VOLUME 49 | SUMMER/FALL 2021
I’d like to personally welcome you to the latest edition of Spectrum. We launched this magazine to bring our clients the latest thinking on topics that matter to them. We understand what’s on your mind, and we’re here to support you every step of the way on your financial journey.
This edition explores several important questions regarding the strength of annuities, the risks and rewards of bitcoin, how best to save for college and how parents can raise children to become financially independent adults.
We deeply appreciate our clients and are committed to being a partner as you work to achieve your goals. I hope you find this issue of Spectrum insightful and inspiring.
As always, please reach out to us with questions.
It’s a privilege to serve you.
Bob Thornton
Executive Vice President and President,
First Republic Private Wealth Management
Since bitcoin’s creation a decade ago, it has survived several boom-and-bust phases — generating large gains over short periods of time for some people, but also significant losses just as quickly for others.
2021, however, has so far been a banner year for bitcoin. The cryptocurrency has surprised even its skeptics by not only recouping its 2018 losses, but also rising well above its previous all-time highs.
Plus, over the last year, a growing number of publicly traded companies have not only begun accepting bitcoin for payment but have also purchased the digital coin using cash reserves from their Treasuries. The growth of the cryptocurrency landscape has also been supported by consumer-facing exchanges, which allow retail users and institutions to buy or sell bitcoin using different currencies.
As bitcoin becomes more mainstream, many investors are asking themselves if it should have a place in their portfolios.
To some investors, this year’s run-up in cryptocurrency prices validates the long-term case for investing in bitcoin. After all, a large part of bitcoin’s valuation is derived from its proponents’ conviction that it will eventually replace government-backed fiat money and displace banks (as bitcoin’s underlying peer-to-peer blockchain network could render financial institutions obsolete).
But while there are numerous benefits to the blockchain’s decentralized-ledger technology, it’s likely that the technology will reinforce the current financial ecosystem rather than replace it. That’s largely because several downside risks, which may not be “priced-in” to bitcoin’s current market value, could get in the way of bitcoin’s large-scale adoption.
For one, governments derive significant benefits from the ability of their central banks to manage the supply of money.
Additionally, the process of creating money represents a source of revenue for governments, which generate billions of dollars each year in seigniorage — that is, profit made by issuing currency. In a scenario under which alternative currencies like bitcoin compete directly with national currencies, seigniorage benefits would be reduced and central banks’ ability to use monetary policy would be significantly constrained.
Thus, as cryptocurrencies gain widespread acceptance and use, governments may view them as a threat to their national authority and enact regulations to control (or entirely ban) them. In fact, Saudi Arabia, Bolivia, Iceland, Ecuador, Vietnam and Turkey are some countries that have already made it illegal to own bitcoin. (Turkey noted bitcoin’s lack of regulation, supervision mechanisms or central regulatory authority, combined with the potential for criminal activity and high volatility, as significant risks.)
Countries also define its tax implications in different ways. In the United States, the Internal Revenue Service views bitcoin as property, making it subject to capital gains tax. Thus, if one person uses bitcoin to buy a product, it is similar to selling an investment asset to do so, triggering the need to report its cost basis and any potential gain or loss on the digital currency. This is one reason bitcoin is mostly being used as a store of value, rather than a medium of exchange.
In response to growth in the crypto space, some nations are contemplating launching their own digital currencies. Similar to bitcoin, these central bank digital currencies (CBDCs) would only exist digitally and would help reduce service and security costs (since creating a digital coin is cheaper than printing a bill).
However, CBDCs would be electronic versions of fiat currencies, preserving central banks’ monetary policy capabilities. Although the largest central banks haven’t rolled out official digital currencies yet, several smaller institutions have begun testing prototypes designed to extend financial services to those sectors of society currently lacking access to banking institutions.
The Central Bank of the Bahamas, for example, has rolled out the Sand Dollar — a digital version of the Bahamian dollar. By deploying this virtual currency, policymakers aim to extend financial services to people and businesses in the archipelago, whose complex geography of 700 islands and islets and over 2,000 cays in the Atlantic Ocean makes it challenging to securely collect and circulate physical cash. Other nations, such as Cambodia, have also taken steps to issue their own digital coins, which are expected to increase financial inclusion particularly in the developing world.
China, too, is already working on a CBDC system as it races toward an entirely cashless society. In turn, the Fed has stated that it will tread very carefully into the digital currency space, given the important role the U.S. dollar plays in the global economy and the lack of an urgent need to shift to CBDCs.
Bitcoin’s negative effect on the environment is another area of governments’ and regulators’ attention. Mining bitcoin is extremely energy-intensive because verifying, processing and recording bitcoin transactions and maintaining the blockchain network require calculating complex algorithms that demand a lot of computing power and electricity.
Scientists believe that the growing energy consumption and associated carbon emissions of bitcoin mining could potentially undermine global sustainability efforts, with projections by the scientific journal, Nature Communications estimating bitcoin mining in China to generate more than 130 million metric tons of carbon emissions by the time the technology’s energy consumption peaks in 2024.
Compared to other existing systems of payment, bitcoin also ranks very low from an environmental perspective — a single bitcoin transaction consumes more than four times as much energy as 100,000 Visa transactions. Therefore, companies that are looking for ways to reduce their carbon footprint and improve their environmental, social and governance (ESG) standards are likely to avoid transacting or investing in bitcoin.
As of today, very few companies have approved bitcoin as a payment method, given that its sharp price swings make it difficult to use as a measurement of value. A report by Bloomberg concluded that bitcoin is still far from becoming a common medium of exchange, with merchants amounting to an estimated 1% of crypto transactions between mid-2019 and mid-2020. The Visa network, for example, handles over 5,000 times more transactions a second than the bitcoin mempool (where all the valid transactions wait to be confirmed by the bitcoin network). This could be a risk to bitcoin’s current price levels, given that valuations appear to reflect the future expectation that bitcoin and its related technology will eventually become a mainstream mechanism for payments.
For these reasons, the price of bitcoin is likely to remain highly volatile and prone to move sharply for quite some time. That said, investors still looking for exposure to bitcoin could have a small place for it in their portfolios. Investing in cryptocurrencies can be done through digital exchanges, open-ended funds or private passive funds.
Please see important disclosure regarding cryptocurrency investing at the bottom of the page.
The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use.
The ultra-low interest rates currently available in cash-equivalent and fixed income markets have created challenges for pre-retirees, particularly those who need a safe harbor hedge against inflation. That’s where an attractive insurance company product — the fixed or indexed annuity — might be considered.
Annuities, in general, may get a bad rap, but this new generation solution is typically inexpensive, easy to understand and low risk. In other words, it’s a consumer-friendly cousin to the complicated annuity products you may have previously come in contact with.
Even better, these fixed or indexed annuities can potentially replace a portion of an investor’s cash or bond allocation with a higher-yielding, investment alternative. Here are some tactics to consider to help optimize your retirement portfolio.
With fixed income yields at historical lows, many long-term investors are seeking cash or bond alternatives that can offer higher gains. And yet, within the current market environment, there are very few options available within the fixed income and cash asset classes.
That’s why some forward-thinking investors are seeking the potentially higher-yielding gains that may be available through certain fixed or indexed annuity products.
While traditional annuities can be expensive or confusing, either of these newer-generation fixed or indexed products are straightforward investment options that can be considered as a potentially higher-yielding complement to or replacement for a portion of an investment-grade allocation.
When it comes to annuities, many investors assume their money is “locked up” and unavailable during the duration of the holding period. For many products, that’s often the case. For these particular fixed and indexed annuities, however, investors often have fee-free access to up to 10% of the contract value each year. That’s true throughout the entire holding period (typically three, five or seven years). Keep in mind that if more than 10% is withdrawn in a contract year, you will be subject to an early withdrawal penalty resulting in losses.
Some of these offerings even come with a “return of premium” feature, which offers full access to the initial investment at any time throughout the contract. In exchange for the return, the investor agrees to forfeit any earned interest. While this isn’t the recommended course of action, the provision provides easy access to cash for those who face a significant life event, are unexpectedly offered a highly attractive investment opportunity or want access to their original investment for any other reason.
When it comes down to it, we believe these fixed and indexed annuities compare nicely to bond and cash alternatives for a number of additional reasons:
Many high net worth investors don’t expect to be in a lower income bracket when they reach retirement. For this reason, the tax-deferral feature provided by most annuities is not attractive when the product is used as an alternative to equity investments (which are often held in tax-deferred retirement vehicles).
However, the tax-deferral feature can be attractive when a fixed or indexed annuity is used as an alternative to cash or fixed income investments, which are often held outside of tax-deferred accounts.
Even so, it’s worth noting that earned interest is taxed as ordinary income when distributed. Earned interest on distributions taken before age 59½ is also subject to a 10% tax penalty. The IRS-mandated order of distributions is earned interest first, principal investment last.
While many annuity products can be expensive and confusing, that isn’t always the case. We believe fixed and indexed annuities can be easy-to-understand investment products that can serve as low-risk, attractive alternatives to cash or fixed income investments, particularly during an ultra-low yield environment.
Indexed annuities can be complex products. Before you decide to buy an indexed annuity, read the contract. You should understand how each feature works, and what impact it and the other features may have on the annuity’s potential return.
Talk to your First Republic Wealth Manager to find out if a fixed or an indexed annuity could be an attractive addition to your overall investment portfolio.
The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use.
1 “We Need to Talk About ‘The Giving Tree,’” The New York Times, Adam Grant and Alison Sweet Grant, April 15, 2020.
2 Highlighted by Harvard Law School's Program on Negotiation as a resource to teach kids conflict resolution through cooperation.
If you’re like many parents, helping your children pay for college is probably on your list of top financial goals. In fact, according to a 2020 Gallup poll, 33% of U.S. parents are either very or moderately worried about having enough money to pay for their children’s college education.
That’s because meeting that goal can be quite challenging, considering the high and ever-growing price of higher education.
According to the College Board’s Trends in College Pricing and Student Aid report for the 2020–2021 school year, the average cost of one year at a four-year public college for in-state students (include room and board and living expenses) is $26,820. Out-of-state students pay an average of $43,280, while those at a four-year private college shell out $54,880.
And those figures are expected to continue to grow. To give you an idea of what college may cost in five and 10 years, here’s a chart based on current costs, assuming a 4% annual inflation rate.
In other words, the cost of your child’s college education may be one of the most significant expenses your family will face. Unfortunately, without ample savings, many parents and students end up taking on student debt burdens that can be difficult to manage. As of 2020, Americans had over $1.57 trillion in outstanding student debt, collectively.
To try to keep up with the rising costs of college, and ultimately borrow less in student loans, it’s most advantageous to start saving when a child is young, and invest wisely. That’s where 529 plans come in.
There are two types of 529 plans: Savings plans and prepaid tuition plans, both of which fall under Section 529 of the Internal Revenue Code (hence the name).
The most popular is the savings plan, which offers a professionally managed investment portfolio. Available in every state, these 529 plans are open to anyone who wishes to save money for college in an individual investment account. You can invest in any state’s 529 plan regardless of where you live, but the specifics of each state’s plan and tax benefits vary.
What they all have in common is that they can be used to pay for your student’s educational expenses at any accredited college or graduate school in the United States or internationally. This includes tuition, fees, room and board, books, and certain other expenses deemed eligible.
As for 529 prepaid tuition plans, those are less common (only 10 states are currently accepting new applications) and are generally limited to state residents. If available to you, it’s something to consider, as prepaying tuition can provide you with some control over the ever-increasing cost of college. Just note that prepaid plans can only be used to cover the costs of tuition and fees, not room and board.
The biggest advantages of 529 savings plans are they enjoy tax-deferred growth, and when you make withdrawals to pay for the beneficiary’s qualified education expenses, those withdrawals are income tax–free. In other words, if used for their intended purpose, you’ll never be taxed on 529 earnings.
If funds are not used for educational expenses, though, the earnings portion of any withdrawals will be taxed at the recipient’s tax rate, plus a 10% penalty. Note: If your child decides not to attend college, you have the option to transfer the 529 savings account to a qualified family member without income tax consequences.
In addition to the federal tax advantages, many states offer tax deductions or credits for making 529 plan contributions. For example, in New York, individuals can deduct up to $5,000 per year and married couples filing jointly up to $10,000 per year, on their New York state tax return.
Everyone who can afford it should consider opening a 529 plan. Unlike some other investment vehicles, 529 plans have no income limits, age limits or annual contribution limits.
The only word of caution is to make sure you don’t save so much for college that you do so at the expense of your own retirement. This can cause you to miss out on years of portfolio growth necessary to retire comfortably. With guidance from a financial professional, however, you can prioritize both goals, and 529 plans are widely considered the best way to save for college in a tax-advantaged manner.
The amount of money you save for college is best determined by how much you can afford while still saving for retirement and other short-term and long-term financial goals. Although it would be ideal to save enough to cover the full cost of attendance, that’s just not feasible for most American families. But that’s OK.
Instead of aiming to pay for the full cost of college, think of 529 plans as just one piece of the college financing puzzle. When you combine 529 savings with other forms of financial aid (like grants, scholarships and work-study), it can help keep student loan debt at a manageable level.
The key is to start early and make regular contributions, just as you do with your retirement accounts. If you start from the time your child is born, you’ll have 18 years of compound interest growth. Take a look at how a monthly investment can grow over time (assuming a 6% rate of return):
Even if you decide you can only make minimal contributions or add a lump sum here and there, every dollar counts, especially since they can grow exponentially over time. Consider setting up automatic deposits for an amount you can afford so you don’t even have to think about it. You can also ask family and friends to contribute to the fund in lieu of other gifts for your children.
Adding a college savings strategy into your overall financial goals is doable, and 529 plans are a very attractive way to get started. When you’re ready to open one, seek out an experienced financial planning professional to help you with your investment choices, and to find the right balance for each of your savings goals.
The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use.
Billionaire Warren Buffett is famous for saying you should give your children “enough so that they can do anything, but not so much that they can do nothing.” Never is this sentiment more true than when parents are planning for their children’s financial independence in adulthood. Most parents hope that their children will be good stewards of their family’s wealth. They envision their grown children spending responsibly and making investment and philanthropic decisions that reflect their priorities and values. On the flip side, no parent wants to see their young adult children burn through an amount of money that was supposed to last a lifetime — and perhaps beyond.
So what makes the difference between the two scenarios? In many cases, the groundwork for financial independence begins long before children come into any wealth of their own. Parents spend time teaching and modeling healthy financial habits. In adulthood, parents can lean on that foundation to have more significant conversations around their generational wealth transfer plan. Ultimately the secret sauce for ensuring that your children are ready for financial independence is education, communication and smart planning. Put those ingredients together, and you’ll cultivate happy, responsible adults more than capable of handling the responsibility that comes with their money.
Preparing your adult children for financial independence is ideally a process that begins early in their middle school or teenage years. At this point, you can start talking to your children more openly about the role wealth plays in the family. If you haven’t, discuss how you acquired your wealth and the values that inform how you save, spend and donate, if applicable. Then allow your children to manage small amounts on their own. This is where establishing an allowance is invaluable. Providing tweens and teenagers with a set amount of money each week or month enables them to figure out how to spend responsibly. If they want to purchase something, but they’ve already used up their allowance, then it’s an easy segue into a discussion about matching your expenses with your means.
As they get older, you can incorporate additional learning tools — and keep the conversation going. For example, create bank accounts and debit cards for middle and high school children. Educate them about the power of compounding interest and how that may apply in their own adult lives. Some families also involve their children in their philanthropic efforts. Parents may explain to their children what organizations they support, their reason and how they make that happen. You might even empower your children to begin doing a small amount of gifting themselves. The bottom line is to ensure your children are financially literate before they leave your home. Ultimately, you want to give them a foundational education that they can draw on in adulthood.
Financial independence doesn’t necessarily occur at a specific age or after a particular event. Instead, the process and concept will vary by family. Broadly, however, we think about financial independence for our clients’ children as the ability for them to support themselves with their own wealth. They’re not dipping into the principal of their investments to fund their lifestyle. Instead, they can afford to meet their current and future needs with the income they generate. When and how this independence occurs varies by family. For instance, some parents may insist that their children “make it” on their own, with little or no financial support. Others may enable a wealth transfer at a specific age or create a staggered strategy that provides young adult children with money at certain life milestones. Perhaps they receive an amount when they graduate from college or get married.
There’s no one right way. However, regardless of what your family chooses, clearly communicating the plan to young adult children is essential. We often help facilitate these crucial conversations, answer questions, walk grown children through the details and provide advice. The discussions — there’s usually more than one — prepare the young adults for this next critical stage in their lives.
The transition to financial independence entails questions and potential pitfalls that few textbooks cover. And there's a whole other layer of complexity when that independence coincides with coming into significant wealth. How do you manage wealth to ensure it lasts? What type of expertise do you need to tap? How do you navigate real estate purchases, first business investments or requests for support from friends and relatives? Young adults will encounter all these issues and then some. Fortunately, establishing early guardrails provides protection and reduces risk while they're learning. For instance, we often advise parents to distribute wealth to adult children in tranches — and avoid the shock of one big wealth transfer event. As noted, tying the distributions to achievements or milestones can provide incentives to pursue degrees or dive into a career.
Guardrails regarding how young adults use and spend the funds are also helpful. For instance, distributions may be designated for educational expenses or real estate purchases. Such parameters can prevent young adults from excessively spending while they’re still learning how to manage their finances. They also can ensure that the mistakes don’t have an outsized impact on their futures. The decisions — good and bad — provide learning moments that will inform how they handle their wealth in the future.
Educating and then empowering children to become financially independent is one of the most significant gifts a parent can give. Start the planning, education and communication early, and you’ll tee up your children for a successful transition into adulthood.
This information is governed by our Terms and Conditions of Use.
Risk Factors Related to Investment in Digital Currencies
The trading prices of Digital Currencies are subject to extreme volatility.
Extreme volatility in the future could have an adverse effect on the value of Digital Currencies and, as a result, investors’ investments in Digital Currencies may lose value. The market price of Digital Currencies is highly volatile and subject to a number of risks, including, but not limited to:
Digital Currencies have been around for only a few years and are continuing to develop. There may be future risks that are unanticipated. There is no assurance that any Digital Currency will maintain its value or that there will be meaningful levels of trading. If the price or the demand for trading Digital Currencies decreases, investors would lose value.
Regulatory changes or actions may affect the value, associated expenses and liquidity of Digital Currencies. Congress and a number of U.S. federal and state agencies as well as foreign governments have been considering Digital Currency Exchanges and Digital Currencies, with particular focus on the extent to which Digital Currencies can be used to launder the proceeds of illegal activities or fund criminal or terrorist enterprises and the safety and soundness of exchanges and other service providers that hold Digital Currencies for users. Many of these state and federal agencies have issued consumer advisories regarding the risks posed by Digital Currencies to investors. Ongoing and future regulatory actions with respect to Digital Currencies may alter the nature of an investment in Digital Currencies. Further, regulatory changes or interpretations could cause a significant decline in value in investments in Digital Currencies.
Digital Currency transactions may trigger tax reporting and payment obligations. The tax treatment may change and become even more burdensome in the future.
Digital Currencies have unique risks relating to legal status, core development and market penetration.
Digital Currency Exchanges and investment in Digital Currencies is relatively new and, in many cases, unregulated. While many prominent Digital Currency Exchanges provide the public with significant information on their ownership structure, management teams, corporate practices and regulatory compliance, many Digital Currency Exchanges do not provide this information. As a result, the marketplace may lose confidence in Digital Currency Exchanges and Digital Currencies.
In addition, over the past several years, some Digital Currency Exchanges have been closed due to fraud and manipulative activity, business failure or security breaches. In many of these instances, the customers of such Digital Currency Exchanges were not compensated or made whole for the partial or complete losses of their investments in Digital Currencies. While smaller Digital Currency Exchanges are less likely to have the infrastructure and capitalization that make larger Digital Currency Exchanges more stable, larger Digital Currency Exchanges are more likely to be appealing targets for hackers and malware and may be more likely to be targets of regulatory or enforcement action.
Digital Currencies are a speculative investment and involve a high degree of risk. As relatively new products and technologies, Digital Currencies have not been widely adopted as a means of payment for goods and services by major retail and commercial outlets, and non-financial use cases for Digital Currencies remain limited. Conversely, a significant portion of the demand for Digital Currencies is generated by speculators and investors seeking to profit from the short- or long-term holding of Digital Currencies. The relative lack of non-speculative uses for Digital Currencies, and the potential failure of such use cases to increase, may result in increased volatility for investment in Digital Currencies.
Digital Currencies were invented, in part, to create a medium of exchange that avoids the expense and delays of the traditional banking system. By holding Digital Currencies through a bank, trust company or broker-dealer, the owner will incur fees, expenses and be subject to transfer delays that could be avoided if the owner held the digital keys directly.
IMPORTANT NOTICE: The foregoing list of risk factors does not purport to be a complete enumeration or explanation of the risks involved in an investment in Digital Currencies. Prospective investors should consult with their own legal, tax and financial advisers before deciding to invest in Digital Currencies.
This document is for information purposes only and is not intended as an offer or solicitation, or as the basis for any contract to purchase or sell any security, or other instrument, or to enter into or arrange any type of transaction as a consequence of any information contained herein.
All analyses and projections depicted herein are for illustration only and are not intended to be representations of performance or expected results. The results achieved by individual clients will vary and will depend on a number of factors including prevailing dividend yields, market liquidity, interest rate levels, market volatilities, and the client’s expressed return and risk parameters at the time the service is initiated and during the term. Past performance is not a guarantee of future results.
Investors cannot invest directly in an index. The indexes referred to do not reflect management fees and transaction costs that are associated with some investments.
Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.
Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. This document may not be reproduced or circulated without our written authority.
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