Information and opinions about Financial Planning and Investing by David Wertz, Ph.D. (856) 581-9075
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Our Philosophy

We are Financial Advisors who help individuals both prepare for the future and give investment advice. Both activites involve taking actions today in order to have a better future. The fact we are taking action today in order to get benefits in the future means that we are forced to make predictions about the future. Unfortunately, no one can reliable predict the future. We deal with this problem in two ways. First we have read every serious study of financial history that we know in order to identify the kinds of things that can occur. Our advice is based on what history teaches us. One of these lessons is that you can simply extrapolate from the past into the future. Second we believe that all financial decisions, both financial plans and investment decisions, should have a "Margin of Safety" to deal with the unexpected when, not if, it occurs.

January 9, 2016

Financial Markets at the Start of 2016

Now is the WORST time ever to be an investor. This is especially true if you are a conservative investor. NOTE: This is not a prediction about wha the market is going to do in the next year or so. Rather it is a prediction of the returns investors can expect over the next 5 to 15 years.

Let us look at the plight of the conservative investor. Right now across the board the interest rates on the safest investments like short term government bonds, bank deposits, CDs, and money market funds are all below the rate of inflation.
Conclusion: You lose money after inflation every year you hold a "safe" investment.

The interest on "safe" long term bonds, e.g. government bonds, are slightly above inflation but below inflation when you include taxes. Unfortunately, these assets are not truly safe. The reason is that interest rates are at record lows. When interest rates rise, as they inevitably will, the value of these bonds will fall.

Things are even worse with common stocks. The thing to remember about common stocks is that a company's stock has value have value only becase the company makes a profit. The more profit a company makes now and in the future the more the company's stock is worth. The second thing to remember is that a company's profits vary widely. They are high when times are good but they fall dramatically when there is a recession. Thus, you have to look at average profits over the business cycle. When you do this the amount you have to pay for each $1 of profit is close to an all time high. The only times it was higher was during the dot com bubble and in 1929. In addition, company profits are unusually high even for this stage of the business cycle. The only time company profits as a percent of the economy were this high was in 1929.
Conclusion: You are paying an inflated price for inflated profits. History says that in these circumstances a fall in stock prices is inevitable. The only question is when and by how much.

The cause of this situation and what it means for the future will be the subject of another post.

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December 19, 2015

401(k) Plans

401(k) are retirement savings plans operated by an employer under section 401(k) of the tax code for the benefits of its employees. Like IRAs, 401(k) come in two types: traditional and Roth. Like IRAs the difference is that contributions to a traditional 401(k) are tax deductable when made but distributions are taxable while contributions to a Roth IRA are taxable when made but distributions are tax free.

A 401(k) plan allows employees to make higher contributions to their 401(k) than they can to an IRA. See below for details. In addition, most companies with 401(k) make additional contributions to each participating employee's 401(k) account based on the amount that the employee contributes. The formula used to determine these employer vary widely from company to company. These contributions can be as high as $1 for each $1 the employee contributes but $0.50 for each $1 is more common. In addition, most companies limit the amount they will contribute to some percentage of the employee's salary. for example 3%.

Note: Many nonprofit organizations offer plans that are similar in nature to 401(k) plans but are organized a different section of the tax code and this have a different name.

401(k) plans have a number of limitations:

  • Your contributions are capped at the lesser of what you earn or $18,000 per year below age 50 and $24,000 at age 50 and above.
  • The combined employer and employee contributions are capped at $53,000.
  • With limited exceptions for education, buying your first home, being disabled, and health care, you can only withdraw money without penalty when you are age 59½ or older.

There is an additional feature of 401(k) plans: You can at any time rollover your 401(k) account into an IRA without penalty. Usually it is not required but many people rollover their 401(k) when they change jobs.

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December 6, 2015

IRAs

IRAs were established by the government to encourage people to save for retirement. Everyone should take advantage of an IRA to the maximum extent that they can. There are two types of IRAs, Traditional IRA and Roth IRA. The differences between a Traditional and Roth IRA are:

  • Contributions to a Traditional IRA are tax free when made. In addition, all earnings on the investments made with the money in the IRA are tax exempt when earned. However, all money withdrawn from a Traditional IRA is taxable income when it is withdrawn. You can only contribute up to age 70½ and you have to start taking distributions at age 70½.
  • Contributions to a Roth IRA are taxable when made. However, all earnings on the investments made with the funds in the IRA are tax exempt when earned. In addition, money withdrawn from a Roth IRA is tax free when it is withdrawn. In addition, you can contribute at any age and are not required to take minimum distributions.

The rules on taxability mean that contributing to a Roth IRA is better when your tax rate during your employment years is the same or lower than when you are retired. However, contributions to a Traditional IRA are better when your tax rate is higher while employed. Thus, I advise people in their 20s and early 30s to contribute to a Roth IRA while most people in their 40s and older should contribute to a traditional IRA.

  • Your contributions are capped at the lesser of what you earn or $5,000 per year below age 50 and $6,500 at age 50 and above.
  • The rules on contributions to an IRA are complicated if you are covered by a pension plan at work. Seek advice if you want to do this. Note that the contributions limits for a 401(k) are higher than for IRAs so if the goal is to maximize your contributions (a very good idea) contribute to your 401(k) first.
  • The ability to make contributions to a Roth IRA is phased out starting at an income of $184,000 of a couple and 119,000 for a single person.
  • With limited exceptions for education, buying your first home, being disabled, and health care, you can only withdraw money without penalty when you are age 59½ or older.

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November 29, 2015

Tax Exempt Bonds: Benefits and Pitfalls

The interest paid on bonds issued by state and local governments are exempt from federal income taxes and are usually exempt from income tax in the state in which they are issued. In addition, bonds issued by authorities created by state and local governments to provide services like water and bridges are also tax exempt.

Things to remember:

  • Like all bonds, tax exempt bonds differ greatly in their quality. Tax exempt bonds can and do go into default so know what you are buying.
  • Right now all interest rates are at historic lows. WHEN, not if, interest rates go up and if you have purchased a long term bond you will be stuck with these low rates for the life time of the bond.
  • While being tax exempt is a BIG plus, it comes at a price. Namely, tax exempt bonds pay less than taxable bonds of equivalent quality. Thus, only if your tax bracket is high enough will tax exempt bonds be beneficial to you.
  • If you are receiving social security the interest on tax exempt bonds can cause your social security benefits be subject to income tax. Contact your tax advisor if you are in this situation.
  • The market for tax exempt bonds is very illiquid. This means that if you buy a tax exempt bond and then decide to sell it the price you receive when you sell will be several percentage points lower than the price you paid. So only buy tax exempt bonds if you intend to hold them until maturity or purchase a tax exempt bond mutual fund. Note, however, that if you purchase a tax exempt mutual fund that you pay a management fee that is a significant fraction of the interest that you receive.
  • Certain tax exempt bonds are classified as "private activity bonds" and the interest on these are tax exempt to most taxpayers but it is taxable if you are subject to the alternative minimum tax.

Further points:

  • Because tax exempt bonds pay a lower rate of interest than taxable bonds you do not want to hold them in tax advanaged accounts like an IRA or 401(k).
  • It is almost always better to max out your contributions to your IRA and 401(k) plan before investing in tax exempt bonds.

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November 7, 2015

The Good and Bad Points About Annuities

An annuity is a promise to pay a fixed amount of money to the recipient for some period of time. The period of time can vary widely. However, the most common use of annuities is in retirement and here the period of time is usually from the time the recipient retirees till their death.

The good thing about an annuity is that it promises to pay you a fixed sum of money every month. For a retiree having a source of income that you can rely on is a good thing.

The bad thing about annuities is that in practice they don't deliver on their promise. The reason is inflation and the fact that you will probably be retired a long time.

  • For a couple retiring at age 65 there is a 50% chance that one of them will live to age 95. This 30 years in retirement presents several serious challenges. One of them is inflation.
  • The Federal government has said that it wants a minimum of 2% inflation. At 2% inflation an annuity, your pension and your savings will lose 46% of their value over a 30 year retirement. At average inflation over the last 100 years both your pension and savings will lose 64% of their value in terms of what they will buy during the course of your retirement.

Thus, over the course of your retirement the income from an annuity will steadily fall in terms of what it will buy. Note that we are not saying that annuities have no place in retirement planning. What we are saying is that if you plan to receive an income from an annuity that your retirement plan must make explicit provision for the fact that this income will fall steadily year after year in terms of what it will purchase.

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October 20, 2015

Using Insurance to Protect Against the Unpredictable

While the future can't be predicted, there are ways to protect yourself from many, but far from all, of life's unexpected and unpredictable events. When it is available insurance is the easiest and usually the most inexpensive way to protect yourself. That is why getting insurance coverage is a recommendation on each of our age specific financial planning pages below.

To summarize the above pages, everyone should have health insurance, if you own a car you need car insurance, if you own a house - homeowners insurance, If you rent - renters insurance, if you are working you need disability insurance and if you have a family - life insurance. If you are at the age where you are into serious retirement planning you should consider long term care insurance -- however, this is a complex subject so you should read our Long Term Care Insurance Options web page first.

Of course not everything can be insured against. For those things you need to not only save but save enough that you have a "Margin of Safety".

NOTE: You may have noticed that annuities are not on the list of recommended insurance products above. We love what annuities promise. Unfortunately, what they deliver is something else. Annuities are the the subject of the blog post above this one.

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Post History

Financial Markets at the Start of 2016

401(k) Plans

IRAs

Tax Exempt Bonds: Benefits and Pitfalls

The Good and Bad Points About Annuities

Using Insurance to Protect Against the Unpredictable