Market Return in Election Years + Financial Market Update + 9.22.20

Market Return in Election Years + Financial Market Update + 9.22.20

FINANCIAL MARKET UPDATE 9.22.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

MARKET RETURN IN ELECTION YEARS

With the first Presidential debate one week away, the focus on the election is likely to intensify. Many investors are concerned about the potential impact on their portfolio, and the financial media knows exactly how to capitalize on this fear. There will be an endless wave of articles warning of grave risks, attempting to predict the future, and providing the exact way to position for it. The responsible stewardship of your life savings is not their objective. The goal of these articles is to attract eyeballs and generate advertising revenue. Be warned.

A few weeks ago, we discussed how the market has performed based on which political party was in power (Read the Article). Contrary to conventional wisdom, there is no discernable pattern between the two. This week we will view the same topic through a different lens. What if the true investment risk lies not in the election outcome, but instead resides within the uncertainty during the lead-up? This would explain investors’ common desire to refrain from investing in new capital or to lower portfolio risk ahead of time. Vanguard recently published some data that illustrates the efficacy of these strategies. The chart below shows the average return during election years versus the average in all others. With data going back to 1860, election years have returned 8.9% on average, exceeding the non-election year average of 8.1%. The implication here is that investors have historically paid a high price in terms of opportunity cost to sit on the sidelines and wait for the dust to settle.

If the volatility that investors must endure around elections to earn a reasonable return is much higher than usual, there would be some justification for de-risking. A second chart produced by Vanguard (below) takes a look at this. As you can see, the months before and after an election have actually been a little less volatile than the long-term norm. Despite the headlines, there is little evidence that election battles have a meaningful impact on the market.

Of course, just because returns have been high and volatility low on average around elections, does not mean it will be the case this time. As the first chart illustrates, there have been episodes with negative returns in the past, and clearly, 2020 is no stranger to high volatility. Still, with as anxious as many investors get about their portfolios around election time, it is surprising to see how benign these periods have been historically. Ultimately, there is almost always going to be an election or some other transitory event that people are fixated on. The key to investment success is being patient and focusing on the long-term. Stay diversified and tune out the noise.

WEEK IN REVIEW

  • Last Wednesday, the Federal Reserve announced its updated monetary policy stance, leaving its benchmark interest rate unchanged at 0-0.25% (as expected). In addition, the committee updated its economic projections for the coming year(s), expanding its forecast horizon through 2023. The median projection for the benchmark federal funds rate is unchanged at 0-0.25% through 2023, affirming the Fed’s previous indications that they will keep interest rates low for an extended period. The median forecast for 2020 GDP growth increased from -6.5% to -3.7%, although growth in subsequent years was revised lower. Inflation forecasts were increased, although inflation is not expected to achieve 2.0% until 2023. Finally, the forecast for unemployment was revised lower for 2020 and in subsequent years.
  • Data reported last week showed U.S. consumer spending slowed in August. Core retail sales, which exclude automobiles, gasoline, building materials, and food services, declined by 0.1% in August and were revised lower in July. According to CNBC, economists estimate that the reduction in extra unemployment benefits from $600 to $300 in July equated to a loss of income of $70 billion for the month, and may have weighed on spending.
  • Highlights for the remainder of this week include an assortment of Fed speakers, including multiple rounds of congressional testimony from Chairman Powell. Additionally, we will get an update on jobless claims Thursday, and durable goods orders data on Friday (which includes a proxy for business investment used in the calculation of GDP).

HOT READS

Markets

  • U.S. Consumer Spending Appears to Slow In August (CNBC)
  • Jobless Claims Were Lower than Expected, but Employment Growth is Still Sluggish (CNBC)
  • Head of Nikola, A G.M. Electric Truck Partner, Quits Amid Fraud Claims (NYT)

Investing

  • Some Investors Tried to Win by Losing Less. They Lost Anyway (Jason Zweig)
  • Negativity is Not an Investment Strategy (Ben Carlson)

Other

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

September Retirement Plan Newsletter 2020

September Retirement Plan Newsletter 2020

 

LUTZ BUSINESS INSIGHTS

 

PUBLISHED: SEPTEMBER 22, 2020

SEPTEMBER RETIREMENT PLAN NEWSLETTER

GOOD NEWS 401(K)

 T. Rowe Price did a deep dive into its recordkeeping data and surfaced with a few important points.

Its “Reference Point Report is an annual client data benchmarking report so plan sponsors can review trends and benchmark their progress and participant behavior across the firm’s client base… ‘We continue to see the importance and significant impact plan design and financial wellness programs have on keeping participants on track with their financial priorities’ by John Sullivan, Editor-In-Chief “

  • Plan participation was greater than 79%
  • Over 61% of plans at Rowe Price automatically enroll participants, with 37% enrolling at a 6% default deferral
  • Average account balances rose to over $100,000, an increase of 8%, although over 34% of eligible participants did not contribute to their plans in 2019
  • Employers are increasing match formulas from 3% to a 4% to 5% effective match rage
  • Direct rollovers of plan assets increased to 76% in 2019 from 74% in 2018
  • Lower rates for cash-out distributions and loans
  • Participant usage of loans decreased in 2019 to 22.1%, down from the seven-year high of 24.9% in 2013, but the optional loan provisions included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act could change that trend
  • Allocations to company stock investments increased more than 11%

For more information on 401(k) participant behavior and plan design trends, see the article in 401k Specialist.

MORE GOOD NEWS

Scoring the Progress of Retirement Savers, a recent report by Empower, shows that the median projected income replacement among participants in our study was 64%. In other words, Americans are on track to replace 64% of their current income in retirement.

“Plan sponsors can take several steps to help facilitate savings within a plan. The first is automatic enrollment. We find an 11-point difference in median income replacement percentages between participants who enrolled automatically versus those who opted into the plan. The difference may reflect an important benefit of auto-enrollment: Many participants begin saving earlier in their tenure, because enrollment begins as soon as they are eligible.

A second feature that correlates with higher median income replacement is auto-escalation. Our survey found that people who participate in a plan with this feature achieve a median retirement income replacement of 107%, a full 27 percentage points higher than participants in plans without it.”

For more information, read Empower’s report on Scoring the Progress of Retirement Savers.

HAVE YOU EVER CONSIDERED OFFERING A PHASED RETIREMENT PROGRAM?

Phased retirement includes a range of flexible retirement approaches that would allow employees approaching normal retirement age the option to reduce the hours worked while phasing into complete retirement.

For employees, phased retirement may be seen as a benefit by many older workers. It allows them to gradually ease into retirement while maintaining a higher income than they would receive if they quit work entirely. It could also help employees prepare for greater retirement readiness.

“Changes in Social Security have made it easier for recipients to continue working after reaching full retirement age without losing their benefits; Americans are living longer, which means that retirees will need greater financial resources to support themselves. In 2020, the IRS allows for $18,240 of income per individual before affecting social security benefits (before reaching full retirement age).”* For employers, phased retirement programs can be used to retain skilled older employees who would otherwise retire.

Employers can benefit from tenured employees knowledge and experience while reducing employer payroll and benefits costs. These employees may want to continue to make a meaningful contribution to your company, while working reduced hours. This concept may involve employees working remotely. During the Covid-19 pandemic, many workers are already becoming comfortable working remotely, and employers in some industries may derive continued benefits of a partially remote workforce.

Employers will likely be surprised at the number of workers willing to accept reduced hours or a lighter workload. A recent study from the Transamerica Center for Retirement Studies* found “that nearly three- quarters of employers polled at 1,800 companies of all sizes reported that many of their employees expect to work past age 65 or do not plan to retire at all. In addition, 43% of working baby boomers are already contemplating a phased retirement. While 4 out of 5 companies surveyed said they plan to support senior employees who want to continue working, just 4 in 10 of the firms currently offer flexible retirement schedules.”*

Working with retirement plan providers and benefit advisers can also help employees smoothly transition out of the workforce. They can consider the plan’s distribution options, financial planning opportunities and individual financial consulting, where appropriate, on how to make savings last.

For more information on this topic, read Transamerica Center’s 17th Annual Retirement Survey.

ARE YOU HEARING ABOUT FINANCIAL WELLNESS?

Employers have heard a lot about financial wellness. However, employers don’t always recognize the connection between financial wellness and improved retirement savings behavior as well as a more productive workforce overall. All employees, no matter what generation they belong to, want to work in a friendly environment where they don’t have to stress about their job. In particular, when it comes to finances. People tend to change jobs more often for one simple reason – money. As a result, companies experience a higher turnover rate and need to take extra efforts to provide their employees with stable and well-paid jobs. Because a happy employee is a productive employee.

A financial wellness program can improve employee productivity, increase employee satisfaction, reduce absenteeism and even help cut down on stress related health care claims. Comprehensive financial wellness programs reduce the disruptions in the employee’s day from concerns over debt, collection calls, missed payments and poor credit scores. Surveys regularly show that finances are the leading cause of stress for Americans, above family obligations, health, and even work. An employee who is financially prepared for expected and unexpected eventualities will exhibit greater engagement at work with less to worry about in their finances.

Financial wellness programs helps employers realize the value of a workforce that is prepared for a successful and secure retirement. With a focus on employee engagement, the best of these platforms offer financial well-being resources that provide a foundation for goal setting, as well as educational material to enhance understanding of retirement planning strategies. With the best financial wellness tools, all employees – regardless of compensation or savings level – should also have access to financial planning support to assist them in achieving their retirement goals.

It is worth looking into a financial wellness program with your advisor, to provide stability to employees. Employees will feel appreciated and motivated. That will translate into higher productivity and better results. Perhaps today is the day to start an internal discussion about how a financial wellness program might support a healthy, focused workforce and the role it can play in affecting your organization’s bottom line.

Speak with your financial professional regarding the best programs that are available!

PARTICIPANT CORNER: FOUR TIPS FOR INCREASING YOUR RETIREMENT DOLLARS

Don’t Cash Out Retirement Plans When Changing Employment

When you leave a job, the vested benefits in your retirement plan are an enticing source of money. It may be difficult to resist the urge to take that money as cash, particularly if retirement is many years away. If you do decide to cash out, understand that you will very likely be required to pay federal income taxes, state income taxes, and a 10 percent penalty if under age 59½. This can cut into your investments significantly and negatively impact your retirement savings goals! In California, for example, with an estimated 8 percent state income tax, someone in the 28 percent federal tax bracket would lose 46 percent of the amount withdrawn. When changing jobs, you generally have three options to keep your retirement money invested – you can leave the money in your previous employer’s plan, roll it over into an IRA, or transfer the money to your new employer’s plan.

Take Your Time: Give Your Money More Time to Accumulate

When you give your money more time to accumulate, the earnings on your investments, and the annual compounding of those earnings can make a big difference in your final return. Consider a hypothetical investor named Chris who saved $2,000 per year for a little over eight years. Continuing to grow at 8 percent for the next 31 years, the value of the account grew to $279,781. Contrast that example with Pat, who put off saving for retirement for eight years, began to save a little in the ninth and religiously saved $2,000 per year for the next 31 years. He also earned 8 percent on his savings throughout. What is Pat’s account value at the end of 40 years? Pat ended up with the same $279,781 that Chris had accumulated, but Pat invested $63,138 to get there and Chris invested only $16,862!

Don’t Rely on Other Income Sources, and Don’t Count on Social Security

While politicians may talk about Social Security being protected, for anyone 50 or under it’s likely that the program will be different from its current form by the time you retire. According to the Social Security Administration, Social Security benefits represent about 34 percent of income for Americans over the age of 65. The remaining income comes predominately from pensions and investments. They also state that by 2035, the number of Americans 65 and older will increase from approximately 48 million today to over 79 million. While the dollars-and-cents result of this growth is hard to determine, it is clear that investing for retirement is a prudent course of action.

Consider Hiring a Financial Professional!

Historically, investors with a financial professional have tended to “stay the course”, employing a long- term investment strategy and avoiding overreaction to short-term market fluctuations. A financial professional also can help you determine your risk tolerance and assist you in selecting the investments that suit your financial needs at every stage of your life.

For more information on retirement tips, contact your financial professional.

DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial (“Lutz”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a Lutz client, please remember to contact Lutz, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Lutz shall continue to rely on the accuracy of information that you have provided.

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Market Return in Election Years + Financial Market Update + 9.22.20

Correction in Growth Stocks + Financial Market Update + 9.15.20

FINANCIAL MARKET UPDATE 9.15.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

CORRECTION IN GROWTH STOCKS

After a blistering summer rally, the high-flying growth stocks of the Nasdaq 100 hit a wall in early September. In just three trading days, the index saw its value drop by more than 10%, exceeding a threshold for what defines a “market correction.” Corrections are a healthy part of the normal ebb and flow of the stock market and help clear away some of the excesses that build up when the market runs too far too fast.

High-growth companies, including many firms in the technology sector, have led the rally following the steep sell-off earlier this year. Intuitively this makes sense. While the response to the coronavirus outbreak continues to wreak havoc on various industries, it has been a tailwind for others. This includes the technology that has enabled the shift to remote work. I don’t believe I had ever heard of Zoom prior to 2020, but even as I wrote this, I had to pause and hop on one of the many Zoom calls I have scheduled this week.

The strong stock performance of high-growth companies may have been justified early in the rally, given their relatively strong operating results. More recently, however, the gains seem to have gone too far. As more investors have piled in to chase high returns, prices have moved beyond reasonable levels. This has been exacerbated by the expanded use of options by both retail and institutional investors to make leveraged bets on continued gains. 

The chart below illustrates a composite of valuation ratios for large-cap growth companies relative to the U.S. stock market as a whole. The key takeaway is that while large-growth companies have enjoyed relatively good operating results, it is not enough to justify the sky-high prices investors must now pay to own them. This is evident by the fact that valuation ratios are rising, which is a consequence of the price gains outpacing the fundamentals. Simply put, prices are rising because investors are willing to pay more of a premium for growth than usual. When valuations become this stretched, it typically does not take much for prices to correct back to normal levels, which is what we have just witnessed.

Source: Morningstar Direct, data through 8/31/2020. The relative measure compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Growth index relative to the Russell 3000.

The opposite is currently true for value companies. These firms typically trade at a discount relative to the stock market as a whole, but that discount is currently significantly larger than normal. The discount effectively prices in the fact that some of these businesses were likely adversely affected by the pandemic. Even small improvements to the outlook for these companies could justify a rise in prices to move valuation ratios to more normal levels.

Source: Morningstar Direct, data through 8/31/2020. The relative measure compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Value index relative to the Russell 3000.

The valuation gap between growth and value stocks remains large and would require more than a 10% drop to normalize. This is particularly true given value stocks sold off in early September as well, just not as severely as growth. It’s possible the correction will signify a change in market leadership, but market imbalances can persist for extended periods. Value investors should be prepared for continued growth out-performance.

WEEK IN REVIEW

  • On Wednesday, the Federal Reserve will conclude its meeting of the Federal Open Market Committee (FOMC). The Fed is not expected to move rates from near zero. They will provide an updated “Dot Plot”, which illustrates the economic projections of the committee, as well as the expected future path of the Federal Funds rate. The market pays significant attention to the Dot Plot, particularly when investors anticipate a potential change in the policy rate (which is not currently the case). Finally, investors will look for details on how the Fed plans to implement its new “average inflation” policy framework, as well as any updates to the current bond buying program.   
  • Data released last Friday showed that inflation accelerated by a small amount in August, but remains below the Federal Reserve’s 2% target. The headline figure increased from 1.0% to 1.3% YoY, while the core CPI (which strips out the volatile food and energy components) increased from 1.6% to 1.7%. Prices for used automobiles were the largest contributor to the increase. As long as inflation remains low, the Federal Reserve has little reason to do anything to tighten monetary conditions.
  • Important events in the week ahead include the FOMC’s policy announcement Wednesday at 1 CT (followed by a post-meeting press conference on Yahoo Finance shortly after). Additionally, the August retail sales figure will be published Wednesday morning and updated jobless claims data on Thursday.

HOT READS

Markets

  • ‘Real’ Bond Yields Help Explain Surprising Market Moves (WSJ)
  • The Wildly Popular Trades Behind The Market’s Swoon and Surge (WSJ)

Investing

  • Are You an Investor or a Gambler? The Stock Market Knows (Zweig)
  • Republicans or Democrats: Who is Better for the Economy? (CFAi)

Other

  • You Have a Million Tabs Open. Here’s How to Manage Them (Wired)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

 

LUTZ BUSINESS INSIGHTS

 

Why High Net-Worth Families Should Review Their Estate Plans Pre-Election

why high net-worth families should review their estate plans pre-election

joe hefflinger, DIRECTOR & INVESTMENT adviser

 

Election day is fast approaching, and with it comes the potential for sweeping changes in our political landscape. While nobody can predict the outcome, those with a high net-worth (in this case, I’m referring to a net worth approaching $20 million) would be wise to start evaluating their current estate plans now.

2020 could be looked at in hindsight as the end of a golden era in estate planning. We have witnessed asset values depressed due to the impact of COVID, historically low interest rates, historically high estate and gift exemptions, and certain key estate planning techniques that are still viable. These all combine to create an ideal environment for the transfer of wealth to future generations in an extremely tax-favorable manner.

A change in our political climate, coupled with our country’s deteriorating fiscal position, could potentially change the estate tax laws. So, there is no time like the present to be considering all your options. And for those of you who may be hesitant about gifting assets now, know that some of these options may allow you to preserve some level of access to the assets you would be gifting.

 

The Estate & Gift Tax Laws – a Refresher on Where we are Now and Where We’ve Been

Currently, the federal estate and gift tax laws in our country work in tandem, which means you have a certain dollar amount which you can transfer to your heirs either while alive or at your passing, tax-free. The exemption amount in 2020 is $11.58 million per individual. This is effectively $23.16 million for married couples as portability allows a surviving spouse to use a deceased spouse’s unused exemption.

You are free to gift away assets up to the exemption amount during your lifetime with no gift tax owed. Still, every dollar you gift away during life has the corresponding effect of decreasing the amount of assets you can leave to your heirs at death estate-tax free, dollar for dollar. An important caveat to this is any gifts you make pursuant to the annual gift exclusion amount (currently $15,000 per individual, or $30,000 per couple, to any number of different beneficiaries per year) doesn’t count towards your lifetime gift exemption.

For any assets that become subject to federal gift or estate tax, the current tax rate is 40%.  This is down from 55% as recently as 2001. Without getting too deep, in addition to the estate and gift tax there is also a generation-skipping transfer (GST) tax that is levied when transfers are made to someone two or more generations below (e.g., to grandkids or below). Right now, the GST exemption levels and tax rate mirror those already discussed for the estate and gift tax.

You may be saying to yourself, “that seems like a really big exemption amount,” and you’d be right! To put how favorable the current exemption levels are in historical context, check out the following chart.

As you can see, going back to 2001, exemption amounts used to be substantially smaller, and the tax rates used to be higher. Note that the exemption levels doubled in 2018 pursuant to the Tax Cuts and Jobs Act of 2017, but also understand that these higher levels are scheduled to “sunset” in 2026. At this time, they will automatically revert back to their prior levels (adjusted for inflation; this is estimated to be around $6.5 million). However, if Congress and the President agree to change them, these exemption reductions could be much larger and could happen much sooner.

 

What a Biden Presidency / Democratic Controlled Congress Could Mean

It’s not my place to speak to the merits or validity of either political party’s policies, whether that’s in regard to tax rates, estate laws, or anything else. You don’t come to your financial advisor for political commentary, and I have no desire to provide any. That being said, as an advisor, it is my job to help clients understand what changes may be coming if the political climate turns and how they could be impacted personally. Note that it’s possible the following changes (if they occur) could be made retroactive to January 1, 2021.

Decrease in the Estate/GST and Gift Tax Exemption

Joe Biden has previously indicated that the exemption for estate and GST could be lowered to pre-Obama levels, which could be as low as $3.5 million per individual, with a gift exemption as low as $1 million (see 2009 in the chart above).

Increase in the Estate and Gift (and Capital gains) Tax Rates

It’s also possible we could see an increase in the estate and gift tax rates, which currently sit at 40%. It’s unclear at this point what that means, but a return to the 45-55% range we’ve seen in the past 10-20 years is possible. While we’re talking about tax rates, Biden has also suggested raising the rate on long-term capital gains to the rate imposed on ordinary income (at least for those with higher incomes, e.g., $1 million or more).

Change in the Basis Rules at Death

Under current law, your heirs will typically receive any assets you leave them upon your death with a “stepped-up basis,” meaning they get to hold those assets with a basis equal to their fair market value on the date of your death. At various times, Biden has floated the idea of eliminating the basis step up at death (meaning heirs would take a lower carryover basis instead) or alternatively the realization of capital gains at death (meaning the deceased individual’s estate would owe capital gains tax on appreciated assets at death). This could obviously be a big deal for your heirs if you hold assets with a large amount of appreciation.

Restrictions on Favorable Estate Planning Techniques

Based on recent Democratic proposals over the past few years, there is also speculation that they could seek to limit the use of valuation discounts and grantor retained annuity trusts (GRATs). It’s currently common when transferring an interest in a closely held business for estate purposes to discount the value based on a lack of control and a lack of marketability (which has the potential effect of increasing the amount of assets you can transfer estate and gift tax free). Similarly, GRATs are currently a popular estate tool and are used to potentially transfer the future appreciation of an asset free of estate and gift tax.

Note that regardless of the outcome of the upcoming election, the fiscal strain caused by COVID could itself be the catalyst for our elected officials to revisit the estate landscape as a source of additional revenue in a time when it may be sorely needed.

 

Estate Moves High Net-Worth Families Could Consider Before Year-End

Given the potential estate law changes that could be made effective as soon as the start of 2021, what estate updates should high net-worth families be considering now? Here are a few to consider:

Outright Gifts

If the estate and gift exemptions are reduced next year, you could miss out on a great opportunity to pass a large amount of wealth free of tax. To lock in the use of the current larger exemption this year, you’d need to be in a position to have at least one spouse transfer upwards of $11 million out of their estate. These types of outright gifts are commonly made to irrevocable trusts for the future benefit of your children and/or grandchildren. Treasury Regulations from 2019 indicate that transfers covered under an individual’s exemption in the year of transfer can’t be “clawed back” later at their death if the exemption has subsequently been reduced.

SLATs

If the thought of transferring that amount of wealth outright this year makes you uneasy (and it probably does), talk to your estate attorney about a spousal limited access trust (SLAT). If structured correctly, SLATs can potentially allow for trust distributions of the transferred assets back to the transferor’s spouse during their lifetime. You wouldn’t go down this route if you expected to need the funds again in the future. But if there is some type of unexpected financial hardship down the road, it can be comforting to know that you have the ability to access the funds again (indirectly through your spouse) if needed.  Obviously, the possibility of a future divorce or the premature death of the spouse beneficiary needs to be considered.

Estate “Freeze” Techniques

If you aren’t comfortable making a large outright gift, an estate freeze may be a better fit for you. A freeze transaction has the net effect of removing the future appreciation of an asset (above a predefined “hurdle” rate established by the government) from your estate. There are several different structures to accomplish this, some of which involve transferring assets to a trust in exchange for a promissory note equal to the fair market value of the assets sold. The transfer to the trust can be structured as either a sale or a gift, depending on whether you want to use up some exemption (and if so, how much).

The use of a promissory note can provide added flexibility. If the potential estate law changes discussed above seem more certain at a later date, it may be possible to “forgive” the note, which would then be treated as a completed gift that would use up some exemption. On the other hand, if you later decide you don’t want to part with the asset, the trust may be able to pay back the note “in kind” by transferring the asset back to you.

Two of the more common freeze structures are intentionally defective grantor trusts (IDGTs) and GRATs (referenced above). Your estate attorney can highlight the key differences between each and which might be a better fit for your situation. Both IDGTs and GRATs can be powerful tools under current law, especially in our low interest rate environment, when the hurdle rate that the transferred asset has to beat is so low. These tools can also be leveraged even further if you have an asset to transfer whose value can be discounted when transferring for estate purposes (as discussed above). However, keep in mind that future estate law changes could impact the ability to use both discounts and GRATs.

 

Start the Planning Process Now

So, what does all of this mean to you? If your personal balance sheet is approaching the $20 million range, it means you should at least be reaching out to your estate attorney and other advisors now to discuss what impact these potential changes could have on your personal planning. If you are uncertain about what amount of assets you can transfer and still have enough left over to live on comfortably, we at Lutz Financial can do a cash flow analysis to help you better answer that question.

From a timing perspective, keep in mind that high-level estate planning of this nature usually takes some time to complete (and your attorney will likely get harder to book as year-end approaches). If appraisals may be needed, those take time as well, as can applying for a federal tax identification number for a newly formed trust. Also, consider that it’s entirely possible that we may not know the results of the presidential election (and other key congressional races) for some period of time after election night. So, waiting to start this discussion until after the election may not allow enough time to get it done before year-end. Whether you ultimately decide to make any estate updates before year-end or not, it’s essential that you at least talk to your advisors and understand your options.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.

ABOUT THE AUTHOR

402.827.2300

jhefflinger@lutzfinancial.com

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JOE HEFFLINGER, JD, CFP®, CAP® + DIRECTOR & INVESTMENT ADVISER

Joe Hefflinger is an Investment Adviser and Director at Lutz Financial. With 15+ years of relevant experience, he specializes in comprehensive financial planning and investment advisory services for professionals, business owners, and retirees. He lives in Omaha, NE, with his wife Kim, and daughters Lily and Jolie.

AREAS OF FOCUS
  • Retirement Cash Flow Planning
  • Insurance Planning
  • Estate Planning
  • Business Owner Exit Planning
  • Charitable Planning
  • Tax Planning
AFFILIATIONS AND CREDENTIALS
  • National Association of Personal  Financial Advisors, Member
  • Financial Planning Association, Member
  • Nebraska State Bar Association, Member
  • Omaha Estate Planning Council, Member
  • CERTIFIED FINANCIAL PLANNER™
  • Chartered Advisor in Philanthropy®
EDUCATIONAL BACKGROUND
  • JD, Creighton University School of Law, Omaha, NE
  • BS in Economics, Santa Clara University, Santa Clara, CA
COMMUNITY SERVICE
  • Partnership 4 Kids - Past Board Member
  • Omaha Venture Group, Member
  • Christ the King Sports Club, Member

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Market Return in Election Years + Financial Market Update + 9.22.20

The Election and Your Portfolio + Financial Market Update + 9.1.20

FINANCIAL MARKET UPDATE 9.1.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE ELECTION AND YOUR PORTFOLIO

With the election just months away, many investors are contemplating how the outcome might impact their investments. For many people, politics can elicit strong emotions. Passion, properly channeled, can lead to major achievements in many aspects of life. When it comes to investing, however, emotion often leads to poor choices and can be detrimental to investment performance. 

Whether or not one’s preferred party is in office can dramatically impact their overall outlook. This is especially true in the realm of investing, and it will lead a subset of investors to liquidate their portfolio in anticipation of their candidate(s) losing. The fact that this pattern repeats over each election cycle would suggest this behavior has been rewarded historically. However, the data suggests otherwise. The chart below illustrates the market performance during the various presidential terms going back to the 1920s. There is no apparent relationship between who controls the White House and how the market performs. Each party has seen negative returns, low returns, and high returns. 

While the President has the power to impact the financial market and the real economy, it is just one of many variables that exerts influence. Global trade, interest rates, inflation, the business cycle, economic conditions outside the U.S., market valuations, war, and pandemics can all significantly influence the trajectory of economic growth and asset prices.

The market hates uncertainty, and a potential shift to policies considered less favorable for businesses would likely generate volatility. Similar transitions have occurred many times throughout history. While there has been heartburn as change was initially digested, the market has hardly skipped a beat. Entrepreneurship and innovation have powered the U.S. market forward and will continue to do so. As the chart below illustrates, long-term investors have been rewarded for staying invested regardless of which party has held power. 

Over the next few months, the election is going to dominate the headlines. There will be an endless supply of people trying to predict the future and how to position for it. This is all noise. The best course of action is for investors to separate their politics from their portfolio and focus on their long-term plan. Don’t bet on a Republican win to achieve your financial goals, and don’t bet on the Democrats either. Bet on the millions of small business owners (including many of our readers) and corporate leaders to adapt to any environment and continue to grow. Your portfolio is invested in them, not a political party.

Nearly a century of market history suggests the market will likely be higher in November 2024 than it is today, regardless of who wins the election.

WEEK IN REVIEW

  • August was a strong month for the S&P 500. The index finished up 7.2%, the largest monthly gain since April, and the best August return since 1986. August has historically delivered the lowest return of any month on average.
  • In a speech last week, Fed Chair Jerome Powell laid the foundation for a new approach to achieving its dual mandate of maximum employment and stable inflation. The new approach will focus on targeting 2% inflation on average. Under this framework, periods of sub-2% inflation, similar to what we have been experiencing, would allow the Fed to subsequently tolerate a modest inflation overshoot in its pursuit of full employment.  
  • Economic data published this morning by the Institute of Supply Management (ISM) showed factory output increased in August at the fastest rate since November of 2018. The data showed that manufacturing firms continued to cut employment, however. Other economic data to look for this week include jobless claims and an update on the services sector on Thursday, and the jobs report on Friday.

HOT READS

Markets

  • Individual-Investor Boom Reshapes U.S. Stock Market (WSJ)
  • When the Magic Happens (Morgan Housel)
  • Tesla To Sell Up to $5 Billion in Stock Amid Its Incredible Rally (CNBC)

Investing

  • Warren Buffett and the $300,000 haircut (Zweig)
  • Warren Buffet, at 90, Still Has an Eye for a Bargain (WSJ)

Other

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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Market Return in Election Years + Financial Market Update + 9.22.20

Ignore the Dow + Financial Market Update + 8.25.20

FINANCIAL MARKET UPDATE 8.25.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

IGNORE THE DOW

Late yesterday it was announced that the Dow Jones Industrial Average (Dow) will be undergoing a major facelift. The update was prompted by Apple’s decision to undergo a 4-for-1 stock split, a move that would have materially altered its composition. As a result, the committee that oversees the index elected to make some adjustments to mitigate the impact. This includes dropping Exxon Mobil, Pfizer, and Raytheon technologies, and replacing them with Salesforce, Amgen, and Honeywell. Exxon Mobil had been in the Dow for 92 years. While this news is getting a lot of airtime in the financial media, and I just wasted a paragraph summarizing it, this is not important news.

While the Dow remains popular with many individual investors and is commonly quoted in the media, it is severely outdated and inferior to many other gauges for the U.S. stock market. For this reason, most professional investors focus their attention on indices that are more comprehensive and better designed, such as the Russell 3000 or the CRSP US Total Market Indices. One drawback here is that these indices are not commonly quoted in the media. The S&P 500 offers the next best, albeit imperfect option.      

The Dow was created in 1896 by the editor of the Wall Street Journal and co-founder of Dow Jones & Company, Charles Dow, and his partner Edward Jones. It is the second longest-running market index in the United States, trailing only the Dow Jones Transportation average, which began in 1884. Compared to today, the makeup of the economy was dramatically different in the late 1800s, with railroads and other transport companies comprising roughly 50% of the stock market at one point, hence the development of the transportation index first.

The Dow is vastly inferior to modern indices for a variety of reasons. The most glaring criticism is the method it uses to weight the constituents. Broadly speaking, the two most common approaches weight companies based on price or market capitalization (market cap).

  • Price Weighting: Company weights are determined by the price of an individual share.
  • Market Cap Weighting: Company weights are based on the actual market value, calculated as the share price times the total number of shares outstanding.

The table below provides a hypothetical example to illustrate how the results differ between the two methods. Since Company A has a much larger share price ($90), it gets a correspondingly larger weight than Company B in the price index (90% vs. 10%). Company B, however, has significantly more shares outstanding, and its total market value (10 x 3,600 = $36,000) is approximately double Company A’s. Clearly, the price index is not accurately reflecting the relative size of the two firms.

 

In the late 1800s, weighting by share price was a simple and straightforward way to calculate an index. The advent of computers, however, made the market cap methodology feasible. Not only does market cap do a better job of reflecting the true relative size of index constituents, but it also handles corporate actions like stock splits better. While Apple’s 4-for-1 split has no impact on cap-weighted indices like the S&P 500, it has a profound impact on the Dow. Apple is currently the largest weighted company in the Dow by far but will fall to the 17th position overnight once the announced index changes are made.

Another common criticism of the Dow relates to its high concentration. The U.S. stock market is comprised of thousands of companies. The best representation of how the market is performing would be an index that tracks all of them. Meanwhile, the Dow only tracks thirty firms. Although it is diversified across sectors (excluding transports and utilities), it still omits a meaningful amount of the market, which can lead to dramatic performance differences over time. This critique can (rightfully) be applied to the S&P 500 as well, however, it covers more than 80% of the market and is the most comprehensive gauge among those commonly quoted in the media.   

In today’s world, where crunching numbers and sharing information are extremely easy, there is simply no reason for a back-of-the-napkin approach like the one used by the Dow to garner so much attention. Investors are better served by ignoring the Dow and focusing on other more comprehensive gauges of the market. 

WEEK IN REVIEW

  • The S&P 500 has recently joined the Nasdaq in pushing to new all-time highs in recent days and closed above 3,400 for the first time yesterday.
  • Investor sentiment was buoyed early this week by the FDA’s emergency use authorization of convalescent plasma for the treatment of COVID-19. Positive developments related to the pandemic have consistently boosted stocks higher, particularly those in the hardest-hit segments of the market.
  • Last week initial jobless claims moved above 1 million after briefly declining below that level. Later this week, look for updates on durable/capital goods (Wednesday), initial jobless claims and a revised estimate of Q2 GDP (Thursday), and inflation and a potentially important speech by Fed Chair Powell in Jackson Hole (Friday).

HOT READS

Markets

  • Powell Set to Deliver ‘Profoundly Consequential’ Speech, Changing how the Fed Views Inflation (CNBC)
  • Coronavirus Lifts Government Debt to WWII Levels-Cutting It Won’t Be Easy (WSJ)
  • Home Prices Show Signs of Recovery, Rising 4.3% in June, According to Case-Shiller Index (CNBC)

Investing

  • The Cost of Anticipating Corrections (Swedroe)
  • This Fund Is Up 7,298% in 10 Years. You Don’t Want It. (Zweig)
  • Reasons Not to Be Cheerful (James Montier)

Other

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY