Perhaps Your Last Chance before the Backdoor Closes

Among the many provisions in the multi-trillion-dollar legislative package being debated in Congress, is a provision that would eliminate a strategy that allows high-income investors to pursue tax-free retirement income: the so-called “back-door Roth IRA”. The next few months may present the last chance to take advantage of this opportunity.

Roth IRA Background

Since its introduction in 1997, the Roth IRA has become an attractive investment vehicle due to the potential to build a sizable, tax-free nest egg. Although contributions to a Roth IRA are not tax deductible, any earnings in the account grow tax-free as long as future distributions are qualified. A qualified distribution is one made after the Roth account has been held for five years and after the account holder reaches age 59½, becomes disabled, dies, or uses the funds for the purchase of a first home ($10,000 lifetime limit) or for qualified higher education expenses.

Unlike other retirement savings accounts, original owners of Roth IRAs are not subject to required minimum distributions at age 72 — another potentially tax-beneficial perk that makes Roth IRAs appealing in estate planning strategies (but beneficiaries are subject to distribution rules.)

However, as initially passed, the 1997 legislation rendered it impossible for high-income taxpayers to enjoy Roth IRAs. Individuals and married taxpayers whose income exceeded certain thresholds could neither contribute to a Roth IRA nor convert traditional IRA assets to a Roth IRA.

A Loophole Emerges

Nearly 10 years after the Roth’s introduction, the Tax Increase Prevention and Reconciliation Act of 2005 ushered in a change that relaxed the conversion rules beginning in 2010; that is, as of that year, the income limits for a Roth conversion were eliminated, which meant that anyone could convert traditional IRA assets to a Roth IRA (of course, a conversion results in a tax obligation on deductible contributions and earnings that have previously accrued in the traditional IRA.)

One perhaps unintended consequence of this change was the emergence of a new strategy that has been heavily utilized ever since: High-income individuals could make full, annual, nondeductible contributions to a traditional IRA and convert those contribution dollars to a Roth. If the account holders had no other IRAs (see note below) and the conversion was executed quickly enough so that no earnings were able to accrue, the transaction could potentially be a tax-free way for otherwise ineligible taxpayers to fund a Roth IRA. This move became known as the “back-door Roth IRA”.

Employees working for companies which had retirement plans that allowed post-tax contributions into their 401(k)’s, along with “in-service distributions”, could replicate the back-door strategy in a potentially much bigger way, which became known as the “mega-back-door Roth IRA”

Note: When calculating a tax obligation on a Roth conversion, investors have to aggregate all of their IRAs, including SEP and SIMPLE IRAs, before determining the amount. For example, say an investor has $100,000 in several different traditional IRAs, 80% of which is attributed to deductible contributions and earnings. If that investor chose to convert any traditional IRA assets — even recent after-tax contributions — to a Roth IRA, 80% of the converted funds would be taxable. This is known as the “pro-rata rule.”

Current Roth IRA Income Limits

For 2021, you can generally contribute up to $6,000 to an IRA (traditional, Roth, or a combination of both); $7,000 if you’ll be age 50 or older by December 31. However, your ability to make contributions to a Roth IRA is limited or eliminated if your modified adjusted gross income, or MAGI, falls within or exceeds the parameters shown below.

If your federal filing status is:Your 2021 Roth IRA contribution is reduced if your MAGI is:You can’t contribute to a Roth IRA for 2021 if your MAGI is:
Single or head of householdMore than $125,000 but less than $140,000$140,000 or more
Married filing jointly or qualifying widow(er)More than $198,000 but less than $208,000$208,000 or more
Married filing separatelyLess than $10,000$10,000 or more

Note that your contributions generally can’t exceed your earned income for the year (special rules apply to spousal Roth IRAs).

Now or Never … Maybe

While no one knows for sure what may come of the legislative debates, the current proposal would prohibit the conversion of nondeductible contributions from a traditional IRA (or 401(k)) after December 31, 2021. If you expect your MAGI to exceed this year’s thresholds and you’d like to fund a Roth IRA for 2021, the next few months may be your last chance to use the back-door strategy.

You can make 2021 IRA contributions up until April 15, 2022, but if the legislation is enacted, a Roth conversion involving nondeductible contributions would have to be executed by December 31, 2021.

Keep in mind that a separate five-year rule applies to the principal amount of each Roth IRA conversion you make, unless an exception applies.

In addition to eliminating the conversion of nondeductible contributions from traditional IRAs to Roth IRAs, the proposed legislation includes a similar prohibition on the conversion of after-tax 401(k) contributions (so-called mega-back-door Roth conversions), as well as other retirement-related provisions affecting those with large account balances ($10 million and higher) and high incomes (more than $400,000 for single taxpayers and more than $450,000 for joint filers).

Don’t wait until the last minute to make these contributions or conversions. Brokerage firms are extremely busy during the last half of December, and will be especially so if tax legislation is passed this year. Now is the time to be thinking about doing this if it fits within your financial plan.

If you would like to review your current investment portfolio or discuss your Roth IRA options, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Medicare Open Enrollment for 2022 Begins October 15

Medicare beneficiaries can make new choices and pick plans that work best for them during the annual Medicare Open Enrollment Period. Each year, Medicare plan costs and coverage typically change. In addition, your health-care needs may have changed over the past year. The Open Enrollment Period — which begins on October 15 and runs through December 7 — is your opportunity to switch your current Medicare health and prescription drug plans to ones that better suit your needs.

During this period, you can:

  • Switch from Original Medicare to a Medicare Advantage Plan
  • Switch from a Medicare Advantage Plan to Original Medicare
  • Change from one Medicare Advantage Plan to a different Medicare Advantage Plan
  • Change from a Medicare Advantage Plan that offers prescription drug coverage to a Medicare Advantage Plan that doesn’t offer prescription drug coverage
  • Switch from a Medicare Advantage Plan that doesn’t offer prescription drug coverage to a Medicare Advantage Plan that does offer prescription drug coverage
  • Join a Medicare prescription drug plan (Part D)
  • Switch from one Part D plan to another Part D plan
  • Drop your Part D coverage altogether

Any changes made during Open Enrollment are effective as of January 1, 2022.

Review Plan Options

Now is a good time to review your current Medicare benefits to see if they’re still right for you. Are you satisfied with the coverage and level of care you’re receiving with your current plan? Are your premium costs or out-of-pocket expenses too high? Has your health changed?  Do you anticipate needing medical care or treatment, or new or pricier prescription drugs?

If your current plan doesn’t meet your health-care needs or fit your budget, you can switch to a new plan. If you find that you’re satisfied with your current Medicare plan and it’s still being offered, you don’t have to do anything. The coverage you have will continue.

Information on Costs and Benefits

The Centers for Medicare & Medicaid Services (CMS)  has announced  that the average monthly premium for Medicare Advantage plans will be $19,  and the average monthly premium for Part D prescription drug coverage will be $33.  CMS will announce 2022 premiums, deductibles, and coinsurance amounts for the Medicare Part A and Part B programs soon.

Where Can You Get More Information?

Determining what coverage you have now and comparing it to other Medicare plans can be confusing and complicated. Pay attention to notices you receive from Medicare and from your plan, and take advantage of available help. You can call 1-800-MEDICARE or visit the Medicare website, medicare.gov, to use the Plan Finder and other tools that can make comparing plans easier.

You can also call your State Health Insurance Assistance Program (SHIP) for free, personalized counseling. Visit shiptacenter.org or call the toll-free Medicare number to find the phone number for your state.

You can find more information on Medicare  benefits in the Medicare & You 2022 Handbook on medicare.gov.

If you would like to review your current investment portfolio or discuss any health insurance concerns, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Tax Proposals in Congress Not as Bad as Feared

The latest tax bill advanced in Congress is notable in its absence of provisions that were expected to be “game changers” (see below). And that’s a good thing for taxpayers.

On Saturday, September 25, 2021, the Congressional House Budget Committee voted to advance a $3.5 trillion spending package to the House floor for debate. The House Ways and Means Committee and the Joint Committee on Taxation had previously released summaries of proposed tax changes intended to help fund the spending package. Many of these provisions focus specifically on businesses and high-income households.

Expect these proposals to be modified; some will likely be removed and others added as the legislative process continues. As we monitor progression through the legislative process though, here are some highlights from the previously released proposed provisions worth noting.

Corporate Income Tax Rate Increase

Corporations would be subject to a graduated tax rate structure, with a higher top rate.

Currently, a flat 20% rate applies to corporate taxable income. The proposed legislation would impose a top tax rate of 26.5% on corporate taxable income above $5 million. Specifically:

  • A 16% rate would apply to the first $400,000 of corporate taxable income
  • A 21% rate on remaining taxable income up to $5 million
  • The 26.5% rate would apply to taxable income over $5 million, and corporations making more than $10 million in taxable income would have the benefit of the lower tax rates phased out.

Personal service corporations (professionals providing services as a regular sub-chapter C Corporation, not an S Corporation) would pay tax on their entire taxable income at 26.5%.

Tax Increases for High-Income Individuals

Top individual income tax rate. The proposed legislation would increase the existing top marginal income tax rate of 37% to 39.6% effective in tax years starting on or after January 1, 2022, and apply it to taxable income over $450,000 for married individuals filing jointly, $425,000 for heads of households, $400,000 for single taxpayers, and $225,000 for married individuals filing separate returns. (These income thresholds are lower than the current top rate thresholds.)

Top capital gains tax rate. The top long-term capital gains tax rate would be raised from 20% to 25% under the proposed legislation; this increased tax rate would generally be effective for sales after September 13, 2021. In addition, the taxable income thresholds for the 25% capital gains tax bracket would be made the same as for the 39.6% regular income tax bracket (see above) starting in 2022.

New 3% surtax on income. A new 3% surtax is proposed on modified adjusted gross income over $5 million ($2.5 million for a married individual filing separately).

3.8% net investment income tax expanded. Currently, there is a 3.8% net investment income tax on high-income individuals. This tax would be expanded to cover certain other income derived in the ordinary course of a trade or business for single taxpayers with taxable income greater than $400,000 ($500,000 for joint filers). This would generally affect certain income of S corporation shareholders, partners, and limited liability company (LLC) members that is currently not subject to the net investment income tax.

New qualified business income deduction limit. A deduction is currently available for up to 20% of qualified business income from a partnership, S corporation, or sole proprietorship, as well as 20% of aggregate qualified real estate investment trust dividends and qualified publicly traded partnership income. The proposed legislation would limit the maximum allowable deduction at $500,000 for a joint return, $400,000 for a single return, and $250,000 for a separate return.

Retirement Plans Provisions Affecting High-Income Individuals

New limit on contributions to Roth and traditional IRAs. The proposed legislation would prohibit those with total IRA and defined contribution retirement plan accounts exceeding $10 million from making any additional contributions to Roth and traditional IRAs. The limit would apply to single taxpayers and married taxpayers filing separately with taxable income over $400,000,  $450,000 for married taxpayers filing jointly, and $425,000 for heads of household.

New required minimum distributions for large aggregate retirement accounts.

  • These rules would apply to high-income individuals (same income limits as described above), regardless of age.
  • The proposed legislation would require that individuals with total retirement account balances (traditional IRAs, Roth IRAs, employer-sponsored retirement plans) exceeding $20 million distribute funds from Roth accounts (100% of Roth retirement funds or, if less, by the amount total retirement account balances exceed $20 million).
  • To the extent that the combined balance in traditional IRAs, Roth IRAs, and defined contribution plans exceeds $10 million, distributions equal to 50% of the excess must be made.
  • The 10% early-distribution penalty tax would not apply to distributions required because of the $10 million or $20 million limits.

Roth conversions limited. In general, taxpayers can currently convert all or a portion of a non-Roth IRA or defined contribution plan account into a Roth IRA or defined contribution plan account without regard to the amount of their taxable income. The proposed legislation would prohibit Roth conversions for single taxpayers and married taxpayers filing separately with taxable income over $400,000, $450,000 for married taxpayers filing jointly, and $425,000 for heads of household. [It appears that this proposal would not be effective until 2032.]

Roth conversions not allowed for distributions that include nondeductible contributions. Taxpayers who are unable to make contributions to a Roth IRA can currently make “back-door” contributions by making nondeductible contributions to a traditional IRA and then shortly afterward convert the nondeductible contribution from the traditional IRA to a Roth IRA. It is proposed that amounts held in a non-Roth IRA or defined contribution account cannot be converted to a Roth IRA or designated Roth account if any portion of the distribution being converted consists of after-tax or nondeductible contributions.

Estates and Trusts

  • For estate and gift taxes (and the generation-skipping transfer tax), the current basic exclusion amount (and GST tax exemption) of $11.7 million would be cut by about one-half under the proposal.
  • The proposal would generally include grantor trusts in the grantor’s estate for estate tax purposes; tax rules relating to the sale of appreciated property to a grantor trust would also be modified to provide for taxation of gain.
  • Current valuation rules that generally allow substantial discounts for transfer tax purposes for an interest in a closely held business entity, such as an interest in a family limited partnership, would be modified to disallow any such discount for transfers of non-business assets.

Notable Absence of Certain Provisions

As mentioned above, what was just as notable is that many feared changes to longtime rules were not included in the proposal:

  • No increases to the current estate and gift tax marginal rates
  • No changes to the current step up basis regime at death
  • No limitations on like-kind exchanges
  • No required realization of gain on gifts or at death
  • No required realization of gain on assets held in trust, partnership or non-corporate entity after being held in trust for 90 years
  • The top capital gains rate for high-income taxpayers going up to “only” 25% instead of the expected 39.6%

Of course, things are quite fluid and much will change before the ultimate passage of the final tax bill. We’re following developments closely and will post and send updates as things approach passage.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Protecting Your Digital Information & Yourself from Ransomware

In a meeting with President Joe Biden last week, business leaders from major technology and insurance firms committed billions of dollars to beefing up cybersecurity defenses desperately needed after several high profile hacks into major infrastructure and technology platforms this year. This is long overdue given the lax approach taken over the past several years by most major firms.

On May 7, 2021, the Colonial Pipeline, which carries almost half of the East Coast’s fuel supply from Texas to New Jersey, shut down operations in response to a ransomware attack. A ransomware attack is where a hacker latches on to your computer or network, locks you out and threatens to delete or make your data public if you don’t pay a ransom (see below). Colonial paid a $4.4 million ransom not long after discovering the attack, and the pipeline was reopened within a week. While there was enough stored fuel to weather the outage, panic buying caused gasoline shortages on the East Coast and pushed the national average price of gasoline over $3.00 per gallon for the first time since 2014.(1)

Ransomware is not new, but the Colonial Pipeline incident demonstrated the risk to critical infrastructure and elicited strong response from the federal government. Remarkably, the Department of Justice recovered most of the ransom, and the syndicate behind the attack, known as DarkSide, announced it was shutting down operations.(2)

The Department of Homeland Security issued new regulations requiring owners and operators of critical pipelines to report cybersecurity threats within 12 hours of discovery, and to review cybersecurity practices and report the results within 30 days.(3) On a broader level, the incident increased focus on government initiatives to strengthen the nation’s cybersecurity and create a global coalition to hold countries that shelter cyber criminals accountable.(4)

Malicious Code

Ransomware is malicious code (malware) that infects the victim’s computer system, allowing the perpetrator to lock the files and demand a ransom in return for a digital key to restore access. Some attackers may also threaten to reveal sensitive data. There were an estimated 305 million ransomware attacks globally in 2020, a 62% increase over 2019. More than 200 million of them were in the United States.(5)

The recent surge in high-profile ransomware attacks represents a shift by cyber-criminal syndicates from stealing data from “data-rich” targets such as retailers, insurers, and financial companies to locking data of businesses and other organizations that are essential to public welfare. A week after the Colonial Pipeline attack, JBS USA Holdings, which processes one-fifth of the U.S. meat supply, paid an $11 million ransom. (6) Health-care systems, which spend relatively little on cybersecurity, are a prime target, jeopardizing patient care.(7) Other common targets include state and local governments, school systems, and private companies of all sizes.(8)

Ransomware gangs, mostly located in Russia and other Eastern European countries, typically set ransom demands in relation to their perception of the victim’s ability to pay, and high-dollar attacks may be resolved through negotiations by a middleman and a cyber insurance company. Although the FBI discourages ransom payments, essential businesses and organizations may not have time to reconstruct their computer systems, and reconstruction can be more expensive than paying the ransom.(9)

Protecting Your Data

While major ransomware syndicates focus on more lucrative targets, plenty of cyber-criminals prey on individual consumers, whether locking data for ransom, gaining access to financial accounts, or stealing and selling personal information.

Most people don’t know that before becoming a full time financial planner, I spent about twelve years working for major consulting firms helping with deployment of software, hardware and networking equipment, so I know a few things about data security (where do you think the “geek” came from in my moniker?)

Here are some tips to help make your data more secure: (10)

Use strong passwords and protect them. An analysis of the Colonial Pipeline attack revealed that the attackers gained access through a leaked password to an old account with remote server access.(11) Strong passwords are your first line of defense. Use at least 8 to 12 characters with a mix of upper- and lower-case letters, numbers, and symbols. Longer and more complex passwords are better. Do not use personal information or dictionary words and use different passwords for different web sites.

One technique is to use a passphrase that you can remember and adapt. For example, Jack and Jill went up the hill to fetch a pail of water could be J&jwuth!!2faPow (please don’t use this example as your password!). Though it’s tempting to reuse a strong password, it is safer to use different passwords for different accounts. Consider a password manager program that generates random passwords, which you can access through a strong master password. My personal favorite that I’ve been using for over 15 years is RoboForm, but most well-known password managers do a good job (if you click on the link and subscribe to RoboForm, we’ll both get an extra six months added to our subscriptions). Whatever you do, don’t share or write down your passwords.

There are no easy answers. Be careful when establishing security questions that can be used for password recovery. It may be better to use fictional answers that you can remember. If a criminal can guess your answer through available information (such as an online profile), he or she can reset your password and gain access to your account.

Take two steps. Two-step authentication, typically a text or email code sent to your mobile device, provides a second line of defense even if a hacker has access to your password. If your device is lost or stolen, immediately call your carrier and lock or wipe your device before they can hijack your accounts. Most devices can be wiped remotely or be set to automatically erase themselves after a set number of failed attempts.

Think before you click. Ransomware and other malicious code are often transferred to the infected computer through a “phishing” email that tricks the reader into clicking on a link. Data thieves have become adept at creating fake e-mails that look 100% legitimate, so you must be vigilant.

If you hover with your mouse over most internet links, you’ll see exactly where they’ll take you, and it’s not necessarily the site that’s displayed in the text. Never click on a link in an email or text (or a photo) unless you know the sender, are expecting it, and have a clear idea where the link will take you. Even then, you can’t be sure your friend’s or relative’s e-mail account has not been hacked and a seemingly innocent attachment or link is laced with malware.

Install security software. Install antivirus/anti-malware software, a firewall, and an email filter — and keep them updated. Old outdated antivirus software won’t stop new viruses. If your computer, laptop or other devices don’t have extra security software, you shouldn’t be online. Period. And no, in my opinion, Microsoft Defender is not sufficient to protect your PC. The old thought that Apple Mac devices are safe from vulnerability is no longer true; though safer than PC’s, they are prime targets for malicious attacks as well.

Back up your data. Back up regularly to an external hard drive. For added security, disconnect the drive from your computer between backups. Backing up to an online service is a great idea, but your backup might also be infected or affected by malware or ransomware. Only an offline backup, when disconnected at the time of infection, is safe. Never attach the external drive to restore data until you’re sure the threat or malware is 100% removed and the device is safe.

Keep your system up-to-date. Use the most recent operating system that can run on your computer and download security updates. Most ransomware attacks target vulnerable operating systems and applications. Fortunately, for better or worse, Microsoft Windows has made is nearly impossible to avoid installing periodic security patches.

Avoid Public Networks for Sensitive or Financial Transactions. Using public Wi-Fi networks is a prime gateway for malware and ransomware attacks. Networks with names like “Free Public WiFi” are meant to lure you in and install Trojan horses onto your device. If you have to type in a password to access an online resource, then you probably don’t want to do this on a public network (or at least use a password manager to log you in so your keystrokes aren’t tracked). Virtual private network software/services are also a help here.

Secure your entry points. This month alone, my home network router blocked over 4 million port scans and thwarted 75 live threats. If you don’t know what this means, then you need a home network security geek or the help of your internet service provider to help you beef up the security of your home network.

Your home network router/switch probably came with a factory set password which is widely known and easily accessed. Changing the default device password is the easiest way to reduce your vulnerability to an outside attack. Most modern day routers come with more user friendly instructions and software on how to disable your guest network and beef up home security. There’s no need to broadcast your WiFi network name to your neighbors, so that should be turned off, or you might as well call your home WiFi network “HACKERSWELCOME”.

If you see a notice on your computer that you have been infected by a virus or that your data is being held for ransom, it’s more likely to be a fake pop-up window than an actual attack. These pop-ups typically have a phone number to call for “technical support” or to make a payment. Do not call the number and do not click on the window or any links. Instead, try exiting your browser and restarting your computer. If you continue to receive a notice or your data is really locked, contact a legitimate technical support provider, but definitely not the one listed in the pop-up window.

For more information and other tips, visit the Cybersecurity & Infrastructure Security Agency website at us-cert.cisa.gov/ncas/tips.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1) (2) (11) Vox, June 8, 2021

(3) U.S. Department of Homeland Security, May 27, 2021

(4) The Washington Post, June 4, 2021

(5) 2021 SonicWall Cyber Threat Report

(6) The Wall Street Journal, June 9, 2021

(7) Fortune, December 5, 2020

(8) Institute for Security and Technology, 2021

(9) The New Yorker, June 7, 2021

(10) Cybersecurity & Infrastructure Security Agency, 2021

Update on the Enhanced Child Tax Credit

Earlier this year in April, I wrote about the changes Congress made to the child tax credit that will benefit many taxpayers. As part of the American Rescue Plan Act that was enacted in March 2021, the child tax credit:

  • Amount has increased for certain taxpayers
  • Is fully refundable (meaning you can receive it even if you don’t owe the IRS any taxes)
  • May be partially received in monthly payments

The new law also raised the age of qualifying children to 17 from 16, meaning that more families will be able to take advantage of the credit for at least one year longer.

The IRS will pay half the credit in the form of advance monthly payments beginning July 15. Taxpayers will then claim the other half when they file their 2021 income tax return.

Though these tax changes are temporary and only apply to the 2021 tax year, they may present important cash flow and financial planning opportunities today. It is also important to note that the monthly advance of the child tax credit is a significant change. The credit is normally part of your income tax return and would reduce your tax liability. The choice to have the child tax credit advanced will affect your refund or amount due when you file your return. To avoid any surprises, please get in touch with us if you’re concerned.

Qualifications and how much to expect

The child tax credit and advance payments are based on several factors, including the age of your children and your income.

  • The credit for children ages five and younger is up to $3,600 –– with up to $300 received in monthly payments.
  • The credit for children ages six to 17 is up to $3,000 –– with up to $250 received in monthly payments.

To qualify for the child tax credit monthly payments, you (and your spouse if you file a joint tax return) must have:

  • Filed a 2019 or 2020 tax return and claimed the child tax credit or given the IRS your information using the non-filer tool
  • A main home in the U.S. for more than half the year or file a joint return with a spouse who has a main home in the U.S. for more than half the year
  • A qualifying child who is under age 18 at the end of 2021 and who has a valid Social Security number
  • Income less than certain limits (see below)

You can take full advantage of the credit if your income (specifically, your modified adjusted gross income) is less than $75,000 for single filers, $150,000 for married filing jointly filers and $112,500 for head of household filers. The credit begins to phase out above those thresholds.

Higher-income families (e.g., married filing jointly couples with $400,000 or less in income or other filers with $200,000 or less in income) will generally get the same credit as prior law (generally $2,000 per qualifying child) but may also choose to receive monthly payments.

Taxpayers generally won’t need to do anything to receive any advance payments as the IRS will use the information it has on file to start issuing the payments.

IRS’ child tax credit update portal

Using the IRS’ child tax credit and update portal, taxpayers can update their information to reflect any new information that might impact their child tax credit amount, such as filing status or number of children. Parents may also use the online portal to elect out of the advance payments or check on the status of payments.

The IRS also has a non-filer portal to use for certain situations.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Inflation: Transitory or Here to Stay?

From leading indicators to business surveys to initial unemployment claims, the economic message is clear: The 2020 COVID-19 recession is over! Although the NBER (National Bureau of Economic Research) has yet to make their official announcement, my bet is that the recession ending point is backdated all the way to last autumn, or even earlier. That’s how economics often works… with perfect 20/20 hindsight.

As the economy’s emergence from pandemic restrictions exceeds widespread forecasts and expectations, so do underlying pressures in other areas vital to the stock market’s outlook. And with the combination of a potential valuation bubble on Wall Street and corresponding housing bubble on Main Street, investor sensitivity to interest rates has never been higher.

In April 2021, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.8%, the largest one-month increase since August 2012. Over the previous 12 months, the increase was 4.2%, the highest year-over-year inflation rate since September 2008 (4.9% over prior 12 months). By contrast, inflation in 2020 was just 1.4%. (1)

The annual increase in CPI-U — often called headline inflation — was due in part to the fact that the index dropped in March 2020, the beginning of the U.S. economic shutdown in the face of the COVID-19 pandemic. Thus, the current 12-month comparison is to an unusual low point in prices. The index dropped even further in April 2020, and this “base effect” will continue to skew annual data through June. (2)

The monthly April increase, which followed a substantial 0.6% increase in March, is more indicative of the current situation. Economists expect inflation numbers to rise for some time. The question is whether they represent a temporary anomaly or the beginning of a more worrisome inflationary trend.

Measuring Prices

In considering the prospects for inflation, it’s important to understand some of the measures that economists use.

CPI-U measures the price of a fixed market basket of goods and services. As such, it is a good measure of prices consumers pay if they buy the same items over time, but it does not reflect changes in consumer behavior and can be unduly influenced by extreme increases in specific categories.

In setting economic policy, the Federal Reserve prefers a different inflation measure called the Personal Consumption Expenditures (PCE) Price Index, which is even broader than the CPI and adjusts for changes in consumer behavior — i.e. when consumers shift to purchase a different item because the preferred item is too expensive. More specifically, the Fed looks at core PCE, which rose 0.7% in April and 3.6% for the previous 12 months, slightly lower than core CPI but much higher than the Fed’s target of 2% for healthy economic growth. (3)

A Hot Economy

Based on the core numbers, inflation is not yet running high, but there are clear inflationary pressures on the U.S. economy. Loose monetary policies by the central bank and trillions of dollars in government stimulus could create excess money supply as the economy reopens. Pent-up consumer demand for goods and services is likely to rise quickly, fueled by stimulus payments and healthy savings accounts built by those who worked through the pandemic with little opportunity to spend their earnings. Businesses that shut down or cut back when the economy was closed may not be able to ramp up quickly enough to meet demand. Supply-chain disruptions and higher costs for raw materials, transportation, and labor have already led some businesses to raise prices. (4)

According to the April Wall Street Journal Economic Forecasting Survey, gross domestic product (GDP) is expected to increase at an annualized rate of 8.4% in the second quarter of 2021 and by 6.4% for the year — a torrid annual growth rate that would be the highest since 1984. As with the base effect for inflation, it’s important to keep in mind that this follows a 3.5% GDP decline in 2020. Even so, the expectation is for a hot economy through the end of the year, followed by solid 3.2% growth in 2022 before slowing down to 2.4% in 2023. (5)(6)

Three Scenarios

As investors have become increasingly concerned about inflation, the Federal Reserve has given countless reassurances that current pricing pressures will be “transitory” and short-lived. Yet mounting evidence has seemingly turned this debate into the Fed versus the World.

Will the economy get too hot to handle? Though all economists expect inflation numbers to rise in the near term, there are three different views on the potential long-term effects.

The most sanguine perspective, held by many economic policymakers including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen, is that the impact will be short-lived and due primarily to the base effect with little or no long-term consequences. (7) Inflation has been abnormally low since the Great Recession, consistently lagging the Fed’s 2% target. In August 2020, the Federal Open Market Committee (FOMC) announced that it would allow inflation to run moderately above 2% for some time in order to create a 2% average over the longer term. Given this policy, the FOMC is unlikely to raise interest rates unless core PCE inflation runs well above 2% for an extended period. (8) The mid-March FOMC projection sees core PCE inflation at just 2.2% by the end of 2021, and the benchmark federal funds rate remaining at 0.0% to 0.25% through the end of 2023. (9)

The second view believes that inflation may last longer, with potentially wider consequences, but that any effects will be temporary and reversible.

The third perspective is that inflation could become a more extended problem that may be difficult to control. Both camps project that the base effects will be amplified by “demand-pull” inflation, where demand exceeds supply and pushes prices upward. The more extreme view believes this might lead to a “cost-push” effect and inflationary feedback loop where businesses, faced with less competition and higher costs, would raise prices preemptively, and workers would demand higher wages in response. (10)

Is Current Inflation “Transitory?

Dual surveys from the Institute for Supply Management (ISM) are ringing alarm bells, as the ISM Manufacturing Prices Paid Index has surged to one of its highest readings on record, led by widespread commodity price increases. As stated by one respondent to the ISM survey, “In 35 years of purchasing, I’ve never seen anything like these extended lead times and rising prices – from colors, film, corrugate to resins, they’re all up.” Likewise, even in the Service Sector the Prices Paid Index shot higher and is nearing a 25-year high.

Low inventories among companies that produce goods will undoubtedly keep price pressures high as companies scramble to replenish their depleted inventory and meet the unexpectedly high demand.” And prices have, indeed, continued to rise, while restocking efforts have been unable to prevent customer inventories from falling to a record low.

Central to the Fed’s “transitory inflation” argument is the belief that supply/demand pressures will quickly subside as inventories rebound. My concern is that broader evidence suggests inflation could be far stickier than the Fed expects.

From groceries to lumber to cars and even chickens, inflation pressures are being felt by consumers and businesses. The widespread nature of today’s inflation is one of the factors that suggest pricing pressures may be more deep-rooted than the Fed believes.

Perhaps most importantly, business owners are also facing higher wage costs as qualified labor is becoming an increasingly rare commodity. The National Federation of Independent Business (NFIB) reports that a record 44% of small businesses have unfilled positions, and over half of those with job openings reported that there were few or no qualified applicants.

Historically, wage inflation can be notoriously sticky, and the disparity between the NFIB Job Openings and reported Wage Inflation is a gap that will almost certainly be closed in the year ahead. This casts further doubt on the Fed’s narrative that inflation will surely be “transitory.” And unfortunately for the Fed, wage inflation–once ingrained–can typically only be reversed by a recession.

As businesses are facing higher input expenses, they are already making plans to pass these costs on to their customers. The National Federation of Small Business’ survey of small businesses shows that plans to raise selling prices have reached the second highest level since 1981 – a time when inflation was running near 10%.

Maintaining Perspective

Although it’s too early to tell whether current inflation numbers will lead to a longer-term shift, you can expect higher prices for some items as the economy reopens. Consumers don’t like higher prices, but it’s important to keep these increases in perspective. Gasoline, jet fuel, and other petroleum prices are rising after being deeply depressed during the pandemic. Airline ticket prices are increasing but remain below their pre-pandemic level. Used cars and trucks are more expensive than before the pandemic, but clothing is still cheaper. (11) Food is up 3.5% over the last 12 months, a significant increase but not extreme for prices that tend to be volatile. (12)

Anyone who has tried to buy or build a home in the past six months is aware of the rising stresses in the housing market. Home prices are soaring, not only here in the U.S. but on a global basis as well.

History has shown that it will be difficult, if not impossible, for the Federal Reserve to dampen or halt the imminent impact of the red-hot labor and housing market on the economy. Any cost surprises will undoubtedly be to the upside in the months and year ahead, and that does not bode well for inflation news OR for the Fed’s reassurance of “transitory” inflation.

For now, it may be helpful to remember that “headline inflation” does not always represent the larger economy. And with interest rates near zero, the Federal Reserve has plenty of room to make any necessary adjustments to monetary policy.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Projections are based on current conditions, are subject to change, and may not come to pass.

1, 12) U.S. Bureau of Labor Statistics, 2021

2, 4) The Wall Street Journal, April 13, 2021

3, 6) U.S. Bureau of Economic Analysis, 2021

5) The Wall Street Journal Economic Forecasting Survey, April 2021

7, 10) Bloomberg, March 29, 2021

8) The Wall Street Journal, April 14, 2021

9) Federal Reserve, 2021

11) The New York Times, April 13, 2021

Enhanced Child Tax Credit for 2021

The American Rescue Plan Act of 2021 (ARPA) ushered in several tax changes that we highlighted in this post last month. One of those tax changes involves the Enhanced Child Tax Credit.

If you have qualifying children under the age of 18, you may be able to claim a child tax credit (You may also be able to claim a partial credit for certain other dependents who are not qualifying children.) The American Rescue Plan Act of 2021 makes substantial and temporary improvements to the child tax credit for 2021, which may increase the amount you might receive.

Ages of qualifying children

The legislation makes 17-year-olds eligible as qualifying children in 2021. Thus, children age 17 and younger are eligible as qualifying children in 2021.

Increase in credit amount

For 2021, the child tax credit amount increases from $2,000 to $3,000 per qualifying child ($3,600 per qualifying child under age 6). The partial credit for other dependents who are not qualifying children remains at $500 per dependent.

Phaseout of credit

The combined child tax credit (the sum of your child tax credits and credits for other dependents) is subject to phaseout based on modified adjusted gross income (MAGI), which for most people, is your total income subject to taxes (this may differ from your taxable income shown on the tax return if you have certain adjustments). Special rules start phasing out the increased portion of the child tax credit in 2021 at much lower thresholds than under pre-existing rules. The credit, as reduced under the special rules for 2021, is then subject to phaseout under the pre-existing phaseout rules.

The following table summarizes the effect of the phaseouts on the child tax credit in 2021, based on MAGI.

Single/Married filing separatelyMarried filing jointlyHead of householdCombined credit
Up to $75,000Up to $150,000Up to $112,500No reduction in credit
$75,001 to $200,000$150,001 to $400,000$112,501 to $200,000Credit can be reduced to $2,000 per qualifying child, $500 per other dependent
More than $200,000More than $400,000More than $200,000Credit can be reduced to $0

Enhanced Child Tax Credit is Refundable

The aggregate amount of nonrefundable credits allowed is limited to your tax liability. With refundable credits, a taxpayer may receive a tax refund at tax time even if they exceed their tax liability.

For most taxpayers, the child tax credit is fully refundable for 2021. To qualify for a full refund, the taxpayer (or either spouse for joint returns) must generally reside in the United States for more than half of the taxable year. Otherwise,  under the pre-existing rules, a partial refund of up to $1,400 per qualifying child may be available. The credit for other dependents is not refundable.

Advance payments

Eligible taxpayers may receive periodic advance payments for up to half of the refundable child tax credit during 2021, generally based on 2020 tax returns.  The U.S. Treasury will make the payments between July and December 2021. For example, monthly payments could be up to $250 per qualifying child ($300 per qualifying child under age 6). Due to correspondence backlogs and under-staffing at the IRS, it remains to be seen if they can make good on sending out those payments on a timely basis this year.

If you would like to review your current investment portfolio, discuss any other financial planning or tax matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Should You Hit the Pause Button on Filing Your 2020 Tax Returns?

Note: Since the original publication of this article, the IRS announced that the federal income tax filing due date for individuals for the 2020 tax year is automatically extended until May 17, 2021.

As you likely know, President Joe Biden signed his sweeping $1.9 trillion Covid-19 economic relief package into law on Thursday afternoon March 11, 2021. Included in this package were several tax provisions that increase child tax credits and exempt certain 2020 unemployment benefits from taxation for lower income taxpayers.

Passing retroactive tax legislation just five weeks before the regular 1040 tax deadline of April 15, 2021, is virtually unprecedented, and has left the IRS and tax preparation software vendors scrambling to update calculations, guidance, tax forms, publications and program logic.

Add to the foregoing the IRS’ backlog of taxpayer correspondence and flood of erroneous taxpayer notices and you can understand that this has prompted the American Association of CPA’s to urge the IRS to extend the tax deadline for filing and payment until June 15, 2021, or at least provide guidance to taxpayers on their thinking about whether they are considering extending the tax deadline.

I was notified today that my own tax preparation vendor, Thomson Reuters, “highly recommends that no returns be filed at this time” due to the preliminary draft nature of several forms (which are based on 2019 forms and not yet approved for filing by the IRS) and the last minute passage of tax legislation. Make no mistake, updating the form calculations and logic is no small feat, especially considering that the IRS has issued scant guidance given that the legislation is still a “newborn”.

I imagine that things will look better in a couple of weeks, but if you’re anxious to file your returns in hopes of receiving a higher stimulus check, I can only advise you to cool your heels and, if applicable, save yourself a fee to have an amended return prepared. Eventually, you’ll receive every penny of stimulus you’re entitled to, albeit perhaps on next year’s tax return. Given that stimulus payments are due to start arriving this weekend, rushing to file your return will have virtually no effect on the amount of the stimulus check you’ll receive over the next month.

If you filed your return early, only your tax preparer can advise you if you’ll need to amend that return to take into account the most recent tax changes. If you have a very simple return (Form W-2 and no deductions), my guess is that you’re OK. If you received unemployment compensation in 2020, then you may need to file an amended return to claim a refund of overpaid taxes.

My standard advice to clients is not to file prior to March 15 each year (because of last minute issuance and changes to 1099s), and it appears that will now extend until at least March 31. I highly recommend that you do the same.

If you would like to review your current investment portfolio or discuss your 2020 tax return, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Making Your Money Last In Retirement

Quick Questions: How much can you safely withdraw each year from your retirement portfolio without the risk of running out of money before you run out of life? How much should you withdraw if you don’t want to leave too much money behind when you die?

If you’re as perplexed about answering these questions as many financial planners are, then this article will help update you on the latest research in this area of retirement planning. Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.

For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a yearly withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year, with inflation-adjusted withdrawals in succeeding years.

The 4% rule has stimulated a great deal of discussion over the years, with some experts saying that 4% is too low, and others saying it’s too high. The most recent analysis comes from the man who studied it, financial professional William Bengen (widely considered in the financial planning profession as the “father of the safe withdrawal rate”), who believes the rule has been misunderstood and offers new insights based on new research.

Original Research

Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprised of 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market, and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more (1).

Of course, no one can predict the future, which is why Bengen suggested that the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprised of 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries (2).

New Research

In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (the annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing for a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase, but just $58,000 with a 2% annual increase.

To measure market valuation, Bengen used the Shiller CAPE, a cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.

5% rule?

Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation (3).

For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession (4)(5). In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years (6). While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.

One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research (7).  His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5% (8) (Inflation was 1.2% in November 2020 (9)). Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5% (10).

It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance. For example, some retirees, in an effort to reduce withdrawals after a “down” year in the market, forego taking an inflation-based increase for the following year.

Although there is no assurance that working with a financial professional will improve your investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.

If you would like to review your current investment portfolio or discuss your current or upcoming withdrawal rate, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1)(2) Forbes Advisor, October 12, 2020
(3)(4)(6)(8,)(10) Financial Advisor, October 2020
(5)(9) U.S. Bureau of Labor Statistics, 2020
(7) multpl.com, December 31, 2020

Disclaimer: All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.

The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

GameStop-Shop, Chop or Slop?

By now, I’m sure you’ve heard or read about the whole GameStop stock market story in the news or online this past week.  I realize a lot of ink has already been spilled on this topic and I am not sure I can add much value or color to the discussion. Nonetheless, perhaps my added value can be to try and explain, in the simplest terms that I can muster, this craziness in the stock and derivatives market.

Let me say that the GameStop “short squeeze” debacle has had little effect on the individual investor, because we, and the majority of registered investment advisors I know, do not short-sell stocks in client portfolios. We typically only invest in blue-chip quality and solid value or growth companies, index funds, and actively managed funds. Short selling is more the domain of large hedge funds, who both buy stocks and sell stocks short. We also don’t invest in companies that were already circling the “bankruptcy drain” such as GameStop and AMC Theatres (GameStop stock traded as low as $2.57 last June).  

So what is short selling?
Short selling is betting that a stock price will go down instead of up (the exact opposite of what everyday stock investors do). To do this, traders ask their broker/dealer if they have any shares that can be borrowed from someone else’s owned shares in the broker’s inventory. If shares are available to borrow, you proceed to sell those shares (short) in the markets at their prevailing price, in hopes that their price/value goes down. Your objective is to subsequently buy them back at a lower price, and “re-pay” your borrowed shares.

Imagine this being done with millions of shares of GameStop, where so many people were already betting that the stock was going down, but instead, the stock went up these past few weeks, and went up a lot. In fact, as unbelievable as it is, more shares were sold short than the entire number of outstanding shares issued by the company (164% to be exact, so many out there were loaning shares they didn’t even have). If you’re short the shares, and they go up in price, you are said to be getting “squeezed”, and your only option is to buy back the shares at much higher prices before your broker/dealer decides that you can no longer afford to stay short, buys them back on your behalf, and charges your account for the losses (the difference between the price you sold them for and the price you paid to buy them back). Imagine selling your shares short for $65.00 per share on Friday, January 22, only to be forced to buy them back at $313 on Friday, January 29 (GameStop traded as high as $483 last week). That’s a loss of 4.8X your money (or if you were lucky and instead bought the shares, you made 4.8X your money).

What we saw this past week was a concerted effort by members of a Reddit subgroup known as Wall Street Bets (WSB) to force these short shareholders to “cover” their short positions. The whole rush to cover short shares is like tinder for a fire because the higher the shares go, the more the short shareholders have to pay to buy them back in a negative “feedback loop” for their positions. Momentum traders and other investors who see this kind of short squeeze also pile on to try and capture or “scalp” some profits.

While some large hedge fund who do/did hold short shares in client accounts lost a lot of money over the past few weeks, the majority of investment advisors and their clients were largely unaffected, other than the fact that these same hedge funds, in an attempt to ride out the short squeeze, used and sold other blue chip stocks (such as Microsoft, Apple, Johnson and Johnson) to cover their losses on the short sales. That’s why you saw the price of those stocks go down last week.

This kind of thing shall pass, and although this may be the first time you’ve heard about this type of “squeeze”, it has happened a lot in the past and will likely happen again. This type of activity tends to crop up when you have a lot of people receiving government checks who have nowhere to go and have nothing better to do (and therefore nothing to lose), so they might as well risk that money in the markets. The current COVID environment has created the perfect stock market storm. I believe that this is more media hype than substance, and will be out of the news cycle in a short time. Cries for regulating or investigating all of this are misplaced in my opinion.

In other words, it’s business as usual in the stock market, unless you owned or shorted the stocks of AMC Theatres, GameStop, Bed, Bath & Beyond, and a few others. As in other newsworthy stock markets “mania’s”, when the dust settles, the majority of the players will likely lose their money because risk management and profit protection isn’t a regular part of their stock trading discipline. If you’re a long term investor, you should grab some popcorn and enjoy the “show” from a distance, and resist the temptation to jump in and risk your hard earned money. Because when the music stops, I believe that GameStop shares will be back to trading in the low-double, if not single-digits once again.

If you would like to review your current investment portfolio or discuss short-selling, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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