Since we’ve still got a little time before tax season really kicks in, I thought I’d share a few things that the recent drama in the stock market has reminded me of, especially when it comes to 401(k)s and how they relate to salaried and hourly employees.
For starters, most every employer-sponsored plan is a “choose your own adventure” for the employees, so now is a great time to actually look at where you are and if the stock market trouble is even an issue for you right now.
Most investors put at least a little thought into their asset allocation during pivotal moments, such as starting a new job or a new 401(k) plan. But few people remember to regularly rebalance, and that can cause them to take more risk than they realize they’re taking. Now, with a Bear market here, it’s a good time to think about where you’ve got your money, besides, as you age and get closer to retirement, you should gradually shift out of stocks and into less-risky investments such as bonds. But often, the exact opposite happens. After a long bull market, the percentage of your portfolio allocated to stocks likely has become larger rather than smaller. That means you’re potentially taking more risk at precisely the time you should be taking less.
There is no “correct” allocation to stocks. But the standard rule of thumb is that the percentage of your portfolio invested in the market should be roughly 100 minus your age – or in more recent models that take into account longer life expectancies, 110 or 120 minus your age. So, if you’re 65 years old, you should have something in the ballpark of 35% (100-65) to 55% (120-65) of your portfolio allocated to stocks. The rest should be allocated to bonds or cash.
These are just rules of thumb, of course. But if you have a lot more than that guideline invested in “true” stocks (or stock-heavy mutual funds), you really might want to consider rebalancing.
Now is also a great time for you to think about the actual costs of your investments’ opportunities. The financial press and in mutual fund literature LOVE to remind us that stocks “always” rise over the long-term.
This may very well continue to be true. But you also should remember that you have limited amounts of capital, and your cash might be better invested elsewhere.
Stocks are not the only game in town.
Even after the recent selloff, the S&P 500 still trades at a cyclically adjusted price-to-earnings ratio (“CAPE,” which measures the average of 10 years’ worth of earnings) of 27, meaning that this is still one of the most expensive markets in history. (Other metrics, such as the price-to-sales ratio, tell a similar story.)
This doesn’t mean that we “have” to have a major bear market, and stock returns may be soundly positive in the coming years. But it’s not realistic to expect the returns over the next five to 10 years to be anywhere near as high as the returns of the previous five to 10 years, if we’re starting from today’s valuations. History suggests they’ll be flattish at best.
It’s not hard to find five-year CDs these days that pay 3.5% or better. That’s not a home run by any stretch, but it is well above the rate of inflation and it’s FDIC-insured against loss.
High-quality corporate and municipal bonds also sport healthy yields these days and it’s hardly ever a bad financial play to have a whole or universal life insurance policy as a part of your overall financial strategy – not for you to have when you die, but for you to potentially use as a supplemental retirement cash supply – remember, if you’re fully vested in a policy, you can draw funds from the insurance policy and never touch the actual benefit.
Obviously, alternatives have risks of their own, and in fact might be riskier than mainstream investments like stocks or mutual funds. So you should always be prudent and never invest too much of your net worth into any single alternative strategy.
Just keep in mind that “investing” doesn’t have to mean “stocks.” And if you see solid opportunities outside of the market, don’t be afraid to pursue them.
I know, I know, you don’t know enough about alternatives to effectively use them as a strategy. I’d be more than happy to share how some of these can provide some tax benefits to you in the coming years – give us a call and let’s schedule it.
If you have questions on taxes, please don’t hesitate to call me on my direct line
at 909-570-1103 by email at Carlos@HealthcareTaxadvisor.com
Carlos Samaniego, EA
Licensed by The Department of Treasury to represent taxpayers
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