Archives for January 2016

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Investing Blog Roundup: How Long Do Bear Markets Last?

This week, I enjoyed two articles that each take a look at how long bear markets tend to last. For me, the biggest takeaway is that there’s a lot of variation. Just because a market decline has lasted a given length of time (or hasn’t yet lasted a given length of time) doesn’t mean that we should/shouldn’t expect anything in particular in the near future.

Investing Articles

Other Money-Related Articles

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Do Target Retirement Funds Automatically “Buy Low, Sell High”?

A reader writes in, asking:

“Like you, I like the idea of ‘all in one funds,’ specifically the Vanguard Lifestrategy series. I have a significant portion of my IRA in Lifestrategy Moderate Growth. What I’ve wondered about is how those funds handle rebalancing during the type of market volatility we’re experiencing now-i.e., is it done on a continual basis, as new cash comes in and distributions go out? Or quarterly? Is it inherent in these fixed-ratio funds that they will, to some extent at least, ‘buy low and sell high?'”

Vanguard’s LifeStrategy and Target Retirement funds use daily cash flows into (or out of) the fund to rebalance the portfolio. Beyond that, further rebalancing only occurs if the fund’s allocation strays outside of a certain target range (which Vanguard does not publish). You can find a bit more info in this interview with Vanguard’s John Ameriks.

And, I would not say that it is inherent that the funds-of-funds will automate a “buy low, sell high” process. In periods during which the market exhibits momentum (as opposed to mean reversion), the funds’ daily rebalancing will actually harm performance rather than help it.

For example, if the stock market continues to drop slowly but steadily for an extended period, an investor in a LifeStrategy fund would experience greater losses than an investor who had a DIY allocation that was originally identical but never rebalanced over the period. (Reason being that the LifeStrategy investor will keep rebalancing into stocks every day, only to see them decline further.)

And the same thing happens if the market goes up steadily for an extended period. That is, the LifeStrategy investor will constantly be selling stocks, only to see them move up further, and he/she will therefore underperform the DIY investor who doesn’t rebalance over the period.

But the opposite can happen as well.

If a decline turns out to be a steep but short-lived dip, the investor in the LifeStrategy fund will have gotten to buy some shares “on sale” whereas the DIY investor who didn’t rebalance will not have purchased any such “cheap” shares.

And if a brief rally occurs during a bear market, the investor in the LifeStrategy fund will have sold some stocks at the temporarily-relatively-high price, whereas the DIY investor who didn’t rebalance will not have done so.

In short, during periods in which the market heads relatively steadily in one direction, frequent rebalancing (as you would experience in a LifeStrategy or Target Retirement fund) will generally underperform a strategy that involves less frequent rebalancing. Conversely, during periods in which the market rapidly bounces back and forth, frequent rebalancing will usually outperform a less frequent rebalancing strategy.

Investing Blog Roundup: Suing for Lower 401(k) Costs

After last year’s ruling by the Supreme Court in Tibble vs. Edison International, lawsuits have been brought against several large 401(k) plans, alleging that the plan fiduciaries have not done a good enough job of selecting the lowest-cost share classes available.

As Morningstar’s John Rekenthaler wrote in a recent article, participants in Anthem’s 401(k) plan have brought an especially ambitious suit, alleging that the plan’s funds are more expensive than they need be, despite the fact that they are mostly relatively low-cost Vanguard funds. It will be interesting to see how such cases play out in the next few years — and whether or not they bring any significant changes to the industry.

Investing Articles

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Is Tax Planning a Good Reason to Delay Social Security?

A reader writes in, asking:

“I have a Social Security strategy that I have not read of or heard about. I am interested in your feedback. Given the size of my tax-deferred accounts, when I am 70 1/2, RMDs will make it such that I will pay tax on the maximum 85% of my Social Security benefits regardless of when I start benefits. I am considering taking benefits at age 62, so I can pay no taxes on the benefits for 8 years, then pay the full tax on the benefits at age 70 1/2 and beyond.”

Unfortunately, tax planning with regard to Social Security is a very case-by-case sort of thing.

Also unfortunately, a comprehensive analysis tends to be very time-consuming. In my opinion, the only way to do it appropriately is to use actual tax planning/preparation software and run through several years of simulations using Strategy A and several years using Strategy B, then compare the results (often in a spreadsheet). When I see people trying to do a DIY spreadsheet-only analyses rather than using tax software, they often end up leaving out something important (e.g., a credit for which they’re eligible in one case, but not in the other — or a tax to which they’re subject in one case but not in the other).

As such, I am convinced that this is one of the areas in which working with a financial planner can be most worthwhile.

With the above caveats, I would say that tax planning tends to be a point in favor of delaying Social Security, for two reasons.

First, each dollar of Social Security income is, at most, 85% taxable. So if a person has the option to, for example, spend down their IRA to delay Social Security and the net result is $100,000 less of IRA distributions over their lifetime but $100,000 more of Social Security benefits, that ends up being a “win” from an after-tax perspective.

Second, increasing the portion of one’s income that is made up of Social Security often results in a smaller portion of Social Security being taxable (because only 50% of benefits are included in the “combined income” figure that determines Social Security taxability).

That is, for many people, delaying Social Security results in:

  1. a larger portion of their lifetime income being made up of tax-advantaged dollars of Social Security and
  2. a smaller portion of those Social Security dollars being taxable.

But the above points don’t always apply. For instance, for the reader who wrote in with the question, it appears that even if he delays benefits and spends down tax-deferred accounts in the meantime, 85% of his benefits will still be taxable.

And there are other factors involved as well. Ultimately, the best claiming strategy often depends on whether there are other tax breaks you’re looking to qualify for or other taxes you’re looking to avoid. For instance, for a person who retires prior to age 65 and who will be buying health insurance on the exchange, keeping “household income” very low until Medicare eligibility kicks in may be very desirable, as Affordable Care Act subsidies can be quite large. And that typically means delaying Social Security (at least until 65) while spending primarily from taxable accounts and Roth accounts.

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Investing Blog Roundup: Picking Funds with High “Active Share”

Over the last few years, one strategy that has been proposed for finding actively managed funds that are likely to outperform index funds has been to find funds with a high “active share” — that is, funds that have holdings very different from the index to which their performance is compared. A recent bit of research from Vanguard suggests exactly what you might expect: Yes, picking funds with a high active share results in a greater chance of finding one that outperforms, but it also increases the likelihood of selecting funds that significantly underperform.

Of note, the Vanguard research only looks at a relatively brief period of time, so more work is needed. But it’s a start in the right direction.

Investing Articles

Other Money-Related Articles

Thanks for reading!

Can I Take a Loan from my IRA?

A reader writes in, asking:

“A friend recently told me that he took a loan from his IRA so he could take money out for a short time without having to pay penalty. I had never heard of that, so I called Vanguard and asked about it. They said that only 401k accounts have loans, not IRAs. Is that true? Was my friend wrong?”

The Vanguard representative is correct that IRA accounts do not have loan provisions, whereas many 401(k) plans do have such an option. (For more on 401(k) loans, see this MarketWatch article from Elizabeth O’Brien.)

Perhaps your friend was talking about the ability to “borrow” from an IRA by using the 60-day rollover provision.

To back up a step, there are two ways to move money from one IRA to another:

  1. Via a direct “trustee-to-trustee transfer,” in which you never have possession of the money, as it goes directly from one financial institution to the other, and
  2. Via a “60-day rollover.”

With a 60-day rollover, the first financial institution sends the money to you, and as long as you deposit an equal amount of money into an IRA within 60 days from the day you receive the distribution, it will be treated as if the distribution did not occur.

The 60-day rollover option exists so that you can move money from one retirement account provider to another. But it can also be used as a sort of short-term “IRA loan” mechanism, because it’s possible to simply deposit the appropriate amount of money back into the same account (rather than into an IRA with a different financial institution).

There is, however, one very important point to be aware of: You can only do one such 60-day rollover per year. So if you have executed such a rollover within the last year, you cannot “borrow” from your IRA in this manner, because you would not be able to put the money back into an IRA. (That is, the distribution would simply count as a normal distribution, potentially subject to the 10% penalty.) Similarly, if you do “borrow” from your IRA in this manner, you won’t be able to do so again within the next year, nor would you be able to do a normal 60-day IRA-to-IRA rollover during that period.

Of note, the one-per-year limit does not apply to:

  • Roth conversions (i.e., rollovers from a traditional IRA to a Roth IRA),
  • Direct trustee-to-trustee transfers, or
  • Rollovers involving an employer-sponsored plan (e.g., from a 401(k) to an IRA or vice versa).

Also, the one-per-year limit is no longer one rollover per IRA per year as it used to be, but rather one rollover per year regardless of how many IRAs you have.

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