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5 Smart 401(k) Moves to Make Now

financial freedomMy Comments: You say you don’t have a 401(k)? Maybe you have a 403(b), or an IRA with exposure to the market. If you are in or close to retirement and your investment portfolio goes to hell, you simply don’t have enough time to hope it recovers and gets back on track. Be defensive for a while and sleep better at night.

by Carolyn Bigda | September 26, 2016


Storm clouds are forming, so take your nest egg off autopilot and steer to clearer skies.

Blissfully, making your 401(k) grow hasn’t been that hard in recent years. Since March 2009, the S&P 500 index of U.S. stocks has more than tripled in value. And thanks to the Pension Protection Act—now celebrating its 10th anniversary—many workers are automatically enrolled in 401(k)s. “Inertia has led to some pretty powerful results,” says Katie Taylor, director of thought leadership at Fidelity.

But inertia works only as long as the winds are blowing in the right direction. Today there are signs that momentum could be shifting. U.S. equities, for one, are as frothy now as they were leading up to the 2007–09 bear market and the Great Depression in 1929. The S&P 500 trades at a price/earnings ratio of 27.3 based on 10 years of averaged profits, a 63% premium to historical averages.

Meanwhile, corporate profits have been declining for five consecutive quarters, the worst such streak since the financial panic. And worried fund managers have amassed large piles of cash, according to a recent Bank of America Merrill Lynch survey.

None of this means your 401(k) needs a major overhaul. This is, after all, your long-term portfolio, meant to endure choppy air from time to time. But a few tweaks now can help ensure that inertia doesn’t work against you—and that you’re still on track no matter what happens in the market.

Get over your fear of bonds

If you haven’t rebalanced your 401(k) in a while, it probably looks different from what you remember. Without rebalancing, a moderate 60% U.S. stock/40% U.S. bond portfolio at the end of the last recession is now closer to an aggressive 80% equities/20% bond mix, according to Morningstar.

The rule of thumb: If your weightings are off-kilter by five percentage points or more from your desired mix, it’s time to take action.

Some investors, though, may be wary of rebalancing into bonds now, notes Maria Bruno, a senior investment analyst in Vanguard’s investment strategy group. That’s in part because fixed-income prices fall when interest rates rise, and the Federal Reserve could lift rates before the year is out.

But “rebalancing helps protect you from short-term volatility,” Bruno notes. Even if fixed-income prices fall, bonds can still serve as a cushion. The worst calendar-year loss for intermediate-term government bonds was 5.1%, in 1994. By contrast, the worst loss for blue-chip U.S. stocks was 43.3%, in 1931.

You can further reduce risk by choosing bond funds with an average “duration” of about five years or less, which are less sensitive to interest-rate moves, says Peter Mallouk, president of Creative Planning in Leawood, Kans. (A duration of five implies that if rates rise one percentage point, the fund could lose 5% in value.) You can look up this figure for your plan’s fixed-income offerings at Morningstar.com. If your 401(k) doesn’t offer a good low-duration option, go with a core fund such as Dodge & Cox Income DODIX 0% , with a duration of just four years, in your IRA. The fund, which has beaten more than 80% of its peers over the past five, 10, and 15 years, is in our MONEY 50 recommended list.
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Trump vs. Clinton: 10 Ways the Next President Will Impact Your Wallet

roulette wheelMy Comments: New and existing clients are asking me what I think will happen to their money after the election. My gut tells me there will be a correction before long anyway. If Trump is the winner, the correction could be dramatic with chaos in the years ahead. If Clinton is the winner, the correction will be muted. Necessary changes are going to happen; it’s the natural order of things. But I’m ready for less drama and an orderly transition into the future. Trump will try and turn back the clock on many levels, including globalization, and it will be disastrous for lots of reasons.

This comes from Kiplinger, and is with most everything I post, I did not ask their permission. I’m giving you the text of the first two, but if you want the rest of it, then here is a link to their site where I found it all.

http://www.kiplinger.com/slideshow/business/T043-S001-clinton-trump-money-issues-affecting-your-wallet/index.html

By Meilan Solly and Douglas Harbrecht | September 2016

The policies that Democrat Hillary Clinton or Republican Donald Trump say they’ll bring to the White House could have a dramatic impact on your wallet, your job, your health care and your retirement. Here’s where the two candidates stand on major economic and financial issues, with key differences in their approaches. We also threw in a few campaign quotes that help illustrate their views. Take a look:

Economic Growth and Jobs

Key differences: Trump wants to pull back from worldwide economic engagement in pursuit of tougher trade deals and creating more jobs at home. His approach is similar in many ways to the Brexit vote to pull the United Kingdom out of the European Union. Clinton emphasizes economic development that relies on trade. And she supports more liberal immigration policies, which Trump opposes.

Key Clinton quote: “We need to raise pay, create good paying jobs, and build an economy that works for everyone—not just those at the top.”

Key Trump quote: “Americanism, not globalism, will be our credo. As long as we are led by politicians who will not put America First, then we can be assured that other nations will not treat America with respect. The respect that we deserve. Nobody knows the system better than me. Which is why I alone can fix it.”

Trump’s proposals are a radical departure from 100 years of Republican pro-business, free-market orthodoxy. He wants to force some American companies to bring their foreign manufacturing operations back to the U.S. from China, Mexico, Japan and Southeast Asia. To put Americans to work, he advocates a huge infrastructure rebuilding program at home (more on that later in the slide show), including building a wall along the Mexican border to stop illegal immigration. He says he’ll deport all 11 million undocumented immigrants living illegally in the U.S. and place new restrictions on H-1B visas, which allow skilled immigrants to work in the U.S. for up to six years.

Trump supports a federal minimum wage of $10. He wants to declare China a currency manipulator and impose huge tariffs on Chinese and Mexican imports “if they don’t behave.” Such threats concern economists, who worry that they will provoke a trade war and increase the likelihood of a global recession.

Where Trump waves a stick, Clinton favors a carrot approach: She would create tax and economic incentives to entice multinationals to bring jobs back to the U.S. She supports creating a pathway to citizenship for undocumented immigrants living in the U.S., and supports the H-1B program. In accordance with the Democratic Party platform, Clinton would increase the federal minimum wage to $15 an hour from $7.25. She says trade has been a “net plus for our economy,” yet she opposes President Obama’s Trans-Pacific Trade Agreement. Economist Chris Farrell worries that neither candidate is embracing retraining and financial support for workers who have lost their jobs to international competition. “Yes, protectionism is wrong. But so is not sharing the bounty from freer trade with those on the losing side of trade liberalization,” Farrell says.

Taxes

Key differences: Clinton’s plan would increase taxes on the wealthiest Americans. Trump’s would cut taxes across the board — from the lowest-income earners to the top 1%.

Key Clinton quote: “I want to make sure the wealthy pay their fair share, which they have not been doing.”

Key Trump quote: “Middle-income Americans and businesses will experience profound relief, and taxes will be greatly simplified for everyone. I mean everyone. […] Reducing taxes will cause new companies and new jobs to come roaring back into our country.”

Under Clinton’s plan, taxes would change slightly or not at all for the bottom 95% of taxpayers, while the top 1% would see sizable increases. This is because Clinton wants to implement a 4% surcharge tax on income over $5 million, plus the Buffett Rule, which would ensure that individuals who earn more than $1 million annually pay a minimum effective tax rate of 30%. Clinton’s tax plan would also cap the value of itemized deductions at 28% for folks in higher brackets. This limitation would apply to other tax breaks, too, such as the write-off for IRAs and moving expenses. And it would nick some currently tax-free items, such as 401(k) payins, tax exempt interest, and the value of employer-provided medical insurance. Finally, her plan would increase estate taxes, and place higher taxes on multinational corporations.

In a speech at the Detroit Economic Club on Aug. 8, Trump modified his proposal for overhauling the tax system.He still wants individual rate cuts, but they’re not as deep as in his original plan. Many said his first plan, with four brackets topping out at 25%, was too costly. Now he sees three brackets, maxing out at 33%, the same as the House GOP plan.

He continues to offer up a 15% rate on corporations and pass-throughs, such as partnerships and LLCs, and would extend the rate to sole proprietors. He favors full expensing for new asset purchases such as buildings and equipment. And he wants to do away with the estate and gift tax.

He’s silent on capital gains for now. His prior plan called for rates from 0% to 20%, compared with a 16.5% top rate under the House GOP blueprint. Also, he gives no details about which write-offs will be on the chopping block. He’ll probably keep breaks for home mortgage interest and donations to charity. But most others would have to disappear to help offset the cost of his proposed rate cuts..

Says Roberton Williams of the Urban-Brookings Tax Policy Center: “The Clinton plan is basically stay as you go. You’ve got a basic tax plan in place right now. She has so far proposed no major changes to that structure other than to raise taxes significantly on some high income people. That’s not a very radical change. Trump’s changes are much bigger.”

Get ready for the mother of all stock market corrections once central banks cease their money printing

dow-2007-2016My Comments: The evidence is almost compelling. Compare this chart with the one I posted yesterday. If you are not on the sidelines, or positioned to go short at a moments notice, prepare for some pain.

by Jeremy Warner | September 20, 2016 | The Telegraph

Global stock and bond markets have been all over the place of late. Rarely have investors been so lacking in conviction. Confusion as to future direction reigns, and with good reason after the spectacular returns of recent years.

For how much longer can stock markets keep delivering? Is there another recession on the way, or to the contrary, is growth likely to surprise positively, underpinning current valuations? Economic turning points are never easy to spot, but right now it’s proving harder than ever.

The immediate cause of all this uncertainty is, however, fairly obvious. It’s the US Federal Reserve again, and quite how far it is prepared to go with the present tightening cycle. Few expect policy makers to act at this week’s meeting of the Federal Open Market Committee.

Even so, a number of its members have once again been making hawkish noises, and another rise in rates by the end of the year is widely anticipated.

Indeed, it is on the face of it quite hard to see how the Fed can avoid such action. Already at 2.3pc, core inflation in the US is trending higher. The US labour market continues to tighten, and money growth, for some a key lead indicator, is strong.

On the stitch in time principle, the Fed ought to be acting now to head off the possibility of over heating further down the line. Policymakers are also desperate to return to some semblance of “normality” after the long, post financial crisis aberration in rates, if only to give themselves room for monetary stimulus when the next downturn does eventually materialise. If there were a recession now, there’s not a lot in the armoury to throw at it.

None the less, the “R” word is once again on many people’s lips. No policymaker would want to raise rates into an impending downturn, even if, historically, they quite frequently seem to make precisely this mistake. Is the Fed about to conform to type, and tip the economy back into recession?

According to Chris Watling, chief market strategist at Longview Economics, a wide range of indicators confirm the message: recession risks are rising. And if a recession is indeed looming, it almost certainly means a bear market in equities. Looking at all the US recessions of the last 77 years, Mr Watling finds that there is only one (1945) which has not been accompanied by a stock market correction.

Complicating matters further is an ever more worrisome phenomenon – that both bond and equity markets are being artificially propped up by central bank money printing. Further easing this week from the Bank of Japan would only deepen the problem. Yet eventually it must end, and when it does, share prices globally will return to earth with a bump. Only lack of alternatives for today’s ever rising wall of money seems to hold them aloft.

Over the last year, central bank manipulation of markets has reached ludicrous levels, far beyond the “quantitative easing” used to mitigate the early stages of the crisis. Through long use, “unconventional monetary policy” of the original sort has become ineffective, and, well, simply conventional in nature.

To get pushback, central banks have been straying ever further onto the wild-west frontiers of monetary policy. Today it’s not just government bonds which are being bought up by the lorry load, but corporate debt, and in the case of the Bank of Japan and the Swiss National Bank (SNB), even high risk equities.

Never mind the national debt, much of which is already on the Bank of Japan’s (BoJ) balance sheet, the Japanese central bank is steadily nationalising the Japanese stock market too. According to estimates compiled by Bloomberg from the central bank’s exchange traded fund holdings, the BoJ is on course to become the top shareholder in 55 of Japan’s biggest companies by the end of next year.

From the sublime to the ridiculous, the SNB now owns $1.5bn of shares in Facebook and is one of the biggest shareholders in Apple. Meanwhile, both the Bank of England and the European Central Bank have announced massive corporate bond buying programmes, including, in the BoE’s case the sterling bonds of the aforementioned Apple. Quite how that’s meant to benefit the UK economy is anyone’s guess.

For global corporations at least, credit has never been so free and easy, encouraging aggressive share buy-back programmes. This in turn further inflates valuations already in danger of losing all touch with underlying fundamentals. By the by, it also helps trigger lucrative executive bonus awards.

Where’s the real earnings and productivity growth to justify the present state of stock markets? As long as the central bank is there to do the dirty work, it scarcely seems to matter.

In any case, the situation seems ever more precarious and unsustainable. Conventional pricing signals have all but disappeared, swept away by a tsunami of newly created money. Globally, the misallocation of capital must already be on a par with what happened in the run-up to the financial crisis, and possibly worse given the continued build-up of debt since then.

So what could come along to upset this already highly unstable apple cart? Too hasty a monetary tightening by the Fed would certain do it. The Fed doesn’t want to risk a repeat of the so-called “taper tantrum” of 2013, when it was forced into retreat from monetary tightening by an adverse market reaction.

Something similar may already be underway today. Financial conditions have tightened considerably since the summer; the dollar has strengthened, stocks have sold off, at least in the US, and bond yields have risen.

The pattern is a familiar one, in which markets tighten by just enough to deter central bankers from actually going through with the deed and lifting rates. It proved hard enough for the Fed to cease QE. Raising rates by a quarter of a point from zero proved equally long winded and traumatic.

Raising them further may be just as taxing. Every time the Fed hints at doing so, markets counter by threatening to tip the economy back into recession. It’s a brutal tread mill that policy makers have made for themselves; getting off without breaking a leg is proving hard to impossible.

Both main US presidential candidates promise fiscal stimulus should they win. China is also set on a path of fiscal easing, at least for now, while even in Britain there is some possibility of fiscal expansion in response to the Brexit vote. This may ease the path of future interest rate increases somewhat. Unwise to count on it, though.

What All Bubbles Have In Common

My Comments: My brain is tired. Too much political angst, too much monetary crap, not enough positive feedback. And here’s some more monetary crap.

But if you are like me and are not expecting to win the lottery anytime soon, then bubbles become important. And like it or not, they tend to burst and create chaos. Look at this chart and read the article to determine where we are right now. Maybe.

bubbles

Sep. 16, 2016

Summary

  • By far, the main cause of bubbles is excessive monetary liquidity in the financial system.
  • Investors are showing signs of behavior consistent with asset bubbles such as herding, hindsight bias, confirmation bias, anchoring, overconfidence and greater fool.
  • We’re at the final stages of the bubble and the rise in the LIBOR and government bond yields are the first warning signs.

What causes a bubble?

By far, the main cause of bubbles is excessive monetary liquidity in the financial system. Axel Weber, former Deutsche Budesbank President puts it this way: “the past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset price bubbles.” This makes you think about today’s Central Banks’ ultra-loose monetary policy for several years, right?

In fact, when too much liquidity is given to normal citizens, it usually ends up in inflation whereas when that additional liquidity finds its way to the hands of the wealthiest, it usually ends up in bubbles. That is because poor people have a higher propensity to consume than rich people who have a higher propensity to save.

So, an extra buck on a poor guy’s wallet will probably end up in consumption while an extra buck on a rich guy’s bank account will more likely end up in savings. This supports the claim that Central Bank’s monetary policy is not reaching the real economy and is only making the rich (who own assets) even richer.

What about investor’s psychology?

Bubbles also have an emotional component. As Dan Ariely said “humans may be irrational, but they are predictably irrational.” Here are a few common behaviors that lead to the creation of bubbles.

Humans are biologically wired to mimic the actions of the group. While this behavior allows us to quickly absorb and react based on the intelligence of others around us, it also leads to self reinforcing cycles of aggregate behavior. This is called herding and it explains popular investment strategies such as momentum or trend following.

Investors also overestimate their ability to predict the future based on the recent past. This tendency to overemphasize recent performance is called hindsight bias and just like herding is one of the reasons behind the success of momentum and trend following investment strategies.

Both herding and hindsight bias, explain why a growing number of investors use technical analysis alone to make their investment decisions and fewer investors care about fundamental analysis and about the price they pay for a certain asset. This is why, when faced with the warning that valuations are currently at very high levels, many investors say this is not “actionable.” For them, what is “actionable” is 2 moving averages crossing on a chart.

People also tend to seek information that supports their own theories, and usually ignore information that disproves their points of view. This is called confirmation bias and can be found in today’s failed attempts to justify expensive valuations with the fact that stocks earnings yield and dividend yield is higher than government bond yields.

Anchoring consists in investors’ need to have references. So, if a stock trades today at $100, investors will perceive $90 as cheap and $110 as expensive.

People also tend to overestimate their intelligence and capabilities relative to others. For example, a 2006 study showed that 74% of professional fund managers believe they delivered above average performance. This overconfidence grows as the asset prices increase and is usually at its high before the crash. It is just like the story of the turkey whose trust in the farmer grows by the day because the farmer feeds him every day. And when the turkey’s trust in the farmer is greater than ever, that’s when the turkey loses his head.

This year has been all about buying the dips because anytime there were bad news on China (in January), on the US (May jobs report), on Europe (Brexit vote in June) or on disappointing earnings (it has now been 5 consecutive quarters of earnings decline), everyone followed the same reasoning: The ECB will ease further, the BOJ will add stimulus, the Fed won’t hike and/or the BOE will cut interest rates.

But the current selloff is about the Fed raising rates and the BOJ and ECB reducing monetary stimulus. Will anchoring and overconfidence make investors buy this dip?

Finally, there’s the greater fool theory that says rational people will buy into valuations that they don’t necessarily believe, as long as they think there is someone else more foolish who will buy it for an even higher value. Do negative yielding bonds ring a bell here?

In which phase of the bubble are we?

Jean-Paul Rodrigue says every bubble goes through 4 stages: stealth, awareness, mania and blow-off.

The way I see it, the S&P 500  took-off in 2009, went through a bear trap in 2012 and is now somewhere between Delusion and the New Paradigm, if not already at the beginning of the denial.

In Summary

There’s evidence of exceptional amounts of liquidity in the financial system today as investors are showing the behavior we see in the final stages of a bubble.

In fact, there are reasons to believe that Central Bank policy is changing and when that happens, the Bubble will pop. On the one hand, the libor rose to 83 basis points over the summer, the highest since 2009 and surpassing the levels seen at the peak of the European sovereign debt crisis and it seems to have already incorporated a potential 25 basis point rate increase by the Fed. On the other hand, Government bond yields in Germany, Japan and the US have been rising over the summer specially in the longer part of the curve.

6 Reasons The US Stock Market Is Doomed

My Comments: My type A personality is having a hard time not knowing just when the next market correction is going to happen. The six reasons expressed in this article are, in my opinion, very credible.

Some clients have recently abandoned me because I’ve been preaching patience. We’re rapidly approaching the point where the only people buying and moving into the market are the amateurs. They are almost always the last to get in when it’s going up and the last to get out when it’s going down. It has always been thus.

by Tony Sagami | Mauldin Economics | September 18, 2016

The Dow Jones Industrial Average has been going sideways ever since the Commerce Department reported that retail sales in July came to a grinding halt (0.0%).

At the same time, companies including Starbucks, McDonald’s, Ford, Burberry, and Gap are reporting disappointing sales. That means trouble in shopping paradise.

Target just reported a Q2 drop of 1.1% in same-store sales. It expects a “challenging environment in the back half of the year.”

There are many reasons why Americans have become reluctant shoppers. I talked about this in my recent article “The Stressed-Out, Tapped-Out American Consumer.” Stagnant incomes and rising debt loads are part of the problem.

But another big factor is a change in spending psychology.
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The World Leans Ever More On America

USA EconomyMy Comments: I’m really conflicted about what to tell my clients about their investments. On one hand I’m persuaded that a severe correction is coming soon, and on the other, there is something going on that suggests otherwise. Damn, I wish I had a crystal ball.

Stephanie Flanders | July 26, 2016 | The Financial Times

Financial markets are like small children. They find it hard to focus on more than two things at once. That is the conclusion drawn by one of my colleagues after a lifetime of professional investing.

Whether small children can focus on anything at all is a matter for debate. Chocolate, perhaps. But he has a point when it comes to global markets. Investors have been so focused on the Brexit vote and its aftermath that they have missed the big picture, which is that the global economy is still worryingly dependent on US growth and the extreme efforts of central banks.

There was a fear, in the days after the EU referendum, that Britain’s troubles would sink the global recovery. But investors have decided that for stocks and bonds this shock is actually a win-win. Why? Because growth will not be much affected outside the UK, but central banks will keep monetary policy looser than it would otherwise have been, just to be safe. That explains why stock markets are reaching new highs, even in the UK, and long-term interest rates are lower in most countries than they were on June 23.

This time last year, the obsession was China and the mood was rather different. Stock markets, you will remember, fell around the world when the Chinese authorities announced a surprise depreciation of the renminbi against the dollar. The fear was that a deflating Chinese economy would export its falling prices to the rest of the world via a lower exchange rate and take another bite out of growth in emerging markets.

Funnily enough, the Chinese currency has been falling again recently — by 3 per cent against the dollar in the past three months. That is bigger than the fall last summer but no one seems to care at all. It would be nice to believe that this was because the world is in a stronger position to cope with a deflationary China than a year ago. I fear it is because investors simply have not been paying attention.

It is true that this depreciation feels somewhat more controlled. What spooked investors about China last summer was the feeling of chaos — the mixed messages about the renminbi and the frantic moves to prop up the domestic stock market all had a whiff of panic. If the authorities could not achieve a smooth transition for the exchange rate, how were they going to deliver one for the broader economy?

It feels different this time because those in charge have a plan, and the currency is supposedly now linked not to the dollar but to a broader basket of currencies known as the China Foreign Exchange Trade System. But anyone who has been watching closely would have noticed that the authorities only follow the new system when it allows the renminbi to fall. When the CFETS was rising against the dollar in the first part of the year, the Chinese currency did not rise with it. The net result is that the renminbi is nearly 6 per cent weaker on a trade-weighted basis than it was at the start of the year.

On the surface, China’s economy does look less scary than it did a year ago. The authorities, though, are using the same tools to support growth that they used in the past — public investment and subsidised credit. Fixed asset investment by state-owned companies grew by more than 20 per cent, year on year, in the past three months.

Big picture: China might be more stable but is no closer to resolving its structural and financial imbalances than it was a year ago, and it is still exporting disinflation to the rest of the world via a weaker exchange rate. US import prices from China fell by 3 per cent in June, the largest monthly drop since 2013.

The US can probably shrug off this imported deflation because domestic prices — and, finally, wages — are picking up as the domestic consumer-led recovery continues. Globally, however, the picture is not nearly as strong. The International Monetary Fund’s forecasts, released last week, show global consumer inflation for advanced countries at just 0.7 per cent in 2016. The central banks in the US and the UK are the only ones in the developed world that are expected to achieve inflation at or above the targeted 2 per cent by 2017.

Those new IMF forecasts are helpful, not because they are likely to be right, but because they let us step back from the day-to-day stories to see how global growth expectations have changed over time. At 3.1 per cent, the new growth forecast for 2016 was only slightly lower than the April number. This was taken as more evidence that the negative effects of Brexit are likely to be centred on the UK. But a year ago the fund was expecting global growth this year to be 3.8 per cent, and growth for the advanced economies to be 2.4 per cent. Now its best guess is for growth of 1.8 per cent in those countries — not just in 2016 but in 2017 as well. The forecast for world trade has also been slashed, yet again. We have now had six consecutive years when world trade has been flat or falling as a share of global gross domestic product.

None of this suggests that the global recovery is about to grind to a halt. It does remind us that the world is expecting an awful lot of the US right now, and an awful lot of its central bank. The US has managed a respectable recovery, despite a deeply needy global economy and an unhelpful rise in the dollar. Investors are betting that this can continue, despite the dysfunctional cacophony coming out of the party conventions. We should all hope they are right. The world does not have a plan B.

The writer is chief market strategist for Europe at JPMorgan Asset Management

A Reverse Mortgage Can Save Your Retirement!

real estateMy Comments: Many of you may react negatively when you hear the term ‘reverse mortgage’. At one time that reaction was a reasonable response, but not any longer.

Reverse mortgages are now a legitimate financial planning tool that advisors like me employ when the circumstances are appropriate. As you will read below, they can be a life saver when cash flow is limited or we’re in the middle of a market crisis and you don’t want to sell your stocks and bonds and lose a ton of money.

They can be a critical element in your efforts to find find financial freedom.

07/31/2016 Robert Mauterstock

Reverse mortgages have been around for a long time. It’s a method that an individual can use to convert the equity built up in their home to a credit line or an income for as long as they remain in the home as their primary residence, without the burden of monthly mortgage payments. But up until recently the fees to establish one were very high. As a result, financial planners (including myself) did not recommend them to clients. In many cases our broker/dealer firms prohibited us from even talking about them.

But recently I met with Bob Tranchell, a senior VP at the Federal Savings Bank. Bob is a specialist in reverse mortgages. He explained to me all the changes that have occurred with reverse mortgages in the last few years. In 2010 and 2013 the federal govt. revised the Home Equity Conversion program (HECM) reduced its costs and made it more secure. Bob showed me how the reverse mortgage could become a very effective tool for aging baby boomers to give them security during their retirement years.

It is estimated that 87 percent of baby boomers will own a home in retirement, but 68 percent of them will still carry a mortgage. Research shows that the foreclosure rate for individuals between ages 65-74 increases by 920 percent. Often seniors who have a reduced income after retirement cannot maintain the payments they made while they were working.

In addition boomers may face the dangers of being in the sandwich generation. They might have to help their aging parents financially at the same time they have to support their children with student loans and no job. A Merrill Lynch survey indicated that more than 60 percent of boomers are considered the family bank, handing out funds to their parents or adult children.

Let’s look at an example of how a reverse mortgage can help a retired boomer. If he or she is at least 62 years old he can take out a reverse mortgage on the value of his home up to $625,000. The percentage available is based on his age, the appraised home value, the lender’s margin and the 10 year LIBOR rate (an interest rate index established by the Fed. Govt.). The 62-year-old will have access to 52.4 percent of the home value or $327,500.

He can take these funds as a lump sum, a fixed income for the rest of his life (Tenure), a term payment (fixed payment for a fixed period) or a credit line. The cost of the reverse mortgage is a 0.5 percent mortgage insurance premium, the loan origination fees and any closing costs. For the $327,500 amount the total costs would be between $6000-$14000 dollars. This can be wrapped into the mortgage. No loan payments are due as long as the individual keeps the home.

Payments that come from the reverse mortgage are received income tax free. If the individual does not tap into the mortgage the credit line increases each year based upon the lender’s margin, a 1.25 percent mortgage insurance premium and the value of the 1 year LIBOR rate. Currently it increases at more than 5 percent a year! Eventually the credit line can exceed the actual value of the home but the heirs of the borrower are only responsible for the value equal to 95 percent of the appraised value of the home. The rest is forgiven! They can chose to sell the home or take out a new mortgage and pay back the reverse mortgage.

Let’s assume the 62-year-old took out a reverse mortgage for $320,000 and didn’t touch it for 20 years. Based on current rates his credit line will have grown to $1,200,000 regardless of the value of the home. Assuming he wants to convert the loan into an income at age 82, he’d receive $10,103 per month for ten years and could still keep $300,000 in reserve as a line of credit (which will grow to $569,391 in another 10 years).

The reverse mortgage can also be used to pay off an existing mortgage and eliminate mortgage payments, pay for long term care or a long term care policy or assist children or parents with financial needs. It cannot be used to purchase an annuity or buy stock. If the borrower is concerned about leaving a legacy to his or her children he and his spouse can buy a second to die life insurance policy and pay the premium with some of the proceeds from the reverse mortgage. When the second spouse dies the kids will receive a tax free death benefit which they can use to pay off the reverse mortgage and own the home debt free.

The possibilities are endless. I have only touched on a few. Key to the program is that payments are received tax free, the loan is unsecured and the heirs are only responsible to pay back a maximum of 95 percent of the home’s value regardless of how much was taken out. It’s a win-win.