Why Every Millennial Should Consider Funding a Roth IRA

Much—too much—has been said and written about the relative superiority of Roth IRAs versus Traditional IRAs. The debate over which is better too often involves the technical numerical merits. In truth, the Roth wins in almost every situation because of its massive behavioral advantage: a dollar in a Roth IRA is (almost) always worth more than a dollar in a Traditional IRA. This is true regardless of one’s age, but the Roth IRA is even more advantageous for Millennials.

I must first disclaim that you can disregard any discussion of Roth or Traditional IRA if you’re not taking full advantage of a corporate match in your employer’s 401(k)—free money is still better than tax-free money. But after you’ve “maxed out” the match in your corporate retirement account, here are the top three reasons Millennials should consider putting their next dollar of savings in a Roth IRA:

1) Life is liquid, but most retirement savings aren’t.

Yes, of course, in a perfect, linear world, every dollar we put in a retirement account would forevermore remain earmarked for our financial futures. But hyperbolic discounting—and the penalties and tax punishments associated with early withdrawal from most retirement savings vehicles—can scare us away from saving today for the distant future. The further the future, the more we fear.

The Roth IRA, however, allows you to remove whatever contributions you’ve made—your principal—without any taxes or penalties at any time for any reason. Therefore, even though I’d prefer you to generally employ a set-it-and-forget-it rule with your Roth and not touch it, if the privilege of liquidity in a Roth helps you save for retirement, I’m all for it.

2) There are too many competing priorities.

Millennials are dropped into the middle of a financial should-fest. You should pay down school loans, save up for a home down-payment, drive a cheap ride, purchase the proper level of insurance, enhance your credit and save three months’ worth of cash in emergency reserves. All while having a life? No chance.

Most personal finance instruction tells you what your priorities should be, and if you’re looking for that kind of direction, I’m happy to help in that regard as well. But it’s also not a mortal money sin to employ some Solomonic wisdom and compromise between, say, two worthy savings initiatives—like short-term emergency reserves and long-term retirement savings. Therefore, while I can’t go so far as to suggest that you bag the idea of building up cash savings in lieu of a Roth, I’m comfortable with you splitting your forces and dipping into your Roth IRA in the case of a true emergency. The challenge we all face is to define “true emergency” without self-deception.  (And no, splurging on concert tickets or a last minute vacation with friends don’t qualify.)

3) Roth contributions cost you less today than they will in the future.

Despite my sincerest attempt, I couldn’t avoid the more technical topic of taxes—and nor should I, in this case. That’s because it only stands to reason that you’re making less money—and therefore paying less in taxes—at the front end of your career than you will be in the future.

Therefore, in addition to beginning tax-free compounding sooner, Roth IRA contributions—which are not tax-deductible—will likely “cost you” less as a career newbie than they will as a seasoned executive. At SpaceX. On the first Mars colony. Furthermore, you can also make too much to contribute to a Roth IRA, progressively phasing out of eligibility at income of $118,000 for an individual and $186,000 for a household.

Like Coachella tickets, the opportunity to invest in a Roth IRA may not be around forever. Tax laws and retirement regulations are constantly evolving, and who knows what the future may hold. This increases their value for everyone, but especially for those who could benefit from them the most—Millennials.

This commentary originally appeared February 22 on Forbes.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

photos courtesy of InvestmentZen


The Three-Step Investor’s Guide to Navigating the Financial Advisory Fiduciary Issue

As an educator in the arena of personal finance, I generally avoid matters of public policy or politics because they tend to devolve into dogma and division, all too often leaving wisdom and understanding behind. But occasionally, an issue arises of such importance that I feel an obligation to advocate on behalf of those who don’t have a voice. The issue of the day revolves around a single word: “fiduciary.”

At stake is a Department of Labor ruling set to take effect this coming April that would require any financial advisor, stock broker or insurance agent directing a client’s retirement account to act in the best interest of that client. In other words, the rule would require such advisors to act as a fiduciary. The incoming Trump administration has hit the pause button on that rule, a move that many feel is merely a precursor to the rule’s demise.

Why? Because a vocal constituency of the new administration has lobbied for it—hard. They stand to lose billions—with a “b”—so they’re protecting their profitable turf with every means necessary, even twisted logic.

The good news is that informed investors need not rely on any legislation to ensure they are receiving a fiduciary level of service. Follow these three steps to receive the level of service you deserve:

1) Ask your advisor if he or she acts as a fiduciary.

It’s not a good sign if you get the deer-in-headlights look followed by “Fid-oo-she-WHAT?” If your advisor gets defensive, telling you that you’re better off with the status quo, that’s also concerning.

2) Ask your advisor if he or she acts ONLY as a fiduciary.

One of the biggest challenges facing investors today is that many advisors with a genuine fiduciary label are actually part-time fiduciaries. This is where it gets tricky, because there are at least three different regulatory requirements in the financial industry.

Those beholden to the Investment Advisers Act of 1940 and regulated by the SEC are fiduciaries already, and they have been for a long time. Those who sell securities—typically known as stock brokers and regulated by FINRA—are held to a lesser “suitability” standard. Those who sell insurance products may be beholden to an even lesser standard—caveat emptor, or “buyer beware.”

But what if your advisor is like many who are licensed sufficiently that they may act as a fiduciary when they choose, but may also take off the advisory hat and sell you something as a broker or agent? Do they tell you when they’ve gone from one to the other?

You want a full-time, one-hat-wearing fiduciary.

3) Determine if your advisor is a TRUE fiduciary.

This may be the hardest part, because it requires you to read between the lines. There are advisors who now realize that it’s simply good business to be a fiduciary. And while there’s nothing wrong with profitable business, you don’t want to work with someone just because they’ve realized fiduciary mousetraps sell better than their rusty predecessors.

Not everyone who is a fiduciary from a legal or regulatory perspective is a fiduciary at heart, and yes, it is also true that there are those who are fiduciaries at their core even though they don’t meet the official definition in their business dealings.

You want a practitioner who’s a fiduciary through-and-through—a fiduciary in spirit and in word.

“The annulment of the government’s fiduciary rule would clearly be a setback for investors trying to prepare for retirement,” says sainted financial industry agitate Jack Bogle. “But the fiduciary principle itself will live on, and even spread.”

Yes, the good news—for both advisors and investors—is that there is a strong and growing community of fiduciaries, supported by the Certified Financial Planner™ Board, the Financial Planning Association (FPA) and the National Association of Personal Financial Advisors (NAPFA).

Advisors can join the movement. And investors can insist on only working with a true, full-time fiduciary.

This commentary originally appeared February 24 on Forbes.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

Dispersion Shows Diversification Matters

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I previously examined a recent study that offered investors powerful evidence regarding a reduction, though not the elimination, of geographic diversification benefits in a flattening world. To more fully understand the integration of global equity markets, I then explored the correlation of returns between international and domestic stocks. Today I’ll resume my analysis with a look at the dispersion of returns among foreign and U.S. equities.

Dispersion Of Returns

In 2009, we saw very wide dispersion of returns. For example, while the S&P 500 was up almost 27%, the MSCI Emerging Markets Index rose 79%. And emerging market small and value stocks produced even higher returns. In addition, international large value and small value stocks, as well as international REITs, outperformed their domestic counterparts by wide margins.

Note the correlations were positive, as all equity asset classes produced above-average returns. However, the world didn’t look very flat in 2009.

In 2010, even though the S&P 500 returned about 15%, emerging markets stocks outperformed it by about 4 percentage points. On the other hand, U.S. large, large value, small, small value and REIT funds outperformed their foreign counterparts by significant margins.

In 2011, while the S&P 500 returned just greater than 2%, in general, international stocks provided negative returns. The MSCI Emerging Markets Index lost more than 18%.

In 2012, the relative performance of U.S. and international funds reversed; international funds outperformed their U.S. counterparts in all asset classes, although the return differences were relatively small.

In 2013, U.S. stocks outperformed international equities by wide a margin. For example, the S&P 500 Index, which returned 32.4%, outperformed the MSCI EAFE Index by about 10 percentage points and the MSCI Emerging Markets Index by approximately 35 percentage points. The world didn’t look very flat in 2013, either.

In 2014, domestic stocks generally not only far outperformed international stocks, but U.S. stocks rose and developed, non-U.S. markets generally fell. Again, the world didn’t look flat.

Integration Doesn’t Erase Diversification

In 2015, returns were all over the place. For instance, U.S. large stocks and developed, non-U.S. stocks produced similar returns, both close to zero. On the other hand, the MSCI EAFE Small Cap Index rose about 10%, while the MSCI EAFE Small Value Index rose roughly 5%. Their U.S. counterparts lost 4% and 5%, respectively. At the same time, the MSCI Emerging Markets Index lost almost 15%. Once again, the world didn’t look very flat.

Through Dec. 16, 2016, the world didn’t look all that flat either, with emerging market stocks underperforming developed market stocks. While Vanguard’s 500 Index Fund (VFINX) had returned 12.7%, the firm’s Emerging Markets Index Fund (VEIEX) returned 10.6%. DFA’s passively managed Emerging Markets Small Fund (DEMSX) returned a similar 10.4%, but its Emerging Markets Value Fund (DFEVX) returned 20.1%.

Once again, we see a wide dispersion of returns, showing the benefits of diversification even in a flatter world. (Full disclosure: My firm, Buckingham, recommends DFA funds in the construction of client portfolios.)

Hopefully, the evidence presented here demonstrates that, even though the benefits of a global equity allocation may have been reduced by market integration, they certainly have not disappeared. Thus, broad global diversification is still the prudent strategy. But there remains another important point we must cover.

The Death Of Diversification Has Been Greatly Exaggerated

Antti Ilmanen and Jared Kizer, in their 2012 paper, “The Death of Diversification Has Been Greatly Exaggerated,” which won a prestigious Journal of Portfolio Management award for best paper of the year, argues that factor diversification has been more effective at reducing portfolio volatility and market directionality than traditional asset class diversification. In other words, investors need to think differently about diversification.

In our new book, “Your Complete Guide to Factor-Based Investing,” my co-author, Andrew Berkin, and I make the case that investors can benefit from diversifying their portfolios across a small number (eight) of the more than 600 factors identified in the literature, a number so great that John Cochrane called it a “zoo of factors.”

We present evidence demonstrating that the market beta, size, value, momentum (both cross-sectional and times-series), profitability, quality, carry and term factors meet the criteria of being persistent across time and economic regimes; pervasive across sectors, countries, regions and asset classes; robust to various definitions; having intuitive risk-based or behavioral-based explanations for why we should believe they will continue to produce premiums; and are implementable (meaning they survive transaction costs).

In addition to each factor having earned significant premiums, they all have low-to-negative correlations to each other, which results in a portfolio with higher Sharpe ratios. The following table shows the annual correlations of the equity factors mentioned above during the period 1927 through 2015.

Note the low-to-negative correlations each factor has with the others, with the sole exception of the correlation between profitability and quality. The high correlation of these two should be expected, because one of the characteristics of quality is profitability.

Integration of Global Markets_Chart

We also present evidence demonstrating that building a portfolio that diversifies across these factors greatly reduces the risk of producing negative outcomes.

The important message from the book is that investors can benefit from changing the way they consider diversification, moving away from the more traditional view of thinking only about diversifying across asset classes.

We believe investors are better served by thinking more broadly and looking at diversification across more unique sources of risk and return, which is really what factor-based investing is all about. And many of these factors, such as value, momentum, quality (also referred to as defensive) and carry, can be diversified across asset classes, bringing further diversification benefits.

Summary

There is evidence that, due to the greater integration of markets, the benefits of traditional global diversification of equity risk have been reduced. However, by accessing other unique sources of risk called factors, and diversifying those unique sources across stock, bond, currency and even commodity asset classes, more efficient portfolios can be created—ones with the important benefit of having less downside risk.

This commentary originally appeared January 6 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

 

Why I’m Hoping the Trump Administration Doesn’t Kill the DOL Fiduciary Rule

Gavel_JoeGratz_Flickr

Advisors to President-elect Donald Trump have been vocal about rescinding the Department of Labor’s new fiduciary rule, introduced earlier this year to protect retirement savers from advice that isn’t fully in their best interests. The rule has already been under fire from the securities industry, and lack of presidential support could spell its ultimate demise.

As someone who has worked on both the fiduciary and non-fiduciary sides of the industry, I think revoking the rule is a bad, even dangerous, move. My rationale for such a position starts with my experience, early in my career, at one of the nation’s largest insurance companies.

“Look, you can set up your business any way you see fit after you’re successful. But right now? With a young family? You need to put yourself and your family first, and that means selling A-share mutual funds,” said my sales manager.

In other words, you must put your interests ahead of your clients’.

As a brand new financial advisor, I was having a heart-to-heart with my supervisor after laying out my plan for creating a fee-based business within the agency, which would have meant recurring revenue for the firm but apparently in much smaller increments than were preferable.

“A-share mutual funds” are a variety with some of the largest up-front commissions—for both the salesperson and the company they represent. Variable annuities were even better, often generating more of a “front-end load.” Whole life insurance was the pinnacle of up-front commissions.

In the newbie bullpen, we were encouraged to sell in various and sundry ways. The general agent in charge of the Baltimore metro area—the self-proclaimed “big dog”—was, indeed, a large man. A former starting lineman for a recognizable college football team, I’m quite sure that he routinely watched the classic Alec Baldwin “motivational speech” from Glengarry Glen Ross (turn the speakers down if you’re at work or children are nearby).

My favorite anecdote from that time, though, was my general agent’s big fish story: “When you get a big fish on the hook, I want you to set a noon lunch meeting at the Oregon Grille.” (The Oregon Grille is an excellent restaurant north of Baltimore in pastoral horse country, where most of us had never dined.) “Go to the restaurant 30 minutes early and introduce yourself to the maître d’. Let him know that you’ll be returning shortly to the restaurant with a guest, and that you’d like to be referred to by name.”

“Then, ask who your server will be at lunch,” he would continue. “Introduce yourself to that person to ensure they know your name as well—and tell them what your drink will be so you can simply order ‘the regular.’”

New recruits to the agency were encouraged to buy a new car with a payment high enough to help maintain our motivation to produce when the going got rough, to get a membership at a local country club and to offer our inexperienced counsel to any local non-profit boards who would have us.

I ended up at this insurance company after getting turned down to join the ranks as an advisor at the biggest brokerage firm in town. I thought I had paid my dues, working in their back office and then as a listed equity trader. By 2002, I had four years of industry experience and all of my requisite securities licenses—but I didn’t have any sales experience (or a natural affinity for it by birth). “You’d be better off with experience as a copier salesman,” I was told on my way out the door, shaking my head in confusion.

It was all about the sale.

Years later, at the end of my time with the insurance company, I called my wife, holding back tears of frustration. I’d been sent to a conference—not a financial conference, but a sales conference.

“I don’t think the job that I’ve been searching for actually exists,” I said. “I’m not sure I can do this anymore.”

I spent the first eight years of my now 18-year career in the financial services industry with proprietary (and independent) brokerage firms, insurance companies and banks. In each case, I experienced significant pressure to sell products that were not necessarily in the best interest of my clients. While I gained invaluable life and occupational experience in each of those roles—and met many genuinely great people I still count as friends—I failed as a salesman before finding the true financial advisory profession.

The first signs of light came when I began taking classes to earn my CFP®—Certified Financial Planner™—designation. Here I was exposed to professional advisors (not professional salesmen) and an academic approach to comprehensive financial planning. I learned of the FPA (Financial Planning Association) and eventually NAPFA (National Association of Personal Financial Advisors), both of which expanded my horizons. What’s more, the latter was filled with advisors who’d pledged to take no commissions for the sale of products and to always act in the best interest of their clients, as fiduciaries.

This word—fiduciary—began to take on new meaning for me. In it, I found an ideal much closer to the professional daydream that so far had driven my career pursuits. Like the medical, legal and accounting professions, these fiduciaries begin practicing their craft at a simple starting point—with a pledge to put their clients’ interests ahead of their own.

Eureka! There were actually real financial advisors out there.

But the majority of the financial services industry—brokerage firms, banks and insurance companies—have resisted increasing the duty of care they owe to their clients, clinging to a lesser “suitability” standard or, in some cases, caveat emptor (buyer beware).

Even following the financial crisis of 2008, largely seen as linked to proprietary conflicts of interest, the majority of the industry held fast. So finally, the Department of Labor stepped in, announcing in April 2016 that it would require anyone advising retirement accounts—like 401(k)s and IRAs—to be held to a new fiduciary requirement.

It’s not a perfect rule, and right now it will only cover retirement-specific accounts, but it represents a major leap forward. However, post-election, it is being mentioned as a candidate for revocation. What could anyone have against a rule that requires financial advisors to act in the best interest of their clients? Only two arguments even deserve mention:

1) That it is a governmental overreach and unnecessary regulation that will only slow economic growth. My default response is skepticism when it comes to new regulation, but the financial services industry has failed to self-regulate in this regard—as the medical, legal and accounting professions have—requiring an outside force to step in.

2) The second reason is barely defensible enough to mention, except that it keeps getting play. The majority industry claims that it is “the little guy,” the proverbial “small investor,” who will lose access to financial advice because the rule will presumably increase costs for financial firms, no longer allowing them to serve smaller clients. The we-have-to-laugh-to-keep-from-crying irony is that most of these firms have already turned their backs on small investors, having discontinued paying their advisors commissions on accounts less than $250,000, a sum well above the average baby boomer’s retirement savings!

Any argument suggesting that smaller investors are better served by advisors who don’t have to act in their best interest is simply logic twisted to serve self-interest. And there is no shortage of fiduciary financial firms able to serve the small investor market that supposedly will be forced to exit big brokerage firms.

What is the real motivation behind the anti-fiduciary movement? I suspect that all you have to do is follow the dollars. It’s estimated that wire houses and independent broker-dealers will lose $11 billion in revenue to the new rule by 2020.

Before you discount me as a blinded romantic painting a black-and-while picture of angelic fiduciaries and Faustian salespeople, let me assure you that there are, without question, “fiduciaries” who are not—and salespeople who are.

There are indeed a lot of good people in the securities industry, but its institutionalized system of incentives to “sell” is still in need of fixing. I implore President-elect Donald Trump, whose rise to popularity was fueled in part by anti-establishment sentiment, and Speaker Paul Ryan to allow the Department of Labor’s new fiduciary rule to be the first step in that repair.

Let’s begin with a simple, sensible premise, one that I believe will actually free many financial advisors from conflicted compensation regimes and help many more of their clients: Advisors must act in the best interests of their clients.

This commentary originally appeared December 3 on Forbes.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2016, The BAM ALLIANCE

A Free Lunch for Investors

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Nobel laureate Milton Friedman is generally credited with stating, “There’s no such thing as a free lunch.” Actually, if you know what you are doing, you can get a free lunch in investing. Unfortunately, most investors get stuck with very expensive meals.

Diversification is a free lunch

Diversification is a free lunch. It basically refers to the concept of not putting all your eggs in the same basket.

There are major benefits of holding a diversified portfolio. Obtaining these benefits costs you nothing. Author and blogger Mike Piper recently explained the benefits of diversification. He correctly explained the likely returns from a basket of only five stocks are extremely unpredictable. That’s because of what is known as “idiosyncratic risk,” meaning risks unique to a particular stock.

Lots can go wrong when you hold just a few stocks. Common examples include embezzlement, natural disasters and expropriation.

You can mitigate idiosyncratic risk through diversification. In addition, you gain a level of predictability regarding returns. As Piper notes, your returns are unlikely to be either spectacularly high or spectacularly low, which is a prudent way to structure a long-term portfolio.

The cost of putting together a diversified portfolio is low and getting lower. Fidelity and Vanguard are currently engaged in a price war. Fees on low-cost index funds and exchange-traded funds (ETFs) have never been lower. The average net expense ratio of Fidelity’s index funds is now only 0.102 percent. Fees on its ETFs are even lower. They are now 0.084 percent, which are currently the lowest in the market.

It has never been easier to own a globally diversified portfolio of low-cost index funds or ETFs in an allocation suitable for you. This is a free lunch. You owe it to yourself and your loved ones to take advantage of it.

A laddered bond portfolio can be a free lunch

Most investors would be better served by owning bonds in a low-cost, high-quality, short- or intermediate-term bond index fund. However, for investors with $1 million or more to invest in bonds, a properly structured laddered bond portfolio can be a free lunch.

My colleague, Larry Swedroe, set forth the requirements for putting together a laddered bond portfolio in this blog. He noted that it’s possible to assemble a bond portfolio with higher-quality bonds (and therefore less risk) than comparable bond funds, at a lower cost. It is also possible to purchase FDIC-insured CDs (which mutual funds cannot purchase) with higher yields than comparable Treasury bonds but no greater risk (since both are backed by the full faith and credit of the U.S. government).

Investors who don’t have large bond portfolios can take advantage of this disparity by buying these CDs instead of Treasuries. Obtaining higher yields with no greater risk is the essence of a free lunch.

Sticking to your investment plan is a free lunch

The precipitous drop in the markets, followed by a rapid recovery, after the Brexit vote was announced illustrates why so many investors don’t take advantage of another free lunch.

When there is a crisis in the market, the financial media often turns to “experts” to explain to the rest of us “what is going on.” Their opinions often vary widely, contributing to investor anxiety.

One economist declared that Brexit would have no lasting impact on the market. Historian Antony Beevor disagreed, noting ominously that “the danger is that Britain suddenly pulling out of the European Union at such a moment of crisis … could pull the whole thing down.”

Investors who panicked suffered meaningful losses when the market recovered.

Investors who have an investment plan in place pay little attention to market gyrations. They understand stocks go through negative periods. Their asset allocation permits them to weather the storm. They stay focused on their long-term goals. They understand that market prices are set by millions of traders viewing publicly available information every minute of every day. The possibility of any “expert” uncovering something missed by the collective wisdom of these traders is highly unlikely.

The ultimate free lunch is ignoring much of the financial media and staying focused and disciplined. It costs you nothing. The benefits in higher expected returns are significant.

This commentary originally appeared July 12 on HuffingtonPost.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2016, The BAM ALLIANCE

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