This past year has reordered our lives in numerous ways as we have all dealt with a seemingly endless barrage of uncertainty and disruption. One thing we know for sure is that this year will end….and soon! As we bid a not so fond farewell to 2020 there are several financial considerations for us all to keep in mind. As always, we recommend working with your RGT advisor if any of these items trigger a question.
- Is your estate plan updated and in effect with trusts funded, beneficiary designations up-to-date, and essential documents saved with those whom you’ve asked to help administer your estate?
- Have you taken advantage of and completed any annual exclusion gifting? You may make a gift of up to $15,000 ($30,000 if it is a joint gift from husband and wife) to as many people as you’d like without using any of your lifetime exemption or paying gift tax.
- Note that this year the CARES Act allows individuals to deduct up to 100% of their Adjusted Gross Income (AGI) for cash gifts to public charities (i.e. not to a Donor Advised Fund or Foundation).
- Consider contributing highly appreciated securities to your Donor Advised Fund. This type of gifting can be deducted up to 30% of AGI in the current year (or carried forward if greater than 30%).
- If possible, you should max out your annual retirement contribution and consider opportunities for Roth conversion.
- The CARES Act waived the required minimum distribution during 2020 for IRAs and retirement plans. This includes beneficiaries with inherited accounts.
Tax Loss (or Gain) Harvesting
- The exercise of selling assets trading below purchase cost to offset realized taxable gains can be an effective method to defer taxes on capital gains. Depending on potential tax law changes, it may be beneficial to realize gains in the current year.
- Each potential trade is unique and should be considered in light of (1) potential tax law changes, (2) a client’s individual tax situation related to capital gains rates and current realized gains/losses, and (3) potential forgone returns due to not owning the asset for 30 days because of the IRS “wash-sale” rule. [Note: This rule prevents investors from using realized losses if they immediately re-purchase the same or substantially identical, security within 30 days. The 30-day waiting period can lead to “forgone” performance, which can quickly wipe out the initial tax benefits of the trade. This opportunity cost is often overlooked but is typically the deciding factor in whether a harvesting trade is ultimately successful for an investor.]
Again, we welcome your questions and we are committed to helping our clients make smart financial decisions whether in person or on Zoom! Stay safe and well.
“A billion here, a billion there, and pretty soon you’re talking real money.” attributed to U.S. Senator Everett McKinley Dirksen.
The first quarter of 2020 brought a tsunami of events that overturned much of the global economy and brought a sense of chaos to financial markets worldwide. Policymakers responded in a swift and decisive fashion. Senator Dirksen, quoted above, would have had to add another three zeros to what he considered “real money” based on the actions of the Federal Reserve and U.S. Congress. The Federal Reserve has increased its balance sheet by over $2.9 trillion since early March and they have indicated that their purchases of securities will continue for as long as they are needed. The fiscal policy response was equally swift and of similar size – with over $2 trillion in stimulus in addition to over $480 billion in forgivable loans to small businesses. If you had a job that paid you $1 per second you would earn your first $1 million in about 11.6 days. You would earn your first billion after 31.7 years. And after 31,700 years you would be at $1 trillion. U.S. policymakers have authorized a combined fiscal and monetary stimulus of over $5.3 trillion (so far). That is indeed “real money.” And those numbers are for the U.S. alone. Governments around the world have embarked on similar stimulus programs that are equally stunning in their scale and scope.
At least from the perspective of financial markets, policymakers have had positive and dramatic impact. Equity markets continued the rebound that began on March 23. For the quarter the S&P 500 rose 20.54%. For the year the S&P 500 has not quite reached the breakeven point, closing the quarter with a loss of 3.08% YTD. Other broad equity market indices rebounded as well but are still much further away from where they started the year. The Russell 2000 Index (U.S. small-cap stocks) was up 25.41% in the quarter, but its YTD return is a painful -12.93%. International stocks as measured by the MSCI-EAFE Index were up 14.88% in Q2, but -11.34% YTD. As has become an all too familiar pattern, growth stocks once again bettered value stocks, and the degree of separation in performance between the two is remarkable. For the quarter the Russell 1000 Growth was up 27.84%, far outpacing the 14.29% return of the Russell 1000 Value. For the year thus far the contrast between growth stocks and value stocks is even more stark. The Russell 1000 Value’s YTD return of -16.26% is woefully behind that of the Russell 1000 Growth, which has returned 9.81% YTD. And over five years the numbers are jaw-dropping: the Russell 1000 Growth returned a total of 109.04% over the trailing five years while the Russell 1000 Value’s total return was only 25.46%.
Bond markets were much more sanguine in the second quarter than the first. The Bloomberg Barclay’s US Aggregate Index rose 2.90% for the quarter, bringing its YTD return to 6.14%. The Bloomberg Barclay’s Municipal Bond 7-Year Index was up 3.31% in the second quarter and 2.28% for the year. The Treasury yield curve steepened ever so slightly in the second quarter. The short end of the curve fell – the two-year Treasury falling from a yield of 0.23% to 0.16% during the quarter. The 10-year Treasury fell only 4 basis points, from 0.70% to 0.66%, while the 30-Year Treasury yield rose, from 1.35% to 1.41%.
Where we go from here in markets is as big a conundrum as it ever has been. It would seem foolish not to anticipate further volatility, though which direction that volatility might take is uncertain. Volatility often provides opportunity as well as peril, even if that opportunity is something as simple as rebalancing portfolios. Rebalancing portfolios from bonds into stocks, even if only a small amount, in March of this year, would have generated a higher return for investors in the ensuing market rebound. Maintaining a diversified portfolio is not just about owning different types of securities, but about owning exposures to a variety of risks that allow a portfolio’s investments to move in an uncorrelated fashion. Diversified portfolios (or said another way, portfolios whose investments have lower degrees of correlation with each other) allow investors the opportunity to rebalance when markets are disrupted by a particular set of risks that impact one set of investments differently from others. Being balanced in one’s approach, and flexible in one’s thinking, are characteristics that have served long-term investors well in the past, and we expect that to continue to be the case, even (and maybe especially) in these extraordinary times.
Growing up in Houston in the 1950s I spent a lot of time playing with the kids in my neighborhood. There were no personal computers, smartphones or cable TV, online streaming, not to mention video games. If the weather was bad, we’d stay indoors and play board games. But if it was good, we’d be outside playing games in the neighborhood. One of our staples was hide-and-seek. I remember many games ending when the person who was “it” gave up and shouted out “Ollie Ollie Oxen Free” which meant that you could safely come out from your hiding place without the fear of being tagged out before you got to home base.
Over the last several weeks of “social distancing” and “sheltering in place” I’ve sometimes felt that I was in an extended game of hide-and-seek. I’ve also just assumed that sooner or later – and hoped sooner – someone would give the all clear, and I would know – with certainty – that I could come out and not have to worry about contracting COVID-19. While I still hope that will be the case at some point, I no longer think that is likely to be sooner rather than later.
I should acknowledge that speculating about the path, timeline, or ultimate impact of this virus is almost certainly a fool’s errand. There are many variables that will come into play. Even experts with similar backgrounds and qualifications have come up with a wide range of scenarios. Andrew Ross Sorkin, in the May 3rd edition of The New York Times, confessed his concern over the number of times even Warren Buffett responded to questions at Berkshire Hathaway’s annual meeting, saying “I don’t know.” If the crystal ball of the “Oracle of Omaha” is cloudy, we mere mortals should no doubt tread carefully.
In addition to a lot of “I don’t knows,” however, Buffett said something else: “The American miracle, the American magic has always prevailed and it will do so again.” We share Mr. Buffet’s conviction in America and its resiliency, realizing that achieving that resilience may take some time.
Unfortunately, what happens in the meantime can only be the subject of speculation. We could spin out lots of different scenarios and try to assign probabilities to each, but the fact is we don’t know and neither does anyone else. Under almost any scenario, however, it would seem we could go through an extended period of time without hearing “Ollie Ollie Oxen Free.”
If you look at the three phenomena we’re confronting here – a public health phenomenon, an economic phenomenon, and a financial markets phenomenon – it’s interesting to consider the extent to which the three are in sync with one another. In simple terms, the data on the public health and economic phenomena are bad and may get worse, and the data on the financial markets is good – if the S&P 500 within 20% of its all-time high qualifies as good – and may get better. So what’s wrong with this picture? Maybe nothing. Maybe there’s a good reason the financial markets seem to have decoupled from the underlying public health and economic phenomena. The financial markets are by nature anticipatory. They always look forward. There’s been an enormous amount of liquidity injected into the economy and financial markets, which may be felt unevenly over time. But in the spirit of hoping for the best, yet preparing for the worst, we also have to acknowledge that the financial markets may have been overly enthusiastic, which is to say the scenario they’re discounting is not nearly so protracted and difficult as the one that will possibly materialize.
If that turns out to be the case it would probably mean additional volatility for a longer period of time. That can certainly be unsettling; though the effects of volatility can be dampened to some degree by being well-diversified. Volatility also presents opportunities, in the form of portfolio rebalancing, tax-loss harvesting, and gifting and other planning possibilities.
So “Ollie Ollie Oxen Free”? Probably not for a while. But in the meantime – which may be a while – we are preparing for further volatility while continuing to invest through a long-term lens. We think there will continue to be opportunities that present themselves and plenty of other constructive work to be done along the way.
For a discussion of specific planning options that may currently be of interest, please see the April 24 blog post on the RGT website by our partner, Mike Shockley, titled “Planning Opportunities During the COVID-19 Era”.
Please reach out to RGT if you would like to discuss your portfolio in more detail.
As RGT settles into the new normal during the COVID-19 pandemic, monitoring asset allocation and opportunistic rebalancing are underway. Long-term planning continues to be front and center on our radar screen. With the passage of the CARES Act last month and the recent market declines, we would like to share several planning ideas that you may wish to discuss further with your advisory team.
No Required Minimum Distributions (RMDs) for 2020
Last year, the SECURE Act increased the age at which RMDs are required to begin to age 72. The CARES Act has suspended all RMDs for IRAs, Inherited IRAs and tax-qualified defined contribution plans for 2020. This is a meaningful benefit for account holders who have seen their retirement balances decline, hopefully providing time for their investments to recover. If the RMD was made within the last 60 days, the distribution may be rolled back into an IRA account and will not be subject to income taxation. Please note, the 60-day rollover exception does not apply to Inherited IRAs.
Impacted Account Holders Eligible for Coronavirus-Related Retirement Plan Distributions
The CARES Act offers a penalty-free withdrawal (up to a $100,000 maximum) from an employer-sponsored retirement plan and/or an Individual Retirement Account (IRA) for those qualified individuals who have not yet reached age 59.5. The term qualified requires the account holder (or their spouse) to have been diagnosed with COVID-19 or have experienced certain other financial consequences due to being quarantined, furloughed or laid off (or other factors).
This distribution is not subject to the 10% early withdrawal penalty or to the 20% mandatory tax withholding. The taxation of the distribution may be ratably spread over the next three years. Additionally, this distribution can be paid back within three years without recognition of taxable income. If some, or all, of this distribution is going to be paid back but taxes have been paid on the distribution, an amended return may need to be filed to obtain a refund.
On a side note, the CARES Act also includes an increase in the loan amount from employer-sponsored retirement plans to 100% of the vested balance, up to a maximum of $100,000 for qualified account owners. As the Coronavirus-Related Retirement Plan Distribution and the increased loan amount are not automatic benefits, please check with your plan administrator to confirm that these options are available to you.
Converting Traditional IRAs to ROTH IRAs
Given current declines in the value of retirement accounts and the elimination of the stretch IRA benefit via the SECURE Act, converting a Traditional IRA to a ROTH IRA may be something to consider. While this conversion is subject to ordinary income tax rates in the year of conversion, doing so when asset values are depressed will help lower the income tax impact. Additionally, ROTH IRAs will not be subject to any further taxation nor are there any RMDs required for the ROTH IRA account owner. Investments in the ROTH IRA accumulate tax-free over the account owner’s lifetime. Once the ROTH IRA transfers to a non-spouse beneficiary (e.g., children), the account must be fully distributed within 10 years, also on a tax-free basis.
Increased AGI Threshold for Charitable Cash Contributions
The CARES Act has temporarily increased the 60% Adjusted Gross Income limit for deducting cash contributions to public charities to 100%, which may allow taxpayers to eliminate their 2020 tax liability. It is important to note that gifts of highly appreciated securities (or other property) or contributions to Donor Advised Funds do not qualify. An interesting planning opportunity arises when considering a ROTH IRA conversion along with increased charitable giving. It may be possible to offset the income tax liability generated from the ROTH conversion by making qualified charitable cash contributions. However, before breaking out your checkbook, make sure to consult your CPA so they can help determine the best solution for the timing of your charitable contributions.
Gifting and Other Wealth Transfer Strategies
Depressed asset valuations coupled with the current estate tax exemption amount ($11.58 million per person) presents an estate planning opportunity. Interest rates are at historic lows and business valuations may continue to decline due to the economic impact of COVID-19. The current estate tax exemption limits are set to decrease to $5 million per person in 2026 (adjusted for inflation) unless new legislation is passed prior. The timing may be ideal to coordinate with your estate planning team to review generational wealth transfer strategies and asset freezing techniques such as gifting or selling assets to Irrevocable Trusts.
We welcome an opportunity to review these planning strategies with you.
“There are decades where nothing happens; and there are weeks where decades happen.” Vladimir Ilyich Lenin.
The quote above has been revisited quite a bit these days because it seems to perfectly capture our current situation. Just a few short weeks ago we had 110 successive months of job growth in the U.S., a bull market in excess of 10 years, the world economy was globalized, companies managed inventories ‘just-in-time,’ we had traffic jams, meetings, and corporate debt. And then, just like that, the world changed. There were roughly 10 million jobless claims in two weeks, we entered a bear market in a record 16 trading days, the world economy is becoming more decoupled, companies (and people) are stockpiling, freeways are all but empty, meetings for many are exclusively online, and corporate debt is in the process of being replaced by government debt. And that’s just a fraction of what has happened in the last few weeks.
On February 19 the S&P 500 closed at 3386.15, up 5.1% for the year, the Russell 2000 was up 1.6%, and the MSCI-EAFE was down -0.8%. Then the trajectory of financial markets reversed. The S&P 500 ended the quarter down -19.6%, the Russell 2000 was down -30.6%, and the MSCI-EAFE was down -22.8%. But these quarter-end numbers bely the severity of the intra-quarter collapse. From its intraday peak on February 19 to its intraday low on March 23 the S&P 500 dropped -35.4%. After the passage of a $2 trillion plus economic rescue package by Congress and aggressive monetary easing by the Federal Reserve, the S&P 500 rebounded 15.2% prior to quarter’s end.
The market sell-off was indiscriminate with all sectors of the market suffering deep losses. But as the market settled a bit, there began to emerge more distinct differences in performance across market sectors. By the end of the quarter Technology (-11.9%), Health Care (-12.7%), and Consumer Staples (-12.7%) were the best performing sectors. Energy (-50.5%) which was clobbered by the one-two punch of both the abrupt cessation of economic activity and a price war between OPEC and Russia, Financials (-31.9%), and Industrials (-27.0%) were the worst performing sectors. And the long-standing outperformance of growth stocks relative to value stocks continued, with the Russell 1000 Growth dropping -14.1% while the Russell 1000 Value fell -26.7%.
Bonds fared better; but still experienced a volatile quarter. The Bloomberg Municipal Bond 7-Year Index was down -1.0%, while the Bloomberg U.S. Aggregate was up 3.2%, largely based on a strong rally in the price of U.S. Treasuries. The 10-Year Treasury yield stood at 1.56% on February 19. As Treasury prices soared due to a swift and sudden flight to quality, yields on 10-Year U.S. Treasuries plummeted to a low of 0.54% on March 9, rose back to 1.18% on March 18, before falling again to 0.70% by quarters end. Corporate bonds, however, fared worse than municipal bonds and U.S. Treasuries due to fears over their credit risk. The Bloomberg Barclays U.S. Corporate Investment Grade Index fell -3.6% for the quarter. High yield bonds declined even more, with the Bloomberg Barclays High Yield U.S. Corporate Index falling -12.7%.
We posted a piece on February 28 addressing the looming threat of the Coronavirus. We still do not know how long this crisis will last or how severe it will be when all is said and done. But the key takeaways from our earlier piece still hold true today, and we would like to reiterate those points as we look forward today. Asset allocation is valuable and is meant to lessen the impact of stock market losses, not eliminate them entirely, so that you don’t succumb to the urge to sell stocks into weakness. Cash reserves earn very little, but we don’t believe that taking on additional risks to achieve marginally higher yields on cash is worth that extra risk. Rebalancing and tax loss selling are opportunities, and you don’t have to get the timing exactly right to take advantage. Remember, you own stocks for a multi-year time horizon, not for what happens in a week, a month, or a year. Market corrections and bear markets can be an opportunity to put cash to work at lower valuations or to rebalance a portfolio into higher quality opportunities at lower prices than were available until recently.
“We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one that we are unwilling to postpone, and one which we intend to win.” John F. Kennedy, September 12, 1962.
If you’re like me, you’ve spent more than a few evenings this summer watching the trove of documentaries that have been airing on PBS and other outlets about the Apollo program in celebration of the fiftieth anniversary of the first lunar landing on July 20, 1969. I find that watching the story of Project Apollo unfold and witnessing the genius, ingenuity, determination, and bravery of the men and women of NASA making the seemingly impossible become a reality to be both fascinating and inspiring.
Revisiting these events has also been an opportunity to see and hear the speech President Kennedy delivered on September 12, 1962 at Rice Stadium in Houston. The quote above, pulled from that speech, has long been one of my favorite presidential quotes. The speech was intended to rally support for the space program, but the rhetoric used to sell the audacious goal of landing astronauts on the moon and bringing them home safely seems to have a much broader application. Just because a task is hard doesn’t mean that it isn’t worth doing. Shirking difficult challenges and opting for the easy way out is not something that can be counted on to produce long-term success.
Our task at hand, managing investments, is certainly a much easier task, by many orders of magnitude, than the challenges faced by NASA and the Apollo program. While the NASA engineers had to solve problems related to the laws of physics and the nature of human biology, the most difficult challenges facing investors are often internal rather external. Being disciplined investors that make good decisions focused on cogent, long-term strategic plans is our ‘hard’ task at hand. The difficulty comes in battling cognitive biases, such as Recency Bias, Hindsight Bias, or Bandwagon Bias (also known as Herding), that are constantly pulling investors in the wrong direction. We are all subject to falling victim to these biases. They are constantly pushing us towards the seemingly easier path and are the most difficult challenges facing most investors.
Recent market performance is providing a plethora of cognitive bias challenges for investors. As has been the case for much of the last 10 years, the S&P 500 was the best performing market index in the second quarter, up 4.30%. This despite some significant intra-quarter volatility. That brought the S&P 500’s year-to-date performance up to 18.54%. This is where our cognitive biases kick in. Recency Bias will lead investors to extrapolate this performance into the future leading them to overweight large-cap US stocks. Hindsight Bias will whisper in the investor’s ear that everyone knew that the S&P 500 was the best place to be – it was obvious. And the Bandwagon Bias will urge investors to jump on board the US large-cap stock train; everyone else has and they are all doing better than you. This is the time that doing the hard thing, maintaining a disciplined long-term approach grounded in fundamental investment principals, becomes most difficult. And it is why investors should be prepared, as Lady Macbeth said, to “screw their courage to the sticking place,” and prepare to do that which is hard, not that which seems easy.
The Tax Cuts and Jobs Act passed in late 2017 provided for tax incentives designed to encourage capital investment in local “zones” in an effort to spur economic development and job creation in distressed areas. The Opportunity Zone, or O-Zone, program encompasses over 8,000 census tracts and more than 30 million residents across the U.S. Texas has approximately 600 Opportunity Zones, with nearly 30 in the DFW area. It is estimated that these new tax incentives will provide over $100 billion of investment in qualifying O-Zones. For investors, income taxes levied on future expected gains can be significantly reduced if the qualifying investment is held for at least 5 years. In addition, if an O-Zone investment is held for longer than 10 years, the gain, which would otherwise be taxable, will be tax-free. Other elements of this new tax law include the chance to reinvest gains incurred from other sales into O-Zone investments and the deferral of any tax that would have been paid for up to seven years. For example, if a business is sold in early 2019 and a taxable gain of $250,000 is recorded, the $250,000 gain can be reinvested in an O-Zone qualified investment fund thereby deferring the taxes due on this $250,000 until a later date. So, there is immediate income tax savings and potential future additional tax savings or elimination of taxable gain, depending on how long the O-Zone investment is held. To provide further guidance, the IRS issued Proposed Regulations in October 2018 as well as April 2019.
Who should consider O-Zone investments? Anyone who has already incurred a taxable gain from sale of any type of investment (no more than 180 days prior to making a qualified Opportunity Zone investment) or who anticipates having a taxable gain in the next 180 days could be a good candidate. Taxpayers can benefit by reinvesting a portion of or the entire gain incurred into a qualified O-Zone fund within the 180-day time requirements. The gain can be from marketable securities, real estate, private investments, sale of a closely held business, gains received through partnership investments, etc. Only the portion of the gain that is reinvested would be eligible for future tax deferral, depending on the holding period of the qualified O-Zone fund investment.
What are the potential rewards? Current year income tax is deferred for any qualified gain invested in an O-Zone fund. For example, if taxes of 20% on $500,000 of gain ($100,000 of income taxes otherwise due) are expected, the taxpayer/investor could choose to invest this $500,000 (or any portion of this gain) in a qualified O-Zone fund. As such, the $100,000 of capital gains taxes would be deferred to a later date and the $500,000 invested would escape taxation if the O-Zone investment is held for a minimum of 10 years. Thus, the tax deferral is immediate as well as the potential savings in the future if the O-Zone requirements are met. Another benefit of the new tax law is the broad range of qualifying O-Zone investment types that qualify (e.g. real estate, equity, loans or other types of legal structures). More IRS guidance is expected to further clarify these criteria.
What are the risks? General investment risk is inherent in any O-Zone fund. While the tax benefits are nice to have, if the O-Zone fund is not successful, any deferral or elimination of taxes would be offset by an unsuccessful investment. It is important to evaluate the investment fund without the tax incentive program benefits being included. If the diligence suggests an investment, the tax savings should be viewed as an added incentive. In addition to general investment risk, there is the risk of a tax law change in the next 10 years that could make this program less beneficial for all taxpayers or select taxpayers above a certain income threshold. Thus, there is the possibility of law revisions which could potentially remove some of the benefits. This needs to be considered before investing.
How do you get more information? Individual circumstances are important to consider when determining whether an Opportunity Zone Investment is appropriate. RGT Wealth Advisors is actively researching the new O-Zone rules and regulations and can provide more analysis and assistance in determining whether these investment funds may be appropriate for an investor. So far, RGT has seen qualifying O-Zone investment funds in NY, CA, TN and AZ. Please contact us for additional discussion on Opportunity Zone investing.
“The investor who says, ‘This time is different,’ when in fact it’s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing.”
Sir John Templeton, Investment Success, 1933.
Sometimes investment market trends are so strong, and extend over so many years, that even time-tested approaches, such as disciplined, diversified asset allocation strategies, can seem “out of touch”. Oftentimes… Click here to view full article.