Higher Interest Rates: One and Done or More to Come?

We all know that we're paying more for almost everything these days. Everything, of course, except money. Interest rates have been at historical lows for more than eight years, even though the economy has steadily improved over this period.

So anybody who was surprised that the Federal Reserve Board (A.K.A. The Fed) decided to raise its benchmark short-term interest rate last week probably wasn’t paying attention.  The U.S. economy is humming along, the stock market is booming and the unemployment rate has fallen faster than anybody expected.  The incoming administration has promised lower taxes and a stimulative $550 billion infrastructure investment.  The question on the minds of most observers is: what were they waiting for?

The rate rise is extremely conservative: up 0.25%, to a range from 0.50% to 0.75%—which, as you can see from the accompanying chart, is just a blip compared to where the Fed had its rates ten years ago.

The bigger news is the announced intention to raise rates three times next year, and move rates to a “normal” 3% by the end of 2019—which is faster than some anticipated, although still somewhat conservative.  Whether any of that will happen is unknown; after all, in December 2015, the Fed was telegraphing four rate adjustments in 2016 , before backing off until now with just this one. Personally, I believe that three interest rate increases in 2017 will prove inadequate, especially if current signs of inflation intensify next year.

The rise in rates is good news for those who believe that the Fed has intruded on normal market forces, suppressed interest rates much longer than could be considered prudent, and even better news for people who are bullish about the U.S. economy.  The Fed may have been the last remaining skeptic that the U.S. was out of the danger zone of falling back into recession; indeed, its announcement acknowledged the sustainable growth in economic activity and low unemployment as positive signs for the future.  However, bond investors might be less pleased, as higher bond rates mean that existing bonds lose value.  The recent rise in bond rates at least hints that the long bull market in fixed-rate securities—that is, declining yields on bonds—may finally be over.

For stocks, the impact is more nuanced.  Bonds and other interest-bearing securities compete with stocks in the sense that they offer stable—if historically lower—returns on your investment.  As interest rates rise, the see-saw between whether you prefer stability or future growth tips a bit, and some stock investors move some of their investments into bonds, reducing demand for stocks and potentially lowering future returns.  None of that, alas, can be predicted in advance, and the fact that the Fed has finally admitted that the economy is capable of surviving higher rates should be good news for people who are investing in the companies that make up the economy. That's not to say that the prospect of more interest rate hikes won't cause volatility in the stock markets.

So there may be a lump of coal on the list for over-exuberant investors in the year ahead. Although the current weight of evidence points to a continuation of this economic recovery, pressures that have been synonymous with trouble in past cycles have been developing. Wage and commodity (oil, raw materials) price increases may be rising faster than anticipated, and the Fed could easily fall behind in their efforts to keep inflation in check.

The bottom line here is that, for all the headlines you might read, there is no reason to change your investment plan as a result of a 0.25% change in a rate that the Fed charges banks when they borrow funds overnight.  There is always too much uncertainty about the future to make accurate predictions, and today, with the incoming administration, the tax proposals, the fiscal stimulation, and the real and proposed shifts in interest rates, the uncertainty level may be higher than usual.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.businessinsider.com/fed-fomc-statement-interest-rates-december-2016-2016-12

http://www.marketwatch.com/story/fed-to-hike-interest-rates-next-week-while-ignoring-the-elephant-in-the-room-2016-12-09

http://www.reuters.com/article/us-usa-fed-idUSKBN1430G4

http://www.usatoday.com/story/money/personalfinance/2016/12/15/fed-rate-hike-7-questions-and-answers/95470676/?hootPostID=32175354f7440337d62a767b3db92c68

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

2017 Retirement Contribution Limits Unchanged

Retirement plan contributions are supposed to be indexed and adjusted annually in line with the change in the rate of inflation. But only in the governmental fantasy world of non-inflation are adjustments not necessary.

That is to say, in case you missed it, the contribution limits to your 401(k) plan, IRA and Roth IRA—set by the government each year based on the inflation rate—will not go up in 2017.  Just like this year, you will be able to defer up to $18,000 of your paycheck to your 401(k), and individuals over age 50 will still be able to make a “catch-up” contribution of an additional $6,000.  (The same limits apply to 403(b) plans and the federal government’s new Thrift Savings Plan.)  Your IRA and Roth IRA contributions will continue to max out at $5,500, plus a $1,000 “catch-up” contribution for persons 50 or older.

SEP IRA and Solo 401(k) contribution limits, meanwhile, will go up from $53,000 this year to $54,000 in 2017.

The government has made small changes to the income limits on who can make deductions to a Roth IRA and who can claim a deduction for their contribution to a traditional IRA.  The phaseout schedule (income range) for single filers for 2016 starts at $117,000 and contributions are entirely phased out at $132,000; for joint filers the current range is $186,000 to $196,000.  In 2017, the single phaseout will run $1,000 higher, from $118,000 to $133,000, and the joint phaseout threshold will rise $2,000, to $188,000 up to $198,000.  Single persons who have a retirement plan at work will see the income at which they can no longer deduct their IRA contributions go up $1,000 as well, with the phaseout starting at $62,000 and ending at $72,000.  Couples will see their phaseout schedule rise to $99,000 to $119,000.

If you would like to review your retirement plan options, current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source:

http://money.cnn.com/2016/10/27/retirement/401k-ira-contribution-2017/index.html?iid=Lead

http://www.investopedia.com/articles/retirement/111516/2017-cola-adjustments-overview.asp?partner=mediafed

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Roth IRA Conversions after Age 70-1/2

A Roth IRA conversion allows you to move a sum of money from a traditional/rollover IRA into a Roth IRA, pay the taxes due, and thereby convert the future distributions into a tax-free stream out of the Roth IRA for yourself or your heirs.  You probably already know that the IRS requires you to start taking mandatory distributions from your traditional IRA when you turn 70 1/2, even if you don’t actually need the money.  A Roth IRA has no such annual minimum distribution requirement for the original owner and spouse. So the question is: can you do a Roth conversion at that late date, and thereby defer distributions forever?

The answer is that you CAN do a Roth conversion at any time, including after age 70 1/2.  But that might not be ideal tax planning.  Why?  Because at the time of the conversion, you would have to pay ordinary income taxes on the amount converted—basically, paying Uncle Sam up-front for what you would owe on all future distributions.  So, from a tax standpoint, you’re either paying taxes on yearly distributions or all at once.  (Or, if it’s a partial conversion, on the amount transferred over.)  If the goal was to avoid having to pay taxes on that money until you needed it, the conversion kind of defeats the purpose. Unless, of course, you have little other taxable income, and adding a Roth Conversion amount costs you little or nothing in taxes

The traditional reason people made Roth conversions was to pay taxes at a lower rate today than the rate they expect to have to pay on distributions in the future.  They might also want to convert in order to leave the Roth IRA dollars to heirs who might be in a higher tax bracket (keep in mind that a heir who is not your spouse is required to take a minimum, albeit non-taxable, distribution from a Roth IRA).  But with the new Republican Administration taking over, and Republicans controlling both houses of Congress, tax rates are odds-on favorites to go down, not up, in the near future.

If you still want to go ahead and make a conversion after the mandatory distribution date, the law says that you have to take your mandatory withdrawal from your IRA before you do your conversion. That means that you can't make a 100% conversion of your traditional IRA if you are subject to minimum distribution requirements.  Regardless, you or your tax advisor should "run the numbers" to ensure that you understand the taxes and tax rates that apply before and after the Roth Conversion.

If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cooki

Source:
http://time.com/money/4568635/roth-ira-conversion-year-turn-70-%C2%BD/?xid=tcoshare

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

e-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Celebrity Apprentice - Presidential Edition

Can lightning strike twice? Apparently it can as pundits, oddsmakers and major polls got it all wrong when forecasting our choice for our next president. Most had Clinton winning in a landslide. The first lightning instance was their wrong call on the Brexit vote earlier this year.

With President Elect Donald Trump, you may be well advised to prepare for a potentially wild ride in the investment markets over the next few weeks; indeed, the markets turned sharply negative in the overnight futures market Tuesday due to the uncertainties ahead. However, the day after the election (Wednesday), the markets closed decisively higher than election day in an opposite reaction to a market crash which some warned about if Trump was elected.

Questions Abound: Will the new President really build an expensive wall across our Southern border?  Will he introduce legislation that will nullify the Affordable Care Act and throw millions of Americans with pre-existing health conditions into health insurance limbo?  Do taxpaying non-citizens who have children born in America have reason to fear deportation?  Are our allies abroad really going to have to renegotiate their trade and security arrangements with the world’s superpower? Will he even the score with his government adversaries, invite them into his boardroom, and tell them "You're fired"?

It is helpful to remember that market gyrations are almost always bad times to trade, and particularly to sell.  We have more than two months before the new president takes office.  Traders and analysts have plenty of time to settle down between now and the first 100 days of the Trump presidency, and evaluate whether America’s corporations are, indeed, worth much less than they were before election night (they're not).  The safest bet you can make is that they  may be unusually jumpy for the next four years.  But in the end, the intrinsic value of stocks doesn’t change with the occupant of the White House.

One of the more interesting things to watch out for is a tax reform proposal sometime in early 2017.  Along the campaign trail, candidate Trump proposed simplifying our taxes down to three ordinary income tax brackets: 12% (up to $75,000 for joint filers), 25% ($75,000 to $225,000) and 33% (above $225,000).  The wish list includes a doubling of the standard deduction, with itemized deductions capped at $100,000 for single filers; $200,000 for joint filers.  Capital gains taxes would be capped at 20%, federal estate and gift taxes would be eliminated and the step-up in basis would be eliminated for estates over $10 million.

However, one should remember that these proposals were made before anyone imagined that Americans would elect an undivided government, with the Presidency, the House and Senate all under the control of one party.  The next four years—indeed, the first 100 days of the new Presidency—represent an opportunity for the Republican party to do something much more ambitious than simply tinker with our nation’s tax rules.  Influential Republican leaders—including House Speaker Paul Ryan—have reportedly been planning for some years to rewrite our nation’s tax code.

What, exactly, would tax reform look like?  At this point, we simply don’t know.  The goal would be tax simplification, but the bet here is that whatever form this takes will add thousands of pages to the current law and will likely look very different from Trump's proposal.

Of course, everything is speculation at this point, which is the most important thing to keep in mind if the markets roil and the shock and awe of the unexpected election outcome begins to sink in and cooler heads prevail.  The very worst thing you could do, over the next few days and weeks, is make a temporary loss permanent by selling into the general panic. Better yet, take advantage of others' panic and add to your investments at prices lower than they were during the past couple of years.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post.

Growing Pains

We measure the economic growth of the country via the Gross Domestic Product. 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. Though GDP is usually calculated on an annual basis, it is calculated and reported on a quarterly basis in the United States. After one of the worst recessions this country has seen ended in 2009, you'd think that the country would ramp up growth, but it has been anything but a ramp.

So why has the American economy grown so slowly since the Great Recession?  This year, GDP growth will fall somewhere in the 1.5% to 1.8% range, below the 3% growth rate that is considered a sign of robust economic health.  Critics have blamed everything from China’s slowdown, to globally outsourced manufacturing, and to fiscal fights in Washington.  But new research from economists at the Federal Reserve Board points to a different—and much simpler—explanation.

The researchers started with a demographic prediction model.  The model recognizes that the economy was destined to grow rapidly when the workforce is heavily weighted toward young accumulators, as it was in the 1960's and 1970's when the Baby Boom generation entered the workforce.  The good times continued as the labor force matured and the Boomers reached a high consumption stage of their lives.

But then the Fed economists asked: what happens when the Baby Boomers start to retire, as they did starting in 2005, and in increasing numbers since?  The boomer generation had fewer children than their parents did, so the research shows that as the workforce aged and retired, there were fewer people left in the workforce.  Economic output inevitably declined, no matter what happened in China or the manufacturing sector.

Over the past decade, the research shows that what economists call “capital”—machines, factories, roads, buildings, etc.—has become abundant compared to labor, which has depressed the return that investors receive for investing in capital.  This doesn’t just mean slower economic growth; it also leads to a decline in interest rates (due to a slowing demand for capital).  This helps explain why interest rates rose in the 1960's and 1970's, and have gradually declined in the subsequent decades.

The conclusion?  The U.S.—alongside many other developed nations—is experiencing a decline in workers compared with retirees, which happens to coincide with the lingering effects of the financial crisis.  The power of demography is like the tide; don’t blame the government or the Fed for not intervening, because they don’t have the power to overcome the shortage of workers (just ask anyone in Japan, suffering from one of the worst economic declines over the past twenty years due to an aging population and tight immigration policies).  More babies, and maybe more immigrants, represent better solutions.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.federalreserve.gov/econresdata/feds/2016/files/2016080pap.pdf

https://www.washingtonpost.com/news/wonk/wp/2016/10/07/theres-a-devastatingly-simple-explanation-for-americas-economic-mess/?tid=sm_tw

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post