Finance 101: December 2023

In December the financial advisors at Ruedi Wealth Management wrapped up the year with four more columns for The News-Gazette’s business extra section. Make sure to look for them every Sunday, but in case you missed any in December all four are below.

Chasing Magnificence

Paul Ruedi

One of the biggest stories of 2023 was the performance of the “Magnificent Seven.” These seven companies (Apple, Alphabet, Amazon, Microsoft, Nvidia, Tesla, and Meta platforms) experienced such a strong burst of performance this year it was nothing short of magnificent.

Though this performance could tempt investors to further pile into this handful of dominant stocks, is that a good idea? Should we expect the magnificent performance to persist into the future?

To answer this question, Dimensional Fund Advisors decided to look at the performance of companies that became one of the top 10 largest in America as measured by their market cap. It was yet another cautionary tale about how investors who chase performance are likely to be disappointed.

When they looked at the data from January of 1927 to December of 2022, they found that these companies experienced significant outperformance leading up to the time they began their first calendar year in the top 10. These companies experienced 12.1% higher annualized returns than the S&P 500 index over the 10-year period leading up to joining the top 10.

If you look at the three years leading up to entering the list, the performance difference is even larger, as companies outperformed the S&P 500 by 27% annualized! That is extreme outperformance. Strong performance that drives companies to join the list of top 10 stocks is nothing unusual. There have been many “magnificent” rises to these top spots in the past.

But what people often forget is the second half of the story: how those stocks perform after becoming one of the top 10. After all, that is the performance people are signing up for if they invest in these companies today.

Unfortunately, the returns going forward are much less magnificent. In the three years following their addition to the top 10 list these stocks outperform the S&P 500 by only 0.6%. Over the following 5 and 10 year periods they actually underperform the S&P 500 by -0.09% and -1.5% respectively.

Companies like the magnificent seven will come and go. Investors should avoid piling into them based on their record of past performance, as that performance isn’t likely to persist into the future. If you have trouble staying disciplined and are tempted to chase the performance of the dominant stocks of the day, you may want to talk to a financial advisor.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.

The Santa Claus Rally

Paul R. Ruedi, CFP®

As we approach the end of the year you will notice a piece of financial jargon start to show up in headlines: the “Santa Claus Rally.” The term Santa Claus Rally was originally coined in 1972 by Yale Hirsch. The founder of the Stock Trader’s Almanac, Hirsch noticed the tendency for the stock market to increase in the final five trading days of the year and the first two trading days of the next year. But how strong is this relationship, and is it something to make an investment strategy out of?

The most compelling data found for evidence of the existence of the Santa Claus Rally was produced by LPL Financial several years ago. When they looked through the data from 1950-2019 they found that the S&P 500 produced a positive return over those 7 days 77.9% of the time. This is a higher positive percentage than any other seven-day period throughout the year. So there really is some truth to this phenomenon, but why does it happen?

The simplest explanation is that the market is being boosted by an optimistic holiday spirit. Another explanation is that people are investing their holiday bonuses. Yet another explanation is that most tax-loss selling gets done in early December which beats down stock prices and leaves them primed to rally into the end of the year. Some people think the rally occurs because professional financial people, who are considered more likely to be bearish short-sellers, tend to go on vacation in late December, leaving bullish retail investors to push up prices. Nobody really seems to know for sure.

The more important question is, should investors try to make an investment strategy out of the information that the market is strong those seven days? Should investors keep money on the sidelines and only invest it during the Santa Claus Rally? That would cause them to miss out on the gains that take place throughout the year. Should investors perhaps use leverage or take on more stock risk during this period to increase returns? This would be risky as well, as the rally can fail to show up.

The most sensible solution is to remain a buy-and-hold investor and plan to enjoy the Santa Claus Rally whenever one occurs. It may not be as exciting as pursuing a strategy to time the market, but it will make sure you participate in any returns the market creates during the holiday season and the rest of the year as well. Those returns can provide a lifetime of holiday cheer.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

401(k) Hardship Withdrawals

Paul R. Ruedi, CFP®

401(k) hardship withdrawals enable a person to access some of the money in their 401(k) plan in the event of some sort of financial hardship. But this money is not without strings attached. Those who take 401(k) hardship withdrawals still have to pay taxes on any untaxed money in the distribution, and those under 59 ½ will usually pay a 10% early withdrawal penalty. Despite this, the number of people taking hardship withdrawals increased 36% in 2023 according to Bank of America.

Per the IRS website, a 401(k) hardship withdrawal can be taken due to an “immediate and heavy” financial need. Their website specifies that consumer purchases do not count as immediate and heavy financial needs, and in most cases credit card debt will not count either. However, it does state “A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.” Though you can’t use a hardship withdrawal to spend recklessly, it appears you can use it to correct problems that arise as a result of your own mistakes.

The IRS provides six “safe harbor” situations in which the withdrawal automatically applies as covering an immediate and heavy financial need. Those include medical expenses, costs related to the purchase of a home (but not a mortgage), tuition and certain educational expenses, payments to prevent an eviction or foreclosure on a primary residence, funeral expenses, and certain expenses relating to damage of a primary residence.

The ability to take a hardship withdrawal is completely at the discretion of the employer. Hardship costs will likely require documentation, and savers cannot withdraw more than the dollar amount of the hardship. In order to take a hardship withdrawal, savers usually must have exhausted all other options to distribute money or take a loan from the plan. They must include in writing that they have insufficient cash or other funds available to help with the hardship.

Taking a hardship withdrawal halts the compound growth of a portion of your retirement savings. You will have to pay taxes on any untaxed money eventually, but taking a hardship withdrawal requires you to pay them sooner. On top of that, you may have to pay early withdrawal fees.

As you can tell, there are a lot of downsides to taking a hardship withdrawal. But if the situation is dire and you really need to take one, you have to do what you have to do. If you are struggling with the decision to take a hardship withdrawal, I’d highly recommend talking to a financial planner.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

Investing vs. Speculating

Paul R. Ruedi, CFP®

There is a thin line that separates investing from speculation. Two people may buy the same stock and while one is investing, the other may be speculating. Though I’m not exactly sure where the line is drawn, there are usually two things that set them apart. Time horizon is one, but even more important is justification for buy and sell decisions.

Investors take a long-term approach. Instead of buying a stock, they view themselves as taking partial ownership of the actual business. They tend to be more focused on long-term buy-and-hold investing strategies with the idea that they are committing to a company or investment for the long haul, and will reap whatever dividends or returns the company produces over that time period.

Speculators, on the other hand, generally are looking to make money on large, short-term price swings. A speculator buys a stock not necessarily intending to commit to ownership of the company, but with the intention of riding a price swing and eventually selling it to someone who will be willing to pay more for it later.

This is the most common justification that allows speculators to abandon all sense, “I’ll just sell it to someone at a higher price later.” This is often called the “greater fool theory.” Other times they will often view themselves as knowing the “correct” price of a stock, and will sell it once the market gets smart and rises to the right price. Assuming the market is dumb now but will be smart later is a troublesome assumption at best.

There are many problems with speculation, not the least of which is that many people completely blow themselves up taking senseless risks with the intention to dump those investments on a greater fool later. Sometimes that bigger fool never shows up, and the fool is you. But investment performance aside, speculation as an “investment policy” is impossible to build a financial plan around.

When a portfolio is committed to buying and holding thousands of stocks for a long period of time, you can use what we understand about the nature of stock returns to build a financial plan around that portfolio. This is completely impossible for a speculator; you simply can’t build a plan around random investment picks and unpredictable buying and selling.

You can tell by the tone of the article I think long-term investing is a better idea for investors. If you find yourself making investment decisions that depend on finding a greater fool to bail you out later, you

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.