Author: Tim Ellis

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The Six Fs: Financial New Year’s Resolutions

The start of a new year strikes me as an inherently optimistic time. There is the afterglow of the holiday season, celebration with friends (during pre-coronavirus times), time for reflection on the previous year, and then turning over a new leaf in a new year. This sentiment is especially true moving on from the extra burdens of 2020. There are also the rituals like the traditional Southern New Year’s Day meal to bring wealth and prosperity. It will be the only time this year that I eat collard greens. Collard greens represent the color of money, and my food preferences should not come between us.

Another ritual is the formulation of New Year’s resolutions. This year, I am focusing on the six “Fs” of life — family, friends, fun, fitness, faith, and finance. If you thought you did not have any Fs left to give after last year, you may be wrong.

The last “F” — finance — can go in many directions. Let me outline some of my financial New Year’s resolutions that may also fit into yours.

I will save at least 10 percent of my income to a 401(k) plan. A 10 percent to 15 percent retirement savings target should put you on a path to be able to retire and maintain a similar lifestyle in retirement. Employer-sponsored retirement plans like a 401(k) or 403(b) are among the most convenient, efficient savings vehicles available to investors. The payroll deduction feature makes saving, as well as investment, automatic. There is preferential tax treatment whether you make traditional pre-tax contributions or Roth after-tax contributions. Last, employers will often offer matching contributions that provide an immediate return on your investment by simply participating in the retirement plan.

I will maintain at least three months’ worth of living expenses in a savings account as an emergency cash fund. The emergency fund can cover expenses in the event of job loss or income reduction. The coronavirus pandemic drove home the importance of these safety nets. Even though the CARES Act and subsequent laws provided expanded unemployment insurance and some direct aid, nothing was assured, nor will it be in the future. The rule of thumb is to maintain three months’ worth of living expenses in a savings account if you are in a dual income household (i.e., both spouses are working) or six months’ worth if only one spouse works and/or income is highly variable.

I will contribute to 529 plan accounts for my children’s college savings. College can be expensive. How expensive? The current estimated annual full cost of attendance at the University of Memphis is $26,386. To fully fund those college costs, you would need to invest approximately $333 per month from birth through their first year of college. Just the direct costs — tuition, fees, and books — are still $11,512 annually, necessitating savings of $145 per month. Make a savings plan that integrates with your personal savings and open a 529 plan account to earmark and invest the funds. 529 plan accounts offer potential tax-free investment growth if funds are used for qualified education expenses.

I will review my home mortgage to potentially refinance. Mortgage interest rates are at historic lows. If you have no plans to move in the near term, refinancing can create significant savings. On a $200,000 mortgage balance, the difference between a 4 percent and 3 percent fixed rate over 30 years is approximately $111 per month or $40,400 over the life of the loan. Of course, refinancing costs and the remaining term of the mortgage must be taken into consideration.

I will blow some of my finances on another “F” resolution — fun. A beach vacation sounds nice after being cooped up. Happy New Year!

Tim Ellis, CPA/PFS, CFP, is senior investment strategist and wealth strategist for Waddell & Associates.

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An Election Digestif

On Saturday morning, the Associated Press called the 2020 presidential election for the Democratic former Vice President Joe Biden. Meanwhile, Congress appears to be headed for a split decision. Democrats lost seats in the House of Representatives but should maintain their majority, and Republicans lost seats in the Senate but should maintain their majority (assuming both Georgia runoff elections do not flip to the Democrats).

The stock market clearly liked the results. The U.S. large company index (S&P 500) increased 7.4 percent for the week, which was its best weekly gain since April. The rise may be attributed to moving past a volatile event — a sigh of relief.

The period of uncertainty over the election results appeared to have a negative impact on markets, as the S&P 500 steadily declined in the three months leading up to the election. However, the more likely reason for the positive reaction is that the market preferred a divided government.

That might seem like a strange preference. Who likes gridlock? Nobody whistles through traffic on I-240. It was Abraham Lincoln who gave us “a house divided against itself cannot stand.” But 2020 is a strange year. Let’s go through the prospects of a (probably) divided government and how that might be a bullish scenario for stock investors.

From an economic policy standpoint, the election results did not fundamentally change the potential for a coronavirus fiscal aid package follow-up to the CARES Act. An aid package might have been larger in a Democratic sweep scenario, but we could still see a $1 trillion bill, and possibly sooner than February. The spotlight of the election drove months’ worth of negotiations to an impasse. Now, post-election, and with the U.S. enduring a third wave of COVID-19 cases, congressional leaders have declared that they are ready to resume negotiations. A $1 trillion (approximately 5 percent of the overall U.S. economy) boost combined with a vaccine and pent-up demand could fuel the economy in 2021 and going forward.

On domestic policies, a divided government should provide President-elect Biden room to negotiate on trade, energy, immigration, healthcare, and regulation while limiting the potential for tax reform and large-scale spending expansions (i.e. healthcare, education, housing reform). And there are some bipartisan issues that could easily come to fruition, like an infrastructure bill, prescription drug pricing bill, and antitrust regulations for technology companies.

On foreign policy, the focus will be mending ties with allies, and then trade policy with China. Biden will likely still be tough on China, although perhaps through multilateral trade agreements rather than bilateral agreements and tariffs. More importantly, a Biden administration should use a more predictable policy approach, which could reduce market volatility and business uncertainty relating to U.S.-China trade.

From a stock market perspective, a “Biden portfolio” favors stocks in renewable energy, infrastructure, emerging markets and international regions, and healthcare (excluding big pharma). Keep in mind that substantial stock sector rotations under different presidential administrations are unlikely. Presidents Obama and Trump could not have been more opposite, but there was a strong correlation between stock sectors under both. Technology and consumer discretionary stocks (e.g. amazon.com, Home Depot, McDonald’s, Nike, etc.) performed the best under both, while Energy stocks performed the worst under both.

Since World War II, there has been a divided Congress in 14 of 76 years. The average annual stock market return during those years is 10.5 percent, which is slightly lower than the entire time frame (11.5 percent). However, there has been one occurrence of a divided Congress with a Democratic president — President Obama from 2010 to 2014 — and the average annual return of 16.7 percent was the highest of any political scenario.

Maybe gridlock is Goldilocks. (Sources: JPMorgan and Bespoke Premium)

Tim Ellis, CPA/PFS, CFP, is senior investment strategist and wealth strategist for Waddell & Associates.

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The NASDAQ is Zooming to new highs. Can it last?

Technology stocks had already been on a good run. From the bottom of the Financial Crisis on March 9, 2009, through the end of 2019, the NASDAQ 100 Index, which is made up of primarily U.S. technology-related stocks, returned 842.8 percent, versus 498.5 percent for the more broadly diversified S&P 500 Index. The outperformance was founded in the latest boom of technology and fueled by the rise of social media, cloud-based technology, e-commerce, and advancement of mobile devices.

Then came the COVID-19 global pandemic, which triggered social distancing measures and forced people indoors, which translated to more time on devices and on the internet. This dynamic uniquely positions the technology sector for supercharged growth through e-commerce, telecommuting, and shifting even more activities online. And once again the NASDAQ 100 is outperforming the S&P 500 — 28.5 percent vs. 3.5 percent — in 2020.

Tim Ellis

Zoom Video Communications could be a poster child for this growth spurt, as I am confident that most of us have participated in a virtual meeting via Zoom during the pandemic. Zoom’s paid subscriber base increased 458 percent, compared to one year ago, and therefore, its stock price has increased 629.7 percent in 2020. Although Zoom is well-known because of its recent success and useful technology, it has only been a publicly traded company since April 2019. After this year’s exponential stock growth, its stock market capitalization is now $140 billion. For comparison’s sake, the century-year-old IBM’s market cap is $105 billion. Investors are currently paying approximately $495 per share for a stock that is expected to earn only $2.47 per share. The justification (if any) is continued hyperbolic growth and converting non-paid subscribers into paid subscribers.

This case study may seem like déjà vu. Pundits are striking comparisons of this period of surging technology stocks to the late 1990s tech bubble, which famously burst and set off a bear market recession from 2000 to 2002. However, there are a couple of reasons to not proclaim the current market environment as a tech bubble redux.

First, there is a fundamental justification for the technology outperformance over the past decade and more recently during the coronavirus pandemic — revenue and income growth. This phenomenon is especially true at the top end of the market, where Apple, Microsoft, Amazon, Google, and Facebook reside. Two decades ago, technology sector revenues as a percentage of gross domestic product (GDP) peaked at 8 percent, yet the technology companies’ contribution to the S&P 500 market cap soared to 34 percent. Today, technology sector revenues make up 17 percent of GDP, and the technology companies’ percentage of S&P 500 market cap sits at 27 percent. Although there are some high-flying outliers like Zoom, the technology companies of today are holding up their end of the bargain with large contributions of revenues, income, and cash flow.

Second, there does not appear to be a mania or air of “irrational exuberance.” A bubble is generally characterized by prolonged upside momentum, whereas this stock market saw a significant downturn at the start of the pandemic in February and March, as well as another pullback in late 2018.

Although I am advocating that technology stocks are not in bubble territory, that does not mean they are the most attractive investment for investors. One of the tenets of investing is that past performance is not a guarantee of future results. Often, there is a period of mean reversion where underperforming and more reasonably valued sectors and stocks catch up. In today’s environment, that may be economically sensitive sectors, such as materials, industrials, and financials, that stand to benefit from a full economic reopening and post-pandemic recovery. (Sources: Morningstar, Barron’s, Business Insider, JPMorgan.)

Tim Ellis, CPA/PFS, CFP, is a senior investment strategist and wealth strategist with Waddell & Associates.

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Independence Day: Charting Your Path to Financial Freedom

Financial planning tends to focus on retirement planning — that holy grail where we ride off into the sunset (literally, to some beach chairs) and never work again while living comfortably off of retirement plan savings and income. Retirement planning is a nice ideal and important, but there can be much more to financial planning than preparing for our last 25 to 30 years. A broader financial planning discipline may have more appeal to you — financial independence.

It’s fairly self-explanatory: The concept is to reach a point where your financial assets can support your living expenses, so you no longer need to work or depend on earned income. Essentially, your time is your own.

Shifting from retirement planning to financial independence helps move the financial concept from a daunting, long-term goal to a process with benefits along the way. It also addresses those blessed people who love their businesses or jobs. In those situations, a full-stop retirement date may not have an appeal, but they still want the freedom to work when, where, and how they prefer — in other words, independence.

What steps can you take to start the road to financial independence?

Let’s start with the foundational equations of finance. For annual income, savings equals income minus expenses, and for financial position, net worth equals assets minus debt.

In the annual income equation, expenses and savings deserve equal attention. The rule of thumb is that you can safely withdraw 4 percent of your investment assets each year, make increases for inflation, and still have assets remaining after 30 years. By inverting the 4 percent withdrawal rule, you should target accumulating 25 times your annual living expenses (e.g. $60,000 annual spending x 25 = $1,500,000 target investment assets).

It is important to dial in your spending number to provide an accurate, realistic target. I advise my clients, regardless of income level, to establish some sort of budget plan. Knowing expenses allows the opportunity for review and adjustment. There are articles that extol the benefits of cutting out Starbucks coffees, but the real focus should be paid to the big three — home, vehicles, and food. Making conscious decisions like staying below the housing cost guideline (housing costs less than 28 percent of income) and making reasonable vehicle purchases help keep expenses at a moderate level and allow for increased savings. Another important factor is avoiding lifestyle creep, in which expenses instead of savings grow with income.

The traditional retirement savings target is 10 percent to 15 percent of annual income. That savings rate over a career should ensure that you can retire and maintain a similar lifestyle in retirement. A 15 percent savings level should be the baseline, with increases shortening your time to financial independence.

There are people who take it to another level, such as the FIRE (Financial Independence, Retire Early) movement that aims for a 40 percent to 50 percent savings rate. Prioritizing savings to that level may not be practical or feasible, but anything over 15 percent will accelerate your timeline and immediately impact your financial position.

There is a hierarchy of savings that helps maximize efficiency while taking advantage of the tax code. After reserving an emergency cash fund (three months to six months worth of living expenses), prioritize savings to 401(k) or 403(b) plans that offer a matching contribution. Next, target any higher-interest loans (anything above 6 percent). Then, contribute to health savings accounts and Roth IRAs if you are eligible. Last, save to brokerage accounts up to your targeted savings rate.

Saving is simple. Sometimes all you need is the right advisor in your corner to assist with an individualized plan that you can follow. With these tips and a little guidance, reaching financial independence is possible, regardless of your age and salary. Plan now and enjoy your freedom later.

Tim Ellis, CPA/PFS, CFP, is senior investment strategist and wealth strategist for Waddell & Associates. He can be reached at tim@waddellandassociates.com.