Want a Better Investment Experience? 10 Principles to Live By

Want a Better Investment Experience? 10 Principles to Live By

With the market’s recent volatility, your portfolio may have taken a hit. And you probably have feelings about that. Maybe some fear. Maybe anger. And you may be wondering what you can do to avoid taking a hit again.

10 Years After the 2007–08 Financial Meltdown, Some Facts to Consider

We are approaching the 10-year anniversary of the 2007–2008 global financial crisis, which imploded in September and October of 2008 but had peaked in July–November 2007. In contrast, we have been enjoying a period of remarkably low volatility. In light of this, consider these “Fun Facts To Know and Tell”: Using the S&P 500 as a stock market benchmark, since it has a long history (although, remember, we like to use the MSCI ACWI as a broader U.S. and global stock index):

The last 3% drop in the S&P 500 was 199 days ago:

  • Longest stretch since 1995–96
  • Second-longest stretch since 1950

The last 5% drop was June 2016, or about 15 months ago, when Britain surprisingly voted to exit the European Union.

The last 10% drop was January and February 2016, over 18 months ago.

[Tweet "Stock market downturns can come without warning. Be ready at all times!"]

By comparison, since 1950 the S&P 500 has declined 3% or more over four times per year, on average, and dropped over 5% about 2.5 times per year.

Our crystal ball is no clearer than yours, and we are not predicting an imminent downturn in the stock market. Stock market downturns can come any time, without warning, and are a challenging part of the investing process. Be ready at all times!

Much has been written about the success of passive, or index, investing, a strategy we have recommended for well over 15 years. As with many things, relative success can run in cycles. Index investing has been extremely successful in recent years, but there have been times, such as the early 1980s, mid-1990s, and late 2000s, when traditional active management fared better.

In investment management, no single strategy works all of the time, so investors should make judgments over reasonable time periods, understand the facts, and be patient. We continue to recommend passive investing for many reasons, but we also recognize that it won’t excel all of the time.

We hope you have logged on to your “My Wealth” database to review your investment portfolio. We plan to update the monthly performance numbers on the second business day of the month, so the data will be very timely. Please contact us with any questions.

We appreciate the opportunity to serve you and look forward to a great future.

As always, please contact us with any questions, news, or comments.

How Do You Get In on the Next Amazon? You Diversify

If you’ve been reading my blogs long enough, you know that my mantra is diversification. If you own everything that the market offers, then you don’t have to worry about picking the next big thing. You’ll already own the next big thing! A recent article in The Wall Street Journal underscores my point. In “Amazon’s 49,000% Gain: The Most ‘Super’ of ‘Superstocks’ Since 1926,” writer Jason Zweig discusses the near futility of trying to hunt down and invest in superstocks.

Here are some eye-opening facts to illustrate why diversification is important:

  • Between 1926 and 2015, just 30 companies out of 25,782 accounted for one-third of the cumulative wealth generated by the U.S. stock market.
  • In that same period, just 0.33% (not even 1%!) of companies in the U.S. stock market accounted for half of the wealth generated for investors.
  • In that same period, fewer than 1.1% of the stocks that existed created three-quarters of the stock market’s cumulative dollar gains, as measured relative to the returns on cash.

It’s obvious that searching for the next superstock like Amazon is like hunting for a needle in the haystack. Actually, finding the needle might be easier! And that is because, as Mr. Zweig points out, the superness of superstocks isn’t immediately apparent. It takes time for these companies to reach their potential, and they often do abysmally before they go big. Amazon, for example, lost 95% between 1999 and 2001.

[Tweet "Investors are less likely to own the next big stock if they don't diversify."]

Only Psychics Know the Winners

The time lag is why I counsel my clients on the benefits of long-term thinking. It is only through the long term that they can expect to hold winners like Amazon.

However—and this is a big however—they are less likely to hold an Amazon if they fail to diversify their portfolio. As the Wall Street Journal article points out, it’s not enough to own 15 to 30 stocks, which amounts to traditional advice on diversification. “Superstocks are so scarce that you need to hold hundreds, even thousands, of companies to be near-certain of matching the market’s return,” Zweig writes.

If you don’t own the high performers, your portfolio is probably going to underperform. But unless you’re psychic, you’re going to have a hard time picking the winners.

Let’s take a look at the S&P 500 top 10 performers in 1980:

  • Global Marine
  • Tandy Corp.
  • M/A-Com Inc.
  • Reading & Bates
  • Wang Labs
  • U.S. Home
  • Houston Oil & Minerals
  • SEDCO Inc.
  • Burlington Northern
  • Fluor Corp.

How many of those companies do you remember? Ten years later, the top 10 were:

  • Home Depot
  • NCR Corp.
  • Nike Inc.
  • Alberto-Culver
  • Service Corp. International
  • IMCERA Group
  • Beverly Enterprises
  • Jude Medical
  • Compaq Computer
  • Biomet Inc.

None of the companies that were top performers in 1980 made the list in 1990.

In 2000:

  • Dynegy Inc.
  • Reebok International
  • EOG Resources
  • HealthSouth Corp.
  • Calpine Corp.
  • Kinder Morgan
  • Power-One
  • PerkinElmer Inc.
  • Coastal Corp.
  • ALZA Corp.

Again, no overlap of high performers. In 2010:

  • Netflix Inc.
  • F5 Networks
  • Cummins Inc.
  • American Intl. Group
  • Zions Bancorp
  • Huntington Bancshares
  • Akamai Technologies
  • Whole Foods Market
  • Inc.
  • Qwest Communications Intl.

And finally, 2016—our most recent year:

  • NVIDIA Corp.
  • ONEOK Inc.
  • Freeport McMoRan Copper & Gold
  • Newmont Mining
  • Applied Materials
  • Quanta Services
  • Spectra Energy
  • Comerica Inc.
  • Martin Marietta Materials
  • Halliburton Co.

Picking the winners from year to year is nigh impossible, yet not owning the top 10 stocks represents an opportunity cost. It’s a mathematical fact:

  • The best-performing stocks can go up over 100% or more in any given year (think Amazon).
  • The worst-performing stocks can only go down 100%.
  • Therefore, a few stocks going up more than 100% can outweigh those that go down 75% or more.

Go Broad to Keep Up

This is why I recommend that investors own index funds that own all the companies, such as the Vanguard Total Stock Market Index Fund. Yes, there will always be companies that hit hard times and whose stocks fall 80 or 90%. But by diversifying your portfolio, you can more easily absorb those losses. Meanwhile, you will also likely own the one or two companies whose stocks skyrocket in any given year.

And you want to own those high achievers. Amazon’s stock price is in the quadruple digits right now. If an investor doesn’t own it, the chances of their portfolio keeping up with the broader market average is slim.

So back to my mantra: Diversify. Invest in a total stock market index fund. Own as much as you can so you have the opportunity to achieve the returns you need to keep up with the market and meet your financial goals.

With the Quarter's End, We Take a Look at Market Returns

Take a look at the following investment market returns as of June 30, 2017. As you can see, general stock market returns have been high, with the pendulum swinging in favor of international stocks (especially international emerging markets) over U.S. stocks. However, value-style and U.S. mid and small company stocks have lagged large company stocks. Bonds have provided modest returns but are our anchor during any storm in the stock market. Overall, we are pleased with our diversified strategy.     Year-to-Date 2017

MSCI ACWI IMI Global Stocks +11.32%
S&P 500 US Large Co Stocks +9.34%
MSCI USA IMI US Value Style Stocks +5.08%
S&P Midcap 400 Stocks +5.99%
S&P SmallCap 600 Stocks +2.79%
DFA US REIT +2.50%
DFA Commodity Strategy -4.09%
MSCI World EX USA International Stocks +13.59%
DFA Int’l Emerging Markets Core Fund +19.00%
U.S. Aggregate Bonds +2.27%

[Tweet "The pendulum has been swinging in favor of international stocks over U.S. stocks."]

Time to Review Your Portfolio? Use My Wealth

We encourage you to explore My Wealth to review your portfolio.

Here’s a helpful hint: Click on the left-hand tab “1-3-5 year history” to see your personal portfolio historical returns. It is quick and easy to use!

Please contact us if you need assistance registering or have any questions.

As always, please contact us with any questions, news, or comments.

When It Comes to Volatility, Let’s Not Get Complacent

We continue to experience slow economic growth, modestly chugging along without experiencing any major stock market turbulence. It has been nearly 10 years since the stock market peaked in July 2007 on the cusp of the 2007–2008 global financial crisis. We haven’t had a major stock market downturn, defined as a drop of 20% or more, since the stock market recovery began in March 2009. While we don’t make forecasts, let’s not grow complacent. Historically, the stock market has gone up about 75% of calendar years and down about 25% of the years. Risk and return are related, and higher potential returns over time from the stock market come with volatility in the short term.

Over five years ago we added a “Low Volatility” category to our asset allocation and mutual fund selection. Given the environment of low interest rates and the fact that bond prices go down when interest rates go up (admittedly, we were early in planning for rising interest rates), the goal was, and remains, to have a category with higher potential returns than bonds but less volatility than stocks. Easy to say, hard to do!

We recently added the Vanguard Global Minimum Volatility Fund to this list. It invests in U.S. and foreign stocks but uses a stock selection methodology to emphasize less volatile stocks that don’t go up as much when the stock market goes up but shouldn’t go down as much when the stock market goes down. Morningstar publishes a statistical measure called the Upside and Downside Capture Ratio to analyze relative performance, and we will use this as one tool to measure the Vanguard fund’s performance. As stated above, we have had remarkably low volatility in the stock market, but we are acting to “be prepared.”

[Tweet "Higher potential returns over time from the stock market come with volatility in the short term."]

My Wealth Update

Last month we announced the rollout of our “My Wealth” web-based service to provide you with easily accessible data about your investment portfolio. The feedback has been positive, and we plan to use the service more fully in our portfolio reporting in the near future.

If you have not already done so, please register for My Wealth and explore the rich, graphical reporting. If you have not saved the link on your desktop, laptop, and phone, we have added a link at the top right-hand page of our website for your convenience and easy access.

My Wealth charts provide multiple levels of portfolio analysis by clicking on each section of a report to drill down to a further level of detail. As with all new technology, the best way to learn about it is explore or hit the “Next” button at the top. We encourage you to “click around” My Wealth and explore it. Please contact us if you need assistance registering or have any questions.

Enjoy these early summer days! As always, please contact us with any questions, news, or comments.

Retirement Roadmap

No April Fooling: Active Management Offers Poor Predictability and Persistence

It is tempting to make the April edition of Fun Facts our April Fools’ joke, but we know our clients are far too smart to succumb to any “fake news.” Nonetheless, we will try to keep it fun! On good days, we like to think that all of our clients go to bed at night reciting the Four Core Principles of Berno Financial Management’s Investment Philosophy:

  1. Total Portfolio Approach
  2. Broadly Diversified Portfolio
  3. Risk and Return Are Related (the 3 R’s)
  4. Minimize Fund Fees, Expenses, and Income Taxes

We are toying with the idea of adding a fifth principle: Manage Predictability and Persistence. (Shall we call it “the 2 P’s”?)

Here is where it gets a little heavy:

  • Traditional active management has very poor predictability and persistence.
  • Passive asset class management has very high predictability and persistence.

According to two separate, long-term studies by Standard & Poor’s titled the SPIVA (Standard & Poor’s Index vs. Active) Scorecard and the Persistence Scorecard, the majority of active managers underperform their respective stock market index, and of those that do outperform, very few outperform consistently in the future.

[Tweet "The risk–reward ratio of trying to pick actively managed funds in advance is not justifiable. "]

Specifically, over five-year time periods:

  • 91% of large-cap,
  • 87% of mid-cap, and
  • 58% of small-cap managers lagged their respective benchmarks.

Furthermore, of the funds that were in the top 25%, only 1% of large-cap funds and 0% of mid-cap and small-cap funds remained in the top 25% at the end of the next five-year measurement period.

Conclusion: The risk–reward ratio of trying to pick successful actively managed funds in advance is not justifiable.

Passive asset class management is both predictable and persistent. No fooling!

As always, please contact us with any questions, news, or comments.

What Difference Can a Couple of Months Make? Take a Look at Recent 12-Month Returns

What a difference a couple of months make! When looking at past 12-month returns, dropping off one bad month and adding one good month can make a huge difference (and vice versa). In the case of 2016 and 2017, January and February 2016 turned out to be down months for global stocks, whereas January and February 2017 were positive months. So dropping two bad months and adding two good months can dramatically impact 12-month returns. For example, the DFA Global Equity Fund was up 12.93% for the 12 months ending December 31, 2016. Fast-forward to February 28, 2017, and the 12-month return jumps to 26.16%—a difference of 13%, or more than double, just because of two months! We all like to see stock market values rise, but remember that stocks are volatile and sharp declines can happen at any time. We are not forecasting a stock market downturn, but it has been several years since we had a sharp and prolonged down period for stocks. Gravity has not been repealed, and patient, long-term investors are rewarded with higher returns for the short-term risks associated with stocks. Remember the 3 R’s: Risk and return are related.

Warren Buffett, one of the most successful investors of all time, recently published his annual report letter for shareholders in Berkshire Hathaway. Here are two quotes:

Buy When Others Are Fearful

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

Vanguard’s John Bogle Is a Hero

If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds … In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.

[Tweet "What a difference a couple of months can make when it comes to market returns."]

One final note: We encourage you to start preparing your 2016 income tax return early. As a reminder, we posted Realized Gains and Losses Reports for your taxable [non-IRA or 401(k)] accounts to the Berno View Portal under Portfolio Reports: Tax Reports. Your TD Ameritrade Form 1099 for taxable accounts includes management fee data.

As always, please contact us with any questions, or news or comments.

Just How Accurate Are Forecasts Anyway?

As this month’s edition was written on Groundhog Day, both Punxsutawney Phil (say that three times fast) and Buckeye Chuck saw their shadows, hence forecasting six more weeks of winter. But how accurate is that forecast? Since 1969 Phil has had a 36% accuracy rate and since 1979 Chuck has had a 47% accuracy rate on early springs only, candidly acknowledging that the definition of “early spring” is subjective and debatable. Even professional meteorologists admit that long-term forecasts are foggy at best. Nice pun! Let’s look at recent consensus forecasts that went awry. General consensus was that:

  • Brexit wouldn’t pass. It did.
  • Donald Trump wouldn’t be elected President. He was.
  • The stock market would go down if Trump was elected. It went up.
  • The Chicago Cubs couldn’t win the World Series. They did.
  • Bruce Berno would become a Masters Swimming Champion. Who said that?!

[Tweet "Let’s look at recent consensus forecasts that went awry."]

Successful investing is the result of discipline, not forecasting.

Successful investing is contrarian. You have to avoid following the crowd, and you have to be willing to ignore your short-term emotions and gut feelings.

Successful investing is a steady, methodical process. The more changes one makes, the more chances one has of being wrong.

Successful investing is humbling.

Successful investing is boring. But fun!


Please join me in congratulating Kim Masco on successfully earning her Registered ParaplannerSM designation granted by the College for Financial Planning. The RP® course of study encompasses the process and five disciplines of financial planning, terminology and general concepts. Well done, Kim!

As always, please contact us with any questions, news or comments.

Looking for a New Year’s Resolution? Here Are a Few Ideas for 2017

In the spirit of the holiday season, here is a list of early New Year’s resolutions and fun things to do in 2017!

  1. Remember, cash flow (income versus expenses) is the key to long-term financial success. If you are gainfully employed, you should save 15% to 25% of your income. If you are retired or not fully employed and are drawing on your investment portfolio, your total annual withdrawals should be 3% to 5% of your portfolio value or less. If your savings rate is low or withdrawal rate is high, review steps to increase your employment income or reduce your expenses.
  1. Insurance is the foundation of sound financial planning. Home and auto insurance, umbrella liability coverage, health insurance, life insurance, disability and long-term-care insurance all require regular review and updating. Funding a health savings account (HSA) warrants consideration. If you own or are considering long-term-care insurance, pay particular attention to and understand the inflation protection options.
  1. Are you maximizing your internet safety and protection by using different passwords, using long and complicated passwords and changing your passwords at least once a year? We highly recommend that you use a password manager program such as Dashlane, LastPass or RoboForm so you can have many different and complicated passwords but you only have to remember one password for your password manager program.
  1. Do your children or grandchildren have employment income that could be used for a Roth IRA contribution? If applicable, have you funded 529 college savings plans for the calendar year for children or grandchildren?
  1. Does a trusted person know where you keep your website usernames, passwords and answers to security questions? Do your family members know where to locate important personal financial papers and how to contact your professional advisors in case of an emergency?

Have a safe and happy holiday season. Take good care of yourself.

[Tweet "Best wishes for a healthy and prosperous new year in 2017!"]

Why Not Chase Past Performance? The Persistence Scorecard Lays It Out

“Don’t chase past performance” is one investment mantra that makes sense but is hard to live by. It applies to both asset allocation decisions (let’s double up on large cap growth stocks since they have been up the most over the last three years) and individual mutual fund selections (let’s buy XYZ Fund—it’s up 50%!). If you need a well-researched reason not to chase past fund performance and another good reason that supports our investment strategy, we have the Fun Facts for you! Standard & Poor’s publishes “The Persistence Scorecard,” which tracks how top-performing funds in one time period continue to perform in future time periods. Bottom line, relatively few funds consistently stay at the top. Specifically, out of 641 U.S. stock funds that were in the top 25% as of March 2014, only 7.3% managed to stay in the top 25% by the end of March 2016. The longer the time period, the lower the persistence: Only 0.78% of large cap funds and no mid cap or small cap funds stayed in the top 25% after five years.

[Tweet ""Don’t chase past performance" is one investment mantra that makes sense but is hard to live by."]

Fortunately, for our clients, we manage and reduce this risk by using asset class or index funds. These funds have a much higher probability of matching their underlying asset class performance due to their broad diversification and low cost. Hopefully, this helps you sleep better at night and increases your financial peace of mind!

Shifting to seasonal highlights, October is National Cyber Security Awareness Month. So appropriate for Halloween! While we are not technology experts, we do recommend that you use long and complicated passwords for financial accounts and websites with personal confidential information, and different passwords for different websites, which may include simpler passwords for websites like general news or sports subscriptions.

Last month I said I had one and only one comment on the presidential election, but here is one more to consider: The stock market reacts strongly to unexpected news. This presidential election and its candidates are more controversial than we have seen in several elections, but all public news is already reflected in the stock market. We know that one candidate will get elected. The stock market isn’t spiraling down in fear that one candidate or the other will get elected. You shouldn’t live in fear either.

Happy October and happy Halloween! As always, please contact us with any questions, news or comments.

Invest in Stocks as a Steady Income Source in Retirement

If you’re close to retirement, you’re probably considering a more conservative portfolio of investments—one designed to produce income rather than capital appreciation. Dividend-paying stocks can play an important part of that portfolio since they may offer lower risk and more stability while generating a steady and generally growing stream of income. In today’s low-interest-rate environment, stock dividend yields and bond interest rates are quite comparable, but stock cash dividends have the advantage of potentially growing over time. Increases in stock dividends also provide protection against inflation.

 Lower Risk, More Stability

Companies that provide dividends are generally mature companies (think Johnson & Johnson or Coca-Cola). The companies tend to be stable and are generating enough profit that they are able to pay out dividends.

This stability helps make dividends a source of income especially appropriate for retirees. Dividend stocks are generally less volatile than stocks that don’t pay dividends. With dividend-paying stocks, you receive spendable cash (usually quarterly) without having to touch the principal. You could even reinvest the dividends to buy more shares, thus increasing your income in the future.

What’s more, because the companies offering dividends are, by and large, established companies with a solid foundation of profits, they tend to increase dividend payouts over time. Say, for example, you purchased shares of Coca-Cola in 2000. In September of that year, the dividend was $0.17 per share. Coca-Cola has since paid out quarterly dividends, now amounting to $0.35 per share. That’s money you would have enjoyed quarterly without having to do anything but collect it. And although—as the Coca-Cola example shows—initial dividend yields may not be high, over time the yield on your original investment could become 10–15% or more.

[Tweet "Stock cash dividends have the advantage of potentially growing over time."]

Dividends as Income

Dividends can play an important role in a retiree’s portfolio—and it’s a role that has become more central in this era of low interest rates. As a retiree, you probably expect to withdraw around 4% from your retirement accounts each year. With a well-executed strategy, a good portion of that could come from stock dividends—say, 2–3%—thus leaving much of your principal intact.

Like any investment, dividend-paying stocks carry risk. The company could suffer severe financial straits, or the markets could hit an extreme point that affects the balance sheets of even stable companies, as in the housing crash and recession of 2007–08. There are always risks in investing, and it’s important to remember that past performance is no guarantee of future results. That said, it is rare that dividend companies have to reduce dividends. You will receive a steady, often increasing source of income that can act as a hedge against inflation and a buffer against volatile markets. That makes dividend stocks, and mutual funds that invest in them, a good investment for almost anyone.

If you’d like to see how dividend-stock mutual funds can play a role in your portfolio, please contact us.


Stock Market Cliché Falls Short This Summer

There is an old stock market saying, “Sell in May and go away,” based on historical cycles that the stock market slumps during the summer (not to mention “going away” to the beach or vacation is more fun!). As with many stock market clichés, this adage is not always consistent given that the summer of 2016 has been strong in both June and July. I know summer isn’t over until after August, but with schools starting earlier every year, summer seems to keep getting shorter! Remember, “the stock market” is not the Standard & Poor’s 500 Index but rather the MSCI ACWI (All Country World Index). The MSCI ACWI rose 4.42% in July and is up 5.7% year-to-date. International stocks as measured by the MSCI World ex USA index were up 5.05% for July but a more modest 2.65% year-to-date.

Our broadly diversified strategy was supported in a recent Wall Street Journal article by personal finance columnist Jason Zweig. In his July 29 article “Your 401(k) Is Not Safe at Home,” he emphasized the risk of having too much of one’s 401(k) plan in employer stock. While the risk of loss is obvious, he pointed out (as we frequently do) that it is what you don’t own that may hold down your returns. He states: “In 2013, when the Wilshire 5000 stock index gained a spectacular 34%, one-fifth of all stocks lost money. … In 2014, although the total U.S. stock market gained 12%, more than four out of every 10 stocks went down anyway. In 2015, only five companies—Amazon, Alphabet (Google), Microsoft, Facebook and General Electric—accounted for well over 100% of the return of the U.S. stock market.” His advice: “Invest in all companies at once, through a total stock-market index fund, and you eliminate your risk of missing out on every other winner out there.”

[Tweet "Our broadly diversified strategy was supported in a recent Wall Street Journal article."]

Two nice personal notes from our office: Donna’s son, Cameron, just graduated from Army National Guard training with honors and will be enrolled at Wright State University this fall. Kathy’s son, Andrew, passed his state boards and is now a licensed physical therapist. Congratulations, Cameron and Andrew!

Enjoy these summer days! As always, please contact us with any questions, news or comments.

Roth IRAs and Children: Never Too Early to Save

You want your child or grandchild to be financially secure—not just now but throughout life. A great way to get a kid started on that path is through a Roth IRA. What is a Roth IRA? Contributions to a Roth Individual Retirement Account (IRA) do not qualify for an immediate income tax deduction; but a child is in a low tax bracket, so a tax deduction is not meaningful. Most important, qualified withdrawals from Roth IRAs are income-tax-free, and there is not a required minimum distribution at age 70 ½ like a traditional IRA, so a Roth IRA can grow tax-free for many years.

Yes, children can contribute to a Roth IRA, or you may do it on their behalf. Either way, by laying the groundwork of saving now, you can help them achieve a secure retirement. In the process they’ll get an early education in personal finance. With many adult Americans woefully illiterate about finance, your kid will be ahead of the pack before they even graduate from college.

How It Works

You can set up a Roth IRA as soon as your child or grandchild starts earning income. That money can be W-2 wages, or it can be self-employment income, like babysitting. An allowance does not count as earned income, but if you own a business, you can employ the child. The job must be age-appropriate, and the wages must be at the market rate.

A bonus to the Roth IRA is that the IRS doesn’t care who contributes to the account. It can be a child, a parent or a grandparent. So, for example, if you want to set up an agreement that for every dollar the child earns, you’ll put a dollar in their Roth IRA, that’s perfectly fine. The only requirement is that the total amount contributed to the account cannot exceed the amount the child earned.

[Tweet "Kids can have Roth IRAs too! Here's what you need to know:"]

A couple of other points:

  • You can contribute as much as $5,500 to a Roth IRA annually. This amount is set by the IRS and will likely change over the years.
  • You can contribute as much as $400 in self-employment income without having to worry about paying Social Security or Medicare taxes. Make more than $400 and a tax return will need to be filed.
  • If a child does not receive a W-2 for the work they do, they need to keep records—which can be a great lesson in organization and responsibility. The records should include the type of work they did, when and who they did it for, and how much money they made.
  • You’ll likely be the custodian for the account until your child or grandchild reaches adulthood—age 18 or 21 depending on the state. After that, they’ll take control of the account.

Using the Roth IRA for Life’s Milestones

Roth IRAs offer flexibility that other retirement accounts don’t. Because they’re funded with after-tax dollars, the contributions can be withdrawn before retirement without penalty or taxes. Not so for the earnings—a nonqualified withdrawal before age 59 1/2 will incur taxes and a 10% penalty.

When it comes to buying a first-time home, the Roth can prove especially helpful since the purchase counts as a qualified withdrawal. So, in addition to contributions, a first-time homebuyer can tap into earnings of up to $10,000 as long as the account is at least five years old and the money is used for the down payment, closing costs and related expenses.

Flexibility like this makes Roth IRAs very attractive. Of course, if your child or grandchild can buy their first home without dipping into their account, all the better since it will leave more for retirement.

One final point: By getting a child saving early, the Roth IRA becomes an effective vehicle for transferring wealth from one generation to the next. Ultimately, your heirs may have a sizeable retirement savings before they even start their career.

As always, consult with a qualified tax advisor about your personal financial situation.

Kick Off Your Summer Reading with Our “Fun Facts”—We’ll Keep Them Short!

Since summer is beginning, I’ll keep “Fun Facts” short and let you get started on your summer reading list, which I’m sure will be more enjoyable but not as “Fun …” Don’t leave home without the four core principles of our investment philosophy:

  1. Total Portfolio Approach. We manage your total portfolio considering all accounts, whether they be single, joint or trust taxable accounts or retirement accounts like IRAs, Roth IRAs or 401(k)s. We consider “asset allocation” for the total portfolio as well as different types of accounts (for example, a Roth IRA may be more aggressively invested for growth and future inheritance). We also consider “asset location” wherein tax-inefficient investments like REITs may be limited to retirement accounts.
  1. Broadly Diversified Portfolio. Investment management is a contrarian process where “buy low and sell high” is easier said than done. Diversification helps smooth the peaks and valleys, although it is challenging not to load up on the most recent best investment and avoid the most recent dog. Discipline helps achieve long-term goals and avoid strikeouts. (A great summer analogy, wouldn’t you say?)
  1. Risk and Return Are Related (The 3 R’s). Nothing demonstrates this principle better than the seemingly perpetual period of low interest rates that we have been experiencing. Low risk yields low return, and higher returns require accepting more risk and potential volatility.
  1. Minimize Fund Fees, Expenses and Income Taxes. Simply said, net returns are what count! Low fund fees are a good predictor of future relative performance.

Enjoy these early summer days!

[Tweet "Simply said, net returns are what count!"]

As always, please contact us with any questions, news or comments.

Title of Popular Soap Opera a Good Theme for Investing

As the World Turns was a popular soap opera for 54 years on CBS from 1956 to 2010. While I never watched it, the title is applicable to investment management in our increasingly global and rapidly changing world. The investment pendulum swung strongly in our favor in both March and April with international and value-style stocks being strong performers. The dog of the past few years—commodities—has been the best performer in 2016. What will the future bring? Stay tuned! Remember: The world does turn, and the stock market goes up and down. A bull market is defined as a time period when the stock market goes up more than 20% from its prior low and never falls more than 20% from a recent high. We are now in the second-longest bull market in history. Much of this bull market, which began in 2009, is recovery from the carnage of 2008. But remember that sharp stock market downturns have not been repealed, and as we wrote recently, recoveries are faster than people think or realize. For you statistics buffs, the longest bull market was October 1990 to March 2000. Those were the days!

U.S. economic growth poses a challenge, with the economy growing only 0.5% in the first quarter of 2016, versus 1.4% in the fourth quarter of 2015 and 2.0% in the third quarter.

[Tweet "The investment pendulum swung strongly in our favor in both March and April."]

We have preached for years that low-cost funds serve our clients better and high-cost funds pose a hurdle that is hard to overcome. This is included in our Investment Philosophy Core Principle #4, “Manage fees and expenses.”

Morningstar recently published updated research on the value and importance of using low-cost funds. Morningstar Director of Manager Research Russ Kinnel defines and summarizes the results of his research as follows (emphasis added in bold): “… the problem with only looking at returns is you generally have survivorship bias … So, success ratio is a way of folding those funds that got killed off back into the performance … It turns out costs do matter … and what's really powerful … is how big the impact is, so for instance, the cheapest quintile of equity funds over the five years and in 2015 had a 62% success ratio versus 20% for the priciest quintile. Meaning, you are three times more likely to be successful shopping in the cheapest bin than the priciest bin. And what's also striking is just how consistent that is. Look at any time period, look at any peer group, asset group and it works and almost always it's that same stair step. So, it's really a remarkably consistent indicator of performance.” I couldn’t have said it better, which is why I quoted him!

As always, please contact us with any questions, news or comments.