It’s safe to say the markets surprised everyone in 2020. After the rapid drop into bear market territory last March—the fastest in history—we don’t think anyone was truly prepared for the fast reversal and strong gains that came after.
With that in mind, it’s not surprising that many of our clients are asking: what’s next? The broad outlook for equities in 2021 range from something around the long-term average of 8% to 10% to far higher. Of course, this isn’t just a stock market question. With Democratic control of Congress and a new president, there are a number of wealth management questions in general that we believe are worthy of attention.
From our point of view, the smart approach right now is to keep driving forward—but with caution. Risks along the road still exist, ranging from technology stocks to tax policy, and we’re staying mindful of these for our clients. In this outlook, we’ll review some of the current policy and market issues we think are most important, as well as how those issues impact the advice we’re sharing with clients.
Policy and the Economy
Where Are We Now?
The Federal Reserve did a terrific job addressing COVID-19 in 2020. Their rapid support for the economy included dropping the federal funds rate to zero, quantitative easing, and an unprecedented expansion of lending facilities for private businesses. Together, these actions probably helped prevent a much more serious downturn.
We expect further stimulus to come through in the first quarter of 2021. The fiscal policy measures taken in 2020 were record breaking, and the White House’s $1.9 trillion American Rescue Plan would expand on that trend.
Beyond policy, we believe that media support, the reopening of local economies, and more widespread vaccination will stimulate a faster recovery in 2021. As of this writing, more people have been vaccinated in the U.S. than were diagnosed with COVID-19, which is an important milestone in the road back to normalcy.
From there, we could see a jump in consumer spending. Consumer savings rates are historically high—the 2020 personal savings rate exceeded 16%, compared with a long-term average of 6.1%—and we think there will likely be pent-up demand for goods and services. This, in turn, could hopefully speed up job growth: as of now, we’re still down over 9 million jobs compared to this time last year.
The Potential Hazards Ahead
While policy support has probably been instrumental in preventing a double-dip recession or even deeper recession, every stimulus comes with a price tag. U.S. government debt is at its highest level since World War II, and at a certain point, climbing deficits might begin to exert pressure on the economy. There is some exceptionalism at play here: the U.S. dollar is the reserve currency of the world, and our economy is robust and flexible enough to allow for more leeway in this area compared with other countries.
However, in our view, the chickens always come home to roost. Pandemic debt must be addressed at some point, as climbing debt levels could impact both monetary policy and government spending later on—especially if interest rates start climbing and debt costs tick significantly higher.
The only real ways to tackle rising debt levels are through growth, spending reductions, and higher taxes. We feel it’s prudent to plan ahead for the latter two, while of course hoping for increased growth at the same time.
As you might expect, debt ties into inflation risk. The yield curve, which shows current yields on government bonds with different maturities, tilted higher in January. This indicates that bond markets expect interest rates to rise in the future. While the Fed has stated that it will keep rates low for the next two to three years, there are concerns about the risks involved in high debt levels and inflationary pressure in the future.
Here’s the logic: with rates at very low levels, it’s much easier for the economy to heat up—that’s why they are cut in the first place. The cost of borrowing is cheaper, making it easier for businesses to invest and expand. At some point, that expansion can start to impact inflation, which is usually when the Fed steps in to raise rates and offset rising price levels. However, higher rates can also make it more expensive for the federal government to pay its debts.
It’s a combination that could leave the federal government between a rock and a hard place on future policy moves.
What about taxes? The reality is that we do expect tax code changes to materialize over the next four years. Even without Congressional intervention, a number of 2017 tax reform policies are scheduled to expire in 2025. The Biden administration has shown its support for several tax changes that could impact wealth planning strategies for our clients.
A few potential areas that we’re monitoring include:
- Changes to the top income tax rate (anticipated to rise from 36% to the previous 39.6%)
- A reduction in the estate tax exemption and potentially, change in accounting for cost-basis upon inheritance; taken together, these could significantly impact wealth planning across generations
- Potential changes to the long-term capital gains tax rate
- Changes to corporate tax rates, which could impact business owners
That said, we don’t foresee significant policy adjustments in 2021: in our view, policymakers will likely stay focused on COVID-19 relief efforts and economic recovery.
Our Guidance for 2021
With so much happening across both policy circles and the economy, we’re focused on helping our clients reap the benefits of the positive trends while sheltering their wealth from potential hazards along the road to recovery.
Consider Insurance as an Investment
For those in need of life insurance, there are strategies that can help you accumulate tax-advantaged savings within your policy. For example, an indexed universal life policy gives you the ability to generate a return based on market returns without risking your principal. This can be a great way to boost the value of your life insurance policy for the future.
This particular type of policy is a permanent life insurance policy, meaning there’s a cash value piece and a standard death benefit. The cash value component earns an interest rate (usually based on a basket of investments) that is credited to your cash account, and in an emergency, you may be able to borrow or make withdrawals on it.
Again, we typically recommend this option for those with a prior need for life insurance. It’s not suitable for every situation, so we’ll want to go through the details of your personal financial situation and needs first.
Annuities: Floors and Buffers
With respect to index-linked annuities, we’ve shifted some of our recommendations to include more floors and buffers on new contracts.
These contracts are designed to track the performance of an index (or a batch of indices), which means they could lose value if markets fall. A floor provides a hard limit on losses—for example, with a 15% floor, you won’t lose more than that even if the tracked index falls further. A 15% buffer is the inverse: it will protect you from the first 15% of losses, but nothing more beyond that.
Using both together means that you can adapt to markets that fall a little (where a buffer helps most) and to those that fall a lot (where a floor is more important).
Start Thinking About a Roth Conversion
Given that we expect taxes to rise in the future, we think it’s a good idea to think ahead about ways to reduce your tax liability sooner rather than later. A Roth Conversion can be a great way to achieve that.
This strategy takes a traditional IRA or 401(k) account and converts it into a Roth IRA (some companies may allow you to convert a traditional 401(k) into a Roth 401(k), but this isn’t as common). You’ll pay income tax today on the amount that you convert, but qualified withdrawals in the future are non-taxable.
In other words, any Roth account gains are completely sheltered from income taxes so long as you follow the withdrawal rules. If you expect your tax liabilities to rise in the future and have the funds available to pay taxes on your conversion today, this can be a powerful tool in minimizing your long-term tax burden.
Finally: Don’t Let Politics Drive Your Investment Policy
This is possibly the most important piece of advice we can offer you. In today’s media environment, it’s very easy to get caught up in the 24-hour news cycle and emotional hype surrounding everything from market news to politics.
But that doesn’t provide a solid foundation for wealth planning. Your investment policy and financial planning strategies must be grounded in long-term strategies and economic outlooks, not short-term hoopla. It’s part of the reason why we created our Overwatch System: it’s methodical, it’s built on best practices that we’ve developed over the course of decades, and it’s designed to help you navigate the big issues that can most significantly impact your life. In other words, it’s built on long-term planning, not short-term news.
Putting Principles into Action
Here’s what you can do to apply some of our planning principles to your life today.
First, maintain appropriate diversification and risk exposure. For example, in an environment of potentially higher inflation, there’s been more attention on gold and other commodities. They could very well outperform in the coming years, but we don’t believe in drastic portfolio shifts away from your long-range strategic allocation. Any changes should be made in a prudent way that will continue to help you achieve long-term goals without exposing you to unnecessary risks—and gold has risk baked into it, just like any other asset class.
Similarly, cryptocurrencies like bitcoin are getting a lot of media coverage these days. They are definitely fascinating and could have an impact on our lives in the long-term, but that shouldn’t prompt you to start replacing your cash reserves or equity allocation with crypto. Bitcoin is extremely volatile, and while it may one day become a store of value, putting too much cash into it today can put your overall financial plan at unnecessary risk.
Generally speaking, we urge you to think about it this way: if something seems like the next best thing that you absolutely can’t miss or, on the flip side, a complete and total disaster, that’s probably your emotions talking. In those situations, it’s important to take a step back, consult with a professional, and find data on the risks, rewards, and other factors involved. We think this is the starting point of good decision-making about wealth.
If you’re like most of our clients, you want to both pursue and protect your wealth—but do so with thoughtfulness and strategy. That’s long been our approach, and we believe it’s what will get you the best results, no matter what’s going on in the news or the economy.