With 2011 in the rear view mirror, investors may look back and consider it to be the “year of the event”. The U.S. economy and stock market was affected by multiple events including the tsunami in Japan, the European Debt Crisis, and the overall ineffectiveness with the handling of the debt crisis by Congress. These events overshadowed an economy that grew at a slow to moderate pace in spite of these events. As we look forward, there are many hurdles that may affect the markets and investor strategy in 2012.
Bush Tax Cuts Set to Expire December 31, 2012
The “Bush Tax Cuts” were extended through the end of 2012. The cuts not only provide lower tax rates for all Americans, but also affect capital gains tax and the estate tax threshold. Should Congress fail to compromise to extend some form of these cuts (and why would we think they would), most investors will have to reconsider their investment and estate planning strategies. There are three main considerations as this debate and the solutions or lack of solutions transpires through 2012
.• How will this affect the economy and subsequent markets?
• Should you recognize long-term capital gains if tax rates increase?
• Is additional estate planning needed?
Without getting into politics, it is unclear what the solution will be for future tax law. This creates uncertainty which the markets do not like. An increase in taxes means American consumers have less money to spend. I don’t think many will argue that the American people may not get a solution until the holiday season in 2012.
Current long-term capital gain rates for many Americans are 15% for taxable accounts. If there is a failure to extend the tax cuts, long-term capital gains increase to ordinary income rates. If this were to happen, many investors would be wise to take gains in taxable portfolios at a lower rate prior to the end of 2012.
With extension of the tax cuts in 2010, the estate tax threshold was set at $5 million. At $5 million, many Americans did not have to implement advanced estate planning to avoid estate tax. If the tax cuts fail to extend, the estate tax threshold falls to $1 million. Many individuals, who found themselves excluded before, now find themselves with a need to speak with their advisor and contact an estate planning attorney.
There is a pattern in an election year for the stock market to increase. Although this is interesting, this does not mean that changes should be made as a result of this data. After all, enough is said if we look at the last presidential election year – 2008. Although interesting, most investors should continue their strategy of a diversified portfolio based on multiple factors.
Interest rates have been at extremely low levels since the end of 2008. Bonds have seen solid gains for the last ten years. As I wrote about in previous articles – bond prices can go down. Bond and bond funds have an inverse relationship with interest rates. Although Bernanke has promised to keep short-term Fed rates low through 2013, this does not mean that interest rates will not rise. With interest rates at all time lows for so long, will 2012 be the year that interest rates rise and bond prices decline? Investors can mitigate losses in this situation by shortening the duration of their bond holdings.
Along the same lines, mortgage rates have reached all time lows. Government programs are also in place that may allow Americans to refinance even if they do not have equity. If investors have not considered refinancing recently, it is worth a second look the beginning of the year. If interest rates rise in 2012, that opportunity may be gone for your lifetime. Please contact me if you would like a referral to a trusted mortgage advisor partner.
As we head into the New Year, there are two events that are at the top of the list that will have an influence on the markets. As with any event, the outcome is impossible to predict. However, the outcome of the sovereign debt crisis in Europe along with the potential extension of the payroll tax cut will influence the markets both in the U.S. and abroad.
The prospect of the New Year brings the optimism of moderate growth in the U.S. economy. Investors that are improperly diversified or ill prepared will have an opportunity cost lost in multiple facets of their financial plan. However, a good investment advisor acts as a client’s CEO so they don’t have to worry about their financial picture. I wrote this article so my clients understand some of the factors I am considering heading into 2012.