What is a yield curve, and why are stock investors interested in its shape?
A yield curve gives a snapshot of how yields vary across bonds of similar credit quality, but different maturities, at a specific point in time. For example, the US Treasury yield curve indicates the yields of US Treasury bonds across a range of maturities. Bond yields change as markets digest news and events around the world, which also causes yield curves to move and change shape over time.
Exhibit 1 includes snapshots of the US Treasury yield curve on the last trading day of September for the last three years. Rates across the entire curve have generally moved higher since 2016. However, short-term rates moved at a faster pace than long-term rates leading to a “flattening” of the slope of the yield curve.
Historically, yield curves have mostly been upwardly sloping (short-term rates lower than long-term rates), but there have also been several periods when the yield curve has either been flat or inverted. One question often posed by investors is whether inverted yield curves predict a future stock market decline. While the handful of instances of curve inversions in the US may concern investors, the small number of examples makes it difficult to determine a strong connection, and evidence from around the world suggests investors should not extrapolate from the US experience.
It’s almost Election Day in the US once again. For those who need a brief civics refresher, every two years the full US House of Representatives and one-third of the Senate are up for reelection.
While the outcomes of the elections are uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the days to come. In financial circles, this will almost assuredly include any potential for perceived impact on markets. But should long-term investors focus on midterm elections?
We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult. While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors.
Look beyond this moment and stay focused on your long-term objectives.
Volatility will always be around on Wall Street, and as you invest for the long term, you must learn to tolerate it. Rocky moments, fortunately, are not the norm.
Since the end of World War II, there have been dozens of Wall Street shocks. Wall Street has seen 56 pullbacks (retreats of 5-9.99%) in the past 73 years; the S&P index dipped 6.9% in this last one. On average, the benchmark fully rebounded from these pullbacks within two months. The S&P has also seen 22 corrections (descents of 10-19.99%) and 12 bear markets (falls of 20% or more) in the post-WWII era.1
Even with all those setbacks, the S&P has grown exponentially larger. During the month World War II ended (September 1945), its closing price hovered around 16. At this writing, it is above 2,650. Those two numbers communicate the value of staying invested for the long run.2
This current bull market has witnessed five corrections, and nearly a sixth (a 9.8% pullback in 2011, a year that also saw a 19.4% correction). It has risen roughly 335% since its beginning even with those stumbles. Investors who stayed in equities through those downturns watched the major indices soar to all-time highs.1
What should you make of recent ups and downs in the stock market? Here’s helpful context on volatility and expected returns.
After a period of relative calm in the markets, in recent days the increase in volatility in the stock market has resulted in renewed anxiety for many investors. From September 30–October 10, the US market (as measured by the Russell 3000 Index) fell 4.8%, resulting in many investors wondering what the future holds and if they should make changes to their portfolios.1 While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
Your Social Security income could be taxed. That may seem unfair or unfathomable. Regardless of how you feel about it, it is a possibility.
Seniors have had to contend with this possibility since 1984. Social Security benefits became taxable above a certain yearly income level in that year. A second, higher yearly income threshold (at which a higher tax rate applies) was added in 1993. These income thresholds have never been adjusted upward for inflation.1
As a result, more Social Security recipients have been exposed to the tax over time. About 56% of senior households now have some percentage of their Social Security incomes taxed.1
A look at how variable rates of return do (and do not) impact investors over time.
What exactly is the “sequence of returns”? The phrase simply describes the yearly variation in an investment portfolio’s rate of return. Across 20 or 30 years of saving and investing for the future, what kind of impact do these deviations from the average return have on a portfolio’s final value?
The answer: no impact at all.
Once an investor retires, however, these ups and downs can have a major effect on portfolio value – and retirement income.
Why are investors and economists getting nervous about Treasury yields?
What is the yield curve, and why is the financial media writing about it? Here is a brief explanation, starting with a clarification.
A yield curve is really an X-Y graph projecting expected rates of return for equivalent-quality bonds with different maturity dates. But it is not just any yield curve that matters. When investors, commentators, and economists talk about “the yield curve,” they are talking about the graph plotting the interest rates of Treasuries: 3-month, 2-year, 5-year, 10-year, and 30-year notes. The “curve” is the line connecting their projected future yields. This Treasury yields snapshot is authoritatively referred to as: “the yield curve.”1,2
The Federal Reserve has hiked the benchmark interest rate twice this year, and it expects to make two more hikes before 2019 arrives. It projects the federal funds rate will approach 3.5% by 2020.1
What could these rate hikes mean for you?
Why you should periodically review beneficiary designations.
Your beneficiary choices may need to change with the times. When did you open your first IRA? When did you buy your life insurance policy? Are you still living in the same home and working at the same job as you did back then? Have your priorities changed a bit – perhaps more than a bit?
While your beneficiary choices may seem obvious and rock solid when you initially make them, time has a way of altering things. In a stretch of five or ten years, some major changes can occur in your life – and they may warrant changes in your beneficiary decisions. In fact, you might want to review them annually.
Beneficiary designations commonly override bequests made in a will or living trust. Many people do not realize this. When assets have designated beneficiaries, they can usually avoid probate and transfer directly to that person.1,2
A move that high earners can make in pursuit of tax-free retirement income
Does your high income stop you from contributing to a Roth IRA? It does not necessarily prohibit you from having one. You may be able to create a backdoor Roth IRA and give yourself the potential for a tax-free income stream in retirement.
If you think you will be in a high tax bracket when you retire, a tax-free income stream is just what you want. The backdoor Roth IRA is a maneuver you can make in pursuit of that goal – a perfectly legal workaround, its legitimacy further affirmed by language in the Tax Cuts & Jobs Act of 2017.1
You establish a backdoor Roth IRA in two steps. The first step: make a non-deductible contribution to a traditional IRA. (In other words, you contribute after-tax dollars to it, as you would to a Roth retirement account.)1
Daniel Shub, AIF®, RFC®
Wealth Management Advisor & Founder.