Brian Perry, CFP®, CFA®, Pure Financial Advisors’ Executive Vice President and Director of Research, sums up the events that moved markets and shaped our lives in 2021:
- Inflation worries
- COVID variants
- Potential tax law changes
Brian covers all these and more as he discusses what’s happened in markets and why. You’ll also learn more about what might be next for the economy, what investment opportunities are available to you during volatile times, and financial moves to consider making now.
From the market lows during the pandemic, how far up are the markets? S&P 500 – 5 Years (as of 11/22/2021)
What are your views around inflation? Inflation rate – 10 years, Producer Prices Up Sharply
What does inflation mean for my portfolio? Market Returns and Inflation
Do you think we’ll see interest rates increase? 10 Year Treasury Yield Since 1962
What happens to my bonds if rates do rise? Interest Rates and Inflation, Not All Bonds Are Created Equal, Debt high but yields low Across the globe
What’s your general sense of the equity markets? It’s Been A Good Year
Should I Just Buy the S&P 500 Index? The Lost Decade
Can stocks keep going higher? Dow Jones Industrial Average Since 1900
What are the most common mistakes you see people who manage their own investments make?
What’s going to happen with my taxes?
What do you think of I bonds for the cash portion of a portfolio?
Should I buy a risk-parity ETF as an inflation hedge?
US markets have beat international for a while now. Will that eventually change?
We’re hearing a lot now about the Omicron variant. What does a COVID surge mean for the financial markets?
Is there a recommended percentage of assets that should be in the three categories of taxable brokerage, pre-tax qualified, and Roth when nearing retirement?
Is it too risky to have 7 or 8% of my portfolio in company stock?
Regarding withdrawals, do you recommend varying from where to pull funds depending on the market? For example, lower withdrawals or pull from cash if the market drops significantly, or pull from stock funds if the market is up significantly?
You always mention the best portfolio is to have a globally diversified portfolio, but don’t really give examples about what that looks like and why. I know it varies by person.
Andi: Please welcome your presenter for today’s webinar. Brian Perry, CFP®, CFA®. Good morning, Brian. How are you? Your microphone is not on.
Brian: My microphone is not on, how about that. There it is. OK, well, you just missed it. I just predicted where the market was going to end in the year.
Andi: Oh dang, I should’ve known.
Brian: Yeah. You always give me those buildups that are hard to live up to, but we’ll do the best we can.
Andi: Well, you know, it’s all true, and that’s the part that’s important. I’m sure that you have lots of great insight for us today.
Brian: We’re going to do our best. What we’re going to do today. We’re going to try to answer some of the common questions we’ve been getting from people out there. It’s been a wild and crazy year. It’s been a wild and crazy couple of years. I hear a lot around, I’m going to wait until there’s more certainty. I don’t know that we ever have certainty. This year does seem more uncertain than most. Let’s see if we can unpack some of that over the next 45 minutes or so.
Andi: Sounds good. First up, I’m going to start with a question: “From the market lows during the pandemic, how far up are the markets, Brian?”
Brian: Quite a bit is the short answer. We’ve got a slide of the S&P 500, which if you look at it, it really just bounces and heads straight up. This is over five years. The reality is markets fell by about a third in March and April of 2020, with the COVID pandemic setting in. Then rebound pretty significantly. We’ve more than doubled from the lows. Kind of an instructive moment that even when things seem dire, it might not make sense to sit on the sidelines and cash. Pretty significant rally. The question becomes, will that continue?
Andi: What are your views around inflation?
Bian: This is a big one. I segway towards will the market rally continue? The big question to answer is what’s going to happen with inflation? The Federal Reserve has been of the mind that inflation is only transitory. If we take a look, we can see that the consumer price index is up quite a bit over the last year or so. We have a slide on that where you can see, in the last 10 years, generally low inflation anywhere from 3½ % to really zero. Mostly below 2% until the last year or so where we’ve spiked and we’re pushing towards 7%. That’s really starting to impact people across the board, whether it’s at the gas pump, food store, in a restaurant, ordering items online, houses, cars, really inflation across the board. When we look at financial markets, really the question is, is there truly inflation or is this just a measurement issue?
We’ve got another slide that looks at inflation in a different way. There’s two kinds of inflation that we’re looking at. There’s the consumer price. What are most of the audience here paying? The answer to that is more in the United States. Then there’s producer prices. There it’s companies. What is the cost of inputs for a corporation to build something? If you’re a car maker, what is it costing you to assemble the parts and the materials in order to build the car? Or if you’re a homemaker or something? Then oftentimes, but not always, those cost increases passed on to consumers via consumer price index. If they don’t pass on that, what happens is that the company’s margins are compressed and they make less money. What you can see here is that producer prices are up even more than consumer prices. If you look at the right hand side, we see consumer prices in the United States, the U.K., France, Spain all up pretty significantly. Look at the producer prices on the left hand side in the US it’s up almost 9%. The U.K. is 8%. Then you’ve got double digits, up towards 30% across Europe. We’ve certainly seen some inflation on the consumer side. We’ve seen even more on the producer side. What remains to be seen is how much of that cost increase can be passed on to the consumers. In the long run, I really think it’s a double edged sword. If you pass too many of those cost increases on to consumers. It probably restrains people’s purchasing power. They have to be more selective about what to buy and the economy probably slows down. That’s probably not good for the stock market. The flip side, kind of equally pessimistic, is if producer prices remain elevated and those cost increases aren’t passed on. Then companies’ margins get compressed.
They’re less profitable, and that’s probably a negative for some companies as well. Certainly some issues out there with inflation relative to the stock market. If we look at the bond market, it’s an even bigger issue.
Andi: What does inflation mean for my portfolio?
Brian: Across the board, I was just talking about some of the negative impacts of inflation, but if we look historically. We’ve got a slide that shows a variety of different inflation environments have actually not spelt a sort of destruction or doom for financial markets. There’s really four different quadrants here and four different inflation environments. There’s high and rising inflation; high and falling inflation, low and rising and then low and falling. This goes back to the late 1980s. Unfortunately, it doesn’t show the experience during the 1970s where we had hyperinflation simply because of data availability. There are several different inflation environments within here. You can see, across the board almost, asset classes have done OK, regardless of those environments. The bottom line is that if we get into a hyper inflation environment similar to what we saw in the 1970’s, where you’re pushing double digit inflation and it’s really sustained, I don’t think that’s good for financial markets. I think, across the board, asset classes would suffer temporarily. In a more modest inflation increase, sort of like what we’re seeing now, if inflation backs off a little bit or it’s only elevated for a brief period of time.
Financial markets, although they’ll certainly be hiccups as inflation readings come out, can broadly withstand higher inflation. The big issue, of course and the question we get a lot is around bonds and what would be the impact there?
Andi: Do you think that we’ll see interest rates increase Brian?
Brian: This is an important question and one that we get all the time. The causality, or the chain of thinking, is that higher inflation leads to higher interest rates and then higher interest rates are bad for bonds. It’s important to remember that when interest rates go up, bond values go down. When interest rates go down, bond values go up. If you keep that in mind, you can understand that higher interest rates, all else being equal, are temporarily bad for bond prices. A lot of people ask about this because, essentially, we’ve been in a bond kind of “bull” market for 30 or 40 years. We saw an increase in interest rates in the 1970s into the early 80s, peaking at north of 15% for the 10 year Treasury. Then we’ve seen this steady decline. Obviously, there are some movements within there. Broadly speaking, if you look at this chart, the 10 year Treasury yield since the early 80s peak has come down to the point where we bottomed out during the depths of the coronavirus pandemic at 0.05% . The question is, don’t interest rates have to go higher? And the answer is, I don’t know. I have worked in the bond market for a long time. I was a portfolio manager there. I was a bond trader for a number of years. I don’t know. I haven’t met many people that are really good at predicting interest rates. If we look at the next slide, which shows a little bit of a tighter range on the Treasuries. This is more just the last five years. You can see that really, we were in the 2.5 to 3% range in 2017 and 2018. As I mentioned, we fell to 0.05% before rebounding to today where we are around 1.5%. Although interest rates are exceptionally low right now, in the middle of the range over the last five years,. If you went back towards ten years, the range has been, for the most part, between 0.05 to 3-3.5%. Maybe interest rates do go higher. I happen to personally think that they might move a little bit higher. I don’t know if they have to spike towards 1970s 8, 9, 10% levels.
Andi: What happens to my bonds if the rates do rise?
Brian: That’s the multi-trillion dollar question. The bond market, although it’s less well understood a lot of times in the stock market. It’s actually twice the size of the stock market. For technical reasons the bond market forms sort of the plumbing of the financial system. If you think back to March of 2020, which was probably the sharpest stock market decline of our generation, although it was really significant, the financial markets didn’t seize up. They were volatile and stuff, but they didn’t seize up. Relative to the 2007, 2008 crisis. That was more bond market driven than stock market driven. In that case, the banks and the financial system really did seize up. The bond market is really important to the global financial system. Higher interest rates, all else being equal, are bad for bonds. But not uniformly so. What happens a lot of times is if inflation gets higher, bond prices get higher. Not all bonds are created equal. We’ve got a slide that takes a look kind of under the hood at those things. There’s a lot of numbers on this slide. If you look at the right hand column, the rightmost column, that shows the correlation to the S&P 500. How closely does this bond move with the S&P? 1.0 would mean that it moves lockstep if the S&P moves up 1%, the bond moves up 1%. -1% would mean that it would move exactly opposite. What you can see is the numbers in red are negative correlations. That’s where you get diversification. You can see at the top, with a number of different treasuries, they move the opposite of stocks. A lot of the time, not all the time, but a lot of the time providing that diversification.
Below the second half of that chart, below the line, are more somewhat riskier types of bonds. You’ve got investment grade corporate bonds. You can see convertible bonds, US HY (means high yield bonds), municipal bonds and whatnot. You can see that most of those are somewhat correlated with the S&P 500, they’re positive numbers, but it’s not 1%. That means that although they move directionally, sometimes with stocks, they don’t move in lockstep. You still get some diversification benefits.
The other part is the correlation to the tenure. That’s the second column from the right. That shows how closely these types of bonds move to the 10 year Treasury. You can see the fourth line from the top. The 10 year Treasury is 1.0 because it’s measuring it against itself. Everything else moves somewhat less or more. Importantly, if you look down at the bottom half of that, you can see that a lot of these bonds are not perfectly correlated to the 10 year Treasury. Corporate bonds have a .42 correlation. High yield bonds are actually negative. That means that they tend to move inversely to the 10 year Treasury. The point here isn’t to become an expert on the nuances of each sector of the bond market. It’s to understand when we talk about the bond market, there’s really no such thing. What you have is a market of bonds. That little twist of phrase is meant to point out that every bond is different. There are millions or hundreds of thousands of bonds out there, and as you look around, you can choose bonds that, if you put them together, don’t move directly with interest rates. Maybe don’t move directly with stocks. You’re really trying to build that portfolio that complements your existing holdings. But at the same time, what you don’t want to do is get overly aggressive in your bonds. You want to remember that for most of you out there, your bonds are probably your safe money. They’re there to support you if you have an emergency cash flow need, or if you’re trying to distribute income from the portfolio over the next several years. A lot of times that’s what the bonds are there for. The stocks or real estate are there for longer term growth.
Andi: As a reminder, if you do have questions for us, you can just type them into the chat and we will get to as many of those as we can throughout the course of the presentation.
Kevin wants to know “what do you think of I bonds for the cash portion of a portfolio?
Brian: Great question. Thanks, Kevin. I bonds are bonds that are issued by the U.S. Treasury, so they’re government guaranteed. The I denotes that their inflation adjusted as opposed to the regular savings bonds issued by the U.S. government that are not adjusted for inflation. Importantly, as opposed to regular Treasury bonds that are issued in trade in the market, they’re very large institutional products. These you go to the bank and buy or you can buy them directly online from the U.S. Treasury. They’re very much a retail product. You might remember, for some of you, maybe your grandparents bought you a savings bond when you were young, and maybe it matured in 10 years and was worth $100 or something like that. This is the same concept. They’re popular because right now the yield is pretty high because they’re adjusted for inflation, so you might get 6 or 7% or something on it. A couple of things, it’s important to remember that that yield is only temporary. If inflation keeps going up, your income will go up. If inflation goes down, you could get less returns and you might even get zero on some of those. The other thing is that if you’ve got a little bit of cash to park, it might work. But the reality is, these are only available in $15,000 increments each year. You’re somewhat limited in how much you can buy. If you have a large sum of money, they might not be the right product for you. They’re also very illiquid. They’re hard to trade in the marketplace,actually, they don’t trade in the marketplace at all.
Once you get in they’re more difficult to get out. An alternative might be to look at something like TIPS, which are Treasury inflation protected securities. They’re the same concept as these I bonds, except they trade in the public markets. They come in issuance of tens of billions of dollars and they trade all day long. You get a little bit more liquidity, a little bit more ability to get in and out of the position. Although keep in mind that you’re still subject to both some interest rate risk and also, if inflation moves down, your return would go down.
Andi: Shall we get back to the slides?
Brian: Sure. As we talk about inflation and interest rates and we want to beat a dead horse on this, we’re trying to answer the questions that we’ve seen the most from the general public. We come into contact with thousands of people a month even. This is really the biggest series of questions we get, it’s all around interest rates, the deficit, inflation, what does it mean for bonds? Ultimately, what does that mean for stocks? This is what a lot of people focus on?
Here this slide to me really just points out the dichotomy that’s going on right now. On the left hand side, it’s gross government debt. The U.S. is at 133% of GDP. That means that the outstanding issuance of government debt is about 1⅓ times the value of our economy each year. All these other countries across Europe are north of 100%. Japan’s at 200%. There’s a lot of government debt out there which people will use to argue. Means that interest rates have to go higher. It’s true that there’s something known as a crowding out effect. Which means that if there is enough debt out there that people are buying from the U.S. government. That’s less capital that’s available to go buy, let’s say, a corporate bond from IBM or something like that. Because of that, IBM has to have higher interest rates and it did kind of distribute across the economy. The important thing to remember, though, is that that’s the theory. The reality is that when you look at Japan. Japan has had very, very high government debt for the better part of three decades. They’ve had extremely low interest rates, often negative. Generally below 1% for the course of several decades. It’s a logical argument that because of high levels of debt, interest rates might go higher. In practice, we haven’t always seen it.
The right hand side also looks at where government bonds are right now in the U.S. and then in Europe. It’s important to remember that there’s a huge group of investors out there that have to buy bonds. If you’re an insurance company by statute, you need to buy bonds and a lot of corporate bonds in order to match your liabilities. If you’re a government in the state of, let’s say, a local government of a city in California. By statute, you have these large reserves of funds that are designed to build a bridge or a road or just fund schools or whatever, you have to buy bonds. You can’t go out and buy stocks instead you have to buy high quality bonds. There are institutions around the globe that need to buy bonds. They’re going to look for what the best return is, and in a lot of cases, the best return is in the United States. There is a lot of built in demand for bonds. Ultimately, interest rates are really hard to predict. We found the best way to protect yourself against rising interest rates is to focus on relatively short and intermediate term bonds. They’re not as sensitive to higher interest rates. By focusing there, if interest rates do go up, you don’t risk as much loss of principal.
The final thing I would point out is that the single best thing that could happen to any of you if you want to invest in bonds or if you are investing in bonds, is for interest rates to go up. I want to emphasize that. It’s really strange to say because so much time and energy has been spent talking about higher interest rates and the worry about it really since 2008. Think of the number of headlines on CNBC or in the newspaper. Interest rates are going to go higher. If you’re invested in bonds and interest rates go up, you just got a pay raise. If you go to work every day and you come home and you tell your spouse that, Hey, I just got a raise. That’s good news. It’s the same thing in the bond market. As long as your portfolio of bonds, as long as the average maturity is less than your investment time horizon, you want interest rates to go higher. You’ll see the value temporarily dip on your bonds but over time those higher interest rates are going to drag the return up. You’re going to wind up with more return over a market cycle than you would if interest rates were low. The key is matching an appropriate average maturity to your bond portfolio. Then honestly, it’s sitting at home with your fingers crossed, hoping interest rates go higher.
Andi: The next question is, “What is your general sense of the equity markets?”
Brian: You missed it at the very beginning. Remember, my microphone wasn’t working. I told you where the stocks were going to end the year. It’s been a good year. I mean, by any standard, it’s been a really good year in the stock markets. If we take a look here, the small numbers here, but down the left hand side, you’ve got a bunch of different indexes. Really just focus on the right hand 2 columns. One is year to date and the other is a 12 month change.
You see a lot of green numbers and most of them are pretty high. What that shows is that stock markets around the globe have done really well. The tide has been rising. The problem with being bearish on stocks is that you’re going to be wrong most of the time. It’s just a matter of fact that over time, stock markets go higher as profits increase from companies and stuff like that. The issue is, if you’re bearish, if you sit out, you might be right sometimes. A broken clock is right twice a day. In the long run, you’re actually better off than if you just invested, rode the tide and took your lumps when the market fell. For a lot of people, that’s the answer.
Andi: The next question is, “Should I just buy the S&P?
Brian: It depends on what you’re trying to accomplish. The S&P is great. Here at Pure we use the S&P 500 and large company stocks as the foundation of most of our portfolios. What we don’t do is concentrate exclusively on the S&P. I would say the answer to your question is, no, you shouldn’t just buy the S&P. The reason is that there’s over 10,000 publicly traded stocks in the world. The S&P is 500 of them. It’s actually 505 due to a technicality. There’s 500 odd stocks in the S&P 500. There’s 12 – 14,000 stocks in the world. Do you really want to invest in less than 5% of the companies in the world? Maybe. But you’re concentrating all of your holdings in large company U.S. growth stocks. There are times when that hasn’t worked out.
We’ve got a slide here that looks at the decade from 2000 to 2010. A lot of people call this The Lost Decade. It’s one of the few times in history that the S&P ended a decade lower than where it started. If you had invested in the S&P 500 in 2000 at the end of the decade, you would have had less money than you started with. In fact, you’d have less money than if you just invested in plain old T-bills. That’s the opposite of what people are trying to accomplish when they’re investing. What you could have done instead was invested in lots of other different kinds of stocks or bonds. There are asset classes out there during that so-called lost decade that were up 50%, 100%, 200%. Emerging markets, small company stocks during that decade were or up 400%. For a lot of investors, it wasn’t a lost decade, provided they didn’t just focus on the S&P 500 and that they were broadly diversified. Now I’m not making a prediction there. I’m just saying that you want to consider where you’re invested and whether or not being concentrated makes sense. There are times when being concentrated on a particular thing might pay off. There are times when it may not pay off so well.
Andi: Mickey has submitted a question and wants to know should I buy a risk parity ETF as an inflation hedge?
Brian: Good question, so what happens with a risk parity? It’s a concept that was really started by a large hedge fund called Bridgewater out of Connecticut. Risk parity refers to the fact that when you buy a portfolio, the stocks have massively more risk than the bonds. Let’s say you are a 50-50 stock bond portfolio and you’re like, OK, I’m diversified, half my money is in stocks and half is in bonds. Because of how much more volatile stocks are, 90% of your risk is probably coming from your stocks. The idea of risk parity is that you want to set it so that the amount of risk generated by each asset class is comparable. There’s a couple of things going on, and it may or may not make sense. For one thing, you need to see if it’s going to get you the return that you want. The goal in investing, the number one goal, is you need to get your required rate of return. That’s the return you need to meet your investment objective. Risk is a secondary characteristic. Risk is bumps along the way. Assuming again, you’re not investing all in one thing where, if you invest all in Dogecoin or something like that, you could have a total loss of principal. You can make a ton of money. If you invest in a broad basket of stocks, you’re probably not going to have a complete loss of principal. You’ll just have volatility on the way. Getting to your destination is more important than the bumps along the way. You need to get your required rate of return if you’re focusing too much on risk parity you might be focusing too much on volatility and not enough on return.
The other thing is that it can be a crowded trade because a lot of funds and a lot of firms have piled into this. What happens is that it’s kind of a small door and they need to, based on calculations, rebalance just in order to maintain parity. Every firm that’s doing it has similar calculations of when it needs to rebalance. What happens is that when a trade needs to happen, like you need to sell some bonds, buy some stocks and a risk parity strategy or something like that. There’s a lot of money moving in one direction or another. You can see where these quantitative strategies tend to break down sometimes. It’s something to perhaps consider for a small slice of a portfolio, but it’s not necessarily something I would want to do for all my money.
Andi: “Can stocks keep going higher?”
Brian: I talked about this a little bit, I’m not permeable. I’m not somebody that says the sky is always blue. The reality is stocks in the United States, and in a lot of places, are somewhat overvalued or at least fairly valued. They’ve gone up quite a bit. It’s hard to argue that they’re cheap. Stocks go up over time. Look at this chart of the Dow. Since 1900. I’m using the Dow because it’s got the longest history series and you see that just goes up and up. There are bumps along the way. But how many times would the outlook have been bad? Would there have been negative news on the horizon? Would you have looked and said, Oh, you know what, I can’t take this anymore. I’m going to get out. The reality is that over time, stocks go higher, and if you try to sit out of the market, you’re fighting a rising tide. While I do think that could be a bumpier year in 2022 than what we’ve seen in2021. There are certain sectors, certain companies that are probably overvalued. A broadly diversified portfolio, over 3, 4, or 5 years, will probably do OK.
Andi: As a reminder, if you do have questions for Brian, you can just type them into the chat. We have a number of them. We’re going to do our best to get through as many of those as we can. I’m going to hit some more of those right now. The next question is from Ella, “The U.S. markets have beat international for a while now. Will that eventually change?
Andi: (laughing) Do you have any more comments on that?
Brian: It’s a softball, you can ask me, is the market going to go down or is the market going to go up? Yes. I mean, the answer is yes. At some point, international markets will outperform U.S. markets. This is a painful topic, Andi. Ella, I appreciate you bringing it up because I feel a little bit like a baby seal because here at Pure we’re global investors and we believe in international markets as well as the U.S. Over the last several years, it hasn’t necessarily been the best place to be. Now, last year, 2020 emerging market stocks did great. It was a really good investment. Broadly speaking, emerging market stocks haven’t kept pace over the last decade. International developed countries like Japan, Australia, Canada, Europe haven’t done nearly as well as the U.S. There’s probably a lot of reasons for that. One that I would point out is that if you look at the companies that have really dominated markets in the last handful of years, they’re very large technology companies and technology in general. When you look at the weighting of technology in the United States versus international markets, there’s a lot more tech companies in the U.S. indexes than abroad. That probably has something to do with it. If we see sector rotation where tech takes a pause. We’ve been seeing that lately with fears of higher interest rates, where people worry about the impact of that on technology companies. So they’re selling some of them and some other sectors are outperforming. I think all else being equal, that would help the international markets. I do think at some point international markets will beat the US. It’s history. If we look at a long term chart, you would see long cycles where the US outperforms the international. In the 90s, the US outperformed. In the 2000’s international did much better. In the 2010’s the U.S. has done better, so we’ll see. It’s important to remember that A-you’re diversifying but B-there are great companies abroad that you don’t get exposure to if you’re invested in the United States only. Companies like Alibaba or Tencent or Samsung or Nestlé or Toyota, none of those are based in the U.S. If you’re only investing in the U.S., you’re missing out on a lot of great companies, as well as a lot of dynamic economic growth and a lot of regions of the world. Also Covid’s been a global pandemic, obviously, and different countries have had different responses and different case rates. I’m not a doctor and I have no idea how it’ll develop around the globe. I do know that different countries are going to go in and out of these COVID cycles at different rates. As we see that, there’s going to be winners and losers, and I don’t know that there’s a guarantee that the U.S. will be the best country coming out of COVID. As far as solving the problem relative to other countries.
Andi: That is actually one of the other questions that we have. This one is from Christine, she says “We’re hearing a lot now about the omicron variant. What does a COVID surge mean for the financial markets?”
Brian: I don’t know. It’s such a touchy subject. People have really strong views on one side or another. On the one hand, if you look at it, I saw new mask restrictions coming in California because the incidence of COVID went from 9 per 100,000 to 14 per 100,000. On the one hand, that’s a 50% surge in COVID cases in California. That’s the glass half empty. The glass half full still means that 99.99% of people in California don’t have COVID. How do you look at these things? I don’t think a surge, at this point with vaccines, of COVID is going to impact financial markets in the long run. Unless it mutates and it turns into something that has a much higher mortality rate or something like that. What I do think will have an impact is more government responses to COVID and depending on how tight restrictions on daily life are and stuff like that. I think that could have an impact. What I think we’ll see is similar to the original pandemic. We see these sharp sell offs, whether it’s omicron or Delta. People step back, reassess what the true incidence rate is, what the true mortality rate is. Then they start looking around for sectors that are going to benefit, depending on what kind of environment we are coming out of. We’ll see more sector rotation and more volatility in 2022 as opposed to a complete collapse of markets.
Andi: The next question is, “What are the most common mistakes, that you see, people who manage their own investments make?”
Brian: This is an easy one. I mean, it’s not an easy one because there’s probably a ton of different answers I could give. A lot of what we’ve been talking about is volatility and markets and these unknowns. I was an institutional portfolio manager and managed money for these really big foundations, hospitals, trusts, municipalities. Hundreds of millions of dollars and they’d have an investment policy statement. It would say, you know, whatever, I’m 50/50 stocks, bonds. In that 50% stocks, I want 30% in the U.S. and 20% international or whatever the numbers are. Then based on being bearish or bullish on a particular sector or what’s going on in the world. We might make a change if we thought stocks were going down, we might underweight stocks. If we thought the US was going to do better, we might overweight the US relative to international. We would go overweight by 3% or 2% or 5% or something like that. We were using our best judgment in order to put into play views on what was going on, but we weren’t making wholesale changes. The reason we make wholesale changes is because we realize that it’s impossible to accurately predict the future. We realize that uncertainty is always there. The only people that have seen the end of uncertainty in their lives are dead people.
The world is uncertain. It’s always the case. In 1962 we had the Cuban Missile Crisis. Kids were hiding underneath their desks thinking that was going to save them from nuclear Armageddon. Russian generals had orders to fire nuclear weapons at the United States if U.S. troops set foot on Cuba. We were that close to nuclear holocaust. The Dow was at like 400. Today it’s at like 35,000. There’s been a lot of uncertainty in that time back then and in the in-between. Yet markets have persevered. The people that have profited are those that have stayed invested, maybe made small tweaks along the way. The people that have suffered are those that are getting in and out and making wholesale changes. The biggest mistake I see people make is having too much conviction in their views, whether that’s fear, greed. The biggest change for that and the easiest change is to have an investment policy statement. Have a written plan in place based on your required rate of return and then invest appropriately. If you have a view, maybe put it into action, but in a small way, don’t make a wholesale change.
Andi: Our next question is actually “What is going to happen with my taxes?”
Brian: This one’s easier than talking about the markets, Andi. If we did an audience poll, I would guess that probably 75% of people think taxes are going higher. They would be right because the way that the tax law is currently written, taxes are scheduled to go higher after 2025. In a few short years, taxes are going to increase as the 2017 Tax Cut and Jobs Act sunset. If Congress does nothing, taxes will go higher. If Congress does something, I don’t know, Andi, what do you think? Do you think Congress is going to act to lower taxes for most people?
Andi: No, I would imagine actually at this point that taxes are going to go up for the highest income earners and that they’re probably going to stay essentially the same for the lowest, but the tax brackets are, are they supposed to be going up in 2026 anyway?
Brian: Yeah, exactly. Tax brackets are scheduled to go up. If Congress does something, I would agree with you. It’ll probably be to raise taxes on certain income earners. Over time, if you just look at both the demographics of the country, our fiscal position as far as debt, our overall tax revenues and then the political climate of the country. I think in all likelihood, taxes are going higher for some people and staying the same for others. I don’t see taxes going lower, so it’s about what steps can you put in place? For those of you familiar with us, you know that a lot of times we reference the tax triangle. That’s basically that in retirement, you have three different pools of money that you can pull from. There’s a tax free pool, a taxable pool and a tax deferred pool. Each of these is treated very differently. The assets in the tax free pool, as they grow, that money that you put in, as well as gains, can come out tax free. Although you didn’t get a tax break for putting money in, and there are rules and restrictions on putting money in. The taxable pool is the most flexible, but it’s also the only one where the taxation of it can vary widely, depending on whether you get the special long term capital gains rates or whether it’s taxed as ordinary income. The tax deferred pool where a lot of people concentrate their savings, which seems like a really good idea to get the instant tax break when you put the money in. The problem, though, is that when you do that, you end up in partnership with the Internal Revenue Service. Because your money grows, their money grows and over time, their slice of what you have is increasing. When you take money out, it’s taxed as if you are at work. If you want to live a similar lifestyle in retirement, you wind up in the same or higher tax bracket. What we’ve discovered is that if for a lot of people, the key to a successful retirement is A-getting that required rate of return, setting up a portfolio they can live with and then B-placing appropriate assets in these different pools, navigating the insanity around the different rules and regulations and the constant proposals we’re getting from Congress around who can and can’t contribute to these accounts in order to make sure that you’ve got tax diversification going into retirement. If taxes do go higher, you’re still OK, you’ve got control over your future.
That’s something that we do a lot of. One of the things that we do is that we offer free financial assessments. For anybody that’s attending this, we’re jammed, we’re meeting with hundreds and hundreds of people a week. All of our thousands of clients are coming in this time of year because of taxes. But for those of you that want to do a free financial assessment, we’ll do everything we can to squeeze you in before the end of the year. If you want to take a look at what your taxes look like, whether or not, potentially you should convert from that tax deferred account for that tax free account. Whether you should make an after tax contribution, a backdoor Roth to your IRA or something like that before the government potentially eliminates the ability to do that starting next year. That’s one of their proposals. If you want to do a free financial assessment, no cost, no obligation. I know that there’s a free offer at the end of this for people that attended. Feel free. Go on their request. You can meet with one of our certified financial planners. They’ll spend a couple of hours with you. Take a deep dive. They’ll have our in-house CPAs look at your tax situation. The investment team here will take a look at your investment portfolio. Give you some thoughts on that. Again, no cost, no obligation. We’re jammed, we’re slamming. We usually charge a couple hundred dollars an hour to meet with people. We waive that for those of you that have attended this webinar and we’ll meet with you, give you a free financial assessment. Kind of give you a half dozen ideas on what you can do from a cash flow perspective, heading towards retirement or saving for retirement. From a tax perspective, either as you’re accumulating or as you’re distributing on your investment portfolio and whether you’re properly insured. If you want to do that, if you want to try and get in, we’ll do everything we can to squeeze you in here before the end of the year. We might need to be a little bit flexible in scheduling up if we’ll do what we can and then, if not, then we’ll meet with you in the new year, but reach out. Like I said, we meet with hundreds of people a week to go through these and there’s a ton of value. No cost, no obligation.
Andi: In the meantime, we have got a couple of more questions that have come up. We’re going to do our best to get to your questions. If you did not get your question answered today or if Brian doesn’t answer it momentarily. You can always email us or call us at either of the email or phone number on screen to get your questions answered.
So next up is from Kate. “Is there a recommended percentage of assets that should be in the three categories of taxable, tax deferred and tax free when nearing retirement?”
Brian: I tell you what, as far as retirement, if I had a dollar for every time I’ve been asked that question, I’d probably be retired. It’s a really good question, Kate. The answer is no. Unfortunately, it would be great if there was a simple formula. You want enough money in your taxable account to give you flexibility because that is the most flexible pool. Then you want to make sure that you get enough money out of that tax deferred account to minimize your future taxes. What you need to do is map out your cash flows year by year, income expenses, etc. That will show you your future tax brackets. Then you can model out how much to convert or how much to contribute to the various pools to see at what point you keep your tax bracket in the future reasonable. The other thing you don’t want to do is to convert so much now that you pay more in taxes now to pay nothing later, that may not make sense. The idea is not to get every dollar out of the, let’s say, the IRA. The idea is to get enough money out to give you control, flexibility in your future tax. That’s going to be individual based on mapping out your cash flows and your future tax brackets, as well as some assumptions around your rate of return during the intervening years.
Andi: Ron says “Is it risky to have 7 or 8% of my portfolio in my company’s stock?”
Brian: Ron, that’s a really good question. The answer is it depends. 7 or 8%, is probably OK. It really depends on what your overall net worth is. What your finances would look like If, let’s say, your company went under and your job went away and you lost the value of the stock. 7 or 8%, is probably OK. Where we start to get worried, in general, is for an individual position if it’s north of, let’s say, 5%. Then if you work for the company, let’s say if it’s north of 10 %, I think at seven or eight, you’re probably OK.
Andi: OK, Jason says, “Regarding withdrawals, do you recommend varying where to pull funds from depending on the market, for example, lower withdrawals or pull from cash? If the market drops significantly or pull from stock funds if the market is up significantly?”
Brian: It’s going to be a little bit individualized for each person, but I think broadly speaking, you’re on the right track there. The reason you have these different asset classes is so that you’ve got flexibility around where to pull. Let’s say again, I keep using just 50/50 for ease of calculation. If 50%, say 50% growth, if the growth is up, you want to rebalance. You take the distribution from there and you rebalance at the same time, killing two birds with one stone and vice versa. I think broadly speaking, that’s on the right track.
Andi: I think we’ve got time for one more question. This is from Jim. “You always mentioned that the best portfolio to have is a globally diversified portfolio, but don’t give examples of what that looks like and why. I know it varies by person. So are there specific recommendations that you would make for what a globally diversified portfolio looks like?”
Brian: Good question. It depends on how you want to look at the global universe. I mean, you can go by what different countries’ share of the economy is. What’s their share of the stock market or global indexes? We look at this a lot. We looked at it maybe six or nine months ago and took a deeper dive again into whether or not we want to make any changes. You can make an argument for anywhere from, let’s say, 20% international up to; you probably can make an argument for 75% international. Personally, we don’t go that high. We range, let’s say, from 15-20% international to about 40% international within our overall portfolios. The truth of the matter is, it leaves us overweight in the US. If you look at most global benchmarks, the reason is that most of our clients live in the United States. They spend their money in the United States. There’s that home bias that makes sense. The other thing is that people in general are a little bit less comfortable with international investments. The more comfortable you are with your portfolio, the more likely you are to be able to stay with it. Obviously, that’s the job of us as financial advisors. But if you’re doing this on your own, you want to make sure it’s a portfolio you can be comfortable with. If you start to tilt much beyond, let’s call it 40% international, you might start to see so much divergence from the S&P or the Dow that you’re seeing every day that you can’t stay the course.
AndI: Thank you very much, Brian, for taking the time to do this today.
Brian: My pleasure, Andi., as always. Always great to do this and hopefully the folks out there who got a little bit of a good recap of what’s been really just a crazy year. If they want to, like we said, take a deeper dive on their particulars, we’ll do that in their free financial assessment.
We’ll certainly be back in the new year with an outlook for what I suspect will be an equally crazy 2022.
Andi: If you do have any further questions, you can email us at info@PureFinancial.com or call 844 fee only. That’s (844)333-6659. Brian, thank you so much. Have a great rest of your day. Take care.
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