Roth IRA Contribution Limits 2024

Roth IRA Contribution Limits for 2024

The Roth IRA contribution limits for 2024 are $7,000 per person, with an additional $1,000 catch-up contribution for people who are 50 or older. There is a $500 increase from 2023.

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Roth IRA income limits for 2024

Roth IRA contribution limits for 2024 are based on your annual earnings. If you are single or a head of household and earn $146,000 or less, you can contribute up to $7,000 per year. If your aggregated gross income is between $146,000 and $161,000, you can still make a partial contribution with a lower value.

Married couples filing jointly can contribute up to $7,000 each if their combined income is less than $230,000. You can still make partial contributions if your aggregated gross income is between $230,000 and $240,000.

What is a Roth IRA?

A Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you retire, your withdrawals will be tax-free as well.

Roth vs. Traditional IRA

The Roth IRA and Traditional IRA have the same annual contribution limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax, depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints. These are some of the Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to plan your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in a Roth IRA if they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either.

There are no penalties if you withdraw your original investment

While not always recommended, a Roth IRA allows you to start your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say you invested $10,000 several years ago. And now the account has grown to $20,000. You can withdraw your initial contribution of $10,000 without penalties.

Diversify your future tax exposure.

A Roth IRA is ideal for investors in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, a Roth IRA adds a flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change when you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA has no minimum distribution requirements. Savers can withdraw their savings as they wish or keep them intact.

Legacy Planning

A Roth IRA is a great tool for general wealth transfer planning. If you decide to leave your Roth IRA to your heirs, they will not pay taxes on their distributions.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $6,000 in 2024, you could only contribute $6,000 to your Roth.

Tax-loss harvesting. How to maximize your after-tax returns.

Tax loss harvesting

What is tax-loss harvesting?

Tax-loss harvesting (TLH) is a strategy that you, as an investor, can use to reduce your capital gains taxes and potentially maximize your future after-tax returns. The TLH strategy involves selling an investment in a taxable account at a loss to offset the taxes on another investment sold for a gain in a different part of your investment portfolio. You can only use the strategy in taxable investment accounts.

For example, let’s say you own 1,000 shares of XYZ stock that you bought for $10 per share. The stock is now trading at $8 per share, so you have a loss of $2 per share. You will realize a $2,000 capital loss if you sell the stock.

Tax-loss harvesting can be a great tool to manage taxes and maximize long-term after-tax returns. It can help you reduce risk in your portfolio and turn losses into wins. According to studies, TLH can contribute up to 1% in after-tax portfolio returns.

A well-executed tax loss harvesting strategy can reduce your current tax bill through tax deferral. That means that you are not only saving money on their taxes in a given year, but you can reinvest those tax savings for potential growth in the future. And the longer your portfolio stays invested in the market, the more time it has to grow and compound.

Long-term capital gains versus short-term capital gains

To understand TLH, you also have to know how the US tax system treats long-term versus short-term capital gains

When you buy and sell an asset with appreciated value, you may have to pay capital gains taxes. The amount of tax you owe will depend on how long you hold the asset before selling it. The gain is considered short-term if you own the asset for one year or less. If you hold the investment for more than one year, the gain is taxable as long-term.

Short-term capital gains

Short-term capital gains are taxable at the same rate as your ordinary income. This means that the higher your income, the higher your capital gains tax rate will be. For example, if you are in the 32% tax bracket, you will pay a 32% capital gains tax on any short-term gains.

Tax Brackets 2023 IRS
Tax Brackets 2023 IRS

Long-term capital gains

Long-term capital gains, on the other hand, are taxable at a lower rate. The exact rate you pay will depend on your income and filing status.

All else equal, holding an appreciated asset for more than one year before selling it is more financially beneficial if you want to pay lower capital gains taxes.

LTCG Tax Brackets 2023 IRS
LTCG Tax Brackets 2023 IRS

Keep in mind that income levels to determine the tax rate for long-term capital gains include income from ALL sources, not just capital gains.

Example 1: You are single and earning $150,000 per year. Also, you have reported a long-term capital gain of $25,000. Your reported income is $175,000, which falls in the 15% tax bracket. Therefore, you must pay a long-term capital gain tax of $3,750 ($25,000 x 15%)

Example 2: You are a retired couple filing jointly. You don’t earn any income but have reported $70,000 in long-term capital gains from your investment portfolio. Since your total reportable income is below the 15% tax threshold, you don’t owe any taxes on your investment gains.

There are a few exceptions to the long-term capital gains tax rates. For example, collectibles such as art, antiques, and jewelry are taxed at a flat 28% rate regardless of how long you hold them.

State taxes

Another layer for the full impact of tax loss harvesting is your state taxes. Some states, like Texas and Florida, do not impose taxes on capital gains. California, New York, and New Jersey treat capital gains as ordinary income regardless of your holding period. A third group of states, like Connecticut and North Carolina, have a flat rate. While state income taxes are typically lower than federal ones, it’s essential to understand the full scope of your tax loss harvesting strategy before moving forward.

Net Investment Income tax

Net investment income tax (NIIT) is a 3.8% surcharge tax on certain types of investment income. It applies to individuals, estates, and trusts with modified adjusted gross income (MAGI) above certain thresholds.

The types of investment income that are subject to NIIT include Interest, Dividends, Capital gains, Rental income, Royalties, Passive income from businesses, and Non-qualified annuities. NIIT does not apply to distributions from retirement accounts, such as IRAs and 401(k)s. Additionally, NIIT does not apply to Social Security benefits, unemployment benefits, or veterans’ benefits.

The MAGI thresholds for NIIT are:

NIIT 2023
NIIT 2023

If your MAGI is above the threshold for your filing status, you will owe NIIT on the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.

What are some of the benefits of tax-loss harvesting?

  • You can reduce your taxes on capital gains in the current and future tax years.
  • Realized capital losses can offset realized capital gains from selling other investments in your portfolio, real estate, private equity, or a business.
  • Tax-loss harvesting can help you lower capital gain taxes from selling stocks from employer incentive stock options (ISOs), nonqualified stock options (NSOs), restricted stock units (RSUs), and restricted stock (RS)
  • You can unload bad investments
  • Turn a loss into a win
  • You can deduct up to $3,000 ($1,500 married filing separately) of capital losses per year against ordinary income.
  • Any residual losses that exceed $3,000 can be carried forward to future years.
  • You can use TLH to diversify your portfolio.
  • It can help you take advantage of market fluctuations and rebalance your investment portfolio.
  • You can use tax loss harvesting to reduce the risk of holding concentrated positions.

What are some of the risks of tax-loss harvesting?

  • You may miss out on future gains if you sell an investment at a loss.
  • You may have to repurchase the investment at a higher price in the future.
  • TLH may trigger a wash sale if you repurchase your investment too soon.
  • You may not be able to offset your losses with gains

Wash Sale Rule

The wash sale rule is an IRS rule that prevents investors from claiming a tax loss on the sale of an investment if they buy the same or substantially identical investment within 30 days before or after the sale. The wash sale rule is designed to prevent investors from artificially inflating their losses in order to reduce their tax liability.

Here is an example of a wash sale:

  • You sell 100 shares of ABC stock at a loss of $1,000.
  • Within 30 days of selling the ABC stock, you buy 100 shares of DEF, which is substantially identical to ABC.
  • You cannot claim the $1,000 loss on the sale of the ABC stock.
  • The loss from the sale of ABC shares is deferred for a later date.
  • The cost basis of DEF stock will adjust with the amount of the capital loss

The wash sale rule applies to a wide range of investments in a taxable account, including stocks, bonds, mutual funds, and ETFs. It also applies to options and futures contracts. The wash sale rule doesn’t currently apply to cryptocurrency, but that could change in the future.

How to make tax loss harvesting work for you

Here are some of the essential requirements and considerations of a successful tax-loss harvesting strategy

  1. Stay invested. When you execute tax loss harvesting, you must continue to invest in the market. Replace the asset you sold at a loss with a similar (but not substantially identical) investment. Leaving the proceeds from the sale on the sidelines can lead to a substantial loss of potential future returns.
  2. Know your goals – tax loss harvesting will be effective only if It is an essential element of your comprehensive financial plan. TLH must be integral to your strategy to achieve your long-term financial goals and milestones.
  3. Avoid breaking the wash sale rule – Not complying with the wash sale rule can lead to confusion and errors. You may not be able to reach the goals of your TLH strategy if you don’t have a proper execution.
  4. Know your investment time horizon – If you plan to hold an investment for the long run, it may not be in your best interest to sell it and harvest losses.
  5. Track your tax bracket – If you are in a higher tax bracket, tax-loss harvesting can be a smart way to reduce your taxes.
  6. Know the overall health of your portfolio. If your portfolio is well diversified, you may not need to use tax-loss harvesting. However, if your portfolio is concentrated in a few stocks or sectors, tax-loss harvesting can help you reduce your risk.
  7. Don’t overdo it – too much TLH activity can draw the attention of the IRS or can prompt mistakes.

Final words

Tax-loss harvesting is a complex strategy. And it’s important to understand the risks and benefits before selling investments at a loss. If you are considering tax-loss harvesting, talking to a financial or tax advisor will ensure you know the full implications of the process. A fiduciary advisor can help you tailor a tax-loss harvesting strategy that is right for you and your financial plan.

Where to invest your money in 2023?

Where to invest your money in 2023

Where to invest your money in 2023? The last few years have been a rollercoaster for stock and bond investors.  First, we had to deal with covid lockdowns and supply chain disruptions. Then came the war in Ukraine and the spike in oil prices, followed by record inflation in developing countries. Most recently, we experienced the second and third-largest bank collapse in US history, driven by the first digital bank run.

Market pundits have been calling for further Fed rate hikes, a recession, a hard landing, more bank failures, a decline in corporate earnings, and anything in between. Even the Fed jumped on the recession bandwagon and called for a mild recession at the end of 2023.

If you follow my articles, you know that I discussed the wide divergence of economists’ opinions of the direction of our economy.

Since the beginning of the year, I have been cautiously optimistic about the economy and the stock market in general. I have been leaning toward the soft-landing camp. Despite the negative rhetoric in the media, there are a lot of secular tailwinds that could support a resilient economy. I am not popping a campaign bottle here, but there is a good chance that the US economy will continue to chug along and avoid a severe outcome.

But in an environment where even experts cannot agree, it’s very challenging for regular folks to decide how to invest their money. Historically, the best time to invest is when everyone else runs for cover. That is why it’s essential that you understand your financial goals, investment horizon, and risk tolerance before making any investment decisions.

Here are some ideas on where to invest your money in 2023.

1. CDs and bonds

After a decade of zero interest rates, CDs and bonds finally pay decent yields. If you are a conservative investor or need to build up your cash savings, you can lock in juicy rates. At the time of this article (April 2023), many online FDIC-insured high-yield savings accounts are approaching 4% interest. You can also buy a money market fund paying 4.5%. You can often find a CD paying 5% annual interest. Indeed, there are more options to park your cash than a year ago.

2. Healthcare

Traditionally, healthcare has been a recession-resistant sector. Under normal circumstances, most people will prioritize their health over discretionary spending. Furthermore, our country is aging. Today, 1 out of 6 Americans is 65 years or older, representing 17% of the population. That number is expected to increase to 22% of the population by 2040. In an all-weather economy, healthcare companies offer a steady, reliable source of revenue and dividends.

3. Discount retailers and fast food

Discount retailers and fast-food restaurant chains will primarily benefit from a slowing economy. Even in weak economic conditions, people must shop and eat. Discount retailers offer bargains that are only sometimes available in large chains. Similarly, fast food (and fast casual) restaurant chains provide affordable meals. For more cautious investors, this group offers a safety net of predictable revenue streams and earnings.

4. Defense

Unfortunately, after the start of the Russian invasion of Ukraine, the world is becoming increasingly polarized. This tragic and prolonged conflict revealed significant gaps in the defense systems and military equipment of many NATO and EU countries. Furthermore, China is circling Taiwan while the Middle East and Africa look like a boiling pot ready to burst. As a result, most US defense contractors have multi-billion backlogs of orders.

5. Utilities

Utility stocks are a traditional safe haven during market turmoil. Because of regulations, utilities don’t have much competition. They offer stable dividends and relative price stability compared to the rest of the stock market. In my view, utilities could be one of the primary beneficiaries of the move towards electric vehicles and clean energy, giving them an additional source of revenue from their traditional markets.

6. Waste management

Waste management companies have predictable revenue, which is often adjusted for inflation. They serve their residential, commercial, industrial, and government customers by picking up and disposing of waste. Despite being boring in nature, waste management companies have a leading role in recycling and environmental services.

7. Traditional and Clean Energy

Our energy independence is crucial when the world is undergoing tremendous polarization and deglobalization. The war in Ukraine and the impact of recent climate events have indicated that we must have a diversified basket of energy sources – oil and gas, solar, wind, and hydrogen.

Not one single source is more important than the others. Even as drivers gradually switch to electric vehicles, the current electric grid will only be able to sustain the growing demand relying on traditional energy sources. I believe it’s a very ambitious goal to require all new vehicles to be electric by mid-2035. Not to mention that an all-electric airplane is far away in the future.  It remains to be seen if and how we can reach those targets. However, it’s clear that we need oil and natural gas to support this transition without disruptions. And even then, we will continue to need oil and gas as a reliable source of energy when the wind doesn’t blow, and clouds cover the sun.

Traditional oil and gas corporations are much better managed than a decade ago. Most of them pay healthy dividends and have very favorable valuation metrics. Many oil and gas firms rank high on various ESG metrics, especially in social activities and corporate governance.

On the other hand., the newcomers in the renewable energy space offer growth and innovation.  The size of the renewable energy market will double between 2023 and 2030, going from $1 trillion to $2 trillion.

8. Technology

Technology alone is the largest sector in the S&P 500, with a 25% share. If you add some tech-driven companies in other industries, technology will be well above 30%. The market capitalization of Apple alone is higher than the entire energy sector. Technology is a quintessential part of our life. Did you know that we touch our smartphones 2,600 times a day?  Google processes over 8.5 billion searches per day. Amazon ships approximately 1.6 million packages daily.

AI and Automation

There are currently nearly 10 million job openings in the U.S. There are two vacancies for every job seeker. More and more manufacturing facilities are moving back to the States. With labor shortages worldwide, there is a strong case for more automation and AI. Companies will push for more automation to provide faster service, better quality control, enhance job safety, meet unexpected demand surges, and maintain profit margins. The artificial intelligence (AI) market is expected to show strong growth in the coming decade. Its nearly $100 billion value today is expected to grow by 200% by 2030, up to almost $2 trillion.

Cloud computing

The Covid pandemic accelerated digital transformation, which requires enormous data storage and I.T. infrastructure.

In 2023, we will generate nearly three times the volume of data generated in 2019. By 2025, people will create more than 181 zettabytes of data. Global spending on public cloud services is forecast to grow 20.7% to $591.8 billion in 2023 and surpass $1 trillion by 2027.

Cybersecurity

Cybersecurity is a crucial need for individuals, businesses, and governments. We all have heard and suffered from data breaches in high-profile corporations.  Digital growth is bringing bad actors looking to profit from our fears and weaknesses.  According to Michael McGuire, cybercriminals earn $1.5 trillion through various channels. Protecting your data is critical for safely navigating the digital universe.

The size of the cybersecurity market was at $203 billion in 2022. It will surpass $500 billion by 2030, with an annual growth of 12.3%.

5G

The 5G is the next-generation mobile network and the new global wireless standard. We are still in the first innings of 5G expansion, which brings higher speed, better responsiveness, and more reliability to our phone calls, text messaging, video conferencing, and home internet. Initial projections estimate we will have a 10X higher speed than current levels. Moreover, 5G will take the world of connected devices to the next level. For instance, the growing network of smart homes, devices, smartwatches, speakers, cameras, and connected cars can dramatically change how we interact with the rest of the world.

Semiconductors

Chips are the new utilities. They are everywhere – in cars, computers, smartphones, home devices, and manufacturing equipment.  The global semiconductor market is projected to grow from $620 billion in 2022 to over $1 trillion by 2030. A big chunk of the growth will come from data centers, consumer electronics, and automotive.

9. Large banks

After the collapse of Silicon Valley Bank and Signature Bank of New York, bank stocks went out of favor. SPDR® S&P Bank KBE ETF is down 15% for the year at the time of this article. SPDR® S&P Regional Banking KRE ETF is down even more at -23%. I believe that the banking sector is a lot stronger than during the financial crisis of 2008 and 2009. The failure of these banks was idiosyncratic and a result of a combination of factors, including rapid growth, power interest rate risk management, and flighty customers.

The recent earnings reports (April 2023) by major regional banks showed relatively stable deposits, liquidity, and capital ratios. In addition to that, after the recent drop, many banks pay a handsome dividend yield. Wall Street tends to throw the baby with the bath water. Many high-quality banks have fallen without merit.  The recent decline in bank stocks offers a lucrative entry level for value investors with a long-term investment horizon.

10. Quality real estate

There are three important factors that drive the value of real estate – location, location, location. Public real estate companies and the real estate market overall have been under pressure due to rising interest rates, the turmoil in the banking industry, and growing fears of recession. Historically, real estate can be a volatile asset class with dramatic falls and epic rises. However, patient investors who are willing to step-in in times of distress have been richly rewarded.

Where is the stock market going in 2023?

Where is the stock market going in 2023

The stock market posted impressive gains in the first two months of 2023. It’s fair to say that the strong market rally in January caught a lot of market experts and investors off guard. The general mood at the end of 2022 was quite negative. The overwhelming consensus expected a recession at the beginning of 2023. Despite that, I issued an article in early January titled “Why investors should cheer this bear market.” I discussed several reasons you should feel excited about the stock market in 2023. And my view hasn’t changed. Let’s dive deeper into what we should expect this year. One thing is for sure, the stock market in 2023 will keep us on our toes as usual.

“The market is a distribution mechanism to transfer wealth from the impatient to the patient.”

Analyst divergence

The current economic environment remains very challenging for analysts. You can see from the chart below that there is a 40% difference in S&P 500 year-end targets, the highest since 2009. A group of gloom and doom analysts calls for another 20% to 30% correction in the stock market. Another group of more optimistic investors believes that the worst is behind us and that the stock market in 2023 will have a strong performance. And there is a whole lot in between.

Analyst divergence, stock market going in 2023

As usual, I remain cautiously optimistic. This is an excellent opportunity for long-term investors to build wealth and dollar cost averaging in the market.

Confusing  environment

Most economists find this environment very challenging to predict. The issue is that the current generation of analysts has yet to live through a period of inflation. We last had over 6% inflation in the early 1980s. Not to mention that the current inflation has unique characteristics coming on the heels of a global pandemic, the war in Ukraine, China lockdowns, and supply chain bottlenecks and labor shortages.

Yours truly, born and raised in Bulgaria, remembers the uncontrolled inflation we had in the 1990s. Bulgaria is coming out of its communist era and making its first steps into the market economy. At some point, inflation hit hard, and the government was forced to implement a currency board, which is still active today.

Inflation is sticky.

There is no doubt in my mind that inflation will remain sticky for many years. However, I also think inflation will settle around 3%-4% annually and stay there for a while. Here is a 40-year view of the CPI index.

Inflation is sticky, stock market going in 2023

In the years since the GFC, the central banks around the world artificially kept zero interest rates. We had cheap labor from China, quickly becoming a global manufacturing hub. Cheap oil fueled consumer spending. The boom in technology – the internet, mobile phones, 3G, 5G, and cloud computing boosted productivity and created deflationary pressure on prices.

These conditions no longer exist. Central banks are racing with the clock to raise rates. China is burdened with its own debt. Oil is no longer cheap, and oil companies are more strategic in capital spending. While the technology factor remains strong, technology companies must reset their business models to the new economic environment.

The economy is resilient.

The U.S. economy remains strong despite negative views and overwhelming predictions of a recession. Last year, many experts called for a recession at the beginning of 2023, but here we are, still chugging along.

In the fourth quarter of 2022, the US GDP rose 2.7%. The unemployment rate is at a historic low of 3.5%. And the total nonfarm payroll employment rose by 517,000 in January 2023. The February payroll figures are also impressive, with employers adding another 244,000 workers.

US GDP growth, stock market going in 2023

As much as I respect Jamie Dimon, the CEO of JP Morgan, his recommendation in June 2022 to brace ourselves for an economic hurricane didn’t age well.

jamie dimon hurricane

Even Elon Musk got pessimistic about the economy in October of 2022.

Elon Musk recession

Where is the recession?

Soft or hard, no or delayed landing. Recession gets pushed forward?

You are probably wondering if everyone is expecting a recession; how come it’s not happening? Here is my view:

Amex CEO no recession

Diversified economy

The U.S. is the largest but also one of the most diversified economies. The consumer drives 70% of the economy. Unlike Europe, China, and Japan, we are energy independent.

Job onshoring

The U.S. is expanding its manufacturing footprint in semiconductors, electric vehicles, battery cell production, and hydrogen facilities. Even old-school industries like steel and lumber are making a comeback.

Tight labor market

The latest data shows over 10 million job openings in the U.S. versus only 5.7 million unemployed workers. Forty-seven million Americans left their jobs in 2021. For context,  that was 23.5% of the U.S. workforce in 2021. Furthermore, the pandemic drove more than 3 million adults into early retirement.

Energy exports

The U.S. is on track to become a net exporter of crude oil with a record sale of 3.4 million barrels per day. The United States became the world’s largest exporter of liquefied natural gas during the first half of 2022, surpassing Qatar, and Australia, on the back of European demand and surging prices.

Technology leader

The U.S. is a technology and innovation leader in software engineering, A.I., cloud computing, E.V., clean energy, biotechnology, medical devices, and robotics. All these services remain in high demand even in a high inflationary environment.

Lagging effect of record stimulus

Nearly $ 5 trillion of the Covid pandemic and post-pandemic stimulus is still circulating in the economy. The money supply went from $15.3 trillion in 2019 to $21.7 trillion at its peak in March 2022.

Covid stimulus

The global picture is even more staggering. Over $10 trillion in the pandemic fiscal stimulus was distributed in two months, three times more than the 2008 – 2009 financial response.

Gloval covid stimulusThe bottom line is that we are in unchartered territory. The economy has way too much stimulus, and its lagging effect may persist for several years.

The U.S. economy is less interest rate sensitive.

The U.S. economy is less susceptible to interest rate hikes. For several reasons, the Fed raising interest rates may have a meaningful short-term impact.

Mortgage Refinancing

Nearly 20% of all homeowners with a mortgage refinanced their mortgage in 2020, and another 25% did it in 2021. Many U.S. homeowners are sitting on a mortgage loan with a record-low fixed interest rate.

Excessive savings

During the pandemic, fiscal support more than replaced other income losses in the aggregate, propping up personal income even as spending fell. By the third quarter of 2021, the excess savings reached about $2.3 trillion, which began to decline as spending picked up and fiscal support dropped. Even so, by mid-2022, extra savings remained at about $1.7 trillion.

Excess Savings by quartile

Housing inventory remains tight.

Single-family home inventory is still low. With more millennials forming a family and having children and existing homeowners willing to stay in their homes for longer, I don’t see an immediate solution to this problem.

Corporations’ balance sheets are healthy.

Most S&P 500 top 20 companies have healthy balance sheets with low debt levels. Corporations like Apple, Microsoft, Google, and Exxon Mobile operate with high free cash flows, allowing them to self-fund their business without borrowing excessively. Furthermore, many companies were also able to lock in lower borrowing costs as interest rates reached new lows in 2020 and 2021. Just 3% of junk bonds or those issued by companies below-investment-grade ratings, only 8% come due before 2025, according to Goldman Sachs.

Monetary policy is weakening.

The Fed Reserve of Kansas posted research in 2015 on the diminished impact of interest rates on the financial markets. Even though the report doesn’t arrive at a definite conclusion, they make three suggestions. “First, changes in the conduct of monetary policy do not appear to be responsible for the shift in interest sensitivity. Second, linkages between the short and the long end of the yield curve, along with linkages between financial markets and the overall economy, have become protracted. Third, structural shifts have altered how employment changes at the industry level feedback to the aggregate economy.”. Not all industries react the same way to interest rate changes, and many sectors move in the opposite direction.

The Fed doesn’t want the markets to go higher.

It’s clear to me that the current Fed regime is hostile to the stock market. Due to its weakened monetary policy, the Federal Reserve uses the stock market as a second derivative tool to control the money supply. Higher stock prices would lead to higher household net worth and improved ability to spend and borrow. I expect the Fed chair and all Fed representatives to continue their tough talk. After underestimating the inflation rise in 2021, the Fed has been playing catch-up for 2022. They want to appear determined to crush inflation. I don’t like that the Fed has become so reactive to backward-looking data while has shown clear signs of declaration. One of the biggest risks for the U.S. economy and stock market in 2023 is a Fed mistake to overtighten and bring the economy to a stall.

Truflation March 2023

 Where will the stock market go in 2023?

“Thousands of experts study overbought indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply…and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.” – Peter Lynch.

The daily swings of the stock market remain challenging for day traders. Today’s market doesn’t give you too many chances in both directions. For long-term investors and those sitting on the sidelines, we see the current market conditions as an excellent opportunity to build a position and prepare for the next bull market.

Merrill advisors like cash

This kind of headline makes me want to buy more stocks. Financial history has shown time and time again that the best time to buy stocks with the highest expected long-term returns is when they are out of favor. Imagine the returns of those investors who continued buying through the market bottom of the Global Financial Crisis. I was there. Nobody wanted to buy stocks then. Some people were even liquidating their 401ks.

S&P 500 price target for 2023

I believe we have a narrow path for the stock market to finish the year higher than where we started, But the ride will be bumpy. We may go a whole lot of nowhere for a while. 2023 is going to be a true test for patient investors. I don’t expect a sharp V-shape recovery back to the prior highs of 2021.

Furthermore,  technology and other growth stocks, which took the poison pill in 2022 and dropped 30%, 50%, and even 80%, may fare better than slow growth slow-moving companies in the consumer staples industries.

My view is that inflation will moderate towards the second half of the year. And corporate earnings will accelerate in the third and fourth quarters of 2023.

This is an ideal environment for companies with solid balance sheets and adaptable management. After a decade of zero interest and low cost of capital., now the bar is higher. Those companies that can adapt to the new economic reality will gain market share and reap benefits in the future.

It’s a stock pickers market.

Why investors should cheer this bear market

Why investors should cheer this bear market

There is no doubt that 2022 has been a brutal year for investors. Many marquee household companies are down 30%, 40%, and 50%. Some have posted their worst performance in their history. The conservative bond investors didn’t have much to cheer about either. The Fed raised their interest rates from practically zero to 4.15%, which led to a drop in the value of most bond investments. For once in a lifetime, both equities and bonds fell simultaneously. Inflation reached a 40-year high.

2022 in the rearview mirror

The world witnessed the first European war and threats of using nuclear weapons since World War II.  And China imposed a zero covid lockdown that led Chinese citizens to be isolated in their homes for weeks and months. Adding to that the persistent covid outbreaks, RSV and monkeypox, $6 oil at the pump during the summer months, Hurricane Ian, the heatwave in California, and the polar vortex in Midwest.

And to add some entertainment to the public, the no longer richest person in the world decided to burn $44 billion on fire just because he could. Another young fellow in shorts and burly hair chose to use $3 billion in customer money to pursue his agenda and earn a comparison with Bernie Madoff. Let’s not forget that we had a mid-year election, and Democrats won the Senate, and the Republicans won the House. I am sure I am missing something.

So the regular folks like you and me could barely catch our breaths from one breaking news to the next in 2022. The journalist had a busy year. One could naturally wonder what 2023 has prepared for us.

Joe Biden, 80, and Trump, 76, declared they will run for president in 2024, as you know. I won’t comment on politics, but I expect the race to keep us glued to our smart devices and TVs through the election cycle.

Wall Street projections for 2023

Wall Street is also very divided in its projections. The S&P 500 ended the year at 3,839. The average estimate is for the index to finish at 4,031, with a huge gap between bulls and bears. The highest forecast is for 4,500, while the lowest reading is for $3,400. As a comparison, for 2022, the lowest forecast was for 4,400. So even the biggest bear got it wrong a big time.

Place your bets and throw the dice. If experts whose jobs are making market predictions can’t agree on where the market is heading, what about the average investor?

Despite all the gloom and doom that the media is trying to throw at us, there are a few things to cheer for in 2023. Let’s go through the list.

1. Earn interest on your cash savings.

After a decade of zero rates, you can finally earn a decent interest on your cash savings. You can easily earn 4% by buying a CD and over 3% in a high-yield online savings account. You have an excellent opportunity to build your emergency savings and earn a small return for keeping your money for a rainy day.

2. Better deals during a recession.

Most Wall Street economists are predicting a recession in 2023. Before you get too caught up in pessimism, I would like to cheer you up with the old Wall Street joke that economists have predicted the 9 of the past 5 recessions.

One thing I learned with great certainty in my forty-something years in this world is that it’s very hard to predict the future.

So whether the economists are right or wrong this time around remains to be seen. However, I clearly remember from the last two recessions in 2020 and 2008-2009 that some of the best deals occur during an economic slowdown. Retailers are clearing inventories at a deep discount. Contractors are willing to take smaller jobs. Family vacations get more affordable.

If you plan a home remodel or a big purchase, this might be your opportunity to lower your cost and negotiate your price.

3. Contribute more dollars to your 401k and Roth IRA.

I bet all devoted retirement savers love the news that 401k contribution limits went up by nearly 10% from $20,500 to $22,500. The catch-up contribution limit for employees over the age of 50 will increase to $7,500. The Roth IRA enthusiasts can save $6,500 in 2023, up from $6,000 in 2022.

4. You are getting a tax break.

Everything is going up these days. You have seen those price anomalies in your local restaurants and neighborhood supermarkets.

The good news is that tax brackets and standard deductions are also going up. Whether you got a promotion last year or your salary remained the same in 2023, you will catch a bit of a tax break.

For example, a married couple earning $250,000 in joint income and using the standard deduction will pay $40,152.00 in Federal Income taxes in 2023 vs. $41,455.00 in 2022.

5. Dollar-cost averaging

With the stock market down and a lot of uncertainty ahead, dollar-cost averaging is ideal for any remaining investors wanting to put new money in the market. I have previously discussed how timing the market can hurt your long-term financial goals. Dollar-cost averaging lets you have one foot in the water without jumping all in.

Dollar-cost averaging is a strategy that allows you to invest a specified amount of money periodically regardless of the market direction. Your bi-weekly 401k contributions are a perfect example of how dollar-cost averaging works. By participating in your employer 401k plan, you make consistent investments in the stock market every two weeks.

6. Lower valuations mean higher expected returns.

If I had offered a year ago to buy Amazon or Tesla shares at a 50% discount, would you have taken my offer? Some of you may have thought that I am crazy. I am sure a few people with an above-average risk tolerance would have taken it. But here we are. A long list of stocks has come down to Earth from sky-high valuations. For us, the investors, these lower prices mean only one thing – higher expected future returns.

Check out the chart below. The average 1-year return after a bear market bottom is nearly 50%. The annualized 5-year return is nearly 18%, and the 10-year return is 13.45%. For compassion, S&P 500 average annualized 20-year return is 9.80%

Stock market performance after bear market

As you can tell, as you get closer to the bottom of the bear market, the risk-reward potential becomes very attractive for both long-term investors and short-term traders. So those investors who are willing to weather the storm can reap the benefits in the future.

7. Stock picking is back.

Passive index investing underscored the last decade of investing after the end of the financial crisis. The mega-cap tech stock like Apple, Microsoft, Google, and Amazon dominated the S&P 500. The near-zero interest rate torpedoed the growth of smaller software and semiconductor firms with little to no earnings. The market wanted to pay for growth at any price until it didn’t.

We reached an inflection point that allows and forces us to evaluate each company individually based on its own merits. The new bull market wave will not take everyone with it this time. Firms that adapt quickly to new economic realities can succeed and reach their prior highs. Others will be left in the dust. New winners will be born.

8. Invest in yourself.

Your biggest asset is yourself. It’s not your house, job, car, or investment portfolio. It’s you.  Invest in yourself by:

  • building new relationships
  • learning new skills
  • getting a new job
  • improving your health
  • focusing on what makes you happy.

Manage your life the same way we manage your retirement portfolio by focusing on your long-term goals, diversifying your skills and connections, and remaining disciplined through lifecycles.

9. Live to fight another day.

You will agree that the last three years were not exactly a walk in the park.

  • 2020 was the year of covid and the great lockdown.
  • 2021 was the year of the great reopening and the supply chain disruption.
  • 2022 was the year of the great reset of expectations.

What will 2023 be? I will tell you for sure in 12 months, but I won’t mind if it’s a bit boring and uneventful.

So whether you are a bull or a bear, an optimist or a pessimist, an extrovert or an introvert, a wine aficionado or a foodie, be nice to yourself. Give yourself a big tap on the shoulder. You made it. Whatever 2023 ends ups being, make it the GREAT YEAR OF BEING YOU.

Bear market bottom and 10 sign to help you recognize it

Bear market bottom

A bear market bottom is often elusive and hard to identify. Every investor dreams of timing the stock market bottom and consistently buying low and selling high. But in reality, catching the bear market bottom is hard, even for experienced traders.

What is a bear market?

A bear market is a stock market correction of more than 20%. A stock or an index enters a bear market when the price drops by 20% or many from peak to trough. A bear market can be nerve-wracking as the stock market rarely goes down in a straight line. There are dramatic price movements in both directions while the general trend points lower.

What is a bear market bottom?

Bear market bottoms mark the end of the bear market and the start of a new bull market. While everyone wants to catch the exact moment, the bear market bottom is visible mainly in the rearview mirror.

Many investors emphasize a specific date when the stock market reaches an inflection point and bounces back to start a new bull market. However, the bear market bottoming is a process and may take several weeks or months before a meaningful rally occurs.

How to time the bear market bottom?

We generally do not advise trying to time the stock market. It’s a fool’s errand. You must be right twice in your investment process – when to cash out and when to get back in. Even if you time your exit correctly, you may be unable to time the bottom. You need to have a disciplined approach to getting back. You would go against the grain, and you would be buying while most people around you are panic selling.

Even though we don’t recommend it to everyone, timing the bear market bottom can help you invest extra cash sitting on the sideline or rebalance your portfolio.

Here are some signs that can help you recognize the bear market bottom either at present or in hindsight.

Peak negativity

There is no doubt that bear markets are bad news for the economy. 401k balances drop, forcing many people to delay their retirement. Some folks have to sell their investments because they lose their jobs or need extra cash. Media pundits go on TV to tell you that stocks are not a good investment and how far the stock market will go.

Companies lower their earnings expectations and announce hiring freezes and layoffs.

Stocks can lose 20% of their market value in a heartbeat. There is negative news everywhere.

The bear market will hit bottom before all the bad news has faded. Remember, the stock market is a leading indicator. It drops before an economic downturn and goes up ahead of an economic recovery.

Emotional capitulation indicates a bear market bottom

Bear markets can mess up your emotions. They are a true test of your risk tolerance and ability to absorb stock market volatility and losses.

The bear market bottom comes with emotional panic and the desire to sell everything. You may have heard of another term – market capitulation. That marks the time when the last bull has finally given up. Investors lose hope. Some people sell at the very bottom and never come back.

Cycle of market emotions and bear market bottom

The extreme negative emotions you may experience during a bear market, such as fear or depression, can leave you vulnerable to overstating the long-term risks of your investments. A few times during a bear market, people have asked me if the stock market is going down to zero.

In a bear market, your fears will magnify by the vivid stories of how bad things will get. You will hear a comparison with the Great Depression, the crash of 1987, the Great Financial Crisis, and the Covid meltdown. The strength of feeling could outweigh the power of the evidence. However, any of those events have been a point of maximum financial opportunity for investors.

Taking down the generals

The stock market will bottom only after causing significant pain to a maximum amount of stocks and market participants. The bear market will continue until it steamrolls all the generals and officers, aka the favored market leaders. Some old leaders may never return to the top, and a new cohort will take their place.

Here is the list of the top 10 stocks in the S&P 500 in 2008, just before the financial crisis –

ExxonMobile, Walmart, Microsoft, Procter  & Gamble, Johnson & Johnson, AT&T, JP Morgan, General Electric, Chevron, Pfizer.

Here is the list of the top 10 stocks in the S&P 500 as of November 1, 2022 – Apple, Microsoft, Amazon, Tesla, Alphabet, Berkshire Hathaway, United Health, Exxon Mobile, Johnson & Johnson, and JP Morgan

Insider Buying

Corporate executives and insiders receive most of their compensation in company stock and stock options. Their paycheck is a smaller portion of their total comp. The purpose of equity compensation is to align the interest of corporate executives with the shareholders. This system is not always perfect, but it serves its purpose.

There are many reasons insiders may want to sell their shares – paying off taxes, diversifying, and legacy planning. Many insiders have been notorious for selling at the top of their company stock price.

Take, for example, the CEO of ROKU, Anthony Wood. He has been consistently selling ROKU shares at various price points.

ROKU insider selling

Remember this signature insider buying when Jamie Dimon, the CEO of JP Morgan, bought 500,000 shares of the bank in the middle of the Global Financial Crisis. He made a 450% return on this purchase alone.

JPM insider buying at the bear market bottom

Regarding the overall stock market, I want to observe a broader insider buying from executives at various levels from companies across different industries and sectors. Corporate executives and board members have a closer view of their companies’ revenue and earnings projections. Meaningful insider buying activity will give us more confidence in the company’s prospects.

Broader insider buying signals a market bottom or a decisive inflection point. However, It’s essential to analyze insider buying in the context of the current macro environment, specific company news, and price action. Insiders are also human.

Increased M&A activities

During a bear market, many stocks are selling at a discount. Larger companies swoop in and swallow smaller competitors at favorable terms.

M&A activities can happen during all economic conditions. However, the combination of stocks down 20% or 30% and higher acquisition activities can indicate that CEOs feel confident about their companies and the strength of the economy.

Stocks go up on bad news.

Eventually, sellers get exhausted. And there is nobody left to sell. All remaining are long-term investors and true believers.

At that point in time, stocks could start going up even after bad news. Why you may ask. The stock market tends to overshoot both on the upside and the downside. All the bad news eventually gets priced in. So every new piece of bad news might be incrementally better news than the previous. There could be a result of various factors, such as margins remaining stable or earnings not being as bad as feared.

Consecutive UVOL days

Here is one technical indicator that frequently precedes the actual market bottom. And often, it gets missed.

UVOL is the percentage of stocks that go up on any given day. Research has shown that after a significant market decline, 2 or 3 consecutive days of UVOL above 90%, followed by at least 80% positive participation, will signal an inflection point. New buyers are stepping in and finding prices attractive.

For example, during the first three months of 2009, the stock market was down nearly 23% and 53% since January 1, 2008.

Consequitive UVOL days at the bear markrt bottom

As you can see, despite the market being down, we had multiple days when 90% or 80% of all stock was up on the same day. Ultimately, the S&P 500 hit bottom on March 6 and never looked back.

Fed policies become more accommodative.

The Federal Reserve is one of the leading players causing recession and bear markets. When the Fed wants to stimulate the economy, it lowers interest and increases its balance sheet to improve liquidity and boost overall economic conditions.

On the other hand, when the Fed wants to slow down the economy, they reduce their balance sheet and hike interest rates.

Why would they want to intervene in the market,  you may ask? The Fed has a dual mandate – full employment and price stability. If unemployment is too high, the Fed will lower rates to help corporations borrow money at a lower cost of capital and eventually hire more people.

When inflation goes above the Fed target rate, as in 2022, the 1970s, and the early 1980s, the Fed hikes the interest rates to slow down the economy and suppress demand.

Steepening yield curve

In a typical economic climate, long-term bonds and loans carry a higher interest than short-term bonds and loans. The premium compensates the lender for taking a bigger risk and waiting longer to receive their money back.

The spread between short-term and long-term rates is an indicator of the health of the economy. An inverted yield curve had preceded nearly all recessions in US history. This phenomenon occurs when short-term interest rates are higher than long-term interest rates.

I102YTYS_chart

An inverted yield curve is a warning sign that the economy will slow down and possibly fall into recession. Higher short-term rates indicate that structural factors are negatively affecting the economy.

When the Fed lowers short-term rates and the yield curve becomes positively sloped, it is usually a sign that economic conditions are improving and business is returning to usual. The timing of slope change doesn’t always coincide with the exact date of the market bottom. You must consider the impact in the context of the macro environment.

Stocks above 200-day moving averages

Remember, we said in the beginning that bottoming is a process. A stock could take 6 to 12 months or even longer to find its bottom and move up. One measure of price trajectory is the 200-day moving average indicator. As the name suggests, 200 DMA is the average stock price for the last 200 trading days. Taking the series of rolling 200-day moving averages should show the trajectory of the stock price. Stocks in a bear market will have a declining 200-DMA curve and will most likely trade below the 200-day curve for an extended period.

XOM 200-DMA

For stocks to complete the bottoming process, they need to shift the direction of the 200 DMA curve from downward to upward. Many traders and investors will wait for the specific stock or index to surpass the 200-day moving average level before buying back.

Stocks in a strong bull market will trade above their 200 DMA curve, serving as a support level.

Bear market bottom and the Fed

The bear markets are volatile. Trying to time the exact bottom is a nearly impossible task. Our emotions will most likely drive us to sell rather than buy at that moment. Also,  not every bear market is the same. All these signals that we discussed may not appear at the same time. Some may not appear at all, as every economic cycle is unique.

Investors have relied on the Fed for years to save the stock market from disseminating losses. The Fed doesn’t have the mandate to support the market. But in recent years, they have used the stock market to achieve their mission of full unemployment and low inflation. The Fed will only intervene in saving the market when it supports its agenda.

Cash is king and stocks are on sale

Cash is king and stocks are on sale

The stock market certainly feels like a rollercoaster these days. We had a strong finish in 2021, but almost everything went downhill from there, except for oil and inflation

It has been a while since I wrote a mid-year market outlook. But after a disappointing first half of the year, I thought it might be an excellent opportunity to throw a few charts and give you a perspective of where we are.

The S&P 500 is in the bear market territory, down 20% for the year. Growth investors have taken a bigger hit, down -28%, while value investors had more modest losses at -12%. US Aggregate Bond is down: -11%, Bitcoin: lost -57%, while Cash: earned a modest 0.1%.

The US is a dominant force.

If you read my newsletter regularly, you know that I was optimistic about the US economy at the beginning of the year. After all, the US has one of the best managed and globally recognized companies and brands.

Let me give you a perspective of the US footprint on the world economy:

  • An estimated 1 billion people worldwide have an iPhone.
  • 1.4 billion monthly active devices running Windows 10 or Windows 11
  • 3 billion people use Facebook
  • 1.9 billion Coca-Cola drinks are served every day
  • 157 million visitors to all Disney parks every year
  • Netflix has 221 million subscribers
  • Amazon ships approximately 1.6 million packages a day, or 18.5 orders per second
  • Google processes over 8.5 billion searches per day
  • P&G’s nearly 300 brands are sold in more than 160 countries.
  • Visa handles an average of 150 million transactions per day

Everyone has a plan till they get punched in the face

When a reporter asked Mike Tyson whether he was worried about Evander Holyfield and his fight plan, he made his famous quote; “Everyone has a plan until they get punched in the face.”
That’s how 2022 feels to me. If you feel the same way, you are not alone.

My investment philosophy is to invest in high-quality US companies with outstanding leadership, a fortress balance sheet, a wide MOAT, and a consistent ability to generate cash. Companies can constantly maneuver between GAAP and NON-GAAP earnings, but cash is always cash.   I expected that 2022 would be volatile, but only hindsight can predict how low the market will go. The plan was to ride the market volatility until we got more positive news towards the year’s second half.

And here we are. 2022 has been one of the most treacherous years for both investing and trading since the Global Financial Crisis in 2008-2009. The negative news on a daily basis can be overwhelming and confusing even for experienced investors.

Let’s summarize what happened in the first half of 2022: 

•    We experienced the third bear market in the span of 5 years – Oct-Dec 2018, Feb – Mar 2020, and now
•    The S&P 500 posted its worst first half-year performance since 1970
•    We marked the worst bond performance in the history of the markets
•    The Fed appeared awfully late and reactive in their monetary policy decisions.
•    Inflation measured by the Consumer price index went up 8.6% by May 2022. The highest rate since the early 1980s.
•    Russia has attacked Ukraine. The first European country to attack another European country since WWII. The two countries combined are one of the largest global exporters of wheat, fertilizers, oil, and natural gas.
•    The EU, the UK, and the US have imposed stiff economic sanctions on Russia to limit their export revenue, adding more fuel to the inflation fire.

•    China has enforced strict zero covid policies and lockdowns in many metropolitan areas.
•    US mortgage rates have jumped to nearly 6%
•    Oil is over $6 at the pump here in California
•    The price of electricity has nearly doubled in the European Union
•    Corporate earnings are expected to decline, but it remains to be seen how far and how deep
•    The average price of a new home in the US is now over 10x higher than per capita disposable income, the highest ratio in history.
•    Consumer sentiment dropped to the lowest level since the Global Financial Crisis
•    Many major retailers reported a sharp increase in inventory

Cash is king?

2022 has been a great year to keep your cash on the sideline, especially if you are a stock or a bond investor. With a return of 0.1%, cash has been one of the best performing asset classes besides oil and natural gas. But before I get you too excited about hoarding cash, look at the 15%-year performance of stock, bonds, and cash.

Since 2007, cash (savings or money market account) achieved a total return of 9% versus 230% for the S&P 500 and 55% for bonds. Besides that, the cumulative inflation was 41% for the same period. In other words, holding cash would have reduced your purchasing power by a third in 15 years.

I would recommend splitting your cash into three buckets. The first bucket is your emergency fund. Keep at least 6 to 12 months of living expenses in this bucket. That is your rainy-day money

The second bucket is money that you will need in a short period of time – buy or remodel your home, get a new car, cover medical bills, etc. While tempting to invest this portion of your money when the market is going up, you should keep them relatively safe in your savings accounts or bonds.

The third bucket is the extra cash you can invest long-term. This bucket contains money you don’t need to touch for at least 5 to 10 years. That is most likely your 401k, Roth IRA, or an investment account with a long-term investment horizon.

Stocks are on sale

Here is a list of some of the worst performers in 2022 in the S&P 500. I am sure you recognize many blue-chip names like Netflix, Nvidia, AMD, Amazon, Adobe, Booking, Microsoft, and Apple. Thermo Fisher, Regeneron, and more. You also need to note that these are some of the companies with the best performance on a 10-, 15- and 20- year basis.

Focus on your goals

2008 was one of the worst years in recent history. Thousands of people lost their homes and jobs. The stock market crashed by 50%. Several banks disappeared overnight. We worked in fear that each day was our last day on the job. It was the dark period to be on Wall Street. Yet, I ran my first marathon in November 2008. I turned a trashy year into personal success. I don’t remember my 401k balance in 2008, but I remember crossing the finish line, getting a medal, and inhaling a bottle of Gatorade.

Today, my advice for you is to focus on yourself and how to achieve your goals. Ignore the negative news and continue working on your plan.

This, too, shall pass. 

I have two young children – a 4-year-old boy and a 1-year-old girl. You can imagine there is a lot of energy at home. So every time one of my kids pours milk on the floor, breaks a glass, or makes a mess, I try to take a deep breath and ask myself, will that matter in a year or ten years from now. In most cases, the answer is no. It won’t.

If the stock market aggravates you today, ask yourself if that matters to you in a year or ten years. Most likely, today will look like a tiny blip on a long-term chart. This bear market is a true test of your risk tolerance and emotional ability to accept market volatility. It’s easy to take a risk when the stocks have only gone up for 13 years. A generation of investors has not experienced an actual bear market and inflation without having the back of the Fed. There is a new sheriff in town. The show will go on, but the players might be different.

Sparks of hope

While we are not out of the woods yet, there are signs of hope that inflation is peaking.
•    Core PCE Price Index (excluding Food & Energy) has declined for three consecutive months, moving from a high of 5.3% down to 4.7%.
•    The price of WTI oil has dropped under $100 at the time of this article
•    Natural gas prices dropped from $9 to $5.7
•    Other commodities such as corn, wheat, soybeans, cotton, and copper are all down over 20% – 30% from their recent highs
•    Consumer spending remains stable, and the saving rate is on a slight upward trend
•    The unemployment rate remains low, and the number of open positions exceeds the number of people looking for work

The game plan

Bear markets are normal. They are not pleasant, but they are an ordinary part of the economic cycle. Did you know that since 1929 the S&P 500 has posted declines in 46% of the days the markets were open? If you check your investments daily, your portfolio will appear very volatile. You will observe almost as many green days as red days. In contrast, the probability of seeing losses over ten years is only 6%.

Two landmark studies from behavioral economists Shlomo Benartzi and Richard Thaler found that the more often we check our portfolio, the lower our long-term returns are likely to be. They found that investors with long-term goals who resisted the temptation to monitor the market earned significantly higher profits over time than those who checked annually. For the average person, the pain of losing is greater than the pleasure of making gains. This phenomenon worsens when you constantly check day to day movements of your portfolio and lose sight of your long-term goals. Mr. Thaler and Mr. Benartzi call this “myopic loss aversion.”

So we are in the middle of a market storm, and here are the steps that you need to follow.

  • Stay the course and follow your goals.
  • If you are already invested, stay invested. There is no benefit to trying to time the market.
  • Dollar-cost averaging your long-term cash. Holding more cash than you need will reduce your long-term purchasing power.
  • Clean up your portfolio from any stocks and funds that keep you from sleeping well at night
  • Rebalance your portfolio according to your risk tolerance and investment horizon.
  • Focus on the long-term and ignore short-term news.

Famous last words

“Buy when there’s blood in the streets, even if the blood is your own.” Nathan Rothschild. a 19th-century British financier and member of the Rothschild banking family, made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon. The Rothschild family had established its own network of couriers, which informed them about the Napoleon defeat before the news reached the British society. 

Bear markets can be long and gut-wrenching. Any positive news gets crushed in a swarm of negativity. Your portfolio gets whiplashed every day. It’s easy to get distracted from following your goals.

Fortunately, this bear market will eventually end. The stock market is a leading indicator. It frequently reaches the bottom before the economy is fully recovered. However, those bottoms are tough to identify because they coincide with a lot of negative economic news, which can be driven by a range of lagging indicators such as CPI, unemployment, corporate earnings, and GDP readings. Timing the market bottom takes a lot of stamina and courage, as often it’s the opposite of what your gut is telling you.

Today offers a great opportunity to reflect on yourself and your financial goals. Review your priorities and determine your path. Let the stock market do the heavy lifting. So you can focus on the things that are in your control.

Ten Successful tips for surviving a bear market

Survive bear market

Surviving a bear market can be a treacherous task even for experienced investors. If you are a long-term investor, you know that the bear markets are common. Since 1945, there have been 14 bear markets—or about every 5.4 years. Experiencing a bear market is rough but an inevitable aspect of the economic cycle.

What is a bear market?

A bear market is a prolonged market downturn where stocks fall by 20% or more. Often, bear markets are caused by fears of recession, changes in Fed policy, political uncertainty, geopolitics, or poor macroeconomic data. There have been 26 bear markets in the S&P 500 Index since 1928. However, there have also been 27 bull markets—and stocks have risen significantly over the long term. The average length of a bear market is 289 days or about 9.6 months. For comparison, the average length of a bull market is 991 days or 2.7 years.

A bear market doesn’t necessarily indicate an economic recession. There have been 26 bear markets since 1929, but only 15 recessions during that time. Bear markets often go alongside a slowing economy, but a weakening market doesn’t necessarily mean an imminent recession.

How low can stock go down during a bear market?

Historically, stocks lose 36% on average during a bear market. For comparison, stocks achieve a 114% return on average during a bull market.

The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday), when the S&P 500 dropped by -20.47%. The next biggest selloff happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. Every time, the end of the bear market was the start of a new bull market. Both times, the stock market recovered and reached historic highs in a few years.

What can you do in the next bear market?

The first instinct you may have when during a sharp market drop is to sell your investments. In reality, this may not always be the right move. Selling your stocks during a bear market could limit your losses but also lead to missed long-term opportunities. Emotional decisions do not bring a sustainable long-term outcome.

Dealing with declining stock values and market volatility can be challenging. The truth is nobody likes to lose money. The bear markets can be treacherous for seasoned and inexperienced investors alike. To be a successful investor, you must remain focused on the strength of your portfolio, your goals, and the potential for future growth. I want to share ten strategies that can help you survive the next bear market and preserve the long-term growth of your portfolio.

1. Stay calm during a bear market

Although it can be difficult to watch your stock portfolio decline, it’s important to remember that bear markets have always had a temporary role in the investment process. Those who survive the bear market and make it to the other side can reap huge benefits.

It’s normal to be cheerful when the stock prices are going higher. And it’s even more natural to get anxious during severe bear markets when stocks are going down.

Here is an example of the typical investor experience during a market cycle. The average investor sells near the bottom of the bear market and goes all in at the top of the bull cycle.

Market cycle
 

Significant drops in stock value can trigger panic. However, fear-based selling to limit losses is the wrong move

Overall, markets are positive the majority of the time. Of the last 92 years of market history, bear markets have comprised only about 20.6 of those years. Put another way; stocks have been on the rise 78% of the time.

If you are making sound investment choices, your patience and the ability to tolerate paper losses will earn you more in the long run.

2. Focus on your long-term goals

A market downturn can be tense for all investors. Regardless of how volatile the next bear market correction is, remember that “this too shall pass.”

Market crises come and go, but your goals will most likely remain the same. In fact, your goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

Your personal financial goals can stretch over several years and decades. For investors in their 20s and 30s financial goals can go beyond 40 – 50 years. Even retirees in their 60s must ensure that their money and investments last through several decades.

Remain focused on your long-term goals. Pay off your debt. Stick to a budget. Maintain a high credit score. Live within your means and don’t risk more than you can afford to lose.

3. Don’t try to time the market

Many investors believe that they can consistently time the stock market to buy low and sell high. However, timing the market is a myth.

You need to be right twice

When you try to time the market, you have to make two crucial decisions – when to get in and when to get out. With a small margin of error, you must be consistently right all the time.

Missing the best days

Frequently the market selloffs precede broad market rallies. A V-shape recovery often follows a market correction.

Half of the S&P 500 Index’s best days in the last 20 years occurred during a bear market. Another 28% of the market’s best days took place in the first two months of a bull market—before it was clear a bull market had begun. In other words, the best way to survive a bear market is to stay invested since it’s difficult to time the market’s recovery.

 

Missing the best days of the market
Missing the best days of the market

4. Diversify your portfolio

Diversification is essential for your portfolio preservation and growth. Diversification requires that you spread your investments among different asset classes such as domestic versus foreign stocks, large-cap versus small-cap equity, treasury and corporate bonds, real estate, commodities, precious metals, etc.).

Uncorrelated asset classes react uniquely during market downturns and changing economic cycles. For example, fixed income securities and gold tend to rise during bear markets when stocks fall and investors seek shelter. On the other hand, equities rise during economic expansion and a bull market,

Achieving divarication will lower the risk of your portfolio in the long run. It is the only free lunch you can get in investing.

5. Rebalance your portfolio regularly

Rebalancing your portfolio is a technique that allows your investment portfolio to stay aligned with your long terms goals while maintaining a desired level of risk. Typically, portfolio managers will sell out an asset class that has overperformed over the years and is now overweight. With the sale proceeds, they will buy an underweighted asset class.

Hypothetically, if you started investing in 2010 with a portfolio consisting of 60% Equities and 40% Fixed Income securities, without rebalancing by the end of 2021, you will hold 85% equities and 15% fixed income. Due to the last decade’s substantial rise in the stock market, many conservative and moderate investors may be holding significant equity positions in their portfolios. Rebalancing before a bear market downturn will help you bring your investments to your original target risk levels. If you reduce the size of your equity holdings, you will lower your exposure to stock market volatility.

6. Dollar-cost averaging

Picking the bottom during a bear market is impossible. If you are not willing to invest all your money at once, you can do it over a period of time. By using the dollar-cost averaging method, you invest your cash in smaller amounts at regular intervals, regardless of the movements in the market. When the stock market is down, you buy more shares. And it’s up you buy fewer shares.

If you regularly contribute to your 401k, you are effectively dollar-cost averaging.

Dollar-cost averaging takes the emotion out of investing. It prevents you from trying to time the market by requiring you to invest the same amount regardless of the market’s conditions.

7. Use tax-loss harvesting during bear markets

Tax-loss harvesting is a tax and investment technique that allows you to sell off stocks and other assets that have declined to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment during a bear market to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction from your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

To take advantage of this option, you must follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market, you can substitute the stock with another stock that has a similar profile or buy an ETF

The actual economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains. Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

8. Roth Conversion

A bear market creates an excellent opportunity to do Roth Conversion. Roth conversion is transferring Tax-Deferred Retirement Funds from a Traditional IRA or 401k plan to a tax-exempt Roth IRA. The Roth conversion requires paying upfront taxes with the objective of decreasing your future tax burden.

The lower stock prices during a bear market will allow you to transfer a larger portion of your investments while paying lower taxes. For more about the benefits of Roth IRA read here. And for more information about Roth conversion, you can read our Roth conversion article.

9. Keep your emergency fund

I always recommend that my clients and blog readers keep at least six months of essential living expenses in a checking or a savings account. We call it an emergency fund. It’s rainy-day money, which you need to keep aside for crises and unexpected life events. Sometimes bear markets coincide with recessions and layoffs. If you lose your job, you will have enough reserves to cover your essential expenses and stay on your feet. Using your cash reserves will help you avoid dipping into your retirement savings.

10. Be opportunistic and invest

Bear markets create lifetime opportunities for buying stocks at discounted prices. One of the most famous quotes by Warren Buffet is, “When it’s raining gold, reach for a bucket, not a thimble.” Bear market selloffs rarely reflect the real long-term value of a company as they are triggered by panic, negative news, or geopolitical events. For long-term investors, bear markets present an excellent opportunity to buy their favorite stocks at a discounted price. If you want to get in the market after a selloff, look for established companies with strong secular revenue growth, experienced management, a strong balance sheet, and a proven track record of paying dividends or returning money to shareholders.

Final words

A bear market can take a massive toll on your emotions, investments, and retirement savings. The lack of reliable information and the instant spread of negative news can influence your judgment and force you to make rash decisions. Bear market selloffs can challenge even the most experienced investors. Don’t allow yourself to panic even if it seems like the world is falling apart. Prepare for the next market downturn by following my list of ten recommendations. This checklist will help you “survive” the next bear market while still following your long-term financial goals.

Inflation is a tax and how to combat it

Inflation is a tax

Inflation is a tax. Let me explain. Inflation reduces the purchasing power of your cash and earnings while simultaneously redistributing wealth to the federal government.

When prices go up, we pay a higher sales tax at the grocery store, restaurants, or gas stations. Even if your employer adjusts your salary with Inflation, the IRS tax brackets may not go up at the same pace. Many critical tax deductions and thresholds are not adjusted for inflation.

For example, the SALT deduction remains at $10,000.

We have a $750,000 cap on total mortgage debt for which interest is tax-deductible. There is a $500,000 cap on tax-free home sales. We also have a  $3,000 deduction of net capital losses against ordinary income such as wages.

The income thresholds at which 85% of Social Security payments become taxable aren’t inflation-adjusted and have been $44,000 for joint-filing couples and $34,000 for single filers since 1994

And lastly, even if interest rates on your savings account go up, you still have to pay taxes on your modest interest earnings.

Effectively we ALL will pay higher taxes on our future income

Here are some strategies that can help you combat Inflation.

(Not) keeping cash

Inflation is a tax on your cash. Keeping large amounts of cash is the worst way to protect yourself against Inflation. Inflation hurts savers. Your money automatically loses purchasing power with the rise of Inflation.

Roughly speaking, if this year’s Inflation is 8%, $100 worth of goods and services will be worth $108 in a year from now. Therefore, someone who kept their cash in the checking account will need an extra $8 to buy the same goods and services he could buy for $100 a year ago.

Here is another example. $1,000 in 2000 is worth $1,647 in 2022. If you kept your money in your pocket or a checking account, you could only buy goods and services worth $607 in 2000’s equivalent dollars

I recommend that you keep 6 to 12 months’ worth of emergency funds in your savings account, earning some interest. You can also set aside money for short-term financial goals such as buying a house or paying off debt. If you want to protect yourself from inflation, you need to find a different destination for your extra cash.

Investing in Stocks

Investing in stocks often provides some protection against Inflation. Stock ownership offers a tangible claim over the company’s assets, which will rise in value with Inflation. In inflationary environments, stocks have a distinct advantage over bonds and other investments. Companies that can adjust pricing,  whereas bonds, and even rental properties, not so much

Historical data has shown that equities perform better with inflation rates under 0 and between 0 and 4%.

Inflation is a tax
Higher Inflation deteriorates firms’ earnings by increasing the cost of goods and services, labor, and overhead expenses. Elevated inflation levels can suppress demand as consumers adjust to the new price levels.

Inflation is a tax

Historically, energy, staples, health care, and utility companies have performed relatively better during high inflation periods, while consumer discretionary and financials have underperformed.

While it might seem tempting to think specific sectors can cope with Inflation better than others, the success rate will come down to the individual companies’ business model. Firms with strong price power and inelastic product demand can pass the higher cost to their customers. Furthermore, companies with strong balance sheets, low debt, high-profit margins, and steady cash flows perform better in a high inflation environment.

You also need to remember that every economic regime is somewhat different. Today, we are less dependent on energy than we were in the 1970s. Corporate leadership is also different. Companies like Apple and Google have superiorly high cash flow margins, low debt, and a smaller physical footprint. Technology plays a more significant role in today’s economy than in the other four inflationary periods.

Investing in Real Estate

Real Estate very often comes up as a popular inflation hedge. In the long-run real estate prices tend to adjust with inflation depending on the location. Investors use real estate to protect against inflation by capitalizing on cheap mortgage interest rates, passing through rising costs to tenants.

However, historical data and research performed the Nobel laureate Robert Shiller show otherwise. Shiller says, “Housing traditionally is not a great investment. It takes maintenance, depreciates, and goes out of style”. On many occasions, it can be subject to climate risk – fires, tornados, floods, hurricanes, and even volcano eruptions if you live on the Big Island. The price of a single house also can be pretty volatile. Just ask the people who bought their homes in 2007, before the housing bubble.

Investors seeking inflation protection with Real Estate must consider their liquidity needs. Real Estate is not a liquid asset class. It takes a longer time to sell it than a stock. Every transaction involves paying fees to banks, lawyers, and real estate agents. Additionally, there are also maintenance costs and property taxes. Rising Inflation will lead to higher overhead and maintenance costs, potential renter delinquency, and high vacancy.

Investing in Gold and other commodities

Commodities and particularly gold, tend to provide some short-term protection against Inflation. However, this is a very volatile asset class. Gold’s volatility, measured by its 50-year standard deviation, is 27% higher than that of stocks and 3.5 times greater than the volatility of the 10-year treasury. Other non-market-related events and speculative trading often overshadow short-term inflation protection benefits.

Furthermore,  gold and other commodities are not readily available to retail investors outside the form of ETFs, ETNs, and futures. Buying actual commodities can incur significant transaction and storage costs, making it almost prohibitive for individuals to own them physically.

In recent years the relationship between gold and Inflation has weakened. Gold has become less crucial for the global economy due to monetary policy expansion, benign economic growth, and low and negative interest rates in Japan and the EU.

 Having a Roth IRA

If higher Inflation means higher taxes, there is no better tool to lower your future taxes than Roth IRA. I have written a lot about why you need to establish a Roth IRA. Roth IRA is a tax-exempt retirement savings account that allows you to make after-tax dollars. The investments in your Roth IRA grow tax-free, and all your earnings are tax=emept.

If you are a resident of California, the highest possible tax rate you can pay are

  • 37% for Federal Income taxes
  • 13.3% for State Income taxes
  • 2% for Social Security Income tax for income up to $147,000 in 2022
  • 35% for Medicare Taxes
  • 20% Long-term capital gain tax
  • 8% for Net Investment income tax (NIIT) for your MAGI is over $200,000 for singles and $250,000 for married filing jointly

Having a Roth IRA helps you reduce the  tax noise on your earnings and improves the tax diversification of your investments

Here is how to increase your Roth contributions depending on your individual circumstances:

  • Roth IRA contributions
  • Backdoor Roth contributions
  • Roth 401k Contributions
  • Mega-back door 401k conversions
  • Roth conversions from your IRA

Roth IRA Contribution Limits 2023

Roth IRA Contribution Limits for 2023

The Roth IRA contribution limits for 2023 are $6,500 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is $500 increase from 2022.

Retirement Calculator

Roth IRA income limits for 2023

Roth IRA contribution limits for 2023 are based on your annual earnings. If you are single or a head of household and earn $138,000 or less, you can contribute up to the full amount of $6,500 per year.  If your aggregated gross income is between $138,000 and $153,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,500 each if their combined income is less than $218,000.  If your aggregated gross income is between $218,000 and $228,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $5,000 in 2023, you could only contribute $5,000 in your Roth

Roth IRA Contribution Limits 2022

Roth IRA Contribution Limits for 2022

The Roth IRA contribution limits for 2022 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is no change from 2021.

Retirement Calculator

Roth IRA income limits for 2022

Roth IRA contribution limits for 2022 are based on your annual earnings. If you are single or a head of household and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $129,000 and $144,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $204,000.  If your aggregated gross income is between $204,000 and $214,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

Achieving tax alpha and higher after tax returns on your investments

Achieving Tax Alpha

What is tax alpha?

Tax Alpha is the ability to achieve an additional return on your investments by taking advantage of a wide range of tax strategies as part of your comprehensive wealth management and financial planning.  As you know, it is not about how much you make but how much you keep. And tax alpha measures the efficiency of your tax strategy and the incremental benefit to your after-tax returns.

Retirement Calculator

Why is tax alpha important to you?

The US has one of the most complex tax systems in the world. Navigating through all the tax rules and changes can quickly turn into a full-time job. Furthermore, the US budget deficit is growing exponentially every year. The government expenses are rising. The only way to fund the budget gap is by increasing taxes, both for corporations and individuals.

Obviously, our taxes pay our teachers, police officers, and firefighters, fund essential services, build new schools and fix our infrastructure. Our taxes help the world around us humming.  However, there will be times when taxes become a hurdle in your decision process. Taxes turn into a complex web of rules that is hard to understand and even harder to implement.

Achieving tax alpha is critical whether you are a novice or seasoned investor sitting on significant investment gains.  Making intelligent and well-informed decisions can help you improve the after-tax return of your investment in the long run.

Assuming that you can generate 1% in excess annual after-tax returns over 30-year, your will investments can grow as much as 32% in total dollar amount.

Tax alpha returns
Tax alpha returns

1. Holistic Financial Planning

For our firm, achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions is at the core of our service. Preparing you for your big day is not a race. It’s a marathon.  It takes years of careful planning and patience. There will be uncertainty. Perhaps tax laws can change. Your circumstances may evolve. Whatever happens, It’s important to stay objective, disciplined, and proactive in preparing for different outcomes.

At our firm, we craft a comprehensive strategy that will maximize your financial outcome and lower your taxes in the long run. We start by taking a complete picture of your financial life and offer a road map to optimize your tax outcome. Achieving higher tax alpha only works in combination with your holistic financial plan. Whether you are planning for your retirement, owning a large number of stock options, or expecting a small windfall, planning your future taxes is quintessential for your financial success.

2. Tax Loss Harvesting

Tax-loss harvesting is an investment strategy that allows you to sell off assets that have declined in value to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction to your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

The real economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains.  Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

How does tax-loss harvesting work?

Example: An investor owns 1,000 shares of company ABC, which she bought at $50 in her taxable account. The total cost of the purchase was $50,000. During a market sell-off a few months later, the stock drops to $40, and the initial investment is now worth $40,000.

Now the investor has two options. She can keep the stock and hope that the price will rebound. Alternatively,  she could sell the stock and realize a loss of $10,000. After the sale, she will have two options. She can either buy another stock with a similar risk profile or wait 30 days and repurchase ABC stock with the proceeds. By selling the shares of ABC, the investor will realize a capital loss of $10,000. Assuming she is paying 15% tax on capital gains, the tax benefit of the loss is equal to $1,500.  Furthermore, she can use the loss to offset future gains in her investment portfolio or other sources.

3. Direct Indexing

Direct indexing is a type of index investing. It combines the concepts of passive investing and tax-loss harvesting. The strategy relies on the purchase of a custom investment portfolio that mirrors the composition of an index.

Similar to buying an index fund or an ETF, direct indexing requires purchasing a broad basket of individual stocks that closely track the underlying index.  For example, if you want to create a portfolio that tracks S&P 500, you can buy all or a smaller number of  500 stocks inside the benchmark.

Owning a basket of individual securities offers you greater flexibility to customize your portfolio.  First, you can benefit from tax-loss harvesting opportunities by replacing stocks that have declined in value with other companies in the same category. Second, you can remove undesirable stocks or sectors you otherwise can’t do when buying an index fund or an ETF. Third, direct indexing can allow you to diversify your existing portfolio and defer realizing capital gains, especially when you hold significant holdings with a low-cost basis.

4. Tax Location

Tax location is a strategy that places your diversified investment portfolio according to each investment’s risk and tax profile. In the US, we have a wide range of investment and retirement accounts with various tax treatments. Individual investment accounts are fully taxable for capital gains and dividends. Employer 401k, SEP IRA and Traditional IRA are tax-differed savings vehicles. Your contributions are tax-deductible while your savings grow tax-free. You only pay taxes on your actual retirement withdrawals. Finally, Roth IRA, Roth 401k, and 529 require pre-tax contributions, but all your future earnings are tax-exempt. Most of our clients will have at least two or more of these different instrument vehicles.

Now, enter stocks, bonds, commodities, REITs, cryptocurrencies, hedge funds, private investments, stock options, etc. Each investment type has a different tax profile and carries a unique level of risk.

At our firm, we create a customized asset allocation for every client, depending on their circumstances and goals. Considering the tax implications of each asset in each investment or retirement account, we carefully create our tax location strategy to take advantage of any opportunities to achieve tax alpha.

5. Smart tax investing

Smart tax investing is a personalized investment strategy that combines various portfolio management techniques such as tax-loss harvesting, asset allocation, asset location, diversification, dollar-cost averaging, passive vs. active investing, and rebalancing.  The main focus of tax-mindful investing is achieving a higher after-tax return on your investment portfolio. Combined with your comprehensive financial planning, smart-tax investing can be a powerful tool to elevate your financial outcome.

Successful strategies for (NOT) timing the stock market

Timing the stock market

Timing the stock market is an enticing idea for many investors.  However, even experienced investment professionals find it nearly impossible to predict the daily market swings, instant sector rotations, and ever-changing investors’ sentiments. The notion that you can perfectly sell at the top of the market and buy at the bottom is naïve and oftentimes leads to bad decisions.

The 24-hour news cycle is constantly bombarding us. The speed and scale of information could easily bounce the stock market between desperation, apathy, and fear to euphoria, FOMO, and irrational exuberance.

In that sense, the market volatility can be unnerving and depressing. However, for long-term investors, trying to time the market tops and bottoms is a fool’s errand. Constantly making an effort to figure out when to get in and get out can fire back. There is tremendous evidence that most investors reduce their long-term returns trying to time the market. Market timers are more likely to chase the market up and down and get whipsawed, buying high and selling low.

The hidden cost of timing the stock market

There is a hidden cost in market timing.  According to Fidelity, just missing 5 of the best trading days in the past 40 years could lower your total return by 38%. Missing the best 10 days will cut your return in half.

Source: Fidelity
Source: Fidelity

For further discussion on how to manage your portfolio during times of extreme market volatility, check my article on “Understanding Tail Risk

Rapid trading

Today’s stock market is dominated by algorithm trading platforms and swing traders with extremely short investment horizons.  Most computerized trading strategies hold their shares for a few seconds, not even minutes. Many of these strategies are run by large hedge funds. They trade based on market signals, momentum, and various inputs built within their models. They can process information in nanoseconds and make rapid trades. The average long-term investors cannot and should not attempt to outsmart these computer models daily.

Reuters calculated that the average holding period for U.S. shares was 5-1/2 months as of June 2020, versus 8-1/2 months at the of end-2019. In 1999, for example, the average holding period was 14 months. In the 1960s and 1970, the investors kept their shares for 6 to 8 years.

Timing the stock market
Timing the stock market

 

The market timing strategy gives those investors a sense of control and empowerment, It doesn’t necessarily mean that they are making the right decisions.

So, if market turmoil gives you a hard time, here are some strategies that can help you through volatile times.

Dollar-cost average

DCA is the proven approach always to be able to time the market.  With DCA, you make constant periodic investments in the stock market. And you continue to make these investments whether the market is up or down. The best example of DCA is your 401k plan. Your payroll contributions automatically invest every two weeks.

Diversify

Diversification is the only free lunch in investing. Diversification allows you to invest in a broad range of asset classes with a lower correlation between them.  The biggest benefit is lowering the risk of your investment portfolio, reducing volatility, and achieving better risk-adjusted returns.  A well-diversified portfolio will allow your investments to grow at various stages of the economic cycle as the performance of the assets moves in different directions.

Rebalance

Rebalancing is the process of trimming your winners and reinvesting in other asset classes that haven’t performed as successfully.  Naturally, one may ask, why should I sell my winners? The quick answer is diversification. You don’t want your portfolio to become too heavy in a specific stock, mutual fund, or ETF. By limiting your exposure, you will allow yourself to realize gains and buy other securities with a different risk profile.

Buy and hold

For most folks, Buy and Hold is probably the best long-term strategy. As you saw earlier,  there is a huge hidden cost of missing out on the best trading days in a given period. So being patient and resilient to noise and negative news will ultimately boost your wealth. You have to be in it to win it.

Tax-loss harvesting

If you are holding stocks in your portfolio, the tax-loss harvesting allows you to take advantage of price dips and lower your taxes. This strategy works by selling your losers at a loss and using the proceeds to buy similar security with an identical risk-reward profile. At the time of this article, you can use capital losses to offset any capital gains from the sale of profitable investments. Furthermore,  you can use up to $3,000 of residual capital loss to offset your regular income. The unused amount of capital loss can be carried forward in the next calendar year and beyond until it’s fully used.

Maintain a cash reserve

I advise all my clients to maintain an emergency fund sufficient to cover at least 6 months worth of expenses. An emergency fund is especially critical If you are relying on your investment portfolio for income. The money in your emergency fund will help you withstand any unexpected market turbulence and decline in your portfolio balance. A great example would be the rapid market correction in March 2020 at the onset of the coronavirus outbreak. If you needed to sell stocks from your portfolio, you would be in tough luck. But if you had enough cash to keep afloat through the crisis, you would have been in a perfect position to enjoy the next market rebound.

Focus on your long term goals

My best advice to my clients who get nervous about the stock market is to focus on what they can control.  Define your long-term goals and make a plan on how to achieve them. The stock market volatility can be a setback but also a huge opportunity for you. Follow your plan no matter what happens on the stock market. Step back from the noise and focus on strengthening your financial life.

Understanding Tail Risk and how to protect your investments

Understanding tail risk

What is Tail Risk?

Tail Risk is the possibility of suffering large investment losses due to sudden and unforeseen events. The name tail risk comes from the shape of the bell curve. Under normal circumstances, your most likely investment returns will gravitate in the middle of the curve. For long term investors, this will represent your average expected return. The more extreme returns have a lower probability of occurring and will taper away toward the end of the curve.

Understanding tail risk
Source: Pimco

The tail on the far-left side represents the probability of unexpected losses. The far-right represents the most extreme outcomes of substantial investment gains. For long-term investors, the ideal portfolio strategy will seek to minimize left tail risk without restricting the right tail growth potential.

Why is tail risk important?

Intuitively, we all want to be on the ride side of the bell curve. We want to achieve above-average returns and occasionally “hit the jackpot” with sizeable gains.

In real life, abrupt economic, social, and geopolitical events appear a lot more frequently than a rational human mind would predict. Furthermore, significant market shocks have been occurring about every three to five years resulting in “fatter” tails.

Also known as “Black Swans, they are rare and unique. These “one-off” events impose adverse pressure on your investment portfolio and create risk for outsized losses. Tail risk events bring a massive amount of financial and economic uncertainty and often lead to extreme turbulence on the stock market.

The Covid outbreak, Brexit, the European credit crisis, the collapse of Lehman Brothers, the Enron scandal, the US housing market downfall, and the 9/11 terrorist attacks are examples of idiosyncratic stock market shocks. Very few experts could have predicted them. More notably, they caused dramatic changes to our society and our economy, our consumer habits, and the way we conduct business.

Assessing your tail risk exposure

Retirees and those close to retirement, people who need immediate liquidity, executives, and employees holding a large amount of corporate stock are more susceptible to tail risk events. If you fall into one of these categories, you need to review your level of risk tolerance.

Investing is risky. There are no truly risk-free investments. There are only investments with different levels of risk. It is impossible to avoid risk altogether. The challenge for you is to have a reasonably balanced approach to all the risks you face. Ignoring one risk to help you prevent another risk does not mean you are in the clear.

Winners and losers

It is important to remember that every shock to the system leads to winners and losers. For example, the covid outbreak disproportionately hurt leisure, travel, retail, energy, and entertainment businesses. But it also benefited many tech companies as it accelerated the digital transformation. As bad as it was, the global financial crisis damaged many big and small regional banks. But it also opened the door for many successful fintech companies such as Visa, Mastercard, PayPal, and Square and exchange-traded fund managers like BlackRock and Vanguard. The aftermath of 9/11 drove the stock market down, but it led to a boost in defense and cybersecurity stocks.

Know your investments

The first step in managing your tail risk is knowing your investments. That is especially important if you have concentrated positions in a specific industry, a cluster of companies, or a single stock. Black Swan events could impact different stocks, sectors, and countries differently. For instance, the Brexit decision mostly hurt the performance of the UK and European companies and had no long-term effect on the US economy.

Know your investment horizon

Investors with a long-term investment horizon are more likely to withstand sudden losses. The stock market is forward-looking. It will absorb the new information, take a hit, and move on.

I always give this as an example. If you invested $1,000 in the S&P 500 index on January 1, 2008, just before the financial crisis, you would have doubled your money in 10 years. Unfortunately, if you needed your investment in one or two years, you would have been in big trouble. It took more than three years to recover your losses entirely.

Diversify

Never put all your eggs in one basket. The most effective way to protect yourself from unexpected losses is diversification. Diversification is the only free lunch you will ever get in investing. It allows you to spread your risk between different companies, sectors, asset classes, and even countries will allow your investment portfolio to avoid choppy swings in various market conditions. One prominent downside of diversification is that while you protect yourself from the left tail risk, you also limit the right tail potential for outsized returns.

Hold cash

Keeping cash reserves is another way to protect yourself from tail risk. You need to have enough liquidity to meet your immediate and near-term spending needs. I regularly advise my clients to maintain an emergency fund equal to six to twelve months of your budget. Put it in a safe place, but make sure that you still earn some interest.

Remember what we said earlier. There is no risk-free investment – even cash. Cash is sensitive to inflation. For instance, $100,000 in 2000 is worth only $66,800 in 2020. So, having a boatload of cash will not guarantee your long-term financial security. You must make it earn a higher return than inflation.

Furthermore, cash has a huge opportunity cost tag. In other words, by holding a large amount of money, you face the risk of missing out on potential gain from choosing other alternatives.

US Treasuries

US Government bonds have historically been a safe haven for investors during turbulent times. We have seen the demand for treasuries spiking during periods of extreme uncertainty and volatility. And inversely, investors tend to drop them when they feel confident about the stock market. Depending on their maturity, US treasuries may give you a slightly higher interest than holding cash in a savings account.

While offering some return potential, treasuries are still exposed to high inflation and opportunity cost risk. Also, government bonds are very sensitive to changes in interest rates. If interest rates go up, the value of your bonds will go down. On the other hand, when interest rates go down, the value of your bonds will decrease.

Gold

Gold is another popular option for conservative investors. Similar to treasuries, the demand for gold tends to go up during uncertain times. The faith for gold stems from its historical role as a currency and store of value. It has been a part of our economic and social life in many cultures for thousands of years.

As we moved away from the Gold standard, the Gold’s role in the economy has diminished over time. Nowadays, the price of gold is purely based on price and demand. One notable fact is that gold tends to perform well during periods of high inflation and political uncertainty.

In his 2011 letter to shareholders of Berkshire Hathaway, Warren Buffet described gold as an “asset that will never produce anything, but that is purchased in the buyer’s hope that someone else … will pay more for them in the future…..If you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Buying Put Options to hedge tail risk

Buying put options om major stock indices is an advanced strategy for tail risk hedging. In essence, an investor will enter into an option agreement for the right to sell a financial instrument at a specified price on a specific day in the future. Typically, this fixed price known as a strike price is lower than the current levels where the instrument is trading. For instance, the stock of XYZ is currently trading at $100. I can buy a put option to sell that stock at $80 three months from now. The option agreement will cost me $2. If the stock price of XYZ goes to $70, I can buy it at $70 and exercise my option to sell it at $80. By doing that, I will have an immediate gain of $10. This is just an illustration. In real life, things can get more complicated.

The real value of buying put options comes during times of extreme overvaluation in the stock market. For the average investor, purchasing put options to tail risk hedging can be expensive, time-consuming, and quite complicated. Most long-term investors will just weather the storm and reap benefits from being patient.

Final words

Managing your tail risk is not a one-size-fits-all strategy. Black Swam events are distinctive in nature, lengh, and magnitude. Because every investor has specific personal and financial circumstances, the left tail risk can affect them differently depending on a variety of factors. For most long-term investors, the left tail and right tail events will offset each other in the long run. However, specific groups of investors need to pay close attention to their unique risk exposure and try to mitigate it when possible.

Benefits and drawbacks to buying Indexed Universal Life Insurance

Indexed Universal Life Insurance IUL

Today, I am going off the beaten path for me and will discuss the pros and cons of buying Indexed Universal Life Insurance. As a fee-only advisor, I do not sell any insurance or commission-based products. However, on numerous occasions, I have received requests from clients to review their existing insurance coverage. I certainly do not know every IUL product out there. And I might be missing some of the nuances and differences between them. My observation is that IUL is not suitable for the average person due to its complexity and high cost. And yet, the IUL might be the right product for you if you can take advantage of the benefits that it offers. 

Retirement Calculator

What is an Indexed Universal Life Insurance (IUL)?

Indexed Universal Life is a popular insurance product that promises protection coverage with stock market-like performance and a zero-downside risk. Like other universal life insurance, IUL offers a death benefit and a cash value. Your cash value account can earn interest based on the performance of a specific stock market index such as the S&P 500, Dow Jones Industrial Average, the Nasdaq 100, and Russell 2000.

IUL Illustration rate

IUL policies use an illustration rate for advertising and hypothetically projecting the policy values in their sales materials. The Illustration rate is the fixed rate derived from historical performance. Usually, the illustration rate ranges between 5% and 10%.

Is IUL right for me?

On the surface, Indexed Universal Life Insurance sounds like a great deal. You receive a stock market upside with zero risks for losses. Nevertheless, IUL comes with some severe caveats.

Let’s break down the main benefits and drawbacks of IUL.

 Benefits of Indexed Universal Life Insurance

Tax-Deferred Accumulation

Index Universal Life Insurance allows you to grow your policy cash value and death benefit on a tax-deferred basis. Typically, you will not owe income taxes on the interest credited to your cash value and death benefit.

Tax-Free Distribution

Life Insurance, in general, is a lucrative tool for legacy planning. With IUL, your policy beneficiaries will receive the death benefit tax-free. As long as you maintain your insurance premiums and don’t take outsized loans, you can pass tax-free wealth to the next generation.

Access to a cash value

You can always withdraw your policy basis (original premiums paid) tax-free. In most cases, you can also access your cash value through tax-favorable policy loans or withdrawals. In case of emergency, you may borrow from your indexed universal life insurance policy. You can access your cash value without any penalty regardless of your age.

Supplemental Retirement Income

You can use the cash value from your policy as a source of supplemental retirement income.  You can also use it to cover future medical expenses.

Limited downside risk

IUL offers protection against stock market volatility. An IUL delivers stock market-linked gains without the risks of losing principal due to the stock market declines. With the IUL’s principal-protection guarantee, your annual gains are locked in. Your principal cash value remains the same, even if the stock market goes down.

A guaranteed minimum rate

Many IUL policies come with a guaranteed minimum annual interest rate. This rate is a floor of how much you can earn every year. The guaranteed allows you to receive a certain percentage regardless of how the market performs. This floor rate depends on the specific insurance, and it could vary between 0% and 2%.

Drawbacks of Indexed Universal Life Insurance

IUL is complex

IUL is an extremely complex insurance product. There are many moving parts in your UIL policy, making it confusing and hard to understand. Most sales illustration packages portray an ideal scenario with non-guaranteed average market performance figures. In reality, between your annual premiums, cap rates, floors, fees, market returns, cash value accumulation, riders, and so on, it is tough to predict the outcome of your insurance benefits.

Upfront Commissions

The people who sell IUL are highly trained sales professionals who may not be qualified to provide fiduciary financial advice. The IUL comes with a hefty upfront commission, which is often buried in the fine print and gets subtracted from your first premium payment.

IUL has high fees

The policy fees will shock you and eat your lunch literally. I have personally seen charges in the neighborhood of 11% to 13% annually. These fees will always reduce the benefits of your annual premium and earned interest.

Limited earnings potential

IUL policies will typically limit your stock market returns and will exclude all dividends. Most IULs offer some combination of participation rate and capped rate in comparison to the illustration rate used in their marketing materials.

Participation Rate is the percentage of positive index movement credited to the policy. For example, if the S&P 500 increased 10% and the IUL has an annual participation rate of 50%, your policy would receive 5% interest on the anniversary date.

Cap Rate is the maximum rate that you can earn annually. The cap rate can vary significantly from policy to policy and from insurance provider to the next.

 Why capped upside is an issue?

The problem with cap rates and participation rates is they limit your gains during, especially good years. Historically, the stock market returns are not linear and sequential, as the policy illustration rates suggest. In the 40 years between 1980 and 2019, the stock market earned an average of 11.27% per year. During this period, there were only eight years when the stock market had negative returns or 20% of that period. There were only seven years when the stock market posted returns between 0% and 10%. And there were 25 years when the stock market earned more than 10% per year. In 17 of those 25 periods, the stock market investors gained more than 20% or 42% of the time.

In other words, historically, the odds of outsized gains have been a lot higher than the odds of losses.

However, as humans, the pain of losing money is a lot stronger than the joy of gaining.

In effect, long-term IUL policyholders will give up the potential of earning these outsized profits to reduce their anxiety and stress of losing money.

Surrender charges

IULs have hefty surrender charges. If you change your mind in a couple of years and decide to cancel your policy, you may not be able to receive the full cash value. Before you get into a contract, please find out the surrender charges and when they expire.

Expensive Riders

Indexed Universal Life Insurance typically offers riders. The policy riders are contract add-ons that provide particular benefits in exchange for an additional fee. These provisions can include long-term care services, disability waivers, enhanced performance, children’s’ term insurance, no-lapse guarantee, and many more. The extra fee for each rider will reduce your cash value, similar to the regular policy fees. You need to assess each rider individually as the cumulative cost may outweigh your benefit and vice versa,

Cash value withdrawals reduce your death benefit

In most cases, you might be able to make a tax-free withdrawal from the cash value of your IUL policy. These withdrawals are often treated as loans. However, legacy-minded policyholders need to remember that withdrawing your cash value reduces your beneficiaries’ death benefit when you pass away.

Potential taxable income

There is still a chance to pay taxes on your IUL policy. If you let your policy lapse or decide to surrender it, the money you have withdrawn previously could be taxable. Withdrawals are treated as taxable when they exceed your original cost basis or paid premiums.

Five Investment Ideas for 2021

Investment Ideas for 2021

Investment ideas for 2021.  2020 was a challenging and transformative year. The world was battling with a new virus that spread nondiscriminatory around the globe. Entire countries shut down to protect themselves from the hidden enemy. As it happens always in human history, crisis creates opportunities.  Established businesses had to adapt to the new regime and emerging companies offered innovative solutions.

In my article  “Investment ideas for 2020“, I set my expectations for double-digit growth in e-commerce, cloud computing, cybersecurity, logistics, work from home, digital payments, 5G, and socially responsible investing. These sectors played a central role in our fight with covid 19 and will impact the economy in the foreseeable future. You can read the full article here.

Today I am offering you the second article in this investment ideas series.  We will focus on areas that will benefit from the reopening of the world economies. With the covid vaccine reaching more people in more countries, we will observe a coordinated global recovery. The unprecedented global financial stimulus and near “boiling” penned-up demand will drive higher  economic activity and consumer spending,

1. Utilities

Utilities are my top investment ideas for 2021. Utility stocks received very little love from the investment community in 2020. They came out of favor despite being one of the best performing sectors the previous decade.  Investors worried about reduced business activity and deteriorating consumer health caused by the covid pandemic. Many of these fears turned out to be immaterial. And most utilities posted stable revenue and earnings in 2020. What happened?  More people worked from home, which caused high home utility bills. Low-income families received various stimulus payments and forbearance options, which allowed them to pay their bills. Even after the sharp drop in March, the US manufacturing and non-manufacturing activity rebounded quickly to pre covid levels.

In spite of their slow growth, historically, utilities have followed the broader stock market very closely. Furthermore, most established utility companies pay a stable dividend in the range of 3% to 4%. They are an attractive option for income-seeking investors. Some experts consider utilities as bond proxies. They tend to have a lower correlation with the rest of the stock market.

US renewable energy consumption is growing

Where we stand today, many utilities are in the front and center of our fight against climate change and global warming. Many utilities aggressively move towards renewable energy sources such as solar panels, hydroelectric dams, wind turbines, geothermal and biomass energy. Renewable energy collectively provided more power than coal plants for the first time in 2019.

Utilities remain deeply dependent on natural gas and fossil fuel. However, I believe that further innovation in battery storage and capacity utilization will continue to boost renewable energy growth. Furthermore, for the firm believers in electric vehicles and clean energy, the boring old-fashioned utilities will become quintessential in moving the needle towards widespread adoption.

2. Healthcare and Life Science

2020 was both ruthless and transformational for the healthcare industry. Healthcare workers around the world have been and remain in the frontline battle against Covid-19. We all have seen images of doctors and nurses sharing pictures after an exhausting shift in their covid unit. I know healthcare workers (including my dad) who lead the fight every day. As someone married to a physician, I have a close-up experience with the challenges and transformations that occurred in the past 12 months.

New chapter for healthcare

Telehealth will become the norm in general medicine. As more professionals and patients become comfortable with the use of technology, telemedicine will offer access to more affordable and better-quality care for many people worldwide. For healthcare systems, it is a chance to cut costs, improve burnout rates amongst doctors and hire top talent without the need to relocate.

Medical Devices. 2021 and 2022 can see a surge for elective and nonessential medical procedures. The global pandemic forced many people and hospitals to delay non-life-threatening, elective, and cosmetic surgeries and procedures. I believe that as we get a tighter grip on the virus through vaccination and rollout of new viral drugs, we can see a slow and steady growth on this side of healthcare.

New Treatments. The pharmaceutical and biotech industry is in the early innings of developing a new generation of patient treatment. From gene sequencing and immunotherapies to multi-cancer screening offer a unique opportunity in the battle against cancer and other rare diseases.

3. Financials

I started writing this article in the first weeks of 2021 before the rally in banks, which was caused by the rise in US treasury yields. As a result, most banks are now trading near or above pre-covid levels.  Nevertheless, financials are one of our investment ideas for 2021.

Despite initial concerns over liquidity and credit losses, banks maintained a strong balance sheet and reported revenue and earnings well above analyst estimates. The unprecedented stimulus has flooded the financial system with cash. The US economy’s cash supply went from $3.9T pre covid to $18.1T as of January 31, 2021. A large portion of the cash is sitting with banks waiting to be deployed.

US M1 Supply 

Furthermore, most banks took significant loan loss provision reserves. For example, Bank of America alone took $11.3 billion in reserves in 2020 versus $3.6 billion in 2019. I expect that the banks will release most of these provisions, which they can use to pay higher dividends, share buybacks, and improve operational efficiencies.

U.S. Bank Stocks – Provisions for Loan Losses (2019-2020)

Before you get too excited about investing in banks, remember that the entire financial industry is undergoing a massive digital transformation.  The old brick and mortar branches are slowly losing their footprint. PayPal and Square are taking market shares in the growing digital payment space. For example, PayPal reported 20% higher revenue in 2020, Square doubled it. While Bank of America dropped revenue by -5%. Therefore, expect the bank of the future to be leaner, less physical, more personalized, more digital, and more focused on user experience.

4. Discretionary spending

Millions of individuals and families have cooped-up in our homes for more than a yearAs many of us were unable to travel and spend time with our friends and family, we will observe a significant increase in discretionary spending as the covid vaccine distribution reaches more people worldwide. Furthermore, the $1.9 trillion Covid relief bill will put cash in the hands of many struggling US families. The latest round of stimulus promises $1,400 payments and child credits.

Bloomberg Economics estimates that Americans have accumulated $1.7 trillion in excess savings since the beginning of the pandemic through January 2021.

With the world economies reopening, discretionary spending will continue to rise.  Therefore, I expect consumers to spend more discretionary income on travel, leisure, wellbeing, luxury goods, 5G phones and gadgets, and home improvement. For one, I cannot wait to be able to travel again.

5. Technology

Technology remains firmly one of our top investment ideas for 2021. Tech stocks will continue to dominate the stock markets and the US economy. The covid pandemic boosted the role of technology in our daily lives. Tech giants were in a unique position in 2020. Their strong balance sheet and ability to adapt quickly accelerated their customers’ awareness and adoption.  From ordering food and groceries online, applying for a mortgage loan online to digital signature, voice control, video calls, and 5G, technology is everywhere.

The covid outbreak pushed every single business sector towards digital transformation.  As a result, more private businesses and government organizations are embracing data analytics, cloud computing, cybersecurity, customer service, experience management to improve their service, understand their customers and strengthen their data. Gartner projects that spending on public cloud services will grow by 18.4% in 2021 to total $304.9 billion, up from $257.5 billion in 2020. Furthermore, the expansion of 5G networks will set the stage for significant innovations in autonomous driving, connected devices, smart homes, artificial intelligence, and virtual / augmented reality.

 

Roth IRA Contribution Limits 2021

Roth IRA Contribution Limits for 2021

The Roth IRA contribution limits for 2021 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

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Roth IRA income limits for 2021

Roth IRA contribution limits for 2021 are based on your annual earnings. If you are single and earn $125,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $125,000 and $140,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $198,000.  If your aggregated gross income is between $198,000 and $208,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

Roth IRA allows you to make after-tax contributions towards retirement. In comparisons. Traditional IRA has the same annual contributions limits. The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and take full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

IRA Contribution Limits 2022

IRA Contribution Limits for 2022

The IRA contribution limits for 2022 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older. Contribution limits remain the same as 2021.

Retirement Calculator

What is an IRA?

IRA or Traditional IRA is a tax-deferred retirement savings account that allows you to make tax-deductible contributions to save towards retirement. Your savings grow tax-free. You do not owe taxes on dividends and capital gains. Once you reach retirement age, you can start taking money out of the account. All distributions from the IRA are taxable as ordinary income in the year of withdrawal.

IRA income limits for 2022

The tax-deductible IRA contribution limits for 2022 are based on your annual income. If you are single and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $129,000 and $144,000 you can still make contributions but with a smaller amount.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $204,000.  If your aggregated gross income is between $204,000 and $214,000 you can still make reduced contributions.

Spousal IRA

If you are married and not earning income, you can still make contributions. As long as your spouse earns income and you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation. Keep in mind that, your combined contributions can’t be more than the taxable compensation reported on your joint return.

IRA vs 401k

IRA is an individual retirement account.  401k plan is a workplace retirement plan, which is established by your employer. You can contribute to a 401k plan if it’s offered by your company.  In comparison, anyone who is earning income can open and contribute to a traditional IRA regardless of your age.

IRA vs Roth IRA 

Traditional and Roth IRA have the same annual contribution limits.  The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. In comparison. Roth IRA allows you to make after-tax contributions towards retirement. Another difference, your Traditional IRA retirement savings grow tax-deferred, while Roth IRA earnings are tax-free.

 

IRA Contribution Limits 2021

IRA Contribution Limits for 2021

The IRA contribution limits for 2021 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older.

Retirement Calculator

What is an IRA?

IRA or Traditional IRA is a tax-deferred retirement savings account that allows you to make tax-deductible contributions to save towards retirement. Your savings grow tax-free. You do not owe taxes on dividends and capital gains. Once you reach retirement age, you can start taking money out of the account. All distributions from the IRA are taxable as ordinary income in the year of withdrawal.

IRA income limits for 2021

The tax-deductible IRA contribution limits for 2021 are based on your annual income. If you are single and earn $125,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $125,000 and $140,000 you can still make contributions but with a smaller amount.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $198,000.  If your aggregated gross income is between $198,000 and $208,000 you can still make reduced contributions.

Spousal IRA

If you are married and not earning income, you can still make contributions. As long as your spouse earns income and you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation. Keep in mind that, your combined contributions can’t be more than the taxable compensation reported on your joint return.

IRA vs 401k

IRA is an individual retirement account.  401k plan is a workplace retirement plan, which is established by your employer. You can contribute to a 401k plan if it’s offered by your company.  In comparison, anyone who is earning income can open and contribute to a traditional IRA regardless of your age.

IRA vs Roth IRA 

Traditional and Roth IRA have the same annual contribution limits.  The Traditional IRA contributions can be tax-deductible or after-tax depending on your income. In comparison. Roth IRA allows you to make after-tax contributions towards retirement. Another difference, your Traditional IRA retirement savings grow tax-deferred, while Roth IRA earnings are tax-free.

 

Investment ideas for 2020

Investment ideas for 2020

Investment ideas for 2020 and beyond. Learn what trends will drive the stock market in the next decade.

Disruption creates opportunity

 2020 has been challenging in multiple ways. The global pandemic changed our lives. We have adapted rapidly to a brand new world. Six months through the outbreak, it is almost unthinkable to go back to where things were before. The covid pandemic accelerated many habits and trends that we were making strides in our lifestyle.

With the world getting closer to a covid vaccine, I want to offer you several investment ideas based on how our life we look like after the pandemic. Technology is bringing a lot of changes. It opens opportunities that have been unimaginable before. All these secular tailwinds make me feel optimistic about the future of the U.S. economy and the stock market since we are already leaders in technology, healthcare, and financial services.

Digital everything

Firstly, my strongest investment idea for 2020 is digital expansion. From online shopping through mobile banking to remote learning, home fitness, and telemedicine, the digital transformation is here to stay. Moreover, we can order our groceries online. And get our dinner delivered at our front door.  Talk to our doctor over Zoom. Take an online fitness class. And deposit our checks on our phone. You can even buy a new house or get a mortgage refi without leaving your home. My two-year-old son knows how to use my laptop by now.

E-commerce has been steadily growing over the years. From merely 4% in 2010, e-commerce now has a 12% share of the total U.S. retail sales in 2020. Even after the covid pandemic, e-commerce has barely scratched the surface and has a massive runway for expansion. Furthermore, besides the U.S. and China, e-commerce is just beginning to spread in the rest of the world. Digital opportunities are still limitless.

The businesses that can rapidly adapt to these changes will become the next industry leaders in their respective fields.

Same day delivery

For all of you, Amazon, Walmart, Costco, and Target fans out there, same-day delivery will become an industry-standard sooner than you think. All major retailers are moving in this direction, and smaller competitors must catch up very quickly to stay in the game.

Instacart, who is the pioneer of same-day delivery, has existing relationships with Walmart, Safeway, Costco, CVS, Kroger, Loblaw, Aldi, Publix, Sam’s Club, Sprouts, and Wegmans. Amazon is already in the running, while more competitors such as Uber and DoorDosh are starting to make strides in the same direction.

Distribution and logistics

With commerce moving quickly from physical retail to online shopping, your local Sears, JC Penny, Neiman Marcus, and Stein Mart will become distribution centers for the e-commerce giants. I visited our local Nordstrom store for the first time in 8 months. Half of their first floor was covered with shipping boxes. Make your own conclusions.

Retailers of all sizes will need to master the art of logistics. They will need to learn how to move goods quickly and cost-efficiently around to country to meet customer demands.

Digital payments

Digital payments is one of our strongest investment ideas for 2020 and the next decade. Major card payment networks comprise barely 12% of the total world payments. Still, 29% of all these payments are in cash, while the remaining 59% are made through bank and wire transfers. I see an enormous opportunity in the growth of digital payments. Within the next decade, the physical credit card will become archaic. Coming soon, we will simply make our payments through digital wallets, Q.R. codes, voice control, and even face recognition.

Cloud computing

The digital transformation requires an enormous amount of data storage and I.T. infrastructure. Every single day, the humankind sends 500 million tweets, 294 billion emails, and 65 billion messages on WhatsApp. We make 5 billion Google searches a day. In 2020 the digital universe is going to reach 44 zettabytes. By 2025, experts estimate that the world will create 463 exabytes of data each day. That’s the equivalent of watching 212,765,957 DVDs per day!

To support this data demand, the global annual spending for cloud computing will grow from $371.4 billion in 2020 to $832.1 billion in 2025. That is 17.5% average yearly growth in the next five years.

Cybersecurity

Cybersecurity is no longer optional. It is a necessity for both individuals and businesses. The digital growth is bringing bad actors looking to profit from our fears and weaknesses. Protecting your data is critical for safely navigating the digital universe.

Here are some numbers. The 2019 U.S. President’s budget added $15 billion for cybersecurity. Microsoft has committed to spending $1 billion annually for safeguarding their customers’ data. The size of the cybersecurity market was at $161.07 billion in 2019. It will reach $363.05 billion by 2025, with an annual growth of 14.5%. Therefore, cybersecurity becomes one of my best investment ideas for 2020 and beyond.

Automation and robotics

There are currently almost 6 million job openings in the U.S. and 1.2 million in Germany. In Japan, there are 1.5 vacancies for every job applicant. Therefore, with labor shortages around the world, there is a strong case for more manufacturing automation and robotics. Companies will push for more automation to provide faster service, better quality control, enhance job safety, meet unexpected demand surges, and keep profit margins high. Today’s general-purpose robots can control their movement to within 0.10 millimeters. The future generation will have a repeatable accuracy of 0.02 millimeters and could go even lower. Advanced sensor technologies and data connectivity will therefore allow robots to take on tasks that are not currently available in real-time.

5G

Another investment idea for 2020 is 5G. The 5G is the next-generation mobile network and the new global wireless standard. For us, the consumer, the 5G, will bring higher speed, better responsiveness, and more reliability to our phone calls, text messaging, video conferencing, and home internet. Initial projections estimate that we will have a 10X higher speed than current levels. Moreover, 5G will take the world of connected devices to the next level. For instance, the growing network of smart homes, devices, smartwatches, speakers, cameras, and connected cars can dramatically change the way we interact with the rest of the world.

Autonomous driving

One of the primary beneficiaries of 5G will be autonomous driving. Driverless cars require a huge amount of real-time data – sensors, GPS, traffic, weather, vehicle to vehicle, and vehicle-to-infrastructure communication. The 5G network alongside cloud computing capabilities will accommodate more driverless cars on the road. Several companies, above all, are pioneering the autonomous driving efforts – from Tesla to Google and Uber. While still unproven and controversial, I could envision early adoption of driverless cars in smaller communities such as college campuses, assisted living communities, and amusement parks. Furthermore, the second wave will expand to robotaxis and commercial short- and long-haul vehicles.

Work from home (anywhere)

You probably got a taste of working from home during the covid lockdown. While WFH is quite popular in California, but it was not as common in other parts of the country. Google, Twitter, Facebook, and other big tech companies are not calling their employees back to the office until the Summer of 2021.

During the Spring and Summer of 2020, we saw a huge spike in housing demand in suburban areas near large metropolitan cities – Marin and Contra Costa County near San Francisco, The Hamptons and Fairfield County, CT near New York City. Furthermore, we also saw a massive demand for remodeling, gardening, and various house improvement projects. Home fitness apps such as Peloton have more doubled their active users in just one year. Athletic apparel giants like Nike and Lululemon continue to attract new customers and gain market share.

Working from home is here to stay. Both public organizations and private companies will have to adapt to this trend. New leaders will emerge, and old vanguards will vanish. To survive in the WFH economy, the new office will turn from a cubicle maze to a collaborative space.

Employers can look for talent not only in the local communities but everywhere in the world. Workers will avoid being in traffic for 2 – 3 hours. Productivity will get an enormous boost by improving work-life balance and remote team collaboration.

Socially responsible investing

Socially responsible investing has been building a strong base in the past decade. It is no longer a niche investment endeavor for altruistic investors. According to Global Sustainable Investment Alliance, strategies that take a company’s environmental, social, and governance factors into consideration — grew to more than $30 trillion in 2018 and expected to grow to $50 trillion over the next two decades.  For example, reporting transparency, green technologies, community support, sustainable operations, carbon neutrality, employee satisfaction, and customer wellbeing will become flagship criteria by how corporate managers will be evaluated in the future. Furthermore, the Security and Exchange Commission is evaluating a playbook to standardize the sustainability disclosure between various sectors and public companies. We will continue to see a steady push towards organic farming, renewable energy adoption, electric vehicle expansion, and community engagement.