Jeff Witz, CFP

Given the market volatility lately, I’m questioning my investment strategy. Is there a preferred approach to follow when investing?

Over time, economic and political climates change, causing investors to question their current investment philosophy. We are certainly in 1 of those environments right now. Physicians, like all investors, constantly strive to achieve attractive returns in their portfolios and grow their financial assets over time. By accomplishing this feat, investors find that their portfolios, whether earmarked for retirement, college education, or other objectives, can be working for them instead of them needing to work harder to save more. This is especially important in an environment where incomes may be declining.

Although the perfect investment would have the attributes of high growth with little or no risk, the reality is these types of investments don’t typically exist. Throughout history, investors have spent significant amounts of time developing methods or strategies that come as close as possible to that “perfect investment.” There are many investment strategies, but none is as popular or compelling as modern portfolio theory (MPT).

Developed by Harry Markowitz and published under the title “Portfolio Selection” in the 1952 

, MPT explores how risk-adverse investors construct portfolios to optimize returns in relation to the risk of the underlying investments. The theory measures the benefits of diversification-not having all your investment eggs in 1 basket.

Although developed in the early 1950s, recognition for the achievement was delayed because the task of applying MPT was only made possible using modern computers that could handle the vast number of calculations and the range of historical data needed by the model. In 1990, 38 years after he wrote the article while teaching at the University of Chicago, Markowitz was awarded, along with fellow academicians Merton Miller and William Sharpe, a Nobel Prize for what has become the most widely used strategy for portfolio selection.

For most investors, the “risk” they take in an investment is that the return will be lower than expected. In other words, it is a deviation from the average return. The MPT model calculated for each investment a “standard deviation” from the mean that the model calls “risk.” What they found was, through diversification, the “risk” of 1 investment may offset the “risk” of another. The key behind the MPT model is determining which combination of investments in a portfolio provides the “maximum return and lowest risk.” Using a tool called the Efficient Frontier, the MPT model looks at desired rates of return and displays the combination of investments that produces the optimal level of return and risk based on past performance of the various investment markets. Although the past is not always a predictor of the future, MPT uses those data to estimate various risk/return scenarios.

The key today to using MPT is understanding that different “asset classes” have different levels of risk and combining investments from different asset classes in a measured way gives the investor the greatest probability of achieving their rate of return objectives while minimizing risk as much as possible. Examples of major asset classes include large US companies, small US companies, international companies, domestic bonds, international bonds, and real estate. How well an investor assigns different amounts of their total investment portfolio to these asset classes and how well that distribution across asset classes applies to their investment objectives, is the biggest determinant of long-term investment success. In fact, Markowitz’s study found that more than 90% of your long-term investment success is determined by asset class selection.

Funding the various asset classes can be easily accomplished through indexed mutual funds or indexed exchange traded funds (ETFs) that mirror a specific index or asset class. Even after all these years, and a number of bull and bear markets and new investment vehicles, MPT continues to play a crucial and meaningful role in investment management strategy.

An indexed mutual fund or indexed ETF is a fund that seeks to mimic a particular index. An index such as the S&P 500, which tracks the performance of approximately the 500 largest companies in the United States (large cap asset class), does not actually invest in these companies, nor can you directly invest in the index itself. Therefore, fund companies create mutual funds or ETFs that mimic the index. It invests in the companies contained in the index and in the same percentages the index uses to track performance. By investing in these funds, you can easily invest in an entire asset class. Finding an index fund for each asset class can help you achieve the asset class diversification that is a key pillar to MPT.

The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.

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"[A study by Harry Markowitz] found that more than 90% of your long-term investment success is determined by asset class selection," writes Jeff Witz, CFP.

How modern portfolio theory can help meet your financial goals

The CARES Act has many features designed to provide relief during the coronavirus disease 2019 (COVID-19) pandemic. What are the most important features I should know?

On March 27, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act in an effort to support US businesses and families. The bill was extensive and wide reaching.

The following details are the most important for individuals to know:

• Payments of $1200 (single/head of household) and $2400 (joint filers) will be sent to taxpayers within certain income limits. An additional $500 payment is available for each qualifying child. These payments will be determined based on your most recently filed tax return or Social Security benefit statement, if no return was filed. The amount of the payment is reduced by 5% of the amount by which income exceeds $75,000 (single), $112,500 (head of household), or $150,000 (joint filers).

• Required minimum distribution (RMD) rules are waived for 2020 distributions from IRAs, including inherited IRAs, and 2019 distributions taken in 2020, which had a required beginning date of April 1, 2020. RMDs are also waived for 2020 distributions from certain defined contribution plans including 401(k), 403(b), 457(b), and IRA-based plans.

• Distributions from IRAs and qualified retirement plans of up to $100,000 received during 2020 for COVID-19–related purposes are allowed without a 10% penalty for individuals aged below 59.5 years. They are taxable evenly over 3 years beginning with the year of distribution and may be recontributed within 3 years. Related purposes include a COVID-19 diagnosis for you, your spouse, or dependent, and financial hardship as a result of business closures, reduced work hours, layoff, furlough, or lack of childcare.

• Loans of up to $100,000 or 100% of the account value, whichever is less, are allowed from qualified retirement plans.

• Student loan payments and accrual of interest under certain federal loan programs are suspended through September 30, 2020.

• A charitable deduction of up to $300 is allowed for those who do not itemize their deductions. The adjusted gross income limitation is waived, allowing you to offset more of your taxable income. These two items apply only to cash contributions and are not available for contributions to donor advised funds or other supporting organizations.

COVID-19 and market fluctuation: What you should do

Provisions that may impact physicians in particular include the following:

• Small businesses, including medical practices, with no more than 500 employees are eligible to apply for the Small Business Administration (SBA) Payroll Protection Program. This allows a small business to apply to an SBA-approved lender for a loan of up to 250% of its average monthly payroll costs to cover 8 weeks of payroll, as well as help with other expenses like rent, mortgage payments, and utilities. The maximum loan amount is $10 million. Sole proprietors, independent contractors, and other self-employed individuals are eligible. A loan can be forgiven based on the business maintaining employee and salary levels. For any portion of the loan that is not forgiven, the terms include a maximum duration of 10 years and a maximum interest rate of 4%.

• Employers and self-employed individuals may defer payment of the employer share of applicable Social Security taxes beginning on the date of enactment through the remainder of 2020. The deferred amount may be paid over 2 years, half in 2021 and half in 2022. These taxes are being deferred, not forgiven, so businesses should be mindful about planning to pay these tax liabilities when they are eventually due.

• $100 billion has been made available through the Public Health and Social Service Emergency Fund to provide immediate financial relief by covering nonreimbursable expenses attributable to COVID-19. Health care entities, including physician practices, that provide health care, diagnoses, or testing are eligible. Nonreimbursable expenses attributable to COVID-19 qualify for funding. Examples include increased staffing or training, personal protective equipment, and lost revenue. 

• Physicians who provide volunteer medical services during the public health emergency related to COVID-19 have liability protections. These new protections are in addition to those provided by the Volunteer Protection Act of 1997.

The bill provides coverage of nonreimbursable expenses attributed to COVID-19, writes Jeff Witz, CFP.

CARES Act: Here’s what physicians should know

With fears about the coronavirus (COVID-19) causing the markets to fluctuate significantly, should I make any adjustments to my investment strategy?

The markets have certainly been a roller coaster lately. At the end of February, the Dow experienced its “first” largest single-day drop, down 1,191 points, then posted its largest single-day gain, at 1,293 points, a couple of days later. On March 10, the Dow beat its single-day loss record again by posting a jaw-dropping 2,021-point loss only to follow this up with a larger 2,997-point drop on March 16.

This volatility isn’t unexpected when you have a stock market that was consistently setting new record highs come face to face with a potential global health threat. With a global pandemic causing countries to limit trade and social distancing limiting people’s ability to purchase goods, it is likely that a highly volatile environment will remain for the short term.

As investors, it is critical not to overreact. You need to block out the surrounding noise and follow your investment strategy in the face of volatile markets. Actions based on emotion and fear can cause you to make mistakes that can negatively affect your long-term investment performance. In 2018, we wrote an article during another period of high volatility and provided some insights for investing in these environments. We would like to share those with you again.

I made an excess contribution to my Roth IRA; how do I fix it?

Fight the impulse to sell your holdings if the markets are dropping.

 Selling after drops can make temporary losses permanent and difficult to recover. Sticking to your investment strategy, although it can be difficult emotionally, may be healthier for your portfolio. It is important to continue monitoring your investments but remember the long-term reasons the investment is in your portfolio. What role is it playing? If it is still a good fit, holding the investment may be the better long-term strategy.

Remember that you are investing for the long term.

 Markets have always fluctuated up and down, and during your lifetime, you’re likely to experience several significant declines. Investors should ignore the noise and stay disciplined to the investment strategy they designed. The strategy was created specifically to avoid falling into these pitfalls.

 Risk you took on years ago may no longer make sense given your current circumstances and stage of life.

Make sure your portfolio is well diversified

Make sure your portfolio is well diversified.

 Volatile markets have a way of exposing improperly diversified portfolios.

 Market volatility can skew your allocation from its original target. Certain assets will be more affected by market swings and will move outside their target allocations. Rebalance your portfolio by selling positions that have become overweight in relation to the rest of your portfolio and move the proceeds to positions that have become underweight.

If you must trade during volatile markets, there are defensive steps you can take to protect your positions. Stop orders and stop-limit orders can help shield unrealized gains or limit potential losses on an existing position.

Self-employed? Here’s how you can save for retirement

Consider adding defensive assets such as cash and cash equivalents, Treasury securities, and other U.S. government bonds. These can help stabilize a portfolio when stocks are slipping.

If I want to take advantage of the down market, is there a preferred way to invest?

First, evaluate if you are in a financial position to invest more and proceed with caution. If you determine you are able to invest during a volatile environment, the best approach is to do so over a period of time. It is impossible to tell when the markets have hit their bottom. Don’t try to guess and invest everything in one lump sum. If markets continue to decline, you could potentially lose a significant amount.

It is better to break up the investment into smaller increments. If you are wrong, you are not wrong with all the money you planned to invest. This strategy is called dollar-cost averaging. With a dollar-cost averaging strategy, it is best to select 1 day a week or 1 day a month to invest a smaller percentage of the total amount you planned to invest. By selecting a day and sticking to it, it will allow you to ignore the outside noise. If markets continue to decline, you are incrementally buying on the downslope and will be in a good position when markets recover.

Avoid making decisions motivated by emotion and fear, advises Jeff Witz, CFP.

I contributed to my Roth IRA during part of the year while finishing my fellowship. Then I began working as an attending and by year end had earned too much income to be eligible to contribute to a Roth IRA. How can I fix this?

The IRS considers this an excess contribution to your Roth IRA. Fortunately, they recognize there are several reasons why this could occur and provide ways to correct it. For example, you could have had a spike in income, you could have accidentally contributed directly to your Roth IRA instead of going through the backdoor IRA, or you just weren’t aware that the IRS sets income limits on contributing to a Roth IRA.

Depending on how quickly you discover the error and correct it, the IRS may not penalize you at all or give you time to fix the error. However, if the money stays in the account long term, the penalties can be severe.

As a reminder, your income plays a significant role in determining whether you can contribute to a Roth IRA. If you file your taxes as single, your ability to contribute to a Roth IRA in 2019 was limited if you earned over $122,000 and was eliminated if you earned over $137,000. For 2020, those amounts have been increased to $124,000 and $139,000.

IRS releases updates for 2020; here’s what you need to know

If you were married filing jointly for 2019, your ability to contribute was limited starting at $193,000 and eliminated at $203,000. Those amounts increased to $196,000 and $206,000 for 2020. If you are married and file separately, your ability to contribute is eliminated at $10,000 of income.

If you earned more than these limits and still contributed to your Roth, you have made an excess contribution, and corrective actions must be taken. The IRS penalty for failing to remove an excess contribution can be substantial: 6% each year the excess amount remains in the account. If you don’t catch the error for many years, the penalty can really add up.

These are your options for correcting an excess contribution:

Withdraw the excess contribution before filing your tax return.

 The IRS treats this as though the contribution never happened, and the 6% penalty will not apply. You must also remove any earnings on the investments during that time period. The earnings must be included in your income, and you will have to pay income taxes on them. If you are under age 59½, you will also need to pay a 10% early withdrawal penalty, but only on the investment earnings attributed to the excess contribution.

Other options for correcting an excess contribution

Withdraw the excess contribution before the Oct. 15 tax extension deadline.

 If you didn’t catch the error before you initially filed your taxes, you can still withdraw the money and submit an amended tax return up to 6 months after your initial tax filing due date (usually Oct. 15). The same rules as above will apply and there is no additional penalty.

Apply the excess contribution to the subsequent year.

 If this was a one-time occurrence where your income exceeded the limits but the following year you will be eligible to contribute to a Roth, you can have the excess contribution amount moved to the next year. You will still have to pay the 6% penalty for the current year, but at least you will avoid incurring future penalties. If your income still won’t qualify the following year, this option is not available.

Some people do not catch their error for years. This can be an expensive mistake, but you will always have the option of taking the money out and correcting the error. However, remember that each year the money stays in the account, you will owe a 6% tax on the excess contribution amount. For example, if you made a $6,000 excess contribution and did not catch the error for 3 years, when you remove the money from the account, you will owe $1,080 in taxes ($6,000 x 6% x 3 years).

An excess contribution into a Roth IRA can be a hassle, but it is correctable. The sooner you fix the error, the less painful and less expensive the process will be. If you discover you made an excess contribution into your Roth IRA, we highly recommend speaking with your financial adviser and CPA to assist you with making the necessary corrections.

"An excess contribution into a Roth IRA can be a hassle, but it is correctible. The sooner you fix the error, the less painful and less expensive the process will be," writes Jeff Witz, CFP.

Author | Jeff Witz, CFP

Articles

How modern portfolio theory can help meet your financial goals

CARES Act: Here’s what physicians should know

COVID-19 and market fluctuation: What you should do

I made an excess contribution to my Roth IRA; how do I fix it?