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Does Fixed Income Still Work with Rates Low?

With stocks on a tear as of 12/3/2020, many globally diversified and balanced investors are wondering why they should maintain any allocation to fixed income. Interest rates are at historic lows and it wouldn’t appear there is a whole lot of reason to invest in fixed income. As stocks continue to inch upwards despite many economic concerns globally, it can be difficult for a participant to continue to invest in a model portfolio or target date fund that is using a large allocation in fixed income.

It is at times like this that we have to remember past performance is not indicative of future results. Interest rates have been low for a long time but at some point that may change. If we look at the late 90’s, it seemed that all you had to do was buy, AOL, and JDS Uniphase and sit back & enjoy. As we all know now however, all stock market cycles are unique and sometimes companies actually have to make money to justify their prices.

Shortly after this .COM bust, we experienced the lost decade in US markets. While the period from 2000 to 2009 was a difficult decade for US equity investors, it was a pretty decent period for those with globally diversified portfolios. It wasn’t as exciting as the late 90’s, but for a retirement investor chasing what has just happened (think large cap US Growth), it provided a smoother path to solid returns.

That brings us to where we are today. Fixed income can continue to play an important role in a diversified portfolio. If you are close to retirement, you very well may need to generate income from your portfolio shortly and by using fixed income you can smooth out some of those rough edges that come with sharp market downturns like we saw at the beginning of 2020. Fixed income can also allow you to rebalance your portfolio during market corrections or recessions so you can take advantage of lower equity prices in a systematic way. While none of this is very exciting, the last place any of us should be looking for excitement now-a-days is in our ability to fund our retirement. Slow and steady will win the race.

Cash Rules Everything Around Me….

As a rule of thumb, it can be helpful to maintain some savings for a rainy day. During times of high anxiety, it can be reassuring to know that you have a few months of breathing room just in case you are suddenly unemployed, there is an unaccounted for expense at home, or you are unable to work due to COVID.

But how much is too much? Financial planners will frequently recommend a three to six month of income buffer. What we have witnessed some of recently is individuals with two to three years or more of cash on hand. The main issue with this can be easily highlighted if we look at the website to get a feel for real yields on treasuries.

The real yield looks at what you would receive from a treasury after factoring in inflation. On a five year treasury, it was at -1.34% on 12/2/2020. So it is almost impossible to maintain your purchasing power by keeping your money in a CD or treasuries and with each passing day while cash in your bank account provides you with comfort to sleep at night, it also comes at a cost.

For those who are in this very fortunate situation, they can consider contributing more to their retirement plan at work. If they are capped out on what they can do there, they can set-up a taxable account and save in a globally diversified portfolio that is managed in a cost effective way. There are many options this individual can pursue but maintaining large sums of cash relative to what you make comes at a cost too.

2021 is almost here, give your future self a raise

For many retirement plan savers, we frequently set a plan in place and leave it alone. Hopefully at a minimum our plan included participating in the plan. But what if we just saved up to the match? What if we put in only what we could afford five years ago? What if we have gotten a raise? What if our income has gone up? What if our expenses have gone down?

There are a lot of “what-ifs”. For most savers that have taken that initial step (or if you are automatically enrolled, your employer has done it for you), the next thing to do is figure out how much you need to be saving and continually improve upon that savings rate. Consider a few examples: Employee A enrolled at 5% to take advantage of their company match. They make $40,000 a year. They are putting in $2,000 a year out of their own paycheck. Employee B enrolled at the same amount and makes the same. She increases her deferral rate by 1% per year.

After 5 years, Employee B is now deferring 10% of her paycheck or $4,000 a year. She has doubled the savings rate of her colleague who hasn’t changed his since he started. She also is now living off of $36,000 a year versus $38,000. This is a key, frequently unacknowledged, advantage of retirement savings plans. It forces Employee B to better budget her spending during her working years which lowers the amount she needs to fund in retirement.

This is a basic example of how paying your future self can pay off over time without breaking the bank in any given year. As we look forward to 2021 (whew!), consider giving your future self a raise and defer more into your company retirement plan.

It Takes Two…

No we aren’t referring to the tango nor are we talking about the classic middle school dance anthem by Rob Base & DJ EZ Rock. We are talking about market timing. For many retirement plan investors, it is easy to get consumed with an onslaught of positive or negative news. Sometimes that news even drives us to the point of wanting to tamper with our long-term investment strategy.

What many of us forget is this “market timing” takes two decisions and unfortunately we have to get both correct. When to move to a more conservative allocation and also when to move back into our normal more aggressive long term allocation. During the past few months we have been inundated with political ads, COVID news, wild fires, and much more.

The news of the day may seem daunting but it also doesn’t really inform us as to where the market may go in the near future. Since markets are forward looking, information is constantly being priced into the prospects and prices of companies. As an investor, we must constantly remind ourselves that our participation in the markets while utilizing a globally diverse portfolio and saving at appropriate rates is the most important factor in our long term success, not making two decisions at the exact right time!

Market Returns through a Century of Recessions

If the past decade has taught us anything, it is that investing can be hard and still very rewarding. As investors, it is very hard to detach the noise in the marketplace from what we should do with our own investments. Should we wait until after the election? Should we sell in May and go away? Is this the next global financial crisis, bust or great depression even?

Take a look out how investors have been rewarded during past difficult cycles to get a better understanding of the forward looking nature of the stock market. The past century.

Jimmy Carter or George H.W. Bush, who ya got?

Every two to four years, we tend to have the same questions from clients. Who is better for stocks, Republicans or Democrats? In many cases, this question is layered with political bias that can force us to take our eye off the ball. The key fundamentals of saving vs. spending, rebalancing assets and tax efficient investing are frankly more important than who is in office.

For a fun test drive, check your political bias at the door and click through the linked article compliments of DFA:

2021 Retirement Plan Limits

The 2021 retirement plan limits have been announced and not surprisingly, they look at lot like the 2020 limits. Yes, there have been some changes in the compensation limits but the big ones to savers have stayed the same. Take a look at the retirement plan limits here.

My employer cut my match, now what?

In these difficult financial times, many industries are continuing to reel from the fallout of the COVID pandemic. Some industries are thriving while others are hanging on by a string. In response to this, many employers have had to make the difficult decision of whether to terminate employees, trim extra expenditures or cut back on benefits such as employer matching contributions.

For employees who work at these firms, this leaves the difficult decision of what to do when your match is reduced or eliminated. This also gets to one of the core mistakes many employees make when determining how much to save within a plan. Employees have continually been told to take the “free money”. Defer up to the match amount to at least get every penny your employer is offering. This is true to a point. While an employee right out of college who doesn’t have emergency savings may just want to contribute to the match for many other employees this is likely a deferral rate that is way too low to maintain an appropriate level of savings for retirement.

This takes us back to our original question. If your employer cuts back on the match, it may very well make sense for the employee to increase their deferral to stay on track. This will provide the added benefit that if the employer can re-instate the match once revenue stabilizes, the employee will then be at a higher overall net deferral rate. This is almost the equivalent of spitting into the wind but if you have an emergency savings account and you are confident your job is stable, it is critical to reassess deferral rates at difficult times like these.

Was Bill Shakespeare Correct?

“What is Past is Prologue” is a famous line from the William Shakespeare play The Tempest. How could it possibly apply to stocks? When we are in the midst of a frenzy, investors frequently get swept up in the moment and can’t see how a company could ever fall off the leading edge.

What was leading edge technology at the time can become dated and a smaller part of our economy going forward. Entire industries can have less of a impact on our economy over time (think big energy companies right now represented by firms like Exxon and Chevron). If you look at the above chart, you will see common names we all know moving into and out of the 10 largest firms over time.

Back in the year 2000, Apple hadn’t even made their first Ipod let alone their Ipad or Iphone which have led them to being one of the top ten companies in the 2020’s. Fortunately for retirement plan savers, you don’t have to discover the next Apple, Microsoft or Google. Through investing in a broadly diversified portfolio of companies, you will be able to take advantage of future technological advancements and industry changes paycheck by paycheck with ongoing investments into your retirement plan. Retirement savers needs to focus less on elections, the next big thing, or their ability to pick winners over losers and focus on the items they control. Spend less then you make, save regularly into your retirement plan at aggressive savings rates, and don’t borrow from your future self.

Long Term & Part Time

The SECURE Act has a number of provisions that will encourage employers to offer retirement plans to employees. But what about those that already offer plans to employees? What is in it for them?

One of the trickier provisions to handle could be the treatment of long term part time employees. Many employers haven’t allowed these employees into their plans in the past because of the effect on testing, audit requirements, matching costs, or perceived lack of potential use by part time employees.

Going forward after December 31st, 2020, employees who have worked over 500 hours a year for 3 consecutive years will be considered long term part time employees (LTPTEs since we need more acronyms). This will extend to deferrals only for those employees. Those deferrals will be excluded for purposes of non-discrimination, top-heavy and coverage requirements.

For implementation,the first 12 month period which must be used to measure satisfaction of the rule begins no earlier then January 1st, 2021. The impact however is significant as Plan Sponsors will have to track this year and hours requirement for all part time employees. If you are a Plan Sponsor that has a large seasonal employee population, Oh Man, this is going to create some headaches.

While the intent of the rule is a great one (more savers, more participation) the side effects are considerable. If you have an employee population that fits this, you will want to speak with your Plan Advisor on possible design changes or platform changes to pursue.