What To Do When Your Employer Cuts Your 401k Matching

The following first appeared on Money & Markets.

It’s rough out there. With much of America still closed due to the COVID-19 pandemic, the unemployment rate is the highest it’s been since the Great Depression. But even many Americans that still have jobs are seeing pay and benefit cuts.

401k matching is often one of the first things on the chopping block, and the 401k matching rules are clear. Unless the matching is part of a union contract, companies have the right to slash or eliminate matching, even mid year. This applies to both traditional 01k plans and the safe harbor 401k plans more popular with small businesses.

Reducing or eliminating the employer matching isn’t particularly popular, but it’s a lot less potentially unpopular than mass firings or pay cuts.

What Are the 401k Matching Rules?

If you work for a large company, matching is almost always completely at the discretion of the employer. They have absolutely no obligation to match. They do, however, have a ton of 401k matching rules concerning nondiscrimination. Essentially, they can’t match for the executives but not for the rank and file workers. They can eliminate matching so long as they do it for everyone.

Smaller businesses often offer safe harbor 401k plans, which avoid the nondiscrimination testing but come with their own set of 401k matching rules.  As a general rule, employers have to offer a dollar for dollar 3% match and a 50% match on the next 2%, or they can offer a flat 3% nonelective contribution irrespective of employee deferrals. (In other words, they “match” you even if you don’t contribute.)

But even here, the employer can suspend matching if the company is operating at a loss, provided they give 30-day notice and follow the “top heavy” requirements that prevent too much of the plans benefits from going to the executives.

What Should You Do If You Employer Quits Matching?

If your employer has eliminated matching for the year, you might be tempted to say screw it and quit contributing to your plan.

Well, if you’re in a financial bind due to the pandemic, that might be your best move. If you’re having a hard time paying your mortgage or putting food on the table, the retirement plan clearly isn’t your top priority.

That said, assuming your finances are stable, you should continue to plow every nickel you can into your 401k plan. In 2020, the contribution limit is $19,500 or $26,000 if you’re over 50. That’s your goal, with or without matching.

I’ll spare you the tired old lecture about how the stock market “always” rises over time. “Always” only holds true if your investment time horizon is 30 years or more. My reasoning here has nothing to do with the stock market.

It comes down to taxes. Every dollar you put into your 401k plan is a dollar the IRS can’t get its grubby hands on.

Let’s say you’re in the 32% tax bracket. You effectively earn a 32% “return” on the tax break alone, even if you leave the cash in your plan’s stable value fund essentially earning nothing. And that cash remains available to invest tax free for the rest of your working life. So, if you’re reluctant to chase the market higher here, that’s fine. You can still get the money into the plan, enjoy the tax break, and then just bide your time until there’s a pullback.

All of this would be true whether your employer matched you generously or didn’t match you at all.

So, if you’re employer had to cut back on your plans matching this year, don’t throw out the baby with the bathwater. It still makes sense to save as much as possible in your 401k plan.

This article first appeared on Sizemore Insights as What To Do When Your Employer Cuts Your 401k Matching

All About the Bitcoin Halving

The following first appeared on Money & Markets.

I don’t normally like to hear the word “halving” associated with one of my investments. If your investment gets halved, you had better hope that there was a stock split. Otherwise, something went terribly wrong.

Of course, “halving” means something very different for Bitcoin and other cryptocurrencies. In case you missed it, Bitcoin just underwent a “halving,” the third in the cryptocurrency’s history, on March 11.

To understand what exactly that means, we need to do a quick refresher on what Bitcoin is and how it works.

Bitcoin runs on a blockchain, the open, distributed ledger that keeps track of every transaction made in the cryptocurrency. Because the ledger is distributed across every computer on the network, it’s nearly impossible to hack.

There is no centralized server in an office building somewhere that can be tampered with. Every transaction in the entire history of Bitcoin is recorded on every computer in the blockchain network and public domain to see. I can’t say it’s impossible to hack. I’m sure there’s some eccentric James Bond-villain hacker out there stroking a Persian cat and laughing maniacally as he hacks my account now.

But let’s just say it’s a lot harder than ripping my credit card number or hacking my checking account.

Nothing is Free

While Bitcoin was born of an idealistic, libertarian experiment, running the network isn’t free. It requires a lot of computational power and electricity usage to maintain the blockchain that supports Bitcoin.

While I’m sure there are some true believers out there that would do it for free, the rest are properly incentivized by being allowed to mine new Bitcoin. (In case you’ve wondered, Bitcoin mining actually does serve a purpose — the mining activity is what runs the payment system.) The algorithm that underpins Bitcoin rewards miners for volunteering their computer resources by giving them freshly mined Bitcoin.

This gets us to halving.

Halving is where the reward for mining gets cut in half. The same amount of processing generates half the number of new Bitcoins.

Why Does the Bitcoin Halving Happen?

We all know why gold and diamonds are valuable. They’re both rare.

Well, so is Bitcoin — by design. The supply of new Bitcoins is controlled by the mining process, and halving slows down the creation process.

By throttling the creation of new Bitcoin, the system avoids inflation.

Bitcoin prices fluctuate wildly due to supply and demand among traders, of course, just like gold, diamonds or any other finite commodity. But it can’t be printed at will by a panicked Fed Chairman.

It’s an Expensive Printing Press

Mining Bitcoin is wildly expensive and uses a ton of energy. A report last year found that Bitcoin mining globally used roughly the same amount of electricity as the entire country of Switzerland. The average cost to mine a Bitcoin was $6,851 before the halving. Now, the cost is around $13,000.

I know it’s folly to try to assign a fundamental value to something as speculative as Bitcoin, but I’m going to do it anyway. If it cost $13,000 to mine a coin, then the price needs to be $13,000 or higher to justify mining. At any price below that, the miner is actually losing money.

If the price of Bitcoin stayed below the cost to mine it for long, there would be no incentive to continue mining. As with any other business endeavor, you can’t operate at a loss forever.

This is where it gets interesting. If miners drop out, the number crunching that supports the blockchain gets easier and less energy intensive. This creates an equilibrium of sorts in which mining costs (what you can think of as the crypto’s “intrinsic value”) stay relatively close to market prices.

We’ll see what the future holds for Bitcoin. While Bitcoin itself has built-in inflation protection, there is nothing to stop inflation in the sheer number of competing cryptocurrencies. I like the concept of the cryptocurrency, but Bitcoin’s lack of monopoly power makes me stop short of betting the farm on it.

Still, it does have first mover advantage over the competitors. And if you’re looking for hedges against dollar devaluation, having a little Bitcoin along with some gold isn’t the worst idea.

This article first appeared on Sizemore Insights as All About the Bitcoin Halving

Picking the Best Small Business Retirement Plan: SEP IRA vs. 401k

The following first appeared on Money & Markets.

If you’re like most small business owners, your main focus is simply getting business in the door. And with business conditions still extremely difficult in the post-coronavirus world, many small business owners are struggling to keep the lights on.

But if your business is stable and cash flowing, adding a retirement plan should be your next priority. Apart from your own retirement security and protection from lawsuits, having a proper retirement plan can help you to attract and retain better employees. So, today we’re going to consider the best small business retirement plan for your company, whether you’re running a one-man shop or employ dozens.

The Best Small Business Retirement Plan for a Sole Proprietor

We’ll start with the smallest of small businesses, the sole proprietorship (we’ll lump in single-owner LLCs and other entities here as well).

For the one-man shop, your best small business retirement plan options are the Individual 401k (also called a Solo 401k) and the SEP IRA.

If you make more than $285,000 in annual income or business profits, there is no functional difference between the SEP IRA and the Individual 401k. At that income level, you can max out either retirement plan at the full $57,000 allowed in 2020.

But at any income level below $285,000, the individual 401k is going to be the best small business retirement plan by a country mile.

Here’s why. With a SEP IRA, the maximum contribution is 20% of your net profit up to a maximum of $57,000. But let’s say your profit is only $100,000. The maximum you could contribute would be $20,000.

Now, let’s compare that to a solo 401k. In all 401k plans – be they individual or large company plans – you can contribute $19,500 via salary deferral or $26,000 if you’re 50 or older. But you can also contribute the same 20% of the net profit. So, on the same $100,000 net profit, you could contribute a total of $39,500 rather than $20,000.

So, for the one-man shop, there is no reason to ever choose the SEP IRA. The administration and investment options are generally going to be the same for both plans, yet the solo 401k allows for higher contributions for a given income level. For the sole proprietor, the individual 401k is the best small business retirement plan.

And if You Have Employees?

If you have employees, it gets a little more complicated. A proper company 401k plan can cost $5,000 or more to administer every year and comes with a mountain of paperwork. For many, this will still be the best small business retirement plan because employees are comfortable with it, and in some cases the owners can contribute as much as $57,000 per year. But those benefits come at a price in terms of high fixed cost and additional work for your payroll staff.

The SEP IRA is cheaper and easier to administer but it’s generally not ideal when you have employees. To start, there is no salary deferral. You can make employer contributions to your employee accounts, but these have to  be consistent throughout the organization. You can’t sock away 20% for yourself and only 3% for your employees.

The best small business retirement plan for many smaller firms with employees is going to be a third option called the SIMPLE IRA. A SIMPLE IRA “looks like” a 401k in that contributions can be a mixture of employee salary deferral and employer matching. But unlike a 401k plan, there are no real administrative costs.

The only real downside to a SIMPLE IRA is the lower deferral amounts. Employees can dump $13,500 into a SIMPLE IRA each year, which is significantly less than the $19,500 currently allowed for 401k plans. But most employees are unlikely to contribute the full $19,500 in any given year anyway, so that’s going to generally be a moot point for most.

If you’re a small business owner, you’ll obviously need to do a little more research than this. But this should at least get you pointed in the right direction.

This article first appeared on Sizemore Insights as Picking the Best Small Business Retirement Plan: SEP IRA vs. 401k

Where to Find Yield Today

The following first appeared on Money & Markets.

Having the Fed funds rate back near zero is fantastic if you’re a borrower. It’s not so great if you’re an investor looking for income. T-bills, savings accounts and money market funds all yield essentially zero, and it’s hard to find CDs yielding more than about 1.5%.

It is still possible to generate a respectable income stream on your investments without taking excessive risk. You just have to look a little harder than usual and be willing to look at new pockets of the market you might not have considered before.  So today, we’re going to cover where to find the highest yields.

Not surprisingly, some of these sectors were badly beaten up in March, and all have to be considered a little risky in the post-coronavirus environment. But at current yields, at least you’re being adequately compensated.

Where to Find the Highest Yields

REITS

I’ll start with real estate investment trusts (REITs). I covered REITs back in early April, noting that the sector had been battered and left for dead.

Not all the negativity in the sector was unwarranted, of course. With most of the country on lockdown for the past two months, a lot of commercial tenants have been unable to pay the rent. Some REITs have lowered or suspended their dividends as they assess the damage.

It might be a while before things start to look truly normal again. Restaurants, gyms and entertainment companies in general will be licking their wounds for months. It may be well over a year before their customer levels recover to pre-crisis levels, which means landlords will need to be flexible. So if you’re a REIT investor, you’ll want to focus on the strongest names with the best access to capital.

Back in April, I mentioned Realty Income (O). While the REIT is focused on retail, its exposure to riskier pockets like full-service dining and gyms is tolerably small. At current prices it yields 5.5%, and I’d consider that dividend safe.

Ventas (VTR), which I also mentioned in the article, today yields a whopping 11.3%. Keep in mind that, as a senior living REIT, Ventas was hit particularly hard by Covid 19, and the company may decide to cut its dividend later this year. I don’t consider that especially likely, but I can’t rule it out in this environment.

I also mentioned EPR Properties (EPR) back in April, and I still consider this entertainment-focused REIT to be a nice value play. Unfortunately, they opted to conserve cash by suspending their dividend. So, if you’re buying specifically for yield, you’ll want to wait on that one.

And naturally, if you want to get out of the stock picking game, you could always just buy the index fund and be done with it. The Vanguard Real Estate Index ETF (VNQ) gives you broad exposure and yields an attractive 4.2%.

Business Development Companies

Last week, I recommended business development companies (BDCs), noting that like REITs, this high-yielding sector has really taken its lumps this year. Business development companies make loans and equity investments in small- and medium-sized businesses, making them a lot closer to Main Street than to Wall Street.

As with REITs, some BDCs have gotten hit particularly hard by the stay-at-home orders. But there are still some real gems out there if you’re willing to roll up your sleeves and look under the hood.

Ares Capital Corp (ARCC) and Main Street Capital (MAIN) were two solid BDCs I mentioned last week. I’d mention again that these two income machines currently offer yields of 12.2% and 9.0%, respectively.

Pipelines

Finally, I’d add pipeline stocks to the list. Anything even tangentially related to energy got utterly annihilated in March. Between the drop in demand from virus lockdowns and the surge in supply due to Saudi Arabia’s price war with Russia, crude oil prices tanked, taking energy stocks with them.

But here’s the thing: Many pipeline companies focus on natural gas far more than crude oil, and their business model depends on volume, not price. There was never any reason for fee-based, natural gas transporters to get roughed up like they did.

Today, you can snap up shares of Kinder Morgan (KMI) at a 7.1% yield and shares of Enterprise Products Partners (EPD) at a whopping 10.3% yield. Note that Enterprise Products is an MLP and has the cumbersome tax reporting that comes with that distinction.

All of these stocks have proven to be volatile this year. But it seems like the worst is behind them. And if you’re looking where to find the highest yields these days, this definitely points you in the right direction.

This article first appeared on Sizemore Insights as Where to Find Yield Today

Warren Buffett Really Rained on the Parade

This piece originally appeared on Money & Markets.

A lot of value investors came out of the woodwork to buy the dip in March and April following the coronavirus rout.

One was conspicuously absent from the party: Berkshire Hathaway’s Warren Buffett.

Buffett is a hero to generations of value investors. In fact, he’s one of my heroes.

One glance at his returns will show you why. From 1964 to 2019, Mr. Buffett grew Berkshire Hathaway’s by an almost absurd 2,744,062%. Over the same period, the S&P 500 returned 19,784%.

In past crashes, Buffett has always swooped in and bought the dip. He certainly did in the last crisis when he bailed out Bank of America, Goldman Sachs and General Electric, making himself billions in the process. The is the man whose self-described secret is being “greedy when others are fearful and fearful when others are greedy.”

But this time around, Buffett chose to sit on his hands. His cash hoard actually grew to $137 billion at the end of the first quarter from $128 billion at year end. At today’s prices, about 30% of Berkshire Hathaway’s market value is just the cash in the bank.

But not only is Buffett not buying. He’s actually selling. The Oracle of Omaha dumped $6.1 billion in stock in April, including his positions in American Airlines, Delta, United Airlines and Southwest Airlines.

This should be sobering to anyone with money in the market.

You can take comfort being in the market when Mr. Buffett is buying. Buffett isn’t always right, and like a lot of value investors he’s often early to the party. But buying by Buffett is that ultimate seal of approval… and that reassuring pat on the shoulders that says it will be all be ok.

In His Own Words

As always, Buffett was eminently quotable at the Berkshire Hathaway annual meeting this past weekend. But one quote really stood out. On why he hadn’t put his cash to work, Buffett said:

“We haven’t done anything because we don’t see anything that attractive to do.”

Furthermore,

“This is a very good time to borrow money, which means it may not be such a great time to lend money.”

There are several takeaways here.

The first is a point that I made last month: Even after the March tumble, stocks aren’t cheap. In fact, they’re still priced a lot more like a market top than a market bottom.

The second takeaway is that bonds aren’t exactly a screaming buy either. As Buffett put it, this isn’t such a great time to lend money.

In a normal, functioning market, interest rates reflect risk. You get rewarded with a higher interest rate for accepting greater credit risk and a longer time to maturity. But in its attempt to save the system from collapse, the Fed has massively distorted the bond market. Interest rates no longer reflect the risk being taken but rather the price at which the Fed is willing to buy.

Now, make no mistake. This isn’t a Fed-bashing hit piece. I understand why the Fed opened the floodgates the way they did, and I don’t think they had much of a choice if we are to be honest. Had the Fed not backstopped everything, we likely would have seen the financial system fail.

But that doesn’t mean we get a free lunch here. We will pay for the Fed’s move with lower bond returns, lower long-term growth and possibly with nasty inflation a few years down the line.

So, What Should You Do?

So, stocks and bonds are both expensive. Fantastic. What are we supposed to do?

I have one recommendation out of Buffett’s playbook. Most of us don’t have $137 billion laying around, but keeping a little more cash than usually on hand would seem like a good idea.

It also makes sense to prune your portfolio a little. Buffett dumped his airlines because he doesn’t have a good read on when their situation improves.

But at the same time, you don’t have to sell everything. Buffett still has a portfolio full of blue chips like Apple (AAPL), Coca-Cola (KO) and American Express (AXP).

I’d also add one final recommendation that the Oracle might disagree with. I think it makes sense to own a little gold. You don’t have to get carried away, but putting something like 5% of your net worth into precious metals gives you a degree of protection from currency instability should the Fed’s bailout efforts take a wrong turn.

This article first appeared on Sizemore Insights as Warren Buffett Really Rained on the Parade

The 60/40 Portfolio is Dead

The following first appeared on Money & Markets.

Responding to rumors that he had taken ill and died while on a speaking tour in Europe, Mark Twain told The New York Times: “The reports of my death are greatly exaggerated.”

Well, I don’t want to “greatly exaggerate,” but I think it’s fair to say that the 60/40 portfolio is dead. Or at the very least, it’s going to be on life support for a while.

It had a good run.

According to Vanguard, a portfolio invested 60% in stocks and 40% in bonds generated a compound annual return of 8.6% going back to 1926. That’s a stretch that includes the Great Depression, World War II, the stagflation of 1970s, the tech bubble and bust, and the 2008 meltdown.

It’s a portfolio that has clearly survived the test of time. And it’s easy to assume that it will continue to post numbers like these indefinitely.

Unfortunately, that doesn’t seem likely.

I’m no permabear and this isn’t an anti-buy-and-hold hit piece. I’m generally the optimistic sort, and when I err it’s usually on the side of being too aggressively invested, rather than too conservatively. But the numbers here are pretty straightforward. And they don’t look great.

Breaking Apart the 60/40 portfolio

We’ll start with the 60% invested in stocks, using the S&P 500 as a proxy.

As I wrote last month, the S&P 500 never got truly cheap during the coronavirus bear market. Yes, the market dropped 35% in record time, which brought it down to something closer to “fair value.” But at no point did it ever approach anything close to the valuation lows seen in previous bear markets.

Furthermore, those lows were short-lived. The market ripped higher in April, and today the S&P 500 is essentially at breakeven for the past 12 months.

The S&P 500 is trading at a cyclically adjusted price-to-earnings ratio (“CAPE”) of 26.5 today. If history were any guide, that would suggest annualized returns over the next decade to be close to zero.

Now, I’m the first to admit that historical comparisons should be taken with a grain of salt. Interest rates are lower today, which means that, all else equal, stock prices should be higher. The S&P 500 is also dominated by capital-light tech companies that should, all else equal, trade at higher valuations than clunky industrial firms.

I get all of that, which is why I think the S&P 500 will generate halfway decent returns over the next decade. But I still expect those returns to be lower than the historical average.

All About Bonds

But let’s say I’m wrong. Let’s say that it really is different this time and for reasons I can’t currently imagine, we really are in a period of permanently higher stock prices.

I actually don’t consider that idea to be crazy. Stranger things have happened.

But even if stock prices continue to push ever higher, there’s a big, gaping black hole where bond returns used to be.

The 10-year Treasury today yields 0.63%. A more diversified basket of bonds, such as the iShares Core U.S. Aggregate Bond ETF (NYSE: AGG) yields a little better at 2.6%. We’ll be generous and use that as our return assumption.

If we invest 40% of the portfolio in bonds, yielding 2.6%, and stocks generate 10% — which is generous given today’s valuations — that gets us a portfolio average of 7%.

That’s not all that bad. But again, it also assumes the market continues to perform in line with past returns, which is a stretch.

Let’s say instead that the stock market returns 5% per year going forward, rather than 10%. That knocks the returns of a 60/40 portfolio down to just 4% per year.

And let’s say the value investors are right and that stocks are priced to deliver essentially zero returns over the next decade. That knocks the return of a 60/40 portfolio down to just 1% per year.

This is why I really believe the 60/40 portfolio is dead, or at least dead for the next decade.

Again, this isn’t a bear hit piece. I’m not forecasting the stock market goes to zero or even that we retest the March lows. Maybe we do, maybe we don’t. Who knows.

Regardless, this should be a wake-up call. If your retirement planning “needs” an 8% return to be viable, you might need to consider working longer or cutting back some expenses.

You may also want to be a little more creative in your allocation. You can leave a good chunk of your investments in a 60/40 portfolio but also carve out some space for active strategies or for alternative investments, including gold or other precious metals.

But the worst thing you can do is carry on as if nothing has changed. Whether or not the 60/40 portfolio is dead, it’s certainly not priced to deliver the sorts of returns we’ve all become accustomed to.

This article first appeared on Sizemore Insights as The 60/40 Portfolio is Dead

Why Dividend Growth Matters More than Raw Yield

When Ray Dalio speaks, people tend to listen. Dalio is the billionaire founder of Bridgewater Associates, the largest hedge fund management company in the world. And it seems Mr. Dalio has a lot to say these days.

Back in January, Dalio said that “cash is trash” in a CNBC interview, and he repeated that sentiment earlier this month, saying that COVID-19 stimulus measures would eventually ignite inflation and that cash would “not be the safest asset to hold.”

I’d agree and would add that bonds — which pay a fixed coupon rate — aren’t much better.

This reminds me of one of my favorite income metrics: yield on cost.

How Yield on Cost Works

The yield on cost is the current annual dividend or interest income divided by your original purchase price. This isn’t going to be a meaningful metric for a short-term trader, but it’s something every long-term income investor will immediately understand and appreciate.

It’s best explained by example. Let’s compare the yield on cost between a hypothetical 30-year junk bond yielding 5.5% trading at par and Realty Income (O), one of my very favorite income stocks. Realty Income also happens to yield 5.5% at current prices.

We’ll start with the bond: $10,000 invested in the bond will produce exactly $550 per year in income in Year 1. But by year 30, it’s still producing exactly $550 per year. Your yield on cost is no different than your current yield. (We’ll also just ignore the likelihood that a company issuing a junk bond goes bankrupt long before we hit the 30-year market. Work with me here!)

Now, let’s compare that to Realty Income. Since going public in 1994, Realty Income has raised its dividend at a 4.5% compound annual rate. Just for grins, we’ll assume that dividend growth is a little slower over the next 30 years and compounds at just 4%.

In Year 1, a $10,000 investment in Realty Income also pays $550. But after 10 years of compounding at 4.5%, that annual payout jumps to $854.13 per year. After 20 years, it grows to $1,326.44. And after 30 years, it grows to $2,059.92.

$854.13 represents a yield on cost of 8.5%.

$1,326.44 represents a yield on cost of 13.3%

And $2,059.92 represents a gargantuan yield on cost of 20.6%.

Now, there are a couple things to keep in mind here. Yield on cost compares the current payout to the original purchase price. It takes no account of the current stock price, which also would presumably rise over time. Compare that to a bond again. The best you can ever hope to get from a bond at maturity is its original par value.

Also, 30 years is a long time to own a stock and might not be realistic for all investors. I’ve personally owned Realty Income for over 10 years and would like to own it for another 20 years. But I also bought the shares when I was a spry 32 years old.  Had I bought the shares having already reached retirement age, the 30-year yield on cost would be a little ridiculous.

And finally, it’s important to remember that dividends can cut just as easily as they can be raised. We’re getting a stark reminder of that this year due to the COVID-19 business disruptions. Goldman Sachs estimated last month that S&P 500 dividends would drop by 25% this year.

So, you’ll still want some cash and bonds in your portfolio, particularly if you’re in or near retirement. But if Dalio is right, and cash really is destined to become trash, you’ll want to own assets that throw off income streams that keep pace with inflation.

This article first appeared on Sizemore Insights as Why Dividend Growth Matters More than Raw Yield

Should I Open a Roth IRA Right Now?

The following article first appeared on Money & Markets.

William Roth, the late U.S. senator from Delaware, should have his face on Mt. Rushmore.

OK, that might be a bit of an exaggeration. He probably doesn’t belong in the American pantheon with the likes of Washington and Lincoln. But as the sponsor and namesake of the bill that created the Roth IRA, Roth certainly has a special place in U.S. history for American retirement savers.

The Roth IRA — its cousin being the Roth 401(k) — can be thought of as the mirror image of the traditional IRA or 401(k) plan.

Traditional retirement plans give you a tax break in the year you make the contribution and allow for tax-free compounding of all capital gains, dividends and interest. You pay taxes as ordinary income when you eventually take the funds out in retirement, and you’re generally required to start taking distributions after the age of 70 ½.

In Roth accounts, you get no current-year tax break. But all investment gains likewise get to compound tax free. All distributions after age 59 ½ are tax free, and – importantly – there are no required minimum distributions, or RMDs. You can let the account grow tax free until you croak, if that suits you, and let your heirs spend it.

So should you open a Roth IRA right now?

That depends.

Most financial planners naturally gravitate toward the Roth accounts, but I take a more nuanced view. Depending on your income level, your other assets, and your retirement planning, a traditional IRA or 401(k) might be a far better option.

Let’s say you’re in the prime of your career and you find yourself in a high tax bracket. Furthermore, you know that once you stop working, your income will drop significantly and you’ll be in a lower bracket. And in any event, you’re going to need these retirement funds to fund your living expenses when the day comes.

Well, if that’s you, you want the tax break today. You should go with a traditional 401(k) or IRA.

Now, let’s say you’re young and you’re in a low tax bracket. Or let’s say that, for some reason, you find yourself in a lower tax bracket than usual. Perhaps your spouse is out of work or you had business setbacks that have temporarily depressed your income. Or, let’s say you already have a nice nest egg set aside to fund your retirement and you’re looking more to leave a tax-advantaged gift to your children or grandchildren.

In any of these cases, the Roth IRA right now or 401(k) is the way to go.

Converting to a Roth IRA

2020 is a strange year, to say the least. With the Covid-19 lockdowns disrupting business, many people are writing it off as a lost year altogether.

But crisis years like this give us the opportunity to make the proverbial lemonade out of lemons. If you are truly in dire financial straits, you shouldn’t be putting money into a retirement account at all. You should be staying liquid in cold, hard cash.

But let’s say your income has taken a hit but that you also have sufficient savings to get through this without distress. In that case, you have options. You can make Roth contributions to your 401(k) or IRA this year and go back to making traditional contributions once your income rebounds and you find yourself in a higher bracket again.

Or, if you want to make a major planning move, you can convert your existing traditional IRA or 401(k) to a Roth IRA right now. Depending on the size of your account, this could land you with a massive tax bill. So you’ll really want to do the math to figure out of this makes sense for you. But if your income is in the toilet this year due to virus disruptions, it very well could make sense.

Also, note that not all company 401(k) plans allow for a Roth conversion. This is something you’ll need to discuss with your plan sponsor.

This article first appeared on Sizemore Insights as Should I Open a Roth IRA Right Now?

Are Dividend Stocks Still Worth Owning?

The following first appeared on Money & Markets.

I probably don’t need to tell you 2020 has been a rough year for the stock market. Even after a spectacular rally, the S&P 500 is still down close to 20% on the year. And frustratingly for a lot of income investors, high-yielding dividend stocks generally thought of as “safe” were some of the hardest hit.

I should know. I have a portfolio full of them, and some are still down more than 50%.

From 5% to 7% is considered a really high yield for dividend stocks these days. But is it worth risking a 50% decline in order to squeak out a single-digit yield?

I’ll answer my own question with an emphatic “yes.”

And to prove my point, I’ll use one of my very favorite long-term income machines, Energy Products Partners (NYSE: EPD). Enterprise owns one of the largest networks of natural gas and natural gas liquids pipelines in the country. It has an excellent management team.

Enterprise Products is an MLP and pays “distributions” rather than “dividends.” But for our purposes here, that’s a distinction without a difference. Enterprise Products is a dividend stock, and a fine one at that. The MLP yields a whopping 11.3% and has raised its payout every year since 1998.

Still, it’s been a rough road for this pipeline blue chip. The stock got slapped down during the 2015-16 oil crash and then was utterly obliterated during the March coronavirus meltdown and corresponding collapse in energy prices.

Today, the shares trade at 2010 prices.

dividend stocks

An investor holding Enterprise Products over the past 10 years — through one of the most explosive bull markets in history — wouldn’t have earned a single red cent … unless, of course you consider reinvested dividends. Taking into account reinvested dividends gives us a very different picture.

During one of the most difficult decades in history for energy-relative stocks, Enterprise Products managed to return about 127%.

dividend stocks

Sure, that’s a lot less than the S&P 500. But that’s not the point here. The takeaway is that high-dividend stocks can still be fantastic investments even during extremely rocky periods.

Consistent dividend payers are getting harder to find these days. Already, about 5% of the stocks in the S&P 500 have reduced or eliminated their dividends since the onset of the coronavirus scare, and we’re not done yet. The longer the lockdowns stay in effect, the more dividend cuts I expect to see. Goldman Sachs recently forecast that S&P 500 companies would spend 23% less on dividends this year.

So, you shouldn’t just buy a stock based on its yield and hope for the best. You need to be confident that the business supporting the dividend is healthy and sound.

As an interesting aside, the single biggest buyer of S&P 500 stocks over the past decade has been the companies themselves. It’s debatable exactly how much of the market’s epic run since 2009 was due to buybacks alone, but it’s safe to say it was substantial.

S&P 500 companies bought back $5.5 trillion of their own stocks between 2009 and 2019.

That’s trillion. With a T.

That represents about a fifth of the entire market cap of the S&P 500.

With a given pool of investors fighting over a shrinking pool of available stock to buy, prices had nowhere to go but up.

That came to a screeching halt with coronavirus. Companies are rightly hoarding cash. And Congress has effectively banned buybacks for any company taking federal assistance (which they should have!) Goldman Sachs expects buybacks to fall by about 50% this year.

One of the biggest drivers of stock returns — buybacks — is going to be on ice for the foreseeable future. This actually makes dividends all the more important. If we can’t depend on general asset price inflation, then we’ll have to settle for getting paid in cold, hard cash.

This article first appeared on Sizemore Insights as Are Dividend Stocks Still Worth Owning?

Retirement Planning in the Middle of a Pandemic

The following first appeared on Money & Markets.

If you’re reading this, I hope you’re still employed or that your business hasn’t been too badly disrupted. I’ve been impressed by the ability of millions of Americans to carry on business as usual despite the stay-at-home orders and closure of offices. It’s a testament both to modern technology and to the get-it-done spirit of America’s business owners and workers.

I’ve lost count of the number of business calls I’ve been on with crying babies, barking dogs or screaming Peruvian mothers-in-law in the background (OK, so that last one might be specific to me as I’m stuck in Peru). But business is still getting done even under those conditions, which is commendable. Unfortunately, there are still a lot of people hurting financially and looking for liquidity where they can find it. And some are naturally looking to their retirement accounts for lack of other options.

I don’t like to give our fearless leaders in congress and the White House credit for much. In fact, I’m generally happy to throw all of them under the bus. But they did throw us a few bones in the CARES Act that directly affect retirement planning. The longer this crisis lasts, the more relevant some of these options will be.

Let’s jump into some of the highlights.

Retirement Planning Amid the COVID-19 Pandemic

No RMDs in 2020

If you are over 70 ½, as part of your retirement planning you should already know you’re required to take required minimum distributions (RMDs) from your IRA or 401(k) plan.

Well, the CARES Act waives RMD requirements for this year. So, if you don’t need to take an RMD this year because you have liquid savings in a bank account or regular taxable brokerage account you can live on, it’s really better if you don’t. Every dollar you take out of your IRA is a dollar you have to pay taxes on. Keeping the cash in the retirement plan for another year kicks the tax liability into a later tax year.

Ultimately, you’re still going to pay the taxes. You know Ben Franklin’s quip: The only two certainties in life are death and taxes. But as far as I am concerned, a dollar in taxes postponed to a later tax year is a dollar saved.

Retirement Plan Emergency Distributions

If you don’t need to take distributions, great! But not everyone is in that situation. If you’re out of work or your business is shuttered due to the coronavirus closures, you may be looking for cash anywhere you can get it.

The CARES Act allows us to withdraw $100,000 per taxpayer without the customary 10% penalty that is levied if you’re younger than 59 ½. And if you pay back, or “recontribute” the funds in your retirement plan within the next three years, there are no tax consequences either.

The criteria here is pretty loose. In order to qualify for this hardship distribution, you have to have a member of your immediate family diagnosed with COVID-19, or you have to have suffered a financial setback due to virus and associated closures. I don’t claim to speak for the IRS, but I’m guessing they’re not going to check all that hard. If you claim to be suffering hardship, that’s likely evidence enough.

Additionally, you can potentially borrow more from your 401(k) retirement plan. Previously, the limits were the lesser of $50,000 or 50% of the account balance. The limit is now the lesser of $100,000 or 100% of the plan’s balance.

But Should You?

Here’s the rub. While you might be eligible to take funds out of your retirement plan, it doesn’t necessarily mean you should.

Remember, IRAs and 401(k) retirement plans are generally untouchable by creditors in the event of bankruptcy. The worst thing you could do would be to liquidate your retirement plan to support your business, only to have it fail in another three months if conditions don’t approve.

Should you be forced to declare bankruptcy – and let’s face it, a lot of people will be in that situation through no fault of their own – it’s better to keep your retirement accounts off limits.

Furthermore,  remember that you’re not the only person suffering right now. If you’re having a hard time making rent or payroll, try negotiating with your landlord or bank. They might not like it, but you won’t be the first person to ask them for help. It’s better to leave your retirement plan intact and deal with an angry landlord or banker than liquidate it and still deal with the same angry landlord or banker a few months later.

There’s also the government. The Paycheck Protection Plan (PPP) hasn’t gone as smoothly as we might like, and it’s already out of money. But it’s a foregone conclusion that the program will be restarted. If you think you might quality, call your bank and start the paperwork now so that you’ll be ready once the plan is given fresh funds.

And if, after all that, you still need to dip into your retirement account … well, do what you need to do. It’s rough out there.

Just make sure you keep this as your absolute last resort. You’ve worked too hard for it to risk exhausting it now.

This article first appeared as Retirement Planning in the Middle of a Pandemic.

This article first appeared on Sizemore Insights as Retirement Planning in the Middle of a Pandemic