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 Good afternoon.
Despite recent volatility with Brexit, the US and emerging markets investment markets are having a pretty good year. As of yesterday, large cap US stocks are up 3.79% year-to-date and emerging markets stocks are up 4.56%. Developed international stocks are not doing as well -- they are down 6.5% for the year. Bonds are having a great year with the broad US bond market up 5.94%.*
As always, please let us know of any suggestions for newsletter topics or questions in your financial world. Thanks for reading, and live well! |
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2016 Social Security and Medicare Highlights
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 Second Quarter Investment Review |
 It certainly feels like we're in a bear market, what with the surprising "Brexit" vote in the UK, the dismal first few days of the year and increased volatility across the board. So it may come as a surprise that the second quarter of 2016 eked out small positive returns for many of the U.S. market indices, and most of them are showing positive (though hardly exciting) gains over the first half of the year.
In US markets, the S&P 500 index of large company stocks posted a gain of 2.46% in the second quarter, and is up 3.84% for the first half of 2016. Small US company stocks, as measured by the Russell 2000 Small-Cap Index gained 3.79%, erasing losses in the first quarter and posting a 2.22% gain so far this year. US Value companies, as measured by the Russell 1000 Value index, gained 4.58% in second quarter and are up 6.3% year-to-date.
When you look at the global markets, you realize that the U.S. has been a haven of stability in a very messy world. The broad-based EAFE index of companies in developed foreign economies lost 1.46% in dollar terms in the first quarter of the year, and is now down 4.42% for the first half of the year. Emerging markets stocks, as represented by the EAFE EM index,were up 0.66% for the quarter, and are sitting on gains of 6.41% for the year so far.
Looking over the other investment categories, real estate investments, as measured by the Dow Jones U.S. Select REIT index, was up 5.42% for the second quarter, with a gain of 10.82% for the year. Commodities, as measured by the Bloomberg Commodity Index, gained 12.78% of their value in the second quarter, giving the index a 13.25% gain for the year so far.
Meanwhile, interest rates have stayed low, once again confounding prognosticators who have been expecting significant rate rises for more than half a decade now. Treasury yields are stuck near the bottom of historical rates; 3-month notes yielded 0.26% at the end of the quarter, while 12-month bonds were yielding just 0.43%. Go out to ten years, and you can get a 1.47% annual coupon yield. Low? Compared with rates abroad, these yields are positively generous. If you're buying the German Bund 10-year government securities, you're receiving a guaranteed -0.13% yield. The 5-year yield is actually worse: -0.57%. Japanese government bonds are also yielding -0.3% (2-year) to -0.23% (10-year).
Bond fund performance in the second quarter was helped because of the falling interest rates and "flight to safety" of some investors. The Barclays US Agg Bond index was up 2.21% in second quarter with a year-to-date total of 5.31%. Global bonds were up 0.72% for the quarter and 1.86% year-to-date.
On the first day of July, the Dow, S&P 500 and Nasdaq indices were all higher than they were before the Brexit vote took investors by surprise, which suggests that, yet again, the people who let panic make their decisions lost money while those who kept their heads sailed through. There will be plenty of other opportunities for panic in a future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S.
How decent? The American economy is on track to grow at a 2.0% rate this year, which is hardly dramatic, but it is sustainable and not likely to overheat different sectors and lead to a recession. Manufacturing activity is expected to grow 2.6% for the year based on the numbers so far, and the unemployment rate has fallen to 4.7%, which is actually below the Federal Reserve target. Inflation is also low: running around 1.4% this year. The unemployment statistics are almost certainly misleading in the sense that many people are underemployed, and a sizable number of working-age men are no longer participating in the labor force, but for many Americans, there's work if you want it. Historically low oil prices and high domestic production have lowered the cost of doing business and the cost of living across the American economic landscape.
Despite all this good news, the market is struggling to keep its head above water this year, and is not threatening the record highs set in May of last year.
You'll continue to see dire headlines, if not about Brexit or the Middle East, then about China's debt situation and the Fed either deciding or not deciding to raise rates in the U.S. economy. Oil prices are going to bounce around unpredictably. The remarkable thing to notice is that with all the wild headlines we've experienced so far, plus the worst start to the year in U.S. market history, the markets are up slightly here in the U.S., and the economy is still growing. Yes, your international investments are down right now, but eventually, you can expect them to come to the rescue when the American bull market finally turns. We'll be reminded, once again, that maintaining a disciplined investment strategy through turbulent times is ultimately rewarding.
If you like this kind of information and would like more detail, we've published a quarterly market review on our website with more details. This quarter's market review also has perspective on the relationship between GDP growth and equity returns.
Source of investment returns is Morningstar for the period ending June 30, 2016. S&P 500 TR USD for the S&P 500. MSCI EAFE NR USD for developed international markets. MSCI EM NR USD for emerging markets stock. Barclays US Agg Bond TR USD for the US Aggregate bond index. Russell 1000 Value TR USD for Russell 1000 Value Index. Russell 2000 TR USD for the Russell 2000 Small Cap Index. Global bonds is the Citi WGBI 1-5 Yr Hdg USD.
Portions of this article adapted with permission of financial columnist Bob Veres.
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| Are Brexit Fears Overblown? |
 In the wake of the Brexit vote in the United Kingdom, and the possibility (though not the certainty) that the U.K. will leave the European Union, you're likely reading a lot of alarmist stories about the vote's impact on the U.S. and your portfolio.
Don't believe half of what you read.
Here are some of the most alarming headlines, and the reality behind them.
1) The Brexit vote has already caused a stronger dollar, which will hurt U.S. exports.
True, the dollar gained dramatically against the British pound, which means exporters to the U.K. might be more than a little bit less competitive than they were a couple of weeks ago. But the U.K. only accounts for 0.5% of total U.S. exports. And there is no reason why the dollar should appreciate in strength against the euro, yen or other global currencies simply because the U.K is less likely to remain in the European Union.
2) The confusion around Brexit will cause turmoil in the stock market because, well, investors hate uncertainty.
When was the stock market NOT in turmoil over one thing or another? When have investors NOT hated uncertainty? We've been uncertain about the Fed raising interest rates for the better part of two years, and also about how long interest rates will continue falling, credit and stock market problems in China and Japan's economic woes for two and a half decades. Let's just add Brexit to the list and move on to the next so-called "crisis."
3) Brexit signals the imminent collapse of the European Union.
Remember this prediction a year or two down the road, and realize that sometimes 'journalists' should be renamed 'alarmists.' The reality is that the U.K. vote has forced the bureaucrats in Brussels to come face-to-face with the unrest caused by their costs and their stifling policies. There are already indications that the EU members will come together and make decisions that would head off other "leave" movements in France, Spain, Italy and Greece. In fact, in the next few weeks, we will almost certainly see the EU relax one of its rules and allow the Italian government to recapitalize its ailing banking system with public funds. Would that have happened pre-Brexit? It's doubtful.
4) Brexit will force the Fed to rethink raising interest rates in the U.S. economy, for fear it would trigger additional market volatility, and a concern that the U.S. might slip into a recession.
Lower interest rates for a few months longer is a BAD thing? And it's not unexpected; after all, the Fed entered the year with a firm plan to raise rates four times, and then, pre-Brexit, scaled the plan back to one rate rise.
We may have to live with low interest rates for another year. Somehow we'll survive.
5) U.S. investment in the U.K. will decline.
It's true that if the U.K. does apply for exit under Article 50 of the Lisbon Treaty, U.S. companies that have significant operations on British soil, primarily to take advantage of tariff-free exporting to the EU nations, might start checking out office space in Frankfurt or Dublin. But there's plenty of time to make that transition. After the U.K. sorts out its government, it may notify the EU that it's leaving, and after that, even the most optimistic estimate suggests that the full details of leaving, and any new tariff regime, are at least two years down the road. Nor is it a sure thing that there WILL be higher taxes on exports from the U.K. to the continent.
The main point here is that there is a lot of alarmist speculation and short-term thinking about a long-term phenomenon that will require years to play out. People who sold in a panic (including a lot of Wall Street traders) right after the Brexit news hit the Internet have egg on their face and real losses in their portfolios. Those of us that stayed the course found in just a few days that most of the immediate impact was quickly recovered.
Article adapted with permission of Financial Columnist Bob Veres.
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| 2016 Social Security and Medicare Report |
 Every year, the Trustees of the Social Security and Medicare trust funds release reports to Congress on the current financial condition and projected financial outlook of these programs. The 2016 reports, released on June 22, 2016, project a small Social Security cost-of-living adjustment (COLA) and Medicare premium increases for 2017, and discuss ongoing financial challenges.
Trustees report highlights: Social Security
The combined trust fund reserves (OASDI) are still increasing and will continue to do so through 2019. Not until 2020, when annual program costs are projected to exceed total income, will the U.S. Treasury need to start withdrawing from reserves to help pay benefits. Without congressional action, the Trustees project that the combined trust fund reserves will be depleted in 2034, the same year projected in last year's report.
Once the combined trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 79% of scheduled benefits in 2034, with the percentage falling gradually to 74% for 2090.
The OASI Trust Fund, when considered separately, is projected to be depleted in 2035 (the same year projected in last year's report). At that time, payroll tax revenue alone would be sufficient to pay 77% of scheduled OASI benefits.
The DI Trust Fund is expected to be depleted in late 2023. Once the DI Trust Fund is depleted, payroll tax revenue alone would be sufficient to pay 89% of scheduled benefits.
Based on the "intermediate" assumptions in this year's Trustees report, the Social Security Administration is projecting that beneficiaries will receive a small cost-of-living adjustment (COLA) of 0.2% for 2017.
Trustees report highlights: Medicare
Annual costs for the Medicare program have exceeded tax income annually since 2008, although the Trustees project slight surpluses in 2016 through 2020 before a return to deficits thereafter.
The HI Trust Fund is projected to be depleted in 2028, two years earlier than projected last year. Once the HI Trust Fund is depleted, tax and premium income would still cover 87% of estimated program costs, declining to 79% by 2040, and then gradually increasing to 86% by 2090. The Trustees note that projections of Medicare costs are highly uncertain, especially long-range projections.
Because of the small Social Security COLA (0.2%) projected, about 70% of beneficiaries (those who have Medicare premiums deducted from their Social Security benefits) may see only a small increase in their Part B premiums in 2017. For these beneficiaries, a so-called "hold-harmless" provision in the law limits the dollar increase in the Medicare Part B premium to the dollar increase in an individual's Social Security benefit. However, the remaining 30% not eligible for this hold-harmless provision may be subject to a much greater premium increase. This group includes new enrollees, wealthier beneficiaries, and those who choose not to have their premiums deducted from their Social Security benefit. These beneficiaries could see their base premium rise to $149.00 in 2017, up from $121.80 in 2016.
The report also projects Part B premium increases for those subject to income-related premiums. For example, for individuals with a modified adjusted gross income above $85,000 up to $107,000 or married couples with a MAGI above $170,000 up to $214,000, the monthly premium is projected to increase to $208.60 per person in 2017, up from $170.50 per person in 2016.
Medicare premium projections are based on the projected Social Security COLA. Consequently, premiums for 2017 may be significantly different once the final COLA is calculated in October.
Why are Social Security and Medicare facing financial challenges?
Social Security and Medicare accounted for 41% of federal program expenditures in fiscal year 2015. These programs are funded primarily through the collection of payroll taxes. Because of demographic and economic factors, fewer workers are paying into Social Security and Medicare than in the past, resulting in decreasing income from the payroll tax. The strain on the trust funds is also worsening as large numbers of baby boomers reach retirement age, Americans live longer, and health-care costs rise.
What is being done to address these challenges?
Both reports urge Congress to address the financial challenges facing these programs in the near future, so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public.
Some long-term Social Security reform proposals on the table are:
- Raising the current Social Security payroll tax rate (according to this year's report, an immediate and permanent payroll tax increase of 2.58 percentage points would be necessary to address the long-range revenue shortfall)
- Raising the ceiling on wages currently subject to Social Security payroll taxes ($118,500 in 2016)
- Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later)
- Reducing future benefits, especially for wealthier beneficiaries
- Changing the benefit formula that is used to calculate benefits
- Calculating the annual cost-of-living adjustment for benefits different
You can view the full summary of the 2016 Social Security and Medicare Trustees reports at www.ssa.gov.
Article adapted with permission of Broadridge Forefield Investor Communications.
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| Roth 401k Q&A |
 The Roth 401(k) is 10 years old! With 62% of employers now offering this option*, it's more likely than not that you can make Roth contributions to your 401(k) plan if you're working and have access to a 401(k) plan. We still see the Roth 401(k) option as being under-utilized -- particularly by individuals early in their career who have not reached their peak earning years.
What is a Roth 401(k) plan?
A Roth 401(k) plan is simply a traditional 401(k) plan that permits contributions to a designated Roth account within the plan. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. This means there's no up-front tax benefit, but if certain conditions are met both your contributions and any accumulated investment earnings on those contributions are free of federal income tax when distributed from the plan.
Who can contribute?
Anyone! If you're eligible to participate in a 401(k) plan with a Roth option, you can make Roth 401(k) contributions. Although you cannot contribute to a Roth IRA if you earn more than a specific dollar amount, there are no such income limits for a Roth 401(k).
Are distributions really tax free?
Because your contributions are made on an after-tax basis, they're always free of federal income tax when distributed from the plan. But any investment earnings on your Roth contributions are tax free only if you meet the requirements for a "qualified distribution."
In general, a distribution is qualified if:
It's made after the end of a five-year holding period, andThe payment is made after you turn 59�, become disabled, or die
The five-year holding period starts with the year you make your first Roth contribution to your employer's 401(k) plan. For example, if you make your first Roth contribution to the plan in December 2016, then the first year of your five-year holding period is 2016, and your waiting period ends on December 31, 2020. Special rules apply if you transfer your Roth dollars over to a new employer's 401(k) plan.
If your distribution isn't qualified (for example, you make a hardship withdrawal from your Roth account before age 59�), the portion of your distribution that represents investment earnings will be taxable and subject to a 10% early distribution penalty, unless an exception applies.
How much can I contribute?
There's an overall cap on your combined pretax and Roth 401(k) contributions. In 2016, you can contribute up to $18,000 ($24,000 if you are age 50 or older) to a 401(k) plan. You can split your contribution between Roth and pretax contributions any way you wish. For example, you can make $10,000 of Roth contributions and $8,000 of pretax contributions. It's totally up to you.
Can I still contribute to a Roth IRA?
Yes. Your participation in a Roth 401(k) plan has no impact on your ability to contribute to a Roth IRA. You can contribute to both if you wish (assuming you meet the Roth IRA income limits).
What about employer contributions?
While employers don't have to contribute to 401(k) plans, many will match all or part of your contributions. Your employer can match your Roth contributions, your pretax contributions, or both. But your employer's contributions are always made on a pretax basis, even if they match your Roth contributions. In other words, your employer's contributions, and any investment earnings on those contributions, will be taxed when you receive a distribution of those dollars from the plan.
Can I convert my existing traditional 401(k) balance to my Roth account?
Yes! If your plan permits, you can convert any portion of your 401(k) plan account (your pretax contributions, vested employer contributions, and investment earnings) to your Roth account. The amount you convert is subject to federal income tax in the year of the conversion (except for any after-tax contributions you've made), but qualified distributions from your Roth account will be entirely income tax free. The 10% early-distribution penalty generally doesn't apply to amounts you convert.**
What else do I need to know?
Like pretax 401(k) contributions, your Roth contributions can be distributed only after you terminate employment, reach age 59�, incur a hardship, become disabled, or die. Also, unlike Roth IRAs, you must generally begin taking distributions from a Roth 401(k) plan after you reach age 70� (or, in some cases, after you retire). But this isn't as significant as it might seem, because you can generally roll over your Roth 401(k) money to a Roth IRA if you don't need or want the lifetime distributions.
*Plan Sponsor Council of America, 58th Annual Survey of Profit Sharing and 401(k) Plans (2015) (Reflecting 2014 Plan Experience)
**The 10% penalty tax may be reclaimed by the IRS if you take a nonqualified distribution from your Roth account within five years of the conversion.
Article adapted with permission of Broadridge Forefield Investor Communications.
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I hope you found this newsletter informative. KFP offers a free, no-obligation initial consultation to start the financial planning process for new clients. To learn more or schedule a time, call 817-993-0401 or e-mail [email protected]. Sincerely,
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Jean Keener, CFP�, CRPC�
Keener Financial Planning
Keener Financial Planning provides as-needed, fee-only financial planning and investment management services.
*Source for investment returns is Morningstar as of July 6, 2016. S&P 500 TR USD for the S&P 500. MSCI EAFE NR USD for developed international markets. MSCI EM NR USD for emerging markets stock. Barclays US Agg Bond TR USD for the US Aggregate bond index. |
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