In December 2018, the markets were reeling from comments made by the Fed that it planned on continuing to raise rates AND that it would maintain an ongoing effort to reduce its balance sheet on “auto-pilot.” Quickly, December devolved into one of the worst months for equities on record. Just as abruptly, however, Fed Chair Jerome Powell changed his course in early January, explaining that the Fed would be “data dependent” in its view to raise rates and would be very moderate in selling securities to decrease its balance sheet.
Fast forward to last week and Powell is making even more headlines by becoming even more dovish. Not only proclaiming that the Fed will NOT raise rates anytime in 2019, he indicated that the Fed would completely stop the balance sheet “run-off” in September. And given their newly reduced estimates on economic growth, Powell even went so far as to project that the Fed would only raise rates one time in 2020 and not once in 2021.
WOW. As notable bond guru, Jeffrey Gundlach, explained last week, “This U-turn—on nothing fundamentally changing—is unprecedented. Three months ago, we were on ‘autopilot’ with the balance sheet—and now the bond market is priced for a rate cut this year. The reversal in their stance is stunning.”
While, in our opinion, it may not be completely fair to say that the Fed caved to political or market pressure, it does seem that their now-cautious stance is curious. Less than three months ago, the Fed seemed perfectly agreeable, if not determined, to “normalize” rates letting them go higher, noting in a December 2018 statement, “the labor market continued to strengthen (in November) and economic activity has been rising at a strong rate.” By contrast, Powell is now signaling no further rate hikes (until 2020) and seems intent on keeping downward pressure on long-term rates.
While this Fed decision has significance on its own accord, perhaps what is even more noteworthy is the effect that the Fed’s comments will have on the market in the broader sense---once the realization of the “sugar high” of lower rates wears off. As Gundlach goes on to say, this change of heart by the Fed “could hurt the U.S. central bank’s credibility,” but it is also true their tepid remarks about the economy could also help to stoke fears of an impending recession—fears that have been rumored for the last few months.
One of the headwinds that the market is facing is the idea that U.S. economy is slowing, with many investors calling for a recession possibly this year or early next. Some point to the “yield-curve inversion” that has now occurred between certain shorter-term rates becoming higher than certain longer-term rates. In the past, this has signaled future recessionary times—but not always.
Simply put, in our opinion it is quite surprising to see the Federal Reserve basically change its policy on a dime: three months ago, the Fed was planning to raise rates twice in 2019 AND significantly reduce the balance sheet; today, the expectation is zero rate increases and the end of quantitative tightening in September. Has the global economy changed that much in such a short period as to have such a dramatic shift in plans? First quarter company earnings season is right around the quarter so we may get some answers to these questions soon.
Popular Questions about 529 Plans……And Fees You Shouldn’t Have to Pay
What are the advantages of 529’s over other plans?
Contributions may be tax deductible (depending on the state), can grow tax-free and can be made by anyone for the benefit of the student.
What if all the money is NOT used in a 529 plan?
The money can be kept in the plan for the original beneficiary’s direct relatives, including siblings, cousins or the person who created the plan. Even grandchildren—who may not be born yet—may benefit from the plan. If you eventually take the money out for non-educational purposes, there is a 10% federal penalty on the gains, plus federal and state income tax on the gains. However, you may be able to withdraw the money without penalty if your child has received a scholarship or you are able to use the American Opportunity Tax Credit for higher education.
Who should own the 529 for financial aid purposes?
Generally, the calculation for financial aid benefits having the parents own the plan; however, grandparents can certainly own the plans for grandkids and there are ways to work around the ownership issues that may affect financial aid.
How to maximize eligibility for financial aid while saving as much as you are able to?
The best bet is to use a 529 with the parent as the owner and the student as beneficiary. However, parents are encouraged to open a ROTH IRA for their children; such accounts will not affect financial aid, although withdrawals will be considered untaxed income and be counted at up to 50%.
Should you use 529 money for K-12 schooling or for college?
529 plans were designed for people to save over longer periods of time. While the option to pay for K-12 tuition is available for most, using the money for college may be optimal. Opening two 529’s may also be an alternative.
What are the consequences of changing the owner of a 529?
Most plans will allow you to change ownership, however, it is important to understand what this may mean for the eligibility of financial aid. If the plan does NOT permit ownership changes, you can roll the 529 into a different 529 for the benefit of the same student or a member of the beneficiary’s family.
With respect to fees within the 529 plans, investors need to be aware of the share class in which their funds are invested. Just as we’ve discussed with regular mutual fund investing, each share CLASS carries with it a different set of internal fees, a portion of which often may be paid to the advisor or broker. These fees can include upfront commissions that can be as high as nearly 6%, while other share classes can pay out to the broker a much smaller amount, but on an annual basis.
At NCM, we regularly assist with college planning and do not charge for the management of these types of plans. We often recommend low-cost state plans that offer attractive investment options that do not require frequent oversight. Our view is that a carefully selected 529 plan is the best vehicle to save for college, BUT you must be mindful of any hidden fees! College planning is another area that is ripe for questionable sales tactics- for example the “buy a ton of life insurance or an annuity” strategy to help qualify for more aid.
Fees: Brokers Get Caught with Their Hand in the Cookie Jar….
It was recently reported that 80 investment advisory firms were required to pay back more than $125 million to clients who were steered into higher-cost mutual funds without being clearly told about cheaper versions.
As we’ve written about many times, is supremely important to find out how your advisor or broker is being compensated. While we do not collect any commissions or selling-commissions from any fund or investment we recommend, many other firms do collect these fees as part of their normal compensation strategy. There is nothing illegal about this and mutual fund families have specifically structured different classes within the same mutual fund enabling these brokers to collect in these fees.
However, investors should inquire as to the cost of the fund (i.e., its expense ratio) and whether there is another lower cost option, perhaps even in the same mutual fund. At NCM, we try to use institutional share classes which generally have the lowest expense ratios, so that the internal fund cost to our clients is the lowest possible. It is all about transparency!
Biggest Risk to Retirement: Becoming a Bank to Your Kids
Those nearing or thinking about retirement will often consider inflation, healthcare and other living expenses, but one factor that is often overlooked is your kids. Nearly 80% of parents give some financial support to their adult children. Consulting firm, Age Wave, estimates that amount to be $500 billion-- almost twice what parents contributed to retirement accounts. In some cases, these well-intentioned acts can foster bad financial habits for children, while possibly derailing a parent’s own retirement plan.
Education is one of the biggest contributors, and paying for school continues to be a dilemma for most people as the cost of schooling has risen dramatically over the years. However, as we have advised many clients, it may make sense to fund an emergency plan, max out a retirement account and THEN allocate funds to a 529 college plan. In fact, by doing it in this order, not only may it increase the chances for a successful retirement plan for the parent, it actually may benefit the possibility of financial aid for the child as it will reduce the amount of parental assets that are included in the financial aid assessment.
Other loans or gifts to children may (…or may not) make sense, but it is important to keep a broader view of the amount being given and what, if any, the prospects are for getting it repaid. Chances are that younger adult children will have a greater time horizon than their parent and finding the money through another source may be a better route. Again, in most cases, funds being loaned to children will necessarily reduce what may be put towards retirement planning. However, that said, each case is unique and can be extremely personal in nature for both the child and the parent.
At NCM, we find ourselves being asked to opine on these situations from time to time. As a parent myself I can understand how hard these decisions can be. We all want to help our children have a better life. As fiduciaries to our clients however, sometimes we have to deliver news that isn’t the most favorable. It is not easy to fund a secure retirement and financially support adult children. (FYI: this topic was the cover story of this past weekend’s Barron’s.)
Appeal of Dividend-Paying Stocks
If you’ve followed our writing for any extent of time, you’ve probably read about our affinity for dividend-paying stocks. And in today’s environment, this class of assets may be becoming even more attractive.
Typically, stock dividends compete against interest rates; that is, if rates rise, then bonds look more attractive and may offer less risk. However, as the Fed has recently pivoted away from its intent to raise rates, dividends (for income) have greater appeal.
But greater income is not the only benefit that dividend-yielding stocks offer. As a recent Wall Street Journal article states: “from 1958 through 2018, the top 20% of the S&P 500 companies ranked by dividend yield and weighted by market cap outperformed the overall S&P 500 by 2.13% annually.” So not only do dividend stocks offer greater income, but in many instances better overall performance also.
The reason for this stems largely because the dividends add significantly to total return—defined as an asset’s capital appreciation plus any income/dividend. In fact, Morningstar Inc. calculates that dividends account for 19% of the S&P 500 index’s return over the last five years. Many would find that this would be a much larger portion if taken over longer periods of time, due to the compounding of the reinvestment of dividends.
Of course, the dividend yield alone should not be the only factor that investors look for when choosing a security in which to invest. Too high a dividend may mean that the company is not investing in its own business, or if the yield (i.e., the dividend amount divided by share price) becomes too high, it may mean that the business is in trouble.
Of course, the converse to this is often true as well: Those businesses that increase dividends over time are more likely to outperform other stocks…and with less volatility because of their strong balance sheets and mature, solid business brands.
End to a Fun Basketball Season
Well, it’s finally the spring season in the northeast and the only thing I typically miss about the winters around here is the end of basketball season. This past winter Derek and I volunteered to coach a 7th grade boys travel team. I’ve typically coached one of my daughter’s teams in the past, but wanted to try something different this year. My youngest daughter is a 7th grader so this boys’ team was comprised of many of her friends and classmates.
It turned out to be a very rewarding season, as it was a great group of boys who worked hard and had fun. We ended up making it to the semi-final game, actually giving the eventual league champion a real run for their money. As for our team, we’d like to think that both players and coaches accomplished far more than we thought we could back at our first practice in November. Just like helping our clients achieve financial independence is incredibly rewarding to us, so is watching a group of good young men accomplish something they didn’t think was possible only a few months ago. Derek and I just had a great time coaching these boys and it will be missed---until next season (hopefully!).
All the best,