For many years, Americans have experienced an unprecedentedly low-interest rate environment. Winners during this period included nearly all borrowers, as mortgages and other financing instruments were essentially on sale. Interest rate increases imposed by the Federal Reserve (FED) over the past year have been “in your face,” both numerous and substantial. Borrowers with variable-rate loans, potential homeowners, people with credit card debt, etc., all have been impacted by frequent and harsh rate elevations.
Losers in our prior low-rate environment included many savers, who watched their fixed-income investment yields nearly evaporate. Money Market Funds, CDs, and Bond Funds were largely shunned for lack of monetary returns. Hit hardest were older savers seeking to protect their principal, while receiving supplemental income. These people are becoming today’s winners, having been presented with income opportunities not seen in many years.
For today’s discussion, we will concentrate on the familiar Certificate of Deposit, or CD. Short-term investments (less than 5 years) can now be safely invested, with CD yields in excess of 4%. Perhaps not show-stopping rates, but compared to former pathetic yields, these new rates constitute a virtual windfall. In our financial advising and investing business, we are currently purchasing CDs for clients, and deployed idle cash into rewarding assets. But not every opportunity is a “no-brainer.”
Laddering refers to the practice of dividing income investments (CDs, Bonds, or even annuities) into units with staggered purchase and maturity dates. Laddering is meant to take advantage of varying interest rates, which normally increase with additional time to maturity. While rates are not yet aligned in a normal fashion (the yield curve is inverted), excellent opportunities exist in the 1 to 3-year range. Many investors are accustomed to renewing their income investments as maturity dates are reached. In a rising rate environment, renewal rates are generally superior to expiring rates.
Most people understand that surrendering a CD early carries a financial penalty, typically two or three months of interest. What may not be intuitive is the number of actual dollars involved in surrendering low-interest-rate CDs. Assuming a 1% CD yield for $100,000, quarterly interest is only $250. Replacing the CD with a 4.5% yield pays a quarterly rate of $1,125, for a net gain of $875 quarterly. For a common penalty of 3 months’ interest, the net gain is well worth the process of surrendering the unexpired CD.
If you currently own any CDs with time remaining to maturity, this is an opportune moment to exercise some creativity by evaluating the costs and benefits of an early surrender.
Van Wie Financial is fee-only. For a reason.
Financial advisors get up every morning dreading reading the day’s financial headlines. If any significant portion of financial headlines were to actually come true, we would not have a country, much less an investment portfolio that actually rewards investors. Some days we just ignore headlines, and other times we get riled up by the attention-seeking “experts.”
Such a day happened last Monday, when on a single page of a commonly visited financial website, three consecutive headlines, each crafted to receive “clicks,” read:
- “Banks Could Seize Your Accounts”
- “The End of the Dollar”
- “Stocks Risk 22% Slump”
Beginning a day like that is enough to send an otherwise sane investor into a tizzy. Multiply that by 100+ clients, and you get an idea how much more frustrating financial advising becomes. Fear is the enemy of advisors and clients alike. Overcoming fear is difficult enough without a daily gobsmacking in the media. Fear is overcome by education and knowledge. Our mission at Van Wie Financial is to counteract and overcome fear using knowledge and facts.
How much truth is behind these headlines? Can banks seize your funds? Yes, they can, if triggered by one of the rare elements in banking and tax laws. Don’t pay IRS, and they might freeze your account. If the bank goes under, Dodd-Frank allows the bank to use your funds while working out the bankruptcy. You get stock shares, and hope they become worth something. Choose your bank wisely, and be sure your deposits are insured. That’s on you.
Is the Dollar doomed? Will it be replaced by government-created crypto? If I said “No,” and someone else “Yes,” who would you believe? Imagine the complexity of a change of that magnitude, add in the number of politicians who would be bombarded with angry constituents, and draw a rational conclusion. Political suicide is shunned by Congress.
Do stocks risk a 22% slump today? Every single day of your life, stocks risk a 22% decline. Likewise, they risk a 22% spurt, and in actuality, even more.
Why is the media replete with such headlines? Could it be that the authors (read: advertisers) are selling something? Perhaps precious metals, newsletters, or annuities, there is always something they want you to buy, and they are willing to scare you into purchasing. Had you not read those headlines, would you be scared by highly improbable scenarios?
Van Wie Financial is fee-only. For a reason.
Portfolio Diversification is rarely disputed as fundamental to investing success. Problematic, however, is finalizing a definition of the term “Diversify.” To many, the answer lies in the number of individual stocks held in an investor’s portfolio. Not only is there disagreement as to “that number,” but in practice, the very premise is debatable.
Prominent among early papers on the subject is a study by John Evans (Evans) and Stephen Archer in the 1968 Journal of Finance. Versions of their results permeate much of today’s financial literature. Evans concentrated on stocks, and specifically the number needed to determine the best 1-year results. Disputed conclusions in Evans included:
- Stock index funds are unnecessary, as 60 to 80 stocks can produce results similar to indexing
- Active portfolio managers should only hold 20 to 30 stocks to prevent “de-worsifying” into 60 or more stocks
- “Do-it-yourselfers” should hold small handfuls of stocks, as they can’t pay sufficient attention to a greater number of holdings
Read that list again, and if you understand the logic, please notify us, as we remain confused by their conclusions.
Unfortunately (in my opinion), far too many investors, apparently in lockstep with their advisors, believe that Portfolio Diversification may be satisfied by the number of individual stocks held in an investor’s portfolio.
Thankfully, there has been extensive research on this very subject, mostly disputing Evans. One recent synopsis is by Yin Chen (Chen) and Roni Israelov of advisory firm NDVR in Boston. While Evans concentrated on one-year volatility, Chen looked at total return over a 25-year period.
Chen found that portfolios holding more stocks were not ever more volatile than those with fewer holdings. Logically, we need to understand the value of experiencing more or less volatility. Greater volatility produces a larger upside potential, but also a greater downside risk. For reasons both mathematical and psychological, less downside risk is most investors’ preference over time, so long as upside potential is sufficient. Losing portfolio value is more painful for most investors than gaining a similar amount is rewarding.
No pure stock portfolio can match results from fully Diversified Portfolios utilizing multiple Asset Classes, and no number of individual stocks will produce better results, in the absence of unusually good luck.
Simply put, whether 20 stocks, 60 stocks, or 500 stocks, the portfolio remains under-diversified in the absence of multiple Asset Classes. We should all focus on the overall process of Portfolio Diversification.
Van Wie Financial is fee-only. For a reason.
Diversified portfolios are the 8th wonder of the modern world. OK, maybe not that spectacular, but extremely important to millions of investors. In a world where individuals are increasingly responsible for their own financial futures, risk (defined as variability of returns) must be mitigated, while allowing (and encouraging) growth in the overall portfolio. A tall order, to be sure. Alone, no individual Asset Class provides both safety and opportunity.
While researchers have identified three key elements of success in portfolio construction and management, multiple studies have concluded (1) Market Timing is insignificant as a driver of long-term success, (2) Securities Selection contributes very little to overall results, and (3) Diversification amongst Asset Classes is the main element of success. In practice, properly mixing assets from various Asset Classes drives over 90% of long-term portfolio returns.
It stands to reason that more attention should be paid to Diversification than to those other two factors combined. Why, then, do so many advisors and investors concentrate on the Selection and Timing of buying and selling individual stocks? Or, if I might, trading?
Primary Asset Classes include Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Real Estate, Cash (and equivalents), and Alternatives, such as Commodities. Diversification involves the selection of portfolio assets from at least two, and preferably more, of these categories.
Even the smallest portfolios can benefit from Diversification. For young and/or novice investors, an all-stock portfolio may be exciting, but their portfolios will benefit over time from Diversification into other Asset Classes. Many people choose Target-Date Funds, which are often called Retirement Date Funds. These funds are diversified, using Bonds and, frequently, International Stocks. Simple to buy and sell, especially in these days of commission-free trading, these funds provide excellent Diversification to even the smallest investors.
Certified Financial Plannersâ (CFPsâ), operating as Registered Investment Advisors (RIAs), apply Asset Allocation techniques to develop and manage individual portfolios, based on individual risk tolerance and the financial goals of investors. For assistance in finding Advisors working in these arenas, we suggest the Certified Financial Planner Boardâ website (letsmakeaplan.org), and the National Association of Personal Financial Advisorsâ website (napfa.org). When shopping for a Financial Advisor, look for the “fee-only” designation to be sure the Advisor is a fiduciary at all times. Do not be fooled by claims of “fee-based” advisors, who are not required to act as fiduciaries at all times.
Next week we will address the age-old dilemma regarding how many stocks are required to sufficiently diversify a portfolio.
Van Wie Financial is fee-only. For a reason.
Last week, we discussed the value of accepting Personal Responsibility for our own financial futures, including starting and/or contributing to an Individual Retirement Account, or IRA. Our primary focus was on potential 2022 tax savings. Our suggestion was to open (or contribute to) a Traditional IRA, in which all contributions are deductible for qualified Account Owners. 2022 contributions can be made up to Tax Filing Day in 2023, but the benefit will still be reaped for 2022.
Today, we shift our focus to the Roth IRA, which does not provide current income tax relief, but provides other worthwhile benefits later, when withdrawals made by Account Owners will be tax-exempt. Despite not having to open a 2022 account and contribute until early next year, there may be a good reason for new investors to open an account in the remaining few days of 2022.
Maximum benefits from a Roth IRA are not realized until the account has been open for 5 years, and until the Account Owner reaches age 59-1/2, at which point withdrawing earnings becomes tax-free. Before the 5-year period is satisfied, contributions may be withdrawn at any age with no tax due, but prematurely withdrawing earnings may require income tax and/or a 10% tax penalty, depending on age.
The full 2022 credit is a result of how the 5-year holding period is calculated. A Roth IRA opened before the end of the year will have satisfied Year 1 at midnight, December 31, 2022. Year 2 starts on January 1, 2023, and satisfies the entire second year of the requirement. This means that on January 1, 2026, the 5-year holding period is considered complete.
Anyone desiring to open a Roth IRA and satisfy the 5-year qualification period can still open an account with a small initial deposit before this year-end. Most custodians will allow a new account to be opened online, or by appointment in a local office. Some banks and credit unions can open a Roth IRA in person, and a deposit can be made, so long as a minimum opening deposit is made.
Another strong argument for starting a Roth IRA lies in the generous rules for making future withdrawals for education, home purchase, etc. Rules can be found on the irs.gov website, or on the website of the custodian you choose to hold the account.
With few exceptions, opening a Roth IRA before year-end will provide benefits to the owner of the account. If you qualify, why not take this opportunity to establish another block in your retirement income foundation? Do it now, and you may be able to receive full benefits sooner, rather than later.
Van Wie Financial is fee-only. For a reason.
Where were you on the Eve of the Millennium? December 31, 1999, was long ago, but like many uber-significant events, it remains unforgettable for those of us who were old enough to appreciate the moment, with the many associated “Y2K” fears. What would happen? Would our cars and planes work? Would the banks reopen? Would our ice cubes melt overnight from blackouts?
As with memories of the Kennedy assassination, the attacks of 9/11, and a few other life-altering events, we retain memories in permanent brain storage. Somehow, reminiscing about important events from long ago tends to render the remaining few days of 2022 seemingly insignificant, and certainly forgettable. But we should remain aware of the opportunities we face currently.
With perfect 2020 hindsight (pun intended), the nation’s economy has been transformed from a prosperity machine into one of uncertainty and doubt. Navigating through the economic (COVID-19-stimulated) rubble, it is easy to understand the primary lesson of the 2020s. Never can I remember a time where self-reliance played a more important role in American life.
As layoffs pile up, prices skyrocket, and interest rates rise, the stock market faces real losses for the year. We need to tend to our own plights. As most Americans are facing zero-to-minus real wage “growth,” one immediate tactic comes to mind. There is no quicker way to save needed dollars than by reducing our tax bills. There’s still time for many to help themselves.
Retirement Planning is a two-sided coin, where Heads we win now, and Tails we win later. When the Individual Retirement Account, or IRA, was introduced, very few people understood what personal responsibility for Retirement Income meant. Being the thoughtful and educated people we are, the IRA caught on like wildfire, and today there is an estimated balance of over $1 Trillion (12 zeroes) in our collective personal IRA accounts.
Much of this cash already served purpose number one, by creating an “above-the-line” tax deduction for contributions. These create the best tax savings, as they have the effect of never being recognized as current earnings. Eligible people should plan to contribute to their IRAs to the extent possible, simultaneously saving taxes and providing for a better future.
With few days left in the year, coupled with slack economic conditions, maxing out IRA contributions by December 31 may seem financially difficult. In a rare user-friendly moment, IRS allows these contributions to be made until Tax Filing Day of 2023, while also providing a 2022 tax deduction. There are more tips and suggestions for late-year tax savings, but none (in my mind) is easier and more important than the IRA. Self-reliance, tax-saving, and Retirement Planning, all rolled into one. It doesn’t get much better than that.
Van Wie Financial is fee-only. For a reason.
Sometimes, at this time of year, I enjoy looking at my past Congressional Christmas Wish Lists. This year, I thought it might be particularly interesting, as my last lookback was in 2018, the halfway point of the Trump Administration. We are now at that point in the Biden Administration.
In 2018, much of my list was due to the need for economic revival. Prior to Trump, my priority was tax cuts, and he delivered with the Tax Cuts and Jobs Act of 2017 (TCJA). As expected, the results were spectacular, with unemployment on the decline in every demographic, wages rising in excess of (almost nonexistent) inflation, and most people enjoying a tangible paycheck increase. The stock market was booming, as my wishes were coming true.
Tragically, the 2020 COVID-19 pandemic interrupted economic progress in unparalleled fashion. Despite temporarily shuttering most businesses, and the resultant deep recession, we began to recover almost immediately. Without TCJA, the recovery would have been much longer and more painful.
Unfortunately, TCJA tax rate cuts were written to expire in 2026, and under the Biden Administration, chances of getting the lower rates made permanent have decreased significantly. Therefore, my 2022/2023 Wish List Priority #1 is to make TCJA tax cuts permanent.
My 2018 Wishes #2 through #10 were smaller, taxpayer-friendly, “tweaks” to the Tax Code, but under the new Administration and Congress, none of them have more than a Florida snowball’s chance of seeing the light of day.
Inadvertently, a few good things have happened in the personal finance arena, albeit some for the wrong reasons. Inflation adjustments in the U.S. Tax Code have allowed savers to increase contributions to Retirement Accounts. My 2022 Wish #2 is to further increase contribution limits in excess of inflation.
Another consequence of the pandemic was the passage of the S.E.C.U.R.E. Act, now dubbed SECURE 1.0, due to a tag-alone version (called SECURE 2.0) is currently pending in Congress. Because of the immediacy of some of its provisions, my 2022 Wish #3 is to get SECURE 2.0 through Congress, and signed by President Biden, with several days left in 2022. Need I say, “Please?”
2022 Wish #4 has already been granted by the voters, who are responsible for changing the majority in the House of Representatives, effective in early January. Faced with a taxpayer-unfriendly Administration for at least two more years, the best we can wish for is a divided government, where further legislation basically grinds to a halt. When in a hole, stop digging and have patience. For now, let’s not make things worse.
Van Wie Financial is fee-only. For a reason.
What passes for financial advice is easy to find without paying a cent out of pocket at the time. Often it is not free, at least in the long run. Advice is a well-defined and regulated concept in the world of financial services. Between two laymen, the law doesn’t get in the way of dispensing suggestions, even when the term “advice” is used incorrectly by either party. In that regard, the information transmitted and received is free. Or is it?
Bad investment advice, when followed blindly, can result in significant costs to an investor. Losses may be direct or indirect, through what we call “opportunity costs.” Choosing one investment to the exclusion of another creates an either/or scenario, where the outcome reflects the quality of the advice taken.
How is anyone to evaluate competing advice? For starters, consider the many sources of “free” opportunities. Television commercials tout precious metals, radio ads promote double-digit returns from real estate, free seminars at local high-class eateries promote Living Trusts (while selling annuities), stockbrokers know the “hot stocks,” and insurance agents can show you how to “participate in market returns while never losing money.” And that nice guy at church has the most successful mutual funds ever. Websites promote tax-free lifetime income. If you need even more help, robinhood.com offers “meme stocks” that show meteoric rises, at least until they crash from lack of fundamental underlying value.
Looking “under the headlines” usually reveals a polished sales job, presented by marketing professionals seeking commissions from sales of products or newsletters. Whether or not their offerings are suitable to you is irrelevant, as they are not required to place your interests ahead of their own. Unregulated industries and providers pose a clear and present financial danger to an unsuspecting and unwary population.
Far too often, sales pitches are built around people’s basest instincts – fear and greed. Numerous studies have shown that Americans fear running out of money more than they fear death. Powerful emotions open up lucrative sales opportunities. In the absence of regulation and potential penalty, the door is open to unscrupulous sales pitches from unethical providers.
In the world of professional financial advising, true “advice” is offered by qualified professional advisors whose businesses require them to serve as fiduciaries. If you are in doubt about the person advising you, simply ask the question, “Are you a fiduciary?” There is only one correct answer, an unequivocal “yes.” And yes, we are fiduciaries.
Van Wie Financial is fee-only. For a reason.
For decades, Congress and several successive Administrations have encouraged individual financial responsibility by authorizing tax-favored Retirement Accounts. Over time, tax benefits from participation in retirement plans have evolved, but the final goal remains constant – encouraging personal retirement income to supplement government-based benefits.
In exchange for tax deferral, or tax elimination on the growth of some assets, Congress requires account owners to begin drawing funds from accounts as they grow older. Dubbed Required Minimum Distributions, or RMDs, these withdrawals are taxable in the year of withdrawal. No tax is due on withdrawals from Roth Accounts, and there is no requirement to take age-based distributions for (non-inherited) Roth IRAs.
Rules for withdrawals and taxes are forever being “tweaked” by Congress and IRS, making it important to follow changes to minimize lifetime tax effects on Retirement Account withdrawals. Passage of the S.E.C.U.R.E. Act (dubbed “SECURE 1.0”) in 2020 changed many rules, and a pending modification called “SECURE 2.0” is likely to further alter RMD rules.
Major changes are pending for Inherited IRAs, but as of this writing these rules have not been finalized. Due to uncertainty, IRS has waived the 50% penalty for missing an RMD on Inherited IRAs, both for 2021 and 2022. This applies to Inherited Accounts where the death of the original owner took place after December 31, 2019.
While we expect finalized rules sometime later in 2022, or certainly in early 2023, anyone who has doubts regarding their RMD status should consult a qualified professional for guidance through the maze of regulations pertaining to retirement savings. We are available on Saturday mornings during the Van Wie Financial Hour radio program on WBOB radio from 10:00 to 11:00. Your account custodian should also be able to address your questions, but they will be extremely busy until year-end.
Other changes made to RMD rules in recent years included the elimination of all RMD requirements for the year 2020 (due to COVID-19), and implementation of new Life Expectancy Tables on January 1, 2021. These welcome changes extended the expected life of affected Retirement Accounts, reflecting increased longevity in today’s citizenry.
Occasionally, IRS implements user-friendly changes, and we give credit when and where it is due. There is, however, a great deal yet to be done to bring benefits for individuals and small company employees in line with those in large company 401(k) Plans.
Van Wie Financial is fee-only. For a reason.
Decades ago, and repeated periodically, increases in gasoline prices elicited demonstrations of our political and public lack of economic understanding. Over and over, “Big Oil” took a very public whipping from politicians and “progressives.” Remember Hillary Clinton in the 2007 Senate saying, “I want to TAKE those [oil company] profits?” Shameful rants by politicians filled the evening news and local papers for weeks. Halliburton moved to Dubai to escape disparagement (and taxes) at home.
Since oil companies were getting so much negative press, I started asking the question, “Who owns ExxonMobil?” Are its owners responsible for perceived problems brought on by “Big Oil?” Many people assume that ExxonMobil is owned by evil executives and fat cat mega-shareholders. In fact, however, only 0.07% of ExxonMobil is owned by employees and executives. 59.65% of XOM is owned by 3,799 institutions and pension plans. The balance of shares are held in retirement accounts and in the hands of individual investors, otherwise not affiliated with company management.
In response to the ownership question, many were surprised to find that they and/or their parents, neighbors, teachers, firefighters, police officers, bus drivers, soldiers, sailors, Marines, and so on, were the owners (stockholders) of ExxonMobil. Nearly everyone with a pension, an IRA containing mutual funds, a 401(k), or any similar investment account, is an owner of ExxonMobil, which is among the most widely held stocks in the world. Steady dividends received from that ownership help pay the pensions for retired people all over the world. Growth in the company, and therefore in stock price, spurs rising account balances and wealth accumulation. This allows an increasing number of people to retire comfortably.
If Congress does not extend the corporate tax rate cut passed in 2017 under the Tax Cuts and Jobs Act (TCJA) of 2017, ExxonMobil and other large corporations will be subjected to a substantial tax increase in 2026. Since dividends are paid to shareholders from after-tax profits, companies will have no choice but to cut future dividends. As a result, individuals, institutions, pensions, etc., all will perform less well, and the “victims” will be various groups and individual shareholders.
Capitalism has long been the object of derision among many Americans, and even more so in foreign countries. An unbiased look into the entire impact of ExxonMobil and other major corporations uncovers the “inconvenient truth” that we are all beneficiaries of a better lifestyle that they help to produce.
Far too many Americans harbor a distorted view of our capitalistic economic system and the modern energy production techniques that underly our success. Without improved understanding, America’s future is in jeopardy.
Van Wie Financial is fee-only. For a reason.