Market Correction – Do Not Let a Market Drop Ruin Your Long Term Investment Plan

The S&P500 has now officially dropped 20% from its market high. It has exceeded the 14% on average drop. Its now officially a correction. I have said multiples times over the past 10 years that most pullbacks are temporary and we should not try to time the stock market. That has proved wise as we experienced a 16% drop in 2010, a 19% drop in 2011, a 10% drop in 2012, 12% drop in 2015, 11% drop in 2016. Each of those times, we were better off assuming things would not get worse.

Last September/October when I wrote that we need to be patient as the drop in the market could be a false alarm as it was the previous times. This time was indeed different and the market dropped quickly in December of 2018. So now, what do we do?

Market Drops from 1980 Through 2018
Market Drops 1980 to 2018


Too Late Market is ALREADY predicting a minor recession

The stock market is a LEADING indicator for the economy. The economy currently as of today, is still showing strength. Unemployment is low and earnings are up. Why is the market dropping then? Future expectations is the answer. With rising interest rates from an aggressive Fed, “the market” is predicting that the economy will worsen and earnings will drop and unemployment will get worse.

Previous Recessions / Bear Markets

Previous Bear Markets and Recessions
Previous Bear Markets and Recessions


As you can see from the chart above, there are some examples where the markets sold off even more than what we have seen.

Great Recession of 2008- a 57% drop
Early 2000s (dot com bubble bursting) – 49% drop
Recession of 1973 – 48% drop
Recession of 1969 – 36% drop

We also had a couple of non-recession bear market drops of 28% and 34%.

Realistically, I think the Great Recession and the Dot Com bubble bursting were two historic events that are likely outliers. Which means if we use history as our guide, we are at a 20% drop and may have some room to drop further but we have likely already seen the worst of it. Is it possible it drops another 30%? Yes but I feel its less likely that being less than 10%.

Market Could Recover at any moment but the longest it should take until the drop stops within 1-2 years of starting

The market hit its most recent high as of August 29th 2018. If we look at the previous chart, most drops end within a year and nearly all within 2 years (dot com bubble lasted a little longer). We are already 3-4 months into this drop. The market could recovery at any moment and return to positive returns. The valuations currently look better than they have for years.

For those arguing that “I don’t have time to make up if it drops more”, even if it lasts on the long side at 2 years, you still are not drawing the majority of your portfolio within the next 2 years. You can wait this out and you will likely be better off for it as when you exit the market, then you will be faced with a tough decision of when do you re-enter. Its important to understand the reversal can come at ANYTIME within 2 years. It could have already started the recovery and we don’t know it yet. When markets reverse from a downturn, they often reverse VERY quickly and experience the largest gains in the beginning when many doubt whether the recovery is real.

Where are Valuations Now?

Most metrics show valuation are undervalued

Looking at the above chart from JP Morgan we can see the past 25 years this market drop has made several measures report that the market is now undervalued. Foreward P/E, Dividend Yield, Price to Book, and earnings yield less Baa bond yield all show a market that is undervalued relative to the 25 year average. The only metric showing the market might be slightly overvalued is the Shiller P/E ratio which uses 10 years of earnings data so its tells us less about where we are now and more about how the past decade compares.

On the whole, I feel better about the valuations of the market than I have in a long time. Bear in mind, these numbers indicate that either 1) market will go up or 2) that a recession is coming and fundamentals will deteriorate relative to prices.

What do we do?

I hate to say nothing but the most prudent action is to review our risk allocations and make sure our portfolios still meets our investment objectives. Valuations look very attractive currently and I do think the outlook for the market is better than it was 1 year ago. It may sound odd but the 20% drop is HEALTHY for the stock market. It reminds investors there is risk that goes with reward.

The market has survived much worse times than the ones we are facing now and it will survive this one as well. The most difficult and critical component to success will be sticking with a long term investment plan and not letting market corrections derail the success of your plan.

I will continue to work hard for you to help you reach your goals and perform actions that are supported by research to help you continue to make good decisions with your finances.

2018 Stock Market Jitters Part Two

2018 Market Jitters Strikes Again


Market Jitters are back.  The stock market pulled back strongly the past few days as shown in the following chart.

SP500 Chart October 2018 ytd
SP500 Chart October 2018 ytd



What is happening and should we be concerned?


Corporate Earnings Growth Has Increase Dramatically

Earnings per share (EPS) has averaged 6.9% from 2001 through 2017.  In the first and second quarter of 2018, EPS grew dramatically at 27%.  The growth was a combination of both better margins and higher revenues.



Wait, Is Earnings Growth Bad?

No growth is not bad.  However, when earnings grow quickly it raises concerns about inflation.  Bond investors seeing that growth became fearful of inflation started selling off bonds.   The 10 year treasury bond increased very rapidly. (Chart below shows yield increase on 10 year bond from 3.05 uo to nearly 3.250 before decreasing as stocks sold off).


Higher Bond Yields Bad for stocks

Stock investors seeing yields increase rapidly became fearful that the higher yields would cots businesses more money and hurt earnings.   The argument goes that higher yields increase business’s borrowing costs which in turn hurt earnings as expenses are higher than previously due to the debt.

This increase in yield drove the stock market lower as investors felt higher yields would be bad for future returns of stocks.


Is this a small bump or a sign of things to come.

For those that have read my analysis for years, probably already know my answer.  It is VERY difficult to predict if there will be a bigger drop.  If you just bet “no” and that it was a bump is the road, you would be correct the majority of the time.  Every year, the market drops on average almost 14% from the market high and every drop feels like we will go further into recession.  At some point, it will not be a false alarm and will be a real drop.  However, we will likely not know it until it is over.  Trying to predict the next prolonged drop would have cost us dearly the past 10 years as the market quickly recovered several times.




Intra Year Stock Market Declines
Intra Year Stock Market Declines


Ok, Steve, We will not panic and we will not be tempted to try to time the stock market.  What else can you tell me right now?


One interesting thing is that history tells us that when yields have been below 5%, an increase in yields has generally been correlated with positive stock market returns as shown by this chart:

Rates and Market Return Correlations
Rates and Market Return Correlations


Does this make sense?  It does  when rates have been below 5%, we typically have been coming out of a period of low rates.  Rates would be increases as a response to growth and in general, growth is good for the stock market.    When rates are above 5%, that has historically been during times where growth was too hot and inflation was a problem.  So rates were raising indicating an overheating  economy with runaway inflation or as was the case in the 1970s, runaway inflation with stagnant growth (stagflation).

What if it does get Worse!  How bad is it going to be!

First, I really don’t know.  However, let’s get some context and see what previous recessions have looked like.



Many are quick to assume we will see a 50%-60% drop in the stock market similar to the Great Recession (Financial Crisis of 2008) or the dot com bubble bursting of the early 2000s.  However, those two recessions we more anomalies than the norm.  The dot com bubble was the recent of irrational exuberance and extreme valuations for stocks and the financial crisis was driven by the fear of our financial system collapsing due to banking risk in mortgages and derivatives based on mortgages.    Both events tended to be anomalies in market history.  Therefore, I feel we are much more likely to see a 15-30% drop than a 50-60% drop.  I would also expect diversified portfolios similar to what I use to go do much less that the 100% stocks, S&P500.  So a diversified portfolio dropping in the 8% – 20% range is more likely in my opinion that the large drop we saw in the financial crisis of 2008.  So while I can’t guarntee we will not have another 2008, I do think its more likely if we have a further drop, it will more likely be similar to our more tame recessions.


What Should We Do?

Ultimately, we need to stick to our long term plan.  It will be nearly impossible to time the next big drop in the stock market.  Should we try, we are more likely to make the call incorrectly and hurt our long term returns.  Attempting to time the stock market is similar to the old “Siren’s song”  longing boats to veer off course and into trouble.  I remain vigilent and will continue to position our portfolios to withstand market jitters and help us reach our long term goals.  If you have any questions, please do not hesitate asking.


I will leave you with the last few times we had similar articles to reassure you that these drops are common and more times than not, they are not signs of worse things to come.



** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Alot of the slides were take from





2018 Stock Market Jitters – Time to Panic or Relax?

2018 Stock Market Jitters


Market Jitters have returned.  It has been a long time since we have had a measurable pull back in the markets.  This past week we have seen the market quickly pull back.  This time is feeling a lot like 2015.  For my clients that were with me then, this market pull back will likely feel familiar.


This post is going to be a review of the last pull back and what we wrote in 2015.  I will be updating data and writing a similar article this time.  The cliff notes version is that this pull back is most likely a pull back and not a recession.  It is possible this time will lease to a recession, however,  the “odds” are in the favor that it’s simply a pull back.  At some point, we will have a pull back that turns into a recession but we are unlikely to know until after the fact.


Stock Market Pullback a Time to Reflect (Article from August 24, 2015)

This article had some key points.

  • The market pulls back on average 14% from the market high every year giving an investor a moment to panic or simply be reminded of the risk with investing. So a double digit pull back is not only normal but common.
  • Pull backs can happen even when markets appear fairly valued
  • P/E Ratio is a poor predictor of short term performance (1 years) and only “ok” at longer periods.
  • Market Timing is difficult and rarely works

A quote from the article

And the Final Reminder – While we try to look at markets rationally, they simply are not rationale in the short term.  If investors start to panic and start selling equities and they witness this downturn, we certainly can see a much bigger drop.  However, if the fundamentals stay strong, it should prove to be another bump in the road.  Pullbacks similar to this are healthy for the market to remind investors that the stock market is risky.” August 24, 2015 blog entry


Mythical Bears and More Stock Market Reflections (Article from August 24, 2015)

This article was conceived because there are always good reasons to think bad things can happen.  Sometimes, its driven by things that make sense other times, myths.

  • Myth 1 – Market is going to drop because rates are going up
    1. Despite the logical myth, when the 10 year treasury bond is less than 5%, rate hikes are associated with a higher stock market (not a drop).
    2. This makes sense in that the Fed is shifting from an accommodating policy to a restrictive policy, they are unable to do so unless the economy is on firm footing which usually means a higher 10 year bond yield.
  • Myth 2 – Companies are Fragile and poised to drop in value
    1. At this time, cash was at an all-time high and dividend payouts were increasing.
    2. Despite share buy backs and dividends increasing, cash was increasing on corporate balance sheets
  • Myth 3 – Bull Market has run for 7 years and we are due for a major correction.
    1. Fact- 1946 to 1961 had 15 years between bear markets
    2. Fact – 1987 until the Tech bubble we had 13 years.
  • Myth 4 – Markets Trend Up and Trend Down over intermediate and long time periods
    1. Over intermediate period (5-10 years) markets have generally trended up or flat vs downward trending.
    2. Marketing timing out of the market during a flat period offers minimal advantage vs staying in the market.


2015 Q3 Stock Market is it 2011 Q3 Again or 2008 Q3?



These articles compare similarities in 2011 and 2008’s Q3 at that point in time.    This article’s point was to argue that 2011’s Q3 , looked as bad or even worth than 2008’s and yet had a favorable outcome. So while we can draw parallel’s to 2008 we also could look at 2011.


The Take Away

We will have stock market pull backs and we will have bear markets.  It will be VERY difficult to tell the difference between the two and most times it will feel like a significant bear market is coming.   At moments like these, it is important to understand that markets have risk and the risk of a pull back is real but we will have several false alarms before the real bear shows up.  Unfortunately in most cases, we will need to participate in the bear market in order to not miss out on the long-term returns of the market.

Do I think we could have a pull back in the 10-15% range?  Yes, I think its possible.   Do I think we can see a bear market drop of greater than 20%?  It is possible but less likely than a smaller drop.   I do not see a drop like 2008 as that was a “once in a lifetime” drop, meaning it is the worst we have seen in our lifetime which means its unlikely to be that bad again (of course the possibility will always exist that we could see a worse drop).


** The information on this website is intended only for informational purposes.  Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Estate Planning – Wills – What Triggers an Update

I thought I would post up a quick posting on when you should update your will or trust:

  1. If you move to a new state – you should see if it requires updated estate planning documents
  2. If you Get Married or Divorced – You might need an estate planning update
  3. If you have a new child – you might need an update to your estate plan
  4. If the law has changed or there is a significant change in financial circumstances you might need an update.
  5. If you want to change beneficiaries or guardians or trustee

The tricky one is #4, so in general if you have not met with an estate planning attourney in several years, it would likely be a good idea to schedule a meeting and determine if you are due for an update.

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Lauren Zangardi Haynes, CFP(R) Guest Article on How Entrepreneurs Can Quickly Maximize RetirementsSavings

How Entrepreneurs can quickly maximize their retirement savings

Are you a small business owner who needs to save quickly for retirement?


Many small business owners are so focused on the success of their business that they forget to protect themselves and their families by planning for retirement. In fact, if you love your work it can be hard to even imagine yourself no longer working! Yet, the hard truth of it is, one day you may not be able to work or may not want to work. And, not all small businesses are easily marketable, so relying on a large windfall from the sale of your business isn’t wise.


Different types of retirement plans work well for different types of employers. A small business owner could be best served using a SEP IRA, a SIMPLE IRA or even a 401(k) plan. Let’s focus on the SEP IRA today, as it can be an extremely powerful savings tool for the right small business owner.

What Is a SEP IRA?

A SEP IRA or Simplified Employee Pension IRA is a retirement account that can be set up by any business, regardless of size. They can be particularly favorable for a solo-entrepreneur or a business with just a few employees. SEP IRAs are funded by the employer only.


A SEP IRA is essentially a turbocharged traditional IRA. With a traditional IRA you can save just $5,500 in 2017 ($6,500 if you are 50+ and eligible for a “catch-up” contribution). Yet with a SEP IRA an employer can contribute up to 25% of your pay — up to $54,000 in 2017.


An important caveat: whatever rate you choose to contribute to your own account is the same rate you will need to contribute as a percentage of pay to all of your employee’s accounts. Also, employees can not contribute into their SEP IRA, only employer contributions are permitted.


If you are a solo-preneur this is an easy retirement savings win-win. If you have a few employees this can still make sense for you in terms of creating a competitive benefits package for your employees and building wealth for yourself on a tax-deferred basis.

Let’s run through a quick example:


Sarah runs a consulting firm and has an office manager named Tom.


Sarah will make $210,000 this year. This puts her in the 28% tax bracket because she is married and will file a joint return.


Tom earns $55,000 a year as Sarah’s office manager.


Sarah wants to save 10% of her pay. Since Sarah is in the 28% Federal Income Tax bracket this means she would need over $29,000 in income to save $21,000 after-tax ($29,000 x 28% = $8,120 taxes owed). For simplicity’s sake we won’t get into self-employment tax savings.


Instead, Sarah decides to reduce her take home pay to $189,000 and have the business make a SEP IRA contribution equal to 11% of her pay to equate to just shy of that $21,000 annual target Sarah was aiming for.


Sarah must also contributes 11% of Tom’s pay to a SEP IRA for Tom. This will equal a $6,050 contribution for Tom.


Now, Sarah saved a huge chunk of money for retirement, she looks like a hero because she just put 11% of Tom’s pay into an IRA for him AND Sarah still netted positive on taxes vs. trying to save after-tax!


Let’s frame it another way, looking solely at federal income tax at 28%, Sarah would have to pay herself over $29,000 to save $21,000 after-tax. In our example Sarah spends $27,050 in contributions to SEP IRAs for herself and Tom, and accomplished some serious savings for retirement at the same time!



Who has to be included in a SEP IRA plan?

An employee must be included in a SEP IRA plan if they have met the following requirements:


Worked for you in 3 of the last 5 years

Are over the age of 21

Earned more than $600 in compensation from your business over the year


However, you can use less restrictive requirements if you want. An important point to consider for the serial entrepreneur – if you have multiple businesses, they may constitute a controlled group. If you are a member of a controlled group, the SEP IRA will have to cover all of your employees under the SEP IRA. Check with your CPA to find out if this rule applies to you.

Great, but what if I have an off year?

Don’t worry, a SEP IRA has got you covered. With a SEP IRA you can contribute different amounts year to year. Some year’s you might contribute the maximum 25% of pay and other years you might contribute nothing. In fact, you don’t have to make a contribution until the deadline to file your business taxes. So you can wait and see how things turn out before deciding to make a SEP IRA contribution. What matters here is that you contribute at the same rate to all employee accounts.

How is a SEP IRA taxed?

Like a traditional IRA, this money is tax-deferred until you take it out at retirement. While the money is in your qualified SEP IRA you do not have to pay any taxes on capital gains, interest or dividends. This allows your money to potentially compound and grow much faster compared to a taxable account.


Also like a traditional IRA, if you withdraw money from the SEP IRA before you are 59 and ½ you will owe an additional 10% penalty tax on that withdrawal.

Pros and Cons


On the positive side SEP IRAs are:


Flexible contribution levels year-to-year

Easy to set-up

Easy to administer (most SEP IRAs do not require any annual filings)

Low cost

You can work with your existing adviser to coordinate it with your financial plan

Large annual savings limit (up to $54,000 in 2017 or 25% of your pay)




Your contributions are capped at 25% of your net earnings from Self Employment

Loans are not available from a SEP IRA

There is no Roth option

Depending on your income, a solo-401k may allow a greater annual contribution

You have to make the same contribution amount as a percentage of pay to all employees


A SEP IRA can be a great option for a small business owner looking to save for their retirement. It’s flexible, inexpensive, and can allow you to sock away a ton of money really quickly on a tax-deferred basis. I highly recommend you speak with your financial advisor and CPA to determine if a SEP IRA makes sense for you!

About the Author

Lauren Zangardi Haynes, CFP®, CIMA® is the founder of Spark Financial Advisors a Fee-Only, NAPFA-registered financial planning firm in Richmond and Williamsburg, VA. Lauren has a blog for young professionals who are ready to create their own version of financial freedom and align their money with their values called Words on Wealth.

Guest Blog Article from Ann Garcia, CFP® – The Secret 529 Plan Bonus

Ann Garcia CFP - Secret 529 Plan Bonus

The Secret 529 Plan Bonus

I would like to thank Ann Garcia CFP® for writing this very informative article on education planning.  Ann Garcia, CFP®, is a fee-only financial advisor with Independent Progressive Advisors and author of The College Financial Lady blog.  Thanks again Anne!  – Steve Reh

When it comes to college savings, the tax benefits of 529 plans are pretty well-known: tax-free growth and withdrawals and in some states, a tax deduction on contributions. Many people, especially those in states that don’t grant a tax deduction for contributions, believe that tax-efficient investments in a taxable account are just as good a college savings option.

Ann Garcia CFP® - Secret 529 Plan Bonus
Ann Garcia CFP®  – Secret 529 Plan Bonus

But 529 plans have another, far less well known but potentially much more significant, advantage over taxable accounts when it comes to college savings. To understand that benefit, you first need to understand the financial aid formulas that colleges use.

Financial Aid Formulas

Eligibility for need-based college financial aid is determined based on the student’s Expected Family Contribution, or EFC. There are two methodologies for calculating EFC: the federal methodology which uses the FAFSA form, and institutional methodology using the CSS PROFILE. There are similarities and differences in these forms; for the purpose of this analysis we’ll use the FAFSA methodology because it is more transparent, and for purposes of this discussion it’s reasonably similar to the CSS PROFILE. Keep in mind that about 70% of college students receive some form of financial aid. Even though a good amount of that is merit aid which typically does not consider ability to pay, need-based aid is granted to students coming from families with household incomes approaching $200,000 annually.

The Four Factors of the Expected Family Contribution (EFC)

Four factors go into the EFC: parents’ income and assets and student income and assets. Each of those has a different formula applied to it to determine how much is “available” to pay for college. The formulas generally assume that students have nothing better to do with their money than pay for college, so their income and assets are assessed far more than parents’: 20% of their assets—including checking and savings accounts—are considered available for college and 50% of their income over about $6,000.

Parents, on the other hand, are assumed to have other uses for their money so they get more favorable treatment. The formulas offer (limited) allowances against income (approximately equal to the federal poverty level) and assets (usually around $20,000 for married parents; considerably less for single parents). Several adjustments are made to income—most significantly, income taxes paid are subtracted from income and pre-tax retirement contributions are added back—and the remaining amount, the “adjusted available income,” is assessed in various brackets, much like income tax brackets. The top rate of 47% kicks in at about $32,000 of available income. Parents with household income of around $100,000 could expect their contribution from income to be around $17,500.

Parent assets—including 529, taxable investment, checking and savings accounts but not retirement savings accounts—are given much more favorable status. Only 5.64% of assets above the asset protection allowance count towards the EFC. $100,000 in savings for education—regardless of account type—would only increase EFC by about $1,125. Again, no matter whether the money is in a 529 account or a taxable brokerage account.

The 529 Plan Asset Distribution Advantage

Once you try to use your savings for college expenses, though, the 529 plan becomes vastly superior to the taxable account. That’s because you don’t have to report the gain in the account as income when it’s distributed, either in your tax filings or on the FAFSA. Here’s a simplified example of how that works. Let’s say you are going to use $25,000 from your savings to pay for freshman year of college. You started saving early and your account has doubled in value while you’ve held it, so your basis is $12,500 and your gain (long term) is $12,500. If you took that money out of your 529 account, you would have $25,000 to spend for college, and the following year your EFC would decrease by $25,000 x 5.64% or $1,410.

If you took it out of the taxable account, you’d report that $12,500 as income next time you file the FAFSA. Assuming you already had $32,000 in other available income, this withdrawal would increase your EFC by about $4,500 net of the withdrawn amount.

529 Plan’s Advantage over Roth IRAs

You may be looking at this and thinking, “Why do either of these? Instead, I’ll use a Roth IRA. I don’t have to report it as an asset, plus I get tax-free withdrawals!” The obvious reply to that is, a Roth IRA is for retirement, not college. Setting that aside, Roth IRAs have a bigger drawback than taxable accounts when used to pay for college: even though the distribution may be tax-free, it still must be reported as income on the FAFSA. In that case, even though none of it may be taxable, 100% of the distribution is considered income for FAFSA purposes. That means your $25,000 withdrawal increases your EFC by $11,750.

All in all, parents of college-bound students are far better served by a 529 plan than any other savings vehicle. Your financial advisor can help you find the best plan for your family’s circumstances.

Ann Garcia, CFP®, is a fee-only financial advisor with Independent Progressive Advisors and author of The College Financial Lady blog.


Guest Post by Michael J. Garry, CFP®, JD/MBA – Taking the Road Less Traveled

Taking the Road Less Traveled


As a continuation of the Fee-Only Financial Advisor blog sharing group, this month’s post comes to us from Michael Garry, a Financial Advisor in Newtown, PA.


 “Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference.”


–Robert Frost, excerpt from the Road Not Taken


Whether you think this poem is about individualism or rationalization, you surely know the poem and how it is commonly construed.

An article was recently published in Financial Advisor Magazine examining the various regrets that people commonly have and one of them was avoiding risks. A quote from the article summarizes this common regret well: “Among the top regrets were: not following their dreams, not taking risks with their careers, not taking risks with their lives in general, and not being gutsy enough in the choices they made.”[i]

Although this could sound depressing, many people that were consumed by these feelings of regret were determined to fix this by taking more risks with the time they have left. It’s a good attitude to have.

The article showed:[ii]

  • Ninety-three percent of Americans have a favorable view of an extended life with the feeling it could open new and interesting possibilities
  • Nearly half feel a longer life can enable a totally different view of how and when major life choices are made
  • A longer life is going to require some different approaches to financial planning.

As a financial advisor one of my main goals is to empower people to take risks in their lives, and lead the lives they imagine, by giving them peace-of-mind with their finances.

It is common for people to feel overwhelmed and uncertain in terms of their financial future and unfortunately, this paralyzes them in other parts of life. People have certain goals/dreams, or simply things they need that they view as unattainable because they feel limited by lack of resources or organization.

Financial plans and investment strategies allow you to determine achievable goals and establish a detailed plan for reaching them. Further, with a clear idea of what resources are available to you and how you can use those resources, you can shift your current financial situation to one that is aligned with your goals and future.

Everyone is unique – simply because one person handled their financial situation one way does not mean that you must do the same. Everyone should accept the challenge of discovering their individuality and embrace it in a way that will aid them in reaching their goals for the future.

Taking the road less traveled, taking risks, living life to the fullest and making your goals a reality may sound like lofty naiveté, but it’s not.

Michael J. Garry, CFP(R), JD/MBA, is the owner of Yardley Wealth Management, LLC, and an independent Financial Advisor who provides Fee-Only financial planning services and investment management in Newtown, PA, and the author of Independent Financial Planning: Your Ultimate Guide to Finding and Choosing the Right Financial Planner



Guest Blog – Gregory A. Johnston, CFA®, CFP®- 401(k) After-Tax Contributions

401(k) After-Tax Contributions



If you work at a company offering a 401(k) plan, you could defer $18,000 of pre-tax wages to the 401(k) plan ($24,000 if you are 50 or older).  The advantage is that contributions are not included in your current income and, therefore, not taxed.


Let’s say you are a heavy saver and have deferred $18,000 of pre-tax income to your employer’s 401k.  Many employers have a matching formula, meaning the employer will also contribute to your account.  Based on a hypothetical matching formula, let’s assume your employer’s contribution is $10,000.  In total, you now have $28,000 deposited to your 401(k) account for the year.


Did you know that the maximum amount of money that can be contributed to most 401(k) plans for 2017 is $54,000?  In our hypothetical example, that means the employee could still put in an additional $26,000.  This type of contribution is known as an after-tax contribution.


As a quick aside, an after-tax contribution is somewhat similar to a Roth 401(k) contribution, but there are important differences.  The similarity between Roth 401(k) and an after-tax contribution is that the amount of the contribution is included in your income and you will pay taxes, today, on the contribution amount.  The Roth 401(k) contribution will grow tax free, whereas after-tax contributions grow tax deferred (similar to your pre-tax contributions).


In the case of a 401(k) plan, tax free means you will never pay tax on the growth or the distribution.  If growth is tax deferred, you will pay ordinary income tax once the money is withdrawn from the account.


After-tax contributions are not as popular because you have to pay tax on the contribution amount as it is included your gross income.  There is also no employer match.  And remember, that while your contributions are after-tax, the earnings of those contributions grow tax-deferred, not tax free like a Roth 401(k) contribution.  Lastly, not all employer plans even allow for after-tax contributions.  But, due to a recent IRS ruling, we may begin to see more plans allowing for after-tax contributions.


So what is the big advantage of after-tax contributions?  After all, an investor could choose a regular taxable account instead of making an after-tax contribution.  Tax-deferred earnings growth is the major reason, whereas you will probably receive a tax bill each year for the taxable account.


Another advantage is due to the recent IRS regulation.  Let’s assume you separate from service (retire or quit) and decide to roll your 401(k) account balance to an IRA.  You can now roll your after-tax contributions to a Roth IRA.  From that point forward, the earnings growth and any future withdrawals will be tax free.



While having the availability of after-tax contributions is nice, it is not a panacea.  Many investors’ will have a variety of accounts they can fund and must choose in what order to fund them.


For each person, based on their specific facts and circumstances, there is likely a preferred funding order they should choose.  For example, if their employer matches contributions, the investor should likely contribute (either on a pre-tax or Roth basis) up to the employer matching limits.  They may also choose to fully fund their 401(k) – even above what the employer will match.


Next, perhaps Roth IRA contributions would be appropriate since they would have both tax-free withdrawals and tax-free growth from day one.  We generally think after-tax contributions should be one of the last components of an investor’s total savings contribution.


In our mobile society, where staying with a single employer is not common, using after-tax contributions could be a powerful way to get a higher level of Roth monies.


For example, a high-income younger person maxes out their 401k contribution, IRA’s, and also makes after-tax contributions.  Assume that in three years they leave their employer to join another firm.  At that point in time is when the after-tax contribution could become “full-fledged” Roth monies — assuming they are rolled to a Roth IRA.  In this situation, the effect is a “delayed Roth” – you do not get the full benefit of tax-free growth until the funds have been rolled to the Roth IRA.  But delayed Roth is better than no Roth.



Be aware that many employer plans do not accept after-tax 401(k) contributions.  You will have to check with HR to determine if it is even available.  If not, ask why not, and enlist your friends to lobby HR.  Plan documents can be changed.


While making after-tax contributions may sound intriguing, most investors should also have taxable accounts to maintain sufficient short- and medium-term liquidity – that can be quickly and easily accessed.


Remember, the after-tax contributions are being deposited to a 401(k) plan and, as a result, are not easily accessible and should be viewed as retirement monies.  In short, the assets cannot generally be converted to “quick cash”.  That is one reason why a sufficient reserve fund (in a taxable account) needs to be available.


About the Author

Gregory A. Johnston, CFA®, CFP®, CPWA®, QPFC, AIF® has over 25 years of investment and comprehensive finanical planning experience.  He started Johnston Investment Counsel in 1997 as an independent,  fee-only investment management and comprehensive planning firm located in Peoria, Illinois.  His clients include individuals, retirement plans, and endowments / foundations.

Guest Blog Entry -Dave Fernandez, CFP® – Fee-only vs Fee-Based

I would like to thank Dave Fernandez, CFP® for providing this excellent article on the difference between Fee-Only and Fee-Based.

What is the Difference Between “Fee-Only” and “Fee-Based?”

Coin stacks with letter dice – Fees

Do you know how your financial advisor is compensated?  Two common forms of financial advisor compensation are called ”fee-only” and “fee-based.”  They sound very similar, but they have vastly different meanings.  Whether your advisor is “Fee-Only” or “Fee-Based” can have a huge impact on the type of advice you are provided and the types of investment products which are recommended to you.

Let me provide a made up example related to the medical industry to help differentiate the two fee compensation terms.  Not everyone has worked with a financial advisor, but we all have visited a doctor.

Let’s assume you decide to visit your doctor because you have a health issue.  Upon the visit, your doctor analyzes your health problem, provides you with a recommendation, possibly sends you to a specialist for further diagnoses, or gives you a prescription to take to your local pharmacy.  In return for the doctor’s time and expertise, you likely paid him/her an out of pocket co-pay and/or your health insurance pays them a fee for your visit and any particular procedures or testing done.  This scenario would be considered fee-only.  You received a recommendation and the doctor received a fee.

Now let’s assume you visit your same doctor for the same health issue.  But we further assume that the doctor’s compensation comes from two sources: 1) a fee for an initial assessment of your health issue and 2) the doctor also receives a commission for any particular health recommendation, procedure, referral to a specialist or pharmaceutical prescription sold.  What if we take this one step further and also assume that not only does your doctor receive a commission for his/her recommendations, but that their commission based revenue can only come from a select group of products or procedures chosen by the health organization they are affiliated with?  Do you see any potential conflicts of interest in this scenario?  Would this cause you to question if you were receiving the best medical recommendation, or, if what your doctor recommended was potentially based on what paid your doctor the highest commission?  This would be considered a “fee-based” compensation arrangement.  The doctor receives a fee for the initial visit but also receives commissions for specific recommendations, procedures, referrals or prescriptions sold.

Consumers are fortunate the fee-based arrangement does not actually exist in the medical industry.  However, it is common in financial services.

The two examples above can be directly substituted into the financial advice industry.  Fee-Only means the only source of compensation your financial advisor receives is from fees paid directly to the advisor from clients. This could be in the form of an hourly fee, a retainer fee or a fee based on a percentage of the assets under investment management. Regardless of the type of fee, the point is that the client pays only a fee and no other type of compensation is charged. No commissions are received. No financial products are sold such as load mutual funds, commissioned based fixed and variable annuities, equity indexed annuities, whole life insurance or universal life insurance.  The advice and compensation is totally independent of the financial products recommended.

Fee-Based is a term the brokerage and insurance community developed to counteract the success of the Fee-Only classification. The terms certainly sound similar and consumers are confused, so their strategy seems to be working.  I can’t tell you how many times I have received a phone call from a consumer looking for a new financial advisor and one of the first things they say is that they are looking for a fee-based advisor.  I always enjoy having that conversation and explaining the terminology differences as most consumers are greatly surprised.

Where Fee-Based can be confusing and potentially misleading is that not only does an advisor receive fees, but they can also accept commissions from financial products recommended such as load based mutual funds, or annuities and insurance. This system creates the potential for a huge conflict of interest. If an advisor, like the doctor above, has the opportunity to recommend a particular financial product that pays him/her a commission versus a financial product that does not pay a commission, do you think they could be incentivized and influenced to recommend the commissioned based product?  Or, what if their product inventory only allows the choice between a select group of commissioned products based on the affiliation of their broker dealer?  Would this raise a question – are the financial products offered to me what is best for my financial situation, and, do they make use of the best potential options considering the whole universe of financial products available?

No compensation system is perfect and free from all conflicts of interest.  And certainly there are some great fee-based advisors doing amazing work for their clients.  But we strongly believe the fee-only compensation method most closely aligns the interest of consumers with their financial advisor.  We are proud and fortunate to belong to a great organization called (National Association of Personal Financial Advisors), which represents a like-minded group of fee-only, fiduciary based financial advisors throughout the United States.

So when deciding which advisor you would like to hire, we suggest that you ask how the advisor is compensated, request that they disclose their compensation in writing and look for someone who is paid as a “Fee-Only” advisor to eliminate as many conflicts of interest as possible.

Or, if you decide to work with a fee-based, commissioned advisor, at least look for one that is licensed under a fiduciary regulation.  The fiduciary law requires that all compensation is disclosed in writing.  Thus if you are going to pay commissions for advice and financial products, you will at least know what you are paying for.

About The Author

Dave Fernandez, CFP® is a native of Arizona and has over 20 years of experience in the financial services industry.  He started his financial services career in 1995.  As a NAPFA Registered Financial Advisor, Dave owns a fee only financial planning and wealth management firm, in Scottsdale, Arizona called “Wealth Engineering, LLC.”

Guest Blog Article Greg Phelps, CFP® How “Safe” Are Your Bond Investments?

How “Safe” Are Your Bond Investments? – A Guest Article from Greg Phelps, CFP®

I want to thank Greg Phelps for his highly timely article on bonds, especially given the recent rise in rates.  Thanks again Greg for your valuable contribution.  If you are in the Las Vegas area looking for an advisor, be sure to look him up. – Thanks Steve Reh

Most investors think of bonds as “safe”. The fact is bonds can be risky as well, not as risky as stocks generally speaking, but risky nonetheless.

Bonds guarantee a return of principle with interest payments. But if their return is guaranteed, why are bonds risky?

Let’s define risk for a moment. Is risk the “loss” of principal, or the “volatility” of your principal? If you define risk as volatility – which could lead to losses if you sell in a bad period – then bonds are risky because values are volatile.


Why Are Bonds Volatile?

Bond values fluctuate with interest rates in the economy. When interest rates rise, bond values fall. When interest rates fall, bond values rise.




This is an important concept, so we’ll walk through a few simple examples.


What If Interest Rates Go Up?

Key and a Stock Certificate. Key To Investing ConceptIf your neighbor bought a 10 year bond paying 3% a year ago, and similar 9 year bonds are paying 4% today – you wouldn’t want to buy his 3% bond. You’d buy a new bond with the higher interest rate.

Purchase Date Bond Investment Coupon Rate Yearly Income Term in years
1/1/2015 $1,000 3% $30 10
1/1/2016 $1,000 4% $40 9



Interest rates rose over that one year period, so your neighbor’s bond value must drop. His bond pays $10 less per year than a new bond after all.

Your neighbors bond value will drop in an amount which compensates a potential buyer for the reduced income (compared to what he could get today). The calculations are complex, and in the real marketplace it’s all based on supply and demand.

Some investors prefer the coupon payment. Others prefer the capital increase in value over time, and don’t necessarily need the larger interest payment. These factors affect the value on the open market.

This drop in value (also called a discount) will bring the total yield up to 4% over the life of the bond, so it matches current 9 year bond rates. The interest payment stays the same at 3%, but the capital gain between the discount paid and the bond’s maturity value compensates the new investor with a total yield roughly equal to 4%.


What If Bond Rates Drop?

Conversely, if you bought a 10 year bond a year ago yielding 5%, and rates today are 3% for similar bonds you’d be able to sell your bond for a premium. A premium means you’ll get more than for your bond than its maturity value. Your bond pays more interest to an investor than they’d otherwise get with current bonds, so you deserve a higher price.


Purchase Date Bond Investment Coupon Rate Yearly Income Term in years
1/1/2015 $1,000 5% $50 10
1/1/2016 $1,000 3% $30 9



These are overly simplistic examples, but they illustrate a concept. When interest rates rise, bond values drop. When interest rates drop, bond values rise.


So Just How Much Do Bonds Fluctuate?

It really depends on supply and demand in the marketplace. This is determined by perceived current and future risk, and most of this risk is in the form of time.

Some bonds mature in the short term, such as a year or two. Some mature in the intermediate term, for example 5 years or so. Some are long bonds and mature in 20 or 30 year.  The longer the bond’s maturity, the more they drop in value when rates rise, and the more they rise in value when rates drop. This volatility is measured by “standard deviation”.


Bond Returns And Risk[1]

US Treasury
BofA ML Six-Month
US Treasury Bill Index
BofA ML One-Year
US Treasury Note Index
US Treasury Notes
Long-Term Gov. Bonds
Return 5.19% 5.91% 6.08% 7.52% 8.31%
Risk 1.66% 2.01% 2.55% 6.34% 12.14%



The longer your bond portfolio’s maturity, the more risk you have in holding those bonds. There’s a point at about 5 years when the risk really starts to spike.

The question becomes “at what point is the volatility with your bond portfolio too high?” In other words, if you’re investing in longer term bonds for the yield, you’re likely taking a lot of volatility risk. There comes a point when the risk of long term bonds can rival some stock investments.


Bonds For Stability

Most investors buy bonds for yield when in fact they should be buying bonds to provide portfolio stability, like ballast in a boat. Ballast provides ship stability when the weather gets rough… and trust me the markets will get rough!

The total return from a portfolio is far more important than the returns generated from any individual investment in the portfolio. Even though shorter maturity bonds pay less interest, the easiest way to reduce portfolio volatility (assuming you’ve reduced your exposure to stocks first) is to reduce bond maturity.


About The Author

Greg Phelps, CFP®, CLU®, AIF®, AAMS® is the President of Redrock Wealth Management, a fee only fiduciary advisor in Las Vegas. Greg has been a financial planner for over 20 years, and specializes in retirement wealth management for baby boomers. He’s also the founder at RetireWire.coma retirement financial and money management blog.

[1] Data calculated (or derived) based on data from the CRSP US Stock Database ©2014 Center for Research in Security Prices (CRSP®)