Medicare: Things May Be Worse Than You Think.

So far, no one’s talking about it, either.

Jim Lorenzen, CFP®, AIF®

Don’t look now, but there are major real problems ahead for Medicare.

And we’re not talking about the “down the road” distant future.

Medicare was signed into law fifty-five years ago and covers more than 62 million Americans.  The are four parts:   Part A (hospital insurance), Part B (outpatient services), and Part D (prescription drug coverage).   Medicare Advantage comes under Part C, which I wrote about earlier.

Parts B and D are funded through collected premiums and the government’s general revenue fund.  Part A is funded by the Hospital Insurance Trust Fund (HI) and covers in-patient care.  That trust fund is funded by payroll tax revenue and requires 10 years’ worth of qualified work credits.  Like any other budget, income has to exceed expenses for the program to survive.

But, it hasn’t worked out that way.  Income hasn’t kept up with the payouts.  The depletion has been going on for years and the HI trust is expected to be exhausted by 2026.  That’s only five years away.  If that happens – and it just might – the HI Trust will be able to pay out only about 90% of Part A expenses. 

What does that mean?  It means a lot of physicians may just quit accepting Medicare insurance.  

President Biden’s plan for Medicare changes

The President has talked about two changes he wants to make; unfortunately, neither addresses the HI Trust shortfall.

1. Allow the federal government to negotiate drug prices with the drug companies.

Part of the deal President George W. Bush made with the drug companies in passing the Medicare Modernization Act was that the federal government would not negotiate drug prices.  This has come back to haunt the U.S, as drug prices have escalated dramatically.   Higher drug prices have not only cost the Medicare program more—drug prices have increase from about $97 billion in 2019 to about $44 billion in 2006—they also cost Medicare beneficiaries thousands of dollars in out-of-pocket spending, especially for high-cost specialty drugs.

Allowing the federal government to negotiate directly with the pharmaceuticals on price would save the program an estimated $456 billion between 2023 and 2029, according to the Congressional Budget Office. The drug makers claim they need these revenues for research and clinical trials. Biden’s healthcare plan would also allow people to buy select prescription drugs from other countries. This would provide for a more competitive marketplace that should also effectively lower prescription drug pricing.

Biden’s Medicare plan would prohibit drug makers from raising the price of their prescription drugs faster than the rate of inflation as a condition of Medicare participation.  Violators would face a tax penalty.

To succeed, however, the federal government needs negotiating clout – and that’s where the shell-game comes in.

2. Lower the Medicare eligibility age to 60.

This step would cover those between age 60 and 64, which would provide an additional 18- 25 million people the option of going on the program.  Not all would enroll, of course.  Of the 10-14 million who have employer coverage, some would likely keep it.

Why lower the age and add people to the program?   The more people enrolled in Medicare, the more clout the federal government has in negotiating drug prices, as well as negotiating prices with hospitals and many outpatient services.  Since those between ages 60-64 have less medical care costs than older patients, the average cost per patient would drop.

But, all that advantage comes with a cost:  about $200 billion over the next decade, depending on what other reforms are made. 

While the program is popular with many Americans, it will face an uphill battle.  Hospitals stand to lose billions of dollars in revenue due to Medicare’s lower fee structure.  Medicare reimbursement rates for hospital patients average about half what commercial or employer-sponsored insurance plans pay… and the American Hospital Association is one of the biggest lobbies in Congress.

Back to the HI Trust

There’s nothing about this in President Biden’s plan.   Campaign rhetoric is always hot from the firebrands, both on the right and left.  After all, it’s the base that goes out, rings the doorbells, and gets people to the polls.  While the Democrats hold a majority in both chambers (the V.P. has the tie-breaking vote in the Senate), neither chamber has a 2/3 supermajority – meaning any significant legislation will have to be bipartisan in order to pass.   They are also keenly aware of down-ballot results at the grass-roots level:  The Republicans picked up 10 seats in the House (Democrats lost 9 along with 1 independent).  In addition, Republicans picked up 1 state governorship bringing their total to 27, vs. 23 for Democrats.

After the political rhetoric dies down (yes, Virginia, I’m dreaming) the course may be more moderate than many on either side expect. 

With COVID-19 on the front burner, this may take time… though not much is left.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

To Roll or Not to Roll

That’s the rollover question. Do you have the answer?

Jim Lorenzen, CFP®, AIF®

Getting rollover advice isn’t always straightforward.

There’s a difference between a “financial advisor” or “financial planner” who really uses “planning” as a vehicle to sell products – yes, Virginia, they do exist – and a true advisor/planner who provides independent and objective analysis as a part of his or her service to clients.

Wasn’t that commercial subtle?

Nevertheless, when deciding whether or not to roll over your company retirement plan to a self-directed IRA, there are considerations and analysis to be considered before making this irrevocable decision.

Here’s a brief – read that as ‘oversimplified’ and incomplete – hint of the types of issues you should consider:

Sample of 401(k) issues:

  • Maybe no required minimum distributions (RMDs) when you hit age 72 if you’re still working and not a 5% owner of the business you work for.   Maybe.  You need to check with your plan administrator – some plans still require RMDs even if still employed.

  • Expenses in the 401(k) plan may be less.  Maybe.  This is a murky area as some plans are sold to employers as being ‘free’.  It’s a myth, of course, as often costs may be hidden even from the company plan sponsor.  Often plans offer a large menu of options, but not all are ‘open architecture’; many are pre-packaged.  Your financial advisor should be able to provide a full independent comparison expense analysis of your plan holdings vs. the IRA holdings you’re considering.

  • ERISA protections (Employment Retirement Income Security Act) protect your 401(k) assets from creditors (except IRS levies).  Only qualified ERISA plans have this protection – 403(b) plans offered by state and local governments might not qualify for this protection.

Sample of IRA issues:

  • You can contribute as long as you’re working, regardless of age.

  • Unlimited menu of investment options.  Many do not allow self-directed brokerage

  • Not protected by ERISA but rollovers is protected under federal bankruptcy law.  Amounts not rolled over (money from other sources) are protected up to $1 million, indexed for inflation every three years.
  • Option to convert an IRA to a Roth IRA.  You’ll need to pay taxes on the conversion – and they should be paid from other assets to capture the full advantage – and the Roth IRA will need to be funded for at least five years with the owner reaching age 59-1/2 (or disabled) when distributions are made.   The current historically low income tax rates are set to expire in 2026 and could be replaced sooner.  Taxes appear to be ‘on sale’ now – so this is an attractive option for many taxpayers, particularly in light of the SECURE Act, but that’s another subject (see SECURE Act under Categories on the right side panel of this blog).

Remember to plan BEFORE you act.  Ready, fire, aim seldom works out well.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

RMDs: We’re Baaaack!

The 2020 RMD waiver is coming to an end. They begin again in 2021!

Jim Lorenzen, CFP®, AIF®

 

The headline says it all.  But, this is a blog; so I guess I’d better elaborate a little.

RMDs do NOT apply to Roth IRA owners, unless it’s inherited.  

If you take more than the required minimum distribution, that’s not a problem; but, distributions of less than the required amount will result in a penalty:  50% of the RMD shortfall!  For example, if your RMD for 2021 is $25,000 and you take only $20,000, you’ll still have to take the $5,000 remainder and the IRS will take 50% of that shortfall amount: $2,500… money you could have used to buy more masks.   

There’s a new age for taking RMDs, brought on by The SECURE Act, which I’ve covered in a couple of previous posts.  See The Game Changer and this overview.  Those two posts should bring you up to speed for most issues.

By the way, if an IRA was inherited in 2020, including a Roth IRA, an RMD must be taken for 2021 if the beneficiary is an eligible designated beneficiary is taking distribution over his/her life expectancy.  There are rules and exceptions, so be sure to get professional guidance.  IRAs inherited in 2021 and forward come under the 10-year rule, covered in the above previous posts.

RMD penalties are high and requesting waivers can result in headaches.  It’s best to do it right instead of having to do it over.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Medicare Advantage Plans May Come With Unpleasant Surprises.

Maybe you should think twice before buying from a celebrity endorser.

Jim Lorenzen, CFP®, AIF®

Let’s start with this:  I’m not a Medicare expert.  My basic knowledge as a CFP® professional certainly helps when it comes to integrating health care into a financial plan, but make no mistake about it:  Health insurance is a highly complex area; so, when it comes to selecting plans, including Medicare, it pays to consult an expert – someone who does nothing but.

That’s why I was intrigued by an article I read last April by Joanne Giardini-Russell* entitled, “Should You Buy a Medicare Plan from Joe Namath?

A few points about Medicare Advantage plans (also called “Part C” plans) that caught my eye:

  • The reason private insurers can offer these plans for zero dollars per month is because the federal government actually pays them to offer Advantage plans to the public – about $1,000 per month, or more, per enrollee.  In exchange, the plans administer and manage the coverage for those who sign up.
  • When enrolling for a Medicare Advantage plan, you still have to pay your Medicare Part B premium.  Most pay around $144 monthly for Part B coverage.   
  • If you see a specialist (like a cardiologist or dermatologist) you still have to pay co-pays
  • Your plan can change mid-year and your physician or facility may no longer be in your network.
  • Many people do not expect out-of-pocket costs – they only remember the “free” parts that were advertised in the commercials.
  • Should you receive a bad diagnosis – cancer, for example – you may be surprised to find that co-pays come with chemo/radiation which can add up to $6,700 annually, and…
  • If you get that bad diagnosis, you may find that if you want to return to original Medicare paired with a Medigap plan – these cost more but can provide more comprehensive coverage – you will have to go through medical underwriting and can be denied coverage.

In other words, these Advantage plans are good if you’re healthy and stay healthy.   But, a bad diagnosis could leave you trapped.

Good to know, ya think?

Jim

*Joanne Giardini-Russell is a Medicare expert with Giardini Medicare.

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Systematic Roth Conversion Strategies Can Be Powerful….

… especially when they’re tied to a plan.

 

Jim Lorenzen, CFP®, AIF®

Do you know what a systematic Roth conversion is?  It’s worth knowing!

Even at modest growth rates, the results of a systematic Roth conversion can be surprisingly impressive over time.   Take a look at this example from Debra Taylor, a tax attorney and advisor in Franklin Lakes, New Jersey, comparing no conversion to systematic conversion.  What would the traditional IRA and the Roth IRA (funded with systematic conversions) look like?

Using a modest growth rate of 5% per year over a ten-year period, here are the results beginning with a $500,000 IRA and converting just $17,500 per year.

With no conversion, the traditional IRA has grown to $1,026,744.  Not bad, except that all that money doesn’t belong to the IRA owner.  Some of it belongs to Uncle Sam – it’s his IRA, too.  How much, of course, depends on what tax rates are in effect when withdrawals occur.

Using a ten-year systematic conversion plan instead, that $500,000 IRA ends-up with only $336,158 at the end of 10-years.   That means lower required minimum distributions (which impact how much your Social Security is taxable and your Medicare premium amounts) and lower taxes, too.  How much lower?  Pick a bracket and do the math on both – you’ll likely be surprised.

Instead, using a systematic Roth conversion strategy, those ten annual $17,500 conversions resulted in a tax-free Roth IRA value of $1,405,285!   Combined with the traditional IRA, results in two retirement accounts now worth a total of $1,741,443 – that’s $714,699 (70%) more!   And, 81% of the owner’s retirement money – the money in the Roth IRA – is tax free!

The best time to begin a strategy like this is after age 59-1/2  and the age when required minimum distributions (RMDs) begin.  That age depends on your birth date under the SECURE Act.  The age is 72 if born on or after July 1, 1949.  It’s 70-1/2 for all others.  Once RMDs begin, you can’t use RMDs to fund Roth conversions; you’ll have to take your RMD first, then take the conversion amount.  Secondly, the strategy works only if you convert the entire amount and pay any tax due from other funds.

It goes without saying – or maybe it doesn’t – that any strategy should be tied to a solid financial plan that can ‘stress-test’ outcomes and probabilities.   Nothing beats experienced and informed guidance.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

When A Loved One Dies

It’s a confusing time; there’s a lot of emotion. Unfortunately, few people have developed a roadmap. Now, you can have one.

Jim Lorenzen, CFP®, AIF®

When  a loved one dies, it can be a bit chaotic. I remember when my parents passed away, they had lived a very long and happy life.   When the time came, it wasn’t unexpected and we had plenty of time to prepare, both emotionally and financially.  This end-of-life timing scenario was predictable.

Unfortunately, that isn’t always the case.  Sometimes it can happen unpredictably.  When that happens, often there’s no plan in place – not even a roadmap.  It can wait.  We’ll do it later.

Not a good idea.

I want you to have something to work with.  You don’t have to fill-out any forms; just click on the form links and you can download them immediately.

These should provide you with the roadmap you need – you may want to print these out or save them to your hard drive – and don’t forget to get help.

Nothing beats experienced guidance.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Stock Market Volatility Can Wreak Havoc on 4% Withdrawal Rates.

Financial planning is often more about what we don’t know than what we think we know.

Jim Lorenzen, CFP®, AIF®

Often financial planning and wealth management is more about the unknowns in life than the knowns.

After years of supporting roles on the Flintstones, Barney and Betty decided to retire from acting in cartoons (it’s hard to be a cartoon character!) and enjoy life.  Using a 4% withdrawal rate, they planned to take $40,000 a year from their $1 million retirement account which, with their Social Security, would provide them with everything they needed for life.  Growth of investments would give them their inflation hedge.

“Security is mostly a superstition: it doesn’t exist in nature”  –  Helen Keller

They retired in 1999.  Unfortunately, after three years his inflation-adjusted withdrawals and the market’s poor performance had eroded his portfolio to less than $540,000.  At this point, his withdrawals now represented almost 8% of his portfolio value.   Bad problem.  Inflation made those withdrawals necessary but the 8% withdrawal rate simply wasn’t sustainable.

The market was good to him for the next five years; but, by the end of 2007, their portfolio was still less than $670,000, meaning withdrawals still amounted to more than 7% of portfolio value.

Then came 2008-9 – the melt-down.  Their nest-egg plummeted to less than $400,000 and withdrawals now represented more than 12% of account value (cost of living still going up!)

4% didn’t work too well for Barney and Betty.  Fred and Wilma (actually, more Wilma that Fred) had told them they needed a real plan that would be stress-tested for all the unknowns in life. 

Planning isn’t about what we know; sometimes it’s knowing what we don’t know – and recognizing that often there are things we don’t know we don’t know.   It’s more about managing risk than money; and planning for the unknowns. 

Nothing beats experienced guidance.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Like the S&P 500 Index?

Maybe you should look under the hood.

Jim Lorenzen, CFP®, AIF®

Like indexing?  Like the S&P?  You can get an index fund!  Sounds good.  Let’s face it, most (virtually all) investment management companies fail to beat the S&P index on a consistent basis.  We all know that.

There’s a good reason for it:  An index doesn’t have expenses while, in the real world, all assets have a cost of ownership – expenses – attached.

If your home is worth $500,000 and your local housing market, including your home, increased by 10%, your home and the market would become worth $550,000.  Did you tie the housing index?  Of course not.  You had to pay property taxes, homeowner’s insurance, maintenance and repair costs, mortgage interest, maybe even HOA and other costs that are required.   Sometime, just for fun, add up all your annual costs and see what your annual expense ratio is (total costs of ownership divided by your home’s current value).  You might be surprised, but I digress.

Expenses aside, how about using a fund replicating the S&P index (that’s as close as you’ll get)?  Let’s look under the hood.

According to Craig L. Israelsen, PhD, an Executive-in-Residence in the Personal Financial Planning program in the Woodbury School of Business at Utah Valley University, if all holdings in the index were weighted equally, each company holding would have a fixed weight of about 0.20% in the index.  However, the holdings aren’t weighted equally; their weighted according to their market capitalization.  This means that roughly 42% of the assets in a market cap-weighted S&P index are held in just 25 of the 500 stocks – another way of saying that the largest 5% of stocks represent over 40% of the allocation.

The practical implication of all this:  half the stocks in the market cap-weighted S&P index have very little impact on performance.

When tech goes up, the cap-weighted S&P index looks good.  When tech takes a nose-dive, not so good.

Is that good for baby-boomers now guarding their serious money for retirement?  Saving a point or two on investment expenses may not be the key issue for this group.  Wealth preservation and maintaining purchasing power for the long term may be more important.

Maybe there’s a better way to achieve long-term goals than riding the index roller coaster.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Does “Bucket Investing” Achieve Goals or Destroy Wealth?

Many investors, and advisors, like it; but there are some experts who apparently aren’t too sure.

iStock Images

Jim Lorenzen, CFP®, AIF®

Does the ‘bucket’ approach to allocating assets to life goals make sense—or does it actually destroy wealth?   Mentally, bucket investing is simply assigning money to ‘buckets’, i.e. goals.  Advisors utilizing this  approach use a variety of buckets.  Even some celebrated elite advisors have used this method.  One uses a two bucket approach:  Bucket #1 contains a five-year cash reserve and  bucket #2 is then free to invest in longer-term investments, typically stocks, stock funds or exchange-traded funds (ETFs).

Many people find the approach appealing for several reasons:

  • No need to  wrestle with sequence-of-returns risk 
  • No need to worry about liquidating assets during a  down market
  • Comfort:  It comports comfortably with the well-know behavioral bias of mental  accounting.  It’s easy to understand having a withdrawal account and a long-term investment account.

Javier Estrada, a professor of financial management at the IESE Business School in Barcelona, Spain conducted a research study, some time back, on the merits of the ‘bucket approach’ to investing for achieving long-term financial goals.  His study included highly-detailed back-testing of both Monte Carlo and  bucket strategies, back-tested over a variety of time periods and methodologies.    His study uses\d a risk-adjusted success (RAS) measurement—it’s defined as the ratio between the mean-expected value of outcomes  and the standard deviation of outcomes

Are you asleep, yet?

Basically, he’s measuring downside risk-adjusted success—measuring only downside volatility—the dispersion of only failed outcomes as opposed to simply looking at the disparity of upside to downside outcomes.  

Okay, enough of the weeds.  His extensive research shows that while the bucket approach may have psychological  benefits, it doesn’t perform so well when tested  for the highest  likelihood of success.   It failed in all performance tests to provide enough money to cover the needed  withdrawals.  Estrada found that as he extended  the number of years for withdrawals to occur, the worse the strategy became.

Reasons for the failure?  Estrada explained:  “Most implementations of the bucket approach… distribute funds from more aggressive buckets into more conservative buckets, but not the other way around.  Put differently, although bucket strategies avoid selling low by withdrawing from bucket #1 after stocks performed badly, they do not take advantage of also buying low as static strategies do with rebalancing.”

The bucket approach is popular due chiefly to a lack of knowledge.  Surrendering to the mental  accounting bias allows investors to conveniently stop worrying.  While increasing the amount of money allocated to bucket #1 might allow them to sleep better, it also increases the odds of running out of money.

Oops.  Not good.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Hidden Surrender Charges

You could be paying them without knowing it. It pays to do some math.

Jim Lorenzen, CFP®, AIF®

I don’t know anyone, certified financial planner professionals included, who is a fan of surrender charges; but, economically they are a fact of life for many products simply to make the offering available and viable for the investment or financial product provider.

For consumers, the surrender charge represents an obstacle that stands between them and having total liquidity—and the charge itself reduces the value of the product should that liquidity be required at some future date.   Sometimes, however, consumers are already paying for the liquidity they desire even if they never need or use it!

Hypothetical example:   Mary and John have $150,000 “just in case”  money set-aside in savings.  They have no particular purpose for it but they like knowing it’s there if they should need it.  They’re not making much interest, of course, probably less than 2% – but they like the liquidity.   They’ve heard about another investment that in all likelihood could help them achieve a 5% return, but it has a surrender charge—something they would like to avoid—so they’re staying with their savings account.    In effect, due to the return difference, they’re paying 3% per year for their liquidity right now.  In three years, they will have paid 9% – $13,500!   In five years the liquidity/opportunity cost will be 15% – $22,500—even without growth. 

Maybe the alternative might be a better bet—especially if other questions result in favorable  answers:  Is the tax treatment different?  How much of the money is even subject to surrender charges and how much might be liquid without surrender charges?   Does it make sense to pay 3% in opportunity cost up front for liquidity they may not even use—or does it make more sense to pay for it when it’s needed?  And how much would it even be?

It pays  to do the math and examine all alternatives.

Jim

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Interested in becoming an IFG client?  Why play phone tag?  Schedule your 15-minute introductory phone call!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.