Forum clients are fully invested in their financial future. So, they ask some thoughtful questions.
Even better, Forum advisors have some pretty good answers.
Q. Why shouldn’t I just use index funds?
Jeffrey Doblin, CFA
Q. I read that Illinois has added financial literacy to its state standards. What does that mean?
Michelle Weindruch, CFP®
Q. What is happening with bonds and the recent higher interest rates?
Nirav Batavia, CFA
Q. How important is it for me to have a property power of attorney in place?
Christopher Genzler, CFP®
Q. What practical steps do you outline with investors over age 50 who are worried they haven’t saved enough for retirement?
John Vires, CFA, CFP®
Q. I’m approaching age 62. Since I will soon be eligible to take Social Security benefits, should I go ahead and claim?
Mary Pat Wesche, CPA, PFS, CDFA®, CFP®
Q. I’ve been thinking lately that maybe we should start tracking our net worth. What do you suggest?
Karma Forrestal, CFP®
Q. I feel like some of my money should be invested in stocks with intelligence, not just diversified. Why shouldn’t we do that?
Nirav Batavia, CFA
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One hidden cost of indexing that not many people know about is the reconstitution effect, which is the process of adding or deleting companies from an index. This occurs when index funds are forced to buy the companies that are added to the index or sell the companies that are being removed from the index. So, while an investor might not incur much of a cost considering expense ratios alone (some index funds have expense ratios lower than 0.05%), when you consider trading costs that are incurred by index funds during reconstitution, the overall costs experienced by investors can be higher.
For many people, it is not enough to simply invest in an index fund. Diversified portfolios include allocations to U.S., international, small and large companies, which means that such portfolios can ultimately include the stocks found in some of the most well-known index funds.
Many parents are uncomfortable speaking to their children about financial topics, so school is the natural option to teach these vital skills. Schools are focused on giving this generation of students a head start on subject matter they will encounter in day-to-day life.
Financial literacy emphasizes several themes for elementary school students. These core topics include discovering how money can be saved or spent for various goods and services, analyzing how goods are produced and differentiating between needs and wants.
Lessons are taught as part of the curriculum covering not only the Social Science standards but English and Language Arts as well as Mathematics. Teachers use classic and current literature such as The Giving Tree by Shel Silverstein and Arthur’s Pet Business by Mark Brown. One of the most powerful lessons happens when teachers integrate financial literacy with real-world applications to encourage students to use their skills outside the classroom.
Money and finances should not be a secret. Instead, the goal of financial literacy is to make these subjects a natural topic of conversation at the dinner table when parents ask, “What did you learn at school today?”
For example, younger investors can afford to take more risk because they have many years to make up for the temporary downturns that come with investing in equities. On the other hand, an investor nearing retirement should be thinking about preservation and sustainable retirement income with some money still invested for portfolio longevity and as a hedge against inflation.
Investors who feel they might be missing out on potential gains available to them often think about increasing their equity exposure while investors concerned about losing some of their portfolio’s value want to reduce their equity exposure. A better approach is to stick to a long-term strategy along with disciplined rebalancing.
Forum’s portfolio rebalancing protocol automatically allocates more into equities when they are underrepresented and reallocates when equities are overrepresented. By taking this approach based on risk tolerance, time horizon and stage in life, you are already doing what investors who are trying to time the market are looking to accomplish.
A key secondary observation though is that you want to think about bonds in the context of your larger portfolio. If you believe in diversification, then you believe in capturing the value by selling what goes up and buying what has gotten cheaper (sell high, buy low). The same effect holds in bonds. It’s why you diversify internationally versus domestic in stocks.
Bonds tend to move slightly opposite to stocks, so when stocks are doing well, you want to be able to rebalance and buy bonds cheaper and vice versa. That is one element that drives long-term returns and wealth.
* Source: For the periods January 1983–July 1984; December 1986–April 1989, January 1994–January 1995; May 1999–May 2000; and June 2004–May 2006 (returns are annualized). Intermediate bonds were proxied by IA SBBIT US IT Government. MPI Stylus, July 2015.
If you have investments, a bank account or other accounts in your name alone and you are not mentally or physically capable of making decisions, the person you have chosen to act on your behalf will need a power-of-attorney document to access your accounts. This includes brokerage accounts, IRAs, 401(k) accounts, credit cards and bank accounts.
Without this document in place, numerous problems can occur. For example, lack of access to your IRA account may lead to missed required minimum distributions. If no one has access to your bank account and you become incapacitated, bills may go unpaid or a lack of funds may affect the ability to continue needed health care.
Many people name a spouse, a family member or a trusted friend. Choosing the right person to act for you is sometimes difficult, but making sure you have a property power of attorney in place is vital to a sound wealth management plan.
Because a power of attorney for property is a legal document, it is important to consult an attorney.
Since you may need to access emergency funds at any time, they should be fully liquid and not tied up in products like CDs. Most traditional banks have been offering interest rates starting at 0.01%, but some banks have online savings accounts offering significantly higher rates. Maintain about a month’s worth of expenses in your primary checking account, from which you’ll continue to pay bills. If your primary bank account balance gets too high or too low, you can transfer funds between accounts.
Emergency savings are especially important for people who revolve credit card balances, which is essentially “negative savings.” Having sufficient savings can prevent you from having to revolve credit card debt when some unexpected major expense comes along.
You may not think it’s important to have emergency savings, but life is uncertain, and you need to be prepared for the unexpected. When the unexpected happens, you’ll be glad you have emergency savings!
If this is an unsatisfying figure, then Step 2 involves determining the investors’ free cash flow, which is ultimately their capacity to save. Step 3 is to test for risk tolerance and compare those results to how they are invested right now.
Finally, Step 4 is implementation in three parts: 1) consolidate assets and invest them according to plan, 2) begin saving more, if necessary and 3) revisit the plan at least annually to make sure the retirement target is in sight.
For more on the subject, see John’s recent Q&A on planning challenges and opportunities after age 50.
Since you are almost 62, your full retirement age is between 66 and 67, depending on your year of birth. There are significant increases in benefits every year that you delay between 62 and 70, and such benefits would be positively affected by future inflationary increases the longer you live. There are also claiming strategies for couples in which one spouse would claim around full retirement age and the other spouse would claim at age 70 to maximize benefits for the spouse who is projected to live longer and while still provide some retirement cash flow prior to age 70.
For most people, Social Security benefits represent an asset worth hundreds of thousands of dollars. At Forum, we have tools that can help determine the optimal age at which to file. The bottom line is that first date of eligibility should not be the only factor you take into consideration.
What’s important to know is that spending during these three phases will not be linear. People tend to spend more in the first phase (a second childhood without a high level of responsibility), less in the second phase (a time of quiet reflection), and then increase spending again in the third phase (often because of medical costs).
There is no one set of rules for how a person travels through these phases. It is truly different for everyone, and a lot depends on what they decide to do with their time, where they are living and how much they spend to sustain the lifestyle they have chosen (and don’t forget, who they are living with). We help pre-retirees (as well as retirees) break all this down to determine a safe withdrawal rate based on their personal situation.
Tracking your net worth is a worthwhile step. You can link up all your financial accounts, home values, debts, etc. and track your net worth daily using our online portal system.
Another way to see how net worth is increasing over time is to view it on paper with a simple spreadsheet. Seeing positive changes over time can be very satisfying, so I like to update net worth statements about once a year. Plus, it’s a great reminder that your dedication to savings is paying off right now for the long run.
There is no such thing as intelligence in predicting the markets, but there is intelligence in process. Studies of predictions have shown that predictions are worse than coin flips (the most famous one, by CXO Advisory, shows that experts are right about 47% of the time — it’s not 50% because of behavioral herding). As soon as you study the data and realize that investing is purely statistical (like flipping a coin), you realize how silly it is to try to predict anything in the markets. It’s the equivalent of saying you can predict a dice roll or a coin flip.
Unfortunately, the media tries to paint everything as a story with financial markets and attach reasoning to what is really a random distribution of outcomes. However, as soon as you internalize that predictions are impossible, then you can open up to building intelligent processes that take advantage of whatever happens in the market.
Diversification, rebalancing and taking advantage of additional risk premiums like small, value and profitability all add significantly to your wealth. From what I’ve seen, investors have no trouble allocating to large and growth, but not so much for small and value. Take a look at the difference between Dimensional Small-Cap Value (DFSVX) at 12.22% versus U.S. small-cap stocks (as proxied by the Russell 2000 Index) at 9.25% and the S&P 500 Index at 9.12%.* That’s because small and value add value, and not just from a diversification standpoint.
We can choose to be gamblers and play a negative-expected-value game (just like playing Blackjack) with the possibility we could hit it big. In investing, however, we can also be like the casino. The casino never wins big, but they win the expected-value game and the law of large numbers. We all have a choice as investors, one that we don’t get when we go to Las Vegas.
Here at Forum, we choose to play the expected-value game because it gives us the best chance to maximize your wealth no matter what the market does.
* For the period April 1993 to December 2016, since inception of DFSVX.
Support for caregivers varies by region, by state and by community. A caregiver needs support just as the person with the disability does. Many times, individuals who are caregivers might be caring for a parent and a child with a disability at the same time.
Caregivers need respite from their caregiving role. What’s more, they need to learn to call for help when they need it — sometimes for an evening, sometimes for a weekend, and sometimes for longer. Being a caregiver is a task that can take over one’s life, and as they say, the caregiver must care for himself or herself first in order to be good enough to be a caregiver.
National and local respite services are available as well as many other support groups. One such resource is the National Respite Network and Resource Center.
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