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"Brexit" - Should We Be Concerned?
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On June 23, the issue of whether Great Britain should remain in the EU (European Union) will be put to a referendum. The uncertainty around this vote has hindered England’s currency, reduced employers’ willingness to hire and caused an uptick in inflation.
We do not think this issue should be a concern because the odds of the so-called “Brexit” are low (20% to 25% depending on which source you consult). However, since England is the fifth largest economy in the world, second only to Germany in Europe, the world is carefully monitoring this issue.
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The camp in favor of leaving the EU says that it has become a powerful bureaucracy that has infringed on Britain’s national interests in trade regulations, immigration and labor. Those who favor staying in the EU cite advantages in trade and economic benefits.
Recent waves of immigration into the EU from war-torn countries in the Middle East have stirred concerns across Europe and other parts of the world.
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Use Lower Tax Brackets To Your Advantage
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A common mistake retirees make is waiting too long to begin using IRA money. This can result in paying higher taxes in later years of retirement.
An example will illustrate this point. If a couple needs $100,000 for annual living expenses, why not take the whole amount from an after-tax account instead of from an IRA? This would save taxes because any money they take from an IRA would be taxed.
However, this would create a problem in the future. Spending down the after-tax account would leave only IRA funds for future distributions. At that point, the couple would have no choice but to take the entire $100,000 from their IRAs. This would push them into the 25% tax bracket (versus 15%).
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In this simple example, it would be better to take $75,000 from the IRA each year (assuming no other income). That would keep them in the 15% tax bracket versus the 25% bracket – a better long-term strategy.
As financial advisers, we take tax consequences into consideration for all distributions.
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Markets have absorbed the first rate increase in December and it looks like more increases are in store. The following chart shows interest rates for the last 10 years. From the chart, it is clear that we have a long way to go before getting to “normal” interest rates.
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As Fed watchers try to predict the next rate increase, some of the more important considerations are inflationary pressures, economic growth (both here and abroad) and employment levels. Only lack of economic growth overseas, along with low or even negative interest rates, have been a deterrent to increased rates by the Fed.
Based on the comments after the last Fed meeting, the chances that the Fed would raise interest rates in June have increased. Additionally, the most recent data show strength in consumer spending, which is another sign that the economy could handle a second rate increase.
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What Could Happen If Interest Rates Increase?
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The implications of higher rates are mixed. If the economy is doing so well that it needs to be cooled off with higher rates, the
effect on
stocks
would be minimal. One risk, probably later in the cycle of rate hikes, is that the cooling could be overdone, sending the economy into a recession. Stocks do not fare well during recessions.
The
effect on
bonds
would be negative in the short run. Those holding bonds at 3%, for example, when rates go up to 4% would experience a reduction in the value of their principal. We have measures in place to offset some of the negative effect of higher rates on bonds. We use active bond managers to control interest rate exposure, short duration bonds to mitigate the negative effect of higher rates and “strategic” managers that use futures to hedge interest rate exposure.
The
effect on
alternative investments
would be mixed. Some strategies (e.g. long-short and merger arbitrage) would likely have a better return with higher rates. Others (e.g. REITs and MLPs) could be pressured by higher rates because bonds would be relatively more attractive.
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Market Factors Affect Interest Rates
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In addition to the Fed policy on short-term rates, market factors, such as supply and demand, affect interest rates.
Between 2008 and 2014, for example, the Fed was a large buyer of bonds. The unprecedented purchases helped to push rates down (rates go down when prices go up) in what was called “Quantitative Easing.” The Fed is no longer a major buyer of bonds, which means unless other buyers pick up the slack, rates will have upward pressure.
Currently, extremely low interest rates overseas have attracted foreign buyers. This has helped to hold down interest rates. For how long – no one is sure.
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Welcome To Our New Associate
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Brian Depa began working with Golden Trail Advisers on May 11 as an Investment Adviser Associate.
Prior to Golden Trail, Brian has worked for nine years in the retirement plan industry with both Lincoln Financial and AON Hewitt. Brian graduated with high honors in Finance from the University of Illinois at Urbana-Champaign in 2006. Brian holds his Series 65 license, Financial Adviser Representative.
At Golden Trail, Brian has been assisting with trades, handling the download and reconciliation of data from custodians, and helping with client risk analysis.
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Feel free to forward these thoughts to anyone who might benefit from them.
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