All posts by Tom Canfield

We’re really within 3% of the prior peak for stocks in November 2021.

We’re within 3% of the inflation-adjusted peak for stocks in November 2021. This is a sharp change from my post at the two-year mark, when I concluded we had to see a real increase of 25% to get back to that peak. Wow. I’m encouraged that we may put that -23% real decline in 2023 behind us. That was the sixth worst calendar-year decline since 1926 and the third worst in my lifetime. If we put that peak from 2 1/3 years ago behind us, this will be one of the fastest recoveries for stocks from a year of steep decline.

 

== Details of the 4% ==

 

I use S&P Global’s index for Total US Stocks. I use the index for Total Return. I use the peak on November 8, 2021. The index, without adjusting for inflation is now more than 9% above that. But we’ve had ~12% inflation. When I adjust, we are less than 3% below the peak, and we have to have a real increase of less than 3% to surpass it.

 

 

== Implications for our SSA ==

 

We might calculate to a real increase in our Safe Spending Amount when we recalculate at the end of this year (SSA, Chapter 2, Nest Egg Care). I previously thought this would be IMPOSSIBLE. Real stock returns were more than +8% in November, and US stocks are up another than 13% from December.

 

I calculate our real portfolio return since December 1 at 8.7%. Patti and I need a 15% real portfolio return for our calculation year (December 1 – November 30) to calculate to a real increase in our SSA next Nov 30 or Dec 1. (You can follow my calculation to find the 15% that we need here.) 10% more from where we are now is not impossible.

 

Your SSR%s are different than ours and your mix of stocks and bonds may be different from ours. But my conclusion is that you also will be close to calculating to a real increase in your SSA at the end of this year if stock returns are +10% over the next nine months.

 

 

Conclusion. We’ve had a steep climb for stocks since early November. The outlook for our portfolio is very different than my look then. We are now just 3% in real return from surpassing the prior market peak in November 2021. If we can pass it and put it behind us, this will be one of the fastest recoveries from a steep annual decline in stocks.

 

The performance over the last four months gives me some hope of calculating to a real increase in our Safe Spending Amount the next time I calculate on December 1. Patti and I need less than 10% real portfolio return for the balance of this year to calculate to a real increase. 10% will put you in the ball park of calculating to a real increase in your SSA.

The latest inflation release confirms the high rate in January

Two months ago, it looked like we were clearly headed to 2% inflation. November inflation, using the measure favored by the Federal Reserve was the lowest in four years. The inflation rate for January was issued yesterday and confirmed a reading earlier in the month. Inflation of 0.4% was four times that of November and the highest in the last 12 months. That one month is an annual rate of 4.8%, but the measure of inflation the Federal Reserve favors tracks to 2.3% annual rate over the past eight months.

 

Going deeper: below I display a table and the same six graphs that I’ve use to follow the trends in inflation.

 

 

====

 

The two most widely-reported measures of inflation are Seasonally-adjusted inflation and Core inflation. These and most all other measures of inflation are reported at about the two-week point in the following month.

 

Seasonally-adjusted inflation increased by 0.38% in January. The rate over the last six months aims at an annual rate of 3.5%.

 

 

Core inflation excludes volatile energy and food components. This is similar to the measure favored by the Federal Reserve. Inflation increased by .39% in January. The last six months aim at an annual rate of 3.7% and the last eight aim at 3.2% inflation.

 

 

Personal Consumption Expenditures (PCE) excluding Food and Energy is the measure of inflation that the Federal Reserve Board favors. Inflation of 0.42% in January was less than the prior January but is greater than any of the last 12 months. The last six months aim at an annual rate of 2.5% and the last eight aim at 2.3% inflation.

 

 

== History of 12-month inflation ==

 

Full-year inflation measured by CPI-U shows that inflation for the last 12 months has been 3.9%.

 

 

== Producer’s Price Index ==

 

The change in producer prices will impact consumer inflation. PPI over the last six months is at a -2.5%. annual rate.

 

== Services ==

The last six months aim at an annual rate of 5.7%.

 

 

 

Conclusion: Monthly inflation in January was 0.4%. The rate for the Fed’s favored measure was the highest in the last 12 months. That’s obviously the wrong direction to the goal of 2% inflation, but the last eight months aim at a 2.3% annual rate.

How much more do you keep from investments in your retirement accounts?

I calculate that you gain at least 20% on the money you invest in retirement accounts relative to the same investment in a taxable investment account. I used a 25-year holding-period for your investment: if you are in the Save and Invest phase of life, that’s how long I assume you will hold your contribution this month to your retirement plan before you sell it for your spending. When I look back in time, that seems about right: Patti and I held the securities we sell for our spending for at least 25 years. Two components contribute to the +20% more: tax-free growth and avoiding tax on inflation. And you need time: those two provide a small benefit in ten years. It takes 25 years to reach that 20% benefit.

 

== Traditional = Roth ==

 

We want to compare the results from an investment in a taxable account to an investment in an IRA. To best understand, we need to start with the fact that a traditional (pre-tax) IRA gives the same after-tax return as a Roth (after tax) IRA; this assumes the marginal tax bracket at the time of contribution is the same as at time of sale of securities and withdrawal from the retirement account. In this example, I assume the marginal tax bracket is 22% at the time of contribution and at the time of withdrawal.

 

 

== Example: 14% more from tax-free growth ==

 

Once we understand that traditional = Roth, it’s a lot easier to understand when we compare an investment in a taxable account with the same investment in a Roth account. You already paid tax on the gross amount to invest in your taxable investment account or to invest within a Roth IRA.

 

• If you keep $1,000 in your taxable investment account, you will pay 15% capital gains tax on annual dividends and on the final gain at the time of final sale. (You may pay tax on capital gains distributions for some mutual funds, but let’s ignore that.)

 

• If you keep $1,000 in your Roth, you never pay these taxes: it’s obvious you will ALWAYS have more from Roth than from your taxable accounts. (The obvious caveat is that you do not violate the early withdrawal penalties from your retirement accounts.) You are not paying 15% tax on the growth over time. You are keeping 17.6% more of the growth for any holding-period.

 

 

The impact on the total that you keep depends on the amount growth vs. the initial investment. For the first few years, the total growth is small relative to the initial investment and the benefit of a retirement account compared to a taxable account is small. In the simple example below for 25 years, the growth portion is 5X that of the initial investment.

 

 

The simple example assumes all the gains are from price, not the combination of dividends reinvested and price. You only pay the capital gain tax at the end of 25 years. You have ~14% more from your Roth than you would from your taxable account.

 

== Perhaps 10 percentage points more ==

 

Three other factors make the benefit of a retirement account greater than 14% – perhaps 10 percentage points more, but I’ll just safely settle that an IRA results in 20% more than a taxable account.

 

 

• +3 percentage points: The benefit is really ~three percentage points greater when one calculates the impact of paying taxes on dividends on a taxable investment. A detailed calculation (It’s a big spreadsheet.) shows that you lose an increment of growth when you pay taxes earlier than in the simple example. This is a small effect for 10 years, but for 25 years the effect cumulates to 6% lower total growth and 3% lower net return.

 

• +2 percentage points: The benefit is two percentage points more because an IRA escapes the capital gains tax on inflation. The cost basis of an investment is not adjusted for inflation. The gain you calculate includes a portion that is just inflation. I calculate that the real capital gains tax rate is about  17% for the example of 25 years and 6X real growth.

 

• +4 percentage points: The benefit could be four percentage greater when one includes state taxes on capital gains. State taxes on gains vary. Nine states do not tax dividends or capital gains. Other states tax gains at 2.5% to over 10%. My state, PA, is on the low end and taxes dividends and capital gains at 3.1% and does not tax withdrawals from traditional or Roth IRAs. That would make the total capital gains tax in the simple case 18.1%. That raises the 14% benefit of an IRA to nearly 18%.

 

 

Conclusions: You benefit by about 20% greater after-tax return when you invest in a retirement account – either a traditional IRA or a Roth IRA – as compared to an investment in a taxable account. Obviously, this is for money you are investing for retirement, and I think 25 years is a proper holding-period for comparison.

 

Traditional (“Pre-tax”) IRA and Roth (“After-tax”) IRAs give you the same, basic after-tax return over time. You are gaining about 14% more in after-tax return primarily from tax-free growth of gains. You get a boost to 20% or more from escaping the tax on inflation inherent in the way gains taxes are calculated and from escaping state taxes on gains (This is varies according to your state).

Does it make sense to convert your IRA to Roth in Retirement?

I subscribe to a stock market newsletter. This month it had an article with the same title as this post, Does it make sense to convert your IRA to Roth in Retirement? I found the article confusing and incorrect. The decision on Roth conversion is pretty simple. I’ve written on this before (here and here), but I think this post gives a shorter, clearer explanation: it makes most sense to me to convert if you avoid paying taxes in a significantly higher marginal tax bracket in the future or if you can avoid a Medicare premium surcharge; you avoid paying taxes you do not need to pay; will have more after taxes than you otherwise would.

 

== It never really hurts ==

 

It NEVER hurts to convert from traditional IRA to Roth: I can’t construct a scenario where a retiree winds up with less after taxes from a conversion. (I’m not counting doing something illogical, like converting a large amount of traditional at a high marginal tax rate only to be in a lower marginal tax bracket later.) In essence, you are spending more now – paying more in taxes – to have more to spend later – pay less in taxes.  It’s always painful to pay more now: you  only want to do that – convert –  if you see real benefits.

 

== Most help: three cases ==

 

There are three instances for a small set of retirees where it makes most sense to convert some traditional IRA to Roth.

 

1) Convert if you are now in the 12% marginal tax bracket and think you will pay the 22% marginal tax bracket in the future. But folks in this situation may have a lot of headroom to keep the conversion amount in the 12% marginal bracket: the top of the 12% tax bracket for a single taxpayer is about $63,000 gross ordinary income for 2024: double that for joint, married filers. They can’t convert large amounts  at the 12% rate any year.

 

2) Those with high income – the top 10% of all retirees – might want to convert to have flexibility to avoid Medicare Premium surcharges.

 

3) Married, joint filers with high income might want to convert even at the 24% marginal tax bracket to avoid the 32% marginal tax bracket that the surviving spouse would pay as a single filer.

 

== More tax now. None in the future. ==

 

The simplest case is that you are in the 12% tax bracket now, but think you will be consistently be in the 22% tax bracket in the future – perhaps after your RMD starts.

 

It makes sense to convert the amount from traditional to Roth that still keeps you in the 12% marginal bracket. You pay the 12% tax now and not the 22% tax later. You will keep about 13% more after taxes on the amount you converted. (If your heirs are in the 22% tax bracket when they withdraw from Roth, they’re getting this 13% benefit.)

 

 

== Other jumps in tax bracket ===

 

This same math applies to other jumps in tax brackets, but only one other jump gets close to the benefit of the 12% to 22% bracket. Folks in these brackets have very high income. You also have to think through: if you convert at 22% bracket and hold Roth at death, will your beneficiaries be in the 22% bracket when they withdraw?

 

 

== Two other cases that make sense ==

 

Those with high income should consider two cases where conversion makes sense: avoid paying taxes that you do not need to pay.

 

• Convert some to Roth to give yourself flexibility to avoid Medicare premium surcharges. (I consider the surcharges as added taxes.) If you are near a tripwire in income that triggers a surcharge, you’d use Roth for your spending and not added withdrawals from traditional IRAs or from security sales in your taxable account .

 

• Married, joint filers with more than about $200,000 of ordinary income, should decide if they want to convert now to avoid the 32% marginal tax bracket when just one will be alive.

 

You can read more here if you are at this level of income.

 

 

Conclusion. Converting traditional to Roth NEVER hurts in retirement. I can’t construct a scenario where you would wind up with less after taxes if you convert. But it does hurt to pay taxes now rather than then. You only want to convert if you see real benefits.

 

Converting to Roth will give you more after taxes in two cases:

 

1) if you can see that you (or the surviving spouse of the two of you) will be in a significantly higher marginal tax bracket in the future. (I’d say at least 8 percentage points higher.)

 

2) if you have high income subject to Medicare premium surcharges, Roth gives you flexibility in a future year to keep your income below a level that triggers a surcharge.

35 times my money

Every January track what happened to the $2,000 I contributed to my IRA many years ago. I imagine that I put my $2,000 contribution in a gift envelope and bought shares of a stock index fund. It sat there untouched for 35 years, accumulating shares from dividends reinvested; price per share also changed. Patti and I open the envelope each January and see how much is there: we know we can spend it all to ENJOY. This January, it had securities worth $69,800. I made ~35 times my money in dollars. That’s about 14 times my money when measured in real spending power. This post shows the details.

 

== Summary ==

 

I did four things right:

 

 • I saved every year at a much younger age;

 

 • I saved in retirement accounts with no taxes on the growth;

 

 • I invested solely in stocks;

 

 • I invested in each year and stuck with the same fund, equivalent to a very low-cost S&P 500 index fund.

 

Details:

 

I can use Morningstar to see the growth in value for any mutual fund over all the years its existed. Here is the history for the past ten “envelopes” from my $2,000 investments. I invested each in an S&P 500 index fund. My $69,800 this year is about 35 times my original $2,000.

 

 

That’s not really an apples-to-apples comparison. I have to adjust for inflation to find the multiple in real spending power. The inflation factor to apply is ~2.5. $2,000 then has the same spending power as $5,000 now. The multiple in real spending power for our latest envelope was ~14: $69,800/$5,000.

 

== How does this happen? ==

 

That real growth in spending power was from the compounding of the long-term real ~7.1% growth rate for stocks for many years. I like this semi-log graph that shows the cumulative real growth in value for stocks and bonds since 1926. If you start way back in 1926, $1 invested in stocks grew 900X and ~90X that for bonds.

 

 

At 7.1% real growth, I would expect stocks to ~double every ten years applying the Rule of 72: 35 years would be 3½ doublings. Three would be 8x (1 to 2; 2 to 4; 4 to 8) and the five years is half way to the next doubling, getting you to 12X. My multiples have been better than that: for example, a straight line from the start of 1989 to January 2024 is ever so slightly steeper than that 7.1% line.

 

 

Another way to see what happened is to plot the real return multiples from all 35-year sequences of return that started in 1871.  We have the inflation-adjusted monthly returns for stocks and bonds since then. (Data downloads from here.)

 

I plot the multiples of return for the rolling sequences of 35 years. The first sequence started January 1871 and ended December 1895. The second one started in February 1871 and ended January 1996. The last one ended in September 2023. (The data hasn’t been updated yet for the last months of 2023.) That’s a total of 1,441 complete 35-year sequences.

 

 

 

You can see from this that the return multiples of the most recent 35-year sequences are greater than a multiple of 12.

 

You also see the folly of holding bonds for a 35-year period. Bonds do not come CLOSE to stocks for any 35-year period.

 

 

Conclusion. Every January I look back to see what happened to the $2,000 that I contributed to my IRA. I started that in 1981 and contributed the maximum for decades. Each year I look back at the contribution that I made 35 years ago. I can see the growth of my investment – which never changed for 35 years – from the Morningstar site. My investment grew 35X in dollars. My multiple in real spending power was 14X. The multiples of my last ten contributions have been slightly better than one would expect from the long-run real return rate for stocks of ~7.1%.

 

The lesson is to save and invest when you are younger. Save in retirement accounts and benefit from no taxes on growth; invest solely in stocks; never vary from investing and holding a very low cost, broad-based stock index fund.

The recent measure of inflation points to 2%.

Two weeks ago I reported on inflation for December for the set of indexes that come out early in the month. This post reports on the important measure that the Federal Reserve uses for its decisions on interest rates. That measure was reported this morning. Inflation for Personal Consumption Expenditures less Food and Energy (PCE less F&E) points more clearly points to 2.0% annual inflation.

 

== PCE inflation ==

 

PCE less F&E is headed to 2% annual inflation. The last six months point to 1.9% annual inflation.

 

 

== CPI Core Inflation ==

 

I repeat the graph from two weeks ago for CPI Core inflation. This measure also excludes the volatile components of energy and food. The last seven months point to 3.2% inflation.

 

 

== Why the difference?

 

The calculation of PCE adjusts the components of the index to more recently reflect changes in consumer purchasing patterns: the index will reflect the effect of consumers buying more lower-cost chicken and less expensive beef, for example. Inflation as measured by PCE has been below Core inflation for most months in the last year.

 

 

 

Conclusion: The measure the Federal Reserve uses to judge inflation is more clearly on track for 2% annual inflation as compared to several other measures of inflation.

Does the December inflation data disappoint?

The BLS issued a number of measures of inflation for December Thursday. A few articles said that inflation in December was high. December inflation was a little higher than October or November, but the charts in this post would not show that it was very high. We are clearly on a track to less than 3% annual inflation and headed to 2%.

 

== CPI Seasonally Adjusted ==

 

This is the inflation rate most often quoted. The December rate of 0.19% translates to an annual rate of 2.3%. The past 12-month rate is 3.2%, 0.1% greater than the prior 12-month rate. That was because this December’s low increase replaced a lower increase in December 2022.

 

Seven of the last 12 months have had monthly increases less than 0.20%. Five had had increases greater than 0.30%. The next four months of inflation will replace three of the five months with higher inflation.

 

== CPI Core Inflation ==

 

This measure excludes the volatile components of energy and food. It’s similar to the measure the Fed Reserve favors: Personal Consumption Expenditures (PCE) less food and energy. (That measure most often shows lower inflation – about 0.7% less on an annual basis; it’s reported in two weeks.) December inflation was greater than October and November. The last seven months aim at 3.0% annual rate.

 

Core inflation increased in December. The last seven months average to a 3.0% annual rate. The 12-month rate should decline, since the next five months will replace the past five highest-inflation months.

 

== Three are headed to less than 3% annual inflation ==

 

The income thresholds for IRMMA tripwires (Income Related Medicare Adjustment Amounts) adjust based on inflation as measured by the CPI-U – not seasonally adjusted. The adjustment is based on the change in the average inflation rate for the period September ‘23-Aug ’24 as compared to average of the prior same 12 months. We’ve now completed four months of cumulative -0.10% inflation. It’s almost certain the adjustment, calculated in September and announced in October or November, will be less than 3%.

 

 

Tax brackets adjust for inflation based on the same calculation as for IRMMA. They will adjust less than 3%.

 

Social Security COLA uses a different measure of inflation, CPI-W. The chart looks similar to the one for CPI-U. The adjustment will be based on the change in the average of third quarter of 2024 compared to the average for the same quarter in 2023. We have the change for first quarter: inflation was -0.51%. Inflation would have to run a bit wild over the next nine months for the third quarter of this year to reach 3%.

 

CPI-U and CPI-W charts look very similar.

 

== The next I-bond interest rate: <0.5%? ==

 

I-bonds were the hot ticket when they paid 4.81% for six months for a bond purchased May 1-Oct 31, 2022. I bought one in late May of 2022. The following six-month period paid 3.24%. That meant I earned $820 on $10,000 that I had to hold for ~15 months.

 

Treasury calculates the six-month inflation rate for the next bond purchased after May 1 on the six-month change in the CPI-U from September through March. We have the first three months for that calculation: -0.34% inflation. Inflation would have to be fairly high over the next three months to exceed 0.5% inflation for the six months.

 

The inflation rate for I-bonds is set by inflation over a prior six-month period. We’re half way through the upcoming six-month period, and inflation is -0.34%.

 

 

Conclusion: A number of measures of December inflation were issued on Thursday. Some articles said that the December rate was disappointing – too high. I show two charts that tell me that it was not that high. The measure the Fed favors comes out in two weeks, and over the past year it states that inflation is lower each month that reported by other measures.

 

The pattern of inflation for the last quarter of 2023 foretells that a number of inflation adjustments that are announced in the fall will be below 3% annual rate: Social Security COLA, IRMAA tripwires, and tax bracket adjustments. The inflation rate for an I-bond will plummet to less than 1% for the next six-month period starting May 1.

What segments of US stocks outperformed in 2022?

I like arranging the most recent calendar year returns in the 3 by 3 matrix of the Investment Style Box. I get a snapshot of what outperformed and what underperformed the US stock market as a whole. This post shows 2023 results: the return for stocks, ~22% real return, was about triple the ~7% long-run average return per year. Almost all the superior return came from Large Cap Growth (LCG) stocks. I hold a Total Market Index fund, and it handily beat the returns in seven of the nine boxes in the 3 by 3 matrix. I conclude the tactic is to Keep it Simple. Don’t try to tilt your portfolio overweight a sector. The winning tactic is to hold a bland, Total Market Index fund.

 

The Nominal return for the Total Market was 26%. This was driven by the ~47% return for Large Cap Growth stocks. Seven other boxes were well below the 26% return of a Total Market Index fund.

 

For perspective, the real return for stocks has been well above the expected rate of return for stocks in four of the last five years. The large negative return in 2022 was so bad – the fourth worst year in my lifetime –that the average real return rate over the last five years of 6.3% per year – is below the long-run average for stocks of 7.1% per year.

 

 

Here are three highlights:

 

• The real return for the total market was +22%. That’s a a good bounce from the -24% real decline of the prior year, but we need a total gain of about 32% to recover from last year.

 

• Large Cap Growth stocks killed every other sector; Large Cap Growth returned 37 percentage points more than Large Cap Value, for example; this is roughly the reverse from last year.

 

The ONLY way to match the return for the total market this year was to hold enough of Large Cap Growth stocks. If you tilted to hold less than what a Total Market index fund, you fell short of the return of a bland Total Market index fund.

 

• If you decided to tilt your holdings away from Large Cap Growth over longer periods of time, you would had about the same return with Large Cap Blend (basically an S&P 500 index fund), but you would have been far behind in seven of the nine boxes.

 

The error in that tactic could have been significant. Over ten years, four of the boxes lag the return for Total Market by an average of 25%; three others lag by roughly 15%. This tells me to NEVER try to tilt to a guess of to the boxes I might think will outperform.

 

Details:

 

The columns in the Style Box are Value, Blend, and Growth stocks and the rows are Large-Capitalization (Cap), Mid-Cap, and Small-Cap stocks. The nine boxes in the 3 by 3 matrix aren’t equal in market value of the stocks they hold. The row of Large-Cap represents about 80% of the total value of all US stocks. I use Vanguard index funds with tiny expense ratios for the returns for each box.

 

For reference, I’ve displayed the Style Box before: for 2017, 2018, 2019, 2020 and 2021. I also display the +26.0% return for VTSAX – the Vanguard index fund that holds ~4,000 all traded US stocks. (Patti and I hold the Total US Stock fund FSKAX, +26.1% in 2023.) You can see the dominant returns for Large Cap Growth.

 

== The boxes for 2023 Relative to VTSAX ==

 

I show the percentage point difference for 2023 in each box relative to VTSAX. This makes the point that you HAD to hold enough of Large Cap Growth to match the market. Seven of the nine boxes lagged and five of them lagged by 10% or more.

 

 

The return for Large Cap Blend (VLCAX) is almost the same as for an S&P 500 Index fund. The return for an S&P 500 index funds is going to be similar to a Total Market Index fund. It will be better when Mid and Small Cap stocks underperform and worse when they outperform. Over the last 15 years, Mid and Small Cap stocks have lagged Large Cap stocks; they wildly outperformed in other periods.

 

== Five years: Large Cap Growth leads ==

 

Over the past five years, Large Cap Growth leads all the other boxes, and leads five boxes by more than seven percentage points return per year.

 

 

== Ten years: Large Cap Growth

 

Over the last ten years, Large Cap Growth was the place to be. VTSAX – and other Total Market funds –outperformed seven of the nine boxes. Mid and Small Cap stocks lag.

 

 

= 15 years: Large Cap Growth ==

 

The picture is similar: LCG is the leader of the pack. VTSAX beats seven of the nine boxes. Mid and Small Cap Stocks lag.

 

 

== Percentage point differences compound ==

 

The differences in annual return rates compound to large dollar differences over time. I display the growth of $10,000 invested. Only Large Cap Growth is significantly better than the Total Market return over a decade. Seven others lag and the percentage difference in growth is significant.

 

 

One cannot predict which style will outperform in the future. One can only guess. I’m not guessing. I’m sticking with my Total Market fund.

 

== 2023 World stocks +22.1% =

 

The total world market stock index, MSCI All Cap World Index was +21.5% for 2023. US stocks are roughly 55% of the total value of all stocks in the world. Total International Stocks (VTIAX) were +15.5% in 2023. (Patti and I own the ETF of this: VXUS = 15.9% for 2023.

 

 

Conclusion: 2023 was a terrific year for US stocks following a horrible 2022. The real return was ~22%. That’s triple the long run or expected return rate for stocks. It’s an excellent bounce back from the large negative return in 2022, but we still need another very good year to get all the way back to where we were at the start of 2022.

 

Every year some segments of the market outperform and some underperform. In 2023, the return for Large Cap Growth stocks SWAMPED the other eight boxes in the 3 by 3 matrix that describes market returns. Large Cap Growth was better than Large Cap Value in 2023 by more than 37 percentage points. This is roughly the opposite of last year.

 

Over a five, ten, and 15-year history, Large Cap Growth has outperformed all other styles. It’s basically the only box that has significantly outperformed a bland Total Market fund.

Do you have enough bonds in your taxable account?

I found my portfolio needed some mechanical repair. I don’t have our bonds in the right location in our portfolio: I have far too little in our taxable Investment account and too much in our Retirement accounts. I scheduled tasks throughout 2024 such that by next December 1 I will have our bonds in the right places in our portfolio. I scheduled to sell stocks every other month to buy bonds to increase the amount of bonds that Patti and I will hold in our taxable, joint Investment account next December 1. This post describes my thinking and actions. As background, you can see how I have organized our Investment and Retirement accounts here.

 

== Bonds aren’t where I want them ==

 

I used our Reserve for our spending in 2023. That meant I sold solely bonds, not stocks for spending in 2023. Bonds are insurance. They aren’t long-term money makers. We want them to sell when stocks crater to give stocks a chance to recover. And, boy, that worked out well for 2023: the nominal return for US stocks (FSKAX) is up ~27% following their -20% decline in 2022; the nominal return for US bonds (IUSB) is up ~7% following their -13% decline last year. Stocks bounced back nicely; bonds not so much. (Both stocks and bonds have a way to go to get back to their real, inflation-adjusted level of two years ago.)

 

 

I want to have the same ability to sell solely bonds in a future year if stocks crater again. I found in this post that the tactic to “solely sell bonds when stocks tank” is sound. This tactic gives the same safety as rebalancing back to a design mix each year: that would be 85% stocks and 15% bonds for Patti and me, and it will result in greater upside once stocks have recovered.

 

To sell solely bonds in a year for our spending without ugly tax consequences, I must have a proper amount of bonds in our Retirement accounts and in our taxable account. Right now, I have more than enough in our Retirement accounts, but I don’t have enough bonds in our taxable account.

 

== Why too little bonds? ==

 

Why did bonds in our taxable Investment account get to be too low? To minimize annual taxes over the years, I have sold relatively more bonds than stocks in our taxable investment account: the taxable gains in bonds have been much lower than for stocks. I net more for spending after taxes by selling bonds, not stocks, in our taxable account. I still maintain a mix of 15% bonds when I rebalance our total portfolio, but all that final rebalancing is in our Retirement accounts, since I have no tax consequences of selling a security solely for the purpose of rebalancing.

 

Following this tactic for a number of years means bonds are far less than 15% of the total of stocks + bonds in our joint, taxable Investment account and more than 15% of stocks +bonds in our Retirement accounts. In a sense, bonds have “migrated” from our Investment account to our Retirement accounts.

 

== The basic math for Patti and me ==

 

I refer to my spreadsheet in this post that I use for my annual tax plan. It tells me that in a typical year, 70% of the gross sales of securities for our spending is from our Retirement accounts as RMD. 30% of security sales are from our joint, taxable investment account.

 

I want to have enough bonds in our taxable account such that all the 30% I would sell can be bonds. I couldn’t do that this last December 1. If I wanted to sell solely bonds for our spending next year, I would have to get most of the 30% from added sales of bonds from our Rretirement accounts. Those added withdrawals would be taxed at, say, 22% ordinary tax rate. Ouch. Those added distributions would also push our MAGI that year toward a Medicare tripwire that could cost the two of us $3,000 in a future year. Double ouch if we cross a tripwire.

 

I need to increase bonds in our joint, taxable investment account to get the structure of my bond insurance in order. It’s much better to sell stocks now to buy bonds in our taxable account: my tax cost is in the range of 6% or so (15% rate*40% gain), not 22%.

 

To get the capacity to solely sell bonds for one year of our spending, I need to have enough bonds in our taxable, joint account equal to 30% of our security sales for spending by next December 1. If I want to have the capacity for two years of selling solely bonds for our spending, I need to double that amount.

 

 

== My decision and schedule ==

 

I picked an amount that is roughly two years of spending that I’d want from our joint, taxable investment account. I set a bi-monthly reminder starting February 1 in my 2Do App. I will sell stocks (mostly FSKAX) to buy bonds (mostly IUSB) throughout the year. By next December 1, my bonds will be in the right location in the event I want to solely sell them for our spending without too high of taxes.

 

 

Conclusion: As I reviewed our portfolio this year, I found I had too little bonds in our joint, taxable investment account. For 2023, I sold solely bonds for our spending, giving stocks time to recover, and they, indeed, rebounded a good bit. I want that same flexibility for the future. To have the ability to do that I needed to repair our portfolio to have bonds in the right locations: I want more in our taxable Investment account and therefore will have less in our Retirement accounts. I developed a schedule to sell stocks (FSKAX) every two months to then buy bonds (IUSB) to get the right total amount of bonds in our taxable investment account by next December 1.

Does it look like we are on track for 2.0% annual inflation?

The Federal Reserve signaled about ten days ago that they would not be raising interest rates in the battle to lower inflation. Most pundits conclude that the Fed will cut rates at least twice in 2024. The stock market loved this news and it’s up 3% in ten days. Are the prospects for low inflation clear? The the data for the Fed’s favorite measure on inflation, Personal Consumption Expenditures less Food and Energy components was issued this morning. The last six months point to 1.9% annual rate, and the rate for the last four months aim at a 1.6% annual rate. This is much lower inflation that I last summarized three months ago.

 

Going deeper: below I display a table and the same six graphs that I’ve use to follow the trends in inflation.

 

 

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The two most widely-reported measures of inflation are Seasonally-adjusted inflation and Core inflation. These and most all other measures of inflation are reported at about the two-week point in the following month.

 

Seasonally-adjusted inflation increased by 0.10% in November. The rate over the last six months aims at an annual rate of 3.1%.

 

Core inflation excludes volatile energy and food components. This is similar to the measure favored by the Federal Reserve. Inflation increased by .28% in September. The last six months aim at an annual rate of 3.2%.

 

 

Personal Consumption Expenditures (PCE) excluding Food and Energy is the measure of inflation that the Federal Reserve Board favors. It’s a chain-type index meaning the weights of components are revised during a year to more accurately reflect changes in purchasing patterns. It’s the measure reported near the end of the following month. The last six months aim at an annual rate of 1.9%. The past 12-month rate likely will decline: inflation in December and January will replace high monthly rates of a year ago.

 

 

== History of 12-month inflation ==

Full-year inflation measured by CPI-U shows that inflation for the last 12 months has been 3.1%.

 

== Producer’s Price Index ==

 

The change in producer prices will impact consumer inflation. PPI over the last six months is at a 0.1%. annual rate.

 

 

== Services ==

 

The last six months aim at an annual rate of 4.3%.

 

 

 

Conclusion: The last six months of the most widely reported measures of inflation – CPI Seasonally Adjusted – aims at 3.1% annual inflation. The Federal Reserve’s favorite measure of inflation, Personal Consumption Expenditures excluding Food and Energy is a different index in that the weights of the components are revised several times during the year to more accurately reflect consumer buying patterns. The last six months aims at 1.9% annual inflation.