January 27, 2015Vol 8, Issue 1 
DFW Financial Planning

Jean Keener, CFPGood morning.  I hope your year is off to a great start.


We have a full 2014 investment market update below.  2015 has started as 2014 ended -- with a lot of ups and downs in the markets.  As of the close yesterday, the S&P 500 is basically flat so far this year.  International developed market stocks are up very slightly.  Emerging markets stocks are up over 3%.  And the US total bond market is up 1.5%.  


In this edition of the newsletter, articles include a listing of the 2014 tax provisions that were extended at the end of the year, the relationship between financial habits and net worth, new IRS provisions permitting the conversion of after-tax dollars to a Roth IRA, and more.


Please let me know if you have suggestions for newsletter articles -- the Roth conversion article in this newsletter was a result of one of those suggestions -- thank you!  I'm also happy to discuss any questions that may arise in your financial world.  Thanks for reading, and live well!

In This Issue
2014 Investment Market Review
Financial Habits and Net Worth
Tax Provisions Extended for 2014
Converting After-Tax 401k Dollars to Roth
Article Round-Up
iPhone app for TD Ameritrade
Why I became a financial planner video
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2014 Investment Market Review

Despite a bumpy ride throughout 2014, the US economy gained pace while the US equity and fixed income markets outperformed most markets around the world. This performance came with higher market volatility in the US, a rallying dollar, slowing economies in Europe and Asia, and rising geopolitical tensions, including conflicts in Ukraine and the Middle East.


The Dow Jones Industrial Average rose for the sixth straight year, posting a 7.52% gain (price-only return). The S&P 500 Index (large US companies) rose 13.69% (including reinvested dividends), marking the third straight year in which the benchmark has returned more than 10%. The Dow closed at a record high on 38 calendar days, while the S&P 500 had 53 record closes. 


The non-US markets followed a much different track:  All major stock indices logged negative performance for the year (in USD). The MSCI EAFE (Developed Markets) Index had a -4.90% return and the MSCI Emerging Markets Index a -2.19% return (net dividends, in USD). The dollar's strong performance relative to major regional currencies contributed significantly to the lower returns for US investors.


Returns of major bond indices were positive due to falling yields and rising prices. One-year US Treasury notes returned 0.18%, US government bonds 4.92%, world government bonds (1-5 years USD hedged) 1.90%, and US TIPS 3.64%.


Real estate securities had a banner year: The Dow Jones US Select REIT Index returned 32.00%, and the S&P Global ex US REIT Index returned 10.94%. Commodities were negative for the fourth year in a row, with the Bloomberg Commodity Total Return Index returning -17.01%.


What about small and value?


While US stock returns were high relative to those of other regional markets, returns within various US market segments diverged. Based on the respective Russell 1000 and 2000 indices, US large cap stocks significantly outperformed small cap stocks, and within the relative price dimension, large value slightly outperformed large growth. Among small cap stocks, growth outperformed value.


In the non-US developed markets (based on the MSCI indices in USD), all segments had negative performance. Negative returns among large and small caps stocks were similar, while large growth slightly outperformed large value. In the emerging markets, small cap, which had a slightly positive return, outperformed large cap, and growth outperformed value, although both returns were negative.


The mixed results of the small and value tilts in our portfolios in 2014 were not unusual from a historical standpoint. Although small cap and value stocks have offered higher expected returns relative to their large cap and growth counterparts, these return premiums do not appear each year. For example, since 1979, US small caps have outperformed large caps in 19 of the 36 calendar years-or 52% of the time. Results are similar for the relative price dimension: Since 1979, value has outperformed growth in 20 calendar years-or 55% of the time. Small cap value has outperformed large cap growth in 58% of the calendar years. 


History also has produced multiyear periods in which small caps and value did not outperform large caps and growth. Noteworthy periods include 1984 to 1987 and 1994 to 1998, when small caps underperformed large caps, often by a wide margin each year. Since 1979, the value premium has also experienced extended periods of underperformance-and, in some cases, the differential exceeded 15% margin. The same is true of small value vs. large growth stocks. In the three-year period from 2009 to 2011, both value and small caps underperformed. Yet, despite even extended negative-premium periods, small caps and value have outperformed over time, and when the premiums reversed, they often did so strongly and in multiple years.


In summary ...


Normally when the U.S. investment markets have posted six consecutive years of gains, five of them in double-digit territory, you would expect to see a kind of euphoria sweep through the ranks of investors.  But for most of 2014, investors in aggregate seemed to vacillate between caution and fear, hanging on every economic and jobs report, paying close attention to the Federal Reserve Board's pronouncements, seemingly trying to find the bad news in the long, steady economic recovery.


One of the most interesting aspects of 2014-and, indeed, the entire U.S. bull market period since 2009-is that so many people think portfolio diversification was a bad thing for their wealth.  When global stocks are down compared with the U.S. markets, U.S. investors tend to look at their statements and wonder why they're lagging the S&P index that they see on the nightly news.  This year, commodity-related investments were also down significantly, producing even more drag during what was otherwise a good investment year.


But that's the point of diversification: when the year began, none of us knew whether the U.S., Europe, both or neither would finish the year in positive territory.  Holding some of each is a prudent strategy, yet the eye inevitably turns to the declining investment which, in hindsight, pulled the overall returns down a bit.  


At the end of the day, we need to focus on what we can control: diversification, keeping investing costs low, managing taxes, and staying disciplined in applying documented academic research to our investment portfolios.  We don't need to predict which asset class will end each year on top to have a successful investment experience over the long term, meet our financial goals, and enjoy our lives.  Which is the reason we do all this, right?

Financial Habits and Net Worth

Financial Habits and Net Worth You already know that our financial habits determine our financial fate.  If we avoid credit card debt, spend less than we earn and create a financial buffer against the unexpected, we tend to thrive financially.  If we carry a lot of debt or live constantly on the edge, with little savings, then our financial future is much cloudier.


Recently, a paper published by the Federal Reserve Bank of St. Louis proved these truisms in the real world.  For eight individual years between 1992 and 2013, the Fed's Survey of Consumer Finances has posted a series of financial questions to thousands of people in all walks of life, at all income levels and ages.  


Among them:


1) Did you save any money last year?

2) Did you miss any loan or mortgage payments in the last year?

3) Did you have a balance on your credit card after the last payment was due?

4) Do liquid assets make up at least 10% of the value of your total assets?

5) Is your total debt service-the cash you devote each month to paying principal and interest-less than 40% of your income?


The paper scored the answers, giving every positive answer (yes for 1, 4 and 5, no for 2 and 3) one point, assigning zero points to the "wrong"answers. Then they added up the scores for each household and looked at a financial health score taken from the same survey, and compared the two.  They found what you would probably expect: that good financial habits are highly correlated with the accumulation of wealth.  A small chart at the back of the study, which divided people according to age and ethnic profile, found that individuals who averaged a score of 2.63 had a median net worth of $25,199, while those who averaged a 3.79 score enjoyed a median net worth in excess of $800,000.  The average score: 3.01, associated with a net worth somewhere in the $70,000 to $75,000 range, which happens to fall neatly in between the median for people age 35-44 ($51,575) and those age 45-54 ($98,350).   


So while I'm not a fan of New Year's resolutions, it's always a good time to consider how your day-to-day habits may be helping (or hurting) your financial health.


 Material adapted with permission of financial columnist Bob Veres.

Tax Provisions Extended for 2014

Tax Provisions Extended While Congress took the extension of many popular tax provisions down to the wire, the Tax Increase Prevention Act of 2014 passed before the end of December.  All of the following provisions were among those retroactively extended, and are now effective through the end of 2014.  


Deduction for qualified higher-education expenses

You may be entitled to a deduction if you paid qualified higher-education expenses during the year--this includes tuition and fees (for yourself, your spouse, or a dependent) for enrollment in a degree or certificate program at an accredited post-secondary educational institution. The deduction doesn't include payments for meals, lodging, insurance, transportation, or other living expenses. The maximum deduction is generally $4,000. However, if your adjusted gross income (AGI) exceeds $65,000 ($130,000 if married filing jointly), your maximum deduction is limited to $2,000; if your AGI is greater than $80,000 ($160,000 if married filing jointly), you can't claim the deduction at all.

Deduction for classroom expenses paid by educators

If you're an educator, you may be able to claim up to $250 of unreimbursed qualified classroom expenses you paid during the year as an "above-the line" deduction. Qualifying expenses can include the cost of books, most supplies, computer equipment, and supplementary materials used in the classroom. Teachers, instructors, counselors, principals, and aides for kindergarten through grade 12 are eligible, provided a minimum number of hours are worked during the school year.

Deduction for state and local general sales tax -- a big deal for Texans!

If you itemize deductions on Schedule A of IRS Form 1040, you can elect to deduct state and local general sales taxes in lieu of the deduction for state and local income taxes. You can calculate the total amount of state and local sales taxes paid by accumulating receipts showing general sales taxes paid, or you can use IRS tables. If you use IRS tables to determine your deduction, in addition to the table amounts you can deduct eligible general sales taxes paid on cars, boats, and other specified items.

Tax-free charitable donations from IRAs

If you're age 70 or older, you can make a qualified charitable distribution (QCD) of up to $100,000 from your IRA and exclude the distribution from your gross income. The distribution must be made directly to a qualified charity by December 31, 2014, and must be a distribution that would otherwise be taxable to you. QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution from the plan. You aren't able to claim a charitable deduction for the QCD on your federal income tax return.

Deduction for mortgage insurance premiums

Premiums paid or accrued for qualified mortgage insurance associated with the acquisition of your main or second home may be treated as deductible qualified residence interest on Schedule A of IRS Form 1040. The amount that would otherwise be allowed as a deduction is reduced if your AGI exceeds $100,000 ($50,000 if married filing separately), and no deduction is allowed if your AGI exceeds $109,000 ($54,500 if married filing separately).

Additional extenders included mass transit, the discharge of debt on a principle residence, and several helping businesses included bonus depreciation, expanded section 179 expensing limits, and exclusion of gain on qualified small business stock. Visit our website for more details. 
Material adapted with permission for Broadridge Forefield Investor Communications Inc.

Converting After-Tax 401k Dollars to Roth

Roth conversion from 401k It's time to reconsider whether making after-tax contributions to a 401k is a good financial planning strategy.


Prior to the IRS' ruling last fall, it was unclear whether you could convert after-tax 401k  contributions to Roth.  And if you did convert them, there was disagreement in the financial planning community on the process you needed to follow to comply with IRS policies.  The IRS has now clarified how this conversion can be correctly accomplished.


IRS Notice 2014-54


Based on Notice 2014-54 (and related proposed regulations), employer-plan distributions can be split into more than one retirement vehicle with, for example, pre-tax money transferred directly to a traditional IRA (with no current tax liability) and after-tax money moved directly to a Roth IRA (with no conversion tax). Even though the new rules didn't go into effect until January 1, 2015, taxpayers could apply this guidance to distributions made on or after September 18, 2014. (The guidance also applies to 403(b) and 457(b) plans.)

The Notice provides the following technical rules:

  • When calculating the taxable portion of a distribution from a 401(k) plan, all distributions you receive at the same time are treated as a single distribution, even if the proceeds are going to multiple destinations. This is important for allocating pre-tax and after-tax contributions to a distribution. For example, assume your 401(k) account is $100,000, consisting of $60,000 (6/10s) of pre-tax dollars and $40,000 (4/10s) of after-tax dollars. You request that $20,000 be rolled directly over to an IRA and $20,000 paid to you. This is treated as a single $40,000 distribution from the 401(k) plan. Of this $40,000, $24,000 (6/10s) is pre-tax dollars, and $16,000 (4/10s) is after-tax dollars.
  • If you receive a distribution (as defined above), and roll all or part of the distribution over to one or more eligible retirement plans, your pre-tax dollars will be deemed allocated first to any direct rollovers you make, and then to any 60-day (indirect) rollovers you make. After all your pre-tax dollars have been so allocated, any remaining amounts rolled over will consist of after-tax dollars.
  • If you are making direct rollovers to more than one eligible retirement plan (or indirect rollovers to more than one plan), you can direct the trustee how to allocate the pre-tax dollars among those retirement plans prior to the time the direct rollovers are made.
Why does this matter?

Prior to this ruling, we generally did not recommend making after-tax contributions to a 401k.  Even though the original contribution wasn't taxed again at distribution, all the earnings were taxed as regular income.  The regular income tax treatment made it unattractive compared to the alternative of putting the money into a taxable investment account and having your capital gains and qualified dividends taxed at the lower capital gain rates.


With this change, you should still make your full contribution as regular (pre-tax) or Roth contributions up to the federal maximums ($18,000 for 2015 plus a $6,000 catch-up if you're 50 or older before 12/31/2015).  But if your employer allows you to make additional after-tax contributions, the opportunity to roll those into a Roth when you leave the company creates an appealing opportunity to get more money into the Roth bucket.  Depending on your situation and other opportunities available to you, it may be a really good option to consider after you've maxed out other sources of tax-advantaged savings.


For examples from the IRS applying this new ruling, please visit our website: www.KeenerFinancial.com.

Portions of this material adapted with permission for Broadridge Forefield Investor Communications Inc.
Article Round-Up

I spend a lot of time in this newsletter encouraging you to ignore the financial news media because often the 24-hour barrage of predictions and sky-is-falling commentary can lead to poor decision making with your investments.  However, there is a lot of good financial reporting being done as well.  So in this month's newsletter, I'm sharing some of the articles I've come across recently that I found compelling.  If you read something worth sharing, I hope you'll send it my way, too.


Washington Post: For Investors, It's a Perfect Time to Go Back to the Basics

Market Watch: 3 Reasons to Give Up Your Search for Stock Market Predictors

Nerd's Eye View / Michael Kitces: Happy Money and The Science of Spending - How Money Really Can (Sometimes) Buy Happiness

The Dallas Morning News / Pamela Yip: Planning is Essential for Security After Retirement

iPhone App for TD Ameritrade

TD Ameritrade has released an app for iPhone for the AdvisorClient website.  This is the website our TD retainer clients use to access their account information.  AdvisorClient Mobile enables you to view real-time account balances, positions and transaction history from your Apple iPhones.

Other features include:

  • Consolidated account balances
  • Remote check deposit
  • Detailed quotes
  • Third-party research
  • Quick access to Keener Financial Planning contact information
To download the app, go to the App store and search for the AdvisorClient app.  Let us know what you think so we can pass feedback onto TD Ameritrade.
Why I Became a Financial Planner

Because a video can sometimes express things better than print, I wanted to share this video with you about why I became a fee-only financial planner and how we're different.
Why I became a financial planner

I hope you found this newsletter informative.  KFP offers a free, no-obligation initial consultation to start the financial planning process for new clients.  To learn more or schedule a time, call 817-993-0401 or e-mail jean@keenerfinancial.com.
Jean Keener, CFP, CRPC, CFDS
Keener Financial Planning

Keener Financial Planning provides as-needed, fee-only financial planning and investment management services.

All newsletter content except where otherwise credited Copyright 2015, Keener Financial Planning, LLC.