Wealth Management
Money has been pouring into fixed income and money markets as investors look to take advantage of high rates and protect their portfolios from inflation and market volatility. While the advantages are clear, investors should also understand the tax implications especially since there are more complications than equities.
For one, taxes on interest income must be paid. However, there are some caveats. For instance, an investor can avoid state taxes by investing in a US government security such as Treasuries although federal taxes must be paid. In contrast, no state or federal taxes are paid on interest income from municipal bonds.
Some investors choose to keep their fixed income investments in a tax-free retirement account. Despite taxes on interest income, fixed income continues to deliver positive, inflation-adjusted returns for investors. However, the tax bill should be considered prior to making these investments especially in high-tax states.
Ultimately, fixed income offers many benefits which investors are eager to capture. In this frenzy and focus on yield, many investors are losing sight that these expectations should be tempered given that the income is taxed. But the challenge is that this ‘penalty’ differs based on every owners’ geography and financial situation.
Finsum: Fixed income has exploded in popularity due to high rates and recession risk. Yet, many investors are overly focused on the income and taking into account tax considerations.
For decades, Americans have relied on pensions to fund their lifestyles during retirement. This is no longer the case with pensions being phased out in most workplaces. Given today’s high interest rates, it’s worth investigating whether annuities are a sufficient replacement.
It’s already clear that many advisors and investors feel the same way given that demand has soared in the last couple of years given the combination of high rates and an uncertain economic outlook. Last year saw a record of $302.9 billion in sales which was a 47% increase from last year. Further, 2023 sales are projected to exceed this figure by a decent margin. Demographics also support continued strength in annuity sales. 2024 is expected to see the largest number of new retirees in history, and around 40% have expressed concern about having sufficient income especially given the jump in inflation.
According to an industry study, 32% of those buying annuities do so to have a guaranteed income stream in retirement. 25% do so to provide protection against their assets losing value. According to the same study, 80% of prospective retirees are interested in annuities, while 82% of recent annuity buyers said they would recommend the product to a friend or family member.
Finsum: Annuity sales are booming due to high rates and an uncertain economic outlook. With a wave of retirees coming, they will play an important role in plugging the gap left by the exodus of pensions.
Most of the attention and chatter in the energy sector have been focused on issues like the price of oil, a potential renaissance for nuclear energy, and whether electric vehicles (EV) will displace gas-powered vehicles.
However, the proliferation of solar energy is less discussed but in many ways, it could be more impactful in the long-term. According to the Solar Energy Industries Association, there were an additional 12 gigawatts of installations in the first-half of 2023. This is a 20% increase from last year’s first-half.
A major factor is the Inflation Reduction Act (IRA) which boosted subsidies for home and corporate solar projects. It’s also boosting the domestic production of solar panels. In 2022, there was production of 10.6 gigawatts of domestic capacity, but this is projected to increase to 108.5 gigawatts by 2026. It’s also notable that capital expenditures in the solar industry were bigger than that of oil & gas last year.
According to the industry group, the solar industry in the US is projected to grow 15% annually. It sees the full-scale benefits of the IRA to start hitting the industry by late 2024. In terms of challenges, it identifies interconnection of grids and cost-prohibitive batteries as bottlenecks for future growth.
Finsum: A trend in the energy sector is the boom in solar due to lower costs and the Inflation Reduction Act. In particular, domestic manufacturing is a major beneficiary..
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In theory, active fixed income offers the best of both worlds. It has all the inherent benefits of an ETF structure leading to more liquidity, transparency, and lower costs, but it still gives managers flexibility to find the best opportunities in the fixed income space.
The category is seeing substantial growth in terms of inflows and new issues. Institutions and advisors are becoming increasingly comfortable with the asset class. Additionally, it’s well suited for this particular moment given the uncertainty about the Fed and the economy’s direction which should create more opportunities for alpha for active managers.
The latest mega-institutions to jump on the trend is the Bank of Japan. The central bank is shifting $62 billion of passively managed fixed income into active management. It believes this will help it finetune the risk profile of their holdings. It’s also consistent with its recent policy to gradually let yields rise in an effort to combat inflation.
In fact, this change in monetary policy is also contributing to bond market volatility. And, this jump in volatility is what is leading to opportunities for active managers that the Bank of Japan is keen to capitalize upon. The Bank of Japan is considered a trailblazer, so it will be interesting to see if other central banks follow suit and increase allocations to active fixed income.
Finsum: The Bank of Japan is converting some of its passive fixed income holdings into active fixed income. Find out why and whether other central banks will follow.
Fixed income markets have faced a major headwind over the last 21 months given the Federal Reserve’s aggressive rate hikes. Regardless, money poured into fixed income ETFs at a record pace even outpacing equity ETFs for the first time in history. Investors were willing to overlook poor, near-term performance due to attractive yields and a shaky economic outlook.
Now, this trend could accelerate further given that the Fed seems to be in the final innings of its tightening campaign, while concerns about valuation in equities linger. Therefore, many believe that the growth of fixed income ETFs relative to equity ETFs is not a blip, but the start of a multiyear trend. And, asset managers are responding with a bevy of new fixed income ETF launches.
Overall, inflows to fixed income ETFs are up nearly 10% compared to last year. Many are eager to lock in these elevated yields especially in areas with lower risk like Treasuries. Of course, the major challenge for fixed income investors is assessing if a pivot in policy will arrive imminently or are we due for a period of ‘higher for longer’. In the latter scenario, short-duration bonds will outperform, while long-duration will struggle.
Finsum: Fixed income ETFs are seeing a surge in new issuances and inflows. Find out why many expect this trend to continue over the next few years.
John Olsen, the founder and president of Olsen Annuity Education and the author of ‘The Advisor’s Guide to Annuities’ recently spoke with ThinkAdvisor to share some insights on how advisors can sell more annuities.
His advice is somewhat counterintuitive. He believes the ‘secret to secret to selling annuities is to give up on trying to sell annuities.’ This is because an advisor must always think about a client’s financial plan and not about potential product solutions. Instead, advisors should consider all financial products, including annuities, like tools to accomplish a job rather than the goal.
Therefore, an advisor’s task is to gain a complete understanding of your clients which includes their financial situation, personality, risk tolerance, lifestyle factors, health considerations, etc., to determine what ‘tool’ will be the most effective. He also believes that most of an advisors’ job is about understanding their clients’ emotions rather than quantitative factors.
Most financial plans fail because advisors don’t understand that emotions are ultimately what drive decision-making. And, a plan that doesn’t take into account these ‘soft’ factors is bound to fail as most decision-making is ultimately driven by emotions.
Finsum: John Olsen, the founder of Olsen Annuity Education and one of the top annuity salesman in past years, shares some tips on selling annuities.