For those who actually have retirement accounts, the median retirement account balance was merely $60,000 in 2016, based on research by the Federal Reserve.
For those who can save but fail to invest and grow wealth in
retirement accounts, such as 401(k)s and IRAs, they have seriously
underestimated the power of tax deferral, especially when combined with the power
Let’s first demonstrate the concept of compounding with a
simple example. Assume we make one-time contribution of $10,000 and earn an
annual return of 6%. In 30 years, the balance grows to $57,435. Notice the
ending wealth is twice the size of a $10,000 starting portfolio that simply
adds $600 per year, which will be $28,000 in 30 years. This is the power of
compounding returns. Because the return earned in previous periods is
reinvested back into the account and continue earning returns of all future
periods, wealth grows exponentially, instead of in a linear manner.
Now let’s compare the wealth accumulation in a qualified retirement account, such as a 401(k) plan, and a taxable account, such as a brokerage account. Assume we make $10,000 in salary and decide to invest it in a 401(k) account. Let’s further assume a permanent 30% ordinary income tax and no taxes on investment income and capital gains. Because contributions to a retirement account are eligible for an income tax deduction, the entire $10,000 can be invested. At a 6% compounded return, the wealth will grow to $57,435 in 30 years. At withdrawal, we pay 30% income taxes and receive $40,204. Alternatively, we can pay 30% income tax upfront and invest the remaining $7,000 in a brokerage account. At 6% compounded return, we will receive the same $40,204 in 30 years.
The situation changes if income tax rates are different at contribution and at withdraw. For most people, the tax rate is like to be lower at retirement due to reduced income levels. Assume the tax rate at withdrawal is reduced from 30% to 15%, the ending balance in the 401(k) account will be $8,615 more, or 18%, than it would be when invested using the brokerage account.
The dynamics completely change when taxes on investment profits are considered. Assume all investment gains are distributed annually as qualified dividends and taxed at 15%. Because a 401(k) plan grows tax-free, the ending balance remains the same, at $40,204. In comparison, the brokerage account can only accumulate $37,800 in 30 years, which is $11,018 or 23% less, because taxes paid cannot be reinvested and earn future returns. Notice the 23% difference is more than the 15% taxes paid on investment gains. The power of compounding now acts against investing in taxable accounts!
Now assume we are frequent traders. As a result, all investment gains are short-term and taxed as ordinary incomes at 30% in the brokerage account. This trading behavior magnifies the gap of ending balances, with the brokerage account accumulating 40% less of wealth in 30 years.
Unfortunately, better investment returns only worsen the situation. At annual returns of 9%, the ending balance in the taxable account is only half of the 401k plan account.
As higher growth rate in qualified retirement accounts comes from three sources: 1. Potentially lower income tax rates at retirement; 2. Tax-deferred growth of investments; 3. Cumulative effect of exponential growth by compounding. Thus, investors should take advantage of the combined power of tax deferrals and compounding returns to grow their retirement savings.
Stock Selling Intensifies – If they don’t hold, a test of their March lows would be next
Stocks are under selling pressure today yet again with Energy stocks
leading the market lower with a drop of more than -3%, while oil is dropping
nearly twice as much. Technology, industrials, and financials are down -2% or
As has been the case this month, trade sensitive stock groups are leading the decline. Communication and material stocks are also being sold. The only gainers are utilities and REITs. They’re getting a lift from a drop in the 10-Year Treasury yield to the lowest level in eighteen months (and safe haven buying). Falling bond yields, however, are hurting financials stocks, and banks in particular. The sharp drop in yields also reflects a flight to the safety of Treasury bonds. Gold prices are also attracting a safe haven bid. Stock indexes are nearing a test of some important support levels.
Chart 1 shows the Dow Industrials trading right on their 200-day moving average in late trading. The Dow may be headed for a test of its March low near 25,200. A drop below that level would signal a deeper retracement of its 2019 gains. The Nasdaq is the biggest percentage loser resulting from weak technology stocks. Chart 2 shows the Nasdaq Composite Index bearing down on its 200-day average. If that doesn’t hold, the next downside target would be its March intra-day low at 7332. Chart 3 shows the S&P 500 also heading down toward its 200-day line. Its March intra-day low is at 2722 (green circle). That coincides with a 38% Fibonacci retracement of this year’s uptrend (top green line), which increases its importance.
Andrei Costas, Senior
Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment
Analyst (Fixed Income Strategies)
Written by: Scott Bishop, MBA, CPA/PFS, CFP®
At STA Wealth, we are starting to hear from clients and prospects in the oil and gas business that they are experiencing more layoffs. Not as bad as it was in 2015-16 when we had a large spike of layoffs in Houston. Back then, those layoffs sparked us at STA Wealth to offer some advice and support for those in need and it was the time I was asked to create the “Houston Layoff Survival Guide”.
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