Once I read Ed Mahaffy’s book titled “How To Select A Financial Advisor: The Least You Should Know”, interviewed him, reviewed his video library, I knew we had the right person for this special financial planning series. On Fridays, TaxConnections presents questions often asked of a Financial Planner.
Ask Ed: Special Financial Questions
Question: The financial challenges of Covid 19 can no doubt cause reductions in retirement contributions. This makes cutting retirement plan expenses even more important. Let’s assume Annual expenses amounting to 0.75%. This may not sound like much but cutting this expense can make a huge difference over time. How much?
Answer: Assume $10,000 annual contributions for 40 years earning a 6 % annual return. Reducing fees by 0.50% could save this participant well over $100,000. It pays to stay on top of your plan expenses.
Question: Is the 60/40 (stock/bond) portfolio asset allocation portfolio still viable with interest rates so low?
Answer: Until interest rates dropped to the near record lows investors and savers now face, the 40% of the portfolio allocated to bonds served as a stabilizer, a safety net that not only generated income with safety but played an important role in behavioral finance. As stocks fell in value, money sought the relative safety of bonds, which cushioned the blow and made investors less likely to panic -sell stocks at just the wrong time.
Now however, the bond allocation of the 60/40 portfolio represents significant interest rate risk should rates rise-the nemesis of a bond portfolio. I realize nobody is worried about rising rates, but the contrarian in me says that’s the time to keep a watchful eye. Consider shorter term bonds, which have less interest rate risk than their longer term counterparts. You will not have to sacrifice too terribly much in yield given the flat yield curve. Thus could prove to be cheap insurance.
Question: How can Interest rates rise when the federal reserve has made it clear that it will not raise rates for the foreseeable future?
Answer: The Fed has a great deal more influence on short -term rates than it does on longer term bonds, 10 years and longer, for instance.
A whiff of inflation could be the trigger for a sell off in bond prices. This could accompany an improving economy.
It’s a good idea to review the “duration” your fixed-income holdings with your advisor. They should provide a stress test that models what to expect given various interest rate environments.
(How To Select A Financial Advisor – Ed Mahaffy)
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