Dear Clients and Friends:
You may have noticed that this quarter’s letter is a bit later than usual. You can blame me personally.
There was no doubt in my mind there was a problem when I hurt my arm. I heard the snap, felt the pain, and knew something bad had happened yet my first reaction was to pretend all was well. My routine continued, and I figured my arm would feel better in a day or two. After a few days, I finally decided to visit a doctor. We tried physical therapy to see if that would help, and when it didn’t a surgical correction was scheduled. The recovery is under way, my arm is healing, and I am doing well.
I’m sharing this not because I seek your attention or empathy, but because one of the lessons I learned while recovering is also directly applicable to financial planning and investing.
Perspective is Important
About a week after the procedure I was in a meeting with some clients. My arm was wrapped in a sling, cast, and bandages so it was an obvious topic of discussion. Answering their questions, I could almost feel my perspective shift. Until that point I was focused on my pain, time lost from work, and the lack of mobility. Suddenly I realized that I was focusing only on the short-term problems when I should be focused on the long-term benefits. The doctors have told me that though it will take some time, I should expect a full recovery. My perspective had changed which, in turn, has made my recovery easier.
Now I can see several parallels to investing.
Accidents happen. We do not get to decide when, how, or where. As the saying goes, “when you least expect it…“. We know this and do everything we can to prevent accidents, but as hard as we try they cannot be totally eliminated. In investing, there will be setbacks. We do not know when, so we diversify portfolios to minimize the impact, yet as hard as we try market setbacks are inevitable.
The markets are much more resilient than the human body. Bodies can be broken beyond repair. Markets may bend, but they do not break. However, there are no assurances that the recovery will be quick or painless. But we do know the markets have always recovered. Patience and understanding will not speed up the process, but they are powerful pain killers.
Despite knowing all of this, when a “market accident” happens, the financial press and the majority of investors will immediately focus on the short-term problems. Only a handful of savvy investors will have the fortitude and discipline to focus on the longer-term benefits. The opportunities are greatest when most are afraid to take action.
Halftime 2018 – Market Report
The tech-heavy NASDAQ Composite and indexes of mid and small sized companies touched new highs in June. Much of the underlying momentum can be traced to faster economic growth, rising corporate profits, and interest rates which are still lower than average (even though they are on the rise). Another contributing factor is stock repurchases. S&P 500 companies repurchased a record $189.1 billion of their own shares in the first quarter and buybacks are expected to remain strong through the rest of 2018.
However, the Dow Jones Industrial and the S&P 500 index, which is made up of the nation’s largest companies, failed to recapture their January highs. Some S&P 500 companies derive a significant share of sales from overseas. Though the index closed the quarter not far from the previous high, a strong dollar may have been a factor by exerting modest pressure on the global companies which comprise the index. Moderation in overseas growth may also have been a factor.
|MTD %||YTD %||3-year* %|
|Dow Jones Industrial Average||-0.6||-1.8||11.3|
|S&P 500 Index||0.5||1.7||9.7|
|Russell 2000 Index||0.6||7.0||9.6|
|MSCI World ex-USA**||-1.3||-4.5||2.1|
|MSCI Emerging Markets**||-4.6||-7.7||3.2|
|Bloomberg Barclays US
Aggregate Bond TR
Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar MTD returns: May 31, 2018-June 29, 2018 YTD returns: Dec. 29, 2017-June 29, 2018 *Annualized **in US dollars
Escalating trade tensions between the U.S. and its major trading partners must also be considered. The “Trade War” is a very complex issue that’s being fought with simple soundbites. Our President believes the United States has not been treated fairly and he is using his authority to selectively levy tariffs against offending nations.
It’s a risky strategy that may eventually break down barriers. Or, it could escalate into a series of retaliatory measures that may impede the U.S. and global economy. For now, the economic data strongly suggests the noise from the trade headlines isn’t affecting the U.S. economy, and GDP growth in the second quarter appears poised to surpass 4%.
You may agree or disagree with the President’s actions but the market, which is collectively made up of millions of large and small investors, hates heightened uncertainty. While the economy is probably stronger than it has been for a decade, the markets will be slow to reflect this strength until investors feel more stable.
We believe that investors who employ patience and understanding will be rewarded. As long as the economy is strong, the businesses in the economy should profit. Ultimately, the best valuation of the markets is a multiple of the profitability of the companies which compose the markets. As the underlying companies increase in value, investors will see growth in their portfolios.
4 Retirement Tax Traps
1.Estimated quarterly tax payments may be required
You are accustomed to having federal, state, and payroll taxes withheld from each paycheck (unless you were self-employed). When you stop working, there are no more W-4s to complete and no one is withholding taxes for you. But that doesn’t absolve you of your year-end tax liability. You may be required make estimated payments each quarter.
Some retirees have taxes withheld from their pension, social security, or retirement account distributions. Social Security allows recipients to withhold 7%, 10%, 12% or 22% of their monthly benefit for taxes but they do not require any withholding.
2. Social security may be taxed
If your MAGI (Modified Adjusted Gross Income) is between $25,000 and $34,000 (single tax filers) or between $32,000 and $44,000 (joint tax filers), you may have to pay income tax on up to 50% of your benefits. If your MAGI is even higher, up to 85% of your benefits may be taxable.
3. Beware of the IRA required minimum distribution
In general, required minimum distributions (RMDs) are minimum amounts that must be withdrawn annually starting with the year you reach age 70½. RMD rules apply to IRA’s, SEP IRAs and Simple IRAs, 401(k), profit-sharing, 403(b), 457(b), and other defined contribution plans. Distributions are not required from Roth IRA’s.
The first payment may be delayed until April 1 of the year following the year in which you turn 70½. After that, you must take the RMD by December 31 of each year.
There are several distribution strategies to consider. For example, if you expect to have large RMDs that could push you into a higher tax bracket, it may be beneficial to begin taking smaller distributions earlier. Or, you could convert some of your IRA into a Roth, which would help shelter gains and future distributions from taxes although you do have to pay some taxes upfront.
The key is to have a plan. Failure to take the required distribution could subject you to a penalty of 50% of the amount you were supposed to withdraw.
4. The hidden cost of selling your primary residence
Downsizing can generate cash and reduce your daily expenses, but it may also trigger a tax liability. If you’ve lived in your primary residence for at least two of the last five years prior to selling, you can avoid paying taxes on the capital gain up to a limit ($250,000 for single and $500,000 for married or widowed filers). The sale could also trigger the 3.8% tax on investment income for taxpayers who have net investment income and MAGI above $200,000.
While the decision to sell shouldn’t be strictly governed by the tax code, it’s important to understand the tax ramifications. The timing of income streams may be important if a sale will trigger a taxable event.
Does it sound complicated? It can be, but you don’t have to go it alone. Tax planning is a part of retirement income planning. If you have any concerns or questions, we can help. There are methods to lower your taxes, including charitable donations. The structure of your retirement income, investments, and distributions from retirement accounts can help to reduce the tax burden.
If you have question or need assistance, please email firstname.lastname@example.org or call (515) 255-3354. We are happy to assist.
Art Dinkin, CFP®
This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks. The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures. The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock's weight in the index proportionate to its market value. The Russell 2000 Index is an unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. The MSCI All Country World Index ex USA Investable Market Index (IMI) captures large, mid and small cap representation across 22 of 23 Developed Markets (DM) countries (excluding the United States) and 23 Emerging Markets (EM) countries*. With 6,062 constituents, the index covers approximately 99% of the global equity opportunity set outside the US. The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Barclays Aggregate Bond Index includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.