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Financial Planning Moves to Make After the Correction

Charles Sizemore
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Aren’t corrections fun?  As we suffer through our first real correction, a lot of investors are scared. There is this nagging feeling that the outsized gains of recent years were somehow “fake,” the result of central bank manipulations and not much else.

I’m not going to recommend you sell all of your stocks and stash the cash under your mattress, but neither am I going to recommend you buy aggressively.  This isn’t that kind of article.  Instead, I want to ask you to think a little more “big picture” here and to use this correction as an opportunity to do a little financial housecleaning. There is nothing like a good stock sell-off to give us that slap to the face we sometimes need to get serious about our financial planning.

With no more ado, here are two planning items to consider as we wrap up what has become a volatile year.

IRA / Roth IRA Contributions

If you are still saving for retirement, you might as well set aside the funds now that you intend to use for your 2015 contribution to an IRA or Roth IRA. You can’t contribute until the first of the year, but it might be a good idea to set the funds aside in a separate checking or savings account so that they don’t get accidentally spent in a Christmas shopping spree.  And if you haven’t made a contribution for 2014, I recommend knocking that out before the end of the year.  Though if cash is a little tight at the moment, you still have plenty of time — the deadline isn’t until April 15 of 2015.

For tax year 2014, the contribution limit for both traditional IRAs and Roth IRAs is $5,500 — with the option to add another $1,100 if you are 50 or over. Watch your income levels though; you start to lose eligibility to contribute to a Roth IRA at adjusted gross incomes of $114,000 and $181,000 for singles and marrieds, respectively.  Official 2015 contribution and phase out levels have not been officially released, but I expect them to be about in line with 2014’s numbers.

IRAs — and particularly Roth IRAs — are the single best investment and estate-planning vehicle available to most Americans. As you sit down to plan out your year, make sure that you are taking full advantage of them.

Portfolio Rebalancing

After the rout we’ve had in several asset classes—including current favorites of mine like MLPs and mortgage REITs—a lot of portfolios could use a good rebalancing.  Yet portfolio rebalancing can be a surprisingly controversial topic because it would seem to fly in the face of that sacrosanct trader’s maxim: “Sell your losers and let your winners ride.”

It may seem like I’m practicing Orwellian doublethink, but I’m actually a firm believer in both concepts.

Allow me to explain. Within your actively-traded stock portfolio, there is no reason to sell a stock simply because it has risen in value. If your investment rationale is still valid — and if the stock is still reasonably priced — then there is absolutely no reason to sell a stock that is performing well, particularly if it is paying a good dividend. Market-leading stocks can remain market-leading stocks for years … or even decades in some cases.

Rebalancing is more about divvying up your assets among asset classes — stocks, bonds, real estate, alternatives, etc. And this is where the real planning comes into play.

The first step in executing a proper portfolio rebalancing? Forget everything you think you know and throw all rules of thumb out the window.

If I sound like I’m being harsh, hear me out. The standard rebalancing models are woefully simplistic and generally only take into account one factor: your age. The most common “rule” is that you should subtract your age from 100 to find your “ideal” stock allocation. So, if you are 60 years old, you would ideally have a portfolio split 40/60 between stocks and bonds. In a nod to lengthening lifespans, newer guidelines suggest subtracting your age from 120. So, a 60-year-old would have a targeted allocation of 60/40 stocks/bonds.

There are two big problems with this line of thinking: It is completely insensitive to market valuations, and it says not a word about what matters most to retirees — regular income. And as a secondary problem, it assumes that all retirees have the same time horizons, which is obviously not true.

Here is my advice for intelligent rebalancing. First, do what pension funds do: Match your assets and liabilities. If you want to buy a retirement home or have a child or grandchild you intend to help through college in, say, 5 years, keep the funds you have earmarked for those expenses in CDs or bonds with a five-year maturity.

For the rest of your funds, the decision gets a little more complicated. The age-based rule is a nonstarter for one critical reason: Bond yields are still pitifully low, and bonds are overpriced relative to stocks and most other asset classes. No matter what you age, having a large allocation to an overpriced asset class is terrible financial planning.

Still, keeping something in the ballpark of 4-5 years’ worth of basic living expenses in a bond ladder is reasonable advice. If the stock market takes an unexpected swoon, you could sell down the bonds and live off the proceeds without having to sell your stocks at depressed prices.

With the remainder of your portfolio assets, consider a diversified mix of dividend-paying stocks, REITs and Master Limited Partnerships. Ideally, you would be able to supplement your Social Security or other pension income with a steady stream of dividends and would not need to dip into principal.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

This article first appeared on Sizemore Insights as Financial Planning Moves to Make After the Correction

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