Manage Your Debt

New Year’s Resolution: Manage Your Debt

As the new year dawns, most Americans are probably happy to bid good riddance to 2020, a year marked by the COVID-19 pandemic, lockdowns, political brawls, and challenging economic times. Many have had to take on debt to tide them over. If you’re among them, or one of the many other Americans who pay an ever increasing portion of their paychecks to service debt, now may be the ideal time to reassess your finances and take steps to manage and reduce your debt.

I Owe, I Owe…

In America today, carrying some debt is unavoidable, and even desirable, for most households. But between mortgages, car payments, student loans, and credit cards, many Americans find themselves in over their heads. In fact, the average U.S. household carries $6,124 in credit card debt, owes $27,649 in auto loans and $46,459 in student loans, and has a mortgage balance of $197,445.¹ Paying off such debt can be costly, in terms of both cash on hand and your overall financial health. So it helps to plan. Start by finding out where you stand, then take the appropriate steps to dig out.

Assessing Your Debt

How much debt is too much? The figure varies from person to person, but in general, if more than 20% of your take-home pay goes to finance non-housing debt or if your rent or mortgage payments exceed 30% of your monthly take-home pay, you may be overextended.

Other signs of overextension include not knowing how much you owe, constantly paying the minimum balance due on credit cards (or worse, being unable to make the minimum payments), and borrowing from one lender to pay another.

Here’s how you can build a clear picture of your debt situation:

List all of your credit cards and how much you pay to them each month;
List all of your fixed loans (such as car loans and student loans) and their monthly payments; and
List your monthly mortgage or rent payment.
Once you are done, add them all up. That’s your total monthly debt load.

If you find that you’re overextended, don’t panic. There are a number of steps you can follow to eliminate that debt and get yourself back on track.

Begin With a Budget

The first step in eliminating debt is to figure out where your money goes. This will enable you to see where your debt is coming from and, perhaps, help you to free up some cash to put toward debt.

Track your expenses for one month by writing down what you spend. You might consider keeping your ATM withdrawal slip and writing each expense on it until the money is gone. Hang on to receipts from credit and debit card transactions and add them to the total.

At the end of the month, total up your expenses and break them down into two categories: essential, including fixed expenses such as mortgage/rent, food, and utilities, and nonessential, including entertainment and meals out. Analyze your expenses to see where your spending can be reduced. Perhaps you can cut back on food expenses by bringing lunch to work instead of eating out each day. You might be able to reduce transportation costs by taking public transportation instead of parking your car at a pricey downtown garage. Even utility costs can be reduced by turning lights off, making fewer long-distance calls, or turning the thermostat down a few degrees in winter.

The goal is to reduce current spending so that you won’t need to add to your debt and to free up as much cash as possible to cut down existing debt.

Three Steps to Reduce Debt

Once you’ve got your budget settled, you can begin to attack your existing debt with the following steps.

Pay off high-rate debt first. The higher your interest rate, the more you wind up paying. Begin with your highest-rate credit cards and eliminate the balance as aggressively as possible. For example, assume you have two separate cards, each with a $2,000 balance, one charging 20% interest, the other 8%. By paying the maximum you can afford on the higher rate card, and the minimum on the lower-rate card until the higher-rate card is fully paid off, you will be able to reduce your overall interest costs — perhaps significantly over time.

Transfer high-rate debt to lower-rate cards. Consolidating credit card debts to a single, lower-rate card saves more than postage and paperwork. It also saves in interest costs over the life of the loan. Comparison shop for the best rates, and beware of “teaser” rates that start low, say, at 6%, then jump to much higher rates after the introductory period ends. You can find lists of low-rate cards online from sites such as CardTrak and Bankrate.

If you can only find a card with a low introductory rate, maximize the value of that low-interest period. By paying off your balance aggressively, you will reduce the balance more quickly than you will when the rate goes up.

You can also contact your current credit card companies to inquire about consolidation and lower rates. Competition in the industry is fierce, and many companies are willing to lower their rates to keep their customers. Even a percentage point or two can make a difference with a sizable balance.

Borrow only for the long term. The best use of debt is to finance things that will gain in value, such as a home or an education, or big-ticket necessities, like a washing machine or a computer — assets that will still be around when the debt is paid off. Avoid using your credit card for concert tickets, vacation expenses, or meals out. By the time the balance is gone, you’ll have paid far more than the cost of these items and have nothing but memories to show for it.

By analyzing your spending, controlling expenses, and establishing a plan, you can reduce — and perhaps eliminate — your debt, leaving you with more money to save today and a better outlook for your financial future.

¹Source: Nerdwallet.com, 2019 American Household Credit Card Debt Study, updated June 2020. Balances are as of June 2020 for households carrying that type of debt.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

January 7, 2021/0 Comments/by Paul Tramontozzi

Should Investors Worry About Federal Debt?

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The National Debt Is at Record Levels. Should Investors Be Concerned?

For years, the mounting federal debt burden has been a major point of contention between political parties, economists, and fiscal planners. Some claim the escalating debt is a time bomb — a mortgage on America’s future. Others see it as justifiable and sustainable — even helpful in stimulating long-term growth. Over time, both sides have flip-flopped, so that today, fiscal conservatives and spending hawks can be found on both sides of the aisle.

Meanwhile, the number keeps growing. In fact, the U.S. national debt has grown every year since 1957, when it was a mere $217 billion, or 57% of gross domestic product (GDP) at the time.¹ Today, the figure has grown to over $26 trillion, or 98% of GDP, and is on target to exceed GDP in 2021.² Debt ceilings imposed by Congress over the years have done little to stop the advance, as they are temporary, and each party justifies its own reasons for borrowing more.

And this year, massive pandemic aid packages have catapulted debt levels into the stratosphere. The Congressional Budget Office (CBO) projects a federal budget deficit of $3.3 trillion in 2020 alone, more than triple the shortfall recorded in 2019. At 16% of GDP, the deficit in 2020 would be the largest since 1945 and well above its 50-year average of 3%.²

Are Deficits Necessarily Bad?

Traditional thinking views federal debt as a necessary evil — helpful in some ways but harmful in others. On the plus side, borrowing is a channel for governments to stimulate the economy, and to respond to shocks like the current pandemic. It’s also much more politically palatable than raising taxes. On the downside, however, excessive borrowing can slow income growth and crowd out other spending priorities. It can also cause interest rates to rise and ignite inflation, in effect, placing a burden on future generations.

The new thinking — or rationale some may call it — is that deficits don’t matter that much, as long as interest rates and inflation remain low. The justification is that today’s borrowing and spending will stimulate tomorrow’s economy, generating more tax dollars, which can then be used to pay down the debt.

But both sides agree on one thing: at some point the debt burden gets too big to sustain. Net interest expense on debt held by the public was about $375 billion in 2019, or 8.5% of total federal outlays — not an onerous burden. And, at 98% of GDP, total outstanding U.S. debt pales in comparison to an estimated 237% of GDP in Japan, where inflation is low and unemployment remains well under 5%. But then there’s Argentina or Greece, to name just two examples, which in the past incurred so much debt that they defaulted on interest payments, restructured, and had to endure painful austerity programs to get back in the black.

Few today question the need to stimulate the economy in the face of the economic ravages brought on by the pandemic. And at today’s exceptionally low interest rates, borrowing is cheap. But at some point, interest rates may rise and the debt service will become much more expensive.

The Takeaway for Investors

The real downsides of deficits for investors are rising interest rates and inflation. When interest rates increase, bond prices fall. Stock prices also tend to fall in a rising rate environment. Meanwhile, inflation erodes the value of just about any investment and can take a particularly hard toll on retirees or anyone living on a fixed income. There is also the possibility of future tax hikes to pay for the mounting debt.

If and when any of this might happen is unclear. The U.S. dollar is in the enviable position of being the world’s reserve currency, and investors domestically and across the globe continue to gobble up U.S. Treasuries, even at today’s historically low rates. That means that demand for U.S. debt remains strong and interest rates are likely to remain low. What’s more, deflation is more of a concern right now than inflation. But if inflation were to kick in and the Federal Reserve needed to raise rates, it would likely coincide with a much stronger economy that would make debt payments easier to bear.

So, for now at least, the deficit does not pose an immediate problem for investors. But it’s worth keeping an eye on as the country, and the world, get back on their pre-pandemic feet.

Notes

¹Source: The Balance, US National Debt by Year Compared to GDP and Major Events, July 30, 2020.

²Source: Congressional; Budget Office, An Update to the Budget Outlook: 2020 to 2030, September 2020.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

December 8, 2020/0 Comments/by Paul Tramontozzi

College Costs in the Era of COVID-19

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Paying for College in the Era of COVID-19

This semester, millions of students, teachers, and college administrators are having to deal with a radically changed landscape while still managing college costs. At many institutions, classes have been cancelled or moved online. Sports programs have been suspended and dormitories, libraries, and labs shuttered. In fact, traditional campus life has been turned upside down thanks to COVID-19, and it’s unclear how long it will last.

Meanwhile, the cost of a college education is higher than ever. According to the College Board, the average total charges at four-year public colleges (in state) for the 2019-2020 academic year were $21,950. Average costs at four-year private nonprofit colleges were more than double that ($49,870).¹ And while increases in costs have moderated in recent years, they continue to outpace inflation and median household income, resulting in a growing dependence on student loans; the average student borrower graduating in 2018 owed about $29,000.²

For cash-strapped students and parents, the current crisis has tipped the scales. Many are rebelling at the high costs in the face of a severely diminished college experience. Others have decided to wait until the crisis has passed before enrolling. Still others are questioning the very value of a college degree under current circumstances.

But the issue of soaring college costs is hardly new, and there are two sides to consider.

Students and Parents: Give Us a Break!

“We are paying a lot of money for tuition, and our students are not getting what we paid for,” comments one California parent, incensed at paying in-person prices for education that has moved online. On-campus facilities and services like computer labs, libraries, and networking opportunities have also been severely diminished by closures.

Already suffering from a pandemic-induced recession, many families are feeling the pinch and want relief. Students in particular have been hard hit with furloughs and layoffs, as many rely on retail service jobs to help them get by — the same jobs that have suffered the most in the face of closures and lockdowns. Many students had also signed leases for off-campus housing and are now stuck with them even if classes are cancelled. In short, students and parents are demanding tuition rebates, increased financial aid, reduced fees, and leaves of absences to compensate for what they feel is a diminished college experience.

Colleges: How Can We Manage?

Meanwhile, colleges and universities are taking a major financial hit from the pandemic. Enrollment is down. International admissions and offshore semesters have been halted. Entire programs have had to be suspended for health reasons. What’s more, substantial resources are required to set up an online curriculum, administer the courses, and train educators. There are also major costs involved with constant COVID testing of students and disinfecting of classrooms, offices, and other facilities. And, colleges must continue to pay existing vendor contracts, maintain facilities, and compensate their own staff. The situation has created an existential crisis among smaller colleges, who lack the endowments and funding of larger institutions. For many, it’s a question of survival.

A Mixed Response to Managing College Costs

Given this predicament and the widely varying circumstances faced by different institutions, it’s no surprise that their responses vary widely. A handful of universities have announced substantial price cuts. Some have cut fees. But most have kept prices flat, and a few have even increased them. While many offer refunds of fees and room and board, the reimbursement policies vary from school to school — and nearly all have drawn the line at tuition. Here’s a sampling of actions taken — or not — by different schools:

Full or partial refunds for room and board costs
Reduced tuition and fees
Discounts in the form of scholarships or loans
Renegotiated financial aid packages
Frozen tuition at previous year’s level
Imposition of “COVID fees” to cover added costs
Increased tuition to cover added expenses

Which of these actions a given school takes depends largely on its financial health and reputation. Smaller, private colleges with more at stake are generally offering more in the form of relief. Larger, well-endowed institutions, such as the Ivy League colleges and large state schools, trend toward the status quo. But there are many exceptions, and each institution has its own approach.

What Can You Do?

If you are a student or parent seeking compensation or relief, your options are limited, especially for the current semester. At nearly all institutions, tuition reimbursement is almost nonexistent after several weeks, no matter what the circumstances. Some schools are now offering tuition insurance, but coverage typically applies only when a student withdraws for medical reasons. To find out what relief may be available at your school, contact the registrar.

Alternatively, you can join the thousands of students and parents who have signed petitions or filed lawsuits demanding tuition cuts, housing reimbursements, and more. Check online to see if any such actions may be already in the works at your school.

In the end, like so many other issues arising from the pandemic, the current predicament facing students and schools is likely to be with us until a COVID-19 vaccine is in place. Even then, skyrocketing costs and mounting student debt pose longer-term issues. Any resolution will take time and likely have far-reaching implications for the costs and nature of a college education.

Notes:

¹The College Board, Trends in College Pricing 2019.

²The College Board, Trends in Student Aid 2019.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

November 5, 2020/0 Comments/by Paul Tramontozzi

Converting a Traditional IRA to a Roth IRA

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Thinking of Converting Your Traditional IRA to a Roth? Now May Be the Time

Anyone who is thinking of converting a traditional IRA to a Roth IRA may want to consider do it this year. Why? Because today’s unique conditions create an opportunity to minimize the tax bite from converting. In fact, many have already taken advantage of this opportunity, with one provider reporting a 67% increase during the first four months of 2020 compared to a year earlier.¹

But before you begin to decide whether or not to convert, make sure you are familiar with what’s involved with a Roth conversion.

What’s a Roth Conversion?

When you convert your traditional IRA to a Roth IRA, any deductible contributions you had made, along with any investment earnings, are taxed as ordinary income for the year of the conversion. That means the taxable value of the conversion could push you into higher federal and state tax brackets.

You will be responsible for full payment of all taxes in the year the conversion is made. If you use assets from the traditional IRA to pay those taxes, the tax amounts could be treated as premature withdrawals, so you could be subject to additional taxes and penalties.

Depending upon your personal financial situation, a Roth IRA conversion could potentially provide a tax-adjusted benefit over time, provided you meet the eligibility requirements.

Why Now?

The coronavirus pandemic has created unique conditions that may make a Roth conversion more attractive than usual.

Your taxable income may be lower

If, like millions of Americans, you have been furloughed or laid off, or your sales commissions are down, you will likely report lower taxable income for 2020. This may put you in a lower tax bracket so that monies converted to a Roth would be taxed at a lower rate than would otherwise apply (unless the amount converted pushes you into a higher bracket). For instance, converting a $15,000 IRA when your marginal federal tax rate is 12% saves $1,500 of tax compared to converting at a 22% marginal rate — and that does not include state tax, which might also drop.²

Your business may incur a loss

The pandemic is causing many businesses to close or incur a loss. If you expect to report a business loss on your personal return, you may be able to convert to a Roth at a reduced tax cost. With the Roth conversion creating additional income, you could use the loss generated by the business to offset some or all of that income.

Your IRA balance may be down

To minimize taxes, it’s better to convert assets when they’re low in value. Although U.S. stocks have recovered most of the ground lost in February and March, it’s possible your IRA balance may still be well off its peak, depending on how it is invested.

RMDs are suspended for 2020

As part of the CARES Act, required minimum distributions (RMDs) for traditional IRAs and qualified retirement plans were suspended for this year. Not taking distributions from a traditional IRA might keep or put you in a lower tax bracket by reducing your taxable income, making it even more desirable to convert to a Roth.

Current tax rates are low and could go up

The 2017 Tax Cuts and Jobs Act (TCJA) reduced federal tax rates, cutting the top marginal rate to 37%. That’s relatively low compared with recent history. Given the staggering price tag of the pandemic bailout (so far) and the ballooning budget deficit, it’s reasonable to assume that at some point, tax rates may increase. When this might happen is anyone’s guess, but converting while rates are relatively low is something to consider.

To Convert or Not?

Whether you would be better off leaving your funds in a traditional account or moving all or some of them to a Roth IRA will depend upon your personal circumstances. Generally speaking, Roth IRA conversions are best suited for investors who have significant time until retirement, are high wage earners, think they may be in a higher tax bracket at retirement, or are looking for an estate planning tool to help pass wealth to their heirs.

Whatever your circumstances, keep in mind that IRS rules governing IRAs and conversions are complex. So be sure to consult with a financial or tax professional before deciding.

Source/Disclaimer:

¹Money, Roth IRA Conversions Are Surging. Here’s Why This Retirement Savings Strategy Is So Popular Right Now, June 4, 2020.

²Example is for illustration only. Your results will differ.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year your convert, you must do so before converting to a Roth IRA.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

October 9, 2020/0 Comments/by Paul Tramontozzi

Retiring Early Because of the Coronavirus

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Should You Take An Early Retirement?

The story is a common one these days. You have been furloughed or laid off, just a few years before you plan to retire. Or, your work-from-home arrangement is ending, and you’re not keen on resuming the commute or going back to a crowded workspace. Retiring early may be a good idea, since fate has presented the opportunity?

Many 50- and 60-somethings are asking themselves this very question. In fact, the average American retires at age 61.¹ But, that’s at least five years away from collecting full Social Security retirement benefits, not to mention pensions, which typically begin at age 65, when available. What’s more, Medicare coverage does not begin until age 65, leaving early retirees with potentially hefty health insurance premiums until Medicare kicks in.

Anyone contemplating retiring early will want to plan carefully and ask several important questions.

When Should You Begin Collecting Social Security?

You can begin collecting Social Security retirement benefits as early as age 62. But you will face a significant reduction if you start before your normal retirement age: from 66 to 67, depending upon when you were born. Those choosing to collect before that age face a reduction in monthly payments by as much as 30%. Also, there is a stiff penalty for anyone who collects early and earns wages in excess of an annual earnings limit ($18,240 in 2020).

What age is best for you will ultimately depend upon your financial situation as well as your anticipated life expectancy. For most people, holding off until normal retirement age is worth the wait. But you may want to consider taking your benefits earlier if:

You are in poor health.
No longer working and need the benefit to help make ends meet.
Earn less than your spouse and your spouse has decided to continue working to help earn a better benefit.

How Will You Fund Health Care Costs?

A big obstacle to early retirement is health insurance. If you are working for a company that pays all or most of your health insurance, you could face hundreds of dollars in added monthly expenses if you retire before age 65. Plus, most companies no longer offer retiree health benefits, and if they do, the premiums can be high or the coverage low. In addition to health insurance premiums, there are also co-pays, annual out-of-pocket deductibles, uncovered procedures, and out-of-network costs to consider — not to mention dental and vision care costs.

On the positive side, the Affordable Care Act (ACA) prohibits insurance companies from discriminating because of preexisting illnesses and limits how much they can charge based on age. And for those with lower incomes, government subsidies may be available.

What Will Early Retirement Mean for Your Investing and Withdrawal Strategies?

Perhaps the most significant concern for early retirees — one that is often overlooked — is how retiring early will impact their investing and withdrawal strategies. Retiring early means taking larger distributions from your retirement savings in the early years until Social Security and pension payments begin. This can have a significant impact on how long your savings last, perhaps more so than if larger distributions are taken later in retirement. Consider the following:

Delay withdrawals from tax-favored retirement accounts, such as individual retirement accounts (IRAs) or 401(k) plans. The longer you wait to withdraw this money, the more you can potentially benefit from tax-deferred compounding. Instead, consider tapping into taxable accounts first.
Adjust your withdrawal rate to help ensure that your savings will last throughout a lengthened retirement. Financial planners typically recommend a 4%-5% annual withdrawal rate at retirement, but you may want to lower this since you will need your savings to last longer.
Structure your investments to include a significant growth element. Since your money will have to last longer, you will want to consider including stocks or other assets that carry high growth potential. Stocks are typically more volatile than bonds or other fixed-income investments but have a better long-term record of outpacing inflation.

So, if the coronavirus pandemic has left you thinking about retiring early, make sure you are prepared. The first place to start is with a detailed plan that includes estimated income and expenses. Work with a financial professional to put in place a plan that factors in all of the necessary elements you will want to consider.

Source/Disclaimer:

¹Source: Gallup, Snapshot: Average American Predicts Retirement Age of 66, May 10, 2018.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

September 8, 2020/0 Comments/by Paul Tramontozzi

Your Estate Plan: Time for a Checkup

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Your Estate Plan: Time for a Checkup

COVID 19 has brought tragedy to many families and businesses and impacted personal finances. It has also rendered many an estate plan inaccurate and unrepresentative of current circumstances. If you, your family or your beneficiaries have been affected by the virus, you may need to review and make changes to your plan. Consider the following questions in your review.

Are your beneficiary designations still accurate?

If you have lost someone named in your estate plan, you’ll need to make the appropriate changes. This could include changing beneficiaries, trustees, executors, healthcare decision-makers, your legal power of attorney or any other parties named in the plan.

You’ll also want to ensure that your beneficiary designations are up-to-date for your retirement accounts, such as an IRA (Individual Retirement Account) or 401(k), where beneficiaries are designated directly, rather than through your will.

Has the size of your estate changed?

If you have taken a financial hit as a result of the pandemic, then you may need to adjust some aspects of your estate plan. Adjustments may also be needed if the size of your estate has increased significantly. A large change in the total value of your assets could affect the distribution of your assets, particularly if you have made specific bequests to individuals or charities rather than dividing your estate proportionally. If you own a business, you may also need to consider how its value may have changed and how that might impact your plans to pass on control.

Are your minor children still protected?

If you have named a guardian for your minor children, check to ensure that person is still willing and able to serve in that role. And ask yourself if you still have confidence in your choice of guardian. A different job, a move out of state, or other changed circumstances may make your original choice no longer optimal.

In addition, it may make sense to keep the financial responsibilities of guardianship separate from the actual care of the minor children. You could choose a professional fiduciary to provide financial management on behalf of the minor children and name a family member to provide their actual day-to-day care.

Is your life insurance coverage still appropriate?

If your circumstances have altered materially as a result of the pandemic, you may also want to take a look at your life insurance coverage, too. Any significant changes to your life — births, deaths, marriages, or divorces — could affect your life insurance needs. It’s important to ensure that you have adequate coverage for you and your loved ones.

Do you have up-to-date documents?

Any updates needed as a result of your review will need to be reflected in your estate documents. These typically include a will, healthcare proxy, and power of attorney. They may also include a living will or trust documents. Keep in mind, however, that estate planning can be a complex endeavor. Therefore, any estate planning decisions or changes are best made with the help of a qualified legal professional and the rest of your professional team.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

August 10, 2020/0 Comments/by Paul Tramontozzi

Irrational Exuberance: Stocks and the Economy

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Stocks and the Economy: Irrational Exuberance

When Federal Reserve chairman Alan Greenspan made his famous pronouncement on the stock market back in 1996, the economy was strong and the Internet bubble was just starting to inflate. In fact, “irrational exuberance” would seem to be a more fitting label for today’s market.

Between March 23 and June 8, the S&P 500 rose over 44%, putting it less than 5% shy of its all-time high set in February. Meanwhile, the Dow Jones Industrial Average topped 27,500, just 7% short of its record and the NASDAQ Composite hit new highs. Although markets have taken some jolts since then, stocks are still doing surprisingly well.¹

The economy, however, presents a very different picture. Unemployment in the U.S. skyrocketed to 14.7% in April and then fell slightly to 13.3% in May, still the highest levels since the Great Depression. Institutional loan default rates are up sharply, and bankruptcy filings are expected to follow suit, especially among retailers. The Congressional Budget Office expects second quarter Gross Domestic Product (GDP) to tumble by 12%, its largest drop since the early 1930s, and the Federal Reserve has cautioned that it could take time for the economy to bounce back, especially if second-wave virus outbreaks emerge. In fact, many economists are calling for a drawn out recovery, with fits and starts, as secondary waves of infections keep some businesses shuttered and scare consumers away from stores and travel.

To put the disparity in perspective, consider some recent bear markets and their economic fallout. In the 2007-2009 financial crisis, the S&P 500 lost 56% of its value. Yet unemployment never topped 10%, and GDP fell only 2.5% in 2009. Or, consider the dotcom bust, when the S&P 500 fell 49% (and the NASDAQ Composite lost three quarters of its value). The ensuing economy saw unemployment top out at 6.3%, while annual GDP growth remained positive.

Clearly, the current market would seem to be at odds with economic reality. But there are several different factors at work here.

Stocks Are Not the Economy

As Nobel Prize winning economist, Paul Samuelson, famously quipped back in the 1960s: the stock market has predicted nine of the past five recessions. Paul Krugman, another Nobel laureate, suggests three rules when considering the economic implications of stock prices: “First, the stock market is not the economy. Second, the stock market is not the economy. Third, the stock market is not the economy.”²

As both men emphatically point out, the dynamics driving stocks differ from those driving the economy. The major market indexes such as the Dow Jones Industrial Average (DJIA) or the S&P 500 reflect a limited segment of the economy, and the majority of stocks are owned by a small percent of the population. The widely followed DJIA, for instance, is composed of just 30 blue-chip stocks. Even the broader S&P 500 index contains only the largest of U.S. companies. Small businesses, which represent the lion’s share of U.S. businesses and employ almost half of Americans working in the private sector, have little representation in stock indexes. Yet it is those smaller businesses, many with limited cash reserves, which are taking the biggest economic hit from the pandemic.

Stock index prices are also driven largely by constituent companies’ earnings and profits, which may have little to do with economic metrics such as unemployment. Furthermore, stocks are highly sensitive to interest rates and monetary policy changes, which typically take much longer to be felt in the economy.

Government Moves to Shore Up the Economy Have Been Unprecedented

The optimism of investors in the face of economic freefall may be justified in part by the bold steps taken by the Federal Reserve and Congress to stem the fallout from lockdowns and closings. The Federal Reserve has slashed interest rates, increased the money supply, and taken different measures to support capital markets. For its part, Congress has passed unprecedented stimulus legislation, boosting weekly unemployment checks by $600, and passing such bills as the CARES Act. Meanwhile, the Small Business Administration is also supporting businesses through its Paycheck Protection Program. Collectively, such moves — and many others by state and local governments — not only provide immediate relief to millions of companies and workers, they also send the message to investors that the government is willing to take whatever steps are necessary to get the economy back on track.

Stocks Are Still the Investment of Choice

Long before the coronavirus struck, anyone seeking return was turning to stocks. Yields on bonds and cash had been historically low for years. Now, with recent interest rate cuts, that trend is more pronounced than ever. As of June 1, the interest rate on 10-year U.S. government bonds was only 0.66%, down from more than 3% in late 2018.³ After inflation is factored in, that works out to a negative return. Meanwhile, higher-yield bonds are riskier than ever as cash-strapped issuers may struggle to make interest payments. So it’s no wonder that capital continues to gravitate toward stocks — even in the face of economic turmoil — since they appear to be the only game in town with potential for return-hungry investors.

The Road Ahead

Whether stocks will continue on a divergent path from the economy is anyone’s guess. Ultimately, the longer-term health of both the stock market and the economy will largely hinge on the success in slowing and stopping the pandemic. But any resolution will take time, and there will likely be bumps in the road.

Also keep in mind that trying to time the market’s ups and downs is a losing game. Anyone heeding Greenspan’s warning back in 1996 would have missed out on three of the best-performing years in recent stock market history. So stick to your plan, expect volatility, and consult with a professional before making any major financial decisions.

Notes

¹Google Finance.

²New York Times, Crashing Economy, Rising Stocks: What’s Going On?, April 30, 2020.

³U.S. Department of the Treasury, Daily Treasury Yield Curve Rates, June 1, 2020.

This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses or sales charges. All performance referenced is historical and is no guarantee of future results.

The Standard and Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Dow Jones Industrial Average is the most widely used indicator of the overall condition of the stock market, a price-weighted average of 30 actively traded blue chip stocks, primarily industrials. The 30 stocks are chosen by the editors of the Wall Street Journal. The Dow is computed using a price-weighted indexing system, rather than the more common market cap-weighted indexing system.

The NASDAQ-100 is composed of the 100 largest domestic and international non-financial securities listed on the NASDAQ Stock Market. The index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology, but does not contain securities of financial companies.

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, through GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

July 12, 2020/0 Comments/by Paul Tramontozzi

The CARES Act and Your Retirement Savings

Featured, Investments, Planning

Think Twice Before Tapping into Your Retirement Savings

New legislation — the CARES Act — permits qualified individuals to take early distributions from their retirement assets, such as their 401(k) or individual retirement account (IRA) — penalty free. The rules – which sunset after 2020 – are designed to help the many cash-strapped Americans who have suffered financially as a result of the coronavirus epidemic. But tapping into your retirement savings has its costs, and there may be better ways to shore up your short-term cash flow.

The CARES Act

The Act permits qualified individuals to take distributions of up to $100,000 from their IRA or workplace retirement savings plan (if allowed by the plan) without incurring the 10% additional tax on early distributions that would otherwise generally apply to distributions made prior to age 59½. Amounts withdrawn may be repaid within three years, if desired. Note, however, that ordinary income taxes apply to all pretax funds withdrawn, although taxpayers may elect to report the income over three tax years instead of one.

These coronavirus-related distributions may only be made to a “qualified individual” on or after January 1, 2020, and before December 31, 2020. A qualified individual includes anyone who has been diagnosed with the SARS-CoV-2 virus or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention, or whose spouse or dependent has been diagnosed. It also includes individuals who experience adverse financial consequences as a result of: being quarantined, furloughed, laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19; being unable to work on account of a lack of childcare due to the virus or disease; closing or reducing hours of a business owned or operated by the individual due to the virus or disease; or other factors as determined by the Treasury Secretary.

The Act also relaxes rules on borrowing from a retirement plan account. If authorized by the plan, qualified individuals may borrow as much as $100,000 or 100% of their vested account balance. These limits are effective from March 27, 2020 to September 22, 2020.

Additionally, qualified individuals with an outstanding loan (on or after March 27, 2020) may delay loan repayments due during the period from March 27, 2020 to December 31, 2020 for up to one year.

Consider the Costs

Withdrawing or borrowing money from your retirement account may seem like an easy way to shore up your short-term cash flow, but there are long-term costs to consider. Most notably, if you withdraw funds and don’t repay them, you’ll be reducing your retirement nest egg, perhaps significantly. And making up for withdrawn balances means contributing more — potentially much more — down the road. That’s because time is a critical ally when saving for retirement. The more time your contributions and earnings have to grow, the better the chance you will be able to reach your retirement savings goals.

If you don’t withdraw the funds altogether, but just borrow them from your plan, you must generally pay back the loan within five years, or earlier if you lose your job or leave your employer voluntarily before the loan is paid back. Otherwise, it will be considered a taxable distribution, requiring you to pay income tax on the amount of the loan. What’s more, current law protects funds held in a qualified plan from creditors in the event of a bankruptcy. So if you are experiencing extreme financial difficulty, keeping funds in your qualified plan may be one way to limit the damage. Even if you’re allowed to defer some loan payments because of the CARES Act, you’ll want to weigh the potential downsides before borrowing.

There May be Better Alternatives

As any financial professional will attest, borrowing from your future to fund today’s temporarily negative cash flow is generally not a good strategy. Instead, consider other sources of funds such as:

Short-term loans
Tapping into a home equity line of credit
Borrowing from friends or relatives

You also may want to consider ways to reduce current costs until your cash flow improves.

Reduce credit card payments by consolidating balances on a low-rate card
Contact current lenders to arrange for a temporary payment freeze
Cut back on discretionary expenses and make a budget

Also keep in mind that the provisions of the CARES Act are temporary. So if the economic fallout from the coronavirus epidemic has left you strapped for cash, try to maintain a long-term focus and stick to your plan.

This material was prepared by LPL Financial.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

June 12, 2020/1 Comment/by Paul Tramontozzi

Managing Finances during COVID19

Featured, Investments, Planning

Smart Financial Strategies for Unexpected Events

A once-in-a-lifetime event such as the coronavirus pandemic forces us to reassess many things we may have taken for granted. Most of us take our personal good health for granted. Many of us assume we will always get by financially, that we will always be able to earn money in some way, and that, in a worst-case-scenario, the government will be there to step in and help.

But assumptions are always there to be challenged. And adverse situations always should teach us some lessons. What lessons can we take away from the current crisis that will help us better prepare for an event that appears suddenly and upends many of our day-to-day activities? Specifically, what steps should we take to ensure that we will have enough money set aside to see us through another crisis? What can we do going forward so that we will be able to pay our bills and handle unforeseen expenses if we lose our jobs? Why is it a good idea to limit our debt burden, and how can we achieve this goal?

Here are some ideas that could jump-start your thinking.

Spend Less Than You Earn

It’s easier said than done. But it is one of the most effective ways of building up your savings and your personal wealth. You may have to reevaluate what you consider important — especially if shopping has always been enjoyable for you. You can still shop, just not as often and only for items that you or your family members truly need.

Set yourself a goal of setting a percentage of your pay aside for savings. If need be, start small so you don’t get discouraged. Then, increase the percentage you save after a few months.

Look for Ways to Boost Savings

Now that you have decided to spend less than you earn, you can start to look seriously at ways to increase your savings. For example, you may be able to find some extra cash by shopping around for better rates on your utilities, cell phone service, and auto or home insurance. If your credit score is good, you may be able to find a credit card with a lower interest rate than you currently pay. And, if you can afford the closing costs, refinancing your mortgage could potentially unlock some solid savings.

If you do not have a budget, now is the time to create one. A budget can help most people organize and control their spending. If you track your spending for a few months, you can use that information to cut back on impulse buying and spending on nonessential items and redirect that money to savings and investments.

Be sure to direct some of that money to your own emergency fund. An emergency fund should be used to pay for unexpected, large expenses so you don’t have to borrow the money. Financial experts say that, ideally, your emergency fund should be able to cover six months of living expenses — including mortgage and auto payments. It sounds like a lot to save, but you may be surprised how much you can save when you focus on that goal.

Take Control of Your Debt

Debt is like savings in reverse. When you are in debt, you keep paying interest on goods and services that you probably consumed two or three years ago. If you carry consumer debt, now is the time to get a handle on that situation. You are not in a good place if:

Your credit card balance is growing
You are paying only a minimum on your bills
You are missing payments or paying late.

For every loan and credit card you carry, find out how much you owe, the interest rate, and the payment schedule. You can use this information to figure how much money you can afford to put toward paying down your debt and how long it will take. These strategies can help:

Pay off the card with the highest interest rate first;
Transfer your balance to a card with a lower interest rate; and/or
Pay more than the minimum amount. Paying more than the minimum is critically important since the less you pay, the greater the interest will be and the longer it will take to pay off your balance.

Every few months, check your expenses to see if you can find other funds to use to reduce your debt. If possible, consider part-time work and use what you earn to pay off your debts. In the meantime, do not take on additional debt. Try using cash (or your debit card) instead of credit for as many transactions as possible.

Protect Your Earning Power

If you are a working parent, your family’s financial well-being is tied closely to your ability to make a living. If you were to have an accident or fall ill, your disability could destabilize your finances. If you do not have a private disability income insurance policy, consider getting one. The payments from the policy would help pay for critical everyday expenses when your disability prevents you from working and collecting a salary. Before you purchase insurance, though, make sure you understand the policy’s definition of disability and all the other policy terms.

You also may want to name someone you trust to make financial and health care decisions if you become unable to make them for yourself. Talk to your attorney to learn more about the options available in your state. And you might consider setting up a living trust that allows the trustee of the trust to handle your financial affairs if you cannot.

Review Your Investing Strategy

Finally, remember that risk is a given in investing. Some investments carry a higher risk of loss than others. However, riskier investments typically offer higher potential returns than more conservative alternatives. When you invest you have to decide how much investment risk you can comfortably handle while seeking higher returns, and choose your investments accordingly. It helps to review your investing approach and your tolerance for possible investment losses at least once a year.

Facing the Future

Every crisis is different. However, those who think ahead and have some strategies in place to deal with the financial aspects of a crisis are potentially more likely to do better than those who do not plan.

This material was prepared by LPL Financial.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

The cost and availability of Life Insurance depend on many factors such as age, health, and amount of insurance purchased. In addition to premiums, there are contract limitations, fees, exclusions, reductions of benefits, and charges associated with policy. And if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Any guarantees are contingent upon the claims-paying ability of the issuing company.

May 11, 2020/1 Comment/by Paul Tramontozzi

Should You Refinance?

Featured, Planning

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