Kuhn Wealth Management

Financial Planning, Asset Management, and 1031 Exchange Professional


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October 2020 Newsletter

October 2020

Reflecting on This Year

We hope this letter finds you safe and healthy. We know that this year has been difficult for so many people for many reasons and, like all of you, I’m looking forward to more normal times in the months ahead. As we move ahead, though, we must address what’s come before us.

Over the course of the year, we have heard from many clients who themselves or loved ones have suffered through COVID infections, In a few instances, the infection led to lengthy hospitalizations and recoveries. We wish all of you a full and quick recovery.

We have also talked with many clients who have lost their jobs, or their businesses are suffering as a result of COVID. Certainly, we hope that as solutions to the pandemic emerge, your jobs and businesses will return.

We also know that many in our country have long suffered injustice. With attention turned to these issues, let’s work together so we can make changes and move forward together stronger and with equality.

During these difficult times, I think it’s common for people to reflect, search for, and find additional purpose and drive. In speaking with Matt and Danny, the other advisors at our firm, I know this is true for us. While I have always found being an advisor challenging, everchanging, and rewarding…this is more true today than ever.

This spring, when the pandemic started, we spent a lot of time on the phone discussing the market volatility with our clients and communicating what our thoughts were during those uncertain times in the market. While our expectation proved to be true—that the stock market would recover prior to the resolution of the pandemic and the unemployment crisis—it certainly was not without some anxious times.

We have said it many times on our calls and in our communication—so I am sure it is no surprise to our investors—that our firm’s overall thesis at the height of market volatility from the COVID crisis was

  1. stick to a personalized financial plan
  2. trying to time the market continues to be a foolish strategy

With that said, when an individual’s situation changed due to COVID, we did not sit idly by. We were quick to identify and suggest appropriate changes; we also saw opportunities with the market down to implement timely strategies such as IRA conversions and increased dollar-cost averaging.

I think it’s also important to point out that many of our investment solutions and strategies proved beneficial during the volatile times in the market. First, we have long been believers in alternative investments, and for many of our clients, holding these assets greatly reduced their overall portfolio volatility, and in most cases continued to provide them with income. Additionally, the asset managers we partner with such as Ladenburg and Blackrock were tactical with allocations during those times; for example, the client portfolios we manage with Blackrock had a medical device ETF added to the allocations. Lastly, the bond ladders and direct bond holdings that we manage for high net worth clients’ fixed income portfolios did what they were supposed to do, allowing those investors to sidestep much of the volatility that materialized in other fixed-income products.

It’s very rewarding for us to help our clients navigate challenging times in the market, alongside the changes in their personal situations, while continuing to execute on strategies that proved to be beneficial for our investors. To be honest, I worried about being overly sentimental in this note, but we genuinely appreciate the trust you have placed in our firm to assist you.

As you continue to navigate all the changes from this year, if you are feeling anxious, concerned, or even excited about new opportunities, please don’t hesitate to reach out. It’s our pleasure to help and guide you on your financial journey.

Best,
Nathan

Market Update

With the 3rd quarter now in the rearview mirror, we continue to see an exceptionally strong bounce off the COVID-19 lows set March 23rd. The S&P 500 has now eclipsed its previous all-time high set back in February and, after an attempt to sprint higher to begin September, we’re now seeing some consolidation around those previous all-time highs.

There are many things worth discussing here, and we’ll begin by marveling at the strength of this bounce. The market rallied for five consecutive months, bouncing some 61.1% before retreating a bit in September. Back in April, there were certainly some people turning bullish on the long-term prospects for stocks, but you’d be hard-pressed to find many who saw this coming. We bring this up because it perfectly highlights one of our core tenants as advisors:
don’t try to time the market.

Following this monumental rally, many investors are becoming cautious and there’s a laundry list of reasons as to why. COVID-19 sent the global economy into a recession the likes of which we’ve never seen. Millions of people have lost their jobs and many of these jobs might never come back. Schools are closed all over the country, forcing working parents to stay at home to monitor their kids as they “attempt” e-learning, reducing economic productivity as a result. Entire industries such as travel, hospitality, and dining are facing generational upheaval from which many businesses will never recover. And all of this with a polarized election on the horizon.

With that said, we would caution anyone against becoming too conservative with their investments. Fundamentally speaking, a bit of productivity already has returned to the economy and, of course, we can’t forget that the market is forward-looking. By this we mean it’s pricing in COVID eventually being a thing of the past, and the economy beginning to grow again as it was before (also doing so with the aid of unprecedented monetary stimulus.) We must also remember the simple fact that strength in the market begets more strength to come, NOT weakness.

Consider these facts:

  • Since 1950 there have been 26 five-month winning streaks for stocks. Looking out a year later stocks were higher 25/26 times, with an average gain of 12.8%
  • We saw back-to-back monthly gains in July and August of 5%. Time to sell right? Not in past instances. This has happened 10 times previously, with the market a higher a year later all 10 times for an average gain of 22.5%.

Now, are these stats a guarantee that stocks will be higher a year from now? Certainly not. As strong as they seem it’s quite logical to point out that none of these occurrences took place during a global pandemic that’s killed around 1 million people worldwide and has put 10s of millions out of work.

When markets are calmer, we stress the importance of designing (and actually following) one’s own financial plan. That proposition is even more critical during volatile periods. Should you have any questions about the current market environment or your investing plan, please reach out to talk.

The Fed and Low Interest Rates

In September the Fed stopped fighting itself and finally made it official: low interest rates are here to stay for the foreseeable future.

Since 1977, the dual mandate of the Fed has been to maximize employment while keeping inflation in check. Generally, this has meant lowering interest rates in times of economic downturns in order to spur economic activity and job creation. Then, raising rates once unemployment fell to an acceptable level as a means of heading off the inflation that was expected to follow.

Recent economic history has shown, though, that perhaps there have been some flaws in this “conventional wisdom”. Rates have remained at or near all-time lows for much of the past 10 years (essentially since the global financial crisis); yet, we’ve seen minimal inflation. Due to these circumstances, the Fed seems to be wisely rethinking their long-held beliefs and warming up to the idea that perhaps they don’t need to be in a hurry to begin hiking rates again.

In terms of our current market environment and Fed activity, nothing really changes. Rates are currently low, and while mired in the middle of a global recession due to COVID-19, no one was expecting the Fed to begin raising rates anytime soon. What’s significant about the announcement is that it appears the Fed is fundamentally changing their outlook and approach to monetary policy. This could have far and long-lasting impacts on how one chooses to invest.
Even in an environment of near-zero interest rates, we still feel that bonds will play an important role in an investment portfolio. Safety of principal simply isn’t something that can ever be overlooked. Conversely, this announcement is another reason that equities continue to look attractive and why they are a great tool for wealth creation over the long-term.

Perhaps the most notable conclusion to draw from this news is that when it comes to income-producing vehicles, investors can stop waiting for bond yields to drastically increase and instead consider other investment choices. We’ve long been a proponent of including alternative investments as a part of our client’s investment portfolios for a number of reasons. In particular, many of these products distribute consistent cash flow and do so without directly dealing with the day-to-day fluctuations of public markets.

The days of the government paying 5% or 6% yields have long been gone and now the Fed is signaling that they won’t be coming back anytime soon. With that in mind, we will continue to evaluate our client’s allocations and utilize alternative investments as a means of generating income when appropriate. To learn more about these products and how we position them inside an investment portfolio, please call or email us.

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SEC Amends Accredited Investor Definition

In August, the Securities and Exchange Commission (SEC) amended its definition of an Accredited Investor.

Individual investors can now qualify based on defined measures of professional knowledge, experience, or certification. This expanded definition is in addition to the existing tests for income or net worth. The list of qualifying entities also expanded to allow any entity that meets an “investment test.”

The thresholds stand at a net worth of at least $1 million excluding the value of the primary residence, or income at least $200,000 each year for the last two years (or $300,000 combined income if married).

The amendments to the accredited investor definition in Rule 501(a) include:

  • add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials, including the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. (The Commission will reevaluate or add certifications, designations or credentials in the future);
  • include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
  • clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers and rural business investment companies (RBICs);
  • add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries;
  • add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
  • add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

    • You might be asking, so what does this mean for me? In our opinion, the way the qualifier was previously set up didn’t make a lot of sense. Simply put, we believe that using a $1 million net worth or a high-income level as the indicator someone is sophisticated or educated enough to access alternative investments isn’t the right approach.

    Now, a dollar amount of net worth is no longer the only qualifier—there are other ways to accredit investors based on their experience and actual education—and these investments are appropriately available to more people. We remain hopeful that this might be a first small step in loosening the accredited investor definition and allowing more investors access to investments that are only available to accredited investors. We certainly believe that net worth or income alone doesn’t indicate an individual’s ability to appropriately evaluate an investment.

    If you’re considering your overall investment strategy and interested in learning more or pursuing an alternative investment, we can help. Please call us at (847) 607-4976 or schedule an introduction today.

An Overview of Alternative Investments

An alternative investment is an investment that does not fall into the traditional asset class of stocks, bonds, and cash. The most common types of alternative investments are precious metals, oil and gas, venture capital, hedge funds, and real estate. An investment made into a DST to complete a 1031 exchange, for example, would be considered an alternative investment.

At our firm, we have years of experience evaluating alternative investments, conducting due diligence, and, importantly, implementing alternative investments into our client’s financial plans.

All alternative investments fall into one of two categories: public or private investments. An example of a public alternative investment is a Real Estate Investment Trust, or REIT. A private alternative investment may include:
– Hedge funds: funds that invest in a broad range of securities, generally limited to publicly traded investments
– Venture capital: equity investment into privately-owned companies
– Private equity: a broad category; this encompasses all other private investments, including real estate, infrastructure, oil & gas, debt, and more

Here, we will focus on private equity investments.

Potential Benefits of Alternative Investments
1. Their value is generally not correlated to the stock market
Alternative investments provide diversification, and their value will generally not change relative to the ups and downs of the market. This can help protect investor’s portfolios from market-related volatility.

2. Lack of volatility
Traditionally, the share price of a public investment fluctuates based on a variety of factors and is generally not tied to an actual asset. Private investments, though, lack the volatility of public investments and are typically backed by an actual asset.

Additionally, while time in the market may help long-term market investors, volatility can depress compounding returns.

3. Direct ownership
With a public investment, your purchase is a paper asset – your ownership is not in a tangible asset. Private alternative investments allow you direct ownership of whatever asset you purchase.

4. Direct tax benefits
Many alternative investments will allow you to keep more of your profit. As a part-owner of an alternative investment, tax benefits can be directly passed on to you. The most important direct tax benefits may include pass-through depreciation and long-term capital gains treatment, among others.

5. Potential for Income
Many alternative investments are cash flowing, with distributions generally paid monthly or quarterly to investors. The amount of cash flow in alternative investments can be substantially higher than what investors may find in public investments.

6. Passive investments
Actively managing a portfolio requires a tremendous amount of work and expertise. A private alternative investment offers funds that are passive and without requirements for ongoing management from investors. They also leverage the experience, knowledge, and skills of fund managers.

Disadvantages of Alternative Investments
While private alternative investments have many potential benefits, there are some disadvantages. As with all investments, there is the possibility that the investment will not perform as expected – thus resulting in loss of income or principal. Additionally, alternative investments are generally illiquid. Lockup periods may range from 3-10 years, which makes sense when you understand private funds are generally tied to an asset—and to liquidate an investment, requires liquidating the asset.

If you’re considering your overall investment strategy and interested in learning more or pursuing an alternative investment, we can help. Please call us at (847) 607-4976 or schedule an introduction today.

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Illinois Graduated Income Tax Proposed Amendment

Our firm serves clients all over the country; however, being born, raised, and now operating our business in Illinois, a large portion of clients are based in my home state of Illinois. This election, those of us who are Illinois residents will be asked to vote on a ballot measure that would repeal the state’s current constitutional requirement for a flat-rate personal income tax is a flat rate. If the repeal passes, the Illinois legislature would be able to change to a graduated income tax system.

We have had questions regarding this potential tax change from a number of clients; therefore, we thought it would be appropriate to address the proposed changes.

Certainly, there are legitimate arguments to be made for both sides. Those who support the amendment argue that a graduated tax would result in a more fair taxing system and improve the financial stability of Illinois. Those who oppose the tax argue that the current proposed tax rate increases are just a start—that tax rates and those who are impacted will continue to grow once legislators have the ability to change taxes on select groups. They also argue that higher taxes will stifle business and push even more people out of the state.

The Proposed Brackets and Tax Rates
The table below shows the initial tax rates that would go into effect if the repeal passes. For income levels that fall below the top bracket, the tax will be a “bracket” system—much like the federal tax system.

As an example, a married filing couple with $255,000 of income would have their first $10,000 taxed at the 4.75% rate, then from 10,000 – 100,000 taxed at 4.9%, from 100,001 – 250,000 taxed at 4.95%, and finally the last $5,000 of income taxed at 7.75%. In this example, only $5,000 fell into the higher 7.75% rate, this rate at which the last dollar is taxed is referred to as the “marginal” rate. Since the actual tax paid is a blend of these rates, the “effective” tax rate would be less than the marginal rate.

At roughly $253,000 of income, taxes under the proposed system would be equal to taxes paid at the current flat rate of 4.95%. It is also important to note that earners with income lower than $250,000 will not see a significant reduction in taxes. This is because the rate for income between $100 and $250,000 is equal to the current tax rate, and even the lowest rates of $10,000 and less and $100,000 and under are not significantly below the current flat tax rate.

I think it is very important to point out that if income for an individual is about $750,000 or above $1 million for a couple, the bracket system discussed above is not applied. Rather every dollar earned is taxed at the highest rate or 7.99%.

To illustrate just how significant this could be, a married couple with an income of $1,000,000 would see their tax under the new system increase by $21,435 (as compared to the current flat tax), whereas a married couple with an income of $1,000,001 would see their tax increase by $30,400. In this extreme example, one dollar of extra income cost nearly $9,000 in taxes!

Our Analysis
There are numerous resources available on the web where information can be found regarding this potential change. With my background in finance and economics, and reading through much of the material, I have a number of concerns regarding the potential change. These are my personal opinions, not facts, and may not be representative of everyone at Kuhn Wealth. Again, because people have been asking me, I thought I would share these concerns.

I think it’s helpful to know the history of the current tax structure. Prior to 1969, Illinois did not have an income tax.n 1970, the constitution was drafted with a flat tax guarantee. This was because, with a flat tax rate – which impacts all residents – it’s easier to hold lawmakers responsible for tax increases.

My concern is that if the flat tax is repealed, it will be easy for lawmakers to raise taxes on one subset of Illinoisans at a time. The current hike is easy for many to get behind as it only raises taxes on a small group of people who earn more than $250,000 per year. However – and importantly – in future years, legislators could raise taxes on other groups without a vote on the ballot. For example, they could target retirees by deciding to begin taxing retirement account distributions.

I realize a disproportionately high number of our clients will see their taxes increase under the proposed new system, as we generally have higher earning and higher net worth individuals as clients. While I am certainly concerned about seeing our client’s taxes increase, my other concern is that part of the argument to change the tax structure is that higher earners can afford to pay more taxes. While higher earners might be able to pay more taxes, they could also take their earnings and move out of state.

The economic impact of this potential change is my biggest concern. With people already migrating out of Illinois at an alarming pace, I would expect higher taxes to drive even more high earners, and importantly businesses, out of state. When people and businesses leave the state the impact is felt by everyone, not just those who earn more than $250,000 per year. In recent times, the only state to move from a flat tax to a progressive tax was Connecticut, and there are numerous studies that show the economic ramifications that the change caused.

A point raised by many opposed to the potential change, which is, in my opinion, an obvious issue, is that the state has not done anything to get out of control spending under control. Raising taxes without addressing expenses could obviously result in more spending, and then a cycle of even higher taxes.

Finally, I think that calling the proposed new tax system a “fair” tax is a bit misleading. Of course, I am not a policymaker nor do I have expertise in tax policy. I do think that keeping the current flat tax is probably best for our state. If taxes must be raised, then they can be raised for all residents and everyone can hold our legislators responsible.

Remember that under the proposed new system, even lower earners will not see a significant drop in the taxes they owe. To help lower-income households, more could be done to provide tax breaks to individuals under certain income thresholds; for example, increasing the personal exemption allowance or increasing the education expense credit. Other taxes often overlooked including taxes on gasoline and car registrations also disproportionately impact lower earners. It’s my opinion that making changes to these tax policies will do exponentially more to help low-income earners than the minuscule reduction in income tax that would be instituted under the potential change.

There is a lot to think about in the upcoming election, both nationally and at a state level. If you did not already have an understanding of the proposal, I hope the details I have provided helped. And of course, while I have expressed my concerns about the changes above, I would like to acknowledge that there are valid arguments to be made for both positions.

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As of 10/15/2020. This is for informational purposes only and does not constitute an offer to buy or sell any investment product. The opinions expressed are those of the writer and does not necessarily represent the views of their affiliates. Past performance and predictions are not a guarantee of future results. The material contained herein is obtained from sources believed to be reliable, but its authenticity, accuracy or completeness is not guaranteed. Projections are inherently limited and should not be relied upon as an indicator of future results. Investments in securities involve a high degree of risk and should only be considered by investors who can withstand the loss of their investment. The S&P® 500 Index is a widely recognized capitalization-weighted index that measures the performance of the large-capitalization sector of the U.S. stock market. Direct investment in an index is not possible. Accredited investors typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.
Because investor’s situations and objectives vary, this information is not intended to indicate direct investment advice and suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation.

Securities offered through DAI Securities, LLC, Member FINRA/SIPC. Advisory services offered through Kuhn Wealth Management, Inc., a state registered investment advisor. Kuhn Wealth Management, Inc. is independent of DAI Securities, LLC. All of whom are unaffiliated with third party sites, and cannot verify the accuracy of nor assume responsibility for any content of linked third party sites. Information available on third-party sites is for informational purposes only.

About us

Since 2003, Kuhn Wealth Management has been committed to providing personalized service and unbiased advice to help our clients attain their financial goals. We learn by listening, and reciprocate by educating our clients on the strategies and alternatives that make sense individually. We invest in long-term relationships and proactively suggest larger scale strategic changes as well as specific portfolio adjustments in order to provide the kind of leadership that allows our clients to feel financially confident and turn their focus toward their passions.

Chicagoland 1031 Exchange

For your 1031 Exchange & DST needs and to register to receive our current availability report, please visit our 1031 Exchange & DST website, chicagoland1031exchange.com. Our professionals help make sense of the process and offer the resources you need to complete your exchange successfully.

Contact us

1827 Walden Office Square, Suite 500
Schaumburg, IL 60173
(847) 607-4976
advisors@kuhnwealth.com