Getting a Larger Social Security Retirement Benefit

Many people decide to begin receiving early Social Security retirement benefits. In fact, according to the Social Security Administration, about 72% of retired workers receive benefits prior to their full retirement age (See Note 1). But waiting longer could significantly increase your monthly retirement income, so weigh your options carefully before making a decision.

SocSecurityTriColiStock_000008528384_sqTiming counts
Your monthly Social Security retirement benefit is based on your lifetime earnings. Your base benefit, which isthe amount you’ll receive at full retirement age, is calculated using a formula that takes into account your 35 highest earnings years.

If you file for retirement benefits before reaching full retirement age (66 to 67, depending on your birth year), your benefit will be permanently reduced. For example, at age 62, each benefit check will be 25% to 30% less than it would have been had you waited and claimed your benefit at full retirement age (see table).

Alternatively, if you postpone filing for benefits past your full retirement age, you’ll earn delayed retirement credits for each month you wait, up until age 70. Delayed retirement credits will increase the amount you receive by about 8% per year if you were born in 1943 or later.

The chart below shows how a monthly benefit of $1,800 at full retirement age (66) would be affected if claimed as early as age 62 or as late as age 70. This is a hypothetical example used for illustrative purposes only; your benefits and results will vary.


Birth year                                                Full retirement age                             Percentage reduction at age 62

1943-1954                                               66                                                            25%
1955                                                         66 and 2 months                                  25.83%
1956                                                         66 and 4 months                                  26.67%
1957                                                         66 and 6 months                                  27.50%
1958                                                         66 and 8 months                                  28.33%
1959                                                         66 and 10 months                                29.17%
1960 or later                                          67                                                             30%

Early or late?
Should you begin receiving Social Security benefits early, or wait until full retirement age or even longer? If you absolutely need the money right away, your decision is clear-cut; otherwise, there’s no ”right” answer. But take time to make an informed, well-reasoned decision.

Consider factors such as how much retirement income you’ll need, your life expectancy, how your spouse or survivors might be affected, whether you plan to work after you start receiving benefits, and how your income taxes might be affected.

Should Stock Investors Sell Now?

Should stock investors sell now? It’s been a good year for stocks — for the year-to-date period ending September 30, 2016, the Standard & Poors 500 has returned 7.84% despite the year’s rocky start in January and early February. But has performance been too good?

fixed-income-investment-strategies-1_1-800X800Seven-and-a-half years into the bull market, valuations are high and there may be little upside in stocks between now and year-end. Volatility has started to increase modestly in recent weeks after a summer period that saw unusually low volatility in the equity markets. So, we may be due for a pullback.

Add to that, October has sometimes been a month characterized by high volatility, especially during an important Presidential election. These factors beg the question: should you sell now? Certainly taking some profits or rebalancing portfolios according to your regular plan is prudent. But in this commentary I lay out reasons why making more dramatic changes in your investment allocation may not be the best move.

Are Stocks Too Expensive?
 Some investors think stocks are expensive. In fact, the LPL Financial Research department explained in a research note last month that the S&P 500 price-to-earnings ratio (PE) using the median calculation is more than 50% above its long-term average. Traditional market cap weighted valuations are also high — the current PE of 18 (trailing four quarters) is above the average of 15.2 going back to 1950, and even above the higher post-1980 average of 16.4.

But are high valuations a reason to sell? Not necessarily! Valuations have not been good predictors of stock market performance over the subsequent year, according to the LPL Financial research note. Other credible investment research has reached similar conclusions.

The correlation between the S&P 500’s PE and the index’s return over the following year, at -0.31, is relatively low (based on 45 years of data). Stocks can stay overvalued longer than we might think they should, so I instead recommend focusing more on macroeconomic fundamentals, and technical factors, not valuations, for indications of an impending market correction or bear market.

Valuations were a reason to sell during the tech bubble, but it was hard to tell when. The one-year return for the S&P 500 from March 31, 2000, at a PE of 28.2, was -21.7%. But valuations were high well before that, suggesting that even at extremes, predicting market direction using valuations is an inexact science at best. Starting in June 1997, with the S&P 500’s PE over 20, the S&P 500 produced gains of 30.2% and 22.8% over the two subsequent 12-month periods.

The relationship between stock market performance and valuation gets much stronger when looking at longer time periods. Once again, a recent report from LPL Financial Research showed that, when plotting PE against stock returns over the subsequent 10-year period, the correlation (negative) is quite strong. 

file0001033439999LPL Research found that, as PEs rise, subsequent returns are lower; and vice versa. Eyeballing the two charts it is easy to see the difference, but we can put numbers on it. The correlation between PE and returns over the next 10 years is -0.87, a much closer relationship than PEs and one-year returns at -0.31 (-1 is perfect negative correlation and 0 equates to no correlation).

More Reasons To Hold Your Current Equity Allocation
Valuations may not be good reasons to sell, but are there, in fact, reasons to consider buying here? In spite of the solid returns so far this year, further equity market gains would not be shocking given the following factors:

Odds For Recession May Be Low
Many market experts, including  LPL Financial, JP Morgan Asset Management, and others continue to see the odds of recession over the next 12–18 months as being in the 20% range based on leading indicators and few signs of excesses in the economy that might lead to major imbalances. If a recession is more than a year away, based on data back to 1950, the odds are over 80% that the S&P 500 delivers a positive annual return.

Favorable Monetary Policy and Low Interest Rates
If the economy weakens further, the Federal Reserve (Fed) may deliver additional stimulus. The Fed could state its intentions to maintain low interest rates for longer, or potentially initiate another round of quantitative easing, i.e., more bond purchases. Investors may understandably not like the idea of primarily relying on Federal Reserve Bank policies to prop up stocks, but the fact remains that markets have responded to them. Furthermore, low bond yields (also a result of Fed policy) continue to enhance the appeal of stocks.

A Rebound in Corporate Earnings
Future earnings estimates have tended to run high historically and are almost always subject to change. However, the economic data, along with stability in oil and the U.S. dollar,  suggest an earnings rebound may be quite achievable. Current earnings growth expectations based on Thomson Reuters consensus data for the fourth quarter of 2016 and first and second quarters of 2017 are +8%, +15%, and +13%. Remember, markets tend to look about six months ahead.

Fourth Quarter Rally?
The S&P 500 has historically performed well during the fourth quarter with an average gain of over 4% (versus a 2.1% average for all quarters), with gains 79% of the time going back to 1950. Fourth quarters of election years are no better than an average quarter, but excluding 2008, the average fourth quarter gain during an election year is 3.6% and the S&P 500 is higher 87% of those quarters. We continue to believe that markets should welcome greater clarity on the potential election outcome when it arrives.

Valuations and seasonality do not appear to be good reasons to sell stocks right now. In fact, a number of factors I have discussed here suggest stocks do offer the potential for growth between now and year end. Although it is also possible that future gains may be limited, don’t be surprised to greater volatility and consider using temporary equity weakness to buy at lower prices.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. All investing involves risk including loss of principal.

Correlation ranges between -1 and +1. Perfect positive correlation (a correlation co-efficient of +1) implies that as one security moves, either up or down, the other security will move in lockstep, in the same direction. Alternatively, perfect negative correlation means that if one security moves in either direction the securitythat is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation;they are completely random.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

 This research material has been prepared by LPL Financial LLC.


Ten Year End Tax Planning Tips for 2016

Here are 10 things to consider as you weigh potential tax moves between now and the end of the year.

1. Set aside time to plan
BF-AA310_401k_D_20101210153343Effective planning requires that you have a good understanding of your current tax situation, as well as a reasonable estimate of how your circumstances might change next year. There’s a real opportunity for tax savings if you’ll be paying taxes at a lower rate in one year than in the other. However, the window for most tax-saving moves closes on December 31, so don’t procrastinate.

2. Defer income to next year
Consider opportunities to defer income to 2017, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.

3. Accelerate deductions
You might also look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year, instead of paying them in early 2017, could make a difference on your 2016 return.

irs-logo-tax-1040-form4. Factor in the AMT
If you’re subject to the alternative minimum tax (AMT), traditional year-end maneuvers such as deferring income and accelerating deductions can have a negative effect. Essentially a separate federal income tax system with its own rates and rules, the AMT effectively disallows a number of itemized deductions. For example, if you’re subject to the AMT in 2016, prepaying 2017 state and local taxes probably won’t help your 2016 tax situation, but could hurt your 2017 bottom line. Taking the time to determine whether you may be subject to the AMT before you make any year-end moves could help save you from making a costly mistake.

5. Bump up withholding to cover a tax shortfall

If it looks as though you’re going to owe federal income tax for the year, especially if you think you may be subject to an estimated tax penalty, consider asking your employer (via Form W-4) to increase your withholding for the remainder of the year to cover the shortfall. The biggest advantage in doing so is that withholding is considered as having been paid evenly through the year instead of when the dollars are actually taken from your paycheck. This strategy can also be used to make up for low or missing quarterly estimated tax payments.

6. Maximize retirement savings
Deductible contributions to a traditional IRA and pretax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2016 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so by year-end.

tax7. Take any required distributions
Once you reach age 70½, you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (an exception may apply if you’re still working and participating in an employer-sponsored plan). Take any distributions by the date required–the end of the year for most individuals. The penalty for failing to do so is substantial: 50% of any amount that you failed to distribute as required.

8. Weigh year-end investment moves
You shouldn’t let tax considerations drive your investment decisions. However, it’s worth considering the tax implications of any year-end investment moves that you make. For example, if you have realized net capital gains from selling securities at a profit, you might avoid being taxed on some or all of those gains by selling losing positions. Any losses over and above the amount of your gains can be used to offset up to $3,000 of ordinary income ($1,500 if your filing status is married filing separately) or carried forward to reduce your taxes in future years.

9. Beware the net investment income tax
Don’t forget to account for the 3.8% net investment income tax. This additional tax may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately, $200,000 if head of household).

10. Get help if you need it
There’s a lot to think about when it comes to tax planning. That’s why it often makes sense to talk to a tax professional who is able to evaluate your situation and help you determine if any year-end moves make sense for you.

Should You Consider a 2016 Charitable Contribution from Your IRA?

Yes, if you qualify. The law authorizing qualified charitable distributions, or QCDs, has recently been made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015.

1417067088h5adaYou simply instruct your IRA trustee to make a distribution directly from your IRA (other than a SEP or SIMPLE) to a qualified charity. You must be 70½ or older, and the distribution must be one that would otherwise be taxable to you.

You can exclude up to $100,000 of QCDs from your gross income in 2016. And if you file a joint return, your spouse (if 70½ or older) can exclude an additional $100,000 of QCDs. But you can’t also deduct these QCDs as a charitable contribution on your federal income tax return–that would be double dipping.

QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to take from your IRA in 2016, just as if you had received an actual distribution from the plan. However, distributions (including RMDs) that you actually receive from your IRA and subsequently transfer to a charity cannot qualify as QCDs.

For example, assume that your RMD for 2016 is $25,000. In June 2016, you make a $15,000 QCD to Qualified Charity A. You exclude the $15,000 QCD from your 2016 gross income. Your $15,000 QCD satisfies $15,000 of your $25,000 RMD. You’ll need to withdraw another $10,000 (or make an additional QCD) by December 31, 2016, to avoid a penalty.

You could instead take a distribution from your IRA and then donate the proceeds to a charity yourself, but this would be a bit more cumbersome and possibly more expensive. You’d include the distribution in gross income and then take a corresponding income tax deduction for the charitable contribution.

But the additional tax from the distribution may be more than the charitable deduction due to IRS limits. QCDs avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity–you don’t report the IRA distribution in your gross income, and you don’t take a deduction for the QCD.

The exclusion from gross income for QCDs also provides a tax-effective way for taxpayers who don’t itemize deductions to make charitable contributions.

Strategies for Retiring in Volatile Markets

In an ideal world, your retirement would be timed perfectly. You would be ready to leave the workforce, your debt would be paid off, and your nest egg would be large enough to provide a comfortable retirement–with some left over to leave a legacy for your heirs.

roller-coasterUnfortunately, this is not a perfect world, and events can take you by surprise. In a survey conducted by the Employee Benefit Research Institute, only 44% of current retirees said they retired when they had planned; 46% retired earlier, many for reasons beyond their control.1

But even if you retire on schedule and have other pieces of the retirement puzzle in place, you cannot predict the stock market. What if you retire during a market downturn?

Sequencing risk
The risk of experiencing poor investment performance at the wrong time is called sequencing risk or sequence of returns risk. All investments are subject to market fluctuation, risk, and loss of principal–and you can expect the market to rise and fall throughout your retirement.

However, market losses on the front end of your retirement could have an outsized effect on the income you might receive from your portfolio. If the market drops sharply before your planned retirement date, you may have to decide between retiring with a smaller portfolio or working longer to rebuild your assets.

If a big drop comes early in retirement, you may have to sell investments during the downswing, depleting assets more quickly than if you had waited and reducing your portfolio’s potential to benefit when the market turns upward.

buckets-of-change-1024x545Dividing your portfolio
One strategy that may help address sequencing risk is to allocate your portfolio into three different buckets that reflect the needs, risk level, and growth potential of three retirement phases.

Short-term (first 2 to 3 years): Assets such as cash and cash alternatives that you could draw on regardless of market conditions.

Mid-term (3 to 10 years in the future): Mostly fixed-income securities that may have moderate growth potential with low or moderate volatility. You might also have some equities in this bucket.

Long-term (more than 10 years in the future): Primarily growth-oriented investments such as stocks that might be more volatile but have higher growth potential over the long term.

Throughout your retirement, you can periodically move assets from the long-term bucket to the other two buckets so you continue to have short-term and mid-term funds available. This enables you to take a more strategic approach in choosing appropriate times to buy or sell assets.

Although you will always need assets in the short-term bucket, you can monitor performance in your mid-term and long-term buckets and shift assets based on changing circumstances and longer-term market cycles. If this strategy appeals to you, consider restructuring your portfolio before you retire so you can choose appropriate times to adjust your investments.

Stretch-IRADetermining withdrawals
The three-part allocation strategy may help mitigate the effects of a down market by spreading risk over a longer period of time, but it does not help determine how much to withdraw from your savings each year. The amount you withdraw will directly affect how long your savings might last under any market conditions, but it is especially critical in volatile markets.

One common rule of thumb is the so-called 4% rule. According to this strategy, you initially withdraw 4% of your portfolio, increasing the amount annually to account for inflation. Some experts consider this approach to be too aggressive–you might withdraw less depending on your personal situation and market performance, or more if you receive large market gains.

Another strategy, sometimes called the endowment method, automatically adjusts for market performance. Like the 4% rule, the endowment method begins with an initial withdrawal of a fixed percentage, typically 3% to 5%. In subsequent years, the same fixed percentage is applied to the remaining assets, so the actual withdrawal amount may go up or down depending on previous withdrawals and market performance.

A modified endowment method applies a ceiling and/or a floor to the change in your withdrawal amount. You still base your withdrawals on a fixed percentage of the remaining assets, but you limit any increase or decrease from the prior year’s withdrawal amount. This could help prevent you from withdrawing too much after a good market year, while maintaining a relatively steady income after a down market year.

Note: Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

1Employee Benefit Research Institute, “2016 Retirement Confidence Survey”

Beyond Politics: What Does the Election Mean for Your Investments?

As the recent Democratic and Republican political conventions are in the rear view mirror, the presidential election season will now move into high gear! The “hype” on everyone’s minds right now is, of course, whether Donald or Hillary should win the election, and that cannot be ignored. If this post was an actual debate and I were behind the podium, the question you might ask is: How will this election affect the markets?

donald-hillary-800In previous communications, I have consistently emphasized the importance of maintaining a long-term perspective. Investors must keep their emotions in check and strive to block out the hype – the noise that can distract any of us from moving toward the attainment of your long-term financial goals.

The elections can sometimes bring out the more emotional side of our personalities, especially during a presidential election year which can cause excitement or despair, depending on your side of the aisle. I have even heard people complain that if a certain candidate wins, “The markets are doomed and so are my investments!”

Although every citizen is certainly entitled to their political beliefs, I think it might likely be very unwise to allow your political passions to drive your investment choices. It’s not about election years, or even political parties – but about investing for the long run. Nonetheless, there are some historical election year patterns that may be worth watching. Here are a few to consider, according to the 2016 Mid Year Outlook recently published by the investment research department at LPL Financial:

file0001935255693The Economic Factor: Income Growth
Income growth is one way to gauge the impact of the economy on election results, as this measure captures the impact of several key factors, including the unemployment rate, inflation, and wage growth. In the year leading up to the election, inflation adjusted, after-tax income growth of about 3% to 4% appears to be the threshold for the incumbent party to win. As of June 30th, this measure is currently growing in the 3% to 3.5% range, suggesting that the incumbent Democratic Party has a good chance of winning just over 50% of the two-party vote in November’s election.

Stock Market Performance Under Different Parties
The often spoken market mantra that “gridlock is good” suggests that a split Congress, or a President from the party opposite the one in control of both houses of Congress, would be better for markets. The downside, however, is that gridlock could limit policy action at a time when many policy experts think changes are needed on several fronts including taxes, entitlement reform, immigration, security, and others.

Historically, the combination of a Democratic President and split Congress has been best for markets, though it has occurred infrequently, with an average gain of 10.4% for the Dow Jones Industrial Average. A Republican sweep of the White House and Congress, on the other hand, has also been positive for stocks as well, with an average gain for the Dow of 7%. Election years have been strong for stocks, excluding the anomaly in 2008, the worst year of the Great Recession. Election year gains have averaged close to 10% and positive returns have occurred in a solid 87% of election years.

RisinginterestratesiStock_000078549611_MediumThe election year pattern for stocks suggests volatility may persist through the summer months until markets have more clarity on the candidates and their platforms. Once that clarity arrives, often before the election itself, stocks have typically staged a late-year rally. The path of bond yields during a presidential election year is very similar to the historical pattern for any given year.

The seasonal tendency is for yields to decline starting in late October through November; but during election years, the tendency has been for an increase in Treasury yields. Taking these historical patterns into consideration, and given the current environment, suggests that we will remain in a similar policy and stock environment as we’ve seen in recent years.

A Winning Platform
The road to long-term financial goals is filled with many potholes and road blocks. But the best election year “trade” might be to stick to your long-term investment strategy and remain focused on your investment aspirations. Over these past seven years, one of the best, but also most befuddling, bull markets in history may have made us feel like the financial markets are not functioning properly, and there’s a need to change something to “make investing great again.”

But even though a changing world presents important new challenges, staying focused on a good plan, and remaining patient may bring out the ways that “investing has always been great.” I think you have the winning platform already: invest early and often, stay diversified, and be patient through the ups and downs.

As always, if you have any questions, please email me at or call me at (925) 464-7057.

Watch Out for These Six Potential 401(k) Rollover Pitfalls

You’re about to receive a distribution from your 401(k) plan, and you’re considering a rollover to a traditional IRA. While these transactions are normally straightforward and trouble free, there are some pitfalls you’ll want to avoid.

401kRollovertoIRA1. The first mistake some people make is failing to consider the pros and cons of a rollover to an IRA in the first place. You can leave your money in the 401(k) plan if your balance is over $5,000. And if you’re changing jobs, you may also be able to roll your distribution over to your new employer’s 401(k) plan.

Though IRAs typically offer significantly more investment opportunities and withdrawal flexibility, your 401(k) plan may offer investments that can’t be replicated in an IRA (or can’t be replicated at an equivalent cost).

401(k) plans offer virtually unlimited protection from your creditors under federal law (assuming the plan is covered by ERISA; solo 401(k)s are not), whereas federal law protects your IRAs from creditors only if you declare bankruptcy. Any IRA creditor protection outside of bankruptcy depends on your particular state’s law.

401(k) plans may allow employee loans.

And most 401(k) plans don’t provide an annuity payout option, while some IRAs do.

2. Not every distribution can be rolled over to an IRA. For example, required minimum distributions can’t be rolled over. Neither can hardship withdrawals or certain periodic payments. Do so and you may have an excess contribution to deal with.

file0002903222023. Use direct rollovers and avoid 60-day rollovers. While it may be tempting to give yourself a free 60-day loan, it’s generally a mistake to use 60-day rollovers rather than direct (trustee to trustee) rollovers. If the plan sends the money to you, it’s required to withhold 20% of the taxable amount.

If you later want to roll the entire amount of the original distribution over to an IRA, you’ll need to use other sources to make up the 20% the plan withheld. In addition, there’s no need to taunt the rollover gods by risking inadvertent violation of the 60-day limit.

4. Remember the 10% penalty tax. Taxable distributions you receive from a 401(k) plan before age 59½ are normally subject to a 10% early distribution penalty, but a special rule lets you avoid the tax if you receive your distribution as a result of leaving your job during or after the year you turn age 55 (age 50 for qualified public safety employees). But this special rule doesn’t carry over to IRAs.

If you roll your distribution over to an IRA, you’ll need to wait until age 59½ before you can withdraw those dollars from the IRA without the 10% penalty (unless another exception applies). So if you think you may need to use the funds before age 59½, a rollover to an IRA could be a costly mistake.

5. Learn about net unrealized appreciation (NUA). If your 401(k) plan distribution includes employer stock that’s appreciated over the years, rolling that stock over into an IRA could be a serious mistake. Normally, distributions from 401(k) plans are subject to ordinary income taxes. But a special rule applies when you receive a distribution of employer stock from your plan: You pay ordinary income tax only on the cost of the stock at the time it was purchased for you by the plan.

Any appreciation in the stock generally receives more favorable long-term capital gains treatment, regardless of how long you’ve owned the stock. (Any additional appreciation after the stock is distributed to you is either long-term or short-term capital gains, depending on your holding period.) These special NUA rules don’t apply if you roll the stock over to an IRA.

6. And if you’re rolling over Roth 401(k) dollars to a Roth IRA…If your Roth 401(k) distribution isn’t qualified (tax-free) because you haven’t yet satisfied the five-year holding period, be aware that when you roll those dollars into your Roth IRA, they’ll now be subject to the Roth IRA’s five-year holding period, no matter how long those dollars were in the 401(k) plan. So, for example, if you establish your first Roth IRA to accept your rollover, you’ll have to wait five more years until your distribution from the Roth IRA will be qualified and tax-free.

Spring Has Sprung: Will the Equity Market “Spring” Continue?

Spring has arrived here in the Bay Area and across most of the nation. Just as we have seen declining rainfall after the wintery “El Nino” conditions, the new season has recently brought a break from the significant volatility we experienced in the first two months of the year.

park practice 052 (1)However, although there is increased clarity on several issues that cast a cloud (was it the El Nino effect?) of uncertainty over financial markets in January and February, it would be unwise to forget that heightened volatility is likely not gone for good.

The first quarter of the year was historic. After being down more than 10% at its lows, the S&P 500 bounced back in March and finished the quarter positive. The S&P 500 hasn’t erased a 10% quarterly loss to finish positive since the Great Depression.

Experiencing market volatility like this is not easy; yet witnessing this kind of reversal reminds us of the importance of maintaining a long-term perspective. So, what changed between January and February and today to help calm markets?

The mid-winter market malaise largely revolved around the Federal Reserve (Fed), China, oil, corporate profits, and the U.S. dollar. Investors were likely concerned that the four 25 basis point (0.25%) rate hikes the Fed projected for 2016 would lead to a recession and exacerbate the imbalances emerging in the global economy.

These imbalances stemmed from a series of missteps by Chinese policymakers, the oversupply of oil, weak corporate profits, and unprecedented strength in the U.S. dollar. In the past couple of months, many of these issues have started to resolve.

2000px-US-FederalReserveSystem-Seal.svgAt its March policy meeting, the Fed changed its tune slightly from the December 2015 meeting and reduced its forecast for rate hikes this year from four to just two, citing concerns around global imbalances and economic growth. This more market-friendly projection helped to push the dollar lower and oil higher, alleviating some stress in global financial markets.

Meanwhile, China, which said or did all the wrong things managing its currency, economy, and financial markets during the second half of 2015 and again in early 2016, has mostly turned that around recently. The weaker dollar, soothing words from China, and the rebound in oil prices helped to renew a slightly more positive corporate profit outlook and sparked an impressive market rebound.

After the market dips, reversals, and dramatic shifts in investor sentiment, what can we expect as we look ahead? In my opinion, the second quarter of 2016-and the rest of the year-may look a lot like the first quarter, as many of the areas of concern we faced (such as Fed rate hikes, oil prices, earnings declines) remain in the background.

Although it is very possible that the heightened volatility throughout the rest of 2016 might continue, some investment management firms, including the LPL Financial Research department, think that the broad US equity market might deliver mid-single-digit returns in 2016 if the U.S. economic expansion continues. Only time will tell whether these prognostications will come true.

To help you maintain perspective and stay on track, please feel free to browse on the right my previous newsletters and a sample of the educational articles from the blog section of my website. And, as always, if you have questions or are seeking clarification about your current situation, please email me at or call me at (925) 464-7057.

Correlation and Portfolio Performance

Different types of investments are subject to different types of risk. On days when you notice that stock prices have fallen, for example, it would not be unusual to see a rally in the bond market.

arrows_sq_452689341Asset allocation refers to how an investor’s portfolio is divided among asset classes, which tend to perform differently under different market conditions. An appropriate mix of investments typically depends on the investor’s age, risk tolerance, and financial goals.

The concept of correlation often plays a role in constructing a well-diversified portfolio that strikes a balance between risk and return.

Math that matters
In the financial world, correlation is a statistical measure of how two securities perform relative to each other. Securities that are positively correlated will have prices that tend to move in the same direction. Securities that are negatively correlated will have prices that move in the opposite direction.

Working people in the officeA correlation coefficient, which is calculated using historical returns, measures the degree of correlation between two investments. A correlation of +1 represents a perfectly positive correlation, which means the investments always move together, in the same direction, and at a consistent scale.

A correlation of -1 means they have a perfectly negative correlation and will always move opposite one another. A correlation of zero means that the two investments are not correlated; the relationship between them is random.

In reality, perfectly positive correlation is rare, because distinct investments can be affected differently by the same conditions, even if they are similar securities in the same sector.

Correlations can change
While some types of securities exhibit general trends of correlation over time, it’s not uncommon for correlations to vary over shorter periods. In times of market volatility, for example, asset prices were more likely to be driven by common market shocks than by their respective underlying fundamentals.

fixed-income-investment-strategies-1_1-800X800During the flight to quality sparked by the financial crisis of 2008, riskier assets across a number of different classes exhibited unusually high correlation. As a result, correlations among some major asset classes have been more elevated than they were before the crisis. There has also been a rise in correlation between different financial markets in the global economy (See Note 1 Below).

For example, the correlation coefficient for U.S. stocks (represented by the S&P Composite Total Return index) and foreign stocks (represented by the MSCI EAFE GTR index) increased from 0.75 over the last 25 years to 0.89 over the last 10 years (See Note 2 Below).

Over the long run, a combination of investments that are loosely correlated may provide greater diversification, help manage portfolio risk, and smooth out investment returns. Tighter relationships among asset classes over the last decade may be a good reason for some investors to reassess their portfolio allocations.

However, it’s important to keep in mind that correlations may continue to fluctuate over time because of changing economic and market environments.

The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. All investing involves risk, including the possible loss of principal. Asset allocation and diversification strategies do not guarantee a profit or protect against investment loss; they are methods used to help manage investment risk.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. When sold, investments may be worth more or less than their original cost.

1 International Monetary Fund, 2015

2 Thomson Reuters, 2015, for the period 12/31/1989 to 12/31/2014

Earn Too Much for a Roth IRA? Try the Back Door

Roth IRAs, created in 1997 as part of the Taxpayer Relief Act, represented an entirely new savings opportunity–the ability to make after-tax contributions that could, if certain conditions were met, grow entirely free of federal income taxes.

These new savings vehicles were essentially the inverse of traditional IRAs, where you could make deductible contributions but distributions would be fully taxable. The law also allowed taxpayers to “convert” traditional IRAs to Roth IRAs by paying income taxes on the amount converted in the year of conversion.

Unfortunately, the law contained two provisions that limited the ability of high-income taxpayers to participate in the Roth revolution. First, the annual contributions an individual could make to a Roth IRA were reduced or eliminated if his or her income exceeded certain levels. Second, individuals with incomes of $100,000 or more, or whose tax filing status was married filing separately, were prohibited from converting a traditional IRA to a Roth IRA.

In 2005, however, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA), which repealed the second barrier, allowing anyone to convert a traditional IRA to a Roth IRA–starting in 2010–regardless of income level or marital status. But TIPRA did not repeal the provision that limited the ability to make annual Roth contributions based on income. The current limits are set forth in the table below:

Phaseout ranges for determining ability to fund a Roth IRA in 2016*
Single/head of household $117,000-$132,000
Married filing jointly $184,000-$194,000
Married filing separately $0-$10,000
*Applies to modified adjusted gross income (MAGI)

Through the back door…
Repeal of the provisions limiting conversions created an obvious opportunity for high-income taxpayers who wanted to make annual Roth contributions but couldn’t because of the income limits. Those taxpayers (who would also run afoul of similar income limits that prohibited them from making deductible contributions to traditional IRAs) could simply make nondeductible contributions to a traditional IRA and then immediately convert that traditional IRA to a Roth IRA–a “back door” Roth IRA.

The IRS is always at the front door…
For taxpayers who have no other traditional IRAs, establishment of the back-door Roth IRA is essentially tax free. Income tax is payable on the earnings, if any, that the traditional IRA generates until the Roth conversion is complete. However, assuming the contribution and conversion are done in tandem, the tax impact should be nominal. (The 10% penalty tax for distributions prior to age 59½ generally doesn’t apply to taxable conversions.)

taxes1But if a taxpayer owns other traditional IRAs at the time of conversion, the tax calculation is a bit more complicated because of the so-called “IRA aggregation rule.” When calculating the tax impact of a distribution (including a conversion) from any traditional IRA, all traditional and SEP/SIMPLE IRAs a taxpayer owns (other than inherited IRAs) must be aggregated and treated as a single IRA.

For example, assume Jillian creates a back-door Roth IRA in 2016 by making a $5,500 contribution to a traditional IRA and then converting that IRA to a Roth IRA. She also has another traditional IRA that contains deductible contributions and earnings worth $20,000. Her total traditional IRA balance prior to the conversion is therefore $25,500 ($20,000 taxable and $5,500 nontaxable).

She has a distribution (conversion) of $5,500: 78.4% of that distribution ($20,000/$25,500) is considered taxable ($4,313.73), and 21.6% of that distribution ($5,500/$25,500) is considered nontaxable ($1,186.27).

Note: These tax calculations can be complicated. Fortunately, the IRS has provided a worksheet (Form 8606) for calculating the taxable portion of a conversion.

There’s also a side door…
Let’s assume Jillian in the example above isn’t thrilled about having to pay any income tax on the Roth conversion. Is there anything she can do about it?

One strategy to reduce or eliminate the conversion tax is to transfer the taxable amount in the traditional IRAs ($20,000 in our example) to an employer qualified plan like a 401(k) prior to establishing the back-door Roth IRA, leaving the traditional IRAs holding only after-tax dollars. Many 401(k) plans accept incoming rollovers. Check with your plan administrator.