Protect Financial Goals by Avoiding Lifestyle Creep and Living within Your Means
With another holiday season in the books, many of us may be facing bigger bills from the extra expenses around gifts and festivities. Thankfully, January is the perfect time to reflect and revaluate current finances and future financial goals.
It may go without saying but making money is much easier than making money last. Look no further than the Forbes 400 World’s Richest List. Seventy percent of the individuals or families who made the list between 1982 and 2014 have lost their status. Falling off the list is rarely attributed to poor investment choices, but rather lifestyle choices and the result of “lifestyle creep,” the problem of spending disproportionately more as one’s income increases.
High income is not the same as wealth
Lifestyle creep can happen to anyone. Time and time again the story is the same. A person comes into a sum of money via an inheritance, their career, a business, winning the lottery, etc., and then proceeds to spend through the sum (often rapidly) and is back to square one. Take an example from one of this year’s top celebrity victims, Johnny Depp. Having made over $650 million dollars through his acting career thus far, he is all but bankrupt. Lack of budgeting and financial management allowed him to feel comfortable spending whatever he wanted. It is easy to often think that the money will never run out, especially with as large an amount of income as Depp had at his disposal, but this false sense of security and lifestyle creep has led to a suggested unsustainable $2 million per month spending lifestyle.
While our bank accounts may not rival Depp’s, living beyond one’s means can happen to anyone, is not sustainable and will not create a bright retirement future. We can, however, move in a positive direction for our retirement and financial future by keeping ourselves on track with some checks and balances based on goals and prioritization.
Best practices to prevent lifestyle creep
- Start each year by defining your big-picture financial goals, and then set a realistic amount needed to obtain them. It is important to note that these financial goals should not be defined by how much income remaining at the end of the month. Simply because there is extra cash does not mean you can afford to spend it!
- If extra funds become available throughout the year, consider whether they are needed to reach your goals. It may be tempting to book a dream vacation but those funds would be better dedicated to goals like retirement or saving for college.
- Means test your retirement savings by imagining how life would be if you stopped working today. We frequently see the effects of the transition from employment to retirement, and it is much harder to spend less than one is accustomed to in their lifestyle than to spend more.
- Living within your means also includes maintaining discipline when your income increases. It is easy to change your spending habits with more income; just ask Depp. Although some items may seem trivial, the little things in your lifestyle do add up. For instance, taking your snack from nachos to a full-blown artisanal cheese board is a significant difference in cost. It is important to remember that you will be living off self-funded savings in retirement, which may not line up with your lifestyle during your highest-earning years.
- The easiest way to save money is to not get used to having extra cash. Automate as many savings processes/contributions as possible in order to limit the amount of “spending money” every month. See if that raise or bonus can go directly to a dedicated saving fund or try automated annual increases in your retirement contributions. If you do not see the entire sum of extra income in your checking account, you will not miss it.
Sticking to your financial goals, automating savings and adopting greater discipline and humility will ward off lifestyle creep and help you live within your means without letting your current lifestyle dictate your retirement.
Retirement contribution limits increase in 2019
There’s good news for retirement savers! In November 2018, the IRS announced cost of living adjustments that affect retirement contribution limits for tax year 2019.
IRAs:The annual IRA contribution limit increased from $5,500 to $6,000, the first increase since 2013. The additional catch-up contribution limit for those aged 50 and over remains $1,000.
The deductible amount of a traditional IRA contributions are subject to income limitations if the taxpayer or their spouse are covered by an employer-sponsored retirement plan. The phase-out ranges have been increased for 2019 as follows:
- For single taxpayers, the phase-out range is $64,000 – $74,000 (increased from $63,000 – $73,000)
- For married couples filing jointly, the limit depends on which spouse is covered by the employer plan. If the taxpayer making the IRA contribution is covered, then the phase-out is $103,000 – $123,000 (increased from $101,000 – $121,000). If the IRA contributor is not covered, but their spouse is covered by an employer plan, then the phase-out is $193,000 – $203,000 (increased from $189,000 – $199,000)
- For a married individual filing a separate return, the phase-out remains unchanged at $0 – $10,000.
Individual are eligible to contribute directly to a Roth IRA if their modified adjusted gross income is less than $122,000 for singles and heads of households or $193,000 for married couples filing jointly. The phase-out ranges are $122,000 – $137,000 for the former and $193,000 – $203,000 for the latter. There is no change for married individual filing a separate return, whose phase-out remains $0 – $10,000.
401(k), 403(b), Profit-Sharing Plans, etc.: Elective deferral limits increased from $18,500 to $19,000. The catch-up contribution limit for those aged 50 and over remains $6,000. Defined contribution limits increased to $56,000, up from $55,000. This is based on the annual compensation limit of $280,000 (increased from $275,000). 457 Plan elective deferral limits increased from $18,500 to $19,000.
SEP & SIMPLE Plans: The maximum SEP contribution increased from $55,000 to $56,000, with the minimum compensation unchanged at $600 and the maximum increased from $275,000 to $280,000. The maximum SIMPLE contributions increased from $12,500 to $13,000. The catch-up contribution limit for those aged 50 and over remains $3,000.
|IRA Contribution Limit||$6,000||$5,500|
|IRA Catch-Up Contribution||$1,000||$1,000|
|IRA AGI Deduction Phase-Outs if Covered by Employer Plan|
|Married Filing Jointly||$103,000-123,000||$101,000-121,000|
|Single or Head of Household||$64,000-74,000||$63,000-73,000|
|Married Filing Separately||$0-10,000||$0-10,000|
|IRA AGI Deduction Phase-Outs if Spouse is Covered by Employer Plan|
|Married Filing Jointly||$193,000-203,000||$189,000-199,000|
|401(k), 403(b) Elective Deferral||$19,000||$18,500|
|401(k), 403(b) Catch-Up Contribution||$6,000||$6,000|
|401(k), 403(b) Defined Contribution Limit||$56,000||$55,000|
|401(k), 403(b) Annual Compensation||$280,000||$275,000|
|457 Plan Elective Deferral||$19,000||$18,500|
|SEP Maximum Contribution||$56,000||$55,000|
|SEP Minimum Compensation||$600||$600|
|SEP Maximum Compensation||$280,000||$275,000|
|SIMPLE Maximum Contribution||$13,000||$12,500|
|SIMPLE Catch-Up Contribution||$3,000||$3,000|
Market & Economic Update
By: Nicholas A. Boyer, Chief Investment Officer/Executive Vice President
Last quarter we described what we believed was a meaningful gap between perception and reality regarding the health of financial markets and the economy. In the fourth quarter of 2018 this gap widened significantly. Despite enjoying the second-longest economic expansion in U.S. history, in which gross domestic product (GDP) will achieve a year over year increase of greater than 3.0% for 2018, U.S. and global equity markets declined significantly on the quarter, ending the year in negative territory.
On a total return basis, the S&P 500 Index declined -13.5% in the fourth quarter and -5.2% for 2018. The declines in total return for both the Russell Midcap Index and the Russell 2000 Index (Small cap) were even more pronounced at -15.4% and -20.2% in the fourth quarter and -9.9% and -11.7% for the full year, respectively. Meanwhile, foreign equity markets didn’t fare much better, as the total return for the MSCI EAFE Index (International Developed) declined -12.5% in the fourth quarter and -13.79% for the full year. The MSCI Emerging Markets Index returned -7.6% in the fourth quarter, and declined -14.8% for 2018.
Nevertheless, it’s important to acknowledge that asset class diversification served investors well over the last quarter, as higher credit quality bonds – specifically U.S. Treasuries (+2.7%), U.S. Agencies (+1.1) and Municipals (+1.7%) – all performed well, delivering positive total returns and serving to reduce risk and provide balance to global equity exposures amidst the sell-off.
Investors Lost Their Courage in 4Q and Monetary Tightening Was The Culprit
Since 2008, asset prices around the world have risen continuously with very little volatility as global central banks expanded their balance sheets. This low interest rate environment made the cost of borrowing historically cheap, and with liquidity readily available to investors across the globe it boosted investor confidence, creating what has been referred to as the “Fed put.” This provided investors a strong incentive to invest in all manner of risk assets, including equities, higher yielding fixed income and other more exotic asset classes. Now that central banks have begun to unwind those easy monetary policies – including the Federal Reserve, which continues to increase interest rates while running off its balance sheet – it should come as no surprise that markets for risk assets globally have begun to react. After a considerable period of extraordinarily low volatility, 2018 marked a sea change as episodic volatility returned to the market.
Importantly, this most recent bout of volatility began in September, with the Federal Reserve removing the word “accommodative” in describing its policy. This was followed by Fed Chair Jerome Powell’s comment in October that interest rates were “a long way from neutral,” suggesting more rate hikes were on the horizon. Then in December, the Federal Open Market Committee (FOMC) raised interest rates again by .25% for the fourth time in 2018. So while a U.S.-China trade dispute that can’t seem to find its way out of the headlines and a meaningful drop in oil prices have certainly hampered investor sentiment, we believe it’s monetary tightening that ultimately robbed investors of their courage. Most recently, as noted by Bespoke Investment Group, “sentiment took an overwhelmingly bearish tone following steep market declines on the FOMC’s rate decision, Fed Chair Powell’s ill-received presser, and a remarkably bad Christmas Eve trading session.”
But Fundamentals Haven’t Changed and The U.S. Economic Super Cycle Continues
Still, despite incredibly negative headlines over the last two years including market pundits lining up to warn about the end of the current economic cycle and a looming recession, we have continued to remind investors that the most important economic indicators, particularly U.S. labor, wage and consumption data, remain remarkably strong. Once again, the most recent economic release showed this strength, as job growth surged in December, handily beating even the most optimistic forecasts while soundly shattering the notion of an impending U.S. recession. Specifically, nonfarm payrolls rose 312,000 in December, bringing the full year nonfarm payroll increases to 220,000 per month in 2018, well above the post-crisis trend. While the headline unemployment rate actually rose to 3.9%, it was primarily due to an unexpected surge in labor force participation – a surprising positive increase in a metric that naysayers have often pointed to as problematic for the economy. Meanwhile, average hourly earnings – a vital indicator of wage growth – rose 0.4% in December and was up 3.2% from a year ago.
As we’ve noted, the consumer accounts for roughly 70% of U.S. GDP and therefore represents an important driver of global economic growth. By all measures, consumption growth remains on track in 2019, supported by healthy income growth, a high personal savings rate and resilient consumer confidence. Additionally, strong business investment growth should continue, supported by steady consumer demand growth, generally easy credit conditions and solid business confidence. While further escalation in the trade dispute with China appears likely, to date it has had only a modest impact on economic activity, and we expect that ongoing strength in all of the economic areas noted above should limit most of the adverse effects of trade on the U.S.
economy. Ultimately, a strong consumer and business investment environment will continue to drive robust economic growth in the U.S. in 2019, and should also provide meaningful positive spillover effects for the global economy.
What Should Matter To Investors Going Forward
While market sentiment collapsed in the last week of 2018 as the S&P 500 closed on Christmas Eve down -19.8% from its September 20 peak, it’s worth noting that as of the time of writing, in less than two weeks, the S&P 500 has rallied back 7.7% from its December 24 low. This kind of volatility certainly challenges investor convictions, but also provides us with an opportunity to reflect on the reality that while equity markets can (and have) delivered incredible returns, those returns don’t come without significant risk. In fact, given that 2018 was a midterm election year, it’s worth considering research which shows that in midterm election years since 1950 the S&P 500 experiences a -17% drawdown (decline from peak to trough) on average, and yet the year following those drawdowns delivers incredible returns for disciplined investors to the tune of a 32% increase on average (see chart below).
Still, there is no way to be certain of how the market will fare in the future, although we have a number of reasons to be optimistic about equity markets in 2019. For one, following the market volatility in 2018, U.S. equity valuations now look much more attractive for new buyers, as the S&P 500 is now trading around 15x forward earnings – a meaningful discount to its historical and ten-year averages. But more importantly, corporate earnings remain strong and are still growing, as earnings per share (EPS) for the S&P 500 are expected to be up 33% in 2018, and even conservative estimates forecast at least 8% for earnings growth in 2019. From the current level on the S&P 500, these earnings estimates would provide for significant upside in price at most reasonable valuations. Meanwhile, cash continues to build up on corporate balance sheets, as companies in the S&P 500 reported a total of over $5.4 trillion in cash and marketable securities in their most recent filings. While many companies have increased their capital investment, other companies have been returning substantial capital to shareholders over the last several years, with $433.6 billion in share repurchases during the 2nd quarter of 2018, nearly doubling the previous record of $242.1 billion in the first quarter. Based on the most recent filings, all indications are for that trend to continue in 2019.
For reasons we’ve noted in the past, U.S. assets – specifically equities – have delivered the most attractive returns in the world. Given the current economic data and the outlook for corporate earnings we see no reason for that to change in 2019. Yet, we note that valuations in international and emerging markets equities still appear attractive, and we remain committed to globally diversified equity portfolios. Additionally, we note that recent market activity further emphasizes the importance of the role of bonds in an investor’s portfolio – particularly during times of increased equity market volatility – and we will look to continue to improve and maintain credit quality in our fixed income portfolios. As always, we will closely monitor developments in the economy and financial markets and we 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 Market Monitor
3 Federal Reserve Bank of Cleveland: The US Economy and Monetary Policy; January, 2016
4 Druckenmiller, Stanley F. and Kevin Warsh. “Fed Tightening? Not Now”, Wall Street Journal, December 17, 2018.
5 Bespoke Investment Group. “Bulls Come Crawling Back,” January 4, 2019
6 Bloomberg Intelligence
7 Sonders, Liz Ann. “2018 Mid-Year U.S. Equity Outlook,” Charles Schwab, July 2, 2018
8 Bloomberg Intelligence
9 Bloomberg Intelligence
10 Hennessy, Niel J. “Outlook 2019: Stay the Course,” Hennessy Funds. December, 2018
Welcome to RKL Wealth Management: Andrew Kurtz
We are proud to introduce Andrew M. Kurtz as RKL WM’s newest Planning Analyst. In his new role, Andrew works closely with clients to help them meet their financial goals. Andrew joins RKL WM from the Audit Services Group of RKL LLP, where he spent a year auditing clients in various industries and recently passed the CPA exam. During college, he completed an internship with a financial advisory firm in the Lehigh Valley. Andrew holds a B.S. in Accounting from Bloomsburg University and currently resides in Bethlehem, PA.
Minimizing the Impact of Kiddie Tax Under Tax Reform
2018 ushered in a host of new individual tax provisions, courtesy of the Tax Cuts and Jobs Act. In particular, families will notice different tax treatment of the unearned income of their children, known as the Kiddie Tax. Read the full post on rklcpa.com that examines what’s changed with the Kiddie Tax under tax reform and flag planning strategies to minimize this levy.
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.
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