Looking in the rearview mirror while driving works…until the road curves. This is a good principle to keep in mind when investing; the past performance of your investments does not guarantee future growth.
When it comes to market performance, we believe the road is heading for a curve.
In the past year, the United States has seen unprecedented fiscal stimulus, with the money supply increasing by 30-percent. The Fed has taken a laissez-faire approach to these developments, keeping interest rates at virtually zero while the economy reopens after pandemic closures. These factors combined will likely result in high inflation over the next few years—something we have not seen in recent decades.
It’s important, as investors, to ask ourselves, “How will I be affected by what is going to happen?” Ultimately, there’s no foolproof way of predicting the future. That is why our Personal Vision Planning® process takes into account periods of uncertainty and market volatility. We believe that with proper planning, you’ll be able to handle any shifts in the economy no matter what transpires.
Having a strong grasp of the macroeconomic outlook and conditions can provide context for planning. There is broad consensus that we can expect higher inflation and higher taxes in the future. The question is, how can we not only protect ourselves but also take advantage of these tax-hikes to build wealth?
Economists Warn of a Sharp Rise in Inflation
Larry Summers is a center-left economist who was formerly the Treasury Secretary under President Clinton and head of the National Economic Council under President Obama. Summers has called Biden’s economic efforts the “least responsible” macroeconomic policy in 40 years.” He believes the amount of extra spending is far in excess of what’s needed to get the economy back to where it would have been in the absence of COVID-19. “If your bathtub isn’t full, you should turn the faucet on, but that doesn’t mean you should turn it on as hard as you can and as long as you can,” Summers told National Public Radio on February 2, 2021.
Jeremy Siegel, Professor of Finance at Wharton, is also forecasting a sharp rise in inflation over the next few years. During an interview on CNBC’s Halftime Report, “Prices are going to be 20% higher three years from now, four years from now than they are today.”
The current chair of the Federal Reserve, Jerome Powell, has the Federal Reserve setting short-term interest rates at essentially zero and buying $120 billion per month in Treasury and mortgage-related securities. Moreover, the Fed is committed to keeping these policies in place for the foreseeable future.
William Dudley, the chief economist for Goldman Sachs and the president of the New York Federal Reserve Bank from 2009 to 2018, has also issued warnings, saying that he thinks the Fed is putting itself in a position where it’s going to have to eventually raise rates aggressively. If the Fed is too slow to tighten “monetary policy” says Dudley, it will have to eventually “catch up.” That caching up, according to Dudley, will not be “pleasant.”
A Market Correction Might Be Looming
Whatever is going on in the world at any given moment affects the stock market—we can all agree that there is a lot going on.
Almost daily, we see a new story featuring economists predicting a market crash due to the current bullishness of the market. That’s to be expected, market corrections are pretty common. In fact, a double-digit decline has occurred in the S&P 500, on average, every 1.87 years since 1950. While it’s important to factor these warnings into your due diligence, it’s even more pressing to note that these peaks and valleys are cyclical.
Fixed-Income Investments
As more investors grow concerned about a significant correction, they begin to consider moving non-negligible portions of their portfolios to fixed income (aka bonds) investments. We believe this is one of the worst things you can do in this environment.
In the past, people have viewed fixed income as safe and stable, so they shift assets to these types of investments when equity markets become more volatile. This worked when interest rates were decreasing, but because we are reaching a bend in the road shifting a large percentage of capital to fixed income might be a mistake due to the predicted increased inflation and interest rates on the horizon.
Consider Equity Assets Instead
The only investment that could provide real returns (returns net of inflation and tax) are equity assets. At this time some equity investments have yields that are higher than those for fixed income, while also offering growth potential
As always, we recommend a diversified asset allocation based on your needs and risk tolerance. We believe it’s important to have enough cash to cover any expenses anticipated in the next 12 months, once you have this under your belt, you can consider what to do for your other investments. For the portion of the portfolio in fixed income, look at very short-duration holdings and tax-exempt bonds if you are in a higher tax bracket.
Chart Your Own Path
Another example of driving down the road, looking in the rearview mirror when you should be watching for curves is planning based on the recent past or on your parents’ financial experiences. The average lifespan is increasing which means people will need more income later in life, that’s why it is important to stay invested for growth. When someone used to retire at 65 and die before 75, growth was not as much of an issue. Now, many people retire before 60 and live well into their 90s—which is an amazing thing, but isn’t so amazing for modest retirement plans. This is yet another reason maintaining a significant allocation in your equity assets vs. fixed income investments is important.
The key to avoiding financial hardships later in life is to actively monitor and rebalance your portfolio with a long-term view in mind. Having equities will help preserve value over time, even if there is volatility in the short run. Trying to time the market does not make sense; rebalancing a portfolio to a predetermined allocation does. This is where a trusted advisor can add significant value.
Our Recommendations
Given all of these confusing, fast-moving shifts and events, here is what we recommend for you:
- Have enough cash that you are never forced to sell in the short run.
- Actively monitor and rebalance your portfolios—do not try to time the market, try to maintain your agreed-upon allocation instead.
- Understand that we might see a rising interest rate and an inflationary environment. Fixed income will be impacted when this happens.
- Think about why you are investing. If your portfolio is generating the income you need to maintain your lifestyle, the value of your portfolio is not important. This is similar to having a rental home—the rent will be paid to you, regardless of the value of the property.
Be Prepared for Rising Tax Rates
We also expect that capital gains, estate, and income tax rates will rise in the next few years—regardless of the party in power. The challenge facing politicians is how to pass increases that will not upset voters. As such, elevated rates are likely to be seen in more arcane categories like the step-up in basis on estates or corporate taxes. Working with your advisor and CPA to manage your portfolio in the most tax-efficient manner is critical to stay ahead of these increases.
At the end of the day, the most important thing is not how much your portfolio earns, but how much you net in your pocket after fees, expenses and taxes. Having tax-exempt growth is a “free lunch” and who doesn’t love a free meal? As taxes go up, it becomes important to be as tax-efficient as possible. We take a very proactive approach to this and work with your CPA to develop a strategy that is best for your situation.
We do not believe major changes to your financial management strategies should be made in anticipation of tax-law changes. We recommend waiting to see what actually passes. The reality is that the actual rules are often less draconian than how they’re presented. That’s why we recommend you:
- See if tax-exempt investments make sense, given your tax rate.
- Consider converting tax-deferred retirement accounts to tax-exempt ROTH IRAs.
- Consider tax swaps and tax-efficient investments.
Look Ahead with Your Professional Team
In summary, we believe we will see higher income tax rates, higher inflation, and more volatility in both the equity and fixed-income markets. Volatility could actually provide an opportunity for people who prepare by taking an active approach to monitoring their portfolios.
As tax laws become more complex, people live longer, and need more income, it’s important to allow your portfolio to grow and evolve with the times. However, the information on the internet can be confusing, misleading, or outright inaccurate, that’s why it’s more critical than ever to work with a trusted advisor.
Having worked in the financial services industry for more than 30 years, I see that individuals who are unprepared or tend to react to short-term events, generally losing wealth over time. These knee-jerk tendencies create a lot of emotional and financial strain. That’s why I always advise a proactive—not reactive—approach to investing.
Our Personal Vision Planning Process® is not dependent on predictions or forecasts. We expect the unexpected and plan accordingly. It is clear that inflation will continue to increase, we believe this is one of the biggest risks that investors face today. And, even though we also expect increased volatility in the stock market, this may be one of the best places to invest.
Those who work with a trusted advisor, stick with their plan, and take a long-term view may actually benefit from periods of volatility while not only maintaining but enhancing their lifestyles. We are being met with economic, political, and market changes we have not seen in decades. The road is curving, those who look ahead—and work with a professional team—can benefit. Those who look in the rearview mirror may ultimately drive off the road.
Randy Carver, CRPC®, CDFA®, is the president and founder of Carver Financial Services, Inc., and is also a registered principal with Raymond James Financial Services, Inc. Randy has more than 32 years of experience in the financial services business. Carver Financial Services, Inc. was established in 1990 and is one of the largest independent financial services offices in the country, managing $2.1 billion in assets for clients globally, as of June 2021. Randy and his team, work with individuals who are in financial transition as a result of divorce, retirement, or the sale of a business. You may reach Randy at randy.carver@raymondjames.com.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Tax-exempt investments may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Tax-exempt investments may be subject to AMT, state, or local taxes. Please consult an income tax professional to assess the impact of holding such securities on your tax liability. All investing involves risks, including the possible loss of principal amount invested. No investment strategy, including diversification and rebalancing, can guarantee your objectives will be met.
Marshmallows and Roth Conversions
