It’s official. ZIRP (Zero Interest Rate Policy) is dead. In fact, the Federal Reserve (FED) has raised interest rates to levels not seen in many years. Car and home buyers are getting hit hard, and at this moment the average potential buyer cannot afford a new car. This is a result of higher interest rates, coupled with high inflation. New car prices average $48,008, and payments are generally over $700 monthly. Grocery prices are out of sight. Eat or drive?
Switching focus to the winners’ side of high-interest rates, lenders are now receiving better returns on loaned funds. Not everyone may realize their own status as a lender. If you own any Money Market shares, interest-bearing bank accounts, or investment bonds, you have loaned money to the issuer. In return, that borrower has promised to pay you interest until the money is repaid, or the bond either gets sold or matures.
Maximizing interest earnings on bonds requires an understanding of the “Yield Curve,” which is a graphical representation of market interest rates. On the graph, interest rates are on the vertical axis, and time is the horizontal component. Understanding a normal Yield Curve is easily demonstrated. Suppose you are buying a car, and you compare loan rates for differing lengths of repayment. You may get a quote like this; 2 years for 1.9%, 3 years for 2.9%, 4 years for 3.9%, etc. Longer repayment periods carry with them higher interest rates. That’s how bond yields work in a normal rate environment.
Plotting those various points on the graph, then connecting the dots into a smooth line, creates the Yield Curve. Normally, it will simply show an upward-sloping curve, looking from left to right. In 2023, we have been experiencing an “inverted” Yield Curve. This results from the perception in the market that current high rates are temporary, so short-term rates are unusually high. Expectations for long-term interest rates are lower than for short-term rates, and plotting those data points creates a Yield Curve with the “wrong” slope (inverted).
Why does this matter to the average American? For savers, elevated short-term rates provide an opportunity for investing in CDs and other short-term, interest-bearing instruments, at attractive rates. For borrowers, it means there is more pain in current (higher) repayment requirements.
Unfortunately, an Inverted Yield Curve generally foretells an economy in decline and signals an upcoming recession. While that result is not guaranteed, the correlation is very strong throughout history. When a recession is actually encountered, the overall state of the economy (and the job market) is unhealthy. Prudent Americans may delay plans for large purchases, in favor of future rate decreases. Economies run in cycles, and the Yield Curve will return to normal. Meanwhile, consumers should be cautious about making costly commitments.
Van Wie Financial is fee-only. For a reason.
As we explained last week, ZIRP is an acronym for the Federal Reserve’s Zero Interest Rate Policy, which tends to divide Americans into winners and losers. Borrowers love cheap money, whereas investors and lenders lose their ability to earn a reasonable return on cash and other short-term investments.
Frequently heard in our office is the pejorative, “I hate bonds.” We find that investors who express that sentiment are relatively uninformed as to the purpose of holding bonds, as well as the mechanics of the bond market.
Like stocks, individual bonds are traded on an Exchange, as are Bond Mutual Funds and Exchange Traded Funds. Market prices are determined by several factors, including time to maturity, the credit quality of the issuer, and market rates of interest. Values at any moment in time are a function of these factors and are quoted in financial media and through bond brokers.
Market prices for bonds are inversely related to interest rate changes. Rising interest rates directly cause lower bond prices. Holders of bonds in a rising interest rate environment experience losses from bond price declines. Logically, the opposite is true as well. A reasonable question to ask might be, “How much do bonds change in value?” The answer is that shorter-maturity bonds incur less price change than do longer-maturity bonds.
Over time, a 64/40 portfolio (60% stocks and 40% bonds) has returned about 7% annually. However, in 2022, that portfolio mix lost 15.3% of its value. Naturally, this caused a great deal of consternation among investors, exacerbating feelings in the “I hate bonds” crowd. This is unfortunate because that drop was unusual and unexpected. So far this year (2023), the same 60/40 portfolio has gained 4.69%.
Since bond pricing rules work in both directions, investors prefer to hold longer maturity bonds while interest rates fall, in order to capture increasing values. During times of rising interest rates (as we have experienced the past few months), savvy investors shift out of longer-maturity bonds, moving their funds into short-maturity bonds, and even to money market funds. When the FED’s rate-rising cycle ends, funds get moved back into bonds with longer maturities.
The FED meeting last week produced another ¼% interest rate hike. Whether this rate increase will be the final step in our current rate-increasing cycle remains to be seen. Most market watchers seem to believe so, but there are no guarantees, so long as inflation numbers remain elevated. My guess is a short-term pause on further increases, with an uncertain future. The FED’s top priority remains a 2% maximum rate of inflation. They have a long way to go.
Van Wie Financial is fee-only. For a reason.
ZIRP is an acronym for Zero Interest Rate Policy and, until recently, a major component of American economic policy for several years. Through the Financial Crisis in 2008 and the economic shock of COVID-19 in 2000, the Federal Reserve (FED) exercised the ultimate “easy money” stance of lowering interest rates to essentially zero. (I suppose we should be grateful they didn’t adopt NIRP, the Negative Interest Rate Program, tried by several countries with no apparent success.) ZIRP’s concept is simply to stimulate economic activity in slow economic times.
To what degree ZIRP has been effective is a discussion I will leave to the academics and politicians. However, one result we criticize is that ZIRP divides Americans into two groups: winners and losers. Winners are large corporations and entrepreneurs, who can borrow cheap money for projects that may otherwise not be justified. Losers include investors and lenders, whose ability to make safe money earning interest, is delayed.
Typical investors employ a long-term strategy of owning stocks, bonds, and cash, plus alternatives such as commodities. During good times in the stock market, the highest returns come from stocks. This phenomenon does not go unnoticed by investors, who reflect fondly on their out-sized stock gains over the years. These people look at the bond market, compare their relatively measly returns, and develop a visceral dislike of bonds.
In our financial planning practice, we hear constantly, “I hate bonds.” While common, this attitude sets up portfolios to experience more volatility than most investors find comfortable. One of the fundamental contributions of bonds is reducing that volatility. Bonds are also accretive to long-term returns, furnishing incremental growth and income throughout the bond’s holding period.
Bond issuers are borrowers. In return for loaning them money, issuers promise investors how much, and when, interest will be paid to the bondholder during the holding period. At maturity, the face value of the bond is returned to the bond investor. So, why do so many investors harbor a deep dislike for bonds? Aside from returning less than stocks (in “normal” times), investors are not aware of the long-term impact of bonds in well-diversified portfolios.
We can’t fault any investor whose experience with bonds has been negative. That is largely due to a lack of understanding of bond pricing and variability. Next week we will look at the effects on bond investing from changes in interest rates, including recent FED policy decisions, and discuss strategies to create successful portfolios that include bonds.
Van Wie Financial is fee-only. For a reason.
Americans aged 75 and over are re-entering the workforce in large numbers, with an expected increase of 96.5% by 2030. With 10,000+ people reaching traditional retirement age daily, a large and experienced talent pool is emerging in our economy.
Two general categories of post-retirement-age workers are emerging: Voluntary and Involuntary. Voluntary Senior Workers spent a lifetime planning and saving, eventually achieving true Financial Independence commensurate with their lifestyle desires. They could (or did) retire safely and comfortably, but many decide to continue (or restart) working for other reasons.
Involuntarily Senior Workers are what I call Retirement Wannabees. This group remains in the workforce to pay their bills, which becomes more difficult daily, due to elevated inflation. Either way, employers are grateful for the very existence of this growing workforce pool. Employers believe that experienced workers are generally more reliable than younger employees.
Retirement Wannabees are found in many situations. People who subscribe to the hype called “Financial Independence Retire Early (FIRE)” believe outlandish promises and ridiculous assumptions made by their gurus. FIRE supporters are instructed to live on a veritable shoestring while young, saving huge percentages of income for “retirement.” Perhaps this sounds enticing (and maybe even possible) to some, but it simply is not practical. Nor is the “do without” lifestyle needed to achieve the impractical goals of FIRE.
In fact, kick the tires on any of the FIRE guides, and you will find one universal similarity – they end up advocating working after retirement. So, the secret to stopping work at an early age is to ……. work? Why are we wasting time reading this tripe?
Aside from pure financial aspects of working later in life, stimulation of mind and body can lend meaning and interest to our “out years.” Getting back into society, interacting with people, exercising body and mind, all can and do contribute to the quality of life. The extra money is, of course, also welcome.
Obviously, arriving at the category of Involuntary Senior Worker is disappointing. Preventing this situation takes a long time, careful planning, and successful investing. Start saving early, work with a qualified Financial Planner, and avoid large, costly mistakes, and you will likely get your choice.
Either way, employers will be happy to meet you.
Van Wie Financial is fee-only. For a reason.
Tax Day 2023 has arrived, albeit a little later than usual, due to a calendar-based adjustment. Unless an Automatic Extension has been granted, which is as simple as filing Form 4868, Individual Returns are due by April 18, 2023. Regardless of Extension status, any tax owed from 2022 is also due. Adding insult to injury, the 2023 Quarter 1 Estimated Tax Payment (Form 1040-ES) is due on the same date for taxpayers who do not have sufficient withholding along the way.
April 18, 2023, is also the drop-dead date for 2022 IRA deposits. These can be made from your tax refund, if available. It is also possible to purchase iBonds from the Treasury with your refund, simply by asking.
Rather than blindly accepting the work of your tax preparer, even if you did it yourself via TurboTax or another online service, April represents the best opportunity to learn from your Individual Return. There are many line items in every Return that can provide insight to help us manage (legally) the amount we are required to pay.
Fundamentally, here is how the Tax formula works: (a) compute Gross Income from all sources; (b) apply specified adjustments on Form 1040 to arrive at Adjusted Gross Income; (c) compute Itemized Deductions, or use the Standard Deduction, whichever is higher, to determine Taxable Income; (d) find your Gross (preliminary) Tax from the Tables or Formulas from IRS; (e) Apply Tax Credits if you are eligible. From there, compare the total amount owed to total payments made along the way, resulting in either a refund or money owed to IRS.
America’s Tax Code is a nightmare of complexity, constantly changing, and seemingly doling out punishment for the simple act of being a hard-working, successful American. As disgusting as that is, we are forced to live with it, and we may as well figure out how to do the best we can for ourselves.
In a few days (or even less), your Tax Return will be filed away, or stored on your computer hard drive. While it is fresh in your mind, learn from current information, and apply the lesson going forward.
Tax Preparers, who are generally in the midst of a hectic and high-pressure time of the year, don’t always have time to ask probing questions and explore options for a reduced tax bill. As Certified Financial Planners®, Van Wie Financial offers Tax Planning services.
Please note that we are not Tax Professionals or Preparers. Our role is in Tax Planning and working with your Tax Preparer to help you save money on taxes while investing for eventual Financial Independence.
Van Wie Financial is fee-only. For a reason.
“People get the government they deserve,” observed Alexander Hamilton, long before his story hit Broadway. Ben Franklin also chimed in. When asked what kind of government the Founders had given the people, he responded, “A Republic, if you can keep it.” Franklin’s classic line is often disputed, but the conclusion is obvious. Starting in the 1770s, Americans were charged with a great responsibility.
Government of the people, by the people, and for the people is a hands-on process, requiring citizen participation in the system. Fundamental to success is casting an individual ballot periodically. Citizens are charged with keeping up on issues affecting our country, and determining where individual candidates stand on these issues. Hardly a burden on the citizenry, in my opinion.
After Iraq was liberated from Saddam Hussein, elections were held in 2005, with a reported 70%+ turnout among eligible voters. Remember beaming faces and purple “I voted” stains on the fingers of Iraqis? Voting was a new privilege, and Iraqi citizens were eager to exercise their newfound rights. Surely this enthusiasm would last a lifetime, making up for decades of oppression.
Not so fast. In recent elections, Iraqi turnout has been estimated in the range of 41% – 43%. A majority of voting-age Iraqis are no longer decision-makers. Rather, they are doomed to live under the policies of a minority of (voting) citizens. The non-voting majority is to blame for any result they don’t like.
Recent important elections in both the City of Chicago (Mayor) and the State of Wisconsin (Supreme Court “swing” Justice) featured extremely polarizing candidates. In both cases, one candidate was an extreme “Progressive,” and the other politically moderate. In each case, crime and punishment were on the ballot, and in each case, the safety and security of citizens were lost to the ”defund the police” crowd.
Is a continuation of “soft on crime” leadership what a majority of citizens actually want? I doubt it, based on escalating crime rates across America. If public safety is that important to citizens, what went wrong?
Turnout. Participation. Responsibility. Apathy. Call it what you like, but for whatever reason(s), only about 1/3 of eligible (and therefore affected) citizens, chose to express their own personal sentiments by voting. No claim of ignorance is now acceptable, given the record spending by both campaigns in the runup. Failure to take individual responsibility has now exacerbated the crime spree in the Midwest. Quality of life will continue to deteriorate, and people will vote with their feet instead. Hello Florida, Texas, and Tennessee.
It was so preventable.
Both Chicago and Wisconsin got the governments they deserve. “Soft-on-crime” candidates secured office with a majority vote from a minority of eligible voters. An apathetic public has only themselves to blame.
Van Wie Financial is fee-only. For a reason.
Gargantuan ships at sea do not turn on a dime (read: Titanic), nor do national economies. Instead, small course corrections, planned and executed intelligently, are required to navigate successfully to the destination. Experienced ship captains and global heads of state are charged with providing direction and orchestrating course corrections. Our currency (the U.S. Dollar) is being threatened, and we need to respond appropriately.
International trade developed rapidly in the global post-WWII economy. When financial stability was needed to facilitate burgeoning international trade, designating a widely trusted currency became necessary. The American economy and currency were leading the world, and in 1944 the Dollar was designated as Reserve Currency for international trade.
Trading in oil was increasingly important, and the Dollar was used for funding transactions. Importers converted their own currency into U.S. Dollars to finance transactions. Exporters then banked the Dollars received, or exchanged them into other currencies, including their own. This system proved tenable for decades, but along the way the USA was tripping over its own prosperity, with plenty of “help” from elected leaders.
Originally pegged to gold (the timeless international form of money), the U.S. Dollar was de-linked from gold by President Richard Nixon in 1971. At the same time, government spending ramped up astronautically. As a result, purchasing power of the Dollar declined steadily. Print money, spend money, print more money to cover spending. Lather, rinse, repeat. The predictable result was inflation, which has eroded more than 96% of our original purchasing power.
America’s spending cycle (and corresponding money printing) accelerated with advances in computer power. Eventually, FED Chairman Ben Bernanke said the quiet part out loud, when he explained that the Federal Reserve didn’t really print money, because electronics “allow it to produce as many U.S. dollars as it wishes at no cost.”
Over time, trading partners began to perform transactions in currencies other than Dollars. Twenty years ago, the amount of International Trade using Dollars was about 70%. It has fallen now to 59%, and the decline continues. Recently, China, Russia, Brazil, and other European and Asian have agreed to trade oil in various currencies.
Important for us to understand is that most countries of the World right now do not have confidence in Russia or China, and will not move away from the Dollar in a panic. Erosion will take time, but the economic Titanic is slowly changing course. Outlook uncertain.
Van Wie Financial is fee-only. For a reason.
All the way back in September of 2022, Congress and the IRS released inflation numbers used to determine important items such as Income Tax Brackets, Social Security COLAs (Cost-of-Living Adjustments), and various other items affecting virtually all Americans. At that time, I was upset that the entity charged with calculating the annual rate of inflation, the U.S. Department of Labor (DOL), again did not apply their calculation equally among affected areas of the economy. That would require applying a single inflation rate to all aspects of the U. S. Tax Code.
Not only has it not been applied across-the-board, but it keeps getting worse.
Perhaps the most noteworthy inflation number is the COLA applied to Social Security Benefits. This year’s 8.7% increase was welcome news to over 66 million people currently receiving benefits, as well as those preparing to file. Assuming the increase was reflective of the actual increase in our daily cost of living, to maintain an individual’s standard of living, tax brackets should be indexed identically to the Benefits increase. This did not happen.
Income Tax Brackets for 2023 were only increased by about 7%, leaving Social Security recipients with a tax increase amounting to a tax on the 1.7% difference between COLA Benefit increases and new tax brackets. Worse yet, the number of Social Security recipients that are subjected to income tax on those benefits increased. This phenomenon is a result of income-based means testing for taxing Social Security Benefits.
For decades now, taxpayers with an annual MAGI (Modified Adjusted Gross Income) exceeding $44,000 (Married filing jointly) are taxed on 85% of monthly Social Security Benefits. Had that $44,000 threshold been inflation-adjusted annually since the law was passed, the MAGI trigger would be more than $93,000 today, exempting millions of taxpayers from owing the additional tax.
Many other items in the Tax Code do not receive an annual inflation adjustment, and there are other provisions that adjust only every few years, as inflated price levels compound. As a result of these factors, thousands of Social Security Benefit recipients pay incrementally more income tax every year on additional Benefits resulting from inflation.
In our opinion, Social Security Benefits should be 100% tax-free, like the System was originally designed, and taxpayers were originally promised. However, if we are forced to pay tax on benefits, at least it should reflect inflation.
Van Wie Financial is fee-only. For a reason.
With March comes basketball, green beer, and …. a banking crisis? During the first full week of March 2023, two significant California-based banks (Silvergate and SVB) closed their doors due to insolvency. While banks do sometimes fail, we have a mechanism for the protection of depositors’ money. Failures are generally (with the exception of the 2008 Financial Crisis) one-offs, taken in stride by investors and the depositing public. This time, there are failures yet to come.
When failing banks are high-profile, such as the Silicon Valley Bank (SVB), the 16th largest bank in the country, that’s headline news. While SVB was the “go-to” bank for Tech Startups, Silvergate (the earlier failure) served the Crypto Industry. Is anyone else thinking, what could possibly go wrong?
Any ranking of risky ventures would most likely include Crypto and Business Startups. Another form of risk is incurred when there is too little diversification in an investment portfolio. With banks, their portfolio is a combination of loans to customers and internal reserve capital. SVB was mismanaged in both. Recent falling bond prices created a liquidity crisis, which might be survivable during good times, but causes trouble when withdrawals suddenly accelerate. That happened at SVB.
Because banking is a highly regulated industry, we expect State and Federal regulators to discover and correct problems before they become dangerous. Were regulators asleep at the wheel? You decide, as information is being released daily. In the case of Silvergate, not much information is being made public, as SVB is causing a gigantic distraction, due to its size.
While the FDIC (Federal Deposit Insurance Corporation) exists to protect depositors and is funded by insurance premiums paid by member banks, coverage limits are only up to $250,000 per account registration. In the case of SVB, many wealthy depositors had accounts far in excess of FDIC limits. This is where we can generally count on the Federal Government to make exceptions for their friends and donors, and once again they did.
Disregarding insurance coverage limits of $250,000, Janet Yellen’s Treasury announced that all SVB deposits would be reimbursed. Sure, they plan to pay the funds from the FDIC, but that will greatly reduce the reserves of the FDIC, which may have to cover additional failures in days to come. Then what? (Hint: they will come after the taxpayers — us.)
This is reminiscent of an old Saturday Night Live skit about the mythical First CityWide Change Bank, whose sole function was to make change (e.g., 4 quarters, two quarters and 20 nickels, or other combination for your dollar). When asked how they made money, the spokesman simply explained, “We make it up in volume.”
Van Wie Financial is fee-only. For a reason.
Nothing is certain, except death and taxes. We’ve all heard that, we believe it, and many of us have a notion as to its origin. According to Quote Investigatorâ, the exact origin remains uncertain. Among the often-attributed authors are Benjamin Franklin, Mark Twain, and Daniel Defoe.
In Washington, D.C., taxation is as polarizing as any issue, divided mostly along party lines. Democrats favor ever-higher taxes, and Republicans prefer lowering taxes, citing the Laffer Curve effect of increasing revenue as tax rates are cut. The tax-hiking crowd ignores econometrics, in favor of some mystical “fairness” and “equity” in society.
True to form, the Biden Administration has produced a proposal for dramatically increasing taxes. Ironically, the proposal has nothing to do with revenue generation. Thankfully, the new Republican House of Representatives considers the proposal D.O.A. In the spirit of the age-old “tax the rich” mantra, punitive provisions would raise the Corporate Tax rate from 21% to 28%, plus doubling the tax on profits earned overseas. Corporate stock buybacks, now taxed at 1%, would quadruple. Taxpayers with incomes of $1 Million+ would see Capital Gains tax rates nearly double, along with incurring a 25% minimum tax on total income.
Taxpayers earning more than $400,000 annually would see an increase in the top tax rate, from 37% to 39.6%. Also, for these people, the Obamacare Investment Tax would increase from 3.8% to 5%. Perhaps the most insidious tax proposal would apply a Wealth Tax to unrealized gains on assets. In a recent Blog, I called this Taxation Without Monetization.
As expected, Biden’s proposal reflects the Administration’s resentment of successful people and wealthy individuals. Strangely, these very taxpayers have become the Democrat voting base in recent years. Americans need to be vigilant about what will happen to them if “progressives” are again handed complete control of our government.
Perhaps the most insidious (and regressive) tax of all is the ever-higher prices we pay for necessities during inflationary times. Getting inflation under control should be the primary focus of the Administration, but that would require a reduction in spending. This proposed tax-and-spend package does the exact opposite.
Added Deficit Spending would increase our National Debt to $51 Trillion, and interest payments would exceed the annual budget for the Defense Department. These are government estimates, which are notoriously optimistic.
I find it interesting that Biden defines “the rich” as people earning more than $400,000 annually. Seems that is the exact salary of the President.
Van Wie Financial is fee-only. For a reason.