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FDS Monthly Newsletter                                                                                                                                                            March 2020 

Page 1: Reassessing the Investment Landscape Page 6:  Free Money May Exist With This Employee Benefit Page 7: Health Insurance Comparison 


Page 8: Events & Frequently Asked Questions

Left to Right: Michelle Smalenberger, Steve Smalenberger, Rob Stoll, Trevore Meyer

Reassessing the Investment Landscape Written By: Rob Stoll, CFP®, CFA

A lot has happened since we published last month’s Investment Newsletter. At that time, the S&P 500 was making new record highs and economic data was solid. There were very few signs of trouble.   Fast forward three short weeks, and the landscape has changed dramatically. The  Coronavirus, which started quietly in China back in January, rapidly expanded to South Korea and  Italy at first. And eventually, to the United States. The stock market responded, entering bear market territory by declining more than 20%. We’re not going to rehash all of our latest thoughts on the virus’ impact. Our latest thoughts are on our blog.

Instead, we think it’s important to consider the broader ramifications of what we’ve just experienced in the markets. Retirement plans, in particular, depend on making assumptions about  future investment returns. With U.S. Government bond yields plunging to less than 1%, we need to take a step back and see how that might impact financial plans.

History of Investment Returns The first place to start the conversation is to look at the long-term history of investment returns.  Credit Suisse, an investment bank from Switzerland – in partnership with the London School of  Economics – publishes an  annual  report on investment returns dating back to 1900. Page 1 

FDS Monthly Newsletter                                                                                                                                                             March 2020 

The chart above looks at historical investment returns for U.S. stocks, government bonds, and short-term Treasury Bills. The chart on the left shows these returns before the impact of inflation (Nominal terms) while the chart on the right shows the same returns after the impact of inflation.  For reference, inflation has averaged ~2.9% over the last 120 years.  We’ll talk about investment returns in nominal terms (before inflation) since that’s an easier concept to think about. When we refer to Treasury Bills, think of money market or savings account rates. Since 1900, stocks, bonds, and bills have generated the following average annual investment returns: Stocks: +9.6% Bonds: +4.9% Bills: +3.7% In the financial planning world, many advisors will assume that clients use a mix of 60% stocks and 40% bonds (a “60/40” portfolio) while they’re in retirement. This allocation has historically generated returns that allowed clients to out-pace inflation while offering enough growth to fund spending needs. Here are the expected returns from a 60/40 and 70/30 portfolio based on historical returns:

Investment returns in any given year can vary wildly from these averages. And the impact of advisory and fund  management fees will reduce these numbers. But in general, long-term  investors could assume investment returns of ~8% over their planning time horizon before fees.

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FDS Monthly Newsletter                                                                                                                                                           March 2020 

Long-term Returns in a 1% World As alluded to at the beginning of this Newsletter, long-term U.S. Government bond yields have plunged in recent weeks. They were already low to begin with, a  hangover from the Global  Financial Crisis of 2008-2009. But the recent Coronavirus scare has sent these yields even lower. To get a sense of how unprecedented current bond yields are, Yale professor Rober Schiller compiled a history of long-term interest rates in the United States going back to 1871. The current level of rates is clearly much lower than anything we’ve ever seen in this country. Interest rates under 1.0% are new for the United States, but not for Japan and parts of Europe.  Long-term rates in Japan have been below 1.0% since 2011 and are currently -0.06%. Likewise,  rates in Germany fell below 1.0% in mid-2014 and are currently -0.55%. Both of those countries  are plagued by low economic growth and population stagnation.

Resetting the Bar Since current U.S. interest rates are far below the long-term average of 4.9%, we need to assess how this may impact future investment returns. For the sake of simplicity, we’ll assume that long-term returns for stocks remain at their historical average of +9.6%. But in assessing 60/40 and 70/30 portfolios, we’ll assume that bond returns are just 1.0%.

Making the somewhat draconian assumption that long-term interest rates stay at 1.0% forever, expected returns for these two portfolios come down meaningfully. Almost 1.5% is slashed off the  60/40 portfolio’s expected return, while the 70/30 portfolio’s expected return declines by over 1.0%.   In our opinion this view of the world is too harsh. The United States is the most dynamic, wealth-creating country in the world. While population growth has slowed and our society has aged, no  other country boasts the type of growth-driving innovation that we have. Additionally, the nature of bond markets has changed dramatically in the last half century. Today,  we have easy access to investment-grade corporate bonds and high-yield “junk” bonds. These bonds generate higher returns than government bonds. This “spread” – as it’s often called – over government bond yields can be volatile since corporate  bonds have credit risk, something government bonds do not. But just as (volatile) stocks have long-term historical averages we can look at, investment grade and high yield corporate bonds also have historical “spreads” that we can use. Page 3

FDS Monthly Newsletter                                                                                                                                                           March  2020 

Put another way, if we were to assume 1.0% government bond rates, then we might expect investment  grade  corporate bonds to yield 2.75% (1.0% + 1.75% “spread”) and high yield bonds to yield 5.75%.

Investment Returns in a “New Normal” Using the above data, we can now construct expected returns in a “new normal” environment, which is characterized by lower economic growth and lower long-term interest rates. To do this,  we’re going to construct a portfolio that includes three types of bonds: U.S. Government bonds, Investment Grade Corporate Bonds, and High Yield Bonds. We’ll also assume that U.S. Government bonds yield 2.0% in this “new normal” vs. the 1.0% they currently yield.

Expected returns in this scenario are lower than what the last 120 years of history generated (see Figure 1 above) but they’re better than assuming yields of 1.0% (Figure 2). What do these lower  returns mean? For an investor with a 25 year time horizon and a $100,000 portfolio, the expected value of their portfolio would look like this:

Clearly, lower long-term interest rates can have a real, negative impact on future investment returns. Page 4

FDS Monthly Newsletter                                                                                                                                                           March 2020 

Impact on FDS Client Financial Plans When we are creating financial plans for clients, particularly those focused on retirement, there are a couple of important “inputs” that we focus on: 1.     Age at retirement 2.    Spending level in retirement 3.    Expected inflation of spending levels in retirement 4.    Investment returns For the sake of this Newsletter, we’re going to focus on #3 and #4.   As you can see in the first chart, inflation has averaged 2.9% since 1900. There have been years where it was much higher than that, while recent years have been lower.    When we construct financial plans for FDS clients, we bake in inflation rates of at least 3.0% and sometimes up to 3.5%. These levels are higher (i.e. more conservative) than what’s actually played  out historically. This “buffer” helps account for any future spending uncertainty (like long-term  care costs). For #4 – Investment returns – FDS has used investment rates of returns of between 5% and 6%  when building retirement projections for clients. This compares to a long-run average of +7.72% (Figure 1). We’ve intentionally built in two buffers that account for the gap between our assumption and actual long-term average returns. First, we assume advisory and fund management fees. If you’re paying us for advice, there’s a cost to that and we 

build that cost right into your long-term plan. Secondly, we’ve been cognizant that we’re in an unusual  environment. Even before the  Coronavirus situation, long-term interest rates were well below normal with little sign of reverting  back to average. While we haven’t officially been making a call that future returns would be lower, we had decided to at least build in some cushion in case these lower rates persisted.

Takeaways We’re going through a unique period for our country. The investment landscape has changed and the need to adjust future expected investment returns seems appropriate.    The good news is that FDS already built buffers into financial plans to account for various  uncertainties. No  financial plan is the “final answer” about what the future will look like, just a road map of what it might look like. What this means for you, FDS clients, is that this “New Normal” does NOT mean we have to go  back to the drawing board on your financial plan. That doesn’t mean we wash our hands and say, “We’re good!” As part of what we do for you, keeping your plan fresh and up to date is important.  If you’ve experienced life changes since your plan was done, let’s schedule a time in 2020 to review and model these changes. We’re here for you in these turbulent times. Don’t ever forget that!

Disclosure footnote: Financial Design Studio, Inc. (“FDS”) is a registered investment advisor offering advisory services in the State(s) of Illinois and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. Follow-up or individualized responses to consumers in a particular state by FDS in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content is for information purposes only. Opinions expressed herein are solely those of FDS, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

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FDS Monthly Newsletter                                                                                                                                                       March  2020 

Free Money May Exist With This Employee Benefit Written by:  Michelle Smalenberger, CFP®

We all like the idea of free money, so I want to walk you through one area where there may be free money available which you are not taking advantage of. In your employer's  retirement account you are contributing money yourself and then your employer may also be willing to put money in as well.  Let’s assume this is all going into your 401(k) or 403(b).  There are a couple of ways this actually happens.  Here are the two most common types of plans:  Employer match or profit sharing. 1.    You may be eligible for an employer match.  This may be explained as 100% of the first 3% you contribute and then 50% up to 6%.  This means your employer is willing to put in 3% of your salary if you are contributing at least this amount.  So they are matching it 100%.  Then on the next 3% (up to 6%) they will contribute half of that (50%).  With this plan you have to make a contribution to receive this FREE money.

One final detail to clarify is which accounts your contributions get deposited into. You can make your employee contributions into a Roth 401(k) if available.  However, by law the employer contributions will be deposited into your Traditional 401(k).  The reason for this is that your income you are making Roth contributions from is being taxed in the year you earn it.  It is not deducted from your total income earned like a Traditional 401(k) contribution.  But the employer contributions made to you has not been taxed so it needs to be put in the traditional 401(k) where it will be taxed when the funds are withdrawn in later years. Let’s review the four things that make this money FREE:   F:  Make sure you’re Fully vested in order to get the total       account value that has accumulated. R:  The funds have to go into a Retirement account. E:  These are contributions from your Employer to you as       the employee. E:  Excuse yourself from spending it today. If we can help explain this so you know what is available to you we are happy to walk through it with you.

2.   Or you may be eligible for profit sharing.  In this plan a company doesn’t define a percentage they will match.  A contribution by you, as the employee, is not required.  Instead this is based on a formula.  For example they may contribute an amount equal to your salary times the number of years or hours you’ve worked or been with the company.   In this type of account the company isn’t required to make a contribution to you each year or even when they have a profit.

Want to share this with someone? Know someone who wants to receive this newsletter? Send us their mailing address at team@financialdesignstudio.com   If you prefer to no longer receive this newsletter please email us at team@financialdesignstudio.com


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FDS Monthly Newsletter                                                                                                                                                                  March 2020 

Health Insurance Comparison Written By:  Trevore Meyer, CFPⓇ CKAⓇ

Today we want to talk about your insurance and how to choose the right plan for you and your family.  There are a lot of factors that go into what we pay for health insurance and the three biggest ones that come to mind are your premium, deductible, and out-of-pocket  maximums. Let’s take a look at two different plans with different variables and see how they impact us throughout the year. 

Premiums First we want to talk about the premium. This is actually what we pay for the coverage on a regular and ongoing basis.

Deductibles Deductibles are how much we cover of whatever expense we incur before the insurance actually comes in and helps us cover some of those expenses alongside us.

Out-Of-Pocket Maximum This is how much we pay before our insurance company will step in and cover the rest of the cost for us. 

Plan A Health Insurance Comparison This is going to have a $100 monthly premium. It’s going to have a $1,500 deductible. And an out of pocket maximum of $5,000.

Plan B Health Insurance Comparison This is going to cost a little bit more on a monthly basis, $200 per month. However the deductible is only going to be $750 and the out-of-pocket maximum is $3,000. 

It may seem as if Plan B is actually going to be a lot more expensive. It's as if we are paying twice as much as if we would for Plan A. The interesting thing however is when we start incurring medical costs, we find that  at the break point of about $15,000 dollars,  Plan B  actually becomes our better option. That is because our out-of-pocket maximum kicks in faster due to the gap between the $5,000 and the $3,000. And furthermore our co-insurance period starts faster as well. We have an extra $750 to cover in Plan A, that we don’t have to cover in Plan B.

Plan A Ideal Health Insurance Situation It is important to note that if you are someone who doesn’t have very many medical costs, doesn’t go to the doctor very often, and there aren’t many chronic illnesses, something like Plan A could very well be a good option for you. 

Plan B Ideal Health Insurance Situation However if there are consistent issues that you run into, or you are concerned about catastrophic care, where you are worried that for some reason something might happen to you, Plan B could end up being the better option. At the end of the day, determining the best plan for you and your family is a challenging task. But if you think we could be helpful, please let us know!

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FDS Monthly Newsletter                                                                                                                                                          March 2020 

   Save the Date: May 30, 2020                 Frequently Asked Questions (FAQs) Saturday, May 30th we are hosting another event where your whole family can come!  We will have things for your kids as well as for you.  Mark it on  your calendars now so you don't miss the fun! WHO: The Whole Family WHEN:  10:30am - 12:30pm (Lunch provided) WHERE:  Our office 21660 W. Field Parkway, Suite 118 Deer Park, IL 60010

Are you a Fiduciary? Yes, we are! This means we have a  duty  to act in your  best interest.  A person acting in a fiduciary capacity is held to a high standard of honesty and full disclosure in regard to the client and must not obtain a personal benefit at the expense of the client. - Winston Churchill

You're Fee-Only: What does that mean? We have chosen to be a fee-only advisory firm. This means we do not accept any fees or compensation based on product sales.  While we know our clients We will update you on any need to postpone this. We need products like insurance we do not receive any would love for you to join us, so please save this date! benefit from any source when you buy a product.

21660 W. Field Parkway Suite 118 Deer Park, IL 60010


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Financial Design Studio Inc. March 2020 Monthly Newsletter  

The Financial Design Studio Monthly Newsletter is filled with a variety of timely financial planning topics and an in-depth investment updat...

Financial Design Studio Inc. March 2020 Monthly Newsletter  

The Financial Design Studio Monthly Newsletter is filled with a variety of timely financial planning topics and an in-depth investment updat...