This past month the financial advisors at Ruedi Wealth Management wrote four more “Finance 101” columns for The News-Gazette’s Business Extra Section. Make sure to look for the columns every Sunday, but in case you missed any of them this past month the columns from June are below.
Pension vs. Lump Sum: Financial Considerations
David Ruedi, CFP®
The choice between receiving retirement benefits as a stream of payments (annuity) or as a lump sum that you will then invest yourself and withdraw from is a complicated one. There are many things you need to consider, some are purely financial and can be fleshed out by crunching numbers, and some are personal and can only be decided based on what makes you feel better. Today I want to cover the financial considerations.
The first consideration is straightforward: which option provides you with higher monthly spending. To make this comparison, you must determine what you could withdraw from the portfolio if you elected to receive the lump sum payout. Everyone’s withdrawal rate will differ depending on their time horizon and how their portfolio is invested.
The second financial consideration is how much you want to leave behind to your heirs. There is a chance of leaving behind an inheritance for your heirs by taking the lump sum, investing it, and withdrawing from that portfolio. However, this is not the case with most immediate annuities.
Another important consideration is the income reduction that can take place when the spouse receiving the pension annuity dies first. Unless you get a joint and survivor annuity, your benefits will go away or reduce at death. By contrast, an income stream based on withdrawing a certain amount from a portfolio does not have to reduce because one spouse passes away.
Other income sources should also be factored into this decision. If you have other guaranteed income streams such as Social Security, a good portion of your financial needs may be covered, making it more desirable to take a lump sum to invest for potential upside in lifestyle and legacy.
The final thing investors should consider is how a lump sum would likely be invested. If you would invest the lump sum almost entirely in bonds or money market funds, you may be better off taking the pension. Though it is hard to make blanket statements, generally speaking the higher the ratio of stocks in your portfolio, the higher likelihood of being better off taking the lump sum.
These are just a few of the financial considerations of taking a pension or a lump sum payout, and as you have noticed, there are a lot of moving parts. That is why this decision is so different for everyone and needs to be made on a case-by-case basis. Next week I will cover the emotional side of this decision, which can further compound an already complex choice.
Pension vs. Lump Sum: Emotional Considerations
David Ruedi, CFP®
The choice between receiving retirement benefits as a stream of payments (annuity) or as a lump sum that you will then invest yourself and withdraw from is a complicated one. There are many things you need to consider, and today I want to cover the personal and emotional side of the decision.
The first thing you should consider is whether you have the expertise and discipline to manage a lump sum. If you plan on taking a lump sum, you must have the knowledge required to develop a properly diversified investment portfolio and the emotional ability to stay invested through turbulent markets. You also need the expertise required to know how much you can withdraw from your portfolio without running out of money.
Another personal consideration is if you have a plan for who will manage your portfolio when you are no longer able. If you can manage your own portfolio now, who will manage it as your cognitive ability declines as you grow older? Does your spouse have the ability to manage the portfolio if something happens to you? Do you have a competent, trusted advisor that can manage the portfolio for you if/when you’re unable to manage the portfolio on your own?
Leaving an estate to your heirs is an emotional decision as well as a financial one. If you highly value leaving money behind to take care of family members or give to a favorite charitable cause, you will probably want to take the lump sum. If that’s not important to you, you may be more likely to choose the annuity option.
Potentially the most important of any of the financial or emotional considerations is which option gives you the greatest peace of mind. Some people feel better receiving “guaranteed” income instead of taking withdrawals from an investment portfolio that fluctuates. That is completely understandable, especially for those who will have the ability to do everything they want with the guaranteed annuity and won’t really benefit from any additional income an investment portfolio may provide.
As you can see, there are a lot of factors to consider when making the annuity vs. lump sum decision. In addition to the emotional aspects of the decisions, some of the considerations involve making calculations, like how much you can withdraw from an investment portfolio, that few people have the expertise to make themselves. If you are struggling to make this decision yourself, it can be very helpful to talk to a financial advisor who can provide you with everything you need to make an informed decision.
Fundamental and Technical Analysis
Paul R. Ruedi, CFP®
When evaluating an individual stock or other type of investment, investors can perform many different types of analyses. These analyses falls into two broad groups: fundamental analysis and technical analysis.
Fundamental analysis deals with the actual underlying characteristics of a company or investment. This can include things like sales, profitability, growth of earnings, assets, debt, and many other characteristics. Some investors look at ratios, for example the price of a stock relative to earnings, to decide the relative attractiveness of an investment to similar alternatives. It can also involve more abstract factors like the effectiveness of a company’s management or their CEO.
If an investor looks at the fundamentals and finds a stock to be “under-valued,” the investor would purchase that stock. But it is important to note a key assumption for fundamental analysis to work: the market must have the price of a stock or investment “wrong” right now, but eventually wise up in the future and move the stock price closer to where it “should” be. That is a very dubious assumption.
Technical analysis deals more with how investments have traded in the past and emphasizes using various charts and trends to try to predict where an investment may be headed in the future. Technical analysts may look at price trends using metrics like moving averages, or look for particular price points where an investment has tended to rise or fall in the past and trade based on that. There are many technical indicators and analysts may consider many indicators at once or look at some while ignoring others.
There is a reason we spent an entire year covering other topics in these columns before getting to the different types of analyses. That is because any analysis, fundamental or technical, is likely based on information that is publicly available. Investors across the globe use this information to make investment decisions, and their buying and selling ensures all publicly available information is incorporated to stock prices very quickly. For this reason, both types of analysis rarely provide any benefit to investors relative to passively owning a diversified portfolio of index funds. Even professional fund managers underperform their benchmarks the vast majority of the time.
This does not mean all types of analysis are useless. If you are looking at investing in an individual company that is not traded on a stock exchange, fundamental analysis in particular can be very helpful. Just don’t try to make a stock-picking or market-timing strategy based on fundamental or technical analysis because you will likely do more harm than good.
Support and Resistance
Paul R. Ruedi, CFP®
In my last column I discussed technical analysis and some of the things people look at when taking a chart-driven approach to trading. Two chart-driven concepts you will hear about the most often in financial media are “support” and “resistance.” Both represent a price level that a stock or other investment seems to have trouble passing through, but are called different things depending on the direction of the stock price.
When a stock or investment falls to a price point it seems to sort of catch itself, this is called a “support.” If every time a stock falls to a price of $100 it bounces back up, you may hear a financial person say it is experiencing support at around $100. Using a recent example, the price of Bitcoin was seemingly in freefall from $60,000 until it received some support at around $30,000.
Resistance is just the opposite. When an investment rises to a certain level where it tends to keep pulling back, it is said it is experiencing “resistance” at that level. For example, the S&P 500 and other major stock indexes seem to be experiencing some resistance these days as they try to exceed previous highs.
There are no officially designated support and resistance levels; they are more or less self-fulfilling as they are based on the behavior of investors. A stock or investment may experience support at a recent low, or resistance at a recent high. Round price points, like Dow 30,000 and other round numbers that represent milestones for investments or indexes, can also serve as support and resistance points.
Investors and short-term traders may consider support and resistance points when buying and selling investments. For example, if an investment is falling, a purchaser may wait until it has fallen to a support point to make sure it doesn’t fall further before purchasing. A short-term trader would potentially sell a stock if it continued to fall through a support point, with the idea that since it has cleared that support level it will continue to fall further. A person may wait until after a stock has passed through a resistance point to purchase.
Though support and resistance lines, and patterns on charts in general, can feel like they are pointing to obvious future price movements, the things they predict don’t always come true. The good news is, short-term price movements around support and resistance levels don’t really make a difference to long-term investors. Long-term investors should focus instead on the long-term growth of their investments, and ignore the short-term noise.