At the end of last year, the Tax Cuts and Jobs Act of 2017 was signed into law, which would cut corporate and personal taxes beginning in 2018. As a result, companies responded by ramping up spending on their businesses. Together, the tax cuts and spending are expected to add up to about $285 billion in fiscal stimulus to the economy this year. Darrell Spence, an economist at Capital Group, says “the amount of money that’s hitting the economy, not only from tax cuts but also because of the spending bill, is having a significant impact that’s likely to carry on into 2019”. With the U.S. economy now in its ninth year of an expansion, the tax cuts and increased Federal spending have boosted the U.S. economy and given it renewed strength.
Companies spending more money, rising wages, and retail sales that are picking up all point to a U.S. economy that continues to grow. But that also brings our attention to the risk of rising inflation. The economy is doing so well that the Federal Reserve continues to raise interest rates to control inflation. An uptick in inflation could cause the Federal Reserve to accelerate the pace of rate hikes in the next couple of years. This could play a role in determining how long it takes for a recession to develop. However, recent inflation readings are not yet at the level that typically put a drag on equities. The current rate of inflation is about 2.80%. According to research conducted by American Funds, the S&P 500 has had relatively strong gains in the majority of years with as much as 3% to 4% inflation. Additionally, Federal Reserve Chairman Jerome Powell recently noted that the two most recent U.S. recessions stemmed from financial imbalances, not high inflation.
If the U.S. economy is so robust, why aren’t the equity markets reflecting that? Many feel that the only dark cloud over the economy right now is our Administration’s stance on trade and the threat of a trade war with several global players. This has particularly been unsettling for the global economy and has depressed stock prices.
As we are now half way through the ninth year of this bull market, there are a few factors to keep in mind. Yes, equity valuations have risen above long-term averages, but non-U.S. equities continue to be more fairly valued than those of their U.S. counterparts. Besides, rising U.S. corporate earnings will help support continued gains in stocks. Volatility has also begun to return to more normal levels. But as it does, investors who have a systematic, automatic investment plan in place can benefit. It affords the opportunity to buy on market dips, while removing the emotion out of investing, which should pay off in the end. Overall, the S&P 500 index has gone up 16 out of 20 calendar years since 1997. That is why long-term investors can more easily weather market declines.
As we continue to remind our clients, holding a diversified portfolio is always recommended, and even more so now. Bonds, though they offer lower returns, play an important role in a balanced portfolio. They offer diversification from stocks, higher yields, protection from inflation, and capital preservation. When looking as far back as 1987, during periods of market declines of 15% or more, bonds have provided relatively significant positive returns.
THE SEC REPLACES THE D.O.L. FIDUCIARY RULE WITH ITS OWN RULE
In our July 2017 newsletter, we wrote about a new regulatory rule, signed by the previous administration, titled the “D.O.L. Fiduciary Rule”, which was to take effect in 2018. The Department of Labor (“DOL”) rule was to consider any financial adviser who gave investment recommendations to any retirement investor for compensation to be acting in a fiduciary capacity. As a fiduciary, the adviser would be required to act in the best interest of the client. However, there was much uncertainty and confusion surrounding the rule. This rule, in our opinion, didn’t standardize the rules and regulations for all financial advisers and for all clients. Ultimately, the courts ruled that the Department of Labor exceeded its statutory authority in promulgating the rule, which means the rule is now dead.
As a result, the Securities and Exchange Commission (“SEC”) came out with their 408-page proposal for the new Best Interest Rule or “Regulation Best Interest” this April. Their new rule would establish a standard of conduct for broker-dealers and their representatives who make a recommendation regarding any securities transaction or investment strategy to any retail investor. Given the rulemaking process, this new rule is not expected to be implemented until late 2020.
Once the details and requirements of this new rule unfold, we will report them to you. However, our hope is that this rule will have little impact on how we work with our clients and the advice we provide, which has always been in the best interest of the client.
TRADITIONAL OR ROTH—WHICH IS BETTER? (continued from July 2017)
In the July 2017 issue of this newsletter, we posed the above question and compared the differences between the Traditional and Roth for personal IRA contributions. But contributions can be made as either Traditional or Roth in many employer-sponsored retirement plans, as well.
When comparing the Traditional versus the Roth for either a 401(k) or personal IRA, the answer to the question “which type is better” depends on several variables, such as your current and future tax brackets, the amount of time before withdrawals are made, and other assets that are owned and their applicable tax treatment.
Here we will continue the conversation by specifically comparing the Traditional and Roth option in an employer-sponsored retirement plan. The tax treatment is, for the most part, the same whether or not you are comparing the Traditional and Roth in a 401(k) versus in a personal IRA. Contributions to a Traditional 401(k) are made with pre-tax dollars. In other words, contributions are made with monies that have not yet been taxed. Therefore, a current tax savings (for Federal income purposes only) is received when the contribution is made. The contributions and earnings grow on a tax-deferred basis, meaning they are taxed later when withdrawn. Conversely, contributions to a Roth 401(k) are made with after-tax dollars. There is no tax savings when the contribution is made. Instead, contributions and earnings are tax-free when withdrawn.
Other than the tax treatment, there is little difference between the Traditional and the Roth 401(k). The table on the next page compares both options in the employer-sponsored retirement plan.
|ROTH 401(k)/403(b)||TRADITIONAL 401(k)/403(b)|
|Current Tax Savings||None||Contributions are pre-tax and reduce taxable wages (for Federal income tax purposes only)|
|Tax Benefits||Tax-Free Growth||Tax-deferred growth|
|Taxation at Withdrawal||Withdrawals of after-tax contributions and earnings are tax-free if "qualified" (made at least five years after the first contribution and after age 59-1/2, death or disability||Withdrawals of pre-tax contributions and earnings are taxable when distributed|
|Eligibility Age||None; other eligibility is usually based on length of service with employer||None; other eligibility is usually based on length of service with employer|
|2018 Eligibility Income||No Limit||No Limit|
|2018 Maximum Annual Contribution Limit||$18,500 (plus $6,000 if you are age 50 or older) for both plans or 100% of compensation, whichever is less|
|Mandatory Distribution Age||Age 70-1/2, unless still actively employed and participating||Age 70-1/2, unless still actively employed and participating|
|Penalties||Withdrawals before age 59-1/3 and five years are subject to 10% early withdrawal penalty, unless an exception applies||Withdrawals before age 59-1/2 are subject to 10% early withdrawal penalty, unless an exception applies|
One other important component of the 401(k) offered by an employer (as compared to a personal IRA) is the possibility of employer matching. In a “safe harbor” 401(k) plan, the employer is required to match your contributions to either the Traditional or Roth with their own money. Please be aware, however, that any employer matching is made with pre-tax dollars, including with the Roth 401(k) or Roth 403(b). The amount the employer will match is according to the Plan they implemented. The most common (and minimum) match is 3% of compensation. Because employer match is free money, it is advisable to participate in your employer-sponsored retirement plan, if possible, when a matching is offered.
Like the Roth and Traditional personal IRAs, if you are in a higher tax bracket now than you will be during retirement, the Traditional IRA may be the better option for you. However, the Roth is a very attractive option to consider, especially for younger individuals who have more time to accumulate tax-free earnings. For more information or to discuss which of the two might be better for you, consult your tax advisor or call our office.
WHAT’S YOUR RISK NUMBER?
We recently implemented a risk alignment platform into our practice designed by Riskalyze. This platform is built on a 2002 Nobel Prize-winning framework that mathematically pinpoints your comfort zone for downside risk and potential upside gain by determining your Risk Number. We then compare your number with the Risk Number associated with your portfolio to make sure both are aligned.
While there is no assurance or certainty that any investment tool or strategy can protect against loss or guarantee a profit, the results obtained from using the Riskalyze platform have been enlightening. To get started, visit our website at www.horizonfinancialadvisors.com. Click on RiskNumber on the Home Page. It will direct to you a page where you can watch a video about the process or just click the “Free Risk Analysis” button to begin the questionnaire. There is no charge for this analysis. Once you complete the questionnaire, we’ll call you to discuss the results.
We are excited to introduce Riskalyze to our clients in order to maximize the service we provide. Whether you just opened an account with us or have been with us for many years, we encourage you to take the questionnaire. If you have questions before or while answering the questionnaire found on our website, just give our office a call and ask for Laura or Mike.
COMING SOON—A NEW LOOK FOR OUR WEBSITE
Later this summer, you will see that our website has a fresh, new look. The new site will provide you with mobile capability, as well as access to various financial calculators, our newsletters, links for easy access to logging into your accounts and policies, and the Riskalyze risk assessment tool. And we’re already looking at technology to further enhance the site. For example, the addition of a client portal would allow us to more easily share information with clients in a confidential, secure manner. As a reminder, it’s not safe to send us anything that contains confidential or personal information via normal email channels. It should be submitted through our secure email portal, which is very easy to do. Just call our office for access to the secure email portal.
Visit us at www.horizonfinancialadvisors.com later this summer and let us know what you think of the changes. Encourage your friends and family to do the same to learn more about us.
Sources: American Funds/Capital Group, Marketwatch, Hays Advisory.
Disclaimer: The opinions expressed herein do not necessarily reflect those of Trustmont Financial Group/Trustmont Advisory Group. Additionally, the information contained herein has been obtained from sources believed to be reliable but the accuracy of the information cannot be guaranteed. Lastly, reference to any product, service or concept in no way implies that it is suitable for everyone. There may also be risks and costs associated with any product, service or concept mentioned herein. Where applicable, a prospectus should be read for complete details. The material presented here is neither an offer to sell nor a solicitation of an offer to buy any securities.