February 2019 Newsletter

It has been nearly 10 years since U.S. stocks were in a bear market. Time to brush up on some proven techniques.

Many investors might have forgotten (or, for the younger ones, never knew) how to survive a bear market—after all, there hasn’t been one, by the most common definition, since the last one ended in March 2009.

But investors got a reminder about down markets and volatility at the end of 2018. The memory is fresh, even after January’s rally—the best January for stocks in 30 years— which won back some of the declines. The Dow is still 7% below its record high in October, before the slides. Watching their brokerage and 401(k) levels fall made investors itch to disregard the buy-and-hold strategy that works best for most individual investors over the long term. Giving in to that itch would be a mistake, experts say.

As investors try to cope with the prospect of a down market, the first thing to remember, says Tim Steffen, director of financial planning at brokerage house Robert W. Baird in Milwaukee, is that “while the movements we saw in December might have seemed extreme, on a historical basis they really weren’t all that extreme.”

Since 1950, there have been 36 stock-market corrections, or drops of at least 10% from recent highs. After each, the market has ascended to new highs, says Kurt Spieler, chief investment officer, wealth management, at First National Bank of Omaha. “How you lose money in the stock market is by selling at the wrong time,” he says. (Meanwhile, by rule of thumb, a 20% drop signals that a bull market has become a bear market. That is the drop that investors haven’t had to endure since 2009.)

Here are some other investing truths about down markets that have stood up over time, and that investors should keep in mind as they navigate forgotten territory:

1. Don’t try the ‘Hail Mary’ pass

It is usually a mistake to double down or pour money into one risky investment in the hopes of making up your losses quickly. The markets aren’t a casino (though they might seem like it sometimes). “Don’t feel the need to try to recover all that in one fell swoop by making it up in one investment,” Mr. Steffen says.

Nick Pennino, a financial adviser at the brokerage Edward Jones in Hermosa Beach, Calif., advises clients to keep an emergency fund for expected living expenses for three to 12 months. Not everyone is able to squirrel away extra cash, of course. But if you’re able, you are less likely to panic when your investments fall and you attempt to sell at a loss, Mr. Pennino says.

2. Use dollar-cost averaging

Don’t keep all your money on the sidelines, experts warn. If a bear market scares you away from investing, you won’t lose money, but you’ll also have no chance of making significant returns. “The best way to build up a portfolio is to stay invested for the long haul,” Mr. Steffen says.

A tactic that many market experts recommend is dollar-cost averaging. This involves spreading your purchases evenly over a long period—say, a year or two years—so that you buy the mutual fund or exchange-traded fund at an average price that smooths out highs and lows. “[Dollar-cost averaging] allows investors to do some of what they need—get the money invested—but gives them some of what they want, assurance that if it all goes down tomorrow, at least I didn’t put it all in,” Mr. Pennino says.

This technique draws on behavioral finance, forcing you to commit to buy a prescribed amount of shares on a set date, without room for emotion or thoughts of market-timing. Many brokerages allow you to set up automatic transfers, removing you from the driver’s seat entirely after you have initially decided what to buy.

But just as dollar-cost averaging saves you from paying the highest prices for the assets you buy, it also irons out the basis in your stocks—which means you won’t have as large a gain as someone who bought at the lowest point. If you have a lump sum to invest, rather than a small amount each month, you may be better off investing it all at once, mainly because keeping it on the sidelines in cash while you wait to meter it into the markets will drag down your returns, a 2012 Vanguard study found.

“If you’re uncertain about the way markets are going to go, to avoid the worst-case scenario, you also have to realize you may not make as much in a year,” says James Cox, managing partner of Harris Financial Group in Richmond, Va.

3. Mind your RMDs

Down markets can be the hardest on retirees. Investors older than age 70½ must withdraw at least some of their money from retirement accounts each year—a painful proposition when markets have fallen sharply. These annual payouts, known as required minimum distributions, are required by law because Congress, when providing tax benefits for individual retirement accounts, 401(k)s and other plans, didn’t want people to shelter all their savings forever.

There are exceptions to the requirement. But in general, remember that you don’t have to take these distributions at any particular point during the year. So, if the market stumbles, you can defer your distribution in hopes that markets recover in the meantime, Mr. Cox says. Of course, the market could drop further, so each IRA owner has to call the market, as it were, when making decisions about when to withdraw. That can be tricky.

It is also permissible to transfer shares or investments from your retirement account into a regular taxable account, taking your distribution “in kind” rather than in cash, as some four out of 10 Harris clients do. When you eventually sell those assets in your brokerage account, you will have to pay capital-gains taxes, but you’ll have more control over the timing of the sale, he says.

A cautionary note: Investors also should keep in mind that they’ll owe tax on the IRA distribution anyway. So, an in-kind withdrawal just means the cash to pay the tax has to come from somewhere else.

One bright spot in a down market: If you sell investments at a loss, you can use those losses to offset capital-gains taxes on other assets you sell, Baird’s Mr. Steffen says.

4. Take time to balance

Some investors lulled by rising markets might be out of practice in this area, but experts remind everyone that to survive a down market it pays to have balanced portfolio allocations of equities, fixed income and other asset classes. Investors who kept a portion of their portfolios in fixed income as the stock market was rising were happy in October, November and December, says Mr. Cox.

“If people have the right level in the stock market to begin with,” says First Bank of Omaha’s Mr. Spieler, “the right question should be, ‘Should I be buying into this downturn?’ not, ‘Should I be selling?’ ”

The winning game plan, experts say, is exactly the same in an upward-bound market as in a downward-trending one. If you stick to your asset allocations and don’t sell too soon, you will likely come out fine in the long term. “High-quality investments, properly diversified, reinvesting dividends: that’s proven over time to be a successful investment strategy,” Mr. Pennino says.

_{Source: Chana R. Schoenberger, Feb. 3, 2019}

The current tax season–for the 2018 tax year–is likely to be pretty different from years past.

The key reason is that changes in the tax code that went into effect last year make it much less likely that most taxpayers will be itemizing their deductions; they’ll get more bang from claiming the new, larger standard deduction.

Yet, taxpayers are apt to see fewer changes on the other side of the ledger with the reporting of their incomes. Employers had until the end of January 2019 to issue W-2s, which report wages paid to employees. Other types of income, whether from contract work or investment income, get reported via a 1099 form. These 1099 forms started hitting your mailbox (and/or email inbox) in January. The forms have changed a little bit with the new tax laws, but not significantly so.

Most investors are familiar with the basic 1099-DIV and 1099- INT forms: The former reports dividends and capital gains from taxable investments during the prior year, and the latter depicts interest income received. Form 1099-B, meanwhile, depicts any capital gains or losses realized in taxable accounts; those gains or losses, in turn, must be reported on Form 8949. Some firms amalgamate all of this information into a single consolidated 1099. Independent contractors and small- business owners may receive a 1099-MISC, which documents income received from businesses or employment in the past year.

There are actually many different 1099 forms. The unifying theme among them is that they document that you received some type of income during the preceding year; that income may or may not be taxable.

Your investment-related 1099s can yield some valuable insights about your portfolio management and its tax efficiency.

If you’re using some type of tax-preparation software or farm your tax prep out to an accountant, you may process these forms with barely a thought.

Before you pop them into your tax file, ask yourself the following questions.

Am I taking a tax-efficient approach to dividends?

The first two boxes (or columns, depending on how your form is laid out) of 1099-DIV forms deal with dividends: Box 1a shows you the total ordinary dividends you received, and Box 1b shows you which of those were qualified. Ideally, all of your dividends will count as qualified, because they’re eligible for a lower tax rate than nonqualified ones. Dividends from most U.S. companies, as well as qualified foreign corporations, count as qualified, though there are holding-period requirements to obtained qualified dividend tax treatment. By contrast, nonqualified dividends, from REITs and some foreign stocks, for example, are subject to your ordinary income tax rate.

If the figure in Box 1a is much bigger than 1b, that’s a cue to assess asset location: If you’re holding securities kicking off nonqualified dividends in your taxable account, could you make room that type of holding within your tax-sheltered accounts, while prioritizing qualified dividend payers for your taxable? And if you have dividend-rich holdings–even if their dividends are qualified–it’s also worth considering whether such holdings might make more sense in your tax-sheltered accounts.

Have I considered whether it’s possible to minimize taxable capital gains?

Box 2a shows whether your mutual fund holdings made a capital gains distributions last year. (If you yourself made a sale, you’ll see that reflected on form 1099-B, not 1099-DIV.) Even though stocks slid in 2018, some funds made big distributions anyway: Funds have gains on their books, and those gains must be distributed to shareholders when those appreciated securities are sold. Yet some funds, especially broad market equity exchange-traded funds, traditional index funds, and tax-managed funds, do a better job minimizing those capital gains payouts than others. Some investors have put off ditching their serial capital gains distributors because of fear of triggering their own taxable capital gain on the sale, but that might not be as big a deal as they suspect.

Have I taken steps to maximize income?

It’s worth noting that you won’t receive any kind of 1099 if your earnings were less than $10. You’re still required to report those earnings to the IRS on your tax return, however. The persistently low-yield environment that followed the financial crisis meant that many savers didn’t receive 1099s from their small accounts for several years running but that’s changing now that yields are trending back up. If you have substantial cash accounts but aren’t earning much income, that’s a wake- up call to seek out higher-yielding cash options. Money market mutual funds, online savings accounts, and longer-term CDs are all yielding well over 2% in many cases.

Have I taken steps to maximize tax-free income?

Box 10 of 1099-DIV depicts the amount of tax-exempt interest dividends that you received. If you’re in the 24% tax bracket or above, the income you receive from a municipal bond (or bond fund) may well be higher than what the after-tax income you receive from a taxable account. The tax-equivalent yield function of Morningstar’s Bond Calculator can help you compare the yields on two investments, one taxable and the other tax-exempt, factoring in the tax effects.

Do I understand how my foreign securities are taxed?

If you hold foreign stock funds in your account–or even U.S. focused funds that dabble in foreign securities–Box 7 of 1099- DIV depicts any foreign taxes paid on those holdings for the year prior. Investors in foreign stocks have to pay taxes on their earnings in the company’s country of domicile, as well as to the U.S. The key to not getting taxed twice is to claim a deduction or credit for foreign taxes already paid. In addition, the ability to deduct foreign taxes paid may make a taxable account a more attractive receptacle for foreign stocks than an IRA or 401(k). Moreover, some dividends from foreign stocks aren’t qualified, so placing them within a taxable account may offset, at least in part, the value of the foreign tax credit.

Am I maxing out my tax-sheltered accounts?

You’ll only receive a 1099-DIV from a taxable (nonretirement) account; you won’t get them from your IRAs and 401(k)s, for example. That makes sense, when you think about it: Any income that these tax-sheltered accounts kick off from year to year isn’t taxable in the year in which you receive it; rather, when you pull the money out you’re taxed on any income that hasn’t already been taxed. (You’ll receive a 1099-R instead when you take those distributions.)

There are several virtues to investing in a taxable account– flexibility and a lack of strictures on contributions and withdrawals, as well as fairly favorable tax treatment currently for dividends and capital gains. But investors who hold long- term assets within a taxable account are giving up the tax- deferred or tax-free compounding that comes along with traditional and IRA accounts, respectively. That’s the key reason I’d put them way down in the retirement-funding queue.

 Is my portfolio as streamlined as it can be?

If you received many 1099s from different providers, that could be a signal that portfolio is “busier” than it needs to be. Is there a way to consolidate your accounts with a single provider or two, rather than maintaining a lot of “onesie” accounts?

_{Source: Christine Benz, Jan. 17, 2019}

What’s the best way to get more people to save for retirement on the job?

In 2019, a large national experiment will take shape that tests two very different approaches. Some large states–including California and Illinois–will launch state-sponsored programs that mandate participation by employers. Meanwhile, Congress likely will approve a new type of 401(k) aimed at small employers that relies on voluntary employer participation.

But new ways to save will be just one of several important stories worth watching on the retirement beat in 2019.

Congress will try to reach agreement on a plan to avert an insolvency crisis in multi-employer pension plans, with the fates of more than one million workers and retirees at stake. And the U.S. Securities and Exchange Commission will move toward adoption of a so-called regulation best interest standard following this year’s death of an advice standard created by the Obama-era Department of Labor.

Workplace Retirement Saving

Experts agree that the workplace is the most effective place to get people saving, due to the automatic payroll deductions, tax breaks and matching contributions often offered by employers. Yet one third of private-sector workers had no access to an employer-sponsored retirement plan in 2016, according to the United States Government Accountability Office. The coverage shortfall is greatest among low-income workers and people working for small companies.

Last year, the Pew Charitable Trusts surveyed more than 1,600 small- and medium-sized business owners about the barriers they face offering retirement plans to their workers; most often, they cited expense, limited administrative resources, and lack of employee interest as top reasons for not offering retirement plans.

The idea of government-sponsored retirement plans dates back to the Obama Administration, which proposed a national “auto- IRA” program as early as 2010. The proposal required employers who didn’t offer their own retirement plans to enable worker contributions via payroll deduction to IRAs that would be managed by third-party financial services providers. The idea was to reduce paperwork burden and cost; it did not require employer matching contributions and even included a tax break to cover cost of the payroll setup. But the auto-IRA died in Congress following passage of the Affordable Care Act due to its mandatory participation feature; the partisan fight about the healthcare law had made toxic any proposal containing the word “mandate.”

The auto-IRA had very bipartisan roots, notes Mark Iwry, a key architect of the proposal. Iwry served as a senior advisor to the Treasury secretary in the Obama administration, and currently is a nonresident senior fellow at the Brookings Institution. “Purported concerns about a ‘mandate’ have served largely as an excuse for inaction on coverage,” he says, noting that the idea was first rolled out at the conservative Heritage Foundation in 2006. “The auto IRA proposal enjoyed as much co-sponsorship and support from Republicans as from Democrats–including endorsement by both 2008 presidential candidates McCain and Obama.”

After the national proposal failed to gain traction, a number of states began investigating the idea of taking the idea local– and 2019 is the year when some very large plans will roll out. Oregon started its plan last year; California and Illinois will start in 2019; Vermont, Maryland, and Connecticut are preparing to begin programs, and New York has passed legislation and is establishing a board to oversee the start of a state program over the next two years. New Jersey also is close to approving a plan.

The states that have approved plans could eventually extend coverage to 15 million workers, AARP estimates.

California’s plan alone could cover 7.5 million workers. The CalSavers program is in a pilot phase through the end of June and will be open to all employers beginning July 1; mandatory compliance will phase in with three waves from 2020 to 2022 based on employer size.

Meanwhile, Congress likely will approve legislation clearing the path for a more voluntary approach. The idea is to make it easier for employers to band together to join a single 401(k) plan that they can offer to employees. These “open multiple employer plans” would be offered by private plan custodians; the aim would be to offer employers low-cost plans featuring simplified paperwork.

Open MEPs are a key component of broader proposed legislation, the Retirement Enhancement and Savings Act. Another key component would make it easier for employers to include annuities in workplace retirement plans by their fiduciary responsibilities when selecting annuity providers. “I’m very bullish on action this year,” says Shai Akabas, director of economic policy at the Bipartisan Policy Center. “A great deal of legislative work already has been done on this, and support for it is very broad.”

What’s the better approach–auto-IRA or open MEP? Iwry sees the two ideas as complimentary, rather than competitive, with auto-IRAs serving as starter accounts likely to lead many more employers adopting 401(k) plans. “It really represents two attempts to do the same thing,” says Joshua Gotbaum, a guest scholar at the Brookings Institution and chair of the Maryland Small Business Retirement Security Board, which is spearheading development of the state’s auto- IRA program.

Multi-employer Pension Meltdown

Did I mention that more than a million retirees and workers are facing sharp cuts in promised pension benefits, and that a key federal insurance program is facing insolvency? That is the financial disaster that a special congressional committee is racing to avert.

The problem centers on so-called multi-employer pension plans. More than 10 million workers and retirees are covered by 1,400 of these plans, which are created under collective bargaining agreements and jointly funded by groups of employers in industries like construction, trucking, mining, and food retailing. Plans covering 1.3 million workers and retirees are severely underfunded–the result of stock market crashes in 2001 and 2008-2009, and industrial decline that led to consolidation and declining employment.

Meanwhile, the Pension Benefit Guaranty Corporation, the federally sponsored insurance backstop for defunct plans, projects that its multi-employer insurance program will run out of money by the end of fiscal 2025, absent reforms.

Congress approved an overhaul in 2014, the Multi-employer Pension Reform Act, but the legislation has faced strong resistance from retiree organizations, consumer groups and some labor unions. It allows troubled plans to seek government permission to make deep cuts in benefits for current and future retirees, if they can show that the reductions would prolong the life of the plan.

Last year, the special congressional committee planned to create a replacement for the Multi-employer Pension Reform Act that would be more worker-friendly but missed an end-of- November deadline to issue its recommendation. But the draft plan that has been circulating in Washington raises the guaranteed minimum benefits that would be paid by corporation to retirees and workers in failed plans. It also would inject federal funds into the PBGC–perhaps $3 billion annually–to expand the agency’s partition program, which allows it to take on benefit payments to so-called orphans– people who earned benefits from employers who have dropped out of plans, often because they have gone out of business.

Best Interest Regulation

Will the fight over regulation of financial advice ever end? No finale is in sight this year.

I refer to the long-running battle to require brokers to look out for the best interests of clients. Registered investment advisers already adhere to a strict requirement to put the best interest of clients ahead of their own, and they are fiduciaries. A rule promulgated by the Obama-era Department of Labor would have brought brokers under a similar standard for any advice offered on retirement accounts, but it died an unceremonious death last year.

The SEC is moving toward adoption of a so-called regulation best interest standard. The SEC rule would require brokers to put their customers’ financial interests ahead of their own, but it does not require them to act as fiduciaries. The rule also would require disclosures to clients of any potential conflicts, and it reaffirms existing higher standards for registered investment advisers. The draft regulation has come under fire from consumer advocates who note that it does not clearly define the term “best interest” and that the proposed disclosure forms are confusing for investors.

The disclosures are a key component of the proposed rule, but usability testing conducted last year of the forms brought up numerous serious problems. The tests–conducted by AARP, the Consumer Federation of America, and the Financial Planning Coalition–showed investors didn’t understand the form’s legal disclosures or the term “fiduciary standard.” They also didn’t understand the term “best interest” and other key components of the disclosure. The SEC is expected to release a final rule in the second half of this year.

_{Source: Mark Miller, Jan. 14, 2019}