The Tariff Tantrum: Why Patience Still Pays

Posted On April 6, 2025 By Scott Stratton, CFP(R), CFA In Financial Planning / No Comments

This week, the stock market threw a tariff tantrum — and for good reason. Economists, business leaders, and investors alike agree: the administration’s sudden new tariffs are bad news.

Starting this week, U.S. tariffs include:

20% on imports from the European Union
24% on goods from Japan
34% on products from China
Overall range: a minimum of 10%, and up to 50%

While the White House describes these as “reciprocal,” they’re not actually based on other countries’ tariffs on U.S. goods. Instead, the new tariffs are tied to each country’s trade deficit with the U.S. — the higher the deficit, the steeper the tariff.

Why Tariffs Backfire

The logic behind these tariffs might sound simple: make imports more expensive so people buy American. Unfortunately, that’s not how the real world works.

Other countries are retaliating. They’re imposing their own tariffs on U.S. goods, making American exports more expensive — and less competitive — overseas.
Prices are rising. Estimates suggest these tariffs could cost American households an extra $2,100 to $4,600 a year.
Factories can’t pop up overnight. Even if demand shifted suddenly, new U.S. production would take 3–5 years to ramp up.

Bottom line? These tariffs aren’t boosting exports or domestic manufacturing — they’re just increasing costs. It’s a lose-lose proposition for families and businesses alike.

The Market’s Harsh Reaction

The response on Wall Street was swift — and brutal. On Thursday and Friday, U.S. stocks lost $6.6 trillion in value. That’s the largest two-day drop in history.

As the saying goes, “Stocks take the stairs up and the elevator down.” The ride down can be fast and painful — but it’s part of the journey.

Panic Will Not Profit

Yes, investors are panicked. And yes, we’ll likely see more selling early this week. But am I selling anything in my own portfolio? Absolutely not. Am I advising clients to “get out” of the market? Again, no.

I don’t have a crystal ball, but I do have history on my side. And if history tells us anything, it’s this:

Panic selling never works.

Here are some interesting charts on market corrections. First, from Vanguard, here are US Equity drawdowns since 1980.

Since 1980, the U.S. stock market has been in correction territory (down 10% or more from recent highs) about 30% of the time. Bear markets — drops of 20% or more — happen, too. And recovery can take time.

Looking at monthly returns, the next chart shows up months versus down months.

You can see that there are nearly as many down months as up months. The stock market does not go straight up nor does it go down forever. It is volatile, with good months and bad months, and good years and bad years.

These charts show the volatility of stocks, but mask the cumulative gains. In fact, since 1980, the S&P 500 has delivered a total return of 16,415%, or about 11.99% annually. That’s the big picture — and it’s why long-term investing works.

No Pain, No Gain

In 2009, I saw that investors who got out did worse than those who did nothing. The same thing happened in March of 2020. The human brain often tells us to do the wrong thing at the worst time. But real success comes from staying invested — even when it’s uncomfortable.

Trying to time the market rarely works. But owning a simple index fund and not selling? That’s the most likely way to access the 11.99% historical returns over time.

We’ve built your portfolio to withstand volatility. Most of our clients have 30% to 50% in bonds, including five-year bond ladders for retirees. That means we don’t need to sell stocks when they’re down.

What We Can Do Now

Even in market downturns, there are smart moves we can make:

Rebalancing: When stocks are down, it’s a chance to buy — not sell.
Tax-loss harvesting: Use losses to offset gains and reduce your tax bill.
Dollar-cost averaging: If you’re still investing, this is your opportunity. Stocks are on sale.

We’ve been saying for a while that the market, especially tech, was overvalued and due for a pullback. Bubbles don’t pop because of valuations — they pop when an external shock happens. This tariff tantrum may have simply triggered what was already overdue.

Keep The Faith

It’s easy to focus on the negative — but don’t let fear cloud your long-term vision. Investors who panicked in 2001, 2009, and 2020 missed out on the powerful recoveries that followed.

I’m no fan of these tariffs. I hope they’re just a negotiating tactic — or that billionaires who lost hundreds of millions of dollars this week can push for a better path. But regardless of what happens next, I know this:

We’ve seen this before, and we’ve come out stronger every time.

Each investor should have a solid financial plan. That plan should account for volatility — even when it’s driven by unpredictable policy. We’re not selling based on headlines. We’re staying focused on long-term goals.

If you’re feeling uncertain or want to revisit your plan, don’t hesitate to reach out. That’s what I’m here for.

Stay steady. Stay smart. And hang in there.

Social Security to End WEP and GPO

Posted On December 27, 2024 By Scott Stratton, CFP(R), CFA In Financial Planning /

In a surprise move, Congress passed the Social Security Fairness Act, which will end the WEP and GPO programs. The WEP (Windfall Elimination Provision) and GPO (Government Pension Offset) reduced Social Security benefits for retirees who receive a government pension that did not participate in Social Security. The legislation is headed to President Biden, who is expected to sign it into Law.

What are the WEP and GPO?

Some government jobs do not participate in Social Security, as they are covered by their own pension program. This includes many police, firefighters, some state employees, and about 40% of teachers. There are about 2.5 million such retirees today. Many who receive a pension also had other jobs (before, after, or during) where they paid into Social Security. The WEP/GPO programs reduced Social Security benefits since these retirees were already receiving another government pension. These were designed to prevent retirees from “double dipping” into two government pensions and have been around since 1983 and 1977.

Employee participation in Social Security was up to state and local governments. For example, teachers in Texas do not participate in Social Security but teachers in New York do. So, the teachers in TX do not have FICA withheld from their paychecks, but do have 7.7% withheld to pay into the Texas Teachers Retirement System. The teachers in NY have money withheld for both Social Security and for the state teachers benefits. And the teachers from NY can collect both a pension and their full Social Security in retirement.

But what was unfair to the Texas teacher is that if they also worked 10+ years at a different job, their Social Security benefits from that job were reduced under the WEP. But the NY teacher does not get dinged for collecting both a pension and SS, and gets the full amounts.

The WEP reduces an employee’s own Social Security benefits, when they also receive a government pension. The GPO reduces Social Security spousal and survivorship benefits by two-thirds, for individuals who receive a government pension.

Planning Strategies

This change creates an opportunity for additional planning for many employees. We should evaluate your individual situation, and make calculations for your exact numbers. Here is our general advice:

1: There is now a larger incentive for teachers, police, etc. to qualify for Social Security benefits. You need 40 quarters of contributions to become eligible for SS. You can track your eligibility online at SSA.gov by creating an individual account. Teachers and others should look for summer work, self-employment, or for a part-time job in retirement, to qualify for Social Security, if they have not already done so. Having both retirement benefits will be enormously valuable.

If you are thinking about going into a career that does not participate in Social Security, please think about how to get 40 SS credits. At the same time, it is now much more attractive for retired police and firefighters to work another type of job after they retire.

2: You will want to think carefully about the timing of your Social Security benefits. In many cases, government employees retire relatively young, but it may pay to delay Social Security to receive a larger benefit. This can help reduce longevity risk. Again, we should be running the calculations individually. You do NOT have to claim both a pension and SS at the same time or year.

3: Spousal benefits. Many more government employees will now be eligible for a larger spousal benefit (based on their spouse’s earnings). And so we now need to think about when a spouse claims their benefit and when the other spouse should claim their spousal benefit. There are no deferred retirement credits for spousal benefits, meaning you should never defer from age 67 to 70, if your SS benefit will be a spousal benefit. If you are divorced, but were married for at least 10 years, you may be eligible for a spousal benefit in Social Security, based on your ex-spouse’s contributions. This is true, even if you never worked in a SS-eligible job.

Really, Washington?

The repeal will increase Social Security benefits for 2.5 million Americans today, and more in the future. The benefits will be retroactive to December 2023. The additional cost will be $195 Billion over the next 10 years. (And more for each subsequent decade.) Unfortunately, Congress did not include any way to fund this increase in benefits, so these costs will be added to the Government debt. This bill will accelerate the bankruptcy of Social Security by about six months, presently estimated in 2033.

While government employees have been lobbying for a repeal for decades, I am a bit surprised that Congress suddenly felt that this was a priority. I didn’t hear any politicians talking about the WEP and GPO during the campaigns this fall or summer. Recently, we’ve heard the goals of trimming $2 trillion from government spending. Instead, some of those same Congresspeople just voted to add $195 Billion in new spending over the following decade.

I have been writing for 17 years about how Social Security is broken. We have to either reduce benefits (such as increasing the retirement age), increase taxes, or some combination of both. Instead of understanding this necessity, our elected officials just decided to make Social Security more expensive. And while I support and appreciate government employees, including many family members, many of the government pensions were already fair, if not generous, compared to Social Security benefits.

There are a large number of retirees who do not need additional Social Security benefits. The average age of millionaires in the US is 61. The average net worth of Americans age 65-74 is $1,794,600 according to a 2023 Federal Reserve Study. (Granted, the median is much lower than the average.) From 2019-2022, 65-74 year olds saw their net worth increase by 27%, whereas Americans aged 35-44 saw only a 9% increase and 45-54 year olds (my age cohort) saw an increase of just 1%. While there are many poor elderly people, there are also many retirees who are doing very, very well.

We Must Save Social Security

Social Security is an entitlement program where current taxes pay for current benefits. The SS taxes you paid in 2024 are not being saved for you. They are paying your parents or grandparents this year. And this worked because there were 40 workers for every retiree in 1940. Today, however, there are less than three workers per retiree and this will gradually approach two workers per retiree by 2050. And so, we ought to ask if ending the WEP and GPO is intelligently alleviating elder poverty, or is it just giving away money to older Americans and leaving a massive debt to our grandchildren?

Unfortunately, we can’t save Social Security by keeping it as is. Something has to change, and soon. In our retirement planning process, Social Security is an essential component of the financial plan. When I remove Social Security benefits from our MoneyGuidePro retirement software, the plans usually project a strong possibility of failure. We need to be telling our elected officials that saving Social Security is a top priority. Some difficult decisions need to be made. We’ve been waiting a long time for politicians to speak honestly about Social Security, to debate intelligently about solutions, and to show the will to do the right thing even if it’s unpopular. Unfortunately for us, the day for fixing Social Security is not going to be today.

How To Invest When Stocks Are High

Posted On November 3, 2024 By Scott Stratton, CFP(R), CFA In Financial Planning /

More investors should be asking about how to invest when stocks are high. The first three quarters of 2024 were the best for the S&P 500 Index since 1997. But what is the outlook going forward for investors?

In a new paper by Goldman Sachs, they project that the return of the S&P 500 Index for the next 10 years, 2024-2034, will be only 3%. How did they reach this dismal projection? The model considers projected earnings growth, current valuations, interest rates, likely recessions, and stock market concentration.

How bad is it?

The return would be in the worst 7% of 10-year returns since 1930.
There is a 72% chance that the S&P 500 will do worse than a 10-year Treasury Bond.
While their median projection is 3%, the 95% confidence range is between -1 and +7%.

The projections from Goldman are quite similar to the analysis from Vanguard. Currently, the Vanguard Capital Markets Model has a 10-year projection of 4.2% for US stocks. Both projections are very alarming, a far cry from the 11% annualized returns of the S&P 500 over the long-term.

Which Projections Matter?

In the short-term, markets are really impossible to predict. Long-term investors should not make portfolio decisions based on short-term projections. I remember one firm said there was a 100% chance of a recession in 2023. But it never happened. Short-Term predictions can be wrong and there are too many variables and surprises to consider. No one has a crystal ball and short-term predictions are about as accurate as guesses.

Long-term projections, however, may have some value in that there can be an eventual reversion to the mean. Periods of above average performance are often followed or preceded by below average performance. If you start with stocks being very expensive, then often the following decade has below average returns. And when you start with cheap stocks, like we had in 2003, March of 2009, or March of 2020, the following periods are typically above average.

Our approach is to ignore the noise of quarterly or annual projections. But we do position our portfolios towards the long-term trends of what the historical evidence suggests, based on today’s situation. We are not going to attempt to time the market, but we are going to listen to what market history tells us. Let’s talk about three ways investors can position their portfolios for a potentially low-return decade ahead.

Which Equities?

While both Goldman Sachs and Vanguard have low projections for the whole market, both also see opportunities in certain areas. The S&P 500 Index has been a great performer over the past decade, but other categories could do better over the next decade.

Goldman’s analysis believes that the current market concentration will be a major detractor from performance. What is market concentration? The biggest stocks have become the most overvalued, and the weighting of the largest 10 companies is exceptionally high today. While the regular, cap-weighted S&P 500 returns are projected at 3%, Goldman projects that the equal-weighted index could return 7%.

What is an equal weighted index? An equal weighted index invests the same dollar amount into each stock. If there are 500 stocks, each has a weight of 0.2%. And there is an easy solution here, because we can invest in an Equal Weighted Index fund.

Vanguard also expects better returns when we look outside of the US Growth segment. Here are their 10-year median return projections:

US Growth: 1.1%
US Value: 5.7%
US Small Cap: 6.0%
Developed ex-US stocks: 8.0%

This is why we diversify. Past performance is no guarantee of future returns. Even with the low projections for the entire market, there can be categories which could do better. This is the first strategy: diversify away from growth and cap-weighted indexes, and towards the areas with higher expected returns, such as equal-weight, value, small-cap, and international stocks.

DCA and Rebalancing

If you are a younger investor, I don’t want you to look at these reports and think you should forget about investing. The market will not go in a straight line over the next decade and there will undoubtedly be both large drops and large rallies. If you are investing monthly into your 401(k) or IRA, keep doing that. You are dollar cost averaging (DCA) and can benefit from all the volatility. Focus on your accumulation and diversify into low cost index funds in many categories.

For larger portfolios, even a relatively low-return environment can benefit from rebalancing and ongoing portfolio management. In fact, it is during long bull markets that rebalancing is the least helpful. In volatile markets, rebalancing allows us to benefit from the differences between stocks and bonds cycles. With rebalancing, we can sell stocks when they are high (like now) and buy stocks when they are low (like we did in March of 2020). This is part of our ongoing risk management process.

Bonds

Our third pillar of investing in a low-return environment is Bonds. Bonds are back. Our approach is to buy individual high-quality bonds and ladder them for five years. This means we have the bonds in place that will mature each year to meet the cash flow needs of our clients. For retirees, this means we do not have to touch our Equities to meet income requirements when the market is down. This gives us additional flexibility rather than always having to sell Equities to meet withdrawal needs. We want to create certainty with our bonds: income and capital preservation.

More conservative investors may find that this is an opportune time to overweight bonds and have more predictability in their portfolio. We can still get up to 5.4% on a 5-year fixed annuity today. That remains a compelling safe return. Most of the time, people are expecting to get 10% in the stock market. But if we are only expecting to get 3% to 5%, then it hardly seems worth it to take the gamble on stocks. Today, the expected return of a portfolio that is 80% stocks and 20% bonds is hardly different from one with 40% stocks and 60% bonds. Historically, those two portfolios are very different, but not today. Unfortunately, however. there will be a lot more volatility with 80% stocks than 40%.

High Stock Market Equals Low Returns

This can be a difficult lesson for investors to accept. Our natural tendency is to project the current returns into the future and assume the bull market continues. And maybe it will for a while longer. But long-term investors should understand that when the stock market is high that means projected returns are low.

Thankfully, we have a plan and our portfolios reflect the long-term outlook. We diversify into other categories with better expected returns. We dollar cost average and rebalance. And we consider the role and weighting of bonds for each client’s needs. There is no doubt that the projections from Goldman Sachs and Vanguard will prove to be imperfect. The future is always an unknown. Our plans will change, evolve, and adapt. But our focus will remain on doing our best work for planning and creating a portfolio strategy using the information, evidence, and research that is available.

The Bank of Mom and Dad

Posted On October 22, 2024 By Scott Stratton, CFP(R), CFA In Financial Planning /

More and more young adults are relying on the Bank of Mom and Dad. For perhaps the first time in US history, today’s 30 year old faces a tougher time than their parents did. Today’s young adults may be worse off than their parents were at age 30. And it’s not because of laziness. It has gotten harder for young people to reach the same milestones as their parents.

Thirty years ago, the average house price in the US was $154,200. Today, it is $501,700. The average private university tuition was $11,481, 30 years ago. Today, my Alma Mater, Oberlin College charges $66,410 for tuition alone and has a total annual cost of $86,800. Many of my classmates pursued a 5-year double degree program, which today will probably cost over $450,000.

Wages in many careers have not kept pace with inflation. Students are encouraged to go to the best college possible and to pursue advanced degrees, racking up massive student debt. 45% of student loans are on an income driven repayment plan, and over one million Americans have so little income that they qualify for a $0 monthly payment on their federal students loans. Of course, the interest still accrues and they cannot discharge student loans in bankruptcy.

The cost of healthcare has risen more than inflation and child care expenses have made it difficult for parents. Many have calculated that after-tax, they are better off having one parent stay home.

I think the Wealth Inequality in America is likely to widen rather than shrink for the decades ahead. Who will come out ahead? Adults from wealthy families will likely stay ahead of young adults from less privileged backgrounds. We would like to think that America is a meritocracy, but it is becoming harder for young people to create their own economic security. 70-year old millionaires can lecture young people about hard work, but it’s not in touch with the reality of the times.

I’ll leave it to Washington to solve the nation’s problems, but I doubt that solutions will be coming soon. I think parents are going to have to look out for their kids more and for longer than just getting them to age 18 or 22. Parents will have a role in making sure their children become wealthy. We can only take care of our own family, so let’s start there.

This does not mean setting up a massive Trust Fund so that your kids don’t have to earn a living. No, parents don’t want their kids to become dependent on their generosity. We don’t want to create the moral hazard that they would fail to pursue their own career to the fullest. But there are ways that The Bank of Mom and Dad can help establish your child’s financial success, security, and stability.

The Good News

The good news is that wealthy parents tend to have wealthy children. At age 30, children’s income is highly correlated to their parent’s income. Children may not listen to what you say, but they often make similar decisions as their parents, including in their careers.

Minimizing Student Loans

Here is an important rule of thumb for college students. Keep your total student loans to no more than one-time (1X) your future salary. Entering a career with a $50,000 salary? Your student loans should be $50,000 or less to allow you to repay over the standard 10-year schedule. And only a surgeon making $350,000 a year should ever consider having $350,000 in student loans. But I have seen people with incomes under $100k with that level of student debt.

Here’s some advice for parents:

Make sure your kids are thinking about the 1X rule and choosing a college which will not cripple them with future debt. It’s okay for your children to have some skin in the game and have to pay or borrow a little for college. But don’t let them be foolish and invest $500,000 into a field that will only pay $50,000 a year. Debt is not the path to economic security.
Start saving earlier in a 529 Plan or be willing and able to absorb more of the college costs at the time they are in school.
Aim to have them go into a field with 90% plus employment. There are great careers which are highly in demand and offer a terrific salary. Are there jobs which will have this exact degree as a pre-requisite? Seek degrees with value.
After college, help your kids be mobile. In their 20’s, it is the time to pursue a career and go where that takes them. If the great jobs are on Wall Street, Silicon Valley, or wherever, that flexibility gives them a leg-up versus older job candidates who are unwilling to move. My wife’s company has promoted her four times, including most recently to Paris. This is how you build a career in 2024, not by going back home and living in the same town as your parents.

Fund Their Roth IRAs

I got my first job at age 16 at the minimum wage of $3.35 an hour. I worked at the Long Point amusement park for about four weeks before it burned down from an electrical short. The owner didn’t have insurance and that was the end of the 80 year old park – and my first job. I do think having a part time job is a great learning experience and can help young people develop important skills.

Anyone who has earned income can fund a Roth IRA, including someone who is 16 or younger. What I would suggest parents do is allow your kids to keep their income while the parents fund their children’s Roth IRAs. You will give them a tremendous advantage in their future wealth by getting this early start. You can invest up to $7,000 a year, or the level of their annual income, whichever is lower.

Let’s say you fund a Roth IRA for your son or daughter for $5,000 for 10 years from age 16 through 25. We invest in an Index Fund and earn 7% per year. By the time they are age 66, they would have $1,181,000 in their tax-free account, all thanks to Mom and Dad funding a Roth IRA for their first 10 years of part-time work. That’s the power of compound interest.

Annual Gift Exclusion

If you have enough in resources to know that your retirement is secure and you will have more than enough, then you may want to start giving away some money during your lifetime to your children. The annual gift tax exclusion for 2024 is $18,000 per person. You can give that amount to each child and a married couple can double that, to $36,000 per child per year.

Every article seems to get this wrong: If you give away more than the annual exclusion you don’t immediately owe a gift tax. But you must file a gift tax return and the amount above the exclusion will reduce your lifetime unified estate/gift exemption. For 2024 that amount is $13.61 million and again it is double for a married couple. Most parents are going to be below the lifetime exemption amount and could give away more. But, the easiest first step is to use the full $18,000 annual exclusion.

This could be a great way to gradually create an account which your adult children could use as a house down payment, or to start a business, or pursue extra career development. This account could also serve to teach them about long-term investing, the benefits of index funds, and planning for goals.

Housing and Living Expenses

Certainly a lot of parents are helping their young adults with housing, a car, health insurance, cell phones, etc. Hopefully, this will allow them to focus on developing their long-term career and avoid going into debt. In a lot of expensive areas, kids are returning home to live with their parents after college. This can help them pay down their student loans faster. And with rents having gone up so much since 2019, this seems to be becoming more and more common.

What about buying a duplex for your child to House Hack? There are lots of creative ways to help your children with expenses. The goal is to have them get started investing and be able to save aggressively or pay down debt faster.

Managing The Bank of Mom and Dad

No One Is Self-Made. We have all benefited from the Education system in America, as well as the laws and regulations which promote free trade and protect employee rights. Compared to the rest of the world, the US remains a great place to become an entrepreneur or highly paid professional. We shouldn’t forget the unique opportunities we have to find economic security in the US. But even with all the benefits, the fact remains that parents have a very large role to play.

It is getting harder for today’s young adults. Inflation is a problem for housing, college tuition, health care, and starting a family. Those costs have grown much faster than incomes. As a result, young adults are falling behind previous generations. The Bank of Mom and Dad can help with planning, wisdom, and yes, sometimes with more money. Nearly half of all first-time homebuyers under age 35 have had some family assistance with their purchase.

Hopefully, well-to-do parents are already thinking about how they can create inter-generational wealth. What are the most effective ways and times to be giving money to your kids? What can go wrong or what are some unintended consequences? How do you treat two or three kids with different needs and abilities to handle the money? These are not easy decisions or conversations. But they are vital discussions to be having as a family, and yes, with your financial planner, too.

We can help you determine what you can truly afford and think about how to best help children with your financial support. We have a number of families where we work with the parents and with their children in their twenties and thirties. Wealth is a habit, and financial planning is a skill. Being good with money is not a skill which is being taught in school, unfortunately. But parents do have a role in talking about money, and even more importantly, modelling the behavior and generosity which you hope to instill in your children.

Home Mortgage Strategies

Posted On December 13, 2023 By Scott Stratton, CFP(R), CFA In Financial Planning /

With the 30 year mortgage rate at 7.50% today, it’s time we revisit home mortgage strategies. Loving your home is an undeniable part of the Good Life. In the past couple of months, we’ve had several clients who have moved or looked at buying a second home.

Understandably, the 7.5% mortgage rate is giving many people anxiety about this decision. And that is exactly what the Federal Reserve wants. To slow housing inflation, they needed to drive out buyers and reduce speculation to cool an overheated market. With home affordability problems in many areas, it may be a good thing to slow the rapidly rising house prices of recent years.

In the past, we might have seen real estate prices plummet given how quickly the Fed has raised interest rates. Prices today are not dropping, but at least the prices have stabilized and are no longer growing at double digit rates. We have an under-supply of housing, and there is relatively little construction of single family homes occurring, given the nationwide need. What is unique for 2023 is that sellers are disappearing, unwilling to move out of a home with a 3% mortgage (you will see why, below). There were 300,000 fewer homes on the market in September 2023 compared to one year earlier. Inventory remains very thin and that is why prices do not appear likely to drop anytime soon.

2023 versus 2021

We’re going to look through some mortgage examples and share some of the numbers that are typical today. We will go over a couple of home mortgage strategies that still make sense today. And we will revisit our philosophy and beliefs about home ownership.

The median home price was recently $412,000. For our examples, we are rounding that to $400,000 and putting down 20%, or $80,000, for a mortgage of $320,000. With a 7.5% 30-year mortgage, your monthly payment including taxes and insurance would be around $2,671 depending on your location.

For the rest of our examples, we are going to strip our taxes and insurance from the monthly costs and only look at the principal and interest payments. Your mortgage-only payment would be $2,237.49 a month. Over 30 years, you will pay a total of $805,495.11, in payments. That will repay your $320,000 loan plus $485,495.11 in interest payments. You will, in effect, be paying 150% more in interest than you borrowed. Borrow $320 thousand, pay back $805 thousand. It is just obscene, although not without precedent. Your parents may have had a similar mortgage rate at some point in the previous century.

Staying Put

If you had made the same purchase in 2021 with a 3% mortgage, or refinanced, it is a very different story. Your principal/interest payment would have been only $1349.13 a month, almost $900 less a month. Over 30 years, you would pay total payments of $485,687.85. That is only $165,687.85 in interest plus $320,000 in principal. And it seems much nicer to know that you are primarily paying principal and the interest payments are much less.

If you have that 3% mortgage, you probably don’t want to move to a new house. The 7.5% rates are keeping you out of the market, which again, is just as the Fed wants. There’s no doubt it can be preferable to stay put and enjoy your low mortgage rate. A few thoughts about your 3% mortgage:

Don’t send additional payments to a 3% mortgage. There are money markets, CDs, and government bonds yielding 5-6% today. Only send the minimum mortgage payment. Talk to me if you have extra cash.
Will it cash-flow? Rather than selling, have you considered turning your house into a rental or Airbnb? It is a lot of work and not for everyone. However, if you have a 3% mortgage, you have a much better possibility to turn a profit than a new investor who is going to have a 7.5% mortgage (or higher).
Downsize. If you have built a lot of equity into your home and have more space than you need, I would not hesitate to downsize. If you can take your tax-free gains and buy a small house for cash, this can improve your retirement readiness. Having no mortgage at all can be very freeing.

Jump Starting Your Amortization

Back to our $320,000 mortgage at 7.5%. You’ve just bought this house and now have a monthly payment of $2,237.49. In the first month, that payment includes $2,000.00 in interest and only $237.49 in principal. In the second month, your payment would consist of $1998.52 in interest and $238.97 principal. These high interest rates have a horrible, ugly amortization schedule. Your initial years of payments are primarily interest and you hardly make a dent on your principal.

After three years of payments, you will have made $80,550 in mortgage payments, but only paid $9,555 in principal. If you go to move, you would still owe $310,455 on the mortgage. All this money spent on interest is gone.

Now, let’s take a look at what would happen if you could make a one-time extra payment of $10,000 in the first month. This is probably the last thing any new homeowner is thinking of doing, but let’s run the numbers and talk about why it might be a good idea.

That one early payment of $10,000 will reduce your loan by 37 months, saving you $73,452 in interest over the life of the loan. And it jump starts your amortization, shifting $62 from interest payments to principal payments every month.

Mortgage Strategies:

If you have a 7.5% mortgage, try to make prepayments as early as you can. This can dramatically shorten your loan. Every dollar of principal will save you a multiple of interest in the years ahead.
Evaluate your cash levels. Keeping a ton of money in the bank at 0% while you have a 7.5% loan isn’t helping. Make those prepayments now and avoid excess cash. Here is a Prepayment Calculator to estimate your situation.

15-Year Mortgage

I’ve long been a fan of the 15-year mortgage and have written about it previously. I’ve used 15-year mortgages previously on primary residences and been very happy with the decision.

Back to our example, we buy a $400,000 house and put down $80,000 leaving us with a $320,000 mortgage. With a 15-year mortgage, the interest rate today is 6.75% rather than 7.50% for the 30-year. Yes, the 15-year mortgage is going to be more expensive. It will be $2,831.71 a month, versus $2,237.49 for a 30-year. For less than $600 extra per month, you can cut your mortgage in half, from 30 years to 15 years. I like that, and it will help reduce expenses for retirement.

The 15 year mortgage also allows you to more rapidly build equity in the house, with more of each payment going towards principal. Remember for the 30-year, the first payment of $2,237.49 consisted of $2,000 in interest and $237.49 principal. With the 15-year, your first payment of $2,831.71 consists of $1,800 in interest and $1,031.71 of principal. I prefer this quicker amortization – the payment is $600 more, but $800 more is going towards principal.

After 15 years, you own a house outright with a 15-year mortgage. You might think that after 15-years, you would be halfway through a 30-year mortgage, but that isn’t the case. You would still have a balance of $241,365 of your original $320,000 loan. In the first 15 years, you paid less than 25% of the principal, and will pay 75% in the second 15-years. So, if you decide to move after 15 years on a 30-year mortgage, you have not accumulated a lot of equity to put towards the next home.

Home Perspectives

No doubt that a home is a key to building wealth. Oh no, I don’t mean that a home is a good investment. Not at all. Rather, a home is an expense, your largest liability. Choose poorly and a house can consume all your income and leave nothing left to save and invest. Living beneath your means remains the way to accumulate wealth. Consider House Hacking if you really want to minimize your expenses. So, a few more thoughts, most of which I have shared previously.

Don’t wait for a housing crash. The supply of homes may be well under the demand for many years. I think we are unlikely to have a repeat of the 2008 housing sell-off, at least on the nationwide level. You can buy now, and potentially refinance in a couple of years if interest rates drop. But we also might see house prices rise again with lower interest rates as houses become more affordable. So, waiting for lower house prices or lower mortgage rates is not guaranteed to be beneficial. If you can find a great long-term home today, maybe it still makes sense long-term.
Renting has become more attractive. In most of the country, renting is now much cheaper than buying. Renting gives you fixed expenses, few surprise repair costs, and the flexibility to move. There is too much pressure to own a home in the US. For many people, renting is preferable, especially if you plan to be there for less than 5-10 years.
Your home is not an investment. Over the long-term, house prices only have done a little better than inflation. And that statistic is highly misleading because it doesn’t account for expenses. Don’t buy a home hoping for substantial appreciation. Buy it as a place to live and for your family.
Tax benefits. Sorry, most people are not getting a tax benefit from their homes anymore. And yet, I still see realtors talking about tax benefits. The standard deduction for 2024 will be $14,600, or $29,200 for a married couple. Very few people will actually have enough in mortgage interest and property taxes to take an itemized deduction. Also, there are caps on what you can deduct: State and Local taxes up to $10,000 and interest only up to $750,000 of a mortgage. Most of my clients used to itemize before 2017 and almost none of them do today.

Financial Planning

Financial Planning is more than just investing well, and that is why we talk about things like Home Mortgage Strategies. The 7.5% mortgage rates are hurting home affordability. If you have to buy a house, understand what your amortization looks like and try to be sure to refi if you can save one percent or more. Back in 2020, I saw people who were looking at paying off a 3% mortgage because cash yields were so low. We discussed the opportunity cost of paying off a mortgage, and that still applies today. Unfortunately now in 2023, the expected 10-year return of stocks have not changed as much as mortgage rates have, and so today the weight of leverage at 7.5% is too great to ignore.

If you are thinking about moving, carefully consider the home mortgage strategies we discussed. Staying put can make sense. If you have an expensive mortgage, consider making prepayments in the early years. If you can afford it, choose a 15-year mortgage. I worry a lot about housing because it has become so much more expensive that people risk being House Rich and Cash Poor. And then, there is nothing left to invest. A home is often the biggest purchase of your life, so choose carefully! Think about how will this help to maximize your future net worth.

Taxes Living Abroad

Posted On November 17, 2023 By Scott Stratton, CFP(R), CFA In Financial Planning, Tax Strategies /

Since we moved to Paris in February, we’ve become much more familiar with taxes living abroad. This may be of interest to anyone who is thinking of living or retiring to another country. I will share the situation for me as a US citizen living in France, but the basics will apply to most countries.

If you thought US taxes were complex, things get really difficult when you add in a foreign tax system and then have to figure out how they will interact together. Given this complexity, this article should be considered just a primer on basic terms and not used as individual tax advice. You need a tax professional who has experience with US clients living abroad.

In general, US citizens have to pay US income taxes on their global income, regardless of where you live. You don’t get out of US taxes by going abroad. But you may be able to reduce your US taxes and that is what we will discuss. Also, there are many other tax considerations besides the annual income tax bill to understand.

Tax Residency

If you spend more than one-half of the year in France (183 days), they will likely consider you a Tax Resident of France. This makes you subject to full France income taxes, which is levied on your global income. If you live in France less than half the year and are not a tax resident, you would still be subject to France taxes on any French derived income.

If all your income sources are from the US, you could potentially live abroad for just under half of the year and not become a Tax Resident. And then you would only have to file US taxes. Currently, as a US tourist, you can stay in the European Union for up to 90 days out of the rolling previous 180 days. Make sure you fully understand the “rolling 180 days” part – it is not based on a calendar year. If you can stay a tourist and not become a tax resident, this will make your life much simpler!

Avoiding Double Taxation

For a US citizen living abroad, you have the problem of double taxation. Your income will be taxed by your resident country and then it will be taxed again by the US. Thankfully, there are tax treaties with 70 countries which provide some benefit and there are several ways to reduce or eliminate the double taxation. Still, you will need to file a US tax return even if you don’t end up owing any US taxes.

Foreign Earned Income Exclusion

The US tax code allows for a citizen to exclude up to $120,000 (2023) in Foreign Earned Income from being taxable on your US taxes. This is doubled to $240,000 for couples who are married filing jointly and who both have foreign wages. You must live abroad for 330 out of the past 365 days. For someone whose income is below the FEIE threshold, you could end up with zero taxable income for the US. You would calculate this exclusion on IRS form 2555 “Foreign Earned Income”.

The FEIE does not apply to any US wages or to any US capital gains, dividends, interest, rent, or other US sourced income. So if you have US wages or income, those earnings are still taxable outside of the FEIE amounts.

In addition to the FEIE, there is also a US tax exclusion for foreign housing expenses, which has a cap of 30% of the FEIE, or $36,000 for 2023. If you reduce your US taxable income to zero through the FEIE and/or housing exclusion, please note that you will be ineligible to make any IRA contributions. (Because your taxable income is zero.)

Foreign Tax Credit

Alternatively, you may be able to claim a credit on your US tax return for foreign taxes paid. The FEIE may take many people’s taxable income to zero and you can stop right there. However, US citizens who make more than the FEIE thresholds, or who have some US-sourced income, may still owe US taxes. And in those situations, applying the Foreign Tax Credit may be preferable. Please note that you have to choose either the FEIE or the Foreign Tax Credit, but cannot do both.

In my situation, we will probably end up using the Foreign Tax Credit. That’s because we have both US and France sources of income (US for me and France for my wife). And since the French taxes will likely be higher than the US taxes, it may take our US tax bill to zero.

Except for one thing: although France taxes us on global income, they exclude Real Estate income. They believe that all real estate income should be taxed locally. And indeed, if you buy a rental property in France, they will charge you income tax on that property even if you never set foot in the country or become a tax resident. As a result, our AirBnb Properties in Hot Springs will remain solely taxed in the US.

One challenge with using the Foreign Tax Credit is that it requires that you finish your foreign taxes before you complete your US tax return. For many, this will require filing a US tax extension past April 15th. And once you are beyond April 15th, you have passed the window to make Traditional or Roth IRA contributions or to calculate 401(k) profit sharing amounts. You may not be able to determine your eligibility until you complete your tax return, so you might miss out on some opportunities.

Social Security

In France, the payroll tax for Social Security is 20%. That is much higher than the US contribution of 7.65% for Social Security and Medicare. However, the French contribution includes all social programs, including Health Insurance, unemployment, maternity leave, as well as “retirement” Social Security.

Although 20% is 12% more than what we would pay in the US, we don’t have any health insurance expenses in France. And so it may be fairly comparable to what we would pay in the US for total costs. As a self-employed person in the US, we might pay $1,200 a month for a family plan with a $5,000 deductible. That’s a $19,400 annual expense we don’t have in France. And the medical system here is excellent.

We just had a baby girl a month ago, and I have no complaints about the value we have received. I will say that the social charges here are a great deal if you have a modest income, but if you have a very high income, you may feel that you are paying in more than you are getting back.

Social Security Vesting

There is one problem for us, however, with social security taxes abroad. Just like the US Social Security, the French retirement system has a 10-year vesting period. Only after you have contributed for 10 years do you become eligible to receive a retirement pension. We do not plan to stay in France for 10 years, so all the money we will pay into their Social Security will not come back to us later in retirement.

Our French earnings are not credited toward the US Social Security system either. US Social Security benefits are calculated based on your highest 35 years of inflation adjusted earnings. We are effectively losing these years of contributions. We are paying in France for no future benefit, while losing the years that could have been added to the US benefits. There’s no 401(k) in France, so no other employer retirement contributions, either.

If you are considering working abroad, make sure you understand its impact on your future benefits! We have enough in ongoing savings and investments for this not to be a major problem, but it is an opportunity cost that we are missing by working outside the US.

Pitfalls Abroad

Besides wages, there are other tax events which could become major pitfalls when living abroad. Here are a few things which could become huge tax bills for US citizens in other countries.

Home capital gains. In the US, we have a $250,000 capital gains exclusion on the sale of your primary residency. France does not. If your US house sale closes a week after moving to France, it occurred while you are a tax resident of France! Maybe you have a $100,000 capital gain which is ignored in the US but now taxable in France. Sell your house before you move! Or keep it.
Gift Taxes. Large gifts to children or others are fine in the US with a lifetime Gift/Estate tax exemption of $12.92 million. Not so in France. Gift taxes could be 20% and apply with thresholds dependent on the relationship. There are even gift taxes between spouses! The French gift tax exemption is only 31,865 Euros per 15 years.
Trusts not recognized. Based on Civil, not Common Law, France does not recognize trusts for tax purposes. Don’t set up US Trusts before becoming a tax resident abroad.
Inheritance Taxes. If you are in France for more than six years, you are subject to inheritance taxes. These are paid by the recipient, unlike US Estate Taxes, which is paid by the Estate. The US threshold is $12,920,000 before any Estate taxes are due. In France, inheritance taxes start at 5% at 8072 euros, but steps up to 45% tax on amounts above 1,805,677 euros (2023).

Get Help

If you are contemplating working or retiring outside the US, taxes living abroad can be complex. Luckily, you’re not the first one to do this. You will want to have tax advisors in the US and in your new country who have experience navigating these complex rules. And having a Wealth Manager who understands the tax implications of your portfolio construction is very important, too.

When my wife’s employer offered her a position in their Paris office, it was an offer we could not refuse! It has been a remarkable opportunity. If you could have the chance to live or work overseas, I would encourage you to see if it is possible. The taxes are a headache and will take a bit more time, but I do think it will be worth it for the experience. Certainly part of achieving the Good Life is being able to fearlessly make the choices to live your life as you dream it could be!

Growth, The Big Picture

Posted On September 18, 2023 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /

With all the noise in today’s markets, it is easy to miss the big picture about growth. 2022 and 2023 have been two of the strangest years in a generation for investors. As a result, it is easy to feel uncertain about investing right now. And that uncertainty often leads investors to make bad choices. So, we are going to step back and look at the 30,000 foot view of what really matters for investors.

In 2022, we saw inflation rise to 9% and the Federal Reserve start the process of slowing the economy. As the Fed raised interest rates, stocks dropped 20%, briefly entering Bear Market territory. In the bond market, rising interest rates snipped the price of bonds, sending the US Aggregate bond index down double digits. For diversified investors, 2022 was a perfect storm where diversification failed and both stocks and bonds were down an uncomfortable level.

Now in 2023, we have seen the Federal Reserve continue to raise rates up to the present moment. At the start of the year, I saw one report that said the probability of a recession in the next 12 months was 100%. 100%, a certainty! And while the full 12 months are not up yet, we have not had a recession. In fact, the S&P 500 Index is up 15.83% this year. While the yield curve remains inverted, a favorite predictor of recessions, it now appears that the likelihood of a 2023 recession is diminished and might not happen at all.

Don’t Time The Market

Comparing 2022 and 2023 doesn’t make sense. The market “should” not be up 15% this year. And yet here we are, with a very welcome gift of an amazing performance in the first seven and a half months of the year. The consensus economic forecasts at the start of 2023 were lousy. If we had listened to them, we would have sold our stocks and hid out in cash. We would have missed out on the gains that we have had for 2023!

There are often compelling historical precedents to entice investors to think we can predict what is going to happen over the next 12 months. Making changes to your investments feels obvious, a smart choice, and low-risk. Unfortunately, history shows us that it is hubris to try to time the market and more often detrimental than beneficial.

It is a challenge to actually stay the course and maintain your discipline. It is difficult to ignore the forecasters and not think that there is an opportunity for you to either protect your principal or rotate into a better performing investment.

Timing the market continues to be a bad idea. I didn’t hear any forecasters in January predict that stocks would be up 15% by August. If we had listened to their predictions, although well-intentioned, we would have made a mistake. Thankfully, we didn’t try to time the market this year. Here is how we manage a portfolio:

Establish a target asset allocation for each client’s individual needs and risk tolerance.
Rebalance portfolios when they drift from the targets.
Adjust our portfolio models annually based on the valuation and expected returns of each category.
Use Index Funds and manage each client’s portfolio to keep costs down and minimize taxes.

Rebalancing

The funny thing about rebalancing is that it often means doing the opposite of what you might expect. When stocks were down 20% last year or in 2020, we were buying stocks. Now, when stocks are up 15-20% and there is a lot of optimism for a soft landing, we are trimming stocks and buying bonds. In hindsight, this looks pretty logical. However, in real time, rebalancing often feels like not such a good idea. And sometimes it isn’t – there’s no guarantee that rebalancing will improve returns. But, what it does offer is a disciplined process to managing an investment portfolio, versus the behavioral traps of trying to time the market. The bizarre markets of 2022-2023 certainly reinforce the potential benefits of rebalancing.

Average Versus Median

Do you remember from high school algebra the difference between Average and Median? Average is the total sum divided by the number of items. Median is the data point in the middle. And there can be a big difference between Average and Median. Stock markets are cap weighted, so the larger stocks move the index more than the smaller stocks. Still, let’s consider how the “average” return of an index can be quite different from the median returns of its component stocks.

The year to date return of the S&P 500 Index ETF (SPY) is 15.83% as of August 16. But that is not the median return of the stocks. Of 504 components of the S&P 500, only 135 have done better than 15.83% YTD and 369 have done worse than the overall index. If you had picked a random stock from the S&P, there was a 73% chance that you would have done worse than “average” this year.

And what is the Median performance of the S&P 500 this year? Only 3.36%, an under-performance of more than 12% than the overall index. Even worse, 212 stocks in the S&P 500 are down, negative for the year.

What is the big picture of growth in stocks? Trying to pick individual stocks is extremely difficult. Don’t think that using an index fund means “settling for average”, the reality is that over time, the index return has done much better than the median stock.

This year has been such a frustrating year for investors because stocks are all over the place. If you don’t own a few of the top performers, you are likely lagging the benchmark by a wide margin. What is a way to make sure you own the winners today and tomorrow? Own the whole market with an Index Fund. Realize that if you pick a stock from the S&P 500, it is not a 50/50 coin toss that you will beat the market average. The chance is lower than 50% because the market average typically does better than the median stock. The stocks which do outperform will move the index disproportionately and they will be fewer in number.

There is a lot of noise and confusion in the markets today, and that’s okay. We are in uncharted waters and seem to be going from one “unprecedented” event to another. Thankfully, I don’t think we need to have a crystal ball to be successful as long-term investors. What I believe can help is stepping back to remember the big picture: don’t time the market, stick to an allocation and rebalance, and use index funds. That’s our roadmap. When in doubt, we can recheck our directions and keep going.

What You Can Control

In the short-term, stock markets can be very volatile. As a result, I believe a lot of inexperienced investors mistakenly think that their success depends on their ability to game the markets. They think that growth is achieved through trading or superior returns.

Unfortunately, trying to outsmart the market often makes your performance worse, rather than better. Active management doesn’t work, at least not consistently over 10 or more years. We stick to passive, low-cost index funds or ETFs for our stock market exposure. And we remain invested in a long-term asset allocation.

Once that investment decision is out of the way, the main determinant of success is your savings rate. How much are you investing each month? That is what you can control. If you want to be more successful in accumulating your wealth, you don’t need to worry about the Jobs Report this week, or what was in the Federal Reserve meeting notes. You need to focus on how can you can save an extra $100, $500, or $1000 a month and make that a habit.

Instead of worrying about your YTD performance, calculate how much wealth you will have in 10 or 20 years, with an average rate of return. Because in the long-run, an average rate of return is excellent. And then what you can control – your savings – is what actually matters more. Growing your wealth is largely a factor of savings and time. Chasing investment performance is a distraction.

Develop Your Saving Habits

Make savings automatic. Put your investing on autopilot with monthly contributions to your 401K, IRA, and investment accounts.
Save More. Don’t just do the 401(k) match, try to put in the maximum to each account. And then ask where else can you invest? Do the math of how much money you want to accumulate. (I can help with that.)
Keep the big expenses down. Living beneath your means is easy if you are smart about your housing costs and your cars. Many Americans who are not frugal in those areas do not have anything leftover to invest.
Develop your career. If you can expand your income without increasing your expenditures, your savings can increase dramatically. If you ever have a chance to work for a company with stock options, go there. I have seen over the years, tremendous wealth accumulated from stock options.
Be an Entrepreneur. This can be high risk, but when they are successful, entrepreneurs earn and save much more than employees. Besides a salary, an entrepreneur is growing a business that has value.

As a financial planner over the past 19 years, I’ve gotten to look at a lot of families’ finances. The difference between those who were struggling and those who were wealthy was seldom just income. I’ve seen a lot of high income folks who were living hand to mouth. Other families who had similar incomes were millionaires or well on their way. The difference was their saving rate. You can’t grow what you don’t save.

There is no substitute for saving. We have to make savings automatic and increase our savings whenever possible. It may help to work backwards: start with your goal and determine how much you need to save and for how long. Then you can see saving as the solution and beneficial process rather than as a sacrifice. Some Americans are saving very well. But the Big Picture is that the average American isn’t saving enough. We need to be talking more about saving, because for too many families, it is the step that they cannot get past.

Our recipe for Growth is simple. Save monthly and dollar cost average into Index funds. You can do this in your 401(k), IRA, or taxable account. The account is less important than the process. The more you save, the more wealth you can accumulate. The younger you start, the better. The faster you increase your saving, the sooner you can reach your goals. Saving is growth and investing is secondary.

Investment Taxes Eat Your Growth

Taxes matter. We work hard to establish a good portfolio and get a respectable rate of return. And then the government wants their cut. How about 37% for Federal Income Taxes (increasing to 39.6% in two years). And another 5% for state taxes. Don’t forget 15.3% for self employment taxes for Social Security and Medicare (or half that number if you’re an employee). Then, if you do well, how about an extra 3.8% in Medicare surtax (“Net Investment Income Tax”).

Once you have your “after-tax” money, it’s all yours, right? Well, not quite. You get to give the government another $5,000, $10,000, or more in property taxes. And when you want to buy something with your after-tax money, you get to pay 8% in sales tax.

The point is that it doesn’t matter how much you make, it matters how much you keep. That is why tax planning is such a big part of our wealth management process. As your portfolio grows, the tax implications can become a significant annual expense and a drag on returns.

What continues to shock me is how many Advisors are making huge mistakes with client portfolios and creating tens of thousands of dollars in unnecessary taxes. Taxes which could have been avoided or reduced substantially through better planning. Sometimes this is because they use a model portfolio that doesn’t attempt to have any tax efficiency. But other times, it is laziness and having too many clients to manage individual portfolios in a tax-efficient way. It’s easier to stick people into a model and let the computer automatically rebalance the portfolio.

This is the big picture for wealthy Americans: Your after tax-return matters more than your pre-tax returns. You have very little control over taxes on a monthly basis, but a great deal of control over taxes in the long run. Here are the mistakes we often see and how we can do better:

Portfolio Tax Efficiency

Mistake 1: Mutual Funds in Taxable Accounts. Mutual Funds have to distribute capital gains annually. Each December, many investors get a surprise tax bill from their funds. BETTER: hold Exchange Traded Funds (ETFs) in taxable accounts. ETFs rarely, if ever, have capital gains distributions.

Mistake 2: Short-Term Capital Gains. Short-Term Capital Gains (less than 1 year) are taxed as Ordinary Income, up to 37%. BETTER: Hold for Long-Term Capital Gains (more than 1 year), which are taxed at lower rates (0, 15 , or 20 percent). Trading which creates ST Gains should be avoided in a taxable account. We are very careful about the tax implications of our rebalancing trades, as well.

Mistake 3: Bonds and REITs in Taxable Accounts. Bond income is taxed as ordinary income (up to 37%). BETTER: Hold bonds in IRAs, which are tax-deferred. Also, IRA distributions will be taxed as ordinary income, so bond income isn’t treated worse in an IRA, unlike capital gains. When you have a LTCG on a stock ETF in an IRA, all that growth will be taxed as Ordinary Income. Traditional IRAs will have the highest tax rate, so it is better to allocate the low growth bonds to IRAs and high growth stocks to Roths and taxable accounts. This process is called Asset Location.

Mistake 4: Not harvesting losses. BETTER: Harvest losses annually in taxable accounts. Losses can be used to offset gains that year, and $3,000 of losses can be applied against ordinary income. Unused losses will be carried forward without expiration.

Mistake 5: Not asking about charitable giving. 90% of Americans are not itemizing and not getting any tax benefit from charitable donations. BETTER: We can get a tax benefit two ways, without itemizing: A) make donations of appreciated securities from a taxable account. Or B), if over age 70 1/2, make Qualified Charitable Distributions (QCDs) from your IRA.

Mistake 6: No Plan for Managing IRA Distributions. BETTER: Do Roth Conversions in low income years before RMDs start at age 73.

Mistake 7: Not understanding Taxes that will be owed by Beneficiaries. BETTER: Working with your Advisor to consider inter-generational taxes in your Estate Plan. For example, taxation of trusts, step-up in cost basis, charitable giving, and Beneficiary IRAs.

Mistake 8: Not doing a Backdoor Roth IRA. I’ve had advisors tell me it’s not worth their time to move $13,000 to $15,000 into a TAX-FREE account each year for a married couple. Not worth it for the advisor, I guess (no additional revenue). BETTER: Although the numbers are small annually, we have been doing back-door contributions for clients for many years, and it does add up.

The Changing Retirement Picture

Did your parents retire with a Pension? Maybe they worked for 30-40 years for the big company in town, or for a municipality, school district, military branch, or government agency. When they retired, they had a pension and Social Security which fully covered their expenses. They might have also had retirement health benefits which paid for deductibles and co-pays which were not covered by Medicare.

You probably don’t have the same benefits. How much is a Pension worth? Well, we can easily compare a Pension to the cost of a Single Premium Immediate Annuity, or SPIA. A SPIA works the same way as a Pension – it is a guaranteed monthly payment for life. For example, let’s consider a 65 year old female who has a pension which guarantees her $2500 a month for the rest of her life. We could buy a SPIA with the same guaranteed $2,500 a month for life, for a cost $437,063. So, a $2,500/month pension is worth $437,063.

To have the same retirement funding as your parents, you may need $400,000 or more in assets than they had. And that is just to replace one modest pension. If your parents had two pensions or had a bigger pension, you might need much more than $400,000 to get the same retirement income.

And you probably won’t buy a SPIA and would prefer to keep your money in an IRA. At a 4% withdrawal rate, you would need $750,000 in your IRA to get $2,500 a month. So maybe you need $750,000 more than your parents, not $437,000, to replace their pension! These pensions were worth a lot. It will take a worker 30 years of saving to build up their 401(k) to $750,000. It’s not impossible, but the big picture is that most Americans aren’t doing a good job of saving. The average 401(k) balance for workers age 55-64 is $207,874. The median balance at 55-64 is only $71,168, meaning that half of all 401(k) accounts are less than $71,168.

I’m afraid the promise of becoming wealthy through your 401(k)s has proved elusive for the average American. It’s a wedge that is driving wealth inequality in our country. But I don’t think Pensions are coming back – retirement preparation rests squarely on the individual’s shoulders. You certainly can get to $500,000 to $1 million in a retirement account, but you have to aim to put in the maximum, not just get the company match. Then you have to not withdraw it and let it compound for 30 to 40 years. That recipe will work, but it’s not easy, it requires some sacrifice and a lot of discipline.

Counting on Social Security

The Social Security Trust Fund will be depleted by 2033. After that, revenues will only cover about 70% of promised benefits. After kicking the can down the road for 20 years, Washington needs to get its act together soon. We can either reduce benefits or increase taxes. It may be a combination of both, but one thing is for sure: keeping the status quo is not going to be an option. The Social Security budget for 2023 is $1.30 Trillion. The Department of Health and Human Services (Medicare, Medicaid, and other health agencies) have a budget of $2.10 Trillion for this year. These two programs, largely for Retirees, have become the biggest portion of government spending.

There will have to be a reckoning in the years ahead about these programs. Something has to change, they are unsustainable in their present form. I think there will be changes in inflation adjustments, a gradual increase in the full retirement age, and probably some means testing which will reduce benefits for high net worth families. Or there could be a whole new system. As difficult as it is to imagine, the system is so broken that starting over from scratch might be better than continuing to try to put new band-aids on this fiscal cancer.

The big picture for the future of government retirement programs is very uncertain. These are not the only issues facing the government. Our debt is growing. This year, the interest payments alone on US Treasury Debt will be $964 Billion. We may top $1 Trillion in interest payments next year. And there is no plan to ever repay this debt, only to grow it every single year. When you look at debt projections, it only reinforces the need to reign in the expenses which are growing the fastest.

In our planning process, we include Social Security projections. But we had better be prepared for benefits to potentially be a bit less than promised. So, once again, it may be that more of your retirement income needs to be self-funded. If you don’t have a pension, the burden of funding your retirement has been shifted to you. Have you calculated what that will cost? That’s what we do with our retirement planning software, MoneyGuidePro. We create an ongoing plan for your retirement needs, which adjusts over time, and where we can continue to refine assumptions and expectations.

I hate to be such a downer, it’s really not my nature. But a lot of Americans are going to have worse retirements than their parents, because they don’t have a pension. The burden of saving for retirement has shifted from the employer to the employee. Now instead of everyone getting a good outcome, many Americans are under-prepared for retirement. And then we have to look ahead at the uncertainty that is facing Social Security and Medicare. It looks like we will have more individual responsibility for our outcomes and less universal assistance.

The Forest For The Trees

The Big Picture for Growth can be hard to see because the fog of current events makes it hard to see the long-term horizon. Here are our four pillars of The Big Picture:

Don’t time the market. Stick to your asset allocation and rebalance. Use index funds.
Once you’ve made the shift away from performance chasing, focus on what really matters: how much you save.
Taxes hurt returns. Tax planning helps.
You are responsible for your own retirement savings and financial security.

I’m sure things are going to change. We don’t really know how, when, or why they will change. While some may find uncertainty to be paralyzing, it doesn’t have to be. Even if the future is a moving target, planning is not a waste of time. Not at all! Being well prepared also includes the flexibility to adapt and evolve.

A lot of my day to day work is focused on the small details of implementing our plans. But the growth is created when we step back and take a long, hard look at The Big Picture. We should all be having more of those conversations, with our spouses and children, our bosses and colleagues, and especially with your financial professional.

Cash Back Credit Cards

Posted On July 20, 2022 By Scott Stratton, CFP(R), CFA In Financial Planning /

I am a big fan of cash back credit cards for good reason: this past year I’ve gotten back $1,294.18 from my two personal credit cards. Both cards have no annual fee and I pay my balances off every month and pay no interest charges. We are moving away from cash payments with our spending today and so it makes sense to get cash back on money you would have spent anyways.

This has certainly been a big spending year, with our wedding last October and a trip to Europe this August. Additionally, we spent over $20,000 in renovations and furnishings for our two new Airbnb properties in Hot Springs. You can check out our listings here: The Owl House and The Boho Loft. So, all the spending adds up.

Two Percent Cash Back

There are a lot of cards that offer 1 to 1.5% cash back, and those should be pretty easy to find. Today’s top cards offer 2% cash back, and there’s a good list of 2% cards on the Nerdwallet site. I’ve had the Fidelity Rewards Visa Card for years. It has no annual fee and gives me 2% cash back, deposited automatically into a Fidelity brokerage account each month. I can then transfer the cash out to my checking at any time. (My brokerage accounts are all at TD Ameritrade – I only keep the cash back at Fidelity.)

I don’t really worry about the interest rates on these cards since I never carry a balance. If you do have a balance, you’re probably better off finding a zero-interest balance transfer card and working on paying off your principal. I do prefer a card with no annual fee. And I’m not a big fan of hotel points or airline miles. I know others who are loyal to one airline and prefer an airline credit card, but I believe the airlines have made it harder to redeem points in recent years. (If you’ve had a great – or a terrible – experience with airline cards, I’d love to hear about it. Please send me a message.)

Discover 5%

I’ve also had a Discover Card since 1999. It provides 1% cash back on everything and 5% cash back on a category that changes each quarter. So, I use my Visa for most purchases and the Discover card for the 5% categories. Here is the 5% Cashback calendar for 2022:

January-March: Grocery Stores and Gym Memberships
April-June: Gas Stations and Target
July-September: Restaurants and PayPal
October-December: Amazon and Digital Wallets

I don’t spend as much on Discover, except for the 5% categories. Customer service at Discover has been excellent.

Store 5% Cards

There are a number of store-branded credit cards which offer 5% discounts or credits. These may not be cash back, but if you frequent these stores, they may be a better deal than your 2% cash back credit card. Presently, the only one I have is the Target Red Card. The Red Card gives me an instant 5% discount off my purchases at Target. I set up the card to autopay from my checking each month and don’t think about it after that.

I’m also looking at three other 5% store cards. The Lowe’s Advantage Card gives a 5% discount on purchases. That’s definitely worth it if you are doing some big projects. Please note that if you get the 10% Military discount at Lowe’s (like my Dad), you cannot stack the 5% on top of the Military discount. However the 5% discount will apply to appliances, unlike the Military discount.

The second card I would consider is the TJX Rewards Card which offers 5% back in certificates to use at the store on future purchases. The card and rewards can be used at TJ Maxx, HomeGoods, or Marshalls. We’ve spent a bit there in the past year, but I’m not sure we need it going forward.

And third is the Amazon Prime Rewards Visa. It offers 5% back at Amazon and Whole Foods, plus 2% back on restaurants, gas stations, and drug stores. There’s 1% back on everything else, and no annual fee as long as you are already an Amazon Prime member. This one may make the most sense for us, given how much we use Amazon.

Spend Wisely

Cash Back Credit Cards are a good deal for consumers. I’ve been getting 2-5% cash back on my spending for years, and it helps. I’ve also added a 1.5% cash back card for my business this year, which I probably should have done years ago! Some people are worried that opening new credit cards will hurt their credit score, but this will probably have little or no effect. And if you aren’t planning to buy a house soon, you shouldn’t worry at all.

It pays to do a little research and find the right card for you. Over time, cash back cards put money back into your wallet. And then you can contribute more to your Roth IRA like I’ve been suggesting, right? Helping you become intentional with your money goals is important to me, even if it is something as small as which credit card you use. Little decisions create good habits that keep you moving forward.

Why Index Funds Are Better

Posted On May 22, 2022 By Admin In Financial Planning /

Twice a year, Standard and Poor’s provides an analysis of why index funds are better than actively managed mutual funds. Their report is known as SPIVA, S&P Index Versus Active. It is compelling evidence that investors would be better off using index funds. We’re going to look at the most recent data, discuss the perils of fund benchmarks, and then explain our approach of using Factor-based strategies.

Most Funds Lag Their Benchmark

Looking at 2021, 79.6% of US stock funds did worse than the overall market, as measured by the S&P 1500 Composite Index. It was a spectacularly bad year for active managers, even worse than most years. I focus on the long-term results, which are fairly consistent from year to year. For the 10 years ending 12/31/2021, 86% of US stock funds under-performed the market. Some of the funds which did out-perform did so by taking on much more risk. When we consider risk-adjusted returns, 93% of funds lagged.

The data is compelling and persistent. 80% or more of actively managed funds cannot keep up with their index over 10 or 20 years. And since that is the time frame that matters for long-term investors, the odds are in your favor if you use index strategies rather than active funds. It is extremely difficult for active managers to beat the index. There are many thoughts why this is the case:

Higher expenses. The cost of running a fund seems to wipe out any value they create through research and active management. Overall, market participants add up to the entire return of the stock market. That is the benchmark. But instead of being average (or actually Median) at 50%, the additional costs mean that 80% of funds trail the benchmark
Chasing performance. Active managers pay too much for hot stocks and ignore cheap stocks which are out of favor. Or they miss the handful of top performing stocks which are often the biggest drivers of market returns. Stocks, categories, and sectors go in and out of favor.
No information advantage. Today, analysts are smarter than ever and information is disseminated instantly online. The markets may have become so efficient that there are no “secret” stocks for active managers to uncover.
The 10-20% of managers who do outperform may have done so through luck, as they are typically unable to sustain out-performance from one period to another. Do we have data for that? Yes. It’s the S&P Persistence Scorecard.

Which Benchmark?

There are a lot of benchmarks and unfortunately, this can be confusing for investors. Sometimes, we might be comparing a fund to the wrong benchmark and not be making the most accurate comparison. Consider, for example, the Fidelity Contrafund. At $126 Billion in assets, it is one of the most successful active funds in history. And over the last 10 years, it has slightly beat the S&P 500 Index: FCNTX is up 282% through April 22, 2022, compared to 279% for the Vanguard 500 (VOO).

Unfortunately, that’s not the most accurate benchmark, because the Contrafund is a Growth Fund. As a better benchmark, you could have been invested in the Vanguard 500 Growth Index (VOOG). And VOOG was up 333% over the past 10 years. In this case, the active fund actually trailed the correct benchmark by 50% over 10 years. With Growth strategies dominating over the past 10 years, a lot of Growth funds look good compared to the S&P 500. But when we consider a Growth benchmark, you probably would have been better off in the index fund. (And for taxable accounts, the after-tax return of active funds are very often much lower than an ETF.)

Here’s another poor benchmark situation. This week, I was comparing two US Low Volatility ETFs with very similar strategies: the SPDR Large Cap Low Volatility (LGLV) and the Invesco S&P 500 Low Volatility (SPLV). Looking at a Morningstar report of 5-year performance, it showed that LGLV was in the 60th percentile while SPLV was better, at the 40th percentile. Unfortunately, the report was using two different benchmarks: large blend for LGLV and large value for SPLV. Their actual 5-year annualized returns were 14.01% for LGLV and 11.36% for SPLV. With different benchmarks, LGLV looked worse (60th percentile), even though it had actually out-performed SPLV by 2.65% a year! Which benchmark you use matters.

Using Factors To Look Forward

Although SPIVA shows why index funds are better, the harder part is deciding which index fund you want to invest in. You could just choose a World Index stock fund, like the Vanguard Total World Stock ETF (VT). And I am confident you would do better than most active managers over the next 10 or 20 years.

But, we don’t invest in an “all-in-one” fund.

Rather, my role as a portfolio manager is to determine the asset allocation for each model and level of risk. We decide which categories we want to own (large growth, small value, emerging markets, etc.) and what percentage to invest in each category. And rather than looking backwards at performance, we use today’s valuations to evaluate future performance. Once we have an asset allocation model, I can select an index fund to use to fulfill each category. It starts with the blueprint, not the funds themselves.

Rather than using generic index funds like a Total World Index fund, we buy 5-8 Index funds that invest using a “factor” strategy. This is a quantitative way of sorting stocks, using a characteristic such as Value, Size, Quality, or Low Volatility. They represent an Index or Benchmark, but have an additional screen to create a portfolio with specific qualities. There is evidence that Factors can outperform a benchmark over time, but clearly, they do not do so every year.

Today, we are concerned about some stocks’ high valuations. We have tilted our portfolios away from the large cap growth and technology names which have had such terrific performance that their values are so expensive today. Some of these stocks, such as Facebook (now called “Meta”) are down 45% year to date. That’s what can happen when a stock becomes too expensive and the market winds change direction.

Instead, we are looking ahead in anticipation of a reversion to the mean in categories such as Value, Small Cap Value, International and Emerging Markets. That’s no prediction that any of these will be up this year, it’s a long-term proposition. When I look at the S&P 500 Index today and see how expensive some of the names have become, I find it hard to stomach. And so, we are looking for ways to take advantage of passive, low cost, tax-efficiency of ETFs, but in a smarter manner than just throwing it all in a generic, market cap weighted index fund.

Once we understand why index funds are better, we are still left with two questions. Which benchmark to use and how do we want to invest? We are fortunate today to have easy access to many low cost index funds. Factor-based funds can help us establish potentially positive characteristics to our portfolios even compared to regular index funds.

We Bought An Airbnb

Posted On April 4, 2022 By Scott Stratton, CFP(R), CFA In Financial Planning /

In January, we bought a house in Hot Springs, Arkansas and have listed it on Airbnb. This is a new venture for us and I wanted to share my evolving thoughts about debt, inflation, cash, and real estate. Although the stock market has been down so far in 2022, don’t think that this means I am giving up on stocks as an investment. Not at all!

If you want to check out our property, here is the listing on Airbnb. My wife, Luiza, has done a great job of decorating and furnishing the house. And I owe a big thank you to my parents who spent three weeks helping us with renovations. It has been live for one week now, and we have eight bookings in April and May. Let me know what you think about the listing!

We Went Into Debt

Prior to this purchase, we were debt free and we purchased our new property with a mortgage. I could have sold investments and paid cash for the house, but I think that would have been a bad idea. Taking a mortgage is the better choice.

Leverage can be a tremendous tool, when used properly. Taking on debt to buy appreciating assets and cash flowing investments can have a multiplier effect. This is “good” debt. Bad debt would be spending on depreciating assets like cars, or using credit card debt to fund a lifestyle. I eventually realized that being debt-free would actually slow down our growth versus taking on some smart debt.

For Airbnb investors, a property evaluation is often based on the “Cash on Cash” return. What does that mean? Let’s consider a $200,000 house which produces a hypothetical $14,000 a year in profit. If you purchase the property with $200,000 cash, your Cash on Cash return is 7%. But if you put only 20% down ($40,000) and make $8,000 (net of the monthly mortgage), your cash on cash return is 20%. In other words, it can be a fairly attractive investment because of the leverage. Without the debt, the returns are not that compelling compared to stocks, for example. And if you use mortgages, you can buy $1 million of properties with $200,000 down. That could grow your wealth much faster than just buying one property for $200,000.

Debt, Inflation, and Government Spending

Beyond the numbers for this particular house, I think the world is now favoring debtors. Our government spending has been growing for years. And then when the pandemic hit, spending shot up dramatically and shows little sign of returning to its previous trajectory.

Our government, and many others, are running massive deficits and have no intention or ability to reduce spending. They will simply never pay off this debt. It will only grow. (See: the US Debt Clock.) We now have inflation of over 7%. I don’t think inflation will stay this high, but I also don’t think it will go back to 2%. Governments will have to inflate their way out of debt. There is an excellent video from billionaire hedge fund manager Ray Dalio: the Changing World Order. He documents historical civilizations who expanded debt and saw resultant inflation. It is a brilliant piece if you want to understand today’s economy.

Inflation favors debtors and penalizes holders of cash and bonds. 7 percent inflation over 5 years will reduce the purchasing power of $1000 to $600. The holder of a bond will see a 40% depreciation of the real value of their bond. And the debtor, such as the US government or a mortgage holder, will benefit on the other side.

I reached the conclusion that I should be a debtor like our government. Staying in cash and a lot of bonds, would be a poor choice long term. I didn’t sell any stocks to buy our investment property, but I did reduce cash and bonds. Today, we can borrow at 3-5% while inflation is at 7%. And if interest rates do come back down to 2%, I can always refinance the mortgage.

Thoughts on Real Estate Investing

Real Estate is a business, not a passive investment. Managing an Airbnb is time consuming and can have headaches of dealing with people and problems. We have spent a huge amount of time (and about $14,000) improving our property and furnishing it for Airbnb. Buying an Index Fund does not carry as much risk or time commitment!
It is the leverage which makes real estate attractive. Without the mortgage, not so much. (Imagine if we could buy $100,000 of an S&P 500 Index fund with only 20% down. That would be incredible over the long term.)
Higher inflation can help real estate prices and rent prices, while our mortgage stays fixed. Besides the cash flow, we also benefit from: 1. Paying down the mortgage and building equity. 2. Increasing home value over time. 3. Some tax benefits such as depreciation.
Your personal residence is still an expense, not an investment. More pre-retirees should be looking into House Hacking. This will enable many to retire years earlier.
I like the returns on short-term rentals. With elevated prices today, many long term rentals have mediocre cash flow potential. Especially if we have some repair expenses and vacancy.

So far, we are happy to have bought an Airbnb. It fits well with our willingness to take risks, start a business, and do repairs ourselves. We are looking to buy another. But we know it’s not for everyone. If this is something which interests you, I am happy to discuss it with you and share what I know.