If you’re in your 20s, 30s or 40s, you should consider a Roth IRA. If you’re self-employed, you may only have an IRA as a retirement savings option available to you. And a Roth IRA can be a great option.
An IRA is an individual retirement account that is available to most people even if they have a 401(k). The main advantage of a 401(k) is the company match feature, but the other benefits apply to IRAs as well:
Pre-tax contributions that save on federal and state income taxes, and
Tax-deferred growth over your entire working life.
A Roth IRA is different from a traditional IRA because contributions are made after taxes have been paid. But since the contributions are made “after-tax,” you don’t have to pay taxes on that money when you withdraw the funds in retirement. Not paying taxes on IRA withdrawals is a huge benefit. Imagine not having to pay taxes on your income. You can have that with a Roth IRA.
Typically, people in their 20s have a lower income than when they’re in their 40s. This means that the younger person would be in a lower tax bracket, let’s say 20% of their gross income. If this twenty-something contributes $800 to a Roth IRA, they must first pay $200 in taxes on the $1,000 in income it took to make this $800 contribution. They would therefore start $200 behind another twenty-something who made a $1,000 contribution to a traditional IRA. How can that be good?
Well, the advantage starts to accrue after the contribution is made and over the rest of the person’s working life (potentially 40 years). Forty years later, with average investment returns of 7.5% per year, that $800 would be worth $14,400.
In a traditional IRA, all of that $14,400 would be taxable once it’s withdrawn. With a Roth IRA, none of that $14,400 would be taxable. At a tax rate which at that point could be 25% or 30%, you would potentially pay $4,000 in taxes on that money in retirement, vs. the $200 in taxes you would have paid in your twenties.
If your investment returns are higher, as they would be with a system like ours, the advantage is even greater. The $800 would grow to $95,500 with our system, not $14,400! In that case, the tax savings (due to the higher tax bracket later in life) could be over $25,000. The tax advantages are much less significant for people in their 50s or 60s because the Roth IRA contributions have less time to grow and because people in their 50s and 60s are typically in a higher tax bracket.
Anyone under the age of 45 should investigate a Roth IRA and see if it makes sense for you. It’s also possible to contribute to both a 401(k) and a Roth IRA. You can contribute as much as you need to in order to max out the company match in a 401(k), and also contribute to a Roth IRA as long as you stay within the annual IRS limits on contributions.
Everyone’s tax situation is different, but you should see if a Roth IRA is right for you or you children. Your Social Security income is taxable when you retire. Your 401(k) and traditional IRA withdrawals are taxable when you retire. But withdrawals from a Roth IRA are not subject to taxes. Not having to pay taxes on retirement income makes it much easier and much simpler to manage your finances at this stage of your life.
Happy investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
With the difficult year of 2022 just ended, let’s look at how the major market indices performed. As of the market close on Friday December 30th, the S&P 500 is down 19.5% from its previous peak at the start of the year. The Nasdaq and the Russell 2000 are down 27.9% and 34.1%% respectively. The Vanguard Total Bond Index (BND) is down 15% for the year. Bonds did not help your portfolio this year. The S&P hit its low of the year (drawdown) on October 12th - down 25%. Also in mid-October, the Nasdaq reached its low (drawdown) of -34.8%.
Here is a comparison of the three indices in 2022. The patterns are very similar, but the S&P 500 has fared much better than the Nasdaq or the Russell 2000. In the graph, you can see how the Nasdaq has lagged the other indices in the last two months. The market continues to punish technology stocks this year.
Throughout 2022, we have been comparing this bear market with the bear market of the 1970’s. The graphs line up well as you can see below, and the seventies were the last period where we experienced high rates of inflation. The 1970’s market was only halfway through its decline at this point and continued falling for another year. It bottomed out with a price drop of 45%. This year’s market is still following the slow and steady decline we observed in the early 1970’s.
Let’s look at another view of the S&P this year to see what the technical analysts are seeing. Charts like the one below shows what are called price support (lower line) and price resistance (upper line) levels. You can see that the trend lines are still heading in a downward direction despite the recent positive move. The S&P is approaching a price resistance level and if it breaks through this upper level, that would be a positive sign. Analysts would become bullish if the S&P index continues its current climb and gets above 4,300.
We are now just about twelve months from the pre-crash peak for the S&P and about fourteen months from the peaks of the Nasdaq and the Russell 2000. The average length of a bear market decline is eleven months, so it is possible that we are in the late stages of this crash. But we just saw that the 1970’s bear market decline lasted two years.
ARE WE OVER-VALUED OR UNDER-VALUED?
Another tool that we use and that other hedge funds use to assess the current stock market is a market value indicator. With all the ups and downs of the stock market, it can be easy to get confused as to whether the market is over-valued or under-valued at any point in time. Many people use a Price to Earnings ratio to make their value assessments. We don’t like this approach because it can be very difficult to know what the “right” P-E ratio should be. We prefer to measure current prices to a consistent “fair value” indicator for the overall market (the S&P 500). Our fair market value indicator is also tied to corporate earnings growth, but it produces an expected value of the market at any point in time versus a P-E ratio.
Here is how the market has compared to a “fair value” over the last five years. As of 12/30/22, our indicator suggests that the stock market was under-valued by 11%. In the third quarter of 2021, our system thought that the market was over-valued by 17%. It is not too surprising, therefore, that the market pulled back in 2022. At the low point of the 2020 Covid crash, we thought the market was undervalued by 17%. So, in an eighteen-month time frame (March 2020 to October 2021), the market went from being under-valued by 17% to being over-valued by 17%. The last two years have been extremely volatile, and this kind of volatility can make even experienced investors uneasy. Our Beyond Buy & Hold system, however, benefits from these wild price swings in short periods of time.
You can take some comfort in knowing that the market is under-valued by 11% at the end of 2022, but we do not recommend trading based on this one indicator alone. We only use the indicator as a guide and as a small part of our trading algorithms. This indicator can be very helpful when you have a unique situation where you plan on investing a lump sum into the stock market or you have the need to execute a large sale of stock.
The reality is that no one knows if the worst is over or not for the stock market. The direction of inflation and the economy and corporate profits will likely dictate when we begin the inevitable rebound. Because of the uncertainty, it is important to follow a disciplined approach to stock market investing. Our approach to investing relies only on quantitative measures of actual price trends. We make no predictions about which way the market will head in the future. Stay disciplined, my friends.
Happy investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
Most financial advisors and RIA’s (Registered Investment Advisors) are very good at:
developing customized financial plans,
tax planning,
estate planning,
insurance advice,
and dealing with complex one-time financial transactions.
They have in-depth knowledge and lots of experience helping people with these specific challenges. These services are typically one-time events. Consumers don’t need these services on an ongoing basis. Most advisors charge about $200 per hour for these services and that is an excellent deal. You can get all these services for around $1,000 once and you would only need to spend about $400 to $500 every three or four years to update and revisit your plans.
But there is not an adequate business model that allows financial advisors to make enough money offering these services in this manner. They end up subsidizing these services by charging an ongoing fee for managing investments. The typical fee they charge for investment management is 1% of your total investment portfolio. They would charge roughly $3,000 per year to manage an investment portfolio of $300,000. The management fee charged typically decreases to about 0.8% for portfolios over $1,000,000. You would pay about $8,000 per year to a financial advisor to manage a $1,000,000 portfolio. For larger investment portfolios like this, you would typically get all the financial and tax planning services at no additional charge.
But there is a big problem with this business model. Paying thousands of dollars per year to a financial advisor for investment management is not a good deal. Financial advisors are not very good at managing investments. They offer mediocre investment management for a very high price. This is not their fault. They were trained by the big financial services businesses who also don’t have good investment management solutions. The SEC (Securities Exchange Commission) does not even allow financial advisors to talk about investment results. The regulatory environment encourages advisors to offer plain vanilla investment strategies. Advisors who offer unique and better solutions risk getting fined by the SEC. As a result, advisors offer the same mediocre investment strategies that end up lowering your investment returns. Paying thousands of dollars or tens of thousands to a financial advisor is one of the worst investments you could make.
The industry (advisors and the big financial firms) tries to justify these fees by making the investment process much more complicated than it needs to be. They use fancy terms like asset allocation models and risk-adjusted returns and correlation. They take you through a lengthy process to assess your risk profile. They build portfolios containing lots of different investments that look very sophisticated. Advisors often invest their clients’ money in many individual stocks or stock sectors. They balance stock investments across large cap, small cap, international, growth and value stocks. They allocate money to bonds or bond funds. They may invest some money in commodities or real estate investment trusts. A complex portfolio like this must be worth thousands of dollars per year, right?
The answer is actually no. The entire financial services industry wants you to be confused with all this complexity and all their fancy terms. They want you to think that you couldn’t possibly figure all of this out on your own. But the investment results they generate with all this complexity is much worse than you could generate on your own. If you simply put all your long-term investments in an S&P 500 index fund, you would generate significantly better results than any advisor or investment professional. And these complex portfolios that they construct do nothing to protect you from bear market collapses. Look no further than your 2022 investment results. As you can imagine, they do not want you to know this.
The investment professionals are not bad people. In fact, they are great people, and they genuinely want to help people. They were just not trained properly and the regulatory environment that was designed to protect consumers is doing the opposite. Investment advisors believe that what they offer for investment advice is actually very good.
The best way to navigate this broken system is to pay by the hour for the excellent things that investment advisors have to offer:
developing customized financial plans,
tax planning,
estate planning,
insurance advice,
and dealing with complex one-time financial transactions.
And for investment management, you can easily do it yourself. Invest all your long-term funds in index funds that track the S&P 500, or the Nasdaq, and you will outperform every financial advisor and every highly paid fund manager for time periods beyond ten years. For people with portfolios greater than $300,000, you will save thousands of dollars per year in fees, and you will gain thousands of dollars per year in investment results. It is not often that you can pay less for something and get better results. This is one of those situations.
And to avoid the pain of bear market collapses and to achieve even better investment performance, you should follow along with our Beyond Buy & Hold system; the only system that beats the S&P 500 consistently and that avoids losses in bear markets.
Happy investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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