“You are right to set that compass to true north, but remember, you will encounter swamps, deserts, and obstacles along the way. If you don’t navigate around them, you won’t reach your destination.”
–Abraham Lincoln
“If you don’t know where you are going, you’ll end up someplace else.”
–Yogi Berra
Both Yogi and Abe were right. That is why I always want to know where I am going.
But it is not easy right now, at least when it comes to your investments and financial planning. The world is unstable—both economically and politically, with significant changes on the horizon. So, it may be that we know economically 1) where true north is and 2) where some basic opportunities and obstacles are. However, I am not sure there has been much discussion of where the risks are in this environment. That is what this post is about.
When discussing risk or opportunity, I don’t believe that merely having direction and being aware of opportunities is enough. How sustainable are opportunities? What are the risks over time? Is there a time limit we should not look beyond? What could erode any gains you make from the passage of the One Big Beautiful Bill (BBB)? Are the long-term risks of investing worth it? And, of course, what should you do right now?
If you want a recitation of the changes made after the (BBB), see here. The analysis, from the Financial Samurai, is comprehensive and good (as usual).
THIS ANALYSIS IS NOT ABOUT POLITICS—IT IS ABOUT FINANCE AND RISK
I try to keep my political opinions out of these posts. However, I cannot divorce legislation like the BBB entirely from politics; instead, I will spend most of this analysis describing the changes the legislation makes. Moreover, I believe it is essential to examine what the drafters of the bill perceived as risks that they had to navigate. That provides a lot of insight into the issues you need to consider moving forward.
The first thing potential investors need to consider is that this is not a popular bill. That realization alone is essential. While BBB changes are relatively safe for the next three years until the next Presidential election, it is not at all clear what happens after that.
Given that reality, financially conservative individuals will take short-term advantage of the bill–but not necessarily consider it a long-term determinant that shapes most of their investment decisions.
BIG BEAUTIFUL BILL BASICS
Here is one way of categorizing what has changed:
Winners
- Persons and businesses that benefit from tax rates that don’t rise—individual taxpayers and companies will keep the current rates, rather than reverting to the previous higher rates.
- Short-term tax cuts—these apply to tips, Social Security, overtime, and State and local taxes, and deductibility of some car interest. These cuts in tax rates end in 2028/29, but may be reauthorized by Congress in the future (mainly because 2028/29 is an election year).
- Subsidies—to owners of start-up businesses who can exclude up to $15 million in stock gains from taxation (Section 1202), and parents who benefit from an expanded child care tax credit.
Losers
- Safety Net Programs and those who use them—cuts depend on when budgets are enacted and could come as soon as the end of 2025, more likely in 2026. Here are the cuts to safety net programs: Medicaid, SNAP/Food aid 20%, Affordable Care Act subsidies (leaving as many as 13.2 million uninsured, according to some estimates).
- National Debt—We will add between $3.2 trillion and $4.5 trillion to the national debt over 10 years, even accounting for cuts to the federal workforce and possible increased tariff revenue.
Most experts feel the cuts are unlikely to pay for themselves, although proponents believe they will.
Proponents also mostly feel that we can grow our way out of the debt crisis. However, that is an untried theory. We will just have to see.
HOW THE BBB PLAYS THE TIMING—THE SUBSIDIES MOSTLY COME NOW, THE CUTS AND PAIN LATER
Tax benefits now.
Most people can expect the tax cut benefits from the BBB to last this year and into the next few years, and will benefit from them.
Let me give you an example. I live in a high-tax state. I recently received an inheritance, but I will have to pay a significant amount of state income tax because the inheritance documents were not drafted as well as they should have been. However, the temporary increase in SALT deductions will help me write off the local taxes from the inheritance against my federal income tax. I will probably itemize.
Positive gratification for me will be immediate. Whether the bill will benefit me much in the long run after that is an open question.
Cuts to safety net programs will begin in 2026, with the impact on the poor increasing over time. Debt will compound, with the most significant impact several years in the future.
People who rely on Federal safety net programs for food, affordable health care, housing, and other programs will be hurt. Over time, as cuts are phased in, the impacts will become increasingly significant. That feature accounts for the bill’s unpopularity. However, the bill’s proponents argue that expanding opportunities on the job front from tax cuts will blunt the impact.
Again, we do not know how that will play out. Nor do we know whether the lack of health care and other services will cause other problems that increase costs in different ways.
The addition to deficits will be small at first and will increase over time as the national debt expands. Just as we have talked about how compounding has built great fortunes, unpaid debts do the opposite. For a discussion about compounding, see here. For an example of the negative impacts of compounding, see here.
Put another way: the bill’s drafters want the credit for changing things now but are less concerned about longer-term consequences, especially beyond the 2028 elections. That includes the deficit.
But what about you? If you are a long-term investor, what does this mean for you?
WHY SHOULD WE CARE ABOUT THE DEFICIT RISK ANYWAY?
Good question. I don’t know about you, but I have been reading that the deficit will sink us for many years. So far, it does not appear to have happened. But our debt was downgraded recently, an indication that we are not as strong as we used to be as a nation.
And again, the negative compounding effect will magnify all of the deficit spending we have done over the last 40 years. The deficit was 7% higher than last year, a trend that does not show any signs of slowing down.
WHY I WORRY: THE RISK OF POLICY MISMATCHES
It is hard to fault finding solutions to the complex problems of keeping the economy on track while keeping deficits and debt low. So, from that point of view, you have to give Congress good marks for trying. But there is a risk to: 1) deferring pain or concentrating pain on one group, and 2) using short-term fixes to deal with long-term problems.
For instance, the short-term nature of temporarily halting the taxing of tips works at cross purposes with the need to permanently reduce interest rates and keep the deficit low. One goal is long-term, while the other is short-term. I would have preferred to use savings and new revenues solely for reducing deficits, not as a sweetener at all.
But the legislation mixes various goals. Investors must consider whether these factors are significant enough to influence their decisions.
THE RISKY ELEPHANTS IN THE ROOM—INFLATION, INTEREST RATES, AND EVEN SOCIAL UNREST
I won’t bore you with lengthy analyses, but here are some common-sense points that were not part of the discussion.
- Congress cannot legislate interest rates. Interest rates will be critical to the legislation’s success or failure due to the rising deficit. Interest rates are determined by several factors, including how many investors outside of the US find our debt to be a worthwhile investment. Congress can dictate tax policy, as it just did, but interest rates are not entirely within its control, no matter how good tax policy is. See where some of these factors have led recently to see how this debate is playing out.
- Inflation and debt are related. The more debt, the higher the chance of inflation. There is a debate right now over whether monetary easing will stoke inflation, given our current debt levels.
- When people cannot make ends meet, it is politically and socially dangerous. We are all hoping that tax policy will create opportunities for the poor. If that does not work out, there could be a rapid reversal of the cuts, changes to policy, and possibly even a societal shift.
Therefore, here are a few things to consider in the next few years as you look out for yourself and your finances.
CONCLUSION 1: TAX RATES ARE UNLIKELY TO GET LOWER IN OUR LIFETIMES—IF YOU CAN PUSH TAXABLE INCOME INTO THE NEXT THREE TO FOUR YEARS, DO IT.
Tax rates are unlikely to get better than this. If the Federal deficit balloons, Washington policymakers will have no choice but to increase tax rates to balance the books when the current administration is no longer in office. So, this tax holiday could only last a few years.
Cashing out will be important. For instance, I inherited a Traditional IRA. Under the Secure Act, I have to redeem it in 10 years. The bad news is that it’s a short time frame. The good news is that future rates could be higher, making it sensible to do most of the work of reducing the balance over the next three years, which is likely to save money in the long term.
CONCLUSION 2: IF YOU FEEL THAT TAX RATES WILL BE HIGHER IN THE FUTURE, CONSIDER A ROTH CONVERSION NOW
Consider converting some of your Traditional IRA/401 (k) to a Roth. Although it will incur some tax, converting later when tax rates are higher will cost you more.
For an explanation about this kind of retirement account, see here.
CONCLUSION 3: INFLATION BEARS WATCHING AMIDST UNCERTAINTY
Given the uncertainty surrounding the exact impact of BBB, it may be time to consider allocating some of your funds to very conservative investments, such as gold or other “hard” assets. I think of that action as a kind of insurance. Having insurance amid uncertainty is a good idea. An example of how inflation works is here.
CONCLUSION 4: THERE IS NOTHING IN THE BILL THAT KEEPS THE RICH FROM GETTING RICHER—RATHER, THE OPPOSITE: SOCIAL CONSEQUENCES BEAR WATCHING WHEN COUPLED WITH SAFETY NET CUTS
The wealthier you are, the more you benefit from BBB. Coupled with simultaneous cuts to the poor, it is wise to monitor social impacts.
I do not know what will happen and whether the stimulus will completely balance the effect of cuts. That is the idea. If it does not, the impact may do more than shape upcoming elections. It may impact the economy and social policy for decades to come.
CONCLUSION 5: YOU MUST EDUCATE YOURSELF ABOUT THE DETAILS IN THE BBB OR RISK LOSING OPPORTUNITY.
Someone will make a lot of money from the BBB. It might as well be you. That is why it is always good to stay informed. If you are informed, you may benefit.
And, this analysis only scratches the surface. If you decide to learn a lot more, two items you must know about stand out:
- Specific programs that may be opportunities for you: the legislation is full of them. One example: specialized savings accounts. It is only a tiny opportunity among many others.
- The opportunity if the BBB works as intended. If a new era of investment and activity results from BBB enactment, are you in a position to benefit? One way to help is to understand the nuances and be prepared, rather than stashing your savings under a mattress.
Disclaimer: Consult with a financial fiduciary before taking any steps outlined here. Not all advice may be suitable for your circumstances or investment style.
Image: Yi Liu
License: Unsplash