Healthcare Costs Continue to Pressure Retirement Planning

Healthcare costs continue to put financial pressure on retirees. Fidelity Investments annually conducts an estimate of future retiree health care costs. In their latest release, they estimate a 65 year old couple with $75,000 in household income who retires this year should expect $10,476 in annual health care expenses and $240,000 over the course of their retirement. This represents a 4% increase from last year’s findings. This calculation assumes the couple is subject to traditional Medicare Parts A, B and D and does not have any employee retirement health benefits through their former employers. It also does not incorporate the cost of nursing home care or dental costs.

How can you account for rising health care costs within your retirement planning? Here are several things to consider:

1.) Account for Higher Costs in Your Planning: The first thing that you need to do is account for healthcare costs as a separate distinct expense in your retirement planning. The reason being is that healthcare costs grow at a faster rate than most other expenses encountered during retirement. Over the course of the past ten years, the inflation rate in the Fidelity study has been about 6% a year. If you are bundling your healthcare costs with other retirement expenses in your assumptions and not applying an appropriate inflation rate, you could be seriously underestimating your financial needs.

2.) Reconsider the Key Financial Planning Pillars: There are four key financial pillars which tend to have the most power in financial planning. This is simply the amount you save, the amount you spend, the time that you give to accomplish a goal and the risk you take in your investment strategy. Rising health care costs all suggest that more pressure needs to be applied to these pillars.

The first element is saving and spending. These are pretty straightforward and work in tandem. Usually higher saving correlates with lower spending and you will need to remain disciplined in your discretionary spending once you stop saving and begin the distribution stage of your retirement cash flow strategy. As discussed above, this includes appropriately accounting for anticipated health care costs.

Time is an issue as well. The earlier you can save towards a goal, the more compound investing can influence the dollars you will have at retirement. Working longer helps, although many people retire early due to health issues. If you want to retire early, bear in mind it is becoming harder and harder to achieve. This is because pre-age 60 retirees have to flip for all healthcare costs without Medicare subsidies, they aren’t entitled to Social Security yet and early retirement means more years of drawing down on financial resources rather than building upon them. I find a year or two can be the difference between successful and unsuccessful retirement projections for the younger retiree.

Finally, rising health care costs lend to a need to take higher risk in your investment strategy. When healthcare costs are rising at a 6% annual rate, it suggests that a portfolio with some element of growth will be required to keep up with expenses. Certificates of deposit, money market accounts and many parts of the bond world at current rates simply will not keep up.
I discussed each of the above in a vacuum. However all of these pillars can be combined and worked in tandem that best fits your needs and circumstances. The overriding theme is that more pressure will need to be applied on your planning and the basic options you have to accommodate healthcare costs if you haven’t accounted for these costs already.

3.) Consider Health Savings Accounts: If eligible, health savings accounts are the best of both worlds. Initially you get an initial up front deduction for the contribution from your income taxes. Then if used for qualified healthcare costs, then any earnings from those accounts are tax free. Now this is great by itself, but if you have a long time horizon and can afford to pay medical expenses out of pocket at this time, I suggest not tapping into this account in the short term and invest the funds in higher risk/return assets. Over time the increased growth can better keep up and match with the medical costs later in life. Unfortunately I see a lot of people using the account to pay current medical bills even when they can pay out of pocket. In addition, most investors seem to have these accounts invested in some cash equivalent bank account paying very little in yield. With trending health care inflation at 6%, the purchasing power of these assets erodes over time and offsets the tax benefit if it isn’t invested properly.

4.) Invest in Healthy Personal Habits: Diet, exercise and preventative care are all attributable to better health and lower medical costs. It doesn’t guarantee health, but studies have shown they all increase the chance of living a healthier life. Over the past several years the financial planning world has not only focused on healthy financial habits, but also encouraging people to live healthier lifestyles due to the influence of these on health care costs.

Healthcare costs will continue put pressure on ones retirement plans. But these simple steps will make this more affordable in your later years.

Butchers, Brokers, Dieticians and Fiduciaries

In the world of healthcare, representatives of pharmaceutical and medical device firms do not administer advice directly to patients. This avoids the inherent conflicts of interest as representatives have a natural incentive to sell as much of their product and this could influence the advice in a manner that it is not in the best interest of the patient. Unfortunately I wish I could say the same for the financial care field.

The financial service industry doesn’t always require the same level of care – it can differ from firm to firm. Some financial service firms recommend products that they create or holdings they have on inventory that they don’t deem worth holding onto anymore. Some are required to act in your best interest first while others only have to determine if a product is suitable. A recent New York Times Editorial by former Goldman Sach executive Greg Smith and the Fox News report “Citigroups Embarrassing E-mails” sheds some appalling light on how the financial customer could be adversely affected in some cases.

What can you do? The first thing that you can do is understand the difference between a fiduciary arrangement and a brokerage engagement in a financial service engagement. A great whiteboard video showing the difference was produced by Hightower Securities which compares brokers to butchers and fiduciaries to dieticians. In simple terms, you don’t want to ask a butcher if a certain cut of meat is healthy for you.

If you then believe that your financial service advice you receive should be held to a fiduciary standard, I recommend going to The Committee for The Fiduciary Standard website a pull up their Fiduciary Oath. I would print this and provide this to your current or prospective financial adviser to sign. If they sign this, it doesn’t eliminate all potential conflicts of interest, but it requires disclosure of material items and that the adviser acts in your best interest. If they refuse to sign it, at least you know the type of engagement you have and you can make the decision to continue the engagement or move on.

Finally there is a debate going on in Washington concerning the subject as some parties don’t feel a fiduciary obligation is necessary or is too onerous and would prefer things to remain “as is” or to create a watered down definition. Unfortunately many of our elected officials haven’t expressed an interest and/or expertise on the subject. If you feel this is important, I recommend that you forward the above whiteboard demonstration to your representatives.

Tax Planning: Better Plan for 2013 Now

Currently millions of taxpayers are trying to get their tax returns prepared. But if you are wise, I would take a look at what’s coming in 2013 and take action now to address it.

If the tax code remains as it currently stands, we will face the largest tax increase in history. The majority of this would come from the expiration of the Bush Era tax cuts. Current tax brackets would go from 10%, 15%, 25%, 28%, 33%, 35% to 15%, 28%, 31%, 36% and 39.6%. Capital gains rates would increase from 20% for those who are currently subject to the 15% rate and those eligible for the current 0% rate would be subject to the 10% rate. The most egregious taxes would be for qualified dividends. Rates would revert back and be taxed at ordinary rates. Those currently paying 0% in the 10% and 15% tax bracket would pay 15% and 28% next year. Those currently paying 15% could be pay either 31%, 36% or 39.6%. Dividend paying stocks have been in vogue these days, but this could quickly come to a halt. In addition, the phase-out of itemized deductions and exemptions would return affecting higher income households while the marriage penalty would return.

Outside of the expiration of the Bush Era tax code, there are a few other taxes coming into play for 2013. The payroll tax cut is set to expire at year. Also the 3.8% healthcare reform act surtax on investment income will start. For those who will be in the 39.6% tax bracket next year, their qualified dividend income will go from 15% to a whopping 43.4% which doesn’t take state income taxes into account.

Now there is periodic talk about extending or modifying these tax issues. But I’m not holding my breath. Election years tend to create standstill before the election. After the election, lame duck politicians are hard to rely on – especially if the power is split up between political parties within Congress and the Presidency. Rather than relying on politics and other things that we can’t control, I am advocating a more proactive approach. These are the things you may want to consider:

Tax Location: This strategy involves allocating your individual investments into accounts in a manner which optimizes the after tax efficiency of your overall portfolio. I like to call this tax account diversification as Roth IRA/401(k)’s are designed to be tax free, Traditional IRA/401(k)’s are tax deferred and then investors can also have regularly taxable accounts. You would want to be more cognizant of placing more of your tax efficient investments within taxable accounts. Low turnover stock funds and index funds and municipal bond funds (if they don’t have a great deal of private activity interest which is subject to the alternative minimum tax (AMT)) are very tax efficient in a taxable account. Roth IRA’s/401(k)’s are a great place to place the high growth portion of your portfolio. The greater the growth potential, the more potential dollars you should have for your needs over the long haul; all of this would be tax free. Mutual funds that invest in higher risk stock and commodities tend to be a good location for a Roth. Tax deferred vehicles such as Traditional IRA’s/regular 401(k)’s tend to be a great place for your slower growing diversifiers within the portfolio. Leaning slower growers in the tax deferred accounts means that less of your dollars will be subject to ordinary tax rates when withdrawn. Taxable bond funds and other high turnover/non-tax efficient strategies tend to fit well within the tax deferred account. If you have a mix of different accounts, you will find this strategy more powerful in the years to come.

Tax Gain Harvesting: Most of the time financial planners talk about tax loss harvesting. But given the higher future capital gain rates, one may want to consider taking capital gains now at the current lower rate rather than incurring a higher tax rate later in the future, especially if you were planning to incur a capital gain with an asset sale in the near future. If you find yourself in the tax bracket where you would be subject to the 0% capital gain rate, it may even make sense to incur a capital gain only to buy the holding back to create the higher cost basis for a later sale date. It may defy common logic, but sometimes the best financial strategies are counterintuitive in nature.

Roth Conversions: If you have a large portion of your portfolio in a Traditional IRA and enough funds outside of retirement accounts available to pay the tax (and if your taxable income will get hit the hardest by the tax increase), you may want to consider converting some or all of your Traditional IRA to a Roth IRA. In the future, I will discuss Roth conversions in greater detail.

Higher Funding of Tax Advantage Accounts: Higher future taxes increase the attractiveness of funding tax advantaged accounts whether they are IRA’s, employer provided retirement plans, health savings accounts, college funding vehicles and tax deferred annuities. You just want to make sure that you have accessible funds available for an emergency fund and future spending needs that aren’t subject to a tax penalty for early withdrawal. But it may make sense to keep your taxable accounts as small as possible.

Don’t Let the Tax Tail Wag the Dog: Be careful to make sure that the funding vehicle fits your goals and future needs. Often times I see people mistake tax efficiency for tax avoidance and they end up investing in areas that are a poor fit for their needs. For example I often times life insurance will be sold as an investment vehicle where a need for the actual insurance need should take precedent over the investment characteristics.

With some careful planning, there is a lot to benefit from if you think about your future tax circumstances right now. Before taking action, I would highly recommend working closely with your financial planner and tax accountant (and coordinate it so they are communication to each other as well) to see what actions make the most sense for you. With our current and projected federal budget deficits, it would suggest we will be more likely to face a higher tax environment in the future. Small tax efficient measures now could potentially make a big difference over the long term.

Time to Check Your Credit Report: Equifax

Four months ago, I suggested you request a free credit report from TransUnion. In order to take full advantage of your free credit reports, I suggest that you request a free report every 4 months, rotating among the different credit agencies each time. This time I’m detailing the process to request a free credit report from Equifax:
Here are the steps necessary:
1. go to
2. select your state and click “request report”
3. fill in your personal information, security characters from picture, and click “continue”
4. select Equifax and click “next”
5. click “next” again
6. confirm personal information and click “continue”
7. answer credit questions and click “continue”
8. choose extras if you want to pay, I never do, click “no thanks, I do not want to see my credit score”
9. click “yes” to answer 1. requesting your credit report online free for 30 days. click “no” for the rest
10. Fill in information to open an account, opt out of privacy if you want to opt out, accept agreement terms if you accept them, click “Submit”
11. click “view and print my report”

I click “print report” to get a copy for my records. This way you can compare them with previous reports you’ve received. If you find there is something amiss, contact that agency immediately.

You can contact Equifax at 866-585-9451. In 4 months I will remind you to get your report from Experian. Make sure to double check the information against accounts on this report. Finally, please forward this to anyone you think might benefit from the knowledge.

Keys to Investing in a Secular Bear Cycle

Over the past several postings, I discussed secular investment cycles and how valuations and volatility influence these cycles. The broad based domestic stock market has been mired in a secular bear market since April of 2001. Secular bear cycles produce little or no gain to many investors, but it doesn’t have to be that way. Here are five keys to investing in this type of environment.

1.) Invest Against Gut Instinct: The average investor has inflicted far more damage to their portfolio than the market has. On an annual basis the research firm Dalbar does a study that compares investor’s earnings to the average investment using the Standard and Poors (S&P 500) as a proxy. Over the past twenty years ending in 2010, the average equity fund investor made 3.83% while the (S&P 500) Index made 9.14%. Why the difference? It’s because people tend to buy and sell in extremes at the very worst time, systematically selling their losers to buy yesterday’s winners when they should be doing the exact opposite.

2.) Diversify, Diversify, Diversify: From April 1st, 2000 to the end of 2011, the S&P 500 has made a paltry .37% annually over this time frame. However, the S&P 500 alone is not a diversified portfolio. If you also invested in stocks of smaller companies and emerging markets, commodities, real estate investment trusts and bonds, you would have done a lot better than solely holding large company stocks over this time period.

3.) Employ Tactical Underlay Using Volatility and Valuations: Forward looking returns for an asset class isn’t stagnant in nature; it depends on valuations. If an asset class goes down, you should only expect higher forward looking returns (the opposite can be said if an asset class goes up in value). Below is an illustration of how this works. This graph is courtesy of the Hussman Funds and was part of their Weekly Market Comment on August 29, 2011. This outlines the projected 10-Year S&P 500 Annual Returns based on historical growth rates and the level of the S&P 500 Index. As you see, the further the market drops (horizontal line), the higher the projected rate of return (vertical line). Although the past can’t always predict the future, valuations have provided a good forecast of what to expect.

How can you take advantage of this? Rather than having a set percentage towards each asset class, allow yourself a range and tactically under or over-allocate depending on where valuations lie. For example, you can target 60% towards stocks, but allow yourself to be in a range of 50% to 70%. If stocks are historically undervalued, allocate towards the high end of the range, if stocks are overvalued from a historical perspective then target stocks on the low end of the range. To avoid timing the market, systematically review and make any necessary changes on a set time interval such as quarterly, semi-annually or annually.

4.) Acknowledge How Bad it Can Get: The chart above notes something that all stock investors should be aware of. The range of the S&P 500 in the graph depicts the historical range of valuations based on today’s fundamentals. With secular bear markets, valuations usually fall to a point where they usually end up in the lowest one or two deciles. This would suggest an S&P level of 400-600. Back in March of 2009, we reached the 665 level. Maybe 2009 was the bottom, but if we re-test lows this would be a significant decline from a current S&P 500 of around 1365. If you can not stomach the loss potential, it may be a better time to dial down your risk now while we are in historically high valuation territory than in the middle of turmoil.

5.) Invest According to Your Goals, Not the Market: Everyone has a targeted rate of return needed from their investment strategy to meet their goals. This required rate of return is dependant on the current and projected level of income, expenses, assets and debt. This return need translates into an allocation of investment classes and sub-classes. Unfortunately most people spend little time trying to figure this out – and the best way to do this is through financial planning. Instead most people let the markets dictate their investment strategy, which is relying on something that can’t be controlled. If more investors began investing on their needs rather than the winds of current market conditions, they would be a lot better off in the long run.

If you follow these steps, it will not avoid losses. But what it will do is help mitigate losses, accelerate the recovery in your portfolio and give you a better opportunity to make positive real rates of return over the long haul. For more information on market valuations, I suggest visiting Robert Shiller’s website and the CAPE Research Catalog.

Secular Cycles and Valuations

My last entry discussed how volatility is a common element in a secular bear market. The second common denominator involves valuations. Secular bear markets tend to start when an asset class has abnormally high historical valuations and a tipping point occurs where valuations begin reverting to the mean. Often times this mean reversion carries enough pessimism where the momentum depresses prices to historically low valuation levels.

For stocks, the price earnings ratio (PE) is a common way to determine valuations. Below is a chart depicting the past secular cycles in the stock market since 1901.

As indicated above, most secular bear markets ended when the PE ratio was in the single digits. The only exception was in 1941 when the PE ratio bottomed out at 12. During this secular bear cycle, the PE ratio hit a low of 13 in March of 2009. Was this the bottom? It’s possible. But with the current PE ratios at 22, I would err on the side of caution. In my next entry I will discuss the keys to investing in this type of environment.

Secular Bear Markets & Volatility

My last entry discussed how investment asset classes and sub-classes go through long term upward or downward trends called secular cycles. Within a secular bear market like we are currently experiencing now in the stock market, there are two key characteristics you need to understand and accept to be able to effectively navigate through this market environment. I appropriately call these characteristics “The Two V’s.” In this entry, I will discuss the first predominant characteristic: Volatility.

A secular bear cycle typically results in flat cumulative returns when you look at the market indices levels from beginning to end. However the path of a secular bear cycle isn’t in the least bit smooth and subtle. Secular bear markets are roller coaster rides with extreme levels of upside and downside volatility. Below is a chart depicting how the Dow Jones Industrial Average fluctuated during our last full secular bear cycle, which occurred from 1965 to 1981:

Graph Copyright ©2012,

The market action of the last secular bear market is eerily similar to the current one. The cyclical bear markets with the greatest drops in this chart could easily been mistaken for 2001-2002 and 2008-2009. The largest cyclical bull runs that followed are similar to what we experienced in late 2002-2007 and early 2009 to early last spring. I’m not suggesting that the current secular bear market will pan out exactly like the one depicted above as each secular cycle will have its unique course of action. But I would continue to expect similar market action over the course of the cycle.

The main takeaway from this is that volatility is normal market behavior in this type of regime. The more than you are able to understand and accept this, the more you can use volatility to your advantage rather than falling victim to it. In my next entry, I will discuss the second of “The Two V’s.”

Stock Market Expectations: Follow the Secular Cycle

Most people are relying on the stock market to provide for their retirement and other long term goals. However, the stock market has been nothing but disappointing for most people over the past decade. To be a successful investor, one important key is to understand the current secular cycle.

Secular market cycles are generally defined as a long term trend in which a particular asset class or sub-class is trending upward (bull) or downward (bear). Within the prevailing secular trend there is short term bull and bear markets action called cyclical cycles. Secular bulls have the higher number and more acute level of cyclical bull markets within it while secular bear markets have a higher number and more acute level of cyclical bears cycles.

Below is a graph showing the secular trends in the U.S. stock market since 1900. Over this time period we’ve had nine secular periods with four secular bull markets and five secular bear markets. Currently we are within a secular bear cycle that began in the early part of 2001.

Graph Copyright ©2012,

Secular cycles usually last from five to twenty years. If the secular bear market follows the historical norm, we are looking at a reversal in the latter part of this decade. Secular bear markets tend to begin when a particular asset class is excessively overpriced from a historical perspective and is usually coupled with some tipping point where a change in geopolitical and/or economic climate usually does not support the asset class in question. For example, our current secular bear market began with stock values at historical highs and since then we’ve experienced several recessions, sovereign debt concerns and an arguable lack of political leadership. Secular bull markets tend to begin when a particular asset class is excessively underpriced from a historical perspective with a tipping point where change in geopolitical and/or economic climate is usually positive to the asset class involved. Our last secular bull market started in 1981 when stock prices were at historically low valuations and was followed by a period of political stability, deregulation, technological innovation, inflation was tamed and the Cold War came to an end.

Why is understanding the secular cycle so important? It’s because certain strategies can be effective in one secular cycle and be less effective in another. In my next blog posting I will discuss what to expect and how to invest in difficult market environments like we are currently experiencing.

Time to Check Your TransUnion Credit Report

To protect yourself against identity theft, I recommend that you periodically check your credit reports. Every year you are entitled to a free credit report from each of the three credit reporting bureaus (TransUnion, Equifax and Experian). To take advantage of the free credit reports and monitor your credit in the shortest amount of intervals, I recommend getting your credit report once every four months, rotating this between the credit bureaus accordingly. About four months ago I wrote a blog about how to obtain your credit report from Experian. This time I will provide instructions on how to check your credit report from TransUnion. Here is the process:

1. Go to
2. Select your state and click “request report”
3. Fill in your personal information, security characters from picture, and click “continue”
4. Select TransUnion and click “next”
5. Click “next” again
6. Once at the TransUnion site, follow the prompts (skip all the extras they try to sell you unless you want your credit score)
7. Answer the verification questions
8. View and print report

Check your report and contact the agency immediately if you find a problem. I will send you a note in 4 months to remind you to obtain your Equifax report.

Time to Fund Your Retirement Account

The two biggest factors influencing how much money you will accumulate for your goals is time and the amount that you will save over this time; this far outpaces the influence investment returns have on portfolio values. For those saving for their retirement goals, the recent market decline provides a great opportunity to fully fund your retirement accounts for 2011. Rather than waiting until the tax deadline in April of 2012 to fund their Roth or Traditional IRA now may be a more opportune time to take care of this.

For those who participate in an employer sponsored retirement plan and want to maximize their contributions, this is a good time to determine if you are on target. Not only to optimize contributions for this year, but also to determine what deferral percentage you will need to maximize contributions for next year. This month, the IRS will announce if any changes will be made as employee contribution limits are adjusted over time with inflation. We haven’t had any changes over the past couple of years so I suspect that we will see some sort of increase for 2012.

Also for those who participate in an employer provided plan where the employer has matching contributions, in most cases you want to make sure you stretch out your employee deferrals throughout the year. By doing so, it optimizes the dollar amount of the employer match. Often times I will see people maximize their employee deferrals way before year end. They think they are doing the right thing, but unfortunately they end up leaving employer provided money on the table. Employees who are subject to large bonuses and/or commission have the most trouble with this as it’s hard to predict incoming earnings. Some employers are now offering programs where they will assume you are making deferrals throughout the year – providing a full match even if you maximize your contributions before year end. You usually have to sign up for this so I would take advantage of this if your employer offers this.

Finally, don’t forget about Roth Conversions. In an off-hand way, the taxes that are paid from the conversion could be considered an additional contribution. Again, with the recent drop in the market, this makes this strategy more attractive and if the market continues to drop throughout next year, you always can re-characterize the conversion before October 15th. Roth conversions usually only makes sense if you have the cash outside the IRA to pay the tax. Just keep in mind that conversions don’t make sense in all scenarios so be careful and fully think this through before executing.

Meeting goals in a low return environment requires one to save more – simple but true. In the long run it’s a lot better to employ strategies that you can control rather than relying on things outside our control (like the financial markets). If any of my clients would like to fully fund their retirement accounts or explore their options, please feel free to call or e-mail.