Monday, January 30, 2017

It's a New (Tax) Year - 2017

Pathways Advisory Group, Inc.

It’s that time of year again! As the joy of the holiday season comes to an end, you now turn to the joy of tax season – preparing the returns for 2016 and looking at what 2017 brings us. Much of the news and excitement over the course of the new year will likely center around what the new Trump Administration will change regarding tax laws, and we’ll be sure to keep you updated throughout the year. As we take note of a few things to keep an eye on, it’s also important to keep the focus on what we know will happen. Here’s a summary of what is currently in place for 2017.

Tax Brackets: The 2017 income brackets increased slightly with inflation. However, this area of planning is one of many to keep watch on, as Mr. Trump has been quite vocal on making changes to the tax brackets. See below for the 2017 brackets for Married Filing Joint Taxpayers and Single Taxpayers:

Married Individuals Filing Joint Returns and Surviving Spouses

Individual Taxpayers
Source: Click here for a complete version of the 2017 Tax Tables.

Itemized Deductions and Personal Exemptions: Most taxpayers benefit from a Personal Exemption (remaining the same in 2017 – $4050) for the filer and each dependent, and Itemized Deductions (on Schedule A). However, both are subject to reductions if AGI is over $261,500 for Single Taxpayers and $313,800 for Married Joint Taxpayers, phasing out completely at $384,000 and $436,300 respectively.

Standard Deductions: If you’re using the standard deduction, here’s some good news: your standard deduction will increase! Individual filers will receive a standard deduction of $6,350, up $50 from 2016. Married couples filing jointly will get a $100 bump to $12,700 in 2017. Those age 65 and over get an additional $250 for the standard deduction. While not a tremendous amount, anything to lower your tax liability is a good thing.

Qualified Dividends and Capital Gain Tax Rates: Qualified dividends and capital gains rates remain the same in 2017 – 0% tax rate for taxpayers in the 10% and 15% marginal tax brackets, 15% for taxpayers in the 25, 28, 33, and 35% tax brackets, and 20% for those in the 39.6% bracket.

Personal Health Insurance
: The individual mandate fine for going without insurance remains the same in 2017. This is also on Trump Watch, as he’s said much about changing the current healthcare law, though what that will look like exactly, and when, is unknown. The tax is the greater of two amounts: The basic fine ($695 per person, and $347.50 for each family member under 18 – maximum $2,085), or an income based levy (2.5% of the household income over the tax return filing threshold – also with a maximum).

Roth IRA Contributions: The maximum Roth IRA contribution remains at $5500 ($6500 for those who attain age 50 or older during 2017). The Adjusted Gross Income (AGI) limit that disallows all direct contributions increased with inflation to $196,000 for Married Joint Taxpayers and $133,000 for Single Taxpayers. Contributions begin to phase out at AGI of $186,000 for Married Joint Taxpayers and $118,000 for Single Taxpayers.

Retirement Account Contribution: The maximum 401(k), 403(b) and 457(Deferred Compensation) contribution remains at $18,000 in 2017 ($24,000 for those who attain age 50 or older during the year).

Estate Tax Exemption
: The Estate Tax Exemption increased from $5.45 million in 2016 to $5.49 million in 2017, making the total exemption for a married couple $10.98 million. The tax rate for amounts exceeding the exemption remains 40%. This is also on Trump Watch, as Mr. Trump has clearly stated he wants to repeal and replace the federal estate tax.

Gift Tax Exemption:  The annual gift tax exemption (amount that can be gifted without requiring a gift tax filing) remains $14,000 per person.

Social Security Benefits: Social Security and Supplemental Security Income (SSI) Benefits will receive a 0.3% cost-of-living-adjustment (COLA) this year. While exciting, Medicare also has a surprise . . . 

Medicare Premiums: We again see an increase in the standard premium for Medicare Part B. For married filing jointly at $170,000 income or less ($85,000 single), it increases from $121.80 in 2016 to $134 per month and moves up depending on income. If you are a new enrollee in 2017 or do not have the premium deducted from your Social Security check, you will pay the full standard premium. However, if you are already receiving Social Security benefits and had at least one premium payment deducted in 2016, you’ll be “held harmless” from the full premium increase. Instead, you’ll pay an increased amount based on the Social Security COLA you were excited to read about above – 0.3%, making the average Part B monthly premium $109.

Social Security Payroll Taxes: The Social Security wage base, upon which payroll taxes are due, increases to $127,200 this year and the FICA tax rate (paid on income up to the wage base) remain unchanged at 6.2% for both employer and employee (12.4% if you’re self-employed).

Medicare Tax: The Medicare tax rate remains at 1.45% (2.9% for Self Employed) for Married Joint Taxpayers with earned income below $250,000 ($200,000 for Single Taxpayers). For earned income above these thresholds, the Medicare tax rate increases to 2.35% (3.8% for Self Employed) on those wages above the threshold.

The above explanation is summarized. It is not all inclusive. Please confirm all specifics with your tax professional. 

Follow our blog for major updates throughout the year from the Trump administration, and we wish you a prosperous 2017 and happy filing!

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Friday, January 20, 2017

2016 Market Review

Bryan Harris
Dimensional Fund Advisors LP.
  Senior Editor

In 2016, the US market reached new highs and stocks in a majority of developed and emerging market countries delivered positive returns. The year began with anxiety over China’s stock market and economy, falling oil prices, a potential US recession, and negative interest rates in Japan. US equity markets were in steep decline and had the worst start of any year on record. The markets began improving in mid-February through midyear. Investors also faced uncertainty from the Brexit vote in June and the US election in November.

Many investors may not have expected global stocks and bonds to deliver positive returns in such a tumultuous year. This turnaround story highlights the importance of diversifying across asset groups and regional markets, as well as staying disciplined despite uncertainty. Although not all asset classes had positive returns, a globally diversified, cap-weighted portfolio logged attractive returns in 2016.

Consider that global markets are incredible information-processing machines that incorporate news and expectations into prices. Investors are well served by staying the course with an asset allocation that reflects their needs, risk preferences, and objectives. This can help investors weather uncertainty in all of its forms. The following quote by Eugene Fama describes this view.

“If three or five years of returns are going to change your mind [on an investment], you shouldn’t have been there to begin with.” ―Eugene Fama

The chart above highlights some of the year’s prominent headlines in context of broad US market performance, measured by the Russell 3000 Index. These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.

The chart below offers a snapshot of non-US stock market performance (developed and emerging markets), measured by the MSCI All Country World ex USA Index (in USD, net dividends). The headlines should not be viewed as determinants of the market’s direction but as examples of events that may have tested investor discipline during the year.

2016 Market Perspective

Equity Market Highlights
After a rocky start, the US stock market had a strong year. The S&P 500 Index logged an 11.96% total return and small cap stocks, as measured by the Russell 2000 Index, returned 21.31%.

Overall, performance among non-US markets was also positive: The MSCI World ex USA Index, which reflects non-US developed markets, logged a 2.75% return and the MSCI Emerging Markets Index an 11.19% return.1 

Global Diversification Impact
Overall, US equities outperformed equities in the developed ex US markets and emerging markets. As a result, a market cap-weighted global equity portfolio would have underperformed a US equity portfolio. Investors generally benefited from emphasizing value stocks around the world, as well as US small cap stocks.

Returns at the country level were dispersed. In developed markets, returns ranged from –24.87% in Israel to +24.56% in Canada. In emerging markets, returns ranged from –12.13% in Greece to +66.24% in Brazil.

Strong performance in the US placed it as the 17th best performing country out of the 46 countries in the MSCI All Country World Index (ACWI), which represents both developed and emerging markets. Although the S&P 500 Index had a positive return in 2016, the year was not in the top half of the index’s historical annual returns.

Brazil offers a noteworthy example of market prices at work and the difficulty of trying to forecast and time markets. Despite a severe recession, Brazil was the top performing emerging market country in 2016. Brazil’s GDP was projected to shrink 3.4% in 2016, according to the OECD in November, yet its equity market logged strong performance. The lesson is that prices incorporate a rich set of information, including expectations about the future. One must beat the aggregate wisdom of market participants in order to identify mispricing. The evidence suggests that this is a very difficult task to do consistently.

In 2016, equity market volatility, as measured by the CBOE Volatility Index (VIX),2  was below average. There were, however, several spikes—as you might expect—as new information was incorporated into prices. The high was reached in early February, and spikes occurred following the Brexit vote in June and again in November preceding the US election.

Premium Performance
In 2016, the small cap and value premiums3  were mostly positive across US, developed ex US, and emerging markets, while the profitability premium varied by market segment.4  Though 2016 marked a generally positive year, investors may still be wary following several years of underperformance for value and small cap stocks. Taking a longer-term perspective, the premiums remain persistent over decades and around the globe despite recent years’ headwinds. The small cap and value premiums are well-grounded in financial economics and verified using market data spanning decades, but pursuing those premiums requires a consistent, long-term approach.

US Market
In the US market, small cap stocks outperformed large cap stocks and value stocks outperformed growth stocks. High profitability stocks outperformed low profitability stocks in most market segments.5  Over 2016, the US small cap premium marked the seventh highest annual return difference since 1979 when measured by the Russell 2000 Index minus Russell 1000 Index. Most of the performance for small caps came in the last two months of the year, after the US election on November 8. This illustrates the difficulty of trying to time premiums and the benefit of maintaining consistent exposure. Through October, US small cap stocks had outpaced large company stocks for the year by only 0.35%. By year-end, the small cap premium had increased to 9.25%, as shown below.

US value stocks outperformed growth stocks by 11.01% following an extended period of underperformance. Over the five-year rolling period, the value premium, as measured by the Russell 3000 Value Index minus Russell 3000 Growth Index, moved from negative in 2015 to positive in 2016.

Developed ex US Markets
In developed ex US markets, small cap stocks outperformed large cap stocks and value stocks outperformed growth stocks. Over both the five- and 10-year rolling periods, the small cap premium, measured as the MSCI World ex USA Small Cap Index minus the MSCI World ex USA Index, continued to be positive. The five- and 10-year rolling periods for the small cap premium have been positive for the better part of the past decade.

Value stocks outperformed growth stocks by 9.26%, as measured by the MSCI World ex USA Value Index minus the MSCI World ex USA Growth Index. Similarly to US small caps, most of the outperformance occurred in the fourth quarter, reinforcing the importance of consistency in pursuing premiums. Despite a positive year, the value premium remains negative over the five- and 10-year rolling periods.

Emerging Markets

In emerging markets, small cap stocks underperformed large cap stocks and value stocks outperformed growth stocks. Despite the underperformance of small cap stocks, small cap value stocks fared better than small cap growth stocks and performed similarly to large cap value stocks. Investors who emphasized small cap value stocks over small cap growth stocks benefited.

Fixed Income
Both US and non-US fixed income markets posted positive returns. The Bloomberg Barclays US Aggregate Bond Index gained 2.65%. The Bloomberg Barclays Global Aggregate Bond Index (hedged to USD) gained 3.95%.

Yield curves6  were generally upwardly sloped in many developed markets, indicating positive expected term premiums. Indeed, realized term premiums were positive in the US and globally as longer-term maturities outperformed their shorter-term counterparts.

Corporate bonds were the best performing sector, returning 6.11% in the US and 6.22% globally, as reflected in the Bloomberg Barclays Global Aggregate Bond Index (hedged to USD). Credit premiums were also positive in the US and globally as lower quality investment grade corporates outperformed their higher quality investment grade counterparts.

While interest rates increased in the US, they generally decreased globally. Major markets such as Japan, Germany, and the United Kingdom all experienced decreases in interest rates. In fact, yields on Japanese and German government bonds with maturities as long as eight years finished the year in negative territory.

In the US, interest rates increased the most on the short end of the yield curve and were relatively unchanged on the long end. The yield on the 3-month US Treasury bill increased 0.35% to end the year at 0.51%. The yield on the 2-year US Treasury note increased 0.14% to 1.20%. The yield on the 10-year US Treasury note closed at a record low of 1.37% in July yet increased 0.18% for the year to end at 2.45%. The yield on the 30-year US Treasury bond increased 0.05% to end the year at 3.06%.

The British pound, euro, and Australian dollar declined relative to the US dollar, while the Canadian dollar and Japanese yen appreciated relative to the US dollar. The impact of regional currency differences on returns in the developed equity markets was minor in most cases. US investors in both developed and emerging markets generally benefited from exposure to certain currencies.

“There’s no information in past returns of three to five years. That’s just noise. It really takes very long periods of time, and it takes a lot of stick-to-it-iveness. You have to really decide what your strategy is based on—long periods of returns—and then stick to it.”
―Eugene Fama

1 All non-US returns are in USD, net dividends.
2 The VIX is a measure of implied volatility using S&P 500 option prices. Source: Bloomberg.
3 The small cap premium is the return difference between small capitalization stocks and large capitalization stocks. The value premium is the   return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
4 Profitability is measured as a company’s operating income before depreciation and amortization minus interest expense scaled by book equity. The profitability premium is the return difference between stocks of companies with high profitability over those with low profitability.
5 Profitability performance is measured as the top half of stocks based on profitability minus the bottom half in the Russell 3000 Index.
6 A yield curve is a graph that plots the interest rates at a specific point
in time of bonds with similar credit quality but different maturity dates.

 Source: Dimensional Fund Advisors LP.

Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Dow Jones data provided by Dow Jones Indices. MSCI data © MSCI 2017, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The BofA Merrill Lynch Indices are used with permission; © 2017 Merrill Lynch, Pierce, Fenner & Smith Inc.; all rights reserved. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio.

Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.

Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.

Eugene Fama is a member of the Board of Directors for and provides consulting services to Dimensional Fund Advisors LP.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.