Financial Market Update + 2.18.2020

Financial Market Update + 2.18.2020

FINANCIAL MARKET UPDATE 2.18.2020

STORY OF THE WEEK

THE DOLLAR IS RISING. IS THAT GOOD OR BAD?

The U.S. dollar has been appreciating relative to other currencies, and it is nearing the highest levels since 2017. Currency movements have both direct and indirect impacts on investors. Whether dollar strength helps or hurts is a matter of perspective.

Source: Koyfin.com

For a U.S.-based investor that has diversified their portfolio abroad, dollar strength can be a headwind. An international stock fund, for example, will take investor dollars and convert them into non-U.S. currencies to then invest in foreign stocks. The performance for this type of fund is therefore based on:

  1. The return of the underlying stock(s)
  2. The return of the currency

To say a foreign currency has weakened relative to the dollar, is to say it now purchases fewer dollars. When the international stock fund converts the foreign currencies back, fewer dollars translates as a negative return. The reverse is true when the dollar weakens. When the stronger foreign currency converts back to more dollars, the return impact is positive.   

A less direct consequence can be seen within the performance of individual companies. Domestic companies that export goods and services abroad can be hurt by a stronger dollar. As the dollar appreciates, U.S. exports become more expensive in the global market, which hurts demand and/or makes alternatives from other countries more attractive. This negatively impacts the exporter’s bottom line, and potentially their stock price as well. The reverse is true for importers, who benefit as the stronger dollar lowers their input costs.

Understanding the direct and indirect impact of dollar strength on a portfolio is not always straight forward. What happens if a U.S.-based investor invests in the stock market of another country that is a heavy exporter? On one hand, there is a negative return on the currency, as it converts back into fewer dollars. On the other hand, the exporters may benefit as their products have become cheaper in the global market place. The two factors offset to a degree, but it’s not easy to estimate how much.

Fortunately, it is not imperative to have a complete accounting of how currency movements have impacted past returns, or how things will play out in the future. Large movements in the dollar are very difficult to predict, but they tend to ‘mean revert’ (return to normal) in the long-term. This means the positive and negative impacts on investor portfolios generally wash out over time. For a diversified investor, dollar strength (or weakness) need not be feared.

WEEK IN REVIEW

  • As of last Friday, 77% of the companies in the S&P 500 have reported Q4 earnings. Blending the earnings growth rate of companies that have already reported with the estimates of companies that have yet to report, Q4 earnings are projected to be +0.9%, vs the initial expectation of -1.7%. With U.S. stocks valuations stretched, companies will need to grow the earnings to justify further/sustainable market gains.
  • The Bureau of Labor Statistics (BLS) published updated inflation data last week. The Consumer Price Index (CPI) increased at a 2.5% YoY clip, the fastest rate since October of 2018. Price gains were led by rising rents. The “core” CPI figure, which strips out the volatile food and energy components increased 2.3%, which has remained unchanged for the last four months.
  • Other data published last week showed that retail sales grew modestly in January (in line with expectations), while industrial production, which measures utilities, mining and manufacturing activity, declined for the fourth time in five months. The decline is being attributed to warmer weather reducing utility demand, and Boeing’s 737 Max issues lowering manufacturing.

HOT READS

Markets

  • ‘Dean of Valuation’ says Tesla would need VW-like sales and Apple-like margins to justify stock (CNBC)
  • U.S. Consumer Spending Picks Up, While Manufacturing Declines (WSJ)
  • Japan’s Economy Shrinks 6.3% as Sales-Tax Increase Cools Consumption (WSJ)

Investing

  • LAnd of the Undead (Prof Galloway) Netflix may not survive the streaming wars
  • Some Lessons From 92 Years of Market Return Data (AWOCS)
  • Crash Course (Humble Dollar) 30 years after their market collapse, Japanese stocks remain 40% off their 1989 peak

Other

  • How George Steinbrenner and the Harlem Globetrotters Changed the NBA Forever (WSJ)
  • The Perils of “Survivorship Bias” (Scientific American)
  • They Documented the Coronavirus Crisis in Wuhan. Then They Vanished (NYT)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

February Retirement Plan Newsletter 2020

February Retirement Plan Newsletter 2020

 

LUTZ BUSINESS INSIGHTS

 

FEBRUARY RETIREMENT PLAN NEWSLETTER

TOO MANY CHOICES: HOW MANY INVESTMENT OPTIONS SHOULD YOU OFFER?

Many plan providers struggle with deciding how many investment options to offer in their retirement plans. While people generally like to have lots of options when making other decisions, having too many plan options can potentially lead to poor investment decisions by plan participants. In addition, increasing plan options can also increase plan costs, as well as the administration associated with the plan.

Choice Overload

In a study on retirement plan options, researchers concluded that it is possible to present plan participants with too many options1. The researchers began by offering people selections of jams and chocolates. Some were offered a wide variety, while others received fewer choices. The wide variety of jams got more attention from people, but more people purchased jams when the choices were limited. When sampling chocolates, people enjoyed choosing from the larger selection more, but also expressed more dissatisfied with the choices. Those who sampled from a smaller selection were more satisfied and more likely to buy chocolates again. The study showed that as the number of options increased, people became concerned with the possibility of making the wrong choice, and were increasingly uncertain that they had made the best choice possible.

Looking at Plan Options

Chocolates and jams aren’t big decisions but the researchers found that these same behaviors carried over to retirement plans. They examined participation rates for 647 plans offered by the Vanguard Group, a large investment management company, covering more than 900,000 participants. They found that as plans increased the number of options, employee participation decreased. In fact, for every 10 options added to the plan, participation dropped by 1.5-2 percent. Plans offering fewer than 10 options had significantly higher employee participation rates.

Rising Costs

In addition, more plan options can increase costs both for participants, in the form of fees, and for plan sponsors, who may face additional administrative charges from third-party administrators for additional options. Further, auditing and other costs may increase, since the number of options could increase the time necessary to conduct audits.
It’s important to balance choice overload against the requirements of ERISA Section 404(c) which requires plan sponsors to have at least three diversified investment options with different risk and return characteristics.

For more information on plan options, consult your plan advisor.

1 http://www.columbia.edu/~ss957/articles/How_Much_Choice_Is_Too_Much.pdf

 

USE PLAN ANALYTICS TO EVALUATE YOUR RETIREMENT PLAN

Your retirement plan is a valuable resource for your employees and serves as a vehicle to attract and retain top talent. Ensuring plan success is crucial. Examining plan analytics can help evaluate its success.

Plan analytics you should explore:

  • Median age, tenure and savings rates of plan participants

These analytics can be helpful to determine which age groups are not strongly participating and may be encouraged to do so via on-site meetings, focused mailings and other communication and education.

  • Participants not contributing sufficiently to receive all eligible employer match

Participants “leaving money on the table” can be studied to explain why contributing to the employer match maximum is so advantageous (e.g., with a 50 percent match, participants automatically earn 50 percent “return” on their contribution before any investment gains occur).

  • Participants, by age, in each target date fund

Another demographic that can be helped by focused participant communications.

  • Participants taking loans

It is important for plan fiduciaries to determine if the plan loan provision is being abused. This can result in significant asset leakage with participants and oversight concerns for plan fiduciaries.

  • Loan default rates

Loan defaults also create problems for participants (taxation & penalties for premature distributions) and plan fiduciaries (loan defaults at 90 days arrear are a fiduciary breach).

  • Dollar amounts of employee contributions by type and source

These analytics allow for a deep dive into appropriateness of participant behavior potentially impacting plan menu design decisions, employee investment assistance, Roth utilization, TDF utilization and more.

Many factors impact the success of your plan. Studying your plan’s analytics helps you improve your plan and ensures your employees reach their retirement goals.

TARGET DATE FUNDS AND FIDUCIARY OBLIGATIONS

 Target date funds (TDFs) — which rebalance investments to become more conservative as a fixed date approaches — are a convenient way for plan participants to diversify their portfolios and reduce volatility and risk as they approach retirement, making them an increasingly popular choice. However not all TDFs are created equal, and selecting and monitoring them can pose unique challenges for plan sponsors and fiduciary advisors.

TDFs were first introduced in 1994. A little over ten years ago, just 13% retirement plan participants were invested in TDFs. Today, that number has risen to more than 50%, according to a new report from Vanguard, which also estimates that 77% of Vanguard participants will be invested in a single TDF by 2022.

However, the “automatic” rebalancing feature of TDFs doesn’t supplant the obligation to monitor funds and educate participants. The Department of Labor (DOL) provides guidance on TDFs in the form of tips for ERISA plan fiduciaries. A fiduciary advisor can help plan sponsors understand the rules and assist with compliance.

TDF Tip Highlights

  • Establish an objective process for comparing and selecting TDFs. Some of the things DOL suggests you consider include: fund performance, fund fees and expenses and how well the fund’s characteristics align with your employees’ ages, retirement dates and salaries.
  • Establish a process for periodic review of your plan’s TDFs. If there are significant changes in any of the criteria you considered when you added the TDF – management staff of the fund, performance, objectives – consider replacing it.
  • Understand the fund’s investments and how these will change over time. Aside from the primary strategy and underlying risk, another important aspect to consider is the fund’s “glide path.” Some TDFs reach their most conservative state closer to the target date, while others continue to become more conservative as participants move through their retirement years, with the assumption that funds will be withdrawn over a longer period of time.
  • Review the fund’s fees and expenses. Even small differences in fees can have a large impact on the growth of participants’ savings over time. In addition to fees and expenses charged by the component funds held by the TDF, are there additional charges for rebalancing or other services?
  • Ask whether a customized TDF that includes component investments not managed by the TDF vendor would be better for your plan. There may be additional costs associated with a custom TDF, but it may be worth it and you should ask the question.
  • Develop effective communications about TDFs for your plan participants, especially disclosures required by law. Check EBSA’s website for updates on regulatory disclosure requirements.
  • Use available sources of information, such as commercially available resources and services, to evaluate and review TDFs as well as any recommendations received concerning their selection.
  • Document your process for choosing and reviewing TDFs, including the decision-making process regarding individual investment options.

*Read the full DOL Target Date Retirement Funds — Tips for ERISA Plan Fiduciaries document here https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/target-date-retirement-funds.pdf). The trend toward TDFs has changed the landscape for retirement plan investors, and it’s a trend that shows no signs of slowing down anytime in the near future. For assistance navigating this relatively recent evolution in retirement planning and investing contact your plan advisor.

1 https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/target-date-retirement-funds.pdf

2 https://pressroom.vanguard.com/news/Press-Release-Vanguard-Launches-How-America-Saves-2018-060518.html

3 http://www.ucs-edu.net/cms/wp-content/uploads/2014/04/I_ABriefHistoryOfTargetDateFunds.pdf

PARTICIPANT CORNER: TAKE ADVANTAGE OF YOUR COMPANY'S RETIREMENT PLAN MATCHING PROGRAM

Over 40 percent of employers now offer at least a small retirement plan match to employees, who can help manage their financial wellness by taking advantage of this offer. Even if your employer only matches a small percentage, you’re losing money by not participating. But before you sign up for your company’s retirement plan, it’s important to know how to make the most of it. Here are a few tips that can help.

Get the Details

If you haven’t already clarified the details of your business’s retirement plan offerings, it’s never too late to find out. Ask your HR representative to list the benefits and find out how you can maximize your savings. Some employers offer a 50 percent match for each dollar you put in, while others match a dollar for every dollar. Find out what your company’s maximum match contribution is and decide whether you want to save only to that point or more.

Don’t Be Afraid to Contribute More

If your employer only matches up to a certain amount, don’t feel you have to only save that up to that point. Every dollar you save will grow tax-free over the years, providing a healthy cushion for your retirement years. The IRS does impose contribution limits, but those are fairly high, so it’s likely you won’t need to worry about it.

Don’t Assume You’re Enrolled

New employees often assume they were automatically enrolled in a business’s retirement, especially if the employer match was a selling point during the pre-hiring process. Make sure to ask if there’s something you need to do to enroll in the retirement plan program and take advantage of the match. Ask for program details and pay particular attention to any vesting schedule. If your employer-sponsored program has vesting requirements, you may find that you only receive the full benefits after a set time of employment.

An important part of financial wellness is getting every benefit possible out of your work-sponsored retirement program. This often comes in the form of an employer match to your retirement plan, which will help you get a big head start on saving for your future!

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.

For more important disclosure information, click here.

RECENT LUTZ FINANCIAL POSTS

Financial Market Update + 2.18.2020

Financial Market Update + 2.18.2020

The U.S. dollar has been appreciating relative to other currencies, and it is nearing the highest levels since 2017. Currency movements have both direct and indirect impacts on investors…

read more
Financial Market Update + 2.11.2020

Financial Market Update + 2.11.2020

It has been a rough start to the year for oil, which has entered a bear market after falling over 20% from its early January peak. The market narrative explaining this weakness…

read more

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Financial Market Update + 2.18.2020

Financial Market Update + 2.11.2020

FINANCIAL MARKET UPDATE 2.11.2020

STORY OF THE WEEK

oil enters a bear market

It has been a rough start to the year for oil, which has entered a bear market after falling over 20% from its early January peak. The market narrative explaining this weakness revolves around the coronavirus and its impact on the world’s largest energy consumer (China). My view is that this narrative is only partially true. While reduced demand in China would certainly be a negative, I think there is probably more at play here. The selloff began before the outbreak became a big story, and energy markets have been dealing with supply and demand imbalances for years as a result of the U.S. shale boom.

West Texas Intermediate (WTI), the U.S. benchmark for oil prices, has declined from over $60/barrel to below $50. Absent a brief period following the 4th quarter selloff in 2018, oil prices are hovering near the lowest levels since 2017.

Source: FRED Database & the U.S. Energy Information Administration. Data as of 2/10/2020

This decline has been painful for energy companies. The Energy Sector ETF (XLE) is down over 10% this year, meanwhile the S&P 500 is up about 4%. Pain in the energy sector, however, has less impact on the stock market as a whole than it used to. In 2009, companies in the energy sector made up nearly 12% of the S&P 500. The weight has since dropped dramatically, finishing 2019 at 4.3% and shrinking further in 2020.

Source: S&P Dow Jones Indices. Data as of 12/31/19. *Real Estate was spun off from the Financial sector post September 16, 2016. **Telecommunication Services was renamed Communication Services, with issues added from other sectors post September 20, 2018

Energy stocks typically carry a heavier weight in value tilted strategies, and have definitely detracted from performance. The silver lining here is that while most U.S. stocks are expensive, the energy sector is priced like a bargain. This should be a tailwind moving forward.

Source Morningstar Direct. The chart compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Energy index relative to the Russell 3000, which is used as a proxy for the U.S. Market.

Outside of the pain being felt in the energy sector, there is a positive side to falling oil prices. Costs for companies that use oil/energy as an input have declined, which could lead to improved earnings. Additionally, more than two-thirds of U.S. GDP comes from consumption. When costs at the pump fall, those savings can be applied to other discretionary spending. After last year’s peak at about $2.90/gallon, the average price in the U.S. has declined by about 16.5%. Prices in the Midwest have declined further, falling 17.9% to $2.32/gallon. This essentially equates to a tax cut for consumers, and is particularly beneficial for those on the lower end of the income spectrum. 

Source: FRED Database & the U.S. Energy Information Administration. Data as of 2/10/2020

Finally, I’ll leave you with this interesting chart from the U.S. Energy Information Administration (EIA). Ever wonder what goes into the price of gas?

WEEK IN REVIEW

  • One of the most closely watched pieces of economic data is the jobs report published by the Bureau of Labor Statistics (BLS) on the first Friday of every month. The February report, published last Friday, showed the U.S. economy added much more jobs in January (225k) than expected (158k). Much of the overshoot has been attributed to unseasonal warm weather that boosted hiring in the construction and leisure/hospitality sectors. The unemployment rate ticked higher from 3.4% to 3.6%, as more individuals were drawn back into the labor force and began looking for a job.
  • The market is expecting the Chinese government to step in with some additional monetary and fiscal stimulus to cushion the impact from the coronavirus. Stimulus is generally a tailwind for stock prices.
  • Data published by the Institute for Supply Management (ISM) for January showed the services sector grew at the fastest pace in 6 months.  The index increased from 54.9 to 55.5, versus expectations of 55.0 (anything above 50 signals growth). The services sector is much larger than the manufacturing sector in the U.S., and this data suggests no recession in sight. 

HOT READS

Markets

  • Tesla’s Stock price Can’t Be Justified. Stop Trying. (Barron’s)
  • The coronavirus is a ‘black swan’ for oil and energy markets, says Ned Davis Research (CNBC)
  • What to Watch for in China Stimulus as Virus Impact Hits Economy (Bloomberg)
  • U.S.-China Trade War Reshaped Global Commerce (WSJ)

Investing

  • Believe It or Not (HumbleDollar) Spotting narratives that are worth your attention, versus those that should be ignored
  • Bond Funds are Hotter than Tesla (Intelligent Investor) 1/8th of muni fund assets arrived last year

Other

  • Here Are the Most Common Airbnb Scams Worldwide (VICE)
  • Men’s College Basketball Has Been Chaotic. But Just Wait Until the Tourney (FiveThirtyEight)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

Financial Market Update + 2.18.2020

Financial Market Update + 2.4.2020

FINANCIAL MARKET UPDATE 1.21.2020

STORY OF THE WEEK

ANATOMY OF STOCK MARKET RETURNS

2019 was an excellent year for the stock market with many major indices, including the S&P 500, reaching all-time highs. Whether investors can expect such strong performance to persist depends on why returns were so strong in the first place. A simple analysis suggest the gains from last year are likely NOT sustainable.

Stock returns can be broken down into three primary components:

  • Earnings Growth(1)
  • Dividend Yield(2)
  • Valuation Change

According to data published by FactSet, 45% of companies in the S&P 500 have reported earnings for the 4th quarter as of last Friday (1/31). If you compare the actual results of the companies that have reported with estimates for those companies that have yet to report, earnings growth for 2019 is expected to be -0.3%. The dividend yield for the S&P 500, meanwhile, has generally fluctuated around 2% for the past couple of years. With the first two components making a negligible contribution, the S&P 500’s 31.5% return for 2019 was largely a function of valuation change. The chart below supports this idea. The price-to-earnings (P/E) ratio, a popular valuation metric that measures the price investors pay to participate in a dollar of business profits, increased substantially during 2019(3).

Source: Morningstar Direct. Chart reflects the P/E ratio for the S&P 500 index from 1/31/01 – 12/31/19.

The implication here is that the S&P 500 did not rise in price due to a tangible improvement in the underlying businesses. Instead, it rose simply because investors were willing to pay more for them. There were a few factors that contributed to this, including:

  • The selloff during Q4 2018 depressed the P/E ratio to a level slightly below the long-term average. Part of the increase was a function of recovering from that decline.
  • Investor sentiment became elevated late last year as news broke that the U.S. and China had reached a “Phase-One” agreement in trade negotiations.
  • Last year the Federal Reserve transitioned from tightening interest rates, to being on hold, to cutting interest rates by 0.25% three times. Lower interest rates are generally considered good for the stock market and supportive of higher valuations.

The valuation change that propelled the S&P 500 last year is NOT sustainable, because it tends to mean revert in the intermediate to long-term. To conceptualize what this means, think of it as a rubber band. When stretched, tension builds as the band wants to return to its normal state. While the forces causing the band to stretch can continue further than expected, the more stretched it gets the more likely it will snap back, and the more dramatic the snap will be when it does. It’s possible that valuations continue to stretch in 2020, but it’s not prudent for investors to expect this to happen. Meanwhile, the dividend yield on the market typically does not change much from one year to the next, and will likely remain in the low single digits. For sustainable market gains moving forward, we need to see businesses grow their earnings.

Notes:

1. A slightly more technical approach would be to separate real (inflation-adjusted) earnings growth from inflation.

2. Practitioners generally include the effect of net share issuance with dividends, referred to the combination as “Shareholder Yield”. When stock buybacks exceed new share issuance it is a positive for returns, while new share issuance exceeding buybacks would be a negative.

3. The P/E ratio is a valuation metric that is sometimes referred to as a “price multiple”, as it measures the price an investor must pay as a multiple of $1 of some fundamental metric. Revenues, cash-flows, or book-value are other types of valuation ratios. When these ratios increase, it is often referred to as “multiples expansion”.

WEEK IN REVIEW

  • Last Wednesday the Federal Reserve concluded its first policy meeting, and as expected left the benchmark federal funds rate in the current range of 1.50-1.75%. The Fed has failed to reach their 2% target on core Personal Consumption Expenditures (core PCE, their preferred inflation gauge) for an extended period of time. As a result they appear biased towards easy monetary policy as they continue to monitor the impact of 2019’s three rate cuts. According to data from the CME Group, the market is expecting the next move in rates to be a cut at the September meeting.
  • Four years after the U.K. voted to leave the European Union, Brexit quietly occurred on Friday (1/31). They have now entered a twelve month transition period, during which the two sides will negotiate a new trade deal that will govern their relationship moving forward.
  • The Bureau of Economic Analysis (BEA) published the first estimate of Q4 Gross Domestic Product (GDP). GDP, a popular representation of economic growth, came in at 2.1% and matched the pace from the previous quarter. Beneath the headline figure, the underlying details were not quite as strong. GDP got a large boost from net trade, caused by a sharp decline in imports. This is generally not considered a sustainable source of growth, and actually reflects weaker domestic demand. Other data published in the U.S. showed manufacturing activity unexpectedly increased in January. The Institute for Supply Management’s Manufacturing Index increased from to 50.9 from 47.8, and showed growing activity for the first time in 6 months (any read above 50 reflects expansion). This is welcome news, as manufacturing has been a real weak spot in the economy.

HOT READS

Markets

  • This Earnings Season Is Better Than You Think (Barron’s)
  • When Does the Federal Deficit Matter? (AWOCS)
  • Yield-Curve Inversion is Sending a Message (Bloomberg)

Investing

  • The Stock Got Crushed. Then The ETFs Had to Sell (Zweig)
  • 3 Big Themes in ETFs Right Now (ETF.com)

Other

  • How much Are We Paying For Our Subscription Services? A Lot (NYT)
  • The Illusory Truth Effect: Why We Believe Fake News, Conspiracy Theories and Propaganda (FarnamStreet)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

The SECURE Act + Planning Considerations for Individual Investors/Taxpayers

The SECURE Act + Planning Considerations for Individual Investors/Taxpayers

 

LUTZ BUSINESS INSIGHTS

 

the secure act + planning considerations for individual investors/taxpayers

nick hall, investment adviser

 

As often happens in Washington, speculation is just that and Congress acts on its own timeline. The Setting Every Community Up for Retirement Enhancement (SECURE) Act was introduced earlier in the summer of 2019 and passed through the House of Representatives at that time. The bill, which proposed several changes to retirement plans and other tax legislation, appeared to be stuck in the Senate and seemed to be something that would not be given life until 2020, if ever.

 However, at the eleventh hour just before Christmas, there was a final push that got the SECURE Act slipped into an appropriations bill. This appropriations bill was required to be passed by Congress to avoid another government shutdown. The bill was quickly passed through Congress and then ultimately signed by President Trump on December 20.

The SECURE Act affects both individual taxpayers and business owners. There are substantial changes to 401(k) plans and other small business retirement plans as a part of this Act. For purposes of this article, I will focus the attention on the major changes made by this bill that will affect individual retirement plans and other planning items for individual taxpayers.

 

IRA Stretch Provisions Eliminated (for most beneficiaries) in Favor of New 10-Year Distribution Rule

One of the most significant changes as part of the SECURE Act is the elimination of the previous law allowing  beneficiaries to “stretch” IRAs. The previous law allowed beneficiaries of retirement plans and IRAs to stretch distributions over their life expectancy, or over the oldest applicable trust beneficiary’s life expectancy if a trust was named. The new law mandates most non-spouse beneficiaries who inherit retirement plans or IRAs after January 1, 2020, to draw down the account now over a 10-year period.

Under this new 10-year rule, there are no mandated distributions annually. Rather, the law simply states that the entire account must be emptied by the end of the tenth year following the year of inheritance. While this offers some flexibility to beneficiaries as to timing of distributions during that 10-year period, it is, in essence, a tax increase on IRAs. Considering many beneficiaries are often much younger than the original account owners, the new 10-year rule is much harsher than the old standard of stretching over one’s remaining life expectancy.

It is important to note the exceptions to this law—certain designated eligible beneficiaries who are not subject to the new 10-year rule. The list of those beneficiaries include:

  1. Spousal Beneficiaries (Most Common)
  2. Disabled Beneficiaries
  3. Chronically Ill Beneficiaries
  4. Individuals who are not more than ten years younger than the decedent
  5. Certain minor children until they reach the age of majority

The most common class of people from this list is spousal beneficiaries. Spouses will still have the ability  for a spousal rollover, allowing them to stretch distributions over their own life expectancy versus a much stricter 10-year period.

The 10-year rule exception for minor children applies only to a child of a retirement plan or IRA owner. Meaning, a retirement account inherited from a grandparent, aunt, uncle, or other relative would still follow the 10-year distribution rule. The old stretch rule only applies until the minor child reaches the applicable age of majority in his/her state of residence, and then the new 10-year distribution rule goes into effect.

Consequences and Considerations Due to Death of Stretch/New 10-Year Distribution Window

It is important to remember that any retirement plan or IRA beneficiary designation trumps what is indicated in a will or trust. Thus, an essential part of estate planning is ensuring designated beneficiaries on retirement plans and/or life insurance coordinate with the rest of the estate plan.

Commonly, individuals designate a trust as the primary or contingent beneficiary of a retirement plan for greater control or an extra layer of protection for a spouse, children, or grandchildren. These trusts must have language in them to allow them to qualify as a “see through” or “tax qualified” trust to preserve the old stretch provision. Some of these trusts are restrictive in that only applicable RMDs from Inherited IRAs are allowed to be distributed each year. In the case of the new 10-year rule, the only year that technically has a RMD is the tenth year following the death of the owner.

Having the whole IRA or retirement plan distributed in the tenth year could have adverse consequences from a tax standpoint, especially for large retirement accounts and beneficiaries in higher tax brackets. Secondarily, other “see-through” trusts are set up to keep any distributions from Inherited IRAs inside the trust. This result may be undesirable given that trust tax rates are much more compressed than individuals’ tax rates, hitting the top tax bracket at around $13,000 of taxable income.

The challenges mentioned above around the 10-year rule should lead many to reevaluate their retirement beneficiary designations. In light of the new rule, I would recommend those who are charitably inclined to consider naming a charity or multiple charities as a beneficiary to receive a portion or all of certain retirement accounts. The 10-year draw down rule will adversely impact beneficiary children who are in a very high tax bracket themselves. In some cases, it will mean losing 50% of the RMD to Federal and state taxes.

One planning opportunity that may arise due to the new 10-year rule is the option to name a charitable remainder trust (CRAT) as a beneficiary of a retirement plan. A CRAT is an irrevocable trust that makes fixed income payments to annuitants/beneficiaries for an established length of time. These fixed payments are based on a percentage of the assets in the trust, and the current maximum length of time is 20 years. The caveat is that any assets remaining in the trust after 20 years, or the specified length of time, must then be transferred to the charity or charities indicated within the trust document.

Because the SECURE Act is so new, there is no precedence on this strategy. I would recommend consulting with an experienced estate planning attorney. Regardless, I expect to see people giving charities much greater consideration to naming them as beneficiaries of retirement plans and IRAs going forward.

 

Required Minimum Distributions (RMDs) to Begin at Age 72

The previous rule stated RMDs from a retirement plan (retired workers) or IRA must begin at age 70 ½. This arbitrary age caused confusion relating to the timing of the first distribution and life expectancy factor used in calculating one’s annual RMD. The new law will now push the first RMD to age 72 for anyone turning 70 ½ on or after January 1, 2020. It’s important to note that individuals who turned 70 ½ or 71 in December 2019 are grandfathered in under the old rules and are still required to take an RMD in 2020. The new RMD rule will match the old rule in that the first distribution technically does not have to be made until April 1 following the year an individual turns 72. However, if the first RMD is delayed until that following year, a subsequent second RMD must also be taken before December 31 of an individual’s 73rd birthday year.

For many of our clients, this is welcome news because it delays taxes associated with the RMD. We often talk to individuals about the “retirement income gap”. Otherwise known as the time between one’s retirement and taking Social Security retirement benefits and RMDs. Upon retiring, many individuals see a dramatic drop in income for a period until they begin Social Security and mandated distributions from pre-tax retirement accounts. A popular recommendation is to maximize lower tax brackets during this period by converting funds from a pre-tax to a Roth IRA. The new RMD age of 72 helps lengthens that “retirement income gap” for many people and allows for a greater period of tax planning.

 

Qualified Charitable Distributions Still Permissible at Age 70 ½

Interestingly, even though the RMD age was pushed back to age 72, Qualified Charitable Distributions (QCDs) remain permissible once an individual turns age 70 ½. Individuals may still take up to $100,000 annually from an IRA and gift it to a 501©3 charity(s). Although it will not offset mandated income the first year and a half, QCDs taken before age 72 will lower the future RMD for an individual by reducing the IRA account balance. Starting at age 72, the QCD will reduce the then-necessary RMD.

 

Traditional IRA Contributions Allowed Beyond Age 70 ½

The old rule disallowed Traditional IRA contributions due to old age, restricting individuals from making contributions after turning age 70 ½. Beginning this year, individuals who remain working or have spouses who have earned income through wages and/or self-employment are permitted to make Traditional IRA contributions beyond age 70 ½. There is little benefit to individuals making traditional IRA contributions after age 70 ½, given the income limit to deduct contributions is still fairly low (AGI of $75,000 for Singles and $124,000 for Married Joint Filers in 2020) and individuals have to begin taking RMDs at age 72 anyway.

However, one advantage of this new law applies to potential backdoor Roth IRA contributions for high-income earners. Individuals who still have earned income and high AGI, are now allowed to make backdoor Roth IRA contributions. This is done by making non-deductible Traditional IRA contributions that were previously exempt in the year someone turned 70 ½. One caveat is that post-age 70 ½ deductible Traditional IRA contributions will reduce any QCDs by the amount of cumulative deductible Traditional IRA contributions.

 

Other Miscellaneous Provisions of SECURE Act

  • 529 plans can now be used for apprenticeship programs. This includes books, fees, supplies, and other required equipment of the program.
  • 529 plans are now permitted to be used for up to $10,000 of qualified loan repayment of student loans. Additionally, $10,000 can be used to pay debt on each of the 529 plan beneficiaries’ siblings. This change is retroactive to 2019.
  • The Kiddie Tax reverts back to previous laws before 2018. Per the kiddie tax, unearned income for children above $2,200 (like Social Security survivor benefits) will again be taxed at the parents’ tax rate and not subject to the compressed trust tax rates like it was in 2018 and 2019.
  • Deduction of qualified tuition and related expenses remains effective through 2020.
  • The AGI hurdle rate to deduct qualified medical expenses remains at 7.5%–extended for tax years 2019 and 2020.
  • Individuals who receive taxable stipends or non-tuition fellowship income may make IRA or Roth IRA contributions beginning in 2020.

ABOUT THE AUTHOR

402.827.2300

nhall@lutz.us

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NICK HALL, CFP® + INVESTMENT ADVISER

Nick Hall is an Investment Adviser at Lutz Financial with over eight years of industry experience. He specializes in comprehensive financial planning and investment advisory management services.

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Financial Market Update + 2.18.2020

Financial Market Update + 1.28.2020

FINANCIAL MARKET UPDATE 1.28.2020

STORY OF THE WEEK

have stocks caught the coronavirus?

Coverage of the Coronavirus outbreak has been dominating headlines over the last few days, and the market seems to have taken notice. For the past several months the S&P 500 has steadily marched higher with very little volatility. That changed this Monday, when the index closed down -1.57%. The decline marked the first daily move exceeding +/- 1% since early October, ending one of the longest such streaks on record.

It is frightening to learn about a new virus that is spreading quickly and has no cure or vaccine. As of this writing, Coronavirus has claimed the lives of over 100 people, infected thousands more, and prompted the Chinese government to quarantine an urban area with a population comparable to New York City.  While the outbreak is undeniably having an adverse human impact, I question the idea that it will have a lasting effect on global stock prices.

To put this into context, consider the common flu (influenza). According to data from the Centers for Disease Control and Prevention (CDC), since 2010 the U.S. alone has had 9 to 45 million people contract influenza each year. Of those, 140,000 to 810,000 people required a visit to the hospital, and 12,000 to 61,000 have succumbed to their illnesses (each year!).  While the media focuses on the frightening new Coronavirus, influenza will likely have the larger impact.

Source: Centers for Disease Control and Prevention (CDC)  

Over the past 40 years we have seen more than a handful of viral scares. The table below, courtesy of MarketWatch, suggests the market impact of these events has historically been muted, even in the short-term. I’ll insert the generic disclosure here: past performance does not guarantee future results. It is certainly possible that Coronavirus will end up being a much bigger deal than these past episodes, though I’m not making that my base case.

In my view, the biggest ailment for the market is the fact that excessively bullish sentiment has pushed stock prices beyond what business results can justify (See the S&P 500 Trailing P/E chart in the Markets at a Glance section). When this occurs, the market generally becomes more vulnerable to a pullback. This is not necessarily a bad thing, however, as corrections are a normal and healthy development and can set the market up for continued gains. Pouring some cold water on investor sentiment may be just what the doctor ordered for your portfolio.  

WEEK IN REVIEW

  • Data published late last week showed an early estimate of January’s manufacturing sector activity, which declined to a three month low. The Manufacturing Purchasing Managers Index (PMI) fell from 52.4 to 51.7 (any reading above 50 signifies expanding activity). The Services PMI, however, accelerated from 52.8 to 53.2. The services sector is a much larger component of U.S. economic activity, and has offset weakness in manufacturing activity.
  • The Federal Reserve’s Federal Open Market Committee (FOMC) will conclude the first monetary policy meeting this week, with the policy announcement tomorrow at 1 PM CT, followed by Chairmen Powell’s post meeting press conference shortly after (you can stream it on Yahoo Finance). The market is not expecting any change to the current level of interest rates (currently at 1.5 – 1.75%).  
  • On Thursday we will get the first estimate of Q4 GDP. The Atlanta Fed’s popular GDPNow model is projecting growth of 1.9%, which would continue the trend of slowing growth that began in mid-2018.

HOT READS

Markets

  • What the 2020s Will Look Like For the Markets (AWOCS)
  • Ultrafast Trading Costs Stock Investors Nearly $5 Billion a Year, Study Says (WSJ)
  • Seth Klarman Passionately Defends Value Investing… (CNBC)

Investing

  • Here’s Why You Should Rebalance (MorningStar)
  • Why Invest? A 22-Year-Old’s Tough Questions About Capitalism (Zweig)
  • The Wager Revisited (HumbleDollar) Lessons from Warren Buffett’s bet against hedge funds
  • Big Mistakes, Don’t Make Them Yourself (Video) (Irrelevant Investor)

Other

  • The Buffett Formula: Going to Bed Smarter Than When You Woke Up (FarnamStreet)
  • SpaceX Crew Dragon Escapes Exploding Rocket (Heavy)
  • The 24 Stats That Explain Kobe Bryant’s Staggering Legacy (TheRinger)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

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jjenkins@lutz.us

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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.

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