How to Be Positively Skeptical: Part 2

In previous installments of our “How To Be Positively Skeptical” series, we covered the many forces that tease us into falling for misinformation. Bottom line, our brains are hardwired to lead with fight-or-flight instincts ahead of rational resolve. As such, our critical thinking often plays second-fiddle to rash reactions such as fear, excitement, overconfidence, and regret.

 

“All media shares one thing: Someone created it. And it was created for a reason. Understanding that reason is the basis of media literacy.”

Common Sense Media

 

In the financial jungle, it’s essential to look before you leap at emotion-triggering misinformation. Here are five “do’s” and “don’ts” for doing your best fact-finding due diligence.

 

  1. Do be positively skeptical. In the courthouse, a defendant is presumed innocent until proven guilty. When managing information overload, we recommend you default to exactly the opposite: When in doubt, remain in doubt until you’ve done your due diligence.

 

Also watch out for confirmation bias. If you want something to be true, you’ll be more inclined to believe it is. Likewise, if you wish something weren’t so, you’ll assume it probably isn’t.

 

  1. Do question the motives. As suggested above, everything you see, hear, or read is driven by someone’s incentive for sharing it. This helpful Life Kit Comic from National Public Radio describes at least four potential motivations: self-interest, malicious intent, financial gain, and/or genuine altruism. Determining which motivations are most likely at play suggests how readily to accept a claim as the whole truth, and nothing but.

 

Also watch out for familiarity bias. We take mental shortcuts to more quickly trust people who are familiar to us, whether or not our trust is well-placed.

 

  1. Do consider the source. Motivation aside, does the source actually know what they’re talking about? If they’re sharing their own insights, do they have the credentials and/or experience to be accurate and objective about the subject matter? If they’re reporting others’ insights, have they first done their own due diligence? Is their “evidence” fact-based, first-hand, and objectively considered? Or is it opinionated, emotionally charged, and largely circumstantial?

 

Also watch out for blind spot bias. We can more objectively spot others’ behavioral biases than we can recognize our own. This is one reason why even a well-intended individual may be unaware of their own misperceptions.

 

  1. Don’t let repetition replace reality. Believe it or not, simply repeating a lie can make it more believable. Citing a pair of studies from the Journal of Experimental Psychology, this Wall Street Journal columnist reported, “When people hear a false claim repeated even just once, they are more likely to let it override their prior knowledge on the subject and believe it.” This all too real “illusory truth effect” explains how effective marketing campaigns often work. It also explains how we can fall for fast-moving falsities, whether unwittingly or intentionally repeated.

 

Also watch out for hindsight bias. Hindsight bias tricks us into altering our memories to reflect current reality. In other words, once you decide to believe a repeated claim, you may forget you didn’t believe it the first time.

 

  1. Don’t rush. Especially in money management, anything that is important today will still be important tomorrow. Take your time, ask critical questions, and ensure you understand the ramifications before you make any move. The same applies when sharing tantalizing social media posts. If something strikes you as either outrageous or too good to be true, avoid getting caught up in the heat of a moment, lest you accidentally fan the flames of an illusory truth.

 

Also watch out for herd mentality. Herd mentality intensifies our greedy or fearful reactions to breaking news. We are prone to run in whatever direction everyone else is headed.

 

How Do You Do Your Due Diligence?

Of course, nobody can research every claim they come across. There are only so many hours in the day! So, what are some practical steps for efficiently differentiating fact from fiction? We’ll cover that in our next, and final installment in our “How To Be Positively Skeptical” series.

 

There are only so many hours in the day to do all the fact-checking you’d like to when deciding who and what to believe.  How do you approach this never-ending challenge? We suggest conducting your due diligence like a tournament. First, eliminate the weakest contenders, then conduct deeper due diligence on the finalists.

 

Truths and Dares

This does NOT mean you should disregard all opposing viewpoints. As you may recall from our last piece, confirmation bias causes us to favor information that supports our beliefs and ignore that which contradicts them. But what if your beliefs are mistaken? One of our goals is to combat confirmation bias by considering any reasoned argument that:

 

  1. Is well-informed, with an objective perspective and minimal conflicts of interest
  2. Prioritizes judicious decision-making over strident calls to immediate action
  3. Inspires a thoughtful approach to touchy topics, instead of feeding fervent fires

 

In other words, when considering whether a claim is credible, it doesn’t matter whether or not you agree with it. What matters is whether it represents a genuine pursuit of the truth.

 

Be particularly wary when you come across startling information – good or bad – filled with superlatives. As this Wall Street Journal article reports, we are all subject to extremity bias, or “our tendency to share the most extreme version of any story, to keep our listeners rapt.” Thus, even if a provocative claim contains an element of truth, it may be overblown.

 

Once you’ve eliminated the weakest claims, you can fact-check the rest.

 

Start With a Reality Check

Does a claim make you wonder, “Really?” Especially if it’s a relatively extreme position, a good first step is to refer to one or more fact-checking resources, such as Snopes, Vote Smart, or FactCheck.org. While none of these are infallible, you should be able to at least filter out any flagrantly false claims before sharing them with others or acting on them yourself.

 

Just Google It

Next, use your favorite search engine to learn more. Don’t just depend on the most popular hits. Just as you wouldn’t turn to tabloids to tell you whether aliens really exist, you should avoid the tabloids’ virtual equivalents and turn to reputable sources offering educated insights.

 

Examples of more robust sources include academic and similar philanthropic institutions, respected journalists, government publications, quality trade organizations, and subject matter experts with appropriate credentials.

 

As we’ve covered before, be sure to consider the source’s dominant motivations, their depth of experience, and their thoughtful vs. emotional approach. Ideally, identify multiple credible sources to substantiate, strengthen, and/or clarify any given claim.

 

Seek the Source

Merely stating a fact does not make it so! When sharing facts and figures, the author should explain how they came up with them, and/or cite a reputable source. Beware if it’s instead left unclear just where the claim came from.

 

Whenever possible, take the time to verify and confirm the validity of original sources. If the author has not provided the links, an Internet search often uncovers them. By the way, don’t be too daunted to read through academic studies or similar reports. Like any skill, it gets easier over time. Plus, cited information is often found in the study’s abstract, introduction, or conclusion.

 

Academically Speaking

While we’re on the subject of academic research, let’s take a closer look at its use, and potential abuse. At least in theory, academics are motivated by discovering and publishing their most objective findings. As such, their findings are typically the gold standard for evidence-based understanding.

 

That said, even academics are human. They are subject to the same biases and misjudgments as the rest of us. Highest priority should be given to studies that exhibit a disinterested outlook; are based on robust data sets; can be reproduced by others and repeated across multiple environments; and have been published and rigorously peer-reviewed.

 

That last point is important, since an academic’s peers are best positioned to spot any flaws the author(s) may have overlooked. Consider this Scientific American report, describing how a set of psychologists peer-reviewed a series of studies on how social media impacts our youth. While it may be headline-grabbing to publish evidence suggesting smartphones are bad for children, this peer review suggested that misleading data analyses and overstated results needed to be replaced with “a much more nuanced story.”

 

The Advisor’s Essential Role: Separating Fact from Fiction

If we’ve not made it clear by now throughout this series, our own and others’ behavioral biases present among your greatest hurdles in separating fact from fiction.

 

As information consumers, we’re inherently susceptible to falling for fake news (especially when we’re tired, by the way). Our challenge is further aggravated by the droves of information out there that is unwittingly or deliberately false.

 

We hope this series has strengthened your “B.S. detector” as you make your way in the world. At least when it relates to financial planning and investment management, we also consider it among our greatest roles as a financial advisor to help families strengthen their financial literacy, see past their factual blind spots, and separate wealth-building facts from fantasy.

 

Please let us know if we can help you with the same.

 

 

 

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

How to Be Positively Skeptical

Whether you’re considering an investment opportunity or simply browsing various media for insights and entertainment, it has become increasingly obvious: You cannot believe everything you see, hear, or read. Much of it is “overdramatic.” Too much of the rest is just plain wrong.

 

Thus it falls on each of us to be positively skeptical in our search for knowledge.

 

To be positively skeptical, we must continue to think and learn and grow.
But we also must aggressively avoid falling for hoaxes and hype.

 

Social Media: An Aggravating Allure

 

Of course, selling proverbial snake oil and falling for falsities is nothing new. As investors, citizens, and individuals, it will always be our task to remain informed purveyors of the truth. But in today’s climate of information overload, this is no easy task. The very features that make online engagement so popular also make it a powerful forum for sowing deceit and confusion.

 

First, it’s now all too easy to share a claim far and wide, long before it’s been through any sort of reality-check. One or two clicks, and it’s on its way.

 

Second, evidence suggests false online news spreads faster than the truth. In a March 2018 Science report, “The spread of true and false news online,” a team of MIT researchers analyzed approximately 4.5 million tweets from some 3 million people from 2006–2017. They found that “Falsehood diffused significantly farther, faster, deeper, and more broadly than the truth in all categories of information.”

 

The authors also found that “human behavior contributes more to the differential spread of falsity and truth than automated robots do.”

 

In other words, we can’t just blame it all on “the bots.” We owe it to ourselves to be vigilant.

 

A Rigorous, But Rewarding Role

 

The challenge is, few of us actually enjoy engaging in detailed fact-checking. That’s not entirely our fault. It’s likely due to a multitude of mental shortcuts, or “heuristics,” which we have honed over the millennia to make it through our busy days.

 

In their landmark 1974 paper, “Judgment under Uncertainty: Heuristics and Biases,” Nobel laureate Daniel Kahneman and the late Amos Tversky are widely credited for having launched the analysis of human heuristics, including when they are most likely to lead us astray.

 

Essentially, we’re more likely to share and comment on a social media post, than to take the time to substantiate its accuracy. When considering an enticing investment opportunity, we find it easier to skim the marketing materials, than to dig for deeper understanding. Academic research that refutes current assumptions can be dense, and difficult to decipher; if a particular assumption is already widespread, we’re prone to simply accept it as fact.

 

Unfortunately, there are legions of cunning con artists and slick sales staff who know all this, and have weaponized our behavioral biases against us.

 

“[T]he challenge for all investors is to consume the news without being consumed by it.”

Jason Zweig

 

 

The Usual Emotions in Unusual Times

 

As fate would have it, we introduced this series earlier this year, before COVID-19 seized almost every headline around. If anything, current events have made this series even more important. Thoughtful, sober answers to our most pressing questions must now compete against a deluge of emotional misinformation that can be as virulent as the ailment itself.

 

First of all, there’s nothing wrong with having emotions – even strong ones.

 

For example, many of us may be grieving the loss of the “normal” life we used to have just a few months ago. It’s important to acknowledge these feelings. In a recent National Public Radio piece, behavioral counselor Sonya Lott explains how unattended grief can impair “every aspect of our being – physically, cognitively, emotionally spiritually …” and financially, we might add. Lott says, “We can’t heal what we don’t have an awareness of.”

 

In other words, emotions are not only unavoidable, they’re essential. But remember:

 

When you put your feelings in the financial driver’s seat, they will steer you toward what your instincts would prefer, rather than what reason might dictate.

 

Behavioral Finance and Emotional Investing

There is an extensive field of study dedicated to understanding how our instincts and emotions often interfere with our ability to make rational financial decisions. This study is called behavioral finance. Suffice it to say here, every investor faces strong, hardwired temptations to:

 

  • Chase illusory trends
  • Fear the very investment risks that are expected to generate our greatest rewards
  • Regret even our most sensible decisions in the face of minor setbacks
  • Disregard the most durable data
  • Overreact to breaking news and emotion-triggering language

 

On that last point, words alone can create a potent brew of emotions. Guns, abortion, climate change, and immigration probably generate a rise out of you, one way or the other. The same goes for financial catchwords: crashing, soaring, crisis, and opportunity.

 

Strong feelings, while natural, WILL create cognitive blind spots in your reasoning. Add the speed and omnipresence of the Internet, and it becomes even easier to lead with your emotions.

 

“There’s no room for facts when our minds are occupied by fear.”

— Hans Rosling, Factfulness

 

Emotional Marketing for Better and for Worse

 

The power of people’s emotional response is so strong, academics like Wharton School’s Jonah Berger have written books on how marketing teams can appeal to them – for better or worse.

 

In his book “Contagious,” Berger describes six triggers companies can use to amplify their marketing messages, including playing to your emotions. In this podcast, he observes: “Companies recognize, ‘Hey, if we can get people to feel emotional, we’ll get them to talk and share.’ … You need to design content that’s like a Trojan horse. There’s an exterior to it that’s really exciting, remarkable and has social currency or practical value. But inside, you hide the brand or the benefit.”

 

Emotion-triggering communications aren’t inherently wrong or bad. Your favorite causes use them to nudge you into giving more generously. We ourselves use them in messages just like this one, to encourage you to embrace your own best investment interests. You may not realize it, but you probably use them as well, to advance your own heartfelt beliefs.

 

Unfortunately, not every application is as well-intended. Profit-hungry wolves on Wall Street won’t think twice about preying on your hopes and fears. Popular and social media alike are forever awash in fervent calls to action. Identity thieves are the ultimate masters of emotional trickery in their quest to rob you of your wealth.

 

Powering Past Your Emotions

 

So, as an evidence-based investor, how do you navigate past these and many other emotional traps? It can help to have an objective advisor point out your own behavioral blind spots. But you can help yourself as well.

 

Has something you’ve seen, heard, or read left you “stirred up”? Again, we’re not suggesting you should repress every feeling. But the more aggressively an appeal tugs at your emotions – in fear, anger, excitement, or elation – the more important it is to avoid being consumed by it.

 

Especially if it involves your financial well-being, we strongly recommend hitting the pause button before making any next move. Take your emotional “temperature.” Wait for the heat to subside. Most importantly, take some time to conduct extra due diligence before taking the bait.

 

This means it’s as important as ever to sharpen your skeptical lines of defense. Granted, it takes more time to carefully separate fact from fiction. But the upfront due diligence should ultimately save you far more time, money, and personal aggravation than it will ever cost you.

 

Being positively skeptical should richly reward you in the long run.

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

WCU Biltmore Park Class Dates – 10/27 and 10/29

Are you prepared for one of the biggest transitions in your life?

 

Tuesday, October 27 and Thursday, October 29

 

Classes are 4:30-6:00 PM Via Zoom

We hold our current classes on Zoom.  Tuition is $59 per person (or couple).

 

REGISTER THROUGH WCU TODAY!

(Click link above to register for Retirement Planning Today through WCU’s website)

 

Contact Instructors Here

(Click link above to contact instructors with any questions)

 

Tuesday, October 27 & Thursday, October 29, 2020
4:30-6 pm
Live, online instruction via Zoom
Registration fee: $59

REGISTER ONLINE

Night 1: Social Security Planning: What We Know and What We Don’t Know

Tuesday, October 27   4:30 – 6:00 pm

Social Security retirement benefits represent over half of the household income for a majority of retirees today.   Despite the dependence most people have on this critical source of income, there are pressures threatening the future of Social Security.  As of 2018, Social Security is projected have sufficient resources to pay 100% of scheduled benefits until 2034. Beyond that point in time, payroll tax revenues alone, will only be sufficient to cover only about 79% of scheduled benefits initially, and the percentage will decline to 74% by 2092 (based on the current formula).

This widely popular program faces an uncertain future. In 1950, as the baby boom was just beginning, there were 16.5 active workers for each Social Security beneficiary. Currently, there are 2.8 workers per retiree. And it’s projected that by 2035, the ratio will fall to 2.2 workers for each beneficiary. Meanwhile, the number of Americans collecting Social Security benefits is expected to grow from about 62 million today to 88 million by 2035.

It is highly likely that Social Security will undergo some major changes in the coming years, but do we know what these changes will be?

This course will walk through the knowns of Social Security Planning today, and address the critical questions around the future of Social Security when planning for your future.  We will cover:

  • History of Social Security, and this historical legacy impacts the strength of the program today
  • Delayed retirement credits
  • Early filing and Retirement Earnings Test
  • Windfall Elimination Provision
  • Spousal benefits and Divorced Spouse Benefits
  • Survivor Benefits
  • Medicare Benefits
  • Taxation of Social Security
  • Restricted Applications
  • And more

Night 2: After the Last Paycheck: Retirement Income Strategies

Thursday,  October 29, 4:30 – 6:30 PM  

What happens when you retire?  Among many things, there is one common experience: Your financial focus takes a dramatic shift. 

For most Americans, this shift means that instead of striving to accumulate assets, you’ll need to figure out how to withdraw assets in an efficient way for income.  What if you encounter turbulent markets soon after retirement?

The guidelines for managing money are different from what they were when you were working.  This discussion will walk through the 3 core steps in developing an income strategy during retirement.

 We will cover:

  1. Pension
  2. Employment earnings
  3. Personal savings and investments

  1. Investment Fundamentals
  2. Modern Portfolio Theory

  1. The 4% Rule 
  2. Endowment Method
  3. Life-Expectancy Method
  4. Three Tiered Strategy

The choices you make when you retire will play a significant role in how you spend your retirement years. Understanding how your strategy works, can lead to a greater sense of confidence and control over your decision making as you transition into a new chapter of your financial life.

For more information call 828-227-7397 or email jcthompson@wcu.edu

Instructors: Joel Kelley, CFP® and Jacob Sadler, CFP®

Getting Real with Retirement Planning: Understanding Sequence Risk

Clearly, there is a lot to think about when planning for retirement. While we have a degree of control over many of the choices involved, there’s one big wild card called sequence risk.

 

Sequence risk is the risk that you’ll encounter negative investment returns in early retirement. This is an important consideration, because the random sequence – or order – in which you earn your returns early in retirement can have a significant impact on your lasting wealth. Simply put, a retirement portfolio that happens to experience positive returns early in retirement will outlast an identical portfolio that must endure negative returns early in retirement … even if their long-term rates of return end up the same.

 

Since nobody can predict which return sequence they’ll experience early in their retirement, every family should prepare for a range of possibilities in their realistic retirement planning.

 

The Significance of Sequence Risk

It’s no secret that global stock markets are volatile. While long-term average annual returns may be in the range of 7%, markets rarely deliver this exact average any given year. Soaring one year, plummeting the next; we never know for sure how far above or below average each year will be.

 

During your career, you’re mostly spending earned income, while adding to your retirement reserves as aggressively as your plans call for. As long as you stay the course – benefiting from the upswings and enduring the downturns – tolerating market volatility is just part of the plan.

 

In fact, when you’re still accumulating wealth, market downturns give you the opportunity to buy more shares than you otherwise could when prices are higher. When the market recovers, you then have more shares to recover with, which ultimately strengthens your portfolio.

 

But then, you stop working, and start spending your reserves. This has an opposite effect. Now, when stock markets decline, you may need to sell shares at low prices, which means you’ll have to sell more of them to withdraw the same amount of cash. Even though the market is expected to eventually recover and continue upward, your portfolio will have fewer shares with which to participate in the recovery. This hurts your portfolio’s staying power. It won’t be able to bounce back as readily as when you were adding shares to it, or at least not taking them away.

 

Sequence Risk Illustrated

Consider two hypothetical retirees, Joan and Jane:

  • Both retire at age 65 with identical $1 million dollar stock portfolios.
  • Both start withdrawing $50,000 annually at the start of each year (not adjusted for inflation).
  • Both earn the same 7% average annual returns over their 25 years in retirement.

 

With so much in common, you might assume their portfolios would perform similarly. But what if Joan happens to enter into retirement during a horrible market? Let’s imagine her portfolio returns –30% and –20% in her first two years, while Jane earns 7% both years, and (implausibly) every year thereafter.

 

Markets recover nicely for Joan after two years so, again, she ultimately earns the same average 7% annual return as Jane. But sequence risk takes a heavy toll on Joan’s remaining shares. She ends up with only about $150,000, while Jane’s portfolio grows nicely to around $2 million.

 

Retirement Planning Asheville

For illustrative purposes only.

 

If we take the same two portfolios and same two sequences of returns – but eliminate the $50,000 annual withdrawals –Joan and Jane would both end up with about $5.4 million after 25 years. This illustrates why sequence of returns is usually not nearly as significant when you’re still accumulating wealth, but can matter quite a bit in the early years of depleting your portfolio.

 

retirement planning Asheville

For illustrative purposes only.

 

Managing the Sequence Risk Wild Card

Sequence risk should NOT change your overall approach to investing. As 2020 has clearly shown us, you never know what’s going to happen next. Crashes usually occur without warning, while some of the strongest rebounds arrive amidst the darkest days.

 

So, whether you’re 20, 40, 60, or 102, we still recommend building and maintaining a low-cost, globally diversified portfolio that reflects your personal goals and risk tolerances. We still advise against trying to pick individual stocks or react to current market conditions. We still suggest you only change your portfolio’s asset allocations if your personal goals have changed – never in raw reaction to changeable market moods.

 

What can you do to mitigate sequence risk if it happens to you?

 

Keep working. If you are willing and able, you might postpone retirement, or even return to the workforce. Even part-time employment can help offset an ill-timed sequence of negative market returns. If your circumstances allow, you may be able to not only avoid spending retirement reserves during down markets, but even add more in (buying at bargain prices).

 

Spend less. Were you planning for higher investment returns than reality has delivered? Since your portfolio is most vulnerable to negative sequence risks early in retirement, you may want to initially spend less than planned, to give your portfolio the fuel it needs to replenish itself.

 

Tap other assets. When you retire, you typically have several sources of income to draw from. You may have traditional investment accounts, retirement accounts, Social Security, or pension plans. Your investments are usually divided between stocks and bonds. You may have equity in your home. You may have, or be in a position to create an annuity. You may have cash reserves. If you encounter stock market sequence risk early in retirement, you might be able to tap a combination of your non-stock assets for initial spending needs. This can mitigate the hit your portfolio will otherwise have to take if you must liquidate shares of stock.

 

Consult with a financial advisor. Sequence risk is usually not the only consideration at play in retirement planning. There are taxes to consider. Estate plans to bear in mind. Carefully structured investment portfolios to maintain. Logistics to learn. All this speaks to the value an experienced advisor can add before, during, and after this pivotal time in your financial journey.

 

At Woodstone Financial we help our clients prepare for and mitigate sequence risk within the greater context of their goals for funding, managing, spending, and bequeathing their lifetime wealth. Please be in touch today if we can help you with the same.

 

 

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Lump-Sum Investing vs. Dollar-Cost Averaging

Some investors favor a dollar-cost averaging (DCA) approach to deploying their
investment capital. Unlike lump-sum investing, in which the full amount of available
capital is invested up front, DCA spreads out investment contributions using installments
over time. The appeal of DCA is the perception that it helps investors “diversify” the cost
of entry into the market, buying shares at prices that fall somewhere between the highs
and lows of a fuctuating market. So what are the implications of DCA for investors
aiming to generate long-term wealth?

 

ENTRY LEVEL

Let’s take the hypothetical example of an investor with $12,000 in cash earmarked for
investment in stocks. Instead of buying $12,000 in stocks today, an investor going the
DCA route buys $1,000 worth of stocks each month for the next 12 months. If the market
increases in value each month during this period, the DCA investor will pay a higher price
on average than if investing all up front. If the market decreases steadily over the next 12
months, the opposite will be true.

While investors may focus on the prices paid for these installments, it’s important to
remember that, unlike with the lump-sum approach, a meaningful portion of the
investor’s capital is remaining in cash rather than gaining exposure to the stock market.
During the process of capital deployment in this hypothetical example, half of the
investable assets on average are forfeiting the higher expected returns of the stock
market. For investors with the goal of accumulating wealth, this is potentially a big
opportunity cost.

Despite the drawbacks of dollar-cost averaging, some may be hesitant to plunk down all
their investable money at once. If markets have recently hit all-time highs, investors may
wonder whether they have already missed the best returns and so ought to wait for a
pullback before getting into the market. Conversely, if stocks have just fallen and news
reports suggest more declines could be on the way, some investors might take that as a
signal waiting to buy is the wiser course. Driving the similar reactions to these very
different scenarios is one fear: what if I make an investment today and the price goes
down tomorrow?

 

Financial Advisor Asheville Woodstone

 

Exhibit 1 puts those fears in a broader context. It shows the average annualized
compound returns of the S&P 500 from 1926–2019. After the index has hit all-time highs,
the subsequent one-, three-, and fve-year returns are positive, on average. After the S&P
500 has fallen more than 10%, the subsequent one-, three-, and fve-year returns are also
positive, on average. Both data sets show returns that outperform those of one-month
Treasury bills. Overall, the data do not support that recent market performance should
infuence the timing of investing in stocks.

 

DIFFERENT STROKES

Both theory and data suggest that lump-sum investing is the more effcient approach to
building wealth over time. But dollar-cost averaging may be a reasonable strategy for
investors who might otherwise decide to stay out of the market altogether due to fears
of a large downturn after investing a lump sum.
The stock market has offered a high average return historically, and it can be an
important ally in helping investors reach their goals. Getting capital into stocks, whether
gradually or all at once, puts the holder in position to reap the potential benefts. A
trusted fnancial advisor can help investors decide which approach—lump-sum investing
or dollar-cost averaging—is better for them. What’s clear is that markets have rewarded
investors over time. Whichever method one pursues, the goal is the same: developing a
plan and sticking with it.

 

 

 

 

 

 

 

 

The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information
only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide
a suffcient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform
themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this
document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
“Dimensional” refers to the Dimensional separate but affliated entities generally, rather than to one particular entity. These entities are
Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund
Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong
Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and
does not provide asset management services.

UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

What Is Fiduciary Advice, and Why Does It Matter (Now More Than Ever)?

How do you know when an investment recommendation is worth heeding?

 

Red tape and legal jargon aside, it’s about finding an advisor who exemplifies a few simple ideals:

 

“There’s no confusion in the minds of investors as to what they want. They’re very clear. They want somebody they trust who makes recommendations that put their interest first and don’t allow the advisor to profit financially at their expense.”

Phyllis Borzi, Dept. of Labor EBSA head, 2009–2017

 

That makes sense, doesn’t it? There’s even a term the investment world has been using since at least the 1940s to describe this highest standard. It’s called fiduciary advice.

 

Why Fiduciary Advice (Still) Matters

Fiduciary advice makes sense to us too. Investors deserve nothing less than the fairest possible shake from anyone entrusted with advising them about their personal wealth. For decades, the fiduciary standard has shaped this highest level of care for those of us committed to delivering it.

 

Having a fiduciary duty to our clients puts us on similar footing with other professional consultants, such as physicians or attorneys. You hire us partly because we have dedicated our career to understanding every facet of your wealth. But you also hire us to always use our knowledge to advise you according to your highest financial interests – even ahead of our own.

 

However, to our frustration, it has probably become harder instead of easier for you to know when you are receiving this level of care … and just as significantly, when you are not. As Borzi adds, “everybody claims to be a trusted advisor when some are really only salespeople.”

 

Unfortunately, the fiduciary standard has been under attack lately. A recent Securities and Exchange Commission (SEC) overhaul has downplayed rather than strengthened its significance by overlaying it with a new industry standard, paradoxically called “Regulation Best Interest.”

 

Regulation Best Interest: One Size Fits None?

You may not have marked the day, but June 30th, 2020 was a big one for financial practitioners across the country. It was the day the SEC’s Regulation Best Interest (Reg BI) took effect.

 

Reg BI does not require you as an investor to do anything. It’s aimed at those of us offering you investment advice or recommendations. Here is an SEC excerpt:

 

“[Reg BI is] designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers, bringing the legal requirements and mandated disclosures in line with reasonable investor expectations, while preserving access (in terms of choice and cost) to a variety of investment services and products.”

 

At face value, this seems reasonable, if vague. Here’s more from the SEC (emphasis ours):

 

“Individually and collectively, these actions are designed to enhance and clarify the standards of conduct applicable to broker-dealers and investment advisers, help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances, and foster greater consistency in the level of protections provided by each regime, particularly at the point in time that a recommendation is made.”

 

Still not crystal clear? In English, the intent is to ensure you (the “retail investor”) have enough information to decide whether a professional investment recommendation is best suited to your needs, essentially no matter who is offering it.

 

That still seems logical enough. But let’s take a closer look at how investment advice “best suited” for you in theory may translate in practice.

 

“Apple and Orange” Advisory Differences

In our mind, new regulations should either eliminate, or at least make it easier for investors like you to recognize two very different practices that still exist side by side in the financial industry:

 

  • “Full-time” fiduciary advisors offer a fiduciary level of care throughout their relationship with you. |
  • “Best interest” recommendations can be one-off pieces of advice you may receive during point-in-time transactions.

 

Despite its promising name, Reg BI may muddy what clarity had existed between these higher and lesser standards of care. By attempting to apply the same broad rules to both, Reg BI has the potential to discount the still-stark differences between them:

 

A Reg BI Checklist for Fiduciary vs. Broker-Dealer Investment Recommendations

  Ideal Full-Time Fiduciary Advice Typical Broker-Dealer Investment Advice
Relationship Your advisor’s sole, continuous duty is to advance your highest financial interests (even ahead of their own). A broker, banker or insurance rep offers other core services, along with point-of-sale investment recommendations.
Primary Role Your advisor deeply understands and accounts for the details of your total wealth interests, and advises you accordingly, always in a fiduciary capacity. A broker’s primary role is to transact trades; a banker custodies accounts; an insurance rep sells insurance. Incidental investment advice is secondary to these roles. Not all transactions are subject to fiduciary duty.
Employment Status As a fully independent Registered Investment Advisor (RIA) firm, your advisor’s only “boss” should be investor clients like you. Employed by a bank, brokerage house or insurance agent, a broker-dealer’s, banker’s, or agent’s “boss” is their employer.
Compensation Your advisor’s compensation should preferably be fee-only, so their only financial incentives come from investor clients like you. Commissioned or fee-based intermediaries earn part or all of their keep from their employer or through other (often opaque) sales incentives.
Investment Plan First, it’s essential to have a plan. It should be grounded in evidence over emotion, structured to manage all your investments in unity, and tailored to patiently capture expected returns according to your personal goals and risk tolerance. Investment recommendations are more typically offered as a point-of-sale, add-on service. They are unlikely to be guided by your big-picture plans; coordinated with the rest of your assets; or personalized to advance your total wealth interests.
Conflicts of Interest Ideally, your advisor has minimized any conflicts of interest by embracing all of the above best practices – not only because it’s required, but because it’s the right thing to do. New regulations aimed at minimizing and disclosing conflicts of interest may have been tacked onto, rather than integrated into the company’s core role and mission.

Our Take on Reg BI: Less Isn’t Always More

How could one set of regulatory rules apply equally to both lesser and higher standards of care?

 

In theory: Both groups should minimize their conflicts of interest, and disclose any inherent conflicts they cannot eliminate.

 

In reality: When is the last time you read a financial disclosure, and understood what it meant or asked probing questions until you did? For most of us, it’s been a while. As such, legal disclosures alone may fail to protect investors from falling for sales pitches in disguise.

 

In practicality, this means:

 

  • Continued double standards: Suffice it to say, Reg BI leaves some large legal loopholes to be leveraged by those who wish to continue offering incidental investment advice.
  • Business as usual: “Best interest” recommendations may still end up tainted by unnecessary conflicts of interest (such as compensation models that don’t actually align with investors’ best interests) and/or an incomplete understanding of your greater financial goals.
  • More due diligence: You, the investor, must still sort out which side of the table an investment recommendation is coming from. Worse, the well-established terminology that used to help you distinguish fully fiduciary from merely suitable advice has been subsumed under the fuzzier, untested language of Reg BI.

 

What Comes Next?

To say the least, we are underwhelmed by Reg BI – and we are not alone.

 

Jane Bryant Quinn, a veteran financial journalist, described the new landscape as follows:

 

“[Reg BI] creates fake fiduciaries. It’s a disaster for investors because now a salesperson can basically say, ‘I have your best interest at heart — I put your interest ahead of mine.’ They’re allowed to use exactly the same language that fiduciaries use but without actually being fiduciaries.”

 

Here is additional commentary from Borzi:

 

“Ironically, the final [Reg BI] product that emerged from the SEC not only did not address this endemic problem of conflicted compensation, but also exacerbated investor confusion by allowing brokers to market themselves as working in their clients’ best interest without actually holding them to a clear, fiduciary best-interest standard or ending the harmful incentives that conflict with that standard.”

 

Here is one more take from “Nerd’s Eye View” financial thought leader Michael Kitces:

 

“[I]n issuing the new Regulation Best Interest rules, the SEC declined to equalize the standard of care for broker-dealer-delivered versus RIA-delivered advice as mandated by Dodd-Frank, and instead expanded the broker-dealer exemption that would allow broker-dealers to even more easily provide comprehensive financial planning advice without being subject to a fiduciary standard for that advice … which creates, literally, a double-standard for the delivery of financial planning advice.”

 

Fortunately, this tale of fiduciary peril is not yet over. We, Kitces, Borzi, and many others like us continue to press for legal, political, and industry reforms to cut through the confusion.

 

We hope to update this important piece over time with improved news. Until then, we encourage you to use the table above as a handy checklist for determining when an investment recommendation is most likely to truly be in your highest financial interest … and when it is not.

 

What additional questions can we address for you at this time?  Please let us know.

 

 

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Market Returns and Election Years

It’s almost Election Day in the US once again. While the outcomes of the elections are uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the months to come. In financial circles, this will almost assuredly include any potential for perceived impact on markets. But should long-term investors focus on elections?

 

Market Returns and Election Years Infographic

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Markets Work

We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult.1 While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors.

The 2016 presidential election serves as a recent example of this. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected.2 The day following President Trump’s win, however, the S&P 500 Index closed 1.1% higher. So even if an investor would have correctly predicted the election outcome (which was not apparent in pre-election polling), there is no guarantee that they would have predicted the correct directional move, especially given the narrative at the time.

But what about congressional elections? For the upcoming midterms, market strategists and news outlets are still likely to offer opinions on who will win and what impact it will have on markets. However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.

Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–December 2019 Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a presidential election was held, with red meaning Republicans won and blue representing the same for Democrats.

EXHIBIT 1

Presidential Elections and S&P 500 Index Returns, Histogram of Monthly Returns

In It for the Long Haul

While it can be easy to get distracted by month-to-month or even one-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time. Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart lays out party control of presidency over time. And again, both parties have periods of significant growth and significant declines during their time of majority rule. However, there does not appear to be a pattern of stronger returns when any specific party is in control, or when there is mixed control for that matter. Markets have historically continued to provide returns over the long run irrespective of (and perhaps for those who are tired of hearing political ads, even in spite of) which party is in power at any given time.

EXHIBIT 2

Hypothetical Growth of $1 Invested in the S&P 500 Index and Presidential terms

Presidential terms and markets

Equity markets can help investors grow their assets, and we believe investing is a long-term endeavor. Trying to make investment decisions based on the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns.

 

 

 

 

 

 

Market Returns During Election Years

These unbranded slides take a historical look at how major US, international developed, and emerging markets indices have performed during or after a US presidential election.

FOOTNOTES

  1. 1This is known as the efficient market theory, which postulates that market prices reflect the knowledge and expectations of all investors and that any new development is instantaneously priced into a security.

  2. 2Examples include: “A Trump win would sink stocks. What about Clinton?” CNN Money, 10/4/16, “What do financial markets think of the 2016 election?” Brookings Institution, 10/21/16, “What Happens to the Markets if Donald Trump Wins?” New York Times, 10/31/16.

DISCLOSURES

In USD. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.

All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

ABCs of Behavioral Bias: O-Z

The last set of behavioral biases in our series!

 

Overconfidence

 

What is it? No sooner do we recover from one debilitating bias, our brain can whipsaw us in an equally damaging but opposite direction. For example, we’ve already seen how fear on the one hand and greed on the other can knock investors off course either way. Similarly, overconfidence is the flip side of loss aversion. Once we’ve got something, we are averse to losing it, so we will overvalue it compared to its going rate. But when we are pursuing fame or fortune, or even going about our daily lives, we tend to be overconfident about our odds of success.

 

When is it helpful? In “Your Money & Your Brain,” Jason Zweig cites several sources that describe overconfidence in action and why it’s the norm rather than the exception in our lives. “How else could we ever get up the nerve to ask somebody out on a date, go on a job interview, or compete in a sport?” asks Zweig, and adds: “There is only one major group whose members do not consistently believe they are above average: people who are clinically depressed.”

 

When is it harmful? While overconfidence can be beneficial, it becomes dangerous when you’re investing. Interacting with a host of other biases (such as greed, confirmation bias, and familiarity bias) overconfidence puffs up our belief that we can consistently beat the market by being smarter or luckier than average. In reality, when it’s you, betting against the trillions and trillions of other dollars at play in our global markets, it’s best to be brutally realistic about how to patiently participate in the market’s expected returns, instead of trying to go for broke – potentially literally.

 

Pattern Recognition

 

What is it? Is that a zebra, a cheetah, or a light breeze moving through the grass? Since prehistoric times when our ancestors depended on getting the right answer, right away, evolution has been conditioning our brains to find and interpret patterns – or else. That’s why, our pattern-seeking impulses tend to treat even random events (like 10 coin flips, all heads) as if they’re orderly outcomes suggesting a predictive pattern. “Just as nature abhors a vacuum, people hate randomness,” says Zweig, as a result of our brain’s dopamine-induced “prediction addiction.”

 

When is it helpful? When we stop at red lights and go on green, we’re making excellent use of pattern recognition. Is your spouse or partner giving you “that look”? You know just what it means before they’ve said a single word. And whether you enjoy a good jigsaw puzzle, Sudoku, or Rubik’s Cube, you’re giving your pattern recognition skills a healthy workout.

 

When is it harmful? Speaking of seeing red, Zweig published a fascinating piece on how simply presenting financial numbers in red instead of black can make investors more fearful and risk-averse. That’s a powerful illustration of how pattern recognition can influence us – even if the so-called pattern (red = danger) is a red herring. Is any given stream of breaking financial news a predictive pattern worth pursuing, or is it a deceptive mirage? Given how hard it is to tell the difference until hindsight reveals the truth, investors are best off ignoring the market’s many glittering distractions and focusing instead on their long-term goals.

 

Recency

 

What is it? Recency causes you to pay more attention to your most recent experiences, and to downplay the significance of long-term conditions. For example, in “Nudge,” Nobel laureate Richard Thaler and co-author Cass Sunstein observe: “If floods have not occurred in the immediate past, people who live on floodplains are far less likely to purchase insurance.” That’s recency, tricking people into ascribing more importance to the lack of recent flooding than to the bigger context of being located on a flood plain.

 

When is it helpful? In “Stumbling on Happiness,” Daniel Gilbert describes how we humans employ recency to accurately interpret otherwise ambiguous situations. Say, for example, someone says to you, “Don’t run into the bank!” Whether you’re currently floating down a river or approaching a financial institution helps you quickly decide whether to paddle harder in the stream, or walk more slowly through the financial institution’s door.

 

When is it harmful? Buying high and selling low is exactly the opposite of investors’ actual aspirations. And yet, no matter how many times our capital markets have moved through their bear-and-bull cycles, recency causes droves of investors to stumble every time. By reacting to the most recent jolts instead of remaining positioned as planned for long-term expected growth, they end up piling into high-priced hot holdings and locking in losses by selling low during the downturns. They allow recency to get the better of them, and their most rational, evidence-based investment decisions.

 

Sunk Cost Fallacy

 

What is it? Sunk cost fallacy makes it harder for us to lose something when we also face losing the time, energy or money we’ve already put into it. In “Why Smart People Make Big Money Mistakes,” Gary Belsky and Thomas Gilovich describe: “[Sunk cost fallacy] is the primary reason most people would choose to risk traveling in a dangerous snowstorm if they had paid for a ticket to an important game or concert, while passing on the trip if they had been given the ticket for free.” You’re missing or attending the same event either way. But if a sunk cost is involved, it somehow makes it more difficult to let go, even if you would be better off without it.

 

When is it helpful? When a person, project, or possession is truly worth it to you, sunk costs – the blood, sweat, tears, and/or legal tender you’ve already poured into them – can help you take a deep breath and soldier on. Otherwise, let’s face it. There might be those days when you’d be tempted to help your kids pack their “run away from home” bags yourself.

 

When is it harmful? Falling for financial sunk cost fallacy is so common, there’s even a cliché for it: throwing good money after bad. There’s little harm done if the toss is a small one, such as attending a prepaid event you’d rather have skipped. But in investing, adopting a sunk cost mentality can prevent you from unloading an existing holding once it no longer belongs in your portfolio. For better or worse, you cannot go back in time and alter what you’ve already done with your investments. But you can (and should) keep your portfolio optimized for capturing future expected returns according to your own goals and the best evidence available to us today.

 

Tracking Error Regret

 

What is it? If you’ve ever decided the grass is greener on the other side, you’ve experienced tracking error regret – that gnawing envy you feel when you compare yourself to external standards, and wish you were more like them.

 

When is it helpful? If you’re comparing yourself to a meaningful benchmark, tracking error-regret can be a positive force, spurring you to try harder. Say, for example, you’re a professional athlete and you’ve been repeatedly losing to your peers. You may be prompted to embrace a new fitness regimen, rethink your equipment, or otherwise strive to improve your game.

 

When is it harmful? If you’ve structured your investment portfolio to reflect your goals and risk tolerances, it’s important to remember that your near-term results may frequently march out of tune with “typical” returns … by design. It can be deeply damaging to your long-range plans if you compare your own performance to irrelevant, apples-to-oranges benchmarks such as the general market, the latest popular trends, or your neighbor’s seemingly greener financial grass. Stop playing the shoulda, woulda, coulda game. Stop chasing past returns you wish you had received based on random outperformance others (whose goals differ from yours) may have enjoyed. You’re better off tending to your own fertile possibilities, guided by personalized planning, evidence-based investing, and accurate benchmark comparisons.

 

We’ve now reached the end of our alphabetic overview of the behavioral biases that most frequently lead investors astray.  If any of these stand out to you in your financial life, be in touch!

 

 

 

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Financial Well-Being In The Time of Coronavirus

For better or worse, many of us have had more time than usual to engage in new or different pursuits in 2020. Even if you’re as busy as ever, you may well be revisiting routines you have long taken for granted. Let’s cover eight of the most and least effective ways to spend your time shoring up your financial well-being in the time of the coronavirus.

 

  1.  A Best Practice: Stay the Course

Your best investment habits remain the same ones we’ve been advising all along. Build a low-cost, globally diversified investment portfolio with the money you’ve got earmarked for future spending. Structure it to represent your best shot at achieving your financial goals by maintaining an appropriate balance between risks and expected returns. Stick with it, in good times and bad.

 

  1.  A Top Time-Waster: Market-Timing and Stock-Picking

Why have stock markets been ratcheting upward during socioeconomic turmoil? Market theory provides several rational explanations. Mostly, market prices continuously reset according to “What’s next?” expectations, while the economy is all about “What’s now?” realities. If you’re trying to keep up with the market’s manic moves … stop doing that. You’re wasting your time.

 

  1.  A Best Practice: Revisit Your Rainy-Day Fund

How is your rainy-day fund doing? Right now, you may be realizing how helpful it’s been to have one, and/or how unnerving it is to not have enough. Use this top-of-mind time to establish a disciplined process for replenishing or adding to your rainy-day fund. Set up an “auto-payment” to yourself, such as a monthly direct deposit from your paycheck into your cash reserves.

 

  1.  A Top Time-Waster: Stretching for Yield

Instead of focusing on establishing adequate cash reserves, some investors try to shift their “safety net” positions to holdings that promise higher yields for similar levels of risk. Unfortunately, this strategy ignores the overwhelming evidence that risk and expected return are closely related. Stretching for extra yield out of your stable holdings inevitably renders them riskier than intended for their role. As personal finance columnist Jason Zweig observes in a recent exposé about one such yield-stretching fund, “Whenever you hear an investment pitch that talks up returns and downplays risks, just say no.”

 

  1.  A Best Practice: Evidence-Based Portfolio Management

When it comes to investing, we suggest reserving your energy for harnessing the evidence-based strategies most likely to deliver the returns you seek, while minimizing the risks involved. This includes: Creating a mix of stock and bond asset classes that makes sense for you; periodically rebalancing your prescribed mix (or “asset allocation”) to keep it on target; and/or adjusting your allocations if your personal goals have changed. It also includes structuring your portfolio for tax efficiency, and identifying ideal holdings for achieving all of the above.

 

  1.  A Top Time-Waster: Playing the Market

Some individuals have instead been pursuing “get rich quick” schemes with active bets and speculative ventures. The Wall Street Journal has reported on young, do-it-yourself investors exhibiting increased interest in opportunistic day-trading, and alternatives such as stock options and volatility markets. Evidence suggests you’re better off patiently participating in efficient markets as described above, rather than trying to “beat” them through risky, concentrated bets. Over time, playing the market is expected to be a losing strategy for the core of your wealth.

 

  1.  A Best Practice: Plenty of Personalized Financial Planning

There is never a bad time to tend to your personal wealth, but it can be especially important – and comforting – when life has thrown you for a loop. Focus on strengthening your own financial well-being rather than fixating on the greater uncontrollable world around us. To name a few possibilities, we’ve continued to proactively assist clients this year with their portfolio management, retirement planning, tax-planning, stock options, business successions, estate plans and beneficiary designations, insurance coverage, college savings plans, and more.

 

  1.  A Top Time-Waster: Fleeing the Market

On the flip side of younger investors “playing” the market, retirees may be tempted to abandon it altogether. This move carries its own risks. If you’ve planned to augment your retirement income with inflation-busting market returns, the best way to expect to earn them is to stick to your plan. What about getting out until the coast seems clear? Unfortunately, many of the market’s best returns come when we’re least expecting them. This year’s strong rallies amidst gloomy economic news illustrates the point well. Plus, selling stock positions early in retirement adds an extra sequence risk drag on your future expected returns.

Could you use even more insights on how to effectively invest any extra time you may have these days? Please reach out to us any time. We’d be delighted to suggest additional best financial practices tailored to your particular circumstances.

 

Read More: Coronavirus Financial Perspective, Action Steps, and Resources

 

Coronavirus: Financial Perspective, Action Steps, and Resources

Evidence in the Face of Uncertainty

We continue to watch with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.

It is a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.

Market declines can occur when investors are forced to reassess expectations for the future. The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.

We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.

Another way some investors might react to a falling market is jumping ship and selling out of stocks. The intuition may be that sitting out of the market for a period of time can help avoid further losses. However, the weight of evidence and data suggest this type of market timing may instead actually reduce investors’ gains over time.

Financial downturns are unpleasant for all market participants. Investors can reduce exacerbating the experience by adhering to core principles. Two such principles supported by a long history of research are broad diversification and maintaining a consistent asset allocation. Investors who deviate from these principles by pursuing stock picking or market timing may undermine their ability to achieve their investment goals.

Action Steps That May Be Appropriate

 

What can we do while we hunker down at home, and wait for better days. As always, our specific advice and actions will vary, depending on circumstance and needs. Here are a few other areas of interest we’re keeping an eye on:

  • Tax planning and money management: Helping optimize new tax breaks, loans, grants, unemployment benefits, and similar relief measures for individuals and businesses

 

  • Financial life planning (pre-retirement, retirement, and everywhere in between): Deliberately assessing the impact of the current market on the overall financial plan. to the opportunities and challenges specific to your near- and long-term interests and concerns. What opportunities and challenges are now presented with the current market.
    • For younger investors (or any investor with a decades long timeframe), current market conditions can actually benefit you greatly. You can buy equities now while prices are low (or at the very least not abandon the ones you already hold), and watch their expected growth compound over time. Especially if you can do this in a tax-sheltered account like a 401(k), traditional IRA, or Roth IRA, you can build even more long-term wealth, even more dramatically.
    • If you are in or near retirement, with a significant (but appropriate) need for portfolio income, the truth is, the current market is not ideal for you. You might face what are known as sequence of return risks if you must sell depressed stock holdings to fund your current spending needs. Essentially, selling stocks at a loss early in retirement inflicts a double-whammy on your portfolio’s future growth potential. Detailed withdrawal strategies for managing sequence risk is beyond the scope of this piece. But best practices do exist. This is one critical reason we are glad to be here as your advisor, to help you weigh the challenges and possibilities ahead of you, and proceed in an informed manner.
  • Investment management:
    • Rebalancing, and maintaining structure in portfolio target allocations – a systematic, objective, and consistent way to buy low and sell high
    • Creating beneficial tax-losses, and making other prudent moves to best position your portfolio for future expected growth
  • Bringing to light the long-term perspective: Looking at the evidence, data, and reality of the crisis, and putting this into a long-term perspective. Avoiding fixating on daily returns or reacting rashly to scary market news
    • We need remain informed about the evolving financial landscape – especially about changes that might directly impact life plans. The structure of the plans and investments should always be built in anticipation of periodic bear markets like the one we’re seeing now.
    • Essentially, among the most important things we can currently do is to largely look past all the market’s mayhem, and focus instead on making the most of your life. Try to “set your egg timer to six months,” as this moving piece by Contrarian Edge’s Vitaliy Katsenelson suggests. Consider his advice (emphasis ours):
      • “We have been given a very unique opportunity to divorce ourselves from material things and spend time with our family. To really spend time with them. We have been given the rare opportunity to prioritize what is most important to us without guilt. The material world is on pause, at least for a few weeks. Try to make the most of it while you can.”

CARES Act Overview

With much of the country in self-isolation, perhaps you’ve got time to read the entire H.R. 748 Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. If you’d prefer, here is a summary of many of the key provisions we expect to be discussing with you in person (virtually), depending on which ones apply to you.

In General

  • Direct payments/recovery rebates: Most Americans can expect to receive rebates from Uncle Sam. Depending on your household income, expect up to $1,200 per adult and $500 per dependent child. To calculate your payment, the Federal government will look at your 2019 Adjusted Gross Income (AGI) if it’s available, or your 2018 AGI if it’s not. However, you’ll receive an extra 2020 tax credit if your 2020 AGI ends up lower than the figure used to calculate your rebate. This Nerd’s Eye View illustration offers a great overview:
  • Retirement account distributions for coronavirus-related needs: You can tap into your retirement account ahead of time in 2020 for a coronavirus-related distribution of up to $100,000, without incurring the usual 10% penalty or mandatory 20% Federal withholding. You’ll still owe income tax on the distributions, but you can prorate the payment across 3 years. You also can repay distributions to your account within 3 years to avoid paying income taxes, or to claim a refund on taxes paid.
  • Various healthcare-related incentives: For example, certain over-the-counter medical expenses previously disallowed under some healthcare plans now qualify for coverage. Also, Medicare restrictions have been relaxed for covering telehealth and other services (such as COVID-19 vaccinations, once they’re available). Other details apply.

For Retirees (and Retirement Account Beneficiaries)

  • RMD relief: Required Minimum Distributions (RMDs) go on a holiday in 2020 for retirees, as well as beneficiaries with inherited retirement accounts. If you’ve not yet taken your 2020 RMD, don’t! If you have, please be in touch with us to explore potential remedies.

 For Charitable Donors

  • “Above-the-line” charitable deductions: Deduct up to $300 in 2020 qualified charitable contributions (excluding Donor Advised Funds), even if you are taking a standard deduction.
  • Donate all of your 2020 AGI: You can effectively eliminate 2020 taxes owed, and then some, by donating up to, or beyond your AGI. If you donate more than your AGI, you can carry forward the excess up to 5 years. Donor Advised Fund contributions are excluded.

For Business Owners (and Certain Not-for-Profits)

  • Paycheck Protection Program loans (potentially forgivable): The Small Business Administration (SBA) Paycheck Protection Program (PPP) is making loans available for qualified businesses and not-for-profits (typically under 500 employees), sole proprietors, and independent contractors. Loans for up to 2.5x monthly payroll, up to $10 million, 2-year maturity, interest rate 1%. Payments are deferred and, if certain employment retention and other requirements are met, the loan may be forgiven.
  • Economic Injury Disaster Loans (with forgivable advance): In coordination with your state, SBA disaster assistance also offers Economic Injury Disaster Loans (EIDLs) of up to $2 million to qualified small businesses and non-profits, “to help overcome the temporary loss of revenue they are experiencing.” Interest rates are under 4%, with potential repayment terms of up to 30 years. Applicants also are eligible for an advance on the loan of up to $10,000. The advance will not need to be repaid, even if the loan is denied.
  • Payroll tax credits and deferrals: For qualified businesses who are not taking a loan.
  • Employee retention credit: An additional employee retention credit (as a payroll tax credit), “equal to 50 percent of the qualified wages with respect to each employee of such employer for such calendar quarter.” Excludes businesses receiving PPP loans, and may exclude those who have taken the EIDL loans.
  • Net Operating Loss rules relaxed: Carry back 2018–2020 losses up to five years, on up to 100% of taxable income from these same years.
  • Immediate expensing for qualified improvements: Section 168 of the Internal Revenue Code of 1986 is amended to allow immediate expensing rather than multi-year depreciation.
  • Dollars set aside for industry-specific relief: Please be in touch for a more detailed discussion if your entity may be eligible for industry-specific relief (e.g., airlines, hospitals and state/local governments).

For Employees/Plan Participants

  • Retirement plan loans and distributions: Maximum amount increased to $100,000 on up to the entire vested amount for coronavirus-related loans. Delay repayment up to a year for loans taken from March 27–year-end 2020. Distributions described above in In General.
  • Paid sick leave: Paid sick leave benefits for COVID-19 victims are described in the separate, March 18 R. 6201 Families First Coronavirus Response Act, and are above and beyond any benefits received through the CARES Act. Whether in your role as an employer or an employee, we’re happy to discuss the details with you upon request.

For Employers/Plan Sponsors

  • Relief for funding defined benefit plans: Due date for 2020 funding is extended to Jan. 1, 2021. Also, the funding percentage (AFTAP) can be calculated based on your 2019 status.
  • Relief for facilitating pre-retirement plan distributions and expanded loans: As described above for Employees/Plan Participants, employers “may rely on an employee’s certification that the employee satisfies the conditions” to be eligible for relief. The participant is required to self-certify in writing that they or a direct dependent have been diagnosed, or they have been financially impacted by the pandemic. No additional evidence (such as a doctor’s release) is required.
  • Potential extension for filing Form 5500: While the Dept. of Labor (DOL) has not yet granted an extension, the CARES Act permits the DOL to postpone this filing deadline.
  • Exclude student loan pay-down compensation: Through year-end, employers can help employees pay off current educational expenses and/or student loan balances, and exclude up to $5,250 of either kind of payment from their income.

For Unemployed/Laid Off Americans

  • Increased unemployment compensation: Federal funding increases standard unemployment compensation by $600/week, and coverage is extended 13 weeks.
  • Federal funding covers first week of unemployment: The one-week waiting period to start collecting benefits is waived.
  • Pandemic unemployment assistance: Unemployment coverage is extended to self-employed individuals for up to 39 weeks. Plus, the Act offers incentives for states to establish “short-time compensation programs” for semi-employed individuals.

For Students

  • Student loan payments deferred to Sept. 30, 2020: No interest will accrue either. Important: Voluntary payments will continue unless you explicitly pause them. Plus, the deferral period will still count toward any loan forgiveness program you’re in. So, be sure to pause payments if this applies to you, lest you pay on debt that will ultimately be forgiven.
  • Delinquent debt collection suspended through Sept. 30, 2020: Including wage, tax refund, and other Federal benefit garnishments.
  • Employer-paid student loan repayments excluded from 2020 income: From the date of the CARES Act enactment through year-end, your employer can pay up to $5,250 toward your student debt or your current education without it counting as taxable income to you.
  • Pell Grant relief: There are several clauses that ease Pell Grant limits, while not eliminating them. It would be best if we go over these with you in person if they may apply to you.

For Estates/Beneficiaries

  • A break for “non-designated” beneficiaries: 2020 can be ignored when applying the 5-year rule for “non-designated” beneficiaries with inherited retirement accounts. The 5-Year Rule effectively ends up becoming a 6-Year Rule for current non-designated beneficiaries.

As such, before proceeding, please consult with us and other appropriate professionals, such as your accountant, and/or estate planning attorney on any details specific to you. Please don’t hesitate to reach out to us with your questions and comments. It’s what we’re here for.

 

 

Reference Materials:

 

 

 

 

 

Woodstone Financial, LLC is a fee-only financial advisor, specializing in retirement planning, comprehensive financial planning, and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.