This issue of “Bernie’s Blog” comes to you from Tim Kriegel who is a CPA, as well as part of our LFS family.

This month we want to look at the tax proposals impacting individuals that have been floated by President Biden. We will keep our discussion to the major points and those that are more likely to impact our clients as there have been a lot of ideas discussed. From what we have been able to discern, even if Congress would pass tax legislation this year, the changes would not be effective until 2022. However, now is the time to start discussing and thinking about the possible implications.

Major potential changes:

• Top income tax rate on individuals increased from 37% to 39.6% for single filers with incomes above $452,700 (joint filers $509,300).
• Long term capital gains of taxpayers (single or joint) reporting $1 million or more income on their returns would pay capital gain taxes at a rate of 39.6% up from 20% today.
• The tax benefit of itemized deductions for those earning over $400,000 will be capped.
• FICA taxes would be imposed on wages above $400,000.
• The current Estate/Gift tax rate and exemption would remain unchanged.

One of the biggest potential items impacting our clients is the proposal to change how unrealized gains are taxed at death. The proposal eliminates the stepped-up cost basis on inherited assets upon death.

There are several exemptions which we will be glad to discuss when we meet.

The President’s proposals are a starting point and will not pass Congress as-is. They are bound to evolve, and compromises will be made, but we should all be aware of the ongoing discussions. The last discussion item will impact a lot of people.

Hi everyone. As you know, investment advisors are heavily regulated, which is a good thing, since the regulations are designed to protect you, our clients. Once per year, we are required to send you an updated copy of Part 2 of our ADV, aka our Firm Brochure and/or to provide you with a summary of material changes over the last year.

In the next few days, we will be emailing this document to those of you who are clients. Clients who prefer hard copy will receive document in the mail.

Two changes this year to make you aware of:

1. We are now being regulated directly by the Securities and Exchange Commission (SEC) rather than by the Secretaries of State of GA and NC. This change is due to the growth in our assets under management – thanks to all of you and a very good stock market.
2. There is a new SEC regulatory requirement called the Customer Relationship Summary (CRS). This document is designed to provide information to clients in a non-technical, simpler, and easier to read format. We will let you decide whether or not it really does that!

As always, feel free to send questions after you get the documents in the next few days.

And time for our annual financial literacy quiz!

As a reminder, financial literacy is defined as the ability to understand and effectively use financial skills and tools, which include personal financial management, investing and budgeting. Ongoing financial education of ourselves, and our children/grandchildren, is considered the backbone of financial literacy so we are furthering the cause by providing some fun and educational questions for you.

Spoiler alert, some of these questions refer to prior “Bernie’s Blog” posts, so feel free to look back as needed. Some questions have more than one right, or wrong, answer.

1. Where should I keep my emergency fund?

a. In 10 coffee cans in my backyard, to ensure proper diversification
b. In my checking account so I can get to it easily when I need it
c. In an online high yield savings account or short-term bond fund
d. In a high growth ETF for tax efficiency
e. No idea. Better call LFS

2. Why are my 2021 Required Minimum Distributions (RMDs) higher than I planned for?

a. What’s a required minimum distribution?
b. Because I/LFS did a lousy job planning
c. Because I didn’t take a RMD in 2020
d. Because the stock market ended 2020 at a record high
e. Because the government needs my tax dollars

3. How should I prepare for these higher RMDs?

a. What’s an RMD?
b. Sell the bonds in my IRA
c. Get a new accountant
d. Adjust my tax withholding
e. No idea. Better call LFS

4. When interest rates rise, what happens to bond prices?

a. They go up
b. They go down
c. They stay the same
d. They get indexed to bitcoin
e. No idea. Better call LFS

Easy part first… A SPAC is a “special purpose acquisition company” also sometimes known as a blank check company. Quite simply, a SPAC creates a way for a private company to go public/get money more easily and more quickly than by undertaking an IPO (initial public offering). In actuality, a SPAC is a shell company with no commercial purpose except to raise money through its own IPO in order to merge with/acquire a privately held company. These SPACs are created and owned by “sponsors” who are usually institutional investors, private equity or hedge funds, often with expertise in a specific industry.

Although SPACs have been around for decades, they became very popular in 2020 because of the economic uncertainty caused by the pandemic. SPAC mergers have created many well-known, now publicly held, companies, including Virgin Galactic, DraftKings, and Opendoor.

How does a SPAC actually work?

After the SPAC is created, the sponsors undertake their own IPO to get investors. Investors in a SPAC have no idea which privately held company will eventually be acquired, so they are essentially handing over money to SPAC sponsors, who also do not usually know which company they will be buying. A share in a SPAC usually sells for $10 and that share will ultimately be exchanged for a share in the acquired company, often with a right to buy additional shares at a discounted price. In general, a SPAC sponsor has two years to find a merger candidate and close the deal. If the deal isn’t closed in two years, the initial investment, plus a small interest payment, is returned to the SPAC shareholders.

Once a privately held merger candidate is identified and vetted, the SPAC shareholders vote to approve or deny the merger. If the merger is approved, the SPAC shares are exchanged for shares in the new company. The sponsors generally retain 20% equity in the public company.

What are the benefits and risks of SPACs for investors?

• Since SPAC shareholders have no real input into merger candidate selection, there is always a possibility that the company selected will be a company that investors do not like or an industry they do not want to participate in.
• There is also more risk for investors because there is much less due diligence required for a SPAC to merge with a privately held company, than there is for a privately held company to undertake its own IPO with the SEC requirements. However, that lack of SEC oversight means that the merger can be done in a matter of months, instead of the multiple years often required for an IPO, which also means the privately held company gets a cash infusion much more quickly.
• Historically, the biggest risk to SPACs has been the over-payment for the privately held company. Critics believe that since it’s not actually the sponsor’s money being spent to acquire, the valuation efforts done by the sponsors might be less robust. In truth, over the last 5 years, the returns from SPAC mergers have been significantly lower than the returns for traditional IPOs.

It’s nearly impossible to miss the news of rising 10-year treasury note yields. What is easier to miss is the explanation of why the yields are increasing so rapidly and what that means to us as investors.

Let’s start with the WHY. As the economy starts to recover, there is an increasing expectation of inflation. As the risk of inflation increases, interest rates are pushed higher. Despite the resulting what we hope will be short-term volatility and pain, there are definitely positives and negatives for rising interest rates as we think about our portfolios. Regardless, we should keep the rising interest rates in perspective. Today’s 1.5% treasury yield seems so high, but it’s still close to the recent era historic low – well below where it was two years ago. It’s the rapid rise from about 1% at the start of 2021 to the current level which is creating the angst. I’m old enough to remember Jerome Powell saying that the Fed has no immediate plans to raise its benchmark interest rate or to reduce its bond purchases, but clearly investors are not as sure as he seems to be.

Now let’s look at happens when interest rates increase. The most obvious result is that bond prices go down. You can see that in your treasury notes and in your bond funds. Short term bond funds, which many of you own as a back-up cash reserve, have definitely been impacted, but less so than the bond funds which hold longer duration bonds. Of course, the monthly interest payable on all bonds will also increase, but that will take a moment to happen and even longer for us to see it.

The less obvious result is that most equity prices have also dropped rather precipitously in the last few weeks. The exception has been “economic re-opening” companies (think Disney) which have taken a beating in the last year. Many of these re-opening companies are in the Dow which is why the Dow has so greatly outperformed the tech-heavy NASDAQ in the last few weeks. Big picture, what is happening is that as interest rates increase, we as investors look hard at the equities in our portfolios and often decide that the risk premium associated with already very high-priced equities just isn’t worth it right now, because we can get an improved return on a presumably safer bond investment. Tech has been particularly hard hit because the prices in the last year have increased significantly. Think Apple, Microsoft, Tesla.

The observation that bond and equity prices have come off their highs while the economy is improving so quickly is certainly disconcerting, but history and economics suggest that this can be a relatively short term reset. We all hope.

So now the obvious question is “you said there is good news, where is that part again?”

• Some industries do better with rising interest rates. Banks for example can do well because they make higher profits on loans. Bank and financial services companies have been good this month so far. Some energy companies have also done well because oil prices tend to go up with inflation. So those of us that held onto those Exxon shares through what was a terrible 2020 might be feeling a little better. For now.
• Our cash reserves in those high yield savings accounts or short term bond funds will eventually deliver a better return. Might be almost time to look for those coffee cans of $10 bills buried in the back yard. It’s about time.
• Many of us own TIPs which are adjusted twice per year for inflation. There hasn’t been much movement in these over the last 18 months but if the current trends continue, it is likely that there will be a bump in the principal value of the existing issues in July and newly issued TIPs will be at higher coupon rates. All good here.

Bottom line, stay the course and remember why we have these diversified portfolios.

As you know, we often say that we don’t invest in things that we do not understand or can’t explain – and there are many of those! But since some of you have asked about Bitcoin and many of us actually own a little in our S&P index funds (thanks to Elon Musk and Tesla) we decided it was time to learn a little and share a little. For you cryptocurrency experts out there, I apologize in advance for what I get wrong here!

Spoiler alert – we still aren’t recommending that anyone liquidate their retirement accounts or even dig up those dollar-filled coffee cans in the backyard in order to buy Bitcoin.

What is it?

Bitcoin is what is known as a “cryptocurrency”. It is actually a system of owning and transferring “bitcoins” to pay for goods and services or to collect currency in exchange for goods and services. Simple, right? Bitcoin has actually been around since 2009. It emerged after the financial crisis because it doesn’t require the use of a bank or a banking system – which were at risk in 2009. There is no governmental oversight or regulation, which can be good or bad, depending on your perspective.

As of today, February 23, the value of 1 Bitcoin is $47,408 USD. IT IS HIGHLY VOLATILE. Bitcoin has value because it is limited in supply – as all currency should be. More on this later.

Bitcoin works a lot like VENMO or any online bank, although there are a few big differences. To participate, a user first installs a “bitcoin wallet” on phone or computer. This installation generates a Bitcoin address which then generates actual Bitcoins, which I think of as virtual $47,000 coins. The user gets a public “key” which he shares with his commerce partners and a private “key” which he keeps safe and sound. I think it’s bad to forget this “key” as it’s then not possible to access the bitcoins. The bitcoins themselves are purchased via a Bitcoin Exchange or Bitcoin ATM!

After a transaction is completed, it is recorded in a Blockchain which feels like a massive checkbook register – but one that is actually used. The blockchain stores all the transactions in the blockchain and then updates the balances in the individual user wallets. This confirmation and encryption process presumably guarantees that the Bitcoins are only used once. In truth, because the value is so volatile, most users are investing in Bitcoin vs paying with Bitcoin. But that too is starting to change.

Users like Bitcoin for transactions because the use does not require ID or a bank so it can be used by the security or privacy conscious or in parts of the world where banking systems are underdeveloped. The currency transfers are fast and always available.

Where does Bitcoin come from?

I said earlier that Bitcoin is limited in supply. So, could the Defense Production Act be used to just make more? I don’t think so – at least not yet. New Bitcoins are Mined into existence by following an agreed upon set of rules. Simply, these rules have to do with finding the solution to a very complex mathematical problem. That solving process unlocks a set amount of Bitcoin, which keeps the supply limited. Math wins. Again.

Why Now?

If Bitcoin has really been around for 12 years, why are we just now hearing so much about it?

• Tesla bought $1.5Bn in Bitcoin stock. And is talking about starting to accept it as payment for its cars.
• Some cities, banks and companies (MasterCard) have announced plans to at least explore the potential benefits and risks to their businesses.
• There has been a lot of interest by retail and institutional investors – along with the creation of cryptocurrency ETFs.
• The pandemic has shifted transactions of all types to on-line.
• It’s seen as an inflation hedge, much like gold or silver.
• But likely the biggest reason: It’s a cultural phenomenon with its own social media push, vocabulary and even preferred purchases. Lambourghinis are reportedly a preferred purchase of Bitcoin zealots. Skeptics say that it’s gambling vs a real solution to a real problem.

Interesting to learn about, but we are still not suggesting that any of you should go stock up! As I said, most of you already own a little in Tesla shares, S&P 500 Index funds or Baron Opportunity. No doubt that some of the recent market volatility is driven by Bitcoin volatility. By the time, this Blog post goes up on March 1, today’s $47,408 USD value will likely be ancient history. But we have no idea whether it will be much higher or much lower!

P.S. On a lighter and more important note, Pfizer has now confirmed the expected news that Marci and I both got the real deal in their vaccine trial in August/September! Mom and dad are also now fully vaccinated. We are ready to see you in person when you are vaccinated and ready to see us!