Beyond Politics: What Does the Election Mean for Your Investments?

As the recent Democratic and Republican political conventions are in the rear view mirror, the presidential election season will now move into high gear! The “hype” on everyone’s minds right now is, of course, whether Donald or Hillary should win the election, and that cannot be ignored. If this post was an actual debate and I were behind the podium, the question you might ask is: How will this election affect the markets?

donald-hillary-800In previous communications, I have consistently emphasized the importance of maintaining a long-term perspective. Investors must keep their emotions in check and strive to block out the hype – the noise that can distract any of us from moving toward the attainment of your long-term financial goals.

The elections can sometimes bring out the more emotional side of our personalities, especially during a presidential election year which can cause excitement or despair, depending on your side of the aisle. I have even heard people complain that if a certain candidate wins, “The markets are doomed and so are my investments!”

Although every citizen is certainly entitled to their political beliefs, I think it might likely be very unwise to allow your political passions to drive your investment choices. It’s not about election years, or even political parties – but about investing for the long run. Nonetheless, there are some historical election year patterns that may be worth watching. Here are a few to consider, according to the 2016 Mid Year Outlook recently published by the investment research department at LPL Financial:

file0001935255693The Economic Factor: Income Growth
Income growth is one way to gauge the impact of the economy on election results, as this measure captures the impact of several key factors, including the unemployment rate, inflation, and wage growth. In the year leading up to the election, inflation adjusted, after-tax income growth of about 3% to 4% appears to be the threshold for the incumbent party to win. As of June 30th, this measure is currently growing in the 3% to 3.5% range, suggesting that the incumbent Democratic Party has a good chance of winning just over 50% of the two-party vote in November’s election.

Stock Market Performance Under Different Parties
The often spoken market mantra that “gridlock is good” suggests that a split Congress, or a President from the party opposite the one in control of both houses of Congress, would be better for markets. The downside, however, is that gridlock could limit policy action at a time when many policy experts think changes are needed on several fronts including taxes, entitlement reform, immigration, security, and others.

Historically, the combination of a Democratic President and split Congress has been best for markets, though it has occurred infrequently, with an average gain of 10.4% for the Dow Jones Industrial Average. A Republican sweep of the White House and Congress, on the other hand, has also been positive for stocks as well, with an average gain for the Dow of 7%. Election years have been strong for stocks, excluding the anomaly in 2008, the worst year of the Great Recession. Election year gains have averaged close to 10% and positive returns have occurred in a solid 87% of election years.

RisinginterestratesiStock_000078549611_MediumThe election year pattern for stocks suggests volatility may persist through the summer months until markets have more clarity on the candidates and their platforms. Once that clarity arrives, often before the election itself, stocks have typically staged a late-year rally. The path of bond yields during a presidential election year is very similar to the historical pattern for any given year.

The seasonal tendency is for yields to decline starting in late October through November; but during election years, the tendency has been for an increase in Treasury yields. Taking these historical patterns into consideration, and given the current environment, suggests that we will remain in a similar policy and stock environment as we’ve seen in recent years.

A Winning Platform
The road to long-term financial goals is filled with many potholes and road blocks. But the best election year “trade” might be to stick to your long-term investment strategy and remain focused on your investment aspirations. Over these past seven years, one of the best, but also most befuddling, bull markets in history may have made us feel like the financial markets are not functioning properly, and there’s a need to change something to “make investing great again.”

But even though a changing world presents important new challenges, staying focused on a good plan, and remaining patient may bring out the ways that “investing has always been great.” I think you have the winning platform already: invest early and often, stay diversified, and be patient through the ups and downs.

As always, if you have any questions, please email me at bill.pollak@lpl.com or call me at (925) 464-7057.

Watch Out for These Six Potential 401(k) Rollover Pitfalls

You’re about to receive a distribution from your 401(k) plan, and you’re considering a rollover to a traditional IRA. While these transactions are normally straightforward and trouble free, there are some pitfalls you’ll want to avoid.

401kRollovertoIRA1. The first mistake some people make is failing to consider the pros and cons of a rollover to an IRA in the first place. You can leave your money in the 401(k) plan if your balance is over $5,000. And if you’re changing jobs, you may also be able to roll your distribution over to your new employer’s 401(k) plan.

Though IRAs typically offer significantly more investment opportunities and withdrawal flexibility, your 401(k) plan may offer investments that can’t be replicated in an IRA (or can’t be replicated at an equivalent cost).

401(k) plans offer virtually unlimited protection from your creditors under federal law (assuming the plan is covered by ERISA; solo 401(k)s are not), whereas federal law protects your IRAs from creditors only if you declare bankruptcy. Any IRA creditor protection outside of bankruptcy depends on your particular state’s law.

401(k) plans may allow employee loans.

And most 401(k) plans don’t provide an annuity payout option, while some IRAs do.

2. Not every distribution can be rolled over to an IRA. For example, required minimum distributions can’t be rolled over. Neither can hardship withdrawals or certain periodic payments. Do so and you may have an excess contribution to deal with.

file0002903222023. Use direct rollovers and avoid 60-day rollovers. While it may be tempting to give yourself a free 60-day loan, it’s generally a mistake to use 60-day rollovers rather than direct (trustee to trustee) rollovers. If the plan sends the money to you, it’s required to withhold 20% of the taxable amount.

If you later want to roll the entire amount of the original distribution over to an IRA, you’ll need to use other sources to make up the 20% the plan withheld. In addition, there’s no need to taunt the rollover gods by risking inadvertent violation of the 60-day limit.

4. Remember the 10% penalty tax. Taxable distributions you receive from a 401(k) plan before age 59½ are normally subject to a 10% early distribution penalty, but a special rule lets you avoid the tax if you receive your distribution as a result of leaving your job during or after the year you turn age 55 (age 50 for qualified public safety employees). But this special rule doesn’t carry over to IRAs.

If you roll your distribution over to an IRA, you’ll need to wait until age 59½ before you can withdraw those dollars from the IRA without the 10% penalty (unless another exception applies). So if you think you may need to use the funds before age 59½, a rollover to an IRA could be a costly mistake.

5. Learn about net unrealized appreciation (NUA). If your 401(k) plan distribution includes employer stock that’s appreciated over the years, rolling that stock over into an IRA could be a serious mistake. Normally, distributions from 401(k) plans are subject to ordinary income taxes. But a special rule applies when you receive a distribution of employer stock from your plan: You pay ordinary income tax only on the cost of the stock at the time it was purchased for you by the plan.

Any appreciation in the stock generally receives more favorable long-term capital gains treatment, regardless of how long you’ve owned the stock. (Any additional appreciation after the stock is distributed to you is either long-term or short-term capital gains, depending on your holding period.) These special NUA rules don’t apply if you roll the stock over to an IRA.

6. And if you’re rolling over Roth 401(k) dollars to a Roth IRA…If your Roth 401(k) distribution isn’t qualified (tax-free) because you haven’t yet satisfied the five-year holding period, be aware that when you roll those dollars into your Roth IRA, they’ll now be subject to the Roth IRA’s five-year holding period, no matter how long those dollars were in the 401(k) plan. So, for example, if you establish your first Roth IRA to accept your rollover, you’ll have to wait five more years until your distribution from the Roth IRA will be qualified and tax-free.

Spring Has Sprung: Will the Equity Market “Spring” Continue?

Spring has arrived here in the Bay Area and across most of the nation. Just as we have seen declining rainfall after the wintery “El Nino” conditions, the new season has recently brought a break from the significant volatility we experienced in the first two months of the year.

park practice 052 (1)However, although there is increased clarity on several issues that cast a cloud (was it the El Nino effect?) of uncertainty over financial markets in January and February, it would be unwise to forget that heightened volatility is likely not gone for good.

The first quarter of the year was historic. After being down more than 10% at its lows, the S&P 500 bounced back in March and finished the quarter positive. The S&P 500 hasn’t erased a 10% quarterly loss to finish positive since the Great Depression.

Experiencing market volatility like this is not easy; yet witnessing this kind of reversal reminds us of the importance of maintaining a long-term perspective. So, what changed between January and February and today to help calm markets?

The mid-winter market malaise largely revolved around the Federal Reserve (Fed), China, oil, corporate profits, and the U.S. dollar. Investors were likely concerned that the four 25 basis point (0.25%) rate hikes the Fed projected for 2016 would lead to a recession and exacerbate the imbalances emerging in the global economy.

These imbalances stemmed from a series of missteps by Chinese policymakers, the oversupply of oil, weak corporate profits, and unprecedented strength in the U.S. dollar. In the past couple of months, many of these issues have started to resolve.

2000px-US-FederalReserveSystem-Seal.svgAt its March policy meeting, the Fed changed its tune slightly from the December 2015 meeting and reduced its forecast for rate hikes this year from four to just two, citing concerns around global imbalances and economic growth. This more market-friendly projection helped to push the dollar lower and oil higher, alleviating some stress in global financial markets.

Meanwhile, China, which said or did all the wrong things managing its currency, economy, and financial markets during the second half of 2015 and again in early 2016, has mostly turned that around recently. The weaker dollar, soothing words from China, and the rebound in oil prices helped to renew a slightly more positive corporate profit outlook and sparked an impressive market rebound.

After the market dips, reversals, and dramatic shifts in investor sentiment, what can we expect as we look ahead? In my opinion, the second quarter of 2016-and the rest of the year-may look a lot like the first quarter, as many of the areas of concern we faced (such as Fed rate hikes, oil prices, earnings declines) remain in the background.

Although it is very possible that the heightened volatility throughout the rest of 2016 might continue, some investment management firms, including the LPL Financial Research department, think that the broad US equity market might deliver mid-single-digit returns in 2016 if the U.S. economic expansion continues. Only time will tell whether these prognostications will come true.

To help you maintain perspective and stay on track, please feel free to browse on the right my previous newsletters and a sample of the educational articles from the blog section of my website. And, as always, if you have questions or are seeking clarification about your current situation, please email me at bill.pollak@lpl.com or call me at (925) 464-7057.

Correlation and Portfolio Performance

Different types of investments are subject to different types of risk. On days when you notice that stock prices have fallen, for example, it would not be unusual to see a rally in the bond market.

arrows_sq_452689341Asset allocation refers to how an investor’s portfolio is divided among asset classes, which tend to perform differently under different market conditions. An appropriate mix of investments typically depends on the investor’s age, risk tolerance, and financial goals.

The concept of correlation often plays a role in constructing a well-diversified portfolio that strikes a balance between risk and return.

Math that matters
In the financial world, correlation is a statistical measure of how two securities perform relative to each other. Securities that are positively correlated will have prices that tend to move in the same direction. Securities that are negatively correlated will have prices that move in the opposite direction.

Working people in the officeA correlation coefficient, which is calculated using historical returns, measures the degree of correlation between two investments. A correlation of +1 represents a perfectly positive correlation, which means the investments always move together, in the same direction, and at a consistent scale.

A correlation of -1 means they have a perfectly negative correlation and will always move opposite one another. A correlation of zero means that the two investments are not correlated; the relationship between them is random.

In reality, perfectly positive correlation is rare, because distinct investments can be affected differently by the same conditions, even if they are similar securities in the same sector.

Correlations can change
While some types of securities exhibit general trends of correlation over time, it’s not uncommon for correlations to vary over shorter periods. In times of market volatility, for example, asset prices were more likely to be driven by common market shocks than by their respective underlying fundamentals.

fixed-income-investment-strategies-1_1-800X800During the flight to quality sparked by the financial crisis of 2008, riskier assets across a number of different classes exhibited unusually high correlation. As a result, correlations among some major asset classes have been more elevated than they were before the crisis. There has also been a rise in correlation between different financial markets in the global economy (See Note 1 Below).

For example, the correlation coefficient for U.S. stocks (represented by the S&P Composite Total Return index) and foreign stocks (represented by the MSCI EAFE GTR index) increased from 0.75 over the last 25 years to 0.89 over the last 10 years (See Note 2 Below).

Over the long run, a combination of investments that are loosely correlated may provide greater diversification, help manage portfolio risk, and smooth out investment returns. Tighter relationships among asset classes over the last decade may be a good reason for some investors to reassess their portfolio allocations.

However, it’s important to keep in mind that correlations may continue to fluctuate over time because of changing economic and market environments.

The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. All investing involves risk, including the possible loss of principal. Asset allocation and diversification strategies do not guarantee a profit or protect against investment loss; they are methods used to help manage investment risk.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. When sold, investments may be worth more or less than their original cost.

1 International Monetary Fund, 2015

2 Thomson Reuters, 2015, for the period 12/31/1989 to 12/31/2014

Earn Too Much for a Roth IRA? Try the Back Door

Roth IRAs, created in 1997 as part of the Taxpayer Relief Act, represented an entirely new savings opportunity–the ability to make after-tax contributions that could, if certain conditions were met, grow entirely free of federal income taxes.

These new savings vehicles were essentially the inverse of traditional IRAs, where you could make deductible contributions but distributions would be fully taxable. The law also allowed taxpayers to “convert” traditional IRAs to Roth IRAs by paying income taxes on the amount converted in the year of conversion.

Unfortunately, the law contained two provisions that limited the ability of high-income taxpayers to participate in the Roth revolution. First, the annual contributions an individual could make to a Roth IRA were reduced or eliminated if his or her income exceeded certain levels. Second, individuals with incomes of $100,000 or more, or whose tax filing status was married filing separately, were prohibited from converting a traditional IRA to a Roth IRA.

In 2005, however, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA), which repealed the second barrier, allowing anyone to convert a traditional IRA to a Roth IRA–starting in 2010–regardless of income level or marital status. But TIPRA did not repeal the provision that limited the ability to make annual Roth contributions based on income. The current limits are set forth in the table below:

Phaseout ranges for determining ability to fund a Roth IRA in 2016*
Single/head of household $117,000-$132,000
Married filing jointly $184,000-$194,000
Married filing separately $0-$10,000
*Applies to modified adjusted gross income (MAGI)

Through the back door…
Repeal of the provisions limiting conversions created an obvious opportunity for high-income taxpayers who wanted to make annual Roth contributions but couldn’t because of the income limits. Those taxpayers (who would also run afoul of similar income limits that prohibited them from making deductible contributions to traditional IRAs) could simply make nondeductible contributions to a traditional IRA and then immediately convert that traditional IRA to a Roth IRA–a “back door” Roth IRA.

The IRS is always at the front door…
For taxpayers who have no other traditional IRAs, establishment of the back-door Roth IRA is essentially tax free. Income tax is payable on the earnings, if any, that the traditional IRA generates until the Roth conversion is complete. However, assuming the contribution and conversion are done in tandem, the tax impact should be nominal. (The 10% penalty tax for distributions prior to age 59½ generally doesn’t apply to taxable conversions.)

taxes1But if a taxpayer owns other traditional IRAs at the time of conversion, the tax calculation is a bit more complicated because of the so-called “IRA aggregation rule.” When calculating the tax impact of a distribution (including a conversion) from any traditional IRA, all traditional and SEP/SIMPLE IRAs a taxpayer owns (other than inherited IRAs) must be aggregated and treated as a single IRA.

For example, assume Jillian creates a back-door Roth IRA in 2016 by making a $5,500 contribution to a traditional IRA and then converting that IRA to a Roth IRA. She also has another traditional IRA that contains deductible contributions and earnings worth $20,000. Her total traditional IRA balance prior to the conversion is therefore $25,500 ($20,000 taxable and $5,500 nontaxable).

She has a distribution (conversion) of $5,500: 78.4% of that distribution ($20,000/$25,500) is considered taxable ($4,313.73), and 21.6% of that distribution ($5,500/$25,500) is considered nontaxable ($1,186.27).

Note: These tax calculations can be complicated. Fortunately, the IRS has provided a worksheet (Form 8606) for calculating the taxable portion of a conversion.

There’s also a side door…
Let’s assume Jillian in the example above isn’t thrilled about having to pay any income tax on the Roth conversion. Is there anything she can do about it?

One strategy to reduce or eliminate the conversion tax is to transfer the taxable amount in the traditional IRAs ($20,000 in our example) to an employer qualified plan like a 401(k) prior to establishing the back-door Roth IRA, leaving the traditional IRAs holding only after-tax dollars. Many 401(k) plans accept incoming rollovers. Check with your plan administrator.

Pros and Cons of Working at Home

Imagine that your employer gives you the choice between either working from home or commuting to the office throughout your work week. You might think the obvious choice is to work from the comfort of your own home; after all, staying in your pajamas all day and avoiding stressful commutes sound appealing. But there are some considerations to think about before you decide that telecommuting is right for you.

Advantages
file0001992856476Working from home could end up saving you a considerable amount of money. It eliminates the cost of commuting by cutting down what you spend on gas, public transportation and parking fees, and car maintenance. And depending on your company’s dress code, you could save what you might spend on expensive work-related clothes.

Besides reducing some of your daily expenses, working from home could provide you with more opportunities and increased productivity. Telecommuting might mean you are no longer tied to a single location, which could allow you to explore more flexible work opportunities within the company. Working from home may also motivate you to use your time more effectively and accomplish more for your company because you’ll save time commuting.

Balancing work and family life could be easier when you work from home, as well. Time that you might spend traveling to work, appointments, and family obligations will be saved when you no longer have to schedule around a daily drive to and from the office.

Depending on your company’s flexibility and the demands of your job, working from home may even eliminate or reduce child-care needs for your children, giving you more time to spend with your loved ones in addition to saving you money.

It’s possible that you could be healthier by working from home. Your exposure to co-workers who come to work with a cold or the flu is reduced, which prevents you from having to take a sick day to visit your doctor. You may also wind up feeling less stressed when you don’t have to worry about commuting or potential work-life issues.

Disadvantages
Before you get too excited about the appeals of working from home, consider the drawbacks. For instance, telecommuting could affect your work performance. Isolation from the office may result in your professional achievements being overlooked, which could potentially delay a promotion or raise.

Less opportunity to interact regularly with co-workers might mean missing out on important information, as well as feeling lonely. Plus, distractions around your home can interfere with your daily responsibilities and could result in a negative response from your employer.

Another financial downside of working from home is the prospect of providing your own office materials. Does your company provide you with supplies such as a computer, printer, and fax machine? Will you need to pay for office setup, postage services, or scanners, among other items?

file00032137357You might think that a home office tax deduction could alleviate the cost of home office expenses, but you’ll need to be careful with your home office use in order to qualify. The space you claim a deduction for must be used for business-only purposes. Any use of this space not related to your work may prevent you from taking this tax break. For more information, review IRS Publication 587, Business Use of Your Home.

You’ll also need to think about how your increased presence at home may result in an increase in your home utility usage. Specifically, you’ll probably spend much of your time using energy-consuming technology to perform your job. In turn, this could cause your electric bill to spike. Practicing energy efficiency may help reduce the bill, but you still might have to pay more than you’d like each month as the cost of working from home.

What works for you?
If your employer allows you to work from home, think about a few other things besides how it would affect your wallet:

1) Consider whether your home has appropriate space to accommodate a home office.
2) Understand that you may need to seek remote tech support on occasion to perform your job.
3) Think about whether you’re self-directed and able to work well independently in a home setting.
4) Set expectations for yourself.
5) Be familiar with any company policies that may apply to remote employees.

It’s possible that you can strike a balance and choose to work from home one or two days a week, thereby reaping more of the telecommuting positives than negatives. You could also ask to undergo a trial period to make sure that working from home is truly what works best for both you and your employer.

Changes to Social Security Claiming Strategies

The Bipartisan Budget Act of 2015 included a section titled “Closure of Unintended Loopholes” that ends two Social Security claiming strategies that have become increasingly popular over the last several years. These two strategies, known as “file and suspend” and “restricted application” for a spousal benefit, have often been used to optimize Social Security income for married couples.

SocSecurityTriColiStock_000008528384_sqIf you have not yet filed for Social Security, it’s important to understand how these new rules could affect your retirement strategy.

Depending on your age, you may still be able to take advantage of the expiring claiming options. The changes should not affect current Social Security beneficiaries and do not apply to survivor benefits.

File and suspend
Under the previous rules, an individual who had reached full retirement age could file for retired worker benefits–typically to enable a spouse to file for spousal benefits–and then suspend his or her benefit. By doing so, the individual would earn delayed retirement credits (up to 8% annually) and claim a higher worker benefit at a later date, up to age 70. Meanwhile, his or her spouse could be receiving spousal benefits.

For some married couples, especially those with dual incomes, this strategy increased their total combined lifetime benefits. Under the new rules, which are effective as of April 30, 2016, a worker who reaches full retirement age can still file and suspend, but no one can collect benefits on the worker’s earnings record during the suspension period. This strategy effectively ends the file-and-suspend strategy for couples and families.

The new rules also mean that a worker cannot later request a retroactive lump-sum payment for the entire period during which benefits were suspended. (This previously available claiming option was helpful to someone who faced a change of circumstances, such as a serious illness.)

Tip: If you are age 66 or older before the new rules take effect, you may still be able to take advantage of the combined file-and-suspend and spousal/dependent filing strategy.

Restricted application

Under the previous rules, a married person who had reached full retirement age could file a “restricted application” for spousal benefits after the other spouse had filed for Social Security worker benefits. This allowed the individual to collect spousal benefits while earning delayed retirement credits on his or her own work record.

In combination with the file-and-suspend option, this enabled both spouses to earn delayed retirement credits while one spouse received a spousal benefit, a type of “double dipping” that was not intended by the original legislation.

Under the new rules, an individual eligible for both a spousal benefit and a worker benefit will be “deemed” to be filing for whichever benefit is higher and will not be able to change from one to the other later.

Tip: If you reached age 62 before the end of December 2015, you are grandfathered under the old rules. If your spouse has filed for Social Security worker benefits, you can still file a restricted application for spouse-only benefits at full retirement age and claim your own worker benefit at a later date.

Basic Social Security claiming options remain unchanged. You can file for a permanently reduced benefit starting at age 62, receive your full benefit at full retirement age, or postpone filing for benefits and earn delayed retirement credits, up to age 70.

Although some claiming options are going away, plenty of planning opportunities remain, and you may benefit from taking the time to make an informed decision about when to file for Social Security.

Rates on the Rise: Strategies for Fixed-Income Investors

A long period of low yields has been challenging for many fixed-income investors, but owning bond investments in a rising interest-rate environment could become even trickier. When interest rates go up, the prices of existing bonds typically fall. Consequently, the Federal Reserve’s rate-setting decisions could affect the entire fixed-income market.

RisinginterestratesiStock_000078549611_MediumStill, bonds are a mainstay for conservative investors who prioritize the preservation of principal over returns, and for retirees in need of a predictable income stream. Although diversification does not guarantee a profit or protect against investment loss, owning a diversified mix of bond types and maturities is one way to manage interest-rate and credit risk in your portfolio.

Consider duration
Overall, bonds with shorter maturities are less sensitive to interest-rate fluctuations than long-term bonds. A bond’s maturity is the length of time by which the principal and interest are scheduled to be repaid. A bond’s duration is a more specific measure of interest-rate sensitivity that takes cash flow (interest payments) into account.

For example, a five-year Treasury bond has a duration of less than five years, reflecting income payments that are received prior to maturity. A five-year corporate bond with a higher yield will have an even shorter duration, making it slightly less sensitive to interest-rate fluctuations. If interest rates increase 1%, a bond’s value is generally expected to drop by approximately the bond’s duration. Thus, a bond with a five-year duration could lose roughly 5% in value. (U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest.)

Build a ladder
Bond laddering is a buy-and-hold strategy that could also help cushion the potential effects of rising rates. This process puts your money to work systematically, without trying to predict rate changes and time the market.

file0001084609609Buying individual bonds provides some certainty, because investors know how much they will earn if they hold a bond until maturity, unless the issuer defaults. A ladder is a portfolio of bonds with maturities that are spaced out at regular intervals over a certain number of years. When short-term bonds from the low rungs of the ladder mature, the funds are reinvested at the top end of the ladder.

As interest rates rise, investors may be able to increase their cash flow by capturing higher yields. A ladder may also help insulate bond portfolios from volatility, because higher yields on new bonds may help offset any paper losses on existing holdings.

Bond ladders may vary in size and structure, and could include different types of bonds depending on an investor’s time horizon, risk tolerance, and goals. Individual bonds are typically sold in minimum denominations of $1,000 to $5,000, so creating a bond ladder with a sufficient level of diversification might require a sizable investment.

Rise with rates
Adding a floating-rate component to a bond portfolio may also provide some protection against interest-rate risk. These investments (long offered by U.S. corporations) have interest payments that typically adjust based on prevailing short-term rates.

The U.S. Treasury started issuing floating-rate notes with two-year maturities in January 2014. Investors receive interest payments on a quarterly basis. Rates are tied to the most recent 13-week Treasury bill auction and reset weekly, so investors are paid more as interest rates rise and less as they fall.

Note: Bonds redeemed prior to maturity could be worth more or less than their original cost, and investments seeking to achieve higher yields also involve a higher degree of risk. Interest payments are taxed as ordinary income. Treasury bond interest is subject to federal income tax but exempt from state and local income taxes.

‘Tis the Season To Unwrap Your Crystal Ball!

It’s that time of year again! No, I am not referring to the Holidays which brings the hustle and bustle of gift buying, parties, and hopefully special time with family and friends. Those subjects could produce material for an interesting read, but there is another annual tradition which I have been thinking about.

file9821301453431I am referring to the scores of prognostications offered by many financial, investing and economic gurus. In a ritual as widely practiced as Holiday gatherings and New Year celebrations, we are hearing (or will soon hear) predictions about what 2016 “will” bring in the world of finance, including the direction and pace of economic growth, the path of interest rates, the outlook for oil prices (a hot topic!), and more!

Some of these pronouncements may sound convincing and could even be very well-reasoned. They will sometimes even come along with advice about the moves you can make to profit from those opinions or how to avoid losses. But I would caution anybody reading these missives to avoid making bold moves, no matter how compelling the prediction.

That’s because I have learned over the years to take these forecasts with a gigantic grain of salt. The business of making reliable forecasts about the sometimes arbitrary movements of the economy and financial markets is a very tough endeavor. As the late, great baseball icon and “philosopher” Yogi Berra once said, “Making predictions is difficult, especially about the future”!

That idea was recently underscored by research I have read from two prominent researchers at the International Monetary Fund (IMF), the well-known international financial organization. In a study published in May, 2014, Prakash Loungani and Hites Ahir, two IMF researchers, studied forecasters’ ability to predict recessions.

This paper, along with previous research compiled by Loungani and other economists, showed that forecasters possess a “record of failure to predict recessions” which “is virtually unblemished.” Ouch!

IMG_1312Does this mean you should ignore all prognostications? Not necessarily! I do read commentaries from many economists and investment experts. Understanding different perspectives about the financial world, especially when there are differing views, can be helpful. They can provide a measure of context and awareness.

But it is important to remember they may not be useful as an infallible investment or financial manual for the next 12 months. The workings of the economy and financial markets are extremely complicated and dynamic, making it extraordinarily difficult to forecast their movements, especially over a relatively short timeframe like one year.

In fact, if a forecaster says they know exactly what’s going to happen next, you might want to view such opinions, based on the aforementioned research, with skepticism. Alternatively, forecasts which acknowledge the possibilities of different outcomes might actually help inform you about unexpected developments.

Regardless of the quality of the forecast and research, I think most individuals and families may likely be much better off by placing their primary focus on having a long-term financial plan and following a disciplined process in making financial and investment decisions.

This approach might actually offer more long-term promise than placing too much emphasis on short-term forecasts which appear to be unreliable, no matter how credible the source.

To help provide context and perspective, this month’s blogs provide information about the recent interest rate hike by the Federal Reserve Bank as well as guidance about potential year-end tax moves:

Federal Reserve Bank Rate Hike: What Does It Mean?

Should You Worry About a Federal Reserve Interest Rate Hike?

2015 Year end Tax Planning Basics

As always, if you have any questions about your situation, I encourage you to email me at bill.pollak@lpl.com or at (925) 464-7057.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Federal Reserve Rate Hike: What Does it Mean?

The events of the past week bring one word to mind: finally. Last Wednesday, the Federal Reserve (Fed) finally raised the target for the federal funds rate by 0.25%. By raising this key overnight borrowing rate, the Fed raised interest rates for the first time in nine years—an event that has been receiving a great deal of attention recently. Surrounding the past several Fed meetings, there has been much talk of “will they” or “won’t they.” Leading up to this meeting, the Fed implied it would raise rates, and the market was expecting it.

file000821289525However, until the announcement was made today, a degree of uncertainty remained. So, what does this really mean? It means the potential for key rates to tick up, such as mortgage or credit card rates. Most bonds have “priced in the hike,” but some could still feel a slight negative impact. However, overall, we should take this as a positive sign. We have not experienced a rate hike in nine years, and, perhaps more importantly, we have not had rates above the 0–25 basis point range (0–0.25%) since late 2008.

The Fed said it would only raise rates if the economic data signaled a healthy economy. We have seen strong numbers posted over the past few months, and the Fed affirmed today it believes this trend should continue. To sum up, the Fed has raised rates because it believes the economy is strong and likely to continue to grow without the added support of near zero interest rates.

For the market, this is potentially a positive event. Yet, rate hikes also reaffirm that we are in the mid-to-late stage of the economic cycle. In this part of the cycle, we can expect additional market volatility. We especially anticipate it in the coming weeks and months, as investors become comfortable with the “new routine” for U.S. monetary policy.

Although we have just experienced the first raise, many will immediately start thinking about what’s next. The debate will continue regarding how fast the Fed will raise rates, how far it will raise them, and when it will stop. Today, the Fed’s own projections put the fed funds rate at 140 basis points (1.4%) a year from now, while the fed funds futures market puts the fed funds rate at just 80 basis points (0.80%) by year-end 2016.

arrowThis difference implies a gap between what the Fed says it will do and what the market thinks the Fed will do. How this gap is resolved will play a key role in the future direction of financial markets, particularly fixed income markets. Luckily, Fed Chair Janet Yellen is aware that markets will continue to debate what may lie ahead. Her comments during the post-meeting press conference suggest the Fed will continue to proceed cautiously, taking into consideration the impact of rising rates on consumer spending, the housing market, business capital spending, the value of the dollar, and overseas economies and financial markets.

A slow path for further increases will give the economy and markets time to adjust to the changes. It has been a long time since we last saw the Fed hike rates. It does feel unusual, but also positive, and hopefully this change is well worth the wait. It means that we are returning to a more typical economic environment, which is a welcome change from the atypical environment we have lived in since the Great Recession.

And even though this is a big change in Fed policy, what shouldn’t change is our commitment to the long-term investment plan that is ultimately our blueprint for success. As always, if you have any questions, I encourage you to email me at bill.pollak@lpl.com or at (925) 464-7057.

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

Economic forecasts set forth may not develop as predicted.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price.

This research material has been prepared by LPL Financial.

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