The Election Changed Washington. It Didn't Change Your Plan.
Maybe you stayed up Tuesday night refreshing the results. Maybe you woke up Wednesday morning relieved. Or maybe you woke up worried about what the next two years will bring.
Either way, if you're an investor, there's a good chance another question followed close behind:
Should I be doing something with my money?
Will the results lead to higher stock prices? Could a shift in congressional control change the direction of tax policy, government spending, or economic growth? And should your investments look different now that the votes have been counted?
These are fair questions.
After all, elections have consequences. The people we send to Washington make decisions that influence the economy, businesses, and ultimately the financial well-being of American households.
But here's what tends to get lost in the post-election noise:
The political landscape changed this week. Your financial plan didn't, at least not yet.
And understanding the difference could save you from making an expensive mistake.
Elections Matter. Just Not the Way Most Investors Think.
Now, to be clear, I'm not suggesting that elections don't matter to financial markets.
Quite the opposite.
During my years developing macroeconomic research and investment strategy at Wells Fargo Investment Institute, evaluating government policy and geopolitical developments was an important part of understanding the economic outlook.
That's because decisions made in Washington can have real consequences for corporate earnings, inflation, interest rates, and ultimately asset prices.
Consider fiscal policy, for example.
Changes to government spending and taxation can influence consumer demand and business investment. Tax reductions may encourage additional spending and investment, but depending on how they're financed, they can also contribute to larger federal deficits.
And those deficits matter because increased government borrowing can influence Treasury yields, which in turn affect mortgage rates, corporate borrowing costs, and the valuation of financial assets.
Trade policy is another example.
Tariffs might provide an advantage to certain domestic producers, but they can also raise input costs for companies relying on imported goods. Depending on how businesses respond, those higher costs can squeeze profits or contribute to higher consumer prices.
So, from this perspective, the composition of Congress matters because it can influence which policies advance, which face resistance, and which remain unresolved.
But here's where things get interesting.
The economic consequences of political decisions aren't always the same as their intended outcomes.
A policy designed to stimulate growth could contribute to inflation. A policy intended to protect domestic industries could create new costs elsewhere in the economy.
And even when investors correctly anticipate a policy change, financial markets may have already reflected those expectations in asset prices.
That's why understanding the election results is only the beginning of the investment analysis.
The more important question is how actual changes in policy interact with the economic environment that already exists.
Midterm Years Look Weak for Stocks. The Elections Weren't the Reason.
Now, if we turn to history, there's good reason to be cautious about drawing investment conclusions from election outcomes alone.
According to research from J.P. Morgan Asset Management, the S&P 500 has generated an average annual total return of 9.2% during midterm election years since 1937, compared with 13.3% during non-midterm years.
At first glance, that might suggest that midterm elections are bad for stocks.
But the numbers don't tell the whole story.
Consider 2018 and 2022.
Both were midterm election years, and both experienced significant stock market declines.
But the primary pressures on markets weren't the elections themselves.
In 2018, investors were dealing with tighter monetary policy, rising interest rates, and concerns about slowing global growth.
In 2022, inflation was running at its highest levels in decades, and the Federal Reserve was aggressively raising interest rates to contain it.
The elections happened against those economic backdrops. They weren't necessarily the reason markets struggled.
And that's an important distinction because correlation doesn't establish causation.
Indeed, research from J.P. Morgan also shows that the S&P 500 has historically generated positive returns in the twelve months following every midterm election since 1950, with an average gain of approximately 15%.
That's an interesting observation, but it isn't a forecast for the coming year.
Those historical returns occurred under very different economic conditions, interest-rate environments, and market valuations.
The takeaway isn't that stocks are destined to rally after an election.
It's that trying to use election outcomes alone to predict future market performance is a much less reliable exercise than many investors might believe.
The Bigger Risk Isn't Washington. It's How We React to It.
There's another factor that makes investing around elections particularly challenging.
And it has less to do with Washington than with how we process political information.
You see, whether we realize it or not, our political beliefs can influence our expectations about the economy.
When the political party we support wins, we might become more optimistic about the future.
When the other party wins, we might become more pessimistic.
But that change in sentiment doesn't necessarily reflect a change in the underlying economy.
Consider research published in The Journal of Finance examining how millions of American households adjusted their investments around the 2016 presidential election.
The researchers found that investors identified as likely Republicans increased their stock exposure following Donald Trump's victory, while investors identified as likely Democrats shifted toward safer assets.
Importantly, these changes were largely driven by a relatively small group of investors making substantial portfolio adjustments.
Think about that for a moment.
Two investors could look at the same election result, face the same economic conditions, and make completely different investment decisions simply because of how they interpret the political news.
Yet neither investor's retirement spending needs, long-term goals, or financial obligations necessarily changed overnight.
That's why I've long maintained that political opinions and investment decisions should be kept separate.
It's certainly reasonable to have concerns about government spending, deficits, taxes, or the direction of economic policy.
And it's equally reasonable to feel optimistic about policies that you believe could support economic growth.
But neither optimism nor pessimism is a substitute for evaluating corporate profits, interest rates, valuations, and the risks embedded in your investment portfolio.
Being right about an election doesn't automatically mean you'll be right about the stock market.
We Plan Around Policy Changes, Not Election Results
So, what does all of this mean for someone preparing for retirement or already living off their investments?
Well, this is where the distinction between monitoring economic developments and reacting to political headlines becomes particularly important.
At Franklin Madison Private Wealth, we approach economic and political uncertainty within the context of each client's broader financial plan.
And that means looking beyond what might happen in Washington to understand how different economic outcomes could affect a client's ability to meet their financial obligations.
Consider a couple approaching retirement that we recently worked with.
One of the central questions in their planning process was how to transition from earning a paycheck to generating income from their investments.
To answer that question, we first examined their actual household spending, separating recurring expenses from discretionary purchases and larger one-time financial commitments.
We then evaluated how their financial situation would change as employment income ended, healthcare costs shifted, and Social Security benefits eventually began.
An important part of that process involved modeling a multiyear Roth conversion strategy to evaluate whether paying taxes on retirement savings earlier could reduce their overall tax burden later in life.
Now, consider how this year's election fits into that picture.
Congressional decisions could eventually affect income tax provisions, healthcare policy, or other factors incorporated into their retirement projections.
But we wouldn't automatically change the couple's investment portfolio based solely on a change in congressional control.
Instead, we'd want to understand whether an actual policy change materially alters the assumptions supporting their plan.
For example, if tax legislation changes the economics of their Roth conversion strategy, we can revisit the timing and amount of future conversions.
If changes to healthcare policy affect their anticipated insurance costs, we can incorporate those costs into their retirement cash-flow projections.
And if changing economic conditions lead to higher inflation or weaker investment returns, we can evaluate how those developments affect the sustainability of their withdrawal strategy.
The key is that we're responding to changes in the client's financial circumstances and planning assumptions, not simply to changes in the political landscape.
You Don't Have to Predict the Next Crisis to Be Ready for It
The same approach applies to how we manage investment risk.
In another retirement planning engagement, our focus was on helping a client establish a more disciplined system for funding ongoing living expenses.
A key consideration was ensuring that the client had an appropriate amount of cash available to meet near-term spending needs without becoming overly dependent on selling investments at unfavorable times.
To accomplish this, we established a cash management framework that coordinated required minimum distributions, portfolio income, and planned withdrawals.
We also developed guidelines for maintaining and replenishing cash reserves, including circumstances in which it might be appropriate to delay selling equities during periods of significant market volatility.
Why does that matter?
Because for a retiree drawing income from a portfolio, the timing of investment losses can have lasting consequences.
A prolonged market decline combined with ongoing withdrawals can reduce the amount of capital available to participate in a subsequent recovery.
This is commonly referred to as sequence-of-returns risk.
Now, having cash available doesn't eliminate investment risk, and there's a cost associated with holding assets that may earn less than stocks over time.
But appropriately sized reserves can provide flexibility in meeting spending needs during market downturns.
And that flexibility is useful whether the next period of volatility comes from political uncertainty, inflation, a recession, or an unexpected geopolitical event.
In other words, we don't need to know which event will cause the next market decline to prepare for the possibility that one will occur.
That's the difference between trying to predict uncertainty and building a financial plan designed to accommodate it.
Ask What Changed for You, Not What Changed in Washington
Now that the election is behind us, the financial news cycle will inevitably shift toward what the new congressional landscape could mean for economic policy.
And there will be no shortage of opinions about which industries might benefit, whether inflation will move higher or lower, and what all of this could mean for stock prices.
Some of those arguments may prove correct.
But before making changes to your investments, I'd encourage you to ask yourself a more practical question:
What has actually changed about my financial situation that warrants a change in my investment strategy?
For instance, has your ability to withstand a market decline changed? Have your cash-flow needs increased? Are you approaching retirement with a portfolio that's more concentrated or aggressive than you originally intended?
And what about your tax situation?
If you're approaching retirement with substantial savings in a traditional IRA or 401(k), have you considered how future required minimum distributions, Social Security benefits, and potentially higher tax rates could affect your retirement income?
These are the types of decisions worth revisiting regularly.
Not because one political party won or lost an election, but because the economic assumptions underlying your financial plan can change over time.
And sometimes, an adjustment will be warranted.
That could mean rebalancing a portfolio that has drifted away from its intended allocation, reevaluating the amount of cash you hold, or updating a multiyear tax strategy following a meaningful change in tax law.
Other times, after reviewing the available information, the appropriate course of action might be to make no changes at all.
That's not ignoring uncertainty. It's managing it deliberately.
The Election Is Over. Your Financial Plan Still Has Work to Do.
As we move beyond the 2026 midterms, there's little doubt that Washington will remain an important source of economic headlines.
Questions surrounding fiscal policy, government debt, taxation, and regulation aren't going away simply because the election has concluded.
And as new policies are debated and implemented, we'll continue evaluating their potential consequences for financial markets and the economy.
But for individual investors, the bigger takeaway is that your investment strategy shouldn't depend on getting the political forecast right.
It should depend on having a clear understanding of what you're trying to accomplish, the risks you're willing and able to take, and the financial resources you'll need along the way.
After all, the next congressional election is only two years away.
Your retirement could last another twenty or thirty.
That's a much longer time horizon, and it's the one your financial plan needs to be built around.
At Franklin Madison Private Wealth, we help individuals and families coordinate their investment, tax, and retirement income strategies so that financial decisions remain grounded in long-term priorities rather than short-term uncertainty.
If you're concerned about how changing economic conditions could affect your retirement, we invite you to schedule a conversation to explore how your financial plan is positioned for the years ahead.
https://franklinmadisonadvisors.com/schedule-now/
Related Reading
Elections: Why You Shouldn't Mix Politics and Your Portfolio
Here's the Cost of Moving to the Sidelines
What Benjamin Graham Can Teach Us About Investing When the World Is Falling Apart
Keep Calm and Trust Your Investment Plan
July Market Update: A Loud Month, a Quiet Market
Research and Supporting Sources
J.P. Morgan Asset Management, "2026 Midterm Election Hub."
https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-themes/us-elections/
J.P. Morgan Asset Management, "How Do Markets Perform Post-Midterms?"
https://am.jpmorgan.com/us/en/asset-management/institutional/insights/market-insights/market-updates/on-the-minds-of-investors/how-do-markets-perform-post-midterms/
Meeuwis, Parker, Schoar, and Simester (2022), "Belief Disagreement and Portfolio Choice," The Journal of Finance.
https://doi.org/10.1111/jofi.13179
Weekly Market Update: The Fed Holds as Growth Runs Hot
Stocks were mixed as investors weighed a Fed decision, strong economic data, and earnings from the largest tech companies.
The S&P 500 drifted higher and the Nasdaq gained nearly 1.5%, while the Dow fell about -1%. Small caps outperformed, with the Russell 2000 rising nearly 2.5%.
Nine of 11 sectors finished higher. Tech led with a 3.1% gain, while Communication Services fell more than -5% after Alphabet's earnings disappointed. High Beta and Momentum stocks outperformed Low Volatility, reversing part of last week's shift toward defensive stocks.
Treasury yields edged higher, and the 10-year yield stayed near 5%. The U.S. dollar firmed. Oil swung after attacks on Saudi energy facilities and ended the week nearly 3% higher. The VIX, a measure of expected volatility, fell back below 20.
Key Takeaways
Economy Grows Faster Than Expected
Real GDP grew at a 3.4% annualized rate in the third quarter, above the roughly 3.2% economists expected and up from 2.2% in the second quarter. Consumer spending rose 3.8%, matching the prior quarter's pace, led by health care and restaurants.
Investment in information processing equipment, which includes the computers and servers used in AI data centers, rose 37.4%, while residential investment declined as high mortgage rates weighed on housing. Real final sales to private domestic purchasers, which exclude volatile categories like trade, inventories, and government spending, increased 4.9%.
Why it matters: Underlying private demand outpaced the headline number. That means the quarter's strength came from households and businesses, not temporary swings in trade or inventories.
Inflation Picks Up as Real Spending Stalls
The PCE price index, the Fed's preferred inflation measure, rose 3.6% from a year earlier in September, up from 3.4% in August. Core PCE, which excludes food and energy, climbed to 3.1%, in line with expectations.
Consumer spending grew 0.5% for the month but was essentially flat after adjusting for inflation. Real disposable income fell -0.3%, and the personal saving rate dropped to 3.8%, its lowest level since 2022, as households saved less to keep spending.
Why it matters: The strong quarter ended on a softer note. Rising prices absorbed the gains in household spending and left consumers with a thinner savings cushion.
Fed Holds, but Two Officials Vote to Hike
The Fed kept its target range at 3.75% to 4.00% after raising rates in September, but two members dissented in favor of a quarter-point increase. The statement said economic activity is "expanding at a strong pace" and inflation "remains elevated," while Chair Kevin Warsh declined to signal the next move.
Markets raised the odds of a December hike to about 80%, according to CME FedWatch. Longer-term Treasury yields rose after the decision, and the 10-year yield closed above 5% on Wednesday.
Why it matters: The dissents show that support for further tightening extends beyond a single official. That's why markets now treat a December hike as the most likely outcome.
Investors Sort AI Spenders by Cash Flow
Alphabet shares fell more than -10% on Thursday after the company reported a second straight quarter of negative free cash flow, as quarterly capital spending of more than $51 billion outpaced the cash its business generated.
Microsoft, by contrast, reported 48% growth in its Azure cloud business along with positive free cash flow, and its shares held up far better. Earlier in the week, Oracle jumped more than 10% after capping how much new capital it plans to raise.
Meanwhile, AI financing keeps growing. Meta launched a stock sale of up to $95 billion to fund new data centers, AI developer Anthropic filed to go public, and Microsoft announced plans to issue $25 billion of debt.
Why it matters: After weeks of focus on how the AI buildout gets financed, investors are rewarding the companies that can pay for it from their own cash flow.
The Roth Conversion Deadline Isn’t April 15
Imagine sitting down with your tax preparer in March 2027 and discovering that you might have been able to convert another $50,000 from your traditional IRA at a favorable tax rate in 2026.
Your income came in lower than expected. Maybe your business slowed down, or a consulting contract ended earlier than anticipated.
Whatever the reason, the opportunity was there.
But there's a problem. The year is already closed.
Unlike IRA contributions, which generally can be made until the following April's tax-filing deadline, a direct Roth conversion must be completed by December 31 to count for that tax year.
And there's another difference worth understanding. Under IRS rules, Roth conversions made since 2018 cannot be recharacterized back into traditional IRAs. Once the conversion is completed, you cannot undo it.
But here's what I think is the bigger mistake.
It's building a multi-year Roth conversion plan and never checking it against the year's actual circumstances before the year closes.
Because a good conversion year only looks good when you compare it with the years ahead.
Why a Roth Conversion Plan Still Needs a Year-End Review
When we develop a Roth conversion strategy for a client, we're making decisions about when it makes sense to recognize taxable income over multiple years.
That requires projecting income, retirement withdrawals, future taxes, and the amount of money likely to remain in tax-deferred accounts later in retirement.
I've discussed how we identify those opportunities in The Retirement Tax Window Most People Miss.
Once we've identified a strategy, we establish a conversion schedule based on what we know at the time.
But that schedule is a starting point, not a standing instruction.
Consider a retiree who's winding down a consulting business. We build a plan in January expecting $100,000 of consulting income, only to learn in October that their actual income will likely be closer to $50,000.
The original conversion schedule might still work.
But the assumptions supporting it have changed.
And if we're not reviewing those changes before December 31, we could miss an opportunity to recognize income at a lower cost than originally anticipated.
The reverse can happen, too. A large capital gain, unexpected bonus, or substantial retirement withdrawal might make the planned conversion more expensive than expected.
That's why we distinguish between establishing the strategy and managing its implementation.
The plan sets the path. The fall review sets the pace.
Four Questions That Drive Our Year-End Roth Conversion Decisions
By the fall, we generally have a much clearer picture of how a client's year is shaping up.
We can compare actual income against our original projections, estimate what remains for the year, and evaluate whether the planned conversion still makes sense.
Four questions drive that review.
1. What Changed Since We Established the Plan?
The first thing I want to understand is whether the assumptions behind our original conversion schedule still hold.
Think back to our retiree winding down the consulting business. By October, their income is running $50,000 below what we projected in January.
Now we need to determine what that difference means for the conversion schedule.
In our planning process, this involves updating the current-year tax projection and comparing it with the assumptions built into the longer-term retirement plan.
A decline in income isn't the only reason to make an adjustment.
An unusually large deduction might reduce taxable income. A market decline could allow us to convert more shares at a lower current value. Conversely, an unexpected capital gain or retirement withdrawal might make converting less attractive.
None of those developments automatically justifies changing the strategy.
But they give us a reason to rerun the numbers.
If the current year has become materially more attractive, I'll want to know whether we should move some conversions originally scheduled for future years into the current one.
The important thing is that we're responding to new information rather than following an outdated schedule.
2. Is This Year More Attractive Than the Years We'd Be Taking Conversions From?
Finding additional room in a tax bracket doesn't necessarily mean we should use it.
For our retiree, we could potentially increase the planned conversion by $50,000. But whether that makes sense depends on what we'd otherwise do with those dollars in future years.
What if next year is expected to be even more favorable?
What if the additional conversion triggers a cost elsewhere in the plan?
And what if the projected benefits don't justify paying taxes earlier than necessary?
Research by Edward McQuarrie and James DiLellio, published in the Journal of Financial Planning, examines how Roth conversion outcomes depend on factors such as future tax rates, investment horizons, and how the conversion taxes are funded.
Their analysis, The Arithmetic of Roth Conversions, illustrates why conversion decisions can't be reduced to filling the available space in a tax bracket.
In our work, that means comparing the revised conversion schedule against the original plan and measuring how the decision changes projected long-term outcomes.
We're not simply asking whether we can convert more this year.
We're asking whether moving a conversion from one year to another actually makes the plan better.
3. What Is Already Scheduled to Change in the Next Two Years?
Before accelerating a conversion, we also need to consider what's immediately ahead.
For our consulting retiree, suppose a deferred compensation payment is scheduled for 2027.
That payment could make 2027 a more expensive year to recognize additional IRA income, strengthening the case for converting more in 2026.
But other circumstances might point in the opposite direction.
For example, a conversion today could affect Medicare premiums two years from now. Or the client might anticipate a large deduction next year that makes waiting more attractive.
I covered the interaction of these retirement milestones in Your Tax Window Doesn't Close All at Once.
For the year-end review, the question is more specific.
Do the changes we know are coming justify moving part of our planned conversions into this year?
And if we do, are we accurately accounting for the costs associated with that decision?
4. Can We Pay the Taxes Without Disrupting the Plan?
This is where an otherwise attractive conversion can become a poor financial decision.
Generally, it's advantageous to pay conversion taxes using money outside the traditional IRA, particularly when that money can be used without triggering substantial additional taxes.
But that money may also be earmarked for living expenses, property improvements, healthcare, or other anticipated costs.
That's why we coordinate the conversion decision with the household's cash management plan.
We look at the additional taxes, determine where the payment would come from, and consider whether using those funds would compromise other priorities.
We also coordinate any required estimated tax payments or withholding adjustments.
A conversion shouldn't create a cash problem simply because the tax projection suggests an opportunity.
How a Good Roth Conversion Plan Can Miss a Valuable Year
Let's put these questions together.
Consider our hypothetical retiree with a substantial traditional IRA and several years remaining before required minimum distributions begin.
Their retirement plan calls for converting $50,000 annually over the next several years.
That schedule was established using projected consulting income, investment earnings, future retirement withdrawals, and expected tax rates.
Then something changes.
During 2026, the retiree begins winding down the consulting business.
By October, it becomes clear that income will be approximately $50,000 lower than originally projected.
Meanwhile, a deferred compensation payment scheduled for 2027 is expected to increase taxable income next year.
Now we have a decision to make.
Do we stick with the original $50,000 conversion for 2026?
Or could it make sense to convert $100,000 in 2026 and reduce the amount originally planned for 2027?
Under the original plan, the client converts $50,000 in 2026 and another $50,000 in 2027.
Under the revised approach, the client converts $100,000 in 2026 and nothing in 2027.
Either way, the total comes to $100,000 over those two years.
What changed is the timing.
If the client's lower consulting income makes 2026 less expensive than 2027, the revised schedule could reduce the total tax cost.
But we wouldn't stop at the tax bracket comparison.
We'd calculate the additional current-year tax, evaluate other income-related consequences, confirm that cash is available to pay the bill, and consider how the revised timing affects the broader retirement projections.
We also need to remember that a lower tax rate today doesn't guarantee a successful conversion.
In his September 2024 paper, Net Present Value Analysis of Roth Conversions, Edward McQuarrie identifies taxpayers who have accumulated substantial tax-deferred savings during high-earning years but temporarily find themselves in a lower tax bracket as among the least risky candidates for conversion.
That's particularly relevant to our retiree.
The temporary income decline could create an attractive opportunity, especially if future retirement distributions are expected to be taxed at higher rates.
But the paper also cautions that the ultimate value of a conversion depends on uncertain future tax rates and the timing of the potential savings.
That's why we'd measure the expected benefit rather than assume the additional $50,000 conversion is automatically worthwhile.
If the updated calculations support accelerating the conversion, we'd coordinate the transaction before year-end.
Now imagine that review never happens.
The client goes through the holidays and doesn't revisit the figures until meeting with the tax preparer in March 2027.
At that point, the income shortfall is obvious.
The 2026 tax return shows that income was substantially lower than originally anticipated.
But it's too late to initiate a direct Roth conversion for 2026.
The client can still convert in 2027, but the income and tax circumstances will be different.
And the opportunity to shift that additional $50,000 into 2026 is gone.
The original retirement plan wasn't necessarily flawed.
The problem was that nobody compared what actually happened with what the plan expected while there was still time to act.
A Roth Conversion Isn't Complete Just Because You've Decided to Make One
There's one final part of our year-end process worth emphasizing.
Once we've decided how much to convert, the transaction still needs to be completed.
That means coordinating with the retirement account custodian, confirming the appropriate assets and dollar amount, and making sure the transaction is processed within the applicable deadline.
For clients whose retirement accounts are held at Charles Schwab, we verify the relevant year-end processing cutoff before initiating the transaction.
As Schwab Advisor Services explains, Roth conversions are among the transactions subject to year-end processing schedules and cutoff times.
We also need to consider whether the conversion involves cash or securities, whether any account transfers are necessary, and whether tax payment arrangements are in place.
And because the IRS prohibits recharacterizing Roth conversions made since 2018, I want the tax projection and funding decision settled before the transaction takes place.
The conversion amount is only part of the decision.
Getting the transaction completed correctly is what turns the strategy into action.
The Plan Sets the Path. The Fall Review Sets the Pace.
A Roth conversion strategy shouldn't be rebuilt from scratch every December.
But it shouldn't run on autopilot, either.
In our work with clients, the multi-year plan gives us a framework for deciding when it may make sense to recognize income.
The annual review gives us a chance to respond to what actually happened during the year.
Sometimes that means accelerating conversions.
Sometimes it means postponing them.
And sometimes, after reviewing the numbers, the original schedule is still the right one.
The value comes from making that decision deliberately, with current information, while we still have the ability to act.
That's why I believe a fall tax review belongs on the calendar of anyone pursuing a multi-year Roth conversion strategy.
Don't wait until your tax return is being prepared to discover whether the previous year offered an opportunity.
By then, the decision may already have been made for you.
At Franklin Madison Private Wealth, we help pre-retirees and retirees coordinate Roth conversion decisions with their longer-term retirement income and tax strategies.
If you've accumulated substantial savings in traditional IRAs or 401(k)s and want to understand whether your current strategy is making the most of the years available to you, schedule an introductory conversation.
Because once you've identified the years when converting makes sense, there's another question that deserves just as much attention:
How much should you actually convert in each of those years?
Related Reading
A Roth Conversion Is Not the Goal
Your Cash Reserve Is Supposed to Run Low
The Tax Bill You're Leaving Your Kids
Will Your Spouse Pay Higher Taxes After You're Gone?
Sources
Internal Revenue Service, “Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).”
https://www.irs.gov/publications/p590a
Fidelity Investments, “Why Convert to a Roth IRA Now?”
https://www.fidelity.com/learning-center/personal-finance/retirement/answers-to-roth-conversion-questions
Edward F. McQuarrie and James A. DiLellio, “The Arithmetic of Roth Conversions,” Journal of Financial Planning, May 2023.
https://www.financialplanningassociation.org/learning/publications/journal/MAY23-arithmetic-roth-conversions-OPEN
Edward F. McQuarrie, “Net Present Value Analysis of Roth Conversions,” Journal of Financial Planning, September 2024.
https://www.financialplanningassociation.org/learning/publications/journal/SEP24-net-present-value-analysis-roth-conversions-OPEN
Charles Schwab Advisor Services, “Digital Tools to Simplify End-of-Year Tasks.”
https://advisorservices.schwab.com/insights-hub/end-of-year-digital-tool-tips
Internal Revenue Service, “Retirement Plans FAQs Regarding IRAs.”
https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras
Weekly Market Update: Housing Hits New Lows as Leadership Shifts Beneath the Surface
Markets traded lower this week, although performance beneath the major indexes was stronger. The S&P 500 fell -1.1% and the Nasdaq declined -3.4%, while the Russell 2000 small-cap index gained 0.3%.
The Equal-Weight S&P 500 rose 1.2%, highlighting broad participation despite tech weakness, and Value 0.9% outperformed Growth -3.6%. Eight of eleven sectors traded higher, led by Consumer Staples 3.5%, Utilities 2.7%, and Financials 2.4%. Technology -3.9% and Communication Services -4.8% lagged.
Bonds rallied as Treasury yields declined, with long-maturity Treasuries gaining 2.3% compared with 0.3% for short-maturity bonds. Investment-grade corporate bonds rose 0.8%, while high-yield bonds were flat. Oil rose 2.8%, the U.S. dollar weakened modestly, and the VIX ended flat after a late-week spike.
Key Takeaways
High Mortgage Rates Push Housing to New Lows
Pending home sales, which measure contracts to purchase existing homes, fell -7.3% in September, leaving the index at its lowest level since tracking began in 2001. Housing starts declined -5.2% to an annualized rate of 1.22 million units, the second weakest reading since the pandemic.
Homebuilder confidence fell to 29 in October, its lowest level since 2012 and well below the neutral level of 50. The weakness is tied to the average 30-year fixed mortgage rate sitting above 7%, among the highest levels since the early 2000s. High borrowing costs and persistent affordability challenges have discouraged buyers. Meanwhile, elevated construction costs have weighed on builders, leading them to cut prices and offer incentives.
Why it matters: The breadth and severity of the latest declines underscore how much housing has weakened relative to other areas of the U.S. economy.
Industrial Output Rises, Led by Utilities and Tech
Headline industrial production rose 0.7% in September, helped by a 3.5% increase in utility output as unseasonably high temperatures lifted demand for electricity and natural gas. Manufacturing output rose a more modest 0.3%.
Over the full third quarter, semiconductor and electronic-component production grew at a 28.4% annualized rate, which helped support factory activity. However, manufacturing output excluding selected high-technology industries was nearly flat, rising at just a 0.1% annualized rate.
Why it matters: Technology-related manufacturing continues to support industrial growth, while activity across the broader manufacturing sector remains more modest.
Trade Prices Point to Broader Inflation
Prices for goods imported into the U.S. rose 1.1% in September and 8.1% over the past year. Higher fuel prices contributed, but import prices excluding fuel still rose 0.7%.
Prices received by U.S. exporters increased 2.2% for the month and 11.6% over the past year. These figures reflect prices paid and received in international trade, not prices charged directly to consumers.
Why it matters: The report adds a business-level view to last week's consumer and producer inflation data, and it's further evidence of how broad September's price increases were.
S&P 500 Holds Near Records as Leadership Shifts
Large technology companies, particularly those tied to artificial intelligence and semiconductors, have seen sharp swings in recent weeks.
However, other sectors, including some that had previously lagged the broader market, have partly offset that weakness.
Why it matters: Recent volatility has largely reflected a change in leadership rather than a broad-based retreat from stocks.
Phased Retirement Has a Tax Price Tag
For many executives and professionals approaching retirement, the idea of doing a little consulting sounds like the perfect transition.
You get to stay engaged, put your experience to work, and earn some additional income without the demands of a full-time career.
And financially, it seems like a pretty good deal. Every dollar you earn is another dollar you don't have to take from your retirement savings.
But there's a cost to that arrangement that often gets overlooked.
The income you earn during phased retirement can take up the very tax brackets you were planning to use for Roth conversions.
To be sure, those first few years after leaving full-time employment can be particularly valuable for retirement tax planning. So then, by continuing to earn income, you may be trading away some of that opportunity without realizing it.
That doesn't mean consulting is a bad decision. In fact, it could strengthen your retirement plan.
However, the question is whether the additional income today is worth what you're giving up in future tax savings.
How Consulting Income Changes Your Roth Conversion Strategy
For many successful professionals, the years immediately following retirement represent a significant shift in their tax situation.
Your salary and bonuses disappear.
Social Security and required minimum distributions (RMDs) haven't started yet.
And for the first time in decades, you have greater control over how much taxable income shows up on your return.
I discussed this opportunity in The Retirement Tax Window Most People Miss. It's the period between your working-income years and the years when retirement income sources begin filling your tax return.
For someone with substantial savings in a traditional 401(k) or IRA, that window creates an opportunity to move money into Roth accounts at deliberately chosen tax rates before RMDs begin. The IRS outlines the applicable distribution requirements, which depend on birth year and account type.
Now consider what happens when you accept a consulting engagement.
Suppose you've determined that converting $100,000 from a traditional IRA would make sense given your projected income and tax situation.
Then you accept a consulting arrangement that produces another $100,000 in taxable income.
Suddenly, much of the tax-bracket capacity you intended to use for conversions is gone. You can still convert, but doing so at the same amount could push more income into a higher marginal tax bracket.
To be sure, the relationship isn't necessarily dollar-for-dollar. Business expenses, deductions, retirement contributions, and other household income all affect the calculation.
But the tradeoff remains. The more taxable income you earn during your conversion years, the less room you have to recognize additional income at your preferred tax rate.
And the consequences can extend well beyond those first few years.
Research by Edward McQuarrie, published in the September 2024 Journal of Financial Planning, examines the economics of Roth conversions intended to reduce future RMDs. His analysis emphasizes that conversion decisions involve an upfront tax cost in exchange for uncertain future tax savings that can take decades to materialize.
That's an important distinction.
That’s because the objective isn't simply to convert more money.
It's to determine whether using today's tax brackets improves your long-term after-tax financial position.
Why Working Longer Can Still Strengthen Your Retirement Plan
Of course, focusing exclusively on lost conversion opportunities would miss the other side of the decision.
Continuing to earn income has real financial advantages, particularly when it reduces the need to withdraw money from your investments early in retirement.
That's because the first few years of retirement are especially sensitive to the order in which investment returns occur.
As I discussed in Why the First Five Years of Retirement Decide the Next Twenty-Five, withdrawing money during an early market decline can leave a portfolio with less capital to participate in the subsequent recovery.
Consulting income gives you another source of money to cover expenses without relying as heavily on portfolio withdrawals.
And that additional income can also make it easier to delay Social Security. For individuals born in 1943 or later, delayed retirement credits increase benefits by 8% annually beyond full retirement age, up to age 70.
And if you're genuinely self-employed, you have another planning opportunity through a solo 401(k).
Traditional contributions can reduce current taxable income, although they also add to retirement savings subject to future RMDs. Roth solo 401(k) employee contributions, if permitted by the plan, don't provide that immediate deduction, but aren't subject to lifetime RMDs.
On the other hand, independent consulting income ordinarily carries self-employment tax in addition to income tax.
So, while consulting provides additional cash flow and retirement savings opportunities, it can also reduce your flexibility to manage taxes later.
The question then becomes whether those benefits outweigh the opportunity cost of delaying Roth conversions.
A Retirement Planning Example: Three More Years of Consulting
To see how those pieces interact in practice, consider a hypothetical 62-year-old executive in Philadelphia we’ll call Craig.
Craig is preparing to retire after a successful corporate career.
Most of his retirement savings are held in traditional retirement accounts. And Craig also also has taxable investments and sufficient cash reserves to support the transition away from full-time employment.
By many measures, Craig is financially prepared to retire.
But as he starts thinking about what he'll do next, a former colleague offers him a three-year consulting arrangement.
The work is interesting.
The hours are manageable.
And the income would cover a substantial portion of his living expenses.
At first glance, accepting the arrangement seems like an easy decision. But before making that commitment, I would want to compare two different retirement paths.
Path A: Retire Fully at 62
Under the first scenario, Craig stops working entirely.
He funds his living expenses from available cash and taxable investments while preserving flexibility over when to withdraw from his traditional retirement accounts.
With employment income eliminated, he has an opportunity to execute Roth conversions within deliberately selected tax brackets during the years before Social Security and RMDs begin.
The drawback is that Craig will need to rely on his investments sooner, exposing more of his portfolio to early-retirement withdrawal risk. He'll also need sufficient assets outside his retirement accounts to cover both living expenses and conversion taxes.
And because he's retiring before Medicare eligibility, I would evaluate how conversion income affects his health insurance costs.
For someone purchasing coverage through the Marketplace, Roth conversion income counts toward the income used to determine premium tax credits, so a larger conversion can mean a larger premium bill.
Path B: Consult for Three Years
Under the second scenario, Craig accepts the consulting arrangement.
The additional income covers his household expenses, allowing him to preserve more of his investment portfolio. Depending on how the arrangement is structured, he could also make additional retirement contributions.
From a cash-flow perspective, that's attractive.
But now Craig has considerably less room for Roth conversions during those same three years.
And if he's buying Marketplace coverage until 65, the consulting income counts toward his premium tax credit calculation too.
To illustrate, suppose his tax projections show $120,000 of available room for conversions within a chosen marginal tax bracket.
If the consulting arrangement adds $80,000 to his taxable income after applicable deductions and adjustments, that room falls to approximately $40,000. That's $80,000 less that he can convert within his targeted bracket that year, and over three years, the cumulative difference becomes substantial.
Those conversions aren't necessarily lost forever.
Craig can revisit them after consulting ends.
But the delay leaves more money in tax-deferred accounts, increasing their exposure to future RMDs and potentially requiring conversions at less favorable tax rates.
So, neither path automatically produces the better outcome. The more important question is what happens when we compare their projected results over the next twenty or thirty years, rather than focusing exclusively on the three years he's consulting.
This example is hypothetical and illustrates the planning tradeoffs rather than an actual client's financial results. The conversion figures are simplified and do not represent a tax recommendation.
How I Evaluate Phased Retirement Decisions With Clients
Which brings us to how I actually work through a decision like his. One thing I've found in retirement planning conversations is that the prospect of consulting tends to get evaluated first as a cash-flow benefit.
The thinking is straightforward.
If you earn another $80,000 a year, that's $80,000 you don't have to withdraw from your savings.
And that's a reasonable starting point.
But it isn't where I want the analysis to end, because the same income changes the tax-planning opportunities available during those years.
This is why I separate the final working years from the years that follow when building retirement income plans.
In a recent client planning engagement, for example, I modeled a couple's remaining two years of employment separately from their full retirement years.
That required distinguishing their actual and projected household spending during the working period, identifying when employment income would end, and adjusting the cash-flow assumptions once retirement began.
The distinction matters because income and withdrawal strategies that make sense during the final working years aren't necessarily appropriate after the paychecks stop.
I apply that same discipline when evaluating consulting arrangements.
First, I establish a retirement baseline without consulting income, including the sources of portfolio withdrawals, Social Security timing, and projected Roth conversions.
Then I introduce the consulting income. Think back to our executive, Craig.
On paper, his $80,000 looks like pure upside. But once I recalculate the tax picture, I can see how it changes the conversion schedule, the taxes paid during the consulting years, and the balances remaining in tax-deferred accounts as RMDs approach.
But I also want to know what happens to the investment portfolio.
Why?
Because the same income that crowds out conversions also means less money coming out of his investments during the first three years.
So, I look at whether preserving those investments improves the plan's ability to withstand an unfavorable sequence of market returns, and whether that benefit is worth the additional tax exposure later.
Finally, I look at Medicare, because the income-related monthly adjustment amount, or IRMAA, generally uses income from two years earlier to determine whether higher-income beneficiaries pay additional Part B and Part D premiums.
That means consulting income earned at age 63 can affect Medicare premiums at age 65. While work reduction or stoppage can qualify for an IRMAA redetermination, I don't assume that relief will offset the projected premium impact.
Once those moving pieces are incorporated, the decision becomes more interesting.
Maybe the better arrangement is to consult for two years instead of three.
Maybe it's to work fewer hours and preserve some conversion room.
Or perhaps the income is worth accepting, with larger Roth conversions scheduled after the engagement ends.
There may also be a case for accepting the higher tax cost if consulting meaningfully reduces portfolio withdrawals during an unfavorable market environment.
That's a legitimate outcome, too.
The point here isn't to convince someone to stop working.
It's to understand what continuing to work actually means for the retirement they've spent decades preparing for.
Before You Accept the Consulting Offer, Run Both Scenarios
Still, none of that analysis captures why most people say yes to consulting in the first place. For many, phased retirement is as much an identity decision as a financial one.
After spending thirty or forty years building a career, it's understandable to want to remain professionally engaged. Consulting can provide structure, purpose, and a gradual transition into retirement.
I've written about that challenge in The First Monday With Nowhere to Be, where I explored how the loss of a working routine can influence retirement spending and financial decisions.
But a decision that makes sense personally still deserves to be evaluated financially.
Here’s the bottom line: Phased retirement has a price tag.
Read it before you sign.
Before committing to another two or three years of work, compare what your retirement looks like with and without that income.
Look beyond the immediate paycheck.
Evaluate the taxes you'll pay today, the withdrawals you'll avoid, the Roth conversions you'll defer, and the impact on your financial position over the coming decades.
That way, your retirement identity and your retirement tax plan get decided together.
At Franklin Madison Private Wealth, I help individuals approaching retirement work through how decisions involving income, taxes, investments, and retirement timing fit together.
If you're considering a consulting arrangement or a gradual transition into retirement, I invite you to schedule an introductory conversation.
Schedule here ==> https://franklinmadisonadvisors.com/schedule-now/
Sources
Edward F. McQuarrie, “Net Present Value Analysis of Roth Conversions,” Journal of Financial Planning, September 2024.
https://www.financialplanningassociation.org/learning/publications/journal/SEP24-net-present-value-analysis-roth-conversions-OPEN
Internal Revenue Service, “Retirement Plan and IRA Required Minimum Distributions FAQs.”
https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
Internal Revenue Service, “Topic No. 554, Self-Employment Tax.”
https://www.irs.gov/taxtopics/tc554
Internal Revenue Service, “One-Participant 401(k) Plans.”
https://www.irs.gov/retirement-plans/one-participant-401k-plans
Internal Revenue Service, “Retirement Plans FAQs on Designated Roth Accounts.”
https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts
Social Security Administration, “Delayed Retirement Credits.”
https://www.ssa.gov/benefits/retirement/planner/delayret.html
Social Security Administration, “Medicare Premiums: Rules for Higher-Income Beneficiaries.”
https://www.ssa.gov/benefits/medicare/medicare-premiums.html
Social Security Administration, “Request to Lower an Income-Related Monthly Adjustment Amount (IRMAA).”
https://www.ssa.gov/medicare/lower-irmaa
HealthCare.gov, “What's Included as Income.”
https://www.healthcare.gov/income-and-household-information/income/
Weekly Market Update: Investors Rotate Away From Tech as Inflation Heats Up
Markets were mixed this week as technology and growth stocks declined while value and defensive sectors traded higher. The S&P 500 fell -0.3%, the Nasdaq declined -2.6%, and the Russell 2000 small-cap index slipped -1.0%.
However, the Equal-Weight S&P 500 gained 1.3%, and Value 1.6% outperformed Growth -2.3%, signaling broader participation and a rotation beneath the major indexes. Health Care 5.6% and Consumer Staples 3.9% led, with nine of the eleven S&P 500 sectors finishing higher. Technology -4.4% significantly underperformed.
Bonds rallied as Treasury yields declined, with longer-maturity Treasuries gaining 2.7%. Investment-grade corporate bonds gained 1.0% and outperformed high-yield bonds, which were flat as credit spreads widened. Oil rose 6.8%, while the U.S. dollar and Bitcoin were little changed.
Key Takeaways
Energy Pushes Inflation Higher
The Consumer Price Index (CPI) rose 0.6% in September, lifting year-over-year inflation from 3.4% in August to 3.7%. Gasoline prices jumped 9.1% month-over-month, accounting for more than half the monthly increase. Underlying inflation also firmed.
Core CPI, which excludes food and energy, rose 0.3%, slightly above expectations. Producer prices climbed 1.3% for the month, their largest gain since March 2022, reflecting both rising energy costs and broader price pressures.
Why it matters: The combination of persistent inflation and slower hiring complicates the Federal Reserve's efforts to balance price stability with economic growth.
Spending Beats Expectations, Helped by Gas Prices
Retail sales rose 0.8% month-over-month in September, beating expectations for a 0.3% gain, and August's increase was revised higher to 1.3%. Part of that strength reflected gasoline prices. Retail sales aren't adjusted for inflation, so higher fuel prices can lift reported spending, and sales at gas stations rose 6.4% in September.
Excluding gas stations, retail sales increased 0.2%. Spending at restaurants and other retailers stayed positive, suggesting consumers kept buying despite higher costs.
Why it matters: The report points to continued consumer spending, although growth outside gas stations wasn't as strong as the headline suggested.
AI Borrowing Comes Under Scrutiny
AI-related stocks declined sharply this week as investors grew more concerned about the heavy borrowing behind AI infrastructure. CoreWeave, a major provider of AI computing capacity, fell roughly -15% on Wednesday. Yields on some of its bonds approached 15%. That's a sign investors are demanding much higher compensation to lend to the company.
Building AI infrastructure takes enormous upfront spending on data centers, specialized chips, and electricity, and some companies are borrowing heavily to fund it. The sell-off came even though semiconductor manufacturers reported strong earnings.
Why it matters: Demand for AI computing and infrastructure remains strong, but higher borrowing costs have increased scrutiny of how companies are paying for that buildout.
Bank Earnings Point to a Resilient Economy
Third-quarter bank results showed continued growth in credit and debit card spending, adding to evidence that consumers remained active. Credit quality was also solid. Borrowers generally kept up with their payments, and loan losses stayed contained despite rising interest rates.
Bank leaders said consumers and businesses were holding up well, though they acknowledged challenges from inflation and higher borrowing costs.
Why it matters: Taken together, the results suggest consumers and businesses remain relatively resilient despite higher interest rates, elevated oil prices, and persistent inflation.
Your Cash Reserve Is Supposed to Run Low
Every retiree is told to hold cash. Almost no one explains how to use it.
That's a problem, because a retirement cash reserve only works when you know when to draw from it, when to leave your investments alone, and when to put money back.
Without those decisions made ahead of time, a reserve tends to fail in one of two ways:
Either it sits untouched while you keep selling investments through a downturn, or it gets spent down with no clear plan for rebuilding it.
And holding too much cash creates a third problem, because money set aside for short-term stability is money that's no longer participating in your portfolio's long-term growth.
So, the question isn't just how much cash you should keep in retirement. It becomes how that cash fits into the way you intend to fund the next 20 or 30 years of your life.
Why Cash Reserves Matter More Once You Retire
While you're working, a falling stock market is usually easier to manage. Your paycheck keeps covering the bills, and regular retirement contributions may even let you buy investments at lower prices.
Retirement changes that relationship.
Once the paychecks stop, your portfolio becomes responsible for some or all of your household income.
What this means is that a market decline can create two problems at once: your investments are losing value at the same time you're withdrawing money to support your lifestyle.
For instance, suppose your stock portfolio falls 25%. If you have to sell shares to cover expenses, you're shrinking the number of shares left to participate in the recovery.
That's why sequence-of-returns risk matters so much in the early years of retirement. As I discussed in Why the First Five Years of Retirement Decide the Next Twenty-Five, the order in which returns arrive can have a significant effect on how long your savings last.
But a cash reserve, on the other hand, gives you some breathing room. Indeed, instead of relying entirely on investment sales during an unfavorable market, what you have is another source of money to pay the bills.
To be sure, a reserve doesn't eliminate market risk, and it doesn't guarantee a better outcome. A diversified portfolio with disciplined rebalancing can also manage withdrawal risk effectively. But what the reserve does give you is flexibility. It separates the timing of your household's spending from the timing of investment sales, and that flexibility is most valuable precisely when markets aren't cooperating.
How Much Cash Should You Hold in Retirement?
So how big should the reserve be?
Well, my starting point is straightforward: size it to the income gap your portfolio needs to fill, not your entire household budget.
Consider, for example, a retired couple who expects to spend $150,000 a year, including the cash they need for taxes and other household obligations. They receive $50,000 in annual Social Security income, which leaves $100,000 to be funded from their investment portfolio. That works out to about $8,333 a month.
For many retirees, I begin by evaluating a reserve equal to roughly 18 months of that spending gap. In this example, that's $150,000.
On the other hand, if the couple held 18 months of their entire $150,000 budget, they'd set aside $225,000. That's an additional $75,000 that could otherwise stay invested in assets with greater long-term growth potential.
Now, there's nothing inherently wrong with keeping more cash.
Some households need extra liquidity because of large upcoming expenses, uncertain income, or a lower tolerance for volatility. Others need considerably less because pensions or other dependable income cover most of their recurring expenses.
The important part is understanding what the reserve needs to accomplish.
Start With Actual Spending, Not an Estimate
Of course, sizing a reserve to the gap only works if the gap is accurate. And this is where I find retirement income planning often takes more work than people expect.
In a recent planning engagement, we compared a couple's anticipated retirement expenses against transactions from their bank accounts. Several spending categories came in meaningfully higher than the household had estimated.
Rather than assume either figure told the whole story, we separated the couple's expected long-term retirement lifestyle from their more immediate spending patterns and reflected both in the planning projections.
That distinction matters when deciding how much cash to keep available.
A reserve built on an understated spending assumption may provide far less protection than intended. At the same time, counting expenses that disappear after retirement, or one-time purchases that won't recur, can lead to an unnecessarily large cash allocation.
So before settling on a reserve amount, I want to know what the household actually spends, which expenses are recurring, which are discretionary, and which income sources will reliably cover them.
I also want the calculation to account for taxes. If the portfolio has to produce $100,000 in spendable cash, the gross amount withdrawn from a traditional IRA may need to be higher.
Only once those questions are answered does an 18-month reserve become a meaningful number.
Where Should You Keep Your Retirement Cash Reserve?
Once you know how much to hold, the next question is where to hold it. And because the reserve has a different purpose from the rest of your portfolio, it belongs somewhere different.
Its primary job isn't to maximize returns. It's to make money available when you need it, without exposing your near-term spending to substantial market volatility.
For most retirees, that points toward fairly unremarkable investments: money market funds, Treasury bills, and other highly liquid, short-duration instruments.
I generally think about the reserve in two parts. The first is the money needed for near-term withdrawals, which might stay in a money market fund connected to the account that distributes household income.
The second is money that won't be needed for several months. Here, short-term Treasury bills with staggered maturity dates may be appropriate, so proceeds become available as upcoming expenses arise.
There are important distinctions, though. Money market mutual funds aren't FDIC-insured bank deposits, and their value isn't absolutely guaranteed. Treasury bills pay their stated face value at maturity, but selling before maturity can expose you to market-price fluctuations.
That's why I prefer aligning available cash and maturity dates with actual spending needs. And it's also why I wouldn't treat a long-term bond fund, a stock fund, or any other investment with meaningful price volatility as interchangeable with a dedicated cash reserve.
How a Retirement Cash Reserve Works During a Market Downturn
With the size and location settled, let's look at how the reserve actually behaves when markets turn. Think back to our couple.
They need $100,000 a year from their investments, or roughly $8,333 a month, and they've set aside an 18-month reserve of $150,000.
In a relatively normal market, their monthly spending comes out of the reserve, while distributions, investment income, and periodic rebalancing provide opportunities to replenish it.
In other words, the reserve works much like a checking account for retirement, with a larger cushion behind it.
Then the market begins to decline.
Instead of automatically selling stocks each month to restore the reserve, we evaluate whether it makes sense to lean more heavily on the cash already set aside.
For this illustration, assume a prolonged selloff makes discretionary stock sales unattractive, so the household uses its reserve to fund the entire $8,333 monthly gap for one year.
After 12 months, the reserve falls from $150,000 to about $50,000, excluding interest. That leaves roughly six months of spending on hand.
Now here's the thing: That decline in the cash balance isn't a sign that something went wrong.
It's the reserve doing exactly the job it was designed to do. The couple kept paying their bills without having to liquidate stocks just to fund living expenses during the decline.
That said, the reserve doesn't remove the need to manage the rest of the portfolio. We still need to evaluate asset allocation, rebalancing, cash-flow sustainability, and whether spending assumptions remain reasonable. And if a downturn drags on, we need to reassess well before the reserve runs out.
Illustrative 18-Month Cash Reserve
Illustrative only. Assumes $8,333 in monthly spending, no reserve interest, no replenishment during the 12-month selloff (months 3 through 14), and portfolio transfers of roughly twice the monthly draw during months 15 through 18. Actual results depend on portfolio performance, spending, taxes, and withdrawal decisions.
When Should You Refill Your Retirement Cash Reserve?
Which brings us to the harder question: when, and how fast, do you put money back?
I don't believe retirees should blindly refill their cash on a fixed schedule, regardless of market conditions. But neither should they wait indefinitely for stock prices to return to a particular level. Instead, the decision needs to be coordinated with the entire portfolio.
Morningstar's Christine Benz makes a similar case for being opportunistic each year about where a retiree's cash comes from.
When markets have performed well, we may have opportunities to trim appreciated investments or bring allocations back toward their targets. During weaker markets, we might rely more on interest, dividends, maturing fixed-income investments, or existing cash.
Either way, the objective is to raise the cash a household needs while avoiding unnecessary portfolio risk and weighing the tax consequences of each transaction.
So, let's go back to our couple, whose reserve has fallen to $50,000.
Suppose conditions improve and the portfolio offers opportunities to rebuild. Over the following four months, they keep withdrawing $8,333 a month for household expenses.
At the same time, portfolio transfers of roughly twice that amount steadily rebuild the reserve, and by month 18, it's back to about $89,000.
It isn't fully restored, but it's moving in the right direction. And here's the important part: the pace of replenishment reflects opportunities within the portfolio, not an arbitrary requirement to get back to $150,000 immediately.
Don't Ignore the Minimum Reserve Level
There's one more consideration here. A strategy that simply waits for markets to recover can become a problem if the downturn lasts longer than expected.
That's why a reserve needs review thresholds, not just a target balance.
For example, if a household's available cash falls below nine months of expected withdrawals, that could trigger a more detailed review of portfolio liquidity and replenishment options. At six months, the conversation becomes more urgent.
At that point, we might need to evaluate additional fixed-income maturities, portfolio sales, changes to discretionary spending, or other sources of household liquidity.
These aren't universal thresholds. Rather, they're examples of the decisions I want established up front as part of a household's retirement income strategy. The goal is to keep a short-term market problem from turning into an unplanned cash-flow emergency.
How We Coordinate Cash Reserves With the Retirement Income Plan
All of this points to a bigger idea. In my work with clients, the cash reserve is only one component of the broader retirement income strategy.
So, I want to understand how the money will actually move through the household: which accounts generate income, where distributions arrive, how taxes are withheld or paid, and how much transfers to checking each month.
For one retired client, our implementation work included setting up a cash management arrangement that receives retirement-account distributions after tax withholding and supports regular monthly transfers to the client's bank account.
We also put an investment monitoring and rebalancing process in place, so distributions and portfolio management are coordinated rather than handled as separate activities.
And why does that operational detail matter?
Because it's one thing to show a projection in which a household withdraws a set amount every year. It's another to make sure the right money arrives in the right account, at the right time.
And where that money comes from matters just as much. Because rebuilding a reserve from a traditional IRA, a taxable account, or a bond maturity can produce very different tax results.
That's why I view retirement cash reserves as part of the household's retirement income map, not as an isolated investment allocation.
The Hidden Cost of Holding Too Much Cash
Still, there's one final tradeoff worth understanding. Cash reserves may make retirement spending easier to manage, but they aren't a free form of protection.
Long-term returns are uncertain. Historically, though, cash has offered lower growth potential than a diversified portfolio with meaningful equity exposure. As a result, holding an unnecessarily large reserve can reduce the assets available to support future spending, particularly as inflation raises the cost of maintaining the same lifestyle.
Indeed, this tradeoff shows up in retirement income research. In a Morningstar comparison of retirement income approaches, a cash-flow-reserve strategy holding one year of spending in cash supported lower viable retirement spending than a systematic withdrawal strategy. Morningstar pointed to the opportunity cost of keeping that money in cash, and an 18-month reserve would carry more of that cost, not less.
However, the same research found that once investors overreacted to a bad market by abandoning stocks, the cash reserve strategy came out ahead.
That distinction is crucial.
The value of a cash reserve isn't that it produces a higher return or guarantees better long-term results.
Its value comes from providing liquidity, supporting a disciplined withdrawal process, and helping retirees make better decisions when markets are unfavorable.
For some households, that's a meaningful benefit. But it still has to be weighed against the growth you give up by holding the cash.
Decide How Your Reserve Works Before You Need It
When it comes down to it, a retirement cash reserve needs more than a dollar amount attached to it. It needs a purpose and a set of operating rules.
Start by sizing the reserve to the spending gap your portfolio actually has to cover.
Keep the money in liquid, relatively stable investments. Then establish how monthly distributions will work, when investment sales may be reduced during a downturn, and what circumstances justify rebuilding the reserve. And revisit those decisions as spending, market conditions, taxes, and household circumstances change.
Most importantly, make those decisions before the market forces you to.
That way, when the next downturn arrives, you won't have to wonder which investments you're going to sell to cover next month's bills. You'll already know where the money is coming from.
At Franklin Madison Private Wealth, we help retirees and pre-retirees connect their retirement income, investment management, and tax strategies into one coordinated plan.
If you're approaching retirement, or you're already retired but aren't sure how your cash reserves should work, let's talk about what it would take to build a retirement income strategy around your own circumstances.
After all, the objective isn't simply to hold enough cash. It's to know how and when to use it, so you can approach retirement with clarity, confidence, and peace of mind.
Sources
Morningstar, Systematic Withdrawal Strategy: Benefits and Risks for Retirement Income
https://www.morningstar.com/business/insights/blog/systematic-withdrawal-approaches
Michael Kitces, Managing Sequence of Return Risk With Bucket Strategies vs. a Total Return Rebalancing Approach
https://www.kitces.com/blog/managing-sequence-of-return-risk-with-bucket-strategies-vs-a-total-return-rebalancing-approach/
Christine Benz, Morningstar, How Do You Maintain a Bucket System for Your Retirement Portfolio?
https://www.morningstar.com/retirement/how-do-you-maintain-bucket-system-your-retirement-portfolio
U.S. Department of the Treasury, Treasury Bills
https://treasurydirect.gov/marketable-securities/treasury-bills/
Your Tax Window Doesn't Close All at Once
Most retirees think of their low-tax years as one window.
The paycheck stops. Required distributions are still years away. And in between, there's a stretch where you control how much taxable income shows up on your return.
That's true, certainly.
But it isn't the whole picture.
Because that window doesn't close all at once. It closes in stages, one door at a time.
And if you don't know the order, you can lose your best planning years before you realize they're gone.
The Window Isn't One Opening
I've written before about the retirement tax window most people miss. It's the gap between your working-income years and your forced-income years.
For many retirees, those years offer rare control over their tax bill.
Now here's the thing. That control has limits, and the limits change as you move through retirement.
A Roth conversion that looks attractive on this year's return could raise your Medicare premiums two years from now.
Selling appreciated stock could land in a higher capital-gains bracket than you planned.
And once Social Security starts, it shares whatever bracket space is left.
So the question isn't just: Do I have a tax window?
It becomes: Which move belongs in which year, before its door closes?
Medicare Starts Counting Before You Enroll
The first door most people miss is Medicare.
That's because Medicare doesn't look at this year's income when it sets your premiums. According to the Social Security Administration, it generally looks at your tax return from two years earlier.
Higher income triggers surcharges on Part B and Part D premiums, known as IRMAA.
So income at 63 can affect your premiums at 65.
To be sure, retirement may support a request to use your more recent, lower income. But that only accounts for the lost paycheck. It doesn't erase conversion income you chose to create.
In my planning work, this is the constraint that comes up most often.
And it means every conversion after 63 has to pass a second test. Is the long-term benefit worth the surcharge it could trigger?
Then Come the Deductions, Benefits, and Distributions
Medicare isn't the only door.
If you're 65 or older, the new senior deduction can be worth up to $6,000 per person from 2025 through 2028. But the IRS phases it out once modified adjusted gross income exceeds $150,000 for married couples. A large conversion can shrink it or erase it. I covered the details in The New Senior Deduction Most People Don't Know About.
Social Security changes the income mix again.
Depending on your combined income, up to 85% of your benefits can be included in taxable income. That's the portion subject to tax, not an 85% tax rate. And until you reach that maximum, extra withdrawals or conversions can pull more of your benefits onto your return.
Then come required minimum distributions.
Under current IRS rules, people born in 1960 or later generally begin RMDs at 75. Those withdrawals arrive whether you need the money or not. And the RMD itself can't be converted to a Roth.
If you're retiring before 65 and relying on Marketplace health coverage, there's one more door. Conversions and realized gains count toward the income that sets your premium assistance. With the enhanced credits expired after 2025, crossing 400% of the federal poverty level can eliminate that assistance entirely.
None of these milestones ends the opportunity.
They change its price.
And sometimes a door opens wider. Once you're fully on Medicare, for example, the Marketplace constraint disappears.
Consider a Couple Retiring at 64
Consider, for example, a hypothetical couple, both 64.
They have a seven-figure IRA, a taxable account that produces steady dividends, and a healthy cash reserve. One spouse also has nonqualified deferred compensation that pays out over five years after retirement. Both were born after 1959, and they plan to delay Social Security.
At first glance, they have about a decade before RMDs begin.
In practice, they have several distinct phases.
The first is the retirement year itself.
Salary, a final bonus, vacation payouts, and any year-end equity vesting may leave less room than they expect. Leaving work in September doesn't turn the whole calendar year into a low-income year.
The second is the deferred comp years.
This is the piece many households overlook. Each payout is ordinary income in the year it arrives. So it fills part of the bracket space they were counting on for conversions.
The question isn't how much room the bracket offers.
It's how much room is left after the payout.
The third is the Medicare transition.
Because of the two-year lookback, a conversion at 64 can affect their premiums at 66. Income at 65 can affect premiums at 67.
Conversions and Capital Gains Compete for the Same Room
Once both are on Medicare, but before Social Security begins, our couple may have their most flexible years.
They're also the years when Roth conversions and capital-gains planning start to compete.
How so?
Well, long-term gains stack on top of ordinary income in the federal tax calculation.
For a household like this, dividends and interest often fill much of the 0% capital-gains bracket on their own. So the real decision is usually whether gains land at 15% or 20%, and whether they cross into the 3.8% net investment income tax above $250,000 of modified adjusted gross income.
Every dollar of conversion income pushes their gains closer to those lines.
One year might favor shrinking the pretax balance.
Another might favor selling appreciated holdings to diversify or rebuild the cash reserve.
But you can't maximize both in the same year and assume the results will fit together.
Then Social Security starts, and we rebuild the projection. Benefits cover more of their spending, which can reduce withdrawals. But the taxable portion takes up room that conversions used to have.
And by 75, RMDs become part of the baseline.
You can't carry this year's unused bracket space into next year.
Each phase offers a different amount of room, at a different price.
This Is How I Turn the Timeline Into a Decision
In our planning process, we don't start with "How much should you convert?"
We start with a retirement income map. What does the household need to spend? What income will arrive each year? And which accounts will cover the difference?
The spending number deserves particular attention.
In one recent engagement, reconciling a couple's bank activity showed several categories running above the figures they'd given us.
Here's why that matters for taxes. If withdrawals must cover more spending than expected, there's less room for conversions. And there's less cash to pay the tax on them.
From there, we pair long-term cash-flow modeling in eMoney with annual tax projections in Holistiplan. The long view estimates future income needs and tax-deferred balances. The annual projection tests what a move costs now.
Then we compare alternatives.
A smaller conversion.
A larger one.
Realizing gains instead.
Or holding the room for a later year.
Sometimes accepting a Medicare surcharge makes sense because the long-term benefit is larger. Sometimes protecting the cash reserve comes first.
Either way, the tradeoff should be deliberate.
Because a Roth conversion isn't the goal. It's a tool for lowering your lifetime tax bill.
That's also why we revisit the projection before implementation, once the year's actual income and gains are clearer.
The Bottom Line
Your low-tax window is real.
But it's a sequence of decisions, not one.
What this means is that before you choose a strategy, you need the dates. Your final working year. Each spouse's Medicare enrollment. Any deferred comp payout schedule. Your Social Security claims. And your RMD starting ages.
Then layer in the income already expected each year and the withdrawals your lifestyle requires.
Only then can you see where each strategy fits.
So map the milestones.
Match each strategy to the years when it works best.
And act before each door closes.
Related Reading
The Retirement Tax Window Most People Miss
The Withdrawal Order You Were Taught Can Quietly Cost You
The Tax Cost of Retiring Without a Retirement Income Map
A Roth Conversion Is Not the Goal
Sources
Social Security Administration, "Premiums: Rules for Higher-Income Beneficiaries."
https://www.ssa.gov/benefits/medicare/medicare-premiums.html
Internal Revenue Service, "One, Big, Beautiful Bill Act: Tax Deductions for Working Americans and Seniors."
Social Security Administration, "Must I Pay Taxes on Social Security Benefits?"
https://www.ssa.gov/faqs/en/questions/KA-02471.html
Internal Revenue Service, "Retirement Plan and IRA Required Minimum Distributions FAQs."
https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
HealthCare.gov, "What's Included as Income."
https://www.healthcare.gov/income-and-household-information/income/
Internal Revenue Service, "Topic No. 409, Capital Gains and Losses."
https://www.irs.gov/taxtopics/tc409
Internal Revenue Service, "Net Investment Income Tax."
https://www.irs.gov/individuals/net-investment-income-tax
Quarterly Market Update: Solid Fundamentals Meet Higher Oil and Rates
The third quarter put two forces against each other. On one side, the economy and corporate earnings stayed solid. On the other, oil and interest rates pushed back. Oil climbed back above $100 per barrel, inflation stayed elevated, Treasury yields surged, and the Federal Reserve raised rates in September.
The S&P 500 still finished higher and set a new all-time high, carried by strong earnings and steady economic activity. But the headline gain didn't tell the whole story. Beneath it, market leadership narrowed as smaller companies and rate-sensitive areas lagged.
Artificial intelligence, meanwhile, kept playing a large role in both the economy and the markets. In this letter, we'll look at the forces pushing interest rates higher, the economic and earnings strength helping offset that pressure, and how AI's influence now reaches everyday borrowing costs, business investment, and the stock market.
Oil Stays Volatile, and the Fed Hikes
Oil was once again one of the quarter's main drivers. Its sharp swings carried implications well beyond energy, touching inflation, interest rates, and economic growth.
The top chart in Figure 1 graphs the monthly change in oil prices this year, and what stands out is how often prices have changed direction.
Oil surged early in the year, fell sharply in May and June, then reversed higher again in Q3, jumping 22% in July alone. The point isn't any single monthly move. It's how frequently the direction has flipped.
Most of that volatility traces back to shifting expectations for Middle East oil supplies and the uncertainty around the Strait of Hormuz. And those swings matter well beyond the energy market.
That's because oil feeds into gasoline and transportation costs, those costs feed into inflation, and inflation ultimately shapes the outlook for interest rates and growth. When oil fell in Q2, some of that pressure eased. When prices climbed again in Q3, concerns about inflation and the path of rates came right back.
That shift had a real impact on the rate outlook. Earlier in the year, investors were focused on how much the Fed could lower rates. But as oil rebounded and inflation stayed above the Fed's target, the conversation gradually turned to whether policymakers would need to raise rates instead.
The bottom chart in Figure 1 shows how that played out. The Fed cut rates by a cumulative 1.75% beginning in September 2024, then held steady for most of this year. After a nine-month pause, it raised rates 0.25% in September, its first increase since 2023.
Markets now expect additional hikes in the coming quarters, although those expectations have shifted often this year. The broader point is that the path for rates remains closely tied to how inflation, oil, and economic growth develop into year-end and early 2027.
Earnings and Growth Hold the Line
So far, that sounds like a difficult backdrop. And in some ways, it was. Yet the underlying data told a steadier story. Corporate earnings stayed strong, and households and businesses kept spending, giving the stock market real fundamental support through the quarter's uncertainty.
The top chart in Figure 2 graphs the year-over-year growth rate of S&P 500 earnings going back to 2001. Over the past year, 12-month earnings for the S&P 500 grew nearly 30%.
Outside of the rebounds that followed the financial crisis and COVID, that's one of the strongest stretches of earnings growth on the chart, and a significant step up from the single-digit pace of 2023 and 2024. So while the macro backdrop was volatile, corporate profits kept growing at a strong pace.
The bottom chart looks beneath headline GDP to show what households and businesses were actually doing. Headline GDP includes volatile categories such as trade, inventories, and government spending. Final sales to private purchasers, on the other hand, focuses on consumer spending and private investment.
Comparing the two helps separate changes in the underlying economy from temporary swings. In the second quarter, headline GDP grew at a 2.2% annualized rate, down from 2.5% in Q1. Underlying private demand, however, grew 4.6%. That gap suggests households and businesses were still spending and investing at a healthy pace, even as the broader backdrop grew more volatile.
Taken together, the two charts help explain how markets absorbed the quarter's volatility. Consumers are still spending, businesses are still investing, and earnings are still strong. That combination has served as a counterweight to higher oil prices, persistent inflation, and rising interest rates.
AI's Reach Keeps Widening
Which brings us to the theme running through much of the year. Artificial intelligence has been a major market story for several years. What's changed is the scale of the buildout, which is making AI more important to the broader economy and financial markets. Figure 3 shows three ways its influence is expanding: business investment, the stock market, and financing.
Start with business investment. The top chart graphs spending on data-center construction and computer equipment, which together serve as a proxy for the physical infrastructure being built to support AI.
Combined investment has grown from roughly $180 billion at the end of 2023 to nearly $490 billion today. That makes AI-related infrastructure an important source of business investment in its own right.
Next is the stock market. The middle chart shows that Technology now makes up nearly 40% of the S&P 500, up from about 34% at the end of 2025.
As that share has grown, the index has become more sensitive to the performance of its largest sector. What this means is that strong AI-related earnings and stock gains can have an outsized influence on the broader index.
And then there's financing. Major U.S. tech companies remain highly profitable, but the scale of their AI investment programs has grown quickly. The bottom chart shows that several of these companies are increasingly turning to the bond market to help fund the buildout. Historically, the group was fairly balanced between issuing new debt and paying it down. The right side of the chart, though, shows a significant jump in new issuance.
The question isn't just how much is being spent on AI anymore. It's how far that spending now reaches. The buildout is supporting business investment, drawing on the bond market for financing, and carrying more weight in the stock market, all at the same time.
AI has moved well beyond a narrow technology theme, and its growing scale means it's now influencing several parts of the economy and financial markets at once.
Equity Market Recap: Leadership Narrows as Rates Rise
The S&P 500 finished Q3 higher and set a new all-time high, but the path there was uneven, and the divergence beneath the index grew as the quarter went on.
Stocks faced some early pressure before rebounding in August, when the Russell 2000, the Dow Jones, and the equal-weight S&P 500 each set new highs. From there, leadership narrowed as larger companies outpaced smaller ones into quarter-end.
The S&P 500 gained 2.3% for the quarter, compared with 0.6% for the Nasdaq 100, -1.5% for the Dow Jones, and -6.9% for the Russell 2000. Most of that gap opened up in the second half of the quarter, which overlapped with a sharp rise in Treasury yields.
The timing suggests rising rates contributed to the divergence. That's because smaller companies tend to be more sensitive to borrowing costs.
Sector performance reflected many of the quarter's main themes. Only four of the eleven S&P 500 sectors outperformed the broad index, a sign of narrow breadth. Energy led with a 17.2% gain as oil climbed from roughly $70 per barrel in early July to more than $100 by mid-September.
That's a sharp reversal from Q2, when Energy was the worst-performing sector as oil prices fell. Technology came in second with a 7.2% gain, followed by Health Care at 6.5% and Communication Services at 3.6%. On the other end, Utilities fell -12.4% as rates rose, while Industrials dropped -9.7% and Real Estate declined -5.6%.
International markets were relatively quiet after their gains in the first half of the year. Developed and emerging market stocks each finished the quarter within 1% of where they started, with developed modestly ahead of emerging.
Even so, both regions are up year-to-date and are still outperforming the S&P 500 over the past 12 months.
All told, the quarter left a mixed picture beneath the major indexes. The S&P 500 reached a new high, while smaller companies and several rate-sensitive areas moved lower as yields rose late in the quarter.
Leadership is narrower now than it was in August, though the major U.S. equity indexes remain higher year-to-date.
Credit Market Recap: Rising Rates Weigh on Bonds
The same rise in yields that pressured smaller stocks made Q3 a challenging quarter for bonds. Figure 4 graphs the change in Treasury yields across maturities during the quarter, and yields rose at every one. The 5-year, 7-year, and 10-year yields each climbed more than 0.80%, and the 30-year rose nearly 0.70%.
Longer-maturity bonds underperformed because they're more sensitive to changes in interest rates. Shorter-maturity Treasuries held up better on a relative basis, though they still traded lower.
Corporate bonds came under pressure too, although they outperformed government bonds. High-yield posted a total return of -1.8%, ahead of investment-grade's -3.7%. Investment-grade took the bigger hit because its longer maturities made it more sensitive to rising rates.
For most of the quarter, though, the main headwind was rising interest rates, not weakening credit conditions. Investment-grade and broad high-yield spreads stayed relatively stable and tight by historical standards, suggesting investors remained comfortable with corporate fundamentals even as borrowing costs climbed.
The clearest sign of caution showed up at the lowest-quality end of the high-yield market. Spreads on CCC-rated bonds, the lowest-rated tier of high-yield, widened even as spreads on higher-quality high-yield bonds held steady. In other words, investors started demanding more compensation to hold the debt of financially weaker borrowers. Broader high-yield spreads, which had been comparatively calm for most of the quarter, also began to widen in late September.
The market grew more selective as the quarter went on, and the impact of higher financing costs showed up first among the most sensitive borrowers.
Put simply, Q3's weakness in bonds came mainly from rising Treasury yields, not a broad deterioration in corporate credit.
The late-quarter widening was concentrated among the lowest-quality borrowers, while investment-grade and broader high-yield spreads stayed relatively contained. Higher financing costs were creating pressure in pockets of the market, not across all of it.
2026 Outlook: What to Watch in Q4
Economic growth and corporate earnings remain strong heading into the fourth quarter, even as higher oil prices and interest rates have made the backdrop more mixed and volatile.
One of the main questions now is whether that underlying strength holds up as households and businesses adjust to higher borrowing costs, persistent inflation pressure, and continued uncertainty around energy prices.
So far, the economy has handled those pressures relatively well. Consumers have kept spending, businesses have kept investing, and unemployment has stayed low.
Those trends have supported growth even as rates and borrowing costs moved higher.
The coming months will show whether that momentum continues, particularly in the data tracking consumer spending, hiring, and business investment.
Corporate earnings will be another important source of information. Profit growth has been strong over the past year and has given the market fundamental support through a volatile macro backdrop.
Third-quarter earnings season, which begins in October, will offer an updated look at how companies are managing higher interest rates, changing input costs, and continued investment while still growing revenue and profits.
The AI investment cycle will remain part of the discussion as well. Spending on data centers, computing equipment, and related infrastructure continues to support business investment, and large technology companies are increasingly using the bond market to help pay for it.
As the cycle matures, the focus is likely to broaden from how much is being spent to what that investment is producing in revenue, profits, and productivity.
Markets have absorbed several changes this year without losing the support of economic growth and corporate earnings. We'll continue watching how these trends develop, while keeping the focus on portfolio diversification, discipline, and meeting your long-term financial goals across a range of possible outcomes.
Weekly Market Update: AI Selloff Overshadows the Post-Election Rally
Major indexes fell as a selloff in semiconductor and other AI-related stocks outweighed a broad rally the day after the midterm elections.
The S&P 500 fell -4.7% and the Nasdaq dropped -9.5%, while the Dow Jones slipped -1.6% and the Russell 2000 small-cap index declined -4.5%.
The Equal-Weight S&P 500 fell a more modest -1.4%, and Value outperformed Growth by a wide margin as Momentum and High Beta stocks dropped -16.2% and -13.5%, respectively. Overall, 7 of 11 sectors traded higher, led by Consumer Staples with a gain of 3.6%, while Tech sank -14.0%.
Treasuries rallied as the 10-year yield fell to its lowest level since September. Oil slid -11.1% on hopes of a diplomatic resolution in the Middle East, gold rebounded above $4,000, and the VIX, a measure of expected volatility, jumped above 25.
Key Takeaways
Midterms Deliver a Divided Government
Democrats won majorities in both the House and Senate, which means major legislation will need support from both parties during the final two years of President Trump's term. Markets initially welcomed the outcome, with the S&P 500 gaining 1.6% on Wednesday as election uncertainty eased and investors anticipated fewer big policy changes.
Treasury yields declined, reflecting expectations of more constrained fiscal spending, although falling oil prices also contributed to the move. Policy uncertainty didn't disappear, however. As discussed below, tech stocks weakened amid concerns about potentially tighter AI regulation.
Why it matters: Divided government (Congress and the Executive) makes sweeping legislative changes more difficult. Attention now turns to deadlines that need bipartisan agreement, such as the debt limit in 2027, while the White House can still act on trade through executive action.
Chip Stocks Lead an AI Selloff
The pressure started last Friday, when Intel fell about -29%, its worst day since 1974, after a weak outlook. The selling spread across chipmakers and continued this week, despite strong results from AMD, whose data-center revenue nearly doubled from a year ago.
Tuesday's midterm elections, in which voters approved local ballot measures restricting data-center construction, weighed on the group as investors considered the prospect of tighter AI regulation and delays to planned projects. An index of semiconductor companies fell more than -12% on Thursday and closed at its lowest level since April.
Why it matters: The debate over AI has broadened from whether the spending will pay off to whether the buildout can continue at its planned pace. That's a question strong earnings alone can't settle.
Oil Slides on Hopes for a Hormuz Deal
Under a plan drafted with Qatari mediators, Iran said it could reopen the Strait of Hormuz within two days of a deal if the U.S. meets its conditions, including lifting sanctions. The U.S. hasn't accepted the terms, but oil prices fell as traders priced in the probability of a negotiated settlement.
West Texas Intermediate crude fell -11.1% for the week, and Brent, the international benchmark, dropped below $100 after hitting a six-month high last Friday.
Why it matters: Lower oil prices ease one of the main sources of this year's inflation pressure, and the decline helped pull Treasury yields lower.
Manufacturing and Hiring Hold Up
The ISM manufacturing index rose to 55.5 in October, above expectations and one of its strongest readings since 2022, while its prices index remained elevated at 75.2. A separate survey showed services activity slowed slightly but continued to grow.
In the labor market, employers added 86,000 jobs according to ADP, above the roughly 75,000 economists expected, and initial jobless claims fell to 189,000, matching their lowest level of the year. Abroad, the Bank of England raised its policy rate to 4.00%, its first increase since 2023.
Why it matters: The weakness in technology stocks hasn't spilled into the broader economy so far, which helps explain why markets continue to price a 70% probability of a December rate hike.