A Trip Down Robinhood Lane

I’ve written several times about the rise in retail day trading last year but, frankly, I am surprised at how many people jumped on the bandwagon in recent months. Millions of new taxable brokerage accounts (industry jargon for not being a tax-deferred retirement account) were opened last year, many in the final quarter, and many of those were opened by Robinhood, the upstart firm that’s been in the news so much lately.

Now, I’ll freely admit to admiring the firm’s espoused principles of making investing and financial education accessible to everyone regardless of net worth. This is laudable and necessary, I think, for a variety of reasons. For one, a large portion of the adult population doesn’t own stock or even have enough in savings to cover an emergency $1,000 expense. Getting those people as much financial knowledge as possible as quickly as possible would benefit the entire country. I don’t know that these folks need to jump right into trading stocks on their iPhone, however.

I also admire how the firm shook up the industry back in late-2019 by offering free stock trading. Other major firms quickly followed and we’re now at a place where investors can buy and sell most investments without paying a trade commission. This dramatically lowered the barrier to entry for new investors. It was also destabilizing in other ways but was still positive, I think, on balance.

The issue I have with Robinhood (and other companies like it) is the so-called gamification it employs to reel you in and hold your attention. This gins up enthusiasm among its customers, at least half of whom are apparently brand-spanking-new to the complex world of investing. From what I understand, the education provided by the firm drives new customers toward trading as opposed to more, shall we say, boring but sound investment strategies.

Robinhood makes more money when its client’s trade more frequently, so it naturally leads me to be a bit skeptical of the “we’re out here for the little guy” routine. Robinhood then sells client orders to third parties to the tune of hundreds of millions in annual revenue, so the firm isn’t in the buy and hold business. In other words, the free trading I just mentioned should be thought of as more of a freemium. It’s the free drinks while playing the tables at a casino. To be fair, this sort of thing isn’t unique to Robinhood. All the major brokerage firms make money like this, just perhaps with less confusion about the firm’s motives.

We know that gamification impacts our psychology, but it can easily be downplayed as something that happens to other people. Along these lines, here’s an article from Jason Zweig, The Intelligent Investor, at The Wall Street Journal. This is from December and I had wanted to bring it up then, but other things took priority. Anyway, check it out for an illuminating look at how easy it is even for the well-informed to get sucked into the Robinhood platform. It should be read as a cautionary tale, even though for Mr. Zweig it was a reporting assignment with little money at risk. Many haven’t been so lucky, and they won’t be the last.

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Saving for Retirement in 2021

Last week I wrote about some important 2021 updates for folks of a certain age who are taking distributions from their retirement accounts. But how about everyone else who’s still scratching and clawing to save enough to eventually retire?

There weren’t many twists and turns in recent Acts from Congress for those actively saving for retirement. Instead, most of the changes were aimed at people who lost their jobs or were (and maybe still are) impacted financially by the pandemic. Understandably, saving for retirement when you’re just trying to put food on the table is hard to do, if not impossible. For those lucky enough to be able to save, however, there are still critical numbers to be aware of in the year ahead.

Here’s a simplified list covering most situations.

The annual contribution maximum for Individual Retirement Accounts (IRA) is $6,000. Those 50 or older get an extra $1,000 of room for a total of $7,000.

Your income needs to be below a certain threshold to deduct Traditional IRA contributions on your tax return. These are listed below as ranges because deductibility phases out as your income goes higher.

Single individuals (and filing as such with the IRS) can make from $66,000 to $76,000 if they also contribute to a retirement plan at work.

Those who are married and filing jointly can make from $105,000 to $125,000 if they’re also participating in plans at work. If one spouse isn’t, the income threshold jumps to $198,000 to $208,000.

For contributing to Roth IRAs, it’s single filers at incomes from $125,000 to $140,000 and others who are married and filing jointly at $198,000 to $208,000. There’s no tax deduction for Roth contributions, so that’s why the thresholds are higher.

As a reminder, you can contribute to a Traditional IRA and a Roth for the same tax year, but it’s still the one annual maximum between the two.

401(k) plans are set up through your employer (or yourself if you’re self-employed) and have different maximums. For 2021, individuals can save up to $19,500 if they’re younger than age 50. Otherwise, you get an extra $6,500 of room to save. This doesn’t include any matching dollars received from your employer, so you could end up saving more after all’s said and done.

But what kind of investment outlook would you be saving into? I’m going to risk omitting important details to provide a brief rundown of where things stand right now with the markets.

Stock prices are elevated but performance across market sectors has been uneven. Certain tech and pharmaceutical stocks have been riding high for obvious reasons and you’ve likely heard about current market darlings like Tesla and even cryptocurrencies like Bitcoin. Those shares have been volatile while seeing their prices rise astronomically in recent months. Stories have been in the news about folks lucking into these huge runups and paying off their mortgage, buying lots of bling, and so forth. Another, GameStop, the gaming store, is currently in the news because it’s share price has risen almost 170% in the past week and over 2,000% since July!

There will always be these kinds of stocks and these sorts of stories. The characters are primarily short-term speculators in options and “short-sellers” who can lose almost as much as they gain, if not more. They typically play with borrowed money as well. Margin debt, or money borrowed against stocks to buy more stocks, is at extremely high levels. GameStop, for example, is riding the wave of borrowed money and options investors who cumulatively have way more “interest”, as it’s called, in the stock than is available to buy in the markets. This means that while some short-term traders can make a killing, most will lose their shirt. It’s like the childhood game of musical chairs except all the chairs can be pulled out at once. But this craziness isn’t impacting the whole market yet.

Instead of all this day-to-day craziness, be a long-term investor. It ain’t easy, however. The S&P 500, the major stock index seen as a proxy for the US market, is trading at about 31x the annual earnings of its average company. This is higher than the 20x long-term average, but not the highest ever. Part of what’s driving this high level is expectations for more relief money from Congress and continued support from the Federal Reserve. Don’t fight the Fed, as the saying goes. We could easily add Congress to that saying, at least in the near-term.

Households have also been savers during the pandemic, on average holding a record amount of cash per person by some estimates. We don’t live in the average, of course, and this number is probably skewed to the uber-wealthy who have been hoarding cash. The point is that there’s a lot of savings sitting around right now. This money, plus pent-up demand from nearly a year of pandemic life, plus more Government stimulus, will eventually enter the economy at some point. Hopefully this year but certainly by next. That’s what many investors are expecting, at least, and that’s the main reason prices are elevated right now.

There’s lots of risk to this outlook, however. Millions are still unemployed and many of those jobs won’t be coming back anytime soon. Millions are also delinquent on their rent and mortgage without the means of paying it all back. And the nation is now vaccinating about 1 million people per day over the past week, but it could be many months before all who want to be vaccinated are. The psychological impacts of all this, both positive and negative, will continue to play out in the economy for some time.

Could investors be getting ahead of themselves in their rosy outlook for corporate earnings? Certainly. Is there likely to be volatility this year as plans for more government spending run into opposition and inevitable issues arise with vaccine distribution? You bet. Will there be one or more unanticipated shocks to the system this year? Plan on it. Will short-term trading equal long-term wealth accumulation for many of the folks playing in the markets right now? Probably not.

So, with that dose of realism, as you look ahead to saving for retirement remind yourself that the real money in investing is made over the long term. Your regular contributions, dividends earned, and compounding will work with the highs and lows of the markets over time. As the saying goes, it’s time in the markets and not timing the markets that makes for successful investing.

Have questions? Ask me. I can help.

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Planning is Still Important

I don’t think anyone really expected that changing the calendar would radically improve our situation. Still, that sense of optimism that typically comes with a new year is facing stiff headwinds as we emerge into 2021. Personally, I’m trying to remain hopeful while also doubling down on controlling those few things that can be controlled.

One of those things is planning. Yes, it’s difficult to plan amid all this chaos but it’s important to think about financial planning specifically as a process, not an outcome. The process is helpful, even necessary, as it helps us understand our options in a rapidly changing environment. So, if you’ve been in your foxhole for a while (which is entirely rational, by the way… I’m thinking of redecorating mine…), maybe now or sometime soon is a good time to peek your head out and assess the situation and what, if anything, has changed for you.

It’s easy do this virtually. I use GoToMeeting and Zoom so we can choose the most appropriate platform for you. We can also just chat via phone or even indulge in a lengthy email string. Whatever method we choose, don’t let your financial questions (or anxieties) fester too long. I’m here to help.

Along the lines of things to think about for the year, here are some parts of a recent piece from Schwab. Most of the issues raised are ongoing, of course, like dealing with holding cash at low interest rates and trying to wait on drawing Social Security. But tax uncertainty and retirement account changes will likely come up soon. The article is a good summary of the financial planning outlook at this point.

Click the link below to continue reading…

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A Mild Rant

By now you’ve likely heard about what some news outlets are making out to be a David vs Goliath sort of battle playing out in the stock market. Day traders (The Little Guy) are battling short sellers (big institutions, or simply Evil Incarnate) by pushing up values on a handful of stocks like GameStop and AMC movie theaters, even Bed Bath & Beyond.

Prices are currently far beyond reasonable for these stocks. It would be perilous at best to enter the fray, but oddly enough people still do, either lusting for a quick buck or trying to avoid the dreaded FOMO, or both. Ordinarily this kind of thing would end with people paying big fines or even going to jail for market manipulation, but nothing seems normal these days.

It’s unsettling for investors when stories like these make national headlines because, among other things, it causes reasonable people to wonder about the health of markets. What does it say about the system if stock prices can be swung around to this extent by people in online chat rooms? If they get together and agree to buy shares of a company’s stock in coordinated fashion to drive the price up, for whatever reason, shouldn’t that be illegal? If they can do it, why couldn’t anyone? Among the many problems with this is it seems to confirm what many already think: the system is rigged. It’s rigged by others who hoard all the goodies and only share with their friends. Except now it’s not only the Fat Cats on Wall Street gaming the system, but also retail investors congregating on sites like Reddit and elsewhere.

The “rigged” narrative is applied to many aspects of our society of late and it’s a shame that it’s also used to describe markets, but it’s true. Or at least partly true.

The true part has to do with exactly what we’ve been seeing with this group of stocks. Prices rose because a lot of day traders made a concerted effort to make them so. Previously, stocks like GameStop were heavily “shorted”, meaning investors such as hedge funds were (and still are) betting against them because they think the share prices will fall. Other traders started fighting this and, over time, many more followed the herd to create a “short squeeze”, or pressure on those firms betting against the stocks by driving up share prices and forcing the shorts to ante up more cash or simply sell at a loss. Regardless of their original intentions (some allude to the nobility of finally sticking it to the hedge funds, and that sort of thing), this is market manipulation, or rigging the system, and it happened in broad daylight.

Many of these traders follow, whether they admit it or not, something referred to as the Greater Fool Theory. The idea is that one could pay a ridiculous price for a stock today because some poor schmo would always be willing to pay more later. We know that throughout history this sometimes works for a little while and is where the theory came from, of course. It’s also what keeps people coming back for more. But most end up being too late and, ironically, become the fool they sought to fleece in the first place. 

Ultimately, it’s clear to just about anyone that prices can be manipulated in the short term through a variety of means, including this latest example. But all is not lost. As I mentioned last week, the real money in investing is made over time, through diligence and patience. Many today have a holding period of moments or days. Instead, think in years and decades. There will from time to time be those who luck into making a lot of money in a short period. History shows us those folks often end up losing their gains eventually because they lack a strategy and the discipline to carry it out. In other words, there are no shortcuts, only scams masquerading as effective strategies that usually end up making someone else rich.

Speculation is as old as time and it’s important to know when too much is exactly that. Lots of people out there in the markets right now have no idea what they’re doing. They think investing is a game. Some brokerage firms and the media reinforce this to make money (what a shocker).

For the rest of us, we’ll try to leave the shorts and other forms of trader behind. Their antics make for interesting reading and, yes, sometimes anxiety in the markets. But as long-term investors we’ll focus on controlling that which can be controlled and the truth that, over time, markets are efficient and always come back to financial and economic principles. That way we can have the best shot at de-rigging the game by not playing it like one in the first place.

Have questions? Ask me. I can help.

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Changes for RMDs and Other Takeaways

If you’re anything like me, it’s a busy time right now; “busy” in all senses of the word. There’s a lot to think about and much to do as we work to get back to life pre-Covid. It’s understandable if investing topics may not be at the top of your list. Assuming this to be the case, here’s a brief rundown of some of the important updates at this point in 2021 for folks currently drawing from their retirement accounts.

Two recent Acts passed by Congress made important changes for those 70 ½ and older. For years this had been the age when Required Minimum Distributions (RMD) needed to start being withdrawn from tax-deferred retirement accounts like 401(k)s and IRAs. These distributions remain based on average life expectancy and the money is taxed as income in the year withdrawn.

The SECURE Act passed a couple of years ago changed this beginning age to 72. Then last year Congress passed the CARES Act that, in part, allowed savers to skip taking their RMDs in 2020 if they wanted to. The idea was to not require investors to tap their portfolios when their investments may have been losing money during the market’s response to the pandemic. In practice, however, most retired folks of RMD age had to take distributions because they needed the money. But deferring an RMD presented an opportunity for others to save on taxes and let their savings continue to work in the markets.

That has changed for 2021. The starting age for RMDs is still 72 but there’s no deferral, so you must take your RMD this year. It’s early days yet, of course, and this could change with new legislation, but it’s unlikely. Stocks and bonds are up handily since the CARES Act was passed last March, so the original intent behind RMD deferral isn’t an issue. At least not currently.

Just in case, however, you can delay taking your RMD until later this year if you can afford to do so. This can help avoid potential headaches associated with trying to return your RMD should the rules change again. As a reminder, the IRS doesn’t necessarily care when you take your RMD so long as it’s done by the end of the calendar year. For example, if you’re turning 72 in June, you could take your distribution at any time between now and 12/31, even a little every day if you really wanted to. The point is that your distributions within the year add up to at least your required minimum.

Another possibility for 2021 is an increase of the RMD starting age to 75. Bipartisan legislation was working its way through the last Congress that would revamp the retirement planning landscape yet again. Some are speculating that it could be brought to the forefront or be folded into broader legislation soon. It’s also possible that anything passed this year would start next year. I’ll be watching closely to see what happens along these lines, but it’s another reason to wait on taking your 2021 RMD if you can afford to.

Also confusing is a decoupling of the Qualified Charitable Distribution (QCD) rules from the RMD rules. This provision allowed savers to give some or all their RMD (up to $100,000 per year) directly to charity. Like RMDs, QCD eligibility began at age 70 ½ but wasn’t changed to 72 along with RMDs. In other words, you may be 71 and not required to take an RMD, but you can still make a QCD. Confusing, right? So, with two different age numbers to remember, some folks skipped making charitable donations from their IRA in 2020 when many charities desperately needed the support.

The last update is for folks of RMD age who are still working. They had previously been barred from contributing to Traditional IRAs but could contribute to a Roth once they crossed the 70 ½ age threshold. Fortunately, the age provision has been repealed, so contributions can be made so long as there’s sufficient income to do so. This change helps those still working at building their nest egg. It also helps those who, rightfully so I think, felt frustrated at losing their ability to save in a tax-deferred way just because they reached a particular age.

So, here are three takeaways for RMD-age savers in 2021:

  • Consider waiting to take your RMD until later in the year if you can afford to. This allows time to clear up any potential legislative ambiguities.
  • Also if you can afford it, consider donating some or all your RMD directly to charity. They likely need the money and it’s simple to do.  
  • If you’re still working and over age 70 ½, try to fund your IRA and perhaps your spouse’s as well. It could be $7,000 each (those age 49 and younger are limited to $6,000 each). Or if you’re working and have access to a 401(k), consider saving even more there.

Have questions? Ask me. I can help.

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Quarterly Update

It’s almost a cliché at this point to say that 2020 was a challenging year, financially and emotionally. Lives lost, but also livelihoods. The year also seemed to show a major disconnect between market performance and everyday reality. That disconnect was a popular topic throughout an eventful and consequential year.

The coronavirus took center stage, of course, with case counts in the US approaching 20 million and 340,000 deaths as we ended the year. Close behind was social and political unrest and violence in the streets. We even managed to sneak in a presidential impeachment trial, a Supreme Court nomination, and a General Election. And we can’t forget our fourth year of fires and smoke-filled skies. Quite the year indeed!

Even though it turned out well by year-end for stocks and bonds, 2020 was also one of the most volatile years on record. The year began strong but the emerging pandemic and stay-at-home orders in early Spring created lots of confusion for everyone. Investors the world over didn’t know what to think. Extreme anxiety and bouts of panic led to wild swings for major market indexes. In March, the Dow experienced some of its largest daily percentage declines in history (down 8, 10, or even 13%) often immediately followed by some of its largest daily percentage gains (up 7, 9, and 11%).

The bond market also struggled at times, especially during March. In a sign of complete panic, investors even shunned US Treasurys for several days during the worst of the virus confusion. Ultimately, the Federal Reserve and eventually Congress stepped up to backstop markets and the economy with trillions of dollars of aid. This emergency support was probably the single most important event for markets during 2020. Who knows where we would have ended up without it? But aid markets it did, and stock and bond prices recovered rapidly and performed surprisingly well, on average, over the remainder of the year.

Here’s a roundup of how major markets performed during Q4 and for the year, respectively:

  • US Large Cap Stocks: up 12%, up 18%
  • US Small Cap Stocks: up 31%, up 20%
  • US Core Bonds: up 1%, up 8%
  • Developed Foreign Markets: up 16%, up 8%
  • Emerging Markets: up 20%, up 19%

This positive performance was not evenly distributed, however. Investors clearly favored industries that stood to benefit from stay-at-home orders while punishing others. The tech sector was a clear outperformer, rising 44% for the year. Consumer Discretionary and Communication Services also fared well. Energy performed worst, showing a decline of 34% for the year due to demand uncertainties. But this could have been much worse given that the price of oil went negative in April for the first time in history. Commercial Real Estate and Financial Services also performed poorly, declining about 2% each during 2020.

But according the Congressional Budget Office, the CARES Act passed in March coupled with the recent year-end aid package could backfill nearly 8% of the estimated 10% hit to GDP caused by the pandemic. Currently, the CBO and others are expecting our economy to recover by 2022. All this aid plus extremely low interest rates, various programs from the Federal Reserve, and expectations for further stimulus from Congress are helping investors to carry this optimism into the new year.

There’s lots of downside risk to this positive market outlook, however. We’re obviously still deep within a renewed wave of the pandemic and the economic impacts are unfolding. Roughly 14 million are still unemployed or underemployed and many jobs lost won’t be coming back. Yelp indicates that around 60% of restaurants closed due to the pandemic won’t reopen. Millions are at risk of eviction or foreclosure and it’s unclear who will ultimately foot the bill for missed payments. So, even assuming the CBO is correct, the road to full recovery will be long and bumpy for many.

Additionally, while typical investors aren’t overly bullish right now, some retail investors have started day-trading again. This helped margin debt (money borrowed against stocks to buy more stocks) hit a record near year-end. Investors on margin can be forced to add money to a declining portfolio or sell stocks to pay off their debt. The latter tends to exacerbate selling pressures, so any near-term volatility could be heightened at times, even as market prices march higher.

Last year was tough for many in a variety of ways, no doubt about it, and this brief letter only scratches the surface. Let’s hope 2021 proves to be a better year for all. As always, please let me know of any changes to your plan and questions that come up along the way.

Brandon Grundy, CFP®

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