Welcome to another edition of Notes Along the Path!
This month's topics:
- How to Manage a Financial Windfall
- Market Update: A Halfway-Point Assessment
- In the News
Please consider sharing this with someone you know who might be asking themselves (or you!) questions about their financial future.
How to Manage a Financial Windfall
Have you ever dreamed of winning the lottery or inheriting a large sum of money? Most people have. Yet, riches that fall into our hands can sometimes quickly slip through our fingers.
One study found that one-third of the people who received an inheritance had negative savings within two years of the event.
Alex Lasarev grew up in a modest household. Thanks to her frugal mother, she inherited over $1 million as a teenager. But a lifestyle filled with luxury and bad investments drained her fortune, and financially, she ended up back where she started.
Maureen O’Conner married the founder of Jack in the Box. His passing left her with an inheritance valued at over $50 million. But a series of unfortunate events left her destitute.
“Dishonest money dwindles away, but whoever gathers money little by little makes it grow,” according to the Book of Proverbs. While a windfall need not be viewed as ‘dishonest money,’ the wisdom from the proverb serves as a warning that a sudden inflow of cash can quickly disappear if proper planning is shunned.
Over the next decade, millennials are expected to inherit $68 trillion, according to a study by Coldwell Banker. While the actual amount will vary wildly, a 2015 HSBC survey suggested that the average inheritance will run about $177,000.
And there are other ways you might come into a large sum all at once. The sale of a property, the settlement of a lawsuit, a year-end bonus, stock options paying off, and yes, a winning lottery ticket can create unexpected riches that can enhance your overall well-being--or turn into an unexpected nightmare.
Eight Ideas for How to Manage and Sustain Your Windfall
The advice we provide is always tailored to your specific goals and circumstances. What we recommend to one individual or couple isn’t always the counsel we provide to someone else. But there are time-tested financial principles that are the foundation of the advice we provide. The recommendations below are general and are based on long-term data and our experience.
- First things first: don’t do anything. That’s right, do nothing. Place the funds in a safe short-term account such as a money market or savings account.* Doing this reduces the temptation to make a big purchase that you may come to regret. It will also give you the time and space to develop a sound financial plan that meets shorter-term and longer-term needs and goals.
*Remember that the limit on FDIC insurance is $250,000 per depositor, per bank, per ownership type (joint or individual).
- Get help. We are always available to entertain your questions and ideas. We’ll assist you in making any adjustments that incorporate the windfall into your financial plan and plug any shortfalls. We may recommend a tax advisor to help you navigate the tax code if your situation is complex. For a truly life-changing windfall, an estate planning attorney will help you create an estate plan.
- Pay down or pay off debt. As you develop a plan, consider paying down debt. If you have credit card debt, student loans, or car loans, you should probably wipe out that debt. You’ll feel an enormous sense of satisfaction, eliminating burdensome liabilities.
- In the same vein, bulk up your rainy day fund. It’s a great idea to knock out debt, but emergency reserves are an essential component of your financial foundation, too. We typically recommend three to six months of living expenses that you can easily access.
- Let’s visit your retirement. Are you on track to comfortably retire? According to the Federal Reserve, only half of all American families even have a retirement account.
Making sure you have enough for retirement is one of the pillars of a financially sound home. If possible, max out your IRA or 401(k). The earlier you contribute, the greater the power of compounded growth, but it’s never too late to start.
If you have children, college savings plans are an ideal way to help them pay for the cost of higher education. Here in Virginia, like most states, contributions to your state's plan can be deducted from your state income taxes.
- Tax time. Did you sell a large property that will incur a capital gain? Don't forget there may be federal and local taxes due. A conversation with your tax advisor is in order so that you can set aside funds to pay the government. Getting caught flat-footed at tax time is something you want to avoid.
- Support causes that are important to you. Your windfall gives you the freedom to help others. It may also decrease your tax liability. Consider giving directly or through a donor-advised fund.
But be cautious of friends or family members that warm to you after your newfound wealth or those that present business ideas to you.
Having a trusted team of neutral advisors will help you weigh the pros and cons of offers that suddenly come your way.
- Take care of yourself. There is nothing wrong with spending a little bit of money on yourself. Earmark some of your windfall for fun.
It may be a short vacation getaway or a few toys that enhance the enjoyment of your hobby. But be careful not to turn one small expenditure into a series of splurges that whittle away at your windfall.
Stocks Cruise at a High Altitude
Investors that have taken a principled approach and have adhered to a long-term investment plan reaped gains in 2020 and have continued to be rewarded in 2021. More importantly, they are making progress toward their financial goals.
As the first half of the year ended, the S&P 500 Index, a broad-based index of 500 larger U.S. companies, ended June at a record high and a gain of 14.4%. The better known Dow Jones Industrials, which comprises 30 large firms, finished the first half with a still significant gain of 12.7%.
Meanwhile, the Russell 2000 Index of smaller companies is up an impressive 17% for the first six months of the year.
Where might we be headed for the rest of the year? While we can use history as a guide, let's also acknowledge that past performance is no guarantee of how we might perform going forward. I think that is something we all understand, but I usually repeat it anyway.
That said, please follow me as I dive into some numbers before giving my outlook.
Using data from our friends at LPL Research, we learn that bull markets that have emerged from a bear market of at least a 30% decline have had strong returns in the first year. The rally that followed 2020's bear market (a 34% decline) is no exception.
The average increase in the six bull markets since WWII that followed a 30% or greater decline was 41% in the first year. It's an impressive one-year return and is a reminder that bear markets usually end unexpectedly. Those who are safely in cash during the decline can find themselves chasing returns.
The first-year increase of 75% from 2020's bottom ranks as number 1, exceeding 2009's second-place return of 69%.
On average, all the bull markets in question have been positive in year two, with an average return for the S&P 500 of 17%.
However, year number two has not been without volatility, with an average pullback during the second year of 10%. Thus far, we have yet to see a meaningful pullback in the broader market indexes, but we are only three months into year two.
What helps drive returns? Momentum, an expanding economy, higher corporate profits, and a generally accommodative policy from the Federal Reserve.
Those variables are in place today, but every cycle has its peculiarities. This one is no different.
The economy has never experienced the kind of lockdown and reopening we see today. It's still uncharted economic territory. So far, growth has been much more robust than most forecasters expected. We can credit massive fiscal stimulus, the reopening of various sectors of the economy, pent-up demand, and the easing and end of social distancing restrictions.
But the benefits have been spread out unevenly.
Inflation also remains a concern, though the recent drop in Treasury bond yields suggests that most investors seem to view the recent surge in prices as temporary.
We could also see the rate of growth peak in the second quarter as fiscal stimulus begins to wane.
It's why we default back to the financial plan. It's the cornerstone of our approach. The short-term traders will react to unexpected events, both positive and negative. But let's be careful about following their lead. What can impact stocks today can be forgotten by investors tomorrow.
Overall, my outlook for the rest of the year is positive but a bit cautious. So why don't I recommend taking profits and reducing exposure to stocks? Because timing the market is a fool's errand. Even if I thought stocks were going down, I would have to be right about that and be right about when to buy back in. If a correction comes (and one always does, eventually), then we can use rebalancing to take advantage of stocks going on sale.
Remember, when it comes to market fluctuations, intelligent reactions always make you money and beat nearly all attempts at prediction.
In the News
Yesterday a reporter (CNBC) asked me, "Would you be able to provide any guidance on why consumer shouldn’t keep ALL their money in a checking account?"
Here is what I wrote back, we shall see if much ends up in their website.
Have you ever heard your grandmother say "don't keep all your eggs in one basket"? Well that applies perfectly to a checking account.
The checking account is very good at what it does. But it is only designed to do one thing. It serves as a place to keep your money that you need to pay this month's bills plus your allowance for spending on yourself. That's it. That's the only function where a checking account is the best option. And for that reason it should not be used for anything else. For every other purpose there are better places for your money.
Emergency savings goes in your Savings account where it can earn a little more interest. If you have built up a few thousand in emergency savings you can even put half of it in bank CDs. Once you have all of your debts paid off (except a mortgage if you own your home) and 6 months of essential expenses saved* it's time to start investing the rest.
*Essential expenses include rent or mortgage, utilities, insurance, transportation, and food, but not vacations and entertainment.
A great place to start investing is Vanguard's Total Stock Market ETF, ticker symbol VTI. It tracks the US total market: Lange-, Mid-, and Small-cap equity. It's passively managed and the expenses are a super-low .03%. For someone in their 20's or just getting started investing it's the one fund to start with.
I trust you've found this review to be educational and informative.
If you have any questions or would like to discuss any matters, please feel free to give me a call.
If you like it this newsletter I encourage you to pass it on to any contacts you have that might benefit.
I remain honored and humbled that my clients have allowed me to serve as their financial advisor. Thank you for your support.
All the Best!