Investing Insights: Preparing Your Portfolio for Inflation and the Bubble

please stay tuned for important disclosure information at the conclusion of this episode welcome to the investing insights podcast from morningstar in this week's podcast ed slot discusses how the end of the stretch ira will affect taxes and retirement planning christine benz tells us why inflation should always be on our radars jason kephart talks about the 2021 target date landscape report and christine ben's braces investors for a bubble let's get started here are christine benz from morningstar inc and tax and ira expert ed slot hi i'm christine benz for morningstar the secure act passed in late 2019 brought about the demise of the so-called stretch ira joining me to discuss the implications for tax and retirement planning is tax and retirement expert ed slot he's the author of a new book called the new retirement savings time bomb ed thanks for being here great to be back thanks christine and let's talk about the stretch ira but first talk about what that was and also i'd like to hear about how many people actually took full advantage of the stretch ira do you have any way of knowing i don't know how many people took advantage of it you know we've talked about it for years in fact i remember when it first came out it's not a real thing it's just the name give it to him i remember many years ago when this first started i had a client i told him about it he called me says i'm at the bank you said get a stretch ira they don't have them it's not a product it's a process it's just the ability or was the ability before 2020 of you naming a beneficiary maybe a younger one a child or grandchild and they could stretch or extend distributions out over their own life expectancy 50 60 70 years for a young grandchild congress thought that was too great of a gift and what they did in the secure act they eliminated it and replaced it with basically a 10-year rule for most non-spouse beneficiaries spouses are unaffected there are a few other exceptions but generally a spouse you don't have to worry you're unaffected the same rules apply to you so now in general the way this new 10-year rule works if somebody died in 2020 that's that's when it was in effect you know most people forgot about this because look what happened in 2020 we had the pandemic the cares act all these tax relief provisions and a stimulus at the end of the year and most of that ended in 2020 but the secure act is still here so that was effective deaths in 20 beginning in 2020 so if you inherited as a non-spouse a child or grandchild you would be stuck with a 10-year rule which means the entire inherited account would have to be withdrawn even if it was a roth by the end of the 10th year after death so unaffected by this would be people who are spouses let's talk about that when spouses inherit an ira from another well spouses like i i equate the spouse in tax law to the queen in chess spouses can do anything most tax law protects spouses so they were they were the number one exemption there are five exemptions but that's the main one because most people leave their ira most married people leave their ira to their spouses so they're unaffected they could still do the same things they could before the secure act like it never happened they could do a rollover they could remain a beneficiary if they want a young spouse might want to do that if they need access to the funds and they inherit before 59 and a half that could help them avoid the 10 early distribution penalty and then do a rollover whenever they want so they still have all of those options the problem is even with a married couple somebody's going to die first and then you're right back where you started then you have a single person unless they get remarried that leads it to a child or grandchild at some point it's going to go to that 10-year rule and the congress by doing that is going to cause the taxes to be accelerated in that 10-year period when some beneficiaries might even be in their own high earnings years and maybe at higher rates at that point so the 10-year window does give inheritors a little bit of latitude to decide when within that window to take their distributions right they could wait until all the way to the end or earlier depending on their situation yeah it's not a bad rule actually it gives you maximum flexibility when we had this stretch before you had to take a certain amount even if it was a small amount every year for all the years there's no more annual rmds required minimum distributions anymore now there's only one rmd whatever the balance is at the end of the 10th year that has to come out but watch it at the end of the tenth year if it's anything remaining in there not only has to come out if it doesn't it's subject to the current 50 penalty for not taking an rmd and you mentioned before how many people actually stretch i don't even know if that many beneficiaries did you know it's very tough for a beneficiary to keep their hands off money that imagine telling a 30 year old just take a little drop for the next 50 years highly unlikely you're going to see that happen matter of fact with this 10-year rule some of them that might have taken it in one or two years of thinking it's better oh i could wait 10 years i wasn't going to wait that long and especially if you inherit a roth that's the time you want to wait the 10 years because if you can keep your hands off it for 10 years all the time it's growing it's growing accumulating tax-free until you absolutely have to take it out by the end of the tent year after death well you mentioned roths i think people sometimes forget ed that those two are subject to uh rmds when they're inherited by other people right and again no annual rmds the 10-year rule so the great part about this 10-year rule whether it's roth or regular ira the beneficiary can time the distributions they can take whatever they want let's take an example let's say a beneficiary inherits i don't know at age 60 parent dies and they they're going to retire in about three years well maybe for the first three years they don't touch anything because they're still in a high bracket and then they start taking it when they're in lower brackets in years seven eight nine and ten maybe so you have a lot more planning flexibility with this ten-year rule there's no requirement to take anything in a particular year as long as it's emptied by the end of the tenth year there's been a lot written since the secure act and the death of the stretch ira about kind of workarounds that people can use if they want their loved ones to be able to maybe take advantage of their assets to receive some tax benefits on their assets what would you say to people who are doing some planning who want to be able to leave as much as they possibly can to their loved ones and to have them take advantage of tax deferral are there any strategies they should consider yes well the ones most affected are the people obviously with the largest iras because there's a more of a chance that more of that balance will be left over to beneficiaries so one strategy is with permanent life insurance and just so you know if you're listening i don't sell life insurance i'm a tax advisor but iras were severely downgraded by the secure act that's what congress meant to do they said no more iras retirement accounts should be for retirement not for wealth transfer or estate planning so they killed the stretch and replaced it with the 10-year rule it might pay if you want the three things that every client i ever had want uh you can get them with life insurance the three things they always said i want larger inheritances more control and less tax you can get that by taking that large ira down now at low rates take advantage of low rates now that the funds are bought and paid for you can put that into a permanent uh life insurance like a cash value life insurance that builds cash value tax free that can be left to beneficiaries either directly or in a trust where you can get that post-step control it could simulate the stretch ira plus the distributions don't have to be taken on a schedule there's no rmds no complicated tax rules and best of all no tax so it can stay protected in the trust or not you can get the plan you actually want it's not for everybody but it really works well for those who have large iras and still want that large inheritance to their children with low taxes or no taxes some people may be struggling with whether their beneficiaries should change as a result of this change i like your point on this topic where you say the person you want to inherit your ira should inherit your ira and that you shouldn't get too caught up in the tax maneuvering right i believe that i always ask people who do you want to inherit the ira that will drive the plan i wouldn't say don't leave it to your son you know leave it to this one don't leave it to your wife don't leave it to your husband because of taxes that's not going to fly you have to have the plan you want and you work around that now you might change some plans for example i see some people updating their their beneficiary forms and estate plans i've been hearing some people they want to for example they might have two children and they were always doing everything equal but one is doing really well and the other not so much and they might change the equation maybe leave the one who needs more more and divvy up with other assets i'm seeing some things like that but not outright changing beneficiaries for tax reasons and it's always great to get your perspective thank you so much for being here thanks christine thanks for watching i'm christine benz for morningstar expand your investing horizons and look to the long term with morningstar's podcast the longview join hosts christine benz and jeff patak as they talk to influential leaders in investing advice and personal finance search for and subscribe to the longview today [Music] now christine ben shares her perspective on inflation with susan jabinski from morningstar inc hi i'm susan jabinski with morningstar some on wall street say the days of low inflation are over should investors be concerned joining me today to discuss the topic is christine benz christine's morningstar's director of personal finance hi christine thank you for being here today hi susan it's great to be here so why all the talk of inflation right now christine well there are a couple of key reasons susan one is that the vaccines are coming on strong and there's a sense that in the second half of the year certainly we could be experiencing a strongly recovering economy so that's a good news story a related issue is the stimulus package where there are some concerns that because it is putting so much money in consumers pocket and help helping them in other parts of their lives as well that we may see some inflation related to that so it's kind of a convergence of factors but the overarching theme is we're coming out of this pandemic there's a lot of pent-up demand and we could see prices start to nudge higher and in fact we have started to see prices much higher in some areas so do you think that investors should actually be concerned about inflation right now well i think they should always have it on their radar and it's an especially vexing thing for people who have a large share of their portfolios in investments that are earning fixed rates of return so say you have nominal treasury bonds that are paying you a pretty small yield today the risk is that if inflation heats up that that could gobble up everything you're earning so it takes a bite out of your income stream so i do think it's worth having on your radar although i would also say that we heard a lot of inflationary worries in the wake of the great financial crisis from 2007 through 2009 where we heard a similar set of concerns that the package passed to rex rescue the economy would stoke inflation we didn't really see it we went on to have a decades worth of very benign inflation so it's hard to say whether the predictions will come true now we've talked a little bit in the past about calculating your own personal rate of inflation and why that's something really to think about doing rather than relying strictly on outside benchmarks like the consumer price index as a gauge of what inflation means for you specifically why do you why are you a big proponent of this personal rate of inflation and how does one go about beginning to get your arms around that right i do think it's something to at least give some thought to and so the way to think about it is we see these inflation numbers like the consumer price index well that's a broad basket and it's making assumptions about how you spend your money and you may not be spending your money on the same basket of goods that is used in the cpi so i do think it's important to think about how you're spending money to be observant about whether the areas where you're spending about whether they're inflating or whether they're holding steady so we've seen food inflation creep up recently if food is a big share of your household budget you probably are experiencing that inflation first hand um if you if health care expenses are a big share of your budget well we know older adults tend to pay more for health care out of pocket than do younger adults so pay attention to what you're spending money on when you're thinking about how much to care about inflation but the short answer is it matters for all of us because we're all spending money on some of these things some of the time so let's say you're a younger investor and you're still in accumulation mode and you do find that okay i am feeling a little bit of a personal rate of inflation going up here what what do you advise these investors be thinking about or doing well the best thing to do is just to make sure with respect to to your investment portfolio that you're maintaining ample exposure to stocks because we know that over time while stocks are not any sort of good hedge against inflation so you won't see stocks go up at the same time inflation goes up what we know is that stocks over long periods of time have tended to have better returns than the inflation rate so making sure that you have ample stock exposure also making sure that you're paying attention to your savings rate because if we're having to pay more for stuff to go about our lives that naturally impinges on our savings rates so making sure that if we do see inflation that that's not unduly affecting your savings rate and then another thing to consider would be home ownership and certainly this is a big question there are many different facets of whether it makes sense to buy a home or not but all else being equal if we're in an inflationary environment it'll tend to be beneficial to be a homeowner be a borrower because the money that you borrow and our pain is that you're paying back is uh worthless so you're sort of locking in a good deal for yourself and then the other thing to know is that um if you are a homeowner you're not exposed to rents which can slide up as we see inflation begin to tick up so those are a couple things for people who are accumulating assets for retirement to think about now what about folks who may be close to retirement or already in retirement and say they are beginning to see that yes my personal inflation rate is going up what are some things that they should be mindful of well this is a bigger deal for people who are in retirement because they are not earning a cost of living adjustment in the paycheck that they're taking out of their portfolios social security gives them a little bit of a bump up to keep pace with inflation but the portion of their portfolios that they're withdrawing to cover their living expenses are not inflation adjusted in any way so i do think that retirees not just when they begin to see inflation but when they embark on retirement should make sure that they have adequate inflation hedges in their portfolio so i think that includes a healthy complement of inflation protected bonds to the extent that they have bonds in their portfolio a good share of them should be inflation-protected bonds and then also making sure that retirees have adequate equity exposure as well because they want the whole of their portfolio to be able to keep pace with inflation in some fashion and we know that stocks over time do that so those are a couple of things to consider also to the extent that you're purchasing any sort of insurance policy say a long-term care insurance policy to the extent that you can add an inflation rider that will protect you against inflation that will increase your coverage to keep pace with inflation that makes sense as well well christine thank you so much for your time today and for some perspective on how we should be thinking about inflation i appreciate it thank you so much susan i'm susan jabinski for morningstar thank you for tuning in six days a week we deliver the latest news for investors just say alexa enable the morningstar skill or visit morningstar.com alexa next jason kephart from morningstar research services discusses the latest target day trends with susan jabinski hi i'm susan chabinski with morningstar morningstar recently published its annual target date landscape report for 2021. joining me today to talk about three key trends from that report is jason kephart jason's one of the paper's lead authors and he's also a strategist with morningstar's multi-asset team hi jason thank you for being here today thanks for having me so one of the trends that you've observed is what we're called we're calling the rise of collective investment trusts or cits and target date assets and cits crossed the trillion dollar mark in 2020. so tell me a little bit about that growth rate what it's looked like and what percentage of target data assets are in cits versus mutual funds today sure we estimate that at the end of 2020 about 42 percent of target date assets were in cits that's almost double what it was just five years ago so clearly we're seeing a lot of growth there and one of the reasons for that is cits are much more popular among the largest 401k plans so the contributions are naturally going to be larger so what are some of the advantages that cits might have over mutual funds so there's one key advantage now imagine we're both defined contribution plans you have 10 billion dollars i have one billion dollar if we both pick the cheapest share class of say blackrack lifepath dynamic under the investment investment act of 1940 we're both required to pay 40 basis points despite our differences in asset levels now in a cit that is not a requirement so you can actually negotiate lower fees so with your 10 billion dollars in assets you may be able to get 35 basis points instead of 40 and you know five basis points might not seem like a lot but in a 10 billion dollar plan that's five million dollars you just save for your participants so from a fiduciary standpoint it always makes sense to for a planned sponsor at least kick the tires and see if they can use their assets to get better fees for their clients now another trend that you talk a bit about in the report is this idea of falling fees and falling investment minimums so let's talk about fees first what have we seen this year when it comes to fees you know the it's no secret that fees are a really critical role in target date funds we've seen that it's been a long-term trend that the cheapest target date funds have tended to collect the most assets we saw that trend continue in 2020 although overall flows were down in 2020 to target dates because of all the economic stress caused by caused by the pandemic we still saw 90 percent of net inflows go to share classes in the cheapest decile so investors are really choosing just the lowest cost target date series and you know we think that over the long term lower fees are going to lead to better outcomes so this is in our view a very positive development now both vanguard and fidelity have lowered the investment minimums on their cheapest share classes so what impact do you expect that to have on the average fees that target date investors pay it should just drive them lower when your vanguard and fidelity and they were talking about their cheapest share classes around 9 or 10 basis points there's really only so much room you can cut before you're getting to zero so they're kind of getting close to that threshold on how low fees can actually go so the next way to compete on fees is just make those cheaper share classes more accessible to more people which again is a big win for investors now as target data investors have continued to gravitate more towards those lower cost options are we still seeing that fees are a predictor of outperformance we still are seeing that we looked at how the cheapest target date funds have done versus those in the middle of the pack what we found is they're continually continuing to outperform and there's always going to be exceptions jerry's going to have an american funds or t row that is very stellar and can overcome its fee hurdles but in general starting with fees as a starting point should lead to better results over the long term and lastly let's talk a little bit about different types of investments that are now available to target date series regulators are now allowing target date investments to purchase alternatives some some alternatives like private equity have we seen any uptake of that yet we haven't seen any uptick of private equity yet i think there are some operational challenges firms are going to have to think through in order to make that a viable part of a target date strategy things like capacity private equity is a very capacity constrained vehicle and a lot of these target date funds are very big so being able to find a private equity fund that could handle enough assets to still make a difference in the targeted fund that's something i think the firms are gonna have to work out so we haven't seen much there yet but we have seen um private real estate already does play a role in at least one target date mutual fund series tia life cycle and it's more popular in collective investment trusts so there are already these illiquid investments are starting to make their way into target date funds well jason thank you very much for your time today giving us sort of a lay of the landscape of target date series today we appreciate it thanks for having me i'm susan sibinski with morningstar thank you for tuning in and lastly christine benz and susan jabinski joined the conversation about the stock market bubble hi i'm susan jabinski with morningstar although the stock market has experienced some volatility this year market watchers are saying that we're headed for a stock market bubble joining me today to discuss the topic is christine benz christina's morningstar's director of personal finance hi christine thank you for being here today hi susan it's great to be here so are we in a stock market bubble in your opinion well i think you can look at it in a few different ways one is starting with market valuation and if you look at a measure like schiller p e which is a cyclically adjusted price earnings ratio for the whole market for the whole u.s market you can see that we're about double the historic medians and averages for shiller pe so that's lofty and we're back near where we were in the late 90s which is the last time that schiller pe kind of peaked out so that's a worrisome sign when we look at the morningstar's price to fair value for all of the companies in our coverage universe it's a little bit less worrisome i would note that it's a global coverage universe so arguably lower valuations overseas bring that down a little bit but it's less of a warning light being flashed by that measure one other thing that i pay attention to though susan is that when you look into the price to fair values for various parts of the market you see some overvaluation in certain segments so in small and mid-cap growth stocks in certain sectors like technology it does appear that stocks are pretty expensive and finally when we look at investor behavior one thing we know for those of us who have been paying attention to some of the newbie investors getting into the market is that we've got a lot of novice investors who seem to be engaging in some speculative behaviors and so all of those point to risk factors for a bubble especially concentrated in some of those areas where there does seem to be speculation and you know you've noted that in markets such as these investors are perhaps a little bit more likely to make some mistakes so what are the things that investors should not should we not be doing right now i think a key point i would make is don't go to extremes so one interesting thing about the rally that we've been living through is that there's sort of been this self-perpetuating quality in some of the stocks that have performed best so if you've bought them you've done well you've continued to do do well my advice is to not expect that to continue to work as an investment strategy past performance is rarely a good signal that you'll do well in the months and years ahead so be careful with the performance chasing because i see a fair amount of that going on also resist the urge to get to too defensive so even though you hear that there could be some warning signals some reasons to be cautious resist those all or nothing moves where suddenly you're out of stocks all together you're in bonds you're in cash one thing we know from surveying the universe of professional tactical asset allocators who jockey among different asset classes is they don't do particularly well with those moves and to me that really casts doubt on whether we as individual investors who aren't doing this for a living can successfully pull off those kinds of shifts so resist the either or mentality so would you suggest at this point that investors do nothing well some investors perhaps that is the right course i think the key thing you want to think about is when was the last time i made any changes to my portfolio and if you've been very hands off that has redounded to your benefit especially if you've had stocks in your portfolio but if you haven't rebalanced recently that would be something i would consider because rebalancing is a sane way to address when the market has moved extremely in one direction or another so if you haven't rebalanced recently i would advise you to do that check up on your portfolios asset allocation today using a tool like morningstar stars instant x-ray and compare that to your target allocation so that would be the starting point i think that that's a good kind of chicken way to address frothy markets to ensure that your portfolio isn't overexposed to those frothy parts of the market is there anything in particular that perhaps pre-retirees those sort of on the precipice of retirement might be doing today or thinking about today so that if there is a down market that their portfolio doesn't get swept up in that well this is such an important point susan and that is the group who needs to be especially cognizant of what's called sequencing risk and what that means is that your goal date is getting closer you're getting close to spending from that portfolio you've worked so hard to save so it makes sense at that life stage to secure a portion of your portfolio so that it's not all rattling around at the time that you get close to spending it down so for that group i would say de-risking at least a portion of the portfolio is mission critical that means rebalancing back to a reasonable asset allocation given your proximity to retirement and then what about young investors do young investors should they be concerned that we we might be in a bubble i think they want to be careful not to be too active in terms of managing their portfolios allocations for young folks saving for retirement they probably want to have the majority of their portfolios in stocks but i do like the idea of them taking a broad look at their portfolio mainly with an eye toward evaluating their global exposure i think there's a fair amount of data pointing to non-us stocks being more attractively valued than u.s today so for younger investors i think the global market capitalization is a really reasonable starting point when deciding how much to have in non-us relative to u.s stocks right now it's about 55 percent u.s 45 non-u.s most young investors don't have that much in foreign stocks and i think that that's a reasonable starting point well christine thank you so much for your perspective today on investing in these kind of interesting stock market times thank you thank you so much susan i'm susan sibinski with morningstar thank you for tuning in that does it for this week's investing insights podcast for morningstar we hope you have enjoyed our program and we welcome your feedback please send your comments and questions to podcast morningstar.com from everyone here at morningstar thanks for listening this recording is for informational purposes only and should not be considered investment advice opinions expressed are as of the date of recording such opinions are subject to change the views and opinions of guests on this program are not necessarily those of morningstar inc and its affiliates morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated morningstar does not guarantee the accuracy or the completeness of the data presented herein the podcast is for informational purposes only and should not be considered tax advice please consult a tax and or financial professional for advice specific to your individual circumstances morningstar research services llc is a subsidiary of morningstar inc and is registered with and governed by the u.s securities and exchange commission morningstar research services shall not be responsible for any trading decisions damages or other losses resulting from or related to the information data analysis or opinions or their use past performance is not a guarantee of future results all investments are subject to investment risk including possible loss of principle individuals should seriously consider if an investment is suitable for them by referencing their own financial position investment objectives and risk profile before making any investment decision

Channel: Morningstar, Inc.

Views: 5,939

Rating: 4.9652176 out of 5

Keywords: investing, stocks, inflation, target date funds, investing news, financial news

Id: zwxk8UudfPU

Length: 31min 18sec (1878 seconds)

Published: Fri Mar 26 2021