Weekly Market Review 12/14/2018

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Domestic markets endured another uneventful week, with two of the three major US indices posting losses over 1% for the period. Coming into the month of December, we were told how, historically, this is a bullish time of year for equities. Unfortunately, “historically” is just another term for “average” and while December may typically be a strong month, that was not the case this year. It’s usually a positive month, rarely negative. But it looks like 2018 will not see a normal December, which would make sense considering how the full year has played out in general.

 

Trade tariffs continue to garner the most attention in headlines. The market tends to have large, upward swings on positive news regarding the US-China debacle, but they are short-lived, as many feel these positive updates simply fall into the “boy who cried wolf” category at this point. We may not see a sustained move in either direction (up or down) until some kind of formal agreement has been reached between the two parties.

To add to the worries, signs from abroad have not been much better. British Prime Minister Theresa May has fallen on tough times in regards to her Brexit battle, now fighting for her own political life. This week, a right-wing faction in her own party triggered a “no confidence” vote following May’s decision to postpone the debate over a deal that could have finally brought closure to the issue as a whole, which initially arose over two years ago. In China, weak economic data shows that the trade tensions are severely affecting their economy, with weaker than expected industrial output and retail sales numbers. On top of this, the reports out of Europe weren’t any better. In fact, the German and French private sectors (arguably the two most important in the Eurozone) are trending downwards in terms of growth. Further, Italian debt issues keep the country on the brink of recession. Despite the headline worries and weak economic showings in foreign economies, the US data continue to produce strong numbers, although some areas are starting to slow. Retail sales remain high, while manufacturing and service sectors output fell to new lows. We are still in an expansion, albeit at a slower than what we have been accustomed to over the past few years.

 

Where is Bitcoin?

Last year’s favorite asset, Bitcoin, is now down over 70% on the year, back to the $3300 area we saw last July 2017.

If your goals for your assets have changed, if you believe your risk tolerance may not be in line with the drawdown you’ve seen in your portfolio recently, or if you just want to talk about your individual situation this is a great opportunity to let us know.

Weekly Market Review 12/07/2018

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We experienced more of the choppy environment in equities this past week. Although these types of swings are more common than many realize (remember, the low volatility environment of 2017 was the real anomaly), we understand that large down days in the market can be bothersome. Most of the drama occurred early on Monday, after positive news that the US and China were inching closer to a truce on trade. As expected, the market didn’t end up buying into the hype after having the “rug pulled out from under them” with similar news being released over the past couple of months and the market selling off after each quick jolt. To make tensions worse, we saw more political chest-puffing, when the CFO of Chinese Tech giant Huawei was detained in Canada on Tuesday night. However, according to the White House, the trade talks and the arrest of the Huawei executive are separate issues altogether. The conflicting positive and negative news has kept us in a large trading range over the last two months, as you can see below.

The US unemployment numbers posted a decent increase this past week, with non-farm payrolls increasing for the 98th month in a row. This is by far the longest streak of month-over-month job growth in history. Average hourly earnings also saw a small bump. The overall unemployment rate still stands at 3.7%, the lowest since 1969. Interestingly enough, a separate gauge that includes discouraged workers and those holding part-time jobs for economic reasons, sometimes called the real unemployment rate, rose from 7.4% percent to 7.6%. I would also like to take this time to point something out for those of you who may be hearing (or reading) a lot lately on the yield curve and how it relates to the US economy.

US interest rates continue to move lower following Fed Chairman Powell’s speech in which he felt that rates were “neutral” in accordance with where we are in the economic cycle. In layman’s terms, he says the Fed sees the current stream of economic data as remaining positive and thus there is no need to rush to raise interest rates, which would theoretically keep the economy from “overheating”, or growing too quickly. This should help damper fears for prospective homebuyers, as many have felt they’d “missed the boat” in regards to purching a home in the near future since mortgage rates had been on the rise

Two closely-tracked energy commodities (due to the fact that they are commonly purchased by a large number of households) have been moving in opposite directions lately and continue to do so. First off, crude oil prices have fallen from $76 to $50 per barrel recently, which should cause some relief at the pump for consumers. In fact, national gasoline prices fell to $2.46/gallon, a new low for 2018. A main cause of the lower prices has been the massive over-production here in the US. On the other hand, natural gas prices have seen a large spike over the last few weeks, in large part due to the lowest stockpiles of gas in nearly a decade. So, while you may be saving money when you fill up your car for a long road trip over the holidays, you may see a higher natural gas than usual as we go further into the winter months.

If you are feeling a little antsy over the recent market volatility, I would like to bring your attention to the chart below. The average intra-year drop on the S&P 500 is roughly 14%. So far this year we have experienced two declines, one of 12.8% (January – February) and one around 11.3% (October). Both are below the average. These types of swings are experienced on an annual basis. Due to the fact that 2017 was such a low volatility year (as mentioned above), recency bias has kicked in and has many believing that the 2018 environment is seeing above-average fluctuations. It is not. However, if your goals for your assets have changed, or if you believe your risk tolerance may not be in line with the drawdown you’ve seen in your portfolio recently, this is a great opportunity to let us know.

Is Your Mutual Fund Tax Efficient?

Well, it’s that time of year again. That time when mutual fund companies report distributions for capital gains taxes. Just in time for the holidays and a total buzzkill on all of that discretionary spending you planned on participating in.

 

“But I’m in a Buy & Hold portfolio and didn’t sell. How can I have a taxable gain?” Ah, this is where one of the (many) hidden flaws of investing in mutual funds comes into the picture. It’s not about what you, the investor and shareholder, buy and sell. It’s about what happens behind the curtains of the fund you’re invested in. Probably not something your advisor has taken the time to explain to you.

 

A capital gains distribution is a payment to shareholders that is prompted by a fund manager’s liquidation of underlying stocks and securities in a mutual fund or derived from dividend and interest earned by the fund’s holdings minus the fund’s operating expenses. Further, these distributions must be made because tax law dictates that substantial portion of investment income and capital gains must be paid to investors.

 

“But my return on the fund is essentially flat (or negative) for the year. Why is the distribution so high?”

 

Again, this is one of the most frustrating things about mutual funds and why they are, for the most part, terribly inefficient from a tax perspective. Regardless of how long the investor owned the fund, the distributions are taxed based on how long the fund itself held the sold holdings.

 

Can you imagine owning a fund that returned 1-2% in 2018 and being told you are going to get hit with a 10% (or even larger in some circumstances) taxable event? It’s not even your choice. Was your “buy and hold” game plan specifically built to be tax-conscious? Well, maybe in theory it was. But reality is different. Even many Vanguard mutual funds are paying massive distributions in 2018. This is a big deal for investors with assets in accounts that aren’t a 401(k) or IRA.

 

In an excellent piece by Christine Benz earlier this month, she points to the fact that “many mutual funds are likely to dish out capital gains distributions that are on par with–or even higher than–years past adds insult to injury.” Mutual funds that need to raise cash can sell profitable investments and create capital gains for investors, even if the fund has performed poorly. This means you can lose money on an investment in a mutual fund but still end up owing taxes. As I mentioned above, capital gains in a mutual fund get passed along to its investors.

An interesting article put out by ETF Trends states that ETFs have tax efficiency built into the structure. The “exchange traded” attribute of the ETF structure allows investors to purchase and sell shares without creating or redeeming small odd-lots. This is very different from mutual funds where every day mismatched buyers and sellers force transactions and tax implication in the underlying fund. The tax implications from these transactions become liabilities to those still holding the mutual fund shares. Furthermore, the creation and redemption process, which allows for in-kind transaction with Authorized Participants (APs) can further reduce the likelihood of creating a distributable capital gain in the ETF structure.

With all this said, I again point to the fact that ETFs, particularly from a taxable income standpoint, are much more optimal for investors over the long term. There are plenty of other arguments (closet indexing, high(er) fees, diversification, etc.) of why we continue to promote the use of ETFs over mutual funds, but tax consequences are by far one of the top reasons we advise clients to steer clear. Forget Sharpe Ratios and standard deviation statistics, if you want to talk about risk…it’s simply not worth the risk of getting hit by a major taxable event. Remove those possibilities from your game plan and look to ETFs as the proper vehicle to reach the goals you’ve set for your portfolio.

 

If you would like to have your portfolio analyzed for fees and tax efficiency schedule a time to chat with us here 

The 2019 Contribution Limits Are Here!

Great news for savers! The IRS announced today that taxpayers will be able to contribute $6,000 to their traditional individual retirement accounts in 2019, up from the $5,500 level in place since 2013. Participants in 401(k) plans will be able to set aside up to $19,000 before taxes next year, up from $18,500. This is a huge positive and should be taken advantage of and we will use these figures to start planning for your 2019 budget and retirement goals.

 

  • The salary deferral limit for 401(k), 403(b) and 457 plans increases to $19,000.
  • The SIMPLE deferral limit increases to $13,000.
  • The annual additions limit for defined contribution plans increases to $56,000.
  • The annual additions limit for defined benefit plans increases to $225,000.
  • The annual compensation limit increases to $280,000.
  • The Social Security Wage Base increases to $132,900.
  • The compensation limit for determining who is a highly compensated employee increased for the first time in five years, and is now $125,000.

For the full list of changes here is the IRS announcement 

Be on the same team! Talking about and managing finances together

Money woes are the leading cause of divorce in American couples. Over ⅓ of people in the United States have stated that financial pressure was the biggest challenge their marriage has faced in the past, and ¼ of Americans have said most of their arguments are money-related. As a financial planner, I work with a lot of couples – and I’m always surprised by how few of them have actually had an honest conversation about their money.

 

The old saying holds true when it comes to household finances – communication is key. When you work toward creating a financial plan with your spouse, you need to talk to each other about expectations, frustrations, and any goals or dreams you may have. That being said, money conversations can also be incredibly uncomfortable – which is probably why so many American couples avoid them altogether. Knowing what you’re walking into, and how to best talk about money with your spouse ahead of time, can help you have a productive conversation.

Know Yourself and Know Your Spouse

Everyone likes to point fingers when it comes to money because it’s frustrating to admit our own faults. We may be harboring some guilt around unhealthy spending habits, or be embarrassed because we don’t know as much as we think we should about saving for retirement. On the other hand, our money mindset may be a direct result of how we were raised – and it may be different from how our spouse approaches their finances.

 

Understanding where you fall down when it comes to your personal finances is key in order to talk to your spouse about building a financial plan that’s going to work for your family. When you know your own flaws, you’re able to create a plan of action that helps you to stay on track – which is something your spouse will appreciate. It’s also important to understand your spouse’s money mindset, as well as their financial strengths and weaknesses. Having a clear understanding of how each of you approach financial decisions, or value your money will help you to align your vision for the future (and avoid arguments down the road).

Approach Financial Opinions With No Judgement

Personal finance is always emotionally charged. Everyone has opinions on how money should be handled, and often they differ dramatically – even between an otherwise compatible couple. Money conversations between two spouses who have different opinions about money can evolve into arguments quickly. The key is to approach all financial opinions your spouse may hold without judgement.

 

On the surface, this sounds easy – it’s not. For example, if you firmly believe in paying down debt and living a debt free lifestyle, but your spouse sees the benefit in carrying some debt and would prefer to prioritize saving before debt repayment – you may find yourself falling into the trap of judging them for their opinion because you strongly believe that yours is “right.” The truth is, when it comes to money, there are no “right” opinions. Opinions are just that – opinions. They’re based on a value set and history that someone has with their personal finances. They aren’t fact, and they aren’t “wrong.” Knowing that your spouse’s financial opinions aren’t right or wrong (and neither are yours) can help you move through conversations without assigning emotional value to their ideas.

 

It’s also important to avoid judgement of each other’s financial past. For example, 1 in 8 divorces are directly caused by student loan debt. The pressure that hefty debt, a lack of savings, or other financial missteps you bring to the table can potentially alienate your spouse. Working together to be on the same “team” when it comes to addressing these money woes is key.

Set Goals Together

As you’re discussing your family’s finances, you’re going to come to a point where you need to set goals that you’re working toward. It’s tempting to set individual goals and work independently toward them, but that’s a recipe for financial dissonance in your household. Talking through your money goals, and working to align them with the values you share as a couple, can help you lay a foundation of financial peace in your home.

 

When you set financial goals together as a married couple, you’re actively working to approach your money situation as a team. You’re building a safety net that protects both of you, planning for the lifestyle you want as a unit, and staying honest with one another. Once you’ve set goals as a team, you can move forward with creating a game plan that puts you on the path to reach those goals. This might mean creating a household budget, setting up automatic payments to knock out your debt or build up your savings, or building in “rewards” like a date night once you hit smaller milestones on your way to your long-term goals.

 

If you’re struggling to find common ground when it comes to your  money, talking to a fiduciary, fee-only financial advisor can help. An impartial third party can often guide you in taking the emotion, or blame, out of your personal finances and help get you and your spouse on the same team when it comes to your money.

Good Judge-ment Means Good Planning

Were you surprised to learn that Brett Kavanaugh, a Supreme Court justice nominee with an annual income of $247,000, could have racked up debt and saved so little for retirement? 

A recent article in Vanity Fair reports that the Washington native accrued between $60,000 and $200,000 on three credit cards and a loan for Washington Nationals tickets as well as home improvement loans. While it’s not hard to imagine going into debt living in the DC metropolitan area, it is surprising to think that we may be investing our money more wisely than someone appointed to the highest judicial bench in the land. 

Brett Kavanaugh’s story unfortunately is not unique. According to a CNBC article 35% of all adults in the U.S. have only several hundred dollars in their savings accounts and 34% of Americans have NO savings at all.  Even 40% of Baby Boomers are not ready for retirement. This shouldn’t be shocking when you look at the savings accounts (or lack thereof) for the vast majority of Americans. According to the EPI, nearly half of families have no retirement account savings at all, including IRAs and 401(k)s.

The median retirement account for U.S. families is just $5,000. Even older workers who can see retirement on the horizon aren’t prepared for it. The median savings for families whose wage earners are between 50 and 55 is only $8,000. For those who are between 56 and 61, it’s $17,000.  That’s not anywhere near enough money to get you through your golden years.

The good news is that this crisis can easily be rectified with self-discipline.  If you can commit to saving only 6% of your salary, or 3% with a match by your employer, you will be able to see the money add up over time. Using a $76,000 annual salary as a basis for our calculations, if you begin saving 6% of this at age 25 (about $760 a month), you will amass nearly $600,000 when you are ready to retire.

It isn’t too late for our potential Supreme Court justice to begin either. With a simple savings plan and some smart budgeting, Judge Kavanaugh will be able to contribute more towards his retirement account, while still managing to keep his kids at Blessed Sacrament School and cheering on his beloved Washington Nationals (a passion those who know me know I share.)

  

Entrepreneurs and Investors: Keeping your eye on the endgame pays off

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Let’s face it – we live in a world where people expect their needs will be met with instant gratification.  Social media, online shopping and the availability of having access to everything right at our fingertips means that consumers have high expectations that their needs will be met immediately without having to wait for what they want.  Unfortunately, these kind of short-term reward expectations can have drastic consequences for us both personally and professionally as well as for the economy overall.

When we focus on the short-term gain instead of the long-term goals for ourselves or our businesses, we deprive ourselves of the full benefits (like all of the compound interest) that can come from patience and being self-disciplined when working toward our future goals and we wind up hurting the economy as well. We recently wrote about the benefits of investing for the long-term and in tribute to our beloved Washington Capitals and DC sports in general, patience pays off and success is the reward. We hope they win the cup after 20 years!

I can attest to keeping a long term vision through the building of my own business, as years of hard work and sacrifice have gone into growing Sherman Wealth Management into what it is today.  I did not start out reaping the benefits of my efforts right away. It continues to take a lot of patience and planning to grow my company into the vision I have for it long-term.  Along the way, I get positive reinforcement that this slow and steady strategy is paying off. In fact, I was just named one of the Top 100 Financial Advisors by Investopedia which certainly did not happen overnight.

Building my company brick by brick and keeping my eye on the endgame is what allows me to successfully grow my company day by day.  What if all workers viewed their endgame instead of what they need immediately? Investing in the future is the only way to make sure your endgame is what you want it to be.  Resist the “I need it now” mentality that our culture pushes and shift your mindset to an endgame view.

Instead of solely focusing on short term profits, companies should look more at their long-term strategy, growth and sustainability.  In this article by Jamie Dimon and Warren Buffet, the pitfalls of what happens to the economy when looking only at the short-term is examined.  The compound interest that can be potentially generated from funds invested for the long-term is lost when companies are focused on the short-term fluctuations of the market. The article states that “Short-term-oriented capital markets have discouraged companies with a longer term view from going public at all, depriving the economy of innovation and opportunity. Fewer public companies has also meant fewer opportunities for retail investors to create wealth through their 401ks and individual retirement accounts.”

What does your endgame look like?  Can you envision kids’ college tuition paid for, a beach house, summers off or traveling the globe?  It is never too late to change your mindset and your daily habits to achieve your dreams.

Patient Investors Come Out on Top

Many feel they don’t have the money they need to invest, so they forego savings altogether. Sound familiar?

If this is you, the time has come for you to stop shooting yourself in the foot, and start saving today. Consistency while saving is key, and can make all the difference over time. Each dollar that you contribute to your portfolio adds up. In the long run, your investments early on can make a real impact, and when the time comes to withdraw your hard earned savings, the interest you’ve earned on your investments will help to provide a comfortable retirement or any long term goal you might be saving towards.

Start Saving Now

Consider the difference of waiting to begin saving. At age 27 you will need to put away $214 a month to reach a goal of $1 million. When you start at age 37, you will need to put away $541 a month to reach your goal. If you wait until age 47, that number rises to $1,491 a month and if you wait until age 57, you’ll need to put away a hefty $5,168 a month. Waiting until the last minute (age 62) would mean having to stash $13,258 a month to reach $1 million by the age 67 – ouch!

When you factor in things like compound interest, the negative impact of delaying your retirement savings becomes increasingly obvious. Compound interest is often compared to a snowball. If a 2-inch snowball starts rolling, it picks up more snow, enough to cover its tiny surface.

As it keeps rolling, the snowball grows, so it picks up more snow with each revolution. If you invest $1,000 in a fund that pays 8% annual interest compounded yearly, in 10 years you’ll have $2,158.93, in 20 years that will be $4,660.96, in 30 years it will be $10,062.66, and in 40 years it will be $21,724.52. It takes patience, but with time you can turn $1,000 into $21,724.52. That sounds like a lot of money, but if we’re being realistic, $1,000 is often spent on:

• A weekend skiing with friends
• A few months of dining out with friends or your spouse
• A new piece of furniture, or tech that you may/may not need

By hitting “pause” on these non-essential goals, you can easily start saving today and take advantage of compound interest.

No matter where you are right now, the crucial point is to begin putting money aside immediately to achieve your long-term financial goals.

What are your future goals?

Travel? Education for your kids? Paying off your mortgage?

Even when you contribute a minimal amount annually, if you’re consistent with that contribution over many years, the growth your investment will make can maximize your wealth in the long ron.

The idea that you don’t have enough money right now to make your investment worthwhile is hurting you and your future. Resist the urge to overthink how much you are investing, and just act by giving what you can to your future savings today. Remember: every dollar counts, and the satisfaction of watching your investment grow over time will give you peace of mind and a freedom to plan for the future.

Don’t Jump Ship When Things Go South

Many investors view themselves as being rationally-minded individuals who don’t take sudden action when the markets become turbulent. Too often, though, people do try to time the markets, and wind up making a wrong decision as a result.

Derek Horstmeyer of the Wall Street Journal writes “Most investors think of themselves as rational and immune from the behavioral elements that periodically roil markets. Human factors, however, do continue to affect our personal portfolio decisions—usually to the detriment of our long-run returns.”

Thinking too much about the “perfect timing” when growing our portfolios is a strategy that will more often than not cause people to lose money in the long run. A far better investment plan is to focus on the big picture, and less on a perfect portfolio – where every decision is made at the exact right time.

Timing the market is less important than time in the market, and getting caught up in getting that “perfect timing” is almost certain to cost you money. Aiming toward a good, solid return on your investment is a smarter strategy than worrying about every detail affecting your portfolio. All too often, people panic as soon as things start to go south (pulling out when the market has already hit bottom and putting in more when at the top). As a result, they often don’t experience this stated return in full. By resisting this urge to make a rash decision, investors showing behavioral restraint may actually wind up saving 1-2 percentage points a year.

Starting early is a critical component to a successful portfolio. It is never too late (or too early) to start, so the sooner the better. Beginning in 2011, studies were conducted where participants were shown a computer generated rendering of what they might look like at their age of retirement. They were then asked to make financial decisions about whether to spend their money today or save that money for the future.

In each study, those individuals who were shown pictures of their future selves allocated more than twice as much money towards their retirement accounts than those who did not see the age-progressed images. Seeing the images gave the participants a connection with their future selves that they did not possess before. As a result, their saving behavior changed dramatically because, “saving is like a choice between spending money today or giving it to a stranger years from now.”

Picture Your Retirement

Instead of viewing your future self as a stranger, think of how you actually might look. Then think of the financial decisions you are making today and how they will affect you in the future.

Are your spending and saving habits today matching up with how well that future self is able to live tomorrow? Every delay you make toward saving for retirement, or investing wisely means a further burden you will place on yourself later on. In fact, starting your retirement saving early is actually more important than earning higher returns at a later date.

The importance of starting now can’t be stressed enough. Luckily, fee-only, fiduciary advisors exist to help everyday people in making wise choices and to lessen the anxiety associated with what can seem like an overwhelming task.

The good news is you don’t even have to be a millionaire to get this customized service. Working with a professional will enable you to maximize your return on investment and tailor a savings plan just for you. Don’t delay getting started. The benefits of starting early and often far outweigh how much you actually save.

Wants vs. Needs; Simplifying your Financial Plan for a Happier You!

We hear from prospects all the time “ I manage a complex budget for my firm, yet I just can’t seem to sift through my personal finances.” Welcome the financial planner to your life. It may sound like a foreign concept to some, but for many simply having their own emotions attached to their personal finances, make it too close for comfort. They say anytime emotions are involved logic can go out the window. Let us help remind you of the logic of needs vs. wants.

 

What is a need? Human basic needs are as simple as food, water, and shelter, therefore, your monthly mortgage or rent payment, monthly food and beverage expenses, and we can also add transportation i.e. car payment, insurance, and gas all go into this category. What may seem shocking to some is that everything else is a want. In the complicated consumer driven world we live in it may be hard to fathom, but if it isn’t necessary for your survival it is a desire, not a necessity. And furthermore, if it’s a materialistic good rather than an intangible experience, experts say you probably won’t even miss it.

 

Ok now that we’ve defined a want and a need, lets practice an exercise. According to David Bach, author of “The Automatic Millionaire” “Becoming rich requires nothing more than committing and sticking to a systematic savings and investment plan” https://www.cnbc.com/2018/01/17/self-made-millionaire-got-life-changing-money-advice-at-age-7.html Ready to get started now? Take out a piece of paper and pen. Create two categories; wants and needs. Start listing everything you spend money on in a month. Determine whether it is a want or need. Create another list. Write your future goals. Picture yourself taking the vacation you’ve dreamed of for years, or retiring early. Whatever your goals are, visualize yourself completing them. Now return to your list of wants and needs. How can you “trim the fat” on your daily spending habits so you really can save more for the things that will fulfill you later. For example : One easy fat trimmer is to shop around for things you already are paying for. Items such as your cell phone, cable, internet, and insurance can easily be shopped around for a lower price. Visualizing yourself completing your long term goals can help motivate you to sacrifice temporary gratification for something that may lead to a happier you in the long run. Now you can put more towards your retirement, so you can vacation permanently, sooner!

 

Finally, what tools will you need to implement to further achieve your goals? Personally, my wife and I are big fans of technology that track our spending, keep us honest and transparent by categorizing each purchase through linking our credit card spending and automatically deducting the budget category the purchase must be subtracted from. Theres nothing to hide when you make a budget, add all of your credit cards, and promise to stick to it. We’ve also found that being realistic and making achievable goals ensures we are more successful, but you know what makes us the most successful? Having a financial plan! Sherman Wealth Management uses tools that will link users accounts so we have access to your budget and balances and can help you come up with a financial plan right for you. Also by hiring a fee only fiduciary financial advisor whose emotions aren’t involved in our spending habits we’ve no longer clouded our logic.

 

Still have your reservations? A study at Princeton found that every 10% rise in annual income moves people up the life satisfaction ladder the same amount, whether they’re making $25,000. Or $100,000. “High incomes don’t bring you happiness, but they do bring you a life you think is better.” That being said; What if we all gave ourselves a 10% rise in income by trimming the fat in our expenses and adding the profit to our bottom line further assisting us in accomplishing our goals.  What if we found that we possess the power and control to increase our actual happiness by simply living with less, saving more, and reaching our goals by following through with them? And what if by living with less we are more fulfilled.  Studies have proven that having less and living more simply does lead to greater overall life satisfaction.

 

Feeling like you could use some help? Sherman Wealth Management is a fee only firm that specializes in financial planning. Schedule a free consultation via this link and please remember that if you aren’t fulfilled and meeting your goals, neither are we!

How Compound Interest Can Help Build Wealth

“Winning the lottery is crucial to my retirement plan.”

Does it surprise you to hear that this is a real quote from an American worker? Sadly, it’s not just one person’s perspective. It’s a sentiment that is shared by the 40-50% of Americans who believe that winning the lottery is the only way they can get what they need for retirement.

The odds of winning a Powerball have recently been calculated to be 1 in 292,000,000. As a financial advisor, I am frustrated by an investment strategy that is based on a verifiably unrealistic longshot. That frustration is only compounded by the fact that there is a simple solution! The real winning ticket to ensure you can live comfortably in retirement is not a lottery ticket, but rather a concept you likely have heard of but brushed aside: compound interest.

It’s Been Said That Albert Einstein Called Compound Interest the Eighth Wonder of the World

And even if he didn’t, it’s still a brilliant investing tool. Simply put, compounding is a process which generates additional return on an asset’s reinvested earnings. To be effective, it requires two simple things: the reinvestment of earnings, and time. If properly managed, compound interest can help your initial investment grow exponentially. For those of you who enjoy math, here’s the formula:

Ending $$ = Beginning $$ * (1 + return) ^ total time frame of compounding

While this is a useful strategy for all investors, for young investors in particular, it is the greatest investing tool for long-term growth, and the #1 argument in support of starting as early as possible. Just look at the graph below, which represents the growth of $100 over 30 years:

 

You can see that without reinvestment, the return potential is significantly reduced no matter what the rate of return is. This is important to understand because many investors are tempted to capitalize on their gains too early. The results reflected in this graph make it clear that choosing to instead reinvest those gains is going to make a significant difference in the long run.

The best advice for how to implement this strategy and maximize your long-run returns is to (1) postpone gains, and (2) rebalance efficiently. When tempted to take a short-term gain, always ask yourself: do you really need to sell? If not, don’t. Committing to a long-range investment strategy will make a world of difference in your returns. And when rebalancing, instead of creating a tax event by taking gains, consider allocating future proceeds into holdings that have underperformed.

Compounding interest becomes more complicated when the effect of taxes is factored in. Investors are often not able to reinvest all of the money that has been paid out because the government takes its cut. In order to get around this, you should try to minimize the effects of taxes by putting money into tax efficient accounts; ensuring that tax inefficient assets/strategies are in kept in retirement accounts; allocating assets to tax efficient areas of the market such as municipal bonds and real estate; and utilizing ETFs to delay tax events for stock holdings.

You don’t have to be Einstein to understand the power of compounding interest. Instead of putting your fate in the hands of the lottery, take control of your retirement plan through smart, well-thought-out investment decisions. If you have any questions, don’t hesitate to reach out to us here.