The 8th Wonder of the World You Need to Know About

Why should you be investing today? Some people are steering away from investing during this pandemic, what with the foreboding headlines and uncertain future. However, investing remains an important way to accumulate wealth in this economic climate.

Saving vs. Trading vs. Investing

Many people confuse the terms saving, trading, and investing. What’s the difference?

Saving is when you put away money securely in a savings account, checking account, certificate of deposit (CD), or money market. Savings typically have easy access, a relatively low and stable interest rate, and an FDIC guarantee. We recommend maintaining emergency savings account with enough funds to get by for six to 12 months. For many people, this is anywhere between $25,000 and $50,000.

Trading is when you buy and sell stocks, bonds, or other financial products. You can make a quick buck, but there’s no opportunity for long-term growth and stability.

Investing is about financial growth over time. Whether you invest in your own business or purchase a share in a Fortune 500 company, you essentially own a slice of that operation. This proposition comes with more risk, but it also has a higher potential for return.

Once you have adequate savings in place, we recommend investing to help you accumulate wealth and prepare for retirement. Ideally, you should work toward having eight to 10 times more money in investments than you do in savings.

Think of investing as a garden. If you plant a tomato seed today, you won’t have a tomato plant tomorrow. There is no instant gratification the way there is in trading. It takes time, patience, and regular attention to build a successful investment portfolio, but if you’re consistent, the results can be amazing.

Investing requires an understanding of opportunity cost as well. This economic concept states that there’s an infinite number of ways you can spend every dollar you earn. Once you decide how to spend it, you can’t spend it any other way. Therefore, you need to earn another dollar to buy the next thing on your list. Thinking about the opportunity cost of every dollar you spend can help guide your investments.

What Makes Investing So Powerful?

Far too many people focus more heavily on saving than investing, but this is a mistake. Why is investing so important?

• Investing offers healthy returns. The historical average gain of long-term investments is 8 to 10 percent compared to 1 or 2 percent for savings.
• Compound interest can build incredible wealth. Dubbed the Eighth Wonder of the World, compound interest means your investment grows each year—not just on the original amount, but on the original amount plus the growth it made that year.
• Investing provides multiple aspects of growth. Dividends, interest, and capital gains are all possible ways to make money from investments.

Successful investing often requires help from a financial planner. Reach out to Nelson Financial Planning at 407-629-6477 or schedule your free initial consultation online to start putting your money to work for you!

The S&P 500 OR the S&P 5?

The S&P 500 is intended to be an index of 500 large companies listed on stock exchanges in the United States. However, if you take a closer look, you’ll find that just 10 stocks—or 2 percent of the total 500—account for almost one-third of the index’s overall performance. Why does this happen, and why should you care? Let’s take a closer look.

The S&P 500 is a Weighted Average

At first glance, it may seem like the S&P is an equal representation of 500 different stocks, but that’s not how it works. The index is actually a weighted average, so larger companies drive a more significant proportion of the index’s performance than relatively smaller companies. As the largest companies continue to grow ever larger, the market is becoming increasingly concentrated. This causes a dramatic lack of diversification, which can be financially catastrophic.

1999 was the last time we saw statistics similar to this. At the height of the dot-com bubble, excessive investments in Internet-related companies led to an inflated market rise. In March 2000, the NASDAQ Composite rose 400 percent, only to fall 78 percent—or $5 trillion—by October 2002, negating all the gains experienced during the bubble. The dot-com crash also caused countless Internet startups to fail.

How to Ensure Portfolio Diversification

The issue of poor diversification lurks beneath the surface of many portfolios, particularly these days, given the massive run-up of a small handful of companies driving a disproportionately high segment of the market. The media has labeled these companies the “FANGs” because they comprise Facebook, Amazon, Netflix, and Google, among others.

Clearly, when it comes to diversifying your portfolio, it’s not enough merely to own index funds. You really need to dig deeper and see what percentage of your portfolio is constituted in your top 10 holdings, which shows you what you ultimately own.

With the way things are right now, index funds may be comprised of the same kinds of companies. Remember, the top 10 holdings in any portfolio should never exceed about 20 percent of the portfolio’s total value. And if your top 10 holdings begin to exceed 30 percent, your portfolio is not nearly as diversified as it should be.

To sum up, it’s vitally important to be aware of the impact of investing in the S&P. If you’re not careful, you could end up with a serious lack of diversification, even when you think you’re diversifying effectively by investing in an index fund. For help digging into your portfolio and optimizing your investments, please contact Nelson Financial Planning. We’ll help you change your life with a successful financial plan.

Buying a House

As a financially savvy individual, you know you should be investing and preparing for retirement. Everyone wants to build a healthy nest egg, but what if you don’t have any extra cash or disposable income each month? These are two major roadblocks to investing. Another is buying a house while making sure you don’t end up “house poor.”

Problems with Rushing into Buying a House

The way you go about buying a house can dramatically impact the amount of money you have leftover at the end of the month. Spending too much on a mortgage or rushing into the wrong opportunity can cause two major issues:

• You rack up debt: If you put all your money into buying a house, you may end up taking out loans or putting day-to-day expenses on credit cards without the ability to pay them off. Going into debt just to make ends meet is never a good place to be financially.
• You have no disposable income to invest in: Because of inflation, money is always more valuable today than it will be tomorrow. As a result, you should strive to always keep your funds growing through wise, diversified investments.

A Look at Florida Homebuyers

Radio show host, author, and businessman Dave Ramsey recommends keeping housing expenses around 25 percent of your income. Following this advice, a Floridian earning the state’s median household income of $53,000 should spend no more than $13,500 per year—or $1,100 per month—on housing.

However, the average American spends about 37 percent of their income on housing. This means a typical Floridian might spend nearly $20,000 per year—or over $1,600 per month—on rent or a mortgage. This is a difference of roughly $6,000 per year.

Putting Your Money to Work for You

$6,000 per year might not sound significant, but this amount can substantially affect your investment portfolio. $6,000 is enough to fully fund a traditional or Roth IRA. You can use $6,000 per year to fund your children’s college educations in a 529 college savings plan. Or you can put $6,000 into stocks and bonds as a personal investment. The possibilities are endless!

Assuming a 7 percent rate of return, investing $6,000 per year starting at age 25 can grow to over $1.2 million by the time you reach retirement age, or 65 years old. However, if you spend an excessive amount of your income on housing and don’t have anything left to invest, you will not end up with the same nest egg when you retire.

Clearly, it’s essential to understand the opportunity cost of buying a house, especially if doing so will push your housing expenses too high. For more on how we can help you determine if a mortgage is within your budget, please contact Nelson Financial Planning. Our team of certified financial fiduciaries focuses every day on helping you change your life through a successful financial plan that provides peace of mind for the future.

Unforeseeable Market Surprises

The current political atmosphere, economic recovery following the COVID-19 pandemic, and recently passed legislation will significantly impact your financial decisions in 2021. Don’t be caught unawares by unforeseeable market surprises! Work with a financial planner to help you navigate your retirement strategy.

Political Control and the Stock Market

Presidential elections tend to significantly impact the stock market and the economy as a whole. With the inauguration of President Joe Biden, you may be wondering, “How will this new presidency affect the stock market?”

No one knows exactly how the market will perform in any given year and past performance is no guarantee of future results. However, MFS Investment Management—an American-based global investment management company—has put together a chart offering some historical perspective. From 1926-2018, the S&P 500 index experienced different annual average returns in relation to the president’s political party and the majority party in both houses of Congress. Consider these five findings:

1. The S&P 500 gained 15 percent per year under Democratic presidents and Republican-led Congresses.
2. The S&P gained 6.6 percent under Republican presidents and Democrat-led Congresses.
3. The S&P gained 11.4 percent when the White House and both Congresses were run by the same political party.
4. The S&P gained 15.6 percent under Democratic presidents and split Congresses (one party controlling the House and the other controlling the Senate).
5. The S&P gained 0.9 percent under Republican presidents and split Congresses. This seemingly skewed data entry could be partly caused by the fact that this scenario has occurred infrequently over the past century.

Having a Democratic president and 50-50 tie in the Senate is the scenario we’re entering right now—the very definition of “divided government.” But if market data tells us one thing, it’s that “gridlock is good.” If the stock market moving forward follows historical trends, we could be in for a healthy S&P 500 annualized return for at least the next four years. That level of certainty—or at least the lack of uncertainty—really boosts the economy and helps businesses make decisions.

COVID-19 and the Economy

While historical market data is useful to consider, a unique and tremendously impactful factor is present in our current economic climate—a deadly pandemic. Moving into 2021, the Biden administration will have to deal with the fallout of COVID-19.

The damage this pandemic has caused is specific to certain sectors of the economy, while others are fairing just fine. Lower-wage jobs have also been disproportionately affected, with engineering, technology, finance, and other professional jobs left relatively unscathed.

Despite undeniable economic damage, the underlying economy is actually showing some strong performance and signs of recovery. Here is some economic data from the end of 2020 to consider as the new year gains steam:

• National unemployment dropped to 6.9 percent—nowhere near 3.3 percent, which is where unemployment was a year ago, but things are moving in the right direction.
• Corporate earnings for Q3 2020 declined by 7.5 percent compared to the previous year. This is far less severe than the anticipated 21 percent decline.
• The Institute for Supply Management (ISM)—a widely looked-at manufacturing index—rose to 59.3, the highest measurement since 2018.
• New factory orders, which serve as forward-looking economic indicators, rose to the highest level they’ve been in 17 years.

Changes Implemented by the SECURE Act

The traditional retirement strategies that financial planners have recommended for decades were upended in early 2020 with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. This legislation is a significant departure from what the rules used to be regarding retirement accounts.

Before this new bill passed, beneficiaries had the option of spreading out distributions from inherited retirement accounts throughout their lifetime. They would have been required to take out 2 to 3 percent each year, but then the rest of the money could remain in the account, earning interest on a compounded, tax-deferred basis for decades.

With the SECURE Act, beneficiaries must empty inherited retirement accounts within 10 years. This new rule greatly accelerates the payment of taxes on that sum of money and shortens the amount of time the funds can grow.

Adjusting Your Retirement Strategies in Response to the SECURE Act

The tax implications of the SECURE Act are profound. There hasn’t been much analysis yet because the COVID-19 pandemic broke out shortly after the bill was passed, distracting the entire country in the process. Still, everyone should adjust their retirement planning strategies in response to the SECURE Act. Here’s how to be more tax-efficient, not just for you, but for succeeding generations.

Use more of your retirement account now.

The old recommendation was to pay for things like end-of-life medical care with an after-tax account to keep taxes low and preserve any IRAs for the next generation. However, because of the new 10-year rule, it now makes more sense to reverse this recommendation in many cases. Using more of your before-tax retirement accounts now means you don’t end up passing on more taxes to your beneficiaries, who may be in a higher tax bracket when they receive the money than you are as a retiree living on social security.

Pull down the balance of your retirement account with a qualified charitable distribution.

This strategy involves sending your required minimum distribution directly to charity so you don’t have to report that portion as income on your tax return.

Consider converting your account into a Roth IRA.

From a historical standpoint, financial planners have generally recommended traditional IRAs to most of their clients. However, because of the SECURE Act’s 10-year rule, Roth IRAs—which are comprised of after-tax dollars—are getting more attention. Just remember that if you convert a traditional IRA into a Roth account, you must be able to afford the taxes now.

If you need help navigating unforeseeable market surprises and changes brought about by the SECURE Act, please contact Nelson Financial Planning for a consultation today.

When Should you Start Investing

When you’re young, you might not think too much about retirement. It seems like a long way off, but in fact, your youth is the best time to start thinking about setting yourself up for the future. When should you start investing? Probably much sooner than you think.

Why should you start saving for retirement when you’re still decades away from it? Investing in your late teens and early 20s is much more impactful than investing at a later age, even if you invest less money. Do you know why? It’s because of compound interest.

Let’s consider the example of two people investing $2500 each year into a tax-deferred account (assuming a roughly 10% return). One starts at age 18 and continues to invest until they’re 27, investing a total of $22,500. The other doesn’t start investing until they’re 27, but continues until he’s 65, for a total investment of $97,500. Now here’s what may surprise you: the person who started investing at 18 will have $1.5 million in the bank, while the one who began at 27 will only have $1.1 million. So even though the first person put in just a little over 25 percent of what the other person invested, they ended up with nearly half a million dollars more.

Investing 10-15 percent of your income each month when you’re young can yield a healthy retirement account when the time comes. Before you get started, though, create a budget and make sure you’re living within your means. Pay down high-interest debt, so that your debt to income ratio is low- preferably below 35 percent. Then make an appointment with a financial advisor, who can help you create a successful financial plan. Because you’re young, you’ve got plenty of time for your money to grow, but the drawback of being young is a lack of experience. Aligning yourself with a knowledgeable professional is one of the smartest money moves you can make.

If you’re over 18 and this information has caused you to feel hopeless, don’t throw in the towel just yet. The magic of compound interest can still help you. You’ll just have to make a larger investment because you’ve got less time. Even in your 40s, if you contribute the maximum allowable amount to a 401k, you should be able to retire comfortably in your 60s. You’ll have to prioritize your retirement fund, though, not siphoning it off to pay for college or accumulating debt. It’s also important not to make risky investments, but with the right financial advice, it’s possible to save for retirement at almost any age.

When you’re ready to create a strong financial plan for the future that will allow you to live the lifestyle you want to live, Nelson Financial Planning can help. As one of the best financial planning firms in Central Florida, we provide guidance and financial advice so that you can make informed decisions about your future. We believe you should enjoy your retirement, so we’ll work with you to create a plan for a stress-free future. Call (407) 307-3061 or contact us today to set up your free consultation.