Economy Is Strong, but Investor Uncertainty Lingers

MIKE TOWNSEND: When I am not recording this podcast, I spend a lot of time on the road talking to investors about what's going on in Washington and in the markets. And that's especially true in a presidential election year when interest in the intersection between politics and the markets is at its peak.

In the last few weeks, I've been on a whirlwind tour that has taken me to places as diverse as New Jersey; Montana; southern California; and Savannah, Georgia. Last week, I was in Pittsburgh, Cleveland, Cincinnati, and Indianapolis.

At every stop, I have great conversations with investors about what's going on in Washington and on the campaign trail and how it might impact the markets. But the most important part of these trips for me is getting to hear what's on the minds of investors. 

The S&P 500^® ended last week up more than 12% for the year. Yet there is an undercurrent of concern and anxiety among investors. It's driven, I think, by the feeling that there are a lot of unknowns right now. It's not clear when the Fed will start cutting rates. Key economic data like the jobs numbers keep surprising economists. And this November's election hovers over everything.

So how do we help investors navigate this unusual environment?

Welcome to the 100th episode of WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. 

As we hit the middle of 2024, I thought it would be useful to check in about a number of issues that are on the minds of investors right now. In just a few minutes, I am going to sit down with Daniel Stein, who manages three Charles Schwab branches. He spends the bulk of his time meeting directly with investors, so he hears their questions and concerns every day. And he's got a great sense of what's on the minds of average investors.

But first, here are three things to know about what's going on in Washington right now.

While Congress has surprisingly few must-do issues on its agenda between now and the election, that doesn't mean lawmakers are sitting idle. Late last month, the House of Representatives passed a bill that investors should be keeping an eye on. It would, for the first time, create a regulatory framework for cryptocurrency. 

The premise here is that crypto just doesn't have the kind of regulatory oversight that, say, the stock market has. Investors don't have nearly the same level of protection.

The bill would give primary regulatory authority over cryptocurrency to the Commodity Futures Trading Commission―the CFTC. It would relegate the SEC to a secondary role. Most popular cryptocurrencies, like Bitcoin and Ether, would be regulated by the CFTC. The bill sets out some rules for crypto exchanges, custodians, and other players, as well as creating some investor protections. 

What was significant about the bill was that it passed the House by a stronger-than-expected bipartisan vote of 279-136. And it feels like something of a turning point in the debate over cryptocurrency in Washington, with members of both parties recognizing that crypto is not going away and that it's probably past time to put a regulatory framework in place.

Bitcoin is growing in popularity among ordinary investors, and a key reason for that has been the SEC's decision earlier this year to approve the first Bitcoin exchange-traded funds. The agency will reportedly greenlight the first Ether ETFs soon. And the bill that has passed the House will likely further bolster the legitimacy of crypto if it becomes law.

The bill next goes to the Senate, where things are not as far along. There are some senators eager to work through this issue, but it's unclear how big of a priority this will be between now and the election. I do think the House vote significantly improves the odds of a bill becoming law next year, if not by the end of 2024. 

Second, the House also took action recently on another issue that investors across the country ask me about. It's whether the Federal Reserve is going to launch a central bank digital currency.

The interest―or concern, depending on your point of view―stems from an executive order President Biden issued a couple of years ago that directed the Federal Reserve to research launching its own digital currency. 

And this is not simply an American idea. There are more than 130 countries whose central banks are at various stages of developing or launching a digital currency. Several large countries, including Australia, Brazil, China, India, and Russia, are at the pilot stage of this process.

But it's become a very controversial idea here in the U.S. because some view it as a way for the government to surveil the personal spending habits of Americans. Others are concerned that it is a way to phase out the use of traditional dollars, that it could be used to undermine the traditional banking system, or that it could be used to manipulate monetary policy.

Proponents argue that it would improve digital payments, strengthen financial stability, and offer new options for populations that have been underbanked or don't have access to a reliable bank.

In March, Fed Chair Jerome Powell testified before the Senate Banking Committee that the Fed was "not remotely close"―his words―to a central bank digital currency. He also said that the Fed had no interest in holding accounts for individuals and competing with the banking system. He said that the Fed would not issue a digital currency without the authorization of Congress.

But some members of Congress want to make their concerns clearer. Last month, the House approved legislation that would bar the Fed from launching a digital currency. The bill was mostly a party-line vote, with 213 Republicans and three Democrats voting in support of the prohibition, while 192 Democrats voted against it. There is similar legislation in the Senate, though it's unlikely to get a vote with the Democrats in the majority there. But if the Senate were to flip to Republican control in the election, a bill barring the Fed from acting in this area could be approved next year.

At the end of the day, the Fed is taking a go-very-slow approach. And it's clear that this isn't happening anytime soon.

Finally, there was an interesting development last week on the regulatory side of things. A court threw out a rule finalized by the SEC last year that would have provided investors with more information about hedge funds and private equity funds. The rule, which was set to go into effect in September, would have provided more transparency into these funds' performance and fees, and it would have prevented funds from giving some wealthy clients better deals than other clients.

At the time, SEC Chairman Gary Gensler said that the industry, which now comprises more than $30 trillion in assets, needed some additional guardrails. It was one of the core rules of his tenure as chairman.

But the Fifth Circuit Court of Appeals, a Texas-based court that has earned a reputation as business friendly and anti-regulation, vacated the rule last week, saying that the SEC had exceeded the authority given to it by Congress. 

And this has become a central issue for the SEC in recent years as it has sought to expand its regulatory reach over different parts of the financial ecosystem. This is not the first time the courts have rejected an SEC rule.

In February, the courts overturned a 2020 rule that impacted proxy advisers, the firms that advise companies on the questions that come up on proxy ballots during their annual meetings. In that case, a different court also decided that the SEC had exceeded its authority.

Another major rule that the SEC approved earlier this year is under similar scrutiny. In March, the SEC finalized a controversial rule requiring public companies to disclose more to investors about the risks they face from climate change, as well as their contributions to climate change via greenhouse gas emissions. There are now eight lawsuits challenging the rule that have been consolidated in the Eighth District Court of Appeals. The SEC has paused implementation of the rule pending the resolution of those cases, which could take many months.

Last week's decision could impact several other SEC rule proposals that are in the queue for finalizing―and could give the business community a path for challenging those rules.

It's becoming increasingly common for the courts to be the ultimate decision-maker on regulatory initiatives, not just involving the SEC, but with regard to regulations that impact every sector of the economy. 

In fact, a Supreme Court decision is expected any day now on an overarching issue about the power of regulatory agencies and how they interpret laws passed by Congress. It could overturn a 40-year standard and significantly narrow the role of regulatory agencies in the future.

Even before that decision comes down, however, regulatory agencies are increasingly finding their efforts facing extreme skepticism from the courts. All of this bears watching because of its potential impact on how businesses and government regulators interact in the future.

On my deeper dive today, as we arrive at the midpoint of 2024, I want to take a look at some of the key issues that are on investors' minds right now. As I mentioned, I've been traveling quite a bit in recent weeks, and what's interesting is that no matter where I am, I'm getting a lot of the same questions, which, I think, are indicative of the underlying level of anxiety a lot of investors feel, even as the market has had a strong positive start to the year. So I wanted to bring on my longtime colleague here at Charles Schwab, Daniel Stein, to talk not just about what investors are worrying about, but what guidance we're offering in response to those concerns. Dan manages our branches in Tyson's Corner and Alexandria, Virginia, as well as our branch in Annapolis, Maryland. He holds the Chartered Financial Analyst designation, and he is a CERTIFIED FINANCIAL PLANNER™. In his role, he leads teams that work directly with investors on a day-to-day basis, helping them with financial planning and ensuring their portfolios are aligned with their goals. Dan, thanks so much for joining me today. 

DANIEL STEIN: It's a pleasure to be here, Mike.

MIKE: Well, Dan, I know you spend the bulk of your time talking to clients, and you're hearing many of the same concerns that I am. So let's start with the one that has been at the top of my list recently, and that is client concerns about the federal deficit and the staggering national debt. What's the impact on the economy? In this rising interest rate environment, will there be enough buyers to buy up all the debt the federal government is generating? 

DAN: Yeah, absolutely. And with the rapid rise in interest rates, that means it's costing more to service that debt. So this has been a big issue amongst investors. 

Now, before I go any further, I do want to point out that these two terms get mentioned together so much that they start to seem like one and the same to some people. So let's just set out what they are. 

Now, the deficit is the annual shortage between what the government takes in and what it spends. So for the last 12 months, ending April of this year, that deficit was $1.6 trillion. Just like in your personal life, if there isn't enough money to meet your spending, you borrow, taking on debt. And all the borrowing to cover the deficit has built up over time to the point where our total U.S. federal debt level today is more than $34 trillion. 

Now, historically, high government spending has generally corresponded with lower economic growth, and that is a concern, but right now, the more immediate concern we are hearing about is the potential impact on the bond market. Now, Kathy Jones, Schwab's chief fixed income strategist, well, she's pointed out the multiple concerns among investors. The first is that to fund the deficit, the Treasury will need to increase the issuance of Treasury securities, and second, while the Fed keeps rates high, the cost of financing that debt will continue to grow. And that leads to the third issue, the fear that the increased supply of Treasuries and/or a lack of confidence in the country's ability to manage the debt will lead to investors demanding even higher interest rates from these investments. 

Now, Kathy points out three key points that can help alleviate some of these concerns. 

The first is that the demand for U.S. Treasuries remains strong. Analyzing bidding data in the quarterly Treasury auctions over the past few years, it shows that there has not been a noticeable change in demand despite this increased supply. After an extremely long period of low fixed income yields, there's been a lot of individual and institutional interest in Treasuries with the high yields that they have relative to the past 15 years. And foreign private investment in Treasuries has also risen sharply. 

Second, Treasuries benefit from the U.S. dollar being the world's reserve currency. The dollar is used in more than 75% of all global transactions, and it accounts for around 60% of reserves at foreign central banks. In reality, there are few alternatives to the dollar and Treasuries for large global investors. The U.S. Treasury, it's the largest and most liquid government bond market in the world, and that appeals to institutional investors. 

Third, there is no historical correlation between debt and interest rates. Historically, there has not been a correlation between rising U.S. deficits or debt levels and rising interest rates. The major factors driving U.S. interest rates, well, they've been Federal Reserve policy, inflation, and economic growth. Treasury issuance. it has not shown to be a significant driver of yields. 

MIKE: Yeah, that's helpful perspective on the bond market, but what are the potential implications for the stock market? 

DAN: Well, Schwab's take on that is that the bond market is likely to remain a key driver of equities. The most significant risk to the stock market related to government debt concerns, well, that would be if there was a significant increase in yields over a relatively short period of time. That, combined with weak economic growth, it would be a challenge for the stock market. But we don't anticipate that significant increase in yields to occur. 

MIKE: Yeah, that's really good perspective. For our listeners, we've just published an extensive article on this important topic. Liz Ann Sonders, our chief investment strategist, Kathy Jones, our chief fixed income strategist, senior investment strategist Kevin Gordon, and I, co-wrote the piece, which is called "Deficits, Debts, and Markets: Myths and Realities." You can find it at schwab.com/learn, and I'll put a link in the show notes. It's a bit longer than our usual articles, but it's got some great information for investors from each of our perspectives―the impact on the stock market, the economy, and the bond market―as well as my thinking about how Washington may or may not try to address the issue over the next year or so. So please check out that article. 

Dan, I want to come back to you on the issue of fixed income investing in light of what you've just shared. We have been in an inverted yield curve environment for nearly two years, with short-term Treasuries offering higher yields than longer-term ones. A few weeks ago, we did an episode strictly on bonds with Collin Martin, and I asked him why should investors ever look at longer-term securities while short-term bonds are paying so well? His answer was that short-term rates won't always be this high, and it pays to lock in some long-term while those rates are still strong. But then the May job numbers came in stronger than expected, likely putting rate cuts on hold, and the yield curve is still inverted. You sit across the desk from clients every day, and they must be asking the same thing, "Why shouldn't I take advantage of these high short-term rates for as long as possible?" So what do you say to them?

DAN: It's a great question, and yes, we get it a lot. Collin is absolutely right. The simplest answer is that staying only in short-term investments like money market funds, that assumes that the current environment will persist long term, and we just don't believe that to be the case. The Schwab fixed income team, they've been projecting fewer rate cuts this year than many other analysts, and we still anticipate one to two cuts this year, and that cuts are far more likely than potential increases. But at some point, the Fed could cut rates by 50 basis points, and when that happens, it could happen quickly. Then the short-, intermediate-, and long-term yields, they could all fall, with short-term rates falling the fastest. 

Fixed income investors that are sitting in short-term investments like money market funds, they're essentially trying to time the market by waiting until the very moment right before rates fall meaningfully to move out to a longer duration and secure those higher rates. And if you wait too long, well, you might have gotten a slightly higher yield for a short period of time, but if rates fall meaningfully, investors, especially those that rely on income from their investments in retirement, well, they might end up kicking themselves for not locking in these higher rates for longer periods when they had the chance. 

MIKE: What about an investor that has a lot of cash or short-term investments that is nervous about making the wrong decision? I know you mentioned the challenge of trying to time the market, but what would you say to people that are hesitant to adopt this longer-term strategy because their entry timing may be off?

DAN: Well, first off, we always recommend having some investments in highly liquid short-term fixed income investments. So this will never be an all or none decision. For those in retirement, we recommend keeping an amount that can cover the next 12 months of expenses in stable short-term instruments, like money market funds, short-term Treasuries, and short-term CDs. Now, as you spend that bucket of funds, we recommend that it's continually replenished to keep your coverage going out for 12 months. Now, this first bucket is refilled from a second set of investments that will fund the next three years of expenses. So this will still be invested in instruments that have one to three years maturity. Then additional parts of the portfolio for longer-term fixed income can be used to lock in higher long-term yields. 

So for those planning income and retirement or those that are still working and they're looking for a more measured approach to locking in long-term yields, a ladder approach could be a good solution. To illustrate a ladder, let's say an investor wanted to lock in some longer-term yields, but as you said, Mike, they were uncomfortable going too far away from short-term yields because they were uncertain about the path of interest rates. Well, that investor could take the amount that they want to invest in fixed income and split it up into equal parts, let's say, seven pools, and invest each in securities maturing one year from now, two years from now, all the way up to seven years out. As the nearest-term investments mature, they can use the proceeds to buy a new security on the back end of that ladder again.

MIKE: Yeah, ladders make a lot of sense in this situation, and all makes it very workable. Certainly, would allow you to not stress over getting in or out at the wrong time. 

Well, Dan, let's shift over to the stock market, and I want to start with a question about the Magnificent Seven. We always hear about them and how they have impacted investment returns in the major indexes. We're talking about Alphabet, which is the parent of Google, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. Nvidia has been a standout even among these amazing seven companies, and Tesla has been a lot less magnificent than it was a year or so ago, but they've all been key drivers of the rally in the stock market. It seemed that that rally was widening, but then it pulled back a bit. So what's happening here? 

DAN: Yeah, the Magnificent Seven, it's a term that was coined for that handful of very large (or mega-cap) companies that you named that certainly had some outsized returns. Now, in 2023, these seven companies were responsible for more than 62% of the S&P 500's gains. But what could be forgotten is their contribution to the plunge that we saw in 2022 as well. Now, this year, while not all of those seven have been magnificent, the group is always closely watched because of their impact on the indexes. It is better when strong stock market returns are supported by a wide range of companies and not concentrated in a small handful. 

Now, as we talk about the market, we often hear from investors that it looks expensive or overvalued based on price-to-earnings (or P/E) ratios. Liz Ann Sonders, she recently commented on this and illustrated that while the forward P/E of those seven stocks was nearly 30 at the end of May, the P/E on the S&P Equal-Weighted Index was much lower at 16.8. 

So looking beyond these Mag Seven stocks can show that the rest of the market is more reasonably valued than one might think. So in addition to the impact that they have on market returns, those Mag Seven stocks are also shaping a lot of people's perception of the stock market and its value. 

MIKE: Yeah, that's really interesting that there may be some opportunities in areas outside of those Mag Seven stocks.

But we can't talk about the Magnificent Seven without talking about artificial intelligence. And this is an area that is really interesting to investors right now, but I think, also, a bit intimidating. While we've seen the impact of AI on investing in companies like Nvidia that you just mentioned, how might investors look at the emergence of AI and its potential impact to the markets? 

DAN: No doubt that over the past year it's been hard to talk about the markets without talking about AI. While a lot of focus has been on the companies that make AI possible, what I think is more fascinating is looking at the ways that AI can transform industries and the companies within them. 

Now, as the capabilities continue to evolve and improve rapidly, there could be opportunities in the industries that can get the greatest lift from the new technology, and there certainly will be opportunity with the individual companies that do the best job of harnessing what it's capable of. AI could power a tremendous lift in productivity and innovation, which could propel some companies ahead and leave others behind. 

MIKE: Give me an example of some of these industries. 

DAN: Well, let's take healthcare for one. So in many ways, diagnosing a patient, identifying health risks of patients, coming up with treatment plans and more, well, it comes down to individuals analyzing the data they receive from testing and observation and comparing that against normalized data in other known cases. Right now, we rely on doctors to use their experience and research to diagnose existing conditions and identify warning signs for future issues. But using AI, well, computers can nearly instantly process not just the recent test results of a patient but compare them to the past results to identify trends, to then compare those trends to other cases all over the world and identify and assess what course of treatment were used in everyone and diagnose their effectiveness. It could significantly reduce misdiagnosis and quickly begin to identify patterns and trends in patients that can greatly increase the early detection of issues and start preventing them before they even occur. 

I also think of any company out there that has a large customer service component. What if when customers call in with questions or issues, an AI assistant could process the dialogue real-time and provide prompts to the agent, clarifying the issue, providing the answer or proper next steps instantly without the agent having to stop to do any research? AI could also provide an immediate analysis of similar questions that have been answered previously and provide suggestions to the agent on additional proactive ways to help the caller. This would reduce the need for a follow-up call, saving the caller and the company time, and AI could also recommend a new product or service to address the caller's needs. Based on the client's demographics and the questions they were asking, they could find a good fit potentially. Now, again, good for both the caller and the company. 

The trick, of course, is identifying which companies are working to get ahead of the pack in harnessing this technology because those that fall behind, they run the risk of rapidly losing market share to competitors that are earliest to implementation. 

MIKE: Yeah, I think this is a really important point because I think a lot of investors right now, when you talk about AI, they're focused on the companies that are making the technology and the technological advances. But I think a really important place to look at is the companies sort of downstream that are potentially beneficiaries of these new technologies. So what's the easiest way for investors who are interested in AI, but maybe don't have the time to do the kind of research we're talking about, to figure out which companies to invest in? 

DAN: Well, you're spot on, Mike. I think a lot of time when the topic of AI investing comes up, people naturally think about Nvidia because of the size of the company, the market returns it's had, and its direct involvement in making the chips that power AI. But there are a whole host of other places to turn to invest in AI. Many companies have been heavily involved in the evolution and implementation of AI for years. Take the rest of the Magnificent Seven, for example. Tesla and Google, they continue to invest heavily in and make breakthroughs in self-driving technology. Google also uses it to detect patterns and analyze search data to provide the most relevant results to each individual. Anyone with an Alexa device? Well, they might be fully aware of how Amazon uses past consumer behavior to provide timely recommendations on reorders or recommend new products. But you might not realize AI's role in optimizing delivery and supply chain management for companies like Amazon. People might remember Clippy, the paperclip from early versions of Microsoft Word. Now that same digital assistant concept, it continues to become astronomically more effective. Facebook uses user data and algorithms to provide suggested content and can help target relative advertising. Apple is another powerhouse with immeasurable amounts of user and consumer data that can be analyzed to influence future enhancements and product releases to stay in front of the competition. 

So the bottom line is there's a great deal of companies out there that have been involved with this technology for years. You don't just need to look to the chip makers that power the technology. You want to identify the companies that continue to get powered by the technology. 

If you're looking for some specific ideas, one place to start is by looking at the Investing Themes on schwab.com. You can quickly view a large list of popular areas that people are investing in, and by clicking in, you'll see a list of relevant companies in that area. Artificial intelligence is one of those Investing Themes that listeners can check out. 

MIKE: That's great advice, Dan, and, you know, this is one of the key issues that I'm also watching here in Washington, where there's a debate going on about how best to put some regulatory guardrails around AI. There's been a notable effort on Capitol Hill over the last 12 months to work in a bipartisan fashion to share information and education opportunities for members of Congress so that they have a good basis of understanding of AI and the potential issues and risks. Last month, a bipartisan working group in the Senate unveiled a plan to allocate more than $30 billion a year to help regulators oversee the AI space. While there's some optimism on Capitol Hill that that legislation could pass before the end of the year, I think it's probably more realistic that we'll see this topic on the agenda next year, but it's definitely an issue to watch. 

Well, Dan, we've talked a lot about investing in the markets, but I want to pivot over to one of the most common wealth management topics that has generated a lot of questions from clients lately, and that's taxes. This is really kind of a look-ahead issue because one of the biggest tax battles in Washington over the last decade or more is looming in 2025. That's because the 2017 Tax Cuts and Jobs Act is set to expire at the end of next year, and that's the law that lowered individual income tax rates, increased the standard deduction, and raised the amount of assets that can be inherited without triggering the estate tax, among dozens of other corporate and individual provisions. In light of the U.S. debt, there is going to have to be some very hard decisions made, and a lot of negotiating next year. So Dan, from a planning standpoint, what are you telling clients who are concerned about potential tax changes that could be on the radar for next year? 

DAN: Well, with the Tax Cuts and Jobs Act reforms expiring at the end of 2025, the two major impacts will be the change to estate tax exemptions and tax brackets.

So starting with estate tax exemption, the Tax Cuts and Jobs Act considerably raised the level of assets that individuals and spouses can pass to their heirs tax-free. The current estate and gift tax lifetime exemption amounts are $13.61 million for singles and $27.22 million for couples. If these are not extended, they fall back to the 2017 levels, adjusted for inflation, and they're essentially cut in half. So many affluent investors don't wish to leave it up to chance that additional legislation will be passed, and they're seeking to take action now. For those currently or with the potential to exceed these thresholds in the future, there's some advanced estate-planning and gifting strategies to consider now. 

Now starting with gifting, the most simple strategy to follow is taking advantage of the annual exclusion gifts. In 2024, the IRS allows for annual gifts of up to $18,000 for individuals or $36,000 for couples per person the gift is made to, and there's no cap on how many people you could gift to. Oftentimes, it is better to gift assets during your lifetime, so your beneficiaries can benefit from them sooner, and you might be able to see them benefit from them. This also allows you to reduce the size of your estate in advance of passing. So if those assets stay in your possession, assuming they grow in value over time, that growth increases the size of your estate and the potential tax consequence even further. But if they're gifted to others, those recipients can benefit from the growth while it's outside of your estate. 

Another popular strategy that we see is people funding education for future generations by frontloading 529 plans. Now, you're allowed to make five years' worth of contributions to a 529 plan in a single year and stay within the annual exclusion amount. So in 2024, this would be $180,000 per couple. Now, let's say you have a large estate, and you have a large family with eight grandchildren. So by funding eight separate 529 plans with this $180,000 each, you could effectively remove nearly $1.5 million from your estate without decreasing your lifetime gift exemption. Those funds, well, they can then grow tax-free in the 529 plans if ultimately used for education, instead of growing in your possession and increasing a future estate tax liability. 

MIKE: Those are a couple of great ideas, but you mentioned these being some of the simpler strategies. I take it that means there are more complex strategies. 

DAN: Well, we wouldn't be talking about tax code if we weren't talking about complexity, would we? So you're absolutely right, and there are several strategies that we regularly help high-net-worth individuals and families implement right now. And even if we are still a year and a half out from the expiration of these cuts, we're helping people with this now so we can take a careful approach, and the estate-planning attorneys needed to implement these strategies have capacity. If we start getting into late 2025, and it doesn't look likely that Congress will be able to address the expiration, well, you can bet it will be an extremely challenging environment to find time with estate-planning attorneys, especially the best ones.

MIKE: So what are some of these complex strategies? 

DAN: Given the complexity, I'll hit two of these high level and add a strong encouragement to any listeners to meet with a financial consultant to discuss your particular situation further and see if using one makes sense. 

But the first strategy, it's for married couples, and they can create dual spousal trusts. So to lock in the current higher exemption limit, married couples can each set up a Spousal Lifetime Access Trust, or SLAT, and then transfer assets for the benefit of their spouse into them. So at 2024 limits, each trust could be funded with the full lifetime exclusion amount of $13.61 million per person. And in addition to removing those assets from the couple's estate, future growth generated within the trust would also be out of the estate. Now, these are irrevocable gifts, and there's some additional complexities to consider, but it is a popular strategy among married couples. 

A second common scenario we see is for business owners. They can set up a family limited partnership or a family limited liability company to transfer business ownership to family and future generations, while still maintaining control in the company. Again, these strategies can take advantage of the current higher lifetime exclusion amount, and in the best-case scenario where it's a business that continues to grow and increase in value, well, those future increases will have been removed from the estate as well. 

These are just two of the many strategies to consider, but the common thread among them is the chance to make larger gifts and transfers now to reduce estate tax liability in the future. 

MIKE: Well, Dan, the other impact to the looming expiration of the 2017 tax package is the impact to tax brackets and rates. So can you talk a little bit about how you're helping to plan for the possibility of higher tax rates in the future? 

DAN: Well, when it comes to our jobs, we can't always control the amount and the timing of the income we receive, unfortunately, but when it comes to our investments, we do have more control. So the first thing to look at is if an investor has traditional IRA assets they might want to convert to Roth IRA assets. As a quick overview, contributions to traditional IRAs and 401(k)s, they're made with pre-tax dollars. So your contributions can be tax deductible, although you need to be below certain income thresholds to deduct the IRA contributions, but although the accounts grow tax deferred, when you take the money out later in life, you then have to pay taxes on the distributions. You can, however, convert traditional retirement assets to Roth assets by paying taxes now on the amount that's withdrawn from the traditional and moved to the Roth. Those assets can then grow in the Roth and are not taxed when they're later removed. 

So we help many clients make systematic Roth conversions over a period of time, being mindful of how much is converted each year to stay below certain tax thresholds to try to avoid distributions being taxed at a higher rate. And even for earners in high tax brackets, if you believe you will always be a higher earner even in retirement, then the prospect for higher tax rates in the future could be a good reason to begin Roth conversions sooner. With the potential for these tax brackets to increase as early as 2026, we would encourage anyone that has thought about Roth conversions but hasn't taken any action to talk to an advisor to see if it makes sense to start in 2024. 

And aside from help with investment vehicles, there is also action to be taken with the securities themselves. One critically important part of investing that's often overlooked is how an investor holds their investments and in which types of account. Not all investments are created equal when it comes to a tax standpoint, and by holding investments that generate taxable income in tax-sheltered accounts and holding more tax-efficient investments in non-retirement accounts, it can have a significant impact on the amount of taxes paid over your lifetime. 

Finally, although the Tax Cuts and Jobs Act does not impact long-term capital gains taxes, this is another tax issue that investors can be concerned about, the prospect of those taxes being increased in the future. So to that end, we can help with tax-loss and tax-gain harvesting, essentially finding investments with losses and others with gains that can be sold and replaced with similar investments to offset the gains and losses against one another. If you're in that fortunate position where you don't have losses to offset gains, well, it can still make sense to purposefully take long-term capital gains in years where you have a lower income and you expect that you could have higher income in years ahead. This is because long-term capital gains are taxed at lower rates for those in lower income brackets. 

So to sum it all up, there are many ways investors can reduce their tax burdens now, regardless of whether or not we see tax rate increases at the end of 2025 or not. 

With that said, as we help clients with these issues just about, everyone still wants to know if we're going to see an extension of the Tax Cuts and Jobs Act provisions and what that timing could look like. So Mike, when do you think we might know about all those potential changes? 

MIKE: Yeah, if only I had a crystal ball. This is definitely the question I'm getting asked the most around taxes, and unfortunately the answer is I have no idea, and neither does anyone else. It's incredibly dependent on the election outcome this fall. If Republicans, for example, were to sweep the White House, the House, and the Senate this November, well, they've already said that they would try to move to extend the expiring tax provisions early in 2025. But if there is a split Congress next year, then it is going to be an extremely difficult journey to a compromise, and that probably means we won't have clarity until very close to the end of the year. As you might imagine, the two parties have wildly different visions of what Tax Code changes in 2025 should be at the top of the priority list. So really, we're all just going to have to wait and see. 

Well, Dan, this has been a great conversation and I want to wrap up with this. What's the most important piece of advice you're giving to clients who are nervous about this environment and all the uncertainties—the uncertainty about when the Fed is going to act, uncertainty about this fall's election, uncertainty about inflation, the job market, the economy in general? What are you telling people? 

DAN: Well, there might be a lot to be uncertain about right now, but throughout history, we have always had periods of uncertainty and periods of incredible hardship, and in time, long-term strategy and investing generally wins out. So in simple terms, have a plan, stick to that plan, and revisit the plan to make updates periodically. Investors that have a comprehensive wealth management plan in place that's guided their long-term asset allocation decisions, they are far less likely to panic in the face of adversity or uncertainty, and then they're also far more likely to reach their goals as a result. So a financial plan can reveal areas of opportunity or concerns with a long-term strategy to address now while there's still plenty of time, but for those on track, it can also illustrate to investors that they're able to weather these storms, and that gives them confidence and peace of mind through uncertainty. fThe easiest recent example to point to, it was the beginning of the pandemic in early 2020. And we had an abrupt downturn of over 30% in about six weeks in the market over February to March, but less than six months later in August, the market was at all-time highs. So the investors that panicked, that sold during the downturn, and they didn't get back in, well, they did some really tough damage to their financial goals, but investors with a plan in place that knew they could weather the storm, well, they ended up in a great place. So a plan can not only help investors stay the course, but it can also help to ensure that they're on the best course possible to begin with. 

Now, in just a short time today, we've addressed a handful of strategies that many investors might not have in place. So in closing, Mike, I'd say to the audience, "Talk to a financial consultant." If you receive calls or emails from someone at Schwab and you just haven't found the time to meet with them, make the time. You won't regret it. You'll be surprised how often in just one hour we can uncover some easily actionable items that make a dramatic impact in wealth generation for our clients. So do yourself a favor, make the time. We're glad to help.

MIKE: Well, Dan, I wholeheartedly agree with that, and I'll just add that, you know, one of the things that I hear the most about is uncertainty around the election, and a lot of anxiety about the election and the potential outcomes. And those emotions are not a good mix with investing decisions. So I really want to urge people to, particularly if you're concerned about the election and what might happen, talk to a financial consultant about your plan. Make sure your plan is still solid and still getting you to where you need to be, and try to avoid making any decisions that are based on emotions, particularly around the election. So you'll be hearing me say that in the months ahead.

But Dan, you've really offered a lot of great perspective and a lot of great advice. I really appreciate your time today. 

DAN: It's always a pleasure to be here, Mike. Thank you so much.

MIKE: That's Dan Stein, vice president and branch manager of three Charles Schwab branches in Northern Virginia and Maryland.

Well, that's all for this week's episode of WashingtonWise. With this being the 100th episode, I want to take a moment to send out a huge thank you to my producers, Gay Matthes and Patrick Ricci, who have worked on all 100 episodes and without whom there would not even be a WashingtonWise podcast. Big thanks, too, to Deborah Hinton-Brown and Adam Bromberg, who play important roles in the background.

We're all ready to launch our second 100 episodes with a new one in two weeks. So take a moment now to follow the show in your listening app so you get an alert when that episode drops and you don't miss any future episodes. And I'd be so grateful if you would leave us a rating or a review—those really help new listeners discover the show. 

For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. 

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.