Asset Protection??

Normally, retirement plans are generally considered safe from creditors. A recent ruling by the Bankruptcy Panel for the 8^th U.S. Circuit Court of Appeals has called that safety into question. An individual was awarded ½ of his ex-wife’s 401(k) plan and her entire individual retirement account in their divorce settlement. He later filed for Chapter 7 bankruptcy and claimed those assets were exempt from creditors because they were in retirement plans. The Bankruptcy Panel disagreed on the basis that the retirement plans were not originally his; thus, they were subject to creditor claims.

Defined contribution 401(k) plans are sheltered from creditors in bankruptcy filings for individuals who own the plan. IRAs are also usually exempt from bankruptcy as well (subject to a cap under federal law that is approximately $1.2 million). However, once the assets are separated from the original owner, you should expect that the asset protection will go away. In the Supreme Court ruling of Clark v. Rameker, the Court held that inherited IRAs are not considered retirement funds for bankruptcy protection.

Although the 8^th Circuit ruling applies only in that district, other courts may follow suit. For protection, IRA assets received in a divorce settlement should not be intermingled with the individual’s own IRA. Co-mingling funds could possibly jeopardize the creditor protection of the entire IRA.

Please note that this discussion does not constitute legal or tax advice; it is informational only. Your individual circumstances should be discussed with your legal and/or tax counsel.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Alternative Investments

It has been a good run. Ten years after the 2008 “meltdown,” the bull market in securities is beginning to show its age. And, after a very placid 2017, volatility in the market is showing it’s alive and well. That volatility has been driven by interest rate expectations, trade/tariff discussions, and the mid-term elections. The elections are (mostly) behind us, but volatility may still be around for a while. Investors have made some money with this long bull market; now the goal is to protect those gains.

 Alternative investments can play a major role in hedging risk in the stock market; however, there are many different hedging strategies available. Many investors are not familiar with these strategies or how to access them. In general, there are two broad categories of alternatives: 1) those investments offering diversification from the stock market, and 2) those investments that reduce risk of loss of portfolio value while still maintaining some return potential.

Access to hedging strategies used to be a major problem; lack of liquidity (the ability to easily buy and sell) being a prime example. Many of these strategies are now available in a mutual fund format. Shares can be purchased or sold daily with valuations set at the end of the day. Some strategies are available as exchange traded funds (ETFs) which provide intra-day liquidity.

Correlation

Correlation is an analysis of the relationship of two data variables, or how the variables move in relation to each other. Normally this relationship is combined into a single number—the correlation coefficient. A correlation coefficient can have a value of +1 to -1. A value of 0 indicates that the variables have no relationship, i.e. they are independent. Positive values (>0) imply that when one variable goes up, the other variable goes up also. Negative values (<0) imply that wen one variable goes up, the other variable goes down. The magnitude of the number (the closer the coefficient is to a value of +/- 1) explains the degree to which moves in one variable are like moves in the other variable.

Diversification Alternatives

Since most investment portfolios contain stocks, alternative strategies which have a lower correlation to them can provide diversification benefits. Listed below are three strategies which have lower correlations to the S&P 500 over the last 10 years.

• Managed Futures- A fund manager utilizing this strategy usually invests in different asset classes (both long and short positions) depending on the manager’s analysis of which asset classes are going to increase or decrease. Successful ability to capture both rising and falling markets have a substantially different return profile from the stock market—a correlation coefficient of about -0.10.
• Market Neutral- A market neutral manager usually has a portfolio long (owned) on stocks the manager expects to rise and short (sold) on stocks the manager expects to under-perform the market. When the portfolio has similar long and short holdings, the return of the portfolio has returns less related to the stock market- a correlation coefficient of about +0.34
• Multi-currency- A multi-currency manager usually invests in different currencies depending on the manager’s perceived relative strength. Since returns are usually different between stocks and fixed income investments, this strategy has had a correlation coefficient of +0.48.

Risk Reduction Alternatives

Ideally, investors would like a diversification strategy that doesn’t significantly sacrifice returns. Such strategies would not only have less losses in down equity markets, but would also have more positive returns in up equity markets. Over longer time periods, these alternatives would outperform those alternatives that provide only downside risk mitigation. Examples include the following:

• Long/Short Equity- A long/short manager usually has a long (owns) position in stocks in which the manager expects to outperform the market and short (sells) stocks which are expected to under-perform the market. The manager may use the sale proceeds from the short positions to increase his/her holdings in the long positions.
• Non-traditional Bonds-Such a manager usually has the ability to invest in bonds of varying maturities, differing credit quality, differing economic sectors, or varying geographic areas as the manager perceives have value. A successful manager has the ability to move according to interest rate changes and other variables affecting the returns markets.

The Bottom Line

Make no mistake—investing involves risk! So does putting money under the mattress in times of inflation. However, if one can mitigate risk (even in a minor way), it surely is worth the effort. Please contact us at Paragon Financial Advisors to see if such alternative investments might benefit your investment portfolio.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Thanksgiving-Turkey or Dressing?

Thanksgiving week, 2018 was an interesting one for the stock market. The S&P dropped 3.8% for the week putting us officially into a market correction. We closed the week down 10.2% from our last market high. This Thanksgiving week was the worst week since 1939. Monday, November 26, 2018 did see the S&P rebound (up about 41 points or one and half percent), but it has been a wild ride.

Why the Market Drop?

Investors are concerned about rising interest rates and tariff/trade talks. Oil has been down seven weeks in a row, dropping more than 20% in November. The EU is in the midst of deciding how Brexit is going to work out and there are additional political challenges in Europe. Tech stocks are down significantly; apparently due to reduced guidance in future earnings. Doesn’t pose a pretty picture, does it?

Things to Consider

Obviously, no one can predict the future; however, there are a few things to consider about what’s going on.

• Thanksgiving week had light trading volume. That trend usually happens over the Thanksgiving holidays. Light volume also tends to magnify pricing trends (down in this case).  The decline we experienced may not be as significant as we see.
• Black Friday shopping was strong. Online purchases were up about 28% over 2017. Employment data may mean that consumers have discretionary money to spend for Christmas.
• The G20 summit is approaching and trade is sure to be a major topic. President Trump and Chinese President Xi are scheduled to discuss trade topics. The fruitfulness of these discussions is definitely uncertain; however, we’ll have to wait and see.
• Further economic data is coming out this week: consumer confidence, GDP, new home sales, jobless claims—let’s see what happens.

The Bottom Line

Remember why your investment goals were established. You established an asset allocation with your risk tolerance and the long term in mind. See if your personal circumstances have changed before making drastic portfolio changes.  

Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Rocky Road Ahead?

October 2018 marked the 10^th year of the longest bull market in history. In 2017, the stock market (S&P 500) moved placidly upward; in fact, the market set record highs over 100 times since the Presidential election in November 2016. This year, 2018, has given investors pause to think, however. In late January, the S&P 500 peaked around 2873, fell just over 10% in February, and recovered to January levels by mid-August. Another record level in late September (around 2930), then the market fell about 7% in mid-October. The roller coaster ride, especially following last year’s “tranquility,” has been a concern to investors. This might be a good time to step back and look at the bigger picture. 

Historical Market Corrections

History can give some guidance on the severity of previous market corrections, as well as how long their recovery took. Since 1926, there have been 16 instances of market downturns more than 10%.

The longest and largest downturn was the Great Depression (Sept 1929-June 1945) during which the stock market lost 83%. That downturn lasted 34 months and the recovery took 151 months. The rampant speculation associated with stocks in the years preceding the downturn resulted in the Securities Exchange Act of 1933 (which regulated the offer and sale of securities—previously governed by state laws, commonly referred to as “blue sky” laws). That law was followed by the Securities Exchange Act of 1934 which created the Securities Exchange Commission and governed the secondary trading of securities.

The second longest downturn was the early 2000 bear market in which the market lost 44.7% and lasted 25 months. The recovery period was 49 months.

The second largest market downturn was the Nov 2007-March 2009 liquidity crisis. The market lost 50.9%, lasted 16 months, and recovered in 37 months.

Let’s look at the record categorically (excluding the Great Depression which, hopefully, won’t happen to such an extreme again because of more stringent securities regulation). The total period is 1926 through October 2018—approximately 92 years.

• Greater than 50% downturn- One occurrence lasting 16 months and recovering in 37 months.
• Greater than 40% but less than 50% downturn- Two occurrences lasting an average of 23 months and recovering in an average of 35 months.
• Greater than 30% but less than 40%- There have been no such occurrences.
• Greater than 20% but less than 30% downturn- Four occurrences lasting an average of 8.5 months and recovering in an average of 18 months. (There have been no instances of a 30-40% downturn.)
• Greater than 10% but less than 20% downturn- Eight occurrences lasting an average of 8 months and recovering in an average of 5 months.

The Take-Away

Make no mistake—watching your investment portfolio lose money is not fun. It brings anxiety, especially for individuals near or in retirement and depending on their portfolio for a portion of living expenses. History is not guaranteed to repeat, but the data above does indicate that “this too shall pass,” and that a portfolio positioned to withstand downturns can prosper. An investor should have cash and short-term fixed income investments needed to cover 36-60 months of normal living expenses in a combination of personal savings and an asset allocation in the portfolio. Stocks remaining in the portfolio will then be given time to recover with no necessity to sell at a loss to cover distribution needs.

For individuals who are not near retirement—congratulations! Stocks just went on sale. You have an opportunity to buy desirable companies at a discount. You should maintain your 3 to 12 months cash “ready reserve,” and consider your risk tolerance and future time horizon, but a downturn may be an opportunity to really boost your future portfolio performance.

Let’s also consider the other alternative—selling stocks when the market is down. We’ll use the 2008 liquidity crisis (market downturn of 50.9%) in our calculations. Our hypothetical stock portfolio will be invested in an S&P 500 index fund with a $500,000 value at the beginning of the market downturn. At the bottom of the downturn, the portfolio retained 49.1% of its original value or $245,500. Definitely an uncomfortable feeling! Now assume the investor takes one of three actions listed below and fast forward to October 17, 2018.

• Sell the equities and go to CDs—Assuming a generous 2% CD rate, the portfolio would now be worth approximately $296,400.
• Sell the equities, wait one year until the market stabilizes, then reinvest in the S&P 500—The investor would have missed a year of gain in the S&P but realized a cumulative increase of 224%: a total portfolio value of approximately $549,900.
• Do nothing, hold the equities and wait—The S&P increased a cumulative of 378%; the portfolio value would be approximately $928,000.

But wait, you say. Suppose the market doesn’t recover as quickly. Let’s look at the periods of consecutive negative stock returns since 1926. There have been four such periods. The market was down four consecutive years during the Great Depression: 1929-1932. In 1933, the market rose 54%. The early 2000s saw three consecutive down years: 2000-2002, followed by a 29% gain in 2003. There were three down years in 1939-1941 followed by a 20% gain in 1942. The market was down two consecutive years in 1973-1974; the market gained 37% in 1975.

There are no guarantees in the stock market. What has happened historically may not happen in the future. However, the next time the market drops, have a cup of coffee and re-consider your long-term investing goals. Maybe the world isn’t ending after all. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Things to Think About: Tempus Fugit! Time Flies!

Time does fly—and with it, some potentially significant tax benefits. There are actions which, if taken in October 2018, can have consequences on taxes—even 2017 retirement plans. We will discuss some of the general rules here; you should discuss the specifics of your situation with your tax professional.

Roth IRAs

• Conversions- Individuals who converted a traditional IRA to a Roth IRA in 2017 may “recharacterize” that conversion back to a traditional IRA if the recharacterization is done by October 15, 2018. Income taxes are due on the amount originally converted from a traditional IRA to a Roth IRA. If the account value has decreased, a lesser tax amount would be due if the Roth was converted back to a traditional IRA, then re-converted to a Roth in 2018. Tax rates have also changed in 2018 due to the Tax Cuts and Jobs Act passed this year. Many individuals may find themselves in a lower tax bracket for 2018; hence, recharacterizing and reconverting in 2018 might mean lower taxes even if the account value remains unchanged. Note that such recharacterizations are allowable only for transactions made in 2017; no such recharacterizations are available for 2018 or later years.

• Recharacterizations- Contributions to a traditional IRA can be recharacterized to a Roth IRA or vice versa. Suppose an individual contributed to a traditional IRA in 2017 but found their income was too high to take a tax deduction. Recharacterizing to a Roth IRA would have no tax increase but would move the future earnings on the account from tax deferred to tax free. While the Tax Cuts and Jobs Act eliminated recharacterization of conversions beginning in 2018, recharacterization of contributions remains in effect.

• Excess Contributions- Excess contributions made into an IRA are subject to a 6% excess contribution penalty. Any excess contribution made in 2017 (plus accumulated earnings thereon) removed from the account by October 15, 2018 will not be subject to that penalty. No relief from this penalty is allowable if the October deadline is missed.

• SEP IRAs for 2017- October 15, 2018 is the deadline for establishing and funding a SEP IRA for businesses if the business filed for an extension. This differs from the “normal” deadline for contributing to a traditional or Roth IRA (the tax filing deadline excluding extensions).

• Simple IRAs for 2017- Employer contributions to Simple IRAs must be made by the tax filing deadline (including extensions) of the business. Again, if the business filed for an extension if 2017, the deadline is October 15, 2018.

Trusts

Inherited IRAs may be “stretched” over the life expectancy of beneficiary—a significant extension in the time over which IRA proceeds must be distributed (and taxed). If the beneficiary is a trust, the trustee has until October 31, 2018 to provide proper documentation that may allow this stretch provision for IRAs inherited in 2017. Miss the deadline and the IRA must be distributed fully over a much shorter period.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Social Security, If Not Now-When?

Social Security benefits are a component in the retirement planning of most Americans. However, those benefits pose questions for both younger and older employees. Younger employees are faced with the long term viability of the system (see our previous posting of “Social Security, Medicare, and You”. Older employees are faced with the question of how, and when, to start taking their benefit.
 
Social Security benefits are a function of age, length of working career, and earnings level. Therefore, we urge you to contact the Social Security Administration to determine your specific benefits. Our discussion here will be more general in nature and cover only the Old Age & Survivor Insurance (OASI) benefit.
 
Full Retirement Age (FRA)
 
Full retirement age is the age at which one is eligible to draw 100% of Social Security benefit earned. Retiring earlier than FRA reduces the amount received; retiring later increases the amount of benefit. Once benefits are begun, the amount is constant, subject only to cost of living adjustments (COLAs); that adjustment amount is tied to inflation. Full retirement age for benefits is shown in the following table:

 

Full Retirement Age

Year of Birth	Age Required for Full Benefits
1954 or Earlier	66 years
1955	66 years + 2 months
1956	66 years + 4 months
1957	66 years + 6 months
1958	66 years + 8 months
1959	66 years + 10 months
1960 and Later	67 years

The earliest age at which one can begin drawing benefits is 62. However, for those born in or before 1955, starting Social Security before FRA reduces the in full benefit by 6.25% per year. For those individuals born in 1960 or later, the reduction is 6.0% per year. Waiting until after FRA to begin drawing benefits increases the benefit by 8% per year until age 70. There are no further benefit increases after age 70.
 
Cost of living adjustments for Social Security are tied to inflation. In 2017, benefits increased by 0.3%. There have been years in which benefits did not increase; however, the average cost of living adjustment for 1985-2017 has been 2.6%.
 
Age 62 or Later?
 
When should one begin drawing Social Security benefits? Should one draw a lesser amount for a longer period of time (longer life expectancy) or a greater amount for a shorter period of time (shorter life expectancy)? That’s a complex question with many variables. What is one’s current financial situation (i.e. does one need the money)? What’s the long term prognosis for life expectancy (current health, heredity, etc.)? How can a couple plan benefits to maximize lifetime income received? There is a “breakeven” point which can be calculated. Consider the following example:
 
John Smith is entitled to $1500 monthly benefit at his FRA of age  66. If he chooses to begin benefits at age 62, his FRA amount will be reduced by 25% (i.e. 6.25% for 4 years) resulting in a benefit payment of $1125 per month. If he waits until FRA and begins  drawing $1500 per month, he will forgo the $1125 per month that he could have been receiving or $54,000 ($1125 x 48 months =   $54,000). If he begins benefits at age 66, that forgone amount will be recovered at $375 per month ($1500 benefit at 66 vs. $1125 at 62) which will require 144 months ($54,000 ÷ $375 = 144 or 12 years). Therefore, John’s breakeven age is 78. If he dies before   age 78, he made the correct decision to take benefits at age 62; if he lives past age 78, delaying until FRA would have been more  advantageous.
 
Obviously, life expectancy is a key component here. In previous postings we have referenced mortality tables. For the above example, the probability of a male at age 62 living to at least age 76 is 73%. There is a 60% probability he will live to age 80, and a 21% probability of living to age 90.
 
To compound the problem, beginning Social Security benefits prior to FRA and continuing to earn income has consequences. There is an annual earnings amount allowed ($16,920 in 2017); for each $2 earned above that amount, Social Security benefits are reduced by $1. That restriction no longer applies if one draws benefits at FRA. There are special rules that may apply here, so individual circumstances must be considered.
 
The Bottom Line
 
Social Security benefits are a key component in retirement planning. How and when those benefits are begun can have a significant impact on long term financial well-being. We at Paragon Financial Advisors can assist our clients in planning for their future. Please call us to discuss your specific circumstances.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

 

 

Old Age and Retirement

The World Economic Forum produced a white paper entitled “We’ll Live to 100-How Can We Afford It?” (Lead Author, Rachel Wheeler, Project Lead, May 2017) The basic premise of this white paper was the status of world-wide retirement plans and potential problems and reforms necessary to address those problems. The disclaimer in the white paper is that “…views in this White Paper … do not necessarily represent the views of the World Economic Forum or its Members…” In addition, these papers “… describe research in progress by the author(s) and are published to elicit comments and further debate.” The report is “… part of the Forum’s Retirement Investment Systems Reform project that has brought together pension experts to assess opportunities for reforms that can be adopted to improve the likelihood of our retirement systems adequately and sustainably supporting future generations.” The paper, in its entirety, can be accessed at  http://www3.weforum.org/docs/WEF_White_Paper_We_Will_Live_to_100.pdf  Our discussion in this posting is done without comment or endorsement of the contents of the white paper. However, in light of the positions taken by some candidates in the 2016 US Presidential election, it behooves us to look at some propositions being espoused in the academic community and conditions that exist in the international community.

Old Age

Life expectancy is increasing. For individuals born in 1947, the median life expectancy is 85 years; for those born in 2007, it is age 103. The increased life expectancy leads to a longer working career. If retirement age remains unchanged and current birth rates continue, the global dependency ratio (the ratio of the workforce to retirees) will decrease from 8:1 today to 4:1 by 2050. The position taken in the Forum’s white paper “…focuses on the sustainability and affordability of our current retirement systems.” Retirement “…system needs to be affordable for today’s workers and sustainable for future generations…"

Challenges to Retirement Systems

 

The primary causes of retirement systems problems, according to white paper authors, are increasing life expectancy and a declining birth rate. The authors identify five additional factors affecting global retirement systems:

1. Lack of access to pensions- Many workers (especially the self-employed) don’t have access to pension plans or savings products. Over 50% of global workers work in the informal or unorganized sectors of the economy. Forty-eight percent (48%) of retirement age people don’t receive a pension.
2. Low investment returns- Long term investment returns over the last 10 years have been significantly lower than historical averages. Equities have returned 3-5% below averages; bonds, 1-3% below. These lower returns have exacerbated pension plan shortfalls and reduced individual retirement savings balances.
3. Personal responsibility for pension plan management- Defined benefit plans have been decreasing in number while the number of defined contribution plans has been increasing. Defined contribution plans now account for over 50% of global retirement assets. The investment risk has thus been shifted from the employer to the employee.
4. Low levels of financial literacy- While investment risk has been shifted to the individual, the ability of those individuals to make sound investment decisions appears to be lacking. Most people are not able to correctly answer questions on basic financial concepts.
5. Inadequate savings- Individual savings in all countries are well below the 10-15% level necessary to fund a reasonable retirement income.

The Retirement Savings Gap

 

Historically, retirement income has come from three sources: 1) governmental sources (Social Security, etc.), 2) employer pension plans, and 3) individual savings. According to the authors of the white paper, the world-wide retirement savings gap in 2015 is estimated to be approximately $70 trillion with the largest shortfall being in the US. Of that gap, 75% is in the government and public pension obligation, 1% in unfunded corporate pension plans, and 24% in lack of personal savings. This gap is predicated on a 70% income replacement in retirement.

 

The Findings

 

The authors of the white paper espoused three key areas to address overall financial security:

• Provide a “safety net” pension for all persons
• Improve access to effective, efficient retirement plans
• Increase personal savings initiatives

The authors of the paper state:

 

“Poverty protection for the elderly should be the minimum requirement for any government pension system. It should be the responsibility of the government to provide a pension income for all citizens that acts at a “safety net” and prevents those who miss out on other forms of pension provision from dropping below the poverty line.”

 

“In countries where there are challenges to establish employer-based or individual pension schemes, introducing universal pension benefits may be the only way to significantly reduce poverty among the elderly.”

 

“Technology can make saving automatic by deducting contributions directly from employees’ pay before it reaches their personal accounts.” “Governments can make it compulsory for all employers to automatically enroll new employees into a retirement savings account and to contribute on their behalf.” (italics added)

 

Principles for Change

 

Authors of the white paper identified four principles that they felt should be addressed in retirement plan provisions.

 

Principle 1: The work force is changing. Occupations that are most sought after today didn’t exist 10 years ago. In addition, about 65% of today’s primary school children will work in jobs that don’t yet exist. The number of workers over age 65 is increasing; it has more than doubled since 1995. The number of employers for whom a person works over his/her career is increasing. That requires “re-tooling” work skills and portability of job benefits.

 

Principle 2: There is a gender imbalance. Retirement balances for women are 30-40% below those for men. Longer periods out of the workforce and lower salaries in general contribute to the lower retirement account balances. In addition, the longer life expectancy of women means those reduced assets need to cover a longer period of time. Unisex life expectancy tables and valuing work performed outside the workplace for retirement benefits could help alleviate this disparity.

 

Principle 3: Shared risks could reduce individual burdens. Collective defined contribution systems (as employed in some countries, such as Canada) could help with the burden on individuals for their retirement savings, account management, life expectancy, etc. Pooled money and risks could be based on “target” benefits. An example of such a plan, as presented by the authors, is shown below.

Defined Benefit Plan	Collective Defined Contribution Plan	Defined Contribution Plan
Pooled assets across all accounts	Pooled assets or notional accounts	Individual accounts
Predominantly employer contributions	Combination employer and individual contributions	Combination employer and individual contributions
Trustees determine investment policy and investments	Trustees determine investment policy and investments	Individual makes investment decisions
Trustees takes investment risk	Investment risk pooled	Individual takes investment risk
Trustees takes longevity risk	Longevity risk pooled	No longevity protection
Guaranteed pension	Target pension, not guaranteed	No target or guaranteed pension

Principle 4: All financial needs should be considered. People who save early for retirement will have much larger retirement savings than those who start later. However, retirement savings may not be a priority for younger employees. Therefore, the authors contend, the full financial picture (assets and debts) should be considered for financial need.

The Bottom Line

When one reads the World Economic Forum white paper and analyzes its recommendations, it is obvious that items presented are significantly different than what we have in the US today. However, as we examine our current public benefit systems (Social Security), it is also obvious that some changes must be made. Prudent financial planning means looking at alternatives and trying to plan for what “might happen.” Visit us at Paragon Financial Advisors to review your individual circumstances. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.