Considering how to thank the people that helped you get through this year? Here are some ideas in the updated holiday gift guide from our sister site, WokeMoney.
Investing has changed as times have changed … financial planning rules need to change too
In the past, when asked by a client about adding principal payments to reduce mortgage debt, so that the mortgage would be paid off sooner, I advised them to invest that payment instead.
That advice was based on the financial planning rule that you do not pay off debt when the after-tax cost of the debt is less than the after-tax return on the investments. Instead, you use cash flow to add to the investment because this is how you increase your net worth – the total of all investments less all debt – over time.
Also, by not paying down your mortgage quickly, you had the added benefit of not tying up working capital in your home. You cannot sell a bedroom when you need funds for a child going to college.
But that was then … things are different now ….
All components of the financial planning rule need to be reevaluated: Interest rates and inflation are at or near historic lows. The tax law on deduction of mortgage and other interest on debts has changed. The disruption to the economy from the Pandemic has hurt businesses and that will affect future investment returns.
Interest rates – With interest rates so low, the investment return on cash is near zero and the return on bonds is very low. Rates are almost certain to rise, which will make bonds today worth less in the future (when low interest bonds compete against newer bonds that offer higher interest rates, they are re-priced to match the new rate and that decreases what anyone will pay for the old bonds).
Tax deductions – The Tax Cut and Jobs Act made the standard deduction the option for more than two-thirds of taxpayers. With the standard deduction, there is no benefit because the mortgage interest is not actually deducted to lower your net taxes due. That means that the after-tax cost of mortgage debt is no better than the before-tax cost.
Investment returns – to get a better sense of the likely investment returns for that side of the rule, I spoke to Hal Hallstein IV of the Sankala Group, LLC out of Boulder, CO. He referred me to their post on Money Supply & Discount Rates, in which they discuss the impact of stimulus checks and PPP loans in an economy where recipients are likely to invest those funds or make financial purchases because simple consumption, travel and entertainment, has been shut down. They also discuss the threshold return required for making an investment decision, viz. the discount rate. In the post, he states:
But simultaneously, we also know buying bonds with zero yields won’t work for people’s retirements, which realistically require 3% yields. Where does this leave us?
He then presents a rationale for owning gold, an asset he has always avoided, as have I. But now it serves as a protection against a downturn when you have a portfolio that invests primarily in the stock market.
In our conversation, we compared the weighted cost of capital, the blended rate on all your debt, against the expected return from investing, which he pegs at 3.5 to 4.25% over the next decade, due to high equity valuations in the US and low interest rates.*
One note of caution: to get those returns will require tolerating substantial volatility.
All of this leads to the following: if your mortgage is at 3.5%, and you get no deduction value, and your potential return is 3.5% before taxes, on which you will have some tax hit, now or later, then paying off the debt is a better choice financially than adding to your investments.
New planning ideas
When you apply the debt to investment rule above, more people may find it best to pay down debt.
For a mortgage, added to your monthly payment will have a substantial impact over time, cutting the total interest paid. If you have a Roth IRA, it may even make sense to distribute funds to pay a student loan or car loan, depending on the loan interest rate.
There are still some reasons not to switch from retirement investing to debt reduction, such as when your employer offers a match for contributions. For a good set of considerations to review before acting, see the Betterment 5-Step Action Plan.
While the planning rule used to lead to the conclusion that you are best off adding to investments rather than accelerating paying off long-term debt like a mortgage or car loan, the conclusion from applying that rule has flipped. Many will increase their net worth by paying down debt sooner.
I hope you and your loved ones are all managing this as well as you can during the Pandemic.
Thank you, and be well
* Sankala Group LLC’s communications should not be considered by any client or prospective client as a solicitation or recommendation to affect any transactions in securities. Any direct communication by Sankala Group LLC with a client or prospective client will be carried out by a representative that is either registered with or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. Sankala Group LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this communication, or by any unaffiliated third party. All such information is provided solely for illustrative purposes.
Steven A. Branson, retirement, investing, Financial Strategies, debt, discount rate, decision making, newsletter, cost of capital
Keeping in touch during these challenging times …
2019 due dates (tax season is not quite over yet)
The IRS extended all of the following deadlines to July 15th:
- 2019 return or extension filing;
- Payment of 2019 taxes due;
- Q1 2020 estimate payment; and
- Q2 2020 estimate payment.
Most states have followed the same delayed dates (but not all). Let me know if you have a question on payment and filing.
So “tax season” will be over soon, yea!
Stimulus checks and other changes
Many people are asking about their stimulus checks and expanded unemployment benefits under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The Act also has other provisions including tax credits for self-employed affected by Covid-19, student loan payment delays, and relief on mortgage payments and rent.
Of the many posts regarding the stimulus checks and benefits, student loans and 401(k) distributions, here is a good summary from the NY Times.
If you want to check on the status of your stimulus check, here is the IRS website to find the status or apply for your stimulus check. If you expect a check that has not arrived, check out the links in this Huffington Post article.
And if you received a check for a deceased relative (over 1 million were sent!), you need to return it to the Treasury, sorry.
CARES Act includes benefits for small businesses: Payroll Protection Program loans; payroll deposit delays; and tax credits. The SBA funds for the PPP ran out initially, but Congress added more funding.
The key is to file so that the loan is forgiven, so that the funds become a grant. The forgiven loan is not treated as income.
If you need more information on these programs, let me know.
2020 tax law changes
The required minimum distributions or RMDs are suspended for 2020. This way, you do not need to sell funds at a low to withdraw and may even be able to redeposit funds that you already withdrew.
The CARES Act waives the 10% penalty for early withdrawals from qualified plans for up to $100,000 for coronavirus-related circumstances. The distribution is taxed over three years. And, if the funds withdrawn are repaid to the plan within 3 years, that is treated as a tax-free roll over. The act also allows loan from the plan up to the lesser of the vested balance and $100,000.
For 2020, there is an above-the-line charitable donation deduction up to $300. This should help charities that are responding to those impacted helping them raise money now.
More Scams and Hackers
Be wary of messages asking for personal information because scams are on the rise. And be careful working from home, as there are more hacker attempts to gain access via the home connections to companies.
If you want help dealing with any, let me know.
Being cooped up is challenging, even if it is the best way to stay healthy. Make sure you practice self-care so you can handle this!
I hope you and your loved ones are all managing this as well as you can.
If you want to just talk, I would be glad to set up a time, just let me know!
Thank you, and be well
I am reading about the impact of Covid-19 as I push to get all client tax returns completed and filed by the deadline, which may or may not be extended.
Everyone is concerned and I wanted to respond.
These are scary times, both for personal health for you and your family and for your finances. We worry about who will get sick, possibly die, and who will be out of work and have major life changes.
Much of the ultimate outcome depends on how quickly governments respond – “stop everything immediately” contains the infections and thus allows the economy to bounce back sooner, while delayed responses mean many more infections and deaths, with a prolonged, deeper hit to all economies.
On investing, to those who ask, “should I cash out,” my answer is, “it’s already too late, the markets have already gone down far, and even if you had sold a month ago, knowing when to buy back in is so tricky that you would probably be worse off.” The truth is, when so many individual investors ask if it is time to sell, that is often a signal to buy.
Here is an excerpt from a Merrill Lynch research post (credited to Jared Woodard, Derek Harris, Chris Flanagan, Justin Devery and Jordan Young) that I received last week, which crystalizes my experience from the downturns I lived through as well as the downturns I have studied:
Why stay invested?
Not staying invested means missing most of the long-term market upside…it’s simply too difficult to time the market. A strong impulse to hide out in cash is often a sign that a buying moment is near:
• We know that the best days often follow the worst and this has been the sharpest drop into a bear market in history (Chart 3);
• Since 1929, in the 24 months following a bear market, S&P 500 total returns have averaged 20%. Excluding the Great Depression, the average gain was 27% (Chart 4);
• Since 1931, an investor who missed the 10 best days of each decade made 91% in equities. Staying invested meant earning 14,962%;
• In the 2010s, missing the 10 best days meant gaining only 95% instead of 190%;
• Over any 10-year period, the odds of ending with equity losses are just 4%;
Let me know if this helps. And let me know if you want to talk.
Again, I hope you and your family stay healthy!
This is my busy time, working long hours preparing income tax returns, but I wanted to respond to your concerns.
News of the coronavirus spread and its impact on the economy and stock markets is constant.
People ask: “can I get the virus from a package delivered to me from China” (the answer via the CDC is “no”).
As some say, it’s not “if” but “when” in terms of you being in contact. That is upsetting.
At that same time, experts ask us all not to panic. And financial people urge us to stay the course.
If you do not already have a plan, here is a good overview with links to CDC posts on making a plan with your family – NY Times prepare for coronavirus.
As for the stock market, here is a good NY Times piece discussing the rationale for sticking to your long-term investment plan: The Market Is Moving. Most People Should Sit Still.
Here is a more sobering assessment: It’s a ‘Swimming Naked’ Moment: The Financial System Has a Real Test
In the end, if you developed a good long-term investment strategy, staying the course should be the best response as it was in the 2008 financial crisis.
Let me know if you want to talk and I hope you and your family stay healthy!