Investors Are Human, Too
In 1981, the Nobel Prize-winning economist Robert Shiller published a groundbreaking study that contradicted a prevailing theory that markets are always efficient. If they were, stock prices would generally mirror the growth in earnings and dividends. Shiller’s research showed that stock prices fluctuate more often than changes in companies’ intrinsic valuations (such as dividend yield) would suggest.1
Shiller concluded that asset prices sometimes move erratically in the short term simply because investor behavior can be influenced by emotions such as greed and fear. Many investors would agree that it’s sometimes difficult to stay calm and act rationally, especially when unexpected events upset the financial markets.
Researchers in the field of behavioral finance have studied how cognitive biases in human thinking can affect investor behavior. Understanding the influence of human nature might help you overcome these common psychological traps.
Individuals may be convinced by their peers to follow trends, even if it’s not in their own best interests. Shiller proposed that human psychology is the reason that “bubbles” form in asset markets. Investor enthusiasm (“irrational exuberance”) and a herd mentality can create excessive demand for “hot” investments. Investors often chase returns and drive up prices until they become very expensive relative to long-term values.
Past performance, however, does not guarantee future results, and bubbles eventually burst. Investors who follow the crowd can harm long-term portfolio returns by fleeing the stock market after it falls and/or waiting too long (until prices have already risen) to reinvest.
This mental shortcut leads people to base judgments on examples that immediately come to mind, rather than examining alternatives. It may cause you to misperceive the likelihood or frequency of events, in the same way that watching a movie about sharks can make it seem more dangerous to swim in the ocean.
People also have a tendency to search out and remember information that confirms, rather than challenges, their current beliefs. If you have a good feeling about a certain investment, you may be likely to ignore critical facts and focus on data that supports your opinion.
Individuals often overestimate their skills, knowledge, and ability to predict probable outcomes. When it comes to investing, overconfidence may cause you to trade excessively and/or downplay potential risks.
Research shows that investors tend to dislike losses much more than they enjoy gains, so it can actually be painful to deal with financial losses.2 Consequently, you might avoid selling an investment that would realize a loss even though the sale may be an appropriate course of action. The intense fear of losing money may even be paralyzing.
It’s important to slow down the process and try to consider all relevant factors and possible outcomes when making financial decisions. Having a long-term perspective and sticking with a thoughtfully crafted investing strategy may also help you avoid expensive, emotion-driven mistakes.
Note: All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.
1 The Economist,”What’s Wrong with Finance?” May 1, 2015
2 The Wall Street Journal,”Why an Economist Plays Powerball,” January 12, 2016
Retain and Reward Key Employees with an Executive Bonus Plan
The success of a business, especially a small business, is often predicated on the performance and retention of a few key employees. The financial impact and stress resulting from the departure of an important employee can be significant. One way business owners can try to retain and reward their key employees is by offering extra compensation in the form of a nonqualified executive bonus (IRC Section 162) plan. These types of plans often use permanent life insurance as the funding vehicle.
What is it?
An executive bonus arrangement is an addition to regular salary or compensation that business owners can provide to key employees or executives of their choice. The bonus may be used by the employee to purchase permanent life insurance.
There are no legal requirements for anything to be filed with the government or for the plan to be in writing. However, a written plan is often desirable because it can outline the conditions that must be met in order for the employee to qualify for the bonus, and it can state the obligations of the business to pay the bonus.
How does it work?
The business provides extra compensation to the key employee in the form of a bonus. If life insurance is used as the funding vehicle, the employer may make the bonus payment directly to the insurance company, or the employee can make the premium payments.
In some instances, the employer will pay a “double bonus” to the employee to pay for any income taxes owed by the employee that are attributable to the bonus. To cover premium payments and to maintain the tax advantages of cash accumulation for the employee, the employer should plan on making ongoing bonus payments instead of a one-time bonus so the policy isn’t classified as a modified endowment contract.
The employee is the insured and owner of the life insurance policy and may name the policy beneficiaries. The life insurance policy may accumulate cash value, which can be accessed by the employee during his or her lifetime. Generally, any cash accumulation within the policy will grow tax deferred. Policy death benefits are paid to the employee’s beneficiaries named in the policy.
What are the tax considerations?
Bonuses are generally deductible by an employer according to the same rules as other forms of cash compensation. A bonus cannot be deducted unless it constitutes a reasonable allowance for services actually rendered.
A bonus is taxed to the employee as ordinary taxable income. Because employees generally file taxes according to the cash method (rather than the accrual method), the bonus is taxable to the employee when it is received.
Considerations for the employer
- Extra compensation in the form of a bonus can attract, motivate, and retain key employees.
- The plan is generally simple to implement and easy to administer, with no formalities or funding requirements.
- The employer has complete discretion in selecting which employees to reward.
- The employer may be able to deduct the bonus as a reasonable business expense.
- The employer can set terms and conditions that must be met by the employee to qualify for the bonus.
Considerations for the employee
- The employee receives life insurance protection for his or her family at little or no cost (assuming the employer also covers the tax obligation of the employee attributable to the bonus).
- The employee owns the policy and names the policy beneficiaries.
- Permanent life insurance may accumulate tax-deferred cash value over time, which the employee can access to supplement retirement or to meet other needs or expenses.
- The bonus may be contingent on continued employment or performance goals.
- The employee must be insurable in order for life insurance to work as the plan funding vehicle.
A way to retain and reward employees
A principal challenge to employers is figuring out how to retain and reward key employees. These goals can be promoted by providing executive bonuses to key employees, who can use the bonuses to fund a life insurance policy. Life insurance may be a useful funding vehicle because it can provide a tax-free benefit to the employee’s chosen beneficiaries and it may accumulate tax-deferred cash value.
How to Get a Bigger Social Security Retirement Benefit
Many people decide to begin receiving early Social Security retirement benefits. In fact, according to the Social Security Administration, about 72% of retired workers receive benefits prior to their full retirement age. 1 But waiting longer could significantly increase your monthly retirement income, so weigh your options carefully before making a decision.
Your monthly Social Security retirement benefit is based on your lifetime earnings. Your base benefit–the amount you’ll receive at full retirement age–is calculated using a formula that takes into account your 35 highest earnings years.
If you file for retirement benefits before reaching full retirement age (66 to 67, depending on your birth year), your benefit will be permanently reduced. For example, at age 62, each benefit check will be 25% to 30% less than it would have been had you waited and claimed your benefit at full retirement age (see table).
Alternatively, if you postpone filing for benefits past your full retirement age, you’ll earn delayed retirement credits for each month you wait, up until age 70. Delayed retirement credits will increase the amount you receive by about 8% per year if you were born in 1943 or later.
The chart below shows how a monthly benefit of $1,800 at full retirement age (66) would be affected if claimed as early as age 62 or as late as age 70. This is a hypothetical example used for illustrative purposes only; your benefits and results will vary.
|Birth year||Full retirement age||Percentage reduction at age 62|
|1955||66 and 2 months||25.83%|
|1956||66 and 4 months||26.67%|
|1957||66 and 6 months||27.50%|
|1958||66 and 8 months||28.33%|
|1959||66 and 10 months||29.17%|
|1960 or later||67||30%|
Early or late?
Should you begin receiving Social Security benefits early, or wait until full retirement age or even longer? If you absolutely need the money right away, your decision is clear-cut; otherwise, there’s no ”right” answer. But take time to make an informed, well-reasoned decision. Consider factors such as how much retirement income you’ll need, your life expectancy, how your spouse or survivors might be affected, whether you plan to work after you start receiving benefits, and how your income taxes might be affected.
How is GDP calculated in the U.S.?
GDP, or gross domestic product, is a measurement of the total value of all goods and services produced in the United States over a given time period. It is used by economists, government officials, market forecasters and others to gauge the overall health of the U.S. economy.
Although there are several ways of calculating GDP, the expenditures approach is the most common. It focuses on final goods and services purchased by four groups: consumers, businesses, governments (federal, state, and local), and foreign users.
The calculation and a description of its components follow:
Consumption (C): Also known as personal consumption, this category measures how much all individual consumers spend in the U.S.
Investment (I): Not to be confused with investments in the stock and bond markets, this is the amount businesses spend on fixed assets (e.g., machines and equipment) and inventories, as well as the amount spent on residential construction.
Government (G): This category tracks the amount the government spends on everything from bridges and highways to military equipment and office supplies. It does not include “transfer payments”–for example, Social Security and other benefit payments.
Exports (X): This is the value of goods and services produced in the U.S. and purchased in foreign countries.
Imports (M): This is the value of goods and services produced in foreign countries and purchased in the U.S.
Historically, the U.S. has run a “trade deficit,” which means imports have outpaced exports.
Once the final GDP values are calculated, the percentage change is calculated from one time frame to the next, generally quarter to quarter or annually. Reported quarterly by the Bureau of Economic Analysis, these percentages can influence both investment markets and policy decisions.
What is an ABLE account?
ABLE (Achieving a Better Life Experience) accounts are tax-advantaged savings accounts for individuals with disabilities that are generally used to cover qualified disability expenses. States can create qualified ABLE programs for persons who become disabled prior to age 26. A disabled person (or the disabled individual’s parent or guardian, or an agent with a power of attorney) can create an ABLE account under any state’s ABLE program. Generally, only one ABLE account is permitted per disabled person at a time. ABLE accounts are relatively new, so you will need to check which states currently have ABLE programs.
Contributions to the ABLE account are subject to an annual and a cumulative limit. The annual limit for total contributions by all contributors combined is equal to the federal annual gift tax exclusion amount ($14,000 in 2016). The cumulative limit applies to the extent that a contribution would cause the account balance to exceed the state’s maximum aggregate limit for all Section 529 qualified tuition program accounts for the beneficiary. (Fees and expenses may be associated with investment options offered. All investing involves risk, including the possible loss of principal, and results are not guaranteed.)
Distributions from an ABLE account can be made only to the designated beneficiary. The ABLE account and distributions for qualified disability expenses of the designated beneficiary are generally not subject to federal income tax.
Generally, the ABLE account is disregarded for purposes of determining eligibility for, and the amount of, any assistance or benefit provided under certain means-tested federal programs. However, for purposes of the Supplemental Security Income program, any distributions from the ABLE account for certain housing expenses are not disregarded, and the account balance is considered a resource of the designated beneficiary to the extent the balance exceeds $100,000.
Upon the death of the beneficiary, any state can file a claim for the total medical assistance paid for the beneficiary under that state’s Medicaid plan (as reduced by any premiums paid under a Medicaid buy-in program) after the establishment of the ABLE account.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed herein.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016