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Understanding Investment Risk

Understanding Investment Risk

Apr 2021

All investors – be they conservative, moderate or aggressive – need to understand that the level of returns they expect to generate is directly related to the amount of risk they are willing to assume – the higher the return, the higher the amount of risk one needs to take. It probably doesn’t dawn on most people that, regardless of where you put your money, you assume some element of risk. For instance, if you focus solely on keeping your money safe from the possibility of loss, you risk not accumulating enough money to meet your goal. In this case, trying to avoid “market risk” increases your exposure to other types of risk, such as “inflation risk” or “longevity risk.”

Essentially, you need risk in order to generate the level of returns you will need to achieve financial independence. However, risks can be managed far more effectively than investment performance. You can’t predict the direction of the financial markets, or which mutual fund will outperform the others; however, you can manage risk and even have it work for you through proper asset allocation and portfolio diversification. While there is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio, by including a mix of assets and securities that act as counterweights to one another, a risk aware portfolio can potentially help returns wherever they might occur while reducing overall portfolio volatility.

Understanding the different types of risks and how they can individually and collectively impact your long-term investment performance is crucial to constructing a well-conceived portfolio that seeks to maximize your returns while reducing your overall risk.

Different Types of Investment Risk

Market Risk: The risk that most people associate with investing is market risk, the possibility of losing money due to the price fluctuations of the markets. Because it is difficult to know which way prices will move, investors can lose money if the market moves against them. However, losses are only realized if the investment is actually sold.

Inflation Risk: Many risk adverse investors and savers prefer the safety of savings accounts, CDs and government bonds. The risk they face is that the growth of their secured savings doesn’t keep pace with the rate of inflation which will, in effect, reduce the value of their money in the future.

Interest Rate Risk: The prices of interest-bearing securities, such as government and corporate bonds fluctuate in response to the movement of interest rates. As interest rates rise, the prices of these securities will decline. So, it is still possible to lose money. If the bonds are held to maturity, which can be as long as 20 or 30 years, the investor receives the full-face value of the bond.

Taxation Risk: With the possible exception of some tax-exempt bonds, all investments will trigger a tax consequence, either as a result of income earned or capital gains realized from the sale of an investment. Over a long period of time, taxes can adversely impact the return on investment. Additionally, tax laws do change, so if an investment was based on its tax treatment, it could change at some point in the future.

Liquidity Risk: Investors who are concerned with having immediate access to their money need to be aware of liquidity risk. The safest of investments, such as CDs, have some liquidity risk because if it is redeemed too early the investor could lose a part of his principal to early redemption fees. And, even though stocks and bonds can generally be liquidated at any time, investors may be reluctant to do so if they are in a loss position.

When investing, all possible risks should be evaluated against your overall tolerance for risk. The most effective way to manage risk is to invest with your specific goals in mind. Also, having a long-term investment horizon may allow your investments to work through the inevitable down and up cycles of any market.

Tags: risk management, risk, investments

Investment Planning for an Uncertain World

Investment Planning for an Uncertain World

Apr 2021

Chances are good that if you turn on the prime-time news on any given day or pull up your favorite newspaper on your iPad one of the top stories will relate to emerging risks around the world. Whether it’s strife in the Middle East, tensions with Russia, or the ever-shifting balance of power between global powers, this much seems obvious: we live in a time of both unprecedented global complexity and the technological capability to watch events unfold in real time.

Investing in a Time of Geopolitical Risk

When large investment houses start talking about geopolitical risk it’s probably a good idea to take note. Some money manager may not spend time discussing the possibility that foreign policies between countries could lead to destabilizing situations, but at the end of 2014 the chair of RIT Capital Partners (a $3.5 billion fund) issued a statement that geopolitical risk was “…as dangerous as any time we have faced since World War II…”.1

Whether such a dire warning sounds overly pessimistic or not isn’t necessarily the point. What’s important is that it reveals that large money managers are starting to pay a great deal of attention to global risk.

But how to address these risks? Historically, moving 100% into cash or government bonds hasn’t been the best way to achieve growth throughout that last 100 years or so, a period of time that has seen more than its fair share of global instability. Without moving into purely defensive investments and making overly-conservative plans how can you plan for tomorrow while being mindful of risks today?

Managing Risk - and Reward - for Potential Long-Term Success

It’s often said that without risk there is no reward, and when it comes to financial planning this maxim is particularly true. For those trying to achieve long term goals, such as retirement or estate planning, it’s often times risky to try and avoid all risk.

Being overly risk-averse toward stocks can result in low returns that hardly keep up with inflation, which may in turn increase the risk of running out of money before you die or failing to fully fund an estate. For some investors cash and bonds alone don’t offer the inflation-beating returns needed to replace an income or provide a legacy to the next generation.

Fortunately, a smart financial plan, built in a way that takes into account global risks but still seeks long term growth, can help avoid these overly-cautious decision biases.

Is Your Plan Risk – and Reward – Aware?

With all the uncertainty in the news now is a great time to evaluate your financial plan to see if its managing risks in a smart way.

Does your plan:

  • Ignore the relationship between reward (investments) and risk management (insurance), or does it address both investments and insurance in a comprehensive way?
  • Diversify investments and insurance to provide multiple sources of return and income?
  • React to the latest headlines or take emotion out of the decision-making process?
  • Rely too much on one company or country? (Note: If your pension, 401k, and life insurance are all provided by your employer or heavily invested in one country this can be a big risk.)

The best way to be sure your plan is well prepared for the risks and rewards of the global economy is to talk with a professional planner today.

After all, wouldn’t it be nice to watch or read the news and not worry about the negative headlines because you know you’ve got the right plan – and the right planner – on your side.

Tags: risk management, investment management

What’s Your Risk Management Plan?

What’s Your Risk Management Plan?

Apr 2021

Most people couldn’t bear the financial hardships resulting from unexpected events, such as a major house fire, a car accident, a disability or the premature death of a family breadwinner, which is why one of the most important component of a sound financial plan should be your personal risk management strategy. Fully protecting your and your family’s financial future against the unexpected will help you to move forward with greater confidence in your wealth management decisions.

What exactly does it mean to “fully” protect your financial future? Of course, it involves insurance planning and the purchase of different forms of insurance. But before you overextend and become insurance poor, it would be important to carefully assess your risk exposures and develop a risk management plan that fits your particular needs. That requires a full understanding of all of the protections available to you and how to optimize their capacity to protect you.

Disability Income Protection

For most people, their most valuable asset is their ability to earn an income. Becoming disabled for a period of six months or longer could have a much greater impact than any of the other threats to your financial security, including losing your home in a fire, or a major car accident, or a premature death. Obtaining the best possible disability income protection plan should be your top risk management priority. Because your risk of disability increases as you get older, disability insurance can become very expensive. The best time to consider purchasing disability coverage is when you’re young and healthy.

The most important considerations for purchasing disability insurance are:

  • Obtaining a policy that protects your occupational specialty for as long as possible
  • Insuring future income increases
  • Relying first on an individual disability insurance plan and only using a group plan as a supplement

Disability income planning has become a specialty in the insurance industry, and it would be important to work with a disability specialist with access to the top disability insurance carriers in the industry.

Property and Casualty Protection

Generally, property and casualty insurance (P&C) protects us against financial loss resulting from damage to our property as well as the liability of someone harmed. Auto insurance, homeowner’s insurance, renter’s insurance and personal liability insurance are all forms of P&C coverage. The general rule is that, if you own it, insure it. Of course, there has to be an insurable interest which an insurance company deems worth protecting.

The other consideration when it comes to P&C coverage is: Don’t skimp on your coverage to save money; rather find all ways to optimize your capacity in your insurance coverage. For example: Choose the highest possible deduction for which you are financially able to cover. Paying a $1,000 deductible for a dented bumper or covering the first $2,500 of the cost of a roof replacement won’t break you. The higher deductible levels will lower your premium costs which should be redirected towards increasing your liability limits.

Personal Liability Protection

One of the least understood forms of protection is personal liability insurance; and with its capacity to form an extensive umbrella of financial protection for a low cost, it can also be the most overlooked. Most people don’t consider it because they think they have plenty of liability coverage in their homeowners and auto insurance policies.

Most people are just a slip on a banana peel away from a major lawsuit; however, people of wealth or high-income earners, such as physicians, can actually become targets of people seeking to benefit from an accommodating court system. For a few hundred dollars a year, you can provide yourself with a million dollars of umbrella protection. As a general rule, you should have umbrella liability protection to equivalent to the value of all of your assets.

Life Insurance Protection

The purchase of a life insurance policy may never make anyone's top ten list of favorite things to do. But, when given the opportunity to consider the range of purposes it can serve, it could turn out to be the most important financial instrument you own.

  • It creates an instant estate – Life insurance creates the capital a family needs when there are sufficient assets to cover their needs.
  • It provides tax advantages – Life insurance has a host of tax properties that make it attractive as a financial instrument. The death benefit is tax free to the beneficiaries. The cash value accumulates tax free. And, under certain circumstances, you can access your cash values tax free. Certain policies, such as Universal Life allow for tax free withdrawals of principal and most cash value policies allow for policy loans which are tax free. *
  • It’s cost effective – Life Insurance is a financial instrument with potential to provide the capital needed to provide for surviving family members or to settle the costs of a large estate, or to buy out the family of a deceased business partner, as inexpensively as life insurance.

The mistake many people make is to wait too long before purchasing life insurance. As with disability income insurance, the time to buy life insurance is when you are young and healthy.

*Policy loans can become taxable should the policy lapse. Also, policy loans, if not repaid, will reduce the death benefit amount.

Loans and withdrawals reduce the policy’s cash value and death benefit and increase the chance that the policy may lapse. If the policy lapses, terminates, is surrendered or becomes a modified endowment, the loan balance at such time would generally be viewed as distributed and taxable under the general rules for distributions of policy cash values.

Life insurance policies contain exclusions, limitations, reductions of benefits, and terms for keeping them in force. Your financial professional can provide you with costs and complete details.

Tags: risk management, retirement

Warren Buffet Retirement Planning Rules: What Would Warren Buffet Do?

Warren Buffet Retirement Planning Rules: What Would Warren Buffet Do?

Apr 2021

Everyone can learn some valuable lessons from Warren Buffet, arguably the most successful investor of all time. Buffet has two strict rules about investing that anyone would find, well, frustratingly simplistic. The first – “don’t lose money,” and the second – “don’t forget rule number one.” But for Buffet, winning can only happen in the stock market. Obviously, when your money sits in low yielding savings accounts it is impossible to win. In fact, if your money is earning below two percent interest, you lose each day to inflation. Over a twenty-year period, your dollars are worth just a fraction of what they were.

What Does Buffet Know that We Don’t?

Over time, Warren Buffet has graciously imparted bits and pieces of his knowledge with us average investors, and for those who really paid attention, they have managed to gain many of the advantages of his practices. See, Buffet adheres to history and he doesn’t fight the facts, while average investors tend to let their emotions guide their decisions. Buffet will be the first to tell you that emotions and investing don’t mix.

  • Fact #1: Bear markets do happen – but then, so do bull markets
  • Fact #2: The average duration of a bear market is 11 months as compared to 32 months for a bull market
  • Fact #3: The average bear market decline is 27 percent; the average bull market gain is 119 percent
  • Fact #4: Since WWII there has been as many bear markets as there have been bull markets, yet the stock market has still managed to advance more than 100-fold.

The takeaway for investors is that the losses of the bear markets have only been temporary while the gains of the bull markets are permanent. With each bull market, the losses of the preceding bear market decline were made up and the gains of the prior bull market were extended. In that perspective, bear markets are nothing more than a temporary interruption of a longer term uptrend. So, the real risk is not in the next market decline of 27 percent; the real risk is not being in the next 100 percent market increase.

How to Invest Like Buffet

The most notable successful investors, such as Buffet, are long term strategists with almost super-human patience. They believe in diversification, buy-and-hold, investing in value with a focus on wealth preservation, not wealth building – apparently a lot easier said than done for most people.

But, there are enough successful high net worth investors around from which we can glean the best practices that, when applied by any investor, can provide the edge that everyone seeks.

  • First: Develop clear and meaningful investment objectives. Many investors focus on investment performance, and, consequently, they often find themselves chasing it by trying to time the markets and making risky buy and sell decisions. Successful investors focus only on their specific objectives and use them as their sole benchmarks as opposed to some irrelevant stock market benchmark.
  • Second: Building and preserving wealth is as much about managing risk as it is managing investment performance. The key is to diversify your asset classes in a way that they act as counter weights to the various forms of risk, such as market risk, inflation, risk and interest rate risk. Periodically your portfolio should be rebalanced to ensure that the exposure to any one risk as not increased due to changes in your portfolio values.
  • Third: Buy stock insurance. Buffet and other successful investor hedge their portfolios with financial instruments called put options that limit their losses when stocks decline. The average investor, especially those closer to or in retirement might be better off by hedging their portfolio and their retirement income with annuities. With fixed indexed annuities a portion of your portfolio can still have access to stock market gains without having to endure the losses.
  • Fourth: Surround yourself with qualified and trusted advisors who have your sole interests in mind when providing you with guidance. The most successful investors rely on a team of advisors that provide unbiased advice in formulating the most appropriate investment strategy to meet their needs.

Not everyone has the courage or the patience (or the billions) that Buffet has to stay fully invested in the stock market, yet constant exposure to equities is vital if you are to have any chance of a secure retirement. And no one can pick individual stocks like Buffet either, nor should they try. Buffet has a fully diversified portfolio of hundreds of stocks invested across many industries, global regions and asset classes. You can achieve the same diversification with index funds or exchange-traded funds with the ability to allocate your assets broadly to reduce risk and volatility. Then, if you can exercise the same level of discipline and patience as Buffet, and hedge your portfolio and retirement income with annuities, you too can win by not losing.

Tags: retirement income, retirement planning, retirement

Securities are offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services are offered through NFP Retirement, Inc., a subsidiary of NFP Corp. (NFP). Kestra IS is not affiliated with NFP Retirement Inc. or NFP.

This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. NFP Retirement Kestra IS and Kestra AS do not provide tax or legal advice. For informational purposes only. Please consult with your tax or legal advisor regarding your personal situation

Trading option security contracts involves risk and may result in potentially unlimited losses that are greater than the amount you deposited with your broker. Because of the leverage involved and the nature of option contract transactions, you may feel the effects of your losses immediately. Under certain market conditions, it may be difficult or impossible to liquidate a position. Under certain market conditions, it may also be difficult or impossible to manage your risk from open options positions by entering into an equivalent but opposite position in another contract month, strike price, through another market, or in the underlying security. You may be required to settle certain option contracts with physical delivery of the underlying security. All option contracts involve risk, and there is no trading strategy that can eliminate it. You should thoroughly read and understand the customer account agreement with your brokerage firm before entering into any transactions in trading security option contracts.

1. http://www.stowefinancialplanning.com/blog/planning-new-normal-retirement

NFPR-2019-86 ACR#324841 09/19

Three Tax Tips That Can Help As You Approach or Begin Retirement

Three Tax Tips That Can Help As You Approach or Begin Retirement

Apr 2021

Retirement is a whole new phase of life. You’ll experience many new things, and you’ll leave other things behind. One thing that won’t disappear, however, are taxes. If you’ve followed the advice of retirement plan consultants, you’re probably saving in tax-advantaged retirement accounts, like 401(k)s or IRAs. These types of accounts defer taxes until withdrawal, and you’ll probably be withdrawing funds from them in retirement. Also, you may have to pay taxes on other types of income, like Social Security, pension payments, or salary from a part-time job. With that in mind, it makes sense for you to develop a retirement income strategy. Here are three tips:

Consider when to start taking Social Security.

The longer you wait to start taking your benefits (up to age 70), the greater your benefits will be. Remember, though, that currently up to 85 percent of your Social Security income is considered taxable if your income is over $34,000 each year.

Be cognizant of what tax bracket you fall into.

You may be in a lower tax bracket in retirement, so you’ll want to monitor your income levels (Social Security, pensions, annuity payments) and any withdrawals to make sure you don’t take out so much that you get bumped into a higher bracket.

Think about your withdrawal sequence.

Generally speaking, you should take withdrawals in the following order:

  • Required minimum distributions (RMDs) from retirement accounts. You’re required to take these, so start here first.
  • Taxable accounts. You should use these up.

Remember:

  • If you sell investments, you’ll need to pay taxes on any capital gains.
  • Tax-exempt retirement accounts like Roth IRAs or 401(k)s.
  • Saving Roth accounts for last makes sense.
  • You can take withdrawals without tax penalties, for example for a large medical bill. You can also use them for estate planning, since your heirs won’t pay any taxes on their distributions, either.

All these factors are complex, and you may want to consult a tax professional to help you apply these tips to your own financial situation. You can test different strategies and see which ones can help you minimize the taxes you’ll pay on your savings and benefits.

Tags: retirement income, retirement


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