Client Newsletter 4Q23
Dear Ambassador Family,
It’s the season of change! We have officially welcomed Fall and completed our merger with Charles Schwab. My team appreciates your patience as we continue to make sure everything is in good order.
You are now able to log in and view your accounts through Schwab Alliance. If you have not already set up your credentials, I encourage you to do so. Visit schwaballiance.com, select New User, and then follow the prompts.
Investment Update
Since the last quarter, our stance on your investments has remained essentially the same: defensive. After posting a strong rally in the first half, equity markets stalled in the summer and have fallen in September. High valuations, bubbly technical factors, and questionable earnings prospects in a slowing economy hurt stocks. Higher interest rates and risk of rising inflation also provide headwinds. Your investments are positioned in a large chunk of T-Bills (minimal credit and low interest rate risk), liquid alternatives (equity long/short, merger arb) with smaller amounts of commodities and equities (mainly US, small emerging market).
Not All Coupons Are Created Equal
A major change over the last year has been an increase in interest rates offered on different investments. Our newsletter from a year ago highlighted emerging opportunities in select high coupon, low credit risk fixed income that we had not seen in previous years. Since then, yields on corporate bonds, preferred stock, bank CDs, and annuities have also risen.
The question remains: does all that glitters equate to gold? We have written an extensive guide that explains why all that glitters is not gold.
We would caution investors not to chase investments simply because they advertise a high yield. Credit risk (“Will they actually pay you back? Are they paying you a competitive rate relative to similar borrowers?”) and interest rate risk (“How will this investment look if markets raise/lower overall rates?” are key factors to consider.
Liquidity is another factor. If you need your principal sooner, how long would it take for you to get it out?
Each investment has specific risks. Bank deposits insure up to $250,000 in FDIC insurance per depositor. But what if you have more money to invest? CDs penalize you on interest earned for early withdrawal before maturity.
Annuities advertise the opportunity to lock in rates for a longer time. Yet, they come with high costs and limited liquidity (surrender charges, minimum withdrawals) over many years. What if you need your money sooner?
T-Bills have minimal credit and interest rate risk. The main risk is if the Fed were to begin cutting interest rates; yields then might fall.
Preferred stocks offer high yields, but they face price risks depending on what both stock and bond markets do. Additionally, if the issuing company faced bankruptcy risk, bondholders would get paid before preferred share investors.
The IRS has introduced new rules for inherited IRA accounts, potentially resulting in higher taxes for heirs who don’t comply. When you inherit an IRA, you used to have the option to stretch withdrawals and taxes over your lifetime. But the 2019 SECURE Act changed this.
Now, it depends on the type of IRA. If you inherit a traditional IRA after January 1, 2020, you have two choices: take all the money at once with taxes, or withdraw it within ten years, paying taxes as you go.
The SECURE Act also sets rules for withdrawals, and if the original owner didn’t take the required minimum distributions, you might face penalties.
If you inherit a Roth IRA, there are generally no taxes or minimum withdrawals for ten years, but this applies to non-spouse heirs. Those who inherited an IRA before 2020 can stick to the old rules.
Estate taxes may also apply if the estate is worth more than $12.92 million in 2023. Beneficiaries can get a tax deduction for estate taxes paid on traditional IRAs, which can offset their IRA-related taxes, even if they didn’t pay the estate taxes themselves.
The Myth of Compound Market Returns and the Reality of Why Timing Matters
When the stock market is doing well, you are likely to hear about “compound market returns.” This concept is often used to convince regular investors to put their money into Wall Street’s hands. But what exactly is it, and is it as great as it sounds?
The idea of compound market returns is based on the belief that the stock market always goes up, making it a good time to invest no matter when. You might have seen charts that suggest if you had invested 120 years ago, you would have earned a consistent 10% annual return (8% after inflation).
However, the problem with this rosy picture is that most people don’t have 123 years to invest. We need to focus on the time we actually have.
For most of us, retirement is not so far away. Many people I know say they have at most around 15 years. This is quite different from the 30 or 40 years often suggested by financial advisors.
Many people don’t start saving seriously for retirement until their mid-40s. By that time, they’d graduated, found a job, gotten married, had kids, and sent them off to college. So, they only have about 20 to 25 productive working years before retirement.
Another factor is Stock market valuations, which go through cycles of highs and lows. When valuations were high in the past, the market didn’t perform well until those high valuations came back down.
The key point here is that when you start investing is critical to your financial future.
Now, let’s address the second myth: “Compound Market Returns.” Albert Einstein famously said, “Compound interest is the eighth wonder of the world.” But he was talking about interest, not stock market returns.
Popular sources have used this quote to encourage people to keep putting money into the stock market consistently, assuming an 8% annual return. They claim compounding will make your money grow.
However, there’s a big difference between actual returns from the stock market and an average or compound market return. Stock market returns are unpredictable and can vary widely from year to year.
In reality, compound market returns are a myth. Market downturns can have a severe impact on your investments, especially if they happen when you’re close to retirement. You might be able to recover lost money over time, but you can never recover lost time.
With current high valuations and interest rates, there’s a real risk of another market downturn. Investors need to be realistic about their future returns and the time it takes to reach their financial goals.
- IRAs can be complicated and confusing. These are 10 common pitfalls.
- Qualified Charitable Distributions (QCDs): QCDs must be categorized properly when the distribution is made.
- Participating in Multiple Work Plans: You can contribute to multiple work plans at multiple employers as long as you stay within the combined limits.
- IRA Deductibility Phase-Out: Your ability to deduct IRA contributions depends on your work plan coverage, not your income.
- Rolling Roth 401(k) into Roth IRA: This involves many factors like age and account history.
- Inherited Roth IRAs: Eligible designated beneficiaries (EDBs) can stretch RMDs; everyone else must follow the 10-year rule.
- Pro-Rata Rule/Backdoor Roth: The IRS views all your retirement accounts as one, affecting taxability during conversions.
- “Not-More-Than-10-Years-Younger” EDB Rule: Anyone not more than 10 years younger can be an EDB on your IRA.
- Roth IRA Distribution Order: Contributions, conversions, then earnings. Always in that order.
- Trust or Estate as IRA Beneficiary: Setting up inherited IRAs for trust or estate beneficiaries isn’t automatic.
- Roth 5-Year Rule: You cannot withdraw earnings tax-free until 5 years after your first contribution.
Beware of Smishing: A Sneaky Cyber Threat
Smishing, a blend of “SMS” and “phishing,” is a real cybersecurity risk. It can happen through text messages, WhatsApp, or other social media chats. Attackers send mass messages with a sense of urgency, aiming to trick recipients into clicking malicious links. Once lured in, victims may end up on fake websites where their personal information is stolen. Be aware of bogus messages posing as trusted banks or financial institutions
Sincerely,
Petr Burunov, CFP®
President / Wealth Strategist