On The Agenda

1. Are renters struggling?

2. Where to live to get the most bang for your buck ^LUMINARY

3. Inflation increased for the first time in more than a year

4. Understanding US household debt in 4 graphs ^LUMINARY 

5. You’re thinking about your Roth IRA all wrong

6. The Golden Rule of IRAs ^LUMINARY 

From Jon Scott, Lead Author 

Are renters struggling?

A recent report from Bank of America indicates that renters’ spending growth is increasing at a slower clip than homeowners. The study hypothesizes that rent inflation (rising rent costs) is the primary cause. Renters have to deal with rising rents while homeowner costs are largely locked in due to fixed-rate mortgages.

Why you should care?

The spending patterns of renters could foretell an impending spending slowdown for homeowners as well. The US is a consumer-driven economy, meaning spending on goods and services is the most important indicator of economic health. If spending decreases significantly over the next few months across both renters and later homeowners, we could see an increased risk of a recession.

Inflation increased annually for the first time in more than a year 

From Bennett Fees, Economic Research Associate

Thursday’s CPI data showed consumer prices increasing 3.2% annually in July, up from June’s 3% rate. Core inflation, which strips out the volatile food and energy categories slowed to a 4.7% annual rate, slightly down from 4.8% in June.

Accounting for 90% of the overall increase for the month was a .4% increase in shelter costs. While this isn’t good, shelter costs in particular lag behind monetary policy by 12-18 months leaving most economists to predict a fall in these costs in future reports.

The Fed’s Mary Daly responded positively but insisted that CPI is only one data source among the many that the FOMC looks at when making decisions.

Within this report, core services, excluding shelter, a very important indicator to Powell and reiterated by Daly, rose by .2% in July.

What does this mean looking ahead?

As long as core inflation remains above 4%, it is unlikely that the Fed will be comfortable cutting interest rates. In fact, investors now price in a 90.5% chance that the Fed will hold rates steady at their next meeting, an increase of 8.5% from just a week ago. Additionally, composition effects will soften future inflation readings since the disinflation trend started in July of last year.

Understanding US Household Debt in Four Graphs ^{LUMINARY SECTION}

US consumer and household debt is… a lot. For starters, this is the US total debt balance as of Quarter 2.

Nebulous, but let’s turn to its composition.

This gives us a good starting point. As seen in the graph, mortgages take up the lion’s share of the composition followed by auto loans, student loans, credit cards, and so on.

Mortgage balances and balances on home equity lines of credit (HELOC) were mostly unchanged, largely due to declining mortgage originations and moderations in home prices. Indeed, consumers polled by the University of Michigan saying that it is a good time to buy a home has dropped to the lowest level in the survey’s history.

So what area has changed recently? Credit Cards.

Credit card use has increased greatly in the past 10 years. In 2013 the number of Americans with credit cards was 59%. As of the second quarter of 2023, this has risen to 69% of Americans! Along with the growth of credit cards themselves, the NY Fed’s Consumer and Household Debt data for Quarter 2 showed that Credit card balances have risen as well, all the way to $1.03 trillion dollars, coming after a sharp 4.6% quarterly increase. Auto loan balances also rose but did so in line with its previous trend since 2011. Most troubling is the corresponding uptick in delinquency rates for these two categories.

Importantly, while these levels indicate tightening, they are near their pre-pandemic levels which leaves economists at the NY Fed unconcerned regarding widespread financial distress.

This dynamic is also made clearer when we look at what age groups are entering into delinquency.

To summarize, we now see what household debt is comprised of, areas of recent growth, areas of trouble, and what age groups are in trouble. This tightening is seen from the consumer side, but credit tightening from the Bank’s side of things shows similar results.

So how bad is it?

This tightening is a predictable consequence of higher interest rates and is incorporated into the Fed’s decisions to raise them. As for now, household credit seems to be reverting to its pre-pandemic levels despite higher nominal balances softening concerns from analysts.

The most common Roth IRA misconception

From Nate Hoskin, Founder & Lead Advisor

Everyone thinks the money they put into their Roth IRA is completely off limits and they’ll get a penalty if they pull the money out. This actually isn’t true! Because you already paid taxes on the money you put in, it’s your money free and clear. Any money you contribute you can pull out without taxes or penalties.

So why do people think you can’t touch the money? Because you can’t pull out any of the gains from the account without paying taxes and a 10% penalty. So if you invest $6,000 and it goes up to $6,500, you can take the $6k out with no issue but you can’t take out the $500 until you turn 59 ½.

Why should you care?

One of the daunting parts of saving for retirement is the idea of locking up money for decades. It feels terrible to not have access to that money, and it’s hard to decide between prioritizing short-term or long-term goals.

Roth IRAs give you an out. The goal will always be to not touch the money in retirement accounts, but having the flexibility gives peace of mind.

I actually used $10,000 from my Roth IRA to start Hoskin Capital because I chose a short-term goal over the long-term. Looking back, I wish I had used other money because I will never get the $6,500 cap back for those years, but I am so so thankful I had the flexibility to pursue this business.

The Golden Rule of IRAs ^{LUMINARY SECTION}

This one most people know by this point, but they still get it wrong. When it comes to contributing to a Roth IRA it doesn’t matter how old you are. The thing that matters is your tax bracket. The Golden Rule of IRAs is that if you are currently in a higher tax bracket now than you will be when you retire, it’s better to do a Traditional IRA. If you are currently in a lower tax bracket, it’s better to do a Roth IRA.

There’s a slight catch to this, which is called “tax rate arbitrage”.

It works like this. Let’s say you make $120,000 right now, so your marginal tax bracket is 24%. If you save $20,000 into a Traditional 401(k), you will save $4,800 in taxes. But if you take that same $20,000 out in retirement, it doesn’t get taxed at 24%, it gets taxed at your lowest tax bracket. So assuming you don’t have any other income, you will only pay $530 in taxes (age 65, standard deduction, filing single), so you saved $4,270.

Another way you can do this is with a Backdoor Roth. The time between when you retire and age 73 is a magical time because you’ll be making way less money than you were when you were working. You can use these years to move money from a Traditional 401k or IRA into a Roth before Required Minimum Distributions (RMDs) kick in. If you delay taking Social Security until the Full Retirement Age (FRA) of 67 or the maximum of age 70, you will also have an income gap where you are not collecting any income and only using savings to pay expenses.

It works the same way. You’ll pay taxes when you roll the money over, but the money will get taxed at your lowest tax bracket first and it grows tax-free from that day on.

When doing a Backdoor Roth at retirement you’ll have to understand the 5-Year Rule, which I will be covering next week!