Tips From Donna Gordon (July 2016 Wesban Monthly)
by Donna Gordon on July 21st, 2016

​Investors Missed the Boat After the Financial Crisis

Looking at where people invest their money on an annual basis can offer some insight into investor behavior. The chart below shows worldwide fund flows into mutual funds and exchange-traded funds by asset class. Historically, the best predictor of future flows is recent past performance. Asset classes with good performance over the last year tend to get strong flows in the following year.
Generally speaking, this is not the best way to invest. For example, in 2009, after the financial crisis and at the beginning of a strong bull market in stocks, the largest flowing category was fixed income. Actually, fixed income received the highest flows from 2009 to 2012. The traumatic experience of the financial crisis scared investors out of investing in U.S. equities all the way until 2013. By waiting so long to invest the average investor missed out on the best returns of the bull market.
Another trend is the strong flows into international stocks. This trend goes against the pattern of flows following performance because international-stock returns have been much lower than U.S. stock returns in the last several years. So, despite their lower recent returns, investors are allocating more money into international stocks. It seems that investors are doing everything they can to avoid buying U.S. equities.
In conclusion, the patterns in this chart show the behavior of the average investor. It is generally not a good idea to follow the crowd in investing. Instead, the more prudent choice is to look to invest in unpopular categories. The best example of this is the fantastic returns you could have received in U.S. stocks over the last seven years.
​What History Says About Safe Retirement-Withdrawal Rates

When approaching retirement, the first question many investors ask is how much money can they safely take from their portfolio each year. A simplistic way of looking at this is a withdrawal rate, expressed as a percentage of your investment assets. To help you make that decision, it may be helpful to look at what previous retirees could have withdrawn over a long retirement.
The chart shows the historical maximum sustainable inflation-adjusted withdrawal rate over rolling 30-year periods for three hypothetical stock and bond portfolios from 1926 to 2015. In the portfolios, stocks are represented by the S&P 500 and bonds by an index of five-year U.S. Treasury bonds. Initial starting values for the three portfolios are assumed to be $500,000. Rolling-period returns are a series of overlapping, contiguous periods. For example, the first point on the chart represents the rolling period of January 1926 to December 1955, the second point moves one month forward to the period February 1926 to January 1956, and so on.
As shown, the amount that could have been withdrawn over each 30-year period varied greatly. If you retired right after the stock market crash of 1929 or in the early 1980s at the beginning of a long 20-year bull market, you could have withdrawn over 10% and still not run out of money after 30 years.
On the other end of the spectrum, if you retired at the beginning of a bear market, the maximum withdrawal rate was as low as 3.5%.
Obviously, you don't know when you start retirement whether market returns will be good or bad, so most people pick a withdrawal rate near 4%, because it works most of the time. While the chart models a fixed withdrawal rate for the entire period, we would advise people to use a more flexible strategy in practice.
When choosing the allocation of stocks and bonds, a portfolio with a higher stock allocation may make the most sense. The chart illustrates that a portfolio invested in 75% stocks has been more volatile but has almost always paid off through higher maximum withdrawal rates.
In conclusion, investors should start retirement with a conservative withdrawal rate near 4% and make adjustments over time based on their income needs and portfolio performance. And investors should consider a portfolio with at least a 50% equity allocation in retirement.

3 Tricks for Getting the Most Out of Your HSA

According to a survey by America's Health Insurance Plans the number of Americans covered by high-deductible health plans (HDHPs)--and who are, in turn, eligible for HSAs--rose by two million between 2014 and 2015, a more than 10% growth rate.

Many workers who are eligible to contribute to HSAs don't take full advantage of them. Even though HSAs offer the best tax treatment of any savings vehicle--pretax contributions, tax-free compounding, and tax-free withdrawals for qualified healthcare expenses--only 4% of HSA holders choose to invest their funds, according to research from HelloWallet, a Morningstar company.

Of course, not everyone has the wherewithal to use an HSA as an investing vehicle; most people need to spend the amounts they've accumulated in their HSAs to cover out-of-pocket healthcare costs. But even those where workers who use a 'spend as you go' approach probably aren't saving enough: The HelloWallet study found that the average HSA deferral was $1,600; the median deferral was $700. Families, especially, are apt to blow through that amount in a hurry in a given year.

If you're considering using your HSA as an investment vehicle, here are three strategies to help get the most mileage out of this valuable account type.

Trick 1: Obtain a payroll deduction while also getting away from a lousy employer-provided HSA.

High-deductible healthcare-plan participants are free to use any HSA custodian they choose, not just the one their employers have chosen. To do so, they would simply steer their contributions into their own HSA, then deduct the contribution on their tax return. (Note that HSA contributions don't fall under the heading of qualified medical expenses, the latter of which can only be deducted to the extent they exceed 10% of adjusted gross income. Rather, HSA contributions are an 'above-the-line' deduction, so they help reduce your adjusted gross income directly, thereby reducing your income to enable Roth contributions and the like.)

But from a practical standpoint, that can be cumbersome and won't likely yield exactly the same tax benefits as having your contribution extracted from your payroll. For one thing, using the payroll deduction enables you to get the tax break right away versus waiting to reap the benefit of the deduction on your tax return. Additionally, HSA dollars extracted via payroll deduction are not subject to Social Security and Medicare taxes, provided the plan is a Section 125 or cafeteria plan.

A workaround is to contribute to your employer's chosen HSA for convenience and tax benefits, then annually roll over or transfer that money to the HSA of your choice. (A rollover, which is allowed once a year, means that you get a check from the first HSA custodian and must get it over to the second HSA custodian within 60 days. A transfer means the two custodians deal with one another on the transaction; you don't receive a check. You can complete multiple transfers per year.) That strategy lets you enjoy the best of both worlds: You get the tax benefit of payroll deductions as well as the long-term benefits of steering your HSA investments to a custodian with better and/or lower-cost options.

A couple of caveats: You can have more than one HSA going at one time, but like IRAs, your combined HSA contribution for a given year cannot exceed the limits--in 2016, that's $3,350 for individuals and $6,750 for families. And if you're employing the two-part strategy I outlined above, it's worth thinking through your investment approach to the employer-provided HSA. Because it's essentially a short-term parking place under the two-part strategy, you'd either want to keep your money liquid while you hold it there or make sure that your hand-chosen HSA includes analogous investment products that you hold in your employer-provided HSA. That way, if one of the investment choices in your employer-provided HSA happens to be in the dumps at the time you plan to transfer your money, you can swap into a similar investment option to maintain like-minded market exposure.

Trick 2: Take a hybrid 'spend/invest' approach.

HSAs offer prodigious tax features--tax-free contributions, tax-free compounding, and tax-free withdrawals for qualified healthcare expenditures. That explains why HSA-eligible investors are often advised to let their HSA assets ride while using non-HSA assets to defray their healthcare costs as they arise. (Doing so has the salutary effect of not triggering point-of-purchase fees that some HSA debit cards carry.)

Yet, even as that makes all the sense in the world by the numbers, from a practical standpoint, paying healthcare expenses with non-HSA assets can be disruptive to a household's budget. For employees who have spent most of their careers covered by traditional healthcare plans like PPOs, it's disconcerting to be suddenly on the hook for hundreds or even thousands of dollars of out-of-pocket healthcare costs.

In that instance, it can be comforting to split the difference: Contribute the maximum to your HSA if you can swing it, park enough in the savings-account option to cover your expected healthcare outlays and pay for them from that account, and invest the rest in long-term investments. If you have had an HDHP for the past few years, your previous out-of-pocket outlays can help you figure out how much to hold in cash.

Trick 3: Use your HSA to cover emergency non-healthcare costs later on.

Despite the very good case to be made for paying healthcare expenses with aftertax assets and letting the assets build inside an HSA, some investors might demur. The HSA is, after all, a single-purpose vehicle--that is, you only enjoy the full range of tax benefits if you earmark your withdrawals for healthcare expenditures.

That's mostly true, but there's actually a workaround in case you need to crack into your HSA for non-healthcare expenses later on. Even if you paid out of pocket (using non-HSA assets) for healthcare expenses in previous years, you can still make a tax-free withdrawal later on for non-healthcare expenses, provided you hung on to receipts for the earlier healthcare costs. An unlimited amount of time can elapse between when you actually incurred the healthcare cost and when you reimburse yourself; the withdrawal will be tax-free as long as you have the proper documentation of the prior expense.

To use a simple example, let's say a person paid $5,000 out of her taxable monies to cover healthcare expenses incurred at the end of 2015. Throughout 2015, she racked up the maximum family contribution of $6,650 in her HSA, letting the money build up rather than spending from it. If she needed a new roof in 2016, she could pull $5,000 from her HSA to steer toward that expense, and that withdrawal would be tax-free provided she could document the 2015 out-of-pocket healthcare costs.

That's not ideal, of course, because she's better off letting the money grow. But a tax-free HSA withdrawal beats other forms of emergency funding, such as credit cards, HELOCs, or 401(k) loans.

The key to preserving this escape hatch, as noted above, is to maintain scrupulous documentation of healthcare expenditures. It's also worth noting that the HSA participant must have established the HSA and made the contribution before she incurred the healthcare cost.


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