Greater 401(k) Focus on Retirement, But Not Annuities

Posted on March 27, 2015 | AAII Journal

About 93% of employers are very likely or likely to “create or broaden focus on financial well-being of employees beyond retirement” this year, according to an Aon Hewitt survey. Yet the focus for many employers will not extend to including annuities or other similar lifetime income products as investment options in defined-contribution [e.g., 401(k)] plans.

Aon Hewitt says seven Americans are reaching age 65 every minute. Given this, it is not surprising that nearly three-quarters of plan sponsors will experience an increase in retirement-eligible employees over the next three years. In response, 52% of employers say they are very likely and 38% say they are likely to offer retirement planning to near-retirees. Slightly more than half (51%) are very likely and 38% are likely to increase communication about the retirement process. Online modeling tools and mobile apps designed to help employees determine how much they will be able to spend in retirement may be made available by 53% of employers (“moderately likely action”), with 17% seeming more certain about providing them (“very likely action”).

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Achieving Greater Long-Term Wealth Through Index Funds

Posted on March 26, 2015 | AAII Journal

John Bogle (JB): Let’s start off with the obvious. Imagine a circle representing 100% of the U.S. stock market, with each stock in there by its market weight. Then take out 30% of that circle. Those stocks are owned by people who index directly through index funds. The remaining 70% are owned by people who index collectively. By definition, they own the exact same portfolio as the indexers do in aggregate, so they will capture the same gross return as the direct indexers. But by trading back and forth, trying to beat one another, they will inevitably lose by the amount of their transaction costs, the amount of the advisory fees they pay, and the amount of all those mutual fund management costs they incur: marketing costs, processing, technology investments, everything. When we look at the big picture of the costs of investing, including sales loads as well as expense ratios and cash drag, it is a foregone conclusion that active investors, in aggregate, will under perform index investors. It’s the mathematics.

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High Buyback Yields

Posted on March 25, 2015 | AAII Journal

Companies with excess cash can pay out dividends as well as repurchase outstanding shares that have been issued to the public. When a company reduces the number of outstanding shares, remaining shares gain a slightly larger proportional claim to the company and its profits. This allows earnings per share to expand more quickly than net income. A share buyback can also signal to the market that management thinks that the shares are attractively priced at current levels.

The easiest way to calculate the buyback yield is to look at the change in the average shares outstanding from one fiscal period to another. For example, DST Systems (DST) had 42.1 million shares outstanding during its 2013 fourth quarter, but it reduced the number of outstanding shares to 37.9 million by its 2014 fourth quarter. The 10.0% reduction in the number of shares is the buyback yield. A company that issues more shares will have a negative buyback yield.

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The “Dirty Dozen” Tax Scams for 2015

Posted on March 24, 2015 | AAII Journal

The Internal Revenue Service (IRS) says aggressive, threatening actions from scam artists have been occurring nationwide during the early weeks of the 2015 tax season. These calls top the agency’s “Dirty Dozen” list of scams.

The top tax scams includes:

Phone Scams: Criminals are calling certain groups, including retirees, with threats of police arrest, license revocation and other things. (The IRS never calls about taxes owed or to demand immediate payment without first having mailed a bill.)

Phishing: Fake emails are being sent and phony websites are being established with the intent of stealing personal information. The IRS says it will not send an email about a tax bill or a refund “out of the blue.”

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A Key to a Lasting Retirement Portfolio

Posted on February 27, 2015 | AAII Journal

If you’re retired—or nearing it—ensuring that your retirement investment portfolio lasts your lifetime is critical. And that’s not easy because by nature the stock market is volatile. What if a market downturn takes a bite out of your investment portfolio?

While you cannot completely control the market’s impact on your portfolio, there are things you can control that can also make a significant difference in how long your portfolio may last. One: your withdrawal rate from your portfolio. The amount you take can directly impact how long your assets could last in retirement.

But what about in difficult markets? At Fidelity, we still believe in inflation-adjusted withdrawal rates of no more than 4% to 5% a year for individuals who retire at age 65. That’s because we did the analysis using our Retirement Income Planner and an inflation-adjusted withdrawal rate of more than 5% steeply increased the risk of depleting retirement savings during an investor’s lifetime. We also ran some further analysis to determine the influence of different market environments.

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The Individual Investor’s Guide to the Top Mutual Funds 2015

Posted on February 3, 2015 | AAII Journal

The returns realized by mutual fund shareholders in 2014 depended significantly on the categories they chose and, at least on the domestic equity front, whether they went with an active or a passive fund.

We bring this up because a significant part of a fund’s returns are influenced by the performance of the category it operates in. For example, the average energy fund plunged 18.0% last year. The culprit: oil. Oil prices fell from $105.37 per barrel on June 30, 2014, to $53.27 per barrel on December 31, 2014. Fund managers required by their funds’ objectives to invest in energy stocks in their portfolios could do nothing but sit and grimace.

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Few Investors Plan to Keep Allocations Unchanged in 2015

Posted on February 3, 2015 | AAII Journal

Last month’s Asset Allocation Survey special question asked AAII members what, if any, allocation changes they expect to make this year. Slightly fewer than three out of 10 (30%) said they don’t anticipate making any changes. About 16% intend to increase their allocations to equities, while 7% plan on reducing their exposure to stocks. Close to 15% intend to boost their bond allocations and just under 10% say they will boost their cash allocations.



A Comprehensive Approach to Covered Call Writing

Posted on January 14, 2015 | AAII Journal

Setting up a covered call portfolio using securities that generated significant dividend distributions was covered by Ben Branch, professor of finance at the University of Massachusetts, Amherst, in two wonderful articles published in the AAII Journal last year.

The articles ran under the titles “Assembling a Covered Call Portfolio on Dividend-Paying Stocks” (June 2014), and “Managing a Portfolio of Covered Calls” (July 2014) and can be found in the AAII.com archives. This article adds information to the key facts highlighted in Branch’s articles and presents another perspective as to how and why such a covered call portfolio can be constructed and managed.

Covered call writing is a strategy where individual investors can sell options against securities—stocks or exchange-traded funds (ETFs)—they already own to generate monthly cash flow. In its traditional sense, profits can be gleaned both from the sale of the option and from share appreciation if the option selected has a higher value than the current market value of the stock. (For example, an investor buys a stock for $48 and sell the $50 call option; this known as an “out-of-the-money” strike.) If the option selected had a strike price (agreed exercise price) the same as (“at the money”) or less than the current market value (“in the money”), the maximum return would be the time value component of the option premium only.

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How Much Is Needed to Start Investing?

Posted on December 22, 2014 | AAII Journal

What is the minimum dollar amount needed to start investing? It is a question some members ask us and likely one that many others have, especially those who are new to investing.

Technically, you are only limited by the minimum amount required by a brokerage firm or mutual fund company to open an account. ShareBuilder, an online broker, has no required minimum account balance. More than 50 mutual funds included in our annual mutual fund guide have minimum purchase requirements of $100 or less, including funds offered by Fidelity, AssetMark, USAA and Oakmark.

Pragmatically, you should weigh the dollar amount you have available to invest against the actual costs of creating a diversified portfolio. Brokerage commissions for buying and selling stocks and exchange-traded funds (ETFs) increase significantly on a percentage basis as the dollar amount invested decreases. Mutual funds, conversely, charge a flat percentage fee. Commission-free ETFs, which are offered by some brokerage firms (including Charles Schwab, Fidelity and TD Ameritrade) are even more advantageous from a cost standpoint.

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Annuities Now Allowed in Target Date Funds

Posted on December 10, 2014 | AAII Journal

Deferred annuities are now to be held by target date funds within qualified defined-contribution plans, such as 401(k) plans. The inclusion of annuities allows target date funds to provide lifetime income to employers holding such funds.

Target date funds alter their allocations by their date. Far-dated funds use an aggressive allocation strategy and the allocations gradually grow more conservative as a target date fund approaches its target date. The changes are designed to match the investment needs of various age groups.

Currently, widely available target date funds do not have an age restriction. This presents a difficulty for insurers, because it makes pricing an annuity contract difficult. Insurers prefer a restricted age group for making actuarial assumptions. By restricting specific target date funds to older employees, however, a retirement plan would run afoul of the discrimination clause in the tax code. The tax code bans qualified plans from discriminating “in favor of highly compensated employees.” To the extent that older employees have higher salaries than younger employees, restricting access to investors within a specific age group by a target date fund could cause problems.

The tax code does allow the Internal Revenue Service some flexibility in establishing guidelines for qualified plans, and the agency used this flexibility to create a special rule. Target date funds in qualified plans can now restrict the age of their shareholders if certain conditions are met. The series of target date funds offered within a qualified plan must all have the same manager and use the same generally accepted investment theories. The target date funds available to older employees can include deferred annuities, as long as those contracts don’t provide a guaranteed lifetime withdrawal benefit (GLWB) or a guaranteed minimum withdrawal benefit (GMWB). Fees and expenses must be determined in a consistent manner and the target date funds can only hold the employer’s securities if such securities are publicly traded.

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