Best Financial Questions 2019

by Sanderson Wealth Management Feb 17, 2020 Investment Consulting, Tax Consulting

Here at Sanderson Wealth Management, we appreciate receiving questions from our clients. They open up dialogue, build trust, lead to better ideas, and facilitate collaboration.

When we look back at 2019, there were a handful of financial questions that came up time and time again. Our team recently sat down to shed some light on these topics.

Insight Highlights: This Year’s Best Questions

Justin Sanderson on timing the market

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Tim Domino on the SECURE ACT

2-Tim-Domino-SECURE-Act

John Gullo on the meaning of the inverted yield curve

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Tim Domino:

Hello, I'm Tim Domino, director of wealth planning here at Sanderson Wealth Management. I'm joined by my colleague, Justin Sanderson, our vice president and today we're talking about some of the best questions that we've got or at least the most persistent questions we've got over the past year. And I know there's one question in particular that we've certainly gotten a lot recently pertaining to cash and when is a time to sell out of the market.

We all know that the market's at a relative all time high and a lot of people saw some great returns last year and they're wondering is it time to lock in those returns and go to cash and wait for this recession that everybody says is coming. Have you been getting a lot of those questions this year, Justin?

Justin Sanderson:

Yeah, I've been getting several iterations of basically the same question of should I be selling assets to pay for these things that I want to buy? I've got a bunch of cash on the sidelines but the market's too high, I shouldn't buy today. Or, Hey, my portfolio has really grown, let's take the money off the table and enjoy this sort of thing. And we've been getting this question really since I started doing this over the past 10 years, which has been a great period in the market. And we also always offer this, Hey, they're really asking should we time the market?

Justin:

Hey Justin, Tim, should we try and time to market this time? I know you've told us in the past and during our onboarding that we shouldn't try to time the market, but should we this time because things are different? And our standard answer is no, we don't try to time the market because we don't know when it's going to go up, we don't know when it's going to go down. We can kind of gauge things over the long run. But in short, you really got to be right twice and it's near impossible. You've got to sell out at the right time and you've got to buy in. And if you are wrong, which most of the time tactical asset allocators aren't correct, it can be devastating to your long-term financial plans.

Tim:

Given that we are at a relative all-time high in the market and we have all this uncertainty on the table in the global markets right now, we can read the list of headlines, but there's certainly plentiful and there's bound to be more coming. Is it time to really take a different look at things this time? History is what it was, but we're a very forward looking investment firm and should our efforts be focused on and going forward here and understanding how that's going to impact things and is it really time to do something different?

Justin:

In answering these questions here today, one of the things I wanted to do is take a step back and look back at history before we start to project further. So I want to take a meaningful amount of time. We're talking about the last 10 years, but I've stepped back all the way to the 1980s so I can look over the past 40 years in the market. Really, how's the S&P 500 looked and what is the shape of that? And that's what you see here on this graph. And here you can look at over the past four decades really what is the shape of the S&P 500 returns looked and you can see it's generally been very nicely up. There are a few notable periods in there of some meaningful downturns. You can see the first long one was the tech bubble in 9-11 kind of piling on top of each other.

Justin:

Also, the ethics crisis for those of us that remember and Ron and Adelphia and the Rigas family, I think they're still in prison, those sort of things. And really it just kind of ran up from there once we got over those huddles all the way through 2007. And then we saw the financial crisis and really the mortgage contagion effect the whole world and saw a big, big pull-down basically back to those 2000 figures.

Justin:

But if you look at the graph, you can see it went down faster, but it also came back much, much faster. Let's fast forward to 2018, in the fourth quarter of 2018 we saw a dramatic sell off in the market over an 11 week period. Intraday, it went down actually 20% so a true correction and the timing of it just worked out that where by the time we were actually opening the statements, they were certainly delivered to you early in January, but by the time you actually opened your mail, most of that money was already back.

Justin:

And so taking a look, it seems like we've started to react faster both in the up, and the down and since that correction the market has continued up another 30% or thereabouts to the all-time high that you're talking about.

Tim:

Yeah, I'm curious if you can see the general slope of that graph. It's obviously there's some dips here and there, but the general slope is obviously up over that time period. So how often do we hit all-time highs in the market? Is it, I mean we feel like we're at an all-time high now, but for every... there's hefty prior all the time highs as well.

Justin:

I wish I had a nickel for every time that we were at an all-time high, that's for sure. Well, let's take a look. So I did this animation here on the graph. They really show us that Hey, each of these copper bars going across is a day where we are the all-time high. And you can look, there's a lot there going across. So while we say, Hey, I'm inclined emotionally and behaviorally to want to sell because we're at an all-time high and want to lock in those gains.

Justin:

Well, you're just missing out perhaps on the next all-time high. And if we look at it by a decade by decade basis in the 80s we hit all-time highs 56 times and now some of the data in the 80s actually monthly. So it's probably far more frequent than that. In the 90s, 355 times, even the 2000s which were relatively ugly period of time here in the US market, we still hit highs 52 different times. In the 2010s, great decade up 316 times and we're already up to seven times so far in the 2020s. My bet is that 2020 number isn't going to end at seven and we're going to continue on here over the next 10 years.

Tim:

Absolutely. So it's great looking back at that S&P 500 performance over how many ever decades you went back. But I think a lot of things we get from clients or questions from clients or aren't things different this time? We're in a whole new world, a whole new set of circumstances. There's new challenges, challenges we haven't seen before. We have viruses we haven't seen before, aren't things different this time?

Justin:

The truth of the matter is that they always feel different, but there's a reason history is a required course and that's because a lot of these things will echo to things we've looked at in the past. You can think about coronavirus today of, yes, this is certainly different. China's different than it was when SARS was out. There's more global trade and that sort of thing. However, there were getting a lot of the same feelings we had back then.

Justin:

And so there's valid concerns and certainly corona could be more damaging than we thought, but when you look at the market's reaction, it was immediately very negative. We saw minus 5% or greater in the emerging markets the first week it came out and it was really revealed of how contagious it really was. But since then we've basically made all that money back because it's been found to be sort of controllable and that sort of thing.

Justin:

So I think short-term reactions can certainly be very negative. But generally what we've need to do is go back to fundamentals and say, Hey, what are we really doing here as equity market investors? Because that's what we talking about is being invested in the global equity markets and we're buying into the success and failure of these global companies that are out there producing goods and services and banking on the expansion of global economy.

Justin:

And I think that's what we really should focus on for the next 10 years of how successful is the economy going to be. Because I trust that these big public companies with smart boards are going to be run very well and should continue to capitalize on the economic activity in the world. So here we're looking at the GDP across the whole world over the next 10 years.

Justin:

In the middle there is the blue line and you see we're expecting about cumulative growth of about 38% over the next decade. That's pretty nice growth annualized three plus percent. Sort of what we've been experiencing over the past 10 and that's been good. The interesting story will be both the developed world they're on the bottom and the orange and the developing world or the emerging markets in the gray bar on top are going to continue moving forward. And that's the interesting thing. And so even in the US and developing world, we're anticipated to continue growing at about 2% per year. Whereas in the emerging markets that they think are going to continue to outpace and really be the driver of economic growth throughout the world at almost a 60% expansion there on economies over the next 10 years.

Tim:

Interesting. Well, you talked about China a little bit before and certainly China's a integral part of this whole conversation and really how has the trade war and the trade differences with China really impacted things going backwards and should it impact our decisions going forwards of whether or not the time in the market, should we wait until this stuff gets taken care of? Should we wait until resolution? Will there be resolution? What are your thoughts on that?

Justin:

Yeah, that's an interesting one. The trade war and the impacts in it and whether they're material or not I think is open for debate and interpretation. And I'm certainly not an expert enough to really, and I don't think anybody is to really know what the long-term impact will be. But I think one of the things to step back in this, to think of where China is today.

Justin:

They've got basically $9,000, US dollars GDP per capita there right now. And that's enough to start really becoming more of a consumer economy than a supplier economy that they've had been having in the past. Here in the US we're very much a consumer economy. Things like 70% of our GDP right now and in China we're going to see that too. So what does that mean for China though, is perhaps they're not going to experience the same level of growth they have in the past.

Justin:

Perhaps their growth will look more developed than it is developing, but we'll see. So what they've said over there is they're still going to be the driving developing country with about 60% returns or 60% expansion of their GDP over the next 10 years. Where the US right on target with the rest of the developing world. Also, we are by far the biggest developed economy in the world of about 2% a year, which has been great for investors.

Justin:

So I know 2% might not get people excited, but it's been really, really great for wealth creation as you know anybody that's been taking a look at their portfolio over the past 10 years. One of the things I want to bring up though is I think there's an interesting story here too. There's about 1.3 billion people in China, but there's also 1.3 billion people in India and India doesn't nearly get the headlines.

Justin:

China's definitely been the great story over the 2000s and 2010s, but I think the importance of India is going to continue to grow here and really the OECD is in their economists are on the same page. So taking a look at India here, in the top bar there and we can see their growth trouncing that of China.

Tim:

Wow. It's incredible.

Justin:

Now, that is on a smaller base, GDP per capita at roughly the same amount of folks. Perhaps there might be more Indians than Chinese relatively soon. But we're seeing near a 9% annualized growth over there and basically a doubling of the size of their economy. So there are about 2000 US dollars per capita today. We'll probably see them somewhere around four plus in the future. And I think that's a really interesting one. Don't know exactly what to do with the information, but I think it's an encouraging thing of seeing, Hey, there's a lot of developing going on across the world that even if growth here in the US is a little slower than some people would like or we were use to in the 80s and 90s, there's still a lot of good stories out in the rest of the world and all companies should benefit from that because really we're investing in big multinationals.

Tim:

So Justin, it's fascinating to see India in this picture and really how you've painted the global markets as a whole. I think it provides a lot of optimism, a lot of sense of growth on the horizon and things. So how should investors think about positioning their portfolios to take advantage of this growth and to really capture all this opportunity that you say is out there?

Justin:

I think this really goes back to the people's, that initial question of timing the market and that sort of thing. And what should people do in light of all of this stuff that we're talking about if we've got great growth prospects for the future. But the big part is to make sure you're in the right portfolio for your willingness to take risk.

Justin:

And I think that's something that could have gotten out of whack over the past decade if you've been on autopilot somewhat because the equity market has done so well in the bond market has also done well, but not nearly as well. So that's one thing we want to keep in mind. And maybe if you're feeling this question of, Hey, should I tie in the market? Should I sell some of my winners rebalance? Let's go ahead and reassess your willingness to take risks.

Justin:

And that's something we can do with you. We've got a nice new tool we've been using over the past year or so. And I think that's a really important takeaway from this is if you're feeling uncomfortable or let's make sure you're in the right type of portfolio and have the appropriate amount of risk for your willingness.

Tim Domino:

Yeah, certainly making sure that your risk tolerance is in alignment is absolutely important. And really, like you said, you could've gotten blinds, but over the past decade when things have been relatively good across the board. So is there anything else that I should be doing besides just risk assessment though?

Justin:

I think one of the things to keep in mind too is with this timing question is it's really a short-term time horizon sort of question of... But your portfolio is really, if you're sitting there watching this, you're likely amassing more wealth than is going to last for another generation or more. Or perhaps you're really focused on retirement spending and should be not just focused on that retirement date, but thinking about longevity and how long retirement might actually be for you.

Justin:

Here's a slide I like to bring up to folks that may be on the easy about current market conditions. Here we're taking a look at the probability of gaining money in the stock market over different time periods and I looked very short, so we started on a daily basis, 52% of the time you're going to make money on daily basis. Well, that's a crap shoot and not anything anybody should be betting on, that's for sure on a daily basis.

Justin:

But as you stretch this time out over a month, you increase a little bit. Over a quarter, you increase even more. You stretch it out to a year, which is still relatively short. We think you should always be making decisions over a five to seven year time horizon, 82% of the time over the past 40 years you would make money on an annual basis. So I think that's one thing people should keep in mind is their time horizon. It really what the true time horizon, their money in their portfolio is impairing that with their risk, willingness to take risks.

Tim:

Well, this is great Justin, thank you so much. I think it was fascinating to see kind of the look back at things and really have a response to what a question that we hear from clients all the time. And I'll, if we had a new all-time high tomorrow, we'll probably get the same question tomorrow, but I think a lot of what you went through gives at least clients and people some comfort in knowing that they're not necessarily missing out on something.

Tim:

That they need to keep that long-term focus going forward, understand history and make sure their risk tolerance, their portfolios are positioned going forward to kind of take that study right up.

Justin:

And I'll just leave with one closing thought here of we talked about analyzing your willingness to take risk, working with somebody like us to also assess your ability to take risk, selecting that appropriate asset allocation target. And the last step of that is rebalancing. And this is one of the important things that we set this allocation is to be disciplined on the rebalance.

Justin:

And right now a lot of people, I've found this in practice have been hesitant to rebalance. What we mean there is to sell your winners and buy the losers and keep your portfolio intact in your portfolio allocation intact or close to those targets. So set a reasonable tolerance band, talk to us. I think it's both an art and a science. I think that's a really important takeaway from this is to really rebalance when you're getting these feelings and uneasiness or you want to take some of the success off the table. And I think that's a key for folks.

Tim:

Great. Well, thank you all for joining us today on our discussion on market timing. If you have a question about the time in the market tomorrow, you can always refer to this video or call Justin or another member of our team. But we hope you found everything informative and enjoyable and we look forward to joining you for future segments.

Justin Sanderson:

Hello, I'm Justin Sanderson and joining me today is Tim Domino, our director of wealth planning here at Sanderson wealth management. And today we're answering questions that had been popular among our clients recently in the past 12 months or thereabouts. Perhaps this one's actually a little shorter because we've heard a lot about these provisions in some deliberations they've had around them, but the Secure Act really just went into place in 2019. Tim, what is the Secure Act?

Tim Domino:

Sure. The Secure Act stands for the setting every community up for retirement enhancement act. There's a lot of words there, but you can see how they could condense it all to secure. And really what it was a bunch of changes to the way we save for retirement or cashflow throughout retirement. Then also some of the incentives that employers have to start employer sponsored plans for their employees.

Tim:

It wasn't so much of a tax act as it was a retirement focus savings act, but it certainly had a lot of tax impacts to it.

Justin:

They really forced that anagram in there, secure. They started there I feel like, and then jammed the setting every community up for retirement enhancement. The E just, at any rate. We know what it is. Who is affected the most?

Tim:

There's generally three groups of people that are impacted by the Secure Act. First, our employers are certainly impacted by it. Then it comes to our retirement savers, those people starting the accumulation phase of their life all the way up to kind of nearing the end and looking for that transition to retirement. Then finally our retirees and really beneficiaries as well. It's whoever is spending retirement plan assets throughout their life or throughout their inheritance.

Justin:

Employers and employees have been affected by this. What are the highlights of how employer sponsored plans have been affected?

Tim:

Sure. On the employer side, I think we see generally a bunch of provisions designed to, number one, increase or promote them to create these plans for their employees because the government wants them to really enhance access to plans for people. And then also they want to encourage participation in the plans by the employees.

Tim:

One of the big things of the Secure Act did was broadened the eligibility rules for long-term part-time employees in order to allow them to actually participate in these plans. Before where they didn't hit an hours requirement or a length of service requirement, now they've relaxed those rules a little bit where they can indeed contribute to an employer sponsored retirement plan.

Tim:

Now this doesn't mean necessarily that they're eligible for matching contributions or safe harbor contributions, those sorts of things. But again, just allows them to be able to save into these plans.

Tim:

The second thing it does is actually gives some employers, small employers, an incentive to actually start these plans for their employees. There's a tax credit now for small employers of up to $5,000. And also some of the restrictions and rules around being part of a multiple employer plan have been relaxed so that it should encourage more of these small employees to group together and start retirement plans for their employees.

Tim:

And then finally it also allowed them, small employers a credit for setting up automatic enrollment aspects of their plans, so just a small side there.

Justin:

Very good. That's a good summary of what's going on for employees and employers. But what about our clients? What about those people in the accumulation phase that been on these financial plans, these savings paths, how might these things be changing now? What provisions are really going to affect those people the most?

Tim:

I think the biggest one that's infects our savers, I guess let's talk about the progression of saving. As a young saver, I mentioned shortly to go about the automatic enrollment provisions that have changed. Well, one of the side effects of that is that now the max default percentage for employee deferral has been moved up from 10% to 15%, so that's going to force people that have automatic enrollment provisions to save more or allow their employers to set a higher savings threshold for them.

Tim:

And really, when you're starting off, you need a little bit of that kick in the pants to save more than you actually do. So that's I think, a pretty good provision to boost savings for young people.

Tim:

Second, for those people who are in the middle of their savings or perhaps increasing towards the end of their savings period, the Secure Act now allows people to convert a portion of their retirement savings to, or portion or all, of their retirement savings to an annuity. There's a variety of reasons you'd want to do that. But a lot of it has to do with retirement income, certainties and guarantees. As you kind of hit that or get closer to that deciding day where you hang it up for a while and rely on your portfolio to supplement your spending needs, people like the idea of having these annuities there to pay out to them over their lifetime. Their annuities are wrought with complexities or tend to be expensive things. But for certain people that might fit the bill.

Tim:

Finally, the big thing is for our people who never want to hang up their shingle and they're planning on working forever, the Secure Act now has eliminated the age threshold of 70 and a half for being able to continue to make traditional IRA contributions. If you're earning money well into your 70s and 80s, you can defer some of that into a traditional IRA, which really helps things, especially if you're at a high marginal tax rate.

Justin:

That's great. What about the folks that are retired that had people like us set up these pretty sophisticated retirement plans? Has this thrown a wrench into some plans for people or what considerations exist now that didn't necessarily before?

Tim:

We'll start on the good side of things. The Secure Act increased the required minimum distribution age to age 72 from 70 and a half. And that applies to people who haven't turned age 70 and a half as of 12-31-2019. For everybody else though, if you're returning, you're 70 and a half after that, your RMD age has been extended to age 72, so that gives us two more years of essentially tax deferred growth and it also extends that pre RMD planning window, which as most of our clients see, can be valuable time for shifting assets or doing different strategies in order to mitigate taxes during their retirement years.

Tim:

On that side of things, I think we see some good planning opportunities and some interesting opportunities for our clients.

Tim:

Now the bad side of things is the elimination of the stretch IRA aspect of IRAs for most non-spouse beneficiaries.

Justin:

What is that? What is a stretch IRA? What does that mean?

Tim:

Prior to the tax act and still in existence for some, spouse beneficiaries as well as any non-spouse beneficiary generally was able to basically take small distributions out or small minimum distributions out over the remaining life expectancy from inherited IRAs and things like that. Essentially you're able to stretch those distributions or make them last your entire lifetime. That's where the stretch moniker comes from. But as I mentioned, the Secure Act took that away for a lot of people.

Tim:

The stretch remains in place for spouse beneficiaries, beneficiaries of IRAs who are chronically ill or disabled, as well as, this is kind of a weird one, beneficiaries who are not more than 10 years younger than you, so perhaps a sister or a sibling which you're leaving your assets too. For those people, they still have that stretch aspect available to them.

Tim:

For our minors that are going to be receiving IRA assets, it's a little bit of a hybrid of both of them. Throughout their minor period, they can stretch those over what would be their life expectancy. But when they reached the age of majority, they're subject to this new tenure distribution window.

Justin:

All right Tim. What is the tenure distribution window?

Tim:

It's a caveat that they put into the tax act that says that you have to take out anything from an inherited IRA within 10 years. Now it doesn't say ratably over 10 years or after 10 years. It's within 10 years. There's a lot of latitude and flexibility there to do some income tax planning over that period and to really try to lower the tax rate that you would have pay on those assets.

Justin:

Who you think are the most effected? What are the two biggest takeaways? Why don't we pick one good one and one loser, one winner of the Secure Act.

Tim:

Sure. I think on the loser's side of things is there can be those beneficiaries that really would have liked to have those IRA assets given to them in trust. If you have a spendthrift concern about somebody spending all the assets that were in the IRA or perhaps taking them out on a tax basis unwisely and not mitigating the tax aspect of things, or you really want to control the ultimate beneficiary of those IRAs, those people now will get those assets within 10 years. You can't direct them through a conduit trust like we used to do. And if you do, there's a lot of uncertainty regarding the trustee's obligation of how much to give out and when and what their duty is to mitigate the tax impact of those distributions.

Justin:

And just thinking about the timing of this, if mom and dad pass in their 90s, chances are the kids are 25-30 years younger. You're probably in the peak earning years of their careers. So this can be forcing a lot of money out.

Tim:

Absolutely.

Justin:

Wrong at a bad period of time.

Tim:

Yeah, so definitely the losers on that side.

Tim:

The winners though, I think though, there's some strategies around re-evaluating who the IRA beneficiaries can be. We talk about that 10 year window and the lack of requirement during that 10 year window. If you consider giving assets to children or grandchildren who might be at low marginal tax rates, that might be great marginal tax planning for them. And if you look at the overall assets to the family and their overall family wealth level, that might be more advantageous than leaving something to a surviving spouse where it was going to come out at a relatively even pace at a high marginal tax rate. So you really got to look at those sorts of things in combination and see what's best for the family unit altogether, assuming you have sufficient assets to direct otherwise.

Justin:

Tim, one last group of people that may be affected by this, and those are for clients that do have a charitable intent and some of their planning has involved planning on leaving these assets to charity or something along those lines. How is the Secure Act maybe changed or effected their planning?

Tim:

I think the Secure Act really places a lot more emphasis now on using retirement plan assets to fulfill your philanthropic goals. And there's kind of two schools of thought around that.

Tim:

The first is if you think about somebody, maybe you're charitably inclined, but your beneficiaries are going to need that cash flow from the IRA over the remaining lifetime. Well a charitable remainder unitrust, a CRUT as we call them, is a great option for those people. It actually reinstates that stretch IRA that we were talking about for non-spouse beneficiaries. You can essentially stretch assets over the life expectancy of a child or grandchild that's inheriting these assets. But at the end of their life, whatever's remaining in that account goes to charity. So you kind of fulfill your charitable intent that way.

Tim:

Now for clients whose beneficiaries will never need those assets or don't need the cash flow of them or who they can substitute other assets to give, leaving your IRA to charity remains one of the most effective things that you can do in your estate plan. Not only the charity does not pay income taxes on the retirement account and your beneficiaries aren't stuck with that burden of those income taxes. So they presumably get higher basis assets that don't have that tax bite and certainly all the complications of that 10 year window and everything that we talked about.

Justin:

Very good. Well this has been great, Tim. I think you've shed a lot of light on the Secure Act that's pretty fresh and I know the planning around this will be evolving over time and it sounds like you and I are going to have quite a bit of work to do here in regards to this plan over time. So thanks for sharing this with us and thanks for taking the time to watch today. If you have any questions, please click the link below and give us a shout. We'd be happy to talk in more detail about your specific situation.

Justin Sanderson:

Hello, I'm Justin Sanderson. I'm joined today by John Gullo, the chief investment officer of Sanderson Wealth Management, to answer some of the most important questions we've gotten from clients in the past year, and especially some of the things that have been occupying a lot of the headlines.

Today, john, I think one of the questions I've received the most this year is what in the heck is an inverted yield curve? And what is this going to do to my portfolio?

John Gullo:

Great question, Justin. Basically a yield curve is nothing more than a line that plots the yield or interest rates of different bonds at one point in time depending on maturity going all the way from three months out to 30 years. When we talk about a yield curve, we're normally talking about a yield curve that is normal shaped, meaning that you get more interest as you agree to lock up your money for longer periods of time. So a 30 year bond pays more interest than a three year bond.

John:

When we get into an inverted yield curve, the opposite is true. So now we have a scenario where interest rates are higher for short term bonds and lower for longer term bonds.

Justin:

Well, that's not great to be a lender in a scenario like that.

John:

It really isn't. It really causes problems for banks and causes problems for investors, especially those that really need the return on their investment to generate income for spending, such as retirees, in that period.

Justin:

Sure. You're probably used to being rewarded for tying up your money for longer periods of time.

John:

Correct, and this causes a problem.

John:

The other problem we have with an inverted yield curve is it's been a predictor of recessions, and that gets a lot of people worried. If we look over the past 50 years, every one of the recessions we've experienced has come with an inverted yield curve proceeding it.

John:

And we can look at this graphically as well. If we take a look, and we look at the 10 year bond, and we subtract out the three month bond, any time that is negative, that's what we're talking about an inverted yield curve. If we plot it out, you can see that every time that this chart goes negative, that's an inverted yield curve. And you can see them highlighted here in yellow. You'll notice that each one of those times where that yield curve becomes inverted is preceded by a recession. Each of those recessions is highlighted here in gray, and that's what has everyone so worried.

John:

The concern was, on the far right here, we had an inverted yield curve for several months during 2019. And most recently, it's turned inverted again with all the concerns about the coronavirus. That's what people are worried about right now. Does this mean that it's going to lead to a recession at some point in the future?

Justin:

How reliable of an indicator is that though? We have, as you mentioned, we have different things going on in the global macro-economic environment today, like coronavirus. We also have unprecedented central bank intervention in the markets. Is that having an unnatural impact on this inverted yield curve? Or is this very similar to those three previous times where there was a reliable predictor of the coming recession?

John:

I hate to use the phrase, this time is different, but this time is really unique. So we have a period in time where the central banks around the world had been so active. They really are distorting interest rates here and abroad. If you look around the globe right now, we've had negative interest rates in several parts of the world in 2019.

John:

If you take a quick peek, we put a chart together for you. You can see that in 2019, several countries in Europe, as well as Japan, had negative interest rates. Sounds ridiculous, but that's the scenario we're in right now.

Justin:

It's unbelievable to try and think about negative interest rates like that and what it really means to be loaning out money in a negative interest term.

John:

Yeah, it basically means you're guaranteeing yourself a loss if you hold that bond to maturity. The funny thing is we're not talking about a few dollars here. It's steadily been increasing over the past few years, and in 2019, it actually hit $17 trillion of bonds across the globe that were trading at a negative interest rate.

Justin:

So why is it that we're seeing trillions of dollars in negative interest rate debt? Who is going out there and buying this stuff? And what are their reasons for doing it?

John:

Well, one of the main reasons we've had over the past few years is you can actually have a capital gain on a negative yielding bond. The key is you need to sell it to somebody else at an even lower yield. So if you buy a bond with a negative interest rate of negative 0.1%, and you sell it to somebody else at negative 0.2% or negative 0.3%, you make a profit.

John:

And what's been happening is everyone has been relying on the central banks to be that buyer. So it's Mario Draghi out there. It's Mr. Kuroda of Japan, who are going out and buying bonds at ever lower interest rates and causing speculators to get a gain on that. So we like to say people don't buy negative yielding bonds. They rent them, and they hope for a capital gain.

Justin:

Oh, that's really interesting. It would make me uncomfortable to go out and lend like that, banking on a capital gain, because really you think about the intrinsic purpose of a fixed income instrument, and it's to generate that reliable predictable stream of income. And capital gain usually isn't in the bond category. That's for sure.

John:

Yeah. They truly have changed the playing field for investors, which also, as you mentioned earlier, makes it very difficult for banks to try and operate in this type of environment right now.

Justin:

So John, this has been great discussion about the current interest rate environment, where we stand, the state of the yield curve and also touching on the central bank activity here. I'm curious though, what should a normal retiree take home from this that they're going out relying on this category to provide safety to their asset class? How should they be thinking about, or what should they be asking their friends or advisors and that sort of thing?

John:

I think one of the important things for people to do, as we say often, is to really take a longer term approach. And also you have to set your expectations for the environment that you're in today. We can't expect to earn 5% on bonds in a portfolio. Those days are long gone. Right now, interest rates are so low that as an investor in the US, maybe you're looking at a 2% return for your bond portfolio or your fixed income. But it's important to focus long-term.

John:

Many people will say, why bother? Why should I own bonds at all in the portfolio when they're yielding so low? And our response typically for them is, that's your safety net. If something happens terrible in the economy or in the world, that's your safety net in a portfolio that provides you stability. It provides you the ability to generate cash quickly if you need it for spending or for emergencies. So there's still a place in the portfolio, but we just can't expect the returns that we've had in the past from bonds inside of someone's portfolio.

Justin:

And I'm just curious here, because thinking about when people read these headlines, and then they make a reaction in their portfolio to it, what are some of the dangers people could be unknowingly getting themselves into today?

John:

Well, one of the things that people will do is they'll see that individuals who held very longterm bonds can make a big capital gain when interest rates go down. That can be risky because the opposite is true when interest rates go up. And we don't know when that's going to happen. When we were sitting here a few years ago, we saw the federal reserve increase interest rates. So that could happen at any point in time. We're not forecasting it any time soon. But for someone who goes out and tries to load up on longer term bonds, they can set themselves up for a big loss in the future. So we want to be conservative with this part of your portfolio that is the safe part of your portfolio that we want to make sure we're not taking too much risk with.

Justin:

When we look at the bond market and see some of the yields that are being pushed out there and seeing what's available on the trade desks and all of that sort of thing, we are seeing some bonds out there paying a pretty nice interest rate right now. And I think that seems tempting to go out there. What should investors be worried about when they're seeing these 4%, 5%, 6% rates when you're seeing treasuries in the 1% and 2%?

John:

I think the big risk when we look at those types of bonds, and we'll call them high yield or junk bonds, somebody is paying that high interest rate for a reason. It's because they may not be able to pay back the principal, or they may not be able to make those interest payments. So you really are speculating or taking a lot of risk when you're reaching out that far to capture that higher interest rate or that higher yield. And the worry is that you may not get your principal back.

Justin:

Well, this has been great, John. Thanks so much for joining us today and providing some insights that I know have been on a lot of people's minds so far this year. And hopefully next year when we sit down and do this again, we're not looking at inverted yield curve or negative interest rates, at least not to the tune of the $17 trillion.

Justin:

Thanks again for taking the time to watch.

John:

Take care.

Disclosure

© 2020 Sanderson Wealth Management LLC. This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting, or tax advice from their own counsel. All information discussed herein is current as of the date appearing in this material and is subject to change at any time without notice. Opinions expressed are those of the author, do not necessarily reflect the opinions of Sanderson Wealth Management, and are subject to change without notice. The information has been obtained from sources believed to be reliable, but its accuracy and interpretation are not guaranteed.