Should you convert to a Roth IRA?

In Brief:

Investors at any level of income can convert assets from a traditional IRA to a Roth IRA. This article explains the potential benefits and tax implications of a conversion.

There are several key differences between a traditional IRA and a Roth IRA that can impact your wallet. So, are there benefits to converting all or a portion of your traditional IRA assets into a Roth? The answer to this query likely depends on:

  • The amount of time you plan to leave the assets invested,
  • Your estate planning strategies, and
  • Your willingness to pay the federal income tax bill that a conversion is likely to trigger.
     

Two Types of IRAs

Each type of IRA has its own specific rules and potential benefits. These differences are summarized in the table below.

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Conversion: Potential Benefits ...

Potential benefits of converting from a traditional IRA to a Roth IRA include:

  • A larger sum to bequeath to heirs. Since lifetime RMDs are not required for Roth IRAs, investors who do not need to take withdrawals may leave the money invested as long as they choose which may result in a larger balance for heirs.
     
  • Additional planning consideration – estate taxes: State estate taxes do not provide an IRD deduction (income in respect of decedent). Therefore, estate tax savings must be balanced against future income tax rates for you and your heirs. In short, estate tax benefits are greater at the state level, and only relevant at the Federal level for IRA-centric estates. Note: After an account owner's death, beneficiaries must take required minimum distributions, although different rules apply to spouses and non spouses.
     
  • Tax-free withdrawals. Even if retirees need withdrawals for living expenses, withdrawals are tax free for those who are age 59½ or older and who have had the money invested for five years or more.
     

... As Well as a Potential Drawback

  • Taxes upon conversion. Investors who convert proceeds from a traditional IRA to a Roth IRA are required to pay income taxes at the time of conversion on investment earnings and any contributions that qualified for a tax deduction. If you have a nondeductible traditional IRA (i.e., your contributions did not qualify for a tax deduction because your income was not within the parameters established by the IRS), investment earnings will be taxed but the amount of your contributions will not.
     
  • The conversion will not trigger the 10% additional tax for early withdrawals.
     

Which Is Right for You?

If you have a traditional IRA and are considering converting to a Roth IRA, here are a few factors to consider:

  • A conversion may be more attractive the further you are from retirement. The longer your earnings can remain invested, the more time you have to help compensate for the associated tax bill. Pay the tax when your tax rate is anticipated to be the lowest.
     
  • Tax equivalency principle: Your current and future tax brackets will affect which IRA is best for you. If you expect to be in a lower tax bracket during retirement, sticking with a traditional IRA could be the best option because your RMDs during retirement will be taxed at a correspondingly lower rate than amounts converted today. On the other hand, if you anticipate being in a higher tax bracket, the ability to take tax-free distributions from a Roth IRA could be an attractive benefit.

There is no easy answer to the question "Should I convert my traditional IRA assets to a Roth IRA?" As with any major financial decision, careful consultation with your financial advisor and accountant is a good idea before you make your choice.

 

Source/Disclaimer:

1. IRA account holders (both traditional and Roth) may avoid the 10% additional federal tax on withdrawals before age 59½ only if they meet specific criteria established by the IRS. See Publication 590-A for more information.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content. Cambridge Wealth Management rewrote parts of the introduction, closing paragraph, and added the section titled "Additional planning consideration – estate taxes," and the term "tax equivalency principle." © 2016 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.

Investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this piece is intended for information only, is not a recommendation and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances. All data are driven from publicly available information and has not been independently verified by Cambridge Wealth Management, LLC. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.

Ready Your Bond Portfolio For Reflation

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In Brief:

  • Donald J. Trump’s surprise election victory is a sea change, opening the way for substantial tax and regulatory reforms that should lead to reflation: improving growth, wage gains, and concomitant inflation.

  • Post-election, the shorter end of the yield curve immediately steepened, suggesting bond investors see more growth in the near term. However, the long end of the yield curve has flattened, signaling that fiscal stimulus now may become a fiscal drag over the long term.
     
  • We expect to see a modest rise in the 10-year Treasury from the current level of about 2.4 percent (watch 2.60 percent level).
     

The Yield curve "Tell"

First, let’s begin by defining a yield curve. A yield curve is a line that plots the interest rates, at a point in time, of bonds having equal credit quality but differing maturity dates. The most commonly reported yield curve compares the three-month, two-year, five-year, 10-year, and 30-year U.S. Treasury debt. [1}

Read more: Yield Curve Definition | Investopedia

The yield curve reflects the collective wisdom of millions of bond investors, and historically, it has been a strong predictor of economic booms and busts. The steepness or flatness of the yield curve is an indication of economic growth. The steeper the curve, the more investors expect inflation and interest rates to rise in the future. Conversely, when the yield curve flattens (or inverts -- shorter-term rates are higher than long-term rates), then investors expect a slowing economy. Also, our Federal Reserve Bank’s buying programs exert influence on the shape of our yield curve.

With the post-election spike in the 10-year Treasury, the bond market is telling us that Trump’s proposed policies are reflationary (see chart below). Over the short run, the bond market is signaling that moderately improving economic growth will lead to gradually rising interest rates. However, the long end of the yield curve has flattened, which means that Trump’s fiscal stimulus plans of lower tax rates and trillion-dollar infrastructure spending could become an economic drag later. And if Trump’s policies add to our $20 trillion in national debt, future costs of servicing our national debt due to higher interest rates could present a real drag on GDP.



The congressional budget office numbers

Each year in February, we review the CBO Budget and Economic Outlook report. According to this year’s report:
“As the slack in the economy continues to diminish, the Federal Reserve will continue to reduce its support of economic growth, in CBO’s view. Thus, the federal funds rate — the interest rate that financial institutions charge one another for overnight loans of their monetary reserves — is expected to rise gradually over the next few years, reaching 1.1 percent in the fourth quarter of 2017 and 1.6 percent in the fourth quarter of 2018, and 3.1 percent in the later part of the projection period. [2]
 

Our bond portfolio base case

  • We advocate holding Treasury Inflation-Protected Securities (TIPS) in bond portfolios.
  • We favor shortening interest rate exposure. (Floating rate bonds look pricey).
  • We prefer financial paper, selective U.S. fixed rate bank preferreds, and investment-grade corporate bonds over Treasuries.
  • President Trump's proposed tax reforms could reduce the attractiveness of municipal bonds and presents risks for investors.
  • We recommend a simple laddered bond strategy.

Historically, the sweet spot in the yield curve during a rising rate environment has been the five-to-seven-year maturity range. While we expect rates to rise from current levels, they should remain low by historical standards for several reasons: slower growth in the labor force, diminishing productivity growth, and continued strong demand for U.S. Treasuries from the European Central Bank and the Bank of Japan.

Footnotes:
1. Investopedia: yield curve definition
2. Congressional Budget Office Report, "The Budget and Economic Outlook: 2017-2027," January 2017.

Investing involves risk, including possible loss of principal, and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Indices are unmanaged, do not consider the effect of transaction costs or fees, do not represent an actual account and cannot be invested to directly. The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.

The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by Cambridge Wealth Management, LLC. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.

Trump's Tax Plan: The Simplified Facts

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We have what it takes to take what you have.
— Suggested IRS motto

In Brief:

  • The current bullish case for a Trump presidency is that corporate tax cuts will unleash animal spirits and spur investment in equipment, buildings, and labor. Investors are drawing parallels with Reagan’s “trickle-down economics.”
     
  • Trump wants to collapse 7 tax brackets to 3 brackets. The tax brackets are similar to those in the House GOP tax blueprint.
     
  • Repeal of the death tax: Trump has stated that he wants to repeal the estate tax. It’s not clear whether he would also propose to repeal the gift and generation-skipping transfer tax.

The markets have experienced a euphoric rally and are currently betting that fiscal conservatives will set aside their principles and give Trump what he wants when it comes to tax cuts. The collision of hope and reality is likely to happen as soon as March, when the suspension of the ceiling on the federal debt ends. Republicans in Congress who used the debt ceiling as a weapon against Obama are unlikely to rollover.

President Trump’s vision, according to his website, is to “reduce taxes across-the-board, especially for working and middle-income Americans who will receive a massive tax reduction.”

Here is a list of the key provisions of the Trump tax plan that, if enacted, will have the greatest impact on individual taxpayers:


Brackets & Rates For Married-Joint Filers: 12, 25, 33%

Less than $75,000: 12%
More than $75,000 but less than $225,000: 25%
More than $225,000: 33%
*Brackets for single filers are one-half of these amounts
 

Capital Gains:

No change: 0,15, and 20% rates
The Trump plan will retain the existing capital gains rate structure (maximum rate of 20%). Carried interest will be taxed as ordinary income.

The 3.8% Affordable Care tax on net investment income will be repealed, as will the alternative minimum tax under Trump’s tax plan. The House Republicans’ plan proposes lowering the effective top tax rate applicable to capital gains, interest and dividends to 16.5%
 

Deductions:

Standard deduction for joint filers moves to $30,000 from $12,600; $15,000 from $7,500 for single filers. The personal exemptions will be eliminated

Itemized deductions capped at $200,000 for married-joint filers; $100,000 cap for single filers. Most taxpayers will have no need to itemize, simplifying their tax returns and making it easier to file. This limitation would impose a significant restriction on the use of the charitable deduction. The House Republicans’ proposal eliminates all itemized deductions other than the deduction for home mortgage interest and charitable gifts.
 

Business Income Tax:

Trump’s plan cuts the corporate tax rate from 35% to 15% and eliminates the corporate alternative minimum tax. This rate is available to all businesses, both small and large, that want to retain the profits within the business.

  • It will provide a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10%.
     
  • Enhanced expensing for manufactures: Firms engaged in manufacturing in the US may elect to expense capital investment and lose the deductibility of corporate interest expense.
     
  • Small businesses would also have the option of continuing to pay their taxes through the individual side of the code, as they do today, or elect to file their taxes as if they were incorporated, whichever is more advantageous for them. The House Republican’s current plan proposes the top rate applicable to the business income of individuals who earn this income directly or receive it from pass-through entities to 25%.

Our view is that Trump, the deal maker, will ask Congress to meet him half-way and split the difference between his plan's corporate tax rate of 15% and the current 35% tax rate. Subsequently, we think that the market, being a forward-looking discounting mechanism, has already priced in a 25% tax rate which equates to an 8 -10% increase in corporate America's 2017 earnings. Only time will tell if markets have become overly optimistic about anticipated tax cuts.


The Bottom Line:

Fundamental tax reform is needed to promote economic growth, job creation, and international competitiveness. Our corporate tax rates are 10 points higher than the global average. The business and investment income of individuals is now subject to a tax rate as high as 43.4% versus the corporate tax rate of 35%! Simply put, our tax code is unfair and penalizes the small business owners in America — the backbone of our economy. The Trump Tax Plan would lower that top tax rate to 33%.

While we don’t yet have yet have a clear understanding of the details of his proposals, it is very likely that some combination of the Trump Tax Plan and the House Republicans’ Plan will become part of our tax law sometime this year. We will keep you informed of material changes to our tax laws as we journey through the uncharted territory of a Trump Presidency.


Sources: Donald J. Trump.com, The Wall Street Journal Online; Bloomberg News; Forbes.com; CNBC News; Reuters News.

 

The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.

The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by Cambridge Wealth Management, LLC. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.

Thank you veterans for your service and sacrifice

This Veterans Day, Cambridge Wealth Management thanks those who have answered the call to serve in our nation’s military. The image posted here today reminds us of the family sacrifices our veterans have made to keep us free and safe. It particularly touched our founder because it reminded him of his brother, Colonel Ernest G. Lockrow, who recently retired as Chief of OB/GYN at Walter Reed National Military Medical Center. Colonel Lockrow was among the first Asian American brigade adjutants at the United States Military Academy at West Point. An airborne Ranger, he served as a flight surgeon with the 82nd Airborne Division at Fort Bragg before becoming an OB/GYN after Operation Desert Shield and Desert Storm. Because of his selfless service to our great nation, he missed out on many of the milestones in his three little girls' lives.

We say “Thank You!” to Colonel Ernest G. Lockrow and all veterans for the many sacrifices you have made for our country, helping to make our communities and nation safe and strong.

2016 Presidential Election & Your Portfolio

After Labor Day, the race for the White House will shift into high gear. Aside from the brief bump post-GOP convention, Trump has consistently lagged Clinton in the polls. However, it’s still too early for Hillary to begin picking out her drapes for the White House. According to a recent CNN Poll of Polls, the race is back to its pre-convention levels. Clinton holds an average of 42% support to Trump's 37% across five nationwide polls.

No matter who wins in November, one thing is sure — the next two months promises to be filled with unprecedented drama – like no other presidential election.
 

It’s all about the economy

In the end, elections come down to the economy — jobs, wages, and trade. In this respect, the differences between the two presidential candidates are significant. With that stated, it’s important for investors to understand global economic and market implications under two very different presidencies.
 

On Global Trade

Markets prefer certainty over uncertainty — who doesn’t. For the most part, the markets suspect they know what they are getting with a Clinton presidency and should react less negatively to a Clinton victory.

About 40 percent of the S & P 500 companies generate about 40 percent of their revenues from global trade, and it should be business as usual under a Clinton presidency.

Unlike Clinton, Trump promises to renegotiate our trade agreements because he believes they are simply “terrible.” The author of the “Art of the Deal” will use his deal making skills to renegotiate trade deals that are "fair." His protectionist rhetoric could make for profound instability in global markets. In fact, markets are scared to death of Trump’s unpredictable patterns of behavior.
 


The financial sector

Under a Clinton administration, financial service companies will be hit with even more regulation. Hillary is also a big supporter of the Consumer Financial Protection Bureau promulgated by her close ally, Elizabeth Warren. New rules will increase costs for the financial companies, yet paradoxically, the financial sector is rising in the belief that a Clinton presidency will be better for the economy. Again, markets prefer certainty.

On the other hand, Trump plans to roll back Dodd-Frank and eliminate the Consumer Financial Protection Bureau. Similar to Bernie Sanders, he promises to bring back an updated version of the Glass-Steagall Act (which should never have been repealed in 1999). The Glass–Steagall Act describes four provisions of the U.S. Banking Act of 1933 that limited securities, activities, and affiliations within commercial banks and securities firms.[1] In theory, this should be better for the economy as it unleashes growth and profits for the smaller regional/community banks and reigns in Wall Street and big government spending.

 

The healthcare sector

The healthcare sector will be facing a very different set of pressures from the two administrations.

Clinton will be tough on the pharmaceutical and biotech sector. However, she will be positive for managed care stocks.

Trump promises to repeal the Affordable Care Act known as Obamacare, a negative for managed care names. He is a positive for big pharma/biotech by his promise of less regulation. He also vows to open state health insurance markets to more competition by eliminating "the lines around states."
 


The Energy Sector

No matter who wins the presidential race, the energy industry is plagued with an oversupply of both oil and natural gas. Countries are producing more oil than current demand, thanks to technology, putting downward pressure on prices. When it comes to this sector of the market, government policy is very different for the two nominees.

Clinton will continue to promote alternative, “green energy” and discourage fossil fuels, particularly coal.

Trump, however, will promote the XL pipeline, and support fossil fuels, such as coal. His populist rhetoric could strengthen the dollar, leading to lower energy and commodity prices.
 

The Industrial Sector

Industrial stocks levered to infrastructure projects should fare well under both Clinton and Trump. Interestingly, industrial stocks rallied earlier this year due to Clinton's aggressive infrastructure spending plan.

Hillary Clinton has proposed $275 billion in direct spending on infrastructure over five years. (click here). That’s not nearly enough, according to Trump, but at least she has a plan.

Trump is crafty and has yet to lay out a clear plan for his ambitious infrastructure agenda, a hallmark theme of his campaign. If Trump wins, congressional Republicans will most likely still control the House and can try to rein in his spending plans.
 

On corporate Taxes

As we have stated in past posts, business spending is lackluster. In fact, if you delve deeper into the numbers, you’ll discover a business recession. And the Fed can’t fix it. Profits, business investment, and ISM manufacturing are all down.

According to Fact Set’s 8.29.16 report on earnings growth: “For Q2 2016, the blended earnings decline for the S&P 500 is -3.2 percent. [2] The second quarter marks the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009.”

So what’s the solution?

Help businesses get out of a recession with tax reform is one possible answer.

Secretary Clinton has yet to announce a corporate tax plan. However, she has stated that she wants to raise taxes across-the-board on individuals, businesses, and investors. At the risk of sounding partisan, raising taxes and regulations on businesses is not a formula for getting out of a business recession. She has proposed a “fair share surcharge” on the rich to ensure the wealthiest are not able to pay lower tax rates. Click here for Hillary Clinton's tax reform plan.

Trump, on the other hand, wants to cut the corporate tax rate from 35 to15 percent, reduce regulatory burdens, and enact a smart repatriation plan to bring a few trillion dollars in corporate cash back to America. He also wants to eliminate the corporate alternative minimum tax.  Click here for Trump’s tax reform plan.


Our bottom line

With all this information, the most important questions are:

  • How will your investment portfolio perform under new American leadership?
  • What changes in strategy are prudent?

Besides election uncertainty, high market valuations and punk earnings growth make us cautious.

The market is anticipating a Clinton win. A Trump victory would surprise markets, particularly as risk-parity trading algorithms used by the largest hedge funds and many money managers, are caught wrong-footed. Subsequently, volatility would pick up and we could experience a market correction of 5 -10 percent as risk markets adjust. Remember how markets reacted after Brexit? However, markets could get an eventual lift from a Trump victory as animal spirits get aroused because of his proposed tax and regulatory reforms.

This October could prove to be a particularly volatile month with game-changing global events converging — Brexit negotiations and the widely anticipated WikiLeaks Clinton email dump, just to name a few.

At this juncture, given our cautious position towards risk assets, we are holding higher levels of cash relative to our benchmark model allocations. A well-balanced portfolio should perform well under either candidate and weather volatile markets. And in a growth-starved world, a disciplined asset allocation strategy will be a key determinant of your portfolio returns.
 

Sources: The Wall Street Journal Online; Bloomberg News; Forbes.com; The Economist.com; CNBC News; CNN.com; Reuters News.

Footnotes:
1.  Glass-Steagall Legislation from Wikipedia, the free encyclopedia.
2.  Fact Set Earnings Insight, August 29, 2016.

GDP growth is grinding lower

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The market, if it can be kept honest and competitive, does provide very strong incentives for work effort and productive contributions. In their absence, society would thrash about for alternative incentives-some unreliable, like altruism; some perilous like collective loyalty; some intolerable, like coercion or oppression.
— Arthur Okun, Economist

On Friday, July 29th, the Commerce Department reported that the economy grew at a meager annual rate of only 1.2 percent for the second quarter, compared with Wall Street estimates of 2.6 percent -- a big miss. GDP growth also was revised down to 0.8 percent from 1.1 percent estimate for the first quarter. 

The one bright spot in the second quarter was consumer spending, but the consumer can’t drive growth single-handedly.
 

Q2 2016 Declining Biz Spending.jpg

Higher Uncertainty

Business investment went into negative territory for the second quarter, reflecting higher uncertainty about the economic and political outlook. Until they have a better sense of the regulatory environment post-election, CEOs will be conservative with their balance sheets and hold off on investing new capital.

 

In our January post entitled “Outlook 2016: correction or crisis?”, we cited the following astute insight from UBS analyst, Stephen Caprio: “While bank lending standards are healthy, we ultimately believe this misdiagnoses the pulse of the corporate credit cycle. Nearly all of the additional financing provided to nonfinancial corporates has come from non-bank sources, post-crisis.” Caprio continued, “In short, non-bank liquidity has been the main driver of the corporate credit cycle post-crisis, and there are now early signs that it is evaporating.”
 

In Brief

  • The current economic recovery that began in March 2009 is the weakest since World War II.
     
  • Stock Market Valuation: the forward 12-month P/E ratio is 17.0, above the 5-year and 10-year averages and median of 14.63. This P/E ratio is based on Thursdays closing price of 2170.06, and the forward 12-month EPS estimate is $127.93. [1] Earnings came in at $120 in 2015.
     
  • The Dollar/Yen & Treasuries: the headwind of a stronger dollar in 2015 is now a tailwind for earnings. My mother traveled to Japan a year ago and $1= 123 yen…today, $1=101 yen. The 10-year treasury yield then was about 2.20 percent...today, 1.54 percent. Both are considered safe-haven asset classes and signs of risk aversion by global investors.
     

national debt: $19.2 trillion

Another harsh reality: as of June 2, 2016, the national debt is a whopping $19.2 trillion, nearly double what it was prior to the Obama presidency.  justfacts.com/nationaldebt.asp.

This amounts to:

  • 105% of the U.S. gross domestic product.[2]
  • 51% of annual federal revenues.[3]

In CWM's "Is this the end of our Goldilocks economy", we cited that: "according to a Congressional Budget Office (CBO) report released in January of this year, once the Fed begins raising rates, the 10-year Treasury note will begin rebounding to its historic norm and reach 4.6% by 2025. This return to normalization will raise our national debt payments from $227 billion a year in 2015 (1.3% of GDP) to over $820 billion by 2025 (3.0% of GDP, the highest ratio since 1996). Future costs of servicing our national debt due to higher interest rates could present a real drag on GDP."
 

The summer of our Disenchantment

After watching both the Republican and Democratic conventions, I didn’t come away feeling enthusiastic about the prospects for a stronger economy. The middle class continues to lose ground in America and abroad, feeling disenfranchised and very concerned for their future. This same atmosphere led to the rise of the populist movement towards de-globalization that resulted in Brexit, the United Kingdom exiting the European Union.

We can’t afford another lost decade in our markets due to lax oversight of Wall Street, misaligned corporate interests, and a dysfunctional government. Unless American leadership get it's act together, we could be headed for a prolonged period of economic secular stagnation. In simple terms, we need real growth spurred by business investment from the private sector and smart fiscal policy. It’s the only way to increase economic growth, create jobs, raise wages, and promote the American Dream for all.

Sources: The Wall Street Journal Online; Bloomberg News; Forbes.com; The Economist.com; CNBC News; CNN Money.com.

Footnotes:
1.  FactSet Earnings Insight, July 29, 2016
2.  Dataset: “Table 1.1.5. Gross Domestic Product.” U.S. Department of Commerce, Bureau of Economic Analysis, May 27, 2016. <www.bea.gov>
3.  Dataset: “Table 3.1. Federal Government Current Receipts and Expenditures.” U.S. Department of Commerce, Bureau of Economic Analysis, May 27, 2016. <www.bea.gov>

Brexit Wins: A vote that changes everything … or does it?

Contrary to what many establishment elites assumed, The United Kingdom voted to leave the European Union in a historic vote on Thursday, June 23. Heading into last Wednesday, the polls were running about even for staying (Bremain) and leaving (Brexit). The final voting tally was 52 percent to 48 percent, and the out-of-touch “establishment elites" are stupefied by the referendum by British voters to leave the E.U.

Markets reacted in dramatic fashion as many investors were caught wrong-footed by the Brexit win, and by the closing bell on Friday, the Dow Jones Industrials had lost over 600 points. The S & P just dropped below its 200-day moving average as of the writing of this piece at 10:15 a.m., Monday, June 27 - an ominous trading sign. Safe haven assets, such as gold and U.S. Treasuries have rallied in typical response to a perceived negative market event.
 

In brief:

  • This is not a 2008-type crisis. We could be heading for a prolonged period of ambiguity as markets sort through the U.K.’s “divorce details” from Europe. We could experience continued bouts of volatility in the weeks ahead, particularly in currency markets.
     
  • The tip of the iceberg? The Brexit trend could have a “domino effect” elsewhere in the world. Voters everywhere have grown increasingly disenchanted with the outcomes of globalization over the past 25 years. Note: next year, France and Germany head to the polls. If "de-globalization" sentiment continues to build, the effects could be significant for the future of the European Union and elsewhere.
     
  • Politically, it’s not over: The U.K. government is in turmoil as Prime Minister Cameron has announced his resignation effective in October. It will be up to the new PM to trigger Article 50 of the Lisbon Treaty and begin the two-year process of negotiating the U.K.’s exit from the EU and new trade deals.
     

Why Brexit now?

There has been a growing populist political movement in the U.K. (as well as in the U.S.), fueled by British middle-class concern over their future due to lax immigration rules and an open-border policy between EU members. The rise of ISIS and recent horrific terrorist attacks have served to fuel voter angst. The Brits evidently have had “enough of experts.” Globalization didn’t work out as well as promised; middle-class citizens have watched their wages remain stagnant for decades.
 


What happens next?

As mentioned above, Prime Minister Cameron, who backed the “Bremain Camp,” has made it clear that the decision to trigger the U.K. divorce with Europe under Article 50 of the Lisbon treaty is for his successor. Many believe the new prime minister will be Boris Johnson, former mayor of London and a chief “leave campaigner.” The new PM will begin the negotiation of new trade agreements with Europe in October, and it could get contentious. The rest of Europe is none too excited about losing one of EU’s largest members.

Between now and October, there is a leadership vacuum that will likely result in continued political turmoil in the U.K. It remains to be seen if the U.K. anti-establishment vote has a “domino effect” elsewhere, particularly here at home in our presidential race. Our equivalent to Boris Johnson, some might say, is Donald Trump. Additionally, given the lack of clarity surrounding Brexit details, business investment spending (capex) is likely to remain on hold, furthering the probability of a recession in the U.K.

The Brexit still needs to be approved by the majority of the remaining European Union members in October. Just as with any divorce, there is going to be a period of adjustment as both sides work out their differences. 

The U.K. is one of the largest economies in the world, and London is a key global financial center. As such, investors are understandably concerned. However, I believe expert economists who are promulgating dire global market consequences from the Brexit are simply wrong. Keep in mind, the European continent has been in a prolonged recession since the U.S. triggered a financial crisis in 2008, with the U.K. being in the best financial shape of the group. While the Brexit hurts European growth in the near term, the U.K. could benefit from better re-negotiated trade deals. A cheaper pound will certainly help U.K. exporters in global trade, offsetting some of the economic damage from the Brexit.
 

 The Pound is getting "pounded" by markets, hitting a 20-year low against the dollar.

The Pound is getting "pounded" by markets, hitting a 20-year low against the dollar.

Markets will continue to be choppy as Brexit angst weighs on investor sentiment. Many banks and money managers will be forced to liquidate holdings to meet redemptions and reduce risk. However, this does not appear to be an '08 - caliber panic event. Central banks have made it clear that they stand ready to intervene and provide liquidity to markets. It’s now likely that the Bank of England will cut rates in July and rate changes by our Fed will remain on hold until after the November elections. From a credit perspective, the ratings agencies have announced that the UK’s sovereign debt will be downgraded as a result of the decision to breakup with Europe. And downgrades could widen credit spreads.


Our bottom line: 

During market corrections, it’s important to remain calm and keep in mind that investment opportunities are borne out of market uncertainty and panic. A post-Brexit backdrop will create some fallout in markets along with inefficiencies, creating opportunity in high-quality U.K. equities, bonds and other global asset classes. U.K. businesses have been hit hard here, and some of the impacts of the Brexit vote may already be reflected in prices.

This is the type of environment where "best-in-class" long-term asset managers would be expected to add value by seeking out undervalued assets. At Cambridge Wealth Management, we will continue to look for opportunities where assets have become attractively priced due to market dislocation. However, we’re not rushing to purchase any assets, as we remain mindful of the challenges in the near–term. Public sentiment and geopolitics are ever shifting, but great leaders and businesses always seem to find a way to adapt quickly and prosper!

 

Sources: The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes.com; The Economist.com; MFS research; Fidelity research; CNBCNews.com.

 

Observations and views expressed herein may be changed at any time without notice and should not be construed as investment advice or to predict future performance. It is not an offer, recommendation or solicitation to buy or sell. It is based on information generally available to the public from sources believed to be reliable. Changes to assumptions may have a material impact on any returns detailed. Past performance is not an indication of future returns. Please consult your financial professional before making an investment decision.

How to Turn Puerto Rico into Hong Kong

How to Turn Puerto Rico into Hong Kong

This article, written by Townhall.com columnist Stephen Moore, provides a concise overview of the imminent Puerto Rican (PR) debt crisis and suggests a grand plan as a solution. Some Puerto Rico municipal bonds have lost 50 to 70 percent of their value, enticing vulture funds to purchase considerable amounts of the distressed debt...

Outlook 2016: Correction or crisis?

Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains.
— Steve Jobs

The choppy trading in global stock markets has set the tone for a turbulent year ahead. Since the start of 2016, investors have pulled about a billion dollars daily out of equity mutual funds through Friday, January 15. The beneficiary of these equity sales has been the natural safe haven: cash and U.S. Treasury bonds. 

With markets off to their worst start since 1927, investors are nervous. And unlike last August, it doesn’t appear this market is going to bounce back anytime soon. The panicky price action has brought the market bears out in full force. On Friday, the Dow Jones Industrials lost another 391 points, oil traded below $30 for the first time in 12 years, and Europe officially entered bear market territory (20% decline from a prior market high). 



Global head-scratching

So what’s causing this dramatic reduction in investors’ appetite for risk?  

Some of the reasons, in our opinion, are familiar:

  • China's slowdown,
  • Plunging oil prices, and
  • The strong dollar.

However, unlike five months ago, when it seemed the global economy was picking up momentum, investors are beginning to think that perhaps there is a fundamental deterioration in global growth. This fear of a recession is fueling a selling stampede in global markets. We think, barring seismic-type events stemming from a sudden devaluation of the Chinese currency, further deterioration in credit spreads, or tensions in the Middle East flaring up, the probability that the U.S. economy slips back into recession remains relatively low.

As this juncture, it’s important to outline some key data points to help put the current market turmoil in perspective. 

To begin with, market pullbacks in the 10% range are not uncommon and are healthy for markets. In fact, we should experience about one per year. However, until last August, we had not experienced a market correction of 10% since 2011, and we thus had grown accustomed to low volatility in markets (thanks to our Fed’s accommodative zero interest rate posture (ZIRP). Last August, when the Chicago Board Options Exchange Volatility Index (VIX), a measure of investor fear, spiked to 50, we mentioned in "China's currency reset is a game changer" that such events tend to cluster -- experiencing a few back-to-back market pullbacks, after such low volatility, should be expected. The VIX recently spiked again and touched 30.95 on Friday.

Cautionary note: the chart below illustrates the market uptrend that began during the European debt crisis in 2011 has been broken. It appears the neckline of a large head and shoulders top (technical analysis jargon) is forming, signaling the reversal of a prior bullish trend.

 Source: Bloomberg

Source: Bloomberg

China's slowdown

The Chinese economy is undergoing a massive transition, from an export-led economy to a consumer-led economy. This means lower rates of growth but just how low remains the big question for markets. The market consensus is hoping for about 6.5% GDP growth rate in 2016, down from about 7% in 2015 (we may never really know the actual numbers). Adding to investor’s concerns, Chinese regulators continue to fumble the ball when dealing with its market regulations. It now seems that Chinese policymakers are struggling to find the proper tools to help engineer an economic “soft landing”in their slowing economy.

If growth rates come in lower than 6% for China's economy in 2016, it could trigger further Yuan devaluation by the PBoC to lift its economy. Yuan devaluation exports deflation globally, and it would likely trigger a new round of global currency wars by Central Banks. China shocked markets when it suddenly devalued its Yuan in August 2015, and central bank officials have been struggling since to make sense of China's intentions.

Another really interesting piece of information related to the Yuan is this:

As the dollar has strengthened, it has become increasingly costly for the Peoples Bank of China (PBoC) to maintain the Yuan's peg to the dollar. It's estimated that China has lost more than 700 billion in foreign-exchange reserves (currently about 3.3 trillion) since mid-2014 by maintaining its currency link to the U.S. dollar.

 Source: Bloomberg&nbsp;

Source: Bloomberg 

Plunging oil

The free fall in crude oil prices has continued to unsettle commodity, stock, and corporate bond markets. Oil prices dipped below $30 on Friday and West Texas crude prices have fallen nearly 20% year-to-date. The current situation appears to be overwhelmingly supply-based and dollar-related. And with sanctions on Iran lifted, there is more oil coming to market. At some point, there will be a balanced market clearing level, perhaps as soon as the second half of this year.

Currently, the plummet in oil prices below $30 a barrel is causing a lot of distress in the energy sector, and banks are preparing for the worst by putting aside extra loan loss reserves. According to a recent Standard & Poor’s report, 50 percent of energy junk bonds are now distressed, meaning they are at risk of default. Distress in the oil patch could reduce S & P earnings by 7 - 8% in 2016.
 

The Strong Dollar

Last, on one hand, the fallout in oil prices can be viewed as a positive for global consumers; on the other, it could lead to geopolitical risks. Commodity exporting countries have seen their currencies continue their year-long decline against our dollar in 2016. The Brazilian real has plunged about 36% against the dollar over the past year.
 

The U.S. economy is in a soft patch

Manufacturing indexes have fallen recently, bordering on contraction, but this has occurred before in mid-cycle ‘soft patches’. Keep in mind, the modern U.S. economy is dominated by services — which have held up to date much better than expected. While recessions are never ruled out as a possibility at any time, key signals continue to show a low probability of a U.S. recession, such as healthy consumer and steady, albeit slow GDP growth.
 

Non-bank lending tightness portends downside growth risk

In an October 2015 research note, UBS analyst Stephen Caprio stated: “In sum, we believe non-bank lending standards illustrate an overall tightness in U.S. financial conditions that signal a downside growth risk in the U.S. economy. While bank lending standards are healthy, we ultimately believe this misdiagnoses the pulse of the corporate credit cycle. Nearly all of the additional financing provided to non financial corporates has come from non-bank sources, post-crisis” Caprio continued, “In short, non-bank liquidity has been the main driver of the corporate credit cycle post-crisis, and there are now early signs that it is evaporating.”


What can you do to protect your portfolio?

Data and sentiment change daily. With so many new market variables at work, it’s important to maintain a clear, calm, and longer-term perspective. It's of particular importance to embrace a disciplined process to guide investment decision-making during challenging periods of heightened volatility. Our disciplined investment approach actively uses a set of principles that grows and protects your wealth as we guide you through the ups and downs of the stock market.

It's also important to keep in mind that markets provide a benchmark for asset valuation. According to a FactSet Earnings Insight report 9.4.15 cited in our market viewpoint entitled "Is this the end of the Goldilocks Economy?", the S&P 500 consensus earnings estimate stood at $128 per share for 2015. Earnings for the S&P 500 came in at about $120 per share in 2015, roughly the same as 2014, resulting in a flat year for the market in 2015.


Uncertainty presents opportunity

For 2016, the S&P 500 Index consensus forward 12-month EPS estimate is $125.48. In our view, market valuations now look pricey at a time when our Fed has begun raising interest rates, global trade is slowing, and corporate profit margins appear to be peaking. Also, the ongoing Chinese yuan depreciation presents significant deflationary/market risks as other countries may be forced to devalue to remain competitive.

Given our outlook for 2016, we maintain our underweight position in equities and overweight cash/credit-related assets relative to our asset allocation model benchmarks. At this market juncture, it's prudent to have above average cash on hand for future undervalued investment opportunities. We remain vigilant as the current market uncertainty presents an opportunity to identify mispriced assets due to disparities between fundamentals and capricious investor sentiment.


Sources: The Wall Street Journal; Bloomberg News; Financial Times; Investors Business Daily; Forbes.com; CNBC.com; The Economist.

Observations and views expressed herein may be changed at any time without notice and are not intended as investment advice or to predict future performance. It is not an offer, recommendation or solicitation to buy or sell. It is based on information generally available to the public from sources believed to be reliable. Changes to assumptions may have a material impact on any returns detailed. Past performance is not an indication of future returns. Please consult your financial professional before making an investment decision.

Planning for Retirement - Explore what's possible

 CWM's newly redesigned retirement section

CWM's newly redesigned retirement section

Happiness is when what you think, what you say, and what you do are in harmony.
— Mahatma Ghandi

Achieving your dream of a secure, comfortable retirement takes proper planning and commitment. Today's retirees are faced with, among others, two key risks:

Investment risk: the possibility that an actual return on investment will be lower than your expected return.
Longevity risk: the probability that you will outlive your savings. We’re living longer, healthier lives and will spend more time in retirement than our parents did.

 

Our approach provides you with the guidance you need to add clarity to your financial future. Partnering with you and best-in-class experts, we bring together all the facets of your financial life, ensuring that the four cornerstones of a smart wealth management strategy — asset management, estate planning, retirement planning, and tax planning — are working in harmony so you can get the most out of your retirement life.
 

Some of the important retirement questions we can help you answer are:
 


Am I investing properly for a comfortable retirement?

Determining a proper asset allocation is critical and it should reflect the goals you are trying to attain as well as your tolerance for risk. With access to more than 12,000 investment options, the flexibility of an open architecture platform allows us to build an extraordinarily competitive investment portfolio for both growth and protection.
 

What will happen to my assets upon my death?

You want to create a lasting legacy for the people and causes that you care about. With smart, holistic planning, we can help ensure that your wealth passes as you want it to and a significant portion doesn't end up in the hands of unintended heirs or go to the government.
 

Will I have enough money to live my ideal retirement life?

Retirement planning has two phases: accumulation and actual retirement. During the accumulation phase, we help clients in setting goals and implementing financial strategies to achieve them. Our retired clients rely on our ongoing expert advice so they can continue to enjoy the lifestyle they’ve earned.

Social Security maximization strategies: There are many combinations of Social Security claiming strategies and rules on benefits are complex. We can help you avoid making a filing mistake that could end up costing you thousands of dollars annually for the rest of your retirement life.
 

 How can I minimize taxes on my retirement income?

Taxes can generally be one of your larger expenses in retirement. We help you take advantage of tax avoidance strategies by reviewing your tax returns and implementing smart, tax efficient strategies, such as placing higher-yielding taxable assets in tax-deferred IRA accounts.

    The better we understand you, the better advice we can give
     

    First, we'll have a conversation about your most important priorities, the values that inspire you, and uncover your vision for retirement. 

    Next, we'll agree on the areas that you would like us to review. We'll gather your financial data, analyze your current position, and design your retirement plan.

    Lastly, we will suggest strategic recommendations and provide guided implementation of your plan. With our ongoing monitoring, we're always there for you to adjust your strategy when your personal situation changes or the markets shift. Learn more >>


    Find Clarity with a Cambridge Wealth plan

     SCHEDULE YOUR FREE CONSULTATION >


    Is this the end of the goldilocks economy?

    Nothing astonishes men so much as common sense and plain dealing
    — Ralph Waldo Emerson

    The extreme volatility that we witnessed in recent weeks continued to recede heading into last week’s Federal Reserve Bank Open Market Committee (FOMC) meeting. 1 I believe that as we slowly transition out of this “Goldilocks economy”, and the Fed begins raising interest rates, market volatility could remain at elevated levels.

    The Fed's Conundrum
    The market initially breathed a sigh of relief as the Fed maintained its accommodative policy on Thursday. According to FactSet's September 4 report, “The second quarter of 2015 marks the first time the index has seen two consecutive quarters of year-over-year revenue declines since Q2 2009 and Q3 2009. It also marks the largest year-over-year decline in revenues since Q3 2009 (-11.5%).”2 The report mentioned that only six sectors were reporting increases in revenue, led by healthcare.

    Slowing global growth, along with the strong dollar, could continue to be a headwind to the earnings estimates. The S & P 500 is expected to earn about $128 based on September 4th closing price of 1951.3 according to FactSect Earnings Insight 9.4.15. In his September Insights piece, Rich Bernstein states: “The Fed now risks being wrong-footed, and the problem for the stock market today is the Fed is ‘threatening' to raise interest rates at a time when the S & P 500® earnings growth is actually negative.”4

    A look at history: Fed rate hikes & market performance
    The chart below illustrates the return of the S & P 500 after the last four Fed rate hike cycles. In most cases, equities struggled after the first hike, only to recover and outperform in the ensuing year following the first rate increase. Click here for a quick lesson from Investopedia on, "How interest rates affect the stock market."

     Source: Morningstar and FPS, Inc.

    Source: Morningstar and FPS, Inc.

    The markets have become addicted to QE and a zero interest rate policy (ZIRP). Getting rid of it will involve some withdrawal pain. According to a Congressional Budget Office (CBO) report released in January of this year, once the Fed begins raising rates, the 10-year Treasury note will begin rebounding to its historic norm and reach 4.6% by 2025. This return to normalization will raise our national debt payments from $227 billion a year in 2015 (1.3% of GDP) to over $820 billion by 2025 (3.0% of GDP, the highest ratio since 1996).3  So, one can imagine why the markets are obsessing over successive rate hikes. Future costs of servicing our national debt due to higher interest rates could present a real drag on GDP.

    Expect lower interest rates for longer
    The Fed's accommodative ZIRP has been a key driver behind the bull market we have enjoyed over the past several years. It’s not the first rate hike that's concerning the market, as it’s been talked about more than just about any other financial topic over the past few years. It's the speed and severity of successive hikes — markets want a slow and steady path back to normalized rates. Our view remains that it could take longer than expected for Treasury yields to normalize because of slow economic growth, low inflation, and robust demand for our 10-year and 30-year Treasury debt from home and abroad.

    Footnotes:
    1.    Investopedia: VIX (CBOE Volatility Index). Definition. http://www.investopedia.com/terms/v/vi
    2.    Fact Set Earnings Insight, September 4, 2015.
    3.    Congressional Budget Office Report, "The Budget and Economic Outlook: 2015-2015" January 2015.

    Observations and views expressed herein may be changed at any time without notice and are not intended as investment advice or to predict future performance. It is not an offer, recommendation or solicitation to buy or sell, nor is it an official confirmation of terms. It is based on information generally available to the public from sources believed to be reliable. Changes to assumptions may have a material impact on any returns detailed. Past performance is not an indication of future returns. Price and availability are subject to change without notice. Consult your financial professional before making an investment decision. Additional information is available upon request.

    China's currency reset is a game-changer

    Don’t ask me where things are the best. That’s the wrong question. Ask me where things are the most miserable.
    — Sir John Templeton

    There was really no new economic data here in the U.S. to justify the 1,000 point slide in the Dow Jones on Monday, August 24 after a 500 plus decline the prior Friday. So what caused such a dramatic plunge? Every self-professed market expert on CNBC has an answer but no one really knows. Some of the explanations I find compelling are China’s currency devaluation and the markets simply being pricey — as in all market corrections, investors were merely selling as prices kept falling. 

    One fact is certain: we learned this past week that the US is not as insulated as we thought from China’s slowdown and the continued economic malaise facing emerging markets. After all, global consumption for every commodity has been driven by China and largely supplied by many emerging markets.

    China devalues
    Fears that economic conditions in China are worse than investors originally thought resurfaced when the People's Bank of China (PBoC) decided to suddenly reset its currency. This move sent the currency markets into chaos and was cause for investors to reevaluate all risk assets. Indeed, the poor communication from the PBoC over China's currency intentions has been a key cause of financial market turbulence.

    I believe China’s currency devaluation was a game-changer for global markets. The sudden move by the PBoC has negative effects for companies with significant production in China. It could also be an even greater drag on U.S. multinationals earnings growth by reducing China's demand for our exports.

    Conversely, by devaluing its currency, China intends to regain competitiveness and boost its exports. I have provided a link below to a recent Bloomberg News QuickTake article entitled "The People's Currency: Freeing China's Yuan" — it provides an excellent historical synopsis and further explanation behind China's recent currency reset.

    A Relapse of Investor P.T.S.D.
    Investor confidence, once again, has been damaged by extreme market volatility, just as it was during the “flash crash” on May 6, 2010. And while it's been almost seven years since the financial crisis of 2008, many investors have yet to recover from the trauma of the near collapse of our financial system. Do you remember that between October 2007 and March 2009, the U.S. stock market dropped in price by over 50%?

    Panic set in on Monday as markets were abruptly awakened from their summer of complacency. In an Investor’s Business Daily editorial, Stephen Porpora, a member of the NYSE for 31 years, made the following observation — “It's not that markets went down — it's how they went down. Certainly, fears of a China slowdown, devaluation, etc. are real. Yet, Monday's volatility was such a wild ride that even seasoned traders and financial news commentators were left shaking their heads. As just one vivid example, KKR & Co., the asset management firm, traded from a high of $19.43 to a low of $8.00 and closed at $19.50 on Monday, August 24th. Yikes!"

    Market volatility reached levels that we haven’t seen since 2011
    On Monday, the CBOE volatility index (often referred to as the “Fear Index”) surged and crossed the 50 level for the first time since February 2009. Sudden spikes, like those illustrated in the chart below, are not to be taken lightly--they are not just indicative of “manic” market behavior or panic-selling. Indeed, I take such market behavior very seriously.

      Source of chart: CNBC.com

    Source of chart: CNBC.com

    Now for some positive news...
    On Wednesday, August 27, The U.S. Commerce Department released revised GDP estimates for the second quarter -- the economy grew at an annual pace of 3.7% vs. the original estimate of 2.3%. The market recovered another 369 points on the Dow by the close on Thursday after closing up 600 points on Tuesday and the S & P closed up 47 points or 2.43%. Here are some more economic positives to ponder:

    • The U.S. should continue to be the engine for global growth—economists surveyed by Bloomberg expect annual GDP to average 2.3% this year.
       
    • The US consumer is doing modestly better – housing is stable and showing signs of strength –much needed at this juncture. Signs of overdone credit expansion are absent from this cycle.
       
    • While the market was overvalued in certain areas, such as biotech and industrials, valuations are not as stretched as they were during the housing bubble and dot com era.

    Unless market turmoil continues and undermines business sentiment, I believe this past week is just a healthy market correction. However, the market could continue to struggle in the coming months as it reassesses risk asset valuations against the backdrop of future U.S. interest rate hikes, China's slowdown, and signs of peaking U. S. corporate earnings. 

    Our bottom line
    Stock prices follow earnings and the path of corporate profits over the next few quarters will tell us whether the bear’s claim that stocks have peaked is true. It’s important to remember that investing is about managing risk. Maintaining a globally diversified portfolio that matches your risk profile is critical, especially in the current environment.

    It's also important to keep a calm, clear perspective during times of heightened market volatility. Take the time to reassess your investments with your advisor as you may be overweight equities due to strong market performance over the past few years. If you are confident with your advice and holdings, you can avoid capitulating and selling into a panic selloff.

    The sudden move by the PBoC to devalue its currency is, indeed, a game-changer for global markets, and we are headed for some heightened volatility. I will continue to be vigilant in the months ahead.

    Sources: The Wall Street Journal; Bloomberg News; Investors Business Daily; CNBC.com.

    Observations and views expressed herein may be changed at any time without notice and are not intended as investment advice or to predict future performance. It is not an offer, recommendation or solicitation to buy or sell. It is based on information generally available to the public from sources believed to be reliable. Changes to assumptions may have a material impact on any returns detailed. Past performance is not an indication of future returns. Please consult your financial professional before making an investment decision.

    Retiree Healthcare: What will it cost you?

    iStock-503458027.jpg
    I’ve been thinking about our healthcare problem and how to pay for healthcare….If we took all the money Republicans have spent trying to stop healthcare reform and all the money Democrats have spent trying to get healthcare reform, we all could afford healthcare.
    — Jay Leno

    I first learned about the complexities and limitations of Medicare when I was 30 years of age due to a family tragedy. On September 22, 1994, my father was diagnosed with pancreatic cancer. He passed away a few months later on December 11, just prior to his 62nd birthday. I contacted our family financial advisor, a Certified Financial Planner (CFP®), and asked her what I should do regarding my mother’s healthcare insurance coverage. She replied:  “Just sign her up for a Medigap plan with Blue Cross of New York; your mother qualifies for Medicare under a widow’s benefit.”— that was it! 

    When I became a CFP® in 2007, I discovered that my mother and I had received poor financial guidance after my father’s death. Needless to say, it upset me, and that’s why I’m writing today about this subject. I never want any of you to go through what I went through due to my lack of understanding of Medicare healthcare choices, poor advice, and blind trust. More on this subject in the coming months in a case study post devoted to Social Security and Medicare strategies (SSA link) for the surviving spouse. It can be very complicated, as I will illustrate, especially for grieving widows or widowers. In my mother’s case, like many women of her generation, she never wrote a check or selected her healthcare plan. Complicating matters further was the fact that my mother is Japanese, and English is her second language.
     

    The Medicare Supplemental Plan Maze

    In January 1995, I found the Medicare coverage options very confusing, and I had no idea what a Medigap plan would cost my mother. It took weeks of research in my spare time to find the answers I needed, and to get my mother appropriate coverage (at least what I thought was appropriate) -- a supplemental plan that overcame the limitations of Medicare.  

    Now, 20 years later, even with great Internet resources, people are still confused about the coverage they need once they're eligible for Medicare. And the costs have skyrocketed -- I have seen my mother’s Medigap plan cost rise over 10% annually on average over the past 20 years. My mother is now nearly 82 and, thankfully, very healthy. I have modified her original Medigap plan over the past 20 years a few times in an effort to keep costs under control. Her current plan is Plan N (one of many letters used by Medicare to categorize Medigap plans). Her plan premiums just went up again in 2015 to $548.64 per quarter from $497.28, and in 2013, it was $429.83 quarterly --- that’s a 15% year-over-year increase!

    Click here (www.medicare.gov) and type:  “A quick look at Medicare” in the search field, upper right [or scroll down] for a quick primer on Medicare coverage choices.
     

    A Startling Statistic

    According to a recent Nationwide Insurance survey, 4 out of 5 people approaching retirement said they could not estimate how much they expect to pay for healthcare in retirement.1 That’s not a surprise; insurance coverage options remain maddeningly complex, and costs have been rising at more than twice the rate of inflation, averaging 6.9% annually since 1960.2  Adding to retiree anxiety are ongoing changes to our national healthcare coverage -- the Affordable Care Act. 


    So how much will healthcare really cost you in retirement?  Here's a rough idea:
    Fidelity’s annual Retiree Health Care Costs Estimate suggests that a 65-year-old couple retiring in 2014 would need $220,000 in total to pay for medical expenses throughout their retirement.  (This is assuming the husband lives to 82 and the wife lives to 85.)  If a husband and wife live to 92 and 94, respectively, the cost estimate grows to $335,000.3 This estimate does not account for the cost of a long-term care facility.

    That quarter-million figure is an essential part of the calculus when you're setting up your retirement plan, and it’s often overlooked. However, it's just an average estimate and this figure will vary depending on your health. For a look at Medicare costs-at-a-glance, click here.


    Fortunately, there are three concrete steps you can take to ease your mind and your retirement budget. These steps are:

    1.  Discovery

    Understand your health-related needs based on your history and current health. Research insurance plans that fit your needs.
     

    2.  Planning

    Take the information from your discovery work and develop a written plan that factors healthcare costs into your retirement income planning.
     

    3.  Implementation

    Be a smart healthcare consumer. It's vitally important to get informed, and above all, stay proactive about choosing your healthcare providers.



    1. Discovery:  Understand your health insurance options

    If current trends continue, in just a few years, healthcare will likely be your second largest expense in retirement, more than food.  

    Medicare is a key part of the equation because it's typically the primary source of health coverage for retirees. However, Medicare only covers about half of your healthcare costs. That means that it's up to you to be able to fund the other half. But before you can assess how to do that, it's important to understand what I like to call the A, B, C, and Ds of Medicare.
     

    Medicare Part A – Hospital Insurance
    Helps pay for inpatient hospital care, limited coverage in a skilled nursing facility, and full coverage for eligible home health care and hospice care.

    This is the original, basic Medicare coverage, first introduced in 1965. Most people automatically qualify for Hospital Insurance, also known as Medicare Part A, as soon as they reach age 65. It's important to note that the 1983 Social Security Amendments included provisions to raise the full retirement age (FRA) beginning with people born after 1938. If your were born between 1943 - 1954, your FRA is 66. And for those who were born after 1960, FRA moves to age 67. 

    Since you paid into it through Medicare taxes during your working years, it doesn’t cost you anything.

    There is a brief window—three months before you turn 65, the month you turn 65, and three months after you turn 65, for a total of seven months—to enroll in Medicare. This is referred to as the Initial Enrollment Period. 
     

    Medicare Part B – Medical Insurance
    Helps pay for  physicians' services, outpatient hospital services, durable
    medical equipment, and other services like physical therapy.

    Medicare Part B is a different story. It’s not free. You pay a monthly premium for it that's based on your Modified Adjusted Gross Income (MAGI), and your Social Security income is reduced by your Part B premium.
     


    2015 Medicare Part B premiums based on income

    Your Annual Income                                                             2015 Premium

    Individual Tax Return             Joint Tax Return                          You Pay

    $85,000 or less                           $170,000 or less                             $104.90

    $85,001 up to $107,000           $170,001 up to $214,000              $146.90

    $107,001 up to $160,000         $214,001 up to $320,000              $209.80

    $160,001 up to $214,000         $320,001 up to $428,000             $272.70

    Over $214,000                            Over $428,000                               $335.70
     


    Part B Late Enrollment Penalty (clickable)
    If you miss this window, your Medicare medical insurance (Part B) and prescription drug coverage (Part D) may cost you more as you can incur penalties. Simply put, if you do not sign up for Part B when first eligible, "your monthly premium for Part B may go up 10% for each full 12-month period that you could have had Part B, but didn't sign up for it," states the Medicare Part B enrollment rules.

    While the late enrollment penalty can be very costly for you, a gap in coverage can be financially devastating since there’s no limit on out-of-pocket expenses. This is where private insurance comes into play. Remember, Medicare only covers about half of your healthcare costs.

    There are two routes to adding health insurance to basic Medicare:

    • Unbundled - Medigap plans or,
    • Bundled - Medicare Advantage plans

    Medigap policies may be the best choice for people who want to keep their original Medicare Part A & B but want more choice in providers. As the term suggests, Medigap policies fill in coverage gaps. You can choose any doctor or facility you like, but there is a higher premium for this privilege. Because they are unbundled, Medigap policies do not cover prescription drug coverage. You still will need to purchase prescription drug coverage, Medicare Part D, with a Medigap plan.
     

    Medicare Part C – Medicare Advantage plans

    Medicare Advantage Plans, also known as Managed Care Plans, are bundled plans. They are designed for people who want an “all-in-one” plan that's similar to an HMO. To enroll in a Part C plan, you need to already have Part A & Part B coverage in place. These plans often include prescription drug plans (Medicare Part D).

    Medicare Advantage plans are popular with seniors and were introduced in 2003 as part of the Medicare Modernization Act of 2003; enrollees now represent about 30% of all Medicare beneficiaries.  


    Medicare Part D – Prescription Drug Plans

    While Part C bundled plans commonly offer prescription drug coverage, insurers sell Part D plans separately to those who have Medigap plans or original Medicare. As per Medigap and Part C coverage, you need to keep paying Part B premiums in addition to the premiums for the prescription drug plan you choose in order to keep Part D coverage.

    There are many private insurance options available. Although it can be time- consuming to select supplemental coverage, it can make a big difference in your $$ outlay. The good news is that the government’s Medicare site, www.medicare.gov, provides tools that make objective and straightforward coverage comparisons. Once you’re in the Medicare site, select “Find health & drug plans.” The site is user-friendly and can help you compare plans in your state that offer the best value for your unique health-related needs.

    It’s important to ask the tough questions to insurers, as well, on how you can keep costs down.  

    More advice can come from your county's State Health Insurance Assistance Program (SHIP) office at no cost to you. Find your closest one by visiting www.eldercare.gov and typing in your zip code. I was very impressed with the help I received from the Rensselaer County SHIP office when I shopped for new Part D drug plans for my mother in November 2012.
     


    2. Retirement Income Planning: Factor in your healthcare costs

    Once you have an idea on the cost of a supplemental plan that best suits your needs, you can model in healthcare spending along with your other retirement expenses. This is an important step often overlooked by financial professionals.

    Make sure you factor the appropriate costs and inflation rates into your retirement plan. Healthcare spending is expected to grow at 5.8% annually through 2022.4  Inflation rates for healthcare coverage also vary based on your health. For example, someone with type 2 diabetes could have an inflation rate of 10% annually vs. the 5.8% average. So it’s possible to get a fairly accurate present value of your future healthcare costs.
     


    3. Implementation: Be a smart healthcare consumer

    We research cars, electronics, vacation resorts, and countless other retail items prior to purchase, but for some strange reason, we don't conduct the same due diligence for our healthcare needs. It's vitally important to get informed, and above all, stay proactive about choosing your healthcare providers. There's a huge disparity in prices, which means smart decisions can save you a lot of money. 

    If you identify the best providers for safe and cost-effective solutions before care is needed, you can save a significant amount of time and money later. Start with knowing the types of providers to turn to in different situations:

    •    Primary care physicians
    •    A specialist for any existing conditions or special needs
    •    An urgent care provider
    •    A full-service hospital

    Take the case of someone who breaks his arm. An emergency room visit could run $2,000 or more, while an urgent care facility might cost $250-500 for the very same care.  

    This brings up another point, especially when you travel during retirement, whether on vacation or to visit friends and family. If you have a Medicare Advantage Part C plan, it doesn’t travel with you, since you're restricted to using in-network providers.

    There is some progress being made to partner with out-of-state/out-of-network providers. But for now, if you get sick or injured when you're away from home, you'll have to pay out-of-pocket for the full tab unless you purchase a travel policy.

    Bottom line: Do your research before you go on vacation, because it can get very expensive quickly if you don't.   

    Wherever you are, if you do fall ill, don't hesitate to ask questions about treatment options, because they will have wildly varying costs. If you're facing surgery, for example, investigate whether an outpatient procedure could be a safe, effective, and lower-cost alternative to traditional in-patient surgery. An additional note: carry a copy of your healthcare proxy in your car's glove box or upload it to a secure file in the cloud.

    Remember that if you’re paying a larger portion of costs yourself with a high-deductible plan, these decisions have an immediate effect on your healthcare budget. 

    Also very important: Know what the charges, fees, and out-of-pocket costs you should expect for the recommended treatment plan before you authorize treatment. Healthcare facilities are "for profit" institutions and you shouldn’t be surprised by the cost of your care when you receive your healthcare bill!

    Prescriptions also can cost thousands of dollars a year. Don’t assume you’re getting the best price with your plan’s distributor. Costs can vary, and there usually are lower-cost generic brands.  (The www.medicare.gov website can help you in this area of comparison.)5  Also know that healthcare costs can vary widely based on geographical region. That may be an important factor in deciding where to retire. Regional costs comparisons can be found on the Centers for Medicare and Medicaid Services website.6

    As stated earlier, if current trends continue, healthcare will likely be your second largest expense in retirement. Therefore, covering healthcare expenses is an essential part of retirement income planning. As life expectancies continue to increase, the money set aside for healthcare costs will have to last longer. In a recent Fidelity survey, 9 in 10 people approaching retirement said they were worried about outliving their savings due to the effect of inflation and the cost of medical care.7  By taking the time now to plan for your retirement healthcare expenses, you'll likely have the confidence and peace of mind to manage healthcare costs in retirement.
     

    For more information on resources or an analysis of your healthcare budget based on your personal health needs, please contact our office at info@cwllc.com or 518.677.3781.

    Footnotes:

    1.  Nationwide Survey “Health Care Costs in Retirement.” Consumer study of 801 respondents, 2013.

    2.  Centers for Medicare & Medicaid Services, National Health Expenditures; Aggregate and Per Capita Amounts, Selected Calendar Years, 1960 -2011.

    3.  Fidelity Investments, “How to tame retiree health costs," May 2013.

    4.  “National Health Expenditure Projections, 2012-22: Slow Growth Until Coverage Expands And Economy Improves.” Health Affairs, September 2013.

    5.  The Patient Protection and Affordable Care Act requires pharmaceutical companies to offer a 50% discount on brand-name drugs that fall into the so-call “donut hole.”

    6.  Centers for Medicare & Medicaid Services: Total All Payers Per Capita State Estimates by State of Residence 2013, and State Health Expenditure Accounts by Residence Location Highlights, http://www.cms.gov. Percentages were calculated by Fidelity.

    7.  Fidelity Advisor 2013 Survey of Investors at Retirement, July 2013. Conducted by Research Now on behalf of Fidelity Investments, this survey included 1,886 investors between the ages of 50 and 75 with investable assets of $100,000 or more.  Fidelity Investments was not identified as the survey’s sponsor.

    Q2 2015 Market Insights & Strategy

    The problem with Socialism is you eventually run out of other people’s money
    — Margaret Thatcher

    The start of the second quarter was greeted by a surprisingly weak employment report on Good Friday. The market bears came out of hibernation and immediately began growling for a market correction after March non-farm payrolls showed an increase of only 126,000 jobs vs. Reuters' expectations of 245,000. After a brief sell-off at the opening bell on Monday, the market has rallied back, and it continues to "climb the wall of worry".

    The current economic recovery that began in March 2009 is now six years old, and it's showing some signs of fatigue. Given this fact and the current market volatility, you may be asking, “What should I do as an investor at this market juncture?” To answer this question, let’s take a look at some of the current market headwinds facing investors:
    •    Europe has essentially been in a depression since the financial crisis of 2008.  The dollar has appreciated about 20% against the Euro since June 2014 as the European Central Bank began its own Quantitative Easing (QE) last June to spur growth and stave off deflation.  QE is buying bonds with money printed by the central banks in order to push down long-term interest rates and encourage investment. The Bank of Japan was the first to engage in QE about 14 years ago, and it's resulted in a period of secular economic stagnation for Japan (perhaps an understatement). Our Federal Reserve Bank began its QE policy in 2008 with QE 1, and then QE 2 and a QE 3 in June 2011 (Europe, as you may recall, was on the verge of disaster). Since then, the Fed has added over 4 trillion of US bonds/debt to its balance sheet, and we've continued to ignore the market mavens and former colleagues call to sell high coupon bonds. Instead, we've bought any spikes in yields for retiree and trust accounts, most recently in December of 2013 when the 10-year Treasury yield approached 3%.
    •    The dollar’s strength has caught many investors by surprise and has led to a precipitous drop in the price of oil from about $99 in June 2014 to current levels around $51. At CWM, we think the strong dollar is a sign of continued strength in the US and not just a flight to quality.
    •    US Treasuries have rallied the past year, particularly the long end. The 10-year Treasury is still below 2.00%.  The US 10-yr @ 1.91% vs. Germany's equivalent @ .016% and Japan's equivalent @.365% as of this writing.

    Chief Economist of Gluskin Sheff, David Rosenberg, thinks the stronger dollar is already acting as a tightening mechanism (higher interest rates) as US corporate profits have begun to get squeezed.  He states, “The Fed would be well advised to sit back, watch, and assess--- and let the dollar do the heavy lifting.” Corporate America, according to some estimates, lost over 18 billion in Q4 2014 due to the stronger dollar. The market is an efficient pricing mechanism, and we think it has adequately priced in the effects of a stronger dollar on corporate earnings going forward.

    In his April Market Insights, Rich Bernstein (a market bull) of Richard Bernstein Advisors begins by stating “Beauty is in the eye of the beholder – the same can be said for equity valuations”. His conclusion based on his quantitative work:  “the market is valued as it would typically be for a mid-cycle period, roughly fairly valued”.

    This bull market is one that many market pros seem to hate--market pullbacks of 5 - 8% are healthy. Once the Fed makes its move, perhaps later this year, we think the markets will act more decisively. We suspect that liquidity will not be shut off by Central Banks in the form of significant tightening this year.
      
    The following highlights CWM’s investment strategy for the balance of 2015:
    •    We're overweight growth vs. value. We expect the US market to move sideways as earnings estimates are too high. German and Japanese markets may play some catch-up.  
    •    In Q1, we closed out our tactical overweight in TLT, (20+ yr. US Treasury Bond ETF).  Its outperformance surprised us as we merely saw value in the long-end of the yield curve.  The return in TLT was accentuated by QE in Europe -- it moved from 101.72 on 01.02.14 to over 131 on 01.06.15.  
    •    We have shortened bond maturities and duration for the first time in nearly a decade. However, we think the move higher in interest rates will be gradual—do not fret.  GDP growth is still anemic compared to prior recoveries and as such, the market has become addicted to QE. There is too much capital, however, chasing too little value in bonds, especially short duration bond funds ( i.e. asset bubble).
    •    We have a tactical overweight in Germany and Japan and expect these markets to outperform the US in 2015 given the dollar strength. The strong dollar favors strong manufacturing, exporting countries such as Germany and Japan.
    •    Cheap energy stocks/drillers do not represent value in our opinion. Value is determined by cash flow and assets, and both are at risk in this sector. We leave it up to the best-in-class private equity and hedge fund managers to determine what represents good value in this sector. We sold our remaining energy MLP in early January 2014 given the inverse relationship between a strong dollar and oil/gas prices.
    •    We think writing covered calls at the upper end of the current trading ranges is a prudent strategy in a range-bound market---enhancing total return with income from premiums while lowering cost basis and volatility.
    •    We continue to favor technology, particularly medical technology, and healthcare at this juncture.
     
    The larger question on our minds is can central banks usher in a new era of economic stability marked by low rates, modest growth, and stable inflation? Only time will tell the economic implications of this great monetary experiment called QE. Like Japan, we could be headed for a prolonged period of secular economic stagnation. Our Federal Reserve Bank Chairman, Janet Yellen, recently voiced such a concern. Much of the excess capital created by our Federal Reserve Bank QE policy has yet to find its way back to Main Street USA in the form of job-producing growth and capital goods expenditures. We think, however, Good Friday's employment report is just another lumpy employment number and not a harbinger of a weakening economy. At this market juncture, it’s time for the consumer to grab the baton it’s being handed and finish the last leg of this economic recovery with strength. 

    *note:  the market prices quoted above are obtained from cnbc.com.  Certain quotes were obtained from Investor Business Daily and Bloomberg news service and are for informational purposes only.  We assume no responsibility for the timeliness, accuracy, or truthfulness of content derived from unaffiliated third-party sources as stated under "Disclaimer of Warranty" under the site's "Terms of Use". 
    Past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Cambridge Wealth Management, LLC) will be profitable or equal the corresponding indicated performance level(s).

    Pre-retirement Anxiety

    Cultivate your intuition to improve your decision making.
    — Herbie Hancock

    On February 23rd, I had a second meeting with a couple nearing retirement. One spouse, whom I will call Sarah, is retiring the end of April. I first met with Sarah and her husband on December 29th, 2014. It was another brutally cold February evening. We were finally meeting again after two major snowstorms had postponed our second meeting. We began our initial meeting on December 29 by talking about Sarah’s retirement concerns.

     #1 CONCERN:  You may have guessed it already…Sarah is retiring at age 62 and will not have a steady paycheck for the first time in a long time. She's concerned about being able to maintain her standard of living. In fact, the uncertainty and anxiety are keeping Sarah up at night lately.

    GOAL:  Create a steady paycheck at 70 - 80% of her current net salary.
    Sarah and her husband agreed to a financial planning engagement after our initial meeting that included an analysis of their budget, liabilities, Sarah’s retirement income plan, and their investment portfolio. Her husband, whom I will call Bob, is retiring in 2017 at age 64. Bob has a six-figure income, and when he retires, he will earn about 75% of his final pay. Bob is one of the few retirees today who has a guaranteed pension that includes health care coverage. Besides a few small student loans from their son and daughter’s education, they only have $35,000 remaining on their mortgage. 

    So, you might be asking, what’s the issue? Change of any kind is unsettling, and retirement is a major change. Sarah simply has a case of pre-retirement anxiety.  It’s well founded in reality as she’s unsure about:
    •    Which pension option out of five choices to take — she has small defined benefit plan, 
    •    ESOP options, 
    •   401k options — where, how, and if to roll over the balance,
    •   Social Security — Sarah filed for Social Security in November to have some form of an income,
    •   Student loans from her son and daughter’s college education are still being paid off — Sarah is concerned about adequate cash-flow.

    SOLUTION:  At the core of Sarah’s anxiety, like many pre-retirees is fear…the fear of making the wrong decisions with all the above options and not having a steady paycheck. Like many couples, Sarah and Bob have been too busy with life to address Sarah’s retirement planning needs. Fear, as we know, stems from a lack of knowledge, confidence, and trust. Sarah and Bob have worked with a few advisors over the years. However, their advisors were not Certified Financial Planners nor interested in completing a formal “cash flow-based” financial plan.

    I analyzed their budget and learned that $700 of their $1,200 monthly student loan payment would be paid off in two months. The remaining student loan balance at an 8% APR is only $8,000. After analyzing their current investment portfolio, I suggested rebalancing in line with Sarah's current risk profile and retirement income goal. Next, I suggested selling a Rochester NY municipal bond holding (a great time to sell) to pay off the remaining student loan balance, solving an immediate retirement cash-flow concern. Further, the muni bond sale will generate minimal capital gains. We addressed all of the above bullet points and created five actionable steps for Sarah's pre-retirement meeting with her company HR department. I also suggested consolidating existing IRA's and other investment accounts with Cambridge to implement Sarah's immediate retirement income plan. Sarah and Bob agreed with my recommendations — they have accounts in many different places. I will be setting up a monthly EFT into Sarah's bank account from an existing annuity and one of her smaller IRAs (another tax-advantaged strategy). Sarah's perceived need to generate 70% of her income is no longer necessary as $1,200 of debt payments will be paid off over the next 60 days. In fact, once the EFT plan and her defined benefit plan payment are implemented, Sarah can immediately suspend her Social Security payment.
     
    At the end of our meeting, Sarah smiled and looked as if a huge burden had just been lifted from her life. She said, “I've been worrying about my retirement income — I should be able to sleep much better now.” I had helped Sarah cure her pre-retirement anxiety by defining a clear, practical retirement income strategy.

    Please stop by again shortly; I will share with you the solution I designed for Sarah and Bob’s Social Security strategy…it will surprise many of you!

    Welcome...

    I have just three things to teach: simplicity, patience, compassion. These three are your greatest treasures.
    — Lao Tzu

    Thank you for taking the time to visit our site today. We will always begin a post with a favorite quote. This week's quote embodies some of the core values of Cambridge's business model.  

    In the future, we will be posting financial life management case studies and tips. We will also share our market thoughts and strategy under our "Insights" tab. As time goes on, we will build out an interactive resource center at this location.

    We promise that the content presented will be relevant, devoid of industry jargon, and educational. It's our goal that we can encourage, educate, and thereby empower you to take action in your financial life with our posts.

    We welcome your feedback and look forward to helping you prosper by creating harmony in your financial life.

    It's good to have you here and please stop by again.