Investor Insights & Outlook November 2015

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Modest Slowdown in Overall Employment Growth

The U.S. economy added 142,000 jobs in September, and the August report was adjusted down considerably from the originally reported 173,000 to a less impressive 136,000. The unemployment rate remained unchanged at 5.1%. The year-over-year employment growth, which is a less volatile indicator of employment strength, decreased modestly from an impressive 2.3% pace in February to a slower-but-still healthy 2.0%.

Overall, the September employment report was disappointing and had many investors worried that the U.S. economy might be deteriorating. While a modest slowdown cannot be denied, it is worth noting that the current pace of employment growth is still faster than what we’ve experienced in the first half of 2014, indicating that the growth has not fallen off the cliff.

Monthly Market Commentary

Morningstar economists continue to believe the underlying growth of the U.S. economy remains 2.0%–2.5%, driven by consumers and housing without a lot of help from any other sector. Better consumer incomes and low inflation combined with better employment prospects should keep these two key sectors moving upward, even in the face of a soft world economy. Of course, this all assumes that the recent terrorist attacks in Europe don’t unfold into something worse.

Employment: The U.S. economy added a much-better -than-expected 271,000 jobs last month. The previous month was revised slightly lower to 137,000, but overall there were improvements, and the gains were spread among many categories. The unemployment rate ticked down to 5%, and that’s despite the actual increase—a very small but nonetheless an increase—in the number of labor-force participants.

Total nonfarm employment continued to grow at about 2%, which is a healthy growth rate. Total private employment continued to grow at about 2.3%, which is slightly slower than in the beginning of the year when it was at about 2.6%, but still faster than in 2014. These are still healthy and stable rates, showing that the recent employment weakness was probably just a temporary fluke.

Overall, the latest JOLTS report seems to suggest that labor shortages are continuing to build and the balance of power continues to shift to the employee. Employment growth is more likely to be limited by a shortage of available employees and not employers’ desire to hire.

Retail Sales: On the surface, the overall retail sales report looked disappointing, as overall sales growth was just 0.1% between September and October. However, excluding gasoline and auto sales, growth was a more respectable 0.3%. Even that number was likely held back by warm weather depressing the sale of fall and winter apparel (the apparel category showed no growth in October) and maybe falling food prices. As the weather grows colder and some of the weekly retail sales data is beginning to show signs of life, the November report might look a little better.

The retail sales report has always been tricky to interpret because it isn’t adjusted for inflation, shifting weather patterns, and new retail channels. But readers need to be careful not to confuse poor results at conventional retailers and a mediocre retail sales report with a slowing consumer. Nothing could be further from the truth. Auto sales were above 18 million units in October on a seasonally adjusted, annualized basis—their best performance of the recovery. Restaurant sales were up 0.5% month to month and 5.5% year over year, hardly a sign of consumer retrenchment.

The Fed: Inflation has been so muted lately that the Consumer Price Index hasn’t been market-moving or even all that relevant. This time around the report takes on a little more significance because of the Federal Reserve’s focus on inflation and the upcoming December rate meeting. The Fed’s core inflation target rate is 2%. If the consensus for October core and headline inflation is correct at 0.2%, the year-over -year core growth rate will move up to 2% from recent readings that have been stuck at 1.8%. We caution

that the Fed prefers to use a separate measure of inflation that is not increasing as rapidly. Nevertheless, a core CPI inflation rate of 2% is likely to mean that Fed probably won’t use a low inflation rate as an excuse not to raise rates.

Global: A recent report from the OECD says that global growth is set to slow in 2015. In 2014, according to the OECD report, the world economy grew at 3.3%. They are now saying that 2015 will be substantially slower at 2.9%, which is also lower than their previous forecast of 3%. Then, for 2016, they are projecting the economy will grow at 3.3%, also slightly slower than they had previously forecast. The report is clearly seeing 2015 as kind of a pivot year and then better growth potential in 2016.

Four Tips for the RMD Season

Complaining about required minimum distribution from retirement accounts might seem a little like grousing that the pool is too crowded in Florida. It may be a nuisance, but it’s a high-class problem to have. That’s because for the majority of people, RMDs are a nonissue. For affluent retirees, however, RMDs can be unwelcome, shrinking the amount of assets that can enjoy tax-deferred compounding. With the deadline to take required minimum distributions fast approaching—Dec. 31—here are some tips to bear in mind.

1) Take the right amount at the right time. If you’ve just turned 70 1/2 this year then your deadline to take the first withdrawal is April 1st of the following year. Calculating RMDs, meanwhile, is a matter of dividing each of your RMD-subject account balances on Dec. 31 of the previous year by your life-expectancy factor. In most instances you’d use the IRS’ Uniform Lifetime table to calculate your RMD. But if your spouse is at least 10 years younger and also the sole beneficiary of your RMD-subject account, you’ll use the IRS’ Joint Life and Last Survivor Expectancy table (Table II in IRS Publication 590), finding the intersection between your age and your younger spouse’s age. That results in a smaller payout than would be the case if you based your RMD on your life expectancy alone. It’s also worth noting that you don’t need to take RMDs from each and every IRA account. As long as you take the right total from at least one of the accounts, you’ve met your distribution requirement.

2) Let your year-end checkup drive what you sell. Before you actually pull the trigger on your RMDs, conduct a thorough year-end portfolio review, taking stock of your asset allocation. Holdings that look unattractive or are simply consuming too large a share of your portfolio might be at the top of your list to sell to meet RMDs. That can serve the dual goal of potentially improving your portfolio and satisfying the IRS’ requirements.

3) Assess how they’ll affect your taxes. Even if you don’t intend to take your RMD until later in the year, it’s still valuable to calculate your RMD as soon as possible. That way, you can take steps to offset the tax impact—with tax-loss selling or accelerating deductions by prepaying property taxes, for example. A tax advisor should be able to help you gauge the impact of your RMDs on your tax bill and may be able to suggest steps you can take to reduce it.

4) Consider a qualified charitable distribution. For the charitably inclined, taking a qualified charitable distribution (QCD) can help kill three birds with one stone. By steering the IRA distribution directly to charity (rather than pulling the money out and then making a charitable contribution which is then deducted), the QCD enables the investor to fulfill the RMD, contribute to charity, and reduce adjusted gross income at the same time. From a tax standpoint, reducing AGI is preferable to taking a “below-the- line” charitable deduction, because a lower AGI may qualify the taxpayer for credits and deductions. Trouble is, Congress typically hasn’t approved the QCD maneuver until the end of the year. But there’s no downside in steering distributions directly to charity anyway. If Congress gives the go-ahead for QCDs, the retiree can use the distribution to reduce AGI. In the worst-case scenario, that the QCD provision remains dormant, the retiree could simply deduct the donation, as with a typical charitable contribution.

This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

Funds in a traditional IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. Contributions to a Roth IRA are not tax-deductible, but funds grow tax free, and can be withdrawn tax free if assets are held for five years. A 10% federal tax penalty may apply for withdrawals prior to age 59 1/2. Please consult with a financial or tax professional for advice specific to your situation.

Existing Home Sales Remain Strong

Existing home sales surged in September to the highest level of the recovery at 5.55 million units annualized. The year-over-year 3-month average growth stood at 8.3%, suggesting a continued strength in the existing home market as well. The demand for existing homes remains strong, and this is reflected in the low inventory levels that have been depleting for four consecutive months now. While existing home sales remain strong, the low inventory levels could potentially limit sales in the long run. Nonetheless, existing home sales are growing at a high single-digit rate based on the data released so far in 2015, which is good news considering that the existing home market actually contracted 3.1% in 2014. Overall, recent economic indicators suggest that the state of the housing industry remains strong, and that consumers continue to be confident about their long-term finances.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook October 2015

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The Fed Kicks the Can Down the Road

The Federal Reserve decided not to raise rates at its September meeting. While admitting that employment and inflation levels were approaching its goals, the Fed worried that slower international economic activity would potentially depress U.S. growth rates (and employment), while a strong dollar was likely to keep inflation lower for longer. Given the uncertainty, it didn’t feel an imminent need to raise rates. On the other hand, their longer-range forecasts show rate increases over the next year, albeit at a pace well below normal cyclical patterns. Current Fed governor forecasts have the Fed Funds rate moving up from 0.12% currently to just 1.4% by the end of 2016, slowly working its way to 3.4% by the end of 2018. In total, that is just barely over a 3% increase in more than three years. The relatively slow pace and small size of the total increase are all well below history.

How Will Bond Funds React to Rising Rates?

It is difficult to predict how the markets will move once the Fed decides to raise rates. That said, this article explores some ideas about how different types of fixed-income mutual funds are likely to react to an increase in interest rates.

Debt securities and funds that invest in them have varying levels of sensitivity to changes in interest rates. In general, the price of a debt security tends to fall when interest rates rise and rise when interest rates fall. Securities with longer maturities tend to be more sensitive to interest rate changes. Funds holding short- term debt securities are the least sensitive to changes in interest rates, while funds investing in longer-term bonds are the most interest-rate sensitive.

That being said, markets have responded very differently in past rounds of rate hikes. For example, during the rate hikes from March 2004 to June 2006, yields on the 30-year bond actually fell as the yield curve flattened; during the September 1993 to December 1994 hikes, yields rose across the yield curve. If the yield curve steepens (the long-end rises faster than the short-end) or shifts upward in a more or less parallel fashion, long-term bond funds could take a significant hit. But if the yield curve flattens, which is not out of the question given the troubles abroad that may continue to push investors toward the safe haven of U.S. Treasury bonds of all maturities, longer-term funds may fare better. For example, during the 2004–06 rate hikes, the 10-year Treasury bond lost 1.7% while the 30-year bond gained 2.2%.

Globally, it’s expected that the eurozone and Japan (the two main non-U.S. developed markets for bond investors) will be relying on quantitative easing much longer than the United States, thus delaying their own rate hikes. But the market for high-quality non-U.S. government bonds, including German bunds and Japanese government bonds, can track U.S. Treasuries when investors seek safe-haven assets. If the Fed continues to delay the rate hike, it could be seen as a signal that it’s concerned about economic growth and may stoke fears of slowing global growth, and German and Japanese government bonds could strengthen. Under the same scenario, the dollar is likely to weaken, which would boost issues denominated in euros or yen. What does this mean for an investor’s portfolio? Predicting the timing and magnitude of interest-rate movements is difficult, and many bond portfolio managers believe it’s folly to significantly change a fund’s position based on interest-rate predictions. Investors may be better off sticking with an allocation that suits their long-term investment goals, and understanding how different bond funds might perform during various rate environments can help.

The investment return and principal value of mutual funds will fluctuate and shares, when sold, may be worth more or less than their original cost. Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should read the prospectus and consider this information carefully before investing or sending money.

Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest. With government bonds, the investor is a creditor of the government. With corporate bonds, an investor is a creditor of the corporation and the bond is subject to default risk. Corporate bonds are not guaranteed.

With international bonds, the investor is a creditor of a foreign government or corporation. International bonds are not guaranteed. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, liquidity risks, and differences in accounting and financial standards.

Monthly Market Commentary

Despite a softening world economy, Morningstar economists’ forecast remains relatively unchanged from their June 2015 forecast. They have upped the 2015 growth by a seemingly small 0.1% to 2.2%–2.6% range; however, it seems that the higher end of the range is now likely. The consumer has continued to do well, net exports haven’t yet proved to be the disaster everyone expected (mainly because imports have done as poorly as exports), and government spending is no longer falling. Housing continues to provide a meaningful contribution to overall GDP growth, too while business investment spending remains soft.

China: Most of the change we saw over the past quarter related to China. The Chinese currency was devalued, and many Chinese economic indicators continued to slow. Many of Morningstar analysts have been warning about China for some time. China has showed lower growth rates and missed growth forecasts for several years. It’s not new news. Still, the devaluation brought some already well-known weaknesses to the forefront. A slowing China generally has helped the U.S. economy as the small decrease in exports has been more than offset by lower commodity prices, which puts more money in consumer pockets.

The Fed: The other big news was that expectations of a Fed rate increase continue to get pushed out in time. At the end of 2014, some speculated that the Fed might take action as early as March 2015. Now in September, a rate increase by December is by no means a done deal. The Fed noted worsening conditions in China that could potentially slow the U.S. GDP growth rate and employment outlook as their reasons for further interest rate hike delay. Now the Fed has sowed doubts and created uncertainty for investors and business people as they openly fret about world growth rates. Uncertainty is the market’s worst enemy, and the markets have reacted accordingly. U.S. equity and emerging markets were little changed at the 2015 halfway point. Now, nearing the end of the third quarter, the S&P 500’s year-to-date performance looks to be down in the mid-single digits, and emerging markets a more worrisome mid-teens decline.

Auto Sales: Auto sales are a very large consumer purchase. The average vehicle price is more than $30,000, so it is not a decision that consumers take lightly. The commitment is large and long term, with some auto loans extending out to seven years. If consumers were worried about their employment or wage outlook, they wouldn’t be committing to big auto purchases. With the help of low interest rates, cheaper gasoline, and better employment data, auto sales in 2015 have done better than almost anyone expected. At the beginning of 2015, most sales focused on the 16.8 to 17.0 million range. It now looks like sales are much more likely to fall in the 17.0 to 17.5 million range for 2015, compared with 16.4 million units in 2014. The unweighted monthly average through August is 17.1 million units, so even the high end of the estimate range looks quite doable. Although there are some calendar effects that may be helping the number along a little, the ever-rising trend in recent months is hard to deny. It hardly suggests that consumers are feeling any fear.

Housing: Requiring even more confidence than buying a car is buying a home. With average new home prices of about $360,000, a home purchase is 10 times bigger than a car and totally dwarfs a $100 restaurant meal. To eliminate the investment aspect of multi-family homes (apartment owners renting out multiple homes or apartments), one should focus primarily on new home sales. Current sales levels at an annual rate above of 500 thousand units, remain near recovery highs. However, they are just off this spring’s levels, which benefited from improving weather conditions. So while new home sales have slowed modestly, the year-over-year growth rates (nearly 20% growth) remain impressive and hardly indicative of any kind of consumer temper tantrum.

A Few Simple Tips for Fund Investing

A few ideas/tips/reminders investors might want to consider when reviewing their existing mutual fund line-up or choosing new funds:

Focus on your plan, not the news. Market-timing is very difficult to do well, so stick to your plan and keep investing.

Look for lower-risk funds. After a long-running bull market, this is probably more important than ever. Lower-risk funds may appear rather unappealing, but you may well hold on to these funds through the next downturn.

Find the right funds for you. If you have made a lot of fund trades over the years, maybe you need to dial down the volatility. Diversified or balanced funds may appear dull, but that may be a good thing. Dullness keeps emotions out of the equation, and it is emotional investing that wrecks a good plan.

Look for fund companies that close funds before they get too big. You can do this by finding funds that have closed in the past but have reopened. In addition, some funds will name a closing target well in advance so you can have some confidence that the fund won’t suffer asset bloat going in.

Low-cost funds should be a key part of your strategy.

The investment return and principal value of mutual funds will fluctuate and shares, when sold, may be worth more or less than their original cost. Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should read the prospectus and consider this information carefully before investing or sending money.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook September 2015

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Small-Business Compensation Plans Prove to Be a Growing Dilemma

The NFIB Small Business Survey is a metric that tracks economic sentiment among small-business owners. The employment portion of the survey is a particularly valuable indicator as small businesses hire almost half of all U.S. employees. The chart below represents results from the August 2015 survey. The results are mixed. The chart shows that small-business owners have an increasingly harder time finding skilled labor, yet they are not quick to raise wages. The gap between the difficulty to hire and the plans for increased compensation is now the highest it’s been ina few years, but the discrepancy between the two metrics can grow only so wide before converging back again. Given the current high demand for skilled and semi-skilled labor, it will be just a matter of time before workers realize that their leverage to demand higher pay is now the highest it’s been in many years.

Four Strategies For A Low Return Environment

For the past several years, sober market watchers have been telling investors to brace for more modest returns from their portfolios. Just as trees don’t grow to the sky, nor do extended market rallies go on forever. If the market provides less of a helping hand in the future than it has in the past, that means that investors will need to do more of the heavy lifting to make their plans work. There are several steps investors can take to help improve their portfolios’ potential returns and, in turn, improve the viability of their plans. Strategy 1: Revisit Key AssumptionsThe S&P 500 has returned about 20% on an annualized basis since the market bottomed in March 2009. But stocks’ long-term returns have averaged less than half of that, and it’s reasonable to assume that returns over the next decade could be even lower than that due to lofty valuations. To help factor in a less-forgiving market environment, it’s a good time to revisit the key assumptions underpinning your retirement plan. For example, you might assume that bonds will return 2% and stocks will return only 6%. If these lower return projections point to a shortfall in your retirement plan, you can push back your retirement start date, or reduce your in -retirement withdrawals. Strategy 2: Assess Your Asset AllocationIt’s difficult to predict the future returns of stocks. On the other hand, starting yields on Treasury bonds have explained much of their performance over the subsequent decade. That means that with yields as low as they are, an investor who hunkers down in bonds and forsakes stocks could well be locking herself into a very low return. Investors who maintain higher equity positions won’t necessarily get rich, but they will at least have a fighting chance of outrunning inflation over time. That’s not to suggest that you throw standard asset-allocation guidance out the window: Individuals who expect to draw money from their portfolios in the near term will need cash and bonds. But it does suggest that the safety of cash and bonds could prove illusory over longer time frames. Strategy 3: Watch Investment Costs Like a HawkLower returns also mean that efforts to control a portfolio’s cost can be even more beneficial than in a higher-returning environment. After all, paying a 1% expense ratio on a balanced portfolio that earns 10% on an annualized basis–as the typical balanced portfolio has during the past five years–takes a 10% bite out of that return; if balanced funds return just 6%, as they have during the past decade, that 1% expense ratio translates into a 17% levy on the portfolio’s return. Given those numbers, investors’ stampede into various types of inexpensive passively managed products, looks quite rational. Strategy 4: Aim to Reduce the Drag of TaxesIn a similar vein, lower returns mean that taxes take a bigger bite of your portfolio’s value, on a percentage basis, than in a more flush return environment. Lower absolute returns can enhance the tax-saving features of vehicle like IRAs, company retirement plans, and 529 college-savings plans; once their tax benefits are factored in, even subpar versions of these accounts usually trump investing in a taxable account and paying taxes on dividends and capital gains on a year-in, year-out basis. That said, investors who are in a position to invest in their taxable accounts alongside tax-sheltered vehicles can take steps to reduce the drag of taxes on an ongoing basis: Favoring exchange-traded funds and index funds, individual stocks, and municipal bonds, as well as limiting trading, can go a long way toward reducing annual tax bills.

Disclosure: This is for informational purposes only and should not be considered tax or financial planning advice. This article contains certain forward-looking statements which involve known and unknown risks, uncertainties, and other factors that may cause the actual results to differ materially from any future results expressed or implied by those projected statements. Past performance does not guarantee future results.This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

Monthly Market Commentary

August was a wild month, with powerful downward movements in most world equity markets early on, followed by equally impressive gains afterward. Investors feared that China’s economic slowdown would drag down the rest of the world just as the Federal Reserve ended its emergency support. However, strong U.S. economic data combined with hope that the Fed will not increase rates in September set off an epic stock market rally.

GDP: The GDP report for the second quarter was revised up to a surprisingly strong 3.7% from just 2.3% in the previous report just one month ago. Although some GDP revision was expected, the quality and size of the upgrade were far better than anyone could have hoped for. Part of the strong increase in the second quarter was because of the abysmal first quarter, when the economy grew just 0.6%. Still, averaging the first and second quarters together, growth in the first half was over 2%, not bad for all the world drama.

Employment: On the surface, the August employment report was a modest disappointment to the market, with the U.S. economy adding 173,000 total nonfarm jobs versus earlier expectations of 215,000 jobs. However, readers should keep in mind that August is the lowest and most revised month in the employment data series. The total worker employment data was consistent with what everyone had been expecting and the average over the past six months.

There was other good news, too. The unemployment rate dropped surprisingly to 5.1% through a combination of job additions and a slightly smaller work force. The year-over-year, averaged data showed more of the same steady-state employment growth of just over 2% that has characterized most of this recovery. The steadiness has occurred despite large month-to-month swings that usually manage to cancel each other out.

Personal Income and Spending: Personal income and real disposable personal income grew 0.4% and 0.5%, respectively, exceeding more modest consumption growth of 0.3%. The battle between incomes and spending continues, with income growth exceeding spending growth for two months in a row after a period when consumption was winning out. Wage growth, due to a hiring binge late in 2014, is still running ahead of consumption, suggesting that there is more room for consumption to expand, especially now that oil prices are on their way back down. Historically, incomes and consumption have tended to move together, with consumption generally not as volatile as incomes. The close relationship and stable trend suggest a very consistent consumer who has not been spooked by world events.

Housing: This month’s forward-looking housing reports support the thesis of a sharply improving housing market. The new-home sales report, in particular, offered some bullish clues indicating that the housing momentum is real and should continue in the months ahead. On the home price front, the news was also good, suggesting that the streak of large monthly increases appears to be moderating as June’s data showed more modest monthly price growth. Housing has already provided a large boost to second- quarter GDP, and it looks like the third quarter is off to a good start, as well, providing hope that housing’s substantial contribution to the GDP calculation could be sustained.

Monetary Policy: The Fed meeting on interest rate policy this week remains the market’s focus. The raw economic data is not strong enough or weak enough
for a firm conclusion, leaving everyone running around dissecting individual words in speeches and examining the circumstances of past rate increases. The Fed seemed to show a great willingness to raise rates, and then the situation in China worsened. It’s tough to justify a rate increase in the face of financial turmoil. The impact of a small trial rate increase on the economy would probably be minimal, while the
market impact of a change is likely to be high.

A Changing of the Guard for Auto, Housing Recoveries

Although the improvements in auto sales have greatly outstripped the housing recovery, that trend should flip in the coming years. The chart below is a tale of two recoveries: the recovery in the auto industry and the recovery in the housing industry. Both of these segments comprise about 3% of the GDP and have knock-on employment effects throughout the entire economy. The chart shows that both of these industries suffered from 2005-08–coming to a real crescendo when things collapsed in 2008. Since then, both segments have improved nicely. However, the auto industry has done far better. The auto industry is now at its previous high, meanwhile, the housing industry still has a long way to recover. Lookingforward, Morningstar economists expect a changing of the guard where the housing industry continues to accelerate and the fully-recovered auto industry will continue to plateau.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook August 2015

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Inflation and Hourly Wage Growth

Wage growth is an important leading metric of consumer behavior, as higher wages increase disposable income, which in turn drives more spending. The chart depicts nominal hourly wage growth and the inflation rate (represented by the consumer price index) since 2010. Both metrics are on a year-over-year basis, and averaged for 3 months in order to smooth out the monthly seasonality.

What really stands out is that nominal hourly wages have been growing at a steady 2% rate for many years now, and they have recently accelerated just slightly to about 2.2%. What contributed to a huge increase in the real wage growth (not shown on the chart), however, was the collapse of the inflation rate that began in the second half of 2014, driven by lower oil and gasoline prices.

Monthly Market Commentary

Majority of the needle-moving economic indicators over the past month were roughly in line with expectations, and the chances of an interest rate increase at the next Fed meeting remain high. Nonetheless, the interest rate hike is not a done deal, and the potential of a bad economic report, such as low August employment numbers, could delay the Fed’s move.

Employment: According to the BLS the economy added 215,000 jobs in July, close to the consensus estimate of 220,000 jobs. The pace was a bit off of the 249,000-per-month average of the past 12 months, which Morningstar economists never viewed as sustainable. Two barn-burner months at the very end of 2014, especially the 423,000 jobs added in November, are still having a dramatic impact on the averages. Also, the revisions to the prior two months were minimal. After a big drop in June, the unemployment rate remained steady at 5.3% even as the labor force increased by more than 100,000 people.

This headline data should be enough to keep the Fed on pace to raise interest rates in 2015, most likely as early as September given that the employment market looks healthy and inflation is moving slowly toward the Fed target. However, the July data, which is relatively stable with small seasonal adjustment factors, was never really our worry in terms of derailing the Fed. It is the August report, which will be the last report to come out before the Fed’s September meeting, that remains the last major impediment for a September rate hike. The August jobs report has been a very rough one over the past several years. This has been especially true for the first version of the August labor report, with subsequent revisions eventually eliminating some of the shortfalls. One recent report actually showed a job loss on the first cut and just last year the originally reported August data was below 100,000 jobs. If this August’s job report shows 150,000 or fewer jobs added, the Fed may choose to delay action at its September meeting. Again, it seems extremely likely that rates will be increased in 2015, but the exact meeting date at which it happens is largely irrelevant to the longer-term outlook for the economy.

GDP: Headline GDP growth rate for the second quarter on a sequential, annualized basis increased a modest 2.3% versus expectations of an increase of 2.8% and Morningstar economists’ forecast of 3.0%. The metric also ran below the long-term average of 3.1%. However, the goal posts were moved substantially, as the first quarter now showed growth of 0.6% instead of shrinkage of 0.2%, a rather substantial swing of 0.8%. Adding that 0.8% revision to the reported growth rate of 2.3% produces 3.1%, which seems more like an apples-to-apples comparison. So the second quarter wasn’t the disappointment that some commentators are making it out to be. In addition, it was a relatively clean quarter with minuscule and offsetting adjustments for inventory and net exports. These two categories have often wreaked havoc on the interpretation of the GDP reports in many recent quarters. For example, falling exports and rising imports deducted almost 2% from the first-quarter GDP report.

China: After moving sharply higher over the past several years, the Chinese government devalued its currency by 1.8%, which is just a drop in the proverbial bucket. If it did one of these each week for the next five, then we might be more concerned. Nevertheless, it is recognition that Chinese growth is not nearly as robust as the government had hoped. And that weakness is not great news for other emerging-market trading partners or commodity producers. Meanwhile, the U.S., which receives just 1% or so of its GDP from sales to China, stands to benefit from cheap commodities more than it will be hurt by weak sales to China. Also, because China has kept such tight control over foreign investment, financial dislocation in China will not reverberate around the world financial markets in the way that U.S. subprime mortgages did.

Four Retirement-Portfolio Withdrawal Mistakes to Avoid

Some errors in retirement-portfolio planning fall into the category of minor infractions rather than major missteps. Did you downplay foreign stocks versus standard asset-allocation advice? It’s probably not going to have a big impact on whether your money lasts throughout your retirement years.

But withdrawal rate errors can have more serious repercussions for retirement-portfolios. If you take too much out of your portfolio at the outset of retirement, and that coincides with a difficult market environment –you can deal your portfolio a blow from which it may never recover. Other retirees may take far less than they actually could, all in the name of safety. The risk is that they didn’t fully enjoy enough of their money during their lifetimes.

Mistake 1: Not Adjusting With Your Portfolio’s Value and Market Conditions. Even though the popular “4% rule” assumes a static annual-dollar-withdrawal amount, adjusted for inflation, retirees would be better off staying flexible with their withdrawals.

What to Do Instead: The simplest way to tether your withdrawal rate to your portfolio’s performance is to withdraw a fixed percentage, versus a fixed dollar amount adjusted for inflation, year in and year out. That’s intuitively appealing, but this approach may lead to more radical swings in spending than is desirable for many retirees. It’s possible to find a more comfortable middle ground by using a fixed percentage rate as a baseline but bounding those withdrawals with a “ceiling” and “floor.”

Mistake 2: Not Adjusting With Your Time Horizon. Taking a fixed amount from a portfolio also neglects the fact that, as you age, you can safely take more from your portfolio than you could when you were younger. The original “4%” research assumed a 30-year time horizon, but retirees with shorter time horizons (life expectancies) of 10 to 15 years can reasonably take higher amounts.

What to Do Instead: To help factor in the role of life expectancy retirees can use the IRS’ tables for required minimum distributions as a starting point to inform their withdrawal rates. That said, those distribution rates may be too high for people who believe their life expectancy will be longer than average.

Mistake 3: Not Adjusting Based on Your Portfolio Mix. Many retirees take withdrawal-rate guidance, such as the 4% guideline, and run with it, without stopping to assess whether their situations fit with the profile underpinning that guidance. The 4% guideline assumed a retiree had a balanced stock/bond portfolio. But retirees with more-conservative portfolios should use a more-conservative (lower) figure, whereas those with more-aggressive asset allocations might reasonably take a higher amount.

What to Do Instead: Be sure to customize your withdrawal rate based on your own factors, including your portfolio mix.

Mistake 4: Not Factoring In the Role of Taxes. The money you’ve saved in tax-deferred retirement-savings vehicles might look comfortingly plump. However, it’s important to factor in taxes when determining your take-home withdrawals from those accounts. A 4% withdrawal from an $800,000 portfolio is $32,000, but that amount shrivels to just $24,000, assuming a 25% tax hit.

What to Do Instead: It pays to be conservative in your planning assumptions. To be safe it’s valuable to assume a higher tax rate than you might actually end up paying.

Disclosure: This is for informational purposes only and should not be considered tax or financial planning advice. Please consult with a financial or tax professional for advice specific to your situation. This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

Housing Construction in Good Shape

The chart depicts the state of the housing construction industry, suggesting that there is still plenty of room to grow in this slow, but steady recovery we’ve seen so far. The latest starts and permits data from the Census Bureau, however, shows a slightly exaggerated picture, as it is the multi-family category that’s been making overall housing construction look better than it is in reality. Both starts and permits picked up in June, as multi-family activity rose sharply amid expiring construction tax incentives for developers in the New York City area. As a result, the housing construction revival is probably not as strong as the numbers seem to currently suggest. Nonetheless, improvements for single-family construction still look healthy, and continue to trend up closer to the 10% rate year over year.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook July 2015

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Aging Millennials Should Drive Up Single-Family Home Sales

In this recovery, there has been a surge in interest in apartment buildings. Meanwhile, single-family home sales are still running about 50% below their previous peak. The chart illustrates what may be behind some of that change. Following the decline in the 24-31year old cohort, that group is now growing again. Not surprisingly, so are multi-family permits and interest in apartment buildings over the last several years. Looking at the data for 2014-2019, that age dynamic will begin to shrink according to Morningstar economists. That’s bad news for people building apartments, but great news for the overall economy. Single-family homes utilize more labor and more materials than apartment buildings do. So, as the age group begins to buy homes instead of living in apartments, it should drive up single-family home sales and boost the economy.

How Much Foreign Stock and Bond Exposure Do You Need?

This is one of the central questions confronting investors putting together their portfolios, yet there seems to be no consensus. Some experts argue for highly globalized portfolios, with allocations to foreign and U.S. stocks and bonds mirroring their market values. But other experts believe that due to the extra costs and volatility that can accompany foreign stocks and bonds—and especially the foreign-currency swings that can occur when those market gains or losses are translated into U.S. dollars—less is more when itcomes to foreign exposure. A related question is whether (and how) a portfolio’s allocations to foreign and U.S. stocks and bonds should change over time.

Stock Allocations: Fully Global, U.S.-Centric, or Somewhere In-Between?

The issue of how much investors should stake in foreign stocks has been a contentious one for years. In the “less foreign is more” camp are experts who believe that because many U.S. blue chips are increasingly global in their reach, investors in them get exposure to foreign markets indirectly, while avoiding the extra costs and volatility associated with foreign stocks (foreign-currency swings in particular). At the other extreme are the “global market-cap agnostics”—those who suggest buying a basket of U.S. and foreign equities weighted according to their market values. The U.S./foreign allocations of global-market indexes have hovered around 50/50 for the past several years.

Meanwhile, most asset-allocation experts recommend a middle ground. Investors may not need to steer half of their portfolios to foreign stocks to obtain most of their diversification benefits. The rationale behind how much foreign exposure an investor may choose gets back to volatility. Because foreign stocks typically entail some currency risk as gains or losses are translated from foreign currencies to dollars, investors who want to reduce volatility may want to also reduce their foreign weightings accordingly.

Bonds: It’s Complicated

Even though more than 50% of the world’s fixed- income investments exist outside the United States, investing in foreign bonds has the potential to add cost and volatility to a U.S. investor’s portfolio. Few asset- allocation experts are in favor of mirroring the global markets’ allocation to U.S. and foreign bonds.

Because types of foreign-debt exposure vary so widely, one-size-fits-all recommendations are tricky. Investors could steer a larger share of their fixed-income portfolio to foreign sovereign bonds rather than corporate and/or local-currency-denominated debt.

The volatility issue can be addressed, at least in part, by hedging out the currency risk of the foreign bonds. That helps ensure that investors partake of foreign bonds’ yields and any price changes, but not the currency-related impact when those returns are translated into dollars. However, hedging strategies entail costs, and in a low-returning asset class like bonds, those costs can take a big bite out of returns.

Past performance is no guarantee of future results. An investment cannot be made directly in an index. Diversification does not eliminate the risk of experiencing investment losses.

Returns and principal invested in stocks are not guaranteed, and stocks have been more volatile than the other asset classes. International bonds are not guaranteed. With international bonds the investor is a creditor of a foreign government or corporation. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, liquidity risks, and differences in accounting and financial standards.

This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

Monthly Market Commentary

The biggest debate in the past few weeks was, what mattered more, the Chinese stock market decline or Greece’s potential exit from the eurozone? With a Chinese economy at $10.7 trillion and Greece at $0.2 trillion, it doesn’t seem like much of a fight. However, Greece does have some potential for wrecking the E.U. system, which is a very large, $13.4 trillion economy. Morningstar economists believe that Greece itself and the solutions to its problems are not likely to have a major impact on the world economy. China’s situation, however, remains much more worrisome.

Employment: The job openings report continued to show growth in May, setting yet another record for job openings at 5.36 million, up over 16% from a year ago and 0.5% (6% annualized) from April. Although records go back only as far as 2000, this is the highest reading in the entire data set.

Most economists have viewed this as a highly positive and leading indicator of future employment data. Morningstar economists, however, have pointed to the job openings data in several reports as an indicator that labor markets are tightening. Indeed, the indicator did a great job of forecasting the surge in hiring in late

2014 that almost no other data series did. Right now, the indicator seems to be saying that job growth may be plateauing as year-over-year averaged growth in openings is showing early signs of peaking. Year-over-year growth is still elevated at 19%, but that is down from a high of 24% several months ago.

Housing: Unfortunately, housing doesn’t seem to be as strong as previously hoped. Demand seems somewhat better, but on the supply side, housing starts still look pretty anemic and inventories of existing homes still aren’t really moving up, which is keeping continued pressure on prices.

Trade: The trade balance was the single largest factor in the U.S. economy’s weak first-quarter performance. Trade took almost 2 full percentage points off of the GDP calculation. Without the negative trade performance, the economy would have grown 1.7% instead of shrinking 0.2%. The trade deficit, which had swung as high as $50 billion in March, moved to $40.7 billion in April and stabilized in May at $41.9 billion.

International: The International Monetary Fund revised its entire world growth outlook last week. These revisions were lower than the prior forecast, produced in January, which, in turn, was also lower than the forecast produced in October 2014. That October forecast predicted world growth of 3.8%, which was reduced to 3.5% in January and now to 3.3% in the July update. That is lower than the 3.4% actual world growth rate for 2014. And much like the United States, it’s stuck in a rut that it can’t dig itself out of, with world growth equaling 3.4% for each year of 2012 through 2014. (U.S growth has been between 2.1% and 2.4% since 2011).

Demographics: Demographics will also hold back the overall growth rates for some time to come. Low population growth (0.7% now, instead of 1.8% in the 1960s) is likely to keep the economy from growing any faster than Morningstar’s 2.0%–2.5% forecast, versus the average GDP growth rate over the last 50 years of around 3.1%. In addition, it isn’t helping that the fastest-growing age group in the U.S. economy is the miserly 65 and over crowd, while the absolute number of free-spending, high-income 50 year olds will be in a pattern of decline over the next five to 10 years.

Quarter-End Insights: Despite a disappointing first quarter, Morningstar economists expect higher growth rates in the second half of the year. Inflation is likely to run considerably higher in 2015 than either 2013 or 2014. Core inflation (excluding food and energy) will likely be around 1.7% for 2015, very similar to the last two years, but the ups and downs of energy prices will cause headline inflation to accelerate in 2015, especially if energy prices don’t fall soon.

Employment Growth Remarkably Strong in May, Wages Push Higher

The U.S economy added 280,000 nonfarm payroll jobs in May, surpassing the consensus estimate of 220,000. Certainly there was some help from the addition of summer jobs in some industries, but generally it was a very strong and clean report. The jobs data also exceeded the 12-month average of about 255,000 jobs per month.

The job growth average for January through April was a mere 200,000 or so jobs added per month, well below the annual averages and a sharp falloff from a very strong autumn. Viewed on a year-over-year, averaged basis, the jobs market has been consistently strong since September 2014. The private sector employment rate has been growing at about a 2.6% rate. Adding in the lethargic government sector, nonfarm payrolls are expanding at a very healthy 2.3% rate.

Month-to-month wage progression was also robust at a 0.3% monthly rate (3.6% annualized) and some previous data was revised, perhaps confirming the overall strength of the jobs market. Though less dramatic, the year-over-year hourly wage growth rates also appear to be improving. Growth in hourly wages and the number of workers added are relatively similar at 2.6% and 2.2%, respectively. While the market always focuses on the jobs number, wage growth is nearly as important. At this stage of the recovery, hours worked provides little help to wage growth and that is the case again now. Combining all three factors, employees, wage rate, and hours worked, total wage growth has been little changed at about 5%.

This article contains certain forward-looking statements which involve known and unknown risks, uncertainties, and other factors that may cause the actual results to differ materially from any future results expressed or implied by those projected statements. Past performance does not guarantee future results.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook June 2015

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April Employment Report: Mixed News

The April employment report wasn’t so strong that it created worries about economic overheating and Federal Reserve tightening, and it wasn’t as weak as to create concern that the economy was about to slide back into a recession.

Looking at private sector job growth, which excludes the much slower-growing government sector, the three-month average, year-over-year growth rate remains relatively high at 2.6%, which is down just a touch from recent highs and still above the 2.4% average growth rate of the past 12 months. Overall, it seems the jobs report was strong enough to keep a rate increase on the table for September, but weak enough that a June rate increase now appears unlikely.

I Bonds Versus TIPS, Part 1

Most investors looking for a low-risk hedge against inflation automatically think of Treasury Inflation- Protected Securities, or TIPS. But under the right circumstances, I Bonds, which also offer an inflation- adjusted interest rate, may be just as useful—provided that investors understand how they work and how they differ from TIPS.

One reason that investors don’t hear more about I Bonds is that, unlike many other bond types, they are not traded on a market. Only the person in whose name they are registered may redeem them. As such, I Bonds are not found in bond funds’ portfolios. These are securities you have to invest in directly.

There are two ways to purchase I Bonds. You can buy them in electronic form directly from TreasuryDirect.gov or you can instruct the IRS (using Form 8888) to use some or all of your federal income tax refund to buy paper I Bonds or to send the money to your TreasuryDirect account, which you can then use to purchase them.

One drawback of I Bonds is that annual purchases are limited to $10,000 per Social Security number for electronic versions and $5,000 per year for paper versions. So, investors who hope to make I Bonds a cornerstone of their inflation-protection strategy and who have a large amount of assets may have to build a suitable position over time. Also, electronic I Bonds may be purchased in any amount of $25 or more, while paper I Bonds are only issued in denominations of $50, $100, $200, $500, $1,000, and $5,000.

Difference in Inflation-Adjustment Methods

Like TIPS, I Bonds are designed to adjust for inflation, although they do so in different ways. For one, TIPS adjust the value of their principal and, thus, the yield, while I Bonds adjust the yield directly with no change to the principal value. Both adjust for inflation semi-annually, and for I Bonds, this happens on the six- and 12-month anniversaries of the date they were issued (the rate of the adjustment is determined every May and November). Both security types use the Consumer Price Index as the basis for their inflation adjustments.

The fact that I Bonds adjust their yields only twice a year and are not tradable means that they can be less sensitive than TIPS to near-term changes in the rate of inflation. For example, if inflation spikes in June of a given year, an investor holding I Bonds would have to wait at least another five months, until November, for the yield on the I Bond to reflect this change (and possibly longer if the anniversary of the I Bond’s purchase falls after November). With TIPS, that’s not an issue because market prices will adjust to reflect more recent changes to the rate of inflation. Of course, if inflation heads lower, the delay in the adjustment could potentially provide a short-term advantage for I Bonds relative to TIPS.

The interest rate paid by I Bonds includes both a fixed rate that remains constant for the life of the bond plus the inflation adjustment. With interest rates as low as they are right now and inflation relatively low as well, newly issued I Bonds aren’t paying much. In fact, the fixed-rate portion of new I Bonds is paying 0%, while the inflation rate for the full year ending with the most recent adjustment last November is 1.48%, for an overall composite rate on the bond of 1.48%. However, one advantage that I Bonds have over TIPS is that their composite interest rate is guaranteed to never fall below 0%, meaning the bondholder is guaranteed to never lose principal. With TIPS, yields can turn negative, potentially leading to losses for the bondholder.

I Bonds Versus TIPS, Part 2

Interest Payments and Tax Advantages

I Bonds continue to earn interest for up to 30 years but can be redeemed as soon as after 12 months. However, a three-month interest penalty applies. They can be redeemed after five years with no penalty. Unlike with TIPS and other bond types, which payout periodic interest payments, I Bond interest accrues

until the bond is redeemed, compounding twice a year while offering no periodic payments.

For those looking for an inflation hedge to be held in a taxable account, I Bonds offer some tax advantages relative to TIPS. The most important of these is that I Bond-holders may defer paying taxes on interest until they redeem the bond. The holder of a TIPS, on the other hand, must pay taxes each year on the interest as well as on any adjustment to the value of its principal (sometimes referred to as “phantom income”). As with TIPS, the interest on I Bonds is taxable at the federal level but is exempt from state and local taxes.

For some college savers, I Bonds also offer a tax advantage in that interest is tax-free if used to pay for college tuition and fees. However, income restrictions do apply. For 2014, the tax break began phasing out at $113,950 in modified adjusted gross income for married couples filing jointly and phased out completely at incomes of $143,950 and above. (For single filers, the tax break starts to phase out at $76,000 and goes away at modified adjusted gross income above $91,000.)

Are I Bonds for You?

If you are an investor looking to add inflation protection to your portfolio and willing to hold on to a security for the long term, I Bonds may be worth a look. But remember that they are designed to serve primarily as a principal-preservation tool rather than a source of periodic income. If you’re looking for inflation protection that also pays regular income, you might want to consider TIPS.

On the other hand, because I Bonds are not traded, they are essentially immune to interest-rate risk because changes to prevailing rates have no impact on their value. The same cannot be said of TIPS, which are traded and, therefore, susceptible to prevailing interest-rate movements.

If you are considering I Bonds as a long-term holding, it might be worth waiting until interest rates begin moving higher so that you can attempt to lock in a fixed rate that is above 0% in addition to the inflation rate on the bond. The I Bond’s fixed rate hasn’t reached 1% since 2007, and there’s no telling when rates will return to that level. But for an investment you plan to hold for many years, any fixed rate is better than nothing.

Debt securities have varying levels of sensitivity to changes in interest rates. In general, the price of a debt security tends to fall when interest rates rise and rise when interest rates fall. Securities with longer maturities and mortgage securities can be more sensitive to interest rate changes.

TIPS are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. TIPS are subject to risks which include, but are not limited to, liquidity risk, credit risk, income risk, and interest-rate risk.

An investment cannot be made directly in an index.

Home Prices on the Rise Amid Low Inventory Levels and High Demand

The latest report from CoreLogic showed that home prices continued to rise at a much faster pace than previously expected, growing 2.0% in March. On a year-over-year basis, the growth stood at 5.9%, the fastest pace since last July. CoreLogic predicts that prices will rise 0.8% in April, and that the year-over- year growth will tick down to 5.4%.

Unusually low inventory levels and a coinciding increase in demand are driving the prices of existing homes higher. Faster-growing prices are both good and bad news. The bad news is that the higher pace of home price increases may put a dent in the affordability of existing homes, which is something that has the potential of slowing down the housing recovery. The good news is that it is reassuring to see many new buyers who feel financially secure and confident enough to buy a home, even at higher prices. Faster price growth also helps existing homeowners to emerge from their underwater mortgages. According to CoreLogic, current home prices are still 11% below their April 2006 peak. More important, as faster- growing prices hurt the affordability of existing homes, the demand might shift toward new homes. The gap between existing-home prices and new home prices had grown unusually wide and declines in that gap could bolster the construction sector. That, in turn, could provide a direct boost to the GDP and employment. CoreLogic predicts that the price growth of existing homes may moderate later this year and that the prices may increase by about 5.1% from March 2015 to March 2016.

This article contains certain forward-looking statements which involve known and unknown risks, uncertainties, and other factors that may cause the actual results to differ materially from any future results expressed or implied by those projected statements. Past performance does not guarantee future results.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook May 2015

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Not All Index Funds Are the Same

The choice to use index funds rather than actively managed funds is a significant one. Index funds tend to be rather straightforward, easy-to-own, and cost- effective investment vehicles. But, just like actively managed funds, index funds also have their differences that investors should be aware of.

Cost Still Counts. Different index funds can charge different fees. Funds that are otherwise virtually identical (meaning they track the same index) can nonetheless produce different returns based on their fees, because fund fees are deducted from returns. This cost difference can have a significant effect on fund performance when compounded over time.

The Challenges of Tracking an Index. Tracking error is the degree to which an index fund fails to mirror its benchmark’s performance during a given time period. As the components and weightings of an index change over time, the fund must buy and sell holdings in an attempt to match it, and some funds may do this better than others.

Subtle Index Differences. Index funds within the same category may not track the same index. Consequently, two index funds that may sound very similar could actually have very different portfolios and performance numbers.

The investment return and principal value of mutual funds will fluctuate and shares, when sold, may be worth more or less than their original cost. Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should be read the prospectus and consider this information carefully before investing or sending money.

Monthly Market Commentary

In recent economic data, employment matches expectations, manufacturing flattens after a period of decline, and auto sales growth continues to moderate.

Employment: The U.S. economy added 223,000 jobs in April, matching expectations. However, it wasn’t all good news; the March estimate was reduced from 126,000 jobs added to just 85,000, providing a much easier set of goalposts to hit for the April report. Furthermore, hourly wage growth, at least on a month-to-month basis, was surprisingly weak with just 0.1% growth or 1.2% annualized. On the positive side, the unemployment rate continued to trend down, ending April at 5.4%, down from 5.5% a month ago and 6.2% a year ago. This is the lowest reading in seven years. For a change, the rate went down exclusively because new jobs were added even as 166,000 people entered the work force in April. The higher percentage of people looking for jobs is a sign of increased consumer confidence.

Looking at private sector job growth, which excludes the much slower-growing government sector, the three-month average, year-over-year growth rate remains relatively high at 2.6%, which is down just a touch from recent highs and still above the 2.4% average growth rate of the past 12 months. Those year -over-year growth rates are likely to continue deteriorating modestly in the months ahead.

GDP: The U.S. GDP report of just 0.2% GDP growth in the first quarter was disappointing to everyone, as falling oil drilling activity ruined a report that was already expected to be hit hard by bad weather and West Coast port-related activities. Drilling activity pushed GDP growth down by 0.8%, about the size of the negative surprise. Still, we wouldn’t be too upset with a GDP report that shows four-quarter-over-four-quarter growth of over 3%. Seasonal factors and weather have really confounded economists and statisticians, who tend to favor the sequential quarter-over-quarter growth methodology.

The individual GDP component factors weren’t too far off of consensus forecasts. Consumption growth was cut in half in a widely expected drop from 4.4% to just 1.9% growth between the fourth quarter and the first quarter. At almost 70% of GDP, that fall single- handedly took off 1.7% from the GDP growth rate (contribution from 3% to 1.3%). The rapid deterioration in consumption, however, was widely expected. Morningstar economists still predict that U.S. GDP will grow at a rate of 2.0%–2.5% in 2015.

Manufacturing: The overall ISM Purchasing Manager Index, a great leading indicator of manufacturing activity, was flat in April at 51.5, after falling for five consecutive months. At a reading of 51.5, the metric shows that more businesses are seeing an increase in activity versus a decline. Still, the number, at least on the surface, disappointed analysts who expected a weather- and port-related bounce to 52.2. That said, the April report was a bit stronger than it looked. New orders—the leading part of the index—increased from 51.8 to 53.5, and current production moved from 53.8 to 56. Exports and imports also showed nice increases, though these are not used in calculating the composite index.

Auto sales: While auto manufacturers were trumpeting good April numbers, the auto recovery is looking a little long in the tooth. The auto sales for April were about 16.5 million units, which marks a 3.1% annual increase. That’s down from the 3.8% rate reported in March. It is now apparent that auto sales growth has peaked and further year-over-year increases will be modest, indicating that the auto industry will have limited impact on GDP and employment going forward.

Key Reasons Why a Taxable Account May Be Underrated, Part 2

In a year like 2008, when stocks were badly in the dumps, the ability to engage in tax-loss selling was a rare silver lining.

Reason 4: You may be able to enjoy no- or low-tax withdrawals.

In addition to being able to keep your tax costs down while you own the securities in a taxable account, currently low capital gains rates also help you limit your tax costs when you eventually sell them. As recently as the late 1990s, a 20% long-term capital gains rate applied to investors in the 28% income tax bracket and above. Now, only investors in the very highest income tax bracket (39.6%) pay a 20% long- term capital gains rate; investors in the 25% to 35% brackets pay 15% and investors in the 10% and 15% brackets currently owe no taxes on long-term capital gains.

Reason 5: You’ll have more control over your tax bill in retirement.

The ability to pull your money out with limited tax liability (because capital gains rates are pretty benign right now) can prove particularly beneficial when you begin taking money out of your accounts during retirement. You’ll owe ordinary income tax on distributions from traditional 401(k)s and IRAs during retirement, and the timing and size of those distributions will be out of your control once you have to begin taking required minimum distributions (RMDs). By diversifying your asset mix across taxable and Roth accounts, you’ll help ensure that at least some of your distributions will come out with low or no tax ramifications.

Holding taxable assets in addition to tax-deferred and Roth also helps ensure that, if you determine that you want to convert some of your Traditional IRA or 401(k) assets to Roth, you’ll be able to pay the conversion-related taxes without having to dip into your IRA/401(k) funds, thereby sidestepping further taxes.

Reason 6: Your heirs will receive a step-up in basis.

Another key advantage to investing inside of a taxable account is that your heirs will be able to take advantage of a step-up in cost basis, essentially wiping out any capital gains tax liability that you racked up over your own holding period. That means that when they inherit assets from you, the taxes they’ll eventually owe when they sell will be calculated by looking not at your purchase price but what they were worth at the time of your death. Even if your heirs end up sellingthe inherited assets shortly thereafter, you’ve still reduced the drag of taxes on your overall estate.

401(k) and IRA plans are long-term retirement- savings vehicles. Withdrawal of pretax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Direct contributions to a Roth IRA are not tax-deductible but may be withdrawn free of tax at any time. Earnings may be withdrawn tax and penalty free after a 5 year holding period if the age of 59 1/2 (or other qualifying condition) is met. Otherwise, a 10% federal tax penalty may apply. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult with a financial or tax professional for advice specific to your situation.

A municipal bond investor is a creditor of the issuing municipality and the bond is subject to default risk. Municipal bonds may be subject to the alternative minimum tax (AMT) and state and local taxes, and federal taxes would apply to any capital gains distributions.

Investing does not ensure a profitable outcome and always involves risk of loss. There is no guarantee that diversification or asset allocation will protect against market risk. These investment strategies do not ensure a profit or protect against loss in a declining market.

Retirement Distribution Pitfalls: Income-Producing Securities

Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement. This can be even more complicated than accumulating assets.

Pitfall: One of the big mistakes of retirement distribution can be relying strictly on income- producing securities to meet income needs. Sticking exclusively with income distributions can leave retirees beholden to the current interest-rate environment. We’ve seen that problem in sharp relief during the past several years, as income-oriented investors have been forced into riskier areas, such as emerging- markets bonds, to scare up the income they need.

Workaround: The bucket approach to retirement income is essentially a total-return approach that relies on regular rebalancing to provide income for living expenses. Using such a structure, a retiree would own bonds and dividend-paying stocks but would also own other stock types, including those that don’t pay dividends. Such a strategy could potentially provide a better-diversified portfolio than the income-only approach for some retirees, and may also allow a retiree to enjoy a fairly stable standard of living.

All investments involve risk, including the loss of principal. There can be no assurance that any financial strategy will be successful. Diversification is an investment method used to help manage risk. It does not ensure a profit or protect against a loss. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances.

©2015 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market

Investor Insights & Outlook April 2015

BRCNewsletter1504Get the pdf version: Investor Insights & Outlook April 2015

Options to Invest Cash

Investors with cash holdings want to invest them in something safe that will earn at least a little interest. Money markets and short-term bond funds are good places to start. Money markets come in two flavors: money-market accounts offered by banks and money- market funds offered by mutual fund companies. Bank money-market accounts are typically protected by the Federal Deposit Insurance Corporation, or FDIC, while money-market funds are not.

For a combination of safety and yield, an FDIC- insured online bank money-market account may be a good option, at least for now. That could change if and when interest rates rise, if such an increase would allow short-term bond funds to begin paying yields that are significantly higher than money-market yields. But given today’s choice between a guaranteed rate of close to 1% and a nonguaranteed rate that’s not much higher, the former appears to be a better option.

The investment return and principal value of mutual funds will fluctuate and shares, when sold, may be worth more or less than their original cost. Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should read the prospectus and consider this information carefully before investing or sending money. An investment in a money-market fund is not insured or guaranteed by the FDIC or any other government agency. Although money-market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in them. Bonds are subject to interest-rate risk. As the prevailing level of bond interest rates rise, the value of bonds already held in a portfolio declines. Portfolios that hold bonds are subject to fluctuations in value due to changes in interest rates.

Monthly Market Commentary

In recent economic data, payroll numbers correct sharply, manufacturing continues to slow down fueled by the strong dollar and low oil prices, and the pace of home price growth increases as inventory levels remain low.

Employment: The U.S. economy added a disappointing 126,000 jobs in March. Certainly the over 300,000 jobs added late last year looked downright out of place. Job growth accelerated in a period when economic growth was slowing. Now with the much slower reported job growth in March and the substantial revisions to prior months, the employment data looks much more in line. However, the 126,000 jobs added in March is not the new normal, it was just an adjustment month.

The strong job openings data (from the end of February versus the jobs report, which is from the second week of March) confirms that the job market is not falling apart. In fact, the huge number of openings suggests that employers will need to pay more or be more willing to train workers before the pace of hiring will increase. Besides the job openings report, other metrics that point to a benign if not robust jobs market include initial unemployment claims, the labor sections of the small-business sentiment report, and various purchasing manager reports, as well as the ADP report.

Manufacturing: The ISM purchasing manager report continued to show a slowing—not panicky—manufacturing sector. The pace of deceleration has continued unabated since October and peaked way back in August. That weakness is now clearly visible in the month-to-month industrial production data that is now down three months in a row. The year-over-year data is at its early stages of deterioration, with more bad news likely with the softer March ISM report this week and a weak durable goods report last week.

The weakness in the ISM data was rather broad-based with just current production levels and prices paid subcomponents showing increases. Employment data was particularly weak, with that index dropping to 51.4, marking a second straight month of sharp declines. ADP payroll data suggested that March manufacturing employment was basically unchanged from February. Order backlogs also dropped sharply in March, although that may be because the port strike settlement in late February enabled manufacturers to clear backlogs. In some more clearly bad news, export orders remained well below the 50 level that separates growth from contraction, falling from 48.5 in February to 47.5 in March. It will probably take either a pop in auto manufacturing or a restart of the housing industry to get the manufacturing data humming again. That’s a real possibility by late summer, but probably not enough to help in the next month or two.

Housing: Recent pricing data suggests that home prices are on the rise again. According to CoreLogic, home prices increased 1.1% between January and February and were up 5.6% February over February. Year-over-year prices have been up for 36 consecutive months, or three years. The rate of home price growth has been slowing since fall 2013 when growth was as high as 11.9% compared with the current single- month reading of 5.6%. Still, it appears that the decline in the rate of home price appreciation has been stopped, with prices moving back up since a low reading of 4.7% in December. The three-month averaged, year-over-year data shows a similar pattern. We have also included CoreLogic-estimated results for March in the table below. We had estimated home price growth in 2015 at 4%–6%. Recent inventory data and price trends suggest that the high end of this range is now more likely.

Auto sales: On a more positive note, auto sales for March showed 17.1 million units sold (on a seasonally adjusted annual run-rate basis), the highest March number going back to 2000. Auto sales are one of the best indicators of consumer confidence, so this may be a sign that consumers are emerging from their malaise and could show some strength as we move into the spring.

Morningstar Research Examines Retirement Costs

Morningstar Investment Management published new research in December that examines the most common assumptions used to estimate retirement needs and lays out a framework for investors to take a more personalized approach to setting retirement savings goals.

“There are three common assumptions that many software tools and financial advisors use to come up with a retirement savings goal—a 70 or 80 percent replacement rate based on pre-retirement income, an income need that rises with inflation, and a 30-year retirement time horizon,” David Blanchett, head of retirement research for Morningstar Investment Management, said. “When we looked at actual retiree spending patterns and life expectancy, however, we found that these assumptions don’t hold true for many people and, on average, can significantly overestimate how much people will actually need to fund their retirement.”

Many expenses disappear after retirement, such as Medicare taxes, Social Security taxes, and retirement savings. The paper first demonstrates the effect on replacement rate calculations of accounting for taxable and non-taxable expenses that are no longer paid after retirement. Next, using government data, the analysis explores the actual spending patterns of retirees, and finds that they grow at a rate lower than inflation through most of retirement and then accelerate in later years because of higher health care costs. While the difference between the actual spending growth rate and the inflation rate is relatively small, it has a material effect over time. When the researchers modeled actual spending patterns over a couple’s life expectancy, rather than a fixed 30-year period, the data showed that many retirees may need approximately 20% less in savings than the common assumptions would indicate.

Results from this research show the actual replacement rate is likely to vary considerably by retiree household, from under 54% to over 87%. Retiree expenditures do not, on average, increase each year by inflation or by some otherwise static percentage; the actual “spending curve” of a retiree household varies by total consumption and funding level. Specifically, households with lower levels of consumption and higher funding ratios tend to increase spending through the retirement period and households with higher levels of consumption but relatively lower funding ratios tend to decrease spending through the retirement period. When consumption and funding levels are combined and correctly modeled, the true cost of retirement is highly personalized based on each household’s unique facts and circum¬stances, and is likely to be lower than amounts determined using more traditional models.

“While a replacement rate between 70 and 80 percent may be a reasonable starting place for many households, we find that the actual replacement rate can vary considerably,” Blanchett continued. “Take, for example, a high-income couple, living in a high income tax state like California, and saving a significant amount for retirement each year. If that couple retires in Florida or Texas, where there is no income tax, the replacement rate might be closer to 60 percent. By contrast, a low-income couple saving very little for retirement and retiring in California could have a replacement around 85 percent. It’s important for investors to consider their level of pre-retirement household income, expenses that discontinue after retirement, and post-retirement taxation.”

These findings have important implications for retirees, especially when estimating the amount that must be saved to fund retirement. A more advanced perspective on retiree spending needs can significantly change the estimate of the true cost of retirement.

Source: David Blanchett, CFA, CFP, Head of Retirement Research, Morningstar Investment Management: Estimating the True Cost of Retirement, Working Paper, Nov. 5, 2013.

Retirement Distribution Pitfalls: Variability in Withdrawals

Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement. This can be even more complicated than accumulating assets.

Pitfall: One of the big mistakes of retirement distribution can be not allowing for some variability in your withdrawals, based on need. Many retirees use the 4% rule, which holds that you withdraw a specific dollar amount in year 1 of retirement, then adjust that dollar amount upward each year to account for inflation. Even though this rule can provide a good starting point, it’s unrealistic to expect that you’ll stick with a fixed withdrawal amount every year. You may have years when you need to spend more, such as for a new car, new roof, child’s wedding, or a special vacation, and years when you can get by with less.

Workaround: Be sure to pad anticipated expenses a bit to account for extras and unanticipated expenditures. Some retirees, for example, forecast when they would need to replace cars, take big trips, and repair roofs. Those padded expenses should be used when determining whether a withdrawal rate is sustainable. Alternatively, retirees could manage their distributions with the expectations that they will in fact not be static from year to year—for example, paying for unanticipated expenses on an as-needed basis with the expectation that they’ll have to tighten their belt in subsequent years.

This is for informational purposes only and should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances. This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook March 2015

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Bond Versus Equity Fund Flows

Fund-flow data can be a useful for analyzing where investor money is going and how fund-flow trends are correlated with asset-class performance. Between 1994 and 2001, equity flows were higher than bond flows, but all that changed after the dot-com crash when investors started losing confidence in stocks.

The 2007–2009 crisis on the graph illustrates how investor behavior is tied to market performance, even though the timing may not always be right. In 2009, as the stock market hit bottom, investors should have been buying cheap stocks, but instead bond flows increased. In 2012, stock inflows started to climb again. The upswing was short-lived, however, and stock flows have once again been on the decline since April 2014.

Success Factors for Retirement, Part 1

OK, folks, here’s what we’re asking you to do. First, save as much money as you can while you’re working, despite ongoing expenses. Next, figure out how to invest the money and, once you’ve gained critical mass on your savings, determine if it’s going to be enough. Is it any wonder so many pre-retirees are overwhelmed by retirement planning?

However, there is good news, as well. Some of the key success factors that have the power to make or break a retirement plan can be simple if understood correctly. While investors don’t need to hit the mark on every last one of them, handling the majority of them correctly increases the chances of a successful retirement plan.

Success Factor 1: A Flexible Retirement Date. For investors who analyzed the numbers on their retirement plans and found that their nest egg could come up short, one option to consider is working longer. Doing so can be advantageous on a few different levels. Investors will have more years to save and fewer years to draw from their portfolios. They may also be able to defer Social Security, which can be profitable, especially for people with a longer-than- average life expectancy. Another option to consider is a hybrid strategy, shifting into a lower-paid, but more rewarding and/or less stressful, career. Alternatively, investors could stay put in their current positions but spend (rather than bank) additional retirement-plan contributions. Such a strategy could allow some people to pay for retirement dreams, such as exotic travel, while still working. Additional retirement-plan contributions in your 60s benefit less from tax-deferred compounding than do contributions made earlier on. Of course, working longer isn’t always a possibility: Health considerations (for oneself, a spouse, or a parent) may interfere, or aging employees may not be able to hang on to their jobs. That’s why working longer can’t be the only fallback plan; investors need to make sure they have other success factors working in their favor, too.

Success Factor 2: A Well-Considered Social Security Strategy. Deciding when to file for Social Security is one of the most consequential financial decisions most Americans will make about their retirement. The 1980s and 1990s were all about maximizing portfolio returns. But the specter of twin bear markets in the 2000s, as well as ultra-low interest rates, shone a light on more mundane matters, including trying to get the most out of Social Security. Even casual students of Social Security planning have heard the admonition to not take Social Security at age 62, when they’re first eligible, as doing so will result in a permanent cut to benefits. And for people who have longevity on their side, it may be better to delay benefits for as long as possible, because benefits increase for every year from full retirement age until age 70. Keeping those rules of thumb in mind is a great first step toward getting a Social Security plan moving in the right direction, but retirement planners can also take advantage of more sophisticated strategies, especially if they’re part of a married couple. More and more financial planners are focusing on Social Security maximization, and there are also a number of online tools that can help craft a prudent Social Security plan.

Success Factor 3: A Large Enough Stock Allocation. The traditional lifetime glide path calls for accumulators to hold very high weightings in stocks, and then gradually peel back equity exposure as the years go by. But make no mistake: Pre-retirees and retirees may need plenty of stocks, too. The key reason is purchasing-power preservation. If inflation runs at 3%, it’s hard to see how a portfolio of nominal bonds and cash yielding 2% to 3% is going to be able to hold up. Of course, there are other ways to hedge inflation risk, but stocks are the asset class with the highest probability of out-earning inflation over time. That argues for most retirees holding at least half of their assets in stocks coming into retirement.

Success Factors for Retirement, Part 2

Of course, holding a higher equity weighting also means higher short-term volatility, but that may be an acceptable trade-off when considering the bigger risk of running out of money prematurely.

Success Factor 4: A Sensible (and Dynamic) Spending Strategy. The size and composition of a retirement portfolio are just one side of the ledger. On the other side? The strategy used for extracting the cash needed from that portfolio on an ongoing basis. Even very large portfolios aren’t big enough to last for an entire retirement if the withdrawal, or spending, rate is too high. That’s why financial-planning researchers have been focusing so much energy on this area in recent years. Many experts think that the old 4% rule, which involves taking 4% of a portfolio’s balance in year one of retirement and inflation-adjusting that amount thereafter, still gives a person with a 60% equity/40% bond portfolio good odds of not outliving their money over a 30-year retirement. But there’s also widespread agreement that retirees can greatly improve their portfolios’ longevity if they’re willing to be flexible about withdrawals, reducing spending in lean years for the market and potentially taking a bit more in good ones. In addition to being willing to adjust their withdrawal rates, retirees may also want to be flexible about withdrawal strategies, using an income-centric approach in more yield-rich eras and relying more on rebalancing proceeds in others.

Success Factor 5: Flexibility on In-Retirement Living Expenses. Even people who aren’t in the habit of driving 16-year-old cars (and don’t plan to) can make their retirement finances better if they’re willing to contemplate a less costly in-retirement lifestyle. One of the easiest ways to bring costs down without throwing quality-of-life considerations out the window is to consider downsizing homes. Like working longer, downsizing can have a positive impact on a few different levels. Even if you own your home free and clear, you’re apt to have lower outlays for taxes, utilities, and maintenance costs than you did in your larger home. And the sale of a home that realizes a profit means more money for retirement.

Success Factor 6: Vigilance on Portfolio Costs. As a portfolio’s asset allocation gets more conservative over time, its return potential declines as well. This means that investment-related costs, on a percentage basis, will extract an even bigger toll than they did when the portfolios was younger and earning a high return. Let’s say a 50% stock/50% bond portfolio earns a 4.5% annualized return, on a pre-expense basis, over the next few decades. Assuming a 3% inflation rate, that’s just a 1.5% real return. And unless investors are careful, nearly all of that return could disappear in investment-related and tax costs. After all, it’s not unusual for funds to have expenses over 1%, and they’re just one piece of the expense pie. The good news is that investment costs are one of the easier factors for investors to control. Another area to focus on is tax management. Retirees may want to hang on to tax-advantaged accounts for as long as possible. When it comes time to pull money out, investors should carefully consider which accounts to withdraw from, with an eye toward staying in the lowest possible tax bracket.

Returns and principal invested in stocks are not guaranteed, and stocks have been more volatile than other asset classes. Investing does not ensure a profitable outcome and always involves risk of loss.

Asset allocation is a method used to help manage risk. It does not ensure a profit or protect against a loss. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances.

This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

Retirement Distribution Pitfalls: Tax Consequences

Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement, which can be even more complicated.

Pitfall: One of the big mistakes of retirement distribution can be neglecting to consider tax consequences of some distributions. Distributions from traditional IRAs and 401(k)s are fully taxable at your ordinary income tax rate, so if you’re not paying taxes at the time you’re pulling money out, remember that the distribution is smaller than it looks because you’ll be paying taxes on it at a later time.

Workaround: It may be a good idea for retirees to pay quarterly estimated taxes to avoid a penalty from the Internal Revenue Service. Also, retirees should consider the tax effects associated with IRA and 401(k) distributions when assessing their portfolio’s long-term viability. Spreading assets among various account types can help lessen the tax shock, as can carefully sequencing withdrawals to lessen the drag of taxes and preserve the tax-saving features of IRAs and 401(k)s for as long as possible.

401(k) plans and IRAs are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Funds in a traditional IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult with a financial or tax professional for advice specific to your situation. This article contributed by Christine Benz, Director of Personal Finance with Morningstar.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook February 2015

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Annual Asset Flows

Looking at where investor money is going may provide useful insight into what’s happening in a financial market. The image below illustrates annual flows for U.S. open-end mutual funds, divided by category: U.S. equity funds, international equity funds, and bond funds.

From 2009 to 2012, bond funds received the great majority of money because investors were shying away from equities after the crisis. That trend switched in 2013, as U.S. and international equity categories received strong inflows. In 2014, international equity and bond funds led the way. The trend since 2007 indicates that investors have been moving away from U.S. equity funds. Even though a few years have passed since the end of the crisis, it seems investor confidence is not that easily restored.

Monthly Market Commentary

Even though it’s always a guessing game, investor fears appear to have changed recently. They’ve shifted from the timing of a Fed interest rate hike and an overheated U.S. economy to slumping economic growth rates.

GDP: The halving of the GDP growth rate from 5% in the third quarter to 2.6% in the fourth quarter was a real dose of cold water. In many circumstances, a 2.6% rate would be something to celebrate. However, following growth of 4.6% and 5.0% in the previous two quarters, there is some worry on the Street that

the economy is slowing. Morningstar economists still believe that the U.S. remains well within its trend line growth rate of 2.0%–2.5%, which is virtually unchanged over the past four years.

Employment: The most recent employment report probably surprised even the more bullish forecasters. The U.S. economy added 257,000 new jobs in January, showing that the fourth-quarter jobs momentum has continued into 2015. Upward revisions were applied to the data, particularly to the November and December numbers—revised up by 70,000 and 77,000 more jobs, respectively. The data now show that there were 752,000 jobs created in those two months alone, and 423,000 new jobs created in November, which is the best single-month result since March 2000. At the same time, looking at 2014 overall, the revisions amounted to only 164,000 more jobs, which by historical standards is not a drastic annual revision.

Year-over-year, three-month average employment growth continues to accelerate. Total nonfarm employment growth now stands at 2.2%–2.3%, while much better performing private-sector employment growth increased to 2.6%. It’s not clear yet whether January’s bullish employment data is a spillover from the high growth in the second and third quarters or actual proof of a further accelerating U.S. economy.

Consumption and Income: Given consumption is 70% of U.S. GDP, it is one of the more critical factors for detecting the direction of the economy. The income data helps determine if changing spending levels happened because of changing attitudes or lack of
ability to spend more.

Month to month, consumption numbers have been on a yo-yo, up 0.7% in November then down 0.1% in December. An unusually cold November followed by a warm December (shifting the timing of seasonal purchases and utility usage) may be responsible for the most recent bout of volatility. In addition, it is very hard to get the seasonal factors exactly right this time of year, further enhancing the already volatile sector data.

The more reliable year-over-year, averaged data shows a consistent pattern of modest acceleration in consumption growth and nicely accelerating growth in both wages and real disposable income. The data, at least at this moment, suggest that consumers are not spending all of their income gains yet again. Currently, wages are growing at a 3.5% annual rate, real disposable income at 3.1%, and consumption slightly lower at 2.8%. The high level of wage growth suggests that there is at least some potential for consumption to improve further in the months ahead.

Trade: The November to December data showed the trade deficit increased from $39.8 billion to $46.5 billion. Exports were down 0.8% and imports jumped 2.2%. That’s not a totally shocking state of affairs, given that the U.S. economy is relatively strong and the rest of the world is slowing.

Pessimists are characterizing the trade report as the worst monthly deficit since 2012. And they will go on to say that the strong dollar can only make things worse and the U.S. competitive position has eroded badly. However, both the month-to-month category data and the year-over-year data suggest that things
aren’t so bad, and that changing oil markets are behind a lot of the apparent deterioration.

Why Cheap Fund Shares May Not Be a Bargain

Some investors make the mistake of treating a mutual fund’s share price the way they would a stock’s share price, but they’re actually quite different. When considering two mutual funds of comparable quality, choosing the one with the cheapest share price may not be the best way to go.

A stock’s share price represents the market value of one small slice of equity in a company. If the company appears to be growing, demand for its shares may increase because investors expect its earnings (and, thus, its dividends) to grow and/or because they think they will later be able to sell the shares at a higher price. This increased demand for the shares drives the share price higher. If demand decreases–perhaps due to a lousy earnings report or a product recall–its share price is likely to fall.

In contrast, a mutual fund’s share price is determined not by market demand for the shares themselves but rather by the value of the fund’s underlying holdings. This is expressed as the fund’s net asset value, or NAV, meaning the value of all its holdings and cash after expenses are paid divided by the number of shares outstanding. (Also, investors can own fractional shares of mutual funds—something they can’t do with stocks.)

To illustrate, let’s say that the holdings in a fund’s portfolio are worth a combined total of $1 billion after fund expenses are paid, and that the fund has 10 million shares outstanding. Therefore, the net asset value of each of those shares is $100, or $1 billion divided by 10 million. But what if another fund of comparable quality has a share price of just $75? That’s a much better deal, right?

Not necessarily. Remember that a fund’s share price is determined in part by the number of shares outstanding. So, the lower share price may have nothing to do with the quality of the fund’s holdings and everything to do with the fact that it simply has issued more shares. As an example, let’s say that Fund A has a NAV of
$20 per share with 100 million shares outstanding and Fund B has a NAV of $15 per share with 200 million shares outstanding. This means that Fund A’s holdings collectively are worth $2 billion (after fund expenses are taken into account) while Fund B’s holdings are worth a combined $3 billion. (The fund’s net asset value also includes the value of any capital gains or dividends received by the fund until they are distributed to shareholders. This is why a fund’s NAV typically drops once those distributions are made.)

But the larger point is that it doesn’t really matter what a fund’s share price is, other than for record- keeping and tax purposes to compute gains and losses. What matters in terms of performance is the change in price on a percentage basis. A fund with a NAV of $5 per share that sees its holdings perform well enough to lift its NAV to $6 per share has effectively provided its investors with a return of 20%. But a fund with a NAV of $20 per share that increases to $21 per share has provided a much lower return of just 5%. Again, it’s not the absolute price of the mutual fund’s shares that matters to investors but rather the percentage change in that price.

Returns and principal invested in stocks are not guaranteed. Investing does not ensure a profitable outcome and always involves risk of loss. The investment return and principal value of mutual funds will fluctuate and shares, when sold, may be worth more or less than their original cost. Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should read the prospectus and consider this information carefully before investing or sending money.

Home Price Growth Returning to a More Sustainable Rate

It is certain that, after a series of fast-paced increases that peaked in late 2013, the rate of home price increases is moderating. As of November, the Case- Shiller Index is showing that home prices are growing at 4.3% year-over-year, which is a much slower rate compared to nearly a 14% pace reported in 2013. The prices recovered about 82% of the previous high, and 14 states are currently either above or close to the previous 2006 peak. Nonetheless, Nevada, Florida, Arizona, and a few other states still remain 20% or more below the peak, and it will certainly take many years for those prices to return to their pre-recession level. On the positive side, slower-growing prices are good news for prospective buyers and for the health of the housing market in general, as they should improve housing affordability, providing an essential boost to this so far anemic housing recovery.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook January 2015

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One of Yellen’s Favorite Metrics ‘Jolts’ Ahead

The formerly unimportant job openings report has taken on a new significance since U.S. Federal Reserve Board Chair Janet Yellen has included this metric in a list of labor market reports that she is watching closely. And this relatively new report is now sending a message that we really haven’t seen before. Job growth isn’t much better than it has been in the past three or four years, while the number of openings per person employed is now at its best level since 2001 and way above year-ago levels.

The chart below illustrates how the growth in job openings is outpacing the growth in hires. This means that there are increasingly less workers matched with the jobs that are being posted, and it may soon force employers to increase wages in order to fulfill those unmatched job openings.

Could Rising Interest Rates Hurt Your 529? (Part 1)

Bond investors have been worried about a rise in interest rates for years now, pretty much ever since the Fed lowered rates in response to the 2008–09 financial crisis. Any rise in rates hurts the value of existing bonds (on the contrary, a drop in rates helps it), and rates have been hovering near historic lows for quite a while.

For families saving for college, bonds have long been seen as a safe-haven investment—a place to park cash reserved for a specific purpose within a specific time frame and a pretty good bet to increase in value faster than cash while avoiding the volatility of stocks. But what happens when bonds themselves become riskier than they’ve been in the past? It’s a question that many college savers, especially those who will need the money in just a few short years, are asking.

529 Plans and Duration

The majority of the $200 billion invested in 529 college-savings plans is held in so-called age-based portfolios—all-in-one investments made up of stocks, bonds, and other securities allocated based on the age of the beneficiary and, in some cases, the risk tolerance of the account holder. Typically these age-based portfolios are heavily weighted toward stocks when the beneficiary is very young, and they gradually shift assets into bonds and cash as the beneficiary gets closer to college age.

With traditional bond funds, the most commonly used method of gauging interest-rate sensitivity is a statistic called average effective duration. The higher the duration, the more sensitive the fund is to interest-rate movements. It works like this: For each percentage point that rates increase, the fund may be expected to lose in value a percentage equal to its duration in years, minus the fund’s yield. For example, if rates increase 1 point, a fund with a duration of 4.5 years and a yield of 2% could be expected to lose 2.5% of its value.

Finding the Numbers for a Specific 529 Plan

Although this rule of thumb may be a convenient way of assessing the interest-rate sensitivity of a single bond fund, most 529 accounts hold multiple stock and bond funds, making it difficult to arrive at a single duration measure for the entire portfolio.

Even though your 529 plan may not provide information on the duration of your portfolio, you might be able to track it down yourself by taking a closer look at the bond funds in the plan.

Unless you have all of your 529 assets in a single bond fund, you might have to do some calculations to figure out how to weight the various duration measures. For example, if your 529 portfolio is made up of 60% equities and 40% bonds, but the bond portion is half intermediate-term bonds with a duration of 5 years and half short-term bonds with a duration of 1 year, then the bond portion of your portfolio has an average duration of 3 years.

On average, an age-based portfolio for a 15-year-old beneficiary holds about 55% of assets in bonds, according to Morningstar data, and by the time most beneficiaries are ready to enroll in college at age 18, that weighting reaches 60%. At the same time, the average allocation to cash increases even more, from about 15% at age 15 to about 30% at age 18.

Options for 529 Plan Holders

Once you have some idea of how vulnerable your 529 assets are to a rise in rates, you then can decide what, if anything, to do next. If stocks dominate your account, leaving just a small allocation to bonds, you may have little to worry about in terms of interest-rate risk. But if bonds make up the bulk of your account and you find the average duration of the portfolio makes you nervous in case rates do rise sharply, you may be contemplating some major changes.

Could Rising Interest Rates Hurt Your 529? (Part 2)

But before you do anything, consider the following for some perspective. Let’s go back in time to May 2013, when interest-rate concerns also were running high because of fears that the Fed would soon begin tapering its bond-buying stimulus program. Rates climbed throughout the summer, and for the year the Barclays Aggregate Bond Index, a proxy for the U.S. investment-grade bond market, lost 2% of its value. By comparison, funds in the Age 13–18 Low Equity category actually gained 1.62% (the category includes conservatively invested age-based portfolios designed for 529 beneficiaries between the ages of 13 and 18 and currently averages a 66% allocation to bonds and a 10% allocation to stocks, according to Morningstar data). Not great, but hardly the disaster some had feared amid a rising-rate environment.

Interest rates have actually been declining in 2014, meaning that you may have been better off holding intermediate- and long-term bonds than stocks. Of course, rates could very well go up in the coming year, and 529 account holders with heavy allocations to bonds could see losses. But the larger point is that interest rates don’t move in a straight line, and predicting their near-term direction (and thus their effect on bond prices) can be just as difficult as predicting that of stocks.

However, if you still wish to reduce the interest-rate risk of your 529 holdings, there are steps you can take. One would be to move the bond portion of your portfolio to a short-term bond option, if your plan offers one (short-term bonds are more immune to interest-rate movements than longer-term bonds), or perhaps to cash. If you’ve been using an age-based portfolio, this might require you to move assets out of it and create your own customized allocation using the plan’s pure-stock-fund and pure-cash-fund offerings. But that might be the only way you can completely remove bonds from the equation.

Keep Calm and Carry On

Although there’s no imminent reason to worry about a rise in interest rates wreaking havoc on the bond portion of your 529 portfolio, investors with heavy allocations to bonds still would be well-served in taking a peek under the hood just to see what’s there in terms of interest-rate sensitivity. If what you find makes you ncomfortable, consider the aforementioned actions of reconfiguring your portfolio. If not, at least now you know what to expect if and when rates do rise.

529 plans are tax-deferred college savings vehicles. Any unqualified distribution of earnings will be subject to ordinary income tax and subject to a 10% federal penalty tax. Tax law is ever-changing and can be quite complex. It is highly recommended that you consult with a financial or tax professional with any tax-related questions or concerns. An investor should consider the investment objectives, risks, and charges and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer’s official statement, and the official statement should be read carefully before investing.

Indexes are unmanaged and not available for direct investment. Past performance does not guarantee future results. Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless.

Unemployment by Education Level

There is a clear connection between educational attainment and unemployment rate. As expected, the people with the highest rate of unemployment are the people without even a high school degree. The unemployment rate for this group is almost triple that of college graduates. In general, the more education you have, the better off you are.

The percentage of the population that has a college degree has been relatively stable in the 30% range. And there is a large part of the population that could probably use yet more college education. Putting these two together, the conclusion is evident: It pays to go to college, and it would also be good if the percentage of the population who are college graduates could increase.

©2015 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook December 2014

BRCNewsletter1410Get the pdf version: Investor Insights & Outlook December 2014

Inflation Can Vary by Category

The general inflation number (the “All items” category) may be a good measure for the economy at large, but the cost of certain goods and services could rise much faster than the average cost of living.

For the past year, tuition, food, housing, and medical care have all experienced much higher inflation rates than the headline number. Gasoline prices, on the other hand, have been declining and are now near four -year lows.

People who need to focus on savings for college or medical care may be left short, as the cost for such items often tends to rise at a faster rate than the average cost of living. Those investors might not be able to keep pace with rising costs if they do not take their real inflation rate into account when planning their investment goals.

Monthly Market Commentary

As 2014 draws to a close, the U.S. is still experiencing a slow and longer-than-normal recovery.

GDP: The GDP growth rate in the third quarter was boosted to 3.9%, up from 3.5%, and well ahead of expectations of 3.3%. A lot of that improvement was due to high-quality items—more consumer and business spending. Unfortunately, that will make growth that much harder to achieve in the fourth quarter, which is now likely to be less than 3%. That would still leave the full-year GDP growth rate at about 2.3%, not much changed from 2012 and 2013. Consumption, business investment, net exports, and even government made decent-size contributions to overall GDP. As expected, residential housing was relatively disappointing, contributing just 0.1%. During this recovery, it has not been unusual for one category to drive most of the growth, while almost everything else showed limited growth or even a negative contribution.

Employment: The jobs report did far better than expected, with job growth of 321,000 for the month of November, the best result of calendar 2014 and the best report since 2012. However, it’s not clear whether this data reflects misplaced seasonal factors or newfound economic strength. November was also a great month a year ago, when 274,000 jobs were added. Indeed, November has generally been in the top half of the 12 months for job growth over the past four years. So maybe at least a portion of the high growth was due to overly aggressive seasonal factors.

Wages: Like the raw employment data, the hourly wage growth was unusually strong in November. Month-to-month wages grew 0.4%, which annualizes to almost 5%. However, monthly data tends to be volatile; looking at year-over-year data, averaged over three months, presents a truer picture of economic activity. The year-over-year, hourly wage growth trend has been consistent at around 2.0–2.1% for the past 12 months.

Consumption and Income: The government restated recent consumption and income numbers so some of the short- term good news has disappeared. In the original government data, incomes went up a whopping 1.4% between March and September while consumption grew a measly 0.6%. The revisions to the six-month data now show that spending increased by 1% while incomes increased just 0.8%. In other words, savings decreased, not increased, over the past six months. In addition, the restated income data would seem to imply that eventually some of the job growth in the period April through June will be revised sharply down.

Housing: 2014 was a rough year for existing-home sales, which now appear likely to fall from 5.1 million units in 2013 to 5 million units in 2014. However, the 2013 data was aided by a rush to close homes before interest rates increased. Slower investor sales, poor weather, higher mortgage rates, and a dramatic price spike all conspired to hit existing-home sales hard in 2014, especially in the early parts of the year. Now interest rates are lower again and the weather has improved some. Sales have moved up from an annual rate of 4.6 million units during the winter to 5.3 million units in October, which just about equaled the best month of 2013.

The pending home sales index, which often portends changes in existing-home sales, was off modestly, just 1.2%, from 105.3 in October to 104.1 in November. However, pendings growth is still ahead of existing- home sales, which means that we can probably expect more improvement in year-over-year existing-home sales. Looking to 2015, Morningstar economists expect existing-home sales to grow at a 6%–8% rate, which would mean about 300,000–400,000 more units than in 2014. That would bring sales to 5.3 million–5.4 million units for the full year.

On the positive side, home prices are growing at a slower rate. This trend, coupled with lower interest rates, should improve affordability, providing an essential boost to this so-far anemic housing recovery.

Employment Continues to Grow at a Slow, Steady Pace

Media and financial news sources often report that the economy added an “x” number of jobs for a particular month. These monthly payroll numbers are polled by the Bureau of Labor Statistics and are published in a report called “Employment Situation” that is typically released on the first Friday of each month. The monthly headline numbers tend to be quite volatile and are often difficult to interpret. In the past two years alone, the number of jobs added varied between as few as 88,000 jobs in June of 2012 to as many as 280,000 in February of 2013. Wide fluctuations in the monthly payroll data occur because the monthly hiring and firing process itself tends to be unpredictable, and seasonal factors that aim to stabilize the data are extremely difficult to measure accurately.

Looking at these figures can usually create more confusion than insight, and that is why Morningstar’s Department of Economic Analysis looks at employment growth through a slightly different lens. When the same volatile monthly jobs data is analyzed not as a monthly net job addition or loss but as a year- over-year 3-month moving average growth rate, a different picture emerges. All of a sudden, it becomes clear that the U.S. jobs market has been incredibly stable despite its monthly ups and downs. As the chart shows, total nonfarm employment has been growing at around 1.7% since early 2011 and has picked up modestly to 1.9% in recent months. Excluding the poorly performing government sector, which constitutes around 16% of total employment, private- sector jobs have been growing at an even higher 2.0–2.1% rate. Combine these results with efficiency and productivity gains and it should come as no surprise that the U.S. economy, on average, grew 2.2% since 2011 based on full-year estimates.

Despite the rock steady growth, the pace of employment recovery has been slow and disappointing to say the least. Considering that the U.S. economy lost over 8.5 million jobs between 2008 and 2010, most economists expected a much faster recovery of the labor market. Instead, it took more than four years to get back the number of jobs lost during the crisis. Seeing those numbers bounce back to their pre- recession level is great news, but it is important to point out that the make-up of the new post-recovery labor force has drastically changed. Unfortunately, the growth in high-paying, long-hours jobs such as construction and manufacturing has been all but robust, and due to efficiency improvements, especially in manufacturing, many of these jobs may never come back. A majority of the labor market recovery has been made in the lower-paying sectors such as retail and leisure and hospitality, which has certainly contributed to slower consumption growth and to the near-anemic pace of the economic recovery in general.

Retirement Distribution Pitfalls: Not Reinvesting RMDs You Don’t Need

Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement. This can be even more complicated than accumulating assets.

Pitfall: One of the big mistakes of retirement distribution can be not reinvesting RMDs you don’t need. Retirees may experience a situation where the amount they must withdraw from 401(k)s and IRAs for required minimum distributions can take them over their desired distribution threshold. The RMD rules require that people initially withdraw less than 4% of assets at age 70 1/2, but distributions can quickly step up into the 5%, 6%, and 7% range.

Workaround: What people might not realize is that there’s nothing saying they have to spend their RMDs; they can reinvest in a taxable account if they’d like that money to stay invested in the market. This can be a wise strategy for retirees who are concerned with legacy planning or long-term care needs down the line. It’s possible to build a taxable account that has many of the tax-saving features of a tax-deferred account.

401(k) plans and IRAs are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Funds in a traditional IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult with a financial or tax professional for advice specific to your situation.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook November 2014

BRCNewsletter1410Get the pdf version: Investor Insights & Outlook November 2014

How Saving Too Much in Your 401(k) Could Cost You

The idea of contributing too much to a company retirement plan may sound strange, but it can happen, especially if an employee contributes high amounts in a short time frame, thereby hitting the annual contribution limit too early and missing out on part of the employer’s 401(k) match, rather than spreading contributions out during the year.

For 2014 the annual 401(k) contribution limit for workers under age 50 is $17,500, and for those age 50 and older it’s $23,000. (Matching contributions from the employer don’t count toward these caps.) Let’s say a 40-year-old worker who makes $100,000 a year contributes 25% of her pay to a 401(k) plan every two weeks starting in January, and that the company matches the first 3% dollar-for-dollar. By contributing at such a high rate, the worker would reach the $17,500 cap on annual contributions sometime in September and wouldn’t be able to make any more contributions after that. Up to that point the worker would have had $2,192 added to her 401(k) through her employer match. But by contributing at a lower rate each pay period (17.5% of pay, to be exact) and spreading her contributions out more evenly throughout the full calendar year, the worker would receive a full year’s worth of the employer match: $3,000. By contributing too much too soon, the worker has cost herself more than $800 in eligible retirement money from her employer.

It’s well worth planning ahead so as not to miss out on matches later in the year. Saving a lot in your 401(k) is a good thing, but when you save it may be nearly as important.

401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.

Employment Continues to Grow at a Slow, Steady Pace

Media and financial news sources often report that the economy added an “x” number of jobs for a particular month. These monthly payroll numbers are polled by the Bureau of Labor Statistics and are published in a report called “Employment Situation” that is typically released on the first Friday of each month. The monthly headline numbers tend to be quite volatile and are often difficult to interpret. In the past two years alone, the number of jobs added varied between as few as 88,000 jobs in June of 2012 to as many as 280,000 in February of 2013. Wide fluctuations in the monthly payroll data occur because the monthly hiring and firing process itself tends to be unpredictable, and seasonal factors that aim to stabilize the data are extremely difficult to measure accurately.

Looking at these figures can usually create more confusion than insight, and that is why Morningstar’s Department of Economic Analysis looks at employment growth through a slightly different lens. When the same volatile monthly jobs data is analyzed not as a monthly net job addition or loss but as a year- over-year 3-month moving average growth rate, a different picture emerges. All of a sudden, it becomes clear that the U.S. jobs market has been incredibly stable despite its monthly ups and downs. As the chart shows, total nonfarm employment has been growing at around 1.7% since early 2011 and has picked up modestly to 1.9% in recent months. Excluding the poorly performing government sector, which constitutes around 16% of total employment, private- sector jobs have been growing at an even higher 2.0–2.1% rate. Combine these results with efficiency and productivity gains and it should come as no surprise that the U.S. economy, on average, grew 2.2% since 2011 based on full-year estimates.

Despite the rock steady growth, the pace of employment recovery has been slow and disappointing to say the least. Considering that the U.S. economy lost over 8.5 million jobs between 2008 and 2010, most economists expected a much faster recovery of the labor market. Instead, it took more than four years to get back the number of jobs lost during the crisis. Seeing those numbers bounce back to their pre- recession level is great news, but it is important to point out that the make-up of the new post-recovery labor force has drastically changed. Unfortunately, the growth in high-paying, long-hours jobs such as construction and manufacturing has been all but robust, and due to efficiency improvements, especially in manufacturing, many of these jobs may never come back. A majority of the labor market recovery has been made in the lower-paying sectors such as retail and leisure and hospitality, which has certainly contributed to slower consumption growth and to the near-anemic pace of the economic recovery in general.

Monthly Market Commentary

Recent U.S. economic reports, while not always meeting expectations, suggested more of the slow and unsatisfying growth rates of the past four years. Businesses are looking and feeling more optimistic at a time that both U.S. and international consumers are sitting on their hands.

GDP: GDP numbers have been volatile lately, with wild quarter-to-quarter swings driven by inventory and export data. The overall growth rate for the third quarter came in at 3.5%, surpassing expectations of 3.1% growth and down modestly from the 4.6% rate of the second quarter. However, both those quarters represent a bounceback from a 2.1% decline in the first quarter. In other words, the recent strength is probably more of a catch-up than the start of a new, higher, sustained growth rate of 3% or more. Looking at the less volatile year-over-year data growth instead of annualizing one quarter of change suggests the economy is growing at 2.3%, just about in the middle of 2.0%–2.5% intermediate- and long-term growth potential of the U.S. economy.

Employment: The October employment report was below expectations but still consistent with trend-line employment growth of just under 2%. Nonfarm employment growth for October came in at 214,000 jobs added, below the consensus of 243,000 but roughly in line with the 12-month average of 222,000. This follows sharp growth of 256,000 jobs added in September, which was revised higher by 8,000 jobs. Government job growth, on the other hand, has been truly awful: The government has lost almost 1.1 million jobs since May 2010.

More interestingly, a lot of analysts are characterizing the current low-level job growth as unprecedented, a kind of new normal (which is another way of saying a new awful). But job growth, looked at year over year, hasn’t been all that much higher, at least for long, stretching all the way back to the 1980s. And some of those earlier periods had the benefit of substantial population growth to help push things along. The average job growth since 1980 has been 1.3%; currently it is running at 1.9%.

Hourly Wage Rates: Besides the raw employment numbers, it’s also important to look at the average hourly wage and the number of hours worked. Combining these can provide insight into consumer wage growth, the fuel for future spending. On a year- over-year, 3-month average basis, wage growth looks consistent at just about 2%.

Consumption and Income: Headline consumption data dropped by 0.2% in September following an unsustainable 0.5% growth rate in August. However, single-month growth rates are volatile and influenced by a variety of variables such as shifting seasonal patterns, weather, changes in tax holidays, and retailer big-event dates. Year-over-year data shows reliable consumption growth of about 2.4% on an inflation-adjusted basis.

Trade: Analysts had expected the trade deficit to widen from $40.0 billion to $41.5 billion. Instead, it widened all the way to $43 billion. Although averaging and inflation-adjusting the data paints a much less bleak pattern, it is still going to mean a downward revision in the third-quarter GDP estimate. Combining the new trade deficit report with a poor construction report probably means that GDP for the third quarter will be revised down from a great 3.5% to a more believable 3.0% rate. However, with inventory data and retail sales revisions yet to come, that GDP downgrade isn’t a sure thing just yet.

Also, falling energy prices in general and gasoline prices in particular should be a huge aid to consumers in the fourth quarter. Going into the last holiday season (2013), saving rates had moved up and gasoline prices had collapsed over the summer and early fall, similar to the set-up we are seeing in 2014.

Retirement Distribution Pitfalls: Not Accounting for Market Fluctuations

Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement. This can be even more complicated than accumulating assets.

Pitfall: One of the big mistakes of retirement distribution can be not adjusting withdrawals to account for market fluctuations. So-called sequencing risk—the chance that retirees may encounter a harsh bear market early in the life of their withdrawal program—can have a big effect on a portfolio’s longevity. Taking fixed distributions from a shrinking pool means that a retirement portfolio could suffer losses from which it would be impossible to recover.

Workaround: Maintaining a well-diversified asset mix may be a retiree’s best weapon for protecting his or her portfolio from a bear market. For example, holding assets in high-quality bonds and cash may allow a retiree to meet desired living expenses without having to withdraw from equity holdings during periods of market weakness. That said, the smartest retirement- distribution plans also make adjustments during times of market duress, possibly reducing withdrawals or, at a minimum, forgoing upward inflation adjustments.

All investments involve risk, including the loss of principal. There can be no assurance that any financial strategy will be successful. Asset allocation and diversification are methods used to help managed risk. They do not ensure a profit or protect against a loss. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances.

©2014 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market

Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook October 2014

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Output Potential Gap Suggests Limited Inflation Risk

Outside of food and drugs, the prospect of high inflation remains dim. The output gap, which compares current and forecasted Gross Domestic Product levels to the estimated potential of the economy, remains at one of its widest levels in history. Every major, sustained bout of inflation in the Post- War era has occurred when the economy has been running above its theoretical capacity. The Congressional Budget Office, the keeper of this key metric, believes that the economy will not operate up to its full capacity until 2017, as shown in the chart. CBO considers unemployment, demographics, capital investment, and productivity, making it a much more comprehensive measure than simpler capacity utilization metrics. Besides the output gap, Morningstar economists believe that monetary and fiscal policy, as well as commodity prices, could also influence inflation levels going forward.

Active or Passive Strategies: How to Choose?

It’s one of the most important—maybe even the most important question—in the fund world. It is possible for investors to reach their financial goals using either approach, or by blending the two. Using an all-index portfolio is generally a low-cost, low-maintenance way to go. On the other hand, investors can also buy and hold active funds; the key is doing their homework and having the discipline to stick with their active managers through the inevitable rough patches.

Here is a quick review of some of the key attributes investors often seek, as well as how index and active funds deliver on each.

Low Expenses. Although not all index funds and ETFs have low costs, and not all active products are pricey, expenses on passively managed products are generally lower than the expenses of active funds. That expense advantage is a big reason that broad-market index funds have delivered solid returns versus market benchmarks over long periods of time in the past.

Simplicity/Ease of Use. Looking to build a minimalist, low-maintenance portfolio? It’s simple to do so by arriving at a target asset-allocation mix, then populating it with just a handful of broad-market- tracking index funds or ETFs. In contrast, by mixing and matching actively managed funds, investors may end up with overlap, and it can be difficult to maintain tight control over the portfolio’s asset allocation. Index-fund investors also don’t have to worry about operational issues such as manager departures.

Tax Efficiency. Although index funds and ETFs aren’t universally tax-efficient (bond index-fund investors may owe taxes on their income just as active bond- fund owners would, and some ETFs have socked their investors with big tax bills), broad stock market- tracking vehicles have tended to be pretty tax-efficient over time. Because active fund managers might trade more often, there’s a greater likelihood that an active fund will pass taxable capital gains on to its shareholders.

Ability to Outperform the Market. Index funds have, on average, delivered fine returns for their shareholders, with the majority topping their category peers’, sometimes by wide margins, over short and long time frames. That’s a huge selling point. But investors hung up on “beating the market” may not get there with index funds. If an index fund is properly tracking its benchmark, the return will be the benchmark’s return, minus expenses. Active funds, by contrast, offer at least the prospect of beating the market.

Ability to Adjust to Changing Market Conditions. One of the key potential benefits of an active approach is that a manager usually has the latitude to make changes based on market conditions. For example, he might decide to hold cash because stocks look expensive and he can’t find things to buy, thereby helping to protect investors if stocks sell off. Alternatively, a manager could take advantage of weak markets to load up on beaten-down securities that short-term investors have discarded. If an index-fund investor wishes to be opportunistic, meanwhile, she’ll have to do it herself.

Investors should bear a few caveats in mind before embracing an active fund for its flexibility and opportunism, however. Many active managers might not be all that active, and different managers have different skill levels in selecting investments. Finally, it’s worth noting that index-fund investors can easily add an element of active management by periodically rebalancing their portfolios.

Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should be read the prospectus and consider this information carefully before investing or sending money.

Monthly Market Commentary

The U.S. market returned 8.3% so far this year (as of the end of the third quarter). The U.S economy appears to be holding its own despite setbacks in the rest of the world.

Employment: Private sector employment growth has been stuck in an exceptionally narrow range of 2.0%–2.2% year-over-year growth since 2011. As suggested by a falling unemployment rate (5.9%), recovery-low initial unemployment claims, and wage growth in select categories, Morningstar economists believe the economy may face spot labor shortages in 2015. That could mean that pay rates in some industries will need to go up. That could also pressure corporate earnings in the year ahead, along with rising interest rates and an increase in the trade-weighted dollar that has now appreciated by close to 12%. 2015 could be the first year when it might be better to be an employee than an employer.

Consumption and Income: For most of 2014, income growth has been excellent while consumption growth has been volatile and much slower. Between December and August real wages are up 3.1%, real disposable income is up 2.8%, and consumption a meager 1.4%. The premise and reason for optimism, at this point, is that incomes don’t grow faster than consumption for long in the United States. As
inflation backs down again and the job market continues to improve, consumers are likely to increase spending in the back part of 2014, which in turn should help push overall third-quarter GDP growth.

Trade: The trade deficit shrank from $40.3 billion in July to $40.1 billion in August. The inflation-adjusted deficits for July and August are running considerably lower than the slightly inflated numbers of the second quarter. Net trade took 0.4% off of GDP growth in the second quarter and is likely to add 0.2% in the third quarter, providing potential for a meaningful swing. Unfortunately, trade may hurt the U.S. economy in the fourth quarter because of a stronger dollar.

Quarter-End Insights: 2014 was to have benefited from a huge swing in the government category as well as a continued big rebound in housing and a strengthening world economy. That didn’t happen. Housing slowed because of affordability and credit tightness. Government did get a little better, but not nearly as much as hoped, as last year’s budget agreement weighed on spending. In fact, as fiscal 2014 draws to a close, federal government spending looks to be lucky to grow at 1%, before adjusting for inflation.

Furthermore, world growth has been a big disappointment. After just one year of mediocre growth, Europe didn’t show any growth at all in the second quarter. China, too, has been a disappointment, with both exports and real estate turning in poor results. China’s currency has been weaker, also, which has helped exports to the U.S. and hurt imports. The bright side to this surprising world weakness has been more liberal central banks, falling inflation rates, and lower interest rates.

Lately, there was some fear that in the long term, U.S. GDP growth could slip well under 2%. That is as overblown as the expected return to 3%-plus growth was just a few short years ago. First and foremost, residential spending has yet to return to its normal level (5% of GDP), despite population growth and five years of economic recovery. Exports to the rest of the world will also help keep the U.S. growth story afloat. Airliners are likely to be in strong demand throughout the world over the next 10 years. With long production and design cycles, competition for the U.S. airliners will prove minimal. Growing agricultural demand and growing oil-related exports should also keep the U.S. ahead of the developed world growth rates. Demographics, however, including lower population growth rates and an unfavorable shift to older, lower-spending consumers, may keep a lid on long-term economic growth.

Get a Tax-Smart Plan for In- Retirement Withdrawals

The following sequence may make sense for retirees to preserve the tax-saving benefits of tax-sheltered investments for as long as possible.

1) For retirees over age 70 1/2, the first stop for withdrawals are those accounts that carry required minimum distributions, or RMDs, such as Traditional IRAs and company retirement plans such as 401(k)s (to avoid paying penalties).

2) For retirees who are not required to take RMDs or have taken their RMDs and still need cash, turning to taxable assets may be an option. A good start may be selling assets with the highest cost basis first and then moving on to those assets where cost basis is lower (and the tax hit higher). Relative to tax-deferred or tax -free assets, these assets have the highest costs associated with them. However, taxable assets could also be valuable to tap in later retirement years because retirees will pay taxes on withdrawals at their capital gains rate, which is generally lower than the ordinary income tax rate.

3) Finally, after taking RMDs or tapping taxable assets, retirees still in need of cash may want to further tap company retirement-plan accounts and IRAs (Roth IRA assets last.)

401(k) and IRA plans are long-term retirement- savings vehicles. Withdrawal of pretax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Direct contributions to a Roth IRA are not tax-deductible but may be withdrawn free of tax at any time. Earnings may be withdrawn tax and penalty free after a 5 year holding period if the age of 59 1/2 (or other qualifying condition) is met. Otherwise, a 10% federal tax penalty may apply. Please consult with a financial or tax professional for advice specific to your situation.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.

Investor Insights & Outlook September 2014

BRCNewsletter1409Get the pdf version: Investor Insights & Outlook September 2014

Consumption Remains Slow, But Stable as Income Fluctuates

Consumption is perhaps one of the best measures of economic activity because of its size (just under 70% of GDP). Without increasing consumption, businesses won’t build more goods, hire more workers or invest in more equipment. The red line on the chart measures year-over-year growth in consumption, and it has been steady over the last couple of years at just over 2% growth on average. That’s not wildly different than the tendency of GDP growth as expressed by year-over- year data. Note that consumers tend to continue deep- rooted spending patterns despite volatility in wages and real disposable personal income. Apparently, consumers are borrowing money, digging into savings or selling stocks to temporarily fund excess spending. However, despite the fact that income and spending can diverge in the short run, it will be difficult for consumers to outspend income in the long run.

Concerned About Longevity? Three Mistakes to Avoid

Longevity is often cheered as an achievement, but the downside of living well beyond one’s average life expectancy is that it can strain (or worse, completely deplete) an individual’s financial resources. The first step in addressing longevity risk is to evaluate just how great the odds are that either you or your spouse will have a much longer-than-average life span. Health considerations, family longevity history, employment choices, and income level may all be factors. If you’ve assessed these considerations and are concerned about longevity risk–or if you’ve determined that you’d simply rather be safe than sorry–here are three key mistakes to avoid.

Mistake 1: Holding a Too-Conservative Portfolio. When investors think about reducing risk in their portfolios, they often set their sights on curtailing short-term volatility—the risk that their portfolios will lose 10% or even 20% in a given year. But a too- conservative portfolio (one that emphasizes cash and bonds at the expense of stocks) can actually enhance shortfall risk while keeping a lid on short-term volatility. But, right now, interest rates have much more room to move up than they do down, which may reduce the opportunity for bond-price appreciation during the next decade. With such low returns, retirees with too-safe portfolios may not even outearn the inflation rate over time.

Mistake 2: Not Delaying Social Security Filing.* Because it provides an inflation-adjusted income stream for the rest of your life, Social Security is designed to provide you with at least some money coming in the door even if your investment portfolio runs low (or out) during your later years. If you file early (you’re eligible to do so as early as age 62), you permanently reduce your annual benefit from the program.

Delayed filing, on the other hand, has the opposite effect, amping up the value of your hedge. Not only will your benefits last as long as you do, but they’ll be higher, perhaps even substantially so, as well. Those who delay filing until age 70 may receive an annual benefit that’s more than 30% higher than what they would have received had they filed at full retirement age (currently 66) and more than 50% higher than their benefit had they filed at age 62.

Mistake 3: Not Adjusting Withdrawal-Rate Assumptions. Just as savings rates are the main determinant of success during the accumulation years (much more than investment selection, in fact), spending rate is one of the central determinants of retirement plans’ viability.

The 4% rule, which indicates that you can withdraw 4% of your total portfolio balance in year 1 of retirement, then annually inflation-adjust that dollar amount to determine each subsequent year’s portfolio payout, is a decent starting point in the sustainable withdrawal-rate discussion. But it’s important to tweak your withdrawal rate based on your own situation. If you have a sparkling health record and it looks likely that you’ll be retired longer than the 30-year withdrawal period that underpins the 4% rule, you may be better off starting a bit lower.

In a similar vein, it’s important to not set and forget your retirement-plan variables, such as your spending rate and your asset allocation, because retirement progresses and new information becomes available about your health and potential longevity, market valuations, and so forth. This is for informational purposes only and should not be construed as legal, tax, or financial planning advice. Please consult a legal, tax, and/or financial professional for advice specific to your individual circumstances. Asset allocation and diversification are methods used to help manage risk. They do not ensure a profit or protect against a loss. Returns and principal invested in securities are not guaranteed, and stocks have been more volatile than bonds.

*Source: Social Security Administration.

Monthly Market Commentary

The U.S. market was up 4.19% in August after a modest pullback in July. Some of the drivers of the stock market included monetary policy news from Europe as well a number of generally positive economic news out of the U.S. Europe: The ECB announced it was reducing several key lending ratesand raising the amount it charges banks leaving reserve balances at the central bank. It also revealed that it would be purchasing some covered bonds and asset- based securities. The details on the new programs were sketchy as to timing and amount. Although these were significant and unexpected actions, the ECB did not make the full move to purchase government securities in the area (so-called quantitative easing, or QE). Indeed, by charter, it would be difficult if not impossible for the central bank to buy sovereign debt, a move Germany strongly opposes. In the short run, all of these moves could modestly help the European economy. However, our economists fail to see how moving interest rates that are already so near zero by small fractions is going to change much. Programs to encourage lending, to be implemented shortly, could help slightly more.

Employment: The August jobs report showed employment grew by a puny 142,000 workers compared with the 207,000 workers added on average for the prior 12 months. The figure was well below the consensus of 228,000 jobs and even below Morningstar economists’ more modest forecast of 200,000 jobs. Our economists don’t view these results as reflective of the current state of the economy and the August jobs report seems inconsistent with other improving labor market indicators. Year-over-year, there-month averaged employment data showed that the private sector employment continued to grow at 2.1%, which is the pace that is consistent with 2.0-2.5% full year GDP growth.

Manufacturing: An array of U.S. manufacturing indicators released in August has shown that the sector is doing incredibly well. Both industrial production and Markit PMI indicated strong growth. U.S. automakers, particularly, are showing signs of strength as both production and sales have risen to 12.85 and 17.50 million units annualized respectively. It is important to note that while manufacturing typically reflects the state of the overall economy, its direct effects on GDP and employment are unfortunately limited, as it is now just a small part of the U.S. economy.

Housing: August was a strong month for the U.S. housing market as starts, permits, existing sales, and pending sales all exceeded expectations. Those great numbers combined with the moderating home price increases (slowing to 8.1% year over year growth in June, according to S&P/Case-Shiller Index) show that the housing market is poised for a health recovery. The slowdown in the price increases is, in particular, a positive development as slowly rising prices help to recover some of the underwater mortgages without drastically ruining affordability. Because of the rapid price increases we experienced throughout 2013, Morningstar economists expect that the price growth moderation will continue at least through the end of 2014.

Retail sales: Consumption is a very important part of the GDP report (about 70%) and often sets the tone for overall economic activity. Retail sales make up about a third of consumption. Excluding the auto industry, which is measured from manufacturers data (and not dealer retail sales), retail sales grew just 0.1% month to month after growth of 0.2% the previous month. Expectations were for growth to accelerate given better employment data. In fact, the consensus, excluding autos, was for growth of 0.4%. Therefore, Morningstar economists are a little suspicious of the July numbers. Weather was good, employment was good, and weekly chain-store sales had shown a marked improvement. Therefore, it is suspected that the July numbers will be revised or August numbers will appear to be unusually strong.

The Rising Cost of Not Going to College

A recent study from the Pew Research Center found that on virtually every measure of economic well-being and career attainment, from personal earnings to job satisfaction, young college graduates are outperforming their peers with less education. Moreover, the findings show that when today’s young adults are compared with previous generations, the disparity in economic outcomes between college graduates and those with a high school diploma or less formal schooling has never been greater in the modern era.

Millennial college graduates aged between 25 and 32 who are working full time earn about $17,500 more annually than their peers who only hold a high-school diploma. This pay gap was significantly smaller in previous generations.

©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. “Morningstar” and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.