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The 2018 Tax Filing Numbers Are In, and Most People Won’t Be Happy

Well, the IRS numbers are in from the 2018 tax-filing year. It’s the first under President Trump’s tax reforms, and the results won’t make anyone particularly happy.

It’s not that most Americans are paying more in taxes. In fact, most are actually paying less. It’s just that the difference isn’t big enough to matter to most taxpayers. The narrative is all wrong.

Red-state voters were really hoping for a windfall, but that didn’t happen. Seventy-nine percent of taxpayers got a refund. Of that, the average was $2,879. The year before the tax cuts, 80% of taxpayers got refunds, and the average was $2,908.

Sure, most taxpayers also benefitted from lower tax withholding throughout the year. It’s just that it wasn’t all that much money. The median taxpayer saw a tax reduction of less than $800. Spread out over an entire year of paychecks, that’s simply not enough to notice, let alone matter.

Meanwhile, blue-state voters believed the tax cuts to be a handout to the rich. Yet exactly the opposite was true. Many high-income earners actually saw their taxes rise by a significant amount, particularly if they were previously benefitting from a large state and local tax (SALT) deduction. The Trump reforms capped the SALT deduction at $10,000, meaning that taxpayers with large state income tax or property tax bills had a major tax deduction taken away.

Those self-employed are happy. The Trump tax breaks on self-employment income and income from LLCs and partnerships likely lowered your tax bill by a meaningful amount. But everyone else who isn’t self-employed has something to be unhappy about.

Well, I have some bad news for you. It’s not likely to get better any time soon…

Tax Rates Will Only Go Up

Let’s say the Democrats take presidency, the Senate, and manage to hold the House of Representatives in next year’s election. It’s going to be tough for them to say with a straight face that they support the downtrodden while simultaneously raising the SALT deduction for high-income homeowners. They’d be more likely to raise taxes across the board and keep Trump’s SALT deduction cap in place.

Now, let’s say that Donald Trump wins reelection and that the Republicans managed to win back to House of Representatives and hold the Senate. Additional tax cuts are still going to be a tough sell with the country running a trillion-dollar budget deficit… in peacetime… and during a steady, stable economy. The rates we have today are likely the lowest we’re going to see for years… if not ever.

Looking at the bigger picture, it’s hard to see a scenario where taxes don’t rise from today’s levels.

Next year, interest payments are expected to make up little over 10% of the total budget. One out of every 10 dollars spent will be to pay the interest on expenses from previous years. Interest is projected to be 13% of the budget by 2024. And from there, it should just snowball due to the compounding effect of interest, eating up a larger and larger share of the budget. New borrowing used to pay back old borrowing won’t leave much room for anything else.

If bond yields continue to drift lower, these numbers might end up being a little smaller. But what difference would a few hundred billion really make when you’re looking at numbers this large?

Enough hand wringing. Let’s talk about more practical matters…

Solutions That Could Save You Thousands

To start, think long and hard before upgrading your house. If you already own an expensive home, consider downsizing. I know that’s easier said than done, but you’re likely facing a future of rising property taxes with no offsetting relief via the SALT deduction. Run the numbers. It could be that renting makes more sense for you.

Secondly, get in the habit of stuffing as much money as you can into a 401(k) plan or IRA. There’s no guarantee that the government won’t move the goalpost and start applying a tax on large retirement plans if things get bad enough later. But if something like that happens, it will likely be years down the road. In the meantime, you can grow your nest egg tax free.

And consider tax-free municipal bond funds as a destination for your savings held outside of 401(k) and other retirement plans. The federal government is unlikely to eliminate the tax-free status of muni debt because it keeps the borrowing costs low for states, cities, and other local governments.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The Student Debt Slowdown: An Overhang of $1.4 Trillion

I was never the biggest fan of John Maynard Keynes. While he was a brilliant economist — and a sometimes solid investor — he was a disaster with policies. His ideas have given generations of politicians from both parties cover to run wildly irresponsible deficits. But while Keynes was wrong about a lot, his thoughts on the Paradox of Thrift are interesting.

The Student Debt Plague 

In a nutshell, frugality is a paradox — what is good for the part is terrible for the whole. If you or I are frugal and save our money, that’s good for us. But if everyone were as big of a cheapskate as me, the economy would grind to a halt, income would drop, and it’d be difficult to save much of anything.

And it’s an idea that pairs well with a current hot topic: student debt.

Just recently I watched a video of Democratic presidential contender Bernie Sanders talking about student loan debt forgiveness.

Now, I’m not a fan of bailouts. I wasn’t a fan of the banks getting bailed out back in 2008, and I’m not in favor of irresponsible universities and their former students getting bailed out today…

And it would absolutely be a bailout for both the universities and the students. I blame the universities more than the students, who were, after all, impressionable children at the time they were suckered into taking on debts. Universities irresponsibly raised tuition prices to unaffordable levels knowing that students could always borrow whatever they lacked. But the students went right along with it, never stopping to ask if the numbers made sense.

That kid who worked his way through college waiting tables… well, he’s just a sucker. Didn’t he know his rich Uncle Sam would have eventually picked up the tab?

And never mind that forgiveness of college loans is about as regressive a tax on poorer and less educated people as you’re ever going to find. Blue-collar taxpayers without a college education would be paying for the educations of white-collar professionals or even doctors who almost certainly make more money than them. That hardly seems fair.

But I digress…

The Potential In Forgiveness

The loan forgiveness debate actually did raise some valid points.

A dollar spent on student debt service is a dollar that’s not available to make a down payment on a house or car. That debt overhang reduces the lifetime spending potential of the debtor. Permanently. And when you’re talking about a large generation of people, that’s a problem.

If they all collectively spend less due to their debt service, then the economy grows much slower, which leads to slower wage growth and makes it harder for them to pay their debts.

There’s no real solution to this problem. If we forgive student debt, then all of us — including the debtors — suffer from higher taxes and slower growth. If we don’t forgive the debt, then we also suffer from slower growth due to the debt overhang.

So, no matter what happens… we’re all paying the price for decisions made by others, even if they’re sometimes underinformed decisions, or misinformed, or just plain poor… There’s a lesson here, and it’s to be sure that your children or grandchildren — perhaps even you, yourself — read and research the risks and costs that come with student loans. And have that discussion with whoever might want to attend college about the cheaper, alternative options — like community college or trade school — instead of going straight to a four-year institute so they can live like Van Wilder.

An Idea To Solve It All…

Here’s an idea. It’s probably not legal, but legality seems to be a murky concept these days. Why not fund partial debt forgiveness with the hundreds of billions of dollars sitting in university endowments?

Harvard alone has nearly $40 billion sitting in its endowment fund. With that kind of money, it’s questionable why they charge incoming students at all. They could certainly afford to chip in. And if we’re voting to spend other people’s money, I’d prefer that Harvard pay rather than the American taxpayer.

Of course, that’s not likely to happen. But there are some other solutions here, too.

College sports are massive money makers for ostensibly non-profit institutions. Perhaps a tax on college football tickets or TV rights with the proceeds dedicated to lowering tuition or outstanding debt of the students of the respective school is a nice start.

Or perhaps rather than a government mandate to raid the college endowments, alumni band together to pressure the endowments to share the wealth a little.

And in your personal life, let’s instead focus on some more practical actions.

If we know that growth is likely to be more modest due to debt overhang, this favors value and income strategies over growth strategies in the decade ahead.

Buying high-quality, high-yielding dividend stocks and other securities that benefit from a low-inflation environment makes sense.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Is Value Investing Dead

For value investors, the past 10 years have been outright depressing.

Since bottoming out in 2009, the S&P 500 is up over 330%. That compares to 235% returns in the S&P 500 Value Index. That’s nearly a 100% difference in returns over the past decade; enough to shake the confidence of even the most steadfast believers. Even lifetime proponents of value investing seem to be throwing in the towel.

Warren Buffett is considered by many to be the godfather of value investing. Yet Buffett’s Berkshire Hathaway has been accumulating shares of growth darlings Apple (Nasdaq: AAPL) and Amazon.com (Nasdaq: AMZN) as of late.

It’s tempting to declare that value investing dead. But I see things a bit differently…

If value investing were a person, it would be tempting to blindfold and kidnap said person, drive them out into the Nevada desert, have them dig his own grave under the moonlight, then… well, I think you get the picture.

Such is the level of frustration for value investors these days. It’s maddening. And this isn’t the first time that value investing has underperformed growth for a long stretch. It certainly won’t be the last stretch…

To illustrate, I graphed the Russell 1000 Value Index divided by the Russell 1000 Growth Index over the last 40 years. When the line is trending downward, value stocks are underperforming growth stocks. When the line is trending upward, value stocks are outperforming growth stocks.

From 1988 to 2000 — the period corresponding to the great 1990s tech bubble — growth absolutely mopped the floor with value. If you were investing back then, you remember what it was like.

The tech-heavy Nasdaq crushed all other indexes, and no one could be bothered with old-economy stocks. This was a period that saw value investors like Warren Buffett massively underperform the market, and it effectively killed the career of hedge fund legend Julian Robertson.

But then, something changed. Investors started to question the sky-high valuations of tech stocks, the tech bubble burst, and value investing came back with a vengeance. Between 2000 and 2007, value investing utterly destroyed growth investing.

Before long, the pendulum swung again.  stocks were hit hard in the 2008 meltdown, and a new generation of tech companies assumed leadership.

So, What Happens Now?

After 10 years of a growth market regime, is it time for value to take the lead again?

This isn’t something you can precisely time to the day. If you could, you probably wouldn’t be reading this. Instead, you’d likely be a reclusive billionaire living on an island somewhere. But I think it’s safe to say that value is well-positioned to outperform growth over the next decade.

J.P. Morgan reported earlier this month that, by their calculations, value stocks were trading at the largest discount to growth stocks in history and offered the fattest premium in 30 years.

Of course, as every value investor knows, cheap stocks can remain cheap forever in the absence of a catalyst to shake them out of their stupor.

Back in 2000, that catalyst was the dot-com bubble crash that forced money out of growth stocks and into value stocks. Alan Greenspan’s aggressive lowering of interest rates helped to push this. Yield-starved investors were pulled out of bonds and into higher-yielding dividend value stocks

History never repeats itself to a tee. But I believe a similar scenario could be unfolding today.

The business models of some of the biggest large-cap tech leaders — Alphabet (GOOGL), Amazon (AMZN), and Facebook (FB) — are under attack from regulators and all may be facing antitrust action from the federal government. Whether the government is successful in breaking up these tech monopolies remains to be seen, but the threat of a prolonged and expensive legal battle should be enough to make investors nervous.

At the same time, a wobbling economy has bond yields sinking again and the Fed openly contemplating cutting rates.

We’ll see how this shakes out. But my money is on value investing making an epic comeback in the years ahead.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Advice to a Young Graduate

Today is a day to remember those who have fallen in the line of duty.

For most of us though, it’s an excuse for the office to be closed and kick off the summer by lounging around the pool, or grilling up some burgers with friends and family.

There’s nothing wrong with that, of course. I like to think that fallen warriors look down in approval knowing that our way of life is made possible by their sacrifice. But we shouldn’t take it for granted.

If you have children, take a minute to explain why today is significant. They need to hear it.

And if you run into any veterans, give them a hardy pat on the back and thank them. If they look thirsty, offer them a cold beer. It would be uncivilized not to.

With the markets closed today, there’s not much to report. But I thought I would share parts of a letter I wrote to my younger cousin who just graduated from college with a degree in engineering.

I’ll refer to him as “W” to keep him anonymous. He starts his new job at Lockheed Martin next month, and we’re all really excited for him.

W,

Congratulations on finishing your degree and on getting the Lockheed job. That first job and getting your career started on the right foot is really important. And you’re getting yours starting right!

At any rate, let me give you a few parting words of advice.

  1. With your first paycheck, have fun. Treat yourself to something frivolous. Blow it. Enjoy it. And then, after that, it’s time to get serious and be an adult. But blowing the first paycheck on something stupid is a nice way to reward yourself for finishing your degree.
  2. I don’t know what your living plans are, but living with your parents for six more months will allow you to pad your savings. You should move out pretty quickly, as that’s important to being a real adult. But another 6-12 months at home won’t kill you, and it will allow you to save up enough cash to buy a car or even make a down payment on a modest house. Just make sure you actually save it and don’t just blow it all.
  3. Open two checking accounts. One will be the account your paycheck goes to and the account you use for your regular expenses. The other should be for saving. You can tell Lockheed to split your check across two accounts. They’ll do that. You can put 90% in the main account and 10% in the secondary account, or whatever makes sense. But keeping that cash separate makes it harder to spend.
  4. Put AT LEAST enough of your paycheck into your 401(k) in order to get the free employer matching. It’s literally FREE money. Ideally, you should put a lot more. You can put up to $19,000 into a 401(k) annually at your age. But at a bare minimum, put whatever you need to put to get the employer matching. It’s just stupid not to.
  5. Don’t get a credit card. Use a debit card or pay cash.
  6. Avoid debt on anything other than a house or car, and even on the car try to keep it minimal. Debt has ruined far more lives than drugs or alcohol ever have.
  7. Learn how to cook. Or, if that is a lost cause, find a girlfriend who likes to cook and treat her right and never let her go. Going out to eat all the time will bankrupt you, and it’s terrible for your health. This is a lesson best learned while you’re still young.
  8. Try to exercise at least a couple days per week. You’ll regret it when you’re 30 (and more when you’re 40) if you don’t.
  9. If your boss yells at you, don’t be a typical thin-skinned Millennial and get offended. Keep the stiff upper lip and use it as an opportunity to learn something and improve your marketability as an employee. I learned FAR more from the mean bosses than the easy-going ones. The boss who is your buddy isn’t going to get you anywhere. It’s the mean bosses that toughen you up who help you advance.
  10. Try to attach yourself to a manager that is really going somewhere in the company. If you do good work for them, they’ll take you with them. If you attach yourself to a manager who’s not really going anywhere, neither will you.

And that’s it. This is the only real wisdom I’ve managed to acquire in the 20 years since I graduated.  

Good luck in the new job, and let’s get the families together for some grilling this summer!

Take care,

Charles

Happy Memorial Day, folks.

Do yourself a favor and turn off your smartphone. The office is closed, and whatever it is you were going to check can wait until tomorrow. Our fallen soldiers didn’t fight tyranny only to have you enslaved by your iPhone.

So, put the phone away and be present with the people you love.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Have a Plan and Stick To It

The difference in life between success and failure, more than anything else, is having a plan and sticking to it.

Whether you’re talking about launching a business, getting through Navy SEAL training, becoming a concert violinist, or even getting a date on Friday night; success comes from seeing a plan through to completion.

This is particularly true when it comes to investing.

Warren Buffett, the legendary Oracle of Omaha and by most accounts the most successful investor in history, is probably a little smarter than you or me. I say “probably” because Mr. Buffett has never published his IQ score, and measurements of intelligence can be subjective.

But, in Buffett’s own words, in order to be a great investor, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ.”

To put that in perspective, the average IQ falls in a range of about 85 to 115. An IQ over 140 is considered genius level, and theoretical physicists Albert Einstein and Stephen Hawking were believed to have respective IQs of about 160 each.

So, according to Buffett, you need to be a little above average to be a good investor. But you certainly don’t need to be an Einstein or Hawking.

Buffett attributes his own success to “being greedy when others are fearful and being fearful when others are greedy.”

In other words, Buffett is Buffett not because of his intelligence but rather due to his emotional control, which allows him to stick to an investing plan even when most other investors are pulling the ripcord.

Now, I don’t claim to have Warren Buffett’s talents. But some of my greatest investment successes have come from being equally stubborn about seeing a plan through to completion.

I don’t have a large enough nest egg to retire today. But it’s big enough that I don’t really need to keep adding to it with fresh savings. Even with very modest growth assumptions, the savings I’ve accumulated already should be more than sufficient to take care of me and my wife in retirement when that day comes in another 20 years. Savings I continue to add just put the icing on the cake.

It wasn’t fantastic investment returns that got me to this point. It was having a savings plan and having the discipline to see it through to completion. I max out my 401k contribution every year, even when doing so is painful. Even when the market looks scary. Even when I’d prefer to blow the cash on something else or when I have to tell my children that I can’t afford something they want right now.

I’ve enjoyed competitive returns on those funds over the years, but the high savings rate has had a much bigger impact on my ability to grow my capital base than my returns.

As another example, I bought 288 shares of Realty Income (O) in 2009 that I swore at the time I would never sell. I committed to reinvesting my dividends into new shares and letting it compound… for the rest of my life. My children may sell the shares when I’m dead and in the ground, but I never will. When I’m old and gray, I’ll simply turn off the dividend reinvestment and take them in cash instead.

Well, after a little over nine full years of dividend compounding, those 288 shares bought for an initial purchase price of $6,620 are now 454 shares worth $32,383.

Using conservative assumptions on dividend growth, I would expect my investment to double every eight to ten years. So, in another 20 years, when I’m getting close to retirement, I’ll have something in the ballpark of $140,000 in Realty Income… still trucking along and throwing off dividends. And all of that on an initial investment of just $6,620.

Now, I’m not recommending you run out and buy Realty Income. I wouldn’t make a major new purchase at today’s prices. My point is simply that having a good plan – in this case buying and holding a high-yield dividend stock bought at crisis prices – works when you actually stick to it.

Disclosure: Long O.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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