What impact could the mid-term elections have on stocks?

Many political and market commentators have been issuing forecasts and analyses regarding the Federal elections in November, particularly the prospect of Republicans taking control of the U.S. House of Representatives and the Senate. While BFA does not take political positions and leaves it in the hands of those better-suited for such prognostications, we know what history has to say about how stocks can act during the lead-up to and the year following mid-term elections, regardless of which party is in control.

In their 2022 Midyear Outlook, LPL Research reports that mid-term election years have not been kind to equities. In the midterm years since 1950, the S&P 500 (U.S. large-cap stocks) has experienced the largest peak-to-trough pullback (down 17.1% on average) during the four years of the Presidential cycle. Indeed, the S&P 500 on a total return basis was down 24% YTD through September 30, 2022. The good news, however, is that once the uncertainty of the election is over after Election Day, stocks generally rebound, and by quite a bit. As shown in Figure 1, the S&P 500 has increased each year after every midterm election since 1950. The average gain is 14.5%.

Furthermore, does it matter which political party is in control? The answer is No.  As seen in Figure 2, the S&P 500’s average annual return since 1950 has been positive, regardless of the party in the White House or the makeup of Congress. In fact, the market seems to prefer a divided government, which may be the result after November. Your BFA Investment Committee is not worried about the outcome.

Financial Planning Concepts

tax incentives for clean energy investments

On August 16^th, President Biden signed into law new tax legislation commonly called the “Inflation Reduction Act of 2022.” The legislation includes tax incentives for businesses to invest in clean energy projects and for individual/family taxpayers who spend money on energy-efficient products. The business tax incentives are easily the most extensive portion of the new tax law but there are a few opportunities for individual taxpayers, too. 

Clean Vehicle Credits

The new legislation changes the tax incentives for purchasing an electric vehicle (EV). First, there is a transition period where if the vehicle is purchased before August 16^th but is not delivered until after, the EV tax credit is based on the prior law: a tax credit of $2,500 + $417 for every kWh over 5 kWh with a maximum credit of $7,500. If the vehicle is purchased after August 16^th but before 2023, the EV must also qualify under a new rule called “final assembly”, a requirement that the final assembly of the vehicle must occur in the United States. There is a 200,000 vehicle sales cap in 2022 and many manufacturers (Tesla, GMC, and Chevrolet) have already phased out. You can find a great resource for additional information here: https://www.efile.com/electric-vehicle-car-tax-credits/

It is important to note that in 2023 there are additional qualifying thresholds that relate to the battery components and critical mineral sourcing for new cars. Because of these additional requirements, far fewer cars qualify for the full tax credit. However, some used cars will become eligible for a tax credit that is 30% of the sales price up to $4,000.

Residential Energy Property Expenditures

There are new credit thresholds for “Residential Energy Property”: geothermal heat pumps, small wind turbines (less than 100 kW), solar water heaters, solar panels (photovoltaic systems), residential fuel cell and microturbine systems, biomass stoves with 75% efficiency ratings, and qualified battery storage technology (residential and >3kWh). In 2022, there is a 26% tax credit for systems placed in service before 1/1/2023. After 2022, there is a credit for 30% for 2023-2032, 26% for 2033 and 22% for 2034.

Qualified Energy Efficiency Improvements

Starting in 2023, there is a tax credit equal to 30% of the costs of all eligible home improvements up to $1,200 per year. The annual limits for specific types of qualifying improvements will be: $150 for home energy audits, $250 for any exterior door ($500 total for all exterior doors) that meet applicable Energy Star requirements and $600 for exterior windows and skylights that meet Energy Star most efficient certification requirements. There is a $600 credit for other qualified energy property including central air conditioners, electric panels and certain related equipment, natural gas, propane, or oil water heaters and furnaces. There is a $2,000 credit for heat pumps and heat pump water heaters, biomass stoves and boilers. This category of improvement is not limited by the $1,200 annual limit on total credits or the $600 limit on qualified energy property. Please consult your tax advisor regarding car purchases, property credits and improvements.

Talk of recession, Part two

High inflation readings and a hawkish Federal Reserve continued to spook the fixed income and equity markets during the second quarter of 2022. The risk of recession is a distinct possibility as consumers have begun scaling back on purchases, mainly in goods and to a lesser degree in services, and dipping into savings to cover essential items such as groceries and gasoline. But what is the definition of a recession, and how do some experts predict its onset with such certainty? Let’s address the last question first. The answer is that it is impossible to know when a recession will start, so be wary of experts and their predictions.

The National Bureau of Economic Research (NBER) is responsible for placing dates on when a recession has started and when it has ended. Thus, a recession could technically end before the NBER confirms it even started, much like the pandemic-induced recession of 2020. According to the NBER, “A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.” One measure of a recession touted by the media is when the country’s Gross Domestic Product (GDP), or the value of the goods and services it produces, declines for two straight quarters. Some economists are predicting a decline in GDP for April-June 2022, which would mean two consecutive quarters of decline. However, the current job market is resilient, and unemployment is at its lowest rate in years. This robust employment is contrary to every recession since World War II, with each of those economic downturns experiencing a rise in unemployment. And, even if a recession has already started or will soon, many economists believe it will be short and relatively mild. 

what does this mean for my portfolio?

The stock market is a leading economic indicator. It is too late to make drastic allocation changes or shifts in the portfolio to avoid the adverse effects of an economic decline. However, in anticipation of an eventual economic downturn, your BFA investment committee has re-positioned our client portfolios over the past few years. These shifts included a reduction in over-valued U.S. small-cap stocks in favor of Emerging Market equities with a value tilt. Value stocks tend to hold up better than growth stocks during a recession. Also, U. S. small company stocks are more sensitive to economic changes and have historically underperformed larger company stocks going into recession. We also picked up yield and thus boosted returns by increasing our allocations to U.S. High Yield Bonds and U.S. Real Estate (REITs). And, even though interest rates have picked up, your BFA fixed-income portfolio will benefit over the next few years from rising coupons as income becomes a more significant part of bonds’ total return. Finally, history has shown that the markets should fully recover from an economic downturn.

Financial Planning Concepts

an antidote to volatility? Try tax planning

In a June 10^th, 2022 article in Kiplinger Online, Rocky Mengle and Joy Taylor say, “Americans are facing a long list of tax changes for the 2022 tax year. Smart taxpayers will start planning for them now.”¹ In fact, smart investors also use times of volatility to both reduce their taxes, now and in the future, and enhance their after-tax returns. During the fall semester of the True Planning Cycle (TPC), Brown Financial is laser-focused on providing tax planning strategies that provide both benefits to our clients. Here are a few notable methods you should expect during your upcoming tax review:

Tax-Loss Harvesting: During times of volatility, BFA begins to frequently and actively review portfolios for opportunities to capture tax losses. By selling positions that have declined and reinvesting the proceeds in similar (but not identical) investments, you can avoid future capital gains taxes and even write off an additional $3,000 per year from your ordinary income while remaining invested. So far, BFA has captured almost $4.5 million of tax losses, resulting in nearly $1 million in tax savings for our clients!

Roth Conversions: Roth IRAs provide tax-free growth and tax-free distributions throughout the life of the account, even after your heirs receive them. Unfortunately, most of us have more in traditional IRAs than in Roth IRAs. To “convert” a traditional IRA to a Roth, you must make a taxable distribution from the IRA that will raise your income taxes for the year. However, market declines create opportunities to buy into the Roth account while the market is low. Converting during market drops builds in a quick recovery of your taxes in a tax-free account. It may take a few years to break even on the taxes, but converting your Roth when the market is down can be a great strategy, especially if you are planning for multiple generations.

Avoid “Extra” Taxes: The IRS is sneaky, if you haven’t noticed. As evidence, there are three additional “taxes” that do not show up in the “brackets”: Net Investment Income Tax (NIIT = 3.8%), additional Medicare Taxes (0.9%), and Income-Related Monthly Adjustment Amount (IRMAA) for your Medicare Part B premium. Although none of these taxes fall within the tax “brackets,” they all apply when your taxable income exceeds certain thresholds. However, there are ways around these taxes, and strategies to avoid them should be part of your tax plan every year. As we run your analysis, we will consider the impact of these individual taxes on your overall plan and offer ideas to lower them, too. We will help you become one of the “smart taxpayers” Mengle and Taylor describe and help you save money in 2022 and beyond. We look forward to assisting you! 

talk of recession amid A rough start to 2022

Global supply shocks and higher interest rates and inflation hobbled global markets during the first quarter of 2022. Those same forces have prompted economists to raise the probability of a recession in the next twelve months for both the U.S. and overseas. Your BFA investment committee is not concerned, however. First, while economists at JP Morgan and those surveyed by the Wall Street Journal, for example, have increased their probabilities of a U.S. recession in the next twelve months, the figures are still relatively low (from 20% at the beginning of 2022 to 30% now). Keep in mind that in an average year, there is a 15% chance of a recession in the U.S. Second, there is growing evidence that supply shortages are easing, which should help satisfy the demand of global consumers, especially in the U.S., who have ample cash reserves and a desire to spend. Third, it is difficult to paint the global economy with broad strokes. While Europe has a higher chance of a recession due to its dependence on Russian energy supplies, the U.S. is not as vulnerable as Europe. Also, Latin American markets tend to be more commodity-based and are enjoying an economic rebound due to increased energy and raw material prices. However, further price spikes in oil or an escalation of the war in Ukraine are wildcards that we will monitor.

HOW SHOULD WE FEEL ABOUT BONDS?

Given the volatility and steep drops in equity and fixed income markets so far this year, some investors are in unfamiliar territory and may be unsure how to feel about their bond holdings, particularly those who have only been in the markets for the past 10-15 years. There is no sugar-coating that bond prices have been hit hard with a double whammy of the highest inflation in 41 years and rising interest rates. However, we also believe in the power of compounding and understand that price return is just one component of total bond return. As interest rates go up, bond coupons are reinvested at those higher rates, which means income makes up even more of the total return of bonds over the medium to long term. Your BFA investment committee wants to reassure you that we feel we are positioned correctly in our fixed income portfolio. Our fixed income managers think that we are now past the inflection point and that the “medicine” we are taking will result in healthier fixed income markets and better returns in the future. So, here is the takeaway: Bonds are down year-to-date. BUT, we have already 1) captured higher than average returns during the falling rate environment of a couple of years ago; 2) diversified to bonds that should generate higher yields through floating-rate bonds and provide corporate bond outperformance; 3) diversified the bond portfolio further with short-term high-yield and international bonds that are not as interest-rate sensitive as core bonds and provide higher yields to maturity; 4) chosen managers who can accumulate stabilizing cash if the bond market continues to be uncooperative; and most importantly 5) significantly outperformed core fixed-income last year and are positioned this year to do the same.

Financial Planning Concepts

A simple new process ensures planning success for everyone

In his most recent book, The Psychology of Money, Morgan Housel makes a powerful observation critical for all of us. He says, “Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.” What does he mean? There are two parts to the statement that should ring true for you: First, there is the assumption that there IS a plan. A plan to purchase a home, educate your children, protect your family, retire, reduce taxes, grow your wealth, leave a legacy, etc., etc. Truly, for those without a plan, the end result is a guess at best and a guaranteed failure at worst. We should all have a Plan.

However, the second part is that constant change necessitates revisions to our Plan to ensure its success. Housel goes on to say, “A plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality.” Like the sand on the shoreline at the beach, as the wind and waves pass over, the picture changes. Sometimes the changes are dramatic and sometimes they are subtle but they are always changing. Your finances are the same.

To help you maintain peace of mind and a successful Plan in the face of constantly “shifting sands”, we are excited to introduce the Brown Financial True Planning Cycle (TPC), a systematic process to partner with each of you to help you achieve all of your goals in the face of risk, uncertainty and constant change.

the true planning process

The TPC is Simply Effective. The hardest part of financial planning is gathering data to complete the plan. To help overcome this annoying hurdle, the TPC breaks the Plan into manageable component parts for analysis over a continuous, two-year cycle. Retirement, Insurance, Investment, Tax and Estate planning all occur in a repeating cycle to ensure impactful focus on each area. As the Plan encounters shifting scenarios, it is regularly updated and adapts. Even when things are not going “according to plan”, the Plan navigates to compensate. Without a doubt, this process is the most powerful tool that you can have to ensure you achieve your goals. It is also unique in our industry. Many firms claim to provide financial planning but few have a systematic process to ensure your Plan is always on track. We are delighted to have the opportunity to present it to you and will discuss it more in your upcoming reviews. Because the TPC is so amazing at producing the results we all desire, financial security and peace of mind, it is now the foundation of what we offer to all of our clients. So, as we tell our friends who are new to the process, “Come and see what you’ve been missing!” 

Another Banner Year for U.S. Stocks

In defiance of the continuing toll of the COVID-19 virus, 2021 was another year of double-digit returns for both U.S. large- (+28.7%) and small-cap (+14.8%) stocks. This was the third year of double-digit returns for those two sub-asset classes. It wasn’t just mega-cap technology stocks leading the way in 2021, either. The S&P 500 Equal Weighted index is made up of the stocks from the S&P 500 (U.S. large-cap stocks) and applies equal weights to the components, unlike the regular S&P 500 index, which is weighted by market capitalization. The equal-weighted index outperformed the regular index in 2021 by almost a full percentage point. This outperformance shows that the market rally since Spring 2020 now includes more sectors of the U.S. economy, which is good news. The award for best-performing equity sub-asset class goes to U.S. real estate, with the MSCI U.S. REIT index up 43% in 2021. The end of lock-downs and more freedom to move around cities and the country meant that retail, apartments, and self-storage REITs drove returns in the index.

Things were not so good for U.S. core taxable bonds, however. Long-term interest rates finished the year higher than at the beginning of the year. As a result, the Bloomberg U.S. Aggregate Bond index was negative on a total return basis in 2021, only the fourth calendar-year downturn in the index’s 42-year history. The three other negative calendar years were 1994, 1999, and 2013. One bright spot in fixed-income was U.S. high-yield bonds, whose performance is more correlated with equities and ended the year up 5.4%. The performance of foreign equities in 2021 was a mixed bag. Foreign developed stocks (Europe and Japan) finished the year up 11.3%. Foreign emerging stocks were negative (-2.5%), mainly due to a correction in the Chinese stock market and a continuation of lock-downs throughout those countries. Finally, foreign equities faced the headwind of a stronger dollar in 2021.

Inflation is the word

Inflation, including inflation expectations, affects many pricing and spending decisions among securities markets, consumers, and corporations. Inflation has thus muscled its way into the headlines, no small feat considering the continuing struggles with COVID-19. The December 2021 U.S. consumer price index (CPI) reading showed that inflation rose 7% from December 2020, its fastest pace since 1982 and the third straight month of inflation exceeding 6%. The U.S. Federal Reserve has indicated it will be more aggressive in its actions toward taming inflation, with many analysts now expecting a hike in short-term rates in March 2022. Higher interest rates are a headwind for fixed-income and technology stocks as future earnings become less valuable. However, one key market gauge of inflation, the 10-year breakeven rate (the difference between the yields on 10-year Treasury and Treasury Inflation-Indexed bonds), is currently at 2.5%, meaning that longer-term expectations for inflation are much lower. Diversification among your equity and fixed-income holdings will be important given higher prices and interest rates.

Financial Planning Concepts

5 tips to maximize your home insurance

After Hurricane Sally hit the Gulf Coast, many of our friends and neighbors were filing claims on their homeowner’s insurance policies. Unfortunately, a few found that they didn’t have the coverage they thought they had and struggled to settle with the companies. Although Sally was a “mild” hurricane, the damages were real and the coverage a necessity in those circumstances. Following is a quick checklist to help you make sure your coverage is adequate to fully protect one of your most valuable assets.

1. Confirm that you have Replacement Cost Value vs. Actual Cash Value coverage. They sound so similar it is easy to get them confused but the differences are dramatic. Replacement Cost Value coverage provides replacement coverage for any damages on the property to restore it to its original state. A water leak that destroys the hardwood floors (one of the most common claims) results in the company covering the full value (less a deductible) to replace the floors. Actual cash value, however, would only cover what the insurance company thinks the floors are CURRENTLY worth; meaning the Replacement Cost less any depreciation. With ACV, you may only receive a fraction of what it would cost to replace the floors. Confirm with your agent that you have RCV.
2. Consider wind, hail and earthquake coverage. Especially on the coast, wind and hail are not typically covered under your normal homeowner’s policy. So in the event of a storm, wind damage (like the roof blowing off) may not be covered without the additional coverage. This type of coverage also typically carries a larger deductible than your typical homeowner’s policy. If you have a large wind deductible, make sure you also have the liquidity to pay it if you need it.
3. Consider raising your deductible. Raising your deductible from say $1,000 to $2,500 may save you a few hundred dollars in premium each year. However, sometimes a higher deductible doesn’t significantly lower your premium, so it is important to compare. Since you will not file a claim for a small loss, because it could increase the likelihood of a premium increase later, you should set your deductible at an amount that is high but not out of reach for you. 
4. During large storms, place your claims quickly. If you find yourself in a large storm and a leak develops on the ceiling, don’t wait until the next day to file your claim. The sooner you file, the sooner you will be paid. And while others will wait for the storm to pass, you can file your claim right then and be in the front of the line to get paid sooner.
5. Remember that you are not insuring the land. Often when homeowner’s protect the value of their home, they consider the MARKET value if they sold the house. However, that includes the land and you do not need homeowner’s coverage for the land. Insuring the cost to replace the structure could lower your premiums.

Fall’s bumpy ride and China in the news

Since the bottom of the COVID-induced market downturn in Spring 2020, it seems like the equity markets have only been going one way: up. However, analysts and investors are keenly aware that, on average, September is the worst month for the S&P 500 (U.S. large-cap stocks), and September 2021 was no exception. The S&P 500 fell 4.8% in September, its largest monthly drop since March 2020. However, the index still finished the third quarter up slightly by 0.6%, its sixth consecutive quarter of gains. Volatility re-entered the bond and equity markets during the third quarter, as well, driven by talk of higher inflation, U.S. Federal Reserve tightening, uncertainty surrounding the Democratic infrastructure and spending bills, possible higher taxes, and a potential U.S. government shutdown. As a result, investors began to sell Treasury bonds in earnest. U.S. core bonds ended the quarter down almost 2% year-to-date on a total return basis. The resulting climb in bond yields has become a headwind for U.S. mega-cap technology stocks, as well, whose long-term earnings become less valuable as yields go up. China’s overheated property market also caused ripples with news of a possible default by real estate developer China Evergrande on its debt. A potential collapse of Evergrande along with ongoing concerns in China of slowing economic growth, a government crackdown on large technology companies, and continued government interference in the equity markets sector led to negative returns in the third quarter for emerging market stocks. Your BFA Investment Committee reminds you of four things, however:

1. As Scott McLeod’s recent webinar explained, volatility is normal and should be expected as we are overdue for some this year.
2. Our fixed income portfolio goes beyond U.S. core bonds and uses managers with flexible mandates to take advantage of higher yields (non-investment grade corporate bonds), geography (international bonds), and to shelter taxable income when practical (municipal bonds).
3. Equities including real estate investment trusts (REITs) have shown over time to be an effective inflation hedge.
4. Our fund selection in the emerging market allocation has outperformed the index due to its focus on smaller and more value-oriented companies.

tax planning in the fourth quarter for client portfolios.

Mutual funds are required to distribute their realized capital gains by year-end, with most of those distributions occurring in December. We will analyze our client holdings for material distributions (i.e., 5% or more of net asset value) and may take action to avoid those distributions. We will also look for opportunities to harvest further capital losses in client portfolios. Given the specter of higher capital gain taxes, loss carryforwards have become even more valuable. These actions could save on taxes for you.

Financial Planning Concepts

4 tips to living the retirement of your dreams

Running out of money during retirement is a fear that nearly everyone faces at one time or another. Rest assured, your friends across the dinner table or on the golf course are just as concerned as you are (at least, at times) about not having enough. Even those you might consider “wealthy” have similar concerns. Nevertheless, there are specific strategies that successful retirees employ to protect and grow their retirement assets, live fulfilled, and have peace of mind. Here are four proven steps for a successful Retirement Plan:

1. Make sure you always have an up-to-date Retirement Plan. Whether you are still working, saving, and preparing for retirement or living the retirement dream now, you should have a realistic Retirement Plan. By projecting your cash flows and considering portfolio growth and taxes, the best Retirement Plan does two things: First, it ensures that you can meet your expectations and have an action plan to do it. Second, it provides peace of mind by showing the long-term implications of your current actions. When you face your fears head-on, you find peace in knowing that you control your destiny. Your Retirement Plan is the only way to accomplish this goal.
2. Manage your spending around your goal. If you are still working, your Retirement Plan defines what savings will be required to meet your standard of living during retirement. “Pay yourself first” by investing what your Plan requires before you start spending. If you are in retirement, use your Retirement Plan to help you develop a spending strategy. Unfortunately, bond yields and stock returns may be lower in the next few years. Knowing what you can spend by having a cash-flow-based plan is critical. The Plan will account for irregular expenses (car purchases, a home remodel, etc.) and help you control your spending to meet your long-term retirement goals.
3. Manage your distributions during retirement. One of the easiest ways to maximize your retirement spending is by avoiding distributions during market declines. After a fall, allow your portfolio to recover before making your next withdrawal. Waiting will help ensure that you are always “selling high,” a key to a successful retirement strategy. Maintain an emergency fund or use a Home Equity Line of Credit as a spending cushion during market volatility.
4. Protect your savings with insurance. There are many risks to your Retirement Plan, but you can protect yourself with insurance. Use “longevity insurance” to protect your income, long-term care insurance to cover unexpected medical expenses or life insurance to replace your spouse’s income. There are many new tools available to help you mitigate these risks.

Brown Financial Advisory is committed to helping you achieve your long-term goals by updating your Retirement Plan regularly and guiding you through the strategies you need to live the retirement of your dreams. Above all, we want you to have the peace of mind you deserve and are happy to help you get there.

Market Growth and Earnings 

The U.S. stock market was positive through the second quarter of 2021, bolstered by the accelerating economic growth of the U.S. economy. JP Morgan reports that,

“Real GDP numbers for the first quarter showed a strong 6.4% annualized growth. However, April data for consumer spending, inventories, and durable goods orders reinforced our view that this growth is accelerating and that second-quarter growth could be over 10%.” 

Even if the economy should begin to slow in the second half of the year, it is not unreasonable to expect the fourth quarter to grow 7.5% over 2020. Amazingly, this would essentially mark a full recovery from the pandemic-induced recession.

When markets rise to new heights, as they have recently, investors become increasingly nervous that the stock prices may be unsustainable and susceptible to correction. Markets tend to be more fragile when valuations worsen due to the earnings of the underlying companies not keeping pace with the prices of the stocks. But so far this year, earnings have recovered remarkably and year-over-year earnings growth is expected to hit an all-time high. Many sectors in the U.S. economy continued to do well during the pandemic and still show healthy revenues. Other companies are showing signs of recovery. Additionally, some companies have shown increased efficiencies, allowing the increased revenues to result in wider margins and increased earnings per share. Although valuations are historically high in the U.S., strong company fundamentals are supporting the current stock prices.

Inflation 

However, looking ahead, growth in the U.S. stock market may be stifled by external forces. Wage costs, higher interest rates, inflation, and, potentially, higher corporate tax rates could negatively impact future growth. Many factors have led to higher inflation but none more significant than increased consumer spending pulling against systemic supply-chain interruptions across the economy. Economics 101 teaches that an increase in demand and a decrease in supply will often result in higher prices. And while reports of rampant inflation may be somewhat overblown in the short term, there has been a material increase in prices, a 4.9% increase in May. The increase was shocking but not entirely unexpected and was due to the state of the economy in May of 2020 and the significant improvements since then. However, more important is the annualized 2.5% increase in the CPI over the last two years. This means the average consumer has seen noticeable increases in costs of goods and services dating back to 2019. Some of these price increases should be transitory but economists suggest inflation could still be 3.0%-4.0% through the end of 2021 and could remain much higher in 2022 than the Fed’s former inflation target of 2.0%.

Financial Planning Concepts

5 ways to improve your estate plan

It is common knowledge in the financial planning community that very few people LIKE working on their estate plans. And while the process may feel like a necessary evil, there are some fundamental steps you can take to help avoid a mess for your heirs after you are gone:

1. Review your estate plan with your attorney at least every 3-5 years.

A quick meeting with your attorney will keep your plan updated from both the personal and legal perspectives and provide a “tune-up” to ensure there are no surprises for your heirs. A regular review is the most crucial step in improving your plan since, of course, you cannot fix problems with your plan after you are gone.

2. Prepare a personal Net Worth Statement that includes the ownership of your assets and your beneficiary designations.

The Net Worth Statement is an essential tool for helping your Personal Representative settle your estate. It includes all your assets and all your liabilities listed by ownership. Simply knowing locations of accounts, account numbers, beneficiary designations, and ownership speeds up the settlement process and can also help avoid the risk of an account or insurance policy not being claimed and ultimately lost (or significantly delayed) in the process.

3. Regularly review the beneficiaries on all your accounts and add them when appropriate.

Naming beneficiaries on your accounts can be a powerful but sometimes dangerous planning strategy. Beneficiaries on retirement plans like 401(k)s, 403(b)s, and IRAs receive special tax treatment and the proceeds of those plans avoid the probate process when properly designated. Non-qualified accounts like bank accounts and taxable investment accounts also avoid probate when a beneficiary is added. However, a beneficiary designation may supersede the provisions of your will. Reviewing your beneficiaries and your will provisions together is the best way to use this powerful tool wisely.

4. Prepare a personal property list.

As most planners know well, families often break apart when trying to settle the sentimental items in an estate. Mom’s pie plate will always elicit more emotion than her checking account, and a well-crafted personal property list with designated heirs can help avoid the trouble that often arises. Talk with your heirs about your plans, gather feedback and write down everything you hope to designate. Most families do not expect the children to disagree, but unfortunately, it happens often. 

5. Prepare the next generation for the inheritance sooner rather than later.

Wealthy families often make a mistake when they depend on the estate plan to “teach” the heirs how to manage the wealth by creating trusts to limit access, appointing trustees, and using guardians to “protect” the heirs from the hazards of wealth.  “Shirtsleeves to shirtsleeves in three generations” is the adage that describes the curse in these families. Involve the children early and often and empower them with responsibility and challenges to help prepare them to take over the reins. Then, when you need help later, you can rely on your children to know exactly what to do. 

An optimistic start to the new year

With a March 2020 COVID-induced market bottom in the rear-view mirror, global equity markets raced ahead over the next twelve months, setting new highs and finishing a solid first quarter of 2021. The S&P 500 index (U.S. Large Cap stocks) gained 56.4% over the past twelve months and 6% during the past three months. It set 17 new highs in the first quarter of 2021 alone and reached the 4,000 level for the first time. Mega-cap technology companies drove returns at first, part of the Work-From-Home trade that characterized so much of 2020. As the year wound down, it became apparent that the Democrat-controlled Federal government would make good on its promises of increased fiscal spending alongside continued monetary stimulus from the Federal Reserve.  With that uncertainty gone, prospects shot up for a much stronger U.S. economic recovery, and economically sensitive stocks such as U.S. Small-Caps assumed the leadership mantle. As measured by the Russell 2000, U.S. Small-Cap stocks were up 95% over the past year and up almost 13% for the past quarter. International stocks have a greater proportion of cyclical stocks than the U.S. market, which along with increased stimulus from overseas central banks/governments and a weaker dollar, pushed them higher. For the past twelve months, Foreign developed (Europe and Japan) gained 45%, while Emerging Market stocks returned 58%. U.S. real estate (equity REITs) made a strong comeback, as well, up almost 9% and 38%, respectively, for the past 3- and 12-months.

Bonds made headlines in the first quarter of 2021, but not in a good way. Afraid that inflation would pick up with strong economic growth, Treasury bond investors sold off the 10-year bond. This liquidation pushed its yield up to 1.75% at the end of the quarter, an increase of 0.84% and the biggest one-quarter gain since 2016. Prices for broader U.S. investment-grade bonds, including corporate bonds, declined as well, dropping 3.4% during the quarter. U.S. municipal and international bonds (USD hedged) held up much better.

What is your BFA Investment Committee’s outlook for the rest of the year?

Your BFA Investment Committee believes that forecasts for more robust global growth particularly bode well for equities outside of the U.S., which are already undervalued compared to U.S. stocks. Our clients should thus benefit from their allocations to foreign stocks. We will also continue to keep an eye on any rising prices for goods and services. U.S. households are flush with cash from fiscal stimulus.  Those savings, in addition to pent-up demand stemming from COVID-19 restrictions, could unleash inflationary pressures not seen for a long time. We also believe that the Federal Reserve may have to confront increasing bond yields. The Fed has been content to let market forces play out, but a steeper yield curve may force the Fed to push back more forcefully. Finally, our clients should benefit from a diversified fixed income portfolio, going beyond core bonds to take advantage of higher yields, geographical diversification, and the shelter of taxable income when practical. 

Financial Planning Concepts

Biden Tax Proposals – Forewarned is Forearmed!

U.S. tax rates today are among the lowest U.S. citizens have ever experienced. But the newly unveiled $2.3 trillion (with a “T”) infrastructure plan will require some significant revenue to offset the spending. Taxes are once again front and center, so it is time to revisit key components of President Biden’s proposed plan. Nothing is permanent yet but “forewarned is forearmed” and we want you to be ready.

1. Corporate tax increases seem most likely. The President has had a long-standing commitment to increase corporate taxes. The corporate tax rate could increase from 21% to 28% and there could be an increase in taxation of international corporate income earned by U.S.-based companies. These increases could take effect as early as January 2022. According to Forbes, analysts from Goldman Sachs have predicted that Biden’s entire tax plan would reduce 2022 earnings-per-share on the S&P 500 by 9%. 

2. Is your net worth greater than $3.5 million? Unified gift and estate tax exemption amounts could decrease from $11.58M to $3.5M for individuals and $23.16M to $7M for married couples. There is talk of doing away with several common estate planning strategies like GRAT’s, family limited partnership discounts, and limiting dynasty trusts and defective trusts, all very effective tools for high-net-worth families. Planning tip: Consider aggressively gifting now, since there are no claw-backs on the gifts. Review all trusts and estate plans and potential estate tax changes and consider setting up trusts now. Life insurance could help if illiquid assets exist in your estate and taxes remain a concern. 

3. Do you own taxable assets that have appreciated in value? The new plan could eliminate the step-up in basis at death and potentially create a taxable event at that time. While this could be the most challenging of all to pass, it could also be the most impactful. Planning tip: Consider “basis management” as an ongoing strategy to bring down gains in your portfolio, particularly if the step-up in basis is eliminated. This may include paying more attention to annual rebalancing, placing stocks that are anticipated to appreciate into retirement accounts and transferring low-basis stocks to lower-income family members (up or down). 

4. Is your income above $400,000? Watch for an increase of the top ordinary income tax rate for income over $400,000 to 39.6% from 37%. Planning tip: Consider all strategies to bring down income, including funding traditional retirement plans, opening profit sharing/defined benefit plans, bunching deductions, etc. There may be an increase in long-term capital gains rates from 20% to 39.6% on income $1,000,000 and over, plus the Medicare Tax of 3.8% on top of those amounts. 

5. Tax-deferred exchanges for real estate performed under IRC 1031 may no longer be available. IRC 1031 applies to like-kind real estate. Planning tip: Consider performing like-kind exchanges this year to defer the gains, but make sure that any transaction qualifies under any tax law changes. 

Global equity markets continued their recovery in the third quarter of 2020.

The S&P 500 index (U.S. Large Cap stocks) finished the third quarter up almost +9% and set a new record in the process. Year-to-date through September 30, the S&P 500 is up +5.6%. The largest technology companies comprise almost 25% of the index and drove returns. For example, Amazon.com Inc. is up +70.4% year-to-date while Apple Inc. is up +58.6% year-to-date. Other index components have more room to go to recover their losses from earlier in the year. Assuming every holding in the S&P 500 has equal weight, the index was up +6.8% for the quarter but down -4.8% year-to-date. U.S. Small Cap stocks gained +5% for the quarter. Equity gains were not limited to U.S. stocks, as Foreign developed (Europe and Japan) stocks were up almost +5%. Emerging market stocks outperformed their U.S. and foreign developed counterparts during the quarter, gaining +9.6%. A continued weakening of the U.S. dollar (-3.6% for the quarter) boosted Foreign stock returns. Non-investment-grade (i.e., high yield) U.S. corporate bonds continued their recovery, gaining almost 5% during the third quarter.

Finally, U.S. Core and International bonds were up +0.6% for the quarter. The 10-year Treasury yield barely nudged during the quarter, ending at 0.68%.

Here are the broad index returns through the Third Quarter of 2020*:

What does the BFA Investment Committee think will drive volatility for the rest of the year?

We expect market volatility to pick up as we get closer to the U.S. Presidential and Senate elections. The markets do not like uncertainty, and the election results may not be final until days or months following the actual voting. While the markets may react negatively to these developments, we believe the reaction will be short-lived. Research shows that the political party in power, either in the Presidential or Congressional branch, is not a major market driver. We also expect an increase in market volatility if the U.S. government does not provide further fiscal stimulus. Chairman Jerome Powell of the U.S. Federal Reserve has been quite vocal about the fragility of the economic recovery and the need for ongoing fiscal stimulus in addition to the monetary stimulus provided by the Federal Reserve. Many investment analysts and economists expect Congress to reach a deal, even if it means doing so after the election.

Volatility could also pick up if the global economy, particularly the U.S., cannot sustain the recovery.

Most economists expect a significant bounce in third-quarter U.S. Gross Domestic Product (GDP). Still, there is concern that employment will not reach pre-pandemic levels for several years, and thus, consumer spending will taper off. However, the Federal Reserve has promised to continue its extremely supportive monetary policy. Global governments and central banks have learned valuable lessons from their initial responses to COVID-19 and should continue to act expeditiously to support their economies. Finally, work continues on a COVID-19 vaccine. Although there is uncertainty around when and how the vaccine will be safely distributed worldwide, unprecedented cooperation between global governments and private corporations has given both citizens and investors hope for economic activity accelerating to pre-pandemic levels. Given these challenges and opportunities, your BFA Investment Committee is cautiously optimistic and maintains its portfolio allocations and fund line-up. We are currently holding cash in place of U.S. high yield bonds, and it could be early next year before we re-enter the U.S. high yield corporate bond sector.

We will increase our focus on tax planning in the fourth quarter for client portfolios. Mutual funds are required to distribute their realized capital gains by year-end, with most of those distributions occurring in December. We will analyze our client holdings for material distributions (i.e., 5% or more of net asset value) and may take action to avoid those distributions. We will also look for opportunities to harvest further capital losses in client portfolios. Given the specter of higher capital gain taxes, loss carryforwards have become even more valuable. These actions could save on taxes for you.

You Are Not Alone

Is there any question that “The Year 2020” will go down as one of the most challenging times in history? Certainly not. But you may wonder why you feel so out of sorts. You should know that most of us are experiencing a nagging sense of disorientation about ourselves and the world around us. It is with good cause.

Consider the stressors we are all experiencing: The pandemic is resurging in many states when we thought the worst was behind us. Most of us are beyond tired of social distancing, and the uncertainty surrounding an effective vaccine seems to add little hope. To add insult to injury, the economy has suffered tremendously under the weight of social distancing strategies, is showing timid signs of recovery and there are millions out of work. While you may not personally experience it, you know it is there and you can feel it.

And now the election is here. The current state of politics in America creates its own burden of mental uncertainty. Deep inside, we all know that there are many things that need fixing in the U.S. and are eager to get something done. But collaboration is difficult in a winner-take-all, zero-sum game. Is there any real solution?

More than any other time, you should know that there is hope. In difficult times, you will hear people seek hope by quoting the Bible saying, “This too shall pass.” While somewhat accurate in sentiment, the phrase is not actually in the Bible. However, there is a scripture that says, “Rejoice in hope, be patient in tribulation, be constant in prayer.” Tribulation is inevitable but we can celebrate in that true hope of a better future; chances are, you are among the fortunate ones now. With patience (and a little time) we WILL see it pass. And through prayer, all of us can find peace, compassion, grace and, of course, hope.

Most of all, we need to care for one another, and we want you to know that we care about YOU. If you are inclined to get in touch and share your uncertainties about the future, we can promise a deep interest in your situation and your concerns. We may not have all (or any) of the answers. But there are times when a good conversation about what is important in life can result in better insights, and sometimes, a sense that we are not alone in our uncertainties.

We look forward to talking with you again soon!

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=Barclays Global Aggregate ex-U.S. USD-Hedged, US Real Estate=MSCI US REIT: Data Source: Morningstar®. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change. The foregoing content reflects the opinions of BFA and is subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.