Target Date Funds Offer False Sense of Security

Not unlike formal living room furniture and nuclear weapons, target date funds are only to be used in case of a dire emergency. Target date funds are offered as investment options within a lot of retirement plans as low risk investments but, are they? Here are some flaws of TDF’s.

For background, a Target Date Fund (TDF) is a fund that combines so-called growth investments with fixed-income investments in a mixture that is supposed to be appropriate for investors who plan to retire in a certain year. So, presumably a TDF for people planning to retire in 20 years will invest in a riskier mixture than a TDF that is structured for those planning to retire in 5. The theory being a person farther away from retirement needs the growth assumed with more aggressive investments and a person close to retirement needs safer investments that have less chance to decline in value soon before they will need those investments for income. Thus, a TDF implies this investment is all one needs in your retirement plan and, rather than you worrying about which investments to choose, the TDF supposedly does all that for you.

TDF’s are certainly better than stashing your savings in a money market funds earning next to nothing. But, aside from that, your choices are usually much better than that.

False sense of security

All TDF’s “mixtures” of investments are different and many may have you invested more aggressively than you’re comfortable with, or realize, close to retirement. A recent review of more than 40 TDF families showed the percentage of stocks in the funds designed for those retiring in the current year ranged from about 25 percent to about 75 percent. 75% in stocks months before you retire? Are you kidding me?

Target date funds give people a false sense of security that they can stop thinking about their investments altogether because the fund will take care of them. In fact, the Wall Street Journal cited a survey by Alliance Bernstein of 1,000 workers where most “mistakenly believed that using target-date funds would guarantee that their retirement income needs will be met.” Holy financial planning, Batman, that’s scary!

TDF’s only consider your date of retirement

Planning for one’s entire financial future involves many variables – your standard of living and it’s cost, your life expectancy, your family income, responsibilities to your children and, of course, the returns generated by your investments. Unfortunately, a vital flaw of target date funds is they take only one thing into consideration when choosing the investments within the fund – when their investors supposedly plan to retire.

But, what if one invests in a TDF assuming you’ll retire in the year 2030 but then, life gets in the way, and your son takes a couple of extra years to finish college and your daughter needs a little help early in her career and, lo and behold, that 2030 goal now becomes 2035? So, rather than still investing for some growth to make up for some leaner saving years, your TDF has you invested in extraordinarily safe, low-return investments because it assumes you will retire that year and should be taking less risk. This scenario may very well leave you short when it’s time to take income in retirement.

TDF’s assume you have no other investments

Depending on one’s circumstances, it’s certainly not unusual for families to have their savings invested in a variety of accounts. Traditional IRA’s, Roth IRA’s, Joint(husband and wife) accounts, each spouse with a workplace retirement plan, etc. Another real flaw with TDF’s is they naturally assume the investor has 100% of their savings in this one investment vehicle. As a result, your total portfolio may actually be taking too much risk or too little because you are essentially blind to how the TDF is invested. Let’s say you have $250,000 in a TDF in your workplace retirement plan and another $250,000 invested in an IRA – how can you be sure they are working in concert to help you achieve your goals?


We taught our kids from an early age not to hate, so I won’t write I hate TDF’s. In fact, they are much better than just allowing your savings to languish in a money market fund earning next to nothing. But, too many people choose them because they believe their decision-making ends with that one choice. As always, reaching whatever life goals you have depends on a solid financial plan supported by a well-thought out investment strategy. On their own, TDF’s offer neither.

The Story of the $9 Million Secretary

Earlier this week, the New York Times ran a front-page story on Sylvia Bloom, the recently deceased legal secretary from Brooklyn who bequeathed $6.24 Million to help disadvantaged students afford college. Ms. Bloom was the epitome of the Millionaire Next Door and readers of this blog know I believe strongly in the ability of us “regular folk” to become one too by following a few simple rules: 1) Live beneath your means; 2) Save for your financial independence; 3) Invest; 4) Get wealthy the old-fashioned way, steadily over many years.

The Times article described Ms. Bloom’s relatives as shocked that she had amassed such a fortune. She never talked about her wealth because, according to her niece, “I don’t think she thought it was anybody’s business but her own.” In other words, her wealth wasn’t amassed to impress her friends or to purchase expensive earthly possessions. She, apparently, wasn’t motivated by nice cars, fancy vacations or a large, Manhattan apartment.

We will probably never know what truly motivated Ms. Bloom, but we can learn from her wealth accumulating strategy. “She was a secretary in an era when they ran their boss’s lives, including their personal investments,” recalled her niece Jane Lockshin. “So when the boss would buy a stock, she would make the purchase for him, and then buy the same stock for herself, but in a smaller amount because she was on a secretary’s salary.” Morgan Housel from The Motley Fool says, “…you can build wealth without a high income, but have no chance without a high savings rate, it’s clear which one matters more.” Ms. Bloom didn’t make big money, but she still accumulated big money.

A child of the Great Depression, Ms. Bloom and her husband, a firefighter, lived modestly and, according to her niece, “…she knew what it was like not to have money.” I suspect that she was motivated to save money for the same reason a lot of us are – because savings offers some peace of mind in a very unpredictable world.

I won’t ever discount creature comforts like a nice home, a functional car or a fun vacation – those things are important. But, savings provides us value too, the value of control of our time. It’s not easy to measure something that we probably won’t use until years later, but how valuable is flexibility? The flexibility to maybe take a few years off work when your kids need you the most; the flexibility to maybe take a job with a lower salary but more purpose; the flexibility to maybe leave a lasting legacy of a college education for people you will never meet – like Sylvia Bloom did.

To quote Morgan Housel again: “In a world where hard skills become automated, competitive advantages tilt toward nuanced and soft skills – like communication, empathy, and, perhaps most of all, flexibility. Having more control over your time and options is becoming one of the most valuable currencies in the world. That’s why more people can, and more people should, save money.”


When You Should File for Social Security

During the 1996 presidential campaign, MTV asked both candidates whether they favored boxers or briefs. Bob Dole, as legend has it, answered “Depends”, as in he was so old he needed their incontinence protection. My answer for when you should take Social Security benefits is the same, it depends. Ultimately, when to file depends on what will benefit you the most in the long term, an answer a good financial plan will provide.

When presenting financial plans for clients we review what they can expect to receive in income from Social Security to cover part of their needs during retirement. Almost without exception, our clients joke that Social Security will surely go bankrupt right before they need it. While one can lose a LOT of money betting on what Congress will ever do, I firmly believe Social Security will always exist – maybe in a slightly different form – and will be an important income source for most of during retirement. So, here are some key things you need to know to help you maximize your benefits:

Social Security (SS) wasn’t designed to replace all of your wages:

As a result, Social Security should not be viewed as your primary source of income during retirement. In fact, we often plan that SS essentially be viewed as supplemental payments to your income from investment assets or pension income. A decent rule of thumb is to estimate you will need to replace about 85% of your pre-retirement income during your actual retirement, at least at first. So, plan to save enough to produce most of that from your 401(k), IRA, etc. and supplement that with SS income.

Your benefits are based on your entire earnings history:

Yes, that 6.2% you pay each pay period to Social Security is what funds most of our benefits. So, your benefit is calculated on your highest 35 years of earnings. If you don’t have 35 years of earnings, your monthly benefit will be reduced.

Do you know your full retirement age for social security?

You can receive Social Security as young as age 62 but you will only receive 75% of your monthly benefit at that age. At what age you can receive 100% of your SS benefit depends on when you were born. For instance, if you were born in, say, 1955 your full retirement age is 66 and 2 months. If you were born in 1960 and later, your full retirement age is 67.

You can benefit by delaying taking Social Security:

Starting at full retirement age, you will earn delayed retirement credits that will increase your benefit by 8% per year up to age 70. For example, if your full retirement age is 66, you can earn credits for a maximum of four years. At age 70, your benefit will then be 32% higher than it would have been at full retirement age – 8% times 4 years.

Social Security benefits may be taxable:

When you begin taking SS may depend, in part, if you are still working because, believe it or not, your Social Security benefits may be taxable at the federal and/or state level. If your adjusted gross income plus half of your Social Security income totals more than $25,000 as a single filer, 50% of your Social Security benefits are taxable at federal ordinary income tax rates. For couples filing jointly, this figure is $32,000. If a couple filing jointly earn more than $44,000, up to 85% of your benefits may be taxable.

Can retired teachers receive their deceased spouse’s Social Security benefit?

As Kentucky is one of the 14 states in the country that do not provide Social Security coverage for teachers, spousal benefits of retired teachers can be impacted. The Government Pension Offset, the GPO, reduces Social Security spousal benefits by two-thirds of the monthly benefit from any government pension the spouse receives for work not covered by Social Security. For example, suppose a teacher receives a $1,000-per-month KTRS pension benefit and is also eligible for $600 per month in Social Security spousal benefits based on her husband’s employment. Under the GPO requirement, the pension offset amount is $660 (two-thirds of $1,000) per month. Since the offset is greater than the Social Security spousal benefit, the teacher receives no Social Security.

A thorough financial plan will examine these factors and more and, ultimately, help us guide you to determine when the best time will be for you to file for Social Security.

Making Charitable Contributions Under the New Tax Law

When the federal tax law changed late last year, part of the concern raised by many was the potential impact of the law on charitable contributions. Specifically, would people still be inclined to give even if they are unable to deduct them from their income taxes? Do people give because they believe in the cause or because they simply want the tax deduction? For charitable organizations, colleges and universities and other groups, these are serious questions that could materially impact their mission. So, let’s walk through the potential deterrent to contributing and offer a solution for those over the age of 70 ½.

When completing your return, you have the choice of taking what’s called the standard deduction or itemizing deductions. Obviously, you deduct the larger amount. Under the new tax law that takes affect in 2018, the standard deduction for a married couple filing jointly doubles to $24,000. Plus, the law caps the deductions for state income and property taxes at $10,000. As a result, the only way to “receive credit” for your charitable contributions now is for them to total more than $14,000 in order for your total itemized deductions to exceed the new standard deduction of $24,000. Quick, raise your hand if you’re still reading this.

Yep, this is pretty awful stuff. So, here is a crisp explanation of how to receive a tax benefit from your charitable contributions if you are over the age of 70 ½:

As you probably know, we all must start taking what are called Required Minimum Distributions (RMDs) from Individual Retirement Accounts (IRAs) in the tax year in which we turn 70 ½. Those RMDs are subject to income tax. However, one can make Qualified Charitable Contributions (QCDs) by transferring up to $100,000 per year from an IRA directly to a qualified charity. This tax-savvy strategy offers the combined benefit of satisfying your annual RMD while lowering your taxable income, resulting in a lower tax bill to you.

Here’s how it works:

Let’s say you and your spouse are both over 70 ½ and your combined RMDs total $24,000. If you wish to contribute $10,000 to say, the Y and God’s Pantry, it will reduce your taxable income by that same $10,000 and now only $14,000 is subject to income tax. And, even better, you still get to claim the standard deduction of $24,000 (plus an additional $2550 because you’re both over the age of 65) So, assuming you’re in the 24% tax bracket, instead of paying income tax of $5760 on that $24,000 of RMD subject to income tax, you would pay just $3360 of tax on the new total of $14,000 of RMD income – a savings of $2400.

This strategy is the classic win-win. 1) You satisfy part, or all, of your annual Required Minimum Distribution; 2) You reduce your tax liability by the amount of your charitable contribution just like you used to; 3) You get to take advantage of the new doubled standard deduction; and, 4) You get the satisfaction of doing good for an organization you care about.

Moneywatch Advisors manages RMDs and QCDs and many other abbreviations for our clients – call us if we can help you.


What We Can Learn About Estate Planning From Prince

Despite having an estimated net worth of about $250 Million, it has been widely reported that Prince died without a will. In other words, Prince did not make it clear legally who should inherit his considerable wealth and valuable stuff when he died. As a result, who ultimately receives his money will be tied up in court for years and years.

Now, in his defense, he may have had the same fear my wife jokes about. Maybe he thought if he wrote a will it would pave the way to his death. “You can take me now, everything is taken care of.”

Estate planning, determining who should get your money and possessions and who should take care of your minor children, isn’t a pleasant topic. So, think about it as a kind and loving gesture to those potentially left behind when something happens to you. Because, even without Prince’s wealth, dying without a complete estate plan causes turmoil to your loved ones when they are already grieving over your loss. Don’t make it worse on them.

So, here is what you should consider before getting legal help with your estate plan:

Probate: I start with probate because this is what you want to avoid as much as possible because a long, drawn out probate process – the legal process of settling debts and transferring property to your heirs – costs money and takes time. The probate process can be made easier with some simple steps. Primarily, titling your property – your money and your stuff – so that it automatically transfers outside of your will is preferable to transferring property through a will, when possible. Your 1978 Camaro is probably best left to your brother through your will. Your retirement account, however, is best transferred to your spouse or children by naming them as beneficiaries.

Who takes care of your children?: For Lisa and me, this was probably the most emotional decision we made during our estate planning process. If something happens to both of us at the same time, my brother and sister-in-law would be the legal guardians of our son. Our daughter is older than 18 so, legally, she would be on her own. Choosing the right people involves asking several questions: are they capable, are they willing and, of course, are you confident they will raise your children the way you want them raised?

For those with children with special needs, this discussion is even more critical as they may require assistance and income for the rest of their lives.

Where do you want your money to go when you die?: This is definitely a conversation worth having before you run to the attorney’s office to start drafting documents. Should it all go to your children? If your children are grown, should some go to them and the remaining amount go to your favorite charity?

Designating Beneficiaries: Much of your financial assets can be transferred automatically, outside of probate and outside your will. Take some time to make sure you have designated beneficiaries on the following: workplace retirement accounts like your 401(k) or 403(b), IRA’s, life insurance, other investment accounts, pensions, etc. This will simplify the process for your loved ones greatly.

Your Will: As I noted earlier, not all property can be transferred via a beneficiary designation, some will transfer through your will. Non-financial assets such as your cars, art, collectibles, your baseball card collection, will transfer through your will. The more you can transfer in a way other than your will, the less hassle and expense there will be for your heirs.

Trusts: Lisa and I established trusts for both the kids if something happens to both of us at the same time. That way our son’s guardian has assets and instructions on how to take care of him financially. Our daughter would also have assets to take care of her and instructions appropriate for her circumstances. Trusts are also good tools for distributing your assets and avoiding, or shortening, the probate process. In simple terms, the assets you designate would move to the appropriate trusts upon your death. It isn’t uncommon to think of a trust as something only very wealthy people have, but it is a common and effective tool for transferring property in a simple and direct manner.

There are a myriad of types of trusts that will have to wait for a blog post in the future.

The estate planning process can be quite simple or quite complicated, depending on your personal circumstances and needs, but it is important. This post merely scratches the surface of the important topics you should consider as you begin to plan. For more help, a comprehensive financial planning firm – hey, I know one – often helps their clients prepare their thoughts for the attorney who will actually complete the legal documents necessary to carry out their wishes.

The Stock Market is Volatile This Year: My Concerns

I love it when we’re about to experience a weather “event” – and when did a snowstorm become a snow “event”? What does that even mean? But, I digress. It’s fun to watch the competing weather forecasters on local TV: which one takes his jacket off first, which one rolls up his sleeves first, when does she announce she’ll be in the studio all night just for us? And, don’t forget, run to Kroger and get all the bread and milk your arms can carry!

During 2018 the stock market has ignited the same kind of breathless commentary from the financial press. Rising inflation, a potential impending trade war with China and others, and potential military conflicts with North Korea, Syria and Russia have sent the stock market rolling like the Banshee at King’s Island. 2017 saw the market at its most docile in more than 50 years. In fact, during the year the S&P 500 didn’t move 2% – up or down – in a day even once. This year? The market has already moved more than 2% in a day seven times! Similarly, last year the market moved at least 1% only 8 times. We’ve seen that 24 times already this year. But, even after enough head-jolting to make an astronaut sick, the S&P 500 is only down a little more than 1% for the year. Yawn.

So, why am I concerned?

Because the last 9 years has essentially been a steadily-climbing Bull market with few ups and downs and I’m not sure people are emotionally prepared for when a Bear market arrives. Notice I say when, not if. Nor are many of them invested properly to blunt the effects of a market collapse.

Let’s face it, if you’re in your early 40’s you probably didn’t really feel the impact of the 2008 market collapse of 40% because you probably didn’t have that much invested then. So, it’s natural to assume that this investing thing is really quite easy. You automatically save through your workplace retirement plan – a 401(k) or a 403(b) – and watch it grow each quarter. Hey, I’m good at this!

Similarly, if you’re in your late 50’s or early 60’s and contemplating retirement, you probably do remember the 2008 collapse but now a decline of your savings of 40% might materially change your retirement plans. Are you invested properly for that?

Here is why this matters:

To use a round number, if you have $100,000 invested in funds that move with the stock market, a decline of 10% will reduce your investments by $10,000 to $90,000. However, after that happens the market must increase by 11.1% to get back to your original $100,000 – a 10% increase, or $9,000, won’t do it. Ergo, in the long run one will be better off if their portfolio doesn’t experience the full swings of the market but, instead, charts a smoother path.

So, what to do:

1. Diversify your portfolio. I know, you saw this coming. But, hear me out. You might be surprised to learn that many people believe diversification means having funds in different accounts. Their thinking may be that if their IRA declines, their 401(k) might not. That’s not diversification. Your portfolio is comprised of all your investment assets, wherever they may be held. True diversification, then, means holding some in mutual funds that invest in companies within the stock market and others in investments separate from the market, such as bonds.

Now, this is more difficult than it sounds. While your ultimate goal is to invest in some funds that zig when the market zags, how much should you put in each? Some experts believe that 70% of a portfolio’s performance depends on this asset allocation – how much is invested in stock funds versus bond funds, real estate, or international funds. At Moneywatch, we spend a lot of time analyzing the funds we recommend and how correlated they are to each other.

Overall, how your portfolio is constructed depends on your age, circumstances and personal goals and should support your financial plan.

2. Review your portfolio periodically and rebalance if necessary. Review the performance of your individual investments at least annually and compare their performance to their benchmarks. Don’t just select them once and forget them. Then, look at your entire portfolio again as a whole to evaluate whether each asset class – stock mutual funds, bond funds, etc. – is invested as a share of your portfolio the way you intend. As valuations fluctuate this asset allocation tends to get out of whack and you may be taking on too much risk when the market climbs or not enough when it has declined.

3. Finally, don’t panic or overreact. The financial media live for market volatility because it gives them something to talk about. Sell this or buy that is their equivalent of telling you to buy bread and milk. If your portfolio is properly structured to support your financial plan then it’s also built to weather the inevitable storms. If that’s the case, blow off CNBC and watch Homeland, much more entertaining anyway.

If you haven’t really looked at your portfolio as a whole – all your investment accounts – now is a good time to do that. You never know when that extra bread and milk will help you through the storm.


My Favorite Lexington Charities and Why We Give

I often tell my kids the best way to make yourself feel better when you’re down is to do something nice for someone else. It may be counter-intuitive, but it really works. Feeling sorry for yourself when you’ve had a bad day – or bad week – only makes you feel sorrier for yourself. Doing something nice for someone else, however, even as small as holding a door or complimenting someone on their appearance, can help you snap out of your funk.

From a financial planning perspective, saving and investing for our financial freedom is important but so is the personal satisfaction of helping others along the way. Webster defines altruism as “unselfish regard for or devotion to the welfare of others.” I don’t think that really captures the full value of charitable giving, though. Let’s face it, we humans are communal animals who would find life intolerable without others. So, any act of kindness isn’t “unselfish” but, rather, quite selfish because we derive great joy by doing something nice for others. The fact that helping others also helps us doesn’t diminish the act, it’s what makes communities work.

So, the two following organizations are special to me, here are their stories:

YMCA of Central Kentucky:

Did you know no one is ever turned away from the Y because they can’t pay? The Y’s Annual Giving Campaign raises over $500,000 each year to help children attend summer camp or take swim lessons if their families can’t afford it. Membership dues don’t pay for this, only dollars raised from this campaign. This is what makes the Y something much more than “swim and gym” and what makes it so special.

At the High Street Y a woman came to our board meeting a couple years ago to thank us for the support she received for providing swimming lessons for her autistic son. She told us that people with autism are naturally drawn to rivers or swimming pools because of the calming effect of the water and, as a result, drowning is one of the leading causes of death among autistic people. She lived in constant fear that she would be separated from her son and he would flee to an unsafe situation, but she couldn’t afford swim lessons for him without help. Now, I don’t know about you, but my memory of swim lessons is an experience filled with cold water, fear and sensory overload – not a good combination for an autistic person. She described her son’s swim lessons at the Y, however, as a soothing exercise where the instructor met her son where he was and helped him learn at his pace. Now, she said, not only does she no longer live in fear for her son’s safety, but he loves swimming.

You may contribute to the Y Annual Giving Campaign here:

God’s Pantry Food Bank:

You may be surprised to learn this, as I was, that in Fayette County approximately 50,000 people are considered to be “food insecure.” Of those, approximately 11,750 are children. What is food insecurity? The USDA defines it as “consistent access to adequate food is limited by a lack of money and other resources at times during the year.” I don’t know about you, but I find it astounding that 50,000 people in Lexington, Kentucky struggle to put food on the table. And I know for a fact that those almost 12,000 kids will have difficulty learning if they are hungry.

In 1955, a woman named Mim Hunt began distributing food out of her basement to those in need of assistance. That initial effort grew and grew and became what we today know as God’s Pantry Food Bank. Today, over 121,000 meals per DAY are provided to people in need across 50 central and eastern Kentucky counties. The Food Bank has a network of more than 300 partner agencies, including food pantries, soup kitchens and shelters, who can order what they need through an online ordering system so they may deliver it to all corners of this huge territory.

This year God’s Pantry will distribute over 25 million meals. While roughly half of the cost to make this happen comes from USDA commodities – essentially food from the federal government – donated food will amount to over $15 Million and contributions from people like you and me will total over $3 Million.

If you’d like to join me, $40 will pay for 320 meals for hungry children; $70 will pay for 560 meals for struggling seniors, $150 will provide 1200 meals at an abuse shelter and $500 will provide 4,000 meals for families struggling with job loss. Contributing online is easy here:

My advice? Find a cause you believe in and donate your time, talent and treasure. It’s a selfish act, but you’re worth it.