Positive developments in 2013
1) Lower expense ratios on many Exchange Traded Funds (ETFs). Last year, Schwab started the trend of lowering ongoing management fees on their ETFs and eliminating the transaction costs to buy and sell these products on the Schwab platform. This move attracted the attention of competitors and now many ETFs are cheaper to own than ever before. These products allow the broadest diversification across entire market segments at the lowest possible cost.
2) The government has increased the contribution limits for retirement accounts for the first time since 2008. Annual IRA contributions were bumped up by $500 to $5,500 for people 49 and under and $6,500 for 50 and over investors. Employer retirement plan contributions also increased. Individuals under 50 can contribute $17,500. The over-50 catch up contribution can add another $5,500 to get to $23,000 total.
3) Congress adopted higher federal estate tax thresholds ($5.25 million per person and $10.5 million per couple in 2013) than expected by most pundits. This effectively eliminates the prospect of paying federal estate tax for 99.86% of estates according to the Tax Policy Center. It also provided much more clarity for estate planning professionals who work with high net worth individuals on estate planning issues. Many states still have lower estate tax thresholds, however. For example, in Washington state the limit is $2 million. If a person dies with an estate value of $1,999,999 no state estate tax is due. But reach $2,000,001 and an estate tax return and payment are necessary.
4) Investors have returned to markets. According to Leuthold Group, through April 24, net cash flow into mutual funds was at its strongest pace ever with year-to-date positive cash flow $223 billion.
Trends that concern us:
1) Regarding that cash flow, the point of concern is that $106 billion of the incoming investments have gone to bond mutual funds. We think bonds will be severely challenged to generate meaningful returns over the next several years. Combine the premium many bonds are trading at with current low yields and the fact that total return could turn negative when interest rates rise and particularly U.S. government bonds will struggle to post returns anything like the past decade. By comparison, $22 billion of new investments have entered U.S. stock funds so far this year.
2) The low interest rate policy set by the Federal Reserve Board. This policy has lowered the borrowing costs for the U.S. Government, but it has also changed the way that we all invest. Bond investors who are searching for yield are taking considerably more investment risk with their fixed income portfolios than ever before. When the Fed finally increases interest rates, three things may happen: inflation could increase dramatically, bond default rates may rise, and returns for bonds could turn negative as investors seek newer bonds at different increasing interest rates.
3) Less affordable long-term care insurance. A few trends are becoming clearer for the LTC marketplace. A) most residents of nursing homes are women, b) Most baby boomers don’t have long-term care insurance because they either feel that it is too expensive or they don’t think that they will ever need it, C) Rates paid for LTC policies are becoming gender based, and although they have stabilized somewhat in the past year, the combination of the continuation of the low interest rate policies by the federal government and higher claims rates by women will force LTC prices to continue to grow at higher rates than inflation.
~ Allyn Hughes, CFP® — Brooks, Hughes & Jones – Partners in Wealth Management, Tacoma, WA