Out goes Janet Yellen...and in comes our new Federal Reserve Chairman Jerome H. Powell

Saying the U.S. economy has strengthened in recent weeks, new Federal Reserve Chairman Jerome H. Powell suggested Tuesday that the central bank could hike its key interest rate faster than anticipated.

Powell said he and his Fed colleagues will try to balance stronger growth with the potential for "an overheated economy" now that "fiscal policy is becoming more stimulative" with tax cuts and increased federal spending.

In his first extensive public comments since taking over as Fed chief at the start of the month, Powell told the House Financial Services Committee that "the economic outlook remains strong" despite recent financial market volatility.

"At this point, we do not see these developments as weighing heavily on the outlook for economic activity, the labor market or inflation," Powell said during his first congressional appearance since becoming Fed chief.

Even though the nine-year economic expansion is the second-longest in the nation's history, Powell said he was not concerned a downturn is looming.

"There's always a risk of a recession at any given point in time," he said. "I don't see it as at all high at the moment."

Then he indicated the forecast for rate hikes this year might increase when the policymaking Federal Open Market Committee meets on March 20 and 21.

"My personal outlook for the economy has strengthened since December," Powell said. "I wouldn't want to prejudge that new set of projections, but we'll be taking into account everything that's happened since December."

OK, we get the hint...interest rates are likely going to continue to rise. 

If that is the case, it is time for us to react. 

Please continue reading below as we discussed BONDS.  

Lets talk Bonds !

Managing money is an ongoing and fluid process. The days of "buy-and-hold" or "set it and forget it" simply do not work for most people. For over 20 years we have been helping clients look for ways to manage risk in their portfolio. We have utilized numerous different investment strategies to do this. Sadly, too many clients lose far too much money after being told by their broker or advisor or trusted money manager that they would not be exposed to excessive risks. Although we still strongly believe in the financial markets for investing for long-term growth and income, there are times in the short term we must be tactical and use our market intelligence (and Spidey senses) to avoid what we feel are some obvious risks. Sometimes you need to make a judgment call based on a collection of pertinent data to mitigate risk and improve the probability of success.

Today we are faced with one of these scenarios...BONDS!

No, not James Bond, or bail bonds. We are talking about the ones that almost anybody with a 401(k) has. The ones that nearly every investor owns whether they know it or not.

When we ask people what they know about bonds, we almost always get an answer that includes 2 words...safety and income.  We are not challenging the fact that bonds are still able to provide income. However, we are challenging the amount of safety that exists today.

Above, we discussed the fact that it seems clear that the intent of the Federal Open Market Committee (FOMC) is to continue to increase interest rates. This process has already begun. Therefore, we have data to use to show us what is beginning to happen.  Bond prices are falling.  Take one of the largest Bond Mutual Funds in the world...Vanguard Total Bond Market Index. This fund has found its way into an incredibly high percentage of 401(k) plans. Further, it is one of only four or five underlying investments in Vanguard's Target Retirement funds. The Vanguard Target Retirement Income fund (VTINX) is the one that bothers us the most.

Here is the fund objective taken right from Vanguard:

"The Target Retirement Income Fund is designed for investors already in retirement. The fund seeks to provide current income and some capital appreciation by investing in 5 Vanguard index funds. The fund holds approximately 30% of assets in stocks and 70% in bonds. This is also the allocation that all Target Retirement Funds are expected to assume within seven years after their designated retirement dates. Investors in this fund should be willing to accept modest movement in share price and be able to tolerate the market risk that comes from the volatility of the stock and bond markets.

Take a look below >>>

You will see that 37.3% of the fund is invested in the Vanguard Total Bond Market Fund. In total, 69.62% of the fund is on bonds. According to a very old but common rule of thumb, "The Rule of 100", this allocation looks to be quite prudent. The rule of 100 simply states that if you subtract your age from 100, that is the percent of stocks you should have in your portfolio. Stated otherwise, your age is the percent of bonds you should have in your portfolio. Therefore, by that guideline, this portfolio would be pretty good for someone age 69. Right? Someone 69 certainly could have retired at age 62 and owned the 2010 fund in their 401(k). If that were the case, according to the summary above, this retiree would now be invested in this allocation (7 years after reaching the target date of 2010). Makes sense?

Please let us know if you currently own a Vanguard Target Retirement Fund.  We would like to review alternatives with you.  If we have previously suggested one of these funds, we will be in contact to reassess.

So... here is the problem. Let me introduce 2 very simple concepts.

First, if interest rates rise most bond prices fall. Imagine a teeter totter. When one side goes up the other goes down. That is one of the few undoubtable facts when it comes to investing.

Second is a term called Duration. Duration is a fancy calculation that simply indicates the risk associated with a bond or bond fund when interest rates rise. The higher the Duration, the more risk. Specifically, Duration is the amount you may expect to lose in value if interest rates were to rise by 1.00%

OK...back to the Vanguard bond fund. The Duration of this fund is currently 6.1 years. Based on that, we would expect the fund to lose 6.1% in value if rates increase by 1.00%. At RAA, we would rather avoid that risk.

Now, please refer to the second chart below >>>

What you are looking at is the yield on the 10-year treasury note going back to 1962. That peak you see occurred in the middle of 1981. We have been in a declining rate environment for a very, very long time! We do not know if a reversal is in the works or not. However, as your fiduciary, we want to prepare you for the possibility.

Luckily, there are alternatives to consider.  Some we have studied carefully and have started to implement are reviewed in detail below. 

We will almost certainly continue to speak about this topic throughout the year.

If you would like to talk about anything we have discussed here prior to your next meeting, please call or email us to set up an appointment.

The "A" word!

Yup, that's right. We are going to talk about annuities.

One of the most misunderstood investment vehicles on the planet is an Annuity.

A common statement we hear is: “I don’t like annuities” or “Annuities are bad investments.”

We are firm believers that there is a time, a place, and a person for almost every investment. 

There and many flavors of annuites.  Annuities can be fixed or variable, immediate or deferred, have fees or have no fees, be liquid or have no liquidity.

Here is a brief crash course on annuities.

Annuity vs. Annuitizing

One of the biggest misconceptions about annuities is that you give your money to an insurance company and they have total control over it and pay it back to you for a set period of time. That is not an annuity, that is annuitizing.

While most annuities have the option to annuitize – if you have a deferred annuity, then this option is purely at your discretion and you never have to annuitize if you do not want to.

What most people don’t realize is that annuities are unbelievably diverse and have a wide range of uses and benefits besides just income. Let’s get into some of the types of annuities.

Types of Annuities:

Single Premium Immediate Annuity (SPIA)

Single premium immediate annuities are what most people think about when they think of annuities. These are basically a pension plan through an insurance company. You give an insurance company a lump sum of money, and they promise to pay back a set amount of income for a set period of time, usually 5-20 years and/or the owner’s life.

These annuities are becoming increasingly less popular because of the lack of liquidity and the low payouts due to low interest rates and increased life expectancy.

At RAA, we are currently not recommending SPIAs...rates are too low

Multi-Year Guaranteed Annuity (MYGA)

A Multi-Year Guaranteed Annuity works very similar to a bank CD. When the account is purchased, there is a declared interest rate for a set amount of years. These are typically between 3-10 years. Like CD’s, most MYGA’s don’t have fees.

Pros / Cons of using a MYGA over a bank CD:

MYGA Pros

• Usually much higher interest rates than bank CDs. As of January 2018, there are 5-year MYGA’s paying over 3% interest, while the average 5-year CD is under 2% interest.
• MYGAs are tax deferred until you take a distribution. CD’s interest is taxed annually. MYGA’s can also be exchanged at the end of their term to a new contract and preserve the tax deferral.
• Most MYGAs allow you to take out a certain amount of money and keep all your interest. These distributions are usually between the total amount of interest earned and 10% per year.

CD Pros

• Bank CDs have government FDIC insurance while MYGAs are backed by the claims paying ability of the insurance company.
• If most CDs are broken (taken out early) you usually just give back the interest. Most MYGAs have surrender charges between 5%-10% if you go over the free amount available.

At RAA, we are beginning to find attractive uses for MYGAs...rates above 3% can be found

Fixed Indexed Annuities (FIA)

Fixed indexed annuity’s interest rates are based on a market index with a guaranteed minimum interest rate typically between 0% and 1% per year. These investments have quickly become one of the most popular choices for retirees because of their high level of stability, potential for growth, and low to no fees. FIAs are one of the only ways that give you the chance to exceed 4% or 5% without risking your principal.

FIAs should be looked at as longer-term investments between 5-10 years. During this period, you will typically can withdraw (without a penalty) from 5%-10% per year.

There are lots of FIA interest crediting methods, so make sure that you understand exactly the way your interest will be calculated before deciding to purchase an FIA.

At RAA, we have begun to implement strategies using FIAs...bond alternative and income guarantees

Variable Annuities (VA)

When someone is talking about annuities having high fees, they’re usually referring to Variable Annuities. That’s because some variable annuities have over 4% in total fees.

Even the 4%+ variable annuities may have their place. The reason you’re paying those high fees is because there are a lot of guarantees tied to high risk investments. Usually you’ll have an income rider and death benefit rider, and the opportunity to participate directly in the market without a cap.

Unequivocally, RAA does not recommend VAs...most are too expensive

In Summary…

For many people, annuities are not an appropriate investment, but there are many people that should be using them and are not because they heard someone overgeneralize them on TV or their friend said that they’re bad investments.

We simply request that you be Open Minded and consider all options especially as you are approaching what Prudential so perfectly called "The Retirement Red Zone"; the 5 years before and 5 years after retirement.

Please let us know if you have questions or would like to discuss if an annuity makes sense for you. 

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Next month, we plan to take a deep dive into something we briefly mentioned some time ago...INCOME ALLOCATION. 

We have spent over a year studying and attending training on this new philosophy. 

In short, Income Allocation examines the percentage of a retiree’s income that is guaranteed versus that portion which is at risk.

We will leave you with this thought provoking statement:

ASSET ALLOCATION is an investment strategy;

INCOME ALLOCATION is a retirement strategy.

Stay tuned for more next time.  

Thanks for reading.