Qualifying Longevity Annuity Contract (QLAC)

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A qualifying longevity annuity contract (QLAC) is technically a deferred income annuity purchased by a tax-free transfer of a portion of your tax-qualified accounts, generally made after age 55. That transfer, in addition to adding a QLAC to your plan, reduces your account to determine taxable required minimum distributions (RMDs).

So, if you used 25% of a $400,000 qualified account, your $100,000 purchase of a QLAC would reduce your RMDs by 25%. And the income from a QLAC could be deferred until as late as age 85.

Net Income vs. Free Cash Flow

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The world of free cash flow (FCF) and net income are intriguing. These two financial metrics often dance around each other, but they’re not quite the same:

  1. What Is Net Income?
    1. Net income (profit or earnings) represents the bottom line on a company’s income statement. It’s the total profit a company has made after accounting for all expenses, taxes, and interest.
    2. Net income is calculated as:
      Net Income=Total Revenue−Total Expenses
  2. What Is Free Cash Flow (FCF)?
    1. FCF is a powerful metric that goes beyond net income. It measures the cash a company generates from its operations minus the necessary capital expenditures (like buying new equipment or expanding facilities).
    2. FCF considers both cash inflows (from operating activities) and cash outflows (such as asset investments).
    3. The formula for FCF is:
      FCF=Cash Flow from Operations−Capital Expenditures
  3. Why Might FCF Be Higher Than Net Income?
    1. FCF can exceed net income for several reasons.
    2. Non-Cash Expenses:
      1. Depreciation and amortization are non-cash expenses that reduce net income but don’t directly impact cash flow. If these expenses are significant, FCF can be higher.
      2. Working Capital Changes: Changes in working capital (like accounts receivable, inventory, and accounts payable) affect cash flow. If a company efficiently manages its working capital, FCF can surpass net income.
      3. Capital Expenditures: FCF can be higher if a company has minimal capital expenditures (e.g., it doesn’t need to invest heavily in new equipment).
      4. Timing Differences: FCF considers the actual timing of cash flows, whereas net income is based on accrual accounting. Timing differences can lead to variations between the two.
  4. Why Does It Matter?
    1. Investment Decisions: Investors often focus on FCF because it reflects a company’s ability to generate usable cash. Higher FCF means more flexibility for growth, dividends, or debt reduction.
    2. Sustainability: A company with consistently positive FCF is better positioned to weather economic downturns or invest in future projects.

Media Perception: Media reports often emphasize net income, but understanding FCF provides a deeper insight into a company’s financial health.

Remember, while net income is essential, FCF tells us whether a company can use that income to fuel growth or weather storms. So, next time you analyze financial statements, watch net income and FCF—they’re like two dancers performing different moves on the same stage!

Inflation and Investments

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Inflation is an economy-wide, sustained trend of increasing prices of goods and services, and loss of dollar purchasing power from one year to the next. It affects investments in several ways:

Real Value Erosion:

The rate of inflation represents how quickly investments lose their real value and how quickly prices increase over time.

As prices rise, the purchasing power of money decreases. For example, if you can buy a burger for $2 this year and the yearly inflation rate is 10%, next year the same burger will cost $2.20.

To maintain your standard of living, your investments need to generate returns equal to or greater than inflation.

Investment Returns and Inflation:

If your investment returns do not outpace inflation, your real returns (adjusted for inflation) may be negative.

Suppose ABC stock returned 4% and inflation was 5%. The real return on investment would be minus 1% (5% – 4%).

Asset Classes and Inflation:

Liquid assets (e.g., cash, short-term deposits) tend to appreciate more slowly than other assets. They are more vulnerable to the negative impact of inflation.

Illiquid assets (e.g., real estate, long-term investments) are also affected by inflation but may appreciate in value or generate interest, providing a natural defense.

In summary, understanding inflation is crucial for making informed investment decisions. Consider investments that can keep pace with or exceed inflation to protect your purchasing power over time.

Retirement Isn’t An Age

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Retirement isn’t an age. It’s a point at which your finances are where you can permanently leave the workforce. ~ USAToday

Retirement refers to the time when someone permanently leaves the workforce, usually in their later years.

Retirement is often synonymous with the idea of financial independence, which is when your savings and investments are sufficient to cover your living expenses and support you for the rest of your life.

Many Americans think of retirement as a certain age. And certain retirement benefits are indeed associated with a specific age. For example, the minimum age to start collecting Social Security benefits is 62, but you’ll have to be 66 or 67 to collect your full benefits.

However, retirement isn’t an age. It’s a point at which your finances (the magic number) are where you can more than cover your monthly living expenses and permanently leave the workforce.

The “magic number” rule of thumb for retirement is to have 25 times your annual expenses or to spend only 4% of your portfolio per year during retirement.

Source:  https://www.usatoday.com/money/blueprint/retirement/what-is-retirement/

The Magic Number Rises

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More Americans say they don’t feel financially secure…rising inflation and incomes that aren’t keeping pace get most of the blame. ~ Northwestern Mutual

The “magic number” for retirement has surged in recent years thanks to high inflation. According to Northwestern Mutual’s 2024 Planning & Progress Study, Americans now believe they need $1.46 million in savings and investments to retire comfortably.

Yet, this number reveals more about Americans’ anxiety than precise planning. We often overestimate our financial needs

This ‘magic number’ figure has leaped 15% in a year and an astonishing 53% since 2020. Meanwhile, retirement savings have dwindled to a mere $88,000.

The “Silver Tsunami” of retirement approaches, with millions of Baby Boomers riding the waves into retirement.

Track and prioritize your spending is vitally critical. This involves prioritizing the spending that’s most important to you and letting things that are less important fall off. You’re saying no to some things so that you can say yes to others. You might even want to employ loud budgeting.

Loud budgeting gives you permission to say no to social engagements by saying you don’t have the money for it. To put loud budgeting to work, you commit yourself and share that you’re doing it. Loud budgeting lets you spend money on true priorities while skipping things that won’t really provide or align with your values and priorities.

Loud budgeting can be a simple way to push back when you’ve spent too much. But it works best when it starts with a solid budget and a financial plan that helps you balance future goals with what you need for today. The idea isn’t to say no to everything, but loud budgeting should help you say no when needed.

Ultimately, your financial goal is to have more income coming in each month than expenses going out.

But make sure that you’re thoughtful about your spending so that you feel good about what you’re getting when those dollars leave.

Source:

  1.  https://news.northwesternmutual.com/planning-and-progress-study-2024
  2. https://www.northwesternmutual.com/life-and-money/what-is-loud-budgeting/

Changing Retirement

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“The traditional idea of retirement, where Americans stop working altogether, is more the exception than the rule these days. The majority of Americans continue to work in some capacity, whether or not they get a paycheck. They’re active, involved, and full of things they want to do for themselves and for others.” ~ Carrie Schwab-Pomerantz, SVP, Charles Schwab & Co., Inc.

Retirement Planning

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Planning for retirement is a way to help you maintain the same quality of life in the future.

You should start retirement planning as early as financially and emotionally possible, like in your early twenties or thirties. The earlier you start, the more time your money has to grow.

That said, it’s never too late to start retirement planning, so don’t feel like you’ve missed the proverbial boat if you haven’t started.

Keep in mind, every dollar you can save now will be much appreciated later. Strategically investing could mean you won’t be playing catch-up for long.

Additionally, retirement planning isn’t merely about counting the days until you hang up your work boots and calculating your magical financial number.

It’s about ensuring that your golden years exudes comfort, financial security, personal relationships, meaning and purpose. Here are five financial steps to guide you as you prepare for career and life transition:

  1. Know When to Start: Determine when you want to retire. Will it be an early retirement at 62 or a grand finale at full Social Security benefits age (around 67)? Remember, the earlier you claim Social Security, the less you will receive monthly, but delaying it can enhance your benefits.
  2. Calculate Your Magic Number: Calculate how much wealth or nest egg you need to sustain your desired lifestyle. Consider living expenses, healthcare costs, and the joys you wish to indulge in during retirement.
  3. Prioritize your financial goals: Pay off debts, build your savings, downside if necessary, and calculate your monthly expenses.
  4. Choose Your Accounts: Explore retirement accounts. Will it be a 401(k), an IRA, or both? Each has tax advantages, contribution limits, and investment options. Mix and match wisely.
  5. Invest Wisely: Your investments must propel you toward your financial destination. In your youth, invest aggressively. As you approach the retirement, dial back to a more conservative mix.

Whether you’re a few decades or a few years away from retirement, having a plan can help you feel confident that you’ll be prepared when the time finally arrives.

Source: https://www.nerdwallet.com/article/investing/retirement-planning-an-introduction

IRS Tax Refunds: Interest Free Loan to Federal Government

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“We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” – Winston S. Churchill

Most Americans perceive a tax refund as a government benefit, rather than recognizing it as an interest-free loan they provided to the government.

According to the IRS, “If you paid more in federal taxes throughout the year than you owe in tax, you may get a refund after you file your tax returns. Even if you didn’t pay tax, you may still get a refund if you qualify for a refundable credit.”

Tax refund, or a refund of overpayment of taxes, are often a source of joy for many U.S. households. For calendar year 2023, the average refund check is expected to be approximately $3,050 according to the IRS.

People use these refunds to pay bills, start emergency funds, or treat themselves to something special. However, it’s essential to understand that these refund checks aren’t free money from the government. Instead, they represent reimbursements from the IRS for overpaid income taxes throughout the year. In fact, last year alone, taxpayers overpaid by a staggering $360 billion.

Essentially, a tax refund isn’t free money. Here’s why:

  • Overpaid Taxes: Throughout the year, you pay income taxes based on your earnings. Sometimes, due to various factors (like incorrect withholding or changes in income), you end up paying more than your actual tax liability.
  • Refund Process: When you file your tax return, the IRS calculates your actual tax liability. If you’ve overpaid, they issue a refund—sending back the excess amount you paid.
  • Interest-Free Loan: Essentially, the refund represents an interest-free loan you provided to the government. Instead of having that money in your pocket throughout the year, you lent it to the IRS without earning any interest.
  • Financial Implications: From a financial perspective, it’s better to adjust your withholding so that you receive more in your paycheck each month. This way, you can use the extra funds for savings, investments, or other financial goals.

Interest-Free Loan Perspective:

Many experts caution that tax refunds essentially represent interest-free loansgiven to the federal government. When you overpay your taxes, you’re effectively lending money to the IRS without earning any interest.

Financially, it’s better to have that money in your paycheck throughout the year. For instance, if the average tax refund is $3,079, that’s equivalent to a $3,000 interest-free loan you’ve provided to the government. Instead, you could have had an extra $250 per month in your budget.

Enforced Savings Perspective:

Some financial professionals argue that receiving a refund can serve as an enforced savings plan. For individuals who struggle to save money, having a lump sum at tax time can be helpful.

However, it’s important to note that adjusting your withholding during the current tax year can impact next year’s refund. If you want to avoid overpaying, consider adjusting your withholding with your employer.

In summary, while tax refunds may feel like a windfall, it’s financially wiser to have that money in your paycheck throughout the year. Ultimately, the choice between a refund and a net-zero tax return depends on individual circumstances and financial goals.

When to expect your refund 

To process your refund, it usually takes:

  • Up to 21 days for an e-filed return
  • 4 weeks or more for amended returns and returns sent by mail
  • Longer if your return needs corrections or extra review. However, you’ll receive interest for delayed tax refund.

References:

  1. https://www.irs.gov/refunds

Small-Cap and Micro-Cap Stocks

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Small-cap and micro-cap stocks outperform large-cap counterparts in the long term but show particular strength after economic shakiness

A small-cap stock is defined as shares of a company with a market capitalization between $300 million and $2 billion.

Small-cap stocks offer an attractive risk-reward profile, as these companies usually have a higher growth potential than large-cap stocks. Although small-cap stocks have a high amount of volatility, they appear to be lucrative bets when the economy is expected to boom.

Micro-cap stocks represent companies with a market capitalization between $50 million to $300 million. Micro-cap stocks have a world of potential. Often they are in niche markets with emerging business ideas or technologies, so there’s a massive growth window for a company that can manage to it its stride.

Also, micro-cap stocks aren’t nearly as well-known as the blue-chip names. If you’re an astute investor, you can get in early before the average investor buys in.

Small-cap and micro-cap stocks are inherently more volatile than those blue-chip established names. That means potentially greater reward and greater risk. To invest in these micro-cap stocks, you should have a pretty high risk tolerance and be ready to ride the waves.

Most companies start out as small-caps or micro-caps, but by continually growing their earnings, their share prices appreciate. This can increase the market capitalization (share price times shares outstanding) of the company to large, or even mega-sized, while investors along for the ride reap the profits.

Big names like Microsoft, Apple and Amazon were all small-caps at one point. But not all small-caps flourish like those giants have. Many fail or stop growing, which means losses or little profit for investors. Great companies reveal themselves over many years and decades by continually producing quality earnings and sales growth.

You can find the best small-cap stocks by looking for companies with strong earnings and sales growth. Analysts must also be forecasting continued growth into the future. In addition, weed out companies with erratic earnings or that are issuing shares excessively, which dilutes earnings and shareholders’ equity.

All stocks should trade on U.S. exchanges, have a share price above $2, a market cap between $250 million and $2.5 billion and have three-month average daily volume of at least 200,000 shares.

Expected EPS growth. Companies are only included if analysts predict at least 7.0% yearly average growth over the next five years. Current-year EPS growth is also expected to be positive (above 0%).

Recent EPS and sales growth. Earnings and sales have increased an average of at least 7.0% per year over the last five years. Earnings were also higher than the prior year for each of the last three years.
Profitable. All stocks on this list have had positive earnings for the last three years.
This methodology focuses on companies that are already profitable. While unprofitable companies can see their share prices rise too, profitable and growing companies have already proven they can do it. It is a less speculative way to play this segment of the market, as opposed to hoping a struggling company can eventually turn it around.

investing in stocks is all about returns, the next step when analyzing small cap stocks is to see how their performance differs from large or mega cap behemoths.