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As a financial planner, I love helping people find answers to their questions. Sometimes they ask me about long-term financial strategy. At other times, their questions are more immediate in nature, like should I take Social Security now or should I do a Roth conversion this year or buy that new car I’ve been thinking about.

The answers to client questions usually rely on information that only the client can provide. Though it often takes some effort, most people can dig through their check registers and credit card statements to get a clear sense of how much money they spend. Likewise, they can look at pay stubs and tax returns to figure out how much they earn. Insurance policies, mortgage statements, investment account statements and employee benefit summaries are also important sources of information for financial plans.

On the other hand, many people shy away from the softer side of financial planning—questions about values and preferences. Coming to grips with this softer side requires introspection. If you are married or involved in a long-term relationship, this “coming to grips” may require you and your partner to discuss things that are emotionally difficult. However, I have also seen that some of the most impactful financial planning happens when clients are willing to engage in this way. The core message is this: If you are going to do a financial plan, don’t neglect the softer side of the plan.

Several years ago, a couple engaged us to do a financial plan. They had recently sold their business leaving them with plenty of financial resources. As we worked through their financial plan, we could see that some aspects of their financial lives did not align with their values. For example, travel was very important to them. Yet they worked long hours as employees in the business they had sold so they could afford a large home they really didn’t want. Their financial plan helped them see this disconnect. They sold their home, quit their jobs and started traveling more. Their planning helped them create a life that was more consistent with their values.

With that in mind, here are 14 “soft” questions you should ask yourself as you work through your financial plan. If you have a spouse or a significant other, you might use these questions as the basis of a very fruitful discussion.

  1. What are your top five priorities right now
  2. If you knew you only had three years to live, how would your priorities change?
  3. What are the top three problems in your life that money can solve?
  4. What are the top three problems in your life that money cannot solve?
  5. If you knew you were going to die tomorrow, what would you regret not doing?
  6. If money were no object, what would you be doing right now?
  7. Do your financial habits create for you a world of abundance or a world of scarcity?
  8. Which is stronger within you, your desire to be part of the group or your determination to fulfill your vision?
  9. Do you tend to be an optimist or a pessimist?
  10. What do you most fear about your financial future?
  11. What do you most eagerly anticipate about your financial future?
  12. Do you have a household budget? If so, how long have you lived with it? If not, why not?
  13. Do you feel like you are on track to achieve your goals?
  14. Which risk concerns you more, inflation or stock market volatility?

 

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell,   2340 Garden Road Suite 202, Monterey, CA  93940 or email them to: smerrell@montereypw.com

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Q: I am very concerned about the risk in my portfolio.  I’ll be 81 this year and my wife just turned 71. At my age, I cannot go back to work, so the savings we have today are all the savings we will ever have. In 2008 stocks fell 50% from their previous highs and took years to recover. If the market drops like that again, we may be forced to liquidate our investments before they have a chance to recover. I’m beginning to feel like I should move money out of stocks. Am I being overly pessimistic? Is it possible to be too conservative?

A: You are wise to be concerned about portfolio risk. Markets have a way of punishing investors who become complacent. But whether you are being too pessimistic or conservative is impossible to know based only on the facts you have given. The amount of risk that is appropriate for you depends on several factors, including your investment horizon and the amount of return you need your portfolio to generate.

There are a lot of different ways to think about portfolio risk. Many people focus on portfolio volatility, or the degree to which their portfolio’s value changes over a specific time interval. That kind of risk measure works well if you are a day trader. However, if you are a long term investor, it is more useful to think of risk as the possibility that your capital becomes permanently impaired.

As your question suggests, being forced to liquidate stocks in a down market is a real risk. It can permanently impair your capital. We call this “liquidation risk.” One way to mitigate liquidation risk is to diversify a portion of your portfolio into bonds. The amount of bonds you should own depends on two things: 1) how much money you expect to withdraw from your portfolio each year; 2) how long it takes for stocks to recover from a bear market. Financial planning can help answer the first question. A study of bear markets can help answer the second.

Since 1929, the U.S. stock market has suffered ten major bear markets, defined as a decline of at least 20 percent. In the longest bear market, the S&P 500 index took more than 15 years to recover to its pre-bear market level. The shortest recovery took only 17 months. On average, across all ten bear markets, the market took 4.6 years to fully recover. The recovery from the 2008 bear market took 4.5 years. 

You can protect yourself from liquidation risk, by holding enough in bonds to fund your expected withdrawal during a bear market recovery. For example, let’s assume you have savings of $500,000 invested in a traditional IRA. As an 81 year-old, the IRS is going to require that you to take annual distributions from your IRA. Over the next five years—the average length of a major bear market recovery—your distributions will total approximately $155,000. Therefore, if you want protection for an average bear market recovery, you should have at least $155,000, or 31% of your portfolio, invested in bonds and cash.

If you want to protect yourself for a longer period of time, you can hold more in bonds. But remember, owning more bonds will reduce your portfolio’s expected portfolio. If your portfolio return is too low, you may not be able to achieve your longer-term goals. In that sense, it is possible to be too conservative in your portfolio strategy. A trusted financial advisor can help you balance the tradeoff between protection from liquidity risk and the need for an adequate return on your portfolio.

 

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell,   2340 Garden Road Suite #202, Monterey, CA  93940 or email them to: smerrell@montereypw.com

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Q: I am 42 years old. I have been working through my financial plan and I am wondering if I should count on receiving a Social Security benefit when I retire. The Social Security website says the trust fund reserves will be depleted by 2034 and “payroll taxes will be enough to pay only 79 cents for each dollar of scheduled benefits.” 

A: You aren’t alone in your concerns about Social Security. A few years ago, AARP asked 1,200 adults about their confidence in Social Security. Two-thirds of the respondents said it is one of government’s most important programs and four out of five respondents said they either rely, or plan to rely, on Social Security in retirement. However, only 42% were “very” or “somewhat” confident in the program’s future. Pessimism was even more pronounced among younger respondents--those aged 18 to 29. Of this group, 55% agreed “completely” or “somewhat” with the statement “Social Security won’t be there when I’m ready to retire.”

Social Security is plagued by a basic actuarial fact: in about four years, Social Security will start spending more on benefits every year than it collects in revenues. To meet the shortfall, Social Security will start tapping its trust fund and by 2034 the trust fund will be depleted. At that point, unless Congress changes something, projected tax revenues will only be able to cover 79% of the projected benefits. As the number of people receiving benefits increases relative to the number of workers paying into Social Security, the shortfall will worsen.

A number of proposals are being discussed, but there are really only two ways to fix the system—we either cut benefits or increase taxes. Every proposal is some permutation of these two basic approaches. And although either option is politically difficult, the longer we wait, the more painful the solution will be.

One idea is to raise the full retirement age. We did this once already (in 1983) with pretty good success. Supporters say this approach is reasonable since people are living longer. When Social Security was launched in 1935, a 65 year-old man was expected to live 13 years in retirement; now he is expected to live 18 years.  Since longevity gains have accrued primarily to the well-to-do, opponents claim this will unfairly punish low-earning workers.

A related approach is to index benefits to gains in population longevity. Under one version, the monthly benefit would be reduced as longevity increases. Under another version, the full retirement age would increase. Both approaches would make a meaningful impact on the funding gap. However, once again opponents claim these options unfairly target low-earning workers.

Another idea is to reduce benefits for those above certain income levels. For example, benefits could be reduced for the highest-earning 50 percent. Benefit reductions would begin small and increase on a sliding scale up to a 31 percent reduction for the highest earning workers. Supporters claim this would close the funding gap with a little wiggle room to spare. They reason this approach is consistent with Social Security’s original intent: to protect against poverty in old-age. Opponents, on the other hand, worry this would actually hit middle-income Americans the hardest, since their benefits would be cut and they have come to rely on Social Security in retirement.

As you consider your financial plan, you can be confident that some form of Social Security will be waiting for you when you retire. However, the amount of your benefit and the cost required to secure your benefit are still very much up in the air.

 

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell,   2340 Garden Road Suite z202, Monterey, CA  93940 or email them to: smerrell@montereypw.com

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