Capital Gains Rates and Market Pain Points

by | Apr 23, 2021 | Podcasts

Yesterday the market dropped after news of a proposal to increase capital gains tax rates. Today, the market is market to normal, but what is it about these market pain points that get everyone on edge?

In this podcast, Tim and Tom discuss a few different market pain points and outline why a proposal is much different than actual law, and why it doesn’t need to impact your portfolio.

Show Notes

‘The Two Most Underappreciated Forces Driving Markets Today’ – Ben Carlson – A Wealth of Common Sense

Capital Gains Rates and Market Pain Points – Transcript

DISCLAIMER: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.

Tom Mullooly: Welcome back to the podcast, this is episode number 351. I am your host, Tom Mullooly and joining me today is my co-host Tim, Tim Mullooly. Good afternoon.

Tim Mullooly: Hello, everybody.

Tom Mullooly: Market got a little rattled yesterday with nothing more than a headline.

Tim Mullooly: There was news about potential changes to capital gains tax rates. I was surprised to see that people seemed surprised by it because this was something that was talked about on the campaign trail with Biden and his administration. It’s not a new situation that’s coming up.

And also, the market yesterday opened and went down. It was down about 300 points and then worked its way almost all the way back to even, and this was all before the news and then it was almost flat for the day, and then the news came out, and then it went back down like another 300 points. So, people were saying that the market got really freaked out by this. It’s like it just went back down to where it was earlier in the day before the news even happened. And today we’re back up a couple of hundred points-

Tom Mullooly: Right. Yeah.

Tim Mullooly: … So, it was just a quick like cough, which is like yeah, we needed to get that out of our system.

Tom Mullooly: That’s a good analogy. I was like you a little stunned to see market followers say a surprising development that the Biden administration is proposing doubling the capital gains tax rate on people making more than a million dollars. For goodness sakes, this is April of 2021. We heard this in June-

Tim Mullooly: Right.

Tom Mullooly: … June of last year.

Tim Mullooly: I guess in the sense it may be, you hear so many things on the campaign trail that you don’t actually expect them to bring them up ever again once they get into office. So maybe the fact that it’s like, “Oh, wait, he was serious about that?”

Tom Mullooly: I keep thinking of that scene from my cousin, Vinny when he’s getting railed at by the judge. “You were serious about that?”

Tim Mullooly: Right. Yeah. So, maybe in that sense it is surprising to people, but the number that you just said to people that make over a million dollars, that’s make over a million dollars, not people that have over a million dollars of net worth-

Tom Mullooly: Yeah, annual income.

Tim Mullooly: … It’s you have to make… Like how many people out there… It’s like not even the top 1%, it’s like the top point something percent of people out there, 0.3% of taxpayers

Tom Mullooly: So, less than a half of 1% of all taxpayers. Now, only half of the people in the country file taxes.

Tim Mullooly: Right.

Tom Mullooly: So we’re really talking about a quarter of 1%.

Tim Mullooly: I guess people maybe they see this and everyone likes to go to extreme, so they sort of extrapolate like, “Oh, well, this is just the first step. What’s coming after that?” And then, you can extrapolate that pessimism or that line of thinking out to like, “Oh, well, they’re not going to stop there, but.”

Tom Mullooly: So, it’s a good segue because these I call them pain points.

Tim Mullooly: Mm-hmm.

Tom Mullooly: The things that people like to worry about unnecessarily. Depending on the client and the relationship I have with the client, I can kind of kid around with some of these folks and tell them, “You need a hobby. Stop watching the market so closely because you’re going to just twist in the wind and drive yourselves batty by following every news headline that that comes out.”

So yeah, yesterday the headline was that the Biden administration is proposing raising, and in this case doubling the capital gains tax rate to something over 39%. But the devil is in the details and that’s what we don’t have.

Tim Mullooly: Right.

Tom Mullooly: We have a headline.

Tim Mullooly: Exactly.

Tom Mullooly: We don’t have any details.

Tim Mullooly: It’s just the top line of what would actually happen.

Tom Mullooly: Yeah. So, my first question was, “Okay, is that $1 million in gross income, or is that adjusted gross income?”

Tim Mullooly: Right.

Tom Mullooly: “Is that taxable income?”

Tim Mullooly: Because that shrinks the already 0.3% even lower.

Tom Mullooly: Yeah. So, they didn’t say.

Tim Mullooly: Right.

Tom Mullooly: Because-

Tim Mullooly: Because they don’t know yet.

Tom Mullooly: … Exactly. They don’t know.

Tim Mullooly: This is just an idea. It’s a skeleton. It’s an outline right now. It’s a proposal.

Tom Mullooly: That’s all it is.

Tim Mullooly: Yeah.

Tom Mullooly: I think we mentioned this a couple of episodes back, but I know when I was in high school, one of my homework assignments every year in January was to watch the State of the Union and take notes on what the president at the time would be proposing. And it’s like a fricking Christmas list, the way these presidents come up with all these wishes that they want to see. So, the president can propose all the laws he wants. He doesn’t make the laws.

Tim Mullooly: Right.

Tom Mullooly: And he doesn’t enforce the laws. That’s judicial.

Tim Mullooly: Right.

Tom Mullooly: So the legislature, the House and the Senate are the ones that actually make the laws.

Tim Mullooly: Right.

Tom Mullooly: So, he can propose anything he wants and whether it’s Biden or Trump or Obama or Bush, whatever, it doesn’t matter. They can propose anything. So it’s always going to be detail-light. It’s never going to look like that in the finished product if there is one.

Tim Mullooly: Yeah.

Tom Mullooly: And so, a lot of people worry and they get that itchy trigger finger when it comes to their investments, when it comes to this stuff. So, when a president puts together a proposal, it still needs to be packaged, presented in the House as a potential law or change to law. So, it’s got to get written. That’s going to take some time.

Tim Mullooly: Yeah.

Tom Mullooly: And then it has to go through a subcommittee, that takes some time and they’re going to wrestle with it and figure out the math on what works and how this is all going to come to be.

Tim Mullooly: Yeah.

Tom Mullooly: And then, because it’s Washington, they have to add in some pork. It doesn’t matter if you’re a Democrat, Republican, they’re going to tack on other things to go with it.

Tim Mullooly: Mm-hmm.

Tom Mullooly: And then they start taking straw votes, like, “Okay, how many people would vote for this in its current form? How many people would not?” They try and gauge where they’re at. And then the real votes actually take place in the House. And if it passes the House-

Tim Mullooly: Then it goes to the Senate.

Tom Mullooly: … Yeah, it’s got a whole other cycle.

Tim Mullooly: Yeah. So, there are a lot of stops along the way from proposal to, “Okay, this is now the law.” And we talked about this in terms of when they were talking about the corporate tax rates and when tax changes from a couple of years ago. When taxes go up or down, corporations and also, you can tie in individuals here for this matter, they’re not just going to put up their hands and say… Wave the white flag like, “All right, taxes are higher now. I guess we can’t make money. I guess we can’t figure out a way to work this in our favor.”

Even if this does go through all the necessary steps and comes out in some form or another, there’s going to be people out there, individuals, you can work with advisors, there’s going to be ways to figure out how to best approach or change the approach when these things get put into place. Like it’s-

Tom Mullooly: Yeah.

Tim Mullooly: … I don’t know. I think people just see the headline and overreact. To me, that says more about how they were previously aligned in their investments than it does about what’s actually being proposed. Like you said, it’s an itchy trigger finger to want to pull the plug on some of your investments and stuff. It’s like, “Well, maybe those weren’t the right investments for you in the first place.”

Tom Mullooly: It was pretty funny just to kind of take a walk down memory lane yesterday. I saw the market go down, then it came back and it started going down sharply in the afternoon and I’m scanning through everywhere to see what headline did I miss-

Tim Mullooly: Yeah.

Tom Mullooly: … that would make this happen. And I saw, “Oh, Biden tax proposal on capital gains rate.” And I’m like, “We knew this. We knew this already.” And so it was honestly astonishing to see market reporters point to that as the reason why the market was going down. Wait, look, we’re sitting here in Wall Township, New Jersey, we knew about this last summer.

Tim Mullooly: Yeah.

Tom Mullooly: This should not have come as a surprise.

Tim Mullooly: I think there needs to be something to worry about when it comes to the markets, whether we had the stretch of couple of weeks where it was inflation and then it was rates rising and rates falling and the Fed and what they’re doing and the new administration. And now we’re seeing this headline about capital gains tax rates.

Tom Mullooly: Right.

Tim Mullooly: So, there’s always something that people think is the driving force behind the market and what’s sending it up or down, but it’s never really just that one thing.

Tom Mullooly: It’s really stunning to see the way decisions get formed in people’s minds. So, we talked to a couple of folks yesterday who wanted to know, should we be making changes to our portfolio based on this? I can tell you that that percentage of taxpayers, 0.3%. That’s not 3%, that’s 0.3%. So less than a half of 1% of taxpayers are going to be impacted by this.

That’s about the same ratio in our book of clients, the same kind of… We may have one or two, three clients who have, let’s just use adjusted gross income or taxable income that are going to be impacted by this. I think that the fear, like you had mentioned a few moments ago is that, “Well, maybe they lower that threshold to $800,000.”

Tim Mullooly: They’re coming for us next.

Tom Mullooly: Yeah, we’re next.

Tim Mullooly: Right.

Tom Mullooly: Right.

Tim Mullooly: Yeah. And where do they get that idea from? From the people writing the headlines on media.

Tom Mullooly: Yeah. It’s like click on my story and the ad right next to it.

Tim Mullooly: Right. Here’s why you could be next.

Tom Mullooly: Yeah. Film at 11.

Tim Mullooly: Yeah.

Tom Mullooly: Yeah. I think when people understand how all of this works, they get a little more appreciation, appreciation is a terrible word, but in this sense, but they get a little better gauge of how meaningful a headline like that might be. So, even to understand how laws get made, like we just kind of went through a back of the envelope sketch to show how laws actually progress through the halls of Congress.

Tim Mullooly: Yeah.

Tom Mullooly: It takes a long time and the finished product will not look like what a president just said in the Rose Garden.

Tim Mullooly: Right.

Tom Mullooly: So, I think when people understand how laws get made and how government, your government actually works, I think people get a little more, a better perspective on, “Okay, is this really going to impact me? Is it going to impact the markets? Is this something that’s actionable?”

At the moment, it’s not. We live in a society where it’s sell first, ask questions or get details later. It was pretty surprising to see the market go down as fast as it did. But that’s also a reminder, Tim, I’m sorry to cut you off that, we saw the market go down about 1%, a little over 300 points in minutes.

Tim Mullooly: I stepped away from my computer for, I think 10 minutes. It was while we were recording a video yesterday and then I came back and sat down and you looked at the little ticker on the Wall Street Journal’s website and it was just a straight line down.

Tom Mullooly: Right.

Tim Mullooly: I was like, “What?”

Tom Mullooly: Yeah.

Tim Mullooly: Like you said, “What happened?”

Tom Mullooly: Yeah. And so, it’s a reminder when we do get these kinds of moves in the market of what happened last spring when we saw the market go down 7%, 7% for a couple of days in a row and then a 10% down day, some very, very frightening moves and it happened very fast.

And so, I’ve adopted a phrase that I heard early on in my career that the market takes the stairs on the way up, but it goes down in the elevator. It goes down fast. This is the kind of stuff that can happen. If everybody decides to hit that sell button all at once.

Tim Mullooly: Yeah. People can get worked up into a panic. Everyone just piles in, or piles out, takes their money out. Yeah, there’s always things that we think are going to have a bigger impact on the market in general than they usually end up doing like if you look at even this story from yesterday, if you didn’t pay attention to what happened yesterday and you came back and looked at the market today, you wouldn’t have any idea that anything happened at all.

Tom Mullooly: That’s right.

Tim Mullooly: It’s been less than 24 hours and it’s already been worked out of market history.

Tom Mullooly: Yeah. I think everybody’s come to their senses like, “Oh, wait. This is just a proposal. The president and his administration, no matter who’s in the office, can propose anything they want.

Tim Mullooly: Right. I propose we’re going to move the White House to Jupiter.

Tom Mullooly: Yeah-

Tim Mullooly: Like, okay-

Tom Mullooly: … I propose we’re going to build a big, beautiful wall and there’ll be a beautiful door in the middle of it.

Tim Mullooly: Right.

Tom Mullooly: Or whatever. Fill in the blank. Yeah.

Tim Mullooly: Anything.

Tom Mullooly: They can propose anything they want. It doesn’t mean that it’s actually going to happen.

Tim Mullooly: Right.

Tom Mullooly: But some of the things that you touched on are things we’ve had to wrestle with over just the last couple of weeks, rising rates. People think it’s the end of the world. Well, we’re going to get inflation. Okay. People are starting to, I think, incorrectly realign their investments because they’re expecting high inflation. I think I would wait before we get an answer on that.

Tim Mullooly: Yeah. How long have people been expecting higher inflation? We’ve been shooting at a 2% inflation rate goal for how long now, and it’s been under it fo-

Tom Mullooly: 10 years.

Tim Mullooly: … Yeah. So you could be very early if you’re repositioning your account for inflation.

Tom Mullooly: Yeah.

Tim Mullooly: I don’t know, at some point, you just become wrong, not early. There are all these things that we were just talking about that people think will impact or move the market. Ben Carlson wrote something yesterday about two very underappreciated factors that drive the market, and the first one that he pointed out was just demographics of the age disparity of who owns these assets.

Tom Mullooly: Right.

Tim Mullooly: There’s more and more with the baby boomers going into retirement. And now the bigger millennial generation and the generation in-between, those underlying demographics seem to be holding the market steady more than just inflation. It’s just like, “Well, who owns all of this stuff?” And you think about where they are in their life cycle and it’s like, “Well maybe this could last a little longer than people think.”

Tom Mullooly: Sure. The demographic story is really important. If you’ve never looked at it before you really should. And we kind of poked fun at Harry Dent a couple of weeks ago in the podcast, but he has built most of his models rightly or wrongly on demographics, that the baby boomers, 20 years ago they were wealth accumulators. And so you really needed to be in the market because the market was going to go. It’s easy after the fact to connect the dots and say, “See, I was right.”

Tim Mullooly: Right.

Tom Mullooly: But he is now forecasting that baby boomers are now retiring at whatever number per day that they’re going to be de-risking their assets.

Tim Mullooly: So that would mean that they would be selling their stocks, which would mean the boomers are going to tank the market.

Tom Mullooly: Right. Net sellers. Thanks, boomers.

Tim Mullooly: Well, yeah, but for every seller, there’s a buyer. So, who’s on the other end of that transaction?

Tom Mullooly: Probably a boomer.

Tim Mullooly: Probably the next… Well, maybe another boomer, but also potentially someone currently in their wealth accumulation phase.

Tom Mullooly: Yeah.

Tim Mullooly: It’s cyclical.

Tom Mullooly: If you go back to the nineties and the previous generation was rapidly de-risking, so through the eighties and then well into the nineties, we saw the boomers really moving into wealth creation and wealth-building stage. That was the time for boomers. These are people who were born after World War II up until 1962. That’s when people really started to move into that phase. And we saw a lot of folks that were in the World War II generation, the greatest generation.

Tim Mullooly: Right.

Tom Mullooly: They were actually massively de-risking.

Tim Mullooly: Right.

Tom Mullooly: A lot of people sold annuities to these folks. If you steal the script and say, “Well, this is now going to happen again.” There’s a problem with that.

Tim Mullooly: Right.

Tom Mullooly: Because in the mid-nineties, in 1994, you could get a one-year CD at your local bank that paid 6%.

Tim Mullooly: Yeah.

Tom Mullooly: Now it’s 0.6%.

Tim Mullooly: Right.

Tom Mullooly: What do you do? Are you going to de-risk into that?

Tim Mullooly: Right. And yeah, I was going to say retirement in general, has changed so much from then until now.

Tom Mullooly: Right.

Tim Mullooly: One, it’s lasting longer. So you need your money to last longer and to your point as well, you’re not earning as much on these safer investments. So, we tell clients here. “Yeah, as you retire, we’re going to slowly bring down the risk on the account, but it doesn’t mean we’re jumping all out of the market because if you’re going to be retired for 30 years, we need a significant portion of that still in the market to keep up with whatever level of inflation over time. It’s not just going to be a quick, everyone sell all your stocks and jump out.”

Tom Mullooly: And there’s also the factor of what they call the real return on an investment and when you’re in a certificate of deposit, you are essentially taking no risk. You’re parking the money at the bank and you’re expecting to get it back in three, six, 12 months, something like that.

Your real return should be somewhere between a half of 1% and 2% over the rate of inflation. And I spent the entire decade of the nineties trying to explain this to people because they said, “Why can’t the bank go back to paying 4% or 5% or 6% on CDs? Hey, I’m not going to be greedy, Tom. I remember getting 15% or 16% on a CD. I’m not going to be greedy, but I’d like to get 4% or 5% or 6%. Why can’t they do that?” Because?

Tim Mullooly: Because there’s no inflation.

Tom Mullooly: Thank you.

Tim Mullooly: Because you were able to get 5%, 6% on a CD because inflation was 3%, 4%, 5%.

Tom Mullooly: Yep.

Tim Mullooly: So when you factor that in, like you said, real return, you’re getting somewhere in-between maybe 1% and 2%.

Tom Mullooly: So, understand that if we do see CD rates again at 4%, 5%, 6%, we’re going to go through a world of hurt to get there.

Tim Mullooly: Right.

Tom Mullooly: We’re going to have a lot of inflation, a lot of inflation.

Tim Mullooly: Yeah.

Tom Mullooly: Fed’s going to have to raise rates. They’re going to have to choke off the economy. It’s… What’s the saying, I hope you don’t get what you wish for or?

Tim Mullooly: Be careful what you wish for.

Tom Mullooly: Yeah.

Tim Mullooly: Right.

Tom Mullooly: So that could wind up really biting in the fanny.

Tim Mullooly: Yep.

Tom Mullooly: That’s the message for episode 351. A lot of people worrying about pain points that they may not necessarily have to worry about. So, take it one day at a time. Thanks for tuning in.

Don’t forget to tune in to this week’s episode of the Mullooly Asset Show!

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