Do you remember your first bank account? I’ll admit, my recollection is hazy. I probably wasn’t older than 10 or 11, and I didn’t do much with the account for the first few years of its existence. I deposited a handful of birthday and holiday gifts each year, and that was about it. A few […]
There is so much money advice for people who have a full-time job, but if you are an entrepreneur handling your finances is a little bit different. Today I’m sharing some money tips if you are an entrepreneur. In this video, I go over topics such as: 1. The difference between having a 9-5 and […]
As the election approaches, investors naturally grow nervous with the uncertainty. With Joe Biden’s promises to increase corporate taxes and capital gains taxes, investors wonder about the effect to the stock market as a whole, and whether they should sell ahead of the election.
Because this is a financial website, I will not bring my politics into this article. Instead, I will try to present all known facts and estimates without bias and using some common sense.
For the following breakdown, I will be referencing statistics from two specific sources:
First, let’s summarize the current tax environment. Since President Trump took office in 2016, the Tax Cuts and Jobs Act (TCJA) changed corporate, capital gains, and individual taxes.
Broadly speaking, taxes in all areas were cut across the board, with additional tax credits and deductions applied as well.
Today, the rates most likely to impact investors sit at:
- Corporate Tax Rate = 21%
- Capital gains (long term) = 23.8%
The potential bigger impact to companies in the stock market, which will be reflected in fundamentals and prices, is the corporate tax rate, which will be the focus in this article.
How a Higher Biden Corporate Tax Could Move the Stock Market
Contributor Cameron Smith wrote a great article outlining how the 21.5% of Net Income savings for U.S. companies from the corporate tax rate being cut from 35% to 21% due to the TCJA led to a similar 29.3% S&P 500 gain in the index.
Two possible scenarios stem from the results of the 2020 election:
- Trump retains presidential seat, the 21% TCJA corporate tax rate stays unchanged.
- Biden is elected and passes a bill to increase the corporate tax rate to 28%.
Note: Of course, Trump could also make a surprise change, or an elected Biden could surprise by failing to follow through on his promise, but let’s ignore those for simplicity sake.
For some context on today’s corporate tax rates versus the past, these tax rates are historically low even if Biden changes them to 28%.
As shared by a website called The Balance, corporate taxes were as high as 53% (max rate) during the Nixon administration and have been falling ever since, with the biggest drops happening in 1988 (from 40% to 34%) and from the TJCA (from 35% to 21%).
Though Biden’s 28% corporate taxes would be lower historically, they would still represent a significant increase that would directly impact profitability and free cash flows for all public corporations in the U.S.
An increase from 21% to 28% would be a change of +33%.
For a simple illustration of this impact, take a corporation with $1,000 in profit for the year. The difference between a Trump Corporate Tax and Biden Corporate Tax:
- 21%: Gross = $1,000, Net = $790
- 28%: Gross = $1,000, Net = $720
Right off the bat, a -8.9% haircut (from $790 to $720) is quite substantial. A company who grew revenues at 10% a year under a 28% corporate tax rate would actually see a drop in Net Income in Year 2 from the transition from 21% corporate taxes to 28%.
With -8.9% less in total Net Income for the year, that would represent -8.9% less available for the public company to either reinvest in the business, pay dividends, or buyback shares.
Though a big number, the impact over the long term lessens over time.
The Potential Long Term Impact of Continued High Corporate Taxes
Like I mentioned, the consequences of higher corporate taxes would naturally decrease investor returns in a market priced on fundamentals.
There’s no question of that.
The question is by how much.
It’s impossible to estimate this precisely for every company, as the impact would likely vary quite a bit between industries and companies. But in general, less profits means less reinvestment, which leads to lower revenues for companies across the board.
With less reinvestment of profits, generally, comes less future growth.
So, with the -8.9% less available profits for reinvestment (per year) due to Biden’s higher corporate taxes, it’s reasonable to revise a 10% growth rate into a 9% growth rate (1.0-0.089)= 0.91; (0.91*0.10 = 0.0911) = ~9%
Note: This 10% is nothing special but we are using it for demonstrative purposes, to acquire appropriate percentages.
With the lower future revenue growth baked into a future earnings estimate, doubly compounded by the continued higher 28% rate on Net Income, would result in the following difference between the incumbent 21% corporate tax rate and the proposed 28% corporate tax rate:
From this, we can make a few very general judgments.
Assuming a full 8 years of this proposed corporate tax policy (2 presidential terms), we’d be looking at a -15.3% decrease in Net Income by the time Year 8 arrives (from $1,693.44 to $1,434.65). In other words, the compounding effect of the -9.7% difference in Net Income from the first year of the new corporate tax structure would accrue to eventually reduce future Net Income by -15.3% by year 8.
Not catastrophic, but not insignificant.
Using a compound interest calculator, we can see that the difference in growth of Net Income is the worst during the beginning of the new tax rate change.
For example, in Year 1, Net Income reduces from $790 to $784.80 (a negative CAGR), while the Net Income continues at the hypothetical 10% CAGR with no changes on the 21% corporate tax rate.
As time goes on, the change in CAGR of Net Income improves as Net Income also starts to compound (and grow exponentially), albeit from a smaller base than if it had been unchanged.
By Year 4, the CAGR of Net Income since the corporate tax change would rise to 6.5%, and would settle at around 7.75% CAGR by Year 8 (close enough to around 8% by Year 10).
How Would That Change Today’s Valuations?
With many financial valuation models dependent on the expected growth rate to estimate the value of a stock, the change in growth rate over 10 years (from 8% at the new 28% tax rate, to 10% if left unchanged) would impact stock market valuations in the following way:
- AAPL valuation at EPS growth = 10% –> $83.49
- AAPL valuation at EPS growth = 9% –> $77.66
- AAPL valuation at EPS growth = 8% –> $72.24
In other words, a decrease in the long term growth rate (10 years, 8%) would result in a -13% drop in the perceived valuation of Apple’s ($AAPL) stock today ($72.24 instead of $83.49).
Solely from the increase in the corporate tax rate and the resultant effects to growth, the bottom line impact to the stock market’s valuation at a whole could be a one-time hit of around -13%, excluding any other outside factors and looking at the impact to corporations as a whole.
The implication is that valuations will eventually recover, as they always do, but there would be softness in the growth of earnings—which leads to weakness in stock prices.
Whether this would come in the form of subdued stock price growth over time, or a one-time hit to valuations leading up to the election is anyone’s guess.
Adding Biden’s Proposed Fiscal Policy Impact to Stock Market Prices
Looking just at the corporate tax rate changes doesn’t encompass the entire picture when it comes to Joe Biden’s major policies and the potential impacts to the markets.
Of course raising tax rates should increase government revenues, which if spent by the government efficiently to create economic growth elsewhere should offset some of the loss in Net Income bore by public corporations due to higher taxes.
According to Investopedia, the two potential Presidents have outlined a desire for the following spending plans on infrastructure (meant to spurn the economy):
- Biden: $1.3T in Infrastructure spending over 10 years
- Trump: $2T in a “very big and bold” plan
Putting context into these large numbers again, the U.S. government is projected to spend between $4T- $5T in 2021.
An increase of $130B from Biden ($1.3T divided by 10 years) or $200B from Trump would represent anywhere between a 2.5% – 5%+ increase in total government spending.
Ignore Trump’s spending bill, which Investopedia doubts the feasibility of, and just apply Biden’s proposed infrastructure spending back into the hypothetical impact to the stock market (since that’s what we’re examining anyways).
With Biden, the $130B per year in infrastructure spending would add 2.5% – 3.5% to total government spending. Assuming that this equates to an equal percentage increase to the revenues of the companies in the stock market as a whole (which is probably a stretch, but let’s illustrate it)…
Revising the Biden Corporate Tax Rate Effect with Infrastructure Spending
In effect, the -8.9% decrease in Net Income from increased corporate taxes could be offset by 3% growth from infrastructure spending, bringing the net effect to corporate revenues and profits to somewhere around -6% per year.
Now take that percentage and apply it to the (old) base rate of 10%.
(1.0 – 0.06) = 0.94; (0.94*0.1) = 0.094 = 9.4%
Remember from above that lower Net Income will likely result in lower revenue growth for the future, which will compound into a greater discrepancy compared to if corporate taxes stayed the same—which we defined as a -9.7% difference in Year 1 and a -15.3% difference by Year 8.
With a new 9.4% growth rate of revenues, we can update the table from above like so:
Using these updated inputs, assuming the infrastructure spending spurned great economic activity by a significant amount, the Net Income of a company by Year 8 would be $1,477.31. This would represent a -13% compounded difference, vs the -15.3% we assumed with just the impact of Biden’s corporate tax rate alone.
Reality is probably somewhere closer in the middle, but now we have a good, common sense (and hopefully unbiased) idea of where valuations could lie—and profitability could land—if Biden is elected president and the corporate tax rate is updated to 28%.
Like with all models, projections, and estimations, this solely tries to examine the impact of tax changes on a statistical basis and must therefore assume no other outside forces.
The real world, as we should know, doesn’t fit tightly into a box like this (thankfully).
I think that a reasonable estimation of the impact of a new Biden corporate tax rate to the average investor holding stocks would be reiterated succiently by what I said at the top:
“Not catastrophic, but not insignificant.”
However, over the long term the consensus is that the President of the United States doesn’t really matter all that much to stock market returns.
The stock market follows the economy and business profitability, and short term adjustments to tax codes and regulations are to be expected over the course of long periods of time. In the aggregate, companies learn to grow and adapt to rapidly changing environments, thus creating significant returns to long term shareholders over time.
While an investor is powerless to the next president elect and the resulting short term impact to the markets, the investor has great amounts of control over his or her behavior and habits.
By sticking to long term principles of sound investment management, you greatly increase your chances of compounding your wealth at great rates, regardless of what happens, politically or otherwise.
These long term principles are as old as time, and have worked to provide sound retirements and financial freedom to many individuals over many decades.
Best of all, these principles are timeless, as relevant today as they were 100 years ago. They include:
- Adequate diversification, to mitigate the risk of any one business going bankrupt
- Dollar cost averaging, to smooth out the effects of short term market timing as you enter positions
- Investing for the long term, through ups and downs (and bear and bull markets), in order to completely absorb the benefits of the long term returns of the stock market.
As much as I love digging into the numbers and getting very specific about companies and their financials, I know that it doesn’t take that level of intensity to earn great returns from the stock market, in a safe and reasonable way.
It’s my hope that as you digest all of the uncertainty that political instability creates, you also have the practical solutions in place to secure your financial future into a lasting source of peace and prosperity.
That’s a REAL plan for life, liberty and the pursuit of happiness.
The post Election 2020: Effect of the Proposed Biden Corporate Tax to the Stock Market appeared first on Investing for Beginners 101.
During this time of uncertainty, everyone is looking for ways to save money. Even small amounts can add up to an emergency fund or just that added bit of security we need to get us through. Here’s an easy money tip that has saved me thousands over the years. The Money Tip that Saves Thousands … Continue reading “The Easy Money Tip That Saves Thousands”
If you’ve been around here for a while, you’ll know that we love a budget.
Budgets help you to live abundantly and without stress- no more wondering where all of your money has gone each month!
When it comes to creating a budget for the first time, there can be a bit of overwelm.
One of the things that you may get stuck on is what budget categories to have.
It isn’t important to have the most perfect looking budget ever, but rather have a budget that you will stick to and what works for you. Whether you do a monthly budget or not.
You may have looked at the budget categories Dave Ramsey shows, and be interested to find out more.
It’s different for everyone, so in this article, we will be doing a deep dive into all of the different budget categories.
What Are Budget Categories?
You may be wondering what are budget categories? And why is it going to help so much?
When you are starting your budget you will be listing out all of your various expenses.
You will then want to group them together in categories so you can see an overall picture of what you are spending on.
A lot of people get stuck on which budgeting categories to choose, so we will have a look through a comprehensive list of budget categories for you to help you out with your budget.
Of course, you could check out our budget spreadsheet with categories, which will do a lot of the hard work for you. We put this together to be as helpful as possible when starting your budget.
There are many budget categories and subcategories that we can go through.
What Are The 3 Basic Budget Categories?
There are 3 simple budget categories that are helpful to use as a good place to start when it comes to looking at your expenses. There are various household budget percentages you can use as well to help.
Needs (Living Expenses)
So firstly, the most important one – your needs. There are some things that you need to pay for in order to survive, and this is where these go.
The sort of things that go into this are expenses such as your housing, your water, electricity and gas, and so on. This is where there are budget categories for households.
Your ‘wants’ are the things that you want to buy but don’t need in order to survive. This is the differentiation between needs and wants.
This category is where most of the overspending and problems come from, but this is where having a budget really helps!
Debts + Savings
As well as the needs and wants, you’re going to want to have a budget category/section for your debt (if you have it) and savings.
How To Organize Budget Categories
Within those 3 broad budget categories, there are lots of smaller budget lines that we can go into a bit more detail on.
1. Needs (Living Expenses)
So, the needs. These are the most important expenses as you need to pay these in order to survive.
You’re going to need somewhere to live, and therefore housing costs are really important.
When it comes to housing costs you may just think of your mortgage or rent payment, but there’s a lot more that goes into running a house, and you want to make sure that you are covered for everything.
The housing costs will vary depending on whether you are renting or own your home. When you own your home you will have to think about additional costs such as for repairs.
Some examples of the types of housing costs that you want to include in your budget are:
- Property Taxes
Another important section for your budget is utilities. We need to pay for utilities in order to keep our home running, and there can be some added extras as well.
Examples of utilities include:
- Cell Phones
Food + Medical
We all need to pay for food! Food is one of the biggest budget categories for a lot of people and something that can be broken down a bit more.
You will also want to think about any medical expenses that you have. Medical insurance is hugely important as well, and any prescriptions that you need to get.
- Eating Out
- Medical Insurance
What are your transportation costs? You’ll want to make sure that you include all of this if you want to get around!
The amount that your transportation costs you will depend on where you live and how much you travel.
- Car Payments
- Gas Money
- Car Insurance
Now on to the “wants.” As mentioned, this is where a lot of people get a bit lost when it comes to sticking to their budget.
That’s ok, as we can make sure that we budget for these, which will mean that we don’t go over budget.
The thing about ‘wants’ is to not think of them as unnecessary or lavish. These are the things that bring us joy – we just need to make sure we don’t go crazy in this area and leave ourselves short.
There will be different budget categories for families – everyone is different.
So what are some examples of wants? Let’s take a look:
You may be someone who believes that tithing is really important and wants to put it in their budget. This, therefore, needs to be a line item in your budget. Tithing and donating will look different for everyone, so think about how much you want to do this for.
- Other Charities
Home Expenses + Personal Care
It costs money to take care of your home, between cleaning, maintenance, or maybe just sprucing up curb appeal.
On top of that, there are personal care items that you will probably want to include in your budget. There are things that we need, but perhaps don’t want to spend a lot of money on.
Examples of these include:
- Cleaning Supplies
- Personal Supplies
- Diapers, etc.
Whilst this sort of thing doesn’t go down as a ‘need’ but can be essential when it comes to living a life that we enjoy.
Life doesn’t need to be all doom and gloom and saving every single cent that you earn. Where’s the fun in that?!
There are all kinds of things that you can include under this budget category – it will be different for everyone!
Here are some examples:
- His + Her “Fun Money”
- Date Night Fund
- Streaming Services / Ebooks / Etc.
- Gym Membership
Don’t underestimate the importance of the miscellaneous budget category.
A lot of the time, the reason for going off-budget is due to expenses that weren’t budgeted for. This is where the miscellaneous budget category can come in!
There are some specific things that you can budget for that aren’t unexpected, but when you are just getting started, the miscellaneous category will really help.
- Gifting (Birthdays, etc)
- Christmas Fund
- Miscellaneous Annual Costs
3. Debts + Savings
You might want to lump all debt and savings in together, but it does help to look at them separately.
That doesn’t mean that you can’t have a budget category called ‘debt’ or ‘savings’ – more so that you break them down to look at.
When it comes to credit cards, you may have a few that you use. If you want to pay off your debt then it will help to list them all out as they are likely all different. You could do it like this:
- Credit Card Debt #1
- Credit Card Debt #2
Same as above with credit cards, you may want to also list out all of your loans and see where you are with them. This could include:
- Student Loan #1
- Personal Loan #1
Immediate Savings + Investing
An important budget category to add is your various savings and investments. You may not have all of the ones that we have listed out below but that’s ok!
These are good examples of some that you should try and work towards:
- $1000 Emergency Fund
- 3-6 Months Emergency Fun
- Retirement Account #1
- Retirement Account #2
Future Savings + Goals
Don’t forget to include budgeting for the future! There are certain savings goals that you may have that you will want to include in your budget. This could look like the following:
- College Fund #1
- College Fund #2
- Car Repair Fund
- Home Maintenance
- Down Payment For Next Vehicle
Budget Categories FAQ
Hopefully, we will have covered a lot of your questions, but if you have more questions on budgeting categories and budgeting tips let’s try and cover some more below.
How Many Budget Categories Should You Have?
The number of budget categories that you have will depend on what your life looks like!
There’s no one right answer to this as we are all so different. However, you may find it beneficial to start off with a lot of budgeting categories (to make sure you cover everything) and then whittle them down over time.
Which Budget Categories Cover Variable Expenses?
Variable expenses are the expenses that “vary” – change each month. There are some expenses that don’t change each month such as your mortgage or rent.
There are some expenses that vary each month, and these are the ones that will be in your variable expenses.
This could be things like your groceries and fun money.
How Can I Set Up A Personal Budget On An Inconsistent Income?
We are believers that absolutely anyone can have a budget, no matter your income.
After all, a budget is just a way of figuring out how you spend the money you are getting in.
If you know how much you are going to be paid for the upcoming month then that is what you will be using as your income to budget from.
If your money is going to be coming in throughout the month then you will want to ideally get one month ahead of yourself.
This won’t be something that can be done straight away but is a good thing to work up to. You may find it useful to use budget categories and percentages.
Should I Include My Business Budget Categories In My Personal Budget?
We believe that you should keep your business and personal budgets separate. If you have business expenses you should be using your business income to pay them.
Try and have 2 separate accounts for your business and personal money so that you don’t get things mixed up. Having them all in one is very confusing and will be a nightmare when it comes to sorting out tax etc.
Final Thoughts On Budget Categories
When it comes to creating a budget we know how overwhelming it can be and you may have lots of questions for things like what budget categories you should have.
Hopefully, we have helped give you some insight and examples of the types of budgeting categories that you can have, but ultimately it will be up to you.
Everyone has a budget that is unique to them, their lifestyle, and family – there is no one budget that is the same for everyone.
What budgeting categories do you have within your budget? Let us know below!
You can’t beat this high-interest rate on cash savings. But there are a few catches. In the same week that NS&I announced huge interest rate cuts, Natwest has introduced a market-leading account offering a huge 3%. But you can’t move all your savings over. The Digital Regular Saver is designed for those starting off their […]
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