Security beneficiaries.  In real terms, that means the beneficiaries would, in 2034, see their payments drop to 77% of what they were promised.

In other words, the money being transferred from current workers to beneficiaries through the FICA payroll program, assuming no course corrections between now and 2033, will be enough to pay retirees 77% of the benefits they were otherwise expecting.

The government actuaries say that if nothing is done to fix the problem over the next 63 years, this percentage will gradually decline to 72% by the year 2078.

So the first takeaway from these analyses is that today’s workers are looking at a worst-case scenario of only receiving about 75% of the benefits that they would otherwise have expected to receive.  This is far different from the zero figure that they’re asking their advisors to use in retirement projections.

How likely is it that there will be no course corrections?  There are two possible ways that this 75% figure could go up.  One lies in the assumptions themselves.  The Social Security Administration actuaries have tended to err on the side of conservatism, presumably because they would rather be pleasantly surprised than discover that they were too optimistic.  But what if the future doesn’t look as gloomy as their assumptions make it out to be?

To take just one of the variables, the actuaries are projecting that labor force participation rates for men will fall from 75.5% of the population in 1997 to 74% by 2075, while the growth in female workers will stop their long climb and peter out around 60%.  If male labor force participation rates don’t fall, and if female rates continue to rise, some of the funding gap will be eliminated.

Similarly, the projections assume that the U.S. economy’s productivity gains (which drive wage increases) will grow 1.3% a year, well below long-term U.S. averages and certainly below the assumptions of economists who believe that biotech and information age revolutions will spur unprecedented growth.  If real wages were to grow at something closer to the post-Great Recession rate of 2% a year, then more than half of the funding gap would be eliminated.  If the current slump in immigration (due to tighter immigration policies) is reversed, and the economy grows faster than the anemic 2% rates the Social Security Administration is projecting (compared to 2.5% recently), then the “bankrupt” system begins to look surprisingly solvent.

A second possibility is that Congress will tweak the numbers and bring Social Security’s long-term finances back in balance, as it has done 21 times since the program originated in 1937.  The financial press often cites the fact that the total future Social Security funding shortfall amounts to $13.6 trillion, but they seldom add that this represents just 3.5% of future taxable payrolls through 2081.  Small tweaks—like extending the age to collect full retirement benefits from 67 to 68, raising the FICA tax rate by 3.5 percentage points or making the current 12.4% rate (employee plus employer match) apply to all taxable income rather than the $118,500 current limit—would restore solvency far enough into the future that today’s workers would be comfortable adding back 100% of their anticipated benefits into their retirement projections.

How likely is it that Congress will take these measures, in light of recent partisan budget battles?  It’s helpful to remember that older Americans tend to vote with more consistency than younger citizens.  The more you’ve paid into the system, the more you expect to at least get back the money you were promised.

The bottom line here is that if you’re skeptical about Social Security’s future solvency, then you should pencil in 75% of the benefits you would otherwise expect—rather than $0.  Meanwhile, as you approach the age when you’re eligible for benefits, watch for signs that immigration restrictions are loosening, the economy is growing faster than the SSA actuaries’ gloomy projections, more people are working during traditional retirement years or yet another round of tweaks from our elected representatives.

If you would like to review your social security payment options or projections, analyze your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://economix.blogs.nytimes.com/2014/03/05/another-way-to-do-the-math-for-social-security-reform/?_r=0

http://www.treasury.gov/resource-center/economic-policy/ss-medicare/Documents/ssissuebriefno.%205%20no%20cover.pdf

http://www.treasury.gov/resource-center/economic-policy/ss-medicare/Documents/post.pdf

http://www.wsj.com/articles/how-social-security-benefits-are-calculated-when-you-wait-to-start-taking-them-1421726460

http://www.usatoday.com/story/money/personalfinance/2013/11/25/nine-surprising-social-security-statistics/3698005/

http://www.huffingtonpost.com/2013/02/18/change-social-security_n_2708000.html

http://www.therubins.com/socsec/solvency.htm

http://www.encyclopedia.com/topic/social_security.aspx

http://fdlaction.firedoglake.com/2012/04/30/growing-number-of-americans-expect-to-rely-mostly-on-social-security/

TheMoneyGeek wishes to thank guest writer Bob Veres for this post.

The Psychology of Investing: How We Cope With Risk

Researchers have found that investors have a tendency to psychologically exaggerate declines in the performance of an investment and to minimize gains. It’s a phenomenon with a complex sounding name — “myopic loss aversion” — but also one that makes a simple point: Psychology plays a role in our investment decisions. Understanding that role, the subject of this second installment of a three-part series on investment risk, may help you stay on course toward your long-term financial objectives.

Word Play

Individuals subconsciously “frame” expectations based upon how the information is presented to them. For instance, would you prefer to invest in a security that has a 40% chance of yielding negative returns or one that has a 60% chance of yielding positive returns? Many people would choose the latter, even though the same investment opportunity was offered in both cases.

Running With the Pack

It’s human nature to want to choose investments that have performed well. On the other hand, many of us are naturally risk-averse. Sometimes these inclinations combine to make us less effective investors. For instance, do you know people who wait to invest until they hear of a security that consistently produces above-average returns? Then, sensing a “safe bet,” they purchase this investment — often when it’s at peak value. If the investment drops in value, they move their money to what they perceive as a less risky security or even pull out of the market altogether — even if such a move clashes with their long-term goals.

This sort of short-term thinking creates risk, too. When investors move in and out of the market, they’re practicing an investment tactic known as market timing. The risk is that they’ll mistime the market and lose out on potential gains. Even professional portfolio managers admit that it can be difficult to predict market moves.

Personal Experiences and Our Portfolios

Research has shown that individuals who grew up during the Great Depression are more likely to invest conservatively, while those who entered the market during the mid-1990s expect high returns and tend to invest more aggressively. Being aware of how past experience may influence your perceptions, can help you avoid financial strategies that may work against you.

So What Can You Do?

Several strategies may help you minimize the role that emotions and psychological tendencies play in your investment decisions. Stay focused on your long-term goals and not the market’s short-term moves. And rather than reviewing your investments’ performance every week, consider scheduling quarterly or semi annual portfolio reviews with a qualified financial professional.

Finally, develop — and stick to — a well thought out plan that’s based on your goals and your personal tolerance for risk. Look for more on these and other strategies that may help you cope with risk in the final installment of this series.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Put Time on Your Side With the Power of Compounding

Sometimes people put off saving for retirement because so many other things seem to get in the way. Do you find yourself among them? If so, try to overcome the urge to procrastinate and start saving as soon as possible. When it comes to investing for long-term goals, time can be a powerful ally.

Time and Investment Returns

The reason time can work for you is because of a concept called compounding. The idea behind compounding is simple — when your investment earns money, this amount is reinvested in your account and potentially generates more earnings. Over time, this process can increase the growth potential of your original investment. If your earnings are reinvested for a long enough period, compounding can reduce some of the pressure on you to invest greater amounts as you approach retirement.

The power of reinvested earnings partly explains why some people who start investing early in their careers often end up with more money than people who start later, even if their total contributions are less.

Compounding With Every Paycheck

Your employer-sponsored plan may be one of the most convenient ways to make compounding work for you. Every paycheck, you have a new opportunity to add to your retirement savings. For 2015, you may be able to contribute a maximum of $18,000 (check with your employer, because some organizations may impose lower limits). If you are age 50 or older, you may also have the opportunity to save up to $6,000 more. Even if you cannot afford to invest the maximum amount, try to do as much as you can.

Of course, you can’t benefit from compounding if you don’t stay invested. Withdrawing money during your working years could wipe out or reduce the savings you have accumulated, which would reduce some of the benefit of compounding.

So don’t procrastinate. Start saving as soon as possible and take advantage of what compounding can potentially do for you.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Financial Habits and Net Worth

You already know that our financial habits determine our financial fate.  If we avoid credit card debt, spend less than we earn and create a financial buffer against the unexpected, we tend to thrive financially.  If we carry a lot of debt or live constantly on the edge, with little savings, then our financial future is much cloudier.

Recently, a paper published by the Federal Reserve Bank of St. Louis proved these truisms in the real world.  For eight individual years between 1992 and 2013, the Fed’s Survey of Consumer Finances has posted a series of financial questions to thousands of people in all walks of life, at all income levels and ages.  Among them:

1) Did you save any money last year?
2) Did you miss any loan or mortgage payments in the last year?
3) Did you have a balance on your credit card after the last payment was due?
4) Do liquid assets make up at least 10% of the value of your total assets?
5) Is your total debt service—the cash you devote each month to paying principal and interest—less than 40% of your income?

The paper scored the answers, giving every positive answer (yes for 1, 4 and 5, no for 2 and 3) one point, assigning zero points to the “wrong” answers. Then they added up the scores for each household and looked at a financial health score taken from the same survey, and compared the two.  They found what you would probably expect: that good financial habits are highly correlated with the accumulation of wealth.  A small chart at the back of the study, which divided people according to age and ethnic profile, found that individuals who averaged a score of 2.63 had a median net worth of $25,199, while those who averaged a 3.79 score enjoyed a median net worth in excess of $800,000.  The average score: 3.01, associated with a net worth somewhere in the $70,000 to $75,000 range, which happens to fall neatly in between the median for people age 35-44 ($51,575) and those age 45-54 ($98,350).

How did you score? Is it time for some changes to your financial habits to bolster your net worth?

If you would like to learn how to improve your financial habits, review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Source:  http://www.stlouisfed.org/publications/itb/articles/?id=2575

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