Author Archives: c10627327

Cause and Effect

Something we tell all prospective clients is we will never ask you to break something so we can fix it because our experience lends to a good understanding of the cause and effect of doing so. We don’t need or want our clients to sell investments, close accounts, or fire other advisors that are working efficiently for them and fit well with their short and long-term strategies. When we identify relationships and areas that have a place in the plan, we don’t have to bash these other firms or advisors to make ourselves look better.

I know I don’t have to tell you this is not the case in many places.

Generally speaking, one of the ways the financial institutions make money is by moving ours around. So, many advisors are trained and compensated to convince clients that the other investments and relationships they have are bad, and the client should break them, so they can fix them. It’s an everyday occurrence and millions of people end up paying taxes and fees they didn’t have to as a result. Cause and effect.

Here’s an example on a larger scale. American and foreign politicians have weakened their currencies in an effort to make the goods and services they export to other countries more competitive. This too is a very common sales practice. Sometimes openly; other times more subtly.   When the dollar is weak compared to other currencies, the goods American manufacturers export to the country with the weaker currency become cheaper relative to the same product produced domestically. There is a trade-off, naturally. There is with every financial decision. To make the dollar weak, the Treasury can borrow and spend more, or cut taxes, which by design, causes inflation. Cause and effect.

Then of course, there are the effects from changing trade policies—expected and unexpected. Over the past couple of weeks, the Argentine peso and Turkish lira have crashed, putting pressure on emerging markets worldwide. When trade policies impact the Gross Domestic Product in other countries, they have to take steps to support their currencies and exports. Cause and effect.

One of the biggest problems, in my humble opinion, with our current political and economic structure is that politicians can hold their seats in government for long periods, and transition to comfortable positions in the industries they have curried favor with in their policy implementation afterward.  This engenders very short term thinking as the sole focus becomes re-election in the next cycle.

Most financial or policy decisions we make, good and bad, have intended and unintended consequences. Shortening the term for the cause dramatically increases the likelihood of more, and worsening, unintended effect.

I think sometimes the best way to help is by giving credit where it is due and leaving things that are working well alone, to continue working well.  Even if it doesn’t provide an immediate gratification of one sort or another.

Labor Day Knowledge

Labor Day is a creation of the labor movement dedicated to the social and economic achievements of American workers. It’s a yearly tribute to the contributions workers have made to the economic strength and defense of our country.

During the peak of the Industrial Revolution, work conditions were pretty grim.  Twelve-hour days, seven-day work weeks, kids operating machinery no kid ever should, and generally exploitative situations for all but the employers themselves.

Historians disagree about who to attribute the concept of Labor Day to but suffice to say it took years of organizing, and surely a lot of pain and suffering, for employees to band together and demand and win basic protections. It’s also worth noting that our constitutional rights, and the very spirit they were written in, are what allowed these brave people to organize in the first place, making Labor Day a uniquely American holiday.

This introduced a period of unparalleled expansion of equality and the birth of the middle class.  This period also saw two World Wars fought primarily by laborers and tooled by a united and eager labor force, on all sides.  To be sure, there were also employers who made sacrifices, willingly and otherwise, to fund those wars, and some who profited significantly from them as well.

Years later, technology advanced and afforded employers the ability to transfer labor costs to other, less organized countries.  American worker incomes stagnated, that new middle class came under pressure, and with the aid of our own government, American Corporate interests made foreign workers in those emerging countries the exploited.

The perception of Labor Day, and that of organized labor itself, has changed over the years.  The causes of those changes are too many and complex to cover in a simple personal finance blog like this, so I won’t try.  Rather, I’ll close with a quote from The Department of Labor itself;

“The vital force of labor added materially to the highest standard of living and the greatest production the world has ever known and has brought us closer to the realization of our traditional ideals of economic and political democracy. It is appropriate, therefore, that the nation pays tribute on Labor Day to the creator of so much of the nation’s strength, freedom, and leadership — the American worker.”

Have a safe, relaxing, and enjoyable Labor Day weekend all.

The Inverted Yield Curve and You

One thing Republicans and Democrats generally agree upon is the importance of avoiding interference with central bank policy. If central bank leaders are politically motivated, they will naturally tend to implement policy that stimulates the economy leading up to elections, which causes high inflation and unfair political advantages.

It’s also worth mentioning that the outcome when they have interfered has been pretty horrific. Two examples? Richard Nixon nominating Arthur Burns as Fed Chairman with instructions to loosen the money supply, leading to the runaway inflation of the late seventies. And Treasury Secretary Robert Rubin influencing Alan Greenspan to lobby Congress to let investment banks keep their derivatives trading completely unregulated, leading to the global financial crisis.

Last week Donald Trump sent tweets indicating his disappointment in the Federal Reserve’s policy decision to raise interest rates, raising question over whether he’ll take steps to erode the Fed’s independence. I’ve been talking about how and why interest rates will go up for a while now (years in fact). But it seems to me that until now, retail investors, and even many institutional investors have been either oblivious to or selectively distracted from what is happening in the bond markets. With the President tweeting about it, ignoring this situation will not be an option any longer, and investors will be forced to take notice.

Additionally, Fed officials may well decide to continue raising short-term rates in an effort to maintain the appearance of independence, which in turn could raise inflation concerns among bond market participants, leading them to sell, putting upward pressure on rates. In other words, calling attention to the issue will likely exacerbate the very thing he’s expressing dissatisfaction with.

Short-term interest rates, the ones the Fed has greater influence (not complete control) over, started creeping up back in 2013 when the Fed announced it intended to “taper” it’s quantitative easing action, that it began as part of their efforts to revive the economy after the GFC (Global Financial Crisis, and yes, it deservedly has its own acronym). The yield on the two-year Treasury Bond went from a quarter of percent to over two-and-a-half percent over the last five years, with the sharpest increase coming from November last year until now. Long-term rates, which the Fed has far less influence over, have increased too, albeit at a slower pace, leading to a flattening yield curve.

I find again and again in conversations I have in our business that people believe the Fed has complete control over the interest rate marketplace. It’s understandable because messages the Fed and the media send say as much. And as I say, the Fed does have significant influence over rates, but they do not control them. The collective sentiment, or more specifically, perception of risk, of bond investors, dictates the direction and volatility of the interest rate market. When bond investors perceive greater risk to lend, they sell, and/or demand higher interest for what money they do lend. And with the amount of debt outstanding at the government, corporate, and consumer level, the perception of risk is bound to increase sooner or later.

You see, in the end, market stability relies entirely on a little thing called trust. In an age when trust in institutions is crumbling, politicizing the most influential central bank in the world is not likely to instill greater confidence in bond investors. Somehow this dynamic appears to be lost on the President.

Beware the Hooks

When my kids were little we watched a lot of SpongeBob SquarePants—so much so that my now 18-year-old still calls up references to it in everyday conversation. SpongeBob aficionados will get this reference.

It is just a cartoon, but the subtle messages are often very deep and very real. I tell you all this upfront because the tone of this post takes a darker turn and I don’t want my reference to a cartoon to trivialize the matters herein.

In this episode, the main characters (small underwater sea creatures) find themselves in a field where human fisherman on the surface above have cast their lines. Grabbing “The Hooks” results in a sudden, adrenaline fueled “ride” to the surface, where they can let go, and drift slowly and safely back down to the bottom. But only if they let go before being pulled out of the water.

The symbolism should be apparent now. “The Hooks” in real life take so many different forms it’s difficult to know exactly when we’re being lured. From the slower, more insidious dietary or overspending variety that could kill us or drive us to bankruptcy, to the more sinister, and immediately threatening, illicit and dark. While we may not be completely conscious of the lure, at some point soon after we begin thinking about grabbing the hook, our instinct tells us we should turn away from it.

When a celebrity dies, especially at a young age by taking their own life, we all mourn publicly in social media because, in a small way, we knew them. When that friend from years ago dies too young from their vice, again, we mourn. Succumbing to temptation is human, and so are the feelings of shame and self-degradation that stem from it. Of course, this doesn’t always lead to suicide or death. But it can. Some might argue that thoughts of suicide themselves are a form of temptation. Non-celebrities die from overdose, war veterans commit suicide, and we all play on the hooks. Every day.

We eat the garbage, take the drink, gamble, or just spend the money, when deep down, we know when we shouldn’t. The gleam of the pointed barb underneath that enticing lure warns and hypnotizes us at the same time.

You might say I’m stretching here. This is a personal finance blog after all, and I’m talking about personal vice. Two counter points to this claim. First, there are no lawyers on a broker dealer payroll scrutinizing everything I say. So it’s my blog and I’ll write what I want. Second, I’ve played on the hooks all my life, and while I may rationalize and live in denial about my own, I immediately recognize when one of our clients is playing on them. Money is emotional, and yes, the money hooks do lead to suicide or death for some.

In fact, much of what concerns our clients and leads them to our door in the first place can be traced back to the hooks. One of our primary responsibilities is listening to what concerns them. After we’ve done that, we give them an honest read back of what they’ve just said to us. I am not afraid to tell a client when I recognize the situation, and sometimes my telling them to beware the hooks is enough to convince them to turn away. Not always, but sometimes.

Whatever your personal hook might be, there is no debating one fact. There will come a time when you are open to a message from within or without that you need to stop. Or there won’t be, and you’ll be hooked forever. Being open is the key phrase in that statement. So open yourself to that message. And beware the hooks lad. RIP Cubby.

Tax Returns: Your God-Given Right as an American

Recently CBS Sunday Morning published a story on the idea of automating the preparation of our tax returns. This is not a new idea. I hope it never becomes law.

Sunday Morning interviewed a Stanford professor named Joseph Bankman. Bankman developed a program designed to have the systems already in place pre-fill our tax returns to save us all time, stress, and in an ideal world, money. He tried, through California’s legislature, to make this program (or one like it) the way Californians file their tax returns, but the effort failed thanks to opposition from corporate lobbyists.

If you’ve read any of our other posts in this blog, you’ll know I’m not one to defend big corporations and their lobbying efforts. But in this case, they make a valid point. They declined a request from CBS for an interview, but offered a statement: “Self-determination powered by an individual’s active participation in the tax preparation process is the backbone of the American tax system.”

That might sound a little hokey, because it is. But truthfully, there is nothing more American than the privilege of calculating your own tax liability and telling your government know how much you owe them, rather than the other way around.

Some countries, like Britain and Norway, use a “Pay As You Earn” automatic tax collection process. But many others do make residents file tax returns. Those that do typically have filing requirements— as the U.S. also does, in fact— which limit the number of people who must file a return.

Of course, the government does know about a lot of our income well before we tell them about it in our returns, but the government doesn’t always know how much of it is taxable, or at what rate. Our tax returns fill in those gaps. Under the current system, the IRS does not have the resources to collect all of this data without our participation. And they say as much in this piece by CBS.

We could all benefit from dedicating more time to monitoring our income and expenses and participating in the preparation of our returns. If you think you can hand a shoebox of papers to a tax preparer and expect that you’re not going to end up paying too much, well, I hate to say it, but you deserve to.

As noted above, in the CBS story, it’s suggested that eliminating our participation would be beneficial because the tax code is too complicated and doing so would save us all time, stress, and money. This is the premise when politicians claim they’re going to pass a law simplifying the tax code, too. Ronald Reagan said it. So did Donald Trump. We’re going to be able to file our returns on a post card. It sounds good, and it does win votes, but it’s not reality.

The tax code is too complicated. But this is because it’s the American way to try and game the system, and every time someone tries a new end around, the IRS has to make a new rule.

Would it be possible for the US Government to take away our ability to participate in the process?  Probably. I value all the rights we enjoy as American citizens, but this one especially. The IRS does not have the same incentives we do to ensure we pay as little as we legally have to. Do we really want to give them all the power over this determination? I sure don’t.

So as April 15th approaches, consider yourselves lucky to have this privilege.  It’s a central part of your freedom.

Drowning in a Sea of Cash

I’ve been reminded a few times this week of how little there is in the way of investment opportunity in the current marketplace, and that we are drowning in a sea of cash.

Recently I read an article about how Warren Buffett (or to be more specific, Buffett’s company Berkshire Hathaway), has $116 billion to spend.  Berkshire Hathaway got shut out of a few deals last year so their cash hoard has gotten bigger. A lot bigger. Buffett said part of the reason they got shut out of the two big deals they worked on last year was because interest rates are so low, the other suitors were able to borrow and offer a lot more than he and Charlie Munger were willing to spend. Buffett and Munger will use debt when called for, but always evaluate a deal on a cash basis first.

So on the big stage, the deals are harder and harder to find, and there’s clearly a lot more competition for them when they do eventually present themselves. What does this mean for people like you? Decent investment opportunities dry up like rain drops in Death Valley.

Stock prices have been higher only once before. Can you say party like it’s 1999?  I guess we might as well.

A lot of our clients invest in real estate, and more of our clients are headed that way as stock prices soar.  But now real estate prices (and property taxes) are skyrocketing too. Even in places that have never been hot markets before, hedge fund managers are deploying cash in amounts never seen before to buy up everything and anything they can in the search for yield.

In 2014 oil went from over $130 a barrel to under $40 a barrel, and the other commodities followed it off the cliff. So I told clients to emphasize commodities in their portfolios. Now even commodities are well off their lows and I’ve read about investment managers recommending them. Prices in this asset class are no where near those of the paper assets (stocks and bonds), but there’s still a sea of cash swishing around.

There is simply too much cash chasing too few investments.

I’m reading Mohamed El-Erian’s The Only Game in Town. In it, he staunchly defends decisions made by central banks, but cautions that they have been asked to do too much. (It’s a great book by the way.) I beat up on the Fed in this blog a fair bit, but I’ve also acknowledged that without their intervention in 2008/2009, we’d probably be in the depths of a global depression to this day. The problem is monetary stimulus has its limits, and without reformative economic policy, it’s limits will be seen.  Probably sooner than later. We’re drowning in a sea of cash right now.  Let’s hope it has a shred of value when the tide finally goes out.

So, you may be wondering: OK, what the heck do I do about it?  And you’d be wise to question this.

To be clear, buying assets at high prices just because markets are appreciating does not make good financial sense (not to me anyway, and not to Buffett and Munger, either, apparently). Sometimes accumulating cash, or its equivalents, makes good sense.

When I say there are high valuations everywhere you look, I’m generalizing. Obviously there are opportunities in every market, but at times like this, you have to be patient, very patient, and look long and hard to find them. When you do, there will be lots of competition for them, so having a pile of cash will help you to capitalize when you find yourself in the right place at the right time.

That said, be mindful of getting caught up in bidding wars if others sniff your deal out before you close on it. Also, if you have not allocated any of your long-term investment money to commodities and natural resources, there’s still time.  As an asset class, they have not been driven into la-la land, yet.  They say patience is a virtue. In the world of investing, it can make or break you.

The Writing on the Wall

They say every prognosticator is eventually right, and I’m starting to feel like it might be my moment.  But it’s a moment I never wanted to come, and it does not feel good.

The bond market is finally opening its eyes to the handwriting on the wall. I’ve been saying interest rates are going to go up for so long I sound like a kook. When I’ve said those words, a few clients have replied “you’ve been saying that for years.” Because I have.

I’m not an economist. But you don’t have to be one to know central banks can only manipulate markets for so long before nature takes over, and the lid they’ve kept on rates wouldn’t last forever.

At the nadir of the last debt crisis in March 2009, The Federal Reserve handed US mega banks a mountain of tax payer cash, with no restrictions, and set them right back to doing the business that brought the crisis on in the first place. Yes, their intervention precluded a much deeper economic decline, which could easily have been a global depression. But they did practically nothing to address the structural problems that lead to the crisis. And neither did Congress. So the stage was set for the next crisis.

After they handed banks all that cash, they proceeded to create and spend four and a half trillion more dollars to buy Treasuries and mortgage backed securities (MBS), in an effort to further contain interest rates. The message they sent us was that this would encourage borrowing and spending, which will stimulate economic growth. And that was accurate. But the other motivation behind keeping a lid on rates has been to contain the cost of borrowing for the drunken sailors in Congress.

Actually, I take that back. Drunken sailors have nothing on Congress.

All that spending in the Treasury and MBS markets drove bond prices higher, and interest rates lower.  But every check they wrote had less and less impact on rate containment. So clearly they saw the hand writing on the wall well before bond investors, and announced they wanted to get out in front of inflation risk, stop all the bond buying, and begin raising rates. Slowly and incrementally.

That messaging has worked brilliantly. When I say rates are going to rise, people say to me, “But she says she’s only going to raise them slowly and a little at a time.” As if to suggest that Janet Yellen has had the interest rate markets on a string, and has complete control over everything.

To be clear, Janet Yellen is a very intelligent woman. Much smarter than me. But she and her successor Jerome Powell and her colleagues at the Federal Reserve Board do not have complete control over everything. In fact, they are in uncharted waters, and I suspect are feeling quite naked right about now.

As the Fed increases the amount of maturing debt proceeds they remove from the market, interest rates have nowhere to go but up. And the nine-year bull market in stocks, which was built on a foundation of more cheap, easy debt, will end by its removal.

We’re Growing!

Last week at QLC we hired a new Associate Financial Advisor, Alison Davis.

Alison has a wealth of experience in managing an office and customer service. She will be shadowing Brendan while learning about the personal and small business planning concepts Quantum leap Capital employs with our clients. We are very excited to have her with us and for this next phase of growth in our little firm.

In time this will enable us to provide service to a higher number of clients.  So keep your referrals coming.

Our business plan calls for me to do less and less of the computery, paper worky stuff, and more of the case analysis, advisory stuff.  Because that’s what I do best, it’s what our clients need most, what separates us from the hordes of other financial firms, and what drives profitability for us as a company.

I’m telling you this because I want you all to know that word about the unique work we do at QLC is being spread far and wide, and I am keenly aware that I have all of you to thank for that.

Your confidence in our advice and the introductions to those you care about it has inspired are the lifeblood of our business. And for this we are eternally grateful.

Welcome to the team, Alison! And many thanks to all of our devoted and loyal clients!

Crisis Breeds Opportunity

No matter how you see things, 2017 was a tumultuous year. Some say we’re in a state of crisis.  Others say we’re on our way out of one. Your perspective may fall in between these two extremes, but one thing is certain: crisis or not, opportunities for improving your financial position are always present if you look hard enough.

To me, financial planning is the ongoing process of examining one’s current position as a collective unit with an eye to mitigating as many of the prevalent risks as possible, thereby minimizing the effect of the things that erode and jeopardize our financial well-being.

In other words, pay attention to the things you have control over, and plug the leaks where money is leaking out, rather than the one thing you have absolutely no control over, and picking the stock or fund that will go up the most.

Taking this approach not only helps us keep more of our money, it gives us financial flexibility, so we can take advantage of opportunities.

Adopting this mindset and executing on it consistently takes practice, presence of mind, and patience. Our ever more short-sighted culture encourages the opposite, though, and this creates even more opportunity for those who have the muscle memory to step back and look for that space when crisis hits.

Flexibility is strength, and developing it takes time, discipline, and planning.

While I can’t help but worry over what’s to come, and every passing day seems to present a new challenge, I’m ready to look for the opportunities that these challenges present. Our business plan for 2018 is done and we’re ready to move forward into 2018, come what may.

From all of us at QLC, here’s wishing you all a happy, healthy, flexible, and prosperous 2018.

Required Minimum Distributions

RMD. If you’re seventy years old, or near it, or you have inherited an IRA from someone, you have probably heard this acronym.

Most retirees have some basic understanding that they need to take money out of their pre-tax retirement accounts at age seventy and a half. Not many understand all the ins and outs of managing them. Even fewer understand the impact Required Minimum Distributions, and the corresponding tax liability, will have on the value of their nest eggs, and the taxation of their other sources of income.

The primary benefit of saving money in a traditional IRA or 401(k) is tax deferral, and in the case of a 401(k), if you’re lucky, a matching contribution from your employer. The money goes in before taxes are withheld, and the earnings accumulate, uninterrupted by taxation. Until it’s time for RMDs.

In my experience, most people end up taking money out of their IRAs well before age seventy and a half, and they take well more than they are required to, because they need or want the money for expenses. These folks are rudely awakened to the impact their withdrawals, and the tax liability, have on the value of their accounts.

For those fortunate enough to have the luxury of not needing or wanting money from their pre-tax accounts until age seventy and a half (isn’t it weird that the rules are made around half ages?), the addition of this income can be a source of frustration. “No one told me I was going to have to take all this money out and pay tax on it” and “If I’d known this was how it worked, I wouldn’t have put my money in this thing” are comments we’ve heard in our office.

Whether you need or want the money, or not, the IRS is going to make you take it out, and pay tax on it. They don’t care if you spend the net proceeds, or if you reinvest them, but they’re going to make sure you take it out of the pre-tax plan, and give them their cut. The fifty percent penalty for failing to do so is a very strong motivator.

Some one may have told them that they’ll be in a lower tax bracket when they retire, so putting money in this account will save taxes. And selective human hearing translates this to “you’ll pay very little tax on the money later” or maybe even “you won’t pay tax on it later”. But other than a very small increase in the standard deduction and exemption amount after age sixty-five, the tax brackets don’t change by age.

I find most folks don’t want to have less income the day after they retire, so almost all of the people I have walked from their working years into their retirement years are paying the same effective tax rate they were before, or more. And we’ve had declining tax rates since the 1980’s.

So when you step back and look at how these things really work, they don’t save taxes, they postpone them. Funny the government doesn’t call them “tax postponed” plans. Something tells me they wouldn’t sell as well.

Here’s some context for you: let’s say I pay a twenty percent effective Federal income tax rate. It’s April 15th and my tax preparer or financial advisor tells me I could reduce my tax bill by $1,000 if I make a traditional IRA contribution of $5,000. Great! Where do I sign?

But where does that $1,000 go? Do you think most people set that money aside to make sure they have it for when RMDs begin?

Mmmm no. I spend it. So in effect, I’m borrowing that $1,000 from the IRS. And I’m borrowing it at a to-be-determined interest rate. If you asked me for a loan and I said sure, I’m flush right now, I’ll let you know what interest rate you’ll pay me when I figure out how much money I need later, would you take that loan? Probably not.

But wait, it gets better.

Once we retire and forgo the ability to earn a paycheck, what we have becomes very, very finite. And our financial flexibility declines sharply.

I have a client, we’ll call her Jane. She retired with a good amount of money that her physician husband left her when he died, in his SEP IRA. After she retired, her expenses stayed at roughly the level they were at before she retired, and for the first year or two, everything went along as planned. And then she took a little extra out one year to help one of her kids. She was unpleasantly surprised by the tax bill the following April, and found she had to take a little more out just to pay the tax on the little more she took out the year before. I see this a lot. I call it the IRA downhill snowball.

When you begin taking your RMDs, if your account grows after this point, so does the RMD amount, because the government wants you to take all the money out and give them their cut before you die. So increasing RMDs also means higher taxable income, potentially an increasing marginal tax bracket, and almost always, an increasing portion of your Social Security benefit being subject to income tax, driving your effective tax rate even higher. And yes, lots of people are surprised to learn that their Social Security will be taxed too.

Now, you might say: “But Brendan, the government is saying they’re going to lower taxes. Maybe that will save me.” You might not guess from the tone of this blog at times, but I am an optimist. I believe in the power of love, and that the truly remarkable adaptability of the human species will lead us to new heights. But if you tell me you believe the government is going to lower taxes for the likes of you and me, and that this will rescue your retirement income plan, I can assure you I will not laugh, but I will be compelled to tell you that you are setting yourself up for disappointment and maybe disaster.

Our national debt is as high as it was during World War II. Our Medicare and Social Security benefit payments are draining the money our politicians want to give their friends. Mark my words: the government will be taking more of your money in the future, not less.

But back to RMDs. After all this, traditional IRA’s and 401(k)s are not in and of themselves, bad. The problem lies in the lack of understanding people (financial and tax advisors too), have of them, and the fact that this is what people are being driven to put all of their retirement savings in. If more truly understood how these accounts work, they would balance what they save among vehicles that offer another form of tax treatment. They would develop a strategy for balancing the tax they pay now, AND in retirement.

If you want to develop a strategy like that, give us a call. It’s what we do all day every day.