One thing we’ve learned as world events have taken us by storm this past year: expect the unexpected. Last summer, a little event called Brexit caught the world by surprise. Markets fluttered again throughout the 2016 presidential election. And just a few months ago, millions of Americans were shocked when the polls came in to show who would be the 45th president of the United States.
What does a new political and market climate mean for your finances this year? Apply these five strategies to your financial plan to weather any new storms on the horizon:
1. Diversify your portfolio to protect against market volatility
We are currently in the ninth year of a bull market, meaning the market has been up since 2009. With a new administration in the White House and the knowledge that volatility can happen at any time, all eyes are on any potential cause for a market swing. While it’s impossible to predict what the new presidency will mean for your portfolio, it’s critical to protect your investments against market uncertainty.
It’s fair to say that we are due for a market correction or a bear market at some point, regardless of the cause. We can’t predict when this might happen – the longest bull market ran 4,494 days from 1987 to 2000 – but it’s important that you prepare for both the best-and worst-case scenarios.
Bottom line? Stay diversified. Don’t get caught up in what everyone else is doing with their investments. Don’t throw all of your money toward the hottest tech stocks. And don’t try to time the market. Protect your portfolio against market bubbles and volatility with a portfolio that is invested across sectors and in both U.S. and international stocks, and isn’t heavily weighted in any given company.
2. Don’t hold too much cash
A common mistake that many investors make when they worry about market uncertainty is holding too much cash. It might feel safer to hold onto your cash now than to watch your investments fluctuate, but inflation will eat away at your cash when you could be earning a larger return over time. And facts are facts — in the past 10 years, cash has never been the best performing asset class across a year. Even in 2008 when the market crashed, there were better places to invest. Both gold and treasuries outperformed cash during 2008’s collapse. For an idea of how much cash underperformed other asset classes in 2016, check out the chart below:
Full-Year Asset Class Return – 2016
*Source: Yahoo Finance
3. Know how to plan for rising interest rates
Although there are many unknowns, one thing we do know is that under the new administration, the Federal Reserve will likely raise interest rates. The Fed’s responsibility is to provide consumers with a safe, flexible and stable financial system. When times are good, the Fed typically keeps rates higher to prevent inflation (i.e. the rate at which the general level of prices is rising resulting in the general value of currency falling). When times are tough, the Fed may lower interest rates to encourage economic activity. The Fed announced a 0.25% interest rate hike in December, which was only the second raise since 2006. The Fed indicated that more hikes would be on the horizon in 2017. With rates likely to go up, it’s important to have an understanding of what this could mean for you.
If you have credit card debt, higher rates are bad news because your bank will likely charge higher interest rates on debt (and be slower to pass on higher yields on your checking and savings accounts). Most credit cards have a variable rate that is based on the prime rate. This prime rate has a very strong correlation to the Fed rate, so oftentimes an increase in the Fed rate means an increase in the prime rate. The Fed’s 0.25% rate hike can mean you’ll pay an extra $25 a year for every $1,000 of debt. That may not seem like a lot, but it can quickly add up over the years if you carry a balance. While credit card rates are already high enough that new hikes may not feel too noticeable, now’s a better time than ever to pay down your credit card balance to avoid the extra expense altogether.
The combination of the Fed’s hike announcements and expectations around the new administration’s policy means that longer-term interest rates have risen, bringing mortgage rates with them. A typical 30-year fixed mortgage now carries a 4.5% interest rate, which is about 1% higher than six months ago. To put this into context, a previous $1,800 monthly payment on a $400,000 home loan is now up to an approximate $2,000 monthly payment. Over the life of that 30-year mortgage, that’s an extra nearly $83,000 you will owe.
Keep in mind that long-term mortgages are based in part on future Fed rate moves in the near term, and the Fed has announced that three more hikes are in store for 2017.
4. Understand the Fiduciary Rule and what a potential repeal/delay means for you
Last April, The Department of Labor announced that a new Fiduciary Rule would be rolled out on April 10 of this year. The rule requires all financial advisors and brokers to act in “the best interest” of their clients when it comes to retirement accounts, including 401k’s, individual retirement accounts, IRA rollovers and other retirement-qualified funds (the rule doesn’t affect non-retirement accounts). Experts believe that the rule will affect more than $3 trillion in retirement assets in the United States.
This new rule has faced fierce opposition from brokers and from the heavily funded financial services lobby, as advisors who are not fiduciaries simply have to meet a “suitability standard.” This means an advisor could conceivably steer a client into a product that pays the advisor a higher commission, as long as that product is “suitable” for the client. The new administration has indicated that it may delay or repeal the Fiduciary Rule. If this happens, then it’s important that you take the initiative to ensure you are working with a financial advisor who puts your best interests before their own bottom line.
To make sure your advisor is giving you advice that is in your best interest, ask how they are compensated, if they have a sales quota to fill, why they are recommending a particular investment and whether they are a fiduciary. If they aren’t a fiduciary – find another financial advisor.
5. Optimize your taxes
Tax season is right around the corner. And if you’re like most Americans, you’ll do whatever it takes to decrease your tax bill this year. Here are a few of the commonly overlooked ways to save big at tax time.
Some often-overlooked deductions and credits include:
- State sales tax – You can choose to deduct either state income tax you paid or the state sales tax you paid. The IRS even has a handy calculator that will help you calculate state sales tax.
Foreign tax credits – You can also deduct or take a credit for foreign taxes on foreign income. Many mutual funds have stocks from foreign and multi-national companies, which could be paying your foreign dividends or capital gains.
- Tuition and education expenses – You can earn an annual tax credit of up to $2,500 per eligible student for the first four years of higher education through the American Opportunity Tax Credit. Or you may qualify for a credit of up to $2,000 per tax return through the Lifetime Learning Credit if you are taking a class or two to improve job skills.
- Child care credit – You may qualify for a tax credit of 20-35% of what you pay for childcare expenses while you (and your spouse, if filing jointly) work. The maximum amount of childcare expenses you’re allowed to claim is up to $6,000 for two or more children.
- Baggage fees – If you are traveling for business and your airline ticket is deducted as part of your travel expenses, make sure you deduct any baggage fees you’re charged. They can be deducted just like any of your other travel expenses.
We’re entering a new political era, but even with uncertainty around what the markets, the president or your portfolio will do this year, you have the power to take control of your financial plan. With a strategic approach, you can protect your finances regardless of what the future holds.
Michelle Brownstein, CFP®
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