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January 2023

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In Reading Recommendations

21 Lessons for the 21st Century

In my reading selection for this month, I go deep. That is, the author raises challenging questions. Having deep, distraction-free time to contemplate what he is saying is beneficial.

In 21 Lessons for the 21st Century, author Yuval Noah Harari says in his introduction: “I want to zoom in on the here and now, but without losing the long-term perspective.”

Harari then asks: “How can insights about the distant past and distant future help us make sense of current affairs and of the immediate dilemmas of human societies? What are today’s greatest challenges and most important choices?”

Chapter titles include: work, equality, nationalism, immigration, ignorance, justice and education.

Harari is an Israeli historian and professor in the Department of History at the Hebrew University in Jerusalem. Other books include Sapiens: A Brief History of Humankind and Homo Deus: A Brief History of Tomorrow.

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In Financial Planning

Secure 2.0 Becomes Law

Last month I wrote about Secure 2.0, the collection of provisions intended to build upon the retirement system improvements that were implemented under the Secure Act of 2019.

Secure 2.0 became law on December 29, 2022.

There are many provisions to this new law. I participated in a webinar led by a leading consultant to financial planners, who said that in Secure 1.0, there were twelve or so changes to the law. Secure 2.0 brings almost one hundred additional changes.

Susan and I will be digesting Secure 2.0 in the weeks ahead to better understand how these changes might affect you and your financial plan.

Here are a few of the key changes to be aware of:

Required Minimum Distributions (RMDs)

  • For individuals who turn 72 in 2023, RMDs will be pushed back one year compared to current rules and will begin at age 73
  • Age 73 will continue to be the age at which RMDs begin through 2032
  • Then, beginning in 2033, RMDs will be pushed back further to age 75
  • Beginning in 2024, surviving spouses can elect to be treated as the decedent for RMD purposes from an inherited retirement account. This is beneficial for older spouses inheriting retirement accounts from younger spouses.

 

Retirement Plan Catch Up Contributions

  • Effective in 2025 and in future years, Secure 2.0 adds a special catch-up contribution limit for employees aged 60, 61, 62, and 63: the greater of $10,000 or 150% of the regular catch-up contribution amount (indexed for inflation)
  • Starting in 2024, Secure 2.0 requires all catch-up contributions for workers with wages over $145,000 during the previous year to be deposited into a Roth

 

Qualified Charitable Distributions (QCDs)

  • The maximum annual QCD amount of $100,000 is now indexed for inflation
  • There is no change to the age for being able to make QCDs from your retirement accounts – you may start at age 70.5

 

529 Plans

  • For 529 plans that have been in existence for 15 years or longer, you are allowed to transfer them into a Roth IRA for the beneficiary, and it appears that you will be able to change the beneficiary of the 529 before transferring it to the Roth
  • Any contributions to the 529 plan within the last five years are ineligible to be moved to a Roth IRA
  • The maximum amount that can be moved from a 529 plan to a Roth IRA in an individual’s lifetime is $35,000

There are also a host of new rules for accessing retirement funds during times of need.

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In Investment Strategy

The Long-Term Outlook for Stocks and Bonds

The corollary to “What Comes Next?” is “What Happens Years from Now?”

This is not an academic question. Big banks and investment firms typically invest a lot of time and money when trying to figure this out.

JP Morgan Asset Management, for example, compiles a comprehensive set of forecasts each year. More than fifty researchers are tasked with this project, and the report they recently produced runs more than 120 pages

These forecasts are commonly referred to as “Long Term Capital Market Assumptions”. This is a mouthful. It translates to researchers’ best guess on how stocks and bonds will perform over the next ten to fifteen years.

The good news is that updated long-term forecasts for 2023 have improved very significantly compared to a year ago. This holds positive implications for long-term financial planning purposes.

I’ll share with you a snapshot of the changes, then use an example to illustrate why this development is so significant for individuals’ financial plans.

The table below compares long-term return expectations at the start of 2022 with long-term return expectations at the beginning of 2023, based on JP Morgan’s data.

At first glance, the percentage changes for the long-term assumptions might appear to be modest, at 3-ish percentage points for stocks and 2-ish percentage points for bonds.

But seeing how these adjustments play out, and how the higher return assumptions enhance wealth over the long-term, are noteworthy.

Here’s an example.

Say a family has $500,000 to invest in a well-diversified portfolio. They select 60% large company US stocks and 40% US Treasury bonds for their long-term asset allocation and decide to rebalance at the end of each year. They will neither make additional contributions nor take withdrawals during the next 10 years.

Under this framework, how much should they expect to have at the end of the 10-year period?

Using the 2022 return assumptions, they would expect to earn 3.3%, on average, per year. To keep things simple, let’s say they earn 3.3% each year for the next ten years. This translates to $692,000 at year 10—for a cumulative gain of $192,000.

Using the 2023 assumptions, annual return expectations rise by 2.9 percentage points to 6.2%. This higher annual return assumption means their portfolio would grow to $912,000—for a cumulative gain of $412,000.

The 2.9 percentage point difference means the family’s gain is more than twice as much in 10 years’ time.

While an actual financial plan has far more variables that what was presented above, you can see from my example that an upward adjustment in return assumptions (similar to changes JP Morgan has made for 2023) can have a very meaningful impact on total wealth over time. 

The Economist magazine summed up the situation well, in a non-statistical way, in the Leaders section of their December 8, 2022 issue:

“This year’s capital losses, however, have a silver lining. If the downside of higher asset prices was lower expected returns, then by symmetry, future real returns have now gone up…

The new regime of higher interest rates and scarcer capital may seem like a shock, but for much of history these were the normal conditions for investors. It was the era of cheap money (that is now behind us) that was weird.”

 

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In Economy

Inflation Watch

Inflation remains a front and center issue for many of us as we start the new year, including consumers, business owners, policy makers and investors. Inflation refers to a broad rise in the prices of goods and services across the economy over time.

For this first letter of 2023, I thought it would be helpful to dig into the inflation issue a bit deeper, and then share some recent good news on the subject.

Price stability is considered a hallmark of a healthy economy. Economists generally consider annual inflation in the range of two percentage points to be a desired inflation target.

There are positive effects of moderate, contained inflation. For instance, it can stimulate spending and spur demand and productivity. But inflation running significantly above target is considered a problem.

The main issue with too-high inflation – a feature of today’s economic environment – is that it is erosive. Inflation erodes the value of income, savings, and investments. It erodes purchasing power for consumers and businesses. In other words, elevated inflation means your dollar will not go as far tomorrow as it does today.

Statistical agencies measure inflation by first determining the current value of a ‘basket’ of various goods and services consumed by households, referred to as a price index, which can be tracked over time to give observers a sense of the path inflation is travelling.

Here’s a picture of how inflation has changed during the past 40 years, as measured by the Consumer Price Index, or CPI, which is calculated by the US Labor Department.

The grey line, labeled ‘Overall’ includes food and energy prices. Since food and energy are considered the most volatile items in the basket, they are excluded from the blue ‘Core’ measure.

Any way you slice it, inflation today is too high for comfort. The most recent CPI reading published in mid-December shows that consumer prices rose 7.1% in November from a year earlier. This is obviously quite far from the 2% target.

The good news is that inflation gauges are now headed in the right direction, and down meaningfully from the high point reached in June 2022 of 9.1%. I expect price indices to show further improvement in the early months of 2023.

Developments in the commodities markets are supportive of this expectation. The recent period of unseasonably warm weather in the northern hemisphere has had a dampening effect on oil and gas prices.

Also, China’s reopening is easing supply chains, which is likely to positively impact goods prices.

And last Friday, January 6th, the US Labor Department provided information that indicates wage growth, a key ingredient in demand for goods and services, seems to be slowing down, too. Wage growth eased to 4.6% from a near 6% annual growth rate at the beginning of 2022.

While a few months of data don’t seal the deal, inflation trends are encouraging.

If inflation continues to moderate, it will give the Federal Reserve, the country’s chief inflation fighter, some room to ease off the pace of interest rate hikes. This, in turn, would mean less pressure on the financial markets, and a backdrop more conducive to stock and bond price gains.

Case in point: following the release of the Labor Department data on Friday, stocks jumped by more than 2% and registered their best day since late November. The bond market got a lift, too, rising by 1% on Friday.

An improving inflation picture in 2023 will go a long way in helping to relieve anxiety associated with the financial markets that has carried over from 2022.

RK

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In Behavioral Finance

Dealing With Anticipatory Anxiety

Anticipatory anxiety describes when people experience worry and apprehension for a future event that may or may not occur. It can begin anywhere from minutes to years before an anticipated event.

People can experience anticipatory anxiety when awaiting an upcoming personal task, like a job interview, or when thinking about unforeseen dangers, like natural disasters.

Individuals experiencing this condition can be overwhelmed by negative thoughts and what-ifs. They often expect the worst and sort through every possible bad outcome, becoming unable to focus on anything else.

Hopefully you do not suffer from acute anticipatory anxiety triggered by your investments. If this is the case, Susan and I will do our best to help. Reaching out to other professionals who counsel in different ways might also be appropriate.

It’s entirely possible that you might be experiencing anticipatory anxiety episodes (but not an acute condition) after living through the financial markets’ wild swings and selloffs of 2022. You’re likely now wondering what’s in store for 2023.

Susan and I encourage long term thinking. This includes building financial plans that extend well into the future and constructing portfolios with well-diversified asset allocations that help clients achieve life goals.

Focusing on long-term financial plans and future outcomes can help relieve anxiety about what will happen in the markets tomorrow or next week. Attempting to forecast what will happen next month, or next year, does little to support long-term thinking.

Yet it’s just human to want to know what comes next. We understand this, too. And we realize that having a framework for thinking about what may lie ahead in 2023 for the financial markets may also help calm anxiety related to your investments.

There are many folks at large financial firms who are paid to work up ‘year ahead’ forecasts, and they tend to share their views around this time of the year. Do the Wall Street Wizards really know what will happen in 2023? Of course not.

But these forecasts can be useful even if they’re not right because they provide a reference point to guide our decisions.

On January 2, 2023, Bloomberg, the news and data service, compiled opinions from researchers, analysts, and economists at fifty large financial firms.

While there are outliers – for example, a researcher at Piper Sandler, known as Wall Street’s ‘Top Bear’, sees stocks sliding another 16% in 2023 – most are more sanguine.

After reading through the projections from the large financial firms, here’s my take on what the consensus forecasts for the year ahead looks like:

  • Economy: things get worse before they get better; there will be a recession in the US, but likely a mild one, with the economy recovering toward year’s end
  • Inflation: continues to decline, reaching 3% – 4% by year end, but still higher than ‘normal’
  • Federal Reserve: stops raising interest rates by springtime
  • Short-Term Interest Rates: reach a high of 5.25% (currently 4.5%)
  • US Dollar: will weaken versus other major currencies
  • Company Profits: likely to decline in 2023
  • Stocks: likely to decline in the first half of 2023, possibly improve in 2nd half; don’t expect a lot from stocks this year

Bracing oneself for the potential rocky ride in stocks during the next year is probably a prudent approach.

However, recognizing that there are many possible paths the financial markets could travel, and being open to the potential of a better future for stocks and bonds (maybe even in 2023) is important for your psychological well-being and encourages perseverance in your investment approach.

RK

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In Market Updates

2022 Market Recap: Bear-Be-Gone

The S&P 500 Index of US large company stocks entered a bear market (defined as a drop of 20% or more from a recent high) in the second quarter of 2022 and then began to climb out of bear territory in the fourth quarter of last year.

The bond market registered its worst year-to-date performance on record by the third quarter of 2022, then showed signs of recovery in the final quarter of the year.

Even though there was improvement in the final months of last year, this was cold comfort to investors. By any standards, 2022 was terrible for the financial markets.

Here’s a chart of quarter-by-quarter returns for stocks and bonds in 2022:

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