The Thucydides Trap:
A Lesson for Investors

Chinese President Xi Jinping has repeatedly invoked an intriguing historical concept when discussing relations with the United States: the “Thucydides Trap.”

The term comes from the Greek historian Thucydides and his account of the Peloponnesian War nearly 2,500 years ago. A rising Athens was challenging Sparta, the established power, and Thucydides observed that the growth of Athens, and the fear it instilled in Sparta, made war nearly inevitable.

Harvard political scientist Graham Allison brought the idea into the modern era, identifying 16 cases over the past 500 years in which a rising power threatened to displace an established one. Twelve ended in war.

That history makes Xi’s references so interesting, because China’s extraordinary rise increasingly challenges America’s position as the world’s dominant superpower. Xi’s argument is that history need not repeat itself and that great-power competition does not have to end in confrontation. The historical odds are not encouraging, but they are not destiny. The two countries are bound together by trade, capital and supply chains in ways Athens and Sparta never were, and both have far more to lose from conflict than to gain. The trap can be avoided, even if it should not be ignored.

Whatever the outcome, the Thucydides Trap is a useful reminder that economic leadership and geopolitical influence shift over time. For investors, that is a compelling argument for diversification. U.S. markets have enjoyed extraordinary success, but history suggests no country holds market leadership indefinitely. Owning companies across countries and regions allows investors to participate wherever the next generation of global growth emerges.

THIS QUARTER’S WINNER

This quarter’s best-performing asset class was one many investors overlook entirely: Emerging Markets.

Two of the largest countries within Emerging Markets—Taiwan and South Korea—have become indispensable participants in the global AI revolution. From advanced semiconductor manufacturing to memory chips and critical hardware infrastructure, these economies sit at the center of the technology supply chain powering artificial intelligence worldwide.

Last year, a meaningful portion of international outperformance resulted from a declining U.S. dollar. This quarter, however, geopolitical uncertainty surrounding the conflict with Iran has strengthened the dollar as investors sought traditional safe-haven assets. Despite that currency headwind, Emerging Markets continued to produce exceptional returns.

Year-to-date, Emerging Markets have appreciated more than 20%, another reminder of why we advocate globally diversified portfolios. While the U.S. market remains near all-time highs, leadership within global markets continually rotates, and no one can consistently predict which region will lead next.

Diversification is not simply about reducing risk. Increasingly, it is proving to be a powerful source of longterm investment returns.

PRIVATE CREDIT
VS. THE PRESS

Recent headlines have drawn comparisons between today’s private credit markets and 2008. Those comparisons may garner attention, but they aren’t supported by the facts. The current environment reflects adjustment, not crisis.

Private credit is central to the U.S. economy. Middle-market companies, the primary borrowers, number roughly 230,000 firms and employ about 40 million people, nearly one-third of all U.S. corporate employment. This is a foundational source of business investment and job creation, not a peripheral corner of finance.

Much of the concern centers on software companies, which represent about 24% of the private credit market, and their vulnerability to AI disruption.² Yet many of these businesses operate on long-term contracts with recurring revenue, meaning any performance adjustments are likely to unfold gradually rather than suddenly.

Redemption gates, or predefined limits on investor withdrawals, have also drawn scrutiny. Rather than being warning signs, these limits are prudent risk-management tools that prevent forced asset sales and protect portfolio value for all investors. Risk in this asset class is best measured by default rates, not headlines. Current credit losses sit at approximately 2.5% per year, broadly in line with historical norms³.

Risks will always exist in investing. Although vigilance is warranted, the evidence today is clear: current default rates are far from concerning, liquidity is available, and private credit markets are functioning as designed. Rather than running for the hills, we’ll continue to closely monitor these assets and evaluate opportunities in the context of your entire portfolio.

KEY TAKEAWAYS

Gold at All-Time Highs:
Should It Have a Place in Your Portfolio?

Could the U.S. Dollar Lose Its Dominance?
It Did Once Before.

The U.S. currency’s rise and fall from prominence in the early 20th century offers
lessons for today’s political leaders.

By Barry Eichengreen
Sept. 11, 2025 at 10:00 am ET

Is the U.S. dollar’s position as the world’s reserve currency on shaky ground?

Some people think so, pointing to President Trump’s tariffs, America’s growing debt and its use of financial sanctions as a foreign-policy tool. Russia, barred from using the dollar in 2022, has shifted to using the Chinese renminbi for its international transactions. Other countries are exploring alternatives, as well, amid concerns that America’s outsize engagement in the global economy could end and debt will force the Federal Reserve to keep policy rates low, fueling inflation and dollar depreciation.

To many others, however, such claims seem far-fetched. The very fact that the U.S. currency is so widely used, and that the U.S. economy is so large, means its international role is secure.

But those espousing this Panglossian perspective forget that the dollar lost its primacy once before. It is a story worth retelling.

The dollar’s rise

The dollar wasn’t used internationally at all before World War I, when Britain’s pound sterling was the world’s currency. U.S. banks weren’t permitted to branch abroad and America had no central bank to backstop its financial markets.

That changed following passage of the Federal Reserve Act in 1913, which created that central bank and permitted American commercial banks to branch overseas.

The Fed’s founders, who needed to overcome Americans’ deep-seated aversion to concentrated financial power, had various motivations for wanting to create a new U.S. banking system. Carter Glass of Virginia, the crusty, self-styled financial expert in the U.S. House and co-sponsor of the Glass-Owen Federal Reserve bill, sought a decentralized system of public banks to provide credit to financially underserved Southerners. Nelson Aldrichof Rhode Island, influential chairman of the Senate Finance Committee, wanted a European style central bank, along the lines of
the Bank of England or the German Reichsbank, to mitigate financial crises.

For Paul Warburg, the cerebral, mustachioed German-American banker and one of the country’s most influential financial commentators, America’s dependence on sterling was a competitive disadvantage because it forced U.S. exporters to source trade credit abroad and shoulder exchange rate risk. Warburg lobbied for a central bank to make a market in dollar trade credits, essentially short-term IOUs that function as a promise of future payment. Warburg’s bank would stand ready to buy those credits, known as trade acceptances, at a preset price, making their cost and availability steady and predictable and allowing U.S. importers and exporters to use the dollar to finance their trade.

Warburg’s vision became reality when he accompanied Aldrich to a secret meeting in 1910 on Jekyll Island, off the coast of Georgia, where a group of prominent bankers hammered out the essentials of the Federal Reserve Act. President Woodrow Wilson appointed Warburg to the Federal Reserve Board, a perch from which he encouraged the Fed to support the nascent dollar credit market. Warburg advocated relaxing restrictions on the types of credits the Fed could purchase or discount, giving the central bank a role in financing not just merchandise trade, but purely financial transactions such as short-term loans and then dollar acceptances originated by foreign banks, as well. To further promote the market, Warburg in 1919 founded the American Acceptance Council to be a policy advocate for the industry.

In 1921, he formed the International Acceptance Bank, under whose umbrella a consortium of banks provided dollar finance for foreign trade.

By the late 1920s, largely through the efforts of this one man, New York had become the leading source of trade credit, and the dollar had supplanted sterling as the leading international currency. To be sure, Warburg’s efforts were supported by favorable structural conditions. The U.S. was the single largest economy from 1880. It became the leading national exporter in 1913. After World War I it had the largest financial markets, and it was the leading source of foreign loans. Thus, there was nothing paradoxical about the dollar’s rise—other than how long it had taken to get there.

The dollar’s fall

But what was gained could equally be lost. Starting in 1929, with the onset of the Great Depression, U.S. imports and exports fell. The Smoot-Hawley Tariff and the foreign retaliation that followed dealt trade another blow.

Three devastating financial crises disrupted the flow of finance and discouraged importers and exporters from relying on the U.S. banking system.

At this time, a third of all outstanding dollar acceptance paper held by U.S. banks and the Federal Reserve had originated abroad, mostly in Germany. In the aftermath of hyper inflation in 1922-23, the German public remained understandably reluctant to entrust its savings to domestic banks. Those cash-strapped banks lent to German importers and exporters only at double-digit interest rates. American banks, flush with funds and finding those rates irresistible, provided trade credit to German banks, which passed it on to German firms. The dollar acceptance market was now underwriting the transactions of foreign, as well as American, merchants and producers, signifying the U.S. dollar’s greatly expanded international role.

It all came tumbling down when distressed U.S. banks stopped lending. The German government responded with a moratorium on the country’s debts, including its acceptance credits. U.S. banks, including the Federal Reserve Banks, were left holding the bag. That is to say, they were left holding potentially worthless foreign acceptance paper.

The Fed refused to step in and sustain the market, compounding the problem. The sharp decline in the share of dollar acceptances purchased by the Reserve Banks spawned an equally sharp decline in the value of acceptances issued in the U.S. By 1934 the value of dollar acceptances had fallen to barely half their sterling equivalent.

Why was the dollar’s international position allowed to erode so dramatically?

First, personnel mattered. Benjamin Strong, the influential governor of the Federal Reserve Bank of New York,was a confidant of Warburg, arguably his dearest friend. A die-hard internationalist, Strong appreciated the role of the Fed in supporting the global dollar. Strong died from tuberculosis in His successor, George Harrison, was less attuned to the need to support the market in dollar trade credits.

Second, politics mattered. Glass had ascended to the Senate, where he chaired the influential Subcommittee on Banking and Currency. Glass blamed the Wall Street boom and bust on lax Fed regulations, adopted at Warburg’s insistence, and on Strong’s hyperactive support of the dollar acceptance market. Their actions, in his view, had fueled reckless speculation leading to the financial collapse, a view echoed by President Herbert Hoover. Glass now pressured the Fed to limit its purchases to acceptances financing merchandise trade. These “real bills” were safely collateralized by underlying merchandise, so they were guaranteed to perform. And because they financed legitimate economic activity, discounting them wouldn’t fan financial speculation.

Sensitive to the criticism, the Reserve Banks curtailed their operations. Commercial banks, uncertain now about whether the central bank would guarantee the liquidity of the market, grew more reluctant to purchase acceptances. Eventually, America recovered from the Great Depression. Its once vital international acceptance market didn’t.

It wasn’t until after World War II that the dollar became the leading global currency once again, in effect by default since the U.S. economy was the only one left standing. The Fed, having been chastened by the earlier experience, now acknowledged its responsibility to act as lender and liquidity provider of last resort, and thereby to promote and sustain the dollar’s dominant international role. That led to a remarkable streak of financial stability in the quarter-century following the war.

The lessons for 2025 are clear. The dollar’s international primacy isn’t eternal. To be sustained, it has to be actively fostered and preserved. It must be supported by competent officials. An astute, experienced Federal Reserve head is key. Politicians interfere at their peril.

ALL TIME HIGHS AREN’T NECCESSARILY A WARNING

When markets reach all-time highs, many feel nervous. Yet history emphasizes why staying fully invested over the long term makes sense.

Since 1950, the S&P 500 has hit over 1,300 all-time highs, accounting for roughly 7% of trading days. An investor avoiding investing during these time periods would be leaving serious money on the table. Notably, 29% of these highs acted as new “floors,” meaning the market never fell more than 5% afterward.³ In other words, time invested in the market is far more valuable than any attempt at outsmarting it.

Staying fully invested means you benefit from compounding growth and avoid missing out on the market’s strongest days – often clustered around highs. Rather than holding back, being invested through peaks and valleys has proven to be a winning long-term approach. All-time highs are not exit signals – they’re reminders of markets’ enduring upward path.

Figure 2

ALL TIME HIGHS AND MARKET FLOORS
S&P 500 Price Index, Daily, 1950-today

Five Key Provisions
of New Tax Law Affecting Estate Planning

IMPLICATIONS OF THE CHANGES MADE BY THE ONE BIG BEAUTIFUL BILL ACT.

Kim Kamin, Les Carter
July 14, 2025

On July 4, 2025, President Donald Trump signed into law the nearly 900-page One Big Beautiful Bill, a comprehensive package of tax cuts and fiscal policy changes. The bill includes significant modifications to individual, estate and business tax provisions. Several aspects of the bill may have a meaningful impact on tax and estate planning strategies.

Transfer Tax Exemptions Increased

Provision: The estate, gift and generation-skipping transfer (GST) tax exemptions, currently $13.99 million per person, were scheduled to be cut in half next year. The bill instead increases the base exemption to $15 million per person beginning in 2026 ($30 million per couple) and continues annual adjustments for inflation.

Implications: With no scheduled sunset, the increased exemption provides additional transfer opportunities and benefits for clients. For most ultra-high-net-worth clients, lifetime gifting advice should remain the same as it was prior to the bill. While lifetime gifting strategies still offer meaningful benefits, clients with smaller estates may now also focus more on income tax planning, including strategies that preserve basis step-up at death.

SALT Deduction Increased 

Provision: For tax years 2025 through 2029, the state and local tax (SALT) deduction cap is raised to $40,000 per household, with this $40,000 limit phasing out for households with more than $500,000 in adjusted gross income (AGI). Beginning in 2026, the $40,000 cap increases 1% annually. In 2030, the cap returns to its current $10,000 level enacted in the 2017 Tax Cuts and Jobs Act (the TCJA).

Implications: Taxpayers with AGI below $500,000 may benefit from accelerating SALT payments, recognizing income strategically, or bunching deductible expenses into the 2025–2029 window. For those near or above the income phase-out threshold, income-spreading strategies,  such as the use of multiple non-grantor trusts, may help preserve deductibility. These structures can potentially multiply the benefit of the increased deduction before the cap reverts to $10,000 in 2030.

Income Tax Rates Established under the TCJA Preserved

Provision: The bill locks in the lower income tax brackets enacted by the TCJA, which were originally set to expire after 2025. More specifically, the top marginal rate remains at 37% (rather than reverting to 39.6%). The broader bracket ranges, standard deduction expansion and compressed rate structure remain in place with no scheduled sunset.

Implications: With the lower TCJA rates now continued, taxpayers can build long-term income recognition, charitable giving and trust distribution strategies with more confidence about marginal rate exposure. Families considering a Roth conversion may benefit from the certainty of the lower brackets, enabling them to convert at a reduced tax cost or bunch income into low-rate years without concern about a post-2025 rate increase.

QSBS Election Benefits Expanded

Provision: The bill enhances the benefits of Internal Revenue Code Section 1202’s qualified small business stock (QSBS) election by shortening the required holding period for partial gain exclusions and increasing eligibility thresholds. Taxpayers can now exclude 50% of gain after three years, 75% after four years and 100% after five years, while the lifetime gain exclusion cap increases to $15 million per issuer (up from $10 million), and the corporate asset threshold rises to $75 million, both indexed for inflation starting in 2027.

Implications: These changes enhance the attractiveness of QSBS treatment for early-stage C corporation (C corp) investments, offering shorter holding periods for partial exclusions and a higher lifetime cap. Investors should review current and prospective QSBS holdings, assess eligibility based on the new asset threshold and consider how entity structure may impact qualification. The expanded benefits may also tilt the balance toward C corp status in certain situations where pass-through treatment was previously preferred.

QBI Deduction Preserved

Provision: The bill continues the 20% qualified business income (QBI) deduction, repealing the sunset provision that would have eliminated the deduction after 2025. This deduction allows owners of certain pass-through businesses, such as sole proprietorships, partnerships, S corporations and some trusts, to deduct up to 20% of their qualified business income, effectively reducing their taxable income and the marginal rate applied to it.

Implications: With the deduction scheduled to continue, individuals with significant pass-through income can plan with greater certainty. Strategic income timing, aggregation elections and use of non-grantor trusts may continue to help preserve QBI eligibility. For clients engaged in specified service trades or businesses, proactive planning remains essential due to ongoing phase-out limitations based on income.

Additional Items of Note

• Trump accounts. Annual contributions up to $5,000 are permitted to a so-called “Trump Account” set up for an individual under 18 years old. These accounts provide for tax-free growth and withdrawals if used for qualifying purposes (for example, first-time home purchase). Certain income limits do apply. For individuals born between 2025 and 2028, Treasury will provide a one-time $1,000 contribution to an account for that individual.
• Scholarship tax credits. Individuals who fund scholarships through approved nonprofit organizations receive a federal tax credit, effectively incentivizing private educational giving.
• Charitable giving limits. Before a taxpayer can take a charitable deduction, a 0.5% AGI floor applies, and the cap on the deductibility of cash contributions to qualified charities was increased indefinitely to 60% of AGI.
• No tax on tips or overtime. Eligible workers can deduct up to $25,000 per year in tip income (regardless of filing status) and up to $12,500 of qualified overtime pay ($25,000 per year if filing jointly), in each case subject to certain qualifications, income phase-outs and a 2028 sunset.
• Car loan interest. Individuals may deduct up to $10,000 in auto loan interest for personal-use vehicles assembled in the United States. This deduction phases out above certain income levels and sunsets in 2028.
• 2/37 limitation on itemized deductions. All itemized deductions are reduced by 2/37 of the lesser of: (1) the total itemized deductions; or (2) the amount of taxable income in excess of the top 37% bracket threshold. This doesn’t apply to determining the deduction for qualified business income from pass-through entities.

Tax-Planning Opportunities

The bill’s elimination of sunset and targeted expansions offer meaningful tax-planning opportunities, particularly for high-net-worth individuals and families. Some provisions, like the expanded SALT deduction, are time-sensitive.

Posted on wealthmanagement.com

Tariffs Explained:
What They Do, Why They Matter, and Who They Impact

By Hillary Chabot
February 20, 2025

As talk of tariffs, global trading, and domestic industry dominate the headlines, we asked Babson College Associate Professor of Economics Joshua Stillwagon to help break down the basics behind this international trade tactic—what are tariffs, why are they implemented, and who do they impact?

What Are Tariffs?

“Tariffs are basically a tax on imported goods,” Stillwagon said. Tariffs can take various forms, such as a percentage of the imported goods’ value or a fixed fee per unit. While tariffs have been used for centuries, their effectiveness and economic consequences remain debated among economists and policymakers.

“Although economists are generally negative on tariffs, targeted tariffs for certain consumer products could be rational in the short term to prevent ‘dumping’ by other countries, which may threaten the existence of our domestic industry,” Stillwagon explained. Dumping occurs when a company sells a product in another country at a lower price than in its home market.

Why Implement Tariffs?

Governments impose tariffs for multiple reasons, said Stillwagon, who also serves as chair of Babson’s Economic Division. The primary motivations include:

PROTECTING DOMESTIC INDUSTRIES
One of the most cited reasons for implementing tariffs is to encourage domestic production by making imported goods more expensive. This can increase demand for locally produced alternatives, boosting profits and growth in the protected industry, at a cost to consumers.

Stillwagon noted that their effectiveness depends on how they are structured.

“If you want to boost production in the U.S., it’s better to have a more targeted approach,” Stillwagon cautioned. “Broad tariffs on essential materials like steel and aluminum increase costs for numerous industries, which would ultimately harm economic growth.

GENERATING GOVERNMENT REVENUE
Tariffs can serve as a source of income for the government, as companies importing goods must pay taxes upon entry. However, if tariffs significantly reduce imports, the revenue generated from them may diminish over time.

TRADE NEGOTIATION LEVERAGE
Tariffs can be used as a bargaining tool to encourage foreign governments to reduce their own tariffs or eliminate unfair trade practices, such as subsidies that allow foreign industries to sell products at artificially low prices in global markets.

“The best argument for our tariffs is to use them as leverage to get other countries to remove their own tariffs or unfair trade practices,” Stillwagon said.

Who Do Tariffs Impact?

While tariffs are designed to protect domestic industries, their effects can be widespread, Stillwagon said. The key groups affected by tariffs include:

DOMESTIC COMPANIES
Competition from imports can hurt domestic companies, leading to layoffs or shipping work overseas to cut costs. The recent 25% tariff imposed on foreign steel and aluminum will help U.S. steel and aluminum
industries, for example.

INFANT INDUSTRIES
This type of tariff helps to foster growth in new or young industries “until they are more established and viable in the face of international competition,” Stillwagon said. For example, a country that imports cars might impose tariffs while they create a domestic auto industry.

IMPORTING FIRMS AND INDUSTRIES
Companies that rely on foreign materials or components face increased costs due to tariffs. For example, U.S. businesses that source steel, aluminum, or auto parts from abroad must pay additional taxes when these goods cross the border.

“Tariffs on ‘upstream inputs’ like steel and aluminum will raise production costs for all the industries that need those materials,” Stillwagon said. “This will have some effect on raising inflation and reducing GDP growth compared to otherwise.”

CONSUMERS
As importing businesses pass on tariff-related costs, consumers often experience higher prices on everyday goods. This is especially true for essential items that are perishable or can’t be substituted, such as food and fuel.

Retaliatory Tariffs and Economic Uncertainty

When a country imposes tariffs, affected trading partners may respond with their own tariffs on exported goods. In 2018, China, Canada and the EU responded by targeting politically-important sectors like American agricultural products, impacting U.S. farmers and food producers. Retaliatory tariffs can shrink export markets, leading to lower sales and potential job losses in affected industries, Stillwagon said.

Another consequence of the tariffs is heightened economic uncertainty, which may cause businesses to delay investments and expansion.

“Economic uncertainty discourages business investments,” Stillwagon noted. “Recent GDP data already show weak investment as a drag on growth. Without clear trade policies, companies may delay expansion.”

Tips for Preventing Fraud

Fraud and cybercrime are serious threats—but you can take practical steps to protect your identity and assets. To reduce your exposure to fraud and reinforce your eff orts, Schwab has mechanisms in place to help safeguard your data and accounts.

You can also have an impact on safeguarding your information and assets by following these guidelines and applying caution when sharing information and executing transactions. This checklist summarizes common cyber fraud tactics, along with tips, best practices, and actions to take if you suspect a breach.

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THE BENEFITS OF
INTERNATIONAL DIVERSIFICATION

Investing in stock markets across the globe offers exposure to a broader range of economies, industries, and sectors than are found in the US market alone. As the saying goes, however, there’s no such thing as a free lunch. The diversification that’s provided by investing internationally often helps over the long term, but there’s no guarantee that these benefits will materialize in any specific period.

A striking example of a period of time when international diversification helped tremendously was during what is often called “the lost decade” for US equities. Pictured in Figure 2, US stocks generated virtually no returns during this ten year stretch from 2000 through 2009, while international markets delivered solid gains. A portfolio consisting only of domestic US equities during this time period would’ve suffered heavily.

In addition to the diversification provided by investing in the largest international developed countries, emerging markets offer access to fast-growing economies that tend to have lower correlations with the US market. Although emerging markets can be more volatile, they also have the potential for higher returns, which, when combined with US and international developed stocks, can help reduce overall portfolio risk.

These diversification benefits can come with a price tag from time to time, however. For the ten years ending September 30th, the US has outperformed International Developed and Emerging Markets indices. Much of this underperformance can be attributed to the dominance of US mega-cap technology stocks, such as the Magnificent 7, which have driven much of the US market’s growth.

Despite the recent lag in International and Emerging Market stock performance, they remain vital components of a well-diversified portfolio. By maintaining exposure to a broad range of markets, investors can better navigate periods of US market underperformance and benefit from the growth of economies outside the US.

‘Uncertainty is underrated’:
Here’s the real reason markets reward
those who stick around

By David Booth
June 24, 2024

David Booth is the founder and chairman of Dimensional Fund Advisors. This article is not intended as investment advice.

Given all that is going on in the world, investors have questions. Will the Federal Reserve cut interest rates, and if so, by how much? Who will win the U.S. presidential election, and will it impact markets? How will global events affect my family and finances? A lot remains uncertain, which can naturally make investors uneasy.

For many people, uncertainty is something to avoid or at least mitigate. People often talk more about the downside to uncertainty than its upside. There’s even a term, loss aversion, that reflects how a loss can feel more painful than a gain of an equal amount can feel rewarding.

However, I have a different view: Uncertainty is underrated. Without it, there would be no surprises, no joy in watching sports, and no 10% average annualized return on the stock market over the past century.

All investments involve risk—there is no guarantee of success. Investors can be rewarded for taking on the risk of not knowing exactly how things will play out. If there was no uncertainty, returns would be predictable and there would be no difference between putting your money in a savings account and investing it in the stock market.

Th ink back to the beginning of the pandemic. At the end of March 2020, the S&P 500 Index was down nearly 20% for the year. Yet investors who stayed in the market were rewarded. At the end of 2020, the S&P 500 Index was up 18.4% for the year, a 38% turnaround from its March lows. March 2020 was a scary time for almost everyone. No one knew what was going to happen. Yet even in those dark moments, I had faith in human ingenuity. When people are met with challenges, they are resilient and work to solve them. Companies are no different. Investing in the stock market means investing in the power of human ingenuity to adapt and innovate.

Because of uncertainty, life is one cost benefit analysis aft er another, and we have no choice but to manage risk. At the extremes, some people may try to completely ignore risk, while others might try to eliminate it. Most of us fall somewhere in the middle.

We manage risk with our health, work, family, and just about every other aspect of our lives—including investing—because while few things are certain, we still have to make decisions big and small. For example, we can’t control the weather, but we can carry an umbrella if it looks like it might rain. And while we can’t predict stock market returns, we can manage the risk in our investment portfolios.

What to avoid

One way of managing risk is to eliminate some of the things you shouldn’t do. When you want to improve your health, you might eliminate fried foods, soda, and sweets from your diet, which can increase your chance of a healthier outcome. It’s the same with investing. Eliminate bad habits, like attempting to predict the unpredictable by trying to time the market or pick winning stocks.

Think of everything that has happened in the past 25 years, including:

• The dot-com bubble.
• 9/11.
• The Global Financial Crisis
  and Great Recession.
• The COVID-19 pandemic.

It would be natural to want to time when to exit and re-enter the market. To put the implications of doing so into perspective, consider a hypothetical $1,000 investment in the Russell 3000 Index made at the beginning of 1999. This turns into $6,449 for the 25 years ending Dec. 31, 2023. Over that same period, if you missed the Russell 3000’s best week, which ended Nov. 28, 2008, the value shrinks to $5,382. Miss the three best months, which ended Jun. 22, 2020, and the total return dwindles to $4,546. See what I mean?

What to do

Positive ways of dealing with risk can help you potentially capture the benefits of what scientific research has shown us. With health, that means exercising more, getting regular checkups, and eating more fruits and vegetables. With investing, that means ensuring our portfolios are diversified across regions and asset classes. While it doesn’t guarantee making a profit or averting a loss, diversification allows us to reduce our risk while potentially capturing the returns of the market.

Since we know risk is unavoidable—and it’s the source of investment returns—you want to find the amount of risk that is right for you. For example, Treasury bills are considered a relatively safe investing asset whose prices don’t fluctuate as much as stock prices. However, Treasurys have provided, on average, a lower return than the stock market. Those tradeoffs can be weighed against your specific needs and preferences, and it’s always good to be prepared for a range of outcomes. The more committed you are to a philosophy and a plan you can count on when you are experiencing the ups and downs of uncertainty, the more likely you are to succeed as a long-term investor.

You are already better at this than you think.

You know more about investing than you think you do, because investing is all about risk and reward, just like every other part of your life. In investing and in life, some years are better than others, but the important thing is to be able to persevere so you’re ready for what comes next. That’s why I see uncertainty as a positive force and have faith in the ability of people to find better ways to manage risk. I’ve worked with thousands of investors during my five decades in finance and seen how, when they manage risk better, they live a better life. Instead of trying to predict your future, plan, adapt, and figure out the most sensible solutions for you.

You may not only be underestimating uncertainty—you may also be underestimating the positive impact of embracing it.

Figure 1

STUDIES ON STOCK CONCENTRATION

NEW TAX SAVING STRATEGY

TAKES OFF

While both death and taxes remain inevitable, our new tax-saving strategy can help delay at least one. We have been using individual stock portfolios to aggressively harvest tax losses for some 20 years (the strategy has just recently made its way to the mass market under the moniker “Direct Indexing”). Our new Flex strategy, which we began to roll out at the beginning of this year, represents the latest and most advanced effort to maximize after-tax returns. Unlike previous strategies that involve swapping stocks when they fall below their original cost basis, Flex takes tax loss harvesting to a whole new level.

By using margin and shorting (which may sound intimidating), we buy favorable stocks and short less favorable stocks. Definitionally, we benefit when stocks we’re long go up in price and when stocks we’re short go down in price. Thus, we’re able to capture losses whether stocks go up or down and later use them to offset capital gains which reduces our ultimate tax bill.

Figure 2 compares the live results of this strategy to the target US market return of the Russell 3000 and even shows the tax benefits. Results will vary, but Flex can significantly benefit clients with liquidity events (think the sale of a company or property), minimize portfolio capital gains taxes, and enhance the effectiveness of charitable giving. Although this strategy is not appropriate for all clients, in the right situation it’s designed to significantly reduce yearly tax bills.

Figure 2

DESIGNED TO PERFORM BEFORE AND AFTER TAXES
Flex 145 All Cap Equity Composite Net of Fee Performance, as of March 31, 2024

Tax Smart Strategies for Account Withdrawals

Understanding the best way to tap your IRAs and other accounts
can help you preserve your savings and lower your tax bill.

By Sandra Block
June 19, 2024

One of the upsides of retirement is that for the first time in years, you have control over your time. If you want to spend the afternoon watching Bonanza reruns, well, no one is going to stop you.

Retirement also gives you more command over your money. While you’re working, you have limited control over how often or how much you’re paid, which limits your ability to lower your taxes. But if you’re drawing retirement income from a combination of different types of accounts, you can control not only the amount you withdraw but also the sources of those withdrawals — and that could have a big impact on your taxes now and in the future.

Conventional wisdom has long held that retirees should take money from their taxable brokerage accounts first, followed by traditional IRAs and other tax-deferred accounts, with Roth IRAs and Roth 401(k)s coming last. The logic behind this strategy is that it gives your tax-advantaged accounts more time to grow. Money in tax-deferred accounts isn’t taxed until you take withdrawals, and withdrawals from a Roth are tax-free as long as you’re 59 1/2 or older and have owned the account for at least five years.

But in recent years, some retirement experts have questioned whether this is the most effective way to lower taxes on your retirement income and preserve your savings for your later years. Postponing withdrawals from your tax-deferred accounts could eventually lead to large, taxable required minimum distributions (RMDs currently start at age 73).

And since those withdrawals are taxed at ordinary income tax rates, which range from 10% to 37%, large distributions could push you into a higher tax bracket and trigger Medicare high-income surcharges, says Wade Pfau, professor of retirement income at the American College of Financial Services and author of Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success.

Roger Young, a certified financial planner and thought leadership director for T. Rowe Price, agrees. The conventional withdrawal sequence “bunches a lot of taxable income in the middle period, where pretty much all of your income is taxable,” he says.

Retirees who have a mix of accounts could generate income more tax-efficiently by withdrawing from a combination of taxable and tax-deferred accounts, as well as making strategic conversions to Roth accounts, while remaining in a low tax bracket, Pfau says. One way to accomplish this goal is to withdraw enough from your taxable accounts to cover spending needs and income taxes. After that, calculate how much you can withdraw from your tax-deferred accounts and convert to a Roth while remaining within your desired tax bracket.

In 2024, a married couple who fi les jointly can have up to $94,300 in taxable income and fall within the 12% tax bracket; for singles, the cutoff is $47,150. These thresholds are close to the points at which taxpayers can qualify for a 0% tax rate on long- term capital gains and qualified dividends (assets held for more than a year are subject to rates for long-term gains). In 2024, the 0% rate applies to capital gains and qualified dividends for singles with taxable income up to $47,025 and married couples with joint taxable income up to $94,050.

Taking strategic withdrawals from a mix of taxable and tax-deferred accounts while remaining within these thresholds provides two benefits. You’ll pay taxes on your tax-deferred withdrawals at a low rate and reduce the size of those accounts, which will shrink your RMDs. You may also qualify for the 0% capital gains rate on income from your taxable accounts.

Meanwhile, you’ll pay taxes on conversions from a traditional IRA to a Roth at a low rate, which will increase the amount of tax-free income you’ll have available in later years. Ideally, you should use assets from your brokerage or other taxable accounts to pay taxes on the conversions, Pfau says.

If you postpone Roth conversions until you’ve depleted those accounts, you may have to use funds from your IRA to pay the tax bill. That’s not the end of the world, he says, because you’ll still benefit from having future tax-free income (and if you’re 59 1/2 or older, you won’t pay a 10% early-withdrawal penalty on those distributions). But it reduces the amount of money you’ll be able to invest in the Roth.

Taxes on Social Security

Converting funds in your traditional IRAs to a Roth can help reduce your taxable income later in life because, ideally, a large percentage of your withdrawals will come from your Roth. This will help you avoid what Pfau calls the Social Security “tax torpedo,” which occurs when up to 85% of your benefits are taxed.

The formula for calculating tax on Social Security benefits is based on what Social Security defines as your provisional income (sometimes referred to as combined income), which is based on half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, including withdrawals from traditional tax-deferred accounts; dividends, interest and capital gains from taxable investment accounts; and interest from municipal bonds.

If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50% of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85% of your benefits will be taxable.

These thresholds aren’t adjusted for inflation, which means the percentage of retirees who pay taxes on their benefits has increased dramatically since the tax was signed into law more than 30 years ago. More than half of retirees pay taxes on a portion of their Social Security benefits, according to the Center for Retirement Research at Boston College.

Withdrawals from a Roth aren’t included in your provisional income, so increasing the size of your Roth accounts through strategic conversions can help lower taxes on your benefits. If you’re able to delay filing for Social Security until age 70, which will maximize the amount of your monthly payouts, you’ll have more time to reduce the size of your tax-deferred accounts and convert some of your funds to a Roth, T. Rowe Price’s Young says.

Charitable Giving

If you plan to give funds in your tax-deferred accounts to charity, you may not need to accelerate certain withdrawals as much as you would otherwise.

One strategy that can reduce your RMDs — and your tax bill — is to make qualified charitable distributions (QCDs), which are donations made directly from your IRA to qualified charities. You can make a QCD as early as age 70 1/2, but when you reach the age at which you’re required to take distributions, the charitable distribution will count toward your RMD.

Although a QCD isn’t deductible, it will reduce your adjusted gross income, which will in turn reduce the provisional income used to calculate taxes on your Social Security benefits. In 2024, you can donate up to $105,000 directly from your IRA to a qualified charity.

Alternatively, if you’re worried about giving away money you may need for long-term care or other late-in-life expenses, you can leave funds in your IRA to charity. The charity won’t have to pay taxes on the money, and you can leave more tax-friendly assets to your heirs. But this won’t absolve you from taking RMDs and paying taxes on those withdrawals while you’re still alive.

Your Estate and Taxes

Shifting more of your assets to Roth accounts won’t just lower your taxes in your later years. It could also benefit your heirs if they end up inheriting money in those accounts.

Under the SECURE Act of 2019, most adult children and other non-spouse heirs who inherit a traditional IRA or other tax- deferred account from an owner who died on or after January 1, 2020, have two options: Take a lump sum and pay taxes on the entire amount, or transfer it to an inherited IRA and deplete the account within 10 years of the death of the original owner.

Depending on whether the original owner was taking RMDs when he or she died, the heirs may also have to take yearly withdrawals based on their life expectancy, which could mean paying taxes during their highest-earning years. (Spouses still have the option of rolling inherited IRAs into their own IRAs.) Because of confusion about the rules, the IRS has waived the RMD requirement for non-spouse heirs the past few years and is doing so again for 2024.

The 10-year rule also applies to inherited Roth IRAs, but heirs aren’t required to pay taxes on the withdrawals or to take RMDs. That gives them plenty of flexibility, including the ability to wait until year 10 to deplete the account, thereby taking advantage of more than a decade of tax-free growth.

If you have a large brokerage account with significant appreciation, you may want to consider preserving some of those assets for your heirs. Under current tax law, inherited investments receive a “step-up” in their cost basis to the current fair market value when the original owner dies. If your heirs turn around and sell those investments right away, they won’t pay tax on any gains, no matter how much the investments have increased in value since you purchased them.

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance.