2021Q3

As we head into the third quarter of 2021, the domestic economic backdrop remains in a reflationary environment.  This past quarter has produced 15 all-time highs on the S&P 500 and an all-time high in high-yield bonds.  This acceleration is seen in a host of markets abroad too.  Germany, Poland, Spain, South Korea, Pakistan, and Australia (which reached all-time highs) have all seen lower volatility and higher equity trends.  As of Friday July 2nd, 66 of 103 S&P 500 companies that issued earnings per share guidance for the second quarter offered a positive outlook that exceeded consensus estimates, according to FactSet data. This would mark the highest number of S&P 500 companies offering estimate-topping outlooks ever recorded in data going back over 15 years.  Treasury yields sank across the curve, with the benchmark 10-year Treasury yield dipping below 1.48%. Major cryptocurrencies steadied after sliding approximately 50% from their all-time high in May.  Bitcoin is currently around $35,000/coin.

Download the full Quarterly here!

We are not complacent.  Many have asked us what would happen if?  We are preparing for some potential market shifts and deceleration.  These market shifts allow us to remove position gains and reallocate to where new opportunities lie.  Within our fixed income allocations, we have added, and subsequently removed our quadratic spread between the 2-10 year treasury (IVOL), added a corporate bond position (LQD) and added a pre-merger SPAC (SPAX).  This was done with the intent of collecting yield where possible, taking some bond term-risk and removing the 2-10 year spread that was being interfered with from the Federal Reserve.  We have added equity positions into energy (XLE) and Real Estate Investment Trusts (CWRE).  These assets were positioned to take advantage of the inflation that affects commodities and real assets that are appreciating from inflation, the devaluing dollar and housing supply constraints.

On the inflationary front, both pandemic dynamics and historic Fed-Fiscal policy support led to massive supply and demand imbalances. We see this flowing from the Goods to Services sectors.  This is encouraging the Fed’s “transitory” stance and leading us to anticipate longer and higher-than-usual inflation in the coming quarters.  Third quarter is primed for deceleration on a global basis.  We believe nearly every G20 country will fall into stagflation or deflationary environments. China spent the second quarter in stagflation, as they were the first to emerge from COVID’s shadow.  We believe that China will continue on this trajectory thru the beginning of next year.  We want to remind everyone that we are discussing market environments in regard to trends developing and NOT the 2-3 year outlook.  We are not entirely pessimistic on our global outlook. Europe is set to be a region with accelerating growth thru the beginning of 2022.  Europe has lagged by 6 months in comparison to the U.S. and is following a similar trajectory that the U.S. has already traversed.

Your job as an investor is to remain patient amidst the volatility and know that we are positioning for market changes and managing the portfolios effectively and incrementally.  As we stated before, we continue to see growth and inflation, we just need to be aware that some shifts may occur.  We would be happy to chat with you at any time and we look forward to the conversation.

2021Q2

As we begin the second quarter of 2021, we are excited to share that we have moved into a new office, located at 1331 Lake Dr. SE, Suite 100 – in Eastown. We are proud of our new office and look forward to having you visit. Now to the market. Let’s start with some market indicators and data. This will provide an overall sense of what the markets have done and what we believe they will continue to do in the next quarter and into the remainder of 2021.

Download the full Quarterly HERE.

The 1st quarter ended with some episodic and non-trending volatility. At the same time, we have seen significant appreciation and increased trading volume in multiple markets areas. We continue to see an uptick in inflation and economic growth. Consumer confidence increased according to the University of Michigan Current Conditions Report and Expectations Report (up 7 and 9% respectively for the month).  Unemployment is at 6%, and GDP is up 4.3% for the year.  Real GDP year over year is up 11%+.  All 11 sectors of the S&P 500 are up in the first quarter of 2021!  Energy, Financials and Industrials have been the leading sectors with returns of 30.34%, 16.38% and 11.54% respectively.  Year to date, the S&P 500, foreign and emerging markets are all positive, to the tune of 7.4%, 4.3% and 4%.  In the U.S., the leading asset class has been in the small cap space, up 14.4%.  Another notable event in the first quarter is the disparity in growth and value names down the market spectrum from large to small companies, illustrated in the chart below.  Lastly, the Barclays Aggregate Bond Index is -3.4%

VALUEGROWTH
Large Cap11.3%0.9%
Mid Cap13.1%0.6%
Small Cap21.2%4.9%
First Quarter Disparity in Growth by Sector

So, what does this all mean?  We believe we are in a growth and reflationary environment.  To put it neatly, we have a massive easing of money and pent-up global demand.  In the U.S., we are expeditiously breaking free of the virus’ constraints as more people are vaccinated.  In the U.S. over 20% of the population have been vaccinated and approximately 100 million American’s have received the first dose. Locally speaking, DeVos Hall has the ability to vaccinate 20,000 people a day.  These vaccinations locally, nationally, and eventually globally, will significantly improve commerce.  We believe that Europe and the rest of the world will lag by about 5 months.  As the U.S. and the world finds their footing, so too will investment capital markets.  We believe that in the next several months we will see global supply chain issues resolve and that there will be a massive increase in inventory levels.  This is a market, that Wallstreet likes to call “risk on”.  Depending on their risk tolerance this is a period of time when an investor should strategically allocate their portfolio to more risk where they can.

This growth and reflationary environment started the last half of 2020 and continues.  This is a relatively short period of time where commodities, equities, credit, and foreign currencies will appreciate.  We believe that during this reflationary trade, technology (even though expensive), consumer discretionary, industrials, financials and energy will appreciate.  We also believe this is a short period to avoid utilities, REITS, Consumer Staples and Healthcare. 

While we don’t have a crystal ball, we maintain our conviction that value and emerging markets should outperform over the next 3-5 years. Markets overall are trading at the highest valuations in decades which is concerning. These high valuations are countered by unprecedented involvement by the US congress with fiscal stimulus and changes to monetary policy by the federal reserve that are driving markets higher which may continue for some time. We are living through an unprecedented time in our country, and we are honored to guide you through this period.

2021Q1

Out with the old…in with the new!

DOWNLOAD THE FULL QUARTERLY

Happy New Year!  We are thankful for this year’s opportunities and for making it thru a very challenging chapter.  We are optimistic for the anticipated vaccine.  We look forward to returning to a life and community that is more open, and we are excited to rebuild.  We all hope 2021 is that new beginning.

In the world of financial planning, there is a calendar year reset that occurs as well.  It’s a new tax year.  Health care deductibles reset, and it is time for new contributions to IRAs, 401ks, and HSAs.  We look back on the returns for 2020 and strategize for the year ahead.

By investment standards, 2020 was a rollercoaster of change and volatility.  COVID-19 brought a swift decline in the financial markets.  The Fed produced trillions of dollars in stimulus and markets ultimately recovered.  By year end, most indexes ended the year in positive territory.

Facebook, Amazon, Nvidia, Google and Tesla led the U.S. stock market into a manic exuberance.  Investment professionals and individuals alike were excited by these tech giants and about their prospects of market dominance.  Let’s face it, the world has changed expeditiously in the past few years.  Tech companies are positioned to propel us into the future.  The question becomes, how much are you willing to pay for these future hopefuls.  Prices of these stocks are expensive.  In fact, all other investments, globally and domestically paled in comparison.  Even the other 490 stocks that make up the broad U.S. large cap market haven’t compared.  Take a look at the following chart.

YTD Tesla has risen 657% and approximately 1100% in the past 18 months.  Here are a couple of numbers to stew on.  Tesla market cap has increased by $500 billion in 2020.  According to the market, Tesla’s value has surpassed that of the nine largest car companies globally.  This includes Volkswagen, Toyota, Nissan, Hyundai, GM, Ford, Honda, Fiat Chrysler, and Peugeot. To bring these numbers into context, Tesla only made ~1% of the total vehicle sales in 2020 or approximately 500,000 vehicles.  We are of the firm belief that those returns won’t continue along the same upward trajectory forever.

We have recently been asked, “Why do we need bonds in a portfolio, especially now?”  Prevailing thought is that if interest rates go up, the price of bonds will surely go down.  Interest rates are almost at zero and inevitably they will go up.  We have had low interest rates for a decade and near zero rates for a year.  Stocks have beaten bonds by 90+% over the rolling average of the past 100 years.  Given where interest rates were, 30-year treasury bonds still produced a total return of 18.88% for 2020.  However, bonds play an important role in a portfolio’s stability.  When equities are bullish, the case for bonds is challenging, but when markets selloff, it is conceivable to experience a 60+% drop in a portfolio without bonds.  We like to think of bonds as an insurance policy.  This insurance policy also allows us to buy equities when markets sell off.

A few salient points that we like to remind folks: we can’t time the market and there isn’t a correlation between GDP and Equity returns.  Earnings look back and stock prices are an anticipation of what the stock earnings and company growth will look like in the future.  If we were to try and time the market this year, many investors would have taken money out when their portfolios plummeted and would have resisted putting money to work when the pandemic was saddling the world with depression like statistics.

So where is the opportunity today?  We see an opportunity in emerging market equities that have been underperformers for several years.  Specifically, we are focused on value categorized companies.  For the past 10 years, we have seen a stark disparity between the returns of value and growth companies.  Value names have experienced their worst decade in history and to further the pain they have just experienced their worst 12 months in history.  We see this underperformance as an opportunity to reallocate portfolios that were in favoring domestic growth equities and shift them towards more international and value-oriented names.  In regard to fixed income, we are favoring some credit risk in exchange for term risk. Currently, inflation remains tepid.  Although current spreads between conventional treasuries and TIPS have widened to 1.8% in the later part of 2020, this is well below the 2% fed target.  If inflation does increase, term risk will weigh more on the fixed income portfolio.

Current portfolio changes for 2021

In order to best position our portfolios and to take advantage of where we forecast returns to come from in the near future, we have made the following adjustments for the first quarter 2021. We exchanged our passive positions in MSCI EAFE Growth and Value for an active position in Oakmark International Value fund.  We added positions to the Sharepost 100, a late-stage private equity fund and the Columbia Dividend Income Fund.  We also increased our positions in Robinson Municipal Bond fund and the ATAC Rotation fund and decreased our positions in Fidelity Conservative Income.

2020Q3

DOWNLOAD THE FULL QUARTERLY

The markets remained resilient through the end of September.  Following four straight weeks of losses, all major market indexes are positive year-to-date.  Specifically, the S&P 500 remains at a positive 3.5% through the 3rd quarter.  The following sectors, Technology (26%), Consumer Discretionary (21%), and Consumer Services (7%), have all generated positive YTD returns.  Current unemployment has fallen to just below 8%. The economy has returned approximately half of the payrolls lost at the start of the pandemic.  Certain economic indicators such as consumer spending, manufacturing demand and durable-goods growth point toward an economy that is recovering.

The quarter was not without its challenges.  The Billy Joel song “We Didn’t Start the Fire” rings in our heads.  Government stimulus, Supreme Court nominations, elections, coupled with the COVID calamity continue to create commotion and noise.  One concern is that while some economic indicators are improving, they are experiencing it at a slower pace than we would like to see.  Although stock market indexes are positive, some sectors, Energy (-48%), Financials (-22%), and Real Estate (-8%), have suffered year-to-date.  Disney announced that 28,000 furloughed workers would permanently lose their jobs.  American and United Airlines cut more than 35,000 jobs.  Positive sentiments in the housing sector have waned.  Housing starts slowed to 0.9% below the July 2019 numbers and 0.01% below the August 2019 numbers.  Furthering the concern, lumber prices have slipped into backwardation pricing, where future bundles are being priced at discounts to current prices.  This may foretell weaker demand.  All the economic stimulus and early access to retirement accounts pushed CPI upward.  This data lends itself to the growing concern that inflation will rear its sleepy head.

Continuing coronavirus challenges persist as well.  The coronavirus has claimed more than 200,000 lives in the U.S.  Although the number of reported cases in the U.S. has leveled off, hotspots are reemerging in the Midwest and even in New York City.  The U.K. is planning for a second shutdown.  France recently reported its highest number of daily cases.  Many are still fearing winter flu season is upon us and the dreaded “second wave” will be inevitable.

Interest rates remain at historic lows and the dollar continues to weaken.  As we write this newsletter, the current 30-year mortgage rate is at meager 2.25%!  The debt markets are so starved for yield that investors have been willing to accept a 30-year bond with a paltry yield of 1.3%.  The demand is further illustrated by the +25% total return of the long bond.

We do believe there are pockets of the market that continue to signal opportunity.  We believe value-oriented companies, specifically in the international value sector, look to be positioned for strong positive future returns.  Antithetical to this, growth companies, globally, continue to price at historically high multiples.  It is our belief that returns will be more pronounced in the value sector in the near term.   Our investment portfolios currently reflect these sentiments.  Please feel free to reach out to us to review this unique situation.  Stay safe

You Might be Saving Too Much in your 401(k)

Allow me to clarify the title right off the bat…I generally don’t think you can save too much.  But I do think you can save too much in your 401k plan and not enough in other tax-favored accounts, like your HSA or Roth IRA.

As Americans, we generally don’t receive enough financial coaching in our youth, adolescence, nor early adulthood.  Yet in that absence, there are two false financial truths we hold to be self-evident: 1) You should save into your 401(k) plan for your future, and 2) You should save into a 529 college account for your child’s future.

I’m here to tell you that you’ve been misinformed…err…not informed…err…developed misconceptions on your own.  In any matter, let me set the record straight here. I’ll be focusing on the first false ‘truth’ in this article, and I’ll hit those 529s next time.

First, let’s develop a brief understanding of how 401(k) plans became the default.  In 1978, Section 401(k) was added to the Internal Revenue Code, allowing employees to avoid being taxed if they ‘deferred’ their income.  A few years later, the IRS provided guidance allowing employees to defer their income via payroll deductions and have their company set aside that money for them into a 401(k) account.  Companies realized they could offer a matching contribution and retirement benefit through a 401(k) plan to employees far cheaper and far risker than through pension plans. 401(k) plans spiked in popularity.  The term “401(k)” has now become synonymous with “retirement plan”, much like “Kleenex” is to “tissue” or “Rollerblade” is to “in-line skate”.  Seriously, did you even know the term “in-line-skate” existed? That synonymousness gave birth to the false self-evident truth that you should save into your 401(k) plan for your future (retirement).

**Spoiler Alert**

The truth is that any savings strategy you have for your future should involve a combination of your 401(k), Health Savings Account (HSA), and Roth IRA.  And it’s a lot less in your 401(k) than you think.

**End Spoiler Alert**

A Quick 401(k) Discussion

The key benefit to the 401(k) is that there is a tax-favored element to it.  Specifically, when you save money into your 401(k), you don’t claim income on that savings in the year you earn it (for clarity, I’m talking about the “pre-tax” source in 401(k) plans, albeit you could also save on a Roth basis – but table that digression for now…), so you pay less in taxes that year. In addition, all investment earnings on your ‘deferred income’ in the 401(k) plan also grow tax-deferred.  You won’t claim any income nor pay taxes until you take a withdrawal from the 401(k) plan. 

A key disadvantage to saving into the 401(k) plan is that your money is tied up in the plan for a long time.  You have less liquidity.  In fact, that money is basically tied up until you turn age 59 ½. Generally, if you take money out of your 401(k) plan prior to age 59 ½, then not only are you going to claim it as income and pay your ordinary income taxes, but you’ll also pay an early withdrawal penalty of 10%! So roughly 30-50% of your withdrawal will vanish to taxes given the current tax brackets for most folks. Sure, you may be able to access some of that 401(k) money via a loan or hardship distribution instead, but those will usually require you to pay processing fees to the recordkeeper.  Ain’t no free lunch here.

A Quick HSA Discussion

Health Savings Accounts are also tax-favored, and most people will recognize the ‘triple-tax-advantage’ term that describes their tax-favored-ness.  Concisely, the ‘triple-tax-advantage’ means that the HSA is the most tax-favored account under the Internal Revenue Code in the great US of A.  Utilizing an HSA is basically the only way that one can actually build tax-free wealth. Similar to deferring income into your 401(k), you won’t pay income taxes on any income deferred into your HSA in the year you earn it. And similar to the 401(k), all investment earnings in the HSA also grow tax-deferred.  But a key difference is that when you take money out of the HSA you will not pay any taxes, assuming that withdrawal is used to pay or reimburse yourself for a prior qualified medical expense.  That sounds like a big assumption and a potential limitation of Health Savings Accounts, but it’s really not.

Consider that some studies estimate that an age 65 couple retiring this year are likely to face approximately $300k of medical expenses from the day they retire to the day they die. Wow, that got morbid fast. Most of those expenses can be paid from tax-free withdrawals from your HSA.  Plus, consider all the medical expenses you’ll have from now until you reach age 65…it’s a lot, especially if you have a kid every 20 months over your 30’s (personal zinger there). The punch line here is that the HSA is more tax-favored than a 401(k), and as such it should be used instead of a 401(k) to generate more tax-favored wealth for your future.  Of course, another key limitation is that you must be covered by a High-Deductible Health Plan to even contribute to an HSA, but most people are these days.

A Quick Roth IRA Discussion

A Roth IRA is yet another tax-favored account, but slightly different than the two we covered already.  In the year that you contribute to your Roth IRA, you still claim that money as income and pay taxes on it.  But once invested within the Roth IRA, all earnings grow tax free.  When you eventually take a distribution from your Roth IRA after the age of 59 ½, it all comes out tax-free.  Yes, this Roth IRA thing also has that darn 59 ½ limitation just like the 401(k), lest you want to pay an early withdrawal penalty.

But here’s one of the most important advantages of the Roth IRA…so do not miss this.  The early withdrawal limitation prior to age 59 ½ only applies to the investment earnings of your Roth IRA. You can withdraw any of your contribution basis from your Roth IRA penalty-free and tax-free at any time. This increases your liquidity, serving as both an emergency fund and also as a funding mechanism for large expenses prior to retirement – such as college expenses for your children or home renovations. 

Before moving on, let me simply explain this ‘contribution basis’ concept.  Let’s say you contribute $6,000 to your Roth IRA for 10 years straight, for a total of $60,000.  At the end of 10 years with investment earnings, your Roth IRA is worth $120,000.  Of that $120,000, $60,000 is considered contribution basis and available at your disposal.  If you’ve got some Roth IRA contribution basis, then you likely don’t need to tap into early withdrawals, loans, or hardships from your 401(k) plan.

A Quick Summary for Completeness

Some Quick Advice

So, what’s the optimal savings allocation across the 401(k), HSA, and Roth IRA? It depends on your situation.  Yup, you knew I had to say that, right? Alright fine, I hear you cursing at me in your head, and this entire article would simply be a waste if I didn’t provide some high-level guidance…right?

First, if your company provides a matching contribution in either the 401(k) or the HSA, then contribute to those accounts the minimum amount necessary to get the free matching dollars from your company.  Free money is free money after all.

Second, fill that HSA bucket with as many Benjamins as you can.  Tax-efficiency is tax-efficiency after all.

Third, if your income is only putting you into the 12% marginal bracket…then load up that Roth IRA.  If your income is putting you into the 32% marginal bracket…then load up that Pre-tax 401(k). You probably could use a tax-deduction more than increased liquidity, and you probably have enough money to fill up your Roth IRA bucket every year anyway as well.  If your income is putting you into the 22% or 24% marginal bracket, then you probably need to figure out if liquidity or tax-deductions are more important to you right now while considering your short-to-medium-term expense needs (like college or cars or vacations or homes).

Fourth, fill up the bucket that’s still available, whether the Roth IRA or the 401(k) depending on what you did on step number three.  Candidly, most people will never get to this point in any year as it’s a significant amount of annual savings.

On the record, I would simply like to state that this is generally good advice and most people can follow the above four step process. I did caveat, however, that it depends on your situation and there are some really good reasons why one would want to deviate from the advice above.

At a minimum, hopefully you’ve realized the self-evident financial truth about 401(k)s is…well…it’s just not the whole truth.

Contributed by Brian Riefepeters, FSA, EA

Medical Receipts…Do you Really need to keep track?

So, you’re finally on the HSA bandwagon.  You now realize it’s the only account within which to build tax-free wealth.  It’s the new 401(k).  You now realize that you need to actually invest the money in your HSA if want to build tax-free wealth and get the triple-tax advantage. You now have taken the extra step of simply paying your medical costs out of pocket and delaying reimbursements from your HSA…until…well, a long time from now, because you want to maximize the tax-free investment gains.

And now you have a problem. You need to keep track of all those receipts for future tax-free distributions from your HSA.  OR DO YOU!?!? [enter twilight zone sound effects]

Ok, yes, you do.  But seriously, don’t get strung out about this.  It’s not as hard as you think, nor do you need to keep some amazingly detailed and up-to-date spreadsheet; nor do you need to take a picture of every receipt and upload it into the cloud somewhere – but you can if that’s your thing.

One of the pushbacks we receive quite often when talking about the magical* essence of HSAs, and how to maximize that magic*, is that people don’t want to do all the recordkeeping of keeping track of their medical receipts.  It’s just such a burden.

I get it.  But I don’t.

Here’s the thing to keep in mind.  The only reason you actually need documentation of your receipt (or documentation of your qualified HSA-reimbursable medical expense) is if you need to prove it to the IRS, which would only happen if the IRS audited your tax return.  See, everything is self-reported on Form 8889 as a part of your IRS tax package. Line 14a basically asks, “how much did you take out of your HSA?” and then Line 15 asks, “and of the amount you took out of your HSA…how much was for qualified medical expenses?”. Line 16 then asks, “so how much was NOT for qualified medical expenses?” because “you’re going to pay us taxes on that amount son!”.  Of course, Line 16 will always be $0, right? I sure hope so. And that’s it.  You don’t need to submit any documentation to the IRS.  You don’t need to prove anything to the IRS about what you noted on line 15…unless they ask you to through an audit.

Now, don’t get me wrong.  I’m not saying pull out money that is NOT for qualified medical expenses, nor am I saying not to have the backup to prove it to the IRS. 

Rather, I’m simply suggesting to minimize the chances of getting audited and also to minimize your recordkeeping efforts unless you actually get audited.  Like, don’t do the work unless you need to, ok?

Now, I don’t work for the IRS and I’m not suggesting I know all their flags to start an audit.  But I have thought of the types of flags I would create if I did work at the IRS.  As an example, if someone took a $150,000 distribution from their HSA (reporting $150,000 on Line 14a of their Form 8889) and then reported $0 as taxable income ($0 on Line 16)…I’d be like, “wait a minute, how is that possible.  Johnny, go check out this guy reporting $150,000 as tax-free distribution from his HSA, because that is unlikely!” But if someone reported $5,000 as a tax-free distribution, I’d be like “oh yeah, that makes sense.  Nothing to find here Johnny.”

So where’s the line? I’d look at what the IRS considers to be a High-Deductible Health Plan in the first place. For 2020, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $6,900 for an individual or $13,800 for a family. (This limit doesn’t apply to out-of-network services.)

Given those figures, I would then cap my annual HSA reimbursement at $13,800 (or, if you reported being able to only contribute the “single” limit of $3,550 on the top part of the Form 8889, then I’d cap my reimbursement at $6,900). The IRS is likely only looking at things on an annual basis. And if you took a distribution of $13,800 in any single year, they’d be like, “Oh yeah, makes sense.  That person hit their out-of-pocket max this year on their health plan.  Bummer.  But there’s nothing to see here Johnny.”

Of course, you savvy financial folk on the HSA bandwagon know that there is no time limit to seek a reimbursement from your HSA for a qualified medical expense.  And yes, you may have accumulated $150,000 of unreimbursed medical expenses over the past 25 years while banking those tax-free investment earnings, but I still think it’s a good idea to cap your annual reimbursement at the $13,800 – or whatever the IRS max out-of-pocket number is indexed to in a future calendar year.

So, what if you do get audited? Either because the IRS got trigger-happy or because you decided that $150,000 HSA reimbursement was a good idea?

Don’t worry, you’ve kept all your receipts.  Because I didn’t tell you not to keep them. I mean, keep them! But don’t waste your time keeping them. Here’s how I would do it.  In fact, here’s how I actually do keep my receipts.  Are you ready for this?

Every time I pay a bill, I just write down “paid date” on the bill and stash that bill in a box in my furnace room.  It’s becoming a big box, but it only takes me 3 seconds to do it.  I’m not spending the time keeping detailed records or tidy records or a detailed log of every expense in excel or in some cloud somewhere.  It’s just a box of papers, and I haven’t wasted any time keeping track.  Yes, I have a rough idea in my head of how much I can reimburse myself, but I’m also not planning on any HSA distribution until a very long time from now…like retirement. I’m also not planning on getting audited, so I have no plans to sift through that box of papers either.  I don’t ever actually want to do any work on this.  I just want to build up some tax-free wealth. So that’s what I’m doing.  But I also know that if I ever do get audited, I have the ability to spend some time sifting through papers and proving my tax-free money really is tax-free. If I ever actually get to that bridge…then I’ll cross it.  But no point in trying to cross a bridge over miles and miles of perfectly mowed pasture grass.

*and by magic, we mean tax-free-ness

Contributed by Brian Riefepeters, FSA, EA

Seeking Income

Are you looking to retire?  Need income?  Investors are often concerned with how much yield or income an investment can generate. Retirees want to invest money and be able to live off of the income that their investments generate.  Often as investors reach retirement age, they want less risk and don’t want to ride the volatility wave of the stock market, particularly with the recent experience and pain of the 2008 recession.  That pain is so memorable that it still plays a role in people’s willingness to take risk.  How does this impact a portfolio?  “Less risk” becomes synonymous with income-generating investments.

Here’s the problem with focusing purely on income-generating investments…Prevailing interest rates will drive the current rates of respective investments.  Note that prevailing rates are quite low today. During yield starved market environments investors become so desperate for yield that they will chase the very thing that they are trying to avoid…risk.  When demand grows for market starved investments, the prices of these investments appreciate, which leads to further price appreciation.  Investors are forced to chase even riskier investments than before.  The result: risky investments with more potential volatility.    

The problem is that retirees are overly concerned with the income or yield opportunity of a portfolio rather than looking at the total return opportunity.  Consider two portfolios.

Portfolio A: Generates 3% income/yield; and a total return of 5%

Portfolio B: Generates 1% income/yield; and a total return of 7%

The income-focused investor will choose Portfolio A due to an annual income that is three times larger than Portfolio B.  Here’s the problem with this choice. Not only did the investor make 2% less on an absolute basis, but the investor made considerably less after taxes. 

Illustration:

Income doesn’t matter.  It is a marketing tool.  We shouldn’t care about yield or income.  We should only care about our bottom line; or what actually hits our pocket book. 

Contributed by Daren Shavell, CFA

Dear Grad, Avoid These Mistakes

Dear soon-to-be college graduate (or parents of a soon-to-be college graduate),

You will soon enter a new era of salaried full-time employment with broad benefits from a great employer.  We’ve seen numerous offer letters and countless benefit packages.  This new era will bring you new financial opportunity, but it also brings a few financial traps to be aware of.  That’s why we’ve compiled this list of four common first-time-job financial mistakes, so that you can be confident in the financial decisions and benefit choices you make on day one of your new gig!

MISTAKE 1: LIVING ON 100% OF YOUR NEW PAYCHECK

You’ve got the offer letter. $60,000 salary. Nice! Quickly, you do the math: just over $1,150/week.  Bazinga! You can have a lot of fun with $1,150/week!  Sadly, that would be a mistake, because you won’t have anywhere near $1,150/week of disposable income. Instead, you’ll likely end up with about 20% of your pay as disposable income, which is more like $230/week.  A healthy way to think about your paycheck would be as follows:

You won’t even see the first 25% of you pay as it will be deducted for taxes and premiums, including federal and state taxes, FICA, and employer benefit premiums. This may come as a shock in the first paycheck you receive!

Now that you’re on your own, you’ll need 40% for essential living expenses such as housing, food, utilities, and maybe even some student loans and debt payoff.

And don’t forget to pay yourself by setting aside 15%. Some will be siphoned off before you see it into your 401(k) and HSA, and some you’ll put into an IRA afterwards. Your future self will thank you for getting into good savings habits early.

Let’s do the math, and that leaves you with 20% as disposable income. Ouch!

MISTAKE 2: RIDING ON YOUR PARENTS’ HEALTH INSURANCE UNTIL YOU’RE 26

You’ve been covered by your parents health insurance for years, and it seems easy to maintain the status quo. But Just because your parent’s health insurance allows them to cover you until you’re 26 doesn’t mean it’s a good idea.  It’s usually a pretty bad idea.  Often, it means higher premiums paid by your parents and lost opportunity to get free HSA money from your employer. You have to review in detail both the insurance your new employee offers as well as the insurance your parents’ employer offers.  Usually, premiums are higher for covered dependents (you would be a dependent on your parents’ insurance) than for the employee themselves. Your parents may be paying premiums that are 50-100% more than what you could pay for similar health coverage.  Plus, as a young and healthy individual, it would probably be a wise decision to enroll in a low premium high-deductible health plan offered by your employer, which often comes with a nice contribution to your Health Savings Account. Bazinga!

MISTAKE 3: SAVING TOO MUCH IN THE 401(K) PLAN

Save…yes.  But only in the 401(k)…no.  If you read the summary of mistake #1, you’ll recall that we suggest saving a total of 15%.  But generally, the most you want to save in the 401(k) right of the college is enough to receive the maximum company match. After that, you should be pumping the rest of that 15% in your Health Savings Account (annually up to $3,500 individually or $7,000 if married) and your Roth IRA (annually up to $6,000). Doing so will increase your Financial Agility, or your ability to react to changes in your financial situation in the future. What you need to know is that any money saved in the 401(k) is basically locked away until the age of 59 ½ unless you’re willing to pay early withdrawal penalties to the IRS. However, money saved into your HSA and Roth IRA may be accessed in the short term and even right away without penalty. The gist is that you’re going to use your Health Savings Account to actually accumulate or save money, pay for medical expenses out of pocket, and those unreimbursed medical expenses become future tax-free and penalty-free withdrawals. Relative to Roth IRAs, your contribution basis (the money you contribute, not the investment earnings portion of your Roth IRA account) is always available to you for withdrawal tax-free and penalty-free in the future. The availability of these funds from your HSA and Roth IRA on a tax-free and penalty-free basis provide you with Financial Agility.…all while you’re still getting tax free investment earnings for the future! Bazinga!

MISTAKE 4: ENROLLING IN UNNECESSARY VOLUNTARY BENEFITS

If your employer offers a nice suite of voluntary benefits, it can be tempting to go on a little shopping spree.  After all, they’d only offer those benefits if they were a good deal – right?  Not necessarily.  Look, you don’t need pet insurance, or critical illness or accident insurance, and you probably don’t need to buy an extra two days of vacation.  If you need life insurance due to debt or dependents, you’re likely better off applying for a term policy and being medically underwritten on your own versus buying one year of life insurance coverage through the company.  Instead of siphoning off your income into these voluntary benefits, you should be setting up a little emergency fund (including your Roth contributions and unreimbursed medical expenses from your HSA) so that you’re able to self-insure those small-ish unexpected expenses as they arise.  Save more into your HSA or increase your Roth IRA contributions to increase your Financial Agility. Bazinga!

So there you have it: four common first-time-job financial mistakes that you can easily avoid to give your working career a lift.  Just keep in mind that this article is written in generalities, and every situation, every employer, every job offer, and every benefits package is different. 

While we’ve captured common mistakes in common situations, you really should find a financially savvy advisor that will work with you in your situation.  Find an advisor that will review your benefits package with you and provide enrollment guidance.  Find an advisor that will give you a plan on how to allocate your income across living expenses, debt, and savings.  Find an advisor that will help you understand all the savings vehicles (401(k), IRA, HSA, etc) available and how and why to allocate dollars to them.  Find an advisor that’s willing to work with you for a small fee, even though you likely don’t have investable assets yet.  There may not be many advisors that fit that pattern, but we may have a reference or two if you need one. 😊

Total Reward Statements Might be a Joke.

The other day I was sitting with someone who just got their Total Rewards Statement.  “It’s such a joke” he said, “We were all laughing at the stuff on the page. FICA taxes?  Why would they take credit for taxes? I guess they’re trying to make the number look as big as possible, right?”

It was clear these statements were met with skepticism. And I don’t think that’s uncommon when it comes to Total Rewards Statements.  As an employee, it’s naturally to question a document that suggests you’re making $100k when you know your salary and bonus is only $70k, and yet you seem to only have $35k of disposable income to live on. You’re skeptical. You don’t want to be fed some bogus story on a piece of paper that you’re actually being paid $100k when you know you’re not.

Here’s the issue. Cash compensation, such as salaries and bonuses, generally only make up 70% ($70k above) of the cost of employment.  The other 30% ($30k, for a total of $100k above) is provided as retirement contributions, health insurance, ancillary benefits, payroll taxes, etc.  The employer knows it does actually cost $100k to pay someone a $70k salary.  As an employer, you hope your employees have a true understanding of the full investment you’re pouring into them! You want them to know and appreciate that the benefits you provide, the culture you have, and the intangibles you offer are better than your talent competitor down the street! 

So, Employer, how do we help your employees understand your investment in them without getting a few chuckles and skeptical comments?

Well, I was just spit-balling on that same topic, so let me know throw some thoughts out there.

What if we turned that reactive end-of-year-look-back Total Rewards Statement into a proactive beginning-of-year-look-ahead Total Rewards Opportunity Statement? What if we focused on those elements of your organization that truly differentiate your employment brand and employment value proposition, rather than trying to get credit for every penny spent…like FICA taxes and unemployment insurance? What if we show the value of those financial opportunities (company contributions & match in 401(k)/HSA)  not only in today’s dollars, but also as of the employee’s potential retirement age? What if you, or a trusted third party advisor, sat down with your employees to help them understand their Opportunity Statement and optimize their benefit elections and financial decisions so that they could increase their take-home value now and/or in the future? What if you added a review of one’s Opportunity Statement to the wellness program you already have in place, making it one possibility to earn the financial incentives of your wellness program?  Or what if you had a mechanism to at least reach out talk directly to those employees that are not optimizing their rewards opportunities like wellness incentives, matching contributions, free gym memberships or EAP programs?

Think about all the value employees receive but don’t understand.  Think about all the value that employees are leaving on the table. 

Opportunity Statements may be one way to flip the script, but that’s just the beginning.  Let’s figure it out!

529s? Nah.

Do you really want to fund a 529?

Answer: probably not.  Don’t get me wrong, I’m with you on your intentions.  And your logic is spot on if it’s anything like that of a new (or experienced) parent, which probably goes something like this: “We have children.  We want the best for our children.  The best includes our children going to college.  We want our children to be able to afford going to college.  Let’s open a 529 account and start saving, because a 529 account is for college.”

That thought process is great.  And it seems quite logical.  But I believe there is one minor flaw.  It assumes that a 529 account is the best tax advantaged account to accumulate funds to pay for that college education.  The reality is that 97%* of us probably should never even consider a 529 account.

To explain why, let’s first remember that a 529 is advantageous for saving for college because it allows us to avoid paying taxes on the investment earnings in the 529 account.  It’s a tax advantaged account.  But what if there was a way to avoid paying taxes on investment earnings while having flexibility to use your money…for things like a home purchase, a large unexpected expense, or even college tuition when the time comes?  

There actually is a way, and it doesn’t involve 529 accounts.  Having your money set up in this ‘way’ is what we define as Financial Agility: optimizing returns, taxes, and flexibility so that you’re in the best position to financially react when the future comes your way.

Instead of funding a 529 account, we would suggest first funding your Health Savings Account and Roth IRAs. Both of these accounts are tax advantaged like the 529, but they will provide you with some additional financial agility.  We’ve discussed Health Savings accounts in our Thought Leadership series, so we won’t go into detail here.  The gist is that you’re going to use your Health Savings Account to actually save money, pay for medical expenses out of pocket, and those unreimbursed medical expenses become future tax-free and penalty-free withdrawals – all while your money is still enjoying tax free returns in the account.  Relative to Roth IRAs, your contribution basis (the money you contribute, not the investment earnings portion of your Roth IRA account) is always available to you for withdrawal tax-free and penalty-free in the future.  The availability of these funds from your HSA and Roth IRA on a tax-free and penalty-free basis provide you with flexibility.  They can be used in the near-term future for college expenses if you need it for that purpose.  Not only that, these funds can really be used as a source of near-term emergency funding for any need: home down payment, broken furnace, etc.  Of course, the hope is that you don’t need these funds in the near term and you can use them to help achieve your financial independence in the future; but the point is that you’ll have these financial resources and financial agility to react at that future point when it comes.

So unless you’re already contributing the maximum amount to your HSA and Roth IRAs, which is $19,000 in 2019 ($7,000 HSA family maximum, $6,000 for your IRA, and $6,000 for your spouse’s IRA), then it probably doesn’t make much sense to set up a 529 account.

* No official study was performed to validate the “97% of us” figure. 97% is a hyperbolized figure, kind of like a wet finger in the air, although the magnitude is likely accurate.