When you invest money, you are putting it at risk. All investments can lose money. The key is to gauge your risk, and do not put more money at risk than you are willing to lose.
This is a relative concept. If you have only $10,000 to invest, then putting $9,000 in a high-risk investment means you could lose almost all of your savings. However, if you have a million-dollar portfolio, putting $10k in a high-risk investment would not be considered all that risky, because a loss of $10k wouldn’t obliterate your portfolio.
As you can see, evaluating risk is just as personal as your financial goals. In fact, defining your financial goals – how much money you need based on what you want it to pay for – is a main factor in establishing your risk tolerance. So is determining your timeline. If you are young and don’t need your investment money for 10 years or more, you can afford to invest in more aggressive holdings than if you need it in six months. The longer you hold an investment, the more time it has to recover from temporary setbacks.
The final risk consideration is just how much you can stomach when it comes to market volatility. If you get nervous when the market declines and keep checking your portfolio every day, you may be better off with a more balanced portfolio. Many investors sleep better at night knowing that the majority of their holdings are not in high-risk investments. Determining your tolerance for risk, your financial goals and timeline for achieving them are the first essential steps to creating a suitable investment portfolio.
In additional to your personal approach to risk, it’s important to understand the various types of risk that exist in the investment markets. For example, if you invest in bonds, you need to pay attention to credit risk. This is measured by independent ratings agencies that determine the viability and financially strength of various bond issuers. Each receives a rating from the agencies based on the likelihood that the issuer may default on bond payments. This higher the rating, the more reliable the issuer. Lower-rated issuers may pay out higher yields on their bonds to make up for the higher risk.
Risk ratings address more than the ability to deliver on financial obligations. Take Russia, for example. Once the war on Ukraine began, the US and other countries imposed widespread sanctions on Russian companies and individuals, basically freezing their ability to do business outside of the country. As a result, Russia’s ratings dropped because its companies lost their ability to trade with global partners, reducing potential revenues and increasing investor risk in those companies – in both stocks and bonds. The Russian government itself was downgraded due to weakened ability to pay debt obligations. Russian insurance companies also were downgraded.
Other types of risk have less to do with the holding or the issuer, and more to do with the current economic environment. For example, inflation risk means your retirement portfolio may not be invested aggressively enough to cover the effects of long-term inflation. Interest rate risks refers to how periodic changes in interest rates – adjusted by the Federal Reserve – can affect current holdings to increase or decrease their value. And then there are currency and geopolitical risks, which refer to activities going on in different countries that Americans have no control over, but can impact their invested holdings.
There are strategies that investors can deploy, such as diversification, strategic asset allocation and periodic rebalancing, to help mitigate investment risk. But ultimately, it doesn’t go away entirely. Leveraging a small amount of money in the effort to earn a higher amount is the basic premise of investing, and it will always incur risk.
How Legal Settlements and Fees Are Taxed
Say you are involved in a serious auto accident. You may even sue the other driver to pay for damages not covered by the insurance companies. Perhaps you receive a large settlement. Are you on the hook for taxes on that lawsuit payout?
It depends. According to the IRS, monies received for personal injuries or illness are exempt from income taxes. If you receive a settlement for mental and emotional distress, that may also be tax exempt if it is directly related to a physical injury or illness.
Moreover, if you receive compensation specifically for vehicle damage resulting from a car accident, that’s not taxable either. This applies to both the cost of repairs as well as coverage for a rental while your car is being repaired.
However, payouts received for punitive damages are subject to income taxes. Other settlements subject to federal income taxes include employment-related lawsuits, such as:
· Wrongful discharge
· Failure to honor contract obligations
· Damages to compensate for economic loss (e.g., lost income and benefits)
· Discrimination lawsuits related to age, race, gender, religion or disability
Also note that attorney and legal fees are generally not deductible on your federal tax return. In the case of a non-injury damages settlement, your attorney may receive 40 percent of the payout, but you’ll be liable for taxes on the full 100 percent of the payout.
Sometimes 100 percent of the proceeds from a legal settlement must be used to pay for bills and expenses based on the origin of the claim. Other times you may come out ahead, with excess money available to spend at your discretion.
Another type of settlement is the malpractice lawsuit. If a physician makes a mistake that results in physical pain, the proceeds from the medical malpractice lawsuit would not be taxable. However, if your lawyer fails to file the lawsuit before the statute of limitations runs out, then you may be able sue that lawyer for legal malpractice. Because that payout is directly related to the physical distress from the original claim, it would not be subject to taxes.
However, other types of legal malpractice lawsuit settlements, such as trusts, divorce, litigation, tax advice, and real estate deals are reported as taxable income.
Although this discussion gives you a general overview of the IRS rules regarding how legal fees and settlements are taxed, every case is different. It’s a good idea to consult with an experienced tax professional to help you assess if, and how much, of your compensatory payouts are subject to taxes.
The Value of Multiple Retirement Income Streams
Historically, retirement planning was a little easier. For instance, the average life expectancy in 1950 was 68 years old. If you retired at age 62, your retirement plan might need only six years of retirement income.
With fewer employers offering a retirement pension, more people are responsible for deciding how much income to set aside for retirement, and how to invest that money. Unfortunately, they are falling short compared to the days when employers sponsored pensions and people didn’t live quite as long. In fact, recent studies show that today’s retired Boomer households that do not enjoy a pension are more likely to deplete their 401(k) savings quickly, which means they are more likely to outlive their savings.
This’s why it’s important to look beyond your company-sponsored retirement plan. You can create a mix of tax-advantaged IRAs, a taxable investment portfolio, guaranteed annuity income, life insurance products that build cash value, and even passive income from a work endeavor (royalties, residual income) or rental property. Even if you can’t afford to fund certain income streams now, it’s a good idea to consider what type of retirement income sources interest you most, and work toward those goals.
Investors may want to consider building a laddered bond portfolio and/or laddered CDs. While this plan locks up money for periods of time, it provides the opportunity to augment funds at different stages of retirement, and can help you from running out of money. An income stream can be generated by interest and dividends from an investment portfolio comprised of bonds, bond funds, CDs, and dividend-paying stocks. This strategy can minimize your risk to principal, but does increase your risk exposure to inflation and changing interest rates.
While Social Security is basically a lifetime annuity, many people have no idea how much payout to expect, especially if they are early in their retirement planning effort. But one tool that anyone can use, at any age, is to register online at ssa.gov for your “my Social Security” account. There you can monitor your personalized retirement benefit estimates and spousal benefit estimates – which change as you move further through your career. The website is free and can be very helpful in creating a long-term retirement income strategy.