CNBC…for Entertainment Purposes Only

A similar form of entertainment...

A similar form of entertainment...

In the late 18th century Austrians were amazed at a mechanical man who could play chess. He became known as the Mechanical Turk. The automaton, consisting of gears and levers, could engage any player in a game while exhibiting stunning skill for a machine. Of course, people eventually learned it was a hoax. A man hidden under the playing table operated the arms.

People today could never be fooled by such a farce, or could they?

Much like the automaton, today’s television financial “professionals” put on a good show but lack any real ingenuity or skill. This passive engagement appeals to the public’s sense of novelty and theatrics. As media theorist, Marshall McLuhan theorized "The medium is the message." The medium is the problem.

Advertising, Not Acumen

The most popular financial shows in the world are not in the business of dispensing financial advice. They’re in the business of generating advertising revenue. They use sensationalism to keep viewers interested. This bombastic approach is not limited to those who unabashedly embrace exuberance like Jim Cramer of Mad Money. Hosts of other shows like Squawk Box and Power Lunch do the same.

The problem is the business model. The networks live and die by their ratings. This metric is critical because it drives their ability to generate advertising revenue. Therefore, the only goal is to bring viewers to the screen, not provide sound financial acumen to the masses. How do they get our attention? They use brute force. Amid an ever-increasing list of entertainment options (Netflix, Amazon, and others) hosts must resort to chest beating analysis to be heard. As one CFP summarizes, “The presentation is superb at creating confusion, yet greatly lacking in delivering worthwhile guidance.”1

The pressure for ratings comes not only from competing channels and sites but the omnipresent data of today’s world. Investors can find up to the minute research anywhere at anytime. With the sum of all human knowledge in our pocket, there is little reason to have allegiance to any particular program. Traditional television programming attempts to compete with sophisticated graphics and charting. The result of these tactics is a cacophony that never rises beyond noise.

More problematic is the authoritative stance hosts take. Jim Cramer has long abandoned any pretense of professionalism or elitism. As a result, he is the more honest of the hosts on TV. He shouts and screams and never pretends to be anyone but himself. For many viewers, this is the basis of his appeal. However, other hosts sporting a tailored suit and perfect tie offer themselves as a sage voice amid the manufactured confusion of the markets. This presentation is dangerous because it invites viewers to see them as Chartered Financial Analysts or Certified Financial Planners when they are neither. The more authoritative the presenter becomes, the more skeptical we should be.   

Reviewing Performance

The president on CNBC once remarked in his discussion of the network’s programming, “some people like politics, some like sports, some like news, but everybody is interested in money.”2 This interest in money that is, making more of it, is the only reason anyone would watch Mad Money, Squawk Box or Power Lunch. For this reason, it seems appropriate to measure the performance.

Researchers at Northeastern University reviewed the performance of Jim Cramer’s stock selections and concluded: "his aggregate or average stock recommendations are neither extraordinarily good nor unusually bad.”3 This finding is in keeping with the tenor of the show. Too often the host predicts all outcomes to hedge their reputation. The exhaustive research arrives at an unsurprising finding that “A portfolio constructed as described from Cramer’s ongoing recommendations would not produce superior performance over the entire period of analysis after adjusting for market performance, size, and book-to-market characteristics.”4

Part of the problem with executing Cramer's buy and sell recommendations is that it requires the investor to make rapid-fire trades. This activity generates burdensome fees, brokerage costs and taxable gains. It’s more than the ordinary investor can track. Following the twisted path of any host’s recommendations will cause the same problem.

However, the cost of fees and taxes are secondary to the costs associated with risk. “Systematic risk is about 20% greater than the passive S&P 500 index” warn the same researchers. While you might make a few gains, the risks incurred are dangerous and unnecessary given the middling returns. From July of 2005 through December of 2007 Cramer issued 1,387 explicit buy recommendations and 534 sell recommendations. Some of the more aggressively low-priced online brokers offer a flat fee of $4.95. However, at Cramer’s trading volume an investor would incur $6,865 in fees alone just to execute the buys. Even if an investor opted to purchase a quarter of the recommendations, their total cost would clock in at $1,716. This total is a high bar to hit just to break even.  

The Heat of the Moment

Sound investing focuses on fundamentals. The brazen hosts of network television, however, focus on the heat of the moment. Their stock selections are designed to capitalize on topical events and other short-term aberrations that have little bearing on a long-term plan.

If an investor embraces the short-term in the drive to wealth, they risk losses from unforeseen events. These television personalities live in the narrow space of intraday news. They attempt to profit from short-lived movements. The inherent problem with this approach this the broad viewership of the shows. Millions of others are watching the same program and hearing the same information. Therefore, any opportunities in the stock market are likely to be fleeting as others act to capitalize on the advice. It simply is not possible to embrace a new wealth management plan every night.

Furthermore, the frenzy of trading means missing the benefits of compounding. As share prices appreciate year over year investors, experience exponential growth as they earn interest on interest. Compounding is possible only with a consistent plan. Deviation disrupts compounding.

Supporting the importance of consistency is research from the University of Texas where academics concluded that “more style-consistent funds tend to produce higher total and relative returns than less consistent funds.”5 With so much influence on the minutia of earnings reports and nuanced company politics the TV, hosts are paying little attention to the underlying fundamentals. As a result, “unintentional style drift can lead to inferior relative performance.”6

This style drift underscores another problem with program hosts; they do not adopt a holistic approach. They choose a stock based on the news of the day without regard to how it will perform in the broader context of a cohesive portfolio. This concept forms the underpinnings of modern portfolio theory (MPT) which works to reduce idiosyncratic risk or the risk associated with the unique characteristics of a particular stock. The goal of MPT is to group various uncorrelated investments so that if one falls, the investor is not faced with a complete collapse in value. In fact, the strategy strives to see one investment rise as another falls, keeping the portfolio more or less even, while the whole of the portfolio increases in value over time.

If an investor blindly follows the recommendations of the hosts, they risk overweighting in a particular sector or succumbing to home bias which is the tendency to have a disproportionate amount of stocks from your home country. Each of the televised selections carries risks. Rarely is the risk factor of one offset by that of another.

In reality, the day to day financial news has very little impact on your overall financial situation. The best approach is to form a plan and stick to it. You are better off financially if you focus only on what you can control. Turn off the TV.




4 Ibid.


6 Ibid.

Key Takeaways from the Davos World Economic Forum

If you are a financial nerd like me you look forward to the Davos Economic Forum every year. It's an event held in Davos Switzerland where great economic minds and financial leaders get together and discuss the state of world from a financial persepctive. If you don't have time to watch hours of coverage you can take a look at our quick guide and see the key takeaways from this years meetings. Just click on the image below for a little lite reading this weekend!

Is the Stock Market Overvalued? Take a look at CAPE to find out.

Today is another article from the Fee-Only Financial Advisor Blog Sharing Group. This group is made up of other like-minded financial advisors from around the country. The purpose of the group is to share useful content and spread the word about the virtues of Fee-Only financial advice. The contributor of this article is Stephen Reh of Reh Wealth Advisors from California. His article looks at whether or not the stock market is overvalued. He uses a rarely heard of metric called the CAPE ratio. He'll explain what this is, how it works, and what it tells us about the current state of the stock market.


The Dow recently hit 20,000! This was a big psychological level for investors. While breaking this barrier is, in reality, insignificant, it symbolizes the continued growth of the stock market but also that the market may be getting too expensive. After all, the stock market has never been higher! But let’s look at the data to see how overvalued the market really is... 

CAPE – Cyclical Adjusted Price Earnings Ratio -  Shiller P/E – P/E 10 Ratio

First off, this is a valuation measure for the stock market which is based on another valuation measure, the price earnings ratio.   So, what is the CAPE? It’s the Cyclically Adjusted Price Earnings ratio!  I’ll bet your next question is “what’s that?”.  In this article, I will break it into simple terms to help you understand better and apply it to today’s stock market.

Price Earnings Ratio

In order to understand the CAPE ratio we need to explain what a Price to Earnings Ratio is and how it works. The Price to Earnings Ratio of the market, or P/E ratio, is simply the price of the stock market divided by the earnings of the market. This can also be applied to individual stocks but in this context, think of the market as a whole. The higher the P/E ratio the more expensive the market is, i.e., you are paying more in price for a relative share of profits (earnings). There is trailing P/E (based on recent historical earnings) and forward P/E (based on projected earnings estimates) but for the scope of this article, just understand it’s the price divided by the earning. <See: More Information on P/E Ratio>

Valuation Ratio

Next we have to look at something called a valuation ratio. This is simply a ratio that attempts to tell you how “expensive” (overvalued) the stock market is relative to its history.  We are going to use this by looking at the current P/E, we can compare to previous years P/E ratios.  If its higher, than we would say values are “rich” or potentially overvalued.  If its lower than average, the valuations are potentially undervalued. Are you getting curious about the current market valuation? Read on, we’re getting there.

So What Does Cyclically Adjusted Mean?

In the case of the CAPE, it’s the average of the last 10 years earnings adjusted by inflation.  The point of the CAPE is to adjust for an entire stock market / business cycle.  In most cases 10 years would capture a complete cycle. It’s really just a way to normalize the data.

What is the Intention of the CAPE Ratio?

The original intent was to forecast future long term returns and if they would be expected to be higher or lower than average. It is not intended to predict market crashes although by definition market corrections happen when markets are overvalued (otherwise they are not really overvalued are they?).

What is the Historical CAPE and Current CAPE?

The mean CAPE ratio is 16.72 since 1880. The current CAPE is 28.41 as of 02/06/2017. <Source: Shiller PE> That sounds like the market is dramatically overvalued. However, the world was drastically different in 1880. The period includes the Great Depression and two World Wars. Since 1990, however, CAPE has only spent 2% of it's time below its historical average. If it’s mean reverting, it should have reverted and returned near its mean.   What does this tell us?  It’s dangerous to use the measure to time the stock market.  Looking at CAPE over the past 25 years reveals a much different story.  According to JP Morgan’s guide to the market, the CAPE ratio has averaged 26.  The current CAPE of 28.5 then feels very normal and that the market is not overvalued.

Further, Jeremy Seigel from Wharton Business School argues that the CAPE uses a measure that is not consistently defined.  Earnings over time have been measured differently.  You cannot compare earnings in 1920 vs earnings in 2017 because the earnings are measured differently.  For example, companies used to have to write off Goodwill over time.  Since 2001, they must test for impairment and only write-off good will if it was no longer worth what the company paid. It doesn’t matter if you know what Goodwill means, the point is the definition of earnings has changed which makes the CAPE ratio flawed.

S&P500 Index: Forward P/E Ratio - Source JP Morgan Guide to the Markets

S&P500 Index: Forward P/E Ratio - Source JP Morgan Guide to the Markets

Moral of the Story?

So what is today’s “moral of the story”?  That I can use CAPE to argue the market is severely undervalued by comparing it to the late 1990's and that I can make it look severely overvalue by looking at periods of time prior to 1990.  Why is this important to you the investor?  It’s important to know that valuation ratios can give us a picture of the market but they can be manipulated by the person telling the story.  Inevitably, I get asked which ratios do I use and why?  I use the 25 year average because I think it’s more applicable to today’s world.  I also use more than one valuation ratio to create a better picture of the market.  Here is the spoiler alert, the vast majority of the time the picture painted is that the market is fairly valued.   According to JP Morgan’s Guide to the Markets, three ratios (P/E, CAPE, and P/CF) show the market is slightly overvalued and 3 ratios (Dividend yield, P/B, and EY Spread) show that market is undervalued.  How do I read into that?  The market is fairly valued or at least reasonably close.

The Swinging Pendulum of Passive Investing


Despite a growing selection of funds investors have centralized around a passive, low-cost strategy. Major names in the financial world have long touted the benefits of a passive approach. Vanguard founder John Bogle has become the face of the movement when he launched the first S&P 500 index fund available to the public in 1975.

The argument for eschewing actively managed funds is based on their well-documented underperformance relative to the broader market. The annual Morningstar active/passive barometer reinforces this truth with a review of the numbers. Their 2015 conclusion that “Actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons,”[1] is in keeping with growing investor sentiment that “If you can’t beat them, join them.”

In a 12-month period through the end of November investors collectively pulled $358.8 billion from actively managed funds based in the U.S. Simultaneously investors put $479.8 billion into passive funds. Choice, it seems, has become something of a burden and the choices keep growing. In 1997 there were 6,778 mutual funds available in the U.S. Today investors can choose from over 9,000.[2]  Technology has enabled a more robust offering, but in a frenetic work environment, people have less time to tease apart the nuanced differences.

For a period niche products like livestock ETFs and other alternative investments carried a cache. However, the disciplined investor of today seeks a reasonable rate of return and therefore has resorted to the terra firma of a passive approach. Some big name players took far too long to respond to the fact that “A generation of 18- to 34-year-olds that is larger in size than the baby boomers is increasingly opting for lower-cost passive funds.”[3]  Fidelity’s sluggish answer to this movement is a collection of six new ETFs launched in 2016.

The relatively strong performance of passive funds is only part of the appeal for investors. People have become savvy on costs. Fees and expense ratios have become part of the investor’s vocabulary. Passive strategies offer inexpensive exposure to all market sectors. Investors are increasingly wary of fees eroding their gains as some analysts point to muted returns and inflationary pressure in the coming years. Studies reflect investor vigilance when it comes to costs; “Over the past decade, 95% of all flows have gone into funds in the lowest-cost quintile. Passive funds have benefited disproportionately.”[4]  The people have spoken.     

Actively managed funds have dropped the average asset-weighted fee by 4.8% in a bid to win back investors. Actively managed bond funds shed 6.0%. Despite these pleas the trend to passive funds continues because superior performance and lower costs can only portend great things to come.

Or can they?

The mounting concentration of assets within these passive funds has brought criticism to the fore. Some managers posit that shareholder-voting power has concentrated around just a few big name managers. Apple’s “top three institutional investors are prominent index fund managers Vanguard, State Street, and BlackRock. Combined, these three institutional owners control 12% of its shares and, naturally, 12% of its proxy votes. That's a lot of power to put in so few hands,”[5] warns one author. As more investors crowd this space equity purchases reach an enormous scale. Such inflows effectively increase the correlation among stock performance. The result: Diversification fails to defray risk.

Additionally, markets will become less efficient. Passive funds are tasked with matching an underlying index. Any decision to buy or sell shares is driven only by the need to maintain symmetry with the index. Therefore, large purchases from the likes of Vanguard and State Street have nothing to do with the fundamentals of the stocks. This phenomenon will ultimately create less efficient markets.

In a less efficient market share prices are slow to respond to factors, which may change the value of a stock. This is problematic because massive index funds will not respond to cogent market information. When you invest in a passive fund, you're committing to a practice of anchoring and holding firm no matter which way the wind blows.

However, sometimes we need to adjust the sails.

If a stock that is part of an index experiences a sharp price increase its market capitalization grows. That is, the share price times the total number of shares outstanding becomes a larger number. In some cases, an increased share price is the result of sound business practices, a competitive advantage or a strong product offering. However, sometimes, markets move with the same irrationality of those trading them. In such cases, an index fund would need to join the buying frenzy just to maintain the proper market capitalization proportions. Buying for this reason is less desirable than buying or selling based on the company’s fundamentals.

Throughout history, investors have seen evidence of these inefficiencies. In the late nineteen-nineties, the “dot com” bubble meant that any startup in the online sphere could enjoy massive share price run-ups regardless of fundamentals. Eventually, the bottom fell out. Following this came the credit bubble. Since that time we’ve seen commodities soar for a period without regard for their fundamental values. Markets are inefficient. The only quest is how inefficient are they?

In time, active managers will be able to capitalize on these inefficiencies brought on by monolithic, immovable index funds. We're not at this point yet. However, the exodus to indexing continues to grow unabated. In 2000 index funds held 9.5% of all stock fund assets. Today it’s nearly double that figure at 18.4%.[6]   

The Eiffel Tower would be a beautiful place if it weren’t for all the people. Perhaps this is also true of index funds. Diversification, consistency, and low costs have always formed the bedrock of a sound investment strategy. However, in the future share prices may be influenced less by their performance and more by the baseless whims of the marketplace.

Investors have long had a critical eye on active funds. Before long it will be time to turn that gaze to the underpinnings of a passive approach.  While we maintain our position that passive funds will outperform their active counterparts, rest assured we are keeping an eye on the markets so that if the pendulum ever swings too far we will be ready to make the appropriate adjustments.








What is Financial Success?

As a continuation of the Fee-Only Financial Advisor blog sharing group, this month’s post comes to us from Michael Garry, a Financial Advisor in Newtown, PA. He enlightens us to what it actually means to be financially successful.


If we look at society and societal norms, a lot of weight is given to success when it comes to defining happiness. If we see a person who is successful, it is often assumed that they are happy. On an existential level we should consider what it all means. In reality, we actually have no idea whether or not that person is either happy or successful; for a couple of reasons: First of all, we can only measure someone else’s success or happiness by what we know about them. Secondly, and more importantly, we can only measure someone else’s success or happiness by how we define success and happiness. There is really no way of knowing whether their measures are even similar to our own.

It is on this concept that we are then able to shift our focus to identifying our own unique definition of success and happiness. Once we identify those things, then we can work on building a plan and setting the goals to achieve them.

When it comes to financial success, the same case can be made as above. Identifying what financial success is, is different for everyone. The following are considerations to make when developing your own unique financial success plan.

Know What Is Important To You:

As with any plan, it is important to begin with what matters. We don’t make plans about things that don’t matter to us, right? When thinking about achieving financial success, identify areas of your money life that you feel need improvement and think about why. Looking at something and judging it might help you make a list, but creating an action plan for change requires delving deeper into why there is something missing in certain aspects of our lives.

Financial success, on a holistic level, is about more than just accumulating money and being financially stable. Success, for most of us, fosters a sense of well-being and peace-of-mind. Setting goals on the foundation of what is important to you and your family will help to accomplish this.

Plan For The Long Run:

Looking far ahead can be overwhelming for some people. It can tend to make people feel like the road is too long and they might never get there. It is important to know that we aren’t just looking from point A to point B. We are looking at the “long run” – the path is part of the process. When we set goals we design a series of steps that will help us achieve that goal. Each step is an achievement and can help us to feel better about the process.

It is important to look at how our plan is going to affect us over time, so considering what will happen over the long term when we make short term goals is an important part of creating your overall financial success plan.

Analyze possible hurdles or obstacles:

Chess is a game of strategy and one that requires us to identify possible obstacles well in advance (plan for the long run) and find solutions to get around, under, over or through them (analyze). Using the chess analogy we can begin to look at each hurdle as a challenge and an opportunity to find new and better ways to plan for and achieve our successes.

Human beings are instinctually drawn to avoiding change and taking the path of least resistance. However, it is often the case that, in order to find that path, we need to think about it far in advance of when the resistance may come. This type of “plan now, act later” strategy can feel uncomfortable for some people.

Many of our clients find this particularly challenging as some of the difficulties that they could possibly face are unknown to them. For example, making a large purchase and using retirement income to fund it can have major tax implications, or it may be in your best interest. There are many factors that go into determining the right choice for a particular situation. We help our clients understand their options and find the path of least resistance to the goal they are trying to accomplish.

Live within your means:

We are practically programmed at birth to look over the neighbor’s fence to see what’s in their yard. When we are young it is a shiny scooter (or these days iPad or Drone or Hoverboard), as we age the shiny things become larger, more expensive and more of a driving force for our day to day money choices. Keeping up with the Joneses is an extremely destructive way to look at and deal with finances. For most of us it might provide some type of short-term satisfaction but, in most cases, that is followed by longer term regret and disappointment.

Having a budget, whether you are of average means or extraordinary means, is important and critical to your financial health and success. When we create and follow a budget, we live within our means and are able to save for our goals and achieve greater success over the long term.

Invest prudently:

What does this mean? Invest prudently. You would get a thousand different answers if you asked a thousand people. But, this is what we know to be true:

·        Investing requires patience, time and commitment

·        Methods to get rich quick don’t often work

·        Diversification is important, the next big stock pick is not

·        The only way to grow your portfolio over the long term is to assume some degree of risk

·        Listening to the media will cause you anxiety and reacting to headlines will cost you money.

·        Markets work

Throughout the world, over the course of the last century, Markets worldwide have a history of rewarding investors for the capital they supply. The competition between companies vying for capital and the competition between investors vying for better returns, drives prices to fair value and so it goes. 

We believe that a prudent investment philosophy utilizes low-cost investments across a global mix of asset classes to create a diversified portfolio that is engineered to provide long-term returns and offer reasonable down-side protection. Often times this investment strategy is better left to a trusted advisor in order to stay focused on the long term goals of your financial success plan.

The desire to achieve financial success is universal, but the way to accomplish it is unique to every individual. Identifying your objectives and creating the path to achieve them takes time and patience. We hope that this helps you create an outline for your financial success. Please let us know how we can help you accomplish your goals.

Michael J. Garry, CFP(R), JD/MBA, is the owner of Yardley Wealth Management, LLC, is an independent Financial Advisor who provides Fee-Only financial planning services and investment management in Newtown, PA, and the author of Independent Financial Planning: Your Ultimate Guide to Finding and Choosing the Right Financial Planner

Just Married and Starting a Family - Role of The Financial Advisor

John and Sally have been married 5 years. The 35-year-old computer programmer works at a major software company, while Sally, 32, works part-time as a freelance photographer and full-time as the mother of a 3-year-old son and a 5-year-old daughter.

The family rents a large apartment, but John and Sally would like to get on the property ladder and buy a house.

While both John and Sally have been busy with their careers and their children, they haven’t devoted much time to their financial affairs. John had done almost all his investing through his company’s 401(k) plan, while Sally had put savings into one major mutual fund. They had never really worked out any long-term financial planning, just paid the bills and let the savings accumulate slowly.

Now, with the prospect of making an important investment in a home, the couple decided they needed advice. They went first to their bank, which proposed a mortgage along with some stock market-linked index funds but they couldn’t decide if this was the best way to manage their savings. 

John and Sally weren’t really sure that they could afford to invest in a home, pay the bills, and save for retirement and their children’s education at the same time. It was the first time in their lives that they were considering very important, long-term financial decisions.

So they sought the help of a financial advisor. The advisor, who earned a fee for his services and didn’t depend on commissions from specific investment vehicles, was able to help them establish a plan for the future.

The first thing the advisor did was to gather all of the requisite information needed to make decisions and to organize it. The advisor developed a balance sheet, listing their assets, liabilities, and net worth, as well as a detailed listing of household costs. The advisor also took a hard look at how the couple was spending money on extras like restaurants or entertainment.

The advisor asked the couple to set goals for their future. How much did they need to save for their children’s education? What amounts should be set for retirement, life insurance, and for the expenses of daily life, including discretionary spending like entertainment.

Then the advisor developed several long-term scenarios for the couple’s future. What would happen if they bought a home? How much of a mortgage should they take on? Were they getting the best return on their savings from the 401(k) investments and the mutual funds? The advisor explained how to adjust investment risks to potential rewards.

The long-term scenario allowed the couple to make intelligent choices about what kind of home to buy and how to achieve their other goals. The advisor helped the couple work out a portfolio strategy.

John hadn’t been actively managing his 401(k) plan, into which almost all of his savings were going.  The advisor helped him change the investments inside the plan so that he got better returns and reduced investment costs. Some of the money in the fund was moved into IRAs, offering tax savings at low cost. Tax efficiency, which neither member of the couple had given any thought to previously, was introduced as a factor in how the couple invested.

The advisor helped Sally to diversify the investments she had made in the single mutual fund, which was not returning well, but which imposed high fees.

And the advisor completely reviewed the couple’s insurance plans, proposing lower-cost alternatives for life and property and casualty insurance.

Thanks to the advisor’s comprehensive long-term planning, John and Sally were able to choose a home they could afford, while saving for their most important goals for the future.

All the Questions You Have Ever Had About RMDs Answered.

We have another excellent blog post from the Financial Advisor Blog Sharing Group. As a reminder, this includes like-minded financial advisors from around the country. All the participating financial advisors are Fee-Only meaning the advice is objective and free from conflicts of interest. This article is from Dave Fernandez of Wealth Engineering. His article is all about RMDs. If you are not sure what that is or even if you do and still have questions then read on:

IRA Required Minimum Distributions (RMDs)

The IRS incentivizes investors to make tax deductible contributions to a number of different tax-deferred accounts such as an IRA, 401(k), SEP IRA, SIMPLE IRA or 403(b).  For many investors this is their primary way of saving for retirement.  The IRS allows the tax deduction on initial contribution and the continuous tax-free compounding of growth until distributions are taken or required.  Any withdrawals in retirement are taxed as ordinary income for federal and state taxes if applicable.  If you initiate a withdrawal prior to age 59 ½, not only will you pay taxes on the distribution, but you will also have to a pay a 10% early withdrawal penalty. 

When do I have to start Required Minimum Distributions (RMDs)?

Once you reach age 70 ½, the IRS requires that you begin taking a mandatory distribution on a yearly basis from your tax deferred account.  You didn’t think the IRS would let you keep deferring taxes forever did you?  If it’s the first year of distribution, you can take the withdrawal by April 1st of the following year after you turn 70 ½, but you would have to take two distributions in this second year.  Most investors take the distribution in the initial year so they do not have as large of a taxable distribution by waiting until the second year to start taking RMDs.

How do I determine the amount of my RMD?

The IRS has a life expectancy table which I have reproduced below.  (Note, this is one of three types of life expectancy tables.  The other two tables relate to inherited IRAs and if you have a spouse more than 10 years younger than you.  For illustration purposes, the table below will apply to most investor’s financial situations.  However, you should consult your CPA and fee-only financial planner to help you with the RMD calculation).  The amount of your RMD is based on dividing your previous year’s 12/31 account balance by the “Divisor” in the table related to your age.  For example, let’s assume you are turning 70 ½ in 2016.  You would take your IRA or other tax-deferred account balance as of 12/31 of the prior year, 2015 in this case.  Let’s assume it was $100,000.  You then divide this by the “Divisor” factor of 27.4, which equals an RMD of $3,649.64.

Source: IRS Publication 590

Source: IRS Publication 590

For fun I added a third column which converts the “Divisor” into a “% Withdrawal” to better show the impact of the RMD increasing over time.  At age 70 ½, the “Divisor” requires a relatively small distribution, equivalent to approximately 3.6% of the tax deferred account balance.  But as you see above, the “Divisor” goes up each year of age thereby increasing the withdrawal rate as a percentage each successive year.  By age 80, the “Divisor” is 18.7, equating to a withdrawal rate of 5.3%, and at age 90, the “Divisor” is 11.4, equating to a withdrawal rate of 8.8%.  The withdrawal rate continues to increase with age as the IRS wants to make sure it is receiving tax dollars in exchange for all those years of tax deferral!

Should I take the distribution all at once?

You have options for the withdrawal.  It can be taken in a lump sum or over a period of time within the year of each RMD.  If the required amount is relatively large, you could pro-rate the distribution and withdraw funds monthly over the course of a year.  Since most people pay their bills monthly, this may help to provide a consistent income stream on a month-to-month basis and allows the funds to remain invested in your IRA/tax deferred account and potentially grow for as long as possible.

What if I have more than one IRA or tax deferred account?

Typically each separate account will require an RMD.  There are situations where you can take one distribution from one IRA to cover for multiple IRAs and meet the RMD requirement for all of your IRAs.  However, you should consult with a fee-only financial advisor and/or your CPA to make sure you are taking the appropriate RMD if you have multiple tax deferred accounts. 

What if I forget to take my RMD withdrawal?

The IRS imposes a 50% penalty on any RMDs not taken.  This is the stiffest of any IRS penalties.  This penalty is in addition to any ordinary income taxes you will owe on the distribution.  Most investment custodians do a good job reminding their investors of the annual RMD.  However, if you do happen to miss an RMD, you will want to consult your CPA as special forms need to be filled out and submitted to the IRS when catching up on any missed RMDs. 

What if my income needs in retirement are greater than the RMD?

You can always withdraw more than what is required by the RMD.  A higher withdrawal amount will generate more ordinary income taxes.  If you have taxable assets, you may be able to take a portion of withdrawal from this source to complement the RMD as taxable assets are typically taxed at more favorable capital gains rates versus ordinary income tax rates. 

Every investor has a unique tax situation.  Your comprehensive financial planner can coordinate and recommend the best combination of withdrawal amounts between your tax-deferred and taxable accounts, in addition to coordinating this with your Social Security benefits, pensions, deferred compensation, rental income, or any other sources of income you may have in retirement.  Your fee-only financial advisor can also ensure you are on track for a successful retirement.   (See: Sources of Income in Retirement)

About The Author

Dave Fernandez, CFP® is a native of Arizona and has over 20 years of experience in the financial services industry.  He started his financial services career in 1995.  As a NAPFA Registered Financial Advisor, Dave owns a fee only financial planning and wealth management firm, in Scottsdale, Arizona called “Wealth Engineering.” 

Wealth Engineering, LLC

If the Markets Are Acting Crazy, Here’s What You Need to Do.

2015 was not the best show for the stock market. The S&P 500 ended the year up only a mere 3 percent. That may seem like a tiny return, especially when considering that not too long ago in 2013, the index surged 30 percent. This year has been similar (albeit slightly better) with the markets up but still only single digits.

Volatility last year is best shown by the Dow Jones Industrial Average which, in the first six months of 2015, was never up or down more than 3.5 percent, something that had never happened before. Within that tight range, the Dow crossed its break-even point more than 20 times by late July. This year we started off with a market correction before everything turned around and started to rise, with a few hiccups like Brexit along the way. 

The reaction of many investors to these market conditions has been to do nothing, stop investing or, worse, get out of the market altogether.  Liquidating your investments at a volatile time is a terrible investment strategy. Investors who flee the market in this type of panic induced selling are reacting in a way that does a lot of harm to their portfolio and chances of financial success.

No one can time the market (buying low and selling high) consistently over any meaningful length of time. So, how does an investor succeed during these periods of volatility?

A strategy that many experts favor is dollar cost averaging. This takes a lot of the fear out of investing in stocks because it's a long-term strategy that takes volatility into account. The key, in dollar cost averaging, is to stick to a regular investment plan by buying at preset intervals and ignore the market gyrations. By doing this you will buy both when the markets are up and when the markets are down. This is especially helpful when we are in a bear market as you can buy more shares for your money.

Here's an example to help understand a little better.  Suppose, you plan on investing $25,000 each quarter for a year. If the stock starts out at $100/share you will be able to buy 250 shares. Assume also the market goes down in the second quarter, and you pay $90/share during the second purchase. The third quarter gets worse, and you pay $70/share.  Finally the market recovers and the shares end the year at $90/share.  During that time you were able to accumulate 1,163 shares worth $104,670.  Not only do you own more than the 1,000 shares compared to making the total investment all in the first quarter but your shares are worth more too even though the price actually decreased from the start of the year by $10/share. 

In the end, the winners in the investment game are those who stay the course and continue to invest, no matter how volatile and crazy the market seems. The losers have invariably been those who sell out after sharp stock-market declines just like what we experienced in 2008 and subsequently buy back in when the markets rebound.   

Using dollar cost averaging helps avoid the risk of putting all your money in the stock or bond market at the wrong time.  It ensures that at least some of your investments will be made at or near market lows. 

Donor Advised Funds - A Good Way to Give

With the holidays coming up, many people are already planning on how they want to make their charitable gifts before the end of the year. There is a a little known account called a Donor Advised Fund that offers an easy way to make your donation "early" and give the money away later. 

First let's discuss how they work and why you may want to use one. When you set up a Donor Advised Fund, you receive an immediate tax deduction on the full amount you place in the fund. They are pretty easy to set up and require a relatively small initial donation of $5,000. Well, it's not that small but it is compared to other options like Private Foundations which have many more rules and restrictions and typical only make sense to start if you will be donating hundreds of thousands of dollars. Subsequent donations, after the initial funding, can be as low as $500 and there is no minimum required annual distribution, which there is with a private foundation.



Once funded you can give all or part of the total to various charitable causes of your choosing. If you don't want to donate all the money right away or aren't even sure who you want to donate it to the money that stays in the fund can be invested and grow tax-free, so there is even more money for charitable giving later on. Although this doesn't increase the size of your tax deduction (since it was already taken when the money was placed in the fund) it definitely increase the funds available for charities. 

The ease of setting up, control, and flexibility are many of the reasons why contributions to Donor Advised Funds grew 14.1 percent or $19.6 billion, in 2014, bringing the funds’ total assets to $70.7 billion, according to statistics from the National Philanthropic Trust.

Future donations are very easy. Once the fund is established, you can make donations to the fund anytime.  It's important to note that any money placed in a Donor Advised Fund is irrevocable, meaning you can't take it back, even though you retain the ability to coordinate the donations.

A neat feature of the fund is that you can make grants from the fund in the name of another person, someone you wish to honor or remember. For example, you could give part of the balance to a favorite charity of a loved one in their name, even though you already took the tax deduction on your personal tax return. It's also possible to set up a memorial fund in your own name that will keep on giving when you are gone. 

Most people who set up Donor Advised Funds do so because they wish the fund to survive them, perhaps to be passed on to their children for future giving. In order to accomplish this it's important to set up the succession plan correctly when the fund is initially set up. You should name specific charities for granting at that time and decide how much and when to distribute funds. This is a good idea if you make donations to small charitable organizations who can't absorb all the funds at once. Alternatively, you can set it up to have all the money distributed in full to the charities of your choosing at the time of your death. Make sure that if you choose to pass the fund onto your children they are prepared to handle it according to your intentions. If you have more than one child, it is important to specify who is responsible for ultimately executing the donations. It is possible to name them as advisors on your account prior to your passing which might be a good idea to get them comfortable with how it works.

You also have the ability to set-up a separate account for each child and let them learn on their own how to make granting choices. This can be a great way to get your children involved in philanthropy early on. If you decide to go this route help your children make choices according to their own charitable causes. Give them control to choose the charities that they think are important and discuss it with them. This will get them comfortable with how things work.

If you are in a charitable mood, consider using a Donor Advised Fund rather then just making a straight donation. They are ideal if you need to make a donation before the end of the year but haven't determined who to actually give the money to yet. If you need help setting one up feel free to reach out to us. We never charge for the management of charitable funds.