Financial Frontlines®

Do you have cash value in a life insurance policy or a commercial deferred annuity and own a long term care policy? If so, it may be possible for you to use the money in your life insurance or annuity to pay for your long term care insurance without paying taxes on the life insurance or annuity withdrawal.

Normally the withdrawal of funds from life insurance cash value or a deferred annuity triggers a taxable event. The portion of the withdrawal that’s considered the ‘gain’ is taxable as ordinary income.

Section 1035 of the Tax Code has always allowed tax-free exchanges of entire life insurance and annuity policies; even tax-free partial payments between life insurance policies and annuity contracts. However, now an enhancement to Section 1035 took effect on 1 Jan 2010 that added long term care policies to the mix.

This means money from the cash value in life insurance policies or deferred annuities can be withdrawn and used to pay premiums of long term care insurance without causing a taxable event.

Keep in mind, we talking tax code here so there are catches. There are so many different types of life insurance, annuities and long term care policies that not all of them qualify. Only your insurance provider, or possibly your financial advisor, knows for sure. Retirement accounts don’t qualify—annuities within an IRA or an annuity form of pension plan.

If your policies are eligible, the transfer must be worked between the two insurance companies. They know the process and paperwork and the transaction has to be a direct transfer from one company to the other.

Besides U.S. Code Title 26, Section 1035 of the tax code, also see IRS Internal Revenue Bulletin, 2011-36, Sept 6, 2011. Your long term care insurance provider will probably be your best bet for information and action.

One of our MOAA members received an unwelcome surprise recently when he tried to enter a Navy facility in Tennessee. His military retiree ID card was confiscated!

His diligent follow-up led him to request MOAA assistance, and it turns out that what happened to him could affect many of our members.

If you have a retiree ID card that was manually prepared (on a typewriter), it’s time to go to the nearest RAPIDS facility (Real-Time Automated Personnel Identification System) to get a new card. How can you tell if you have a manually prepared ID card?

• If your picture was cut from photographic paper and pasted on the card before lamination, leaving a raised photo on the card;
• If there are no bar codes on the reverse; or
• If the card stock is a version prior to Oct 93 (printed at lower left on reverse)

then you have a manually prepared card, and should get a new one. In these days of heightened security, the manually prepared card just can’t meet today’s tighter standards.

The military stopped issuing manually prepared ID cards in 1993. A base commander has discretion to bar access to a military facility of any retirees with these manually prepared cards. If you attempt to access that facility, your card may be confiscated. It may be returned to you, but the card will be invalidated, usually with a hole punched through the Social Security Number (SSN). You will need to get a new ID issued. Spouses aren’t affected by this issue, because until recently, their ID cards needed to be renewed every four years.

The modern ID card has some distinct advantages. It will mask your SSN for one thing. It will also enable electronic scanning at military facilities for another, making your identification quicker and less prone to errors.

You can make an appointment at a RAPIDS facility to get a new card issued to you. Visit http://www.dmdc.osd.mil/rsl/appj/site?execution=e1s1 or type RAPIDS Site Locator into your internet search engine. Once on the RAPIDS page, enter your zip code and RAPIDS will serve up the ID card facilities in your geographic area. Call ahead to the ID Card issuing facility for any special requirements. Remember that you will need two forms of ID to receive a new card. Your old ID and a passport or state-issued driver’s license is usually sufficient.

Plan ahead, and don’t have your next base visit interrupted before it begins.

Part 1    Part 2

ALLOCATION–Managing Your Portfolio

Allocation, the mix of stocks, bonds and cash (among other things) you have in your investment account.  An illustration of an allocation is 80% stocks, 15% bonds and 5% cash.

Over the long haul, 10+ years, stocks (TSPers: C, S, I funds) outperform bonds (F fund) and bonds outperform cash (G fund).  Stocks are more volatile than bonds and bonds more than cash.  So put those stats together and you get greater returns over time with stocks but the ride will be much more volatile.

I know some of you bond people will call me on the issue of bond returns over the last few decades.  But as I discussed in my last post, that was due to a unique situation where the planets aligned for bonds during that period of time and those days are over.  Now we revert back to normal.

A better return over the long term with lots of ups and downs in the short term, it’s a perfect environment for averaging down into stock funds.  Taking the long view, you’ll be glad every time that stocks drop because each dip is a chance to rake in more shares before the next higher advance up the stock chart.  Notice the chart below with the performance of various asset classes over time and the levels of volatility.

The Importance of a Big Picture View

A big picture view is critical to serious investors.  We humans tend to focus on current events.  And the media reinforce a short-term view.  Managing by current events kills investor returns.  Big picture wise, you can see from the chart below how the down periods (peach colored areas) don’t last long enough to buy as many shares as you would like to buy.  Technically, even when viewing the scary period of the 1920s and 30s, the market hit a bottom and started up again.  So even though the market is down from a previous high, all the shares bought on the way down and at/near the bottom provide a very quick profit.

The DOW industrial index was up 72% of the time going back to 1896.  Think about that; you only had 28% of the time to accumulate wealth in down markets.  Think of the world’s history since 1896.  Up 72% of the time in light of some very bad periods of history.

For those who question the “averaging down” strategy, they usually point to how it doesn’t work in down markets.  Granted, if you only evaluate the strategy during the period Oct 2007 to Mar 2009, it doesn’t work.  But after what I’ve explained, how likely is that? Or how likely is it that the markets take a cataclysmic dive and never come back up?  If they did, nothing else would matter.  A possible concern could be a short-term period where there’s a dive in the market and you don’t have the time to recover above your average costs.  Again this is for a short-term investor.  If you’re a short-timer, you should use other strategies anyway.

How about you folks who prefer to be safe and conservative?  See how much potential wealth you sacrificed and how much more you’ll have to contribute to make up for returns you won’t get?  And this chart doesn’t factor the eroding impacts of taxes and inflation.  What’s your return in bonds and cash after taxes and inflation?

Manage your portfolio using your allocation.  People a long ways from retirement should be heavy stock people.  People closing in on retirement, inside 10 years, want to shift gears.

Younger investors want and need the volatility in combination with the greater returns to build wealth.  Younger folks are accumulators of wealth; that’s your mission.  The value of your account is not an issue at your point in time.  The accumulation of shares is everything.  Lots of ownership creates wealth.

More “seasoned” workers and investors need to start the shift from share accumulation to the protection of account value.  When you retire, that money has to be there.  You don’t want to be one of those folks who get close to retirement and the stock market dumps causing your nest egg to crack.  If your portfolio is too stock heavy and the market dips, down goes the account value and now you’re faced with a lower standard of living or working longer.  Not pleasant choices.

Here’s how to manage your portfolio and make your allocation work for you.  The following chart is based on actual situations.

The S&P500 index bombs out 48% between September 2008 and March 2009.  You see how different allocations reacted to the 48% drop in the pie charts.

Younger folks.  The 80/20 portfolio dropped 38%.  Excellent!  Tell your buds your portfolio dropped 38% and you love it and catch their reaction.  You’re accumulating wealth as the market drops.  Your friends won’t be because they’ll be taking action to stop the bleeding.  Don’t feel pressure to follow the herd.

Seasoned folks.  You’re protecting value with a 40/60 split.  You still went down but it’s a more reasonable amount.  Actually, you could have protected more value with fewer stocks but you have a balancing act to keep in mind.  You’ll be retired a long time; 20, 30, 40 years.  Your accounts still have to grow and have to offset taxes and inflation to ensure you don’t run out of money.  So you can’t totally shun stocks.  Stocks provide the ability to grow your money over time and offset the impacts of taxes and inflation.

That’s it.  Stop trying to time the market by guessing when to buy or sell shares of specific funds in your account.  No one knows when it’s the best time to buy or sell and you have better things to do in your life.

We have one more strategy to discuss, rebalancing.

REBALANCE–Buy Low; Sell High, Like You Mean It

Rebalancing is a simple concept.  You have a set allocation.  Over time the stock and bond markets go up and down.  Eventually, your allocation will get out of balance.  Say your allocation was 80% stocks, 15% bonds and 5% cash.  As the markets rise and fall, your account may come to look like this, 70/25/5.

Just ask your 401k or TSP provider to “rebalance” your account back to your established allocation of 80/15/5.  To put your allocation back in original shape, the plan administrator will have to sell bonds funds.  The bonds are at 25% and they should be at 15%.  Technically that means you have a profit in your bonds.  You sell the bonds which is selling high; a good thing.  The stocks are down from 80 to 70%.  The profits from the sale of bonds will be used to buy stocks.  The stock are down at this point so you will be buying low; another good thing.  Now your allocation is back to normal.

Do this annually.  Each time you do it you will be buying low and selling high.  Something we can’t do on purpose.

See Part 1      See Part 2

Part 1         Part 3

AVERAGING DOWN–A down market is your friend

Averaging down is what you do when you make regular contributions to your 401k/TSP every pay period.  You know the investor’s rule of buying low and selling high?  Well, averaging down forces you to buy low.  That’s important because when left to our own devises, we don’t buy low.  Investors don’t buy low because “low” is when stock fund returns are ugly, the economy is in the dumpster, and everyone else is fleeing the stock market in droves—and you don’t want to be the last on a sinking ship.  As for you folks who stuck with your stock funds, good for you!

Here’s how many people view their investment accounts and how averaging down works to counter these misplaced views of investing.

It’s common for me to hear people talk like this about their accounts, “My account value used to be a buck now it’s down to 50 cents.  Stupid stock market, I’m losing my shirt.  Now it will take forever for me to get back to a buck!”  It’s at this point the media support this misconception by reporting the DOW, S&P and NASDAQ are down and how you lost money.  Every down market will cause the media cry “crisis!” because it sells better.

At some point during this down time, investors took their money out of the stock fund options in their accounts to stop the bleeding in their account value.  They probably put their money into something they considered safer.  Or maybe they put their money into something they thought would increase their account value to its original value faster.  That’s the mistake.

What Happens When You Take Your Money out of Stock Funds

Here’s what happens when people take money out of their stock funds during “bad” times.  The result is they aren’t in the stock market during the market’s best days.  The best days are the days the market rebounds off the bottom.  Here’s the damage:

 And that’s not the worst of it.  Stats indicate that investors don’t get back into stock funds until they are doubly sure the market is “safe” to return to.  They actually end up missing the best 700 days of the market before getting back in.  By that time, the stock market is getting heated again and ready to take the next plunge.

So these stock fund late comers “buy high” and get taken for a bath again as the market goes over the top.  They regret getting back into stocks and take their money out of the stock funds (“sell low”) once again sealing their fate for negative returns in the future.

Not meaning to be hard on the investors in the last paragraph but a dose of reality therapy is required.  If we don’t understand the problem and the psychology behind it, we are doomed to repeat the bad behavior.  Typically, folks blame the stock market for their woes.  This allows them to label themselves as victims of the market.  In labeling yourself a victim, you take the power to control your own results and assign it to unknown entities beyond your control; rendering you helpless.  We investors must face the fact that we can control our results, we aren’t victims, and we just need to be smarter about what we do and why we do it with these accounts.  If we don’t, our futures will rest on Social Security.

Instead, suppose the person had bought a share (paycheck contribution) at a buck and bought another share when the market was at 50 cents.  Now the investor’s average share price for their investment is 75 cents.

The investor is breaking even at 75 cents.  You are no longer waiting for your account value to return to a buck before you are even again.  Suppose you loaded up on shares at 50 cents.  That would lower your average share cost even more and you would be breaking even and showing a profit even sooner.  That’s what happens when you make regular contributions to your account every pay period.  You profit sooner and more often because you buy more shares when the share cost is at its lowest.

We need the down times in the market to build our wealth.  Wealth is about ownership; lots of ownership.  The shares in stock funds represent your ownership in some of the world’s best companies.  People aren’t wealthy because they own one or two properties or own 500 shares of stock.  You’re wealthy because you own lots of properties or own tens-of-thousands of shares of stock.  The name of the game is s/he who retires with the most shares wins.

Notice in this next chart the difference from the top box and the bottom box examples.  The person in the top box has a $400 investment.  He watches his account value go down and back up.  He owns 40 shares and the share price goes from $10 to $8 to $4 and back to $8.  In the end, his $400 investment is worth $320.  He watched the stock market volatility, was fearful, and was glad he wasn’t invested more in stocks given the sick feeling he has as he watches his account value.

 The person in the bottom box is making regular payroll contributions into her account.  At the end of the period, her account has $400 invested but her account value is $480.  This investor focuses on the accumulation of wealth and not her account value.  When the fund was $4 a share, she raked in 25 shares.  She understands ownership is the name of the game.  She bought more shares when they were “on sale.”  That allowed her to lower her average share cost and turn a profit sooner.

The top box person hates life when the shares are $4.  The bottom box person is loving life at $4 a share.  Think like an owner not like the holder of a savings account.

That’s why I’ve said before; a down market is your friend.  A down market is the only way average wage earners and investors can build wealth.  If the market only went up (the unrealistic expectation many have of investments), our money would buy less and less over time due to ever increasing prices.  The stock and bond markets are dependably up and down; and that’s a good thing.

Let’s take that up-and-down-market lesson to the next step…  If up and down is good, can you enhance the up and down movement of your account?  Why yes you can.  The up and down movement by the way is called volatility.  That’s where your allocation comes to play.

Part 1      Part 3

Part 2     Part 3

Positive Results in a Negative Environment

I’ve made reference to the importance of several key investment concepts many times in this blog.  They are averaging down, allocation, and rebalancing.  This post will look at a real life example of the concepts in action by using my own results.

Before I start, some of you have wondered why these topics keep coming up in my posts.  That’s simple.

• Senior NCOs and officers in my classes tell me the troops need to know this.
• I’m regularly involved in conversations where people unknowingly hurt themselves by not knowing what to do or how to do it.
• I’m told you are busy professionals and family members who need strategies you can put in place and forget (sort of).
• Because studies indicate active management of your retirement accounts is not a practical or successful option.

My 401k calculates my investment return over different periods of time.  I’m choosing the 5-year period for this illustration, because as you see, it was an ugly period of time in the stock market.  I use an S&P500 graph.  Most of you probably have an investment option that allows you to invest in an S&P500 index fund.  For you TSPers, it’s the “C” fund.  I pulled my 5-year report in January 2012.  Here’s the S&P500 over the 5-year period (click on the picture to enlarge it):

Besides the 3 obvious significant drops over the period, from the top of the period to the ending level, the market is still down 16%.  If you are an investor in the S&P500 Index fund in your 401k/TSP, you may expect your account to be down 16% or at some other return in negative territory.

It’s this type of market environment that has many people spooked about investing in stocks.  They see their account values go up and down.  Maybe their account balance has gone nowhere.  Maybe they pulled their investments out of the stock market somewhere during the big dive between October 2007 and March 2009.  Many are still out of the stock market waiting for more consistent positive returns and the economy to improve.  The professionals who follow the money flows among 401k/TSP investment fund options still speak of the huge outflows of money from stock funds in retirement accounts.  This is too bad.

First the ground rules.  Before you read my results, this is not a competition.  Plus it has absolutely nothing to do with tooting my own horn since some of you may see nothing worth tooting about.  My results will vary from yours for many reasons; different fund choices, different allocations, different rebalancing times, different plan costs.  Some of you will have better results and some worse.  This is only an illustration to show you the investment concepts I write about in operation during an actual period in the stock market.

The point is, if you are frustrated at your retirement account results after watching your account value, take note.  If you judge your success by your account value, even though you have a ways to go before retirement, learn to refocus your attention on what’s really important.  It’s not your account value by the way.

My 401k investment annualized rate of return was 5.1% over the above period.  My allocation is 55% stocks, 35% bonds and 10% real estate.  I’m 54 years old.  I hope to work another 10 to 12 years.  I wouldn’t mind if the stock markets stayed on this rocky course for another 5 years or so.

I will earn a better return in the future as the economy improves…and I believe it will improve regardless of the elections or world events.  Of course no one can know when it will improve, but history, the striving of people to thrive, and the nature of business cycles will drive the improvement.  Politicians are just along for the ride even though they’ll take credit or be the goat depending on their timing in the market cycles.  Not to be political, it’s just that people always bring up politics when they talk to me and politics aren’t a factor when talking about your future.

How did I have a positive return over this 5-year period when the chart, and the media at the time, may lead you to believe I should have a negative return?  It’s all about averaging down, allocation and rebalancing; all working in concert with one another.

See Part 2   Part 3