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It's Not Too Late to Contribute to an IRA for 2016

It's Not Too Late to Contribute to an IRA for 2016

The deadline for making 2016 contributions to an IRA is April 18, 2017. The contribution limit is the lesser of your earned income or $5,500 ($6,500 if you were over age 50 on December 31, 2016). You may also be able to contribute to an IRA for your spouse, even if they didn't have any income for the year.

Traditional IRA

To contribute to a traditional IRA, you must have been under age 70 1/2 by December 31, 2016. If you or your spouse was covered by an employer plan (e.g. 401k) for 2016, your ability to deduct your contribution may be limited depending on your filing status and modified adjusted gross income (MAGI) (see table below). If you won't be able to deduct your traditional IRA contribution, evaluate whether you can make a Roth IRA contribution (see below) as this is almost always better than making a non-deductible traditional IRA contribution.

2016 Income Phaseout Ranges for Traditional IRA
If covered by an employer-sponsored plan and filing as... Your IRA deduction is reduced if your MAGI is: Your IRA deduction is eliminated if your MAGI is:
...Single or Head of Household $61,000 to $71,000 $71,000 or more
...Married Filing Jointly $98,000 to $118,000 $118,000 or more
...Married Filing Separately $0 to $10,000 $10,000 or more
If not covered by an employer-sponsored retirement plan, but filing joint return with a spouse who is covered by a plan $184,000 to $194,000 $194,000 or more

Roth IRA

While there is no tax deduction for Roth IRA contributions, the earnings and eventual distributions are tax-free. For those who expect to be in a higher effective tax bracket when they begin distributions, a Roth IRA may be your best bet. In addition, there is no age limit to contribute to a Roth IRA and no required minimum distributions once reaching age 70 1/2. There are however income limitations that can reduce or eliminate your ability to contribute to a Roth IRA (see table below).

2016 Income Phaseout Ranges for Roth IRA
Your ability to contribute to a Roth IRA is reduced if your MAGI is: Your ability to contribute to a Roth IRA is eliminated if your MAGI is:
Single or Head of Household $117,000 to $132,000 $132,000 or more
Married Filing Jointly $184,000 to $194,000 $194,000 or more
Married Filing Separately $0 to $10,000 $10,000 or more

Make Too Much Money?

If your income is too high to contribute to a Roth IRA and you're unable to deduct a traditional IRA contribution, there are some advanced tax planning techniques that may allow you to make a non-deductible traditional IRA contribution and later convert it a Roth IRA, paying little or no tax in the process. There are a number of considerations that need to be taken into account before attempting a "back-door" Roth IRA strategy to ensure that you don't inadvertently create a large tax bill or run afoul some of the IRS's principle-based doctrines. Contact us if you think you might be a candidate.

TD Ameritrade Lowers Prices

TD Ameritrade Lowers Prices

Last week, TD Ameritrade Institutional, the brokerage firm we typically recommend to our clients to custody and safeguard their managed assets, announced it was reducing their prices.

Mutual Funds
Dimensional Fund Advisors (DFA) funds are now $9.99 per transaction, down from TD's standard pricing of $24 per transaction. This is exciting news since we use several Dimensional funds in our clients’ portfolios. Vanguard mutual funds, which we also use, remain at $24 per transaction and allow our clients access to the lower expense ratio Admiral share class with no minimums. By way of comparison, other custodians charge as much as $50 per transaction for mutual funds from Dimensional and Vanguard.

Exchange Traded Funds (ETF)
Standard ETF pricing has been lowered from $9.99 per trade to $6.95 per trade. In the equity portions of our portfolios we often use the ETF version of Vanguard's offerings, so this is welcomed news, as well! Sadly, starting November 20, 2017, the limited number of Vanguard ETFs that have been on TD Ameritrade Institutional’s commission-free list, including several we used regularly will be removed. While this is unfortunate, the new standard pricing of $6.95 per trade is still competitive and a worthwhile cost to access Vanguard ETFs. We will, however, modify our trading guidelines slightly, to ensure this change does not have a material impact on our client's trading costs.

Our Relationship with TD Ameritrade Institutional
The recent pricing changes are overall great news for our clients and reaffirm our confidence in TD Ameritrade Institutional. In addition to competitive pricing, they continue to be at the forefront of technology solutions and client service. As an independent Registered Investment Adviser (RIA), we are completely independent of TD Ameritrade Institutional, but recommend them because of the value they offer our clients.

Posted: March 6, 2017.

Updated: October 16, 2017 to reflect the removal of Vanguard ETFs from TD Ameritrade Institutional's commission-free list, effective November 20, 2017.

The Impact of the Election on Your Portfolio

The Impact of the Election on Your Portfolio

With the election now over and the outcome a surprise to many, you may be wondering how this will impact your portfolio. It’s no secret that markets don’t like uncertainty. Last night, as the votes were being counted and the expectations of who would be our next president began to shift, stock market futures began to drop. By midnight they were down over 5%. As markets around the world began to digest this new information we saw a rebound. By morning, the S&P 500 Index opened only 0.37% down from yesterday’s close, significantly less than suggested by the futures market at midnight and well within normal daily volatility.

While presidential elections always add a layer of uncertainty into the markets, they historically haven’t had a long-term impact. Short-term volatility often spikes leading up to and immediately after the election, but then stabilizes within 100-200 days after.

In the days, weeks, and even years to come there will likely be debate about the impact our new president will have on the long-term performance of the stock market. If history is any guide, it may not matter much. Since 1853 there has been no difference in the average annual stock market returns based on which party controlled the White House. The average annual market returns have been 11% under both political parties (1853-2015, source: Vanguard).

I did not recommend any portfolio changes as we headed into the election and I am not recommending any now. Changes to your financial plan should be made in response to changes in your personal goals and informed by long-term expectations. While we may experience some short-term volatility as a result of the election, long-term market expectations haven’t materially changed. I continue to believe the most meaningful factors investors should focus on in their portfolios are diversification, costs, and taxes. Whenever we are tempted to make changes in response to factors we can’t control, it’s important to remember to stay the course!

Posted: November 9, 2016

Inflation & Deflation Risk

Inflation & Deflation Risk

Throughout history two of the biggest long-term risks to investors have been inflation and deflation. Unlike the risks we examined in prior posts—personal goals, lifestyle considerations, planning assumptions, market volatility—investors have little control over their occurrence and limited tools to manage their risk.

Prolonged hyper-inflation is perhaps the most likely “long-term” risk to modern-day American investors. Such an event could severely erode the purchasing power of your savings for decades, possibly creating a big enough loss that recovery would not be possible within your lifetime. Over the past century, this very scenario has happened in many developed nations.

On the other side of the coin, severe and prolonged deflation may not seem like such a bad thing at first glance, since it would increase the real value of money. However, deflation is typically associated with unemployment and a struggling economy, which can further lead to significant geopolitical turmoil.

Prior to the 20th century, most of the world relied on hard-money, that is currency backed by silver and gold. During these times, a common cause of inflation and deflation was simply the changes in the supply of these precious metals. After the World War I and the Great Depression, nations abandoned the gold standard, established central banks, and issued fiat currency (not backed by silver and gold). With these changes, deflation has mostly disappeared, since central banks now have the ability to print money in order to drive up prices and combat deflationary pressures. As a result of the same ability, the risk of inflation has perhaps increased.

While stocks in the local market may suffer, at least initially from either inflation or deflation, a globally diversified stock portfolio actually provides some of the best long-term protection to both scenarios. In the more likely inflationary scenario, a portfolio that is tilted toward value stocks would be expected to perform even better as these companies tend to be more leveraged and benefit from the real value of their fixed-rate liabilities declining.

Bonds, particularly those with long durations, tend to get decimated by unexpected inflation. Conversely, long-term bonds perform quite well during deflationary environments. Given the belief that inflation is the more likely risk, the deflationary benefits of long-term bonds do not outweigh their inflationary risk. Most investors would be well-served to maintain a short to intermediate duration in their bond portfolio. An attractive alternative to longer-term nominal bonds is Treasury Inflation-Protected Securities (TIPS). TIPS are bonds issued by the US Treasury and backed by the full faith and credit of the US Government but pay a fixed real interest rate plus an adjustment for actual inflation. They allow investors to avoid the short-term volatility risks of stocks without assuming the purchasing power risk that comes with nominal bonds. Those in or approaching retirement should probably consider having a healthy allocation to TIPS.

Gold, often thought to be a natural inflation hedge, doesn’t actually perform that spectacularly during periods of prolonged inflation, and in fact does better during periods of deflation. When inflation is high, it appears that gold is just another commodity to measure inflation against so there’s little reason to assume it would perform better than other metals, grain, or oil. Conversely, when the public loses faith in the financial system, which is often associated with deflation, panic ensues and people flock to tangible gold bullion.

The takeaways for investors are relatively straight-forward. In the long-run a globally diversified stock portfolio, which represents ownership of thousands of companies around the world is one of the best hedges against macroeconomic events such as inflation and deflation. Still, most investors do not have time horizons long enough or risk tolerances high enough to be fully invested in stocks and therefore should invest a reasonable portion of their portfolio in bonds. As the proportion of bonds to stocks increase, the portfolio becomes more susceptible to unexpected inflation and this risk should be hedged by allocating at least the longer portion of the bond portfolio to TIPS. In all but a deflationary environment, gold is probably not going to be a productive investment in the long run. If deflation or geopolitical instability is of particular concern, then owning gold bullion may provide some protection, but it’s best to think of it as insurance rather than an investment.

What Brexit Means for You and Your Portfolio

What Brexit Means for You and Your Portfolio

Yesterday Britain voted to leave the European Union, sending shock waves through the market today. The US stock market declined approximately 3.6% and international markets were down approximately 7.7%. Many investors are left feeling uneasy and uncertain about how this impacts them and what they should do now. Here are three considerations:

1) For the long-term investor, this is just noise
Today’s volatility may have you thinking it’s time to get out of stocks or at least out of international stocks. In times like these, it’s important to remember your long-term plan. Your financial plan is the result of your life goals as well as your ability, willingness, and need to take risk. Changes to your plan, and therefore your portfolio, should be driven by changes in your life, not market volatility.

A well-constructed portfolio includes stocks for long-term growth. Even in the long run, there is a significant amount of uncertainty involved with stocks, which is why broad diversification across geographic regions is so important. If we knew for sure what the best-performing parts of the stock market would be over the coming decades, we would invest our entire stock allocation there, but alas we don’t. In fact, this uncertainty about the stock market contributes heavily to the expected premium stocks earn over less volatile investments like bonds. Unfortunately diversification across different segments of the stock market (e.g. owning domestic and international stocks) often doesn’t help much with systematic declines like we experienced today, but broad diversification still gives you the best probability of long-term success and thus is important to maintain.

To help mitigate short-term stock market declines and ensure you have the money you need for shorter-term goals, part of your portfolio should also be invested in bonds. Your ability, willingness, and need to take risk determines what the proportion of stock to bonds in your portfolio should be. Unlike stocks, where the primary objective is long-term growth, the purpose of bonds is it to be the ballast in your portfolio, which is why you should only invest in very high-quality bonds. The bond allocation of our clients’ portfolios is heavily composed of US government bonds, which are considered the lowest-risk investment available. As a result, the expected return on these type of bonds, albeit low, is very reliable and easy to estimate ahead of time. In addition, the value of these bonds often increases amidst global market concerns, which helps to offset some of the stock market declines and even provide “dry powder” to rebalance your portfolio. Having an appropriate allocation to high-quality bonds better allows investors to weather the storm and stay the course amidst stock market volatility.

With a well-constructed long-term portfolio and the right mindset, today’s events are simply noise that you should ignore. While it’s natural to feel compelled to take action, history has taught us time and time again that when it comes to investing the best thing you can do is follow your plan instead of your emotions.

2) For the tax-smart investor, this is an opportunity to reduce your tax bill
While long-term investors shouldn’t change their exposure to international stocks, they should review their portfolio for any positions that have an unrealized loss. With relatively low returns over the past several years and today’s precipitous market decline, many investors will find the international positions in their taxable accounts are currently at a loss. Capital losses on your investments can be used to offset capital gains and even a small portion of ordinary income. By selling positions that are at a loss you’re able to “harvest” this tax loss. You can then immediately reinvest the proceeds into a similar (but not substantially identical) investment so that you can maintain your desired asset allocation. This way you won’t miss out on future growth or a rebound, but you'll also get the real economic benefit of lowering your tax bill for the year. This morning I reviewed all of my client’s portfolios for opportunities to tax-loss harvest and took advantage of them wherever it made sense.

3) For the world traveler, this is a great time to visit England
The stock markets aren’t the only thing that fell today - so did the value of the British Pound. Relative to the US Dollar, the Pound fell almost 9%. This means that for Americans converting US Dollars to buy goods and services in the UK, everything just went on sale. If you’d been thinking about making a trip across the Atlantic, it should be even more compelling now!

Posted: June 24, 2016