Understanding Required Minimum Distributions (RMDs) From Your IRA

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When you reach age 70½, the Internal Revenue Service instructs you to start making withdrawals from your traditional IRA(s). These withdrawals are also called Required Minimum Distributions (RMDs). You will make them, annually, from now on. (1)

If you fail to take your annual RMD or take out less than the required amount, the I.R.S. will notice. You will not only owe income taxes on the amount not withdrawn, you will owe 50% more. (The 50% penalty can be waived if you can show the I.R.S. that the shortfall resulted from a “reasonable error” instead of negligence.) (1)

Many IRA owners have questions about the rules related to their initial RMDs, so let’s answer a few.

How does the I.R.S. define age 70½?

Its definition is pretty straightforward. If your 70th birthday occurs in the first half of a year, you turn 70½ within that calendar year. If your 70th birthday occurs in the second half of a year, you turn 70½ during the subsequent calendar year. (2)

Your initial RMD has to be taken by April 1 of the year after you turn 70½. All the RMDs you take in subsequent years must be taken by December 31 of each year. (1)

So, if you turned 70 during the first six months of 2020, then you will be 70½ by the end of 2020, and you must take your first RMD by April 1, 2021. If you turn 70 in the second half of 2020, then you will be 70½ in 2021, and you won’t need to take that initial RMD until April 1, 2022. (1)

Is waiting until April 1 of the following year to take my first RMD a bad idea?

The I.R.S. allows you three extra months to take your first RMD, but it isn’t necessarily doing you a favor. Your initial RMD is taxable in the year that it is taken. If you postpone it into the following year, then the taxable portions of both your first RMD and your second RMD must be reported as income on your federal tax return for that following year. (2)

An example: James and his wife Stephanie file jointly, and they earn $78,950 in 2019 (the upper limit of the 22% federal tax bracket). James turns 70½ in 2019, but he decides to put off his first RMD until April 1, 2020. Bad idea: this means that he will have to take two RMDs before 2020 ends. So, his taxable income jumps in 2020 as a result of the dual RMDs, and it pushes the pair into a higher tax bracket for 2020 as well. The lesson: if you will be 70½ by the time 2019 ends, take your initial RMD by the end of 2019 – it might save you thousands in taxes to do so. (3)

How do I calculate my first RMD?

I.R.S. Publication 590 is your resource. You calculate it using I.R.S. life expectancy tables and your IRA balance on December 31 of the previous year. For that matter, if you Google “how to calculate your RMD,” you will see links to RMD worksheets at irs.gov and a host of other free online RMD calculators. (1,4)

If your spouse is more than 10 years younger than you and happens to be designated as the sole beneficiary for one or more of the traditional IRAs that you own, you should use the I.R.S. IRA Minimum Distribution Worksheet (downloadable as a PDF online) to help calculate your RMD. (5)

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If your IRA is held at one of the big investment firms, that firm may calculate your RMD for you and offer to route the amount into another account of your choice. It will give you and the I.R.S. a 1099-R form recording the income distribution and the amount of the distribution that is taxable. (6)

When I take my RMD, do I have to withdraw the whole amount?

No. You can also take it in smaller, successive withdrawals. Your IRA custodian may be able to schedule them for you. (7)

What if I have more than one traditional IRA?

You then figure out your total RMD by calculating the RMD for each traditional IRA you own, using the IRA balances on the prior December 31. This total is the basis for the RMD calculation. You can take your RMD from a single traditional IRA or multiple traditional IRAs. (1)

What if I have a Roth IRA?

If you are the original owner of that Roth IRA, you don’t have to take any RMDs. Only inherited Roth IRAs require RMDs. (7)

Be proactive when it comes to your first RMD

Putting off the initial RMD until the first quarter of next year could mean higher-than-normal income taxes for the year ahead. (2)

▼RMDs at a Glance for All Account Types

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Sources

  1. irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions
  2. kiplinger.com/article/retirement/T045-C032-S014-avoid-the-5-biggest-ira-rmd-mistakes.html
  3. taxfoundation.org/2019-tax-brackets/
  4. google.com/search?client=firefox-b-1-d&q=how+to+calculate+your+RMD
  5. irs.gov/pub/irs-tege/jlls_rmd_worksheet.pdf
  6. finance.zacks.com/everyone-ira-1099r-4710.html
  7. fidelity.com/viewpoints/retirement/smart-ira-withdrawal-strategies
  8. https://static.twentyoverten.com/58e639ce21cca2513c90975b/CMPlElT87-y/RMDMFSFlyer.pdf

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Why You Shouldn’t Take a Loan From Your Retirement Plan

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Thinking about borrowing money from your 401(k), 403(b), or 457 account?

Think twice about that because these loans are not only risky, but injurious, to your retirement planning.

A loan of this kind damages your retirement savings prospects.

A 401(k), 403(b), or 457 should never be viewed like a savings or checking account. When you withdraw from a bank account, you pull out cash. When you take a loan from your workplace retirement plan, you sell shares of your investments to generate cash. You buy back investment shares as you repay the loan. (1)

In borrowing from a 401(k), 403(b), or 457, you siphon down invested retirement assets, leaving a smaller account balance that experiences a smaller degree of compounding. In repaying the loan, you will likely repurchase investment shares at higher prices than in the past – in other words, you will be buying high. None of this makes financial sense.(1)

Most plan providers charge an origination fee for a loan (it can be in the neighborhood of $100), and of course, they charge interest. While you will repay interest and the principal as you repay the loan, that interest still represents money that could have remained in the account and remained invested.1,2

As you strive to repay the loan amount, there may be a financial side effect. You may end up reducing or suspending your regular per-paycheck contributions to the plan. Some plans may even bar you from making plan contributions for several months after the loan is taken. (3,4)

Your take-home pay may be docked.

Most loans from 401(k), 403(b), and 457 plans are repaid incrementally – the plan subtracts X dollars from your paycheck, month after month, until the amount borrowed is fully restored. (1)

If you leave your job, you will have to pay 100% of your 401(k) loan back.

This applies if you quit; it applies if you are laid off or fired. Formerly, you had a maximum of 60 days to repay a workplace retirement plan loan. The Tax Cuts & Jobs Act of 2017 changed that for loans originated in 2018 and years forward. You now have until October of the year following the year you leave your job to repay the loan (the deadline is the due date of your federal taxes plus a 6-month extension, which usually means October 15). You also have a choice: you can either restore the funds to your workplace retirement plan or transfer them to either an IRA or a workplace retirement plan elsewhere.(2)

If you are younger than age 59½ and fail to pay the full amount of the loan back, the I.R.S. will characterize any amount not repaid as a premature distribution from a retirement plan – taxable income that is also subject to an early withdrawal penalty. (3)

Even if you have great job security, the loan will probably have to be repaid in full within five years.

Most workplace retirement plans set such terms. If the terms are not met, then the unpaid balance becomes a taxable distribution with possible penalties (assuming you are younger than 59½.(1)

Would you like to be taxed twice?

When you borrow from an employee retirement plan, you invite that prospect. You will be repaying your loan with after-tax dollars, and those dollars will be taxed again when you make a qualified withdrawal of them in the future (unless your plan offers you a Roth option). (3,4)

Why go into debt to pay off debt?

If you borrow from your retirement plan, you will be assuming one debt to pay off another. It is better to go to a reputable lender for a personal loan; borrowing cash has fewer potential drawbacks.

You should never confuse your retirement plan with a bank account.

Some employees seem to do just that. Fidelity Investments says that 20.8% of its 401(k) plan participants have outstanding loans in 2018. In taking their loans, they are opening the door to the possibility of having less money saved when they retire. (4)

Why risk that? Look elsewhere for money in a crisis. Borrow from your employer-sponsored retirement plan only as a last resort.

FINAL-2019-GTR-2_22_HIGH-RES-46
▲The toxic effect of loans and withdrawals

The top chart shows that employees who took loans and a withdrawal from their account may end up with significantly lower balances in the end. The bottom chart shows that the employee did not get the benefit of contributions and company match when paying back their loans. To avoid this scenario, stress the importance of an emergency reserve and savings for other goals outside of the retirement account. If the employee must borrow, if they keep contributing while paying back the loan that may mitigate the negative impact of the loan.

Sources

  1. gobankingrates.com/retirement/401k/borrowing-401k/
  2. forbes.com/sites/ashleaebeling/2018/01/16/new-tax-law-liberalizes-401k-loan-repayment-rules/
  3. cbsnews.com/news/when-is-it-ok-to-withdraw-or-borrow-from-your-retirement-savings/
  4. cnbc.com/2018/06/26/the-lure-of-a-401k-loan-could-mask-its-risks.html
  5. https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/guide-to-retirement

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Covering the Cost of College Using 529 Plans, Coverdell ESAs, UTMA or UGMA accounts

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You can plan to meet the costs through a variety of methods.

How can you cover your child’s future college costs?

Saving early (and often) may be the key for most families. Here are some college savings vehicles to consider.

529 plans

Offered by states and some educational institutions, these plans let you save up to $14,000 per year for your child’s college costs without having to file an IRS gift tax return. A married couple can contribute up to $28,000 per year. (An individual or couple’s annual contribution to the plan cannot exceed the IRS yearly gift tax exclusion.) These plans commonly offer you options to try and grow your college savings through equity investments. You can even participate in 529 plans offered by other states, which may be advantageous if your student wants to go to college in another part of the country. (1,2)

While contributions to a 529 plan are not tax-deductible, 529 plan earnings are exempt from federal tax and generally exempt from state tax when withdrawn, as long as they are used to pay for qualified education expenses of the plan beneficiary. If your child doesn’t want to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from a 529 plan into another 529 plan established for the same beneficiary (or for another family member) without tax consequences. (1)

Grandparents can start a 529 plan, or other college savings vehicle, just as parents can; the earlier, the better. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself. (1)

529 plans have been improved with two additional features. One, you can now use 529 plan dollars to pay for computer hardware, software, and computer-related technology, as long as such purchases are qualified higher education expenses. Two, you can now reinvest any 529 plan distribution refunded to you by an eligible educational institution, as long as it goes back into the same 529 plan account. You have a 60-day period to do this from when you receive the refund. (3)

Investors should consider the investment objective, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer’s official statement, which should be read carefully before investing. A copy of the official statement can be obtained from a financial professional. Before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

Coverdell ESAs

Single filers with adjusted gross income (AGI) of $95,000 or less and joint filers with AGI of $190,000 or less can pour up to $2,000 annually into these tax-advantaged accounts. While the annual contribution ceiling is much lower than that of a 529 plan, Coverdell ESAs have perks that 529 plans lack. Money saved and invested in a Coverdell ESA can be used for college or K-12 education expenses. Coverdell ESAs offer a broader variety of investment options compared to many 529 plans, and plan fees are also commonly lower.(4)

Contributions to Coverdell ESAs aren’t tax-deductible, but the account enjoys tax-deferred growth and withdrawals are tax-free so long as they are used for qualified education expenses. Contributions may be made until the account beneficiary turns 18. The money must be withdrawn when the beneficiary turns 30 (there is a 30-day grace period), or taxes and penalties will be incurred. Money from a Coverdell ESA may even be rolled over tax-free into a 529 plan (but 529 plan money may not be rolled over into a Coverdell ESA). (2,4)

UGMA & UTMA accounts

These all-purpose savings and investment accounts are often used to save for college. When you put money in the account, you are making an irrevocable gift to your child. You manage the account assets. When your child reaches the “age of majority” (usually 18 or 21, as defined by state UGMA or UTMA law), he or she can use the money to pay for college. However, once that age is reached, that child can also use the money to pay for anything else.(5)

Imagine your child graduating from college debt-free. With the right kind of college planning, that may happen.

JPM_CPE_19
▲Comparing college savings vehicles
  • 529 plan: Potential for tax-free investing for qualified education expenses;* high levels of flexibility, control and contribution maximums along with special gift and estate tax benefits.
  • Custodial account: Less tax efficiency and control than other accounts; higher impact on financial aid eligibility.
  • Coverdell account: Potential for tax-free investing for any qualified education expense; more restrictions and lower contributions than other accounts.
  • Key takeaway: Not all college savings plans are the same. Differences among accounts can have a major impact on current taxes and future college funds.

* Earnings on non-qualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. Federal law allows distributions for tuition expenses in connection with enrollment or attendance at an elementary or secondary public, private or religious school (“K-12 Tuition Expenses”) of up to $10,000 per beneficiary per year. Under New York State law, distributions for K-12 Tuition Expenses will be considered non-qualified withdrawals and will require the recapture of any New York State tax benefits that have accrued on contributions.

Sources

  1. irs.gov/uac/529-Plans:-Questions-and-Answers 
  2. time.com/money/3149426/college-savings-esa-529-differences-financial-aid/ 
  3. figuide.com/new-benefits-for-529-plans.html
  4. time.com/money/4102891/coverdell-529-education-college-savings-account/ 
  5. franklintempleton.com/investor/products/goals/education/ugma-utma-accounts?role=investor
  6. investopedia.com/articles/personal-finance/102915/life-insurance-vs-529.asp
  7. https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/products/college-savings-plan/college-planning-essentials

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

How to Use a Bucket Strategy to Help Guard Against Market Volatility

 

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Image by TRIXIE BRADLEY from Pixabay

The Bucket Strategy can take two forms.

1. The Expenses Bucket Strategy:

With this approach, you segment your retirement expenses into three buckets:

  • Basic Living Expenses – food, rent, utilities, etc.
  • Discretionary Expenses – vacations, dining out, etc.
  • Legacy Expenses – assets for heirs and charities

This strategy pairs appropriate investments to each bucket. For instance, Social Security might be assigned to the Basic Living Expenses bucket. If this source of income falls short, you might consider whether a fixed annuity can help fill the gap. With this approach, you are attempting to match income sources to essential expenses. (1)

The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contact. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).

For the Discretionary Expenses bucket, you might consider investing in top-rated bonds and large-cap stocks that offer the potential for growth and have a long-term history of paying a steady dividend. The market value of a bond will fluctuate with changes in interest rates. As rates fall, the value of existing bonds typically drop. If an investor sells a bond before maturity, it may be worth more or less than the initial purchase price. By holding a bond to maturity an investor will receive the interest payments due, plus their original principal, barring default by the issuer. Investments seeking to achieve higher yields also involve a higher degree of risk. Keep in mind that the return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost. Dividends on common stock are not fixed and can be decreased or eliminated on short notice.

Finally, if you have assets you expect to pass on, you might position some of them in more aggressive investments, such as small-cap stocks and international equity. Asset allocation is an approach to help manage investment risk. Asset allocation does not guarantee against investment loss.

International investments carry additional risks, which include differences in financial reporting standards, currency exchange rates, political risk unique to a specific country, foreign taxes and regulations, and the potential for illiquid markets. These factors may result in greater share price volatility.

2. The Timeframe Bucket Strategy:

This approach creates buckets based on different timeframes and assigns investments to each. For example:

  • 1 to 5 Years: This bucket funds your near-term expenses. It may be filled with cash and cash alternatives, such as money market accounts. Money market funds are considered low-risk securities but they are not backed by any government institution, so it’s possible to lose money. Money held in money market funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Money market funds seek to preserve the value of your investment at $1.00 a share. However, it is possible to lose money by investing in a money market fund. Money market mutual funds are sold by prospectus. Please consider the charges, risks, expenses, and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money.
  • 6 to 10 Years: This bucket is designed to help replenish the funds in the 1-to-5-Years bucket. Investments might include a diversified, intermediate, top-rated bond portfolio. Diversification is an approach to help manage investment risk. It does not eliminate the risk of loss if security prices decline.
  • 11 to 20 Years: This bucket may be filled with investments such as large-cap stocks, which offer the potential for growth.
  • 21 or More Years: This bucket might include longer-term investments, such as small-cap and international stocks.

Each bucket is set up to be replenished by the next longer-term bucket. This approach can offer flexibility to provide replenishment at more opportune times. For example, if stock prices move higher, you might consider replenishing the 6-to-10-Years bucket, even though it’s not quite time.

A bucket approach to pursue your income needs is not the only way to build an income strategy, but it’s one strategy to consider as you prepare for retirement.

FINAL-2019-GTR-2_22_HIGH-RES-37

▲ Structuring a portfolio in retirement – the bucket strategy

Experiencing market volatility in retirement may result in some people pulling out of the market at the wrong time or not taking on the equity exposure they need to combat inflation. Leveraging mental accounting to encourage better behaviors–aligning a retirement portfolio in time-segmented buckets–may help people maintain a disciplined investment strategy through retirement with an appropriate level of equity exposure. The short-term bucket, invested in cash and cash equivalents, should cover one or more years of a household’s income gap in retirement–with the ideal number of years determined based on risk tolerance and market conditions over the near term. A ‘cushion’ amount should also be maintained to cover unexpected expenses. The intermediate-term bucket should have a growth component, with any current income generated through dividends or interest moved periodically to replenish the short-term bucket. The longer-term portfolio can be a long-term care reserve fund or positioned for legacy planning purposes, and pursue a more aggressive investment objective, based on the time horizon. (2)

Sources

  1. kiplinger.com/article/retirement/T037-C000-S002-how-to-implement-the-bucket-system-in-retirement.html
  2. https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/guide-to-retirement

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

How Fixed-Income Can Help Protect Your Retirement Savings During Market Volatility

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When stocks soar, fixed-income investments have comparatively little allure.

Investors hungry for double-digit returns may regard them as bland, vanilla securities saddled with an opportunity cost, geared to risk-averse retirees who are “playing not to lose.”

An investment earning a consistent rate of return on a fixed schedule is not a negative. Fixed-income investments are something you may want as part of your portfolio, particularly when stocks fall.

Fixed-income investments have a steadiness that stocks lack.

Most are simple debt instruments: an investor transfers or pays money to a government or financial institution in exchange for a promise of recurring payments and eventual return of principal. (1)

Corporate and government bonds are popular fixed-income investments. U.S. Treasury bills, bonds, and notes, all backed by the federal government, pay interest based on the duration and nature of the security. States and municipalities also issue bonds to generate funds for infrastructure projects. Corporate bonds usually have 10-year or 20-year durations; the interest on them may exceed that of Treasuries and state and muni bonds, but the degree of risk is greater for the bondholder. Firms with subpar credit ratings issue bonds that are junk rated, offering a relatively higher return and higher risk. (1)

There are bond funds that also pay a set rate of return. Some of these funds trade like stocks and can be bought and sold during a trading day, not merely after the close. They typically contain a wide variety of both corporate and government bonds. (2)

Additionally, there are money market funds and money market accounts. They do differ. A money market fund is a managed investment fund made up of assorted fixed-income debt securities. A money market account is simply a high-yield bank account insured by the Federal Deposit Insurance Corporation (FDIC). (3)

Consider certificates of deposit as well. Banks create these debt securities to generate pools of capital to use for their business and personal loans. Some CDs have terms of less than a year; many are multiyear. Typically, the longer the commitment a CD investor makes, the greater the coupon (annual interest rate) on the CD. These investments are FDIC-insured up to $250,000. (1,3)

At some point, you might want less of your portfolio in equities. That realization might be prompted by a consideration of the markets or simply by where you are in life.

When the financial markets turn volatile, the last thing you want is to have all your investments moving in the same direction at the same time.

If your portfolio includes a balance of investments from different asset classes, some with little or no correlation to the stock market, then you may take less of a loss than someone whose portfolio is overloaded in equities.

The risk is, this “someone” could be you. Across a long bull market, the equity investments within your portfolio will usually outgain the non-equity investments. That can throw your original asset allocations out of whack and leave you mostly invested in stocks. If stocks plunge, the value of your portfolio can drop rapidly. (4)

The conventional wisdom is to lessen your equity position as you age. You may currently hold stocks across many sectors of the S&P 500, but that is not diversification. True diversification uses multiple asset classes – and conservative, fixed-income investments – to try to minimize risk.

Fixed-income investments may not always return as spectacularly as equity investments, but they are also less prone to spectacular losses. They are designed to provide some stability for an investor, and as you get older, stability becomes increasingly important.

MI-GTM_3Q19_August_High-Res-60

▲ Asset class returns

This chart shows the historical performance and volatility of different asset classes, as well as an annually rebalanced asset allocation portfolio. The asset allocation portfolio incorporates the various asset classes shown in the chart and highlights that balance and diversification can help reduce volatility and enhance returns. (5)

Sources

  1. thestreet.com/investing/fixed-income/what-is-fixed-income-investment-14758617
  2. investopedia.com/articles/investing/041615/pros-cons-bond-funds-vs-bond-etfs.asp
  3. thebalance.com/certificates-of-deposit-versus-money-markets-356054
  4. fool.com/investing/2018/01/29/heres-how-bull-markets-can-be-bad-for-your-portfol.aspx
  5. https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/guide-to-the-markets/viewer

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Why Portfolio Diversification Is Important During Volatile Markets

brown eggs in brown wicker basket

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A multiple asset class portfolio prevents having all your investment eggs in one basket.

Diversification Helps You Manage Risk

We all want a terrific ROI, but risk management matters just as much in investing, perhaps more. That is why diversification is so important. There are two great reasons to invest across a range of asset classes, even when some are clearly outperforming others.

REASON #1:

Potentially Capture Gains in Different Market Climates

If you allocate your invested assets across the breadth of asset classes, you will at least have some percentage of your portfolio assigned to the market’s best-performing sectors on any given trading day. If your portfolio is too heavily weighted in one asset class, or in one stock, its return is riding too heavily on its performance.

Your portfolio is like a garden. A good gardener will plant a variety of flowers to ensure something is always blooming. The gardener knows that some flowers eventually die off or may not grow well but if there is enough diversity the overall picture will still look good.

REASON #2:

Potentially Less Financial Pain if Stocks Decline

If you have a lot of money in growth stocks and aggressive growth funds (and some people do), what happens to your portfolio in a correction or a bear market? You’ve got a bunch of losers on your hands. Tax loss harvesting can ease the pain only so much.

Diversification gives your portfolio a kind of “buffer” against market volatility and drawdowns. Without it, your exposure to risk is magnified.

ADVICE:

Don’t put all your eggs in one basket!

Believe the cliché: don’t put all your eggs in one basket. Wall Street is hardly uneventful and the behavior of the market sometimes leaves even seasoned analysts scratching their heads. We can’t predict how the market will perform; we can diversify to address the challenges presented by its ups and downs.

MI-GTM_3Q19_August_High-Res-60

▲ Asset class returns

This chart shows the historical performance and volatility of different asset classes, as well as an annually rebalanced asset allocation portfolio. The asset allocation portfolio incorporates the various asset classes shown in the chart and highlights that balance and diversification can help reduce volatility and enhance returns. (2)


Sources

  1. usatoday30.usatoday.com/money/perfi/retirement/story/2011-12-08/investment-diversification/51749298/1
  2. https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/guide-to-the-markets/viewer
  3. This material was prepared, in part, by MarketingPro, Inc.