The popular press is fond of pointing out how old the bull market for stocks is. After bottoming in 2009 we have seen stocks march upward for for nearly a decade. Many of today’s younger investors, say those in their thirties, have seen the stock market fall, but never felt the pain in their own portfolio.
Yet for another class of investor, those who have invested in bonds, the bull market run has been even longer. Going back to the days of President Jimmy Carter in 1981, bond yields have fallen, year after year. Because bond prices move inversely to interest rates, bond prices have been rising for the last 36 years. That means someone who entered the workforce in the early eighties, bond prices have always gone up.
For some perspective the Certified Financial Planner Board of Standards was formed in 1985. As a group, CFP® practitioners have never experienced a true bear market in fixed income securities. Although the credit freeze that coincided with the great recession bear market for stocks, had a short, sharp panic in the fixed income markets; a long drawn out bear market for fixed income has been an experience the profession will for the most part find alien.
The closest thing to the pain of a bear market in bonds experienced by this group was the 2004 to 2006 Chinese water torture of the Greenspan/Bernanke Fed. During the thirteen months that spanned June of 2005 to July of 2006, the Federal Reserve raised rates 25 basis points every time they met. Although the aggregate bond index only fell in price by about 5%, the constant barrage of interest rate increases was hard to live through.
That pain was nothing compared to the Burns/Miller/Volker era where we saw the Fed raise rates from 4.75% in November of 1976 to the 20% Fed Funds rate of May 1981. That was the last true bear market for fixed income products in the United States. Although your grandfather might wistfully talk about getting 18% on his CDs, the path that led to those astronomical rates was littered with bond investors who saw the value of longer term bonds fall by 50% or more.
When I hear today’s press ask what will happen if the 10-year Treasury bond breaches 4% I am astonished. It is not a question of if, but a question of when.
If we can avoid creating a trade war with the rest of the world, there are some very expansive monetary policies recently enacted by congress and the Trump administration investors can benefit from. The tax overhaul will provide a good measure of impetus to the economy, and the budget bill recently signed into law gets us away from the restrictive spending of the sequestration agreement and into a more expansive government spending era.
Yet, the Federal Reserve must walk a fine line between economic growth and containing inflation. GDP growth has entered a more normal territory.
Inflation, while still subdued, has shown signs of rebounding. The uptick in inflation is related to a small increase in wage growth, which is in turn related to the continued implosion of our unemployment rate. You also will note a similar uptick in mortgage rates.
As investors search for yield in a low rate world, we have seen a compression in the interest rate spreads between high quality bonds and low quality (junk) bonds. With rates as low as they are today and with the economy growing it is inevitable that interest rates will rise. The end of the 36-year bond bull market is likely upon us.
A flattish yield curve where the difference in a two-year treasury and a ten-year treasury is a mere 52 basis points, puts bond investors in a peculiar spot where an interest rate increase of just 1% could potentially wipe out three to five years of interest income.
The take away from all this is bonds are a minefield for investors today. A small misstep can be very costly and the rewards for investment are very small. Many advisors are ill-prepared for a world of falling bond prices.
Unless you or your advisor are true experts with fixed income investments, your best option in today's environment is to keep your maturities very short. That means you should be selling any bonds or bond mutual funds that have long durations. You should direct those allocations to short term treasuries, certificates of deposit, and bonds in the 1 to 3 year maturity range. Hopefully you will ladder those investments so you have new money available to invest at progressively higher rates throughout this interest rate cycle.
For those of you who need to squeeze every last drop of return out of your fixed income investments, I recommend you read an article I had selected for publication in the "Journal of Financial Planning" in July of 2011. In this article I explain how thinking about the life of a bond as it moves toward maturity can produce positive returns even when interest rates are moving up.
The recent income tax revamp has made income tax planning early in the year a must for many self-employed professionals. The ability to take a 20% deduction of business income, available for single filers with income below $157,500 and married filers with income below $315,000, is too good to pass up. Filers with taxable income at these levels will be in the 24% marginal tax bracket, so being able to qualify for the business income deduction is worth thousands, particularly when proper tax planning can prevent many from reaching the next 32% bracket. There are a number of ways to game your reported income, allowing many filers with reportable income well above these limits to qualify for the 20% exclusion.
First, the exclusion counts toward reducing your income below the phaseout thresholds. A married couple with employment income of $175,000 and a like amount received as business income would see their total income of $350,000 reduced by 20% of the business income or $35,000 allowing them to remain within the proscribed income limits.
Contributions made to an Health Savings Accounts will also reduce your taxable income. For 2018 single filers can deduct up to $3,450 and couples up to $6,900.
A real biggie for high earners looking to qualify for the 20% exclusion is retirement plan contributions. Money contributed to your qualified retirement plans can make a huge difference. For 2018 those under age 50 can contribute $18,500 to a 401k and those 50 and above can contribute up to $24,500. Presumably as a business owner you can also be sure to offer a generous match. Matching contributions are a deductible business expense that benefits you the owner directly yet reduces your reported profits and thus your total income for purposes of qualifying for the 20% deduction. And for very high earners, adding a defined benefit plan to your existing defined contribution plan might be a smart move, depending on the demographics and size of your workforce.
Don’t overlook simple things like using tax free municipal bonds for your savings versus taxable bonds and CDs.
Going beyond the basics, some business owners could benefit from reimagining their business ownership. Suppose you are a professional who owns your place of business. Setting up a separate company to own the real estate could be a smart move. You lease the building back from the owner at a fair market rate creating business income that is not subject to the target income limits.
Busy professionals have little time to devote to income tax planning and their CPAs are busy during tax season, but the difference between qualifying for the deduction and not qualifying could hinge on how soon you begin a given strategy.
It has been a long time since we have seen the stock market exhibit this much volatility. Corrections are a normal and healthy part of investing. Corrections weed out the speculators and hot money. For a clearer view of what is happening, we offer a few charts with longer term views.
Carrying mortgage debt can be a contentious subject among financial planners. Some look at the leverage as an opportunity to build net worth. Others see mortgage debt as merely a necessary evil. Often clients believe the mortgage interest deduction is valuable, but with the new income tax rules effective January 1, the deduction is limited for some and worth less for others.
So when should you try to be mortgage free?
Certainly, by the time you plan to retire. I have given this advice to everyone who has the means to do so, and to a person, they have always commented that it was the best advice they ever received. The reason has little to do with money, but everything to do with peace of mind. Not having the expense of a mortgage often reduces your need for significant cash flows. Being mortgage free also means that if push comes to shove, how much does it really take to live each month? Your basic expenses are then whittled down to food, energy, medical, and insurance expenses.
Retirement is also the point in your life where growing your net worth takes a back seat to generating income. I explain to clients that the easiest and safest way to earn 4% on your money is to avoid paying 4% for your money. Paying off a mortgage can be compared to purchasing a bond with a yield equal to your mortgage interest rate.
I like to illustrate the value of paying off your mortgage in a very simple way. Below is a chart of the annual payments for a $250,000 mortgage at 4% interest. We can ignore escrow amounts, because that covers expenses that will continue regardless of whether or not you pay off the mortgage debt.
Cash flow expense is simply the mortgage payments for the year divided by the payoff amount, or if you had the cash available to pay off the mortgage how much cash flow that money would have to produce to cover your mortgage payment.
You can see in this example that by year 15 the amount of money needed to pay off your mortgage would need to produce returns close to the historical equity market rates to be an even trade-off. By year 20 of a 30-year mortgage, or around the time many people are reaching retirement, the return on cash needed to make your mortgage payments has reached double digits.
If you were retiring at that point and had $117,886 available in a taxable account I would encourage you to use that money to pay off your mortgage. With a cash on cash return of over 12% the odds of earning a higher return on that money is slim, and it gives you an extra ten years of a less stressful retirement.
I once had a planning client come to me complaining that low CD rates were cutting into their lifestyle. The client felt they needed more income, but they were very risk averse. For them using the $100,000 to pay off their mortgage saved them from having $9,000 in annual expenses and did so without exposing them to any investment risk at all.
Every situation is a bit different, but you should challenge your assumption that carrying mortgage debt in always a good strategy.
The tax plan passed at the end of 2017 has a bonus for parents whose children attend private elementary and high schools. You can now use funds from a 529 savings plan to pay for these expenses. In South Carolina and other states that allow a tax deduction for 529 plan contributions, this change can mean significant savings on your state income taxes.
For example, the Charleston, SC both Porter-Gaud and Ashley Hall have high school tuition that exceeds $23,000 per year. By using the SC Future Scholar program as the funding vehicle for this tuition, families can save between $1,150 and $1,610 on their state income taxes.
To take advantage of this income tax break, simply open a Future Scholar 529 plan and fund the plan with the money you will be sending to the private school anyway. Then, request the plan send the money to the students account at the school of your choice. By using the 529 plan as a middle man in the transaction you will save yourself 5% to 7% on your annual tuition expenses by lowing your state income tax liability for the year you make the contribution.
It is also important to understand any sales charges associated with your 529 plan investments. In South Carolina you can open a 529 plan directly with the sponsor and avoid sales charges and loads. If you go through a broker your savings could be negated by the additional expenses. Another good reason to work with a fee-only financial advisor.
While there are no limits to the amount you can contribute each year to a 529 plan, you should understand that contributions are considered gifts. Contributing more than $14,000 per parent per year can be complicated but there are strategies to contribute much more in a single year and stretch the tax benefits of doing so.
You should also understand how using this tax saving strategy will impact your savings goals for post high school education. College expenses will still need to be planned for and funded, so have a plan in place to address both education funding needs. Talk to your tax professional or financial advisor about not only maximizing the tax advantages of a 529 plan for college- but for private elementary and high school as well.
Even the most independent among us, if fortunate to live long enough, may experience a decline in mobility or health that can strip away our independence and diminish the quality of our lives. Great advances in medicine have extended our average life expectancy to a record high of 78.7 years. Living longer means more years spent in the struggles that accompany old age. Add to that the increase in geographic mobility of our families and the result is millions of seniors left behind, hungry and alone.
Meals on Wheels has been guided by a single goal since the first known U.S. delivery by a small group of Philadelphia citizens in 1954 – to support our senior neighbors to extend their independence and health as they age. What started as a compassionate idea has grown into one of the largest and most effective social movements in America, currently helping nearly 2.4 million seniors annually in virtually every community in the country.
You can help today!
At this time of year, when we all gather with our families to share the love of the holiday season, we want to take some time to help those who are less fortunate. Yes, our stockings are hung, but there are those who have no stockings and those who have no place to hang a stocking, or are simply too sick to hang a stocking. This is the first of twelve pleas for your support to make this holiday a better time for all. A plea to do your part in bringing "Peace on Earth and goodwill to man"
I begin with the American Red Cross because in time of disaster they are often the very first on the scene. Let me share some of the ways the Red Cross makes a difference in the lives of those in need.
Wherever the is need you will find the Red Cross. Ninety percent of Red Cross workers are volunteers. An average of 91 cents of every dollar the American Red Cross spends is invested in humanitarian services and programs.
Please join me in making a donation to help support the mission of this charity. And please share this with your friends and neighbors. #12DaysofChristmasCharityChallenge
This month we hear from clients Bob and Bobbie S.
"Life is short and we all need an adventure once in a while. We had a wonderful adventure this year that we will never forget and highly recommend to all. We went on a tour of the Canadian Rockies and Glacier National Park In Montana.
At Glacier National Park you can ride the 'Red Jammers Buses' along the Logan Pass. You can take a gondola ride to the top of the mountains in Banff National Park (Canada), or catch a Snow-Coach ride to the Columbia ice fields, you can even ride the rapids in Jasper. Best of all some of the most dramatic mountain scenery in the world can be found in the Canadian Rockies.
If you are looking for adventure and you love to take pictures of magnificent mountain ranges, ice fields, and beautiful lakes and rivers, this type of tour just might be for you."
Thank you for sharing, Bob and Bobbie!
The holidays may be on your mind now, but taking steps to reduce your income tax bill for 2017 could make for a merrier April. If you wait until the start of the New Year to think about income taxes, you will be too late. To help us understand the steps we should be considering, we enlisted the help of Myrtle Beach CPA Bart Buie.
With the proposed changes to deductibility of state and local income taxes it makes sense to accelerate the current year deduction. That means you should make your estimated tax payments In December of 2017 rather than waiting until January of 2018. You may even want to purposely over pay your state income taxes this month to get a bigger deduction when you file in 2018. Don’t worry if you overpay you will get that refunded to you in April of 2018.
Business owners should be doing a pro forma income tax calculation now to be sure they are minimizing their taxes. With rates purportedly going down in 2018, it makes sense to push as much income as possible into the new year. That means any billing should be delayed to the end of the month, if possible, so that the receipt will post to your books in 2018. Also, business owners should be looking to pay all the bills they have incurred in calendar year 2017 before December 31, even if they are not due until January of 2018. This will reduce 2017 taxable income by increasing expenses for the year.
Bart also talks about purchasing equipment needed for your business now. He offers an example of purchasing a work vehicle in December to qualify for a 2017 deduction, even though your payment may not begin until 2018.
December is also the last month to establish 401(k) and solo 401(k) plans to save on 2017 income taxes. Bart points out that an S-Corp with one employee can establish a plan before year end and the business owner can then make a salary deferral contribution in 2017; with the company match being made by their tax filing deadline in 2018. Because an S-Corp is a pass-through entity, the matching contribution will still lower your income tax bill for 2017.
Bart also encourages clients to accelerate charitable donations. If you have planned giving, you can go ahead and make the contribution to reduce your tax liability.
Don’t forget to look for chances to offset any realized capital gains with any capital losses available. You can use losses to offset 100% of any gains you claim plus $3,000 of other taxable income. There is talk of eliminating your ability to designate which lot of stock you sell in the future, so now would be a good time to review your accounts for places where the FIFO accounting method might be a negative for you. Be careful not to run afoul of the thirty-day wash sale rule as you implement this strategy.
Even adults can score some freebies on Halloween.
Krispy Kreme is giving out free donuts for Halloween at participating locations. With the promotion, you can get any doughnut you want (even a fancy Halloween-themed creme-filled number) for free. So you’re not stuck waiting in line to just get an original glazed (even though they are delicious).
Krispy Kreme’s Facebook event for the promotion says that the deal excludes grocery and convenience stores, and is not available at Krispy Kreme stores in Mobile or Foley AL, Jersey City NJ, Iowa, Louisiana, or Nebraska.
Fortune reports that Chipotle will be giving anyone who shows up to one of its stores in costume on Halloween a burrito, burrito bowl salad, or taco for just $3, and By texting “Boorito” to 888222, patrons will be entered into a contest for a year of free burritos, as long as they don’t live in Alaska, Hawaii, or Canada.