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Investment Debate: Stocks or Real Estate

By | 2021, Money Moxie, Newsletter | No Comments

I am often asked if real estate is a better investment than stocks. The answer depends on several variables. Both real estate and stocks have their advantages. They both can offer great returns, passive income, and inflation protection. They also carry their own risks and challenges.

As with any investment opportunity, an understanding of the return potential, the risk involved, and the objective are fundamental to making a wise decision. While real estate and stocks are certainly not the only investment options available, they are the only asset classes that will be considered here.

Unsystematic Risk
One aspect that makes real estate investing difficult to assess generally is that every property is different. Therefore, each investment opportunity must be analyzed by its own unique characteristics. While some properties may provide fantastic returns, others are a bad investment.

Like real estate, stocks also have significant variability in returns. The risk of a poor-performing stock is easily reduced by diversification. Diversification in real estate is challenging, expensive, and for many investors, unattainable.

Leverage
One of the benefits of investing in real estate is the ability to use leverage. Debt always adds risk to the equation, but debt can be a powerful tool if used properly. Lenders typically require a down payment of at least 20% for an investment property. But that 20% allows the investor to participate in 100% of the property’s appreciation.

Leverage can also be used to purchase stocks, but it is usually not recommended. Margin trading means borrowing money from a broker to purchase stocks. Trading in a margin account increases your purchasing power, but it also amplifies losses.

Liquidity
At one point or another, liquidity becomes important to every investor. Stocks are liquid. If a stock investor needs cash, she can place trades and usually receive the money within a couple of days.

Real estate is not liquid by comparison. In most circumstances, a real estate investor cannot pull cash out of a property without a refinance or complete liquidation. This can be problematic.

Taxes
A real estate investor has the advantage of deducting expenses to reduce tax liability. He or she can also depreciate the asset over time. This can be beneficial year to year; however, one major problem is the taxes due upon the sale of the property. Depreciation recapture can assess taxes on the depreciation previously claimed, and the appreciation becomes taxable all in the same year as the sale. This can create a significant tax bill. A 1031-exchange defers the tax liability but only if the money is quickly reinvested into a like-kind asset. This does not help an investor looking to cash in on their investment.

Stock investors do not have the ability to deduct expenses or depreciate assets. There are several tax-advantaged accounts that give the investor tax-free or tax-deferred growth. These accounts provide significant control over how and when investments are taxed. When losses occur in taxable accounts, the stock investor can strategically sell to offset gains. They can also sell portions of the portfolio as needed and spread the tax liability over many years, thus reducing the marginal tax rate.

Costs, Fees, and Expenses
Costs, fees, and expenses can significantly eat into returns. The expenses with real estate are significant and impossible to project. Transaction costs are high. Maintenance and repair costs are ongoing. Property taxes, insurance, and possible HOA fees need to be considered. If hired, a property manager will take a good percentage of the profit. If a property goes unrented for a time, monthly costs can significantly increase.

Stocks, on the other hand, have a low barrier to entry, and fees are minimal. Opening a stock account is generally free, and trading costs are zero in many cases. Sales loads, management fees, and annual expenses are all comparably small and remain relatively consistent.

Demands
Real estate can be demanding, especially if the investor decides to cut costs by acting as the landlord. Appliance failures and other problems can occur day or night and often require immediate attention. Work, holidays, and family vacations can all be interrupted. Finding renters, enforcing house rules, and property maintenance takes time and energy. Dealing with renters and evictions can be stressful and time-consuming.

Stocks are very low maintenance. Generally, the less attention you give a proper portfolio allocation after purchase, the better.

Volatility
Both the real estate market and the stock market deal with volatility. Both markets suffer periods of depreciation and loss. But stock market volatility is measured daily and is constantly called to our attention. We cannot escape it. This can lead to emotional volatility, which can result in bad investment decisions.

Real estate volatility is more hidden. An investor may become aware of large swings but is mostly incognizant of market movements.

Historical Returns
According to the Federal Reserve Economic Data website, the S&P 500 index has consistently outperformed the general real estate market. Note, these numbers reflect gross appreciation and do not take into account income or dividends. They also do not consider costs, expenses, or fees (of which real estate has many).

Conclusion
Although I believe stock investing is better suited for most people, the right real estate investment can be advantageous and profitable. Before you make any significant financial decision, reach out to your Private Wealth Manager at Smedley Financial. We can help provide you with the information needed to make the best decision for you.

*Data from Federal Reserve Bank of St. Louis. Returns through March 31, 2021. Investing involves risk, including the potential loss of principal. The S&P 500 index is widely considered to represent the overall U.S. stock market. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on changing conditions. This is not a recommendation to purchase any investment.

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Higher Inflation is Here

By | 2021, Money Moxie, Newsletter | No Comments

In 1979, global oil production dropped roughly 4%, primarily due to the revolution in Iran. This triggered panic among Americans who still remembered the shortages of 1973. The price of oil doubled in 12 months as lines started to build at gas stations, sending prices for all kinds of goods through the roof.

Since World War II ended, U.S. inflation has averaged 3.9%. In the decade prior to 1979, prices averaged a 6.6% increase per year. America had not seen back-to-back double-digit inflation since 1920, but in 1980, prices rose another 13.5%, then 10.3% in 1981. We have not seen anything like this since.

Inflation has been incredibly low over the last 40 years, thanks to technology, globalization, demographics, and the Federal Reserve. During this time, inflation has averaged just 2.7%.

Demand and supply of goods are the basics of economic pricing. If either one rises or falls without the other, prices move. When panic demand for supplies hit in the spring of 2020, we did not see huge changes.

We did see a lot of changes in other areas. Oil demand fell around 10%, and the price of oil at one point went negative. On April 20, 2020, the prices of West Texas Intermediate oil fell to -$40 per barrel. Unbelievable! Companies could not give it away. Gas prices stayed positive (around $1.50 per gallon in Utah).

The U.S. government slammed on the economic brakes and then created around $12 trillion to keep things going. That is in an economy that produces less than $22 trillion in a year. It was massive, and it appears to have worked. Now, the government seems to have the economic tiger by the tail. It is hard to say what will happen if it lets go.

As stimulus efforts continue, prices will probably continue to rise. Official inflation came out on May 13, 2021, at 4.2%. That is a long way from 1979 levels, but it is the biggest number in decades. Many of these numbers are being compared to unusually low prices from a year ago. The Fed refers to this as a base effect.

Fed Chair Jerome Powell insists that these significant increases are temporary. If Powell is correct, then I expect we will begin to see price changes calm down by the end of summer. That does not mean prices will fall; it means they should stop rising so quickly. There is also a reasonable chance the Fed is wrong, so I will be keeping an eye on inflation.

*Research by SFS. Data from the Federal Reserve Bank of Minneapolis and the U.S. Bureau of Labor Statistics. Investing involves risk, including the potential loss of principal. The S&P 500 index is widely considered to represent the overall U.S. stock market. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based upon changing conditions. This is not a recommendation to purchase any type of investment.

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The American Families Plan – the Good, the Bad, and a lot of Debt

By | 2021, Money Moxie, Newsletter | No Comments

The U.S. middle class is shrinking. There has been growing polarization as the rich become richer and the poor become poorer. The Biden administration is proposing the American Families Plan to be a “once in a generation investment to rebuild the middle class and invest in America’s future.”1 Here are some of the key points and their potential impact if the plan is enacted.

Making Education Affordable
The Biden administration plans to make education more affordable and expand opportunity. It is proposing two free years of community college and lower costs for minorities to attend college or a university. The amount of Pell Grants may increase. There could also be universal access to free pre-kindergarten (preschool).

Providing Economic Security for Families
The goal is to make it easier for everyone to have “the opportunity to join the workforce and contribute to the economy.” The plan does this by ensuring that no one earning under 150% of the state median income pays more than 7% of their income on high-quality care for children. The plan also provides paid family and medical leave to care for a new child or for a serious illness.

Expanding Tax Credits to Help Workers and Families
The plan uses tax credits to transfer wealth to those with lower income. It proposes tax credits of up to $8,000 to cover childcare expenses for a family with children under age 13 who make under $125,000. The income phase-out moves from $125,000 to $438,000. The plan also increases child tax credits for the next 5 years from $2,000 per child to $3,600 for children under age 6 and $3,000 if over age 6. It also makes permanent the earned income tax credit for low-income childless workers.

Impact
As with all legislation, there would be good, bad, and unintended consequences. We do need a workforce educated for our modern economy. Education is a key to opening opportunities.

Families with children stand to benefit, especially low-income families who would gain access to childcare.

There is some concern that the administration “strongly prefers getting kids out of the home and parents into the workforce.” There is also a concern that “too much focus on federal mandates might be detrimental to the effects on children who otherwise might be raised with the involvement and investment of a parent.”2

Taxes are another concern. Right now, the administration is only planning tax hikes for high-income earners, investors, and corporations. Additionally, the administration is planning an infrastructure spending bill. We are facing a massive national debt that is at $28 trillion and may reach $89 trillion by 2029.3

Social Security and Medicare also have to be fixed. There isn’t a way to tax the “wealthy” enough to account for all of the government spending. As taxes go up, the economy may slow. This could be the unintended consequence that we fear.

Most people agree with the stated goals of this plan: providing education and opportunity. We want to help families have financial security. The challenge is paying for these programs. It will remain to be seen what the final impact is on the economy, the lower and middle classes, and the family as the fabric of society.

1 https://www.whitehouse.gov/american-families-plan/
2 https://www.ksl.com/article/50168776/mitt-romney-i-didnt-realize-i-was-at-a-disadvantage-because-my-mom-stayed-home
3 https://www.forbes.com/sites/mikepatton/2021/05/03/us-national-debt-expected-to-approach-89-trillion-by-2029/?sh=5bd9292a5f13

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The Pendulum Swings

By | 2020, Executive Message, Money Moxie, Newsletter | No Comments

There is a giant pendulum that swings ever so slowly. When it gets to one extreme, the gravitational force pulls it back the other direction. Because of the Great Depression and World War II, the pendulum of national debt rose to an astounding 106% of GDP* in 1946.1 The pendulum took until 1974, or 28 years, to swing the other direction and get down to 23% of GDP.

With the back-to-back economic crises of the Great Recession in 2008 and COVID-19 in 2020, the debt to GDP ratio has swung dramatically back in the wrong direction. We now sit at 100% debt to GDP with a projection to get to 106% of GDP by 2023.2

What will be the long-term impact? Undoubtedly, taxes will go up. I recently heard it said, “The politicians that are telling you they can cut taxes are just bad at math.” If you look at history, tax rates shot up to 94% in 1944 for the highest tax bracket.3 That’s right, 94%! This was done with more marginal tax brackets. There were 24 brackets back then compared to just 7 today.

In 1965, the highest rate declined to 70%. It stayed around there until 1982 when the highest rate became 50%. Currently, our highest tax bracket is 37%.

I’m not a doomsday predictor. I don’t believe a new tax bracket will send rates up to 94%. However, I do worry about taxes going up for almost everyone. You can’t tax the “rich” enough to cover the current deficit and make the pendulum swing the other direction.

Thankfully, I believe there are prudent tools we can use to help protect you against future taxes. If you aren’t retired, you can contribute to a Roth IRA or Roth 401(k), depending on your income. If your income is below $139,000 (single) or $206,000 (married), consider a Roth conversion from your IRA or 401(k). If you are over age 70½, you can make tax free donations to a charity from your IRA.

These are just a few options to help protect against future taxes. For our clients, we will continue to review your personal financial plan to make sure you are prepared for the future regardless of what may come. If you want to schedule a review appointment, please contact us.

*GDP or Gross Domestic Product is the total output of the economy for one year. SFS and its representatives do not provide tax advice; it is important to coordinate with your tax advisor regarding your specific situation.
(1) https://www.washingtonpost.com/opinions/2020/05/27/this-is-not-your-grandfathers-debt-problem/
(2) https://www.bloomberg.com/graphics/2020-debt-and-deficit-projections-hit-records/
(3) https://fred.stlouisfed.org/series/IITTRHB

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Retire without Debt

By | 2018, Newsletter | No Comments

Only 38% of American retirees are debt free. The type of debt may surprise you—mortgage, credit card, auto loan, and even student loan. The impact of debt on a fixed income can be distressing as it reduces discretionary spending and, in some cases, forces retirees to cut their standard of living.

Source: Society of Actuaries® 2017 Risks and Process of Retirement Survey – Report of Findings

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Millennial Financial Success

By | 2017, Money Moxie, Newsletter | No Comments

Each generation seems to think the next generation is less prepared and doesn’t appreciate what they have. In reality, each generation is changing and evolving to its surroundings.

Time described generational issues, “The young seem curiously unappreciative of the society that supports them. ‘Don’t trust anyone over 30,’ is one of their rallying cries.”1 Surprisingly, this was printed in 1967.

Millennials–those born between 1981 and 2001–are the generation that will be required to forge financial success without a pension. As investors, they need to redefine their landscape. These are some common Millennial financial mistakes:

1. Not having a proper emergency fund: When you don’t have an emergency fund, every little unexpected event is a catastrophe. Paying with credit cards is easy, but hard to pay off. Avoid this trap by having an emergency fund of three to six months of living expenses readily available.

2. Forgoing the employer retirement match: About 75 percent of millennials are saving in their employer retirement plan; however, only 40 percent take advantage of the full company match.2 Those are free dollars that can help fund a retirement.

3. Holding onto debt: Student loans and car payments seem to hang around for way too long. Most people can afford to pay off debt faster than the minimum payment yet choose not to. Paying off fixed monthly payments frees up money that can work for you, instead of against you. Get aggressive and start to chip away at that debt.

4. Not using a financial advisor: A financial advisor can help you dream with numbers. Between work, social commitments, and family, most millennials don’t have time to focus on their finances. Financial advisors are here to help and work with all ages, incomes, and stages in life. We can create a plan and help you work toward making it a reality.

(1) Time Magazine, 1967
(2) http://www.benefitspro.com/2014/11/17/millennials-arent-meeting-their-match-in-401ks

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3 Myths of the Market

By | 2014, Viewpoint | No Comments

Every year we find reasons to question the future prosperity of America. We wonder whether investors’ prospects are dimming. Last year, our minds were occupied with government slowdowns and shutdowns. This year, we are more focused on the question, “Has the stock market come too far too fast?” While the problems are real, they should not derail us from our plans. Most difficulties are overcome and the myths of the market are not true. Keeping proper perspective will help us make better financial decisions.

Myth #1: Investing is rigged
The U.S. stock markets are the most efficient in the world. All investors have the potential to build their wealth as they participate in it. The longer we invest in a diversified portfolio, the more likely we are to have success.

There is a related question, “Is investing like gambling?” The clear answer is no. When we invest we purchase part of a company (stock) or a promissory note (bond). We become owners of these and we have rights to future cash flows that may come from them. The risks and outcomes are determined by the free market. If a company is successful then all investors that own it have the potential to benefit.

This does not mean that markets are perfect. There have always been some who try to take advantage of others. However, investors become their own worst enemies when they make poor financial decisions. Saving too little and trading too often are two of the most common mistakes. Save sufficiently and invest wisely to attain your goals.

American Manufacturing

Myth #2: America is broke
The United States is in better shape now than it has been for many years. The unemployment rate is down to 6.3 percent and consumer confidence is up. Workers are expecting raises, and according to surveys of executives it looks like it may actually happen this year. Household debt is at record-low levels and corporations have more cash than ever.

Some people may argue that we don’t make anything in this country. This is false. U.S. manufacturing is up 22 percent since 2009 and near record levels. We have an abundance of natural resources, educated workers, and innovation. We have laws to protect and promote business.

Worries over ballooning government debt (over $17 trillion) are diminishing for now. The expanding U.S. economy has led to greater tax revenue (up 8 percent) and a lower deficit ($306 billion). These numbers may not sound great. We still have a long way to go to reach a surplus so we can pay off some debt, but these are the best numbers since 2007. The future appears brighter.

Myth #3: A market crash is imminent
Herbert Stein famously said, “If something cannot go on forever it will stop.” We all know that when the market stops climbing, it can be painful. Two stock-market crashes in the last 15 years are still vivid in our memories. However, just because stock prices have increased doesn’t mean a crash is coming this year.

What can we expect?
The Dow Jones index had double-digit increases in 2012 and 2013. This has happened more frequently than one might think. In the last 99 years, returns of this magnitude have occurred back to back 22 times. What happens in the year that follows two positive, double-digit years? The average return is a positive 5 percent. That would be a reasonable expectation for 2014.

When we examine critical factors for a healthy market, we see more positives than negatives right now. Of course, there are no guarantees.

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