Looking Back

What a difference a year makes.

The markets were quietly making new highs in February 2020. Economic growth was slow and steady with GDP close to 2 percent, and inflation largely nonexistent.

Then Covid arrived, disrupting economies around the world and ushering in some of the biggest changes to how we live and work in our lifetimes.

Looking at the events that unfolded, and the government and Federal Reserve Bank's response to them, is still jaw-dropping.

The decision to shut down the economy in the wake of the unknown threw it into immediate recession. The Dow and S&P dropped over 20 percent is three weeks. The bond market, the plumbing of all the markets and the economy, essentially froze.

It was not just any recession. It was actually five times the average of recessions since World War II. It also happened in just a quarter of the time. Eleven million people lost their jobs, the biggest percentage drop since the Great Depression.

The government was quick to respond with the Cares Act, including direct payments, loans, and rent and mortgage payment forbearance. In three months, these trillions of dollars increased the deficit by more than the past five recessions combined. So much was distributed that even with the job losses, net income increased by the largest amount in 20 years.

That was the fiscal side. On the monetary side, the Fed immediately slashed interest to zero, and then started buying bonds on a massive scale to get both the bond market functioning again and to bring longer term rates lower. In six weeks, the Fed bought more bonds than it had in the previous 10 years.

Corporations, rather than reduce debt to shore up their balance sheets as they had in previous recessions, took advantage of the Fed's largesse and issued $400 billion in new debt. By way of comparison, they reduced it by $500 billion during the last crisis.

But it had the desired effect, for Wall Street anyway, and the massive stimulus drove the market, led by technology shares and online shopping, to new heights. Who could have predicted how well the economy would fare in the wake of the shutdown? Imagine if this had happened 10 years ago, or even 5. From an infrastructure standpoint, we were prepared for this and didn't know it.

All this stimulus does come at a cost. On the chart below, the blue line shows how the money supply has exploded since the pandemic started. In fact, it is up 20 percent in just under a year. When asked on 60 Minutes where all the money to pay for everything was coming from, Chairman Powell famously deadpanned, "We print it, digitally." Creating money to spur growth was the easy part. Ratcheting it back now that things are stabilizing may prove more difficult.

The purple line is the velocity of money--how fast it moves around the economy. If people put money in the bank, it slows, and if they spend it it speeds up. The velocity has been dropping precipitously for obvious reasons, but as the economy opens up money will start to get spent. On top of that, we are getting the long-awaited stimulus package that could put up to another $2 trillion in spending power out there. While all this liquidity is great for Main Street, it is starting to get the bond market spooked.

Higher inflation rates lead to higher interest rates. Interest rates were steadily moving higher as the economy improved, but recently have started to accelerate higher at a faster pace.

The Fed has explicitly said that it wants to see inflation rise for a sustained length of time as a sign of a growing economy. However, too much at once could lead to an interest rate spike. Low rates have underpinned both stocks and real estate, the two biggest bright spots since the whole pandemic started. All eyes are on the Fed as it navigates its way through this.

GameStop

I could not talk about markets without commenting on the price action in GameStop stock which has been capturing a lot of headlines.

Shorting may seem like a newfangled Wall Street invention, but investors have been betting on the price of some stocks to go down for as long as they've been looking for prices of others to go up. Although short sellers are unpopular (after all, what kind of person wants a stock to lose value?) they provide a valuable service to the markets as a whole. For example, it was noted short seller Jim Chanos who exposed outright fraud in Enron back in 2000.

The mechanics of shorting a stock are straightforward, but there is an additional step. If you sell something you don't own, you still have to deliver it to the buyer. So before hitting the sell button, you have to find someone who owns the stock that will lend it to you (for a fee). If the stock goes down as the seller hopes, they can buy it back at a lower price than they sold it, and return the borrowed shares.

Even though shorting stocks can be profitable, is is inherently extremely risky for a simple reason. If you buy a stock and it goes to $0, all you can lose is your initial investment. There is a floor underneath you. For a short seller however, there is no ceiling. If you sell a stock and the price goes up, there is no limit to where the price can go. You can actually lose multiples of your original investment.

How many shares of a company have been sold short is public information. You can look up a stock at any time and see it. (It's not just companies, but funds as well. For instance, right now the short interest of the S&P 500 is 18 percent). If the shorts become to big it could trigger a short squeeze. For instance if all of a sudden something brightens the company's prospects and all the short sellers are forced to buy at the same time. Below is a twenty year chart of Volkswagen. See if you can spot the short squeeze that briefly made it the most valuable company in the world.

What is unique about the GameStop squeeze is that it wasn't any dramatic change in their prospects. Everyone believes it will go the way of Blockbuster, made obsolete by the migration of games and video to online platforms. The belief is so strong that more and more investors sold the stock until the shorts eventually went over 100 percent. There were more shorts in the stock than the number of shares outstanding. And someone on a Reddit investor blog saw it, posted about it, and with the speed at which information is disseminated today, mobilized thousands of investors to buy the stock all at once.

One of the reasons for this story getting so much traction is because it has a David v Goliath feel to it. It was hedge funds and institutional investors getting squeezed by the little guys rather than the other way around. I don't think it is the beginning of any kind of trend however. It was a perfect setup, and I doubt there will be as much complacently by short sellers in the future as there was with GameStop.

Unexpected Expenses in Retirement

Comprehensive retirement planning requires careful construction of an investment portfolio designed to provide a lifetime of sustainable income, but that is only part of the equation. Just as important to a successful outcome is the spending side. You can take months monitoring your spending habits and structuring a budget that seemingly covers everything, and then you have a record snowfall that destroys your roof. Or you need dental surgery. Or your roof collapses while you're having dental surgery. How do you plan for the unexpected?

Firstly, have a reserve fund (not just a miscellaneous line item) on your budget. It is recommended to have six months’ living expenses available while you're working; similarly, it makes sense to have this during retirement. Then, add to it every year, putting aside 10 percent of your retirement income, if possible. My parents lived in their house for 20 years after retiring and in that time replaced the roof, well, plumbing system, electrical system, furnace, and septic. Fortunately, they were able to do this over time to lessen the bite, but it was still a financial adjustment.

If you are planning to stay in your home, take stock as you get closer to retirement. If your roof is 20 years old, think about replacing it while you're working. The same with an old creaky furnace.

Healthcare costs also can come out of the blue. Be familiar with what Medicare will cover. It does not cover eye care, dental care, or long-term care, three variables that are likely to come into play as you get older. Also, know what the deductibles and co-pays are, and budget for them.

Fortunately, a chunk of healthcare risks can be insured away. Be sure to purchase a supplemental Medigap insurance policy that will cover a lot of the things that Medicare doesn't. Long-term care insurance, while expensive, can remove a lot of that worry too.

Donor Advised Funds

Employing a donor-advised fund (DAF) is a "super-charged" charitable-giving strategy. You contribute cash or investment assets to the fund, which is a charity in the eyes of the IRS. You can then direct contributions from the donor-advised fund to various charities over time, and can also contribute additional monies to the donor-advised fund. Because of the recent increase in the standard deduction on federal income tax filings, only about 13 percent of taxpayers itemize so they don't receive all the tax savings benefit they could. DAFs help with this because you can contribute multiple year's contributions all at once.

As the donor, you're also in charge of how the money is invested; most donor-advised funds feature a short menu of investment options ranging from very conservative (for monies that will be disbursed soon) to more aggressive (for assets that will be distributed to charity further in the future).

From a tax standpoint, the key benefit of using a donor-advised fund is that you gain an immediate tax deduction on the amount contributed. If you contribute cash, you can take a deduction of up to 60 percent of adjusted gross income; if you contribute long-term securities, the deduction is limited to 30 percent of adjusted gross income. The contributions are irrevocable, which is why you can obtain the tax benefit right out of the box, even though the amount isn't necessarily being disbursed straightaway. Annual gifts to charity would in most cases be swallowed up by the standard deduction on your income taxes. By contributing in a lump sum, you retain the ability to claim that tax deduction.

Adverse Market Refinancing Fee

The plunge in interest rates in the wake of the pandemic offered homeowners yet another opportunity to refinance their mortgages. They have been, in record numbers. The cost of refinancing will now be getting more expensive with the implementation of the Federal Housing Financing Agency's (FHFA) "Adverse Market Refinancing Fee."

All refinances backed by Fannie Mae and Freddie Mac (~70 percent of all mortgages), which the FHFA oversees, will be subject to the Adverse Market Refinance Fee, equivalent to 0.5 percent of the total loan amount. The fee is intended to help cover at least $6 billion of projected losses incurred by the Covid-19 crisis, the FHFA said in an August statement. Originally slated to go into effect on September 1, it was pushed back until December 1st due to the dislocations in the economy.

The fee actually will be charged directly to lenders by the FHFA, who will then most likely pass it on to customers. The way in which borrowers will get charged might differ from lender to lender. For example, lenders might tack the fee onto the closing costs, add it to the loan amount or raise the interest rate. Since the fee is 0.5 percent, lenders will be looking to recoup $500 for every $100,000 lent out.

There are some borrowers who will escape the new fee, including those whose loans are $125,000 or less, "nearly half of which are comprised of lower income borrowers at or below 80 percent of area median income," according to the FHFA. On the other end of the spectrum, jumbo mortgages, which are loans over $510,400, will not be required to pay the fee.

Additionally, lenders that don't sell their loans, also known as a direct lender or a portfolio lender, won't be charged the fee, which can put them (and their customers) at an advantage.

However it gets paid, whether built into the rate or the amount borrowed, it is just another piece of the equation of determining if a refinancing makes financial sense.

Residence vs. Domicile

When the pandemic and subsequent quarantine struck earlier this year, a lot of city dwellers escaped to vacation areas and more rural environs. As two months became four months, and is now extending through the end of the year, many are asking if they can change residency to their current location and avoid paying income tax back in their home state.

It's not that easy. The key concept is the difference between residence and domicile.

Every state that has an income tax follows the concept of a taxpayer's domicile. The domicile concept is that you can only have one domicile. It's your principal, primary home, the place you intend to return to when away. You can have ten residences across the country or across the world, but you can have only one domicile.

To change your domicile you need to have intention. Residence without intention in any location doesn't change your domicile. Even if you expected to stay there two years but ended up staying ten, it still wouldn't be your domicile. If you have an intent to remain indefinitely and you're there, you can still go back to where you came from.

It is confusing. You definitely want to work with a CPA or tax attorney to get it right. Otherwise, you may find yourself in a situation where two states are coming after you for income tax.

One other situation that could come up for someone headed for the hills is that many states want you to file a return for income earned while working there. In fact, 24 states require a nonresident employee to file a tax return if they've worked only one day in the state. However, in a world where you need only a laptop and an internet connection to be up and running, this is one that you should be able to avoid.

Two Documents for an 18-Year-Old

This weekend Lisa and I joined countless other parents around the country in taking a child off to college. One thing we have that many of those families won't (but should) is a signed durable power of attorney and a health care proxy.

In most states, parents don't have the authority to make health-care decisions or manage money for their kids once they turn 18--even if they are paying the tuition, still have those kids on their health insurance plans and claim them as dependents on their tax returns. That means if a young adult is in an accident and becomes disabled, even temporarily, a parent might need court approval to act on his or her behalf. With these documents, you can be assured that if your child develops a medical problem, his privacy rights under HIPAA will not prevent you from accessing medical information and making appropriate healthcare decisions.

Additionally, if she attends an out-of-state college, it's advisable to have health-care proxies in both the home and away states. Make sure to have your child provide a copy of his or her health-care proxy to the campus health center.

Do not limit this to kids off to college. I recommend this for any unmarried adult children as well.

Time to Refinance?

The main reason the Federal Reserve lowers rates in reaction to an economic shock is that interest rates are the price of money. The lower the interest rates, the more people and businesses will borrow and spend, turning the wheels of the economy. The biggest ongoing expense most people have is their mortgage, and if you haven't looked at refinancing your existing loan in a while, the time is now.

Lowering your monthly payment is the number one reason to refinance, and rates have rarely been lower. Additionally, if your current mortgage has an adjustable rate, it would be prudent to switch it to a fixed-rate loan.

From a financial planning standpoint, if your current payment fits into your budget with-year mortgage, shorten the new loan into a 20-, or even 15-year term. That would save thousands in the years ahead.

The last reason to refinance is to take cash out of your home. If the value of the home has increased since you purchased it, or if you've paid down a chunk of the mortgage already, you could take out a new loan, pay off the old one, and have cash left over. You might use the extra money borrowed to pay off higher-cost debt, cover the kids' college costs or remodel your home. Just be careful that you don't get back into that same higher-cost debt again while having given up the equity you'd built up.

Credit Unions

If you do your personal banking at one of the large national banks, you've seen your fees for basic services creep up over the past couple of years. In their struggle for profitability, these banks are putting the squeeze on their customers.

One way to counteract this is by joining a credit union (CU). Credit unions can offer friendlier terms on loans and fees because they are member-owned, not-for-profit institutions, so they are exempt from federal income taxes. You qualify for membership if you have a "common bond," such as where you live, work, attend school, or worship. You may also qualify due to an affiliated association, or because a family member belongs. You can find one in your area by clicking here.

How much can you save? The rate on new car loans at CUs recently averaged 3.4 percent, or 1.5 percentage points lower than at banks. On credit cards the rate was 1.4 percent lower. And because CUs are not-for-profit, you will not encounter all the monthly maintenance fees that have become prevalent at larger institutions.

Your deposits are safe because they are federally insured by the National Credit Union Administration up to $250K per account, similar to FDIC insurance for banks. The biggest drawback could be that CUs are local. If you do a lot of traveling you may want the option of visiting a branch wherever you go. In that case, it would be advantageous to keep your savings in a CU with its higher rates and lower costs, and your checking account at a traditional bank.

A Different Take on LTC

Boston College, my alma mater, has become one of the go-to places for the latest research on retirement issues. Its Center for Retirement Research, recognized by the New York Times as "the nation's leading center on retirement studies," covers the multitude of issues affecting individuals' income in retirement, from finances to healthcare.

A new study by its senior economist Anthony Webb sheds new light on who may need long-term care insurance (LTC). He finds that U.S. nursing home stays are relatively short: 11 months for the typical single man and 17 months for a single woman. This is shorter than previously thought. There's some unpleasant news in the study, too: It shows that the risk of older persons needing nursing home care is 44 percent for men and 58 percent for women. The significance is that nursing home stays are higher-probability, lower-cost events than previously thought, which reduces the appeal of purchasing long-term care insurance.

One of the largest deterrents of purchasing LTC insurance is certainly the cost of the premiums. Another big reason for the lack of interest in insurance is that Medicaid pays for a long-term stay in a nursing home for those who can't afford one. The upshot for individuals weighing whether to buy the private insurance is that the benefits of doing so often accrue not to the individual who bought the policy but to the government, in the form of reduced Medicaid payments.

However, one major point the study fails to address that not everyone who needs long-term care goes into a nursing home. In-home care and assisted living are the two biggest recipients of LTC payments, and Medicare and Medicaid do not typically cover these expenses.