A new year and new look for this report

You will notice that your quarterly BFA report looks a little different than usual. As we mentioned last year, we have invested in a more robust portfolio accounting and reporting system. This new system gives us powerful reporting capabilities, and this report is just one example. Our goal in this report is to provide you information that reinforces our planning efforts and supplements your custodial statements’ content. This report will also tie in with the review reports you receive during your meetings with us. Let us know what you think!

What drove market returns in 2020?

The S&P 500 index (U.S. Large Cap stocks) gained 18.4% last year and set 33 new closing records in the process, driven in large part by mega-cap technology companies. U.S. Small-Cap investors, heartened by brighter prospects for economic growth and continued low interest rates, pushed the Russell 2000 up by 31.4% during the fourth quarter and 20% for the year. Foreign stocks finished the year in positive territory, as well, with Emerging Market stocks up over 18%. China and other Asian economies were the first to recover from the pandemic and drove the performance in international stocks. A weaker dollar in 2020 boosted foreign stock returns, too. Finally, investment- and non-investment-grade (i.e., high yield corporate) bonds across the globe were positive for the year, driven by price appreciation.

What is the outlook for 2021?

Your BFA Investment Committee believes that the global distribution of the COVID-19 vaccine will take longer than many investors are expecting. As a result, the rebound in economic activity will stall (but not decline) in the first quarter of 2021 and then accelerate during the rest of the year. It will be essential to remain balanced among growth and value stocks, both in the U. S. and abroad. Also, we believe that emerging market economies and particularly China will continue to be a bright spot in the global markets, especially if the U. S. tones down trade rhetoric under President Biden. We expect the Federal Reserve to keep fixed income yields, across the curve, at low levels. We have already diversified U. S. core bonds to include a fixed-income manager who has a flexible mandate so he can cautiously go where the yield is. Rebalancing your portfolio is vital, so we are doing another round this month to sell Equities and purchase Fixed Income to bring the Equity allocation back down to its target weight (i.e., sell high and buy low). Finally, we have had several clients ask if a Democratic-controlled Federal government will negatively affect their portfolio. We have managed situations like this before and are not concerned. Fortunately, we know that markets historically take in stride which party controls the Presidency and Congress. Your portfolio is well-positioned for whatever may happen, including any correction in U.S. Large Cap stocks in 2021.

Financial Planning Concepts

How should I plan for the policies of the new administration?

The Biden administration intends to hit the ground running on several policy changes that will directly impact your financial plan. Right now, it is impossible to know how Congress will view the policy changes and if he will have enough support. Nevertheless, some of the policies could significantly change how you pursue your financial plan and having a strategy in place now is critical. Here are 3 important considerations for your financial plan:

#1 Will my income taxes go up?

Probably, but maybe less than you think. First, Goldman Sachs believes the President will be focused on vaccine distribution and COVID relief stimulus that will slow the implementation of additional taxes early in 2021. However, there are a few things to remember, in case they get to the tax law changes this year: 1) The top tax tier above $400,000 per year is expected to rise to 39.6%. Remember, this is about what the rates were in 2016. 2) Payroll taxes will increase for those making more than $400,000 per year, as well. 3) For those who have income above $1MM, capital gains taxes will increase to ordinary rates. This is significant for those selling businesses and high-income households and will make investment-tax-planning more critical. 4) The State and Local Tax deduction cap is likely to be removed, reinstating this great tax deduction for those who pay property taxes, etc. 5) Finally, corporate taxes are expected to increase and a new minimum corporate tax instituted. All in all, we will not know until the proposals make it through Congress and the result could be much different than proposed. Just be prepared.

#2 Is inflation going rise?

The stimulus we have seen and the resulting increase in the money supply may fuel inflation for the first time in years. JP Morgan is predicting 3% inflation soon due to the pent-up demand. It may be necessary to update your inflation assumptions in your financial plan to reflect the new outlook and to maintain your equity exposure to combat the additional inflation.

#3 Is my estate plan at risk?

Biden is proposing changes to the estate tax system that will change the way capital assets are taxed and the number of estates that will pay estate taxes. First, they have proposed the elimination of the “step-up” in basis for inherited capital assets. This means that if there is any appreciation in an asset (stock, real estate, business, etc.) it will be taxable to the heirs at the original basis. This is a truly significant change to the current system. Also, they intend to lower the exemption amount that may be passed tax-free in your estate. The new amount may change back to $5MM per person or even to $3.5MM per person. When combined, these two changes could significantly increase the taxes to your heirs. If these changes occur, you will likely need to update your estate plan right away. We are conducting estate plan reviews now to prepare, so please let us know if you would like for us to review your plan.