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Top 3 Actions to Take if Your Tax Outcome Was Unexpected

Receiving a tax refund larger than expected or owing more tax than anticipated can both be surprising. Such scenarios often indicate discrepancies in your tax planning or withholding. Whether you’re puzzled by a hefty refund or a significant tax bill, here are three practical steps to manage and adjust your tax situation for future financial stability.

1. Reassess Your Withholdings

If your tax refund is larger than expected, it could mean that too much tax is being withheld from your paycheck. While a large refund might seem like a boon, it’s essentially an interest-free loan to the government. To optimize your cash flow throughout the year, consider adjusting your withholdings. You can do this by filling out a new W-4 form with your employer to decrease the amount of taxes withheld from your salary. This adjustment will increase your take-home pay, allowing you to invest, save, or spend those funds throughout the year instead of waiting for a lump sum refund.

Conversely, if you owe more tax than you anticipated, this could be a sign that not enough tax is being withheld from your earnings. In this case, you might want to increase your withholdings by updating your W-4 form. For instance, even if you’re married with kids, it may make sense to claim “Single” to ensure more dollars are paid in through payroll. This can help avoid owing a large sum when you file your next tax return, and it can also prevent potential penalties for underpayment throughout the year.

2. Review and Adjust Estimated Tax Payments

For freelancers, self-employed individuals, or those with additional income sources (such as rental income or dividends), large discrepancies in expected tax outcomes may suggest that estimated tax payments need adjustment. If you owe a significant amount, consider recalculating your estimated payments for the current year to better align with your actual income. This proactive approach can help manage cash flows more efficiently and avoid surprises in the next tax season. Conversely, if your payments are too high, reducing them can free up monthly resources for other financial priorities.

3. Consult a Financial Planner and a Tax Professional

Changes in income, life events (like marriage or having a child), or changes in tax law can all affect your tax liability. If you receive a much larger refund or owe more than expected, it may be time to consult with a financial planner and a tax professional. A professional can help you understand why your tax outcome was different than expected, provide guidance on adjusting your withholdings or estimated payments, and help you plan for future tax implications of any major financial decisions you anticipate making in the upcoming year.

In conclusion, an unexpected tax outcome, whether it’s a larger refund or a bigger tax bill, often signals a need for adjustments in your financial planning. By taking these steps, you can ensure that your tax withholdings or payments align more closely with your actual tax liability, avoiding surprises and optimizing your financial strategy for the year ahead. This approach not only helps in better managing your finances but also in making informed decisions that enhance your overall financial well-being.

Cahaba Wealth Management is registered as an investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability. Cahaba Wealth Management is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Content should not be construed as personalized investment advice. The opinions in this materials are for general information, and not intended to provide specific investment advice or recommendations for an individual. Content should not be regarded as a complete analysis of the subjects discussed. To determine which investment(s) may be appropriate for you, consult your financial advisor.

Investment Strategy Done Right!

By Don Keeney, CFA, CFP®

An individual’s investment strategy can take many forms – from more traditional buy/hold portfolio management spanning all the way to speculative meme stock day trading. No matter what strategy one chooses to implement, it is important to have a plan in place prior to deploying hard-earned capital. The term investment strategy refers to a set of principles designed to help an individual investor achieve their financial and investment goals. At Cahaba Wealth Management, we believe that taking the time to understand our clients’ financial situations and building a holistic approach is by far the “better way”. Let’s investigate what this looks like.

An Investment Strategy typically involves three main components: Cash Flow Needs, Time Horizon and Risk Tolerance. If you are familiar with Cahaba Wealth Management, then you are surely aware of how important an understanding of these things is to the implementation of our strategy.  If you Google “components needed to create an investment strategy”, many of the generic responses include other components, such as fees and the tax efficiency of the investments. These are no doubt very important, but aren’t really a part of the strategy … they are more a part of the implementation of the strategy.

Cash Flow Needs

Unfortunately, many other financial advisers gloss over this important component. They often only ask basic questions such as whether you are working, when your expected retirement is, and, if you are already retired, what your cash needs are. While the answers to these questions are also vital to an investment strategy, we at Cahaba Wealth believe a deeper understanding of our client’s situation is necessary. Creating a financial plan (with an understanding of a client’s financial goals and aspirations) helps us outline upcoming cash needs that don’t fall into the “surface investigation” done by many others. Things like a future need for a new car, college expenses for children (or grandchildren), business expenses, family trips, and healthcare costs are all factored in to our cash flow projections. Having a plan for these types of future cash needs is essential to the design of an investment strategy.

Time Horizon

An investment time horizon is the period of time one expects to hold an investment before capitalizing on it. In conjunction with cash flow needs, time horizon considers (among many other items) the investor’s age, the time to retirement and the types of accounts that an investor has. For example, if the investor has a taxable account, a Roth IRA, and a 401(k) through work, the potential time horizon for each of those accounts may be different.

Generally speaking, the longer the time horizon, the more reasonable it is to take a higher level of risk. The reverse is also true – the shorter the time horizon, the less aggressive the investments should be.

Risk Tolerance

Risk tolerance is a measure of the degree of loss an investor is willing to endure within their portfolio. Age, investment goals, and income contribute to an investor’s risk tolerance. Stock volatility, market swings, economic or political events, and regulatory, or interest rate changes can also affect an investor’s tolerance for risk. If the prior two components (cash flow needs and time horizon) allow for a more aggressive investment strategy, but the investor is not able to emotionally handle the volatility/risk of that type of strategy, then the strategy is destined for failure! Ultimately, it is our job to create an investment strategy that the investor can stick to regardless of the movements in the markets.

An investor’s future earning capacity, the presence of other assets (such as a home, pension, and Social Security), and a potential future inheritance typically affect risk tolerance. Generally, an investor can take greater risk with investable assets when they have other, more stable sources of funds available. Regardless of this general rule of thumb, it is important to strike a solid and grounded balance between risk and the expected return of the overall portfolio. Understanding the unique mechanisms of an investor’s risk tolerance helps us choose an investment strategy that properly aligns their emotional and financial capacity. With this understanding, our hope is that the investor can handle market fluctuations with the expected return that is needed to accomplish all of their financial goals.

Appropriately combining these three components leads to a truly customized and highly functional investment strategy. A successful strategy ensures that all cash flow needs are met across the time horizon spectrum and that the investor is comfortable with the level of risk required to achieve their financial goals. It is important to note that all three components will change over time; none of them are static. As the investor’s financial situation, goals, income level, and family situations evolve, there is the potential that the investment strategy should change. Cahaba Wealth meets with our clients to review all of these components periodically, working to ensure their needs are being met now and into the future.

Don Keeney, CFA, CFP® is a financial advisor in the Nashville office of Cahaba Wealth Management, www.cahabawealth.com.

Cahaba Wealth Management is registered as an investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability. Cahaba Wealth Management is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Content should not be construed as personalized investment advice. The opinions in this materials are for general information, and not intended to provide specific investment advice or recommendations for an individual. Content should not be regarded as a complete analysis of the subjects discussed. To determine which investment(s) may be appropriate for you, consult your financial advisor.

The Case for International Stocks

By Don Keeney, CFA, CFP®

Many of us have heard statistics1 claiming:

  • Domestic stocks have outperformed international stocks eight out of the last ten years.
  • Domestic stocks have outperformed international stocks by a cumulative 20 percentage points over the last three years.
  • Domestic stocks have outperformed international stocks by a cumulative 50 percentage points over the last five years.

These truths make it seem as though investing in international stocks is a complete waste of time. To help explain why that’s not the case, let’s take a look at some additional data.

Figure 1

The above chart containing data from 1973 to 2022 outlines the following:

  • Over the last 50 years, domestic stocks have outperformed international stocks only 59% of those years.
  • International stocks have outperformed domestic stocks 100% of the time when domestic stocks had returns of less than 4% for the year.
  • International stocks have outperformed domestic stocks 96% of the time when domestic stocks had returns of less than 6% for the year.

Some of what we hear is rooted in Recency Bias. Recency bias is a behavioral pattern in which people incorrectly believe recent events will soon either occur again or persist indefinitely. This bias inhibits an individual’s ability to objectively gauge probabilities, which can lead to poor decisions. While domestic stocks have outperformed international stocks more recently, this has not consistently been the historical norm – nor can we say it will be the case in all future years. We have to separate recent market occurrences from future anticipated market movements.

There is solid evidence that shows the outperformance of one stock market over the other occurs in long cycles (see figure 2). The current cycle is now over 12 years long (including 2023 year-to-date). However, immediately before the current cycle started, international stocks outperformed domestic stocks for roughly eight consecutive years. While the below graphic consists of 5-year rolling returns and not stand-alone calendar years, the perspective remains meaningful. The current cycle is not going to last forever. Investors should acknowledge recency bias and expect the market to NOT stay that way.

Figure 2

When is the next cycle going to start? Who knows! Was international’s outperformance in 2022 the start of a new, long-term outperformance cycle? Who knows! Only one thing remains certain: at some point, the current performance cycle will flip, and international stocks will outperform domestic stocks (at least until the next cycle begins).

With this in mind, Cahaba Wealth Management appropriately constructs your investment portfolio to maximize the potential return for an appropriate amount of risk over the long term. The conversation above about which asset class is going to outperform another asset class actually misses the bigger, more important idea at play: diversification. Diversification is the process of spreading your investments around to multiple different asset classes so that your exposure to any one type is limited. As we tell our clients, diversification is the only “free lunch” in investing!

In other words, an investor can purchase two (or more) risky assets and simultaneously (1) improve the expected rate of return for the combined portfolio AND (2) reduce the portfolio’s overall expected risk. Diversification is a true “two-for-one special”! The only caveat is that the assets cannot act exactly like each other – meaning the assets should not have the same performance and volatility patterns. The more dissimilar the returns are, the larger the “free lunch”.

The takeaway is not to ask if international stocks will ever outperform domestic stocks again (or vice-versa); instead, it is to capitalize on the value of diversification and the resulting higher expected returns, with lower volatility, over your long term investing horizon. The inclusion of temporarily underperforming asset classes will always remain a positive contributor to your portfolio, given the power of diversification!

Don Keeney, CFA, CFP® is a financial advisor in the Nashville office of Cahaba Wealth Management, www.cahabawealth.com.

Cahaba Wealth Management is registered as an investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability. Cahaba Wealth Management is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Content should not be construed as personalized investment advice. The opinions in this materials are for general information, and not intended to provide specific investment advice or recommendations for an individual. Content should not be regarded as a complete analysis of the subjects discussed. To determine which investment(s) may be appropriate for you, consult your financial advisor.

1Source: ycharts.com