Insights: Quarterly Newsletter from RKL Wealth Management (Winter 2018)
A Message to Our Clients
Contributed by: Judson S. Meinhart, Wealth Advisor
Nothing in life is to be feared, it is only to be understood. Now is the time to understand more and fear less.
The previous has been attributed to Marie Curie, a French physicist who, among her other achievements, is the only individual to win the Nobel Prize in two different sciences. While her words could quite easily be misconstrued as an overture towards our current political climate, it also very succinctly describes some of the thought process behind our wealth management philosophy.
As human beings, we all have an inherent fear of loss. This predisposition is something behavioral economists have defined as “loss aversion.” This phenomenon was demonstrated by two psychologists, Amos Tversky and Daniel Kahneman, who conducted an experiment centered on the outcomes of a coin flip. If the coin lands on tails, the subject would win $20. If the coin lands on heads, the subject would lose $20. Despite the flip of a coin being a 50/50 proposition, for most people the amount they could win would need to be twice as large as the amount they would lose before accepting the risk.
As demonstrated by Tversky and Kahneman’s experiment, fear of loss can lead us to irrational decision making. It’s why companies make a small fortune selling extended warranties on electronics and why we are all resistant to raising the deductible on our auto insurance, even though it makes sense. It also likely explains why we spend more time thinking about why the market is due for a correction instead of focusing on why it can continue to rise.
As your partner in wealth management, our goal is to provide you with a full understanding of your financial picture, because when you have a clear understanding of the risks, rewards, and potential outcomes of your plan, we can remove fear from the equation.
Market & Economic Update
By: Nicholas A. Boyer, Chief Investment Strategist
2017 was an eventful year by any standard given extraordinary geopolitical headlines, natural disasters, acts of terror, cyberattacks and the unveiling of an array of disgraceful institutional and individual scandals. While these events brought adversity we will not soon forget, the year also gave us much to be thankful and excited for including a self-sustaining global economic expansion, exceptional financial market performance, an improving outlook for employment and wages, and major technological advancements in science, healthcare, transportation and finance. As we head into 2018 and our intermediate and long-term macroeconomic investment thesis continues to play out, we are encouraged by the improving health of the global economy and stability in financial markets, and yet we remain focused on managing risks across all of our client portfolios. As always, we at RKL Wealth Management are committed to cutting through the noise and hype to bring our clients a thoughtful, disciplined, evidence-based approach to asset management.
Strong Earnings Continue to Trump High Valuations. No Euphoria
On the year, both U.S. and global equity markets generated remarkable total returns, with the S&P 500 delivering 22.5% and the MSCI All Country World Index (ACWI) returning nearly 24.7%. International and emerging market equities indices led the way, with MSCI EAFE returning 25.2% and MSCI Emerging Market Index delivering an incredible 36.9%.[1] Of course, 2017 did nothing to remove the proverbial elephant from the room as valuations of multiple categories of financial assets, specifically U.S. equities, increased to extraordinary levels.[2] Consequently, investors struggled to find explanations as to why valuations don’t seem to matter, as the market continued to grind higher, global equity returns exceeded Wall Street’s most bullish expectations and the S&P 500 increased in all 12 months for the first time in history. Of course the answer, in part, is that companies around the world continue to benefit from steady economic growth, low inflation, modest wage growth and extremely accommodative financial conditions – all of which have driven robust corporate profits. So while valuations matter, earnings were the primary driver of S&P returns in 2017 and given a healthy outlook for 2018 earnings this is likely to continue through the new year. While some pundits and analysts talk about euphoria in the market, investors that we speak with are far more measured and cautious than euphoric, and a number of metrics indicate that sentiment is only now catching up with stronger growth as the economic narrative has changed. [3]
(Source: EvercoreISI: Portfolio Strategy Weekly; December 5, 2017)
The Self-Sustaining Recovery Has Arrived. Accommodative Monetary Policy Remains
Any analysis of the current market must begin with an acknowledgement of the macroeconomic environment which made this performance possible. In what has been most aptly described as “synchronized global easing,” central banks have taken unprecedented measures over the last several years to ease monetary policy, pumping colossal amounts of liquidity into global financial markets. This activity played a key role in driving equity valuations higher, keeping market volatility low and ultimately resulting in the “synchronized global growth” we are now experiencing.[4] Importantly, there are signs that global monetary policy has begun to shift, as the Federal Reserve started unwinding its balance sheet in 2017 and raised the Fed Funds rate for a third time while signaling three potential rate hikes in 2018.[5] Meanwhile, the Bank of England raised rates for the first time in a decade and the European Central Bank indicated it may end its stimulative bond purchasing program in 2018 if the Eurozone economy remains strong.[6]
Nevertheless, while a rapid reversal in monetary policy and favorable financial market conditions represent meaningful risk to economic growth and financial markets in 2018, minutes from the Federal Reserve’s most recent meeting revealed “they saw the incoming information on spending and the labor market as consistent with continued above-trend growth and a further strengthening in labor market conditions,” suggesting Fed officials were less worried about downside risks and more focused on a potential rebound in inflation.[7] Interestingly, while the U.S. economy is currently in its third longest expansion on record dating back to June 2009, there are a number of compelling indicators, including real interest rates, the Leading Economic Index (LEI) and cyclical expenditures, that suggest we are not as late in the economic cycle as some may assume.[8] Moreover, other important economic indicators like the “Big Four,” namely non-farm employment, industrial production, real estate sales and real personal income (ex-transfer receipts), continue to demonstrate steady improvement supporting a strong outlook for growth in 2018.[9]
Capital Is Abundant and Will Continue to Flow into Disruptive Technology
With over $11 trillion (USD) in liquid reserves on central bank balance sheets globally, the world is awash in liquidity.[10] It remains critically important for investors to consider the short and long-term implications of unprecedented levels of liquidity permeating the global economy. As that excess capital continues to search for higher yields and higher short-term returns, perhaps the most obvious implication is the increasing investment in new, disruptive technologies. This is a trend that began well before the 2008 financial crisis and one that some researchers expect will soon result in a tech-driven explosion in productivity and economic growth.[11][12] In their working paper, Brynjolfsson, Rock and Syverson address the productivity paradox – namely the issue that U.S. productivity growth and real incomes have stagnated since the late 90s despite significant investment in technology – and point to a lag in technological implementation and a breakdown in traditional economic statistics as the key reasons for the disconnect. They further note, “going forward, national statistics could fail to measure the full benefits of the new technologies and some may even have the wrong sign.”
Whatever the economic outcome, it’s impossible to ignore the disruptive impact of technology on the investment landscape, as 52% of Fortune 500 companies have disappeared in the last 15 years, while the average lifespan of a company in the S&P 500 in 1955 was 61 years versus only 17 years in 2015.[13] Non-tech incumbents are no longer the largest companies globally, as they continue to lose market cap to major tech companies. Additionally, market analysis further reveals that tech investments by non-tech corporations are on pace to surpass tech investments by actual tech firms, as 51% of Fortune 500 investments into private tech companies have come from non-tech corporations in 2017, up from only 29% in 2014.[13] We believe these signals represent a critically important and perhaps underappreciated theme in the market, and expect global capital to continue to flow into disruptive technologies.
Like Other Digital Assets Before It, Bitcoin Is Here to Stay.
With the recent wave of technological advancements, it’s been nearly impossible to miss the sensational news surrounding emerging financial technologies such as Bitcoin and cryptocurrencies. As always, we want to remind our clients that one of the most important practices of successful investors is to avoid getting caught up in hype and allowing emotions like “FOMO” (Fear of Missing Out) to drive your investing decisions. Nevertheless, it’s important to understand that Bitcoin and other cryptocurrencies are digital assets – a category of assets including things like emails, spreadsheets, word processor documents, digital photographs, presentations and other media – which are hardly new at all. In fact, pioneering researchers have been studying and developing frameworks for using, managing and protecting digital assets for decades.[14]
That said, for those looking to understand Bitcoin and the technology behind it, there is no better place to start than reading the original white paper authored by Satoshi Nakamoto.[15] One might also consider a sound and credible summary of its economic potential penned by legendary entrepreneur, investor and software engineer Marc Andreesen of venture capital titan Andreesen Horowitz. [16] In an New York Times article, Horowitz concludes, “Far from a mere libertarian fairy tale or a simple Silicon Valley exercise in hype, Bitcoin offers a sweeping vista of opportunity to reimagine how the financial system can and should work in the Internet era, and a catalyst to reshape that system in ways that are more powerful for individuals and businesses alike.”
From an investment perspective, perhaps the most cogent and important piece on the subject is a paper by Chris Burniske and Adam White, exploring the investability of bitcoin (lower case “b” references the currency itself, as opposed to Bitcoin the protocol and network) and the consideration of cryptocurrency as a new asset class.[17] The authors introduce many casual observers to some important metrics, including bitcoin’s exchange-traded volumes, which recorded a daily average of $1.5 billion in 2016, reaching over $4 billion during December 2016. Notably, they write, “as of December 30, 2016, bitcoin’s average daily liquidity for the trailing three months was more than threefold the SPDR Gold Shares ETF (GLD) and nearly 10 times that of the Vanguard REIT ETF (VNQ).” While acknowledging bitcoin’s limited history, Burniske and White conclude, “Bitcoin exhibits characteristics of a unique asset class— meeting the bar of investability, and differing substantially from other assets in terms of its politico-economic profile, price independence and risk-reward characteristics.”
As always, we caution investors against investing in any asset class, cryptocurrencies or otherwise, that they do not fully understand. Additionally, we currently make no recommendations as to the advisability of buying, selling or holding any cryptocurrencies. Nevertheless, we note that from the standpoint of a prudent investor, ignoring the emergence of a potentially transformational asset class is a decision as precarious as ignoring the technological disruption that is occurring throughout the world and economy.
Outlook Positive: Financial Markets and Global Economy Remain Strong
Ultimately, improving global economic conditions in the U.S. and other key economies including China, Japan and the broader Eurozone have improved investor sentiment and provided further support for global equities. As we’ve noted previously, while equity valuations remain high and a market correction is always possible, we believe the merits of a correction (10% sell off) or a major market reversal remain unconvincing given the current economic landscape, the accommodative nature of global monetary policy and the strong outlook for corporate earnings. Still, we remain cognizant of the risks to investor portfolios, particularly in bond markets as inflation and interest rates rise, and we will continue to improve credit quality and manage fixed income portfolios accordingly. As always, we will be closely monitoring developments in financial markets and the economy, and encourage our clients to reach out at any time to discuss our strategy and individual circumstances in further detail.
1 Bloomberg Market Monitor
2 Bloomberg Intelligence
3 EvercoreISI: Portfolio Strategy Weekly; December 5, 2017
4 Federal Reserve Bank of Cleveland: The US Economy and Monetary Policy; January, 2016
5 Goldman Sachs: As Good As It Gets; November, 2017
6 Reuters: ECB may end bond buying in 2018 if economy stays strong: Nowotny; January, 2018
7 Capital Economics: U.S. Rapid Resonse – Fed Minutes (Dec); January, 2018
8 EvercoreISI: Morning Economic Report; December 15, 2017
9 Advisor Perspectives: Big Four Economic Indicators: Real Personal Income in November; Jill Mislinski, December 2017
10 Bloomberg Intelligence
11 Brynjolfsson, Erik and Rock, Daniel and Syverson, Chad, Artificial Intelligence and the Modern Productivity Paradox: A Clash of Expectations and Statistics; November 2017
12 Wall Street Journal: A Tech-Driven Boom Is Coming; Please Be Patient; December 2017
13 CBInsights: Fortune 500 Tech Investment and M&A Report; August 2017
14 Nick Szabo, Smart Contracts: Building Blocks for Digital Markets, 1996
15 Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, 2008
16 New York Times Dealbook: Why Bitcoin Matters; Marc Andreesen, January 2014
17 Burniske, Chris and White, Adam, Bitcoin: Ringing The Bell For A New Asset Class, January 2017
New Tax Law: Top-Level Impacts for Businesses and Individuals
By Robert M. Gratalo, CPA, MST, Partner and Leader of RKL’s Tax Services Group
The U.S. tax landscape will undergo significant changes, with the sweeping overhaul bill on its way to the president’s desk for signature. At RKL, our tax team has been monitoring this tax overhaul push through its various forms and stages. The new law is sizeable and complex, so we’ve assembled a quick primer on some high-level takeaways for business and individual taxpayers.
An important point about this bill is that some of its provisions are temporary, while others are permanent. Without additional legislative action, some of the tax breaks and benefits in this bill will expire in the future.
Key Individual Provisions
Reduced Tax Rates
The new law temporarily adjusts the individual income tax rates. Previously, the rates were 10, 15, 25, 28, 33, 35 and 39.6 percent. Starting in 2018, the rates will be 10, 12, 22, 24, 32, 35 and 37 percent. These rates will return to previous 2017 levels after 2025. The IRS recently announced that it will issue updated guidance next month on withholding under the new law (Notice 1036).
AMT Retained, Exemption Temporarily Increased
While the individual alternative minimum tax (AMT) remains in the new tax law, there are some alterations, including a temporary increase through 2025 of the exemption amount to $109,400 for joint filers and $70,300 for all others (excluding estates and trusts). The exemption phase-out level is also raised to subject income of $1 million and above (joint filers) and $500,000 (all other filers) to AMT. These amounts will be adjusted annually for inflation.
Standard Deduction Doubled
The law nearly doubles the standard deduction. For married taxpayers filing jointly, the standard deduction rises to $24,000; for head-of-household filers, it increases to $18,000; and for individual filers, the amount jumps to $12,000.
The standard deduction increase is intended to offset another component of the law – the elimination or reduction of many tax credits and deductions. Many taxpayers who previously itemized deductions may now fall under the standard deduction threshold.
Numerous Deductions and Credits Changed
As with the new tax rates, all changes made to individual tax credits and deductions are temporary and generally expire after 2025.
Starting in 2018, the mortgage interest deduction is reduced to mortgages of up to $750,000, from a previous $1 million level. Second home mortgage interest is still deductible, within the limit listed above, but deductions of home equity loan interest are now disallowed.
The combined deductibility of state and local income taxes, sales tax in lieu of income taxes and real estate taxes is capped at $10,000, starting in 2018. The law also disallows a 2017 deduction for the prepayment of state and local taxes attributable to taxable income earned in 2018 and beyond.
Miscellaneous itemized deductions, including professional service fees, are repealed under the tax bill. The deduction for medical expenses, however, remains and is temporarily lowered for tax years 2017 and 2018 to a threshold of 7.5 percent of adjusted gross income.
Under the new law, alimony payments are no longer deductible, nor must the recipient report such payments as income.
Child Tax Credit Doubled, Eligibility Expanded
The law temporarily doubles the child tax credit from $1,000 to $2,000 per child, with up to $1,400 of the total amount refundable. The adjusted gross income (AGI) phase-out thresholds are also raised, starting at $400,000 AGI for joint filers and $200,000 AGI for the rest. An additional $500 nonrefundable credit for dependents other than children was also introduced in the new law.
Estate, Gift Tax Exemption Doubled
While previous iterations of the tax legislation proposed a full repeal of the estate tax, the bill signed into law instead doubles the exclusion amounts for estate and gift taxes, effective January 1, 2018. This doubled exclusion sunsets after January 1, 2026.
The maximum federal estate tax is 40 percent for tax year 2017 remains in place moving forward. The estate and gift exclusion amount for married couples, however, increases from $10.98 million in 2017 to $22 million in 2018. In future years, the $22 million joint exclusion will be adjusted annually for inflation.
Individual Mandate Repealed
The tax law repeals the individual shared responsibility requirement of the Affordable Care Act by reducing penalties assessed after 2018 to $0. The IRS recently cautioned that returns submitted for tax year 2017 that do not report full-year coverage, report a shared responsibility payment or claim a coverage exemption will be rejected as incomplete and inaccurate.
Key Business Provisions
Corporate tax rate reduced, excluded from AMT
The tax law permanently reduces the corporate tax rate from 35 to 21 percent, and also excludes corporations from AMT.
Asset Purchase Tax Benefits Expanded
Under the new law, bonus depreciation doubles from 50 to 100 percent for property purchased between September 27, 2017, and January 1, 2023 (or January 1, 2024, for a small category of property). After that date, at 20 percent phase-down takes effect. Also, bonus depreciation amount is now permitted for the purchase of used property, in addition to new property.
The tax law also raises the cap on depreciation write-offs for business-use vehicles (now including passenger automobiles) purchased after December 31, 2017. The new cap schedule is: $10,000 (up from $3,160) for the first year a vehicle is used; $16,000 (up from $5,100) for the second year; $9,600 for the third year (up from $3,050); and $5,760 (up from $1,875) for each remaining year until all costs are fully recovered.
The Section 179 expensing limitations under the new law are $1 million (dollar) and $2.5 million (investment).
Favorable Treatment for Pass-Through Businesses
Generally taxed at the top individual rate, owners of so-called “pass-through” entities – partnerships, S corporations, most LLC’s, and sole proprietorships – are permitted to deduct 20 percent of qualified income, subject to variety of qualifications and limitations.
Small Business Expansion
The definition of “small business” has been expanded to include many companies with average annual gross receipts of less than $25 million, allowing these taxpayers to take advantage of several favorable tax accounting rules previously only available to taxpayers with under $10 million of gross receipts.
One-Time Repatriation Tax
In addition to systemic changes to the taxation of multinational companies, the new law imposes a one-time reduced tax on overseas-held earnings and profits: 15.5 percent for cash and 8 percent for illiquid assets.
In addition to these top-level impacts, the new tax law alters a number of other tax policies, deductions and strategies. Over the coming weeks and months, RKL will drill down into the changes and assess the impact to various industries and segments of the business community, so be sure to sign up for RKL’s monthly e-news, follow us on LinkedIn and stay tuned to rklcpa.com.
As always, contact your RKL tax advisor or one of our local offices with any questions.
Notable 2017 Deadlines and Updates for 2018
Don’t Forget!
The deadline to make 2017 contributions to Traditional and Roth IRA accounts is April 17, 2018. Limits for 2017 and 2018 contributions are $5,500 with an additional catchup contribution of $1,000 for taxpayers age 50 and up.
For self-employed individuals, 2017 contributions to SEP-IRA and Individual 401(k) accounts can be made up until the due date of the individual tax return, including extensions which is October 15 in 2018. However, contribution limits depend on income earned in 2017.
Tax rates on qualified dividends and long-term capital gains
Amended tax brackets for 2018 mean that the 20% top tax rate for qualified dividends and long-term capital gains will kick in for joint filers with taxable income above $479,000. The same rate applies to singles earning more than $425,800. It is a 15% tax rate for the remaining income level.
Singles with taxable income below $38,600 and joint filers below $77,200 will pay no tax on qualified dividends and long-term capital gains in 2018.
Retirement Plans
Maximum employee contributions to 401(k), 403(b), and 457 plans received a slight increase to $18,500 in 2018 or $24,500 for those 50 and older.
SIMPLE IRA contributions in 2018 remained the same at $12,500 or $15,500 for those 50 and older.
The total contribution limit for defined contribution plans increases to $55,000, not including catchup contributions, and plan contributions can be based on up to $275,000 of salary.
IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. The information and data contained herein was obtained from sources we believe to be reliable but it has not been independently verified. Past performance is no guarantee of future results.
RKL Wealth Management LLC is a registered investment adviser. To learn more about how we can help you meet your goals, please contact our office at (717) 399-1700 or via our website, rklwealth.com. Additional information is available upon request.
© 2018 RKL Wealth Management LLC – All rights reserved.