Tax Time – What to do with your refund?

Receiving a tax refund can be a great way to boost your savings, pay down debt, or invest in your future. But once you have that money in your pocket, where should you put it? Here are some of the best places to save a tax refund.

  1. Emergency fund

An emergency fund is a crucial part of any financial plan. It’s a safety net that can help you weather unexpected expenses or job loss without going into debt. If you don’t have an emergency fund yet, using your tax refund to start one can be a wise choice.

  1. Retirement account

If you’re not already contributing to a retirement account, using your tax refund to start one can be a great way to secure your financial future. Whether you opt for a traditional IRA or a Roth IRA, putting your refund into a retirement account can give you a tax break now and help you build a nest egg for later.

  1. Debt repayment

If you have high-interest debt, such as credit card debt or a personal loan, using your tax refund to pay it down can be a smart move. By reducing your debt load, you’ll save money on interest charges and improve your credit score. Plus, you’ll free up more cash flow each month to put towards other financial goals.

  1. Education savings account

If you have children or plan to go back to school yourself, using your tax refund to start or contribute to an education savings account can be a smart move. Depending on the type of account you choose, you may be eligible for tax benefits and the money can be used to pay for qualified educational expenses.

  1. Health savings account

If you have a high-deductible health plan, you may be eligible for a health savings account (HSA). HSAs allow you to save money tax-free to pay for qualified medical expenses. Using your tax refund to fund your HSA can help you prepare for future healthcare costs and reduce your taxable income.

There are many options available when it comes to saving a tax refund. The best choice for you will depend on your financial situation, goals, and personal preferences. By considering your options carefully and seeking the advice of a financial professional, you can make the most of your tax refund and set yourself up for a more secure financial future.

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Rockbridge Institutional – March 2023 Market Review

Stocks

After enduring ups and downs due to the uncertainty in the financial system and the Fed’s response triggered by the collapse of Silicon Valley and Signature banks, stocks ended the first quarter in positive territory. Domestic large cap stocks, International developed markets and emerging markets were up between 4% and 8%, small cap stocks and REITs up just under 3%. Over the trailing twelve months, on the other hand, except for International developed markets, stocks were down significantly because of rising interest rates and inflation uncertainty.

While the past year was not kind to stocks, the story has been mostly positive over longer periods. The past three years saw a portfolio diversified among several markets earning about 15%. Although with considerable variability among individual markets, a diversified stock portfolio earned about 4% and 7% over the last five and ten years, respectively.


Bonds

Recent turmoil in the banking system drove bond yields down, especially for longer maturities. Since prices move inversely to yields, this downward trajectory in yields pushed first quarter bond returns up between 1.5% and 2.8% depending on maturity. The Yield Curves below show the extent to which yields have climbed since March 2022. The primary culprit is the Fed increasing its Federal Funds rate to dampen inflation. While yields fell back a little this quarter, with the recent 0.25% increase in the Federal Funds rate, the Fed seems committed to keeping rates high for the immediate future.

The spread between nominal- and inflation-adjusted five- and ten-year yields, which is a reasonable measure of the market’s expectation for inflation over these periods, is close to the Fed’s inflation target. The shape of the yield curve can be a harbinger of future interest rates – today’s downward sloping shape implies reduced rates ahead. These signals are positive for future inflation.


Failure of Silicon Valley and Signature Banks

The turmoil in banking brought on by the collapse of Silicon Valley and Signature Banks has not only unsettled markets, but also increased uncertainty in the financial system associated with rapidly rising interest rates and the fight to dampen inflation. These two banks failed because after being accustomed to low interest rates, management lost track of the impact of rising interest rates on bond values. It was surprised by the prices at which its bonds had to be liquidated to meet unanticipated depositor withdrawals, causing sharp losses and eventual failure.

Further exacerbating this interest rate risk, these banks had a concentrated base of large depositors. In response, the Fed has stepped in to protect all depositors. While this intervention has lessened the impact of this crisis, the extent to which it creates a moral hazard that distorts future economic decisions is a downside.

While the implications of the failure of these two banks appear to be well-known and somewhat manageable, it brings heightened uncertainty, not only in the banking system, but also with the Fed’s continued resolve to squeeze out inflation, the availability of credit and economic activity going forward. While the market has absorbed this uncertainty reasonably well so far, we can anticipate continued market volatility.

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Avoiding Surprises at Tax Time: The W-4 Form

The tax filing season can often be filled with angst as many filers are unsure whether they will receive a tax bill, a refund, or make it through unscathed. Fortunately, much of this stress can be avoided by properly filling out (or updating) your W-4 form. Employees are required to fill out their W-4 forms when starting a new job. As a result, this form is often included amidst a mountain of paperwork or e-forms and can go overlooked. In some instances, this form was filled out several years ago and has been long since forgotten as you’ve remained with the same company. However, buried in the details of this 4-page document are the instructions that can help you gain a better understanding of what to expect when filing your annual tax return.

The W-4 form collects pertinent tax filing information that is unknown to your employer such as filing status, deductions, etc. This information helps your employer determine how much federal income tax should be withheld from your paycheck based on your responses. Many of the line items are representative of questions or calculations one would see on their 1040. In essence, the W-4 helps your employer capture a high-level picture of your filing status and projected taxable income as well as deductions and break it down into a “per paycheck” amount of federal taxes to be withheld.

At the end of the year, your total federal withholdings are included on your W-2. This amount will help determine if you are owed a refund or must pay the federal government as a result of an overpayment or underpayment of your federal taxes for the year. While there are many deductions, credits, and other sources of income that can impact your return, for most individuals their annual salary is the largest determining factor. As such, having proper federal withholdings applied each pay period can eliminate much of the unknown.

Below we will discuss and summarize the different Steps of the W-4:

Step 1:

Enter your personal information — in step 1 (c) you will enter the filing status that matches your filing status on your 1040.

Step 2:

This step is only applicable for an individual that has more than one job or those that file as “Married Filing Jointly” and each spouse is employed. If neither of these is apply, this step can be skipped. If Step 2 is applicable then you will follow the instructions for only one of the options listed under (a), (b), or (c).

If you and your spouse each have only one job and your salaries are roughly the same, you can check the box at 2(c) — this box should be checked on each spouse’s W-4.

If one spouse earns a salary that is more than double the other’s salary, then you should consider completing the “Multiple Jobs Worksheet” on page 3 of the W-4 and follow the instructions based on the tables provided.

Step 3:

This step is only applicable to those that will claim dependents and have an income of $200,000 or less for Single filers, and $400,000 or less for Married Filing Jointly filers.

Step 4:

This step captures any other potential adjustments such as income from other jobs, or deductions such as student loan interest and deductible IRA contributions. To assist you in completing Step 4(b) there is a “Deductions Worksheet” on page 3. While most individuals apply the standard deduction, this section helps refine your withholdings for those additional circumstances.

Step 5:

Don’t forget to sign and date your form.

As most individuals would like to avoid a large tax bill, we recommend revisiting your W-4 annually, and at a minimum, after a significant life event (marriage or birth of a child) to avoid any potential surprise when filing your tax return. If you are often presented with a large tax bill each year, reexamining this form may help you avoid that inconvenience.

In addition to the instructions included on the form, there are many sources available to assist with any questions you may have as well as reaching out to your tax professional or financial advisor.

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Bank Run News

It’s hard, and often counterproductive to comment about breaking news while it’s still moving through the proverbial grinder … which is why we usually don’t do so. However, we feel it’s worth commenting on the current, growing number of regional bank runs.

Before taking a look at the details, we’ll lead with two larger assurances:

We’re Here, as Usual

If you have let us know about cash holdings at an affected bank, we are reaching out to you directly to help you navigate your next best steps. If you have such holdings we aren’t yet aware of, please let us know, so we can advise you accordingly.

Even if your money remains safe and sound, we are available to speak with you about any questions or concerns you have at this time. This is one of the biggest reasons you hired us: to serve as an informed sounding board during confusing times.

Our Broad Advice Remains the Same

As you know, we typically seek to optimize your personal long-term outcomes by recommending against reacting to near-term upsets. This philosophy is based on our own and others’ best thinking about how to improve your odds for investment success over time. As such, our strategy already expects that the unexpected WILL happen now and then. To a point, the stress of realized risks can even contribute to our expected returns.

Next, let’s summarize our understanding of the goings on, to aide in rational decision-making.

What Happened?

As usual, there are a number of smoking guns. Perhaps the biggest shot has come from banks that have been holding exceptionally large reserves of low-yielding bonds in today’s higher interest rates.

In the case of Silicon Valley Bank (SVB), for example, its tech-heavy clientele deposited large amounts of cash during the pandemic when the industry was awash in undeployed assets. In turn, the bank used the money to buy Treasury and other bonds. [Source]

As interest rates rose, prices for SVB’s bond holdings fell. Normally, this wouldn’t be a problem; whether you’re a bank or an individual investor, as long as you simply hold low-yielding bonds to maturity, you can expect to be made whole at the end. But if too many of a bank’s customers pull out their money all at once, the bank may be forced to sell their low-yielding bonds at a loss, to meet the sudden demand for cash.  Just as in the classic film “It’s a Wonderful Life,” these sorts of bank runs can spin out of control.

What’s Going To Happen Next?

In the midst of the fray, it would take far more hubris than we have to predict the future. That said, here are our observations to date:

Bank Risks: To date, it would appear that the most at-risk banks are those that are:

  • Serving clients in cash-heavy industries, such as technology, cryptocurrency, venture capital, and private credit; and
  • Perhaps more significantly, holding large percentages of uninsured deposits.

To expand on that second point, today (versus during the Great Depression’s bank runs), the FDIC insures up to $250,000 of each bank customer’s deposits. If you’re married, each of you receive protection of up to $500,000 on a joint account. If an account exceeds FDIC limits, the excess is uninsured. In the case of SVB at year-end 2022, its deposits were valued at around $200 billion, but only about $30 billion of those deposits were insured. That translates to a lot of big accounts with uninsured balances. [Source]

Government Action: As we might expect, the government is not sitting idle as events unfold. It’s “all hands on deck,” with rapid-fire announcements coming out of the Treasury Department, the Federal Reserve, and the FDIC.

  • To staunch the immediate “bleeding,” these Federal institutions are taking a number of joint emergency actions to protect affected account holders, in some cases promising to protect even those whose accounts exceed FDIC insurance levels.
  • There is also talk of walking back the originally projected March 21–22 Federal Reserve rate hike, to help stabilize banks’ bond reserves in general. Time will tell whether broad market predictions here prove correct. [Source]
  • Discussion is underway on how to shore up any systemic concerns over time. For example, there’s already calls for re-tightening banking controls such as capital requirements and liquidity rules for small- and mid-sized banks. [Source]

As such, while the news is as noisy as usual when fear is in the air, we are cautiously optimistic a worst-case scenario is avoidable. That’s no guarantee. But if we place today’s news in historical context, the banking system has been under similar and worse strains, and remained resilient.

You and Your Money

In the meantime, there are your own cash reserves and investments. During times of heightened risk, the longing to take hurried action becomes a pull that’s often too strong to overcome on your own. Before taking any immediate steps, we urge you to talk it over with us.

Unfolding events do underscore one action that may be advisable from a “better late than never” perspective. If the cash you hold in any one bank exceeds FDIC protection (or, in the case of brokerage cash accounts, SIPC limits), there may be value in working out a plan for addressing that issue. That said, whether during the Great Depression or today, panic is rarely an advisable way to proceed.

Again, we are here. Our broad advice remains the same. Our particular advice is guided by your unique circumstances, and grounded in the context of financial best practices.

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