PRIORITIZING RETIREMENT SAVINGS

MARKETS MIXED IN Q3

Asset classes posted mixed results in the third quarter as the COVID-19 delta variant raised concerns about the sustainability of the economic reopening and recovery. Wrangling in Washington over the federal budget, infrastructure investment, tax proposals, and the debt ceiling roiled markets in September. However, despite a rocky third quarter, U.S. and international stocks, real estate, and commodities remain firmly in positive territory for the year. • U.S. large-cap stocks rose slightly, and small-cap stocks fell modestly in the third quarter. Despite recent volatility, they have posted double-digit year-to-date gains thanks to a resilient economy and the U.S. consumer’s health. • International developed stocks slipped in September and continue to trail U.S. stocks for the year. Emerging market stocks fell modestly and are now slightly negative for the year driven by slower growth and regulatory actions in China. • Bonds treaded water in the third quarter. Despite their rise in September, interest rates were little changed for the period. • Commodities were the standout performer for the quarter (and the year so far), fueled by a rebound in oil prices.

Commodity prices have risen due to supply constraints and rising demand as the economy reopened. • Public real estate notched a small gain in the third quarter as interest rates marked time.

MARKET INDEX PERFORMANCE

(as of 9.30.2021)

U.S. Bonds Large-Cap Stocks Small-Cap Stocks

15.9%

12.4% International Stocks

8.8% Emerging Markets Stocks Real Estate

21.3% Commodities

29.1%

6.6%

0.6%

-4.4% -0.4% -1.0% 0.9%

Q3 2021 YTD 2021 -8.0%

LOOKING FORWARD

Record levels of household wealth, extraordinary stimulus, and vaccine availability have set the stage for robust economic growth. While the COVID-19 delta variant has tempered growth in recent months, the economy will likely reaccelerate as the virus’s toll eases. Meanwhile, we see several reasons for caution. The U.S. policy response has been a driver of the global recovery, but we are nearing a point where the Federal Reserve may begin to wind down its bond-purchase program. Global supply chains have faced significant bottlenecks this year, leading to supply constraints for some industries. Lastly, geopolitical tensions have risen in a number of areas, most notably in China.

Asset class returns are represented by the following indexes: Bloomberg Barclays U.S. Aggregate Bond Index (U.S. bonds), S&P 500 Index (U.S. large-cap stocks), Russell 2000® (U.S. small-cap stocks), MSCI EAFE Index (international developed market stocks), MSCI Emerging Market Index (emerging market stocks), Dow Jones U.S. Real Estate Index (real estate), and Bloomberg Commodity Index (commodities).

Fighting Recency Bias

by John Curry

If movie review website Rotten Tomatoes’s readers are to be believed, the last decade was a golden age for moviemaking. In fact, 59 of the films in the website’s Top 100 Movies of All Time list were released during the 2010s.

Apocalypse Now?

While the website’s readers included several great films from the past decade, including Parasite, The Shape of Water, Knives Out, and a few other Academy Award Best Picture nominees, they also included nine superhero movies, 12 sequels, and any number of movies that will certainly fail the test of time.

Rotten Tomatoes’s readers seem to have some fondness for classic films, as shown in Figure One, but the 50-year period from the 1960s through the 2000s appears to have been a vast movie wasteland—with only eight movies on the list. Surprisingly, E.T. the Extra-Terrestrial and Schindler’s List are the only films on the list for the 30-year period from 1980 until 2009.

What about The Big Chill, Titanic, and Million Dollar Baby? More importantly, what is going on with Rotten Tomatoes readers?

Answer: Like most humans, they suffer from recency bias. Figure One: Top 100 Movies by Decade

Source: Rotten Tomatoes

Invasion of the Body Snatchers

Recency bias is a cognitive bias that causes us to place too much emphasis on recent events or experiences—even if they are less relevant. Conversely, recency bias causes us to deemphasize events further into the past. Specifically, recency bias is a memory bias, a type of cognitive bias that enhances, impairs, or alters the recall of a memory.

In a nutshell, recency bias results from our brain’s preference for more easily accessible information over the harder work of analysis and decision-making. We prefer matching patterns from recent memory to deeper, intentional thought.

Maybe misremembering movies—like how good Road House really is—isn’t such a bad thing, but, like many cognitive biases, recency bias can also keep us from making high-quality decisions in other aspects of our lives.

For example, after an hour-long job interview, you’ll likely recall the last 20 minutes of your conversation more vividly than the first half. That means you will perceive a candidate who starts strong and finishes weaker more negatively than you would have otherwise. The converse is true as well. And candidates interviewed later in your process will be more likely to advance.

Meanwhile, in competitions such as the Eurovision Song Contest and world and European figure skating, Wändi Bruine de Bruin, provost professor of public policy, psychology, and behavioral science at the University of Southern California, found in her research that judges gave higher marks to competitors who performed last. In a nutshell, recency bias results from our brain’s preference for more easily accessible information over the harder work of analysis and decision-making. We prefer matching patterns from recent memory to deeper, intentional thought.

Of course, recency bias affects us as investors as well, and it can be hard to avoid, partly because it is informed by facts. Not just facts—but recent facts that may seem indisputable due to their freshness.

During a stock market selloff, it’s easy to believe that stock prices will keep falling. Think back to early last year when the first coronavirus-induced waves of selling hit the market. It seemed like the bottom dropped out. And it did … right up until the breathtaking rally that recovered all of their lost ground (and more). Conversely, investors tend to jump on board during the tail end of a market rally only to be surprised that the rally doesn’t continue.

Here are three investing narratives supported by recency bias that will be true right up until they aren’t.

The market’s at an all-time high, so it’s not a good time to invest. If you’re prone to believe this, you will find ample proof, even as the market continues to hit new record levels. Rather than failing to invest, it might be more productive to create a dollar-cost-averaging program to move into the market in increments. That way, you can both participate in any future records and take advantage of an eventual pullback.

Growth stocks are doing so well, I don’t need to own value stocks. Growth stocks have, indeed, done well for the past several years when compared to value stocks. While it might be tempting to jump ship on your value stocks, mutual funds, or exchange-traded funds, ensuring that you have exposure to both is wise. This trend will end at some point, perhaps with a vengeance.

All I need is a simple portfolio of 60 percent U.S. stocks and 40 percent bonds. According to Morningstar, if you had invested $100,000 in a simple, cost-effective strategy like this in 1980, rebalanced it quarterly, and stayed the course—fees and taxes aside—your portfolio would be worth $6.8 million. That’s a 10.86 percent annualized total return over a 40-plus-year period. Wow! Why wouldn’t you just do that?

The easy answer is that the next 40 years cannot possibly look like the past 40 years. Much of the return of that minimally diversified portfolio came from exposure to U.S. bonds during an extended period of falling interest rates. During that period, the yield on the benchmark 10-year U.S. Treasury fell from 13.6 percent to 1.3 percent today. That literally cannot happen again.

Not Mission Impossible

While it might seem difficult to do, you can thwart recency bias—or at least minimize it—to help yourself make higher-quality investment decisions.

Get historical. In the immortal words of Mark Twain, “History never repeats itself, but it does often rhyme.” Pulling back the lens to view the longer sweep of history is often a helpful input into decision-making. For example, in the turmoil of a market pullback, looking at the frequency of past corrections could inform your view. History tells us that 5- and 10-percent pullbacks happen every year or two and that a 20 percent pullback is likely every seven years or so.

Look downstream. Making sure that you understand the implications of your decision may be helpful. Are there transaction costs? Will you owe significant taxes if, for example, you sell a highly appreciated position? How will you reinvest the proceeds? The answers to these questions may cause you to think twice.

Revisit your plan. Your financial plan can also provide important information for investment decision-making. Knowing, for example, the portfolio hurdle rate needed to fund your important life goals can be invaluable. You may find that it will be quite easy to achieve, so you can worry less about market pullbacks and won’t need to take an extraordinary amount of investment risk to get there.

Kick it around. You may want to seek opposing views to investment ideas you’re exploring. Many people process their thinking by speaking, so having a trusted sparring partner (or partners) to debate with can be a helpful way to expand your thinking. The more viewpoints, the better. This will add nuance to your ideas and help ensure you are thinking rationally.

Successful tactics to address recency bias tend to have two complementary characteristics to help you make better decisions: They provide both additional perspective on a topic, and they slow down the decision-making process.

While it is unlikely that Rotten Tomatoes is concerned about the influence of recency bias on its Top 100 Movies of All Time list, you might want to slow down and gather more information before your next movie night.

Exploring other sources—like the American Film Institute’s 100 Greatest American Movies of All Time or the Academy of Motion Picture Arts and Sciences’ list of past Oscar-nominated best pictures—can provide a much richer picture of quality films to spend your time on.

Successful tactics to address recency bias tend to have two complementary characteristics to help you make better decisions: They provide both additional perspective on a topic, and they slow down the decision-making process.

INVESTORS IN TRAINING

by Jeanne Lee

There’s no doubt about it: Passing along financial wisdom to children can help them live better lives, enjoy greater freedom, exercise more control over how they spend their time, and afford a degree of comfort and security that otherwise may not exist.

A lot of ways exist to help kids—grandchildren, nieces, nephews, godchildren, or any other young people in your life—build their financial muscles. Many of us utilize common practices like helping a child fill up a piggy bank over time, involving youngsters in small purchases using cash, helping them join the local bank or credit union to open an account, or by the different examples we set, such as sticking to a budget.

But it’s also important to teach kids lessons in investing, says father of two and Wilmington-based CAPTRUST wealth management advisor Buck Beam.

So, when it came time to pass on some of these lessons to his own two sons, Beau, 12, and Wayland, 9, Beam was “looking for a way for the kids to connect real money to the stock market and learn about how the stock market works,” he says.

All the Action in Just a Fraction

For the Beam family, it all started with the ubiquitous delivery trucks driving through their neighborhood, dropping off brown boxes adorned with a smile logo. “How about Amazon?” Beau and Wayland asked. There was just one problem: The boys’ stock pick was totally out of their budget, with a price tag in the thousands of dollars for a single share, says Beam.

Then he looked into fractional shares. While buying entire shares of stock in big name companies can get expensive, Beam quickly discovered that fractional shares are a fantastic way to get young people excited about investing and to help them develop valuable financial skills that will be with them for life, without committing a lot of money.

Since then, Beam has seen his two sons bloom into precocious investors. While working from home in the early days of the pandemic, the family even got into a routine of eating breakfast together while watching the business news, which led to the kids peppering their dad with questions about companies and how the stock market works.

“The idea of investing some of their own money was thrilling to the boys,” Beam says. They already had some savings—from birthday money and allowances—and Beam was excited to foster their interest. He even upped the ante by pledging to match their investments dollar for dollar.

A Long-Term Lesson

“Fractional shares of stock are a great opportunity for young investors because it can teach kids how money actually grows,” says Beam. “And kids are eager to learn—particularly when Disney and Apple could be involved.”

The idea is simple: Instead of buying whole shares of stock, parents, aunts, uncles, grandparents—or anyone with a young person in his or her life—can buy partial shares by the dollar amount. Also called dollar-based investing, this capability was first offered by some technology startup companies and then introduced by companies like Fidelity and Charles Schwab in 2020. With dollar-based investing, even someone with just a little bit of money can buy in and diversify his or her small-dollar portfolio.

“Investing in fractional shares is a neat activity to do with the kids,” says Beam, “and it has the long-term benefit of helping create savers and investors out of your kids and grandkids without putting a lot of money down.” According to Beam, fractional shares are for everyone—at the collective age of 21, his boys hold investments in Amazon, Microsoft, Roblox, Disney, and Apple.

Hands-On Investing

For Beam’s sons, their dad’s idea of investing in fractional shares meant they could afford to get into some of the brand-name stocks that they were familiar with. And that got their attention. The boys became very engaged and excited to talk with Beam about their personal stock holdings and their own investment ideas.

Beam quickly noticed a stark difference from his previous attempts to educate his kids on the workings of the stock market. In the past, his lectures were largely ignored. But kids, like adults, absorb complex concepts much better through experiencing them than by passively listening.

“A lot of kids don’t make financial decisions,” says Beam. “So it’s very interesting to them to have some skin in the game and then get to live with their decisions and see how it goes.” Above: Buck Beam; his wife, Caroline; and his sons, Beau and Wayland.

Investing in fractional shares is a neat activity to do with the kids. And it has the long-term benefit of helping create savers and investors out of your kids and grandkids without putting a lot of money down.” Buck Beam

In fact, one day last winter, Beau watched a news report about the airline sector being hard hit by travel bans and pandemic restrictions. Since the sector was down, he pondered, wouldn’t it be a good time to buy some airline stocks and hold them until they recovered? Beam was delighted to encourage him to follow his instincts. “I said, ‘Maybe! For the amount of money we’re talking about, it’s worth a try.’”

Beau invested $40 in an airline stock when the share price had dipped to the high $30s, getting a bit over one share’s worth. Since then, the stock has had ups and downs, trading above $50 at one point and back down to around $40.

“Beau and Wayland have seen the markets go up and go down,” Beam says. “They’ve watched Amazon trade at its highest price ever and then come down significantly.” It’s a small amount of money that they’ve invested, but to them, he says, it’s a really big life lesson.

When Beam comes home from work these days, Beau or Wayland will rush to him, asking, “What’s my stock worth now?”

Hungry for More

When Beam comes home from work these days, Beau or Wayland will rush to him, asking, “What’s my stock worth now?” Father and sons pull up the Fidelity mobile app and put their heads together, checking on the latest progress of their investment portfolios.

The experience has shown Beam how he can talk with his kids about the stock market. “This has been the first time in their lives they would ask me questions, instead of me just explaining what I do and why it matters. Now they’re curious. They want to understand. Once their money was on the line, they were hungry for more information,” says Beam.

What to Do with Winnings

Another important lesson for young investors is what to do with winnings. “When one of the stocks went up, their natural question was, ‘Can we get the money out and buy something?’” says Beam.

While Beam and his wife, Caroline, have not allowed the boys to take any money out, they have been asked by the boys repeatedly. While we can’t blame the budding investors for fantasizing about cashing in, rightfully so, Beam has “encouraged them to look at this money as a long-term savings account, not a source of money for buying a toy or a treat or a video game.”

Beam also wanted the boys to avoid short-term gains, which might have tax consequences. More importantly, he was teaching them to become savers and long-term investors—a habit that is truly a valuable gift to impart on a child.

START WITH A CUSTODIAL ACCOUNT

Depending on which stock your little one wants to invest in, fractional shares could be a practical option worth considering. Here is what you need to know about getting started. Kids and teens can own stock by having an adult on the account with them. If you want to open an account for someone under the age of 18, you’ll need to open a custodial account in person or online through a brokerage. You will be the custodian, and the minor will be the beneficiary, Beam says. “Your child will own the assets, but you’ll control the investments and have legal responsibility over the account until your child is 18 to 21, depending on your state.” Custodial accounts for kids are easy to set up and monitor so they can embrace investing early in life, Beam says, but be sure to confirm beforehand that the brokerage allows for fractional investing, as not all of them do. Also, look for an account that offers commission-free trades. When you’re investing small amounts, fees can quickly erode your returns.

READER Q & A

In this installment of Client Conversations, the team at VESTED gets into old-world and modern-day tactics crooks use to steal from 401(k), 403(b), and other retirement accounts. From contacting financial institutions pretending to be the account holder to convincing the account holder to transfer funds out of the account—we’re exposing what you need to know to safeguard your accounts. Also included are insights on the potential age delay in RMDs. With change expected to become law by the end of the year or sometime in 2022, VESTED dives into the ways that the extra years could provide more time to strategize.

Are criminals targeting retirement accounts? If so, what do I need to know to protect myself?

AAttempts to steal from 401(k), 403(b), and other retirement accounts are, in fact, on the rise. But while it might feel like crooks always seem to be a step ahead of the good guys, you should know that stealing from a retirement account isn’t easy.

Criminals try to steal from retirement accounts using both old-world and thoroughly modern techniques. They might try calling the plan’s recordkeeper and impersonating you or sending a faxed distribution request with your signature.

That’s right—crooks can even lift signatures from other documents to create an initial online identity or steal the one you have in place through hacking.

Each approach requires different knowledge about you, and there are several barriers in the way. In addition, 401(k) accounts are more difficult to steal from than typical bank accounts because they often require additional paperwork from the employer to access the money, but these retirement accounts can also be easily subject to fraud if the crook has the right information. Crooks can lift signatures from other documents to create an online identity or steal the one you have in place through hacking.

Experts say criminals use a few common tactics. One is acquiring an account holder’s statement or website credentials and contacting the financial institution pretending to be the account holder trying to get his or her money out.

The other way crooks make off with retirement savings is by using a technique called social engineering (which is what used to be called a con or a grift), persuading the account holder to transfer funds out of the account.

Fortunately, there are some things you can do to protect yourself from frauds like these. Taking the following steps can help safeguard IRAs and retirement plan accounts like 401(k)s.

Create an online account. Experts recommend setting up online account access even if you prefer paper statements. It’s easier for impersonators to take control of your account online if you haven’t claimed online access for yourself.

Check in regularly. Check your retirement account, including your email and street addresses, at least monthly. Sign up for text alerts that notify you of changes or transactions, and use multi-factor authentication (MFA). MFA is a security enhancement that allows you to present something you know— like your password—with two credentials when logging into an account. Credentials fall into any of these three categories: something you know, like a password or PIN; something you have, like a smart card; or something you are, like your fingerprint.

Practice good internet hygiene. Avoid public Wi-Fi, and never click on suspicious or unfamiliar links in emails, text messages, or instant messaging services seeking personal information, including passwords.

Design good passwords. Choose unique passwords that you keep confidential. Long passwords are stronger, so make your passwords at least 12 characters. Try using a lyric from a song or poem, a meaningful quote from a movie or speech, or a passage from a book.

Dispose of printed statements carefully. Shred printed statements along with other sensitive documents. Local office supply stores offer shredding by the pound in case you have lots of old statements to dispose of.

If you see something, say something. If you are personally affected, immediately call your recordkeeper and employer and have a freeze put on your account. You may also want to report it to the Federal Trade Commission (FTC) at ftc.gov, the Treasury Inspector General for Tax Administration (TIGTA) at tigta.gov, and your local police department.

I’ve heard Congress might raise the age for taking RMDs. What do I need to plan for if the age moves to 73?

AIt is true. The age when Americans must start making withdrawals from traditional individual retirement accounts (IRAs), IRA-based accounts, and most employer-sponsored retirement plans could change again, and potentially soon. The proposed new legislation, nicknamed SECURE Act 2.0, would increase the required minimum distribution (RMD) age to 73 starting in 2022, then to 74 in 2029 and 75 in 2032. This change is expected to become law either by the end of this year or sometime in 2022. However, the potential impact of a higher age requirement on your RMD timing is mixed and depends on how quickly you need the money. The majority of retirees will not be impacted. According to the Internal Revenue Service (IRS), 79 percent of retirees take more than their RMD annually because they need the money. However, for the 20.5 percent who take only the minimum amount required, the extra years could provide more time to strategize. If you have income sources in addition to your IRA and company plan, waiting another one to three years can be a big plus because it allows your savings to grow on a tax-deferred basis for longer. Another big planning opportunity related to RMDs at 73 is that the SECURE Act leaves the eligible age for qualified charitable distributions, or QCDs, intact at 70 1/2. The QCD gives charitably inclined retirees the opportunity to make tax-free gifts using assets from their tax-deferred accounts. The mismatch between the QCD-eligible age (70 1/2) and the new RMD age of 73 provides an opportunity to use QCDs aggressively when first eligible with an eye toward reducing RMDs when they commence. However, it is a short window, and QCDs are limited to $100,000 per year. A delay in the RMD age is also an opportunity to convert more of a traditional 401(k) or IRA over time to a Roth IRA. While taxes are paid on the converted money, withdrawals down the road would be tax-free, unlike distributions from a traditional IRA or 401(k), which are taxed as ordinary income. Similarly, those post-retirement, pre-RMD years allow for tax-lowering maneuvers not directly related to the IRA. For example, tax-gain harvesting in taxable accounts can help reduce or eliminate capital gains taxes eventually due on those assets. While the first SECURE Act eliminated the stretch IRA for the majority of beneficiaries who inherited IRA assets in 2020 or later, it does provide a big opportunity for Roth IRA beneficiaries. Distributions from inherited Roth IRAs are almost always tax-free. A beneficiary could take no distribution until the tenth year after inheriting the account, leaving all the earnings in the inherited Roth IRA to grow tax-free. The account could then be emptied in the tenth year after years of tax-free growth with no tax bill for the beneficiary. If you are considering your estate plan and are thinking about how your beneficiaries will fare under the new rules, now may be a good time to consult with a knowledgeable tax or financial advisor.

Another big planning opportunity related to RMDs at 73 is that the SECURE Act leaves the eligible age for qualified charitable distributions, or QCDs, intact at 70 1/2.

If you have a question for the VESTED team, we’d love to hear from you and see if we can help. Please send your questions to us at VESTEDmagazine@captrust.com.