Finance 101: October 2022

In October the financial advisors at Ruedi Wealth Management wrote 5 more “Finance 101” columns for The News-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from October all five are below.

The Importance of Stress Testing Retirement Plans

Paul A. Ruedi

Though the average annualized return of a diversified stock portfolio has been in the ballpark of 10% based on data going back to the 1920’s, lurking within that average are periods of significantly worse performance. This makes funding a multiple decade retirement quite complicated, because although we would like to expect average returns, we simply have to anticipate the possibility of returns that are much worse than that.

As retirement planners, we have to recognize the uncertainty of returns and make sure our clients’ financial goals are not derailed by something like the bear market we are experiencing right now. For this reason, we have to “stress test” any financial plan we build against a wide range of possible outcomes. Instead of assuming average returns, we use what we know about markets to anticipate thousands of possible outcomes, and make sure our clients’ financial plans remain intact.

This may sound technical, but we use stress tests in our everyday lives. In his book the The Flaw of Averages, Sam L. Savage uses the example of shaking a ladder. When someone is about to climb on a ladder, they don’t simply look at how the ladder is standing and take comfort that it is standing where it is. Everyone feels compelled to shake the latter first, testing a lot of different forces and positions and making sure the latter still stands.

We do the same thing with our financial plans. Though it would be nice to look at the average return of a portfolio and just assume a client will receive it, that just isn’t reality. Even if they do receive that average return over the long-term, the path their portfolio takes to get to that return matters greatly. Much like shaking a ladder, we must test any financial plan against an array of forces and stressors that could be placed upon it.

Though you cannot predict when bear markets will occur, we know they happen, and you can account for them in your planning process. Lurking within our stress tests are not just bear markets like the current one, but stressors that are much worse. Retirement plans have to stand up to a range of outcomes before we feel comfortable putting a client on that particular path. If you aren’t sure if your retirement plan has been stress-tested, you may want to seek the help of a retirement planner.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.

Which Account Comes First?

Ryan Repko, CFP®

The modern person’s financial life is complicated. With so many investment accounts with different names and features, people often have no idea which one they should put money in, or max out first. Though there is no one-size-fits-all answer, I will provide a commonly prescribed savings account order.

The first priority would be a checking or savings account so an emergency fund can be established. This is essential to smooth out any cashflow issues, and it provides a buffer so one doesn’t need to withdraw from their investment accounts, should an unexpected expense occur. A sufficient emergency fund is the building block to investing.

The next would be a Health Savings Account (HSA) if you have one. Contributions to an HSA lower your tax bill now and can be withdrawn tax-free if used for qualified medical expenses. Money in an HSA can also be invested and can grow tax-free, with no tax on the earnings when they are withdrawn, provided they are used for qualified medical expenses.

After that would be a 401(k), especially if your employer provides a match. Traditional 401(k) contributions lower your tax bill now and will grow tax-deferred until retirement, when both contributions and earnings are taxed upon withdrawal. Roth 401(k) contributions don’t lower your tax bill now, but withdrawals are tax-free if you follow all the rules. A person could also fund a Roth or Traditional IRA, which receive similar tax treatment but have lower contribution limits.

Finally would be contributions to “taxable” brokerage accounts. These accounts receive no special tax treatment, but it is better to have those extra dollars invested even if they will be taxed. Since you don’t have to wait until a certain age to withdraw from them without penalty, taxable brokerage accounts are more flexible than retirement accounts.

I find this savings hierarchy to be sensible, but there are also reasons to go in a different order. If someone has a generous employer match on their 401(k) and low medical expenses, they may want to contribute enough to get the full 401(k) match before they max out an HSA. If an employer doesn’t match and their 401(k) has bad investment options, a person may fund an IRA instead of putting money into the 401(k). A person may value the flexibility of a brokerage account and contribute to that before maxing out retirement accounts.

Clearly, there is no one-size-fits-all order. You have to consider the specifics of your situation and fund the accounts accordingly. If you aren’t sure how to do that yourself, you may want to talk to a financial advisor.

Ryan Repko is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

It’s Always Scary to be an Investor

Paul Ruedi

It is a scary time to be an investor. With both stocks and bonds down and inflation running high, it is understandable people would be nervous about the future. But as I look back and think about the times it was easiest to take the leap of faith that is investing, I have found that there really wasn’t one. Though we look back on the past with rose-colored glasses, it almost always feels scary to take the risk of being an investor.

After the pandemic-induced decline early 2020, the market came roaring back. When the market reached new highs some people celebrated, but many people became concerned about investing when prices were so high. That’s right, people were concerned about investing when things were going so well stocks were making new highs. When the market came along and delivered lower prices, investors didn’t celebrate, they began to worry about all the reasons it was down and if it would fall further.

There will never be a time where it feels 100% safe to be an investor. No matter the conditions, people will always find something to worry about. That is because stock returns are inherently uncertain, and we as humans are hard-wired to hate uncertainty. The human brain will always find a convincing reason to avoid the uncertainty of investing.

We should not wish this uncertainty away, but actually embrace it, as it is the very reason stocks or any other investments provide a return. The fact that investors loathe uncertainty so much causes them to price in some sort of expected return as compensation for taking on that uncertainty. We should be happy to have the opportunity to accept that compensation, even if it requires taking on some uncertainty.

Though it doesn’t happen every year, over long periods of time investors are rewarded for the uncertainty they take on. But you must look past the short-term swings in the stock market and focus on the long-term return investors receive as compensation for signing up to live through those swings. It sounds simple, but it isn’t easy. After all, the human brain will always find a good excuse to avoid uncertainty.

If you struggle to overcome your fear of investing, I highly recommend you talk to a financial advisor. If he or she does nothing more than make you comfortable enough to invest throughout what are seemingly always scary times, it will have a tremendous positive impact on your life.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.

Should I Stop Investing?

Paul R. Ruedi, CFP®

I received an interesting email this week that I think captured the way a lot of people are feeling right now. The email explained that the sender automatically contributes money from each paycheck to a retirement account. The question was, should a person ever stop contributing and investing based on how the market has performed recently?

It is an attractive idea. If we could simply avoid investing during periods when the market is falling and only invest when things are going up, we could have the benefit of investing without the pain. The idea makes so much sense intuitively, but it tends to break down in practice. I think the fact that I received this email during a major low point for the stock market shows how it would likely manifest itself.

Most people who attempt to time the market end up doing the opposite of what they had hoped. That is because investors will inevitably fall prey to their emotions. When the market is down, expected returns are actually higher. After all, you are buying the same assets “on sale.” But stocks only go on sale because conditions are terrifying and the perceived risk is very high. It is at this moment a person would likely sit on the sidelines to “wait until things get better,” only to miss out on the inevitable recovery.

Moral of the story, you can’t hope to time the market and have a better experience than you would simply buying and holding. Investors are just too likely to get overly enthusiastic when prices are high and avoid investing when things are down. Chasing performance is more likely to lead to significant underperformance than excess returns.

However, for those who are in the process of patiently accumulating stocks for retirement, I do make one exception: if the stock market is down significantly you can feel free to buy more while prices are down. When anything else goes on sale, people have an easy time loading up on items at temporarily low prices. Investors should do the same with stocks.

This doesn’t mean go crazy and bet the house on stocks. But if you are investing 10% of each paycheck, you may want to consider temporarily increasing that a few percent or even as high as 15% to take advantage of the temporary sale. Of course, you must recognize that things could get worse before they get better. But if they do, it will be an even bigger opportunity for people who are consistently investing to load up on stocks. Don’t miss it.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

Are Markets Crazy?

David Ruedi, CFP®, RICP®

If you watch the daily swings of the stock market, you will find it is often hard to make any sense of market pricing. How could something be worth a few percent less today than it was yesterday? Significant daily price changes can make the market seem completely crazy. But a market that bounces around daily is a sign that the market is working properly.

The stock market is a highly efficient information processing machine. When buying or selling a stock, investors transact at a price they believe is fair based on the information they know about the company. With so many investors buying and selling at all times, new information is reflected in stock prices quickly. At any moment, our best estimate of what something is worth is the current market price. That is the value the overlapping minds in the market have put on it with their buying and selling.

Stock prices are constantly changing because new information is always coming out. When new information is released, investors react (often overreact) to that information, and stock prices change. Why is the stock market down compared to yesterday? Likely because new information has come to light that negatively affected investors' outlook for the future of the stock market.

Although daily price swings can be rational, that doesn't necessarily mean the movement of stock prices is predictable. By definition, new information that moves the stock market was not previously known or expected by investors. Making matters worse, investors are emotional human beings, and it can be challenging to predict exactly how they will react to news. This is why it's so difficult to time the market.

Fortunately, investors don't have to time the market to have a successful investment experience. Historically, investors have been handsomely rewarded for simply buying and holding a diversified portfolio of stocks and bonds. Investors simply have to tune out the daily noise and wait through the seemingly "crazy" short-term swings to reap those long-term returns, which is often easier said than done. If you aren't equipped to do that yourself, you may want to talk to a financial advisor.

David Ruedi is a CERTIFIED FINANCIAL PLANNER ™ professional with Ruedi Wealth Management in Champaign, Illinois.

Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.