Inflation: Data released in April continued to paint a picture of sticky inflation, with most metrics coming in slightly higher than consensus expectations. Core CPI is now +3.8% y/y based on the most recent print, while the Core PCE Deflator (the Fed’s preferred inflation gauge) stands at +2.8% y/y, both of which are above the Fed’s 2% inflation target. Moreover, real time inflation data suggests that core inflation (CPI and PCE) has been running at an annualized pace of around 4.5% so far in 2024.
Monetary Policy: There were no FOMC meetings in April (technically a meeting began on April 30, to conclude with a rate decision and press conference on May 1), and thus no changes to overnight interest rates. However, sticky inflation data caused market participants to further reassess the timing and magnitude of a rate cutting cycle. At the start of April, futures markets were pricing in 2 or 3 rate cuts in 2024, most likely beginning sometime over the summer. By month end, futures markets implied only one rate cut this year, occurring in either November or December.
Economy: Data released in April was mixed. The labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (8.75 million per the most recent JOLTS report), job creation continues (303k nonfarm payrolls added), and unemployment is low (3.8%). There have been signs of a trough in US manufacturing, which has been in recession for nearly 2 years. However, consumer confidence has wanted in recent months thanks to sticky inflation, and higher mortgage rates appear to have stalled the upward momentum in housing sector activity. Q1 corporate earnings growth has been modest so far at +3.5% y/y, roughly in line with inflation meaning that real (inflation-adjusted) growth is close to flat.
Bond Market: Treasury yields moved higher over the course of April as market participants further recalibrated their expectations regarding the so-called “Fed pivot”, resulting in lower bond prices across the board. Credit spreads remain tight by historical standards, pricing in very little default risk. Mortgage spreads tightened a bit further in April, driving a smaller increase in mortgage rates (+38bp on average for 30y fixed) compared to the move in 10y Treasury yields (+48bp).
Stock Market: After posting significant gains in Q1, most domestic and international stocks struggled in April. China was a notable exception, with the MSCI China Index posting a 6.4% gain on the month, pushing E/M benchmarks into positive territory. In the US, all sectors except Utilities finished in the red, with rate-sensitive sectors like Real Estate and Technology facing the most selling pressure.
S&P 500 Total Return by Sector – April 2024
Albion’s “Four Pillars”:
Economy & Earnings
The US economy has been resilient despite the higher interest rate environment. Analysts are forecasting low double digit EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.
Valuation
The S&P 500’s forward P/E of 20x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Interest Rates
Futures markets imply that the Fed will cut overnight interest rates once or possibly twice in 2024, most likely at some point in the 2nd half of the year. Rate cut expectations have been tempered recently due to sticky inflation prints.
Inflation
After falling rapidly in late 2022 and all of 2023, inflation has become sticky in the 3-4% range in early 2024. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs. Rising oil prices driven by armed conflicts in Ukraine and the middle east are also a risk to the inflation outlook.
Thanks to all of you who were able to join us at our annual Albion ski day. As most of you know our roots as a firm are in Alta, Utah. We began our investment management and financial advising journey in the basement of the Alta Lodge in 1982 and through the rest of the 1980’s officed up at the end of Little Cottonwood Canyon. While we’ve long since moved down into the Salt Lake valley our hearts are still attached to that mountain oasis. On to this quarters’ musings.
Money Laundering. Shell games. Hiding the true owner of assets for nefarious purposes. These are a handful of reasons behind one of Washingtons’ efforts; the Corporate Transparency Act (“CTA”), a part of the Money Laundering Act of 2020. Turns out rulemakers believe our current system of LLC’s, Partnerships, and Corporations allow the actual humans who own these entities to hide behind a nearly impenetrable wall of structures to mask their ownership. And perhaps through these opaque structures engage in illegal activities with very little risk of being discovered. The purpose of this law is to pierce that veil.
Unfortunately this will apply to many of our clients. Those with closely held businesses, family partnerships and/or limited liability companies, and closely held entities will find themselves subject to the reporting requirements.
The provided information is not public. Rather, the gathering entity – the Financial Crimes Enforcement Network (“FinCEN”) is authorized to disclose information to U.S. federal law enforcement agencies, with court approval to certain other agencies, to non-US law enforcement agencies upon request of a US federal law enforcement agency, and with consent of the reporting company to financial institutions and their regulators.
Prior to this act the burden of collecting beneficial ownership information fell on financial institutions. This shifts the burden to the entities themselves.
None of us are happy about additional reporting requirements and what feels like further intrusion of the federal government into our affairs. And this note could wax philosophic for paragraphs on the topic. But we’ll spare you such a soliloquy. And focus instead on who this applies to and what you must do to comply. To be clear we are not attorneys and nothing here should be considered legal advice. We encourage every reader to consult with counsel to determine if they have a reporting requirement under the act and if so to ensure reports are filed in a timely manner.
There are twenty-three exempt categories which can be summarized in a few categories. First are financial institutions; for example banks, securities issuers, credit unions, bank holding companies, broker-dealers, money services businesses, securities exchanges and clearing companies, investment companies and investment advisors, venture capital fund advisers, insurance companies, state licensed insurance producers, entities registered with commodity exchanges, accounting firms, pooled investment vehicles. These entities already have stringent reporting requirements.
The next significant category is made up of governmental entities. This includes federal, state and tribal entities and includes political subdivisions which means counties, cities, towns and school districts.
The final category are “large” operating companies. For this law “large” is considered to be companies with over twenty employees, over $5,000,000 in gross receipts from US customers, and with an operating presence at a physical office within the United States.
Know that the entities as outlined above are but an approximate summary of exempt organizations. It’s essential to dive into the details and if there is any question to retain counsel to determine whether or not your entity is exempt. Fines for non-compliance are punitive and run up to $500 per day of non-compliance which can accumulate up to $10,000. None of us want to get this wrong.
So what types of entities will be subject to the reporting requirements? Unfortunately many of the small family partnerships, LLC’s, trusts, and corporations we and our clients work with on a daily basis are subject to this law.
The information required with the reporting includes the legal name, any trade names, DBA’s or trading as names, the current street address and principal place of business, the jurisdiction of formation or registration, and the tax ID number. Beneficial owners must report their name, date of birth, residential address, an ID from an acceptable document (passport, US driver’s license), and the name of state or jurisdiction issuing the document. An image of the document must be provided and it cannot be expired.
Businesses in existence prior to January 1, 2023 must file by January 1, 2025. Businesses formed during calendar year 2024 must report within 90 days of creation of the entity and businesses formed after January 1, 2025 must file within 30 days of creation of the entity.
More information can be found through your legal counsel and online at fincen.gov/boi.
This quarterly note differs from the usual fare. However given the circumstances we believe it’s important to front and center with all of you regarding this new requirement as year end (and the risk of non-compliance) will be here in the blink of an eye.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
If something cannot go on forever, it will stop. Economist Herbert Stein articulated this principle nearly forty years ago when discussing growing trade deficits with lawmakers. This humble insight can be applied to many situations. These days it feels as though post-pandemic economic strength will go on forever. Yet, we know that it won’t. It can’t. Our central theme of “normalization” is evident over the past eighteen months, and eventually the business cycle will overcorrect causing recession (not to be feared entirely as contractions cleanse the system). But that day isn’t today. Indeed, as we exit the first quarter the US economy is doing fine. Better than fine really, it’s quite robust. Consumer spending is resilient, jobs are plentiful, businesses are investing, and government budgets are expansionary. Real GDP grew by +2.5% in 2023, accelerating from the previous year, and estimates for Q1 sit around +2%. While these are backward-looking figures, more current information – like spending data from credit and debit card companies, retail sales, services PMIs, jobless claims, and even (recently) improving consumer confidence – suggests that momentum has carried into 2024.
But why the potency? The simple truth is economic strength is closely tied to jobs, which remains solid. And because the economy is strong that keeps the labor market strong as business profits support employment and wages. It’s a virtuous loop. And while signs of normalization (there’s that word again) in the labor are present, like softer demand for workers and increased supply, layoffs are low and hiring is steady. This balance is beneficial nurturing a more secure foundation. Until this situation changes, economic expansion should continue. The critical question is now, can we successfully move from too tight to well-adjusted in the jobs market without the pendulum swinging negative? Time will tell.
Inflation’s stride has also cooled over the past 20 months, from over 9% to roughly 3%. While much progress has been made, Jerome Powell asserts more work and greater confidence in the trend is needed to declare victory. We agree. The Fed’s target is ~2% and the “last mile” won’t be easy. Still, our long-held view endures – the contemporary war against inflation will be won.
Speaking of the Fed, last July we opined that the central bank was done hiking interest rates. Be it lucky or good, that view proved correct. We continue to reason that the Fed won’t need to raise rates further. We’ve gone from 0% to ~5.5%, a ton of credit tightening, and without a jump in unemployment. Job well done. The new Wall Street parlor game centers on how long the Fed will maintain its current stance before lowering rates. The answer hinges on the trajectory of the economy, employment, and inflation. Our best guess is the first cut will occur in the second half of this year.
All told, “soft landing” odds have increased compared to a year ago, a time when our preferred forward indicators signaled maximum caution. Several indicators have improved, meaning there’s been considerable diminution of risk over the past year. At this point we see recession odds at about a coin toss (down from over 80%). Historically, in any given year it’s ~15%.
In bonds, the action will likely be on the front end of the yield curve as big moves further out have mostly occurred. While things can move cyclically based on data and mood, structurally speaking longer duration securities appear sensibly priced for the current environment.
Meanwhile, firms are in good shape with profits holding steady in 2023. Despite “no growth”, revenues were higher last year due to an advancing economy and increasing prices. But so too were costs, in many cases more than revenues, resulting in compressed operating margins and inert profits. Looking ahead, analysts predict energetic earnings growth of +11% in 2024 and +13% for 2025, driven by a healthy economy and margin re-expansion. Those are high bars. From our perch, margins may have indeed bottomed if we can avoid a downturn. Thus the near-term direction of profits will largely hinge on the macroeconomy. Regardless, our primary attention is the longer-term outlook. Especially for those investments we own on your behalf. And here, we are optimistic for the years ahead.
For its part, the stock market has continued its momentum, driven by expectations of no recession and Fed rate cuts. Despite unease over the looming election, investor attitudes are (unsurprisingly) cheerful on the back of impressive recent performance. Moreover, the inflation problem is under control and geopolitics, while tense, sit more at a simmer than a boil. Yet risks remain if fundamentals, including lofty earnings expectations, fail to deliver.
On valuation, there’s some level of enthusiasm to be sure, particularly in areas like AI. However, at this juncture, this verve is probably more rational than irrational (paging Alan Greenspan and Bob Shiller!). As declared, the economy is sound, inflation is falling, the 10-year Treasury yield is off its peak, the Fed has finished raising rates, corporate earnings are ample, and technology is bliss. Given this backdrop, although the stock market is not exactly cheap, it is also not overly expensive when you consider where key factors like inflation, interest rates, and profits are expected to be in the coming years. Moreover, there is still approximately $6 trillion in cash “on the sidelines,” mainly in money market funds, a portion of which (not all, but some) will likely seek higher returns when the Fed eventually begins to ease.
Bottom line: while short-term estimates vary, our longer run outlook for US equities remains wildly bullish.
As always, there is perpetual motion in economics and financial markets, so it’s vital to make decisions based on the available information. We find great joy in this important vocation. Which I suppose leads us back to where we began, with Mr. Stein’s observation … but with a twist. What happens if something, like the work of a steadfast financial advisor, can go on forever? Thanks for your unrelenting trust.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
Retirement planning in America is constantly transforming. The widely accepted concept that everyone can retire is only a few generations old. In such a rapidly changing world, how we achieve such a feat will also continue to evolve, which means that traditional approaches to securing retirement income need to be revised. Longevity is on the rise, traditional pensions (defined benefit plans) are becoming relics of the past, and the onus of retirement planning now squarely rests on the individual.
Given the statistical likelihood of living well into our 90s, especially for non-smokers and those of higher socioeconomic status, the necessity for robust and foolproof retirement planning strategies has never been more apparent. This reality drives us to rethink and innovate in how we protect your financial future.
When creating comprehensive retirement plans for clients, it is important to identify and address some of the potential hurdles future retirees face. I often return to a list that author Larry Swedroe coined as the “Five Horsemen of the Retirement Apocalypse.” One of these five included “historically low bond yields,” which is no longer as relevant today, but I still find this list useful when trying to understand how to best plan for our clients’ futures. So, the following Four Horsemen remain top of mind for retirement planning in 2024:
Historically High Equity Valuations: With the U.S. stock market’s long bull run, it is wise to adjust expectations and prepare for potential downturns in equity investments.
Increased Longevity: As life expectancy rises, retirement planning must account for potentially longer retirement periods, necessitating a portfolio that can last 30+ years.
Long-Term Care Costs: With the likelihood of needing long-term care increasing with age, planning for these costs is essential to avoid financial burden and ensure quality of life.
Social Security and Medicare Benefits: There’s a chance that benefits could be reduced or taxes might go up to support these programs. We need to plan for multiple outcomes.
All we have to do is look at annuity sales in 2023 to see that consumers and advisors alike are turning to insurance contracts for peace of mind in the face of these headwinds. In ways, it’s unfortunate to see a record 25% increase in year-over-year annuity sales, as often, it’s primarily the agents who benefit from these products. Most annuity sales tactics use the same general concerns discussed above to incite fear and force quick action at the client’s own peril. My general thought process for insurance and annuities is straightforward: insurance is a great risk transfer tool but an expensive way to invest. If an annuity contract cannot be clearly explained, including all fees and market-based outcomes, I’m not interested.
A critical, yet often missed, step in sound financial planning is customizing withdrawal strategies to suit individual needs. This should usually be the first move in crafting a tailored retirement income strategy. When done in concert with a comprehensive financial plan, customized retirement withdrawal strategies can provide greater financial security because they allow for flexibility. None of us know what the future holds and unlike an annuity contract that locks you into a particular set of terms with possible penalties for making changes, customized income strategies allow you to make adjustments at the margins or pivot when necessary as your retirement years unfold.
As we consider the often jarring transition from saving to spending, it is essential to understand the various withdrawal strategies for portfolio assets available in retirement, which broadly fall into four categories:
Constant-Dollar Withdrawal: Start with a fixed percentage, then adjust annually for inflation. It can suit those needing a consistent income to cover fixed expenses.
Constant-Percentage Withdrawal: Withdraw a consistent percentage of your portfolio each year. Nice for those with flexible spending needs and lower fixed costs.
Variable-Percentage Withdrawal: The withdrawal percentage adjusts based on your portfolio’s annual value. Suitable for flexible spenders without the aim to leave a significant inheritance.
Spend Only the Income: This approach only spends dividends and interest, preserving the principal. It suits individuals with low expenses compared to their portfolio size or those wishing to use their current asset base for legacy planning.
Note that none of these strategies are a set-it-and-forget-it approach. They are part of a constant discussion about how we can help you most efficiently and comfortably spend the money you have worked so hard to earn.
Morgan Housel’s “The Psychology of Money” emphasizes the personal nature of financial decisions, reminding us of the wide variance in how people view and manage money. This diversity points to the absence of a one-size-fits-all approach to retirement planning. The goal is to find a strategy that aligns with your needs, ensures stability, and adapts to life’s uncertainties.
As your financial planners, we’re dedicated to navigating the complex landscape of retirement planning with you. If you have friends or family who require sound advice and a comprehensive review of retirement income planning options, please reach out and refer them to our team. Our goal is to ensure that our client’s retirement strategies are not only robust and tailored to their needs but also flexible and ready to adjust to the constantly evolving financial world.
Albion Financial Group is an SECregistered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
As we end another tax season, it’s crucial to address prevalent misconceptions surrounding taxes. Despite their annual familiarity, taxes remain a topic shrouded in confusion and misunderstanding. In this guide, we aim to shed light on some of the most pervasive myths and clarify the nuances of tax deductions, credits, penalties, refunds, and more. By debunking these misconceptions, we hope to empower readers with a clearer understanding of their tax obligations and opportunities for financial optimization.
Tax Deductions
There’s a common misconception that tax deductions automatically translate into a dollar-for-dollar reduction in taxes owed. This is not the case. While they do lower taxable income and can result in less taxes owed, tax savings thanks to deductions are based on your tax rate, unlike tax credits which offer a direct offset of taxes.
Deduction Example:
Last year, we aided a client in donating $20,000 worth of equipment to charity. Despite the substantial donation, the actual tax benefit depends on various factors, most significantly the client’s tax bracket. If the client’s income were to put them into the highest federal income tax bracket of 37%, the donation would lead to a total tax reduction of $7,400, not $20,000 ($20,000*0.37). A deductible expense simply means that you get a discount on the expense and are not required to pay income tax on the purchase.
Tax Credits
When it comes to tax credits, it is often understood that they’re interchangeable with tax deductions, which is not true. Tax credits directly reduce the amount of tax owed, dollar for dollar. Once your taxes have been calculated, any tax credits will subtract the total amount of taxes owed.
Tax Credit Example:
Take, for instance, the Child Tax Credit, which offers a $2,000 credit for a child 17 and under who is claimed as a dependent. If a single parent with a young child has a federal tax liability of $5,000, they could likely claim this credit thus reducing their tax liability to $3,000.
Additionally, it’s important to note that tax credits aren’t necessarily free money. While they can be an added bonus, most credits only provide a refund if you owed taxes to begin with, meaning you earned enough in taxable income during the year to qualify for the credit, but not too much to no longer qualify. Understanding these distinctions is key to maximizing your tax benefits and avoiding misconceptions.
Tax Deductions vs. Tax Credits
Consider the comparison of tax deductions and tax credits in a shopping context. A tax deduction resembles a favorable promo code, providing a certain percentage off your total purchase—equivalent to your marginal tax rate (or the highest rate your income is taxed). Conversely, a tax credit operates akin to a gift card, offering a specific dollar amount reduction from your overall purchase. While not precisely free money, it’s a close second.
Tax Penalties
Another misconception exists around tax penalties, which are often believed to apply solely to those intentionally evading taxes. Tax penalties can stem from various factors, including underpayment, late filing, or inaccuracies on your tax return, regardless of intent.
Tax Penalty Example:
I received a letter a couple years back detailing an underpayment penalty on my tax return. The letter outlined that I owed more than what was listed on my tax return. Since it had been many months since filing my return, I was also being charged additional fees on the “late” amount because the additional taxes were due by April 15 (as federal taxes always are). Despite the stressful process, I enlisted the help of a CPA to appeal the penalty and avoided owing the additional taxes and penalties. If you end up owing more tax than originally paid, you will owe penalties on top of the underpayment amount for however long it takes for the IRS to notify you of the underpayment amount.
Tax Refunds
Regarding tax refunds, many believe that refunds are free money from the government. It’s important to understand that a tax refund is not a gift from Uncle Sam, but rather signifies the return of your overpaid taxes throughout the year, though that doesn’t stop them from feeling oh so nice to receive.
Tax Refund Example:
If you owe $10,000 in federal taxes for 2023 and $9,000 was withheld from your paycheck for federal taxes throughout the year, you will owe $1,000 at tax time. Conversely, if $11,000 was withheld, you would receive a $1,000 refund. I spoke with a CPA friend recently who said that the only thing clients ever want is a refund, joking that he would be seen as a magician if he increased his clients’ paycheck withholdings for them to get massive refunds upon filing their tax returns. Many personal finance gurus have strong opinions for how to optimize withholdings. Find what works for you, just withhold enough that you don’t incur penalties.
Business Write-Offs/Deductions
There’s a common misbelief that all business expenses are automatically deductible. Not all expenses qualify for deductions. Business expenses must meet the criteria of being regular, ordinary, and necessary for the operation of your business to be deductible, with certain limitations and rules in place.
Business Deduction Example:
An individual takes a business trip to a tropical destination, intending to deduct all associated expenses, such as hotel stays and meals. The IRS may deny such deductions if the trip is deemed primarily for personal enjoyment rather than business purposes. Make sure your business expenses qualify to be deducted prior to spending money you hope will be tax deductible.
Gifting
It is often believed that gifting will result in taxation for gifts exceeding the annual gift exclusion limit. While true in a way, it’s essential to understand that the tax-free exclusion amount—$17,000 for 2023 and $18,000 for 2024—applies on a per person basis. Also, individuals can give up to $13.61 million (2024 amount) in tax-free gifts in their lifetime (known as the lifetime gift exclusion), so this exclusion of $18,000 (for 2024) is the amount that can be gifted without counting against the lifetime exclusion. This can get very complex as there are varying gifting strategies to consider, and attempting to implement any of them on your own can be extremely difficult.
Gifting Example:
Consider an older couple aiming to provide generous gifts to their two married children without incurring taxes. In this situation, each spouse could gift $18,000 to both children and their spouses, totaling $72,000 in tax-free gifts per spouse or an impressive $144,000 collectively as a couple. All of this could be done without counting against the lifetime amount in tax-free gifts that can be given.
529 to Roth Conversions
A common misconception exists regarding education savings and deductions, particularly regarding the conversion of unused 529 balances to a Roth IRA (a new strategy from the Secure Act 2.0). While there is some truth to this notion, it’s crucial to understand the limitations involved.
529 to Roth Example:
Consider a scenario where you have $50,000 sitting in a 529 account but decide not to pursue further education. In such a case, you may contemplate rolling the funds into a Roth IRA, which could be an option. This maneuver comes with restrictions. For instance, the 529 account must have been open for at least 15 years, and the rollover cannot exceed the current year’s Roth contribution limits—$7,000 for 2024. There’s also a lifetime maximum of $35,000 per beneficiary for these rollovers. While there are more intricacies to be aware of, the process is not as straightforward as commonly believed.
Tax Preparer Liability
There’s a common belief that the liability for errors or inaccuracies associated with tax returns is solely on the tax preparer. It’s imperative to recognize that the individual, the taxpayer, is responsible for the accuracy of their tax returns, regardless of professional assistance.
Tax Preparer Liability Example:
If someone hires a CPA to file their tax return but provides inaccurate income information or doesn’t send all required information/supporting documents, they remain accountable for any discrepancies. In the event of an IRS audit uncovering errors, the individual is liable for rectifying the mistakes and covering any resulting back taxes and penalties.
Conclusion:
As we end tax season for tax year 2023, we extend our gratitude to the remarkable CPAs we collaborate with. As we at Albion Financial Group are not accountants and do not give tax advice, their expertise ensures accurate tax filing and reporting, guiding us away from the pitfalls of common misconceptions. To those dedicated CPAs tirelessly navigating the complexities of the tax code, we salute your unwavering commitment. Here’s to the invaluable knowledge they impart and the smooth tax planning ahead!
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
In a financial landscape where interest rates on savings accounts are enticingly high, the decision between paying down debt or stashing cash becomes more intricate. This article aims to unravel a few of the complexities, arguing that even with the allure of a 5% interest rate in a High-Yield Savings Account, strategically paying down debt can often be a superior financial move. We will delve into the nuances of tax considerations and the importance of setting concrete financial goals to guide this decision-making process.
The Emergency Fund
Prior to exploring better potential use-cases for idle cash, a proper emergency fund should be established. It is understood that the purpose of cash in an emergency fund is to provide financial security during uncertain times. For this reason, these funds need to be liquid, and as such, a High-Yield Savings Account is an adequate place to house this cash.
The Temptation of High-Interest Savings
For funds above and beyond what is needed in an emergency fund, a 5% interest rate on a High-Yield Savings Account can be a tempting prospect, seemingly outpacing the interest paid on certain debts. However, the true impact of this nominal rate needs to be dissected, especially when considering the after-tax reality and the inherent trade-offs.
Tax Considerations and the Reality of After-Tax Returns
One critical factor often overlooked is taxes. Interest earned in savings accounts is subject to ordinary income tax (the highest tax rates individuals can be subject to), which can significantly diminish the apparent superiority and allure of a 5% interest rate. The effective return, or after-tax return, will likely be much lower, potentially making the decision to pay down debt more appealing.
Strategic Goal Setting
Rather than being swayed by high interest rates alone, individuals should set clear financial goals to guide their decisions. It comes down to determining a concrete purpose for every dollar in a financial plan. This could include saving for a home, funding education, or securing retirement. Defining a goal for each dollar allows for a clear answer as to how the funds should be used or invested. Rather than chasing the highest interest-bearing savings account in the short-term, it is necessary to shift to a long-term view. With a long-term focus and a goal for every dollar, the decision of what to do with additional funds becomes increasingly clear.
Paying Down Debt
A Closer Look at Mortgage Considerations: Take the example of a 3% mortgage on a home. While the nominal rate appears lower than the 5% savings interest rate, the tax implications must be considered. After accounting for ordinary income taxes (federal, state, and potentially net-investment income tax) on the interest earned in savings, the effective return may not be significantly higher, if at all (surprisingly, in the highest of personal income tax brackets, the calculation tips the scales in favor of paying down the debt in this scenario). In this light, paying down a low-interest mortgage, even in the current higher interest rate environment, can be a financially prudent move if there is alignment with the overall financial plan.
Long-Term Debt as a Strategic Asset
Even when interest rates on savings appear attractive, individuals with long-term, low-interest debt, such as a mortgage, may find value in paying down this obligation. By strategically reducing debt, they enhance their financial flexibility and free up cash flow to use in pursuit of other goals. For this reason, paying down debt is saving.
Conclusion
In the dynamic interplay between high-interest savings and debt repayment, strategic wisdom lies in the details. Nominal interest rates on savings accounts can be alluring, but after-tax considerations and the strategic goals one sets can redefine the narrative. As advocates for financial wisdom and well-being, we urge careful consideration of the overall impact on goals before deciding to invest or pay off debt.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
Additional information about Albion Financial Group is also available on the SEC’s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.
Albion Financial Group – February 2024 Conference Call Video Recording
In our most recent conference call our panelists delved into the economic context of early 2024, touching upon various topics such as tax deadlines, interest rates, Artificial Intelligence, recession forecast, inflation and pricing trends, monetary policy, portfolio asset allocation, Secure 2.0 legislation, estate planning, and more!
Stream the audio of yesterday’s conference call at this link.
Data released in January showed that as 2023 drew to a close, inflation was generally tame, but not quite tame enough for the Fed to declare victory. The Core PCE Deflator (the Fed’s preferred inflation metric) stood at +2.9% y/y as of the end of December, the first sub-3% print since March of 2021. Meanwhile, Core CPI printed at +3.9% y/y, also the lowest since the first half of 2021. While these figures are directionally encouraging, the pace of disinflation has slowed in recent months, and both metrics remain solidly above the Fed’s long term 2% target.
Monetary Policy
The main event for market participants in January was the FOMC meeting that concluded on Wednesday the 31st. While no one expected a change in overnight interest rates out of that meeting, everyone was interested in getting an answer to the question of “will they or won’t they” begin cutting rates at the March meeting. The answer, delivered as clearly as can be given the constraints of Fed-speak, is no. Jerome Powell made it very clear that the committee does not anticipate that economic conditions will justify the start of a rate cutting cycle in March.
Economy
Outside of the manufacturing sector, which mostly remains in contraction, economic data released in January was solid. Consumer confidence continues to climb, thanks in part to falling inflation that everyone can see at the gas pump. Lower mortgage rates stimulated activity in the housing sector. And the labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (9 million per the most recent JOLTS report), and job creation continues to chug along (216k nonfarm payrolls added in the most recent monthly BLS job report).
Bond Market
The yield curve steepened in January, with 2y yields falling slightly while yields in the belly and (especially) the long end rising a bit. Longer term yields continue to be challenged by the outlook for US budget deficits, making them somewhat more attuned to the election cycle (and especially growing populist impulses across the political spectrum) that will unfold over the course of 2024. Most bond prices finished the month lower, although a contraction in credit spreads (to levels that are nearing historic tights) helped to cushion the downside in corporate bonds.
Stock Market
US large caps enjoyed a solid first month of 2024, but as was the case last year the gains were concentrated in a comparatively small number of individual stocks. Cyclicals and defensives were much more of a mixed bag, resulting in underperformance of small and midcap benchmarks that have greater exposure to such industries. International markets were mixed as well, with emerging market indices especially weak due to sharp underperformance in Chinese equities.
January 2024 S&P 500 Total Return by Sector
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.
Valuation
The S&P 500’s forward P/E of 20x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Interest Rates
Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in the past few months.
Inflation
After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.
Albion’s Dashboard of Key Leading Economic Indicators as of 01/31/24
“Consider it as sculpting a financial architecture…”
Embarking on the journey of retirement is akin to laying the foundation for a fresh chapter in your financial life, where the structure of your income becomes pivotal. In this exploration, we’ll delve into the art of income planning beyond retirement—a strategic composition not just to make your money last but to construct a financial foundation for a lifetime. Consider it as sculpting a financial architecture to support your lifestyle and aspirations.
Understanding the Blueprint of Retirement Income:
“The initial step is to decipher the blueprint of your income sources.”
In the realm of retirement income planning, the initial step is to decipher the blueprint of your income sources. Begin by evaluating and documenting your existing and potential retirement income streams, including pensions, Social Security benefits, and withdrawals from your investment portfolio. This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation.
Key Considerations:
Pensions and Social Security: Scrutinize the reliability and sustainability of these income sources, weighing factors like lump-sum versus annuity payout for pensions and potential changes in Social Security regulations or benefit age.
Investment Portfolio: Consider how your investments will contribute to your retirement income. Evaluate the risk profile of your current portfolio and its role in shaping your overall financial structure.
Building a Structure of Sustainable Income:
“This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation.”
Once the blueprint is clear, the subsequent step is to construct a plan for sustainable income. During this phase, you are crafting a framework for your retirement income that not only covers your basic needs but also adapts to the dynamic nature of your financial landscape.
Strategies to Consider:
Systematic Withdrawals: Establish a plan for systematic withdrawals from your investment portfolio, ensuring a steady income flow. There are various withdrawal strategies worth considering; this one proves relatively easy to implement.
Tax-Efficient Strategies: Explore tax-efficient methods to optimize your income. This may involve considering Roth conversions, strategic charitable giving, or other approaches to minimize tax implications. Remember that reducing your total lifetime tax payments holds more impact for your financial plan than merely reducing your current year tax liability.
Fine-Tuning for Resilience:
“During this phase, you are crafting a framework for your retirement income…”
Just as architects prioritize resilience in building design, your retirement income structure needs fine-tuning for resilience. Integrate risk management strategies to guard against unforeseen challenges and disruptions. The focus should be on the goals you’ve defined for your retirement, without succumbing to the uncertainties of the world around you.
Resilience Strategies:
Emergency Fund: Maintain an emergency fund to cover unexpected expenses and ensure a buffer against financial uncertainties.
Insurance: Review insurance strategies to ensure alignment with your needs, providing a safety net for unexpected healthcare or other significant expenses you prefer not to bear.
Adapting to Change:
“Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events.”
Bestselling author Morgan Housel encapsulates the transformative nature of time with his statement, “World War II began on horseback in 1939 and ended with nuclear fission in 1945.” In the realm of retirement, where uncertainties abound, one undeniable certainty is change. Your retirement structure should be dynamic, embodying a key principle of financial planning—adaptability. Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events.
Adaptability Strategies:
Regular Reviews: Schedule periodic reviews to assess the effectiveness of your income plan and make adjustments as needed.
Flexibility: Build flexibility into your plan to accommodate changes in lifestyle, healthcare needs, or financial goals.
The Completed Project:
“Be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals.”
As you conclude the process of crafting your foundation for lasting income in retirement, be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals. In this endeavor, you’re not only securing your own financial future but also building a legacy to endure for future generations.
Just as a completed architectural project stands as a testament to the vision and skill of its creators, your retirement income structure becomes a tangible representation of your financial success. It’s a timeless blueprint, offering enduring stability to enrich your retirement journey and providing a solid foundation for the chapters that follow. As you navigate the complexities of retirement income planning, you’re not just securing your own well-being, you’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time.
“You’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time.”
It is strongly advised to seek counsel from a qualified financial adviser, tax professional, or attorney before implementing any strategy or acting upon any recommendation outlined herein. Albion Financial Group disclaims any responsibility for the consequences of individuals’ decisions based on the information presented and encourages thorough consultation with a financial professional to ensure the appropriateness of any financial decisions made in consideration of personal circumstances and financial objectives.
For the last year and a half Albion has been sponsoring children at the Woodrow Wilson school, a Salt Lake City elementary school where 90% of the students qualify for food aid. Each month in conjunction with the Utah Food Bank we fill grocery bags for the children to take home to their families.
The students are just like you’d expect from a group of youngsters. Curious, energetic, funny, loud, silly, and occasionally contemplative. The food makes a significant difference for them and their families. For us it highlights the similarities among all of us. Regardless of economic circumstance most of us hope to have strong and caring relationships with our family and friends and live in a world where we are safe and find fulfillment while earning a reasonable living. Most of us do strive to get along with our neighbors despite differences of opinion we may have. You wouldn’t know that by reading the headlines. A recent sampling (with names removed) includes:
“Presidential Candidate augers divisive year in angry Christmas rant”
“2024 could bring a radical upending of the global order”
“The Supreme Court could correct Politicians’ huge mistake”
“With support fading and corruption building, will politician quit the race?”
“National anthem kneeler cancels Christmas and gift giving”
“Campus antisemitism finally gets its reckoning after students cheer terrorism”
From these headlines, and hundreds more like them, one might surmise that our overriding emotions are anger and fear. Yet that’s not the case. Yes, there is anxiety and anger in the population. And yes, unfortunately some of the most prominent voices feel they benefit by stoking anger, resentment and fear. Yet the facts show a different story.
Per FBI data violent crime fell 8% in the third quarter of 2023 compared to the same quarter last year and property crime fell 6.3% to its lowest level since 1961. But the dire headlines do work. Per Gallup 92% of Republicans, 78% of Independents and 58% of Democrats believe crime is rising.
We hear a lot about unemployment. Some choose to focus on job losses and high unemployment while others are focused on job creation. The current unemployment rate is 3.7% which is close to the low end of the long-term historical range. That’s impressive particularly in light of the rise in interest rates over the last several quarters. However despite high employment and consistent economic growth over half of us think the economy is getting worse, per a recent CNN poll.
Misleading headlines can be found regarding virtually any quantifiable measure. Why do we bring this up in an Albion letter? To highlight that in the work we do we must look past the headlines to what the underlying data tells us is actually happening. While there are clearly challenges in the world, the economic outlook has several bright spots. The Federal Reserve effort to rein in inflation is working. Higher interest rates, while clearly slowing economic activity, have not tipped us into a recession.
Consumers have remained resilient as spending has held up even in the higher rate environment. Companies continue to innovate and in many cases continue to show solid year-over-year earnings growth. Our professional goal for 2024 is to continue to scour the many opportunities to invest in what is working in the world and build and manage portfolios around those bright spots. Our personal task is to see the humanity in everyone and do what we can with our family, friends, colleagues and peers to ratchet down the temperature that headlines work to inflame. We wish you all a peaceful and prosperous new year.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
