No shortage of financial news in July, folks. Here's a round of up a few things you should know about, and some actions you can take.
Fed hikes rates...now what?
This one has been in the news a lot, so here's the deal, in plain English:
In order to not set the economy into a COVID-sparked downward spiral, the Fed made it nearly free to borrow money to encourage people to spend. Disaster averted, the economy didn't disintegrate. We're all good now, so the days of 0% APR on your car or 2.75% on your mortgage are gone. Rates are going back up to more reasonable, normal ranges. For context, before The Great Recession (2007-2009) rates got up to 5.25%. In the early 80s we were looking at a whopping 22%.
With Wednesday's hike of 75 basis points (3/4 of a percentage point) we are at 2.5%. This is right where we were in 2019, before we ever dreamed we'd be swabbing our kids' noses so we could send them to daycare or detailing our cold symptoms to coworkers on Zoom calls. Analysts think we'll end the year somewhere around 3.75%.
TL;DR - It's interesting to follow, but there's no need to panic. Yes, things will change. But all of this is cyclical, and to be expected. It'd be weird if it weren't happening.
Remember those student loans?
The average college grad has $30k of student loan debt and an average monthly payment of almost $400. A lot of them have probably forgotten about all of that because student loan payments have been on pause since March 2020 due to COVID.
There are two years worth of grads who have entered the work force, signed leases, and financed cars having never paid a single dime on their student loans or included this expense in their budgets. As you know, housing prices aren't exactly affordable. How many students have overspent on housing during this time where they weren't obligated to pay student loans and are now going to face a serious budgeting problem to try to make ends meet?
The good news is, there's likely a bit more time. Borrowers are currently set to resume payments on August 31, after six extensions. BUT, Biden told the loan servicing companies this week to hold off on sending information to borrowers. So the working theory is is that there will be yet another delay in those payments coming due.
So, what should students do? Students loan borrowers should use this time to start living as though the loans were due. Take the $400/month payment and set it aside and make whatever adjustments are needed in other areas so that this monthly bill becomes an expected part of the budget now vs waiting until the first payment become due.
Don't let the Backdoor hit you on your way out.
A Roth IRA allows investors to pay tax on their investment now instead of later (or if you are under a certain income level, avoid tax altogether.) Why would you do that? Well, if you're not going to use the money for a while and are expecting significant growth it can be cheaper to pay tax on today's smaller amount. Or if you believe taxes will be higher in the future, a Roth IRA strategy can minimize your tax bill by paying now when tax rates are historically low.
The problem is, if you make too much money you can't access a Roth. That is, unless you use the "Backdoor" strategy, in which you contribute to a Traditional IRA (using taxed money) and then convert that into a Roth. Your contribution grows tax free and there's no required distribution at age 72 triggering more taxes.
Sound too good to be true? Yeah, Washington thought so, too. But, as most things in politics, there's rarely consensus and the Build Back Better legislation, which would have banned this practice, has died in Senate.
Backdoor conversions are safe for now. That can always change but with everything going on, it seems most analysts don't feel like this is a big priority for the government right now. My take? Typically politicians don't like to do things to anger particular segments of the population leading into an election. I think they'll leave it alone.
If it does comes up again, it's highly unlikely that they would retroactively banish the practice, meaning your completed conversions would be safe.
Best Practice: Regardless of legislation, this is a good reminder to take a look at all your old 401ks, all of your IRAs and your current 401k contribution strategy and make sure everything is optimized because things can and do change.
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