Achieving tax alpha and higher after tax returns on your investments

Achieving Tax Alpha

What is tax alpha?

Tax Alpha is the ability to achieve an additional return on your investments by taking advantage of a wide range of tax strategies as part of your comprehensive wealth management and financial planning.  As you know, it is not about how much you make but how much you keep. And tax alpha measures the efficiency of your tax strategy and the incremental benefit to your after-tax returns.

Why is tax alpha important to you?

The US has one of the most complex tax systems in the world. Navigating through all the tax rules and changes can quickly turn into a full-time job. Furthermore, the US budget deficit is growing exponentially every year. The government expenses are rising. The only way to fund the budget gap is by increasing taxes, both for corporations and individuals.

Obviously, our taxes pay our teachers, police officers, and firefighters, fund essential services, build new schools and fix our infrastructure. Our taxes help the world around us humming.  However, there will be times when taxes become a hurdle in your decision process. Taxes turn into a complex web of rules that is hard to understand and even harder to implement.

Achieving tax alpha is critical whether you are a novice or seasoned investor sitting on significant investment gains.  Making intelligent and well-informed decisions can help you improve the after-tax return of your investment in the long run.

Assuming that you can generate 1% in excess annual after-tax returns over 30-year, your will investments can grow as much as 32% in total dollar amount.

Tax alpha returns
Tax alpha returns

1. Holistic Financial Planning

For our firm, achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions is at the core of our service. Preparing you for your big day is not a race. It’s a marathon.  It takes years of careful planning and patience. There will be uncertainty. Perhaps tax laws can change. Your circumstances may evolve. Whatever happens, It’s important to stay objective, disciplined, and proactive in preparing for different outcomes.

At our firm, we craft a comprehensive strategy that will maximize your financial outcome and lower your taxes in the long run. We start with taking a complete picture of financial life and offer a road map to optimize your tax outcome. Achieving higher tax alpha only works in combination with your holistic financial plan. Whether you are planning for your retirement, owning a large number of stock options, or expecting a small windfall, planning your future taxes is quintessential for your financial success.

2. Tax Loss Harvesting

Tax-loss harvesting is an investment strategy that allows you to sell off assets that have declined in value to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction to your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

The real economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains.  Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

How does tax-loss harvesting work?

Example: An investor owns 1,000 shares of company ABC, which she bought at $50 in her taxable account. The total cost of the purchase was $50,000. During a market sell-off a few months later, the stock drops to $40, and the initial investment is now worth $40,000.

Now the investor has two options. She can keep the stock and hope that the price will rebound. Alternatively,  she could sell the stock and realize a loss of $10,000. After the sale, she will have two options. She can either buy another stock with a similar risk profile or wait 30 days and repurchase ABC stock with the proceeds. By selling the shares of ABC, the investor will realize a capital loss of $10,000. Assuming she is paying 15% tax on capital gains, the tax benefit of the loss is equal to $1,500.  Furthermore, she can use the loss to offset future gains in her investment portfolio or other sources.

3. Direct Indexing

Direct indexing is a type of index investing. It combines the concepts of passive investing and tax-loss harvesting. The strategy relies on the purchase of a custom investment portfolio that mirrors the composition of an index.

Similar to buying an index fund or an ETF, direct indexing requires purchasing a broad basket of individual stocks that closely track the underlying index.  For example, if you want to create a portfolio that tracks S&P 500, you can buy all or a smaller number of  500 stocks inside the benchmark.

Owning a basket of individual securities offers you greater flexibility to customize your portfolio.  First, you can benefit from tax-loss harvesting opportunities by replacing stocks that have declined in value with other companies in the same category. Second, you can remove undesirable stocks or sectors you otherwise can’t do when buying an index fund or an ETF. Third, direct indexing can allow you to diversify your existing portfolio and defer realizing capital gains, especially when you hold significant holdings with a low-cost basis.

4. Tax Location

Tax location is a strategy that places your diversified investment portfolio according to each investment’s risk and tax profile. In the US, we have a wide range of investment and retirement accounts with various tax treatments. Individual investment accounts are fully taxable for capital gains and dividends. Employer 401k, SEP IRA and Traditional IRA are tax-differed savings vehicles. Your contributions are tax-deductible while your savings grow tax-free. You only pay taxes on your actual retirement withdrawals. Finally, Roth IRA, Roth 401k, and 529 require pre-tax contributions, but all your future earnings are tax-exempt. Most of our clients will have at least two or more of these different instrument vehicles.

Now, enter stocks, bonds, commodities, REITs, cryptocurrencies, hedge funds, private investments, stock options, etc. Each investment type has a different tax profile and carries a unique level of risk.

At our firm, we create a customized asset allocation for every client depending on their circumstances and goals. Considering the tax implications of each asset in each investment or retirement account, we carefully crate our tax location strategy to take advantage of any opportunities to achieve tax alpha.

5. Smart tax investing

Smart tax investing is a personalized investment strategy that combines various portfolio management techniques such as tax-loss harvesting, asset allocation and asset location, diversification, dollar-cost averaging, passive vs. active investing, and rebalancing.  The main focus of tax mindful investing is achieving a higher after-tax return on your investment portfolio. Combined with your comprehensive financial planning, smart-tax investing can be a powerful tool to elevate your financial outcome.

Successful strategies for (NOT) timing the stock market

Timing the stock market

Timing the stock market is an enticing idea for many investors.  However, even experienced investment professionals find it nearly impossible to predict the daily market swings, instant sector rotations, and ever-changing investors’ sentiments. The notion that you can perfectly sell at the top of the market and buy at the bottom is naïve and oftentimes leads to bad decisions.

The 24-hour news cycle is constantly bombarding us. The speed and scale of information could easily bounce the stock market between desperation, apathy, and fear to euphoria, FOMO, and irrational exuberance.

In that sense, the market volatility can be unnerving and depressing. However, for long-term investors, trying to time the market tops and bottoms is a fool’s errand. Constantly making an effort to figure out when to get in and get out can fire back. There is tremendous evidence that most investors reduce their long-term returns trying to time the market. Market timers are more likely to chase the market up and down and get whipsawed, buying high and selling low.

The hidden cost of timing the stock market

There is a hidden cost in market timing.  According to Fidelity, just missing 5 of the best trading days in the past 40 years could lower your total return by 38%. Missing the best 10 days will cut your return in half.

Source: Fidelity
Source: Fidelity

For further discussion on how to manage your portfolio during times of extreme market volatility, check my article on “Understanding Tail Risk

Rapid trading

Today’s stock market is dominated by algorithm trading platforms and swing traders with extremely short investment horizons.  Most computerized trading strategies hold their shares for a few seconds, not even minutes. Many of these strategies are run by large hedge funds. They trade based on market signals, momentum, and various inputs built within their models. They can process information in nanoseconds and make rapid trades. The average long-term investors cannot and should not attempt to outsmart these computer models daily.

Reuters calculated that the average holding period for U.S. shares was 5-1/2 months as of June 2020, versus 8-1/2 months at the of end-2019. In 1999, for example, the average holding period was 14 months. In the 1960s and 1970, the investors kept their shares for 6 to 8 years.

Timing the stock market
Timing the stock market

 

The market timing strategy gives those investors a sense of control and empowerment, It doesn’t necessarily mean that they are making the right decisions.

So, if market turmoil gives you a hard time, here are some strategies that can help you through volatile times.

Dollar-cost average

DCA is the proven approach always to be able to time the market.  With DCA, you make constant periodic investments in the stock market. And you continue to make these investments whether the market is up or down. The best example of DCA is your 401k plan. Your payroll contributions automatically invest every two weeks.

Diversify

Diversification is the only free lunch in investing. Diversification allows you to invest in a broad range of asset classes with a lower correlation between them.  The biggest benefit is lowering the risk of your investment portfolio, reducing volatility, and achieving better risk-adjusted returns.  A well-diversified portfolio will allow your investments to grow at various stages of the economic cycle as the performance of the assets moves in different directions.

Rebalance

Rebalancing is the process of trimming your winners and reinvesting in other asset classes that haven’t performed as successfully.  Naturally, one may ask, why should I sell my winners? The quick answer is diversification. You don’t want your portfolio to become too heavy in a specific stock, mutual fund, or ETF. By limiting your exposure, you will allow yourself to realize gains and buy other securities with a different risk profile.

Buy and hold

For most folks, Buy and Hold is probably the best long-term strategy. As you saw earlier,  there is a huge hidden cost of missing out on the best trading days in a given period. So being patient and resilient to noise and negative news will ultimately boost your wealth. You have to be in it to win it.

Tax-loss harvesting

If you are holding stocks in your portfolio, the tax-loss harvesting allows you to take advantage of price dips and lower your taxes. This strategy works by selling your losers at a loss and using the proceeds to buy similar security with an identical risk-reward profile. At the time of this article, you can use capital losses to offset any capital gains from the sale of profitable investments. Furthermore,  you can use up to $3,000 of residual capital loss to offset your regular income. The unused amount of capital loss can be carried forward in the next calendar year and beyond until it’s fully used.

Maintain a cash reserve

I advise all my clients to maintain an emergency fund sufficient to cover at least 6 months worth of expenses. An emergency fund is especially critical If you are relying on your investment portfolio for income. The money in your emergency fund will help you withstand any unexpected market turbulence and decline in your portfolio balance. A great example would be the rapid market correction in March 2020 at the onset of the coronavirus outbreak. If you needed to sell stocks from your portfolio, you would be in tough luck. But if you had enough cash to keep afloat through the crisis, you would have been in a perfect position to enjoy the next market rebound.

Focus on your long term goals

My best advice to my clients who get nervous about the stock market is to focus on what they can control.  Define your long-term goals and make a plan on how to achieve them. The stock market volatility can be a setback but also a huge opportunity for you. Follow your plan no matter what happens on the stock market. Step back from the noise and focus on strengthening your financial life.

Understanding Tail Risk and how to protect your investments

Understanding tail risk

What is Tail Risk?

Tail Risk is the possibility of suffering large investment losses due to sudden and unforeseen events. The name tail risk comes from the shape of the bell curve. Under normal circumstances, your most likely investment returns will gravitate in the middle of the curve. For long term investors, this will represent your average expected return. The more extreme returns have a lower probability of occurring and will taper away toward the end of the curve.

Understanding tail risk
Source: Pimco

The tail on the far-left side represents the probability of unexpected losses. The far-right represents the most extreme outcomes of substantial investment gains. For long-term investors, the ideal portfolio strategy will seek to minimize left tail risk without restricting the right tail growth potential.

Why is tail risk important?

Intuitively, we all want to be on the ride side of the bell curve. We want to achieve above-average returns and occasionally “hit the jackpot” with sizeable gains.

In real life, abrupt economic, social, and geopolitical events appear a lot more frequently than a rational human mind would predict. Furthermore, significant market shocks have been occurring about every three to five years resulting in “fatter” tails.

Also known as “Black Swans, they are rare and unique. These “one-off” events impose adverse pressure on your investment portfolio and create risk for outsized losses. Tail risk events bring a massive amount of financial and economic uncertainty and often lead to extreme turbulence on the stock market.

The Covid outbreak, Brexit, the European credit crisis, the collapse of Lehman Brothers, the Enron scandal, the US housing market downfall, and the 9/11 terrorist attacks are examples of idiosyncratic stock market shocks. Very few experts could have predicted them. More notably, they caused dramatic changes to our society and our economy, our consumer habits, and the way we conduct business.

Assessing your tail risk exposure

Retirees and those close to retirement, people who need immediate liquidity, executives, and employees holding a large amount of corporate stock are more susceptible to tail risk events. If you fall into one of these categories, you need to review your level of risk tolerance.

Investing is risky. There are no truly risk-free investments. There are only investments with different levels of risk. It is impossible to avoid risk altogether. The challenge for you is to have a reasonably balanced approach to all the risks you face. Ignoring one risk to help you prevent another risk does not mean you are in the clear.

Winners and losers

It is important to remember that every shock to the system leads to winners and losers. For example, the covid outbreak disproportionately hurt leisure, travel, retail, energy, and entertainment businesses. But it also benefited many tech companies as it accelerated the digital transformation. As bad as it was, the global financial crisis damaged many big and small regional banks. But it also opened the door for many successful fintech companies such as Visa, Mastercard, PayPal, and Square and exchange-traded fund managers like BlackRock and Vanguard. The aftermath of 9/11 drove the stock market down, but it led to a boost in defense and cybersecurity stocks.

Know your investments

The first step in managing your tail risk is knowing your investments. That is especially important if you have concentrated positions in a specific industry, a cluster of companies, or a single stock. Black Swan events could impact different stocks, sectors, and countries differently. For instance, the Brexit decision mostly hurt the performance of the UK and European companies and had no long-term effect on the US economy.

Know your investment horizon

Investors with a long-term investment horizon are more likely to withstand sudden losses. The stock market is forward-looking. It will absorb the new information, take a hit, and move on.

I always give this as an example. If you invested $1,000 in the S&P 500 index on January 1, 2008, just before the financial crisis, you would have doubled your money in 10 years. Unfortunately, if you needed your investment in one or two years, you would have been in big trouble. It took more than three years to recover your losses entirely.

Diversify

Never put all your eggs in one basket. The most effective way to protect yourself from unexpected losses is diversification. Diversification is the only free lunch you will ever get in investing. It allows you to spread your risk between different companies, sectors, asset classes, and even countries will allow your investment portfolio to avoid choppy swings in various market conditions. One prominent downside of diversification is that while you protect yourself from the left tail risk, you also limit the right tail potential for outsized returns.

Hold cash

Keeping cash reserves is another way to protect yourself from tail risk. You need to have enough liquidity to meet your immediate and near-term spending needs. I regularly advise my clients to maintain an emergency fund equal to six to twelve months of your budget. Put it in a safe place, but make sure that you still earn some interest.

Remember what we said earlier. There is no risk-free investment – even cash. Cash is sensitive to inflation. For instance, $100,000 in 2000 is worth only $66,800 in 2020. So, having a boatload of cash will not guarantee your long-term financial security. You must make it earn a higher return than inflation.

Furthermore, cash has a huge opportunity cost tag. In other words, by holding a large amount of money, you face the risk of missing out on potential gain from choosing other alternatives.

US Treasuries

US Government bonds have historically been a safe haven for investors during turbulent times. We have seen the demand for treasuries spiking during periods of extreme uncertainty and volatility. And inversely, investors tend to drop them when they feel confident about the stock market. Depending on their maturity, US treasuries may give you a slightly higher interest than holding cash in a savings account.

While offering some return potential, treasuries are still exposed to high inflation and opportunity cost risk. Also, government bonds are very sensitive to changes in interest rates. If interest rates go up, the value of your bonds will go down. On the other hand, when interest rates go down, the value of your bonds will decrease.

Gold

Gold is another popular option for conservative investors. Similar to treasuries, the demand for gold tends to go up during uncertain times. The faith for gold stems from its historical role as a currency and store of value. It has been a part of our economic and social life in many cultures for thousands of years.

As we moved away from the Gold standard, the Gold’s role in the economy has diminished over time. Nowadays, the price of gold is purely based on price and demand. One notable fact is that gold tends to perform well during periods of high inflation and political uncertainty.

In his 2011 letter to shareholders of Berkshire Hathaway, Warren Buffet described gold as an “asset that will never produce anything, but that is purchased in the buyer’s hope that someone else … will pay more for them in the future…..If you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Buying Put Options to hedge tail risk

Buying put options om major stock indices is an advanced strategy for tail risk hedging. In essence, an investor will enter into an option agreement for the right to sell a financial instrument at a specified price on a specific day in the future. Typically, this fixed price known as a strike price is lower than the current levels where the instrument is trading. For instance, the stock of XYZ is currently trading at $100. I can buy a put option to sell that stock at $80 three months from now. The option agreement will cost me $2. If the stock price of XYZ goes to $70, I can buy it at $70 and exercise my option to sell it at $80. By doing that, I will have an immediate gain of $10. This is just an illustration. In real life, things can get more complicated.

The real value of buying put options comes during times of extreme overvaluation in the stock market. For the average investor, purchasing put options to tail risk hedging can be expensive, time-consuming, and quite complicated. Most long-term investors will just weather the storm and reap benefits from being patient.

Final words

Managing your tail risk is not a one-size-fits-all strategy. Black Swam events are distinctive in nature, lengh, and magnitude. Because every investor has specific personal and financial circumstances, the left tail risk can affect them differently depending on a variety of factors. For most long-term investors, the left tail and right tail events will offset each other in the long run. However, specific groups of investors need to pay close attention to their unique risk exposure and try to mitigate it when possible.

Benefits and drawbacks to buying Indexed Universal Life Insurance

Indexed Universal Life Insurance IUL

Today, I am going off the beaten path for me and will discuss the pros and cons of buying Indexed Universal Life Insurance. As a fee-only advisor, I do not sell any insurance or commission-based products. However, on numerous occasions, I have received requests from clients to review their existing insurance coverage. I certainly do not know every IUL product out there. And I might be missing some of the nuances and differences between them. My observation is that IUL is not suitable for the average person due to its complexity and high cost. And yet, the IUL might be the right product for you if you can take advantage of the benefits that it offers. 

Retirement Calculator

What is an Indexed Universal Life Insurance (IUL)?

Indexed Universal Life is a popular insurance product that promises protection coverage with stock market-like performance and a zero-downside risk. Like other universal life insurance, IUL offers a death benefit and a cash value. Your cash value account can earn interest based on the performance of a specific stock market index such as the S&P 500, Dow Jones Industrial Average, the Nasdaq 100, and Russell 2000.

IUL Illustration rate

IUL policies use an illustration rate for advertising and hypothetically projecting the policy values in their sales materials. The Illustration rate is the fixed rate derived from historical performance. Usually, the illustration rate ranges between 5% and 10%.

Is IUL right for me?

On the surface, Indexed Universal Life Insurance sounds like a great deal. You receive a stock market upside with zero risks for losses. Nevertheless, IUL comes with some severe caveats.

Let’s break down the main benefits and drawbacks of IUL.

 Benefits of Indexed Universal Life Insurance

Tax-Deferred Accumulation

Index Universal Life Insurance allows you to grow your policy cash value and death benefit on a tax-deferred basis. Typically, you will not owe income taxes on the interest credited to your cash value and death benefit.

Tax-Free Distribution

Life Insurance, in general, is a lucrative tool for legacy planning. With IUL, your policy beneficiaries will receive the death benefit tax-free. As long as you maintain your insurance premiums and don’t take outsized loans, you can pass tax-free wealth to the next generation.

Access to a cash value

You can always withdraw your policy basis (original premiums paid) tax-free. In most cases, you can also access your cash value through tax-favorable policy loans or withdrawals. In case of emergency, you may borrow from your indexed universal life insurance policy. You can access your cash value without any penalty regardless of your age.

Supplemental Retirement Income

You can use the cash value from your policy as a source of supplemental retirement income.  You can also use it to cover future medical expenses.

Limited downside risk

IUL offers protection against stock market volatility. An IUL delivers stock market-linked gains without the risks of losing principal due to the stock market declines. With the IUL’s principal-protection guarantee, your annual gains are locked in. Your principal cash value remains the same, even if the stock market goes down.

A guaranteed minimum rate

Many IUL policies come with a guaranteed minimum annual interest rate. This rate is a floor of how much you can earn every year. The guaranteed allows you to receive a certain percentage regardless of how the market performs. This floor rate depends on the specific insurance, and it could vary between 0% and 2%.

Drawbacks of Indexed Universal Life Insurance

IUL is complex

IUL is an extremely complex insurance product. There are many moving parts in your UIL policy, making it confusing and hard to understand. Most sales illustration packages portray an ideal scenario with non-guaranteed average market performance figures. In reality, between your annual premiums, cap rates, floors, fees, market returns, cash value accumulation, riders, and so on, it is tough to predict the outcome of your insurance benefits.

Upfront Commissions

The people who sell IUL are highly trained sales professionals who may not be qualified to provide fiduciary financial advice. The IUL comes with a hefty upfront commission, which is often buried in the fine print and gets subtracted from your first premium payment.

IUL has high fees

The policy fees will shock you and eat your lunch literally. I have personally seen charges in the neighborhood of 11% to 13% annually. These fees will always reduce the benefits of your annual premium and earned interest.

Limited earnings potential

IUL policies will typically limit your stock market returns and will exclude all dividends. Most IULs offer some combination of participation rate and capped rate in comparison to the illustration rate used in their marketing materials.

Participation Rate is the percentage of positive index movement credited to the policy. For example, if the S&P 500 increased 10% and the IUL has an annual participation rate of 50%, your policy would receive 5% interest on the anniversary date.

Cap Rate is the maximum rate that you can earn annually. The cap rate can vary significantly from policy to policy and from insurance provider to the next.

 Why capped upside is an issue?

The problem with cap rates and participation rates is they limit your gains during, especially good years. Historically, the stock market returns are not linear and sequential, as the policy illustration rates suggest. In the 40 years between 1980 and 2019, the stock market earned an average of 11.27% per year. During this period, there were only eight years when the stock market had negative returns or 20% of that period. There were only seven years when the stock market posted returns between 0% and 10%. And there were 25 years when the stock market earned more than 10% per year. In 17 of those 25 periods, the stock market investors gained more than 20% or 42% of the time.

In other words, historically, the odds of outsized gains have been a lot higher than the odds of losses.

However, as humans, the pain of losing money is a lot stronger than the joy of gaining.

In effect, long-term IUL policyholders will give up the potential of earning these outsized profits to reduce their anxiety and stress of losing money.

Surrender charges

IULs have hefty surrender charges. If you change your mind in a couple of years and decide to cancel your policy, you may not be able to receive the full cash value. Before you get into a contract, please find out the surrender charges and when they expire.

Expensive Riders

Indexed Universal Life Insurance typically offers riders. The policy riders are contract add-ons that provide particular benefits in exchange for an additional fee. These provisions can include long-term care services, disability waivers, enhanced performance, children’s’ term insurance, no-lapse guarantee, and many more. The extra fee for each rider will reduce your cash value, similar to the regular policy fees. You need to assess each rider individually as the cumulative cost may outweigh your benefit and vice versa,

Cash value withdrawals reduce your death benefit

In most cases, you might be able to make a tax-free withdrawal from the cash value of your IUL policy. These withdrawals are often treated as loans. However, legacy-minded policyholders need to remember that withdrawing your cash value reduces your beneficiaries’ death benefit when you pass away.

Potential taxable income

There is still a chance to pay taxes on your IUL policy. If you let your policy lapse or decide to surrender it, the money you have withdrawn previously could be taxable. Withdrawals are treated as taxable when they exceed your original cost basis or paid premiums.

Five Investment Ideas for 2021

Investment Ideas for 2021

Investment ideas for 2021.  2020 was a challenging and transformative year. The world was battling with a new virus that spread nondiscriminatory around the globe. Entire countries shut down to protect themselves from the hidden enemy. As it happens always in human history, crisis creates opportunities.  Established businesses had to adapt to the new regime and emerging companies offered innovative solutions.

In my article  “Investment ideas for 2020“, I set my expectations for double-digit growth in e-commerce, cloud computing, cybersecurity, logistics, work from home, digital payments, 5G, and socially responsible investing. These sectors played a central role in our fight with covid 19 and will impact the economy in the foreseeable future. You can read the full article here.

Today I am offering you the second article in this investment ideas series.  We will focus on areas that will benefit from the reopening of the world economies. With the covid vaccine reaching more people in more countries, we will observe a coordinated global recovery. The unprecedented global financial stimulus and near “boiling” penned-up demand will drive higher  economic activity and consumer spending,

1. Utilities

Utilities are my top investment ideas for 2021. Utility stocks received very little love from the investment community in 2020. They came out of favor despite being one of the best performing sectors the previous decade.  Investors worried about reduced business activity and deteriorating consumer health caused by the covid pandemic. Many of these fears turned out to be immaterial. And most utilities posted stable revenue and earnings in 2020. What happened?  More people worked from home, which caused high home utility bills. Low-income families received various stimulus payments and forbearance options, which allowed them to pay their bills. Even after the sharp drop in March, the US manufacturing and non-manufacturing activity rebounded quickly to pre covid levels.

In spite of their slow growth, historically, utilities have followed the broader stock market very closely. Furthermore, most established utility companies pay a stable dividend in the range of 3% to 4%. They are an attractive option for income-seeking investors. Some experts consider utilities as bond proxies. They tend to have a lower correlation with the rest of the stock market.

US renewable energy consumption is growing

Where we stand today, many utilities are in the front and center of our fight against climate change and global warming. Many utilities aggressively move towards renewable energy sources such as solar panels, hydroelectric dams, wind turbines, geothermal and biomass energy. Renewable energy collectively provided more power than coal plants for the first time in 2019.

Utilities remain deeply dependent on natural gas and fossil fuel. However, I believe that further innovation in battery storage and capacity utilization will continue to boost renewable energy growth. Furthermore, for the firm believers in electric vehicles and clean energy, the boring old-fashioned utilities will become quintessential in moving the needle towards widespread adoption.

2. Healthcare and Life Science

2020 was both ruthless and transformational for the healthcare industry. Healthcare workers around the world have been and remain in the frontline battle against Covid-19. We all have seen images of doctors and nurses sharing pictures after an exhausting shift in their covid unit. I know healthcare workers (including my dad) who lead the fight every day. As someone married to a physician, I have a close-up experience with the challenges and transformations that occurred in the past 12 months.

New chapter for healthcare

Telehealth will become the norm in general medicine. As more professionals and patients become comfortable with the use of technology, telemedicine will offer access to more affordable and better-quality care for many people worldwide. For healthcare systems, it is a chance to cut costs, improve burnout rates amongst doctors and hire top talent without the need to relocate.

Medical Devices. 2021 and 2022 can see a surge for elective and nonessential medical procedures. The global pandemic forced many people and hospitals to delay non-life-threatening, elective, and cosmetic surgeries and procedures. I believe that as we get a tighter grip on the virus through vaccination and rollout of new viral drugs, we can see a slow and steady growth on this side of healthcare.

New Treatments. The pharmaceutical and biotech industry is in the early innings of developing a new generation of patient treatment. From gene sequencing and immunotherapies to multi-cancer screening offer a unique opportunity in the battle against cancer and other rare diseases.

3. Financials

I started writing this article in the first weeks of 2021 before the rally in banks, which was caused by the rise in US treasury yields. As a result, most banks are now trading near or above pre-covid levels.  Nevertheless, financials are one of our investment ideas for 2021.

Despite initial concerns over liquidity and credit losses, banks maintained a strong balance sheet and reported revenue and earnings well above analyst estimates. The unprecedented stimulus has flooded the financial system with cash. The US economy’s cash supply went from $3.9T pre covid to $18.1T as of January 31, 2021. A large portion of the cash is sitting with banks waiting to be deployed.

US M1 Supply 

Furthermore, most banks took significant loan loss provision reserves. For example, Bank of America alone took $11.3 billion in reserves in 2020 versus $3.6 billion in 2019. I expect that the banks will release most of these provisions, which they can use to pay higher dividends, share buybacks, and improve operational efficiencies.

U.S. Bank Stocks – Provisions for Loan Losses (2019-2020)

Before you get too excited about investing in banks, remember that the entire financial industry is undergoing a massive digital transformation.  The old brick and mortar branches are slowly losing their footprint. PayPal and Square are taking market shares in the growing digital payment space. For example, PayPal reported 20% higher revenue in 2020, Square doubled it. While Bank of America dropped revenue by -5%. Therefore, expect the bank of the future to be leaner, less physical, more personalized, more digital, and more focused on user experience.

4. Discretionary spending

Millions of individuals and families have cooped-up in our homes for more than a yearAs many of us were unable to travel and spend time with our friends and family, we will observe a significant increase in discretionary spending as the covid vaccine distribution reaches more people worldwide. Furthermore, the $1.9 trillion Covid relief bill will put cash in the hands of many struggling US families. The latest round of stimulus promises $1,400 payments and child credits.

Bloomberg Economics estimates that Americans have accumulated $1.7 trillion in excess savings since the beginning of the pandemic through January 2021.

With the world economies reopening, discretionary spending will continue to rise.  Therefore, I expect consumers to spend more discretionary income on travel, leisure, wellbeing, luxury goods, 5G phones and gadgets, and home improvement. For one, I cannot wait to be able to travel again.

5. Technology

Technology remains firmly one of our top investment ideas for 2021. Tech stocks will continue to dominate the stock markets and the US economy. The covid pandemic boosted the role of technology in our daily lives. Tech giants were in a unique position in 2020. Their strong balance sheet and ability to adapt quickly accelerated their customers’ awareness and adoption.  From ordering food and groceries online, applying for a mortgage loan online to digital signature, voice control, video calls, and 5G, technology is everywhere.

The covid outbreak pushed every single business sector towards digital transformation.  As a result, more private businesses and government organizations are embracing data analytics, cloud computing, cybersecurity, customer service, experience management to improve their service, understand their customers and strengthen their data. Gartner projects that spending on public cloud services will grow by 18.4% in 2021 to total $304.9 billion, up from $257.5 billion in 2020. Furthermore, the expansion of 5G networks will set the stage for significant innovations in autonomous driving, connected devices, smart homes, artificial intelligence, and virtual / augmented reality.

 

Roth IRA Contribution Limits 2021

Roth IRA Contribution Limits for 2021

The Roth IRA contribution limits for 2021 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

Roth IRA income limits for 2021

Roth IRA contribution limits for 2021 are based on your annual earnings. If you are single and earn $125,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $125,000 and $140,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $198,000.  If your aggregated gross income is between $198,000 and $208,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

Roth IRA allows you to make after-tax contributions towards retirement. In comparisons. Traditional IRA has the same annual contributions limits. The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and take full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

IRA Contribution Limits 2021

IRA Contribution Limits for 2021

The IRA contribution limits for 2021 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

What is an IRA?

IRA or Traditional IRA is a tax-deferred retirement savings account that allows you to make tax-deductible contributions to save towards retirement. Your savings grow tax-free. You do not owe taxes on dividends and capital gains. Once you reach retirement age, you can start taking money out of the account. All distributions from the IRA are taxable as ordinary income in the year of withdrawal.

IRA income limits for 2021

The tax-deductible IRA contribution limits for 2021 are based on your annual income. If you are single and earn $125,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $125,000 and $140,000 you can still make contributions but with a smaller amount.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $198,000.  If your aggregated gross income is between $198,000 and $208,000 you can still make reduced contributions.

Spousal IRA

If you are married and not earning income, you can still make contributions. As long as your spouse earns income and you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation. Keep in mind that, your combined contributions can’t be more than the taxable compensation reported on your joint return.

IRA vs 401k

IRA is an individual retirement account.  401k plan is a workplace retirement plan, which is established by your employer. You can contribute to a 401k plan if it’s offered by your company.  In comparison, anyone who is earning income can open and contribute to a traditional IRA regardless of your age.

IRA vs Roth IRA 

Traditional and Roth IRA have the same annual contribution limits.  The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. In comparison. Roth IRA allows you to make after-tax contributions towards retirement. Another difference, your Traditional IRA retirement savings grow tax-deferred, while Roth IRA earnings are tax-free.

 

Investment ideas for 2020

Investment ideas for 2020

Investment ideas for 2020 and beyond. Learn what trends will drive the stock market in the next decade.

Disruption creates opportunity

 2020 has been challenging in multiple ways. The global pandemic changed our lives. We have adapted rapidly to a brand new world. Six months through the outbreak, it is almost unthinkable to go back to where things were before. The covid pandemic accelerated many habits and trends that we were making strides in our lifestyle.

With the world getting closer to a covid vaccine, I want to offer you several investment ideas based on how our life we look like after the pandemic. Technology is bringing a lot of changes. It opens opportunities that have been unimaginable before. All these secular tailwinds make me feel optimistic about the future of the U.S. economy and the stock market since we are already leaders in technology, healthcare, and financial services.

Digital everything

Firstly, my strongest investment idea for 2020 is digital expansion. From online shopping through mobile banking to remote learning, home fitness, and telemedicine, the digital transformation is here to stay. Moreover, we can order our groceries online. And get our dinner delivered at our front door.  Talk to our doctor over Zoom. Take an online fitness class. And deposit our checks on our phone. You can even buy a new house or get a mortgage refi without leaving your home. My two-year-old son knows how to use my laptop by now.

E-commerce has been steadily growing over the years. From merely 4% in 2010, e-commerce now has a 12% share of the total U.S. retail sales in 2020. Even after the covid pandemic, e-commerce has barely scratched the surface and has a massive runway for expansion. Furthermore, besides the U.S. and China, e-commerce is just beginning to spread in the rest of the world. Digital opportunities are still limitless.

The businesses that can rapidly adapt to these changes will become the next industry leaders in their respective fields.

Same day delivery

For all of you, Amazon, Walmart, Costco, and Target fans out there, same-day delivery will become an industry-standard sooner than you think. All major retailers are moving in this direction, and smaller competitors must catch up very quickly to stay in the game.

Instacart, who is the pioneer of same-day delivery, has existing relationships with Walmart, Safeway, Costco, CVS, Kroger, Loblaw, Aldi, Publix, Sam’s Club, Sprouts, and Wegmans. Amazon is already in the running, while more competitors such as Uber and DoorDosh are starting to make strides in the same direction.

Distribution and logistics

With commerce moving quickly from physical retail to online shopping, your local Sears, JC Penny, Neiman Marcus, and Stein Mart will become distribution centers for the e-commerce giants. I visited our local Nordstrom store for the first time in 8 months. Half of their first floor was covered with shipping boxes. Make your own conclusions.

Retailers of all sizes will need to master the art of logistics. They will need to learn how to move goods quickly and cost-efficiently around to country to meet customer demands.

Digital payments

Digital payments is one of our strongest investment ideas for 2020 and the next decade. Major card payment networks comprise barely 12% of the total world payments. Still, 29% of all these payments are in cash, while the remaining 59% are made through bank and wire transfers. I see an enormous opportunity in the growth of digital payments. Within the next decade, the physical credit card will become archaic. Coming soon, we will simply make our payments through digital wallets, Q.R. codes, voice control, and even face recognition.

Cloud computing

The digital transformation requires an enormous amount of data storage and I.T. infrastructure. Every single day, the humankind sends 500 million tweets, 294 billion emails, and 65 billion messages on WhatsApp. We make 5 billion Google searches a day. In 2020 the digital universe is going to reach 44 zettabytes. By 2025, experts estimate that the world will create 463 exabytes of data each day. That’s the equivalent of watching 212,765,957 DVDs per day!

To support this data demand, the global annual spending for cloud computing will grow from $371.4 billion in 2020 to $832.1 billion in 2025. That is 17.5% average yearly growth in the next five years.

Cybersecurity

Cybersecurity is no longer optional. It is a necessity for both individuals and businesses. The digital growth is bringing bad actors looking to profit from our fears and weaknesses. Protecting your data is critical for safely navigating the digital universe.

Here are some numbers. The 2019 U.S. President’s budget added $15 billion for cybersecurity. Microsoft has committed to spending $1 billion annually for safeguarding their customers’ data. The size of the cybersecurity market was at $161.07 billion in 2019. It will reach $363.05 billion by 2025, with an annual growth of 14.5%. Therefore, cybersecurity becomes one of my best investment ideas for 2020 and beyond.

Automation and robotics

There are currently almost 6 million job openings in the U.S. and 1.2 million in Germany. In Japan, there are 1.5 vacancies for every job applicant. Therefore, with labor shortages around the world, there is a strong case for more manufacturing automation and robotics. Companies will push for more automation to provide faster service, better quality control, enhance job safety, meet unexpected demand surges, and keep profit margins high. Today’s general-purpose robots can control their movement to within 0.10 millimeters. The future generation will have a repeatable accuracy of 0.02 millimeters and could go even lower. Advanced sensor technologies and data connectivity will therefore allow robots to take on tasks that are not currently available in real-time.

5G

Another investment idea for 2020 is 5G. The 5G is the next-generation mobile network and the new global wireless standard. For us, the consumer, the 5G, will bring higher speed, better responsiveness, and more reliability to our phone calls, text messaging, video conferencing, and home internet. Initial projections estimate that we will have a 10X higher speed than current levels. Moreover, 5G will take the world of connected devices to the next level. For instance, the growing network of smart homes, devices, smartwatches, speakers, cameras, and connected cars can dramatically change the way we interact with the rest of the world.

Autonomous driving

One of the primary beneficiaries of 5G will be autonomous driving. Driverless cars require a huge amount of real-time data – sensors, GPS, traffic, weather, vehicle to vehicle, and vehicle-to-infrastructure communication. The 5G network alongside cloud computing capabilities will accommodate more driverless cars on the road. Several companies, above all, are pioneering the autonomous driving efforts – from Tesla to Google and Uber. While still unproven and controversial, I could envision early adoption of driverless cars in smaller communities such as college campuses, assisted living communities, and amusement parks. Furthermore, the second wave will expand to robotaxis and commercial short- and long-haul vehicles.

Work from home (anywhere)

You probably got a taste of working from home during the covid lockdown. While WFH is quite popular in California, but it was not as common in other parts of the country. Google, Twitter, Facebook, and other big tech companies are not calling their employees back to the office until the Summer of 2021.

During the Spring and Summer of 2020, we saw a huge spike in housing demand in suburban areas near large metropolitan cities – Marin and Contra Costa County near San Francisco, The Hamptons and Fairfield County, CT near New York City. Furthermore, we also saw a massive demand for remodeling, gardening, and various house improvement projects. Home fitness apps such as Peloton have more doubled their active users in just one year. Athletic apparel giants like Nike and Lululemon continue to attract new customers and gain market share.

Working from home is here to stay. Both public organizations and private companies will have to adapt to this trend. New leaders will emerge, and old vanguards will vanish. To survive in the WFH economy, the new office will turn from a cubicle maze to a collaborative space.

Employers can look for talent not only in the local communities but everywhere in the world. Workers will avoid being in traffic for 2 – 3 hours. Productivity will get an enormous boost by improving work-life balance and remote team collaboration.

Socially responsible investing

Socially responsible investing has been building a strong base in the past decade. It is no longer a niche investment endeavor for altruistic investors. According to Global Sustainable Investment Alliance, strategies that take a company’s environmental, social, and governance factors into consideration — grew to more than $30 trillion in 2018 and expected to grow to $50 trillion over the next two decades.  For example, reporting transparency, green technologies, community support, sustainable operations, carbon neutrality, employee satisfaction, and customer wellbeing will become flagship criteria by how corporate managers will be evaluated in the future. Furthermore, the Security and Exchange Commission is evaluating a playbook to standardize the sustainability disclosure between various sectors and public companies. We will continue to see a steady push towards organic farming, renewable energy adoption, electric vehicle expansion, and community engagement.

 

IRA Contribution Limits 2020

IRA contribution limits 2020

The IRA contribution limits for 2020 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

What is an IRA?

IRA or Traditional IRA is a tax-deferred retirement savings account that allows you to make tax-deductible contributions to save towards retirement. Your savings grow tax-free. You do not owe taxes on dividends and capital gains. Once you reach retirement age, you can start taking money out of the account. All distributions from the IRA are taxable as ordinary income in the year of withdrawal.

IRA income limits for 2020

The tax-deductible IRA contribution limits for 2020 are based on your annual income. If you are single and earn $124,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $124,000 and $139,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $196,000.  If your aggregated gross income is between $196,000 and $206,000 you can still make reduced contributions.

Spousal IRA

If you are married and not earning income, you can still make contributions. As long as your spouse earns income and you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation. Keep in mind that, your combined contributions can’t be more than the taxable compensation reported on your joint return.

IRA vs 401k

IRA is an individual retirement account.  401k plan is a workplace retirement plan, which is established by your employer. You can contribute to a 401k plan if it’s offered by your company.  In comparison, starting in 2020, anyone who is earning income can open and contribute to a traditional IRA regardless of your age.

IRA vs Roth IRA 

Traditional and Roth IRA have the same annual contributions limits.  The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. In comparison. Roth IRA allows you to make after-tax contributions towards retirement. Another difference, your Traditional IRA retirement savings grow tax-deferred, while Roth IRA earnings are tax-free.

 

Roth IRA Contribution Limits 2020

Roth IRA contribution limits for 2020

The Roth IRA contribution limits for 2020 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

Roth IRA income limits for 2020

Roth IRA contribution limits for 2020 are based on your annual earnings. If you are single and earn $124,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $124,000 and $139,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $196,000.  If your aggregated gross income is between $196,000 and $206,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

Roth IRA allows you to make after-tax contributions towards retirement. In comparisons. Traditional IRA has the same annual contributions limits. The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and take full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

Navigating the market turmoil after the Coronavirus outbreak

Navigating the market turmoil after the Coronavirus outbreak

Here is how to navigate the market turmoil after the Coronavirus outbreak, the stock market crash, and bottom low bond yields.

The longest bull market in history is officially over. Today the Dow Jones recorded its biggest daily loss since the October crash in 1987.  Today will remain in the history books. After the Dow Jones index dropped more than 20% from its February 2020 high, we are formally in a bear market.

Navigating the market turmoil after the Coronavirus outbreak
S&P 500 12 year performance

Investors’ flight to safety has pushed 10-year Treasury rate to 0.8% and 30-year treasury to 1.4%, all-time lows.

Navigating the market turmoil after the Coronavirus outbreak

Where are we standing

The coronavirus outbreak is spreading globally. The virus fears are halting public events and forcing companies to change the way they conduct business. The US has imposed travel restrictions on China and the European Union. Many countries in the US are imposing border control restrictions on their neighbors. While the virus outbreak in Wuhan is officially contained according to the Chinese government, large parts of the country remain in lockdown.
The inability of governments around the world to contain COVID-19 spooked investors. We are now observing the worst stock market selloff since the financial crisis of 2008. In certain ways, the daily market conditions are more brutal and unpredictable than a decade ago. Currently, close to 80% of the stock trading is generated by computer algorithms who can send thousands of trades in milliseconds.

Date Dow Jones Index Change % Change
12-Mar-20 21,200.95 -2,352.27 -9.99%
11-Mar-20 23,553.22 -1,464.94 -5.86%
10-Mar-20 25,018.16 1,167.14 4.89%
9-Mar-20 23,851.02 -2,013.76 -7.79%
6-Mar-20 25,864.78 -256.50 -0.98%
5-Mar-20 26,121.28 -969.58 -3.58%
4-Mar-20 27,090.86 1,173.45 4.53%
3-Mar-20 25,917.41 -785.91 -2.94%
2-Mar-20 26,703.32 1,293.96 5.09%
28-Feb-20 25,409.36 -357.28 -1.39%
27-Feb-20 25,766.64 -1,190.95 -4.42%
26-Feb-20 26,957.59 -123.77 -0.46%
25-Feb-20 27,081.36 -879.44 -3.15%
24-Feb-20 27,960.80 -1,031.61 -3.56%

The virus fears initially caused by a meltdown in travel-related stocks. Many airline and cruise ship stocks are now trading at a multi-year low. The heightened concerns for the global recession and the lowered commodity demand from China pushed the price of the oil down significantly. After failed negotiations between OPEC and Russia, Saudi Arabia decided to lower the sale prices of oil by 20% and increase its daily output. In turn, the prices of US oil companies collapsed due to fears that US oil producers can not maintain profitable operations at these low levels. During the previous in 2016, many small oil producers shut down or filed for bankruptcy. The expectation is that many more will follow the same faith soon.
Since the oil and gas and travel-related industry make up for more than 10% of the US GDP, it’s easy to understand that lower revenues and potential job cuts can trickle down to the rest of the US economy.

Are we in a recession?
We wouldn’t know the exact figures until April. The likelihood that the US economy will be in recession in Q1 and Q2 of 2020 is very high. The best-case scenario is for a sluggish economy. We started the year on a strong footing with low employment and strong job growth and housing sales, low price of oil and low-interest rates. However, the crisis in US travel, entertainment, and the energy sector can push the economy down.

What can you do now?

Focus on what you can control.

Have a plan
Having a robust financial plan will help you ensure that you are following of your long-term financial goals and staying on track. The investment performance of your portfolio is a key component of your future financial success but it’s not the most important factor. Be disciplined, patient and consistent in following your long-term goals while putting emotions aside
If you don’t have a financial plan, this a perfect time to initiate it. A holistic financial will help you create a comprehensive view of your personal and financial life and have a clear understanding of core risks and abilities to achieve financial independence and confidence.

Do not read the headlines

Wall Street resides in its own bubble and often overreacts to news whether that is good or bad. Right now, all news is bad news. The only thing that will provide confidence in the market is finding a treatment against the COVID-19, which is probably months or weeks away or drop in virus cases in both the US and Europe. A coordinated effort between the Fed, the Congress and the current administration can provide some stability. Let’s hope that all interested parties can come together and create a working plan.

Assess your risk tolerance
Risk tolerance is how we measure our emotional ability to accept market volatility. It’s not always easy to quantify emotions with numbers. As humans, we are always more likely to be risk-averse during market turbulence and more risk-tolerant when the stock market is going higher. If you want to know how you would feel when the stock market drops 20%, open your investment account today. When you are willing to accept short losses, then your risk tolerance is high. If losses are unacceptable then your risk tolerance is very low.

Review your investment portfolio

Perhaps not today, but soon, you should review your investment portfolio in connection with your long-term financial plan and risk tolerance. Make sure that your investments are aligned with your financial goals and needs.

Do not drop your 401k

One of the biggest mistakes you could possibly make now is to drop and stop contributing to your 401k plan. Many people gave up on their retirement savings during the financial crisis and never restarted them. As a result, we have a generation of people with no retirement savings. As a 401k participant, you make regular monthly or semi-monthly payments to your plan. Despite current losses, you benefit from dollar-cost averaging and buying stocks at lower prices.

Invest now

It may sound crazy but if you are a new investor there is no better time to start investing than now. Stocks rarely go on sale. This is one of those opportunities that come only once in a decade. Remember Warren Buffet’s famous quote:

Be fearful when others are greedy and to be greedy only when others are fearful”

Check my blog for guidance and ideas

  • In late January I posted “How to Survive the Next Market Downturn”. I didn’t think that we will need my guide so soon but here we are. I offer nine steps on how to navigate any stock market crash.

 

  • If you are a conservative investor, who mostly invests in bonds, you were probably somewhat sheltered from the March Market Madness. However, the future for income-seeking investors is cloudy. Current bond yields cannot support future bond investors and will likely deteriorate the economy. For more information on how to traverse from here, read my article on “Why negative interest rates are bad for your portfolio

 

  • Amid market volatility and uncertainty, dividend growth ETFs can provide some shelter. In my latest article “Top 5 Dividend Growth ETFs” I discuss five ETF strategies that offer lower volatility and extra income.

Final words
If you have any questions about your investments and how to update your financial plan, feel free to reach out. if you are worried about finances I am here to listen and help.

Top 5 Dividend Growth ETFs

Dividend Growth ETFs

Dividend growth ETFs offer a convenient and diversified way to invest in companies that consistently grow their dividends. Certainly, dividend-paying stocks provide a predictable stream of cash flows to investors looking for extra income. Companies that steadily grow their dividends year over year are known as dividend aristocrats. Investors often view high dividend blue-chip companies as financially stable and less volatile than growth companies. Above all, the extra cash from dividends provides a buffer from market volatility. Many retirees use dividends to supplement their income during retirement. In the current low-interest environment, dividend growth ETFs are a compelling low-cost option for investors looking for extra yield. With a 10-year US treasury paying below 1%, income investors will need to look elsewhere for income. Furthermore, compared to mutual funds, exchange-traded funds offer an inexpensive and tax-efficient way to invest without worrying about annual capital gains distributions.

Retirement Calculator

Our top Dividend Growth ETF picks

I have prepared a list of my favorite five dividend growth ETFs. Besides their shared focus, these dividend ETFs have a different approach in constructing their underlying portfolio. Depending on your goals, each ETFs will give you a different exposure and dividend payout.

Dividend Growth ETF Performance 2010-2019

Ticker CAGR St Dev Best Year Worst Year Max. Drawdown Sharpe Ratio US Mkt Correlation
VYM 12.86% 11.16% 30.08% -5.91% -11.84% 1.09 0.95
SDY 13.07% 11.15% 30.07% -2.74% -11.00% 1.11 0.92
VIG 12.63% 11.30% 29.62% -2.08% -14.18% 1.06 0.96
DVY 12.96% 10.60% 28.85% -6.32% -10.08% 1.15 0.88
FVD 13.18% 10.21% 26.77% -3.48% -11.11% 1.21 0.91
SPY 13.44% 12.44% 32.31% -4.56% -16.23% 1.04 1.00

Source: portfoliovisualizer.com

Vanguard High Dividend Yield ETF – VYM

Vanguard High Dividend Yield ETF, VYM, tracks the FTSE High Dividend Yield Index. The index selects high-dividend-paying US companies and weights them by market cap. The underlying index excludes real estate investment trusts (REITs).

VYM ETF offers a low-cost, diversified, conservative exposure to high dividend yield large-cap stocks. Vanguard High Dividend Yield ETF charges 0.06% fee and currently pays a 3.2% dividend yield.

The ETF selects its holdings by ranking companies by their forecast dividends over the next 12 months. Only the stocks in the top half are selected. The remaining stocks are weighted by market capitalization. Due to its methodology, VYM tends to hold a large basket of large-cap value stocks.

SPDR® S&P Dividend ETF – SDY

SPDR® S&P Dividend ETF, SDY, tracks a yield-weighted index of dividend-paying companies from the S&P 1500 Composite Index. SDY uses dividend sustainability screens and only holds companies that have increased dividends for the past 20 years. The highest yielding firms are then weighted by dividend yield.

Many tech companies do not meet the strict requirements of paying dividends in the past 20 years. Therefore, SPDR® S&P Dividend ETF has minimal exposure to technology stocks.  Nevertheless, SDY is one of the few dividend growth ETFs that provides exposure to REITs.

SPDR® S&P Dividend ETF charges 0.35% fee and pays a 2.6% dividend yield. Unlike VYM, which ranks its holdings by market capitalization. SDY has a slight tilt towards mid-cap stocks. Investors looking for a broader exposure to the US dividend-paying stocks may find this ETF compelling despite its higher fee.

Vanguard Dividend Appreciation ETF – VIG

Vanguard Dividend Appreciation ETF, VIG, is the most growth-oriented ETF on our list of Dividend growth ETFs. VYM is the largest fund by assets under management (AUM). It tracks a market-cap-weighted index of US companies that have increased their annual dividends for ten or more consecutive years. VIG charges a 0.06% fee and pays a 1.8% dividend. Notably, this ETFs dividend yield is a tad smaller than the yield on the S&P 500.

VIG focuses on dividend growth rather than dividend yield. The fund selects firms that have increased their dividend payments for the past ten years and market-cap-weights its holdings. VIG has the biggest exposure to large-cap and mid-cap growth stocks. In conclusion, investors looking for exposure to high-quality dividend-paying large-cap stock may wish to consider VIG for their portfolios.

iShares Select Dividend ETF – DVY

iShares Select Dividend ETF offers the highest dividend yield on our list of Dividend growth ETF.  DVY pays 3.7% in dividends and charges 0.39% in fees. DVY tracks a dividend-weighted index of 100 US companies. The index selects dividend stocks from the Dow Jones broad market-cap index, excluding REITs.

DVY offers exposure to the US high-dividend stocks that skews towards large, mid, and small-cap value firms paying consistent dividends. DVY’s methodology has a strict sustainability screen, designed to select companies that pay steady and rising dividends. The screening process includes companies with at least $3 billion of market capitalization. Further on, the ETF selects stocks with five-year dividend growth, a coverage ratio of 167 or higher, positive trailing 12-months earnings per share, and high trading volume. The DVY portfolio has significant sector bets towards utilities and financial services.

First Trust Value Line® Dividend ETF – FVD

First Trust Value Line® Dividend ETF, FVD, aims to track an equal-weighted index of dividend-paying companies. The ETF uses a proprietary screening process that only includes companies with more than $1 billion in market cap. FVD has the highest fee on our list. It charges 0.7%, and it pays a 2.1% dividend.  FVD has the best 10-year performance and has reported a slightly lower risk of all five ETFs. Despite its higher than average performance, it produces one of the lowest yields in the group.

FVD creates its portfolio in two steps. First, it uses Value Line’s proprietary ‘safety rating’ system to select low-beta stocks from companies with strong balance sheets. Then it chooses the stocks with above-average yields and weights them equally. The methodology includes REITs and foreign ADRs. As a result, FVD has the highest exposure to international stocks in our list of Dividend growth ETFs. FVD makes big sector bets towards utilities and financial services.

Additionally, it has a slight tilt towards mid-cap stocks. Despite its higher than average performance, FVD produces one of the lowest yields in the group.  In conclusion, investors willing to accept the high cost of FVD may like to use it as an alternative to the more popular dividend growth ETFs.

Dividend Growth ETF Summary

As a group, dividend growth ETFs offer a steady income for yield-hungry investors. Even though none of them have outperformed the S&P 500 in absolute terms, most of these ETFs reported better risk-adjusted returns. In times of market turmoil and uncertainty, dividend growth ETFs offer extra income and lower volatility

 

Disclaimer
Past performance does not guarantee future returns. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. Before investing, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The Coronavirus and your money

Coronavirus and your money

The Coronavirus and your money.  After an unprecedented 10% rally, which started in October of 2019, the stock market is finally hitting a rough patch. The quick spread of the coronavirus in China and around the world made investors nervous about the future of the global economy. The 2% pullback on January 31 wiped out most of January gains. Despite the quick recovery in early February, the outbreak of the virus in South Korea, Japan, Iran, and Italy triggered a massive sell-off on Monday, February 24. The major US indices dropped 3.5% in one day, with DOW falling over 1,000 points.
Investors seeking safety pushed the price of Gold to $1,650. The 10-year treasury rate fell to 1.34, and the 30-year treasury bonds now pay 1.85%. The price of crude oil fell to $51 per share.

About the virus

The coronavirus, called COVID-19, started in the city of Wuhan in the Chinese province of Hubei. Until now, there were over 80,000 reported cases in China and around the world and nearly 2,700 fatalities. The virus spread came on the heels of Chinese Lunar Year celebrations, which is a primary holiday and travel period. It is estimated that Chinese travelers make 3 billion trips in the 40 days surrounding this major Chinese holiday. Currently, more than 60 million people have been locked down in China alone.
The governments around the world have limited or directly banned travelers coming from China. Many foreign businesses like Apple, IKEA, Disney, and Starbucks have shut down stores and theme parks.

The impact on Wuhan

Wuhan is a major transportation and industrial hub in China. More than 300 of the world’s top companies have a presence in Wuhan, including Microsoft, German-based software company SAP, and carmakers General Motors, Honda, and Groupe PSA.
The total value of trade imports and exports in Wuhan reached $35.3 billion in 2019, a record high that was 13.7% above the previous year.

The Bear case

A continued outbreak of the coronavirus can shave off between 0.5% to 1% of the already slowing Chinese GDP. As the second-biggest economy, China is one of the largest importers of commodities and materials.
An extended lockdown will hurt sales of all foreign companies doing business in China. It can trickle down to the already fragile economies of the EU,  Japan, and other export-oriented countries.
The lockdown in China will hurt the global supply chain and the limit the manufacturing abilities of companies making their products in China.
The virus outbreak in Italy, South Korea, and Iran creates a lot of uncertainty and puts pressure on local authorities to control the further spread out.
The previous virus threats (Ebola, SARS, Zika) hurt travel-related businesses and took several months before the markets fully recovered.

The Bull case

The US economy remains strong. The unemployment rate is at record low levels of 3.5%. Low-interest rates and low gasoline prices will support further growth in consumer spending and housing sales.
While not completely sheltered, the US economy is less dependent on exports to China.
The Fed has more room to cut rates if the US economy experiences a slowdown as a result of the virus.
The Chinese government is introducing a new monetary and fiscal stimulus package to support the economy.
Slowing GDP will make the Chinese government more willing to sign the Phase 2 trade deal with the US.
Pharma companies (reportedly Gilead and Moderna) are pursuing a virus vaccine.
Spring is coming. The warm weather could limit the impact of the virus around the world.

Your investments

  • Keep the course. Have a long-term view and focus on achieving your financial goals.
  • Market volatility is a normal part of the investment cycle.
  • S&P 500 index pays a 1.8% dividend versus a 1.3% yield for the 10-year treasury. A long-term income investors may find it compelling to invest in dividend-paying stocks over bonds.
  • A significant stock pullback will be an opportunity to buy high-quality US companies.
  • If you are looking for a specific action, check out my recent article on how to cope with market downturns:  https://www.babylonwealth.com/survive-market-downturn/

How to Survive the next Market Downturn

How to survive a market downturn

Everything you need to know about surviving the next market downturn: we are in the longest bull market in US history. After more than a decade of record-high stock returns, many investors are wondering if there is another market downturn on the horizon. With so many people saving for retirement in 401k plans and various retirement accounts, it’s normal if you are nervous. But if you are a long-term investor, you know these market downturns are inevitable. Market downturns are stressful but a regular feature of the economic cycle.

What is the market downturn?

A market downturn is also known as a bear market or a market correction. During a market downturn, the stock market will experience a sharp decline in value. Often, market downturns are caused by fears of recession, political uncertainty, or bad macroeconomic data.

How low can the market go down?

The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday), when the S&P 500 dropped by -20.47%. The next biggest selloff happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. Every time, the end of the market downturn was the start of a new bull market. Both times, the stock market recovered and reached historic highs in a few years.

What can you do when the next market downturn happens?

The first instinct you may have when the market drops is to sell your investments. In reality, this may not always be the right move. Selling your stocks during market selloff may limit your losses, may lock in your gains but also may lead to missed long-term opportunities. Emotional decisions do not bring a rational outcome.

Dealing with declining stock values and market volatility can be tough. The truth is nobody likes to lose money. The volatile markets can be treacherous for seasoned and inexperienced investors alike. To be a successful investor, you must remain focused on the strength of their portfolio, your goals, and the potential for future growth. I want to share nine strategies that can help you through the next market downturn and boost the long-term growth of your portfolio.

1. Keep calm during the market downturn

Stock investors are cheerful when the stock prices are rising but get anxious during market corrections. Significant drops in stock value can trigger panic. However, fear-based selling to limit losses is the wrong move. Here’s why. Frequently the market selloffs are followed by broad market rallies. A V-shape recovery often follows a market correction.

The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis. If you had missed the ten best market days, you would lose 2.4% of your average annual return and nearly half of your dollar return.

As long as you are making sound investment choices, your patience, and the ability to tolerate paper losses will earn you more in the long run.

2. Be realistic: Don’t try to time the market

Many investors believe that they can time the market to buy low and sell high. In reality, very few investors succeed in these efforts.

According to a study by the CFA Institute Financial Analyst Journal, a buy-and-hold large-cap strategy would have outperformed, on average, about 80.7% of annual active timing strategies when the choice was between large-cap stocks, short-term T-bills and Treasury bonds.

3. Stay diversified

Diversification is essential for your portfolio preservation and growth. Diversification, or spreading your investments among different asset classes (domestic versus foreign stocks, large-cap versus small-cap equity, treasury and corporate bonds, real estate, commodities, precious metals, etc.), will lower the risk of your portfolio in the long-run. Many experts believe that diversification is the only free lunch you can get in investing.

Uncorrelated asset classes react uniquely during market downturns and changing economic cycles.

For example, fixed income securities and gold tend to rise during bear markets when stocks fall. Conversely, equities rise during economic expansion.

4. Rebalance your portfolio regularly

Rebalancing your portfolio is a technique that allows your investment portfolio to stay aligned with your long terms goals while maintaining a desired level of risk. Typically, portfolio managers will sell out an asset class that has overperformed over the years and is now overweight. With the proceeds of the sale, they will buy an underweighted asset class.

Hypothetically, if you started investing in 2010 with a portfolio consisting of 60% Equities and 40% Fixed Income securities, without rebalancing by the end of 2019, you will hold 79% equities and 21% fixed income. Due to the last decade’s substantial rise in the stock market, many conservative and moderate investors are now holding significant equity positions in their portfolio. Rebalancing before a market downturn will help you bring your investments to your original target risk levels. If you reduce the size of your equity holdings, you will lower your exposure to stock market volatility.

5. Focus on your long-term goals

A market downturn can be tense for all investors. Regardless of how volatile the next stock market correction is, remember that “this too shall pass.”

Market crises come and go, but your goals will most likely remain the same. In fact, most goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

Your personal financial goals can stretch over several years and decades. For investors in their 20s and 30s financial goals can go beyond 30 – 40 years. Even retirees in their 60s must ensure that their money and investments last through several decades.

Remain focused on your long-term goals. Pay of your debt. Stick to a budget. Maintain a high credit score. Live within your means and don’t risk more than you can afford to lose.

6. Use tax-loss harvesting during the market downturn

If you invest in taxable accounts, you can take advantage of tax-loss harvesting opportunities. You can sell securities at depressed prices to offset other capital gains made in the same year. Also, you can carry up to $3,000 of capital losses to offset other income from salary and dividends. The remaining unused amount of capital loss can also be carried over for future years for up to the allowed annual limit.

To take advantage of this option, you have to follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market, you can substitute the depressed stock with another stock that has a similar profile or buy an ETF.

7. Roth Conversion

A falling stock market creates an excellent opportunity to do Roth Conversion. Roth conversion is the process of transferring Tax-Deferred Retirement Funds from a Traditional IRA or 401k plan to a tax-exempt Roth IRA. The Roth conversion requires paying upfront taxes with a goal to lower your future tax burden. The depressed stock prices during a market downturn will allow you to transfer your investments while paying lower taxes. For more about the benefits of Roth IRA, you can read here.

8. Keep a cash buffer

I always recommend to my clients and blog readers to keep at least six months of essential living expenses in a checking or a savings account. We call it an emergency fund. It’s a rainy day, which you need to keep aside for emergencies and unexpected life events. Sometimes market downturns are accompanied by recessions and layoffs. If you lose your job, you will have enough reserves to cover your essential expenses. You will avoid dipping in your retirement savings.

9. Be opportunistic and invest

Market downturns create opportunities for buying stocks at discounted prices. One of the most famous quotes by Warren Buffet’s famous words is “When it’s raining gold, reach for a bucket, not a thimble.” Market selloffs rarely reflect the real long-term value of a company as they are triggered by panic, negative news, or geopolitical events. For long-term investors, market downturns present an excellent opportunity to buy their favorite stocks at a low price. If you want to get in the market after a selloff, look for established companies with strong secular revenue growth, experienced management, solid balance sheet and proven track record of paying dividends or returning money to shareholders.

Final words

Market downturns can put a huge toll on your investments and retirement savings. The lack of reliable information and the instant spread of negative news can influence your judgment and force you to make rash decisions. Market selloffs can challenge even the most experienced investors. That said, don’t allow yourself to panic even if it seems like the world is falling apart. Prepare for the next market downturn by following my list of nine recommendations. This checklist will help you “survive” the next bear market while you still follow your long-term financial goals.

Market Outlook October 2019

market Outlook October 2019

Highlights:

  • S&P 500 recorded a modest gain of 0.9% in the third quarter of 2019
  • Ten-year treasury rate dropped to 1.5% before bouncing back to 1.75%
  • S&P 500 dividend yield is now higher than the 20-year treasury rate
  • Manufacturing index hits contraction territory

Economic Overview

  • The US economy continues to show resiliency despite increased political uncertainty and lower business confidence
  • The consumer sentiment – The US consumer is going strong. Consumer sentiment reached 93 in September 2019. While below record levels, sentiment remains above historical levels. Consumer spending, which makes up 68% of the US GDP, continues to be the primary driver of the economy.
Market Outlook October 2019 Consumer Sentiment
Consumer Sentiment
  • Unemployment hits 3.5%, the lowest level since 1969
  • Wage growth of 2.9% remains above-target inflation levels
  • Household debt to GDP continues to trend down and is now at 76%.
Market Outlook October 2019
Household debt to GDP
  • Fed rate cuts – Fed announced two rate cuts and is expected to cut twice until the end of the year.
  • The 10-year treasury rate is near 1.75%
  • The 30-year mortgage rate is near 3.75%
  • While low-interest rates and low unemployment continue to lift consumer confidence, the question now is, “Can the US consumer save the economy from recession’?
  • The probability of recession is getting higher. Some economists assign a 25% chance of recession by the end of 2020 or 2021.
  • The ISM Manufacturing index dropped to 47 in September, falling under for a second consecutive month. Typically readings under 50 show a sign of contraction and reading over 50 points to expansion. The ISM index is a gauge for business confidence and shows the willingness of corporate managers to higher more employees, buy new equipment and reinvest in their business.
  • Trade war – What started as tariff threats in 2018 have turned into a full-blown trade war with China and the European Union. The Trump administration announced a series of new import tariffs for goods coming from China and the EU. China responded with yuan devaluation and more tariffs. France introduced a new digital tax that is expected to impact primary US tech giants operating in the EU.
  • A study by IHS Markit’s Macroeconomic Advisers calculated that gross domestic product could be boosted by roughly 0.5% if uncertainty over trade policy ultimately dissipates.
  • Chinese FX and Gold reserves – China’s reserve assets dropped by $17.0b in September, comprising of $14.7bn drop in FX reserves and a $2.4bn decline in the gold reserves. China has been adding to its gold reserves for ten straight months since December 2018.
  • Political uncertainty – Impeachment inquiry and upcoming elections have dominated the news lately. Fears of political gridlock and uncertainty are elevating the risk for US businesses.
  • Slowing global growth – The last few recessions were all domestically driven due to asset bubbles and high-interest rates. This time could be different, and I do not say that very often. Just two years ago, we saw a consolidated global growth with countries around the world reporting high GDP numbers. This year we witness a sharp turn and a consolidated global slowdown. EU economies are on the verge of recession. The only thing that supports the Eurozone is the negative interest rates instituted by the ECB. China reported the slowest GDP growth in decades and announced a package of fiscal spending combined with tax cuts, regulatory rollbacks, and targeted monetary easing geared to offset the effect of the trade war and lower consumer spending. So even though the US economy is stable, a prolonged slowdown of global economies could drag the US down as well.

Equities

US Equities had a volatile summer. Most indices are trading close to or below early July levels and only helped by dividends to reach a positive quarterly return. On July 27, 2019, S&P 500 closed at an all-time high of 3,025, followed by an August selloff. A mid-September rally helped S&P 500 pass 3,000 level again, followed by another selloff. S&P 500 keeps hovering near all-time highs despite increased volatility, with 3,000 remaining a distinct level of resistance.

In a small boost for equities, the dividend yield on the S&P 500 is now higher than the 10- and 20- year US Treasury rate and barely below the 30-year rate of 2%.

For many income investors equities become an alternative to generate extra income over safer instruments such as bonds

Market Outlook October 2019
S&P 500 dividend versus 20-year treasury rate

Growth versus Value

Investing in stocks with lower valuations such as price to earnings and price to book ratios has been a losing strategy in the past decade. Investors have favored tech companies with strong revenue growth often at the expense of achieving profits. They gave many of those companies a pass in exchange for a promise to become profitable in the future.

However, while economic uncertainty is going up, the investors’ appetite for risk is going down. The value trade made a big comeback over the summer as investors flee to safe stocks with higher dividends. As a result, the utilities and consumer staple companies have outperformed the tech sector.

The IPO market

The IPO market is an indicator of the strength of the economy and the risk appetite of investors. In 2019, we had multiple flagship companies going public. Unfortunately, many of them became victims of this transition to safety. Amongst the companies with lower post IPO prices are Uber, Lyft, Smiles Direct Club, and Chewy.com. Their shares were down between -25% and -36% since their inception date. Investors walked away from many of these names looking for a clear path to profitability while moving to safety stocks.

Market Outlook October 2019, Uber and Lyft since IPO

Small-Cap

Small caps have trailed large caps due to increased fears of recession and higher market volatility. Small caps tend to outperform in a risk-on environment, where investors have a positive outlook on the economy.

Market Outlook October 2019, Small Cap versus Large Cap

International Stocks

International stocks continue to underperform. On a relative basis, these stocks are better valued and provide a higher dividend than US stocks. Unfortunately, with a few exceptions, most foreign stocks have been hurt by sluggish domestic and international demand and a slowdown in manufacturing due to higher tariffs. Many international economies are much more dependent on exports than the US economy.

Fixed Income

The Fed continued its accommodative policy and lowered its fund rate twice over the summer. Simultaneously, other Central Banks around the world have been cutting their rates very aggressively.

The European Central Bank went as far as lowering its short-term funding rate to -0.50%. As a result, the 30-year German bund is now yielding -0.03%. The value of debt with negative yield reached $13 trillion worldwide including distressed issuers such as Greece, Italy, and Spain.

Investors who buy negative-yielding bonds are effectively lending the government free money.

In one of my posts earlier in 2019, I laid out the dangers of low and negative interest rates. You can read the full article here. In summary, ultra-low and negative interest rates change dramatically the landscape for investors looking to supplement their income by buying government bonds. Those investors need to take more risk in their search for income. Low rates could also encourage frivolous spending by politicians and often lead to asset bubbles.

The Yield Curve

The yield curve shows what interest rate an investor will earn at various maturities. Traditionally, longer maturities require a higher interest rate as there is more risk to the creditor for getting the principal back. The case when long-term rates are lower than short-term rates is called yield inversion. Some economists believe that a yield inversion precedes a recession. However, there is an active debate about whether the difference between 10y and 2y or 10y and 3m is a more accurate indicator.

Market Outlook October 2019, Yield Curve

As you can see from the chart, the yield curve gradually inverted throughout the year. Short-term bonds with 3-month to maturity are now paying higher interest than the 10-year treasury

Credit spreads

The spread between AAA investment-grade and lower-rated high yield bonds is another indicator of an imminent credit crunch and possible economic slowdown.

Market Outlook October 2019, Credit Spreads

Fortunately, corporate rates have been declining alongside treasury rates. Spreads between AAA and BBB-rated investment grade and B-rated high yield bonds have remained steady.

Repo market crisis

The repo market is where banks and money-market funds typically lend each other cash for periods as short as one night in exchange for safe collateral such as Treasuries. The repo rates surged as high as 10% in mid-September from about 2.25% amid an unexpected shortage of available cash in the financial system. For the first time in more than a decade, the Federal Reserve injected cash into the money market to pull down interest rates.

The Fed claimed that the cash shortage was due to technical factors. However, many economists link the shortages of funds as a result of the central bank’s decision to shrink the size of its securities holdings in recent years. The Fed reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.

Gold

Gold has been a bright spot in our portfolio in 2019. After several years of dormant performance, investors are switching to Gold as protection from market volatility and low-interest rates. In early September, the precious metal was up nearly 21% YTD, but since then, retracted a bit.

Market Outlook October 2019, Gold

Gold traditionally has a very low correlation to both Equities and Bonds. Even though it doesn’t generate income, it serves as an effective addition to a well-diversified portfolio.

The Gold will move higher if we continue to experience high market volatility and uncertainty on the trade war.

Final words

The US economy remains resilient with low unemployment, steadily growing wages, and strong consumer confidence. However, few cracks are starting to appear on the surface. Many manufacturers are taking a more cautious position as the effects of the global slowdown and tariffs are starting to trickle back to the US. An inverted yield curve and crunch in the repo market have raised additional concerns about the strength of the economy.

Despite the media’s prolonged crisis call, we can avoid a recession. The recent trade agreement between the US and Japan could open the gate for other bilateral trade agreements. Given that the US elections are around the corner, I believe that this administration has a high incentive to seal trade agreements with China and the EU.

The market is expecting two more Fed cuts for a total of 0.5% by the end of the year. If this happens, the Fed fund rate will drop to 1.25% – 1.5%, possibly flattening or even steepening the yield curve, which will be a positive sign for the markets.

Those with mortgage loans paying over 4% in interest may wish to consider refinancing at a lower rate.

Market volatility is inevitable. Keep a long-term view and maintain a well-diversified portfolio.

The end of the year is an excellent time to review your retirement and investment portfolio, rebalance and take advantage of any tax-loss harvesting opportunities.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is the founder of Babylon Wealth Management and a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning and investment management for growing families, physicians, and successful business owners.

 

If you have any questions about the markets and your investments, reach out to me at [email protected] or +1-925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

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10 Behavioral biases that can ruin your investments

10 Behavioral biases that can ruin your investments

As a financial advisor, I often speak with my clients about behavioral biases. Our emotions can put a heavy load on our investment decisions. In this article, I would like to discuss ten behavioral biases that I encounter every day. It’s not a complete list, but it’s a good starting point to understand your behavioral biases and how to deal with them.

We have to make choices every day. Often our decisions are based on limited information or constrained by time. We want to make the right call every single time. But sometimes we are wrong. Sometimes we can be our worst enemy. Stress, distraction, media, and market craziness could get the worst of us.

Behavioral finance

In 2018 Richard Thaler won the Nobel prize for his work in behavioral economics. In his 2009 book “Nudge” and later on in his 2015 book “Misbehaving: The Making of Behavioral Economics,” Thaler reveals the architecture of the human decision-making process. He talks about behavioral biases, anomalies, and impulses that drive our daily choices.

In another study about the value of the financial advisor or the advisor alpha, Vanguard concluded that clients using a financial advisor have the potential to add 1.5% of additional annual returns as a result of behavioral coaching. Further on, Vanguard concludes that because investing evokes emotion, advisors need to help their clients maintain a long-term perspective and a disciplined approach.

 

Afraid to start investing 

Social Security is going into deficit by 2035. And most employers moving toward Defined Contribution Plans (401k, 403b, SEP-IRA). It will be up to you and me to secure our retirement by increasing our savings and investments. However, not everybody is in tune. For many people, investing is hard. It’s too complicated. Not all employers provide adequate training about retirement and investment options. And I don’t blame anyone. As much as I try to educate my blog readers, as well as many colleagues, we are outnumbered by the media and all kinds of financial gurus without proper training and credentials. If you are on the boat and want to start investing, talk to a fiduciary financial advisor, or ask your employer for educational and training literature. Don’t be afraid to ask hard questions and educate yourself.

“This time is different.”

How many times have you heard “This time is different” from a family member or the next financial guru, who is trying to sell you something? Very likely, it’s not going to be any different. As a matter, it could be worse. As humans, we tend to repeat our mistake over and over. It’s not that we don’t learn from our mistakes. But sometimes it’s just more comforting staying on your turf, not trying something new, and hoping that things will change. So, when you hear “This time is different,” you should be on high alert. Try to read between the lines and assess all your options.

Falling for “guaranteed income” or “can’t lose money” sales pitch

As many people are falling behind their retirement savings, they get tempted to a wide range of “guaranteed income” and “can’t lose money” financial products. The long list includes but not limited to annuities, life insurance products, private real estate, cryptocurrency, and reverse mortgage. Many of these products come with sky-high commissions and less than transparent fees, costly riders, and complex restrictions and high breakup fees. The sales pitch is often at an expensive steakhouse or a golf club following a meeting in the salesperson’s office where the deals are closed. If someone is offering you a free steak dinner to buy a financial product that you do not fully understand, please trust me on it – you will be the one picking the tab in the end.

Selling after a market crash

One of the most prominent behavioral biases people make in investing is selling their investments after a market crash. As painful as it could be, it’s one of the worst decisions you could make. Yes, markets are volatile. Yes, markets crash sometimes. But nobody has made any money panicking. You need to control your impulses to sell at the bottom. I know it’s not easy because I have been there myself. What really helps is thinking long-term. You can ask yourself, do you need this money right away. If you are going to retire in another 10 or 20 years, you don’t need to touch your portfolio, period. Market swings are an essential part of the economic cycle. Recessions help clean up the bad companies with a poor business model and ineffective management and let the winners take over.

You may remember that the rise of Apple coincided with the biggest recession in our lifetime, 2008 – 2009. Does anyone still remember Blackberry, Nokia, or Motorola, who were the pioneers of mobile phones?

Keeping your investments in cash

Another common behavioral bias is keeping your investments in cash…..indefinitely. People who keep their 401k or IRA in cash almost always miss the market recovery. At that point, they either have to chase the rally or must wait for a market correction and try to get in again. As a financial advisor, I would like to tell you that it is impossible to time exactly any market rally. By the time you realize it. It’s already too late.

To understand why timing the markets and avoiding risk by keeping cash can be harmful, see what happens if an investor misses the biggest up days in the market. The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis.

10 Behavioral biases that can ruin your investments - Keeping Cash

As you can see, missing the ten best days over between 1998 and 2018 meant earning nearly 2.5% less on an annual basis and leaving half of the potential absolute gains on the table. Here’s the kicker: Six of the 10 “best days” in the market were within weeks of the worst days in the market. In other words, some of the best days often happen as “v-shaped” bounces off the worst days. Going to cash on a big negative day means increasing the risk of missing a big positive day which, as can be seen from the table above, can have a substantial impact on your returns over time.

Chasing hot investments

One of the most common behavioral biases is chasing hot investments. People generally like to be with the winners. It feels good. It pumps your ego. There is a whole theory of momentum investing based on findings that investors buy recent winners and continue to buy their stock for another 6 to 12 months. We have seen it time and time again – from the tech bubble in 2000, through the mortgage-backed securities in 2008, to cryptocurrency and cannabis stocks in 2018. People like highflyers. Some prior hot stocks like Apple, Google, and Amazon dominate the stock markets today. Others like Motorola, Nokia, and GE dwindle in obscureness. If an investment had a considerable run, sometimes it’s better to let it go. Don’t chase it.

Holding your losers too long

“The most important thing to do if you find yourself in a hole is to stop digging.” – Warren Buffett. 

In a research conducted in the 1990s by professor Terrance Odean, he concluded that investors tend to hold to their losers a lot longer than their winners. A result of this approach, those investors continue to incur losses in the near future. Professor Odean offers a few explanations for his findings. One reason is that investors rationally or irrationally believe that their current losers will outperform. A second explanation comes from the Prospect Theory by Kahneman and Tversky (1979). According to them, investors become risk-averse about their winners and risk-seeking to their losers.

When it comes to losing bets, they are willing to take a higher gamble and seek to recover their original purchase price. A third theory that I support and observed is based on emotions. The pain from selling your losers is twice as high as the joy from selling your winners. We don’t like to be wrong. We want to hold on to the hope that we made the right decision. After all, it is a gamble, and the odds will be against you. At some point, we just need to make peace with your losses and move on. It’s not easy, but it’s the right thing to do.

Holding your winners too long

There is a quote by the famous financier Bernard Baruch – “I made my money by selling too soon.” Many people, however, often hold on to their winners for very long. Psychologically, it’s comforting to see your winners and feel great about your investment choices. There is nothing wrong with being a winner. But at some point, you must ask yourself, is it worth it. How long this run can go for and should you cash in some of your profits. What if your winners are making up a large part of your investment portfolio? Wouldn’t this put your entire retirement savings at risk if something were to happen to that investment?

There is no one-size-fits-all answer when it comes to selling your winners. Furthermore, there could be tax implications if you realize the gains in your brokerage account. However, it’s prudent to have an exit strategy. As much as it hurts (stops the joy) to sell the winners, it could lower the risk of your portfolio and allow you to diversify amongst other investments and asset classes.

Checking your portfolio every day

The stock market is volatile. Your investments will change every day. There will be large swings in both directions. So, checking your portfolio every single day can only drive crazy and will not move the needle. It could lead to irrational and emotional decisions that could have serious long-term repercussions. Be patient, disciplined, and follow your long-term plan.

Not seeking advice

Seeking advice from a complete stranger can be scary. You must reveal some of your biggest secrets to a person you never met before. It’s s big step. I wish the media spends more time talking about the thousands of fiduciary advisors out there who honestly and trustworthy look for your best interest.

My financial advisory service is based on trust between you as a client and me as the advisor . So, do not be afraid to seek advice, but you also need to do your homework. Find an advisor who will represent you and your family and will care about your personal goal and financial priorities. Don’t be afraid to interview several advisors before you find the best match for you.

Final words

“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” – Warren Buffet.

Investing is an emotional act. We put our chips on the table and wish for a great outcome. We win, or we lose. Understanding your emotions and behavioral biases will help you become a better investor. It doesn’t mean that we will always make the right decisions. It doesn’t mean that we will never make a mistake again. We are humans, not robots. Behavioral biases are part of our system. Knowing how we feel and why feel a certain way, can help us when the markets are volatile, when things get ugly or the “next big thing” is offered to us. Look at the big picture. Know your goals and financial priorities. Try to block the noise and keep a long-term view.

Reach out

If you have questions about your investments and retirement savings, reach out to me at [email protected] or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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The biggest risks for your retirement savings

Biggest risks to your retirement savings

Whether you are just starting your career or about to retire, you need to understand the risks you are facing when you plan for your future retirement.

Most experts recommend that you should aim to replace about 80% of work income during your retirement. Part of your retirement income will come from Social Security. Other sources could be a public pension, IRAs, 401k, rental income, sale of real estate or business, royalties, or a part-time job. However, the 80% is not a definite number. The amount you need in retirement could vary substantially depending on your lifestyle, family size, number of dependents, health issues, and so on.

Social Security benefits

The maximum Social Security benefit in 2019:

  • $3,770 for someone who files at age 70.
  • $2,861 for someone at a full retirement age of 66
  • $2,209 for someone aged 62

For reference, very few people reach these upper limits. The average Social Security retirement benefit in 2019 is $1,461 a month. The average disability benefit is $1,234.

Unfortunately, the Social Security trust is already running a deficit. Currently, the Social Security is paying more benefits than all the proceed its receiving from the payroll taxes. Its reserve will be depleted by 2035. After that point, social security recipients will have to receive only a portion of their actual benefit. The current estimate is around 75%.

Pension Shortfall

Similarly to Social Security, most of the public and private pension plans nationwide have an enormous shortfall between assets and their future liabilities. According to a recent study by Pew Charitable Trust and Pension Tracker, US public pension shortfall is over $1 trillion. States like Alaska, California, Illinois, Ohio, Hawaii, and New Jersey have one of the highest pension burdens in the nation. Even after ten years of economic recovery and bull market, most state pension plans are not prepared to face another downturn. Policymakers must take urgent measures to close the pension funding gap, which remains at historically high levels as a share of GDP.

Low savings rate

With social security benefits expected to shrink, I advise my clients that they need to increase their savings in order to supplement their income in the future. Retirement savings in IRA, 401k and even a brokerage account will provide you with the necessary income during your retirement years.

Unfortunately, not everyone is forward-looking. The average 401k balance, according to Fidelity, is $106,000 in 2019, while the average IRA is $110,000. The sad reality is that most Americans do not save enough for retirement and we are facing a retirement crisis.

Not saving enough for retirement is the highest risk of enjoying your retirement years.

Relying on a single source

Many people make the mistake of relying on a single source of income for their retirement.  

Imagine that you were planning to retire in 2009 upon selling a piece of real estate. Or you had all your retirement savings in a 401k plan and the market just crashed 50%.  Many of these folks had to delay their retirement for several years to make up for the lost income. Similarly, selling your business can be risky too. With technology advancements, many businesses are becoming obsolete. You may not always be able to find buyers or get the highest price for your business.

We always recommend to our clients to have a diversified stream of retirement income. Diversifying your source will create a natural safety net and potentially could increase the predictability of your income in retirement.

Market risk

We all would like to retire when the market is up and our retirement account balance is high. However, the income from these retirement accounts like IRA, Roth IRA and 401k are not guaranteed. As more people relying on them for retirement, their savings become subject to market turbulence and the wellbeing of the economy.  Today, prospective retirees must confront with high equity valuations, volatile markets, and ultra-low and even negative yields.

In my practice, I use my clients’ risk tolerance as an indicator of their comfort level during market volatility. With market risk in mind, I craft well-diversified individual retirement strategies based on my clients’ risk tolerance and long-term and short-term financial goals.

Sequence of returns

The sequence of returns is the order of how your portfolio returns happen over time. If you are in your accumulation phase, the sequence of return doesn’t impact your final outcome. You will end up with the same amount regardless of the order of your annual returns.  

However, if you are in your withdrawal phase, the sequence of returns can have a dramatic impact on your retirement income. Most retires with a 401k or IRAs have to periodically sell a portion of their portfolios to supplement their income. Most financial planning software uses an average annual return rate to project future account balance. However, these average estimates become meaningless if you experience a large loss at the start of your retirement.

Our retirement strategies take the sequence of returns very seriously. Some of the tools we use involve maintaining cash buffers, building bond ladders and keeping a flexible budget.

Taxes

Your IRA balance might be comforting but not all of it is yours. You will owe income taxes on every dollar you take out of any tax-deferred account (IRA, 401k, 403b). You will pay capital gain taxes on all realized gains in your brokerage accounts. Even Social Security is taxable.

With skyrocketing deficits in the treasury budget, social security and public pensions will guarantee one thing – higher taxes. There is no doubt that someone will have to pick up the check. And that someone is the US taxpayer – me and you.

Managing your taxes is a core function of our wealth management practice. Obviously, we all must pay taxes. And we can not predict what politicians will decide in the future. However, managing your investments in a tax-efficient manner will ensure that you keep more money in your pocket.

Inflation risk

Most retirees have a significant portion of their portfolios in fixed income. Modern portfolio managers use fixed income instruments to reduce investment risk for their clients. At the time of this article, we are seeing negative and near-zero interest rates around the world. However, with inflation going at around 2% a year, the income from fixed-income investments will not cover the cost of living adjustments. Retirees will effectively lose purchasing power on their dollars.

Interest risk

Bonds lose value when interest rates go up and make gains when interest rates go down. For over a decade, we have seen rock bottom interest rates. We had a small blip in 2018 when the Fed raised rates 4 times and 1 year’s CDs reached 2.5%. At that point in time, many investors were worried that higher interest rates will hurt bond investors, consumers and even companies who use a lot of debt to finance their business. Even though these fears are subdued for now, interest rates remain a viable threat. Negative interest rates are as bad for fixed income investors as the high rates are. Unfortunately, traditional bond portfolios may not be sufficient to provide income and protect investors for market swings. Investors will need to seek alternatives or take higher risks to generate income.

Unexpected expenses

Most financial planning software will lay out a financial plan including your projected costs during retirement. While most financial planning software these days is quite sophisticated, the plan remains a plan. We can not predict the unexpected. In my practice, I regularly see clients withdrawing large sums from their retirement savings to finance a new home, renovation, a new car, college fees, legal fees, unexpectedly high taxes and so on. Reducing your retirement savings can be a bad idea on many levels. I typically recommend building an emergency fund worth at least 6 months of living expenses to cover any unexpected expenses that may occur. That way, you don’t have to touch your retirement savings.

Healthcare cost

The average health care cost of a retired couple is $260,000. This estimate could vary significantly depending on your health. Unless you have full health insurance from your previous employer, you will need to budget a portion of your retirement savings to cover health-related expenses. Keep in mind that Medicare part A covers only part of your health cost. The remaining, parts B, C, and D, will be paid out of pocket or through private insurance.

Furthermore, as CNBC reported, the cost of long-term care insurance has gone up by more than 60% between 2013 and 2018 and continues to go higher. The annual national median cost of a private room in a nursing home was $100,375 in 2018.

For future retirees, even those in good shape, healthcare costs will be one of the largest expenses during retirement. In my practice, I take this risk very seriously and work with my clients to cover all bases of their health care coverage during retirement.

Longevity

Longevity risk is the risk of running out of money during retirement. Running out of money depends on an array of factors including your health, lifestyle, family support and the size and sources of retirement income.  My goal as a financial advisor is to ensure that your money lasts you through the rest of your life.

Legacy risk

For many of my clients leaving a legacy is an important part of their personal goal. Whether funding college expenses, taking care of loved ones or donating to a charitable cause, legacy planning is a cornerstone of our financial plan. Having a robust estate plan will reduce the risks to your assets when you are gone or incapacitated to make decisions. 

Liquidity Risk

Liquidity risk is the risk that you will not be able to find buyers for your investments and other assets that you are ready to sell. Often times, during an economic downturn, the liquidity shrinks. There will be more sellers than buyers. The banks are not willing to extend loans to finance riskier deals. In many cases, the sellers will have to sell their assets at a significant discount to facilitate the transaction.

Behavioral risk

Typically, investors are willing to take more risk when the economy is good and the equity markets are high. Investors become more conservative and risk-averse when markets drop significantly. As humans, we have behavioral biases, Sometimes, we let our emotions get the worst of us. We spend frivolously. We chase hot stocks. Or keep all investments in cash. Or sell after a market crash. Working with a fiduciary advisor will help you understand these biases. Together, we can find a way to make unbiased decisions looking after your top financial priorities.

Final Words

Preparing for retirement is a long process. It involves a wide range of obstacles. With proper long-term planning, you can avoid or minimize some of these risks. You can focus on reaching your financial goals and enjoying what matters most to you.

Reach out

If you need help growing your retirement savings, reach out to me at [email protected] or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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Market Outlook July 2019

Market Outlook July 2019

Breaking records

So far 2019 has been the year of breaking records. We are officially in the longest economic expansion, which started in June of 2009. After the steep market selloff in December, the major US indices have recovered their losses and reached new highs. The hopes for a resolution on trade, the Fed lowering interest rates and strong US consumer spending, have lifted the markets.  At the same time, many investors remain nervous fearing an upcoming recession and slowing global growth.

S&P 500 in record territory

S&P 500 hit an all-time high in June, which turned out to be best June since 1938. Furthermore, the US Large Cap Index had its best first quarter (January thru March) and the best first half of the year since the 1980s.

S&P 500 Performance since January 2018
Market Outlook July 2019

US treasuries rates declined

Despite the enthusiasm in the equity world, fixed income investors are ringing the alarm bell. 10-year treasury rate dropped under 2%, while 2-year treasuries fell as low as 1.7%.

10-year Treasury versus 2-year treasury and 3-month treasury.

We continue to observe a persistent yield inversion with the 3-month treasury rates higher than 2-year and 10-year rates. Simultaneously, the spread between the 2 and 10-year remains positive. Historically, a yield inversion has been a sign for an upcoming recession. However, most economists believe that the 2-10-year spread is a better indicator than the 3m-10-year spread.

Gold is on the move

Gold passed 1,400. With increased market volatility and investors fears for a recession, Gold has made a small comeback and reached $1,400, the highest level since 2014.

Bonds beating S&P 500

Despite the record highs, S&P 500 has underperformed the Bond market and Gold from October 2018 to June 2019 S&P 500 is up only 1.8% since October 1, 2018, while the 10-year bond rose 8.7% and Gold gained 16.8%. For those loyal believers of diversification like myself, these figures show that diversification still works.

S&P 500 versus 10-year treasury and Gold

Defensive Stocks lead the rally in Q2

Consumer Staples and Utilities outperformed the broader market in Q2 of 2019. The combination of lower interest rates, higher market volatility and fears for recessions, have led many investors into a defensive mode. Consumer staples like Procter & Gamble and Clorox together with utility giants like Southern and Con Edison have led the rally in the past three months.

Utilities and Consumer Staples performance versus S&P 500.

Small-Cap lagging

Small cap stocks are still under all-time high levels in August of 2018. While both S&P 600 and Russell 2000 recovered from the market selloff in December o 2018, they are still below their record high levels by -13.6% and 10% respectively

S&P 600 and Russell 2000 9-month performance.

International Stocks disappoint

International Developed and Emerging Stocks have also not recovered from their record highs in January of 2018.  The FTSE International Developed market index is 13.4% below its highest levels. While MSCI EM index dropped nearly 18.3% from these levels.

International stocks performance

The Fed

After hiking their target rates four times in 2018, the Fed has taken a more dovish position and opened the door for a possible rate cut in 2020 if not sooner. Currently, the market is expecting a 50-bps to a 75-bps rate cut by the end of the year.

As I wrote this article, The Fed chairman Jerome Powell testified in front of congress that crosscurrents from weaker global economy and trade tensions are dampening the U.S. economic outlook. He also said inflation continues to run below the Fed’s 2% target, adding: “There is a risk that weak inflation will be even more persistent than we currently anticipate.”

Unemployment

The unemployment rate remains at a record low level at 3.7%. In June, the US economy added 224,000 new jobs and 335,000 people entered the workforce. The wage growth was 3.1%.

Consumer spending

The US consumer confidence remains high at 98 albeit below the record levels in 2018. Consumer spending has reached $13 trillion. Combined with low unemployment, the consumer spending will be a strong force in supporting the current economic expansion.

Manufacturing is weakening

The Institute for Supply Management (ISM) reported that its manufacturing index dropped to 51.7 in June from 52.1 in May. Readings above 50 indicate activity indicate expanding, while those below 50 show contraction. While we still in the expansion territory, June 2019 had the lowest value since 2016. Trade tensions with China, Mexico, and Europe, and slowing global growth have triggered the alarm as many businesses are preparing for a slowdown by delaying capital investment and large inventory purchases.  

Trade war truce for now

The trade war is on pause. After a break in May, the US and China will continue their trade negotiations. European auto tariffs are on hold. And raising tariffs on Mexican goods is no longer on the table (for now). Cheering investors have lifted the markets in June hoping for a long-term resolution.

Dividend is the king

With interest rates remaining low, I expect dividend stocks to attract more investors’ interest. Except for consumer staples and utilities, dividend stocks have trailed the S&P 500 so far this year. Many of the dividend payers like AT&T, AbbVie, Chevron, and IBM had a lagging performance. However, the investor’s appetite for income could reverse this trend.

The 3,000

As I was writing this article the S&P 500 crossed the magical 3,000. If the index is able to maintain this level, we could have a possible catalyst for another leg up of this bull market.

The elections are coming

The US Presidential elections are coming.  Health Care cost, rising student debt, income inequality, looming retirement crisis, illegal immigration, and the skyrocketing budget deficit will be among the main topics of discussion. Historically there were only four times during an election year when the stock market crashed. All of them coincided with major economic crises – The Great Depression, World War II, the bubble, and the Financial crisis.  Only one time, 1940 was a reelection year.

S&P 500 Returns During Election Years

YearReturnCandidates
192843.60%Hoover vs. Smith
1932-8.20%Roosevelt vs. Hoover
193633.90%Roosevelt vs. Landon
1940-9.80%Roosevelt vs. Willkie
194419.70%Roosevelt vs. Dewey
19485.50%Truman vs. Dewey
195218.40%Eisenhower vs. Stevenson
19566.60%Eisenhower vs. Stevenson
19600.50%Kennedy vs. Nixon
196416.50%Johnson vs. Goldwater
196811.10%Nixon vs. Humphrey
197219.00%Nixon vs. McGovern
197623.80%Carter vs. Ford
198032.40%Reagan vs. Carter
19846.30%Reagan vs. Mondale
198816.80%Bush vs. Dukakis
19927.60%Clinton vs. Bush
199623.00%Clinton vs. Dole
2000-9.10%Bush vs. Gore
200410.90%Bush vs. Kerry
2008-37.00%Obama vs. McCain
201216.00%Obama vs. Romney
201611.90%Trump vs. Clinton

Final words

The US Economy remains strong despite headwinds from trade tensions and slowing global growth. GDP growth above 3% combined with a possible rate cut lat and resolution of the trade negotiations with China, could lift the equity markets another 5% to 10%.

Another market pullback is possible but I would see it as a buying opportunity if the economy remains strong.

If your portfolio has extra cash, this could be a good opportunity to buy short-term CDs at above 2% rate.

Reach out

If you have any questions about the markets and your investment portfolio, reach out to me at [email protected] or +925-448-9880.

You can also visit my Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

8 reasons to open a solo 401k plan

8 reasons why entrepreneurs should open a solo 401k plan

What is a solo 401k plan

The solo 401k plan is a powerful tool for entrepreneurs to save money for retirement and reduce their current tax bill. These plans are often ignored and overshadowed by the more popular corporate 401k and SEP IRA plans.  In fact, there is a lack of widely available public information about them. Simply put, not many people know about it. In this article, I will discuss 8 reasons why entrepreneurs should open a solo 401k plan.

Solo or one participant 401k plans are available to solo entrepreneurs who do not have any personnel on staff. If a business owner employs seasonal workers who register less than 1,000 hours a year, then he or she may be eligible for the solo 401k plans as well. The solo plans have most of the characteristics of the traditional 401k plan without any of the restrictions.

Learn more about our Private Client Services

What are some of the most significant benefits of the self-employed 401k?

Maximize your retirement savings with a solo 401k

Self-employed 401k allows a business owner to save up to $56,000 a year for retirement, plus an additional $6,000 if age 50 and over. How does the math work exactly?

Solo entrepreneurs play a dual role in their business – an employee and an employer. As an employee, they can contribute up to $19,000 a year plus catch-up of $6,000 if over the age of 50. Further, the business owner can add up to $37,000 of contribution as an employer match. The employee’s side of the contribution is subject to 25% of the total compensation, which the business owner must pay herself.

Example: Jessica, age 52, has a solo practice. She earns a W2 salary of $100,000 from her S-corporation. Jessica set-up a solo 401k plan. In 2017 she can contribute $18,000 plus $6,000 catch-up, for a total of $24,000 as an employee of her company. Additionally, Jessica can add up to $25,000 (25% x $100,000) as an employer. All-n-all, she can save up to $49,000 in her solo 401k plan.

One important side note, if a business owner works for another company and participates in their 401(k), the above limits are applicable per person, not per plan. Therefore, the entrepreneur has to deduct any contributions from the second plan to stay within the allowed limits.

Add your spouse

A business owner can add his or her spouse to the 401k plan subject to the same limits discussed above. To be eligible for these contributions, the spouse has to earn income from the business. The spouse must report a wage from the company on a W2 form for tax purposes.

Reduce your current tax bill

The solo 401k plans contributions will reduce your tax bill at year-end. The wage contributions will lower your ordinary income tax. The company contributions will decrease your corporate tax.

This is a very significant benefit for all business owners and in particular for those who fall into higher income tax brackets. If an entrepreneur believes that her tax rate will go down in the future, maximizing her current solo 401k contributions now, can deliver substantial tax benefits in the long run.

Opt for Roth contributions

Most solo 401k plans allow for Roth contributions. These contributions are after taxes. Therefore, they do not lower current taxes. However, the long-term benefit is that all investments from Roth contributions grow tax-free. No taxes will be due at withdrawal during retirement.

Only the employee contributions are eligible for the Roth status. So solo entrepreneur can add up to $19,000 plus $6,000 in post-tax Roth contributions and $37,000 as tax-deductible employer contributions.

The Roth contributions are especially beneficial for young entrepreneurs or those in a lower tax bracket who expect that their income and taxes will be higher when they retire. By paying taxes now at a lower rate, plan owners avoid paying much larger tax bill later when they retire, assuming their tax rate will be higher.

No annual test

Solo 401k plans are not subject to the same strict regulations as their corporate rivals. Self-employed plans do not require a discrimination test as long as the only participants are the business owner and the spouse.

If the company employs workers who meet the eligibility requirements, they must be included in the plan.  To be eligible for the 401k plan, the worker must be a salaried full-time employee working more than 1,000 hours a year. In those cases, the plan administrator must conduct annual discrimination test which assesses the employee participation in the 401k plan. As long as solo entrepreneurs do not hire any full-time workers, they can avoid the discrimination test in their 401k plan.

No annual filing

Another benefit of the 401k plans is the exemption from annual filing a form 5500-EZ, as long as the year-end plan assets do not exceed $250,000. If plan assets exceed that amount, the plan administrator or the owner himself must do the annual filing. To learn more about the annual filing process, visit this page.

Asset protection

401k plans offer one of the highest bankruptcy protection than any other retirement accounts including IRA. The assets in 401k are safe from creditors as long as they remain there.

In general, all ERISA eligible retirement plans like 401k plan are sheltered from creditors. Non-ERISA plans like IRAs are also protected up to $1,283,025 (in aggregate) under federal law plus any additional state law protection.

Flexibility

You can open a self-employed 401k plan at nearly any broker like Fidelity, Schwab or Vanguard. The process is relatively straightforward. It requires filling out a form, company name, Tax ID, etc. Most brokers will act as your plan administrator. As long as, the business owner remain self-employed, doesn’t hire any full-time workers and plan assets do not exceed $250,000, plan administration will be relatively straightforward.

As a sponsor of your 401k plan, you can choose to manage it yourself or hire an investment advisor. Either way, most solo 401k plans offer a broader range of investments than comparable corporate 401k plans. Depending on your provider you may have access to a more extensive selection of investment choices including ETFs, low-cost mutual funds, stocks, and REITs. Always verify your investment selection and trading costs before opening an account with any financial provider.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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Saving for college with a 529 plan

College savings with a 529 plan

What is a 529 plan?

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.

In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation.  Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.

College tuition and fees growth between 1998 and 2018.
Source: College Board

With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.

Student Debt is Growing

The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.

Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.

Let’s break down some of the benefits of the 529 plan.

College Savings Made Easy

Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.

529 plan offers flexible Investment Options

Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.

Alternatively, you can design your portfolio choosing between a mix of actively managed and index funds, matching your risk tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed options, which limit your investment risk but also cap your upside.

Earnings Grow Tax-Free

529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Tax-exempt growth
529 plan versus taxable investment account
The chart hypothetically assumes a $6,300 annual contribution, a 5% average annual return and a 20% average tax rate on taxable income in a comparable brokerage account. The final year post-tax difference would be $14,539, without taking into consideration state tax deductions.on contributions and impact on financial aid application.

Your State May Offer a Tax Break

Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.

If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.

Use at Schools Anywhere

529 funds can be used at any accredited university, college or vocational school nationwide and more than 400 schools abroad. Basically, any institution eligible to participate in a federal student aid program qualifies. A 529 plan can be used to pay for tuition, certain room and board costs, computers and related technology expenses as well as fees, books, supplies, and other equipment.

The TCJA law of 2017 expanded the use of 529 funds and allowed parents to use up to $10,000 annually per student for tuition expenses at a public, private or religious elementary, middle, or high school. However, please check with your 529 plan as not all states passed that provision

Smaller Impact on Scholarship and Financial Aid

Many parents worry that 529 savings can adversely affect eligibility for scholarships and financial aid. Fortunately, 529 plan savings have no impact on merit scholarships. You can even withdraw funds from the 529 plan penalty-free up to the amount of the student scholarship.

For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.

Lower Cost versus Borrowing Money

Starting the 529 plan early can save you money in the long run. The tax advantages of the 529 plan combined with the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.

529 plan provide Estate Tax Planning Benefits

Your 529 plan contributions may qualify for an annual gift tax exclusion of $15,000 per year for single filers and $30,000 a year for couples. The 529 plan is the only investment vehicle that allows you to contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for a single filer and $150,000 for couples.

Other Family Members Can Contribute Too

Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.

Transfer funds to ABLE Account

Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.

Under the TCJA law, 529 funds can be rolled over into an ABLE account, without paying taxes or penalties.

Assign Extra Funds to Other Family Members

Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.