Are Wall Street and Main Street disconnected?
Elections and the markets.
How to handle IRA beneficiaries under the new tax laws.
We each give our tip of the month.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements and President, Peter Mallouk this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Transcript:
Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, president of the firm, and we are Down the Middle. Peter, it’s September 1st and once again we are talking about the markets and the coronavirus. And the big question I keep hearing over and over again is, has Wall Street gone crazy? Why is there this big disconnect between what people are seeing on Main Street and what’s happening on Wall Street? Is there a disconnect or does the performance of the markets make sense?
Peter Mallouk: I think the performance of the markets makes perfect sense and you hear a lot about the disconnect. I think the market is more connected to the economy than ever before. And I think the big misperception is that the market is reflecting the economy in real time. And what the market is looking at is it’s looking forward. And that’s why in March the market could lose a third of its value in just a couple weeks because it looked forward and said, “People aren’t going to go to restaurants, people aren’t going to buy clothes, people aren’t going to buy Nike shoes, they’re going to stay in their homes. We don’t know how bad this is going to be.” That was rational today the market looks ahead and says, “We’re going to get through this election, we’re going to come up with some resolution to the social issues that are plaguing us, we are going to, and most important what the market cares about is we’re going to find a way through the coronavirus.”
People are kind of figured out how to navigate it themselves. People that are at risk are staying home and other people are now spending money. And so, the market’s looking forward and saying these companies are going to survive and continue to do well and even thrive. And so, it makes perfect sense. And the best analogy I’ve heard, and I can’t remember who came up with it, is it’s kind of like I take my dog for a walk, and I’ll walk him around the park, and I’ll go home, and I’ll follow the path. The dog will run to the right, the dog will run to the left, behind me, on top of me. It’s not following me exactly, but we both get to the same place. And that to me is how the market is connected to the economy. How do you see it?
Jonathan: What I’ve been so impressed by in recent months is the inventiveness of Americans. I mean, we presented with this unprecedented situation where we worry about going out and becoming infected and faced with this, people are figuring out how to navigate their lives and how to continue to do business and how to get ahead. One of the great examples I think, is how restaurants are functioning. Now, every restaurant in my town has seating outside. I mean, this is not going to be sustainable in December, but right now they are able to do business and it’s extraordinary and it’s what, in many ways, makes America the country that it is, that based with adversity, people figure out how to get ahead. Every day, every morning in America, people get up and say, “How am I going to make my life better today?” And that in the end is what drives the economy, and it drives the stock market. And we’ve seen that in spades this year.
It’s just to me, absolutely extraordinary. And we’re starting to see it spill over, not into the stock market generally, but also into the stocks that are doing well. So, we go back to March, and we saw this extraordinary performance by these five big tech stocks. So, everybody was talking about Amazon and Apple and so on. And now as we start to say, “Hey, people are figuring this out and it’s not just these five tech stocks that are going to do well, but all companies.” Or maybe not all, but many companies are figuring out how to survive or thrive in this environment. And suddenly it’s not just five tech stocks, we’re seeing a broadening of the market recovery and we’re seeing smaller starts picking up steam, we’re seeing non-tech stocks in the S&P 500 start to do well and we’re seeing foreign markets start to do well. And in many ways for people who hung tough with a diversified portfolio through this period, they are now getting rewarded.
Peter: Yes.
Jonathan: So, you said the market, Peter is looking beyond the election. Do you actually think that there’s anything about the run up to the election that could royal up the financial markets?
Peter: There’s nothing worse than talking about the election nowadays. And I remember when President Obama won, fielding a multitude of calls of people that were telling me they were going to switch, move to different countries. And a lot of concern about the market not doing okay, the market had one of its best eight year runs in history and I fielded the same calls after President Trump won, that the market can’t, won’t be able to handle this and all the uncertainty and he’s crazy and all of that stuff. And I’ll never forget, I was in Connecticut in a parking lot mucking into another client meeting and I took 15 minutes to try to convince this client not to go to cash and I was unsuccessful. And of course, that was the only year in stock market history, the year following Trump selection where the market went up every single month.
So, the point is, President Obama and President Trump are very, very different people and the market somehow went up through all of it. But every election we create these narratives that somehow people are going to stop going to McDonald’s and buying iPhones and buying Nike shoes based on whether someone’s politics matches us. And I understand that politics impacts economics, and it impacts taxes and regulations impact businesses. But I think people underestimate, dramatically, how much the markets are all about earnings and how these are incremental to earnings and that there’s a very different deal between the markets and how, say someone is taxed. And so, I think the connection is in people’s minds much greater than it is. And factually, if we look historically, whether it’s a blue sweep, a red sweep, split either way, with Republican or Democrat as president, the market performs within a couple points of each other. It’s a factor, but it’s not something that people should be making decisions around in terms of, are they going to invest or not?
Jonathan: So, Peter, this week I had two wonderful emails from readers. One reader wrote to me and said, “Clearly investors are betting that Donald Trump is going to get reelected because that’s why share prices are going up.” And literally the next day I had an email from a reader that said, “Clearly investors are betting that Joe Biden is going to get reelected and that’s why stock prices are going up.” Trying to figure out what is happening with stock market and why, particularly when it comes to politics, I mean, you can’t do it. We have millions of investors, who with every trade that they make, are voting on the future of stock prices. Nobody can summarize that, particularly in the short term. In the long term. We know earnings growth drives stock prices, but in the short term anybody’s guess what will happen.
Peter: That’s right.
Jonathan: But before we leave the financial markets behind, I just want to take a moment and go back to late February and early March of this year because it was such an extraordinary period.
I mean, we saw the market shared 34%, as measured by the S&P 500 in a few short weeks, and in many ways, it was crucible in which investors were tested. And I didn’t know what lessons you took away from that, Peter, but one of the ones that was hammered home for me is, once again, how bad we are at predicting what could happen in the financial markets.
So, remember it was that Monday when the stock market turned around and soared in, was it March 23rd? And that was the market bottom. That weekend, somebody wrote to me after I penned a piece that was bullish on stocks and said, “You’re out of your mind. When you have a market decline like this. You have to wait for capitulation. We haven’t seen small investors selling on mass. There are always three stages to a bear market. We’re barely through stage one. This is going to go on for months longer. It’s way too early to sell.” And boom, stock prices soared. All of these clever forecasters really have no idea what’s going to happen next in the financial market. So, I think that’s the number one lesson that I took away from this market decline. Anything else that strikes you? Peter,
Peter: I remember we actually recorded a video the day before. I had done just kind of a video for our clients from my home the day, at the market bottom by coincidence, by just explaining why to stick with it. And I had only had just a few hours to get blasted for that video before the market soared at the open. And I really never looked back, and the Fed had intervened. And of course, ever since then we know mortality rates are better and so on that the market’s rallied, that the issue is, to your point, the market is connected.
Stocks meet their fair value, eventually, so that it will always find its way there. It’s just going to take some time, some time. And we need there to be things like the coronavirus crash and the 08, 09 crash, and the nine 11 crash, because if the market just went up every day, there would be no excess return over bonds. That’s the reason people go to stocks over bonds is to get a better return. You get a better return because you understand the movement that comes with it. So, it’s a blessing to investors because it’s what creates the risk premium.
Jonathan: Yeah, there is no excess return without risk. And if you want to know what risk is, we saw it in March of this year.
Peter: Yes.
Jonathan: One of the other lessons I take away from earlier this year is how bad many people understand their own risk tolerance. Everybody’s big and brave when share prices are soaring, but when it comes to it’s amazing how quickly people’s appetite for risk evaporates. And again, going to my emails, I was really disappointed in some of the emails I got from people who are regular readers of my staff and then wrote to me and said, “I went to cash.” And I assume that the readers I get are relatively sophisticated and yet they couldn’t hang tough. And for those people, this is where the value of a good financial advisor to coach them through a market decline really pays off. And whatever they thought they were saving, they lost it in spades by bailing out during that market decline.
Peter: That’s right.
Jonathan: So, let’s switch gears here, Peter. We’re going to talk a little bit about estate planning and specifically what assets you should leave behind for your heirs. And this question that’s become more pressing after the death of the so-called Stretch IRA. So now if you bequeath an IRA, whether it’s a Roth or a Traditional IRA, your heirs, instead of being able to spend down that account over their lifetime, now have to empty the account within 10 years. Does that change the calculus on what you should sort of set aside to leave for your heirs?
Peter: It really does because it changes how much that IRA can grow Before with a Stretch IRA, the IRA could grow and grow and grow, all the beneficiaries were taking it out. And the reason they changed that law was to accelerate the taxes, to accelerate the depletion of the IRA to which winds up going to the US Treasury. So, one thing to think about, is for people that are making charitable gifts, and now more than ever it makes sense to use your IRA, your Traditional IRA to make that gift.
So if you’re making a $50,000 gift to charity on your death, whether it’s your own foundation or church or big brothers, big sisters or whatever, instead of giving it out of your trust or will where it might come from the sale of your home or your taxable investment account, give it from your IRA, you can split your IRA in two or three or four and have the IRA that has the amount you want to go to charity go to that charity and you will skip all the income taxes. The charity will if you give 25,000 IRA to charity, the charity gets 25,000. If you give a 25,000 IRA to your kids over 10 years, it’s going to be depleted and after taxes they’re going to get more like 15 to 18,000.
Jonathan: So, this new 10-year period to empty an IRA applies to both the traditional IRA and a Roth IRA. But if you’re advising your kids on what they should do when they inherit those accounts, the advice should be somewhat different. So if you are leaving a traditional IRA to your kids, you probably want to say to them, “Hey, you have 10 years to empty this and you probably want to do it sort of one 10th every year over the 10 years because all of that will be taxable income to you in any given year and you don’t want to load it all into a single year. Delaying until the end of the 10-year period, so you get the tax deferred growth for 10 years may actually turn out to be a big mistake. So, you could end up pushing yourself into a very high tax bracket.”
By contrast with the Roth IRA, yeah, you probably do want to wait until the year 10 so you get maximum growth from the 10 years of tax-free appreciation within the Roth IRA. So, one, the Traditional IRA, spend it down slowly once you inherit it. The Roth IRA, wait till the end of the 10-year period. So, if the traditional IRAs become a less attractive inheritance, what about leaving your kids your regular taxable account? I mean that’s going to be income tax free to them because the money coming out of it is going to enjoy the step up in cost basis, so any stocks that you have when they will inherit at their current market value, so they immediately sell them, there will be no capital gain. Is a taxable account a better thing to leave your kids or is there some political risk there as well?
Peter: Well, I think capital, today giving a taxable account or real estate or something like that where it’s appreciated in value is the perfect thing to give them because it gets a step up in basis. If you paid $20,000 for a stock, it’s worth a hundred thousand and your kids inherit it, they get the whole hundred thousand, they can sell the stock and pay no taxes. Now one of Biden’s proposals, more of a trial balloon proposal, not a formal proposal, is to get rid of the step up in basis. Meaning if you pay 20,000 for a stock and it’s worth a hundred and your kid sells it on your death, they’re going to pay capital gains from 20 to a hundred. That will change all of estate planning if that law passes and it seems to be gaining a little bit of traction, so we’re going to be revisiting a lot of things depending on who wins the presidency, how Congress plays out and what the world looks like. I suspect we’re going to be seeing some tax changes regardless of the outcome.
Jonathan: And for people are saying, “Oh, the step up in basis and cost basis, I thought that was sort of sacrosanct and it’s been with us for years.” But Obama made the same proposal back in 2015. I mean it didn’t become law, but it was discussed on Capitol Hill. So often with these ideas, rather like the end of the Stretch IRA, they get kicked around Capitol Hill for a while. They don’t become law of the first time around or even the second time around. But once they get into the political atmosphere, those ideas tend to start to gain traction. Next thing you know, this is another tax break we say goodbye to.
Peter: That’s right.
Jonathan: So, for insurance agents, all this question about, okay, the big tax bill from a Traditional IRA, maybe they’re just appearance of a cost basis. Let’s step up in cost basis on a taxable account means that their old favorite, the one where they can own a big commission, cash value life insurance is the thing that you want to leave to your kids. So, if somebody is hearing from an insurance agent and says, given all this uncertainty, what you want to do is buy cash value life insurance and hang on to leave that to your kids, what would you say, Peter?
Peter: I think that if you already have a policy, you should you go ahead and get it evaluated because sometimes it makes sense to keep the policy. If you don’t have a policy and you don’t have an estate tax issue, which today it’s kind of hard for, most people don’t have an estate tax issue. You have to have more than 11 and a half million dollars and if you’re married, double that. If you don’t have an estate tax issue, permanent insurance with cash value almost certainly does not make sense for you. It’s one of the general rules. If you’ve got a business, a real estate, pushes you over the estate tax limit. There are some situations where it can make sense, but definitely not a tool that we recommend to our clients.
Jonathan: So final question on this topic of what to bequeath, what is it that you could bequeath that your kids or other family members will not want to inherit? What don’t they want to get?
Peter: Well, it’s interesting just because we have a very, very large estate planning practice here. So, we help people, settlers, there’s always estates being settle at creative planning and the kids just aren’t into your stuff. You know what I mean? I have revisited everything that I personally have from baseball collections to sports memorabilia collections to music collection… Kids really, they just liquidate it. They just do. And so, if you feel like you’re hanging on to things for your kids, you might have a conversation about them, about what they’re really interested in. What you’re probably going to find is, it might be a couple pieces of jewelry, something that has some special sentimental value to them, maybe something you’re not even thinking of, and do yourself a favor and write out which kid’s supposed to get it so there’s not a big fight about it, and then don’t hang on to stuff that you think other people want because they probably don’t. Most stuff winds up at an estate sale. We just don’t want to admit it.
Jonathan: One of the things that, as a person who spent his life writing, I have tons of pieces of writing. Articles, books, I have letters I’ve received, I have letters going back to when I was in boarding school in England. And I figure that after my death, maybe my kids will read 12 pieces of paper they leave behind. So that’s my goal. Get it down to 12 pieces of paper.
Peter: That’s ambitious.
Jonathan: Well, if you leave more, then not be able to discriminate. Right? They’re just going to the whole lot.
Peter: That’s right. That’s exactly right.
Jonathan: When my stepfather died, he was a collector of antique cars. He had a couple of Rolls, Bentleys from the twenties and thirties. And not only for my stepbrother and stepsister, not only was it difficult to sell, but when they went to sell, they didn’t get anything close to what we thought the cars were worth. So, collectibles generally are not a good idea. Time shares your kids are not going to want. And frankly, selling real estate is a pain. I have to live somewhere, so you’ll probably own a home at the end of your life, but if you own multiple homes, your kids are not going to be happy about it.
Peter: Right. Agreed.
Jonathan: So, Peter, it’s that time of the podcast, your tip of the month. What do you get for me?
Peter: So, sticking with the estate planning theme a little bit, we had a client pass recently and his wife came in and she can’t find the marriage license anywhere, marriage certificate, and it’s impacting her ability to settle the estate. And I just feel terrible for this person that she’s going through the worst time of her life, and she can’t find this document. Now she’s only a client of our law firm. At Creative Planning, the wealth management firm, we get all that stuff together for all of our clients. And so I would just say if you’re a client of Creative, you’re probably already in great shape and you’ve got a place that we put together for you that holds all these records, but if you’re not, create a folder that has your birth certificate, social security card, marriage license, passports and deeds and titles, because these are things that are needed to settle an estate to transfer assets that can be asked for by third parties. And at the worst time of your life, you’re not going to want to go looking for them. And a lot of people put it off going, “Oh, it’ll take me forever to do that.” Well, it’ll take you forever to do it when you’re alive. I mean, imagine what it’s going to be like for your heirs. So that’s my tip is just take 15 minutes, throw all that stuff in a folder, make sure someone knows where the folder is.
Jonathan: And so, my tip of the month, Peter, is we are two thirds of the way through the year. So, at this juncture, most folks have a pretty good idea of what our income is going to look like for 2020. And you may be in the seemingly unfortunate position of having a relatively low income for 2020. And I would say you should seize the opportunity because this is your chance to take advantage of the low tax bracket that you find yourself in. And you might use that as an opportunity to convert your Traditional IRA to a Roth IRA. You don’t have to do the whole thing, just do a small portion of it. You can cash in some of those savings’ bones, you might realize some capital gains on stocks you were looking to get out of. And when you think about what sort of income level we’re talking about, if you’re married, filing jointly, and you take the standard deduction, you know can have income of up to $105,000 and stay within the 12% income tax bracket.
If you’re single and you take the standard deduction, you can have up to $52,500 in income and still stay within 12% tax bracket. And if you have capital gains on top of that, they’re only going to be taxed at 15% once you get into the next bracket. So, this could be a great chance to take advantage of your low tax bracket and get out of assets that you might be wanting to exit at a relatively low tax cost.
Peter: Yeah. Good advice.
Jonathan: All right, Peter. Anything else from you or should we wrap it up here?
Peter: That’s all I got.
Jonathan: All right. So, this is Jonathan Clements, structure for financial education for Creative Planning. With me is Peter Mallouk, President of the firm. It is September 1st. Thanks for joining us. We are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.
