It looks like the U.S. stock market will finally get something that happens, on average, about once a year: a 10+% percent drop—the definition of a market correction. The last time this happened was a whopper—the Great Recession drop that caused U.S. stocks to drop more than 50% - so most people today probably think corrections are catastrophic. They aren’t. More typically, they last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%). Corrections are unnerving, but they’re a healthy part of the economy—for a couple of reasons.
Reason #1: Because corrections happen so frequently and are so unnerving to the average investor, they “force” the stock market to be more generous than alternative investments. People buy stocks at earnings multiples which are designed to generate average future returns considerably higher than, say, cash or municipal bonds—and investors require that “risk premium” (which is what economists call it) to get on that ride. If you’re going to take more risk, you should expect at least the opportunity to get considerably more reward.
Reason #2: The stock market roller coaster is too unsettling for some investors, who sell when they experience a market lurch. This gives long-term investors a valuable—and frequent—opportunity to buy stocks on sale. That, in turn, lowers the average cost of the stocks in your portfolio, which can be a boost to your long-term returns.
The current market downturn relates directly to the first reason, where you can see that bonds and stocks are always competing with each other. Monday’s 4.1% decline in the S&P 500 coincided with an equally-remarkable rise in the yields on U.S. Treasury bonds. Treasuries with a 10-year maturity are now providing yields of 2.85%--hardly generous, but well above the record lows that investors were getting just 18 months ago. People who believe they can get a decent, relatively risk-free return from bond investments are tempted to abandon the bumpy ride provided by stocks for a smoother course that involves clipping coupons. Bond rates go up and the very delicate supply/demand balance shifts, at least temporarily, in their direction, and you have the recipe for a stock market correction.
What factors should you consider before you make the irrevocable choice?
If you get a pension buyout offer from your former employer it may cause some anxiety. You have to decide if the lump sum offer is a better deal for you or the corporation making the offer.
Your decision to accept or reject a buyout offer can only be made after you consider some key variables. Consult a trustworthy financial advisor to help you analyze the variables and make a decision that is in your best interest.
How large is your buyout offer? Compare the lump sum to the total pension payments you think you will receive over your lifetime. Consider how much you would receive if you live another 10, 25, or 40 years. Keep in mind that the effects of inflation mean that a dollar today is worth more than a dollar will be worth even five years from now.
How long do you think you will live? If you have health concerns you may want to take the lump sum now. On the other hand, if you expect a long retirement then the regular payments may present less risk and provide you with a regular income when other funds have run out.
What about taxes? A lump sum distribution from a pension or retirement account is "taxable income" according to the IRS. In addition, if you are under 56 1/2 years old, you will likely have to pay a 10% penalty on the distribution. A direct rollover to an IRA or other qualified retirement account is not subject to tax or IRS penalties.
What kind of return could you get if you invested the money? Could you invest your lump sum so it keeps up with inflation? Could your investment generate more retirement savings and income for you in the long run?
Who will help you invest a lump sum? Pension funds are overseen by professional money managers. Could you manage your retirement savings in a similar manner? It would be wise to talk to an investment advisor. Market volatility can result in lower values once you reach retirement - are you comfortable with the risk inherent in market investments? A monthly payment will help you avoid that loss of principal.
A lump sum distribution could change your life. Sometimes a "windfall" can change a person's lifestyle in even subtle ways. If you have cash in hand, or in the bank, then you are more likely to splurge on little things and "one time" purchases. It can be surprising how quickly a person can spend through $300,000 or more and lose your retirement savings. A direct rollover or monthly payments can help you avoid this risk.
Get an unbiased analysis of your options. Bring your buyout offer letter to a free consultation to get help running the numbers and evaluating your options. I will give you a complementary report showing the present value of your pension payments over the years. We can talk about investment options and your risk number. There is no obligation and no charge for this meeting and report.
Little steps you can take to keep from getting carried away.
You’ve seen the footage on the news. You’ve been in the middle of it. You’ve stood in the vexing lines. You’ve circled for the elusive parking spots. Holiday shopping can be downright frenzied – and impulsive.
You don’t necessarily need to go to the mall to feel the pressure and the urges – a half-hour with your laptop or tablet can put you in the same frame of mind.
But how do you keep your spending under control, whether in a brick and mortar store or at home? Here are some tips.
Make a plan. Most people do their holiday shopping without one. Set a dollar limit that you can spend per week – and try to spend less than that. As you plan your financial life – and check on your plan every few days – you may feel a little less stressed this holiday season. In fact, you might want to make two budgets – one for shopping, the other for entertaining.
Remember that your kids look to you to build habits when they are adults. If they see you overspending and using credit to buy gifts then they will do the same. If they know you plan your budget and your gift giving responsibly then they will be less likely to carry high interest debt in the spirit of the holidays.
If you aren’t vigilant, the holiday season could leave you with a “debt hangover,” or contribute to a severe debt load you may be burdened with.
Recognize the hidden costs. Holiday shopping isn’t just a matter of price tags. When you don’t visit brick-and-mortar retailers, you don’t eat at the food court or coffee shop and you don’t spend money for gas. Carpooling to the mall or taking public transit can help you save some cash.
On the other hand, when you shop online, there’s always shipping to consider. It can make what is seemingly a bargain less so. Online retailers can be very finicky about returns. Miss a deadline to return something to an online retailer (who hasn’t?) and you may end up paying sizable return fees or just getting stuck with what you purchased.
Counteract those holiday expenses elsewhere in your budget. Maybe you spent a couple hundred more than you anticipated on that flat-screen. To offset that extra spending, pinpoint some areas where you can save elsewhere in your budget. Could you find cheaper auto insurance? Could you eat in more this month? Could you drive less or cancel that gym membership or premium cable subscription?
If you do go overboard, strategize to attack that excess debt. You may want to pay off the smallest debt first, then the next smallest and so forth onto the largest. Or you may want to pay down the debt with the highest interest rate first, then the one with the second highest interest rate, and so on.
With the latter method, you can potentially realize greater savings on interest charges, but you lose the accomplishment of quickly erasing a debt. Both strategies have you making the minimum payment on all debt but selecting debt to which you will devote all your extra cash. The benefit is that as you pay off your first debt, the second debt in line will have a larger payment and be paid off faster. The option you select should be based on whether it is more important to you to get the psychological “high” from paying off a debt or to save money on interest paid on your debt.
If you feel like indulging yourself, indulge sensibly. Some people do give themselves holiday gifts, and the same logic applies – whether it is a meal, a motorcycle, or a spa package, don’t break the bank with it.
Consider how your loved ones would feel about your debt. Family and friends are likely to be perfectly happy with a gift that involves more personal thought than something that has a high price tag. Ask yourself if your family would want you to be burdened with debt throughout the year just so they can get an expensive gift. A new holiday giving strategy can put more emphasis on people than material objects (without suggesting that you are watching your budget).
Lastly, think about setting aside some “gift money” for 2016. If your finances allow, how about putting $100 or $200 aside for next season? Invested in interest-bearing accounts (or elsewhere), that sum could even grow larger. Some people open bank accounts (be aware of potential monthly fees) just for gifts so they can approach gift giving with a ready budget.