“God give me the serenity to accept the things I cannot predict, the courage to predict the things I can, and the wisdom to buy index funds.” —Nate Silver, Statistician
Clearly, this past year was momentous on the geopolitical front, with two events in particular—the results of both the Brexit vote and the U.S. presidential election—surprising the vast majority of prediction experts and pollsters. From an investing perspective, 2016 provided several examples of the importance of maintaining discipline in the face of uncertainty. After all, not only were the aforementioned events largely unexpected, but also the stock market’s reaction, at least to date, has confounded many, serving as yet another reminder that trying to outguess the market is often a losing game.
It bears reiterating that the market is an effective information processing machine, as asset prices offer an instantaneous snapshot of the aggregate expectations of market participants. This includes expectations about the outcome and impact of elections. While unanticipated future events—in other words, surprises (both good and bad)—may trigger price changes when they occur, the nature of these surprises cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically identify mispriced securities or, more broadly, to time entry and exit points in anticipation of a market correction. Indeed, such actions can lead to costly mistakes. Hence, Nate Silver’s timely and relevant quote above: Index fund investors (and we emphasize the word investors, as distinguished from short-term speculators), by embracing market pricing, harness the real-time predictions and expectations of all the experts, rather than placing potentially risky wagers on just one or a select few.
It is a simple statement of fact, rather than a biased, partisan observation, that many remain unsettled about the incoming president. Moreover, it is generally acknowledged that the U.S. election outcome and Brexit reflect broader global concerns about rising income inequality and job-loss anxiety. Yet nothing suggests to us that capitalism—and the capital markets—shouldn’t continue to function normally. Widespread voter anger at the ballot box appears to be driven by a underlying desire to see more boats lifted by capitalism’s rising tide, as opposed to converting to a different economic system altogether—specifically socialism in its purest form, where the means of production are collectively, as opposed to privately, owned. As elaborated by Warren Buffett in this year’s annual Berkshire Hathaway shareholder letter:
“Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided will remain fiercely contentious. . . . Clashes of that sort have forever been with us—and will forever continue. . . . The good news, however, is that even members of the “losing” sides will almost certainly enjoy—as they should—far more goods and services in the future than they have in the past. The quality of their increased bounty will also dramatically improve. Nothing rivals the market system in producing what people want—nor, even more so, in delivering what people don’t yet know they want.”
While stocks, particularly in the United States, have been buoyed since the election by expectations of tax reform, deregulation, and infrastructure investment, these stimulative/inflationary policy proposals have had the reverse effect in the fixed-income markets, particularly with regard to U.S. government and municipal bonds. It is worth noting, however, that despite the recent rise in interest rates (and the consequent decline in bond prices, which move conversely with interest rates), the yield on the benchmark 10-year U.S. Treasury note is only modestly above where it started the year, having merely ascended from its lows during midsummer.
While no one enjoys seeing interim paper losses on their fixed-income holdings in a rising rate environment (particularly fixed-income mutual funds, which don’t have maturity dates), high-quality bonds, such as those we prefer, continue to play a valuable role in terms of overall portfolio diversification and downside protection. On the whole, the amount you can potentially lose in stocks (as an owner) versus bonds (as a lender) differs significantly. Furthermore, with regard to bond mutual funds, higher rates can offset price declines over time, as interest payments and bond maturity proceeds are reinvested at higher yields.
On to general financial planning matters. Here are some key items and figures to keep in mind for 2017:
- The maximum federal tax rate on qualified dividends and long-term capital gains remains 20%, but only for taxpayers who are in the 39.6% marginal income tax bracket. Investors below those thresholds will continue to pay a maximum 15% rate on qualified dividends and long-term capital gains. However, these figures do not include the 3.8% Medicare tax on so-called unearned income for singles earning more than $200,000 and couples earning in excess of $250,000, as mandated under the Affordable Care Act.
- Maximum IRA contributions remain $5,500 for those younger than 50 and $6,500 for those aged 50 and up.
- Eligibility income ceilings for Roth IRA contributions increase, with contributions phasing out at adjusted gross income thresholds of $186,000 to $196,000 for married couples filing jointly and $118,000 to $133,000 for singles.
- The annual contribution limit for 401(k), 403(b), and 457 plans remains unchanged at $18,000 for those younger than 50 and $24,000 for those aged 50 and up.
- The limit on defined-contribution plans (Keogh profit sharing and SEP-IRA) increases from $53,000 to $54,000.
- The federal estate, lifetime gift, and generation-skipping tax exclusions, which remain uniform and indexed annually to inflation, increase from $5.45 million to $5.49 million per person. The top tax rate remains 40%.
- The annual gift tax exclusion amount remains $14,000 per recipient.
With one party now controlling the White House and both houses of Congress, there is a decent chance of tax law changes in the near term (expectations of which, as noted above, were rapidly reflected in the equity and fixed-income markets). However, just as with the markets, we would advise not making any bold or premature moves, given that it is difficult to predict exactly what Congress will do, or when. With that said, as always, we will inform you of any developments that seem pertinent to your individual circumstances.
And despite our own reluctance to make short-term predictions, it is probably fair to assume that politics will continue to be a dominant story in 2017, given more upcoming elections in Europe, forthcoming debt ceiling negotiations (yet again!) here in the United States, etc. Unfortunately, as much as we’d all wish otherwise, uncertainty is always present, and no one can control the direction of the markets or reliably predict how they will fare in the near term. But as we’ve said before, there are important things we can control, including how we react—or, just as importantly, don’t react—in the face of uncertainty and during occasional challenging market environments.
Furthermore, keep in mind that uncertainty cuts both ways—there can be both negative and positive surprises. And while global politics remain the subject of much focus and concern, various far-reaching positive trends continue unabated, such as the digital revolution and ongoing scientific innovation and progress. As Bill Gates (who also happens to be Warren Buffett’s fellow Berkshire Hathaway board member and periodic online bridge partner) recently wrote in a blog post, “When it comes to choosing a side in the debate between optimism and pessimism, my money is on the incredible forces of technological progress at work every day.”1To which we will simply add, on a closing note: It is optimism, not pessimism, for which investors have been broadly rewarded over time.
1. “America’s Best Days Are Not Behind Us,” www.gatesnotes.com, July 26, 2016.