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Pain or Gain in your retirement accounts?

     My goal is to make you feel confident about your long-term investment strategy.  I know it can be tough for you not to panic during times of extreme volatility like  we have seen the last few months but I hope this month's newsletter will help ease your fears.  Let's take a look at what's been happening in the market. 
What Caused All of the Market Turbulence?
     Last month my wife and I traveled to Dana Point, California for the National Association of State Boards of Accountancy's National Convention.  NASBA hosted the board's that regulate the CPA certification in each state.  The purpose of the board is to uphold the standards of CPA's and to protect the public from those holding themselves out as CPA's.  I was honored to be appointed by Governor Pat McCrory last year to sit as a public member of our State's CPA Board of Examiners.  
     The West Coast was beautiful and it was trip that I won't forget.  Not only in part due to the Conference, the Hollywood sighting, and a getaway trip to the San Diego Zoo, but also because of our plane ride through a major storm across the Mid West.  About 30 minutes into our flight, the pilot woke me up with an announcement to the passengers that we would be going through a storm and to expect some turbulence.  Sure enough, the plane started dipping and seemingly struggling through the changing airflows in our path.  I know nothing about flying an airplane, but I do know that investors fears and stomachs feel the same during airplane turbulence as they do during a volatile stock market.
     Take a look at the chart above showing the price action of the S&P 500 from December, 2014 to now.  Did you feel the turbulence (big "W" in the chart) in your investment accounts as the market dropped over 10% in just a few days in August? What caused this extreme volatility?  The answer is fear. The average investor was taken on a ride by the media and Wall Street. The media sells fear by reporting every data point and current event that could possibly affect the markets.  If you listened to the media, they said that a combination of a slowdown in China's economy, a spike in the U.S. dollar, an over production of oil worldwide, and a looming Federal Reserve interest rate hike would cripple the US economy and the profits of U.S. corporations. In reality, the market moves according to supply and demand, or how much buying and/or selling occurs.  In my opinion, institutional investors on Wall Street used this fear the media produced as an opportunity to dump stocks all at once and then re-buy at much lower levels.   
    Yes, the Fed will raise interest rates soon, but not by much.   The futures market is pricing in that there is a 70% chance that the Fed will raise rates by 25 basis points (0.25%) at its December 25-26 meeting.  This would be the first time in nearly a decade that the Fed has raised rates. This is a good sign because it means employment rates and inflation are to the point where the Fed believes the economy can handle the push of rates back towards normal levels.  It's also true that the dollar is strengthening against other currencies.  This is because the U.S. economy is expanding, although slowly, but not slowing like it is in China and Europe.  And lastly, although oil and gas companies provide thousands of jobs in America, the majority of these companies are still well positioned with oil at current levels. Plus, lower gas prices are putting extra money back into consumer's pockets. That will eventually hit the bottom lines of the company's that fuel our economy. In fact, I believe this could be the factor that drives what we call the "Santa Clause Rally" in the markets going into the new year.
    What you need to know is that there's an over abundance of data, breaking news, and fear selling being delivered 24/7 by the media.  Don't let fear stop you from sticking with your long term investing plan, or from taking a trip via air plane.  There is undoubted proof that the rewards outweigh the risks.  Make sure your investments are well diversified across and within different asset classes.  Use the volatility of the market to your advantage through dollar cost averaging. Give me a call if you would like to discuss your retirement plan and investment strategies.

The Best Long Term Investment and Why

     Let me remind and reassure you that equities have proven to generate higher returns than any other asset class over the long-term.  In order to explain why, it's important to first understand the different asset classes from low to high risk.
    The asset class scale starts with FDIC insured savings, money market accounts, and CDs.  Then it moves into Short-term and then Long-term Treasury Bonds which are backed by the full faith and credit of the U.S. Government. From there, you get into corporate bonds and then equities.  Bonds offered by long-standing, dependable companies like Utility company's borrow money (issue bonds) at yields lower than start up companies looking for funding. This is because of the risks in each situation of getting your money back.  Corporations use the interest rate of Treasuries (known as the risk-free rate) to price their bonds.  Isn't it fascinating how the free market works?
     At the top of the asset class scale, in terms of risk and reward, are small cap equities.  These are the stocks of small companies focused on growth.  Indexes that track this group of stocks have outperformed the S&P 500 (index of 500 largest companies) which has an average annual return of 10%.  In order to get investors to invest in these smaller growth companies instead of CD's, Treasuries, corporate bonds, and high paying dividend stocks, the CEO's and management teams of small cap companies have to work extra hard to provide a growth strategy that makes the risk, and volatility, worth the time and money of investors.  If you are looking for more information, there's a short course at that I encourage you to read.  Number 6 of 7, titled "Why Stocks Perform The Best" gives a great explanation that all investors should understand.  Before investing in small cap stocks, it's important to understand your own risk tolerance and your time horizon for investing.

Dividends, Capital Gains, and Taxes
   As the end the year approaches, I thought I should go into some detail on how your investments are taxes.  Most of you probably have a professional do your taxes but this is some good information to know yourself.
  Did you know that tax rates on qualified dividends* and long-term capital gains on investments held more than a year are lower than short-term capital gains on investments held less than a year?  If you invest solely into a 401k, IRA, or other tax-deferred retirement plans, you should not be as concerned about taxes. Distributions from those accounts after age 59 1/2 will be taxed at your ordinary income tax rate.
    For those that are no longer eligible to contribute to a retirement plan (no earned income) or those who have investment income in taxable (brokerage) accounts, it is important to understand how you are taxed on gains within these accounts.  
    Long-term capital gains and qualified dividends are both taxed at 15% if your are in a tax bracket greater than 15% but less than 39.6%.   For those in the 10% or 15% tax bracket, you pay no taxes on LTCG or qualified dividends.  If you are in the highest tax bracket of 39.6%, you pay 20% on LTCG and dividends. The only way to avoid paying these taxes is to cancel out your gains by selling investments for a loss.  If you own mutual funds within taxable accounts, you lose your control of when you pay taxes.  Fund managers of mutual funds buy and sell stocks throughout the year and pass the tax expenses on to investors.  

    For those looking to create tax efficient retirement income streams that offer protection from inflation (above the risk free rate mentioned earlier), it may be best to invest in a diversified group of high yielding, consistently increasing dividend paying stocks. Another option are Exchange Traded Funds (ETFs) 
that can group together these dividend paying stocks which gives you diversification and allows you to decide when to trigger taxes.   As a reminder, reinvested dividends are taxable in the same year that they are disbursed by the company, even if you don't receive the cash.
    Let this also be a reminder of the benefit of maxing out your tax-deferred contributions while you're young and working.  This allows your investments to compound overtime without having to pay taxes on capital gains or dividend until you withdraw the money.  The IRS says that you don't have to withdraw money in your 401k's and IRA's until you are age 70 1/2 which offers a significant tax advantage.

*Qualified Dividend
1. The dividend must have been paid by an American company or a qualifying foreign company.
2. The dividends are not listed with the IRS as dividends that do not qualify.
3. The required dividend holding period has been met.
I hope you enjoyed this month's newsletter.  Feel free to contact me with any questions and topics of interest for next months newsletter. Thank you.
Picture of JB
Justin Burgess
Investment Advisor
Copley Investment Management
5025 B Wrightsville Ave
Wilmington, NC 28409

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