Near-Zero Interest Rates: Trade-Offs for Investors
The Federal Reserve’s policy of low short-term interest rates presents potential plusses and minuses for investors.
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Consider your exposure to interest rate risk when evaluating your portfolio.
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Excited about two more years of near-zero interest rates? There’s also a flip side.
The Federal Reserve’s recent announcement that it will maintain the federal funds rate in a range between 0.00% and 0.25% through December 2014 has generated the usual analysis about whether Chairman Bernanke and his colleagues are doing the right thing. But the Federal Reserve’s policy may be less about right versus wrong than about the trade-offs for investors and consumers.
When the Federal Reserve makes a determination about movements in interest rates, it bases its decision on prospects for economic growth and whether existing growth can be sustained. The Federal Reserve considers the outlook for inflation, the federal budget, consumer finances, corporate earnings, and a variety of other factors. Maintaining interest rates at a historically low level, which has been the Federal Reserve’s policy since December 2008, is a tool for stimulating economic growth.
A Domino Effect
The fallout from the Federal Reserve’s actions can be significant. The federal funds rate influences the prime rate, which in turn has a bearing on rates that lenders charge for consumer and corporate borrowing. When the prime rate is relatively low, lenders may offer lower rates for mortgages, credit cards, and other forms of credit than they otherwise would. It is important to remember that consumer demand and a household’s creditworthiness are also significant factors in interest rates assessed by lenders.
There are other plusses associated with low short-term rates. Borrowing costs are relatively low for corporations, which can impact earnings and escalate stock market returns.1 In addition, with banks offering marginal returns on savings products, investors have a strong incentive to add to equity allocations with the goal of earning higher returns.
A Flip Side
Just as low short-term interest rates bring certain benefits, there may be drawbacks for investors and also for the broader economy. When short-term rates eventually go up, the situation is likely to be a negative for bondholders because of the inverse relation between interest rates and bond prices.2 Historically, rising interest rates have caused the prices of existing bonds to decline because newly issued bonds carry higher rates, which push down the value of previously issued securities. Holding a bond until maturity, when an investor can recoup principal, can lessen interest rate risk.
Low interest rates also are a potential negative for savers, in particular retirees who depend on savings products to finance living expenses. In addition, there remains the question of whether low short-term interest rates encourage certain investors to gravitate to assets that are relatively risky given the investor’s tolerance for volatility and time horizon. A recent blog post noted that flows into high-yield bond funds have exceeded those for ultra-short and U.S. government bond funds.3
Economic policy frequently presents both plusses and minuses, and low short-term interest rates are no exception. You may want to evaluate your exposure to interest rate risk and think about how you will cope with the situation when Federal Reserve policy changes.
Source/Disclaimer:
1Investing in stocks involves risks, including loss of principal.
2Bonds are subject to market and interest rate risk if sold prior to maturity. Bonds are subject to availability and change in price.
3Source: www.vanguardblog.com, “Why Investors Should Ignore the Fed,” April 19, 2012. Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer.
Required Attribution
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 S&P Capital IQ Financial Communications. All rights reserved.
May 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP(r), a local member of FPA.
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Does Your Portfolio Reflect Your Risk Tolerance?
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This article provides an overview of the different types of investment risk you may encounter in a retirement portfolio — and offers insights to help you determine which investments may be appropriate for your situation.
When it comes to investing, many people associate risk with losing money. But investing entails different types of risk. Understanding each type of risk and the potential return associated with your retirement portfolio can help you determine whether your investments are appropriate for your situation.
Examining Risk and Return
Stocks historically have exhibited the highest level of market risk — the potential that an investment may lose money in the short term. Over the long term, however, stocks have outperformed both bonds and cash investments.1 This risk/return tradeoff may influence how you allocate your investments. For instance, consider weighting assets that you intend to keep invested for 10 years or more toward stock funds.
Bond funds carry their own risks — credit risk, the possibility that a bond issuer could default on interest and principal payments; and interest rate risk, the chance that rising interest rates could cause a bond’s price to fall. Ascending interest rates historically have influenced the prices of bonds more directly than stocks.1 When short-term rates are on the rise, investors may sell older bonds that pay a lower rate of interest — causing their prices to fall — in favor of newly issued bonds that pay higher interest rates. On the plus side, bonds historically have exhibited less short-term volatility than stocks.
It’s also important to look at cash investments, such as money market funds, from the vantage point of risk and return.1 Although money market funds typically experience a low level of volatility, they may be subject to inflation risk — the possibility that their returns may not keep pace with the rate of inflation. For this reason, you may want to invest in money market funds in short-term situations when you expect to access your money within 12 months or less.
Putting Risk in Perspective
Because all investments entail risk, you may want to review your mix of stock funds, bond funds, and money market funds with an eye toward creating the risk/return tradeoff that is appropriate for your situation. Owning different types of assets may increase your chances of experiencing the benefits associated with each while mitigating the corresponding risk. Your retirement portfolio won’t be risk free, but you’ll have the confidence of knowing you’ve done what you can to manage a potential downside.
1Past performance does not guarantee future results. Investment in a money market fund is neither insured nor guaranteed by the U.S. government, and there can be no guarantee that the fund will maintain a stable $1 share price. The fund’s yield will vary.
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April 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP(r), a local member of FPA.
Required Attribution
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 S&P Capital IQ Financial Communications. All rights reserved.
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2012 Elder Law Numbers
There are several figures of interest to seniors and their families for 2012. They include long-term care spousal standards, annual gift tax exclusion rates, long-term care premium deductibility limits, and Social Security benefit changes.
The Center for Medicare and Medicaid Services (CMS) has announced changes to the long-term care spousal standards that apply to a community spouse. A community spouse is a person who is not an inpatient in a medical institution or a nursing facility, but is married to a person who is an inpatient in a medical institution or a nursing facility (the institutionalized spouse). The standards that changed in 2011 or will change in 2012 include, but are not limited to, the Maximum and Minimum Spousal Resource Standards and the Maximum Monthly Maintenance Needs Allowance (MMMNA).
The Protected Resource Allowance (PRA) (often referred to as the Community Spouse Resource Allowance, but technically this is incorrect), is the amount of assets that the community spouse is allowed to retain when the institutionalized spouse is eligible for Medicaid. The PRA is the greatest of either: (1) the Spousal Share (one-half of the total amount of joint countable assets as of the first day of continuous institutionalization for the institutionalized spouse), or (2) the Maximum Spousal Resource Standard at the time of application, or (3) the amount actually transferred to the community spouse as court-ordered spousal support, or (4) an amount determined at a hearing by the Department of Medical Assistance Services (DMAS). The PRA can be no more than the Maximum Spousal Resource Standard and no less than the Minimum Spousal Resource Standard. The Maximum and Minimum Spousal Resource Standards increase each year based on changes in the Consumer Price Index. On January 1, 2012, the Maximum Spousal Resource Standard increased to $113,640. The Minimum Spousal Resource Standard increased to $22,728 on January 1, 2012.
The MMMNA has a minimum allowance amount and a maximum allowance amount. The MMMNA for 2011 was $1,837.75, effective July 1, 2011, and this amount will remain as the minimum allowance for the first half of 2012. The maximum maintenance needs allowance was $2,739 in 2011, and this amount will remain the same for the first half of 2012. The community spouse excess Shelter Standard for 2011 was $551.63, and this amount will remain the same for the first half of 2012. The utility standard deduction (SNAP) changed from 2010 to 2011. For 1 to 3 household members, the utility standard deduction decreased from $303 per month to $274 per month effective October 1, 2011, and the utility standard deduction decreased from $382 per month to $345 per month for 4 or more household members. The Medicaid minimum home equity limit will be $535,000, and the maximum will be $786,000.
The annual gift tax exclusion will remain at $13,000. This exclusion is the amount that a taxpayer can give to another individual without filing a gift tax return. The IRS established limitations for 2012 and future tax years for the deductibility of long-term care insurance premiums from federal taxes. Premium amounts above the limits are not considered to be a medical expense. For those 40 years of age or less, the maximum deduction is $350; for those more than 40 years of age to 50 years of age, it is $660; for those more than 50 years of age to 60 years of age, it is $1,310; for those more than 60 years of age to 70 years of age, it is $3,500; and for those over 70 years of age, it is $4,370. In Virginia, premiums that are not deductible on the federal income tax return can be taken as a deduction on the Virginia state income tax return.
For those on Social Security, there will be a cost of living increase for 2012. The estimated average monthly Social Security benefit payable in 2012 will remain $1,229. The maximum taxable earnings will increase to $110,000, and the maximum Social Security benefit will remain $2,513 per month. The Supplemental Security Income (SSI) federal payment standard will increase in 2012, and it will increase to $698 per month for an individual and $1,048 per month for a couple. Most Medicare Part B enrollees will see an increase in their Part B premium payments. The basic premium will be $99.90 per month, and the maximum Part B premium will be $319.70 per month (individuals with annual incomes of $214,000 or more and married couples with annual incomes of $428,000 or more). Premiums for other individuals will be between the minimum and maximum and will be determined based on annual income for 2012.
The financial advisers at Ariba Asset Management and the attorneys at The Estate Planning & Elder Law Firm can assist families with their estate, financial, insurance, long-term care, veterans’ benefits, and special needs planning issues.
Contact us at 1-800-808-7488 ext. 101 for a financial assessment and portfolio review.
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Retirement Investing After the Bear: Less Risk, Better Balance
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A new report by the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI) shows shifting allocations within 401(k) plan holdings.
The recession keeps older investors out of stocks, but younger workers keep the faith.
Once burned, twice shy. That essentially describes the average retirement investor’s behavior in the wake of the past decade’s two bear markets, according to a new report by the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI).1 The report shows shifting allocations within 401(k) portfolios.
The study, which looked at allocations of more than 23 million 401(k) accounts, showed that the share of participants with more than 80% of their balances invested in stocks dropped from 54.1% in 2000 to 40.0% in 2010. Older investors in particular reduced their stock holdings — with those in their 60s reducing their equity allocations from 39.7% in 2000 to 21.4% in 2010.
Yet the report also showed that younger investors have not shied away from stocks. On the contrary, the percentage of 401(k) participants in their 20s with 80% or greater allocation to stocks rose from 55.3% in 2000 to 60.4% in 2010. The report attributes this to the greater use of target-date funds.
“Growing use of target-date funds appears to be helping to keep younger 401(k) participants invested in balanced portfolios, with equity exposure to help their assets grow over the long term,” said Sarah Holden, ICI senior director of retirement and investor research. “While our surveys and others have shown that investors are less willing to take on stock market risk, 401(k) plan features are countering that trend for plan participants. That’s particularly valuable to provide younger participants diversified portfolios that include growth-oriented investments.”
Other study findings:
- The shares of 401(k) participants who had either no equities at all or high concentrations of equities were lower in 2010 than in 2000.
- The share of 401(k) assets invested in company stock fell to 8% in 2010.
- The average 401(k) balance was 3.4% higher at year-end 2010 versus a year earlier.
- In 2010, 21% of all 401(k) participants eligible for loans had loans outstanding against their 401(k) accounts, unchanged from year-end 2009, but up from 18% at year-end 2008.
- Participants’ 401(k) loan balances declined slightly. Loans outstanding amounted to 14% of the remaining account balance, on average, at year-end 2010, compared with 15% at year-end 2009.
For a copy of the full report, go to http://www.ebri.org/or www.ici.org.
Source/Disclaimer:
1Source: EBRI/ICI, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2010,” December 2011.
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April 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP(r), a local member of FPA.
Required Attribution
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 S&P Capital IQ Financial Communications. All rights reserved.
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I Get Short-Term Disability Insurance as a Benefit at Work. Do I Need More Coverage?
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The need to purchase supplementary short-term disability insurance depends on a whether the coverage provided through an employer-based policy covers most of a worker’s living expenses. If there is a considerable gap between the income required and the coverage provided, additional coverage may be needed.
Short-term disability insurance is meant to provide a stream of income during times when you are unable to earn a paycheck but don’t fit the bill for long-term or permanent disability coverage.
Some employer-funded short-term plans can be quite generous, offering full income replacement for as long as six months for a wide range of disabilities. Others provide more limited resources. If your employer-sponsored coverage does cover everything fully, then you may be all set. But if not, you may want to consider a supplementary short-term policy.
Family Expenses
Your first step should be to take a hard look at your personal situation. Try to estimate whether your employer-funded plan by itself would give you enough cash to get by comfortably until you get well. Start by listing all of your essential expenses. Food, shelter, and utility costs always seem to come to mind quickly, but don’t forget the long list of other things that have become essential for many families’ well-being. That list may include cable television, cell phone services, computer broadband, and children’s after-school activities, among other things.
Think you can get by with the resources you already have? You’re in very good shape, and by many measures, you’re also in a minority. For example, more than half of U.S. adults say they would be unable to pay their bills or meet expenses if they became disabled and could not work for a year or longer, according to a poll commissioned by the National Association of Insurance Commissioners. Known informally as NAIC, this is the association of state officials who regulate insurance activities around the country.
NAIC has put together of list of considerations for consumers shopping for short-term disability coverage. Among the highlights:
- Young families who rely on both spouses’ incomes should consider both incomes in their calculations. Acknowledging the risk that either partner might become disabled, they should have coverage on both.
- Established families should also factor in their long-term savings plans when they assess their needs. These families should plan to maintain contributions to retirement plans and tuition savings programs even while a wage earner is temporarily disabled.
- Keep in mind that disabilities growing out of preexisting health conditions are typically not covered by new policies, or if they are covered, may result in extra charges.
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April 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP(r), a local member of FPA.
Required Attribution
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
© 2012 S&P Capital IQ Financial Communications. All rights reserved.
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