Personal Benefit Buckets

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The sources were income and benefits originate.
Social Bucket- Generally, government sponsored programs.
Private Bucket- Items a person controls directly.
Public- Traditional investment vehicles.

Traditional Financial Planning vs Values Based Financial Planning

I help Purdue faculty make the most of their benefits and 403(b) retirement plan.

Build Your Financial House Mini Series


Like the three little pigs, financial houses may be constructed of weak straw or sticks while sturdy homes are built with bricks.

– Traditional planning focuses heavily on returns.

-Values Based Planning focuses on promoting and living in accordance with your personal values.


Fed Fundamentals

As bond market volatility increases, analysts areMarketVolatility-image-3 heightening their watch on Federal Reserve commentary. Turn on any financial channel and see how long it takes to hear the word Fed or Federal Reserve.  While many of the organizations provide insight (with no lack of opinion,) it would be a good idea to explain a few basic principles of the Federal Reserve and then review the tools it can use.

First, let’s start with the dual mandate which Congress amended in 1977. The Federal Reserve Act.  The stated objectives follow:

“The Board of Governors of the Federal Reserve System and the Federal Open Market federal-reserveCommittee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” (1)

So what tools does the Fed have in the toolbox to help manage the economy? Traditional tools which typically help fight off high inflation are listed below:

Open-Market Operations- the Fed can buy and sell U.S. government bonds to increase or decrease the money supply, thus helping keep inflation in check.

Discount Rate- This is the rate banks pay on short-term loans from the Federal Reserve. This is closely linked to the federal funds target rate, a rate banks charge each other for overnight lending.  The Federal Open Market Committee, FOMC, publicly announces their preference for the rate. The FOMC does not directly control the fed funds rate.

Reserve Requirements- The amount banks are mandated to keep against their deposits are known as reserve requirements.  While the tool is not one normally used over the short run, it directly affects the aggregate dollar amount in loans.

What does this mean in light of the recent bond market volatility and media coverage?

Most analysts point to the raising of the fed funds discount as source of worry since an inverse relationship exists between the price of a bond and the yield.  However, this blanket and often sighted relationship implies the entire yield curve moves equally up or down across all maturities. The investing environment does not really behave in a uniform fashion. For example, one can review the last interest rate hikes in 2004-2006 and see that shorter term rates were altered less than their longer brethren. After a self study, one will understand the Fed does control short-term rates; one additionally observes the intermediate and longer maturities will be moved by market forces, not the Federal Reserve.

What about the other tools mentioned? The discount rate and reserve requirements do not change very often.  Recently, the FOMC exercised on a grand scale program to buy large amounts of bonds which reached $85 billion of bonds per month for a while. 0930_high-interest-rates_327x185

The next time an analyst discusses the Fed raising interest rates, notice if the commentator illustrates how his view relates directly with the dual mandate or is he just sharing his opinion with a few numbers thrown in for good measure. As the global economy moves forward, conditions will warrant flexibility in changing the interest rate which will likely happen at a measured pace.  However, no one can exactly predict when this will transpire.  There are other various forces influencing conditions such as: other central banks, strength of the dollar, lack if inflation and lower expectations for growth, aka new market realities.



Pension: Lump sum payout or Annuity payout?

620-stay-at-home-mom-social-security-questions-hinden.imgcache.rev1408719990575.webFrequently, people will ask for help answering the question if a lump sum or annuity payments should be chosen when a pension fund offers a buyout. While the topic has been examined in many blog posts, articles, and other financial media, here we want to review the subject while providing a history on how we got here. The resulting information produced two articles, one with considerations for the dilemma at hand while the second discusses the technical background of the companies offering payout options on a grand scale.

Evaluate your cash flow need

People whcash-flow1o examine the payout options on their own frequently limit their analysis based on the moment.  Many take the lump sum, spend the funds and end up owing a large tax bill.  Before anyone gets to this point, list out all of your sources of income to be received later in life.  You know in fact, that social security will be a source that will not pay out a lump sum, but rather a monthly cash flow.  How much will you need to support your standard of living, and how much income will need to be generated from sources not producing regular and predictable cash flow from sources like Social Security and annuities? Some individuals will include dividends and interest from their portfolios as part of a regular income.  Will these sources be enough to cover your essential expenses? If yes, the lump sum may be more attractive.  If the answer is no, the edge may lean towards the recurring monthly payments.

Evaluate your likely lifespan

Does longevity run in your family? If so, you need to weigh the fact most pensions do not adjust for inflation, but a reciprocal benefit is knowing you will not outlive the income stream.  Additionally, if your expected lifespan is short, a lump sum creates more flexibility in passing assets on to heirs besides a spouse. While this is not a promotion nor an endorsement of any site, the links below may help give you clarity on answering how you long you may live.

How important is flexibility for you?

People in general like options; however, too many options can also most paralyze one from making a decision.  Most companies offer the typical payment choices, but if you take the lump sum, you can also look at buying an annuity later transferring the longevity risk back to another institution.   One should note, however, at the time of this writing, more monthly payments from a pension are higher than an immediate annuity.

How disciplined are you?

Let’s face the fact some of us are more disciplined than others regarding money. For those of us who have a hard time keeping funds in a checking account, the monthly income will provide sustainability to our situation. If you are disciplined, still consider those who will end up with the income or asset after you are gone.

What is the state of the pension fund?


Part of evaluating options mean assessing the motive of the corporation offering the lump sum payout.  Is the company in trouble financially, which could increase the probability the Pension Benefit Guarantee Corportation, PBGC, may take over the liabilities.  Is the company looking to get the obligation off its books to reduce any future burden?  You may not be able to clearly articulate the motive, but look for signs of financial distress.

Comparison Points

So you have given adequate thought to the points above, maybe you have come to the point of comparing lifetime cash flows or break-even points. What rates of return were used, are the rates realistic, was inflation a consideration?  As you can see, the math becomes complicated very quickly. Here is a site that may help you in evaluating the cash flow.

After evaluating the points above, you should have an indication of which option is best for your situation. If not, contacting an advisor to assisting should be the next step.


The third quarter is coming to a close in a few weeks and soon people will start asking where the year has gone.  Considering the recent market volatility, people will start wondering where their portfolio returns have gone or where will they come from to finish the year strong.  When investors start this cycle, Morningstar ratings are frequently used to help identify “opportunities” when a fund gets an upgrade to a four of five stars or to avoid pitfalls if a downgrade happens to one or two stars.  Does the star rating give the investor anything meaningful to make an informed decision?

How are Morningstar ratings figured?

Start by examining language directly from Morningstar:  “The Morningstar RatingTM for funds methodology rates funds based on an enhanced Morningstar Risk-Adjusted Return measure, which also accounts for the effects of all sales charges, loads, or redemption fees. Funds are ranked by their Morningstar Risk-Adjusted Return scores and stars are assigned using the following scale:

Examine the table above, noting that a new fund of fewer than five years of age will have an overall rating of the three-year rating.  As the fund gets older, the weighting changes for the overall star rating.  If a novice investor is reviewing his 401k options, for example, and looking at the overall star rating with a 12 year old and say a three year old fund, the same overall star rating will not be an apple to apples comparison.  The older fund will have likely gone through a market cycle or two while the younger fund may have luckily entered the marketplace at the right time.

Vanguard Comparison

Vanguard completed a study in 2010 asking two questions. 1. Why do index funds tend to receive average ratings? 2. Do ratings provide any actionable information?  Even though Vanguard is noted for low-cost index funds, the study did confirm the important point that cost does matter, but it also highlights other important factors (1.)

The study notes the probability of excess returns with the following graph. Note the one-star funds have a seven percent better probability of generating excess returns than the five-star funds on average.

Wall Street Journal Investigates

The Wall Street Journal produced an article in the 9/7/2014 publication titled “Mutual Fund’s Five Star Curse.”  Most top performing funds lose their five-star rating. In fact, only 15% maintained the highest rating over the ten-year period examined by the study.  Other noteworthy points include:

  1. Watch for growing pains in the fund. As a fund performs better and the rating increases, funds may have a large influx of cash. The manager may become paralyzed on where to invest the funds.
  2. Keep it simple. The article highlights the easy articulation of the DFA Core Equity 1 fund.
  3. Get the balance right. Highly rated funds that maintain a balance of stocks and bonds tend to maintain a consistent Morningstar rating.

Next Steps

When your 401k statement comes, be mindful of how you evaluate or choose your mutual fund investments.  The Morningstar rating is not a buy or sell recommendation.  Talk to your advisor or use an online assessment tool to help you develop a holistic investment plan.

Please remember Morningstar even notes “(The) Ratings are objective, based entirely on a mathematical evaluation of past performance. They’re a useful tool for identifying funds worthy of further research, but shouldn’t be considered buy or sell signals (3.)”








Health Savings Accounts: Possible Retirement Supplement

Health Savings Accounts: Possible Retirement Supplement

How often does one find the need to balance financial priorities; college or retirement, emergency fund or the family vacation?  Rarely, does an opportunity come through the tax code similar to what a Health Savings Account, HSA, provides.  As it currently stands, a large portion of “traditional” health plans is going away, while being replaced with the high deductible care options in order to help contain costs.  It is each employee’s responsibility to weigh options which may become a monumental task.  Let’s examine what this tool is and how to use it.

What is an HSA?

An HSA is a tax-favored account used in conjunction with a high-deductible health insurance plan. The account should receive funds for healthcare related expenses.  The list of possibly covered items includes things like some premiums (please see IRS Publication 502 for more details), deductibles, vision, and dental expenditures.

As previously mentioned, one needs to be covered under a high deductible plan in order to have an HSA.  For an individual, the plan must have a $1300 deductible and $2600 for a family.  Contribution limits to the plan are capped at $3350 for the individual and $6650 for a family.  Additionally, anyone over the age of 55 may contribute another $1000 for the year.

How does the HSA work?

With your plan, contributions are tax deductible as an adjustment to income and the distributions are tax-free if used for qualifying medical expenses.   Once your insurance deductible has been met, your insurance provider will cover expenses in accordance to the plan provisions. You may use the HSA funds as previously noted to cover premiums in addition to hearing aids, eyeglasses and contacts, chiropractor, stop smoking programs, and several other items.  However, funeral expenses, cosmetic surgery, and weight loss programs are not covered. (For a full list of covered and ineligible expenses, please check with your HSA provider.)

The other important aspect of the account is the fact you may keep the monies in the account as long as you need them.  It is a “not use it or lose it mandate” similar to a flexible spending account making the HSA more attractive for longevity.  In fact, you may even be in a position where you contribute and later move to a non-high deductible plan and still withdraw funds for qualified expenses from the account.

How can an HSA be used as a retirement income supplement?

One of the lesser known provisions of the tax code involves the fact anyone over the age of 65 may withdraw funds from an HSA for living expenses. Pre age 65 withdraws for ineligible expenses are included in taxable income and subject to a 20% penalty.   For age 65 or older, withdrawals for non-medical expenses, the amount is taxable, but the penalty is avoided.

Other noteworthy aspects currently include, currently no required minimum distributions, the account may initially be funded with one year’s deductible from an IRA or Roth IRA (ongoing SEP’s and Simple IRAs are not eligible), and many providers have investment options attached to the account.

If you do elect to use the investment options, make sure you keep enough cash available to cover your medical expenses. The excess funds invested may be used as a backup in case the liquid portion of the account is spent.

The health savings account allows a family to maximize contributions while not feeling comprised about saving for retirement.

Pit Falls

Most importantly, the HSA should not be used as a replacement for retirement savings accounts, but rather as a supplement.  As mentioned earlier, the penalty for nonqualified expenses is 20% versus the 10% penalty on most IRAs.  The contributions, if coverage is for a single individual, are lower when compared to IRAs.  If investment options are available, there is usually only a hand full.

Review your health care plan options with your employer or insurance agent.  Weigh your options and include the HSA as part of your overall financial picture.