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Sequels are Never As Good – Are They?

Sequels are never as good – are they? Well, that may just hold to movies. There’s plenty of new tax & retirement planning implications from SECURE Act 2.0, passed Dec. 29, 2022.

The original 2020 act had many impactful provisions, but we’ll remind everyone of one very significant change: money in retirement plans that is inherited by non-spouse beneficiaries generally must be taken out (and taxed) within 10 years. Previously, tax law allowed distributions from inherited retirement money to be stretched over the course of the beneficiary’s lifetime.

The retirement and tax planning implications from the SECURE Act 2.0 are far broader – there are over 100 provisions – but no single change is as impactful as the elimination of the stretch IRA in the first bill. Given the breadth of provisions, we’ll focus on three of the most important areas for our clients and their families.

Required Minimum Distributions:

The first Secure Act pushed the required age at which distributions must be taken from retirement plans back from age 70.5 to 72. If you were was born before 1951, there’s no change since you’re already taking distributions. For those born between 1951 and 1959, RMDs now begin at age 73. If you were born after 1960, the first RMD has been pushed back to age 75.

What’s the impact on me?

For those who started taking RMDs in 2022 and prior, there’s no impact.
For everyone else, there will be a longer gap of time between retirement and your RMD age. The potential for lower income during that “gap” allows for additional tax planning – such as Roth conversions, taking capital gains at 0% or 15%, and even taking a distribution from a retirement plan voluntarily while in a low tax bracket. It also means your tax rate on distributions from age 73/75 through the end of your life could be higher, since there will be more income those years.

There are a number of other provisions relating to distributions as well – two of which we discuss below.

For those that are charitably inclined: there’s no impact to the age at which a “qualified charitable distribution” (QCD) can be made (age 70.5). However, the wider gap between when someone may take RMDs and their age 70.5 opens the door to more tax planning opportunities.
- There are several other provisions related to QCDs that don’t apply to many retired givers, such as an inflation-indexed maximum and a one-time ability to fund a split-interest entity (e.g., a Charitable Remainder Annuity Trust).
Lastly, we’ll note that there’s a provision allowing a spouse to elect to take RMDs as if he/she was the original IRA’s owner. It gets complicated, but this could make sense for the older spouse to elect before a younger spouse passes away so that the older, surviving spouse can use the decedent’s life expectancy to delay and stretch out required distributions.

Next up: there were many provisions related to Roth contributions. Notably, this bill did not close the ability to make “back-door Roth IRA” contributions. Rather than restricting Roth access, the bill’s various provisions expand access to or in some cases even require Roth contributions instead of the traditional “pre-tax” contributions. The idea behind why Congress is expanding Roth features is straightforward: it benefits the government via higher current tax revenue, and it helps savers via additional opportunities to grow tax-free wealth. Here are some details on two of the more interesting provisions:

Catch-up Contributions:

Effective in 2024 and for plans offering a Roth option, high wage earners will be required to contribute after-tax money via the Roth option of a retirement plan for any catch-up contributions. High wage earners are defined as making at least $145,000 from the employer whose plan the catch-up contributions are being made into. Catch-up contributions are allowed for employees age 50+. For 2023, after contributing the regular maximum of $22,500 into a retirement plan, employees age 50+ can still make their optional catch-up contributions of $7,500 with pre-tax money.

Further, catch-up contributions for participants aged 60-63 will be bumped up to a maximum of 150% of the regular catch-up amount. Though this provision takes effect in 2025, if it did apply to 2023 contributions, the “bumped up” maximum would be $11,250. Keep in mind that all this would have to be after-tax wages going into the Roth portion of the plan starting next year.

529-to-Roth Transfers

Starting in 2024, it will now be possible to transfer money leftover in a 529 plan to a Roth IRA for the beneficiary. In the past it usually didn’t make sense to fully fund a 529 plan since earnings on non-qualified withdrawals are subject to taxes and a 10% penalty. But now that there’s a release hatch for excess dollars, there will be more client situations where attempting to fully fund college with 529 plans will make sense. There is still some cloudiness that the IRS will clarify but as the law is written this release hatch is here to stay. Here are some major restrictions on this new ability:

The transfer must be a direct rollover into the Roth IRA of the 529 plan’s beneficiary. It can’t go to the owner’s Roth IRA.
The beneficiary must have earned income during the year of the rollover. However, the income limit that normally applies for Roth IRA contribution eligibility will not apply for these rollovers.
The IRA contribution limit still caps the total amount that can go into the Roth IRA each year ($6,500 in 2023). The maximum applies to the combined total of contributions and rollovers from a 529 plan – no doubling up!
The 529 plan must have been maintained for at least 15 years and money contributed within the last 5 years cannot be moved into the Roth IRA.
A lifetime transfer maximum of $35,000 applies to each beneficiary.

As you can see, these limitations mean that 529 plans should still be used with education funding as the intent. But this provision will provide flexibility to fund a 529 plan more aggressively if considered along with cash flow, retirement plan strength, and estate planning considerations.

There are over 100 provisions in the SECURE Act 2.0 – so we’ve only scratched the surface when it comes to the breadth of new changes. However, these are some of the most applicable changes for Boardwalk clients. Please let us know if you’re interested in learning more about the SECURE Act 2.0 and how it applies to your situation. But rest assured, we will be bringing planning considerations to you as we meet – including any financial planning recommendations based on the other provisions not outlined here.

Financial Planning Secure Act 2.0

Six Financial Best Practices for Year-End 2022

Mike Rodenbaugh

Founder

To say the least, there’s been plenty of political, financial, and economic action this year—from rising interest rates, to elevated inflation, to ongoing market turmoil.

How will all the excitement translate into annual performance in our investment portfolios? Markets often deliver their best returns just when we’re most discouraged. So, who knows!

Over the past few weeks, we have taken these six action steps on behalf of our clients. However, if you are not a client of Boardwalk Financial Strategies, now is a good time to take action before 2022 is a wrap.

1. Revisit Your Cash Reserves

Where is your cash stashed these days? After years of offering essentially zero interest in money markets, savings accounts, and similar platforms, some banks are now offering higher interest rates to savers. Others are not. Plus, some money market funds may have quietly resumed charging underlying management fees they had waived during low-rate times.

It might pay to …

Shop around: If you have significant cash reserves, now may be a good time to compare rates and fees among local institutions, virtual banks, and/or online services that shift your money around depending on best available offers (for a fee). Double check fees; make sure your money remains FDIC-insured; and remember, if it sounds too amazing to be true, it probably is.

2. Put Your Money to Work

If you’re sitting on excess cash, you may be able to put it to even better use under current conditions.

Here are three possibilities:

Rebalance: You can use cash reserves to top off investments that may be underweight in your portfolio. Many stock market prices have been depressed as well, so this may be an opportune time to “buy low,” if it makes sense within your investment plans.

Lighten your debt load: Carrying high-interest debt is a threat to your financial well-being, especially in times of rising rates. Consider paying off credit card balances, or at least avoid adding to them during the holiday season.

Buy some I bonds: For cash you won’t need for a year or more, Treasury Series I bonds may still be a good deal, as described in this Humble Dollar post.

3. Replenish Your Cash Reserves

Not everybody has extra money sitting around in their savings accounts. Here are a couple ways to rebuild your reserves.

Earning more? Save more: To offset inflation, Social Security recipients are set to receive among the biggest Cost-of-Living Adjustments (COLAs) ever. Or, if you’re still employed, you may have received a raise or bonus at work for similar reasons. Rather than simply spending these or other new-found assets, consider channeling a prescribed percentage of them to saving or investing activities, as described above. If you repurpose extra money as soon as it comes in, you’re less likely to miss it.

Tap Required Minimum Distributions (RMDs): If you need to take required minimum distributions (RMDs) from your own or inherited retirement accounts, that’s a must-do before year-end. Set aside enough to cover the taxes, but the rest could be used for any of the aforementioned activities. Another option during down markets is to make “in-kind” distributions: Instead of converting to cash, you simply distribute holdings as is from a tax-sheltered to a taxable account. Or, to avoid being taxed on the distribution, you also could donate the assets through a Qualified Charitable Distribution to your favorite non-profit organization.

4. Make Some Smooth Tax-Planning Moves

Another way to save more money is to pay less tax. Here are a couple of year-end ideas for that.

It’s still harvest season: Market downturns often present opportunities to engage in tax-loss harvesting by selling taxable shares at a loss, and promptly reinvesting the proceeds in a similar (but not identical) fund. You can then use the losses to offset taxable gains, without significantly altering your investment mix. When appropriate, we’ve been helping [firm name] clients harvest tax losses throughout 2022. There still may be opportunities before year-end, especially if you’ve not yet harvested losses year to date. We encourage you to consult with a tax professional first; tax-loss harvesting isn’t for everyone, and must be carefully managed.

Watch out for dividend distributions: Whether a fund’s share price has gone up, down, or sideways, its managers typically make capital gain distributions in early December, based on the fund’s underlying year-to-date trading activities through October. In your taxable accounts, if you don’t have compelling reasons to buy into a fund just before its distribution date, you may want to wait until afterward. On the flip side, if you are planning to sell a taxable fund anyway—or you were planning to donate a highly appreciated fund to charity—doing so prior to its distribution date might spare you some taxable gains.

5. Check Up on Your Healthcare Coverage

As year-end approaches, make sure you and your family have made the most of your healthcare coverage.

Examine all your benefits: For example, if you have a Health Savings Account (HSA), have you funded it for the year? If you have a Flexible Spending Account (FSA), have you spent any balance you cannot carry forward? If you’ve already met your annual deductible, are there additional covered expenses worth incurring before 2023 re-sets the meter? If you’re eligible for free annual wellness exams or other benefits, have you used them?

6. Get Set for 2023

Why wait for 2023 to start anew? Year-end can be an ideal time to take stock of where you stand, and what you’d like to achieve in the year ahead.

Audit your household interests: What’s changed, and what hasn’t? Have you welcomed new family members or bid others farewell? Changed careers or decided to retire? Received financial windfalls or incurred capital losses? Added new hobbies or encountered personal setbacks? How might these and other significant life events alter your ideal investment allocations, cash-flow requirements, insurance coverage, estate plans, and more? Take an hour or so to list key updates in your life, so you can hit the ground running in 2023.

How We Help?

At Boardwalk Financial Strategies, we do all of this and more for our clients. We are with them through every transition and help them navigate life’s changes. We ensure every component that contributes to their financial well-being is well positioned—today, and throughout the years ahead.

Financial Planning

Reasons to Keep Focused in Market Turbulent Markets

Mike Rodenbaugh

Founder

There’s no sugar coating it – the first three quarters of 2022 have seen almost all asset classes down and the fourth quarter hasn’t started off on a good note. The widely quoted S&P 500 index lost 4.9% in the third quarter and is down 23.9% so far this year. To make matters worse, bond prices have fallen as well (rather than provide stability) due to rising interest rates and credit risks. During times like these, the best—albeit difficult—advice is to try to “tune out” noise in the market and to focus on your longer-term investment horizon and financial planning optimization.

Last quarter we featured a look back in history at past recessions, noting that market downturns come in all shapes and sizes. This year’s drawn-out bear market may prove to be far more painful for investors than the sharp crash and fierce recovery of early 2020. It will also look different than the great financial crisis, the tech bubble’s bursting, or even the inflationary bouts of five decades ago.

There are a few patterns that tend to repeat themselves in bear markets:

The market is forward looking, so there is typically NOT a clear resolution to the cause of the bear market by the time the stock market begins to recover.
The media characterizations of the market and economic environment can still be downright scary when the market begins its recovery.
The subsequent recovery after market declines is typically strong, although the timing and nature of the recovery varies in each case.

Here are a few strategies that can be helpful in combatting the (counterproductive) human urge to act in the face of a market like this:

Based on the patterns above, realize that it’s very unlikely that you’ll be able to “time” the market bottom and that a “wait until things start to stabilize” likely means you’ll be late.
If you’re a saver, try to appreciate the opportunity to invest at lower prices. Continue to save and invest to enhance the “dollar cost averaging” effect (buying more shares for the same dollar due to lower prices).
If you’re living off your portfolio, we’ve regularly discussed cash reserves and (if possible) had you sock away enough so that you don’t have to sell stocks in a downturn. If that wasn’t possible, we can fund withdrawals from short-term bonds to allow time for stocks to recover.
Try to mentally put your stocks “in a drawer.” We’re not planning on selling them any time soon, so try not to be overly concerned with today’s price. You don’t check the price of your home every day or every month. Why? Because you’re not planning on selling it. The same is true for stocks!

History suggests that market downturns represent a buying opportunity for the long-term. Looking at rolling 10-year returns for the S&P 500, you can see the wisdom in a long-term investing approach that avoids market timing – it’s rare to have a poor 10-year return. By combining other asset classes with US stocks, a diversified portfolio stands the best chance of meeting your long-term goals.

At Boardwalk, we have crafted your diversified portfolio with your unique long-term goals in mind, strategically balancing various asset classes and risks. This year, the team at Boardwalk has been focused on revisiting our clients’ long-term financial goals, ensuring adequate cash flow and proper cash reserves for short-term needs, and, potentially, investing excess cash. We’ve executed on rebalancing, tax loss harvesting, and, where possible, transitioned to more tax-efficient Exchange Traded Fund (ETF) versions of our recommended funds in taxable accounts.

There may be short periods like 2022 when all asset prices seem to be falling in tandem, but tuning out the noise and looking to the future is the best course of action for your portfolio (and your blood pressure). We know maintaining peace of mind during global economic instability is easier said than done and we’re here to discuss any concerns or questions you may have.

Recession and Your Portfolio

“No man ever steps in the same river twice, for it’s not the same river and he’s not the same man.” – Heraclitus

This insight from an ancient Greek philosopher is a relevant way to consider financial markets. Many parallels can be drawn between the financial markets today and those of years past, including what things looked like heading into prior recessions. It’s very possible we’re already in – or will soon experience – a recession here in the United States. GDP contracted 1.6% in the first quarter of 2022, and the widely used definition of a recession is two consecutive quarters of negative GDP growth.

Research shows that market downturns – often contemporaneous with recessions – are, on average, accompanied by positive returns over subsequent one-, three-, and five-year periods. Through the first two quarters of 2022, the S&P 500 has fallen 20%. On average since 1926, a 20% decline in the value of the total US stock market had positive cumulative returns of 22.2% over the next one-year period, 41.1% for the subsequent three-year period, and was up 71.8% after five years. Similar returns have occurred for smaller (10%) or larger (30%) drawdowns. Here’s an interactive exhibit compiled by Dimensional Fund Advisors showing returns, inflation, and other metrics surrounding past recessions that you may find interesting to read in conjunction with our commentary below.

In the 4^th quarter commentary for 2021, we pointed out some of the similarities to the US market of the dot com era. In particular, valuations were frothy. Depending on the metric, prices for publicly traded growth stocks had eclipsed their tech bubble highs of two decades prior. While the timing was never certain, that’s a recipe for a healthy pullback in the stock market. This year has featured dramatic declines for (previously expensive) shares of growth companies to the point that some are even getting picked up by value-style mutual fund managers! The bursting of the tech bubble took several years and a mild recession followed in 2001. It’s possible that today’s market also needed a healthy correction to valuations and a cooling of excesses (such as the NFT of Jack Dorsey’s First Tweet selling for $2.9M and then losing 99% of its value). Like Heraclitus would say, however, it’s not the same “river” and investors crossing today have many other currents to consider.

Inflation during the 1970’s consistently registered in the double digits. Having peaked about a year prior to the onset of the 1973-75 recession, the US stock market fell over 46% before hitting bottom. Occasionally the term stagflation gets tossed around as a risk facing the economy today. It’s a period with both flagging growth and high inflation. America experienced this in the 70’s and it is a scenario the Federal Reserve is anxious to avoid, even if that means continuing to hike interest rates higher. The good news is there are many reasons that financial markets see higher inflation coming to an end. In fact, expected average inflation for the next five years as measured by the Treasury breakeven rates has fallen from 3.5% per year in March to about 2.5% per year now. That’s a far cry from June’s 9.1% reading but goes to show that the market is not anticipating high inflation to continue for much longer.

Of course, one could draw similarities to many financial conditions we’ve experienced before to argue for how the economy and your investments may fare in the near future. We think that the markets do a good job of ‘pricing in’ the probabilities that various outcomes will occur, such as peaking inflation or a looming recession, as over $700 billion of trades occur daily (2021 global average) based on new information and best expectations of what will happen. Therefore, rather than focusing time on the hopeless task of predicting the future, we’re at work maintaining a disciplined approach and making strategic (not market timing) changes in conjunction with your long-term financial plan to help you meet your goals.

Investors’ Largest Concern and How to Manage It

And just like that, two years have passed since spring 2020! In our daily lives and in the markets, it has been both rewarding and challenging. There has been a lot – I repeat, a lot – of things outside of our control over these two years.

For most people, it’s hard not to let uncertain and often significant external events influence how we feel about everything else in our lives. Though often necessary over the last two years, I found the time I spent focused on things largely outside my control was frustrating and disheartening. Conversely, I think many people can relate to the inner peace and happiness we can get when we focus on things within our control, spending time doing things that we enjoy with people we love.

Similar in many ways, a focus on the right portfolio composition and personalized financial planning allows Boardwalk and our clients to enjoy the benefits of managing wealth and achieving goals even in the face of external pressures (such as blistering inflation).

Numerous polls show inflation is now the American public’s largest worry. It’s one of the biggest concerns for investors, too, which is why it’s been featured in our commentaries. The April consumer price index (CPI) change over the past 12 months has now spiked to 8.5%, up 1.2% since last month’s reading. The Federal Reserve has embarked on a rate hiking cycle to combat this, with the goal of orchestrating a ‘soft landing’ – where inflation subsides, but unemployment remains low and economic growth continues. There are some indications of the pace of inflation topping out, but there is a long way to go.

While we can’t control market returns over this uncertain period, there are aspects of portfolio management that are within our control as investors. Here are a few examples:

Most important is determining the right asset allocation based on your individual circumstances and risk tolerance. The mix of stocks and other risky assets to bonds and less risky assets is the largest driver of both risk and return, regardless of where the market moves. We believe academically driven, globally diversified investing is key to meeting your long-term goals.
Ongoing portfolio management such as rebalancing is also within our control. Staying exposed to out-of-favor asset classes is part of this disciplined approach, since rebalancing is in effect trimming recent winners to buy beaten down asset classes. As an example: for years, commodities dragged on performance but have been worth their weight in gold (pun intended) lately as an inflationary hedge and diversifier.
We can also optimize tax efficiency by strategically placing assets in certain account types according to their tax characteristics, minimizing turnover in taxable accounts, and managing portfolio withdrawals.

Within the realm of financial planning, cash flow planning and revisiting long-term goals are important ways to address current concerns of inflation and market volatility.

Cash flow planning: as costs rise for retired clients, increasing portfolio withdrawals (tax efficiently) is often necessary when inflows don’t match higher spending needs. For everyone, budgeting can also become more important as the same dollars need to be stretched. We help you think about proper cash reserves too, so that you can rest assured important goals can be met while minimizing cash on the sidelines being eaten away by inflation.
Long-term projections: revisiting your long-term plan keeps you aware of how you’re progressing towards your goals. As things change – including higher spending needs – we adjust our projections and can model scenarios that show persistently high inflation relative to a long-run inflation assumption. There’s comfort in knowing how market volatility, higher inflation, and personal changes impact your ability to meet your long-term goals and whether any current adjustments need to be made to help align your financial picture to your vision.

With market uncertainty and inflationary concerns mounting, lean on us to provide peace of mind or a course correction to help you stay disciplined and on track to meet your goals.

Whistling Happy Tunes in 2021

Can Inflation be a Good Thing?

When it comes to inflation, a small amount of it is healthy for the economy. That’s because when consumers and businesses expect prices to continue rising, they are more likely to buy something today. Strong current demand spurs growth on the supply side of the economy since businesses expand their workforces and production to meet this demand. As you can see, low and consistent inflation creates a virtuous cycle that is good for economic growth. In fact, the opposite scenario – deflation – would likely be more problematic than moderate inflation. The US Federal Reserve has set a target of 2% for core inflation with the duel aim of avoiding deflation or high inflation.

As we transition ‘back to normal’ there has been high consumer demand, massive governmental stimulus, supply chain issues, and global shortages of raw and manufactured goods. The Federal Reserve anticipates that most of these inflationary forces will abate. Caught between managing inflation and spurring growth, they’ve emphasized their goal of bringing employment back to pre-pandemic levels. If inflation proves to be less transitory than most economists expect, the Federal Reserve will likely take steps such as raising interest rates to avoid overheating the economy.

Inflation becomes dangerous when it causes too much growth and prices rise faster than wages, with everyone worse off in terms of purchasing power. To help counteract this effect for many retirees, the Social Security Administration bumped benefits for 2022 by 5.9% (compared to an annual average adjustment of 1.65% over the last decade)! For wage earners, incomes have and should continue to rise. So, for most clients there is a good amount of insulation against inflation via higher cash inflows. We also recommend appropriate cash reserves since cash is very susceptible to inflation. The inflation-adjusted ‘return’ of cash is virtually guaranteed to be negative. The risk of losing purchasing power can be mitigated through long-term, thoughtful investments and cash flow planning.

When it comes to the portfolio, we’ve designed the investment allocations with risks – like inflation – in mind.

Stocks typically hold up well against inflation in the long-term because companies can pass higher costs along to consumers. The bulk of most client portfolios are invested in US, developed international, and emerging market equities.
Bond returns may be muted or negative on a “real” (inflation-adjusted) basis in an inflationary scenario. This is especially true if interest rates rise – which is likely if the Federal Reserve deems it necessary to rein in inflation.
- We have positioned portfolios with a healthy allocation to short-term bonds to diminish this risk. Shorter maturity bonds are less impacted by rising interest rates because they mature more frequently and can reinvest into higher interest rates.
- We also avoid any allocation to long-term bonds right now because those would be most significantly hurt by rising interest rates. Yields at those maturities are not compelling enough for this large risk.
Commodities and real estate are “hard assets” that should do well in an inflationary scenario.
- Real estate investments provide a hedge due to land scarcity and because rents tend to adjust with inflation, providing income protection.
- Commodities have been the best performing asset class this year in part due to inflationary factors. While a laggard in the low yield and low inflation environment of the late 2010s, commodity funds have done well as an investment because prices for goods as far ranging as copper, lumber, and crude oil have all risen considerably this year.

No one knows which portfolio risk will present itself next, so we want to stress the importance of remaining diversified and disciplined in achieving long-term investing success. If you have any questions or concerns about the positioning of your portfolio, let’s discuss it at your earliest convenience.

Inflation Investment Allocation investment portfolio

The Cost of Timing the Market

Markets have come down a bit from all-time highs, but the S&P 500 index is still up over 17% this year. Since March 23^rd of 2020, the S&P 500 is up over 55%! For all investors, intense rallies like this beg the questions:

Is now a good time to put cash to work, or should I wait until the next correction?
Should I be trimming my winners by selling stocks and buying bonds?
I’m not sure the market or economy can keep this up and there are a lot of risks out there for the next year and even next decade, should I change my strategic allocation to hold fewer equities?
Or maybe: I know people who talk about their big gains and I don’t want to miss out – should I be changing my portfolio so that I can participate more in this exciting rally?

These are good questions to be asking. We want to talk with you about your feelings towards the market’s rally and future expectations. More importantly, we want to talk with you about how that fits into your risk tolerance, protecting your current needs, and meeting your future goals.

Many times, at the essence of these questions lies the concept of market timing – predicting when to enter and exit stocks, bonds, and cash as various investments experience rallies and corrections. The fact is, timing the market is extremely difficult.

Even missing just a few of the best days in a market rally has an enormous impact on an investor’s returns. Here are some stunning statistics put together by Dimensional Fund Advisors:

As we can see, missing the best 15 days of S&P 500 returns in the last 30 years would result in about one-third as much ending wealth!

Short periods of time “out of the market” could have huge opportunity costs, and it’s extremely difficult to accurately and consistently time entries and exits from the market. For example, someone might have seen the early declines of February 2020 and sold their stocks – correctly predicting that further losses were yet to come. But without a quick reentry, they would have been far better off to simply “ride out” the market correction and fully participate in the speedy recovery. Similarly, an investor today might leave cash on the sidelines, predicting an upcoming correction. If the market continues to rise, it often becomes harder to abandon the cash position, fearful of “buying high.” Many investors experience this ‘paralysis’ and miss out on the growth that disciplined, long-term investors receive.

On Monday, there was a great article on Morningstar that highlighted the long-term returns of market timing by professionals. Mutual funds with this focus are known as tactical asset allocation funds, and they’ve lagged their benchmarks significantly. Quite simply, it’s just hard to predict the future!

At Boardwalk, we believe in the importance of discussing our clients’ needs, goals, risk tolerance, and emotions when making investment choices and we use robust empirical findings to help clients be comfortable with their portfolio and confident in their decisions.

investments Market Timing

Investing Lessons From the Birthday Paradox

I was recently with a group of friends, and we were astonished to learn that two pairs of us had shared birthdays – out of 10 people! We were all blown away by this and assumed that the likelihood of even one pair of us having a matching birthday would be close to zero. Naturally, we turned to Google rather than our calculators, and found that a matching birthday is not nearly as rare as you would imagine. With just 10 people, there is over an 11% chance that two people will share a birthday! Perhaps even more surprisingly, the odds that two people will share a birthday are better than a coin flip within a group of 23 people and essentially guaranteed with a random group of 57! This “phenomenon” is known as the Birthday Paradox because it seems counterintuitive. But it started to be less surprising after reading about it.

Rather than thinking about the odds of getting a specific date (out of 365) to match, we need to consider the pairs of individuals present – because each person needs to be paired up against every other person in the group to see if they share a birthday. As an example, with two people there is only one pair (and very low odds of a birthday match). But with 10 people, there are 45 pairs! The number of pairs grow so quickly that with 57 individuals there are 1,596 pairs – hence the almost certain probability of a match.

Our brains have an extremely difficult time understanding this, because probabilistic and exponential calculations are not how we usually think about the world, birthdays, or money.

But perhaps they should be – even if we cannot wrap our minds around it fully! Thomas Edison’s quote, “The strongest force in the universe is compound interest,” is surprising in the same way that the Birthday Paradox catches our mind off guard. We’ve all heard the question: Would you rather have $1,000,000 today or a single penny that doubles in value each day for 30 days? And the answer…the power of compound interest is exhibited by the $5,368,709.12 you would have after a month if you opted for the penny.

Getting our minds to consider the world like this can be difficult, but it is important when it comes to investing.

To me, the lessons from the Birthday Paradox can be applied to market pricing efficiency. In liquid, transparent markets, pairs consisting of buyers and sellers trade constantly based on current information and their best future expectations. If only a few trades occurred for a stock, the odds of finding the “right price” may be low. But for markets like the S&P 500, there have been between 4-10 billion trades each day over the first three months of the year according to S&P Global Market Intelligence. Everyone is trying to assess the value of those 500 stocks, every day. And while there are certainly instances where individual stocks do not seem to trade “normally,” the market as a whole is very efficient in finding the matching price to value a company. New information and even expectations of future developments (like the odds of the next inflation reading being higher or lower than expected) are constantly assimilated into the price. This makes it very difficult to consistently outsmart the market through stock picking or market timing.

If you can’t beat ‘em, join ‘em! Despite the difficulty our brains have in understanding probabilities and exponential functions, we can still use them as we participate in the stock market. Taking Edison’s advice, saving earlier and often results in greater wealth down the road as we use compound growth to our advantage. And considering market efficiency, usually the best way to invest for the long-term is through more passive investment approaches and investing excess cash right away – because while no one knows what the future holds, our collective best guess is already “priced in.” The fruits of disciplined investing are not seen every week, month, quarter, or year, but over time will serve you well.

Investing Market Efficiency

Do I Need a Will? What About Life Insurance?

Estate planning and personal risk management are usually not dinner table topics. And if there is going to be a conversation about personal finance among friends and family, these days a betting person would guess Dogecoin or AMC’s stock price would come up before wills or life insurance. That’s okay, they certainly are more interesting! But just because something is not interesting doesn’t mean it’s not very important. The information below is definitely less interesting than the GameStop stock drama, yet it is important to the financial wellness of your family.

Estate planning can get complex very quickly. While it is important to get a professional involved to determine what level of estate planning is appropriate, a basic “Last Will and Testament” document is typically a great start for every adult to have. So why do you, your family members, and friends need a will? A will ensures that property and assets get distributed according to your wishes. This distribution is done by a person of your choosing (the executor of your estate). Additionally, your named guardians will be responsible for your children. Without a written and legal will, a court process governed by state law determines who inherits assets and who raises children. This legal process is usually far more expensive and time consuming than setting up an estate plan. If you are married or have children, you certainly need a will. Even if someone is single and without dependents, they should strongly consider having a will if they have a positive net worth. A will eases the estate transfer process, reduces the potential for conflict among family members, and eliminates “room for error” in court interpretation.

So, what about life insurance – do we need that? Most of us also avoid talking about life insurance (or at least procrastinate on getting it)! According to Business Insider, that leaves more than two-thirds of Americans underinsured, despite a majority having some coverage. The key distinction here is whether merely having some life insurance is fine – and for those that need it, the answer is usually no. Basic coverage through an employer usually does not go very far when replacing an income, paying for childcare, or funding bigger goals like paying off the mortgage or funding a college education. As personal savings grow, children become adults, and retirement nears, life insurance can become less important or even unnecessary. Every situation is unique, but most people with dependents should get professional guidance from an independent financial advisor to ensure they have adequate coverage. The good news is that term life insurance can be very affordable, unlike whole life insurance and other complex policies. Whole life policies remain in place through a policyholder’s lifetime and pay a benefit at death, but these can be very expensive and provide coverage long after it is no longer needed. Term insurance is in place for a set period (such as 20 or 30 years) and only provides a benefit if someone passes away during that time. It is meant to act like true insurance – protecting your loved ones against an untimely death, when lost income during working years and inadequate savings could severely impact their financial wellbeing.

Here are Boardwalk, we believe in financial planning because our choices beyond the portfolio have large impacts – financial and otherwise! Actionable steps in estate planning and personal risk management have controllable outcomes (unlike the markets) and the feedback we have received from our clients demonstrates the peace of mind and financial benefits of proper planning. We encourage everyone to seek out quality, independent advice to ensure they have adequate life insurance coverage and estate planning in place.

Estate Planning Last Will and Testament Life Insurance Wills

Category: Blogs

Mike Rodenbaugh

Mike Rodenbaugh