COVID Relief Bill

COVID Relief Bill Passes

A new bi-partisan COVID Relief bill passed Congress this week and will impact almost every American in a positive way. This stimulus legislation creates additional income and tax benefits to offset the economic damage of Coronavirus. The $900 Billion bill includes another stimulus payment to most Americans, an extension of unemployment benefits, and seven tax breaks. As of this morning, President Trump has not yet signed the bill.

$600 Stimulus Payment

The CARES Act provided many families with stimulus checks this summer. Those checks were for up to $1,200 per person and $500 per child. There will be a second stimulus check now, for $600 per person. Parents will receive an additional $600 for each dependent child they have under 17. Adult dependents are not eligible for a check.

Like the first round of checks, eligibility is based on your income. Single tax payers making under $75,000 are eligible for the full amount. Married tax payers need to make under $150,000. There is a phaseout for income above these thresholds.

Payments will be distributed via direct deposit, if your bank information is on file with the IRS. If not, like before, you will be mailed a pre-paid debit card. This payment will not be counted as taxable income. Payments should start in a week and are expected to be delivered much faster than the two months it took this summer.

These $600 payments are again based on your 2019 income, but will be considered an advanced tax credit on your 2020 income. What if your 2019 income was above $75,000, but your 2020 income was below? If you qualify on your 2020 income, the IRS will provide the $600 credit on your tax return in April. If they send you the $600 based on your 2019 income and your 2020 income is higher, you do not have to repay the tax credit. This is a slightly different process than the first round of checks, and will benefit people whose income fell in 2020.

Unemployment Benefits

The CARES Act provided $600 a week in Federal Unemployment Benefits, on top of State Unemployment Benefits. This amount was set to run out on December 26. The new COVID Relief Bill provides an 11-week extension with a $300/week Federal payment. Now, unemployed workers will have access to up to 50 weeks of benefits, through March 14. Unfortunately, because of how late the legislation was passed, states may be unable to process the new money in time. So, there may be a gap of a few weeks before benefits resume.

Seven Other Tax Benefits

  1. Child Tax Credit and Earned Income Tax Credit. Under the new legislation, tax payers can choose between using their 2019 or 2020 income to select whichever provides the larger tax credit.
  2. Payroll Tax Deferral. For companies who offered a deferral in payroll taxes in Q4, the repayment of those amounts was extended from April to December 31, 2021.
  3. Charitable Donations. The CARES Act allows for a $300 above-the-line deduction for a 2020 cash charitable contribution. (Typically, you have to itemize to claim charitable deductions.) The new act extends this to 2021 and doubles the amount to $600 for married couples.
  4. Flexible Spending Accounts (FSAs). Usually, any unused amount in an FSA would expire at the end of the year. The stimulus package will allow you to rollover your unused 2020 FSA into 2021 and your 2021 FSA into 2022.
  5. Medical Expense Deduction. In the past, medical expenses had to exceed 10% of adjusted gross income to be deductible. Going forward, the threshold will be 7.5% of AGI. This will help people with very large medical bills.
  6. Student Loans. Under the CARES Act, an employer could repay up to $5,250 of your student loans and this would not be counted as taxable income for 2020. This benefit will be extended through 2025.
  7. Lifetime Learning Credit (LLC). The LLC was increased and the deduction for qualified tuition and related expenses was cancelled. This will simplify taxes for most people, rather than having to choose one.

Read more: Tax Strategies Under Biden

Summary

The new COVID Relief Bill will benefit almost everyone and will certainly help the economy continue its recovery. For many Americans, the stimulus payments and continued unemployment benefits will be a vital lifeline. Certainly 2020 has taught all of us the importance of the financial planning. Having an emergency fund, living below your means, and sticking with your investment strategy have all been incredibly helpful in 2020.

Read more: 10 Questions to Ask a Financial Advisor

If you are thinking there’s room for improvement in your finances for 2021, it might be time for us to meet. Regardless of what the government or the economy does in 2021, your choices will be the most important factor in determining your long-term success. We will inevitably have ups and downs. The question is: When we fall, are we an egg, an apple, or a rubber ball? Do we break, bruise, or bounce back? Planning creates resilience.

How to Increase Your Yield

How to Increase Your Yield

Opportunities for a Low Yield World, Part 2

Last week, we discussed how not to increase your yield today: by replacing safe bonds with high yield bonds. That’s because the potential for rising defaults today in junk bonds could have a major drag on what would otherwise appear to be a healthy yield. While the typical default rate for single-B and double-B bonds is 2-4% a year, in a crisis it could go much higher. In 2009, for example, global high yield bonds saw a 13% default rate that year.

It’s important to understand the risks in your bond portfolio and know what you own. There are four opportunities today for investors to improve their yields today, without simply trading down to junk bonds. None of these are home runs, but offer a bit more yield. And in the current low interest rate environment, increasing your yield by even one percent could be doubling your rate of return from your bonds. Some investors will choose to skip bonds altogether and add to their equities, but that would take on a lot of additional risk. For investors who want the risk and return profile of say a 60/40 portfolio, there’s no substitute for the safety of bonds.

1. Cash: Online Savings Account, not a Money Market Fund

Today, the Federal Reserve has lowered rates to basically zero. There is almost no yield on T-Bills, bank accounts, and short-term CDs. I see a lot of investors who park significant cash in a money market fund or in a Bank savings account. Those rates may have been near two percent a year ago, but many are now at 0.01%. That’s a whole one dollar of interest for a $10,000 investment each year! Not only are you not growing your cash, you probably aren’t going to keep up with inflation either. Your purchasing power is likely to decline with each passing year.

Instead of a money market at 0.01%, park your cash in an online savings account. You can link it to your primary checking account, and transfer money as needed. Most are FDIC insured, and several have no account minimums and no monthly fees. The one I use: Marcus.com from Goldman Sachs Bank. The current rate is 1.05%, with no minimums and no fees. You can open an account in about 1 minute and there’s an app for iOS and Android. I cannot think of any reason to not do this if you are presently earning 0.01% on a money market.

2. Buy Insured Municipal Bonds, not Taxable Corporates

The Coronavirus didn’t just hurt companies. Municipal Bonds – which are issued by cities, states, schools, and local entities – depend on taxes or revenues. Revenues from Stadiums, Toll Roads, etc., are down and so are taxes from sales, restaurants and bars, gasoline, income, and everything else which is taxed. The municipal bond market really doesn’t know how to evaluate this unprecedented problem. Compounding this issue is the fact that there are hundreds of thousands of different bonds, issued by 50,000 different entities. Some of these bonds are so small that they rarely trade.

The result is that we can now buy a tax-free, A-rated municipal bond with a higher yield than we can buy an A-rated corporate bond which is taxable. This doesn’t help retirement accounts, like a 401(k) or IRA, but if you are buying bonds in a taxable account, taxes matter. Imagine two bonds both yield 2%. One is tax-free and the other one is going to cost you 22 to 37 percent in income taxes. That’s a big difference when we consider after-tax returns!

It is unusual to find yields on tax-free municipal bonds being higher than on corporate bonds of a similar credit quality and duration. For folks in a high tax bracket, taking profits on your corporate bonds and shifting to munis can make sense. (Profits on your appreciated, high-priced corporate bonds can qualify for long-term capital gains rate of 15%, a lower tax rate than receiving the bond’s income and waiting for them to mature at par.)

If you are concerned about the credit quality of municipal bonds, look for bonds which are insured. Bond insurers offer protection to muni bond holders to cover losses of income and principal, should a municipality default. At this point, defaults on municipal bonds remain much lower than from corporate bonds. The highest rated insurer is AGMC, and those bonds remain AA- rated.

We build portfolios of individual municipal bonds for clients with taxable accounts over $250,000. For investors with smaller portfolios, you can achieve a similar benefit with an intermediate municipal bond fund.

3. Buy 5-year Fixed Annuities, not 5-year Bonds

Where are the yields of 5-year fixed income products this week? The 5-year Treasury bond has a yield of 0.27%. The best rate I have on a 5-year CD is 0.55%. I see an A- rated 5-year corporate bond from JP Morgan at 0.95%. Munis are better, but still only 1.0 to 1.3% tax-free for an A-rated bond.

The best place to park money for five years remains a fixed annuity. Today I see several annuities in the 3.0 and 3.1 percent range for a five year product. That’s basically triple the yield of corporates and about 6-times the yield from CDs. A fixed annuity is guaranteed, both for the rate of return and your principal. There is a trade-off with annuities. They charge very steep surrender charges if you need to access your money early. However, if you aren’t going to tap the account for 5+ years, it can make sense to put some money into an annuity.

Whenever people ask me how they can earn more while keeping their money safe, I discuss the pros and cons of an annuity. For today’s bond investors, a Multi-Year Guaranteed Annuity (MYGA) can be a way to increase your yield while keeping high credit quality.

4. Buy Preferred Stocks, Not a High Yield Fund

The High Yield ETF (HYG) currently has an SEC yield of 5.06%. There are a couple of reasons I prefer to own preferred stocks, besides the default risks I shared last week. First, I can save the ETF expense ratio of 0.49%. This is actually low compared to most high yield funds. When you own Preferreds directly, you might be saving one-half to one percent versus paying the expense ratio of a fund. At a 5% yield today, that is a 10-20% improvement. Yields are very low today, but expense ratios have not come down. Now, expenses eat up a larger portion of your return, leaving you with less income.

Second, preferreds today are offering a yield of 5-7%, which is attractive compared to bonds from the same company. For example, AT&T has preferred which yields 4.8% and is callable in 5 years. The February 2030 AT&T regular bond, however, yields less than 2.25% today. First Horizon Bank sold a 6.5% preferred this year, callable in five years. Their five year bonds, today, are available for a purchase with only a 1.865% yield.

Generally, the bonds are “safer” than preferreds, as they would rate higher in a bankruptcy liquidation. That’s one reason for the different yields, as well as the longer duration of the preferreds. Still, if you are comfortable with the credit risk of a company, the Preferreds may be trading at a significantly higher yield than the bonds of the company. That’s an opportunity today.

Why do we write so much about fixed income? For many of our investors who have achieved their accumulation goals, moving from growth into preservation and income is important. And there is an opportunity for us to add value through our fixed income choices: to increase yield, improve credit quality, or to reduce your risks. While it is relatively easy and fast to trade equity ETFs, buying individual bonds can require hours of research and trading.

Stocks have gotten all our attention this year, but don’t ignore your fixed income. The great return of fixed income in recent years has largely been the result of falling yields increasing the value/price of your bonds. Today, at nearly zero, yields could prove disappointing going forward. Our goal is to help you get more yield without simply taking on a lot of credit or duration risk.

Of these four ideas, you can certainly do #1 on your own. For #2 through #4, though, I think you will want to work with a financial professional. If you’d like to learn about individual municipal bonds, fixed annuities, or Preferred Stocks, please give me a call.

The High Yield Trap

The High Yield Trap

Opportunities for a Low Yield World PART 1

Everyone wants their investments to make more money, but we have to be careful to avoid the High Yield Trap. Since the Coronavirus Crash, central banks have been lowering interest rates to near zero. Last year, I was buying CDs at 2-3%. This week, I’m looking at the same CDs with yields of 0.1% to 0.2%. To which, my client innocently asks: What can we buy that will make more than a couple of percent with low risk?

Nothing, today. The five-year Treasury Bond currently yields 0.22%. That’s unacceptable for most investors, and it will push them out of safe fixed income, like Treasuries, CDs, and high quality municipal and corporate bonds. The yields are just too darn low.

Where will they go in pursuit of higher yields? Oh, there are plenty of bonds and bond funds with higher yields today. Credit quality has been plunging, as rating agencies are trying to keep up with downgrading firms that are being devastated by the shutdown or low commodity prices. In fact, through June 16, $88 Billion in BBB-rated bonds were downgraded to Junk Bond status this year. Each downgrade causes selling, which lowers the price of the bond, and the yield goes up (at least for new buyers).

Why It’s Called Junk

Before you get too excited, there are reasons to be concerned about buying lower grade bonds. In an average year, 2% of BB bonds and 4% of single-B rated bonds will default. That’s why high yield bonds are called junk bonds.

When those companies file for bankruptcy, the bond holders won’t be getting paid back their full principal. They will have to wait for a bankruptcy court to approve a restructuring plan or to dissolve the company. According to Moody’s, the median recovery is only 24 cents on the dollar when a bond defaults.

And while a 2-4% default rate might not sound too bad, that’s in an average year. In a crisis, that might rise to 8-10% defaults. In 2009, global high yield bonds had a 13% default rate in that year alone. These are historical rates, and it could be worse than that in the future. Additionally, the possibility of default increases as a company gets downgraded. If your BB-rated bond gets cut to CCC-rated, the chance of default is now a lot higher than 2%. And the price will probably go down, which creates a difficult choice. Do you sell for a loss or hold on hoping that the company can pay off your bond?

Here in Dallas, we are seeing a lot of companies go bankrupt, pushed over the edge by the Coronavirus. Big names like J.C. Penney, Neiman Marcus, Pier One, Chuck E. Cheese, Bar Louie, and others have filed for bankruptcy in 2020. Most of these companies were issuers of high yield bonds and had a lot of debt. When they got into trouble, they could not keep up with their debt payments and had to fold. Expect more retailers, oil companies, and restaurants to go under before the end of 2020. Bond holders in those companies could lose a lot. (In all fairness, stock holders will do even worse. There is usually zero recovery for stock holders in bankruptcy.)

Funds versus Individual Bonds

If you are investing in a high yield bond fund, you may own hundreds or thousands of bonds. The fund may have a 7 percent yield, but don’t get too excited. A high yield fund is not a CD. You are not guaranteed to get your principal back. It’s likely (even more likely in the current crisis), that your return will get dinged by 2-4% in defaults and losses due to credit downgrades.

If you own individual high yield bonds, it can be even more precarious. Either the bond defaults or it doesn’t. Having the potential for an 75% loss, while earning an average 5-7% annual yield, is dangerous game. Everything is fine until you have a default. A single loss can wipe out years of interest payments. That’s why I generally don’t want to buy individual high yield bonds for my clients.

The quoted yield of 5-7% for high yield bonds does not reflect that some of those bonds will default. If you consider a 2-4% default rate, your net return might be more like 3-5%. That’s the High Yield Trap. Your actual returns often fall short of the quoted yield.

High Yield bonds are issued by companies. Stocks are companies. If companies do poorly – really poorly – both the stocks and bonds can get walloped at the same time. That’s the opposite of diversification. We want bonds to hold up well when our stocks are doing poorly. In finance jargon, we would say that there is a high correlation between high yield bonds and stocks. We want a low correlation.

Instead of High Yield?

What I would suggest, if suitable for an investor, would be a 5-year fixed annuity at 3% today. That would give you a guaranteed rate of return and a guaranteed return of your principal. That’s not super exciting, but it’s what investors need from fixed income: stability and dependable income. Don’t buy bonds for speculation. And above all else, Bonds should avoid the possibility of massive losses.

Be wary of the High Yield Trap. The yields appear attractive in today’s super low interest rate environment. But let’s be careful and not take unnecessary high risks. All bonds are not created equal. When you reach for yield, you are taking on more risk. Defaults have the potential to drag down your performance in a fund. In individual bonds, they could almost wipe out your original investment.

High Yield bonds are not inherently bad. If you bought at the bottom in 2009, they recovered very well. But I am very concerned that today’s yields are actually not high enough to compensate for the potential risk of defaults. We’ve already started to see corporate bankruptcies in 2020 and it’s possible we will have above average defaults in the near future. Until we have a real fire sale in high yield bonds, I’d rather stay away.

We will discuss ways of improving your yield next week. Yes, it’s a low interest rate world, but there are ways we can incrementally improve your portfolio while maintaining good credit quality. We will also discuss financial planning strategies for low rates in an upcoming post. If you’d like a free evaluation of your portfolio, to better understand your risks, please send me a message for an online meeting.

Have stocks risen too fast?

Have Stocks Risen Too Fast?

Many investors today are asking, Have stocks risen too fast? We’ve had a terrific rebound off the lows of March and US stock indices are largely back in positive territory for the year. It has been quite a roller-coaster ride.

Unfortunately, uncertainty about Coronavirus remains high. We have neither a cure nor do we have the contagion under control in the US. The economic fallout from unemployment, consumer spending, and falling corporate profits remains unknown. It’s easy to make a case that the stock market has gotten ahead of itself and is being too optimistic.

That could be the case. But we shouldn’t be surprised that stocks are up. The stock market is a leading economic indicator. Traders are betting on things that they expect to happen, not waiting to respond to things that have already happened. Yes, the market is pricing in things improving. And if the market is wrong, stocks could respond negatively.

What should investors do? Run for cover? Buy gold and guns? No, I don’t think we should attempt to time the market. Trades based on what we think might happen in the next 12 or 24 months are not likely to add any value, in my opinion.

While our approach is focused on long-term results, I do not think investors should be complacent today. There are steps we are taking, without trying to bet on the short-term direction of stocks. Here are six strategies:

Stock Strategies for Today

  1. Rebalance. When there’s a big move in the market, up or down, rebalance to your original allocation. This creates a process to buy low and sell high.
  2. Re-examine your risk profile. Did the March collapse make you realize that your portfolio is too aggressive? If so, let’s take a closer look at your overall risk profile. This shouldn’t be guesswork. We use FinaMetrica, a leading Psychometric evaluation tool, to measure each client’s risk tolerance. If you should be less aggressive, now is a good time to make trades. Not when there is panic like March.
  3. Consider your return requirement. Two people could have the same risk tolerance. But if one has $100,000 and the other has $2 million, it is possible that they need different returns to meet their goals. One might need growth and the other might favor more stability and income. You only need to get rich once.
  4. Add alternative sources of return. The more we can diversify your portfolio, the better. Investments that have a lower correlation to stocks and less volatility can help create a smoother overall performance. That’s why we have taken the time to educate our clients about investments such as Preferred Stocks and Convertible Bonds.
  5. Look to lagging parts of the stock market. US Large Cap Growth is leading the rebound since March. Other areas are not yet back to even. For example, international stocks, or US Mid Cap Value. Today, some parts of the market are more expensive than others. If all you are doing is buying the best recent performers, you are looking in the rear view mirror. Instead, look at the fundamentals. Which stocks are less expensive today and a better relative value going forward?
  6. Lower your expense ratio. If your expected return on stocks is less today, a lower expense ratio will help you keep more of the market’s returns. That’s a big advantage of Index Funds. But we also like actively managed funds from companies like Vanguard, who recognize the importance of low costs.

Fixed Income

As you are worrying if stocks have risen too fast, don’t neglect your fixed income. Yields are way down in 2020. The good news is that the price of bonds has risen, which has helped your portfolio. Now, the problem is that people aren’t looking at the current yields. Money markets are yielding 0.01%. The five year Treasury Bond was at 0.22% this week. Your Investment Grade bond fund may be at 1.25% or less.

What worked in fixed income over the last 1-2 years is unlikely to produce much return going forward. We have ideas to upgrade the yields on your fixed income – from cash to intermediate bonds – while maintaining your credit quality and risk. That won’t have any impact on what stocks do, but your fixed income can create safety and income that gives you a smoother portfolio result.

The fact is that no one knows if stocks have risen too fast. It’s unknowable. We should resist the temptation to try to time the market today. We prefer to focus on what we can control: our asset allocation, good diversification, implementing portfolio alternatives, and keeping expenses and taxes low.

2020 RMDs

2020 RMDs Fixed

At the end of March, the CARES Act waived 2020 RMDs (Required Minimum Distributions) from retirement accounts. This will help people who do not need to take distributions. They can leave their IRAs alone and not be forced to take a taxable withdrawal while the market is down.

Unfortunately, this change created a couple of problems. People could have started their 2020 RMDs as early as January 1, but the waiver didn’t occur until late March. Some people set up monthly distributions from their IRA, but can only put back one, due to the rules regarding 60-Day Rollovers. Later, the IRS said that if you took a withdrawal between February 1 and May 15, you could put it back before July 31. But that left out people who took RMDs in January.

This week, the IRS corrected both of those situations with IRS Notice 2020-51. The ruling will provide relief for anyone who wants to put back their RMDs taken after January 1. You have until August 31 to roll them back into your IRA. Also, if you took multiple withdrawals, you can put them all back. That’s because this one-time rollover is not going to be considered a 60-Day Rollover. (You con only do ONE 60-day rollover in a 365 day period.)

Also, Inherited IRAs (Stretch or Beneficiary IRAs) were never allowed to do 60-day rollovers. Under this week’s ruling, if you had taken your RMD from an Inherited IRA, you can put now return the money to the account through August 31. Unprecedented!

As a reminder, the age for RMDs increased to 72, from 70 1/2, last year. It’s good that the IRS has provided relief from the quagmire Congress created with CARES Act changes in March. So, if you don’t want to take an RMD, you don’t have to. And now you can reverse your RMDs if you had already started.

Planning Opportunities

Currently, tax rates are low, but the Federal rates are supposed to sunset after 2025. So, if you have a choice between paying some taxes now at 12% or 22% that might be better than paying 15%, 25%, or more down the road. Also, if you anticipate needing to take more than your RMD next year, you might be better off spreading that amount over 2020 and 2021, if it will keep you in a lower marginal tax bracket.

Another opportunity afforded by the 2020 RMD waiver is to do a Roth Conversion. If you had planned to pay the taxes on a $50,000 RMD, you could do a $50,000 Roth Conversion instead. Once in the Roth, your $50,000 is growing tax-free with no future RMDs. You paid some taxes at today’s lower rates, and reduced your future RMDs by doing a conversion in 2020.

A Roth Conversion does not count towards your RMD amount. So for people over 72, most never want to do a conversion because they are already paying a lot in taxes on their RMD. It’s best to do conversions after you retire – and are in a low bracket – but before you start RMDs. For people who missed that window, 2020 is the year to do a Roth Conversion.

Retirement Income Expertise

Creating tax-efficient retirement income is our mission and passion. If you want professional advice on establishing your retirement income plan, we can help. Here’s how:

  • We stay informed. Rules regarding your IRAs and 401(k) accounts have actually seen significant changes in the past couple of years.
  • Tools, not guesses. We analyze the likelihood of success of your retirement income plan through MoneyGuidePro. You will create a baseline scenario, which we will monitor and adjust based on market changes.
  • Asset location. Improving tax-efficiency through placing investments which generate ordinary income into tax-deferred accounts, and keeping long-term capital gains and qualified dividends in taxable accounts. Research and select more tax-efficient investment vehicles.
  • Sequence of Withdrawals. Determine the optimal order of withdrawals by account type and asset. Evaluate when you begin Pension payments and Social Security.

I suspect that there are not a lot of my readers who need to put back RMDs from January and are impacted by Notice 2020-51. But, I do have clients in this exact situation, and this type of detailed work is how I can add value to your financial life. Whether you are already retired, soon to be retired, or it’s just a dream at this point, we can create a plan to take you through the steps you need to feel comfortable about retirement.