February 2020 Newsletter
When describing the market in past newsletters, we’ve often used the term “resilient.” And when you look at the issues facing investors over the last few months--from the continuing effects of the China trade tariffs, to the Iran military conflict, to the recent Coronavirus outbreak, resilient can almost be an understatement in describing the market’s performance.
However, what is also true is that many positive factors for the market continue to exist: low unemployment, historically low interest rates (….and a Fed intent on keeping them that way) and, of course, decent corporate earnings. In fact, as we are now ending the reporting period for the 4th quarter, company numbers have been mixed, but certainly not bad.
As has been the case for most of the last decade, we start 2020 with the US Large Cap Growth asset class as the clear leader and more specifically, large tech stocks. But true long-term investors understand that all asset classes go through cycles that can’t be timed or predicted. For example, just as in the last decade where it has been US large growth stocks that have been the clear winner, in the previous decade US large growth stocks were the clear loser.
Many market pundits claim that valuations are too high for stocks, but there are many different metrics that can be used to evaluate market valuations. For example, by one valuation indicator (price-to-book ratio), yes, US large growth stocks--as the clear leader in the last decade--have appreciated greatly as their price-to-book ratio has increased by 113%; their valuations have indeed exploded! But going deeper and examining other asset classes tells a slightly different story: other parts of the market are not nearly as expensive as large US growth stocks. For example, US large value stocks have only seen their price-to-book ratio increase by 32% in the last decade. How about US small caps? Small growth has only seen a 26% increase in their price-to-book ratio. And small value? Only 4%!
What does this all mean? Well, maybe, just maybe, the only overvalued part of the market today is in US large growth stocks--which to no surprise is where all the fund flows are going now! While all investors should have a reasonable allocation to large technology stocks, now may be as good a time as ever to make sure that allocation is not excessive.
SECURE Act: New Planning Strategies
Under the new SECURE act, IRA investors have some decisions to make. Among other changes from this bill, the elimination of the “stretch” IRA is perhaps the most impactful. The stretch IRA previously allowed beneficiaries to withdraw an inherited IRA over the course of their own lifetime, thus gaining years of tax-deferred benefits. Under the new legislation, however, this period—for all non-spouse beneficiaries--has been shortened to 10 years. In other words, those who inherit a traditional or Roth IRA as a non-spouse are required to withdraw 100% of the account balance by the end of 10 years. This creates a number of discussions about what is not only practical, but necessary, for this type of legacy planning.
First, as a reminder, traditional IRA’s are usually funded with pre-tax money; any distributions are taxed as ordinary income. Traditional IRA owners also are mandated to take required minimum distributions (RMD’s) at age 72, previously 70 ½. Roth IRA’s are not subject to RMD’s, while any distributions can be taken tax-free. However, regardless of whether one is dealing with a traditional or a Roth IRA, individuals must know the importance of who is listed as the beneficiary on these accounts.
For example, prior to the new law, leaving a traditional IRA to a grandchild (rather than a spouse) was a popular planning idea which would extend the withdrawal period for an inherited IRA to the younger heir. However, with the new law, any NON-spouse is held to the 10-year withdrawal period; therefore, leaving a traditional (or, for that matter, a Roth) IRA to someone other than a living spouse--with the intent of having a longer distribution period for that younger heir--becomes a non-issue. Instead, naming the living spouse will likely increase the amount of time that the IRA maintains its tax-deferred status as the holding period includes the mandated 10-year period, but which doesn’t begin until the passing of the living spouse who became the new IRA owner.
In that same vein, when it comes to traditional IRA’s and the associated RMD, the living spouse could then use those required distributions to “gift” amounts to heirs over time. Or as an additional step in estate planning, the spouse could invest these distributions in taxable accounts; taxable accounts receive a “step-up” cost basis which benefits the inheritor.
Second, and perhaps more importantly, individuals may want to consider whether to convert a traditional IRA to a Roth IRA. The biggest advantage of converting all or a portion of a traditional IRA to a Roth is to relieve future tax burdens to the inheriting owner. For example, an heir of a traditional IRA today will have 10 years to withdraw the entire amount of the account. Whether they take distributions each year for 10 years, a combination thereof, or the entire lump sum in year 10, they will have to pay taxes on those withdrawals. These amounts can be quite large and may end up pushing those individuals into a higher tax bracket.
Conversely, with an inherited Roth, yes, heirs still will have to zero out the account by year 10, however, they will not face any associated income tax on the withdrawal, as this will have been paid at the time of the conversion by the original owner. This is particularly significant if one believes that taxes may be higher over time than they are today.
That all said, converting a Roth should not be done without discussion. For one, individuals need to be conscious of how much they are able to convert; that is, how much their income will increase for that year and what the tax implications will be. In addition, there needs to be a consideration for what effects the converted amount may mean for their Social Security taxes and Medicare.
In many cases, conversions make sense, but individuals should NOT disadvantage their own retirement plan.
Investment Spotlight: Gold
Over time, we often receive the question: “What are your thoughts about gold?”
Well, as with nearly every investment, it depends primarily on the client’s situation and what their goal is for holding it. As most know, gold has typically been considered a “safe haven” from riskier assets. It also has a very low correlation to most financial assets, meaning that gold represents a level of diversification away from traditional stocks and bonds. Gold also becomes very popular during periods of financial crisis as it has shown to maintain its purchasing power as stock prices deteriorate and bond yields fall.
The downside to holding gold—in the form of gold bullion or through an ETF, though, is that there are costs to store and insure it. And as gold bullion does not pay a dividend, these holding costs can erode profits over time.
However, a second way to invest in gold is by buying the actual companies that harvest it, i.e., gold miners. Gold mining companies provide similar diversification from most equity and fixed-income holdings, but they can also be very volatile in their stock prices. Such volatility will enhance profits if gold prices increase, but also can sharply impact gold miners’ profits on the downside as well. In essence, you are buying shares in a company with operating expenses that sells one shiny commodity; common corporate issues involving financing, costs for new development projects, expansion, etc. all will play a factor in the gold miner’s earnings…and hence, its share price.
As far as our own investment philosophy, gold is not an asset that we generally recommend in our strategic long-term asset allocations. Although for certain clients, and again, depending on their strategy, we do--and will--hold gold mining stock through ETF’s. Because of the low correlation between gold mining securities and traditional stocks and bonds, we believe the increased volatility of gold mining stocks (compared to gold bullion) is a BENEFIT to a diversified portfolio. Because we don’t believe in forcing every client into a one size fits all model, we can have these discussions with clients and determine if an allocation to gold is appropriate. Again, in many instances, our view is that it is not.
Sage Advice From “Old” Self To “Younger” Self
Jonathan Clements is an excellent writer, author of many financial books and a former columnist for the Wall Street Journal. He also spent six years working on Wall Street on the wealth management side. Earlier this month he issued a list of ten lessons he “wished (he’d) been told in my 20’s.” Here are our favorite ones which we feel could apply to most people, irrespective of their age.
All the best,
Nick
However, what is also true is that many positive factors for the market continue to exist: low unemployment, historically low interest rates (….and a Fed intent on keeping them that way) and, of course, decent corporate earnings. In fact, as we are now ending the reporting period for the 4th quarter, company numbers have been mixed, but certainly not bad.
As has been the case for most of the last decade, we start 2020 with the US Large Cap Growth asset class as the clear leader and more specifically, large tech stocks. But true long-term investors understand that all asset classes go through cycles that can’t be timed or predicted. For example, just as in the last decade where it has been US large growth stocks that have been the clear winner, in the previous decade US large growth stocks were the clear loser.
Many market pundits claim that valuations are too high for stocks, but there are many different metrics that can be used to evaluate market valuations. For example, by one valuation indicator (price-to-book ratio), yes, US large growth stocks--as the clear leader in the last decade--have appreciated greatly as their price-to-book ratio has increased by 113%; their valuations have indeed exploded! But going deeper and examining other asset classes tells a slightly different story: other parts of the market are not nearly as expensive as large US growth stocks. For example, US large value stocks have only seen their price-to-book ratio increase by 32% in the last decade. How about US small caps? Small growth has only seen a 26% increase in their price-to-book ratio. And small value? Only 4%!
What does this all mean? Well, maybe, just maybe, the only overvalued part of the market today is in US large growth stocks--which to no surprise is where all the fund flows are going now! While all investors should have a reasonable allocation to large technology stocks, now may be as good a time as ever to make sure that allocation is not excessive.
SECURE Act: New Planning Strategies
Under the new SECURE act, IRA investors have some decisions to make. Among other changes from this bill, the elimination of the “stretch” IRA is perhaps the most impactful. The stretch IRA previously allowed beneficiaries to withdraw an inherited IRA over the course of their own lifetime, thus gaining years of tax-deferred benefits. Under the new legislation, however, this period—for all non-spouse beneficiaries--has been shortened to 10 years. In other words, those who inherit a traditional or Roth IRA as a non-spouse are required to withdraw 100% of the account balance by the end of 10 years. This creates a number of discussions about what is not only practical, but necessary, for this type of legacy planning.
First, as a reminder, traditional IRA’s are usually funded with pre-tax money; any distributions are taxed as ordinary income. Traditional IRA owners also are mandated to take required minimum distributions (RMD’s) at age 72, previously 70 ½. Roth IRA’s are not subject to RMD’s, while any distributions can be taken tax-free. However, regardless of whether one is dealing with a traditional or a Roth IRA, individuals must know the importance of who is listed as the beneficiary on these accounts.
For example, prior to the new law, leaving a traditional IRA to a grandchild (rather than a spouse) was a popular planning idea which would extend the withdrawal period for an inherited IRA to the younger heir. However, with the new law, any NON-spouse is held to the 10-year withdrawal period; therefore, leaving a traditional (or, for that matter, a Roth) IRA to someone other than a living spouse--with the intent of having a longer distribution period for that younger heir--becomes a non-issue. Instead, naming the living spouse will likely increase the amount of time that the IRA maintains its tax-deferred status as the holding period includes the mandated 10-year period, but which doesn’t begin until the passing of the living spouse who became the new IRA owner.
In that same vein, when it comes to traditional IRA’s and the associated RMD, the living spouse could then use those required distributions to “gift” amounts to heirs over time. Or as an additional step in estate planning, the spouse could invest these distributions in taxable accounts; taxable accounts receive a “step-up” cost basis which benefits the inheritor.
Second, and perhaps more importantly, individuals may want to consider whether to convert a traditional IRA to a Roth IRA. The biggest advantage of converting all or a portion of a traditional IRA to a Roth is to relieve future tax burdens to the inheriting owner. For example, an heir of a traditional IRA today will have 10 years to withdraw the entire amount of the account. Whether they take distributions each year for 10 years, a combination thereof, or the entire lump sum in year 10, they will have to pay taxes on those withdrawals. These amounts can be quite large and may end up pushing those individuals into a higher tax bracket.
Conversely, with an inherited Roth, yes, heirs still will have to zero out the account by year 10, however, they will not face any associated income tax on the withdrawal, as this will have been paid at the time of the conversion by the original owner. This is particularly significant if one believes that taxes may be higher over time than they are today.
That all said, converting a Roth should not be done without discussion. For one, individuals need to be conscious of how much they are able to convert; that is, how much their income will increase for that year and what the tax implications will be. In addition, there needs to be a consideration for what effects the converted amount may mean for their Social Security taxes and Medicare.
In many cases, conversions make sense, but individuals should NOT disadvantage their own retirement plan.
Investment Spotlight: Gold
Over time, we often receive the question: “What are your thoughts about gold?”
Well, as with nearly every investment, it depends primarily on the client’s situation and what their goal is for holding it. As most know, gold has typically been considered a “safe haven” from riskier assets. It also has a very low correlation to most financial assets, meaning that gold represents a level of diversification away from traditional stocks and bonds. Gold also becomes very popular during periods of financial crisis as it has shown to maintain its purchasing power as stock prices deteriorate and bond yields fall.
The downside to holding gold—in the form of gold bullion or through an ETF, though, is that there are costs to store and insure it. And as gold bullion does not pay a dividend, these holding costs can erode profits over time.
However, a second way to invest in gold is by buying the actual companies that harvest it, i.e., gold miners. Gold mining companies provide similar diversification from most equity and fixed-income holdings, but they can also be very volatile in their stock prices. Such volatility will enhance profits if gold prices increase, but also can sharply impact gold miners’ profits on the downside as well. In essence, you are buying shares in a company with operating expenses that sells one shiny commodity; common corporate issues involving financing, costs for new development projects, expansion, etc. all will play a factor in the gold miner’s earnings…and hence, its share price.
As far as our own investment philosophy, gold is not an asset that we generally recommend in our strategic long-term asset allocations. Although for certain clients, and again, depending on their strategy, we do--and will--hold gold mining stock through ETF’s. Because of the low correlation between gold mining securities and traditional stocks and bonds, we believe the increased volatility of gold mining stocks (compared to gold bullion) is a BENEFIT to a diversified portfolio. Because we don’t believe in forcing every client into a one size fits all model, we can have these discussions with clients and determine if an allocation to gold is appropriate. Again, in many instances, our view is that it is not.
Sage Advice From “Old” Self To “Younger” Self
Jonathan Clements is an excellent writer, author of many financial books and a former columnist for the Wall Street Journal. He also spent six years working on Wall Street on the wealth management side. Earlier this month he issued a list of ten lessons he “wished (he’d) been told in my 20’s.” Here are our favorite ones which we feel could apply to most people, irrespective of their age.
- A small house is the key to a big portfolio. Spending more on a house than needed can be a huge waste of money. And having a manageable mortgage and being able to pay it off as soon as possible is tremendously advantageous. Our take--live within your means; retirement planning becomes much easier if so!
- Debt in almost every form is a negative; it looms as an unwelcome overhang to most people’s financial independence. Even mortgages or educational loans should be paid back as quickly as possible. Our view is that debt is more of a personal decision and not one size fits all. There is good debt and there is bad debt.
- Tracking the market every day is a waste of time. It won’t affect the performance of your portfolio, and it will take away from time that could otherwise be better spent. Our take--absolutely! There is too much focus on day to day market movements.
- A larger portion of stocks (vs. bonds) in your portfolio provides the best chance for longer term financial success. Over time, adding to your stock positions, in good times and bad, will put you in a better position to meet your financial goals. Our take--stocks are the best game in town.
- Nobody knows what the market will do in the short-term. Plenty of smart and articulate pundits make a lot of money speculating on the direction of the market; most of these people are wrong and can negatively influence investor behavior. Our take--nobody can time the market successfully and consistently.
- Put your retirement first. This should be the top goal for everyone. Start saving as early as possible and make it a priority. Our take--the sooner one starts to save the easier long-term financial planning becomes.
- Try to work for yourself. Find something that you enjoy doing; you will want to work hard at it, you will most likely become proficient in it, and, most importantly, it will be rewarding knowing that you are doing it for yourself. My personal view-I couldn’t agree more-it’s been just over 10 years since I’ve become self employed and these 10 years have been the most rewarding by far in my career. Find something you love to do and do it for yourself. Your quality of life will increase exponentially.
All the best,
Nick