Maintaining Equity Exposure in the Current Interest Rate Environment

In today’s interest rate environment, some investors are tempted to lock in “guaranteed” returns through fixed income instruments yielding 5% or more. However, investing solely in fixed income would be a mistake for most long-term investors. Discussed below are a few reasons why that is the case:

Higher Long-Term Returns

Over the past 90 years, the stock market has delivered average returns of ~10% per year, well above even the highest fixed income rates offered today. While stocks carry higher short-term volatility, their long-term return potential is much greater. Investing consistently in equities through low-cost index funds is likely to generate significantly higher lifetime wealth compared to parking your money in fixed income assets.

Inflation Protection

In order to preserve purchasing power within your portfolio, long-term expected returns need to at least match your rate of withdrawal plus the rate of inflation. If long-term inflation expectations are 2-3% and a sustainable portfolio withdrawal rate is 4-5%- fixed income returns of ~5% won’t provide your portfolio with inflation protection. This could result in the need to reduce spending or portfolio assets being spent down more aggressively than recommended.

Growing Income

Both stocks and bonds can generate income. Stocks provide dividends that change based on company earnings, while fixed income offers steady interest payments tied to a fixed rate. Given the connection to earnings, stocks provide growing dividend income over time. S&P 500 dividends have grown at around 6% annually. Reinvested dividends can turbocharge total returns. Meanwhile, bond interest can’ be immediately reinvested into the originally purchased bond, which also adds reinvestment risk. Relying solely on fixed income can mean missing out on this compounding engine.

Diversification Benefits 

While bonds are not typically thought of as a “risky” investment, there are risks associated with being highly concentrated in the bond market. Changes in interest rates can have drastic impacts on the value of your portfolio if you’re only invested in bonds. Given that stock and bond markets are not highly correlated and often move independently, having a mix of both should benefit your risk-adjusted return.

In summary, locking yourself into fixed income today means forfeiting higher growth and income potential from stocks. Though requiring patience and discipline, the stock market remains a key engine for building long-term wealth. Don’t make short-term decisions that compromise your future financial security. Maintain reasonable stock exposure to benefit from long-term growth. Talk to a Rockbridge Advisor today.

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Changes for Unused Funds from 529 Plans Beginning in 2024

To address investor concerns related to 529 Plan savings going unused, a provision of SECURE ACT 2.0 allows the opportunity to rollover unused 529 education savings into a Roth IRA in the beneficiary’s name, penalty free. As a result, investors should feel a sense of relief about leftover 529 savings that weren’t used for education. Likewise, parents of younger children may have more confidence about saving in a 529 plan knowing they have this option for future unused 529 assets.

Of course, the increased flexibility surrounding 529 savings is not without some constraints. Below is a list of items that investors should be mindful of:

  • Effective beginning in 2024.
  • The lifetime limit eligible for rollover to Roth is $35,000 per beneficiary.
  • 529 account must have been open for at least 15 years before making the rollover to avoid taxes and penalties.
  • The amount that can be rolled over each year is limited to the Roth IRA contribution limit for the year ($6,500 in 2023, $7,500 for those 50 and older), less any other Roth IRA contributions.
    • As an example, if the beneficiary contributed $3,000 to their Roth IRA, the amount remaining that could be rolled over from the 529 plan is $3,500.
  • Roth IRA beneficiary must be the same beneficiary of the 529 plan.
  • Contributions (and investment earnings on those contributions) made within the last 5 years are not eligible for rollover to a Roth IRA.

Given the annual rollover limit, coupled with the restrictions on contributions made within the last 5 years, this rollover strategy may take more than one year to complete depending on the size of the rollover.

Once in the Roth IRA, the funds can now be used for other purposes beyond education, such as retirement savings.

This new consideration may allow families to begin saving for a child’s education AND/OR retirement at an early age. By opening a single 529 Plan early on, contributions and growth could accumulate for 18+ years, and up to $35,000 of unused funds (per beneficiary) could be rolled over to a Roth IRA, kickstarting retirement savings. With an initial rollover of $35,000 after college plus annual contributions of $6,500/year and a reasonable investment return of 6%, the balance of the Roth IRA could exceed over $1,000,000 by the beneficiary’s retirement age.

Important Note:

Whether or not 529 rollovers to a Roth IRA are determined to be a qualified distribution for state tax purposes will depend on each state. States are still working out these details.

Please reach out to your Rockbridge advisor with any questions.

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S&P 500

Adam Gagas

Chief Investment Officer

October 3, 2023

The S&P 500 Index is often thought of as a proxy for the US stock market. In truth, the S&P 500 is an index that represents only a narrow slice of the domestic marketplace. Recently, the index is showing signs of getting even narrower by two important measures. While investors should be happy to participate in the performance so far, it reinforces our determination to maintain diversification to broader markets.

The 10 largest stocks of the S&P 500 now account for 33% of the value of the index, higher than at any point in the past several decades. Concentration means index returns are determined by the performance of just a few companies. When the list of the largest stocks also includes the best performers in the market, the effect is multiplied. For example, Nvidia (up +198% YTD), Facebook (+150%), and Tesla (+103%) together account for more than three-quarters of the year-to-date advance in the S&P 500 Index.

There is increasing concentration by valuation, as well. Investors are affording the largest companies a higher price/earnings ratio (P/E), indicating a willingness to pay more for every future dollar of earnings. For example, the P/E ratio for the handful of the largest stocks is 27.7, well above the historical average of 20.2. Moreover, that’s higher than the 17.6 assigned to the other 490 stocks in the index.

The same top 10 stocks aren’t contributing a larger share of earnings, however. Despite their above-average proportion in the total index, they are expected to contribute to total earnings in line with historical averages.

When the P (or Price) of the P/E ratio advances at a faster pace than the E (or Earnings) – driving the whole ratio higher – stocks experience “multiple expansion”.  With multiples already 30% higher than historical averages, there may not be room for the P/E to expand.  Future earnings projections will need to climb at a faster pace to justify current valuations.

So, what next? Earnings may accelerate and bring multiples back to historical norms. If not, valuation alone isn’t usually a cause for a decline in stocks, but above-average values may make them more sensitive to shocks. Sometimes stocks simply “tread water” while they grow into valuation. In any event, optimism for perpetual growth isn’t an unusual occurrence, and is the reason diversification into other parts of the market is an important part of well-positioned portfolios.

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Estate Planning Awareness Month

October is Estate Planning Awareness Month, which serves as an important reminder for all of us to take time to review our estate plans or create one if we haven’t already. Estate planning is not just for the wealthy or elderly – it’s important for everyone to have a plan in place to protect your assets and ensure they are distributed according to your wishes in the event of incapacity or death.

Having an up-to-date estate plan can save your loved ones significant time, money, and stress in the future. There are three key legal documents that everyone should have:

  • Will – This lets you determine who inherits your assets and allows you to name a guardian for minor children. For families with young children, this guardianship provision is extremely important.
  • Durable Power of Attorney – In the event that you become incapacitated, this document will allow someone of your choosing to make legal and financial decisions on your behalf.
  • Healthcare Proxies – This document outlines your preferences for healthcare treatment in various situations and allows someone to make medical decisions on your behalf if you become incapacitated.

In addition to the basics, there may be other estate planning strategies to consider based on your specific situation, such as setting up trusts, making gifts, or transferring property. For example, trusts can help minimize estate taxes, avoid probate, or set aside assets for special purposes. Proper titling of assets, beneficiary designations, and joint ownership provisions are also important components of an estate plan.

We recommend that our clients review their estate plans regularly and update them as needed when life circumstances change. Events like marriages, divorces, births, deaths, retirement, or moving to another state are all good reasons to review and potentially modify your existing documents. Keeping beneficiary designations up-to-date is particularly important.

The estate planning process can seem daunting, which is why many people put it off. But having a thoughtful plan in place is one of the best gifts you can leave for your loved ones. Reach out to a Rockbridge advisor if you have questions about starting or reviewing your current estate plan.

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