Hugh Wynn's Two Cents

While I'm not an investor by profession, I have been curating sound personal financial habits and practicing those techniques since I was a youngster. Although the focus of this blog is on our three youngest generations, I will ceaselessly emphasize to all investors the importance of an early and routine savings habit, a common sense buy-and-hold strategy, a diversified investment portfolio, the wisdom of shunning market timing, and a “stick to your guns” attitude regardless of negative outside influences. I believe it is imperative that you keep your investment strategy simple and your investment costs as low as possible. Like the small investor’s best friend, Jack Bogle, was quick to remind us, “In the fund business, you get what you don’t pay for.”

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past Posts

The Mythical Millionaire
February 20, 2020
A couple of subscribers I’ve chatted with recently seem to think that if they retire with a million bucks in their retirement account, they’ll be in hog heaven. No doubt, it’s a very comforting figure. But should it be?
READ MORE
Fund Distri-fusion
February 13, 2020
I detect a bit of confusion among certain of my subscribers regarding who pays taxes on capital gains of stock sold during a given year by fund managers.
READ MORE
The Coronavirus Crisis
February 6, 2020
Investors shouldn’t dismiss out the impact of the Coronavirus virus, in particular, on the Chinese behemoth. That nation has quarantined 56 million of its citizens in an attempt to arrest the virus.
read more
More Rules For The Tools
January 30, 2020
The main concern folks – especially young folks – have with IRAs is their “forever” feature. “I make contributions to the darn thing, and it’ll be FOREVER before I have access to those dollars,” they grumble.
read more
Tools with Rules
January 23, 2020
Because time is money and money buys time, it’s important that Millennials and Gen-Zers begin saving (and investing) early in life in order to optimize The Amazing Power of Compounding.
READ MORE
Save A “Real” Million Bucks By Retirement
February 20, 2020

A couple of subscribers I’ve chatted with recently seem to think that if they retire with a million bucks in their retirement account, they’ll be in hog heaven. No doubt, it’s a very comforting figure. But should it be?  I ran a hypothetical calculation for myself assuming I was 28 years of age. Hey, don’t giggle, I’m only about twice that age (if you’ll permit me to use the term “about twice” quite loosely).  I simply want to present an example that at age 28, with a good job, and already having saved $10,000, how much more money would have to be tucked away monthly, invested at 7%, compounded annually, to achieve millionaire status at age 68 (40 years hence).  

More Than Meets the Eye

I grabbed my abacas (Source: Bankrate’s Investing & CD Calculator - Save a Million Dollars Calculator), slapped around a few beads, and Voila! I had my answer. In addition to the $10,000 seed money, I’ll need to invest another $343 per month to reach that million-dollar goal. Seems doable – particularly if I have a generous employer who matches some of my contributions. And there should be nice raises in this mythical future even as my family grows and requires a bigger house, dependable cars and college or trade school educations.

But then I realized that there is more to the calculation than first meets the eye. I forgot to allow for Izzy The Inflation Monster! So, I threw in a 2.5% per year inflation factor to feed that hungry beast who will gobble up as much of my purchasing power as it can during those intervening 40 years.

The Inflation Monster

Using that 2.5% inflation factor, here are the numbers. Beginning with the $10,000 initial investment and adding $343 each month for 40 years, I do end up with roughly $1 million in my retirement account at age 68. Unfortunately, those “gray bearded” million bucks will only purchase $373,300 worth of goods in today’s dollars.

So, I go back to the abacas and bean-count how much more I must save to end up with $1 million in purchasing power at age 68. And boy is that a Zebra of a different stripe! To have $1 million in today’s purchasing power 40 years hence, I will need almost $2.7 million in my retirement account, not just $1 million.

What the...???

To achieve this new goal, it will require a monthly savings of… gasp… $1,020 instead of the $343 I mentioned earlier. But being a “glass-half-full” chap, I desperately try to see the silver lining of this cloudy dilemma. By saving at the $1,020 clip per month, I’ll have about a million bucks sitting in my retirement account by age 55 – a “fat-cat” millionaire 13 years ahead of the original schedule… for whatever that’s worth.

Still, take heart in the fact that although inflation steals an individual’s purchasing power, it also tends to exert upward pressure on paychecks. In short, the higher $1,000 per month savings requirement might be more achievable than one might imagine. Inflation tends to lift all boats… income as well as expenses.

Clear as Mud

But don’t forget, this scenario is hypothetical. Future rates of return aren’t predictable with any certainty (they can vary widely over time, especially for long-term investments like I assumed here). Investments that pay higher rates of return invariably come with higher degrees of risks and more volatility. And to really brighten your day, the loss of investment principal is also a possibility. So, immerse yourself in a bowl of Blue Bell® ice cream and hope that the (also mythical) Social Security trust fund (like so much of the other money we send to politicians) doesn’t soon disappear into that fetid, alligator-infested, Washington D. C. swamp – and for goodness sake, start saving!

By the way, there’s stirrings among political investment advisers about tax-free investment accounts for lower and middle-income families – and they’re not retirement accounts. These accounts would accumulate funds that, after five years, could be used to buy or improve homes, start new businesses, send kids to college or private schools, supplement income after job loss, or yes, even for retirement. It’s an interesting idea. We’ll talk more about it in a week or so.

Who Pays Taxes On Fund Distributions?
February 13, 2020

I detect a bit of confusion among certain of my subscribers regarding who pays taxes on capital gains of stock sold during a given year by fund managers. A couple of folks asked why shareholders had to pay taxes on those gains when the “fund” had already paid them. Well, first of all, the fund hasn’t already pay taxes on those distributions. [To view the video below click here.]

Shareholders Pay

Shareholders of the funds – you – end up with the tax bill. And you pay taxes on those distributions whether or not the distributions are reinvested in additional fund shares or received in cash. To clarify, let’s venture behind the scenes to see what actually happens.

Federal law requires fund managers to distribute all dividends, interest and capital gains to shareholders…and report those distributions to you as they occur, typically quarterly and at year-end for dividends and capital gains… and monthlyfor interest.

Although it’s common – and wise – for shareholders to automatically reinvest distributions in additional shares of the mutual fund, that doesn’t eliminate their obligation to pay taxes on such distributions quarterly or by no later than April 15 of the following year.  In short, shareholders are responsible for reporting such distributions on their next year’s federal tax return and for paying any tax due, when due.

Tax-Deferred Exception

If a mutual fund is held in a tax-deferred account (i.e., a 401(k), IRA, etc.), the rules regarding distributions are different than as explained above. In tax-deferred cases – those funded with pre-tax contributions – with few exceptions, shareholders will be taxed when the money is withdrawn from such accounts – whether voluntarily or as Required Minimum Distributions (RMDs). However if the account is a Roth IRA or a Roth 401(k), shareholders won’t be taxed on withdrawals since those accounts are funded with after-tax contributions. And there’s a different set of rules, maybe even penalties, covering “early” withdrawals, but that’s another story.

Recap: You Pay

To recap, mutual fund entities do not pay taxes on capital gains, interest and dividends earned by their shareholders. That’s a shareholder’s obligation. So, keep detailed records of all mutual fund distributions – and on your own purchases and sales of fund shares. And report these activities without fail to Uncle Grabby.

Remember, the mutual fund company has already reported the distributions to Uncle Grabby on a 1099-DIV. And Grabby’s watching to make sure you, the shareholder, reports those same distributions on your federal tax return.

The Coronavirus Crisis: Could it Infect the Market?
February 6, 2020

Today’s blog takes me down a road less traveled - the discussion of a current event and how it might impact short- and long-term market values and an investor’s response to such an event. Specifically, I want to address the effect of the Coronavirus that reared its ugly head recently in China, and its slow but steady infection of China’s trading partners. (Click here to watch the video below.)

Going Viral?

Investors shouldn’t dismiss out of hand the impact of the Coronavirus virus, in particular, on the Chinese behemoth. That nation has quarantined 56 million of its citizens in an attempt to arrest the virus. To date, investors in the United States seem to be of the mind that the American economy is less vulnerable to external shocks than the rest of the world. There’s an element of truth to that. Still, according to the Wall Street Journal’s insightful editorial staff,  U. S. companies, Apple, Starbucks and other American stalwarts have temporarily closed stores in China for good reason. And Ford, Apple and Tesla have temporarily halted the production of their commodities in China. Of note, one-sixth of Apple’s sales and close to one-half of chipmaker Qualcomm’s revenues are generated in China. And 80% of active ingredients used by drug-makers to produce finished medicines come from China. Such statistics and a random sampling of corporate activity in reaction to this virus are meaningful red flags. Unless the spread of this virus is arrested soon – and normal business activity resumes – markets across the world, including our own, will feel its impact.

Too Big to Ignore

When an economy the size of China’s – the world’s largest oil importer and a major manufacturer – faces a sizable quarantine of citizens, suffers airline service disruptions from many countries and must deal with the closure of international borders and of the aforementioned factories, financial markets there… and here… can’t help but be impacted. China’s loss of 2-3 million barrels per day of oil-related demand alone will be felt worldwide. U. S. crude oil prices have declined over 20% in the last month. Although such price decline could give a boost to motorists at the pump, the Coronavirus crisis is being less than kind to the stocks of major domestic energy companies. Middle East catbird, Saudi Arabia, is advocating a brief curtailment of OPEC production to combat declining demand, a development that would be helpful to U. S. shale producers.

It's Anybody's Guess

Will this virus have a short- or long-term market impact on the world market? That's the question of the moment. Although various flu viruses impact our country on a much greater scale annually, they are familiar viruses. Not so much the Coronavirus, thus, the greater uncertainty surrounding it. My guess is that, due to this uncertainty – the absence of an effective Coronavirus treatment – the world’s marketplaces will experience increased volatility leaning toward bearish declines. In this country, the Centers for Disease Control and Prevention (CDC) and other federal, state and local health authorities are reacting in an expeditious and professional manner – China, not so much. The impact of the virus on that country is still unfolding… yet to be defined. But it seems to finally have grabbed their government’s belated attention. Past outbreaks such as SARS (severe acute respiratory syndrome) caused stocks to drop initially only to bounce back once the rate of new infections slowed. To date, cases of this new virus in China have doubled the number afflicted by the SARS virus two decades ago – a troubling trend.

Take Two Aspirin...

Opportunistic investors holding highly-diversified, well-balanced portfolios can weather this significant market uncertainty by judicious buying in a declining market should it occur, but the word of the day is patience… patience to await the opportunities of a soft market and to outlast it if and when it occurs. Despite our country’s own low risk for infection, China’s outbreak will continue to reduce its energy consumption and disrupt the world’s second-largest economy for some time to come.

To wise investors, steady as she goes.

More Rules For The Tools: IRA Withdrawal Exceptions
January 30, 2020

Generally speaking, an early withdrawal from an IRA prior to age 59½ is a big no-no, subject to being included in gross income plus a 10% additional tax penalty. There are exceptions but avoid them if you can.  

The main concern folks – especially young folks – have with IRAs is their “forever” feature. “I make contributions to the darn thing, and it’ll be FOREVER before I have access to those dollars,” they grumble. Well, sort of true. IRA rules are designed to discourage you from dipping into the till prematurely as opposed to waiting until the greybeard years (post-59½) for access. After all, IRAs are instruments of retirement. But to assuage some of the apprehension related to this “forever” feature are a few exceptions to the 10% additional tax penalty on early withdrawals.

Exceptions

As youngsters mature and adults grow older, they will come to appreciate the benefits, and on occasion, the early withdrawal exceptions of an IRA – the ability to tap the account for certain very specific purposes. Let’s discuss a few, keeping in mind that the exceptions I mention also have some very specific provisos that must be met to avoid triggering that darn early withdrawal tax penalty. Let’s consider a few exceptions:

1. In the event of job loss, you can make early withdrawals to pay for healthcare insurance premiums.

2. You can pay for medical expenses that exceed 10% of your adjusted gross income.

3. If disabled, to qualify as a tax penalty exception, you must obtain a doctor's verification as proof of your inability to do productive physical or mental activity indefinitely.

4. You can pay qualified higher education expenses for yourself, a spouse, and for offspring, but only if paid to eligible educational institutions.

5. You can early withdraw to buy, build, or rebuild a first home for a parent or grandparent, yourself, a spouse and for offspring, but you must meet the IRS definition of a first-time home buyer. If both you and your spouse qualify as first-time home buyers, then each of you can withdraw $10,000 from each of your respective IRAs without penalty.

6. A qualified reservist distribution is not subject to the penalty tax if certain requirements are met, including a call to active duty for more than 179 days or for an indefinite period as a member of a reserve component.

7. The Substantially Equal Periodic Payment (SEPP) rule allows holders to withdraw retirement account money at any age, penalty-free. There are 3 IRS-approved methods for calculating SEPP withdrawals and you must adhere to such schedules for at least 5 years, or until age 59½ (whichever occurs later), or all amounts withdrawn may become subject to the 10% penalty tax.

8. We’ll discuss inherited IRA withdrawals at another time.

I purposely mention these exceptions because so many folks avoid using IRAs using the excuse that they tie up money “forever” that might be needed to meet more pressing current needs. In doing so, these same people overlook an IRA’s tax-advantaged value of saving money for retirement, long-term exposure to an up trending market, and the benefit of The Amazing Power of Compounding.

Before dismissing IRAs out of hand, remember that there are ways to access IRA accounts for specific purposes, but fair warning, the rules covering Traditional and Roth withdrawals are not all the same. Do your homework and think twice before making a withdrawal.

Ah, More Examples

Let’s review some examples of what The Amazing Power of Compounding can do for savers who follow different contribution patterns. A single $2,000 IRA contribution made at age 15 could grow to almost $59,000 after 50 years, assuming a 7% investment yield, compounded annually. If that same saver contributed the initial $2,000 but added an additional $50 each month for 50 years, the account would grow to about $312,000, earning the same 7% per annum. And if the saver doubled the contribution to $100 each month, the account could reach over $565,000 after 50 years. As youngsters “earn” more money after entering the adult workforce, their annual contributions are likely to be higher, and the resultant IRA balance will grow correspondingly. Amazing, huh?

What’s The Point?

Aside from pointing out the withdrawal flexibility of IRAs, another purpose of today’s discussion is that since America has devolved into a “do-it-yourself” retirement system (Defined Contribution Plans) as opposed to the old pension system (Defined Benefit Plans)¹, the so-called “wealth gap” between wise early savers and those who choose to wait has morphed into a “wealth chasm”. Contributing to the chasm is the choice of wise savers to avoid the 10% early IRA withdrawal penalty, a penalty our legislators included when passing laws establishing IRAs and other retirement accounts. The withdrawal message is simple: Follow the rules and reap major rewards – violate them and suffer the consequences.

Summary

In summary, teaching our younger generations the value of opening Traditional or Roth IRAs – and yeah, Gramps, occasionally providing matching contributions – helps provide them with a head start on saving for retirement. You can also teach them useful lessons about taxes, smart investing, The Amazing Power Of Compounding, and the very important relationship between earning, saving and spending. Discipline, discipline, discipline is the watchword – so important in developing healthy financial habits.

Finally, don’t be intimidated by the “forever” nature of IRAs. There are ways to access funds in both Traditional and Roth IRAs prior to retirement. Still, IRAs should be funds of last resort to raid, but if the pitcher of life throws you an occasional wicked curve, well…

¹See my archived blog “The Tottering Three-Legged Stool” dated 07-26-2019.

Tools with Rules: Those Fantastic IRAs
January 23, 2020

Because time is money and money buys time, it’s important that Millennials and Gen-Zers begin saving (and investing) early in life in order to optimize The Amazing Power of Compounding. Have I mentioned that before? Let's flesh out a couple of extraordinary wealth-building tools for our youngsters!

Time Is Money

Members of my target generations who are not yet saving have already lost valuable time. Still, as I have pointed out time and again, it’s never too late, but early is best. Almost nothing matters as much in personal finance as deciding NOT to violate the fundamental principle of saving early in life. If you violate this principle, you’ve helped neuter The Amazing Power of Compounding. But enough sermonizing.

Youngsters And Earned Income

Most investors are familiar with Individual Retirement Accounts (IRAs) – and understand that IRAs represent important tools for young investors, who because they are young, can take maximum advantage of time and its supportive co-conspirator, compounding.

Surprisingly, many parents don’t know that youngsters, regardless of age, can contribute to IRAs, but, with rare exception, only if they have earned income. That, of course, is a big “if” especially when paired with a big “maybe” – will a youngster with earned income choose to contribute money to an IRA versus spending it on movies, video games or some early-stage million-dollar habit? More about this later…once we get Grandpa involved.

Both types of IRAs – Roth and Traditional – are suitable for children. Their difference stems from when the individual pays taxes on contributions to the plan. In short, a Traditional IRA is funded with pre-tax dollars, whereas, a Roth IRA is funded with after-tax dollars. Regarding Traditional IRAs, taxes are paid when money is withdrawn from the plan beginning no later than age 72 (at the then-applicable personal tax rate).

The Appeal Of Roth IRAs

In both Traditional and Roth IRAs, money accumulates tax free. But here’s the appealing kicker of a Roth. If and when Roth withdrawals begin decades later, no income tax whatsoever is due. And the Roth is not plagued by Required Minimum Distributions (RMDs) that begin at age 72 for Traditional IRAs – subject, of course, to Uncle Grabby’s IRS rule changes. And he’s capable of that on a whim, re the recent SECURE Act, which curtailed the tax benefits of “stretch” IRAs. Requiring annual payouts from Roth IRAs was not included in this most recent legislation, but what about the next Congressional whim?

Speaking of Uncle Grabby, always be mindful of tax considerations. The contributing child may be required to file a tax return if his or her income exceeds a certain amount. If the child earns less than this amount, he or she will likely be in a 0% tax bracket – and will not benefit from an up-front tax deduction associated with Traditional IRAs. In that case, it makes sense to focus on a Roth, the IRA of choice (in my opinion) for children with limited income.

A Wise Move

As suggested earlier, creating an IRA for an eligible youngster is a wise move. Because of the youth factor, The Amazing Power of Compounding will work its magic over a longer period, and the results will be – well – truly amazing. But remember, the child must keep a Roth until age 59½ for all withdrawals to be tax-free. (Prior to age 59½, Roth contributions, but not investment earnings, can be withdrawn for any reason without tax or penalty under existing Uncle Grabby rules).

Don’t Forget Gramps

In summary, children, regardless of age, can contribute to an IRA if they have earned income. Others (including Gramps) can contribute to the child’s IRA, too, as long as the amount of the child’s earned income is not exceeded. By the way, a minor’s IRA must be set up as a custodial account by a parent or other adult.

Also, there are opportunities to contribute to an IRA without a job! We’ll talk more about that next week.