For many of us, our employer’s 401(k) plan is our primary retirement savings vehicle. Participating in the plan is generally easy and painless. Your contributions are deducted from your paycheck each pay period, there is nothing that you need to do other than select how you want your money invested. Some companies even offer a matching contribution on top of what you contribute.
Even with these attributes, you still want to be sure that your company’s 401(k) plan is a good one and that it is a good place for your retirement savings. It's important to evaluate the plan in several areas.
A key factor in evaluating your company’s 401(k) is the quality of the investment lineup offered. Quality encompasses several features.
Do the mutual funds or other investment offerings allow you to build a diversified portfolio? Are there funds offered across a range of asset classes and sub-asset classes for stocks, bonds, and a cash option? Does the plan offer several low-cost index funds, for example, an S&P 500 index or one that replicates the total U.S. stock market?
How do the funds compare to other funds in the same asset class? Where mutual funds or ETFs are used you can check on this using a service like Morningstar. The annual fee notice report that you receive from your employer will generally show a comparison of the investments to a benchmark like the S&P 500 or the Russell 2000, but usually not to other funds in the same asset class peer group.
Matching from your employer can help increase your plan balance. This is basically free money. The matching formula might be on the order of a 50% match on the first 6% of your salary deferral contributed to the plan. The higher the match obviously the better.
Another aspect of the employer match is the vesting formula, this refers to the time period in which the company match is yours should you leave the company. A typical formula is that you earn ownership in 20% of the match each year with full ownership occurring after five years with the company.
In addition to a matching contribution, some companies will make an annual profit-sharing contribution to your 401(k) account. These contributions are optional, the company can skip a year if they had a bad year financially or for any other reason.
All of these company contributions serve to enhance your retirement savings efforts beyond your own contributions. The amount that your company contributes to the plan on your behalf is a factor in evaluating the quality of your plan.
High expenses are a major impediment to retirement savers trying to build a retirement nest egg. Studies by the SEC and others have shown that even a relatively small difference in investment expenses can have a dramatic impact on the growth of your investments over time.
Plan expenses come in several forms. There are the expense ratios of the mutual funds or other investments offered. Expense ratios are deducted from the gross returns of the funds the same as with investments in mutual funds made outside of the 401(k).
Some plans may also charge some or all of the administrative costs of running the plan to the accounts of the participants. This is generally done on a pro-rated basis determined by the relative size of your balance as a percentage of the total assets in the plan, but there may be a different formula used in some cases.
Plan expenses are disclosed in the annual fee notice that your employer is required to send to you. You may have to dig through it a bit to determine what expenses beyond the mutual fund expense ratios are being charged to your account. What you will need to do is to look up the fund’s expense ratio in the prospectus that you were given, or in the case of mutual funds, you can do so on a site like Morningstar. If there is a difference between the expense ratio of the fund and the amount listed on the annual fee report, this will represent the plan administrative fees being charged to your account.
If you’ve done your homework and you decide that your company’s plan is not as good as it could be, you have some options. One is to not contribute to your plan or to only contribute enough to receive the full match offered by your company if they do matching contributions. This isn’t the most preferable option as you are missing out on the ability to contribute to a tax-advantaged retirement account.
If you are married and your spouse has access to a good plan through their employer, be sure to max out contributions to that plan.
If you feel your employer’s plan could be improved in terms of the plan’s expenses or the quality of the investment menu, it can pay to voice your concerns to the plan’s administrator or to senior management. Of course, you want to be respectful in voicing your concerns, and you will need to be able to articulate the issues you see. Perhaps it is with the quality of the investments or the costs of the plan. With the rash of participant lawsuits against 401(k) sponsors in recent years, many employers are more receptive to this type of feedback. For many companies having a good 401(k) plan is a vehicle to attract and retain top employees in a competitive job market.
We periodically review our client’s 401(k) plans as part of the financial planning and investment services we provide. The assets in their 401(k) accounts are a key piece of their overall investment portfolio. In the process of determining how they should invest their 401(k) assets, we review the overall quality of the plan to help us make those recommendations.
If you have any questions about your investments, including your 401(k) plan, please reach out.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor
Asset allocation is an investment strategy that adjusts the percentage of each holding in an investment portfolio according to the investor's risk tolerance, goals and investment time frame.
One famous industry study indicated that over 90% of the return from an investment portfolio was attributable to the portfolio’s asset allocation. While some have questioned whether or not the percentage is actually this high, there is little question that your portfolio’s asset allocation is a critical factor in determining your return.
Here are some thoughts as to why asset allocation is so important to your investment portfolio.
A key factor in any sound investment strategy is a strong consideration of the investor’s risk tolerance. This might be tied to their age, time horizon, or if the portfolio is needed for a specific goal like retirement.
Asset allocation is a tool to balance the management of the portfolio’s potential downside risk with its potential return through the appropriate allocation to holdings in various asset classes.
One of the basic tenets of long-term investing is portfolio diversification. In a nutshell this means holding a variety of investments that are not all highly correlated to each other. Asset allocation is the most efficient way to set up an investment strategy that accomplishes this for our clients.
For example, bonds have a correlation of -0.20 to U.S. large cap stocks. A correlation of 1.00 would mean that these asset classes were perfectly correlated to each other. A perfect correlation means that the price movements of holdings in the two asset classes would move roughly in lockstep with each other and that these price movements would be influenced by the same market and economic factors.
On the other hand, a correlation of 0.00 would indicate little or no correlation in the price movement or in the factors that influence these price movements.
In the example above, there is a very low correlation between the two asset classes. Additionally, the negative correlation indicates that factors that might push one asset class higher would tend to push holdings in the other asset class lower. As we’ve seen over time, bonds tend to hold up better than equities when the stock market is experiencing a period of correction.
Certain asset classes and individual holdings will outperform others at different points in time. Having a target asset allocation helps investors in that it provides a “starting point” so to speak. A key piece of the portfolio review process is a review of your asset allocation. Is it still in line with your portfolio’s target asset allocation?
Reviewing your portfolio periodically is important. This is typically done quarterly. We discourage clients from looking at their portfolios daily and we feel that rebalancing too frequently may do more harm than good. Reacting to every movement in the market is at odds with the benefits of taking a long-term approach to investing.
Many advisors set a range for the various asset classes within a client’s portfolio. If an asset class falls outside of that range then they will rebalance those holdings back to within the target range. A range of +/- 5 percentage points deviation for the target is common for many advisors.
It’s human nature to want to let an investment that has recorded large gains keep running. This may be fine for a period of time, but invariably these gains will level off or be reduced when the holding turns around and gives some or all of those gains back.
The discipline that an asset allocation target brings to investing is that as one or more asset classes grows to a level that exceeds the target allocation by the stated percentage, a portion of the holdings in this asset class are then sold to bring the overall asset allocation back to within the target allocation range. This helps maintain the balance between the portfolio’s upside potential and it’s downside risk.
Many investors have multiple accounts of different types. This might include taxable accounts, IRAs, a 401(k) or similar workplace retirement account or others. The retirement accounts may be traditional, Roth or both.
While the asset allocation of the various accounts may differ a bit, taking a total portfolio approach to asset allocation is important. This helps you focus on the overall level of investing risk you are taking.
A part of a total portfolio approach includes paying attention to asset location as part of this process. Certain types of investment assets are more tax-efficient if held in one type of account versus another.
For example, stocks or equity ETFs or mutual funds that you plan to hold for a period longer than one year are a good fit for a taxable account due to the preferential tax treatment of long-term capital gains. Taxable bonds, including ETFs and mutual funds that invest in them, may be a better fit for an IRA or other tax-deferred (or tax-free in the case of a Roth) retirement account due to the level of fully taxable income they throw off each year.
Asset allocation is meant to be a target that you try to maintain over time. As a key part of the overall financial planning process, your target asset allocation provides a base point for rebalancing over time when the markets move in one direction or another.
Over time, your target asset allocation will likely change as part of the ongoing financial planning process. As you get older an asset allocation that takes less risk might be appropriate for you. You might also adjust your asset allocation to take less risk if your portfolio performs exceptionally well over a several year period. You may find that you are farther along towards accumulating the amount needed to achieve your goals than your financial plan had called for.
Asset allocation is perhaps the most important part of crafting and implementing an investment strategy. It is also an integral part of your overall financial planning efforts.
If you are looking for a fee-only fiduciary financial advisor who will always put your interests first, please give us a call to discuss your portfolio’s asset allocation or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Investment Advisor
Tina Alteri, CPA, Tax Advisor
Inflation is frequently mentioned in the news and particularly by the financial press. Lately we’ve heard about inflation connected with many products and services as we emerge from the pandemic. Inflation is often linked with Federal Reserve policy as well.
Inflation is a key variable to consider in your financial planning, especially for those nearing and in retirement.
Inflation is generally defined as a loss of purchasing power due to increases in the cost of various goods and services in the economy. Inflation is often discussed in terms of the Consumer Price Index (CPI). This is a measure of the price increases of a specific basket of goods and services that is used as a proxy for the entire economy.
The problem with CPI or similar inflation benchmarks is that this is not representative of everyone’s situation. Different types of goods and services are impacted in different ways by inflation and at different times. At a personal level, the impact of inflation on your situation is a function of the specific goods and services you consume.
In some periods, the supply of money set by the Federal Reserve may outstrip the growth in supply of some goods and services. This is a situation where there is too much money chasing too few goods. There is more money in the hands of many people and they want to spend it. If the supply of the goods and services they want hasn’t grown in proportion with the money supply, this can cause inflation as these consumers use their extra cash to bid up prices.
Inflation that is based on supply and demand is different. The inflation may be based on a lack of supply relative to the demand for a product or service. As we’ve begun to emerge from the pandemic, we’ve seen a shortage of workers in many industries. This has led to wage inflation in some cases as restaurants, airlines and other employers are forced to pay up to be able to hire the workers they need.
Many of the products and services used by retirees have been hit inordinately hard by inflation in recent years. As a case in point, take the price of prescription drugs and healthcare. These costs have risen at a higher rate than the general rate of inflation that might be reflected in an index like the CPI. Another area that has seen dramatic price increases over time is the price of long-term care and related services.
Inflation in these and other critical goods and services frequently used by retirees comes against a backdrop where retirees are often on a fixed or semi-fixed income. Their portfolios may be invested in a fashion to minimize downside risk that may not fully keep pace with the inflation on the basket of goods they normally consume.
Sources of income such as a pension or Social Security may offer minimal or no cost of living adjustments (COLA). For example, most private sector pensions do not offer any COLA increases. Public sector pensions and Social Security do offer COLA adjustments, but these inflation adjustments are often based on a benchmark like the CPI which doesn’t reflect the true impact of inflation on the goods and services used by retirees.
Inflation is a function of supply and demand. If something is in short supply but there is a high demand for it, the price will likely increase. As we come out of the pandemic we are seeing many examples of this.
The housing market in many areas of the country is hot. We’ve read about instances where home buyers are bidding on homes without ever seeing them in person. This is an outgrowth of the desire of many residents of major cities to move to desirable suburban areas with more space.
The price of many new cars has risen due to a shortage of microchips used in the manufacturing process for most modern day vehicles. This chip shortage has impacted a number of other industries and has helped to drive prices up in many cases. The cost of travel and related costs has risen as people long to go on a trip after being at home so much as a result of COVID.
Regardless of your age, it’s important that your investments generate returns that stay ahead of inflation. Asset classes like stocks, real estate, some commodities, precious metals and others have generally outpaced inflation over the long-term. For bond investors there are even inflation protected Treasuries (TIPs) where the interest rate is tied to an inflation benchmark.
For younger investors this generally will not be too much of an issue. Their portfolios should be weighted towards equites and other investments that can generate the types of returns. They have a relatively long time horizon until retirement, and they are young enough to weather the types of fluctuations that these types of investments might experience over time.
For those who are nearing or in retirement, this is where the right asset allocation is critically important. Investing in retirement is a balancing act between managing downside risk and taking enough investment risk to stay ahead of inflation.
Regardless of your age, a diversified portfolio is important. Holding assets that can serve as a hedge against inflation is a key component of your asset allocation at all ages. Some of the asset classes that serve as hedges against inflation also serve as solid portfolio diversifiers due to their relatively low correlation to asset classes like stocks and bonds. Examples include gold and other precious metals, commodities, and real estate.
Certainly investors want to minimize the potential for losses on their investments from a decline in the value of their holdings. Lost purchasing power due to the impact of inflation on your investments is another type of loss that you want to avoid as well.
We can help allocate your investments to provide protection against the impact of inflation. Give us a call to see how we can help you implement an investment strategy that is tailored to your unique situation.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Investment Advisor
Tina Alteri, CPA, Tax Advisor
Ballston Spa: 518-885-3230
Naples: 239-435-0090
For investors, there are two key metrics, risk and return. Return is the reward for investing. Investment returns are what fuel the attainment of financial goals such as retirement and funding your children’s education.
Managing your portfolio’s investment risks is a key factor in achieving the types of long-term returns you are seeking.
There are a number of definitions of risk. In general investment risk is the risk that the returns from your investments will differ from their expected returns. Most investors, however, define risk as the risk that their investments will decline in value.
In our experience, the risk of a significant loss on their investments is how investors typically define risk.
In building and managing portfolios for our clients, the balance between potential downside risk and potential rewards are the main driver. Factors such as the investor’s time horizon for needing the money and their personal risk tolerance need to be considered in determining how much potential risk is appropriate for their portfolio.
Beyond the risk of loss, there is the risk of the investor falling short of their goals by not taking enough risk. For example, an investor entering retirement needs to balance out the potential for downside risk with the need to invest aggressively enough to stay ahead of inflation and to help ensure they don’t run out of money in retirement.
Diversification is the investment version of the old adage, don’t put all of your eggs in one basket. A well-diversified portfolio contains some holdings that are not highly correlated to the rest of the portfolio. By not highly correlated we mean that some investments will behave differently from each other under the same set of market or economic circumstances.
For example, a popular large cap stock ETF and an ETF that tracks the total bond market have a correlation of -0.05 to each other over the past decade. The low, negative correlation means that these two ETFs will often behave quite differently in many market environments. Building a diversified portfolio that consists of some holdings with low and/or negative correlations can help in managing the portfolio’s overall risk.
A key tool in implementing portfolio diversification and managing investment risk is asset allocation.
Asset allocation is the distribution of the investments in an investor’s portfolio among various asset classes such as stocks, bonds, and cash. A client’s asset allocation generally goes to another level to include sub-asset classes such as large-cap stocks, small caps, foreign, and so on. There might be several types of bonds such as short-term, corporates, and others.
The exact asset allocation will depend upon the client’s unique situation in terms of their investment time horizon and their tolerance for risk.
Check Your Risk Tolerance Here Using Our Risk Questionnaire
In some cases investors may find themselves with a concentrated position in one or more individual stocks. This might arise from an inheritance, from stock-based compensation from their employer or from a position that has been held for a period of time where the stock has experienced unprecedented growth.
In any event, a concentrated position in one of just a few stocks can increase investment risk. If a concentrated position experiences a significant drop in price this can have an outsized impact on the investor’s portfolio.
If the concentrated position is in the stock of an investor’s employer and the company experiences financial difficulties, this could create a double risk. Not only might the stock decline in value, but the investor’s job might also be in jeopardy.
We try to work with clients to deal with concentrated stock positions in the best way possible for their situation, including the potential for using some of the shares for charitable contributions if desired.
While it is not a perfect solution, periodic portfolio rebalancing is critical to maintaining an investor’s asset allocation. Rebalancing means “resetting” the investor’s portfolio back to their target asset allocation. It's typical to set parameters that are acceptable and where no action is taken if the allocation is within those parameters. A common example might be +/- 5% of the target allocation for a given asset class.
The performance of different portfolio holdings relative to one another can cause a portfolio’s asset allocation to deviate from the target asset allocation. Using a simple two security portfolio as an example, an investor’s target allocation might look like this:
After a significant rally in stocks, their allocation might look like this:
At this level for stocks, the investor is taking on too much risk in the event that the stock market corrects.
Under a scenario where we’ve experienced a significant stock market decline, the investor’s portfolio might look like this:
In this case, the reduced level of stocks means that the investor is likely taking too little risk and may not be able to generate sufficient gains to meet their financial objectives.
Rebalancing is commonly done by selling positions in asset classes that are above the rebalancing threshold and reallocating the proceeds to holdings in asset classes that are below their thresholds.
Rebalancing can also be accomplished by taking any new funds added to the portfolio and directing this money to asset classes that need to be shored up.
When rebalancing it's important to take a full portfolio view to include taxable accounts as well as retirement accounts. The overall portfolio allocation is key to controlling overall investment risk. Tactics such as tax-loss harvesting are used with taxable accounts where applicable to minimize the tax impact of rebalancing when it makes sense.
Our investment team at CFM believes that a review for potential rebalancing should be conducted at regular intervals such as every three months.
We feel the best tool to mitigate investment risk is the regular review of our client’s portfolios. This review combines a review of the portfolio’s asset allocation versus the target as well as a review of the portfolio’s holdings.
Are these securities still performing in line with our expectations in terms of relative risk and return compared to other securities in their peer group?
Moreover, we review the portfolio in light of the client’s current financial situation to ensure that their investments are properly positioned in terms of the balance between potential returns and potential downside risk.
Check Your Risk Tolerance Here
Bill Canty, CFP®, CPA
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
