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How Bad Is the Stock Market Right Now?
For those of you paying attention to the stock market returns over the past several months, you have likely seen your balances trimmed by a hefty percentage. Since the start of the year the Dow Jones is down 15%, the S&P is down 20% and the NASDAQ is down a whopping 29%. And those figures include a slight recovery at the time of writing this in the past week. Even the normal safe haven of bonds has taken a beating with long term treasuries down 20%. So just how bad are things? To put things in perspective let’s go back and look at the past couple of years as we have been in a very unique place in market performance due to Covid. While Covid started making the news in early 2020 it wasn’t until late February that the markets started to react. Looking at weekly charts, the S&P was at 3380 on Feb. 14, 2020. It had a slight drop the following week but then fell over 10% the week of Feb 21, another 7% two weeks later and then the bottom fell out with another 15% drop the week of March 13. In just five weeks, the S&P had lost over 1000 points, a 32% drop. That is a huge fall in that short of a time period. But I think we could all understand why this was happening. While the science still had a way to go we were seeing cases spread around the globe and countries were starting to shut down. No one really knew how bad this was going to be or how long it would last, and you have heard me say this here before, markets hate the unknown and this was a doozy. Markets tend to overreact to big news that rocks the status quo. Was 32% too much of a downside? Maybe. But very quickly the markets started to bounce back. A month after hitting the lows, the S&P was back up to 2835, an increase of 23% from the bottom and didn’t stop there. In fact, the market kept chugging along in a positive direction and by August had fully recovered. Now here is where we should have asked the question, does that make sense? Should our stock market really have been at the same place in August 2020 as it was prior to Covid? You could make the arguments that new technologies were being adapted at record pace to allow people to work from home, conduct commerce and interact with each other but there were entire industries that were completely stuck in the mud; travel, hospitality, entertainment, sports. There was nothing happening in these areas. Now here is the odd thing. The market didn’t just get back to where it was, it kept going and going and going. By early September 2021, the S&P sat at 4535, 34% higher than the pre-Covid peak. Can anyone really say we were in a 34% better position at that time than pre-Covid? I doubt it. But when things are rolling in the right direction, we tend to convince ourselves that it all makes sense and we ignore the warning signs. From an academic stand point the price of a share of stock is based on the future cash flow of the company. Refer to the chart below and you can see that historically the S&P has traded at about a 16 to 17x P/E ratio. This means that the price of an average share of stock costs 16 times the earnings of that share. That was until the end of 2014 when the P/E ratio started climbing steadily and we sat in the 23-24 range until we had a correction at the end of 2018 when it dropped back to 19. By the time Covid came around the P/E ratio was up to 26. Understandably, the PE ratio goes up and down with the markets so when the market dropped due to COVID so did the P/E ratio to 21 at the end of April 2020. We already discussed how the markets not only rebounded but went on a huge run through the end of 2021. The P/E ratio was all the way up to 46 by the of June 2021 and was still at 30 at the end of 2021, well above normal levels. Different companies and industries will have different values depending upon where they are at in their growth lifecycle, but this average has been a pretty decent standard for a while. What this can tell an investor is that if the P/E ratio gets above historical ranges that is an indicator stocks might be getting over priced and are due for a correction to get back in line. Likewise, if the P/E gets below those marks that can indicate a buying opportunity. With P/E ratios in the 30s it was a clear sign the market had gotten too expensive. Tech stocks which, in general, have a higher rate of growth will carry a higher P/E ratio with the thought that the company’s profits will grow into a reasonable P/E. Well, during the bounce back from Covid this theory was on steroids. We can all remember the darlings that benefitted from everyone staying at home during Covid; Zoom, Peloton and Docusign among others. Plus, you had tech companies that facilitated everyone working from home and allowed us to access things from the cloud. These companies saw P/E ratios in the hundreds and in many cases weren’t even profitable. In this segment, things had gotten completely out of control from a stock price standpoint Welcome to 2022 and the adjustment is in full swing. Many of those high flying tech companies that benefitted from stay at home are down as much as 75% while even mainstays like Apple, Google and Amazon are down 20% or more from their highs. We are back to a P/E ratio of under 20 as of this writing so have come more than full circle from where we were pre-Covid. It feels like the sky has fallen a little bit in terms of the market and many of our portfolios. But has it? Look at the chart below. The S&P ended May 2022 at 4132. That’s 750 points, or 22% higher than that pre-Covid Feb 14, 2020 number. Any reasonable investor would take that gain over a two year period. It feels hollow because at one point the market was up over 100% in less than a two year timeframe and has since fallen. So what lessons about investing does this cycle teach us? Many are the same that have been mentioned here before. 1. Have a diverse investment portfolio – Some areas of the market will get crushed in a downturn and others will do better. An investment portfolio that has holdings across the board is key to having access to those areas which are performing a little better. 2. Rebalance your portfolio – This keeps you from being too heavily weighted into an area that has great results. Having some high growth tech might make sense for your portfolio. Let’s say you targeted 10% of your portfolio to that segment and after the run up you were up to 20% in high growth. You then would have suffered a 30% loss. Instead, had you rebalanced from high growth to an underperforming area like small value when high growth hit 15% you would have kept your gains and then gone into another area that had growth when high growth had its troubles. In short, rebalancing keeps your diversified portfolio at proper levels. 3. Stay invested for the long run – This goes hand in hand with not trying to time the market. It is very difficult to know exactly when to move in and out of the different areas of the market. That is a full time job to know what to look for and even then you are likely to be wrong half the time. 4. Have a risk appropriate portfolio – This recent downturn should not be a major concern for those in their 30’s as there is plenty of time for their investments to recover. But for anyone within five years of retirement or already retired, this has likely been concerning because they need this money for their retirement in the near term. As you near retirement, it’s a good idea to keep a portion of your portfolio in cash-like safe investments so you can ride out these short term periods of volatility. That way you have the money you need for the next several years that stays safe while the rest has time to rebound. What do you do now? As with everything in financial planning it depends on your particular situation. For those that have a longer time horizon for their investments you are much more likely to be able to ride this out and wait for the market to rebound. That doesn’t mean you don’t need to work at it but by following the steps mentioned above you can keep yourself on track for the long run. On the other hand, if you need to tap into the money within the next few years, you likely need to take a different approach. Not that you run for the exits and pull your money out of the market, but you need to be aware of the risk within your portfolio. For example, a 30 year old might be able to let everything ride for the next five years but a 60 year old that retires in two years should have been diligent along the way updating their portfolio so they are positioned appropriately from a risk standpoint. As I frequently say with investing, the starting place is to know why you are investing and what your objectives are. Develop a strategy that is based on your goals, risk tolerance and other key life circumstances. Stick to this long term plan and don’t make wholesale changes every time there is a new shiny object or sign of trouble. Make the small adjustments as needed mentioned above to help stay on track. If your long term goals and objectives change then adjust your strategy accordingly. My guess is most of you reading this have felt pain with your investments so far in 2022. I am not here to tell you everything will turn around any day soon. Investing is fraught with this type of short term risk but also has consistently rewarded investors over the long term. We don’t know how much longer this will continue or if/how much lower things might go. Re-evaluate your plan and hang in there. 7th St. Financial Inc. (“7th St. Financial”) is a registered investment adviser offering advisory services in the State of Minnesota and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by 7th St. Financial in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of 7th St. Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.
Price of Gas - What You Need to Know
Normally, I like to speak about traditional financial planning topics here to inform people but every now and then there is a topical issue that is getting enough attention it is worth commenting on. This is one of those times. We all have been feeling the pain of high inflation over the course of the past year. While prices on many products have been going up across the board the price of gas always seems to elicit a bigger response. The recent invasion of Ukraine by Russia has done nothing but accelerate those price increases. Many people are frustrated and there is a lot of blame to go around. Complicating people’s views and understanding of what is going on is that too many news outlets today politicize these events and push out cute soundbites that direct blame in a direction that supports their own narrative. The truth is far more complex than that. I will try to explain below the main drivers of how we got here, what is driving the price and what can be done about it. Along the way, I will address many of the talking points you may be hearing and discuss the impact they may be having. I am no expert on the oil industry so to help me out with this I turned to an old friend who has spent the past 25 plus years in the oil trading industry. His job is to understand every single factor that impacts the price of oil, the impact if one of the variables changes and to be on the right side of those price moves. There is no room for politics in this position. This is simple business and economics. The following comments are a summary of what he shared with me. The price of oil and therefore gas is a simple study in the basic law of economics: supply and demand. To understand how we got where we are now, we need to go back a few years. In late 2019-early 2020, most of the world’s major oil producers were running full speed. At this time, the price of oil sat around $60 per barrel. In early 2020, we were hit with Covid, and we had a massive change in one of the two supply-demand components. Demand cratered almost overnight. We found ourselves quarantined at home, not going into work, not driving around town because everything was closed, and not traveling either. The problem was we had this massive supply because everyone was running full speed on oil production. The price of oil went to negative $30 per barrel in April 2020. Tanker ships were stuck floating around the ocean filled with oil and nowhere to put it as all our holding tanks on land were full. There was nowhere to put the oil because so little was being used. Going back to our supply-demand model, the only way to get the price back to a reasonable level was to shrink supply to meet the demand level. With oil at such low prices, the oil companies shut down production, refineries where oil is turned to gas shut down, companies stopped exploring new areas to drill, and instead redirected their funds away from R&D, and instead paid down debt, bought back stock and increased dividends in an effort to keep their stock price afloat. The break even price for oil production is somewhere in the $40 per barrel range so there is little to no incentive to drill when prices are lower than that. We also need to remember this was not just a US phenomenon, this decrease in production was across the board amongst all oil producing nations. It took until January 2021 for a decent level of equilibrium to be reached. Oil was back to $50 a barrel, a level at which companies can profit and consumers get a reasonable price. Covid was still hanging over the entire situation though. We had worked through our initial over supply issue, but demand was still low compared to previous levels and production levels stayed relatively low as well. The price of oil continued to rise through 2021 and hit a peak of $80 per barrel in late October. You can see the historical oil prices on this chart here. This was mainly due to production still lagging but demand continuing to rebound slowly but surely. Once we largely got past the Omicron variant, we were back to pre-Covid levels of demand but our global supply still had not caught up which was why prices had gone higher. With oil prices already high we were dealt with the Russian invasion of Ukraine. While the US doesn’t rely that heavily on Russian oil (more details on that later), oil is a global commodity, and the world still needs its overall supply. The other thing commodity markets hate, just like the stock market, is uncertainty. The invasion brought up all sorts of new risks and the price of oil skyrocketed to almost $130 in early March. So how much oil was Russia really providing? The global demand for oil sits at about 100 million barrels per day. Russia was providing about 7% of the export market meaning if the world decides to forgo Russian oil, we have a shortage of about 7 million barrels per day. To get oil prices back to where they were we need to replace those 7 million barrels or decrease demand. US daily demand alone for oil sits at about 20 million barrels per day. If gas prices go high enough people will drive and fly less, they will decide to skip summer road trips and the demand will come back down. But we don’t know exactly where that breaking point is. Ideally, we don’t have to find out either. So that is a little history on the price movements given the supply-demand changes over the past two years. Now let’s get into some of those other factors that could be happening to change the supply-demand equation. 1. The obvious question is why can’t the US just produce more oil? According to my source, the US has the capacity to add somewhere between 800,000 to 1,200,000 barrels per day to their output using the current supply of wells. There really is nothing stopping our oil companies from increasing their production and they have begun taking steps to do just that. The reality is though that it could take 6-12 months for this extra supply to hit the market. It isn’t so simple as to flip a switch and a week later we have a finished gasoline product available to us. We also have that dreaded covid-related supply chain problem that is impacting our ability to do this. Oil companies, like everyone else, are short of workers and certain materials needed to drill. For instance, there is a shortage of sand which is a key component for drilling. Expect US production to increase but it won’t have an immediate effect on your gas prices. 2. What about those 9000 unused leases? The government has historically granted leases to oil companies to drill for oil on federal lands. All this amounts to is the right to drill on that land. Going back to what we discussed earlier about what happened to oil during Covid, the oil companies haven’t spent the money on R&D to see if these leases would even produce much oil. This is where politics enters into the equation. The Biden administration has been in favor of a clean energy agenda which has left the oil companies unsure of how smart it is to make the investments into exploring these leases. Publicly the administration has said they have the green light to drill but there is lingering doubt from the oil companies on the true level of support. Again, it would take up to a year for this oil to hit the market if these leases were to be developed. 3. Would the Keystone XL pipeline help? The Keystone pipeline itself has been up and running since 2013. This pipeline brings in oil from Canada and routes it to various areas of the United States. All told, the existing portions of the pipeline deliver about 1.3 million barrels per day to the United States. The Keystone XL pipeline was to be an addition to the existing pipeline that would have added roughly an additional 800,000 barrels per day from Canada to the US. The XL segment was to bring in a heavier type of crude oil which raised environmental concerns. The project was put on hold in 2015 by the Obama administration and revived by the Trump administration in 2017. Soon though the project was subject to litigation and got hung up in the courts. Eventually, the Biden administration struck it down and the company that was going to build it said they were canceling the project for good. I have zero knowledge of what the real environmental risks of this project were so won’t try to quantify that here. That said, my industry contact does think this was a mistake by the Biden administration and would have helped our oil supply situation. It is not clear if the pipeline had been allowed to move forward if it would even be operational yet though. Had it been up and running it would have only replaced about 11% of the shortage from Russia. So, while this would have potentially helped our current situation, it is not the magic bullet that some people are touting it to be. 4. Where can we get extra oil supply to make up for Russia? What happened with our oil situation in 2020 happened everywhere. All oil producing nations slowed way down and are still not back at their previous levels. OPEC has decreased its exports as well. My industry contact said OPEC countries could very quickly add about 400,000 barrels per day, Iran could add 1-3 million barrels per day over the next three to six months and between Saudi Arabia/UAE and Venezuela we could see another 1.5 million barrels. All of this combined with what the US can add gets us pretty close to replacing the 7 million barrels from Russia. Again, this won’t happen overnight though. It will take three months to start to see the initial benefits and could take up to 12 months for everyone to be running at full speed. So far though these other countries have been slow to respond. My source shared with me a point that doesn’t get mentioned often. An oil well is a machine and like any machine needs maintenance and upkeep just like a car. One of the risks is that over the past two years while some of these wells have been mothballed is that they haven’t been maintained. Remember that some of these countries have nationalized oil, meaning it is not done by private companies as we have in the US. Some of these countries may not have the financial resources to maintain their wells so it could take longer for them to get up and running and/or they may not be as efficient once they are running. 5. Why were we buying Russian oil to begin with? I have heard we were energy independent. There is a lot to this point. First, let’s understand how we define energy independence. If you mean we do not rely on or import energy products from other countries, then no, we were never energy independent. Even people touting the Keystone Pipeline are advocating for the US importing oil as all of that comes from Canada. This chart here shows the history of US oil consumption, production, importing and export levels. There was a time in 2020 when we produced more oil than we consumed and we became a net exporter of oil, meaning we exported more US produced oil than we imported from foreign countries, by about 700,000 barrels per day. That said, we continued to import oil the entire time from a number of countries. We were still importing almost 8 million barrels per day, so we never relied solely on US oil production to meet our needs. This chart shows our level of imports by country over the years. This also shows a measurable amount of oil imports from Russia beginning way back in 2002 and never really subsiding, and in fact, saw an increase starting in 2019. By far, our biggest trading partner is Canada with almost 40% of our oil imports coming from our neighbors up north. With regards to Russia, they are a very small player for US imports overall. Especially, we don’t use much of their crude oil as it is the typical thick black sludgy oil you think of, and we tend to prefer the lighter oil found in Texas and parts of Canada. That said, we do rely fairly heavily on Russia for a number of other petroleum related products as you can see here. These products tend to be used in mixing and added to other fuels to make our gasoline. While the US and our NATO partners may eliminate or cut way back on Russian oil imports, that oil will still find a way to be sold. Russia may have to sell it at a discount, but China will likely buy all they can and India has been reported to be buying some as well. Those two countries account for over 2.5 billion people so there is plenty of demand. The truth is oil, and its related products are truly global commodities. We rely on peace in the world to let free markets and trading partners work in harmony. Even when our production was at its highest, we still imported oil from all over. This is because it costs less to import oil from a foreign country in some cases than transport that oil from a refinery to its end destination within the United States. So, we may sell our product and ship it to South America but we buy oil from somewhere else because it can be delivered to the east coast at a lower total cost. We could do away with this global system, but it would result in higher gas cost and that is the very issue we are concerned with. 6. How about if we made the switch to clean energy? I think it is clear we are heading in this direction. While this topic gets highly politicized as well, there are many strong reasons to keep moving in this direction. There is an environmental need to do it, it allows us to use renewable sources instead of oil which will run out at some point (although likely not for 100 years) and moves us further in the direction of true energy independence. We don’t have to rely on another country to supply sun, wind, water or electricity to us. And, the truth is, many of the major oil producing companies tend to be viewed as bad actors on the world stage and it allows us to get untangled from that mess. But it will take time. In the US alone we consume 20 million barrels of oil per day. Each barrel contains roughly 40 gallons. That is a total of 800 million gallons per day. That is a huge process to turn around that level of consumption. If you want to make the argument that the Biden administration has been no friend of the oil industry and we are not where we should be with our oil production, then you can make the same argument that the Trump administration largely turned its back on the clean energy industry as well and we aren’t as far along as we should be with our clean energy production and infrastructure. Regardless of how you feel about that, we would still not be in a position from a clean energy perspective to replace those 800 million gallons of gas per day. That will likely take decades and massive amounts of investments in a clean energy network. The other issue we have with clean energy is that it still requires natural resources to produce the equipment needed to harness the source of the energy and make it usable. For instance, EV vehicles rely on batteries and these batteries use resources like nickel, cobalt, and lithium while semiconductor chips used to run the cars need neon. And wouldn’t you know, Russia is among the leading producers of Nickel while Ukraine is the dominant player in neon. If you’re worried about the cost of oil, you would be shocked to see what has happened to the price of Nickel since the start of the invasion. While clean energy is the direction we are headed, it will take time and further developments, so we don’t just trade a dependence on oil for nickel and neon. 7. So why did gas prices go up so quickly when oil prices increased but didn’t really change when oil got cheaper? For those of you paying attention, the price of oil came down from its high of $130 per barrel all the way down to under $100 on March 16th. Blame your local gas station for this. Gas at a gas station is a very low margin business. When the price of oil increased quickly we saw the price of gas go up in lockstep. That price of oil is tied to the spot price for a barrel purchased at that time. The gas that was in the tanks at your local gas station had already been purchased at a lower price but they increased the price immediately so they made a nice profit off that. On the flip side, when oil fell by 25% to $100 per barrel we saw the average price of gas decrease by just 1-2%. What happens within the local gas station market is that each station bought their gas potentially at a different time and a different price but they all have to sell at pretty close to the same price or people will just go to the lower priced station across the street. When one station is able to purchase their gas at a lower price and lowers their price to the consumer then all the other stations lower their price as well even if they bought that gas at a higher price. As a result, the local gas stations take their profits when there is a window to do it. 8. So what can the government do now to help? My source indicated that there isn’t much they can do to move the needle very far in the short term. One thing he mentioned and is something I had not heard of was that they could relax the rules on the various grades of gas. Each state can set its own specs for various grades of gas which ends up creating a large number of boutique gas products. This means the refineries have to create a number of unique products which increases cost and slows down the delivery of the various gas specs to their final destination. A waiver could be done for certain types of gasoline which would result in a more uniform gas product that could be distributed more quickly and help with supply. That is a not so quick run down of some of the various factors impacting where we are with the current price of oil and gas. You can go back quite a way with our US government decisions on energy policy and find that all administrations have probably made some decisions that have helped and some that have hurt our overall energy situation. There might be a tactical decision that works for now but hurts down the road or on the flip side, hurts now but is positive for the long term. For all of the various reasons laid out above, we are limited in what we can do to change the supply side of the equation in the short term. In order to change the price to be something more palatable, the change most likely has to come from the demand side. This was one of the drivers for the drop in oil price last week as Covid (still impacting things) related shutdowns in China were going to put a damper on demand. The other option for changing demand is that the price gets high enough that families start making choices that impact their usage. Do they not make the summer road trip? Do fuel prices drive airfares high enough that people don’t make a trip at all? Do workers decide to continue to work from home to avoid their commute? This is your most likely solution in the short term before oil production can catch up. Look, I’ve talked to a lot of people who are upset by gas prices and understandably so. We don’t have enough fingers to point at all the parties who share in the blame (Covid, Putin, every administration going back to Carter, all other oil producing nations, our own insatiable demand). The bigger takeaway though is the reality that the price of oil goes way beyond just what our government can control. There are hundreds of various factors and players that impact the supply and demand balance which determines the price of oil and gas. In a global marketplace, so many things get intertwined that when there is a disruption to the smooth flow of goods it can get very complicated very quickly. For now, it sounds like we likely will have higher prices for at least the next three months. By the way, the next similar situation we could face like this is semi-conductor chips that are used for the processing all of our computerized devices. 80% of this production takes place in Taiwan which could be in China’s sights. I hope that helps explain and brings some clarity to this complex issue. As always, if you have any questions, comments or concerns feel free to reach out or respond in the comment section. I am always interested to see what people have to say. 7th St. Financial Inc. (“7th St. Financial”) is a registered investment adviser offering advisory services in the State of Minnesota and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by 7th St. Financial in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of 7th St. Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.
Investing Risk vs Real Life Risk
We all know investing entails some degree of risk, but what do we really mean when we talk about investment risk, and how does that compare with the risks we take in our daily non-investing lives? When we think about risk in our to day to day lives it can have several meanings. Many of us may think about risk in terms of a negative outcome to a given event or it might simply be that an outcome is unknown. These day to day views of risk are both very applicable when it comes to investment risk, but let’s take a deeper look at that. The most straight forward comparison is risk being an unknown outcome. This doesn’t even have to mean the outcome will be negative, just unknown. Think about the things where this applies to in our non-investing life. Maybe you try a new recipe, get a new hairstyle, ask someone on a date, ask your boss for a raise or some other thing that puts you out of your comfort zone or has you trying something new. If it goes well, you get a nice win. If it goes bad, you may not like it, but the downside is generally limited, and you will recover quickly. Now, let’s think about risk that can result in a truly negative outcome. Risky behaviors and activities can possibly result in a big payoff, but the downside can be severe if it doesn’t work out. Watching the downhill skiing event last night in the Olympics made me think of the comparison. They were competing for a gold medal, the height of their profession, but a slip of a ski could cause a nasty crash resulting in a concussion, torn ligaments or even broken bones. Taking that a step further, think about skydiving. A successful jump can be a once in a lifetime thrill ride (at least it was for me) but if it goes bad the consequences are obviously dire. When it comes to risk in investing there is always risk of the unknown. About the only "risk-free" assets are cash and Treasury Bonds. Even these “risk-free” assets come with some risk. While the face value of cash is safe it can lose real value with inflation. Treasury bonds are considered safe because we can count on the US Government to pay the stated interest but fluctuating interest rates can cause the value of the bond itself to go up or down. When it comes to investing, we take a calculated risk when we purchase an asset. We can look at historical data and trends to tell us that stocks will return an average of 8-10% a year and bonds 3-5%. We know that the actual annual returns will vary though. Some years will be better, some will be worse. That is our unknown. We never know from year to year exactly what we will get. Depending on where you are at with your investing lifecycle these year to year fluctuations might be no big deal or they could have a very detrimental impact. This is a concept called sequence of return risk. A 30 year old investor has plenty of time to ride out these year to year unknown returns and can rely on the long term averages to get them where they need. A 20% market downturn next year likely doesn’t submarine their long term goals as there is plenty of time to recover. On the other hand, for someone who is one year away from retiring a 20% downturn in the market could be devastating. With proper financial planning though you mitigate this risk by adjusting your portfolio so a 20% market downturn doesn’t have as big of an impact on your personal situation. If your portfolio has the appropriate amount of risk, then the risk of unknown returns is hopefully similar to that of the minor risks you take in life. There might be a short term unpleasant impact but it shouldn’t really hurt you in the long run. We can see some parallels between the smaller scale risks we take in our life and investing. But what about the big negative outcomes. Usually, when people have big concerns with investing it is about losing all of their money, the equivalent of skydiving gone bad. I call this absolute risk, the risk of losing your money. The truth is it is very, very rare to lose all of your money on an investment. There are specific investments such as options where this can happen but the vast majority of investing is done buying individual stocks, mutual funds and ETF’s. The truth is these hardly ever go to zero. Enron is a classic example, and more recently Sears, but with Sears it was a slow death that was very easy to see coming. In the 2000’s we have had multiple instances where the market has taken a big hit. The dot com crash of the early 2000’s, the financial crisis of 2007-2009, the initial impact of Covid in early 2020 and, most recently, the tech correction of late 2021-early 2022. In all of these cases, broader markets fell at least 20% and as much as 40%, while individual stocks or funds may have been down by as much as 75%. For instance, a bank stock like Wells Fargo was down 75% from September 2008 to March 2009; Paypal is down almost 60% since September 2021, and everyone’s favorite Covid exercise fad, Peloton, is down over 75% in the past year. If you have suffered these types of losses, it probably feels like the equivalent of that bad downhill skiing wipeout. It’s not quite like the parachute failed to open but you are bloodied and bruised. You can recover with time, but it might take a while. Again, though with proper portfolio allocation these losses won’t hurt nearly that bad. Take, what has been happening in the market the last few months. Certain high flying companies in the tech sector have seen huge drops, like the one I mentioned for Paypal. Proper portfolio allocation and diversification results in a portfolio that is spread out among many different areas. To that point, the S&P 500, is down just 7% since the first of the year, XLF (the financial sector ETF) is up 2% year to date, and XLE (the energy sector ETF) is up 19% so far in 2022. Having a diversified portfolio can go a long way to reduce the pain that one part of the market is suffering. The primary way we measure risk with investments is volatility. Another way to think about this is the unpredictability of the investment returns. For instance, investment A has returned 30% over the past 5 years and if the annual returns are all in the range of 2-8% there is very little volatility. Investment B has returned 60% over the past five years but the annual returns range from -20% to 40%. This is deemed a much riskier investment even though the overall returns are higher. This is because we have much less confidence how that investment will perform year to year. This takes us back to our sequence of return risk. As we get closer to needing that money, we need to reduce the risk of the portfolio. There is a relatively easy way to see how volatile an individual investment is. By using a tool like Yahoo Finance, Morningstar, or any other brokerage site you can see the details of an individual investment like this image below. In the risk section, you will find a value for standard deviation. Remember your stats class from years ago? Here is a real world use of it. The lower the standard deviation, the less volatile the returns. Let’s be very clear. There is risk with investing. You can lose some of your money and you don’t know what your returns will be from year to year. But, by having a well diversified, risk appropriate portfolio you can enjoy the benefit of long term returns and avoid the parachute not opening.
3 Things You Need to Know Before Investing
We all know we are supposed to invest money to build our financial future. You can invest in many different types of accounts, types of investments, and then a nearly endless array of individual investment options. Each account type, each asset class, and each individual investment serve some sort of purpose in the investment world. While not everyone may understand all of the details around stocks, bonds, 401k, IRA, Roth, etc… we are familiar enough with them to understand we should be doing these things to some degree. How do you know which ones to pick? How do professionals know what to suggest to you?. In order to work our way through the decision tree to understand what investments make sense for you, there are three things that are fundamentally important to know before you begin investing. 1. What is your investment objective? Before investing any money, this is the first question you need to ask yourself. Very simply, what am I investing this money for? This seems like such a simple concept but is overlooked by so many people. Too many people want to get straight into the conversation about what stocks they should buy. Should I buy an S&P 500 index fund or that new ESG fund, is Apple still a good investment or should I go for Tesla in my Robinhood account? While these may be valid questions eventually, they should come much later in the process when trying to determine what to do with your money. Think about all of the different reasons we might save or invest money. Retirement, college savings, wedding, vacation, charitable giving, down payment for a house, rainy day fund, a new car, leaving money for your kids. You get it, the list goes on and on. Let’s go through some examples. If I understand that a client wants to save money for retirement that immediately focuses me on a certain set of retirement related accounts. Based on a client’s desired retirement age I can determine that the client is knowingly setting aside this money for a longer period of time. Now depending on other pieces of information such as employment situation, benefits, and income I can narrow down further to what I think the best account type might be (401k, IRA, Roth, SEP, Solo 401k, etc..). What if you use my Robinhood or similar brokerage account for this? A Robinhood type of account might come into play here too but probably only after I’ve exhausted what I can do with tax advantaged retirement accounts. The government has given us tax benefits for money set aside for retirement so why wouldn’t we put money for that purpose in those accounts? If I can avoid paying tax on the money now (like an IRA or 401k) that makes more sense than putting it into a brokerage account where I contribute after tax money and then get taxed again when I sell the investment. What if you use your savings account? With a savings account, we avoid the taxes on the back end but you just don’t get the growth that most of us need for retirement. Most standard savings accounts are paying a fraction of 1% right now. That money is losing ground right now to inflation. That certainly doesn’t work when we need that money to grow for our long term future. Understanding that we want that money for retirement drives a decision process that provides a clear benefit for us when compared to putting that same money into a savings account or brokerage account. That example seems pretty straightforward, right? How about a rainy day fund? Does that same retirement account work here? Most likely not. The point of the rainy day or emergency fund is that we need to be able to access the funds quickly to deal with whatever is going on. Getting money out of an IRA may take time and you will have to pay taxes on the withdrawal and possibly a penalty as well. This might be a better spot for a traditional savings account. How about If the client wants to save for their child’s wedding? Does the same account we used for retirement work here? Maybe, but maybe not. I’ll address the rest of this scenario in a later section. Understanding your investment objective is the first step to knowing what investment you should make. Without knowing this, you may not have access to the investment options you need for adequate growth, it might be tied up in an account you can’t access or you may have to pay a penalty to get the money. 2. What is your investment timeline? Put another way, when do you need the money? Once we have determined why we are saving or investing money we need to know when we need it. Think about the items listed above for why we save money. For some of these, we may need the money in a few months and others may be 40 years. This can drive several decisions for us such as account type and maybe the asset class we invest in. Let’s go back to our retirement scenario. Hopefully, you have already been investing in tax advantaged retirement accounts but what about the next step in the decision tree? Let’s say you are 58 years old and want to retire at age 60. That leaves you with a two year investment timeline. Do you want the money that you need in two years invested in something volatile like Bitcoin or a single company stock? Riskier assets tend to have higher returns in the long term but can be very up and down in the short term. You need to make sure that money will be there because you are depending on it. Two years may not be enough time for your investment to recover if something goes sideways. Now that doesn’t mean you can’t be invested in things like Bitcoin or own a volatile stock like Tesla for your retirement. They just need to be in the part of the portfolio dedicated to your longer term needs. You may benefit from the long term growth in money that can sit there for 10 years and ride out the short term ups and downs but overall have a higher rate of return over that timeframe. So what about our rainy day fund? The point of the rainy day fund is we don’t know when that rainy day will be. You may go to start your car tomorrow and find you need a major repair. Next week your furnace may go out. Your employer could do a round of layoffs this spring. Or maybe none of this happens for several years. We just don’t know. Because of that, we keep this money very safe, usually in cash or some sort of low earning account. Again, we may need access to the funds in the next day or two. Ok, then, what about your child’s wedding? We punted on that one in the first section. The answer may vary depending upon a number of factors. What age will you be when your child will likely marry? If you had your child under the age of 30 there is a decent chance you will still be working if/when they decide to take this step. As a result, planning on using your 401k money for this might not be the best idea. Again, risk of taxes and penalties. Having money in a Roth or a brokerage account might make more sense for this purpose because we make withdrawals without penalties to an extent. Now for the second part of the equation, we now know the account to use, but what type of asset should I invest in. If your child is 8 and you are really into planning ahead then you can be riskier with this as hopefully, you won’t need it for quite some time. On the other hand, if your child is 25 and is in a serious relationship you may need that money much sooner and may want to make sure it is in something more stable. Another way to think about investing timeline is how much risk can you afford to take? This is different than our next section, risk tolerance. You may be very risk tolerant and not worry when markets become volatile, but the bottom line is, when you need the money, it needs to be there and you need to invest accordingly. 3. Risk Tolerance This is simply the amount of risk you are comfortable taking. We use this in conjunction with the previous section’s topic, investment timeline, to determine the proper amount of risk in your savings/investments. To illustrate risk tolerance, let’s go back to our retirement scenario. We have already established that we have a 58 year old who is looking to retire in two years. We now know that the portion of her investments she will need in the next few years should be less risky because they are depending on that money being there for their living expenses. Does that mean we go aggressive with the rest of the retirement savings? Not so fast. Our near retiree will have gone through the dot com crash in 2000, the aftermath of 9/11, and the financial crisis of the late 2000’s. Living through these experiences impacted us all in different ways. Some gained confidence in the economy and the financial market’s ability to rebound and come back to new all time highs. Others were scared off and live with the worry that they might see their retirement savings go up in smoke or don’t trust the market. To be clear, there is no correct way to feel about this. There is no right or wrong approach to take. This is a completely individual feeling and needs to be considered when investing. Just because I have confidence that the market will rebound doesn’t mean you are required to feel the same and as a result, be forced to have more risk in your investments than you are comfortable with. Look, it’s one thing to say you don’t care when there is a one day 300 point move in the Dow. It’s another to stick to your guns when the market has 10 days of 1000 point plus swings like we did in early 2020 as a result of Covid or when the market was going down 40% in 2007-2008. These things can and do happen in the market. There is a real risk with investing and we need to be aware of it and you need to be honest about how much you are willing to take on. Going back to our near retiree, if they came out of those experiences feeling comfortable about market risk, we may be more inclined to put more risk in that portion of investments intended for longer term use. As a result, maybe they have some Tesla or Bitcoin alongside that ESG and S&P 500 fund as part of a diversified portfolio. We still would keep that portion we need in a few years less risky even if they are comfortable with the risk because, again, they need that money to be there. If, on the other hand, those past experiences gave them doubts about the safety of their investments, we would be inclined to make that longer term portion less risky. As a result, maybe we forgo Bitcoin and individual stocks and have more broad index funds, bonds or low volatility funds. Conclusion If you find yourself with $10,000 and are looking to invest, don’t just buy some stock in a brokerage account because you heard about it on tv or through a friend or feel like it has to go in a retirement account. Invest with a purpose. Think through what you want to do with that money, when you will need it and how much risk you are comfortable with. By addressing these three fundamental questions you can get a much better understanding of what an appropriate investment for you is. This may not get you all the way to picking a specific stock, mutual fund or ETF but should get you to the right accounts, asset classes and investment mix. To be honest, that’s probably more important than picking Apple versus Tesla. This is not intended to be taken as specific advice for an individual or a recommendation of any specific individual investment. Any investments mentioned in this post are for illustrative purposes only and are not intended to show approval or disapproval of those investments. Please contact a financial professional prior to investing to understand the risks involved and identify items that are appropriate for you.
How an ACT prep course can help you reduce the cost of college
This blog is a companion piece to the third and final installment of my discussion with Steve O’Toole of O’Toole Educational Services on how an ACT prep class can be of benefit. As we discussed in part 1 of our conversation, high schoolers take the ACT test to either enhance their odds at getting into the school of their choice or help to secure scholarships due to their academic track record. I do not claim to have any expertise as a college admissions expert, but I do work with families to help them find colleges that are a financial fit for them. This is where the ACT can be a valuable asset. To understand what an ACT score might be worth in terms of scholarships we need to first understand the different type of college profiles and how they award scholarships. One of the things that surprises many families is when their child achieves a high score on the ACT and doesn’t receive scholarships from every school they apply to. Each school has their own approach to attracting students and criteria for scholarships. There are many sources of scholarship money for prospective college students. First, there are numerous scholarships given by local organizations and these tend to be in smaller amounts. Next, there are scholarships given out through the university via departments or various memorial funds. These can be for large dollars but are usually awarded to a single student or at the most a select few and many come with a specific set of criteria to meet. I call these the “George Anderson memorial scholarships”. These might be awarded to a single student majoring in a specific field and meeting some other criteria. The ACT might help in getting these scholarships, but it has very hard to count on receiving any of these as there are so few recipients. By far the biggest source of scholarship dollars is awarded simply based on your GPA and/or ACT. Many schools even automatically award scholarships based on the student achieving certain thresholds. These scholarships can be worth tens of thousands of dollars a year, are available to many students and you can readily count on receiving them if you meet the criteria. Large state schools These are big public schools with enrollments in excess of 20,000 students. This group has a diverse approach to awarding scholarships. As I live in Minnesota, I will use regional schools as my examples. This category would include the University of Minnesota, University of Wisconsin – Madison, University of Iowa and Iowa State from neighboring states. Minnesota and Wisconsin don’t really play in the merit aid space except for the one off “George Anderson” scholarships mentioned above. On the other hand, Iowa State is generous with automatic merit aid awards ranging from 6 to 11 thousand per year. Thresholds based on GPA and ACT start as low 3.3 and/or a 24. The University of Iowa also has automatic merit aid but the threshold is much higher, requiring close to a 30 ACT and a higher GPA. Smaller state schools Schools in this group include the University of North Dakota, North Dakota State University, St. Cloud State, University of Minnesota – Duluth and Mankato, University of Wisconsin – Eau Claire, Whitewater, Stout to name a few. Many of these schools do offer automatic scholarships in addition. The general range for qualifying for these scholarships is a 3.5 GPA and 25 ACT. These schools have a lower cost of attendance than their larger school counterparts. As a result, the scholarships they offer are in lower amounts than the big schools. Here you might be looking at an award of maybe $2500 per year but the starting price for the school might be closer to $20,000. Liberal Arts private schools Schools in this category include the University of St. Thomas, Carleton, Gustavus Adolphus, St. Olaf, Lawrence University in Wisconsin amongst many others. These schools can also be a mixed bag when it comes to offering merit aid. Some are very stingy while others can be very generous. There are no published automatic thresholds for these private schools and they will tell you that they review each students application on its individual merits but at some of these schools an ACT score of 22 can be worth $20,000 per year and higher scores can be worth an additional $15,000. Elite schools This category goes beyond just Ivy League schools and includes well known schools such as Duke, Notre Dame and even certain state public schools like the University of Michigan, University of North Carolina, and University of Virginia. This is the category that results in the most confusion with families. These schools are very expensive and attract the best of the best students. Many families think that their brilliant student will get huge offers at these schools, but the truth is the exact opposite. These schools are in very high demand and every student is an academic rock star so they don’t have to offer much for scholarships. That is not to say these schools don’t make funds available for students. If you have a financial need these schools will be the most generous of any of the categories and some will meet 100% of your financial need with grants. How has the test optional movement impacted this? Prior to Covid there was a small subset of schools that had gone test optional. This means that the school doesn’t require the submission of an ACT test score to be a factor in either admissions or for scholarships. Covid resulted in mass cancellations of ACT tests across the country so many more colleges hopped on the test optional bandwagon for the 2021 admissions cycle. If you have a school on your list that is test optional the ACT score should be treated as one of the assets in your tool kit. If you have a score that is below the university average, then it might be in your best interest to not report it and rely on your GPA instead. Test optional schools will still award scholarships solely based on your GPA. Here is an example of how this worked out this past year: GPA: 3.7 ACT: did not report School A: 24 ACT and 3.0 GPA was $12,000; 26 ACT and 3.5 GPA was $13,000; 28 ACT and 3.7 GPA was $14,000 School B: 3.5 GPA was $6,000; 24 ACT and 3.3 GPA was $8,000; 26 ACT and 3.5 GPA was $9,500; 28 ACT and 3.7 GPA was $11,000 At school A the offer was a $14,000 scholarship based on the GPA even though the ACT did not meet that requirement. School B offered $9,500 even though the GPA alone would have qualified for a higher amount. Covid has thrown many unknowns into this process. Admissions for the fall of 2021 ushered in a new wave of test optional schools and scholarships based on GPA. It remains to be seen how this will work for the fall of 2022 admissions. Will schools stay with the test optional movement or go back to requiring an ACT score for scholarships? Summary Even if the test optional movement continues, it can be a good idea to take the test and see if it can be used as an additional asset. If the score can be used in your favor, then use it to your advantage. If the score isn’t an asset, then don’t use it and rely on hopefully a strong GPA. An ACT score can still be worth tens of thousands of dollars in scholarships. If you have a student that is close to a threshold for receiving merit aid or a larger amount of aid it can be a wise investment to pay for an ACT prep class like O’Toole Educational Services. A one time investment of less than $1000 may pay back over $10,000 per year. If you want help navigating through college financing and how much it is going to cost you to send your student to the schools they are considering contact 7th Street Financial and sign up for our College Planning services where we work with you to find colleges that will be a financial fit based on your budget and what you can expect from aid based on your financial situation and your student’s profile.
Is an ACT Prep Course Right for You?
Every year millions of high school students go through the process of applying for college to continue their education. Some will look at community colleges or tech schools, others will look to attend big state schools, smaller private schools or even elite Ivy league schools. Each of these types of schools comes with their own pros and cons and any one of them might be the best fit for a given student. One of the components of this process each year is the taking of ACT tests. These tests are used by colleges to help them with both their admissions process and doling out academic scholarships. I recently had the chance to sit down and talk with Steve O’Toole of O’Toole Educational Services about his ACT prep service. Here are some highlights from the first portion of our conversation. You can see the video here. Does the ACT even matter anymore with schools going test optional? Prior to Covid there was a small movement with some schools deciding to go test optional. This meant that applicants didn’t need to submit a test score as a requirement for the schools to consider in the admissions process. This movement accelerated in 2020 as Covid wreaked havoc with test scheduling and the ability for many students to take the test. As a result, many schools in the last year have dropped the ACT requirement for the 2021 admissions cycle. It remains to be seen how schools will adjust in 2021 and moving forward assuming that groups will be able to gather again for testing. Will the schools that made this change for the past year continue with that policy or go back to wanting to see an ACT score. One other thing to consider is that many schools may have been test optional only for the purposes of admissions but still wanted to see an ACT score for academic based scholarships. An ACT score should be considered one of the items in your toolkit when it comes to college. If you have a good score that will make you look more favorable in terms of admissions and scholarships, then by all means use it to your advantage and include it. If you don’t have a good test score, then don’t include it and rely on your grades and other items on your resume. Is an ACT prep course worth it? Studies have shown that an ACT prep course can help improve an overall score by 3-4 points. A lower score can be improved by even more. A 3-4 point improvement might be the difference between getting admitted into the school you want or not. It might also make the difference in qualifying for an academic scholarship that can save you thousands of dollars a year in tuition. As an example, at Iowa State University, a combination of a 3.30 gpa and a 24 ACT score will score you a $36,000 academic scholarship worth $9,000 per year. If you have a student with the required gpa and an initial ACT score of 22 an increase of just two points can be worth $36,000. Depending upon the review class you sign up for you will likely pay $1,000 or less. That is a pretty good return on investment. There is more coming from my conversation with Steve. Stay tuned for the next segment which will be released next week. If you want to see the entire video you can do so here.
3 Tips Women Over 40 Should Ask An Advisor
In the life of a person, 40 years of age is an especially important milestone. You are starting to think about your financial future and cannot afford to make the same financial mistakes that you made in your 20s. 40 years of age is also a milestone from the perspective of a woman because you may be raising your kids, taking care of your home, looking after aging parents, and managing your career. Indeed, women in their 40s, have no time to look after themselves! As a result, you may not have time to tend to your finances as they demand. That is why a woman in her 40s should consult a financial advisor regarding money and personal finance tips. You can have a look at what kind of financial help to expect from the financial advisor Before going into more detail about personal finance tips that you can ask a financial advisor, you can check out a few data points. AARP data says that only 39% of women are confident they will have enough resources to live a comfortable life for 25 years of retirement compared to 54% of men. That is not good from the viewpoint of a woman. You can take a look at how to be in a financially sound position in your 40s by taking assistance from a financial advisor. Tip 1 - Budget and Debt: Maybe, until now you have not given much thought to your budget. But now time has come to be financially conscious and think seriously about your budget. You can consult with your financial advisor and seek suggestions from the expert regarding what can be your ideal budget strategy in your 40s. Other than budget, the next important financial point, you can consult with your advisor is debt. Be it a long-term mortgage, high-interest rate credit cards, or emergency-basis-taken payday loans; none of it is good for your financial life. So, you can ask your financial advisor about ways to solve your secured and unsecured debt problems like mortgage, credit cards, and student loans. With the help of an expert, you can use several debt repayment ways like refinancing, debt management, etc to solve your debt problems. Thus, in your 40s, you are going to get the best personal finance tips over budget and debt from your financial advisor. These tips may prove to be highly beneficial for you. Tip 2 - Intelligent investments Creating a budget and safely repaying the debts by consulting a financial advisor is a great start but your relationship with the financial advisor does not end here. With the help of the financial advisor, you can make intelligent investment decisions that can help you in post-retirement savings and achieving your financial goals. Maybe, you are already making investments but the financial advisor can help you to make risk-appropriate, and goal-oriented investments. Tip 3 - Retirement taxes and college savings You may think that you are only in your 40s, why do I need to think about taxes in retirement? But, by thinking about it now you can avoid paying huge tax bills while in retirement. You may consult your financial advisor regarding what is the best retirement account for you. Is it 401k or Roth IRA? The difference between 401k and Roth IRA is in a 401k account you contribute pre-tax money. In a Roth IRA, you contribute after-tax money. Your money is going to be taxed when you withdraw your money from the 401k account.You can make a tax-free withdrawal from the Roth IRA account. Remember, it is important to make proper financial decisions in your 40s! So, after discussing with your financial advisor, you can decide what is the right kind of retirement account for you. In the same way, you have to think about the expenses related to your kids' college education now. There is a good chance that once you are in your 40’s, college will be in your child’s near future so you have to think about how to save for their college education now. With the help of your advisor, you can invest in a 529 college savings plan. The big benefit of the 529 college savings plan is you won’t have to pay any taxes on your investment gains if you use the money for qualified college expenses. Thus, with the help of a financial advisor, you can find the right way regarding how to save for your kids’ college education and how to deal with your retirement tax. These are the 3 basic personal finance tips you can ask your financial advisor. Final words, You have to perform a lot of financial tasks in your 40s Whether it is thinking about your kids’ education, planning retirement or managing your investments. Consult a financial advisor to help strike a balance between enjoying today and taking care of your future needs. Author Bio: Catherine Burke is a financial writer for https://www.onlinepaydayloanconsolidation.com/. She provides information on successful cash loans and payday loan consolidation to help people get over a difficult patch. She lives in Kansas and has earned a frame in the matter of payday loans. 7th Street Financial is happy to provide an opportunity for a diverse group of finance bloggers to submit items for publication. All written content on this site is for information purposes only. Opinions expressed herein are solely those of 7th St. Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.
The Reddit Phenomenon – What You Need to Know
Normally I keep my blog posts related to core financial planning topics that can help you better understand the personal finance landscape but every now and then something happens that needs to be addressed. Over the past several weeks we have seen one of those examples, the Reddit short squeeze trade. This post will give an understanding to what happened, what it means to you and discuss if you need to jump into the action. To start, we need to understand what a short squeeze is. 98% of the activity in the stock market is people going long on an investment. When you buy a share of Apple or contribute to your 401k plan you are going long on those assets. You are buying a share at the current price in hopes that the asset price will increase over time providing you a gain on your investment. Shorting an investment is just the opposite concept. You do this when you think a particular stock or fund will decrease in price. This is normally done when someone thinks a particular company is in trouble or if they think a recession or other economic downturn is coming. To do this, an investor borrows a share of stock from their broker and sells it at the current market price but they are required at some point to purchase that share back from the broker. This type of activity is most frequently done by hedge funds and not individual investors. A short squeeze occurs when those that have shorted the stock feel pressure about their position because the price of the stock is heading up and not down like they had hoped. Remember, the person shorting the stock has to buy a share at current prices to make their broker whole. So the more the price goes up the more money the person shorting the stock is at risk of losing. This pressure can lead them to buy and cut their losses. In this most recent scenario, let’s look at what happened with GameStop (ticker GME). GameStop is a company that relies on physical stores to sell video games and related accessories. This was a solid business years ago but like what happened to Blockbuster when Netflix came around things have gone online and many of these games are now downloaded or streamed. GameStop has continued with its existing business model and as a result has seen a steady decline over the past few years in revenue and profits. Revenue is down almost 30% since 2016, net income has gone from $500 million in 2016 to negative in both 2019 and 2020, cash flow has gone from over $500 million in 2016 to a negative $250 million in 2020, and finally, this has led to a decreasing amount of cash on the balance sheet. The stock price has reflected this business downturn going from about $29/share down to $4 in the fall of 2020. This all points to a company that is in a slow death spiral. They have an outdated business model for their industry and declining business performance. This is the type of company frequently targeted by short sellers because unless the company overhauls their business it appears they will continue to slowly decline and eventually go the way of Sears and JCPenney. So selling a stock even at $4 and then buying it back at mere pennies results in a great trade and huge return for that investor. Now, here is what happened that makes this story fascinating. A group in the sub-Reddit community WallStreetBets got together and decided to go against these hedge funds and make some money along the way. This Reddit group is normally thought of as retail investors, in other words, non-professional investors. GameStop actually started ticking up in the fall of 2020 going from $5 to $19 by the end of the year. Then things got crazy. Below is a chart of how the stock has performed since January 11th. In that first week the stock went from $20 to $39, that’s a huge move for any stock in one week with almost a 100% increase. The following week saw the stock increase to $77, another 100% return. Then the week that made this a news story. By closing price: Jan 25th – 76.79 Jan 26th – 147.98 Jan 27th – 347.51 Jan 28th – 193.60 Jan 29th – 325.00 Those are absolutely crazy moves in a single stock in that short of a period of time. The stock actually reached an intraday high of $483 on January 27th. While GameStop had made a somewhat notable personnel move that might bode well for the company, the future prospects for the company did not suddenly improve by 1000%. This was move was not based on the fundamentals of the company. It was solely driven by an artificial demand intended to punish those who had shorted the stock. So how did the short squeeze work on the hedge funds? As the stock price went up some short sellers were forced to cover those borrowed shares and buy them back at current market prices which had gone to almost $500. This is obviously a huge loss as they had borrowed those shares most likely at a price under $20. Melvin Capital was the poster child for this as their hedge fund lost 53% of its value just in the month of January due to its 5.4 million share short position in GameStop. This loss totaled $6.5 billion for the fund. Not all hedge funds got beat up on this though. Senvest got in on the action and actually made $700 million. After the peak Now here is the thing with a bubble like this, it has to burst. Almost as quickly as the rise of the stock price was the collapse. As the price skyrocketed the new people buying in at higher prices were tying up more of their capital. The only way they can make money on their investment was for more new people to come in and agree to buy in at the artificially elevated or even higher price. Once that well runs dry the price starts to fall and it fell fast. Since the mania of the week of Jan 29th the stock has fallen back to $51, a drop of 89%. Who were the winners? Those that started buying the stock last fall as it rose to $20 and were able to get out during the huge push upward are the real big winners here. Even those that bought in on say Jan 25th or 26th and sold within a couple of days made a tidy profit. Lastly, and ironically, those who shorted the stock as it reached its peak did very well as within 10 days later the stock settled into a $50-60 range. Who were the big losers? As mentioned, Melvin Capital is the headliner of this group. Unfortunately, some of these retail investors were left holding the bag as they bought in at the peak, thinking the party would continue, only to see it break up much earlier than they thought. This was the dangerous part of this game. Like a Ponzi scheme, it works only as long as new buyers come in agreeing to pay a higher and higher price but eventually you run out of people to buy at a higher price especially when the stock price isn’t based on anything tied to the company’s performance. When people sold and took their profits the stock price dropped like a rock. Robinhood also falls in this camp. Robinhood is the preferred trading platform for this new wave of retail investors. The problem was they had issues dealing with all of the activity and halted trading of certain stocks when the mania was at its peak freezing out stock holders from getting out of their positions as prices were falling. They took a major PR hit but it remains to be seen if they actually lose investors off their platform. Did this impact me? Probably not. While this story got a lot of attention the companies involved are all fairly small in terms of impact on the overall market. So if you own an S&P 500 fund which is all larger companies there was no impact. If you owned a small or mid cap fund you may have seen a small impact as these funds typically hold hundreds or more individual companies within the fund and the movement of one company won’t have a material impact on the entire fund. Should you get in on future Reddit trades? While GameStop was the highest profile example of the power of the Reddit trade it was not the only example. There were others and will continue to be more. In fact, as I write this today there has been a major move pushing marijuana based stocks higher. To come out on the right side of this requires a good degree of market timing which is an incredibly difficult thing to do. You might catch the upswing and make money or get caught holding the bag when the euphoria wears off. And with the type of price swings we saw in GameStop those losses could be substantial. Just don’t make the mistake of assuming a given stock price will continue to go up as part of a movement. What do you do moving forward? If you have a long term investment plan that helps you reach your goals, stick with it. Don’t get thrown by the white noise these types of trades create in the news or get caught up in the rush of a get rich quick trade. Wealth is built over time, not in a week and these types of stories always have someone who is on the wrong end of things. The news will move on and you won’t hear much about the regular investor who lost $10,000 on GameStop because that doesn’t get anyone’s attention even though to that regular investor that $10,000 means a lot. This has been a fascinating story to follow and there will continue to be other episodes of this but none may quite grab the spotlight like GameStop did. I hope this helps you understand what happened, what the fallout was, and what it means to you. As always if you have any questions about your investments or others of your personal finances reach out to us at firstname.lastname@example.org or click here to schedule time to talk. All written content on this site is for information purposes only. Opinions expressed herein are solely those of 7th St. Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.
How Long Will My Retirement Savings Last?
This is a featured guest blog from GoodLife Home Loans. The original blog post can be found here. Retirement is one of the most important things you can plan for in life, yet many adult Americans find themselves unprepared as they near the end of their career. Seniors often find themselves wondering how much they need to retire and how long those retirement savings will last. Many feel concerned about whether they’ll be able to cover medical bills and afford day-to-day expenses while keeping up with the cost of living. There’s no one-size-fits-all answer to how long your retirement savings should last; it depends on a wide variety of factors. Today’s post goes over all the considerations you should keep in mind when contemplating the longevity of your retirement savings, so you can feel financially confident heading into your post-career years. How long will my money last in retirement? According to AARP.org, your retirement savings should last you 30 years—but that’s dependent on a number of variables and will vary from person to person. AARP and many financial planners estimate an individual’s necessary retirement funds and corresponding withdrawal rate by using the four percent rule. This rule of thumb assumes you’ll earn a 4% annual return on your investments and therefore suggests that you can withdraw 4% of your savings account(s) (including stocks, bonds, mutual funds, bank CDs, and so on) in the first year you retire. The next year, you would withdraw that same amount plus an adjustment for inflation. Essentially, if you withdraw 4% and earn 4% back, you should have enough savings to safely last your retirement. Here’s an example: Say you have $1,000,000 in savings and we assume that the average rate of inflation will stay stable at 3%. Your initial 4% withdrawal would be $40,000, the next year would be ($40,000 x 1.03) $41,200 and so on. Take a look at the four percent rule in action below. Bear in mind, however, that this is just a general rule of thumb. There are several factors that could affect whether this method will successfully make your savings last throughout long and vibrant retirement, such as the rate of inflation or one of your investment portfolios taking a hit, since this formula assumes that your account will see an annual return of at least 4%. When it comes to your personal retirement planning, it’s always best to speak with a qualified financial advisor who can analyze your circumstances and offer a strategic savings plan customized to your needs. What factors affect how long my retirement savings will last? Every financial situation is unique, so be sure to run through this list of considerations when estimating how long your money will last in retirement, including the duration of your retirement, which assets you hold, and how you spend money. ● The Age You Choose to Retire You can claim Social Security as early as age 62, but it’s generally wise to wait to claim Social Security until you reach your full retirement age (FRA) or even waiting until age 70. Your FRA depends on the year you were born; for those born in or after 1960, the FRA is 67. According to SSA.gov, you will be penalized for every month you retire early with a reduction of benefits up to 30% for those retiring at age 62. In order to retire at 62, you’d need to have a lot more in savings because the amount of your Social Security benefit will be substantially smaller. A lower monthly income will force you to rely more heavily on the money you’ve saved up, causing your savings to not last as long. Alternatively, if you wait until age 70 to retire, you can accumulate delayed retirement benefits that will increase your Social Security benefit and allow you to dip less into your savings so that they may last longer—ideally between 20-30 years considering the rapidly increasing rate of life expectancy. ● The Type of Retirement Account Which type of retirement account you have—a traditional 401(k), IRA, Roth IRA, or pension—dictates when you have to withdraw from your savings. Congress recently passed the SECURE Act and changed the age at which you must take required minimum distributions (RMDs) from your 401(k) or IRA account at a specific rate calculated by your life expectancy; as of Jan. 1 2020, you must begin taking RMDs at age 72 compared to the previous requirement of 70½. Failure to take RMDs will result in a penalty of 50% of the amount you should have withdrawn. However, there is no such rule for Roth IRAs and pensions, so your savings may last longer in these types of retirement accounts. Additionally, the different assets you have within your portfolio can dramatically impact how long your savings last through retirement. There are many types of investments, some of which are low- or high-yielding with low- or high-risk of market volatility. Depending on your investment strategy and how you allocate funds in retirement, your portfolio may have a higher yield and last much longer. Correspondingly, an aggressive asset allocation could take a serious hit in the event of a market crash, essentially draining your savings, and your portfolio may not have enough time to recover and help fund your retirement. ● The Location Where You Retire Where you choose to retire also has a large role in determining how long your retirement money will last. Some states have a much lower cost of living and allow you to stretch your savings further than if you were to live in a state with high housing costs. GoBankingRates surveyed the entire U.S. and calculated the average cost of living in each state to identify the top 15 places where your retirement savings can last the longest. Look at the map above to see how much more you could save by retiring in a state like Arkansas, where the annual cost of living came in at $30,960 or Mississippi, where you can live on $31,039 in a year—compared to states like California and Hawaii where the same amount of retirement savings would only last you 10-13 years. ● The Taxes You Pay in Retirement Retirees often find themselves relocating to tax-friendlier states if they’re worried about how long their retirement money will last. Some states, for example, do not include Social Security benefits as taxable income while other states assess no income tax at all. It’s also wise to check the tax obligation on your retirement distributions; in most states, you must pay tax on income from a 401(k) or traditional IRA, whereas no income tax is charged on Roth IRAs (as long as you’ve held the account for a minimum of five years and are at least 59½ years old). Even after you’re no longer working, retirement taxes can be a very large expense and may cause you to use your saved money more quickly than if you were to live in a state with lower income, property, capital gains, inheritance, or estate tax rates. ● The Money You Spend While Retired It should come as little surprise that the amount you spend on retirement expenses will weigh heavily on how long your savings last. There are fixed needs such as housing, nutrition, and health care that must be budgeted for, but variable spending can deplete savings more quickly. While it’s important for seniors to enjoy their new-found free time by traveling in retirement or exploring new hobbies at their leisure, they should be sure to have a rainy day fund set aside that can cover any large, unexpected medical costs that Medicare insurance does not adequately cover. ● The Duration of Your Retirement Finally, the answer to questions such as “How long will my money last in retirement and do I have enough?” depends on the duration of your retirement and how many years you will need to support yourself with savings. Your life expectancy can be estimated by your gender and quality of health, but no one can know exactly how far, or for how long, you will need to stretch your savings to enjoy a comfortable life. How can I make my retirement savings last longer? If you’re concerned that your savings won’t support your retirement, you’re not alone—in fact, EBRI.org reports that eight out of 10 people expect to continue working for income after they retire. There are many retirement employment opportunities and methods to earn supplemental income, but this option may be unavailable to seniors with deteriorating health or may seem unattractive to retirees looking forward to enjoying their new free time after working their entire careers. An alternative option that retirees may consider is to supplement their savings with reverse mortgage proceeds. A reverse mortgage allows eligible seniors ages 62 years and older to tap into a portion of their home equity and turn it into loan proceeds that can be used to support a more comfortable retirement. The added stream of revenue from a reverse mortgage can help cover medical bills, home renovations, travel costs, and other day-to-day expenses in retirement so that seniors can preserve their other savings. GoodLife is committed to helping seniors enjoy the Good Life in Retirement, enjoying every moment to the fullest, free of financial hardship. If you would like to learn more and see whether this may be the right solution for your circumstances, contact one of our Reverse Mortgage Specialists who will be happy to answer any questions you have.
2020 Personal Finance: A Year in Review
I think I can safely say that most of us are happy to see 2020 in our rearview mirror. Between the onset of Covid, a crashing economy that led to many people losing jobs, personal lives being turned upside down with kids taking classes from home, parents working from home, sports canceled, political/social upheaval, and the elimination or scaling down of many of the things that bring us joy (travel, eating out, being with friends, etc..) it will not go down as a fondly remembered time. But when things seem at their worst there is always an opportunity to reflect and learn lessons that can be valuable to us in the future and 2020 certainly provided us with many of those. As a financial planner, I would like to take this time to reflect back on the year and see what 2020 taught us about personal finance and what you can use moving forward. 1. Focus on financial fundamentals If you have read my previous posts you may know that I put a big emphasis on financial fundamentals. I like to think of your finances as a pyramid and each level of that pyramid represents a different area of your finances. The concept is that you can’t build a solid structure without having a strong base. In the case of your finances that base is the financial fundamentals which consist of your budget, debt management, and emergency savings. Unfortunately, this year saw a big spike in people losing jobs, being temporarily furloughed, seeing reduced hours, or taking a big income hit due to the Covid impact. Having strong financial fundamentals will help you stay afloat during hard times. Budget: If you are aware of where your money is being spent you are in a better position to react quickly and cut costs in certain areas helping you stretch your dollar during a period of reduced income. Debt management: The major drag with debt is that it comes with mandatory monthly payments. When your income takes a hit this means less income for living expenses because you are still having to make those fixed debt payments. I am not here to say all debt is bad and you should never have any. The key is to keep your debt manageable so that if you have reduced income you still have money left for living expenses. Emergency savings: This is having the 3-6 month of living expenses rule of thumb you always hear about. And you hear about it because it is a really good rule. This protects you from job loss or reduced income. Likely you will still cut back on certain expenses but you can use these savings to still pay for your necessities and not lose sleep at night about keeping a roof over head or food on the table. In general, having sound financial fundamentals keeps you in the position of saying “that sucks”, because you know you may have to cut back or cancel some plans in bad times instead of saying “oh sh*t, now what do I do?” That is not a position any of us want to be in. 2. Have a long term investment strategy While we have been living with some periodic volatile markets over recent history, 2020 presented with the biggest drop in the markets we have encountered since the financial crisis. Fortunately, this drop didn’t last very long and the markets came back with a vengeance and ended the year at all-time highs. For those of you looking at your investments for a long term goal like retirement, 2020 reinforced that the best thing to do is hang in there even when things get dicey and stick to your plan. The long term returns of the market have a very good track record. You might take a short term hit every now and then but over the long haul you will come out ahead. Those that stayed the course were rewarded with a tremendous rally and even a positive return on the year while those that panicked and sold likely missed out on a good portion of the recovery waiting for things to feel safe again. Now, I am not here to advocate that everyone should be all in no matter what. You need to have a portfolio that is constructed to contain the appropriate amount of risk for you and your circumstances. 3. Don’t try to time the market This one is closely related to the previous point. Financial planners give a lot of advice in a lot of different areas but we are pretty consistent with talking about long term investment strategies. We don’t recommend you check your 401k balance on a daily basis because the up and down swings will be too stressful for many people. The key is to make sure that over time you are making the progress you need to reach your goals. Many people though get caught up in the moment and either buy or sell their investments in an attempt to protect against further losses or take advantage of cheap asset prices. As a financial planner, I pay more attention to the workings of the economy and the markets than the average person but none of us know which day will see things turn a certain direction. That is why we advocate patience and to ride out the good and bad as history is your favor for good results. 2020 saw 8 of the 9 single biggest daily gains in the history of the Dow Jones and 8 of the 10 largest single day losses. In every one of these cases, the market moved at least 1,000 points to the good or bad. All but 2 of these 16 days occurred between February 24 and March 26th, a window of just 24 trading days. Had you lost hope after an almost 3,000 point loss on March 16th and gotten out of the market you would have missed out on the 1,050 point gain the following day. While that certainly didn’t get you back to even it was a 5% gain that you would have missed. If you could have guessed right on a daily basis over the course of that month you would have made a fortune but had you guessed wrong you would have lost one too. 4. Be flexible When I create a financial plan for a client that plan reflects data, analysis and recommendations for that specific moment in time. While the initial financial plan is an important document as it provides guidance it is just as important, if not more so, to provide ongoing analysis and recommendations as clients continue through their lives and deal with all the changes that occur as time passes by. The financial plan needs to be thought of as a living document that will change along with the changes in a client’s life. 2020 presented us with change on many fronts. Whether it was how we worked, how we schooled, ate, visited with family. You name it, life was different. Our finances were different too. As a result of Covid related restrictions and lockdowns, we didn’t have as many options for spending money. Instead, we were able to pivot and invest in our health with home gym equipment, make overdue home improvements or set aside money for other long term goals. People’s long term goals may also have changed as a result of what they lived through in 2020. Maybe you decided to live closer to family, came to the conclusion life is too short and want to retire earlier, travel more in the future, or deemed that some other goal is now more important. Your plan and goals are subject to change and that is okay. You just need to know it will have an impact and you will need to adjust accordingly. 5. Be opportunistic This goes hand in hand with being flexible. When hard times hit opportunities are often created. In February and March our markets were in free fall. To help prop up the economy the Fed lowered interest rates. This created multiple opportunities. With lower interest rates, it made financing a new home or refinancing an existing home more attractive. As people were looking to move out of urban areas and into suburbs it resulted in sharply rising home prices in the now in-demand suburban areas and falling prices where people were leaving. For those who have thought about downtown living, it created an opportunity to sell high and buy an urban home at a discounted price. Maybe you were thinking this was a move you would make five years from now but the opportunity was too good to pass up. With the markets dropping by thousands of points at a time it created an opportunity for those that stayed calm and had the strength to buy when things looked dire. They were rewarded with a massive rebound. I previously mentioned not trying to time the market. Being opportunistic is not about trying to find the date when those assets were at their cheapest, that is market timing. Being opportunistic is about identifying an asset you feel is undervalued and you are comfortable getting in at that price. The price may go down further from there and you are okay with knowing in the long run you made a good deal. While I don’t like to promote the purchase of individual stocks, companies like Microsoft, Google, Amazon and Apple which were well positioned to survive the pandemic and whose business wasn’t really hurt by it either saw their value drop by as much as 40%. By mid-June, some of these stocks were at new all-time highs. Those who had the foresight to invest in companies like Zoom, Peloton and other work from home/stay at home companies saw values go up by over 300% in the year. Again, this is not about waiting for Apple to drop 40% before your pounce. You might have looked at Apple dropping 25% and thinking to yourself this is a good price to buy this stock because I am sure it will bounce back. With many of our usual outlets for discretionary spending limited we were able to find other uses for that money. Whether it was shoring up emergency savings, paying down debt, propping up your kids' college fund, adding an extra percent or two to your 401k fund there was a way to make positive strides towards financial goals. I am not calling for taking advantage of other's misfortune here but simply being on the lookout for opportunities that arise when a situation results in either bargain priced assets or a chance for you to make bigger contributions to your own financial goals. 2020 sucked, but if we take the time to reflect we can learn some of our most valuable life lessons coming out of dark times including your financial life. Let’s hope 2021 provides a smoother ride. I’ll be okay taking a year off from learning hard lessons. The foregoing content reflects the opinions of 7th St. Financial, Inc. and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.
What Rate of Return Should Your Portofilo Deliver?
As investors, many of us watch to see how the stock market is doing on some sort of regular basis. We have seen the big market collapses of the dot com bubble, financial crisis and more recently this spring due to Covid. We have seen massive market recoveries in recent history such as 2009 and this summer/fall as the economy tries to recover from Covid shutdowns. As financial advisors, we often speak to clients about their investments with projections in the 6-8% range. The truth is only three times since 1930 has the annual rate of return actually been in that range for a given year. A look at the chart below shows that actual returns tend to be much more volatile than that. So what should you be looking for as a proper rate of return for your portfolio? How many of you have heard someone you know saying they made a killing on a particular stock and found yourself feeling a little jealous that you weren’t in on that action as you can’t help but think this person just fast tracked their retirement by five years. This might make you think that if you’re not getting 35% plus in returns you’re missing out. The truth, as with most matters in personal finance, is that it depends on your situation. The ‘market’ may be up 15% in a given year and you may find yourself looking at your own returns and it is only up 10%. Should you be upset about this? Maybe, maybe not. If you are 26 and invested fully in a growth portfolio you may want to look at things. For the rest of us, remember to get that 15% return you would have to be 100% invested in that particular index. In this case, if we are talking about the S&P 500, you would need 100% of your investments in the IVV ETF (iShares Core S&P 500 fund) for example. Now don’t get me wrong. This is a good fund (or another S&P 500 index fund) and absolutely has a place as one of your core holdings, but I don’t think anyone would ever feel comfortable having every penny they have invested in a single fund even if that was a fairly diverse fund. The moment you add another fund into the mix you will get away from that specific 15% market return. Say you add an International fund as 20% of your portfolio and that space doesn’t perform as well this year and is only up 5%. Now your portfolio has an overall return of 13%. Again, should we be upset because our portfolio didn’t match ‘market’ returns? Now say we make 30% of your portfolio bond/fixed income holdings and they return just 3%. Now our overall portfolio return drops to 9.4%. We are nowhere close to the 15% ‘market’ return. Time to be upset yet? Before you react, take a look at the thought that went into creating your portfolio. First, was an analysis done to determine your risk tolerance? As an advisor, we should work with our clients to determine this so we know the mental comfort level you have to ride out the ups and downs of the market (again, see chart above). Was analysis done to determine your risk capacity? We need to understand how long to expose your investments to risk before you need the funds. The longer you can leave them invested the more risk you can take because you have time on your side for any losses to recover. But, if you need the funds in a few years then the mindset switches more to preservation than focused on growth. The combination of these two items will help determine the proper allocation of your portfolio and how much risk you can take on (i.e. stocks vs fixed income). You might match market returns but if you lose sleep every time the market goes down 1% in a day then being 100% invested in that index is probably not a good thing for you. Next, is your portfolio well diversified? In our example above we talked about having your entire portfolio in one S&P 500 index fund. Again, no one is going to advocate being all in on a single fund. We want to spread our investments around to different sectors and segments of the overall market. As a result, we add in some mid and small cap funds, throw in some International and Emerging Markets. Maybe you even dedicate a little chunk to a dedicated area (tech, healthcare, ESG, etc..). We do this to cover our bases. In our example, the S&P 500 was up 15% and International was only up 5%. But how would you have felt in 2016 when the S&P returned 9.5% but the small caps returned 18.2% and small value returned 24.6%? Bet you wished you would have been invested in something other than just large cap that year. Nobody really knows what exact date a particular segment of the market will take off or when it will cool down so by being in a little bit of everything at all times you are always participating in what is working, and on the flipside, what isn’t as hot. This works to smooth out the average portfolio return. The fact is that once you construct your portfolio to be diversified and have the proper allocation there is no way you can compare your rate of return to a single market index. You’re just not comparing apples to apples at that point. Instead, try thinking of your returns in a different way. Instead of comparing your rate of return to a certain benchmark try tracking the progress you are making towards your goals. As an advisor, I never work with a client and have a stated goal of returning 12% on investments. Instead, the goal the client might really care about is to retire at a certain age. When I meet with a client we review how we are tracking towards that goal, what possible challenges could prevent them from achieving that goal, and are there any changes we need to make to the plan. Over time we track the progress towards achieving this goal and make sure we are heading in the right direction and course correct if we are not. For example, if the client is at age 48 and we show a 70% chance of success in achieving that goal, assuming a 6% average return in a portfolio that is 60% equities and 40% fixed income, it would appear we have some work to do here to meet our goal. To increase our chance of success we may need to bump up the portion of the portfolio that is in equities to say 70% which will increase our chances of having higher overall returns. Maybe we can see if they can increase the amount they are saving for retirement. Maybe the answer is a combination of the two. There are a lot of different levers we can pull to get to that goal. The best solution will depend on what makes sense given the client's specific situation and comfort level. As time moves on, let’s say at age 58, they now are at a 97% chance of achieving their goal. Obviously, the client is in a very good position now and there is no reason to take unnecessary risks that might result in missing a goal we are so close to achieving. Here, we might be perfectly happy with that 6% return even if the market returns 20%. Why? Because the risk to get the extra return isn’t worth the downside of screwing up obtaining their goal. Sure, maybe we could have added an extra $50,000 in returns by having 75% of the portfolio in equities but if the market took a downturn that year we would have increased losses and now retirement at age 64 could be a challenge. The bottom line is there is no magic number you should be tracking against for your portfolio returns. Don’t worry about your brother, co-worker, or friends and what they are doing. As we mentioned earlier, they may mention a specific move they made that gets you doubting yourself but you don’t know how many times a similar move went against them or how they are tracking towards their long term goals. Your portfolio needs to do what you need it to do to meet your goals. There is an obvious emphasis on focusing on you here. If you are on track to achieve what you want to financially out of life that is all that really matters. You can go to bed and rest easy dreaming of the life you want. Thanks for reading and hopefully you found this informational. As always, I love to hear any thoughts or questions you might have. Please email email@example.com and let me know what is on your mind.
10 Things You Need To Know About FAFSA
It is October which means the beginning of the financial aid season for college bound students. The FAFSA, short for Free Application for Federal Student Aid is the first step in the process for financial aid. The FAFSA form became available for families to fill out on October 1 and must be filled out in order to be considered for financial aid. Each year the US Department of Education doles out almost $30 billion in grants and another $100 billion in loans. Here are 10 things you need to know about the FAFSA. 1. The goal of the FAFSA is to determine your EFC (Expected Family Contribution). The output of the FAFSA is your EFC which is the amount the US Dept. of Education calculates you should be able to contribute towards the cost of college for your family in the upcoming school year. This does not mean you have to pay that much towards the cost of college just that this will be the number used to determine your eligibility for various forms of need-based aid. Here is how it works. Say your EFC comes back at $30,000. This amount will be the same for each school. School one has a cost of attendance (COA) of $28,000. Since the formula indicates you should have the resources to pay the full amount and will not be a candidate for need based aid. But at school two, which has a COA of $55,000, you have a demonstrated need of $25,000 which leaves you as a candidate for need based aid. 2. The FAFSA information is shared with individual schools so they can prepare your financial award package. On the online FAFSA form, there is a section where you can provide the code of the various schools you want the FAFSA information to be sent. The Dept. of Education will share this data with those schools allowing them to prepare a financial award package specific for you. 3. The primary drivers of the EFC calculation are income and certain assets. Both the parents and the student’s data is taken into consideration. For most people, their income will the primary driver. Retirement funds and home equity are not considered which for most people are their two largest assets. Non-retirement investment accounts, vacation or rental properties, and the value of a business are considered though. In general, assets in the parent’s name are considered at a rate of 5.6% while those belonging to the student are considered at 20%. So the general rule of thumb is that an advantage to have assets in the parent’s name than the child’s. 4. In the case of divorced parents, the only parent who needs to report income and assets is the custodial parent. Even if the non-custodial parent provides more than 50% of the financial support and/or claims the child as a dependent for taxes, only the custodial parent needs to report data for the FAFSA. In addition, if the custodial parent has remarried, it is still only the custodial parent who needs to report data and not the step parent. 5. 529 plans are treated as an asset of whoever is listed as the account owner. In most cases, these belong to the parents and are assessed at the 5.6% rate. If a 529 plan is owned by a grandparent it is not counted as an asset on the FAFSA but once funds are taken out and used for the student then that will be treated as income for the student and will be assessed at 20%. 6. When filling out the FAFSA you will use the income reported on your prior, prior year tax return. This can be a bit confusing but here is how it works. If you are applying for financial aid for the 2021-22 school year you will use the data from your 2019 tax return so at the time the aid will be received it will be based on the prior, prior year. If you file the form this fall the 2019 return will be your most recent return. 7. During the process of filling out the online form you will have the option to use a data retrieval tool to get your IRS tax return information. This will greatly reduce the amount of time required to fill out the form. You can expect the process to take 1-2 hours depending upon the complexity of your information if you use data retrieval. 8. You may need to file a separate form depending upon the schools you are interested in applying to. FAFSA is widely used by most public schools but many private schools use a form called CSS that has a slightly different formula it uses and some of the assets that are not considered by FAFSA will be considered on the CSS. 9. You will need to refile the FAFSA every year you want financial aid. This is not something you do prior to your freshman year and have the totals carry over each subsequent year. Your financial details will vary year by year so might your ability to qualify for needs based aid. 10. Everyone should be urged to fill out the form regardless of whether you think you are a need based candidate or not. The FAFSA is the basis for determining other types of aid as well including some non-need based aid. For instance, to qualify for the Unsubsidized Federal Direct Loan you will need to have filled out the FAFSA and this is a loan that is available to everyone regardless of your financial situation. So even if you are sure you won’t get grants that is no reason to not fill out the form. If you are unsure of how to complete the form or have questions please reach out to info@7thstfinancial to get the guidance you need. Make sure you have the correct information so you are in position to get financial aid you have coming to you.