Lobster Today, Shrimp Tomorrow

On Tuesday, August 27, the yield on the 10-year Treasury note fell below the 2-year Treasury rate, resulting in an inverted yield curve.

Source: treasury.gov

This is a big deal because the bond market is a key indicator of economic health.

When returns on long-term bonds (10-year Treasuries) fall below short-term bonds (2-year Treasuries), it generally signals that investors are concerned about a slowing economy and are increasingly focused on near-term economic conditions.

And while parts of the curve have inverted in recent weeks, the 2- and 10-year spread — spread is the yield difference between the two — has not inverted in 14 years.

Yield curves

First, some perspective on how a yield curve is typically shaped.

A “normal” yield curve slopes upward, with short-term rates lower than longer-term rates.

This is because investors generally demand a premium to hold debt for longer periods of time — they are taking on more risk after-all.

An inverted yield curve seems counterintuitive then. Why would long-term investors settle for lower rewards than short-term investors, who are assuming less risk?

The answer: long-term investors believe that this is their last chance to lock in current rates before they fall even lower.

To quote a colleague of mine, would you rather eat lobster today or save for 10 years and eat shrimp instead?

The image below is a real-world example of what yield curves can look like. The yield curve on 8/22/2018 was normal, with long-term rates higher than short-term. More recently, the yield curves are increasingly inverting.

Source: FactSet Research Systems, August 23, 2019

Risk of an inverted curve

As you might expect, since lower interest rates generally mean slower economic growth, an inverted yield curve is often taken as a sign that the economy may soon stagnate.

While the past is not a predictor of the future, the reason an inverted yield curve unnerves many investors is that it has historically been a predictor of a recession.

In fact, an inverted Treasury yield curve has preceded all nine US recessions since 1955, according to a study conducted by the Federal Reserve Bank of San Francisco.1 

should you be worried?

Regardless, predicting a recession from past events isn’t foolproof and a yield curve inversion does not necessarily mean imminent doom for the stock market.

Even the New York Fed has noted that by even the most aggressive predictions, a recession is at least 12 months out.2 And, after the inversion of the 2- and 10-year spread in December 2005, the S&P 500 rallied for nearly two more years, peaking in October 2007.

But what can you do to protect yourself in the event of an economic downturn?

There are two things that you should be doing now to hedge against a recession and they both revolve around your cash flow: 1) make yourself indispensable to your employer and 2) have enough cash on hand in case you do lose a job.

As far as investments go, tune out the noise and remain focused on your long-term financial goals. Market volatility is no reason to abandon your investment strategy.

In fact, when markets are down, it’s a great time to increase contributions and take advantage of purchasing assets while they’re cheap!

1. Federal Reserve Bank of San Francisco, “Economic Forecasts with the Yield Curve,” March 5, 2018, www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve

2. Federal Reserve Bank of New York, “Probability of US Recession Predicted by Treasury Spread,” August 2, 2019, https://www.newyorkfed.org/medialibrary/media/research/capital_markets/Prob_Rec.pdf?mod=article_inline

The Pitfalls Of Sudden Wealth

Sudden wealth can take many forms, including selling a business, winning the lottery, reaching a legal settlement, or the result of an inheritance.

Receiving a large windfall, especially when tied to the death of a loved one, can trigger powerful and conflicting emotions that may lead to risky financial decision making.

Below are some common pitfalls of sudden wealth and ways to overcome them.

Pitfall #1 – Hasty decision making

Do you ever hear of lottery winners going broke only a few years after they won a large sum of money? How is that even possible?

I think it’s because these ordinary people all of a sudden became extraordinary. They become euphoric and lose all sense of reality.

No matter the source of the windfall, it can oftentimes trigger those visceral emotional responses and all logical thinking goes out the window.

The best course of action to take after a windfall is to do nothing – at least for a while. Take a step back and figure out your priorities and create a plan.

Determine what decisions you have to make in the short-term, like tax planning, and what decisions you can wait to make, such as how to maximize the impact of your newfound wealth.

Pitfall #2 – caving to the pressure

Once friends and family learn that you’ve received a large sum of money, they may have an expectation that they are entitled to it. Depending on your relationship with those people, it can be hard to say no.

Once you start giving money away though, it’s difficult to reverse course.

The easiest solution is to rely on a third party to act as a gatekeeper, such as your financial advisor or attorney, to intercept the flood of requests and take the emotion out of the decision-making process.

Pitfall #3 – Withholding information

A windfall can prompt people to be more close-lipped about their finances. Some feel uncomfortable about their new wealth, others feel isolated from their former peers, and still, others are wary of those seeking handouts.

This instinct to withhold information often extends to your financial adivsor as well.

However, during every big transition, especially sudden wealth, it is critical to provide your advisor with a full picture of your financial situation. Your advisor will serve as a partner to assist you through the decision-making process and help you to spot issues before they become problems.

Pitfall #4 – Failing to update plans

After receiving a financial windfall, it is crucial to review the financial planning framework you previously had in place.

Financial plans will almost always need to be revisited, along with insurance policies and estate plans.

Your financial advisor can lead this team — financial advisor, lawyer, accountant, and insurance agent — to create a plan for your future that stays true to your priorities and goals as your financial situation changes.

Are Brokered CDs FDIC Insured?

Certificate of Deposits, or CDs, are typically issued by banks directly to a customer and have a fixed interest rate and date of withdrawal, known as the maturity date.

They also are insured by the Federal Deposit Insurance Corporation (FDIC) which covers up to $250,000 of your money in traditional types of bank deposit accounts – including checking and savings accounts, money market deposit accounts (MMDAs), and certificates of deposit (CDs).

As such, CDs are generally considered to be simple, conservative products that carry few risks.

But what if you buy a certificate of deposit through a broker, do you get the same FDIC protection as if you individually bought it?

The reality is that it depends on a number of factors. Some brokered CDs may actually be securities and, if they are, they won’t qualify for FDIC insurance at all.

what is a brokered cd?

Brokered CDs are CDs issued by banks to brokers, which in turn sell interests in the CD to individual investors.

Brokered CDs are sometimes arranged by a broker directly for a single client, but it’s more common that they’re bought in the name of the brokerage firm and sold to many clients.

In general, brokered CDs have longer maturity dates (in some cases, 20 years from the date of issuance), than traditional CDs. The interest rate terms of brokered CDs can also differ significantly from the simple interest rate terms usually used by traditional CDs.

For example, some brokered CDs have their interest rates tied to a market index, such as the S&P 500. Brokered CDs also may have special features that allow the issuing bank to terminate the CD after a specified period of time if interest rates drop.

To compensate for these additional features, brokered CDs frequently pay a higher interest rate than traditional CDs.

Although brokered CDs may have certain features that traditional CDs do not have, as long as a banking institution issues the brokered CDs and sets all of their features, brokered CDs are generally considered bank products — not securities — and FDIC insurance applies to them.

When does a Brokered CD become a Security?

However, there are several circumstances under which a brokered CD may be considered a security.

For example, if a broker materially alters the terms and features of a brokered CD (e.g., offering a different interest rate than the interest rate set by the issuing depository institution), the brokered CD is arguably a different investment vehicle that could be considered a security.

Additionally, some brokers maintain a limited secondary market for customers who have bought brokered CDs. If a broker, as an incentive to purchase brokered CDs, offers and/or maintains a secondary market for customers to rely upon to provide additional liquidity to their brokered CDs, this may make brokered CDs securities.

Something else to keep in mind is when a broker buys CDs as an agent for many clients, all bank information passes through the brokerage. Each client is protected only if the broker meets FDIC record-keeping requirements.

Those requirements include titling the account so it’s clear that the funds are being held in a fiduciary capacity. In other words, if it’s actually owned by the investment broker, and not you personally, the FDIC insurance may not apply.

If the institution that issued the CD fails, the FDIC would make payment to the brokerage since the only name on the account records would be the broker’s. Whether the brokerage transfers this payment to you or not is up to them.

Make sure all of your deposit will be fully insured. 

To protect your brokered CD from loss if the bank fails, follow these steps to confirm that your money is placed in a properly titled deposit account at an FDIC-insured bank and that all of it is within the deposit insurance limits.

First, get the name of the bank where your money is to be deposited and verify that it is FDIC-insured by calling the FDIC toll-free at 1-877-275-3342 or searching BankFind, the FDIC’s database of insured institutions at http://research.fdic.gov/bankfind.

Second, ask your broker to confirm that the deposit account records for its brokered CDs reflect the broker’s role as an agent for its clients (for instance, by titling the account “XYZ Brokerage, as Custodian for Clients”). This will ensure that your portion of the CD qualifies for full FDIC coverage.

You’ll also need to be aware of how much money you have at one particular bank. Your brokered CDs are added to any traditional CDs that you have at the same bank when calculating FDIC coverage. So, if your combined brokered and traditional deposits at a single bank exceed $250,000, you won’t have protection on the amount above the $250,000 limit.

Keep in mind that brokerages are also required to insure the assets in your account which they hold on their balance sheets (cash, bonds, stocks, and mutual funds). This is provided by SIPC, the equivalent of FDIC in the brokerage world.

So even if your brokered CD is considered a security, you’re still insured against the risk that the brokerage firm goes bankrupt.

Why You Should Keep Personal and Business Finances Separate

If you are a business owner, it’s important to remember that your company is an independent entity; it’s free-standing from you and your personal finances.

As such, separating your personal and business finances can help ensure you treat your business like the independent entity it is while safeguarding your personal finances.

Why You should keep them separate

It may seem apparent, but there are several reasons to be proactive about separating business and personal finances.

The following breaks down some of the more important reasons why you should consider doing so yourself.

Tax Reasons: One of the major reasons to separate your personal and business finances is for tax purposes.

The ability to take advantage of tax deductions — including writing off business expenses — is a huge reason many business owners choose to split their personal and business finances.

Keeping accurate records of business expenses is vital when running a company, as the IRS is more likely to audit your business and deny deductions and businesses losses if you have no clear separation between business and personal expenses.

The IRS also puts the burden of proof on you to disclose your business expenses and income. Maintaining good records saves you from having to dig through a huge box of receipts to figure out which purchases were for business and which were for your personal expenses.

Personal Liability: Separating your personal and business finances is important for tax reasons, but perhaps equally important, is separating your personal finances for the sake of your personal security.

 If you don’t treat your personal and business finances separately, the law won’t either.

This is known as “piercing the corporate veil” which means the courts will hold a business’s owners, members, or shareholders personally liable for business debts or legal judgments.

Business Credit: Another important reason to detach your personal and business finances is to build business credit.

The ability to obtain working capital for your business is often vital to growing it but many times business owners find themselves signing personal guarantees for leases, loans, and lines of credit because the business doesn’t have established credit.

The goal should be to avoid personal guarantees as much as possible because it means you would be personally responsible for any debt incurred by the business in the event it defaults.

How To keep them separate

Determine How To Structure Your Business: Deciding the legal structure for your business the most important step you can take in separating your finances.

Whether you’re operating as a sole proprietor, corporation or an LLC, the legal structure of your business will basically dictate everything from your risk and liability, to how the IRS will retrieve your business taxes.

In order to make the best decision, take the time to discuss your options with an attorney, CPA, and financial planner.

Maintain Separate Accounts: The ability to distinguish between personal and business finances is critically important.

Open a bank account for your business which will help differentiate between personal and business expenses. It will also help your case if the IRS ever questions the legitimacy of your business.

You’ll also want to get a separate credit card for the business. This will help streamline business finances and helps the business build credit.

Make sure you treat your business checking account and business credit card like it’s someone else’s. You’ll be less likely to raid it in times of need — or for personal use — if you consider it like you’re the employee of the business.

Pay Yourself A Salary: Another tip for keeping personal and business finances separated is by paying yourself.

Write yourself a check each month from your business checking account. Transfer this to your personal checking account, and then behave as you would if you were working for someone else.

Paying yourself a salary can help isolate the line between business and personal profits, instead of haphazardly pulling money from the business.

Should I Use Qualified Charitable Distributions?

Beginning in 2018, there were significant changes to the allowable itemized deductions that could be taken on Schedule A and the standard deduction was increased substantially.

As a result, many taxpayers are no longer be able to itemize deductions which means they don’t receive a tax benefit for making charitable gifts.

However, there still remains a very appealing tax-planning option for folks who are age 70.5 and older called a Qualified Charitable Distribution (QCD).

What is a Qualified Charitable distribution?

A Qualified Charitable Distribution is a direct gift from an IRA (including traditional, rollover, inherited, SEP, and SIMPLE) to a qualified charity.

These distributions have the benefit of satisfying the annual Required Minimum Distribution (RMD) rules while also avoiding income taxes on the distribution — RMDs are taxed as ordinary income.

In fact, QCDs are not included in your adjusted gross income (AGI) at all. Depending on how much you give, this can lower the odds that you’ll be affected by various unfavorable AGI-based rules such as those that can cause more of your Social Security benefits to be taxed and Medicare premiums to increase.

Should i use one?

How do you know if making Qualified Charitable Distributions makes sense for you and your financial situation?

This flowchart will help you get the conversations started with your financial or tax advisor.

things to consider

If you think this strategy is a fit for you, there are some things you’ll want to consider before jumping in head first.

  1. Decide early in the year if you want to use a Qualified Charitable Distribution to satisfy your Required Minimum Distribution. The first dollars out of an IRA are considered to be the RMD. If you satisfy your RMD in February but want to do a QCD in November, that income can be excluded, but it won’t offset the income from the RMD taken earlier in the year.
  2. Each person can donate up to $100,000 annually using the QCD rule. If you’re married filing jointly, and each of you has an IRA, you can both QCD up to $100,000 per year. Keep in mind that that extra distribution can’t be carried over—i.e., used to meet the required minimum distributions for future years. This contrasts with other strategies, such as a donation of cash and appreciated securities, where a large donation can be made in one year and the tax benefits can be carried forward.
  3. Work with your IRA custodian to make sure the QCD is completed correctly. The funds will need to be made payable directly from your IRA to the charity, which means they can’t send you a personal check and you turn around and give it to charity.
  4. Make sure your tax preparer knows that you completed the QCD. Your IRA custodian will send you a 1099-R showing the amount withdrawn from your IRA but the QCD may not be clearly identified. If the QCD isn’t properly listed on your tax return, you won’t get the tax benefits of doing it.
  5. You can make QCDs to multiple charities, just keep meticulous records for your tax preparer.
  6. Verify that the organizations you are giving to qualify. The organization must be a 501(c)(c) and you can’t be receiving a benefit for giving (raffle, sporting event seats, etc.).