This week brought quite a roller coaster ride in the stock market. What caused it, and what does it mean? Also, should you keep your company 401k when you leave that job or retire? What about company stock in the 401k? This episode provides the answers.

Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.

For more information, visit Medina Law Group or  Private Client Capital Group.

Click below to read the full transcript…

Bert:  Welcome to “Make it Last,” helping you keep you legal ducks in a row and your nest egg secure, with your host, Victor Medina, an estate planning and elder law attorney and certified financial planner.

Victor J. Medina:  Well, welcome back, everybody, to Make it Last. I want to thank you all for joining us this Saturday morning. I’m happy to have you with us because we’re going to discuss the roller coaster that the stock market went on and, importantly, what it means for you. If you want to be up to speed on that, this is the time for this kind of a show.

We’re going to take the first segment on that topic. Then we’re going to take the second segment and talk a little bit more about whether or not you should be in your company 401(k) and, specifically, whether or not you should be holding your own company’s stock in your 401(k). I want to offer some of my thoughts on that.

By full disclosure, we’re recording this on Wednesday, February 7th. The roller coaster of the stock market, basically, was there Friday and there, again, on Monday. We don’t know what’s going to happen today.

I hope that by the time this broadcasts on Saturday, by the time you’re listening to it, we’ve recovered somewhat. It looks like, in some indications, in the Asian markets that we might be doing that. The real question is, “Why did it happen and why is it important for you?” The first thing we need to understand is what occurred.

If you’ve been under a rock, for whatever [laughs] reason, you missed that the Dow Jones, as one indication of the US stock market, went down about 666 points on Friday. Take that for what you will. It was not Friday the 13th, if that’s [laughs] at all important. Then another 1,500 points on Monday.

In fact, it closed a little bit higher than that, but plunged down below 1,500. It was being recorded as the largest single sell‑off of the points on the Dow Jones. That’s not a significant number, right? The Dow Jones was at 24,000 or so, 25,000.

For it to sell‑off 1,100 points over the course of the closing of the day really needs to be expressed as a percentage. It needs to be measured more in the context of what percentage of that number was sold off.

It turns out that it was only about 4.5 or 4.6 percent of the Dow Jones. The S&P, which stands for Standard and Poor’s, tumbled about 1,100 points, or 4.1 percent, so about the same. The S&P representing the 500 largest companies in the US and their stock prices. As a percentage basis, although the numbers are really high, their percentages were not all that impressive.

We saw that the Dow Jones fall ranks as its 100th biggest sell‑off over all. The S&P was about 127 in the indices history. If you were at all paying attention in 1987, the Dow was down 500 points, but that was 22 percent of its value. It was October 19th, 1987. It was commonly referred to as Black Monday. The S&P was down 57 points or 20 percent of their value.

That was a petrifying moment because that was an even bigger decline in both points and percentages than the stock market crash of even 1929. Unlike 1929, the slide in 1987 didn’t contribute to a wider economic slump. The stock market recovered its losses early by, 1989, but the plunge did prompt regulators to introduce special breaks that kick in when the market falls too far too fast.

It is not as worrisome, I think, even though the TV stations are telling you all about the facts that this is the largest points drop in history. Yeah it is, but as a percentage it’s not all that impressive. The real question is, “What happened and why?” Economic theorists and stock market theorists are going to come up with lots of different ideas.

I will share with you what I think contributed to it from my lay person’s perspective. It’s a little bit better than lay person. I’m in this field. This is what I do. I’ve got some advance certifications in it, but I certainly don’t have a PhD in economics. I’m not somebody that studies the market as closely as others, but here’s some of what I thought occurred.

We passed a massive tax cut last month. That tax cut is largely deficit financed. What does that mean? It means it’s going to increase the deficit by the amount limited when the terms of the reconciliation crosses $1.5 trillion over 10 years.

From a business cycle, it comes as a crazy time to be deficit financing a tax cut because the US economy is operating at nearly full capacity. You get this huge tax cut and that is like another shot of adrenaline into the economy, which means that it can only drive inflation higher.

Inflation is often tempered by the numbers that are issued in the Federal Reserve. Those are the lending rates on which we figure out how cheaper, how expensive money really is. We had a change in leadership in the helm of that. Janet Yellen is stepping down, being replaced by Jerome Powell.

Is there going to be a lot of difference in the policies between the two? Who knows? Probably not, but it adds a layer of uncertainty. Remember that the market hates uncertainty. Hates, hates it, hates it.

When you add all of these things together, you see that people are starting to get nervous about what these costs, the deficit financing and the cost of inflation, are going to do to the value of their stocks and what they hold. What ends up happening is that you get a sell‑off. People are trying to take their gains in the market and go home.

We also need to understand that most of these trades that occur, about 90 percent of them, are being done by a computer. It’s being driven by computer models. You get a tumbling effect when all of the models say to sell at the same time. Here we get a drive down further and further and further.

Part of all of this jumbling together suggests that this was a market correction driven a lot by the instability of the tax cuts as well as the threat of inflation coupled with computer modelling that says when you get certain limitations and things start to correct then you need to sell‑off, too, because you need to protect against your losses.

For all of those reasons, we saw this correction happening. It is a lot linked to people’s emotion and behavior in the area. I will tell you that we do investment management. We do investment management for people of very significant wealth, people of moderate wealth as well.

Everyone should be nervous about their money, but nobody called me this week wondering what to do in response to the stock market because the answer largely is nothing. Nothing to do. We’ll hold where we are at. We have got a smart portfolio. We expect corrections like this. You don’t need the money right now.

If you did need the money, we were already in cash for some of the distributions on that. We’ll hold fast and ride the roller coaster the way that it needs to be. If you’re looking to secure against that, then you need to set up some smarter investing.

If you were chasing this, and you got nervous, and you started to sell‑off, you lost a lot of money on this. It’s very difficult to understand when to get back in. Most people sell too low and buy too high to really time the market for their own investing.

This is even further exacerbated by the sell‑off of an exchange trade fund that was betting on the stability of the market. That [laughs] lost almost $2 billion worth of worth of its own money on Monday as people realized, “Well, may be the market’s not all that stable after all.” No, it’s not that stable. It is predictable.

In the long run, the house doesn’t win, you win, but you have to be in it for the long haul. If you can’t be in it for the long haul, then you ought to be thinking about something else to do with your money. You shouldn’t be investing it.

Victor:  That’s a little bit on the stock market. We are going to take a quick break. When we come back we will talk a little bit about 401(k)s ‑‑ why people have them, what you should do if you are leaving your employment, and why you should or shouldn’t have your company stock in your 401 and keep it. Stick with us. We’ll be right back on Make It Last.

 

Victor:  Hey, everybody. Welcome back to Make It Last. We spent the first segment talking about the stock market plunge, the roller coaster ride of this week. We’re now going to transition to talking a little bit about 401(k). They can’t be linked.

If you’re staring at your 401(k) balances as they go up or down based on what the market is doing, you could be very nervous about what is in your retirement fund and whether or not you’re doing the right thing with that money.

I want to talk a little bit about 401(k)s. What are they? It’s important to set up what they are because then we’ll discuss why you should or shouldn’t stay in them. Specifically, why you should or shouldn’t have your company stock in them over time.

Let’s first talk about what 401(k)s are. 401(k)s essentially are an employer‑sponsored plan that encourages you to put tax deferred dollars away for your retirement. The encouragement comes not only because the growth of the fund is tax deferred over time, but because you can take a tax break on the contributions up to certain limitations in every year.

Even though your company is paying you a $100,000 a year, you can defer up to $18,500 of that into this 401(k). If you’re older, you have some catch‑up contributions. You can contribute that money in there and then take it off of your income taxes for that year.

401(k)s can have all kinds of different flavors, and bells, and whistles to them. You can have company matching of the money that’s contributed. You can be granted company stock as part of an incentive to remain employed there, especially if the stock is publicly traded. That’s a good value in that.

There’s lots of different things that you can do with a 401(k). 401(k) comes under the IRS code 401(k) that basically gives tax deferral to those contributions. If you’re not a private sector employee, if you worked in a public sector, you might have a 403(b), also linked to the IRS code, or a 457, which is involved with a lot of government retirement plans.

You can have these tax deferred plans. They’re setup by your employer, whether that is a private company, or school district, or the government, those plans are there for you to contribute your money and let it grow, tax deferred. Then, when you retire, separate from service, there is a nifty little sum there that you can then use for your retirement.

Because it’s a company sponsored plan, the company sponsor gets to the pick the investments that are inside of the plan. They don’t necessarily do this all on their own. There are these third‑party administrators that are subcontracted out to put up a portfolio of investments from which you can choose.

Nowadays it’s more of a website. [laughs] I remember the days it was a catalogue. You can look up in a paper catalogue about what the investments are. Traditionally, what they’re giving you is a list of mutual funds for variable annuities that you can park your money in. They’re trying to give you a menu of options that would encourage you to save and to invest those savings.

When you think about it from a behavioral finance standpoint, you actually want to limit the number of investments overall. Most behavioral finance suggests that, when you give to people too many options, they, in fact, won’t invest at all. They get scared. There’s a paralysis analysis that happens and people don’t invest at all.

You want to shrink those down to a menu of maybe 20 or so different investments. Then you’re on your own to pick the investments that you think are going to be best and then to allocate your money across those investments.

What ends up happening is that, because the menu of options is so small, you don’t necessarily get the best in class options across the board. There isn’t an advisor getting paid on this. One of the ways that the people who are running these make sure that they have enough money to keep the lights on is they pick more expensive funds than others.

That’s a way to make money off of what’s being invested. It’s not good for you the consumer, but I need you to understand that that’s the way many of these companies work in how they set everything up.

Because the menu of options is small and they might be expensive, now we’re starting to take a look at reasons why it may not be to your advantage to keep the money in your 401(k) when you retire or finally separate from employment. We have met with a number of people over the course of just this last year.

In fact, I had a meeting earlier this week with somebody that had three different accounts from three different employers and they all remained at the company. When we evaluated what the options were for this person to stay invested, it turned out that none of those options were things that we could support. They were either too expensive, they weren’t well diversified enough.

The options were in there couldn’t give us what we needed in a model portfolio. The recommendation was, “Now that you’ve separated from service, it’s time to move this money and get it to work smartly for you rather than just leaving it out there and leaving it in investments that aren’t working to your best advantage.”

How can you know whether or not this is the case? One of the first things we always recommend, especially when somebody comes and visits us, is to go ahead and get that menu or go on the website and print out what the investment options are.

If they’re in the form of mutual funds, which most of them are because it’s a good way to diversify, they’re not going to necessarily give you individual stocks that you can invest in. Nor do they want to be in a position of recommending stocks. If they’re mutual funds, then you can go on to Morningstar and you can type in the symbols and then go get information about that.

You may not be qualified to evaluate the performance of this. I often use my mother‑in‑law as an example of what not to do with investing. She typically chased the funds that did the best in terms of their performance and would be consistently moving her money around and then wondered why she didn’t have anything extra.

When we took that over, we were able to produce a better result. It’s not because we were constantly moving money to better options. In fact, we set up a great portfolio for her and then we just let it be. Just let it be.

In this case, you may not be in a position to evaluate specifically what the performance of these funds are, but you can evaluate what the expense ratio is. That’s a really important number to be paying attention to because you want to, all things being equal, pick the lower cost fund for your investment as between the two of them.

There’s another story of another client that I came across. We were advising money that they had that we could help them invest, but money that they had to keep with their employer. We needed to give them a recommendation about what to invest and then the options.

They was, essentially, two investments that they could have chosen from. They were both what we would call target date funds, which is to say that they are, in themselves, a diversified portfolio being managed towards a target date in the future. One was by Fidelity and one was by Vanguard.

They both were the same target date fund. Target date, 2055. That’s when the person was supposed to be retiring from that. Well, the costs of those funds were very, very different. Vanguard, known for low‑cost funds, essentially had an expense ratio in just one or two basis points, really super low. Four basis points. Really, really super low.

Whereas the Fidelity fund was over one percent a year, and there was about a one percent differential. We crunched the numbers on that, and it turns out that, when you have a one percent differential over 20 years at seven percent return, you actually lose about 20 percent of your money to expense fees.

It really becomes important to get the lower cost fund. Again, all things being equal, but you can punch these numbers into Morningstar and get it out.

Victor:  We have a system in our office that allows us to do that pretty easily in terms of getting up the entire portfolio and showing where the expenses are and what the performance is. If you’re interested in that and you haven’t worked with us in the past, we can certainly help you with that, but it’s a good way for you to figure that out.

Now, in the last segment, when I come back from the break, I’m going to talk to you about company stock in your 401(k), when you should think about rolling that over, and what you should be looking for. Stick with us. We’ll be right back on Make It Last.

Victor:  All right, welcome back to Make It Last. We have been talking about your 401(k) and whether or not you should keep it with your company or roll it over. Now we’re going to hit that final topic about your company’s stock and what you should do with that inside of your 401(k).

I should have probably mentioned in the prior segment that not everybody has the opportunity to roll that money over when they are interested in doing so. That 401(k), as long as you remain employed, most of them do not permit what we call in‑service rollovers.

That is to say, you can’t necessarily, in the middle of your employment, take that money and then roll it over into a traditional IRA. You typically need some sort of a qualifying event like a divorce, a separation from employment, retirement, something like that. Those events allows you to move the money over.

This is really a discussion for people that have dormant 401(k)s, people who have worked for other companies, saved money there, but then left that employment and jumped a job ‑‑ very common these days ‑‑ and they left the money there. This is a good opportunity to evaluate that and try to figure out what should we do with that money.

It’s also a discussion as you enter retirement. If you’re looking to finally retire, whenever that is, you are now looking at this money that you have in your 401(k) and what you should do with it. Now, I’ve been pretty clear that although the evaluation is done on a client‑per‑client basis, in my experience, the majority of time clients are better served by rolling that money over.

Getting it out of the 401(k) allows you to, first of all, have a broader set of investment options. Remember? Before, we had that small menu of options to encourage you to not only save and invest, we played into the behavioral finance aspects that said, “Look, you actually should save this money and invest it.” We didn’t want you to be paralyzed by all the options. We made them smaller.

Now, we actually are going to open up the world of investments when you roll it over. If you work with an independent advisor, such as we are, every investment on the market is available to you. Now we can pick the best ones for you, which are often better ones than what you had in your current plan. To increase the options is definitely one of the reasons.

To lower the cost is often a reason, and to get smarter about the management in retirement. There is both not only asset allocation, but product allocation. You want to have both of those in your investments because you don’t necessarily want a retirement portfolio that is exclusively stocks and bonds.

You may want other products that serve the purpose of your retirement and basically allow you to be in a better position because you’ve selected from these different products. You’ll have the opportunity to do that ‑‑ rolling it out of the 401(k) ‑‑ because not only will you have investment options increased, you’ll have product options that can increase as well.

Final question really is, “What should we do, if anything, about the company’s stock in there?” People tend to have an emotional attachment to their company stock. I understand it. You have spent a lifetime working for this company. It has treated you well in many cases.

Not only does the company continue to do well, which is the reason why you had a job all those years, but you saw the great people that worked there and you might think, in fact, that you’ve got a better read on the company and what it can do in the market. I hate to be that guy, but I’m going to be that guy, and I’m going to tell you, “No, you don’t.”

There’s far more that goes into the calculation of what the value of a company is than you are privy to having worked for the company, even if you were the CEO. Especially, if you were somebody just under the CEO because, as we’ve seen, companies that people thought could never lose money, never lose money, might get rocked by a sexual harassment scandal.

Just this week, the casino, Steve Wynn stepped down as CEO and the stock value tumbled. Everyone thought, “There’s no way that this company can lose money. It’s casino money. They literally print money there.” No, it lost all of its value. The people there could have said, “The casinos work really, really well. I’m going to keep my money in that company stock.”

It turns out, that was a bad decision. I want to, first, suggest that you may not be in the best position to be making the determinations about what is valuable for your company, like whether or not it has the right value for what you’re doing. The second thing I want to suggest is that you probably should be diversified even if you knew what that future held.

Even though the stock itself might have a great, long‑term prospect, maybe we even agree that that’s the case, proper diversification says that, based on the roller coaster of what investing is, there are times in which you don’t want to be in that stock, and diversification is probably a better option.

Now, you have different ways of doing that depending on how comfortable you are with the implications of moving out of that position. What I mean by that is that many times people are uncomfortable moving it all out. Maybe they’re worried about selling at a low on the value of that stock.

What you can actually do is what we would consider to be reverse dollar cost averaging. You’re going to dollar cost average out of a position instead of into a position by selling off a portion of that stock a little bit at a time. If it’s in your 401(k) or if it’s in your IRA, you can actually go ahead and do that with no tax consequences.

Remember, anything that’s in a 401(k) and an IRA, you don’t pay taxes on it until you take it out of the account and put it in your own pocket ‑‑ putting it in a checking account, putting it in an investment account.

You can reverse dollar cost average to get out of that position or you can do something called net unrealized appreciation, which says that if you had special rules for stock, if you had that stock which increased a lot of value, you can pay the taxes on the original amount on there and then cause that to be capital gains tax later. You would pay the 15 percent instead of the ordinary interest.

That’s actually a calculation for a different time and, in fact, a topic in the show for a different time, but there are ways of getting out of there. My most typical recommendation is to get out of concentrated positions.

Now, you might ask, “Well, what’s a concentrated position?” I’m really uncomfortable with clients holding more than about five percent of their company stock in their portfolio. I think that that’s probably the threshold of the total amount that should be in there, even if you thought it was the absolute best, best, best company in the world.

I think that I do my job as an investment management professional by keeping you away from that kind of position because of the way that it can impact your long‑term returns. Again, we don’t know if it’s going to be up, it’s going to be down. We can’t really tell, but because we don’t know, we want to be well‑positioned to be able to survive that roller coaster.

In summary, what you should be thinking about if you have dormant 401(k)s or if you’re on the verge of retirement and you have a 401(k) or a 403(b), it is appropriate for you to look at talking about this with a qualified investment professional who can tell you what your investment options are, where you are, and what options could be outside, and whether or not you should take advantage of that.

An investment professional, certainly, like me, somebody who is independent and who’s a fiduciary, those are the kinds of people that you want to be talking to in order to really understand what your options are.

I hope you’ve enjoyed our show for today. Again, if you love the show, please subscribe to it online, get the podcast delivered to your phone, and leave a review on iTunes, and tell people what you think about it, share the link. Remember, we’re also simulcasting these as video podcasts.

Not only can you see us live as we record the show on Facebook Live, you can sign up for notifications by going to the Medina Law Group page and liking it, and asking for notifications on that, but you can also see the video recording on YouTube, which would give you an opportunity to see my lovely face, if you’d like to say that.

Some people say I got a face for radio. You can also watch the entire production and then watch it instead of listening to it, if that’s what you like as well. I’m trying to do a better job of looking into the camera for that.

Anyway, this has been Make It Last where we help you keep your legal ducks in a row and your financial nest egg secure. See if I can do my own call line. [laughs] We will catch you next Saturday. Thanks for joining us. Bye‑bye.

Bert:  The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or sale of any security, or to follow any legal strategy.

There is no guarantee that the strategies, statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.

All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.

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