Financial Insights- May 15, 2021

Written by V. Raymond Ferrara, CFP®

On May 14, 2021

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EARNINGS WERE GREAT…NOW WHAT? 

First-quarter corporate earnings have not disappointed. With roughly 88% of the companies in the S&P 500 having reported at this point, 86% have beaten expectations. If that trend continues, it would be the highest on record going back to at least 2008. The blended earnings growth rate of 49% is well above the 24% estimate back at the end of the first quarter and would mark the highest year-over-year growth since at least 2010. By all accounts, this has been a historic quarter for many public companies. Wall Street analysts expect the growth to peak next quarter before slowly coming back down to more normalized levels over the next year.

Despite the incredible earnings growth, stocks have not had a commensurate positive reaction – reflecting the extremely high expectations already embedded in some stock prices. Inflation concerns are also weighing on the market, particularly on growth stocks, as investors weigh the combined impact of easy monetary policy, fiscal stimulus, supply chain bottlenecks, and labor shortages. Ultimately, the market will digest all of these factors (and more), even if sentiment prevails in the near term. As the father of value investing, Benjamin Graham, once said “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

HOW BIG IS THE U.S. DEBT NOW AND WHAT HAPPENS NEXT? 

The national debt rose to 100% of the Gross Domestic Product (GDP) following the two stimulus bills. With the most recent edition from President Biden, it now approaches 108%. With a debate getting ready on the “infrastructure bill” at $2.1 trillion more, it will rise to 114% within a year. That is a new record. The previous record was 106% following World War II. With the surge of Baby Boomers retiring over the next several years (increased Social Security and Medicare costs), and if the tax cuts do not expire in 2025, it could be 130% in 2026. With interest rates remaining low, it “only” takes 5.3% of federal spending to service the debt. But if interest rates move upward as projected it could jump to 17%. Both political parties are responsible for these events. (Source: Kiplinger Letter)

TO PAY OFF THE MORTGAGE, OR NOT?  THAT IS THE QUESTION

As people enter into retirement and look forward to living without a paycheck, they often ask us about paying off the mortgage to reduce their monthly outlay. Let us start out by saying that for anyone who is itemizing deductions, and even for many who do not, the math says keep the mortgage. If you have a mortgage at say 4% and are itemizing in the 25% tax bracket, your net cost is 3%. So, do you believe that your investments over time can earn more than 3% after tax? If so, don’t pay off the mortgage. If not, then let’s go to step two. What is the source of the money that you will be using to pay off the mortgage? If this money is invested in cash above and beyond your emergency and opportunity fund, or perhaps bonds, where you are earning very low interest, these could likely be good sources. However, money from an IRA is typically not a good source since you would have to pay taxes on this withdrawal. If the mortgage only has a few short years to go, then the payments are basically going to principal each month so why pay it off? If you have the extra cash flow to pay the mortgage faster, you could make an extra payment each month and save some interest costs. You need to consider how long you intend to stay in the home during retirement. Having said all of this…sometimes the best plan mathematically isn’t the best plan for you. If it feels good to get rid of the mortgage for the emotional element of owning the house free and clear, then that could trump the math.

BIDEN’S PROPOSAL TAXES THE RICH–DEMOCRATS OR REPUBLICANS? 

It seems that the new tax proposals being advanced by President Biden are aimed at the “rich”, which many voters assume means the Republican rich, but apparently that is not the case. According to IRS data, it is estimated that 65% of those affected are registered Democrats. The bet is that these wealthy Democrats are okay with increased taxes if it used for the general good of righting the wrongs of inequality in society as perceived by the Democratic Party. Interestingly, the last time a President asked for a tax increase the Congressional districts represented by Republicans were 14% richer than those represented by the Democrats. Today, those same Republican districts are 13% poorer. Even though the tax increases would not affect as many Republicans as Democrats, the Republicans seem more opposed to any tax increase. It remains to be seen if the rich Democrats accept the increases. It creates an interesting political dilemma and paradox.

BIPARTISANSHIP DOES EXIST IF STILL ELUSIVE 

The House Ways and Means Committee last week unanimously passed the Securing a Strong Retirement Act, also known as SECURE 2.0. Yes, that’s right…unanimously. Hard to believe, but true. Among the many provisions in the bill is raising of the required age for distributions from retirement plans from 72 to 75 but does so over a 10-year time period. It was originally the SECURE Act that raised the age from 70½ to 72, hence the reference to 2.0. It will increase to age 73 next year, age 74 in 2028 and age 75 in 2030. Who knows how and why they decided to do it that way. The penalty for failing to take a Required Minimum Distribution (RMD) would be reduced from 50% to 25%. The catchup provisions for IRAs would be indexed for inflation and a special catchup will be introduced at age 62 whereby a participant could put in $10,000 instead of $6,500 to a 401(k) and from $3,000 to $5,000 for a SIMPLE IRA. In an interesting twist, however, all catchup monies must be placed into a Roth bucket that means they would not be tax-deductible but would be tax free when withdrawn. IRA owners and beneficiaries with inherited IRAs may make Qualified Charitable Distributions (QCDs) from those accounts currently up to $100,000. The bill would index the limit for inflation. Further, it will formalize the ability of firms to make matching contributions in a 401(k) for any employee who is paying down student debt. The bill still has a long way to go before becoming law, but if this bipartisanship continues, it might get done before the end of the year.

GOOD NEWS…BAD NEWS ON JOBS 

When the April employment numbers came in at a disappointing 266,000 new jobs since something just short of a million jobs was expected (bad), most thought that the stock market would go down. Of course, it didn’t…266,000 new jobs is a solid if not great month (good) and the three-month rolling average is still over 500,000 (good). The pessimist might say that the economy is not bouncing back fast enough, and we need more stimulus, and another pessimist might say what do you expect with all that unemployment money being paid, who wants to go back to work. They are probably both a little right. There are plenty of jobs available at all levels and employers may have to raise wages to attract people back to work (bad for inflation implications and good for workers). The optimist says – wait until next month.

HEALTHCARE COSTS IN RETIREMENT REACHES $300,000 

Fidelity Investments recently concluded that an average 65-year old couple will need $300,000 just to cover healthcare costs in retirement. For single woman, at age 65 the costs are $157,000 and for a single man, it is $143,000, which should not be too surprising since women live longer on average. Over the past decade, retirement healthcare costs are up 30%, but up only 1.7% this year. Fidelity first reported a need for $160,000 in 2002 so their estimated cost has increased 88% since then. Here is the really scary part – 58% have no or very little time thinking about retirement and on average they thought they would only need $50,000 for medical expenses after turning 65. Financial literacy is obviously a major issue.

WOMEN’S UNIQUE RETIREMENT CHALLENGES AND FIRST STEPS

For a variety of reasons including the gender pay gap as well as caregiving responsibilities, women face different retirement challenges. As a result, many women save less than men during their careers but will live longer and have higher expenses.  Though it is never too late to save for retirement, we highly recommend starting your retirement planning early giving your investments time to grow and allowing compound interest to work. Here are a few helpful hints for women and men in their 20s and 30s who may be entering the workforce or changing jobs.

  • When you start your job, ask the question: “Does my employer offer a retirement plan?” and “When am I eligible to participate?”
  • If you are eligible to participate in your company’s 401(k), take the first step and start contributing. You may start slowly by making 5% contributions and move up to ideally 20% of your pay. In 2021, you may contribute up to $19,500 to your 401(k).
  • Most employers will match your contribution to a certain percentage meaning “free money” and helping you get closer to your retirement goals.
  • When you change jobs, remember that you will need to make decisions about what to do with your old 401(k) because your contributions and any investment growth remain your assets.

With college graduations and first jobs on the horizon, we are advocates of parents and grandparents having conversations with young adults about starting retirement planning in the early decades of their careers.