When Will the Fed Say, “Take a Hike?”

By Modern Wealth Management

February 17, 2022

When Will the Fed Say, “Take a Hike?”

Key Points – When Will the Fed Say, “Take a Hike?”

  • Inflation Remains Top of Mind
  • Being Prepared for the Fed’s Hike(s) Is Pivotal
  • How Will the Market React?
  • The Federal Reserve and Bond Buying
  • Looking at Your Financial Plan to Dictate What You Should Invest In
  • 20 minutes to read | 36 minutes to listen

It feels like it’s only a matter of time before the Fed says to, “Take a hike?” Interest rate hikes are likely on the horizon. Bud Kasper and Logan DeGraeve look at what the impact could be from any of the Fed’s rate hikes and how big they could be.

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Inflation Remains Top of Mind

Bud Kasper: Hello everyone and welcome to America’s Wealth Management Show. I’m Bud Kasper. Unfortunately, Dean Barber can’t be with us this week, but he’ll be back next week to add content to the program that is meaningful to you.

With me today is Logan DeGraeve. He’s one of our CERTIFIED FINANCIAL PLANNER™ professionals at Modern Wealth Management. Logan and I are going to discuss a few things that are on top of everybody’s mind. That includes what’s going on with the interest rates, the Federal Reserve, and inflation. And boy, that’s a lot to discuss.

Logan DeGraeve: Absolutely, Bud. I’m glad to be joining you. And you know what? We can’t get away from inflation. It’s everywhere you go— grocery stores, gas stations. It’s top of mind for everyone.

Bud Kasper: I filled up yesterday and I paid $3.75 a gallon. It was premium, but $3.75 a gallon is a lot of coin.

Logan DeGraeve: I have another example, too. Valentine’s Day was Monday. I figured I would go get a filet for Alex and I to have a nice dinner. It was $28. Maybe next time we’ll get strips or something like that.

Bud Kasper: That’s a drive-thru date is what that turns out to be. We’re going to get into some of the details of how inflation is impacting everybody around the country. What I really want to talk about first, though, is how the Federal Reserve is going to react to this.

How Far Can We Expect the Fed’s Hike(s) to Be?

The Fed has already told this is going to happen, but they’re more than likely going to need to raise interest rates. Last summer, I suggested that the Federal Reserve ought to start raising rates in December. I thought that because I was afraid that inflation was going to get ahead of us. And if we didn’t end up in front of inflation, we’d end up in a Paul Volcker situation. As the Fed Chairman, he had to make 0.5% and 0.75% interest rate hikes. Doing that really scares the market.

The Federal Reserve isn’t in the control seat as they normally are. What’s going to be the procedure this time? The main takeaway of this situation is to be prepared for whatever the Federal Reserve decides to do. As we look ahead to March and when the Federal Reserve meets, what do you think will happen, Logan? Is the Fed going to do a 0.5% or 0.25% rate hike?

Logan DeGraeve: I honestly think the Fed will have a 0.25% rate hike. A 0.5% rate hike would be aggressive, but I wouldn’t be shocked by it.

Bud Kasper: I agree.

Being Prepared for the Fed’s Hike(s) Is Pivotal

Logan DeGraeve: To your point, Bud, we need to be prepared, whether the Fed does a 0.25% or 0.5% hike. How would that impact your financial plan? How will that impact the market? If you are working with financial planner, make sure you’re having these conversations sooner rather than later. Bud mentioned that he that the Fed should start the rate hikes in December, but he was talking with clients about this a year or so ago.

Bud Kasper: That’s right. I think we need to be prepared for these scenarios. I’ve been doing this for well over 30 years and I still need to ask myself the question, is it different this time? It could be.

Just know what Fed Chairman Jerome Powell is about, I think it’ll be a 0.25% hike. However, the one thing the Fed doesn’t want to do is start out with 0.25% hikes, and then toward, let’s say in November of next year, go with a 0.5% hike. By doing that, the Fed would essentially be admitting that they should’ve started the hikes earlier.

Logan DeGraeve:  You never want to get more aggressive because you were wrong in the start. You’re right, Bud. That would not only cause panic within the markets, but they’d be doing a higher correction point because they didn’t do it right the first time.

Bud’s Regional Insight from the Federal Reserve

Bud Kasper: The public at large—meaning investors, retirees—is going to call into question whether the Fed knows what they’re going to do with the hikes. I had an interesting situation last week with St. Louis Federal Reserve President Jim Bullard and Kansas City Federal Reserve President Esther George. They were suggesting that a better starting point for the Fed might be a 0.5% hike.

Now, what has the market’s reaction been to these talks? Not good. It really signals that the Fed is behind the game with the hikes. They feel the need to catch up, which brings in a little bit of fear.

Logan DeGraeve: It does bring in a lot of fear, Bud. It’s been at the top of mind for our clients. In every review I’m having, inflation’s the biggest thing. You just can’t get away from it. How are we going to combat that? Unfortunately, it’s out of our control.

Bud Kasper: Absolutely. Another thing that people need to also think about is that the Federal Reserve is a committee. It’s called the FOMC, Federal Open Market Committee. Presidents of the various Fed banks nationwide vote on whether they want a 0.5% hike or sticking to a 0.25% hike. Everyone is kind of on the seat right now. They’re trying to make a decision that’s going to be best for the country and the economy.

How Will the Market React?

Logan DeGraeve: Let me ask you a question, Bud. If we were to see the Fed make 0.5% hikes and those type of things, how do you think the market would react?

Bud Kasper: My opinion would be very little because I think the market is efficient. I think that the Fed is reading into today’s market activity with the anticipation that a 0.50% hike could be the worst case. Although a 0.5% hike certainly isn’t the worst case.

Logan DeGraeve: Agreed. I think that this is something that we’ve all anticipated. And you know what? We’ll work with it when we need to work with it.

Think of the Fed’s Upcoming Rates Hikes as Taking Medicine

Bud Kasper: People are going to need to exercise some patience. It’s no different than taking medicine. As you take it, you don’t instantly feel well. But as the medicine has a chance to work its way through your immune system, it makes you feel better. I want people to think of that the same way with what the Fed’s hikes are going to be. It’s going to take a while for this to move through the system and provide the necessary outcome that we want, which is a healthy U.S. economy.

Inflation As It Relates to the Supply Chain

As we continue to talk about inflation, supply chain issues are clearly something that’s associated with it. We can’t get all the goods we want in stores because the supply chain is broken. When goods are scarce, prices usually rise. Businesses need to be careful with that from the simple reason that people will say, “You’re gouging me.”

But there is a cost for goods that needs to pass through one way or the other. Otherwise, corporations don’t make money, they lay off people, and it gets worse. What Logan and I are trying to explain here is to not be so worried about it and to understand that the Fed has a plan with their interest rate hikes. Is the plan going to be successful? Most of the time, they are successful, but we need to be measured in our approach. I think that’s exactly what we’re going to see.

Logan DeGraeve: Absolutely, Bud. You make a great point in that people need to realize that it’s more than just, “Hey, my gallon of gas or milk is way more than it used to be.” Inflation is a real thing. People have kind of forgotten that because a lot of people have been shortsighted over the past 10 years when there wasn’t much inflation.

Bud and I talk about what we look at in financial plans with inflation. Inflation needs to be considered when you’re building your financial plan. However, throughout the last five to 10 years, people have said, “Logan, you have an inflation rate at 3% or 4% in the financial plan. We haven’t seen that level of inflation.” Now, they come back in and say they get it now.

The Background Behind the Pain at the Pump

Bud Kasper: You should’ve heard the words I said under my breath at the gas station yesterday. I was thinking to myself while watching the price on the pump tick up to $40, $45, and so on. I kept thinking that it doesn’t have to be this way because we have reserves.

Remember, a year and a half ago, we were energy independent. We were exporting oil. The gas prices are so high because we’re importing all this oil in at a higher price now. Oil is up because of scarcity in this country.

We see what’s happening on the supply chain by looking at the ports in California, Florida, or wherever. It’s still not fixed yet. So why did we cut off the oil at this time? We’re paying the price for it now.

Logan DeGraeve: It’s probably not going to get better anytime soon.

Bud Kasper: The sad part of it is that it’s all about politics. Politics shouldn’t get into the economics of everybody’s life, but that’s exactly what’s happening now.

How Is Inflation Measured?

Logan DeGraeve: Unfortunately, that is something that always kind of co-mingles. Another thing I know that you want to talk about is how inflation is measured. What are they looking at? It’s not just you and I up here telling you, “Hey, inflation’s going up. Things are more expensive.” Let’s dig into what they look at and how things are measured.

Bud Kasper: I’ll be happy to do that. First, though, I want to encourage people to check out Shane Barber’s latest article, What Is Going on with Interest Rates? I consider Shane to be one of the best writers on finance. A lot of what we’re talking about is also referenced in his article.

But to answer Logan’s question of how inflation is measured, there are a few different methods. Everybody has heard of the Producer Price Index (PPI) and Consumer Price Index (CPI), but most people have not heard about CPI-U, CPI-E, C-CPI-U.

The CPI-U covers urban consumers. So rather than people that are out in the country, it’s more focused on big city expenses. When you go to CPI-E, we get to the elderly. Elderly in this case is 62 and older, so I guess I’m elderly. We look at that because the elderly has different needs than the general population. The C-CPI-U is the chain-weighted price level of consumer goods.

What Do Those Indexes Measure?

Let me give you a sample of the type of things are looking at. It includes basic foods and beverages, such as cereal, milk, and coffee. It also includes housing costs, bedroom furniture, apparel, transportation, expenses, medical care costs, recreational expenses, toys, and museum admissions. I don’t know how that got in there but it’s there. It also includes education and communication expenses.

In other words, just about everything that we purchase, need, or use every day is inside of these. Of course, that’s one of the things the Federal Reserve needs to keep their eye on.

Logan DeGraeve: Absolutely. And you forgot one piece there, too. The government also includes random things like haircuts. Haircuts have gotten substantially more expensive.

Bud Kasper: You know, they could just charge by the hair. I’d be a wealthier man today.

Logan DeGraeve: Dean would as well. Right?

Bud Kasper: He’s not here to defend himself.

Logan DeGraeve: I’m just giving him a hard time. But to your point, people should know that a lot of things are used to measure inflation and a lot oof things that are measured. It’s not just your gasoline or milk. The average person isn’t expected to know what the C-CPI-U or CPI-E is, but we just want you to be aware of the different things they’re looking at.

The Federal Reserve and Bond Buying

I wanted to segue into what you and I were talking about earlier. It’s not just that the Fed can implement interest rate hikes. They also do things with bond buying, laying off bond buying, tightening money supply, and those type of things. Let’s discuss that and where your thoughts lead there.

Bud Kasper: Sure. I think we’re right on target with this in our discussion. When I look at what the Federal Reserve has been doing these past few years, there are two things to think about.

The first has to do with COVID. When COVID hit, the Federal Reserve, wanted to re-stimulate the economy to make sure that the disease wouldn’t drag down our economic progress. In doing that, that’s when they came in and they started lowering interest rates.

Quite frankly, that is the right approach because it makes things cheaper. But the other part of that is the bond buying. At that time, they initiated buying $120 billion worth of U.S. treasury bonds every month.

When you think about that from the perspective of the action that occurs in the market, buying bonds leads to liquidity. They’re trying to put more liquidity back into the system when they do that. As that goes forward, that should be stimulus economic growth from that perspective.

How Much Bond Buying Will Be Cut?

In fact, I’ll even go out as far to say that they could go in and just cut the amount of bond buying and not do anything with interest rates. I don’t think that’s going to happen because that’s a headliner on the interest rates. But we’ve already been told that they plan on cutting that in half to $60 billion.

If you look at the balance sheet of the Federal Reserve, it’s $8 trillion. If you look at the balance sheet of the country, it’s $30 trillion. But what people need to remember as well is that a ton of bonds are maturing while they’re buying. That gives them money supply to do that without fabricating money. Most of the time, people think the that’s the only thing that’s going on.

As these bonds mature, then what? Well, if we’ve cut the bond buying down now, we have a chance of driving down the $8 trillion balance sheet of the federal reserve.

Logan DeGraeve: That’s an interesting topic. We talked about the two moves the Fed has of rate hikes and less liquidities to tighten the money supply. That’s what Shane talks a lot about in his article. What are going to be the outcomes and what are the things we need to think about as rates increase and money supply tightens? What are your thoughts on that moving forward, Bud?

The Fed Is Dealing with a Two-Headed Monster

Bud Kasper: It’s a concern, but I trust the market for its ability to read the tea leaves. In other words, we have anticipation of what would happen when this occurs. It’s a two-headed monster that the Fed is trying to deal with, that being interest rates and the bond purchase program. The significance of what can do with both of those tools should have a positive impact. And, of course, what we’re trying to do right now is build more confidence back into the economy through the leadership of the Federal Reserve.

Chairman Powell has a lot on his plate. But as he had stated before, since they haven’t moved interest rate at this time, I don’t think the Fed is going to get overly aggressive at the first part of these hikes. That could change, though, if there’s more data that comes in that indicates that it’s time to step on the accelerator.

How Is This Going to Impact You?

Bud Kasper: While Shane’s article was titled, What Is Going on with Interest Rates? he posed another very important question within the article. That question is, “How is this going to impact me?”

When we look at inflation above 2%, we know that the asset purchases we were talking about earlier will more than likely be decreasing from $120 billion per month to around $60 billion. They’re just simply reducing the bond holdings on the sheet, which will take some of that debt that they have off the table.

The Goldilocks Theory

It’s such a difficult process to go through. It’s well definable because it’s not like we haven’t seen this before. But Shane had a point that he made in his article that I thought was rather apropos for this, and that was the Goldilocks theory.

Logan DeGraeve: Absolutely. If you think about this from a monetary policy, the Fed is like Goldilocks. Their job is to find that porridge that’s not too cold, not too warm, but is just right. That is a little easier said than done. As we all know, that the bears eventually come back from their walk from the woods and Goldilocks jumps out the window.

Bud Kasper: Exactly right. People wanted this situation we’re in to be transitory. That was a word that was introduced to us by the Federal Reserve well over a year ago. Transitory simply means short term. I do believe that Chairman Powell is still hoping that it holds true, even though the facts aren’t lining up to point us in that direction.

How Is This Going to Impact the Stock Market?

The reduction in bond buying, which started in January over the announcement that they made at the end of last year, is taking place today. As we look at the situation at hand, people are worried about how this going to impact the stock market. Should you be in bonds or stocks? Should you be in cash? Is gold a good investment right now? I’ll even add into something that I far from an expert in and that’s crypto.

You can learn more about how to deal with this situation by reading another one of our latest articles, 10 Ways to Fight Inflation in Retirement. Let’s talk a little bit more about this.

Logan DeGraeve: As Bud mentioned, both of us are CERTIFIED FINANCIAL PLANNER™ professionals. Where we really want to start is making sure that we understand what you’re trying to accomplish before we’re making any investment recommendations.

Gold is always a hedge for inflation. Do you want that in your portfolio? Maybe, maybe not. You talked about crypto. I’m no crypto expert either, but I can tell you that it’s an alternative asset class. Get educated on it and talk to someone about it.

Our average client is someone that’s retired or within about 10 years of retirement, so bonds and fixed income are part of their portfolio. Well, we know as rates go up, bonds prices usually go down. How are we going to combat that? I’m curious what conversations you have had with your clients about the fixed income space in the last year or even the last few weeks?

Shifting to Short-Term Bonds

Bud Kasper: My experience tells me to use short-term bonds because you have lower volatility. Anything that’s about to mature between roughly one and five years is going to have less of a negative impact. The sad part of it is that bonds have not been our friend over the past year or so.

The type of bonds that you own, whether they’re mortgage-backed bonds, government bonds, each has a different characteristic associated with them. Therefore, they will react differently. The craziest thing is going back to what happened during the onset of COVID. On February 19, 2020, it was up 4.81%. By the time we got to March 23, 2020, it was down 30.5%. That was the fastest drop to a bear market in stock market history. It most certainly caused a lot of concern.

Looking Back on the Fed’s Response to COVID

During that time, the Federal Reserve stepped in to try to reassure people that things would be OK. But in the process of that, I believe we had no reason to go back up because the COVID case load was increasing, not decreasing. I illustrated this to our clients with how the market was going down as significantly as it was. I did the same with the bond market, which was going down as well. As a normal investor or retiree, the logical question to ask was, “Where can I go at this point?”

Finding Alternative Investments

Logan DeGraeve: Bud, you make a great point there. I want to go back to what you said about a minute or two ago about bonds having not been our friend lately. There’s no doubt about that, but what does that lead to? Well, that leads to finding alternative investments. But what does a lot of that lead to?

If you look at last year and the average investor, a lot of people wanted to take on more risk. They didn’t want to be in bonds since they weren’t going to make them any money. They wanted to be in equities and take on more risk.

Looking at Your Financial Plan to Dictate What You Should Invest In

Let’s fast forward to the first quarter of this year. Well, it has not been a great year to start for equities or for bonds. However, remember a bad year in bonds is a lot better than a bad year in stocks. Just because you see those bond prices and don’t like the returns, don’t forget what you need to be invested in. Your financial plan should dictate how you need to be invested.

Bud Kasper: Staying on the theme of COVID breaking out in 2020 and going back to that time in March, after we hit that low, we had an approximate 12% increase coming off the bottom in three days despite COVID cases getting worse. You need to rationally ask yourself, what in the world is causing this buying of the stocks at that time? I can’t give you an answer other than people said, “I may never be able to buy this at this low a price. I’m going to go in regardless of what the future might bring.”

Logan DeGraeve: You’re right. And you’ve seen that a little bit in first quarter of this year, Bud. We hit certain points and the market has been bouncing up. Obviously, there’s a lot going on with Russia and Ukraine, the 10-year treasury above 2%, the supply chain—the list goes on.

But the list is always going to go on. Bud, when you look at your clients’ portfolios and what you’re doing with them now, have you made any changes minus lowering duration on the bonds? Have you gone in and changed anything with the investments?

Being Nervous Is Understandable, But Talk with Your Advisor to Attain Clarity and Confidence

Bud Kasper: Specifically, no. I like the ETF space just because it’s a lower-cost factor. When you get into a difficult situation, you need to control the cost because that’s going to impact what’s going to happen on the returns. Outside of that, though, no.

A lot of people say, “Well, I’ve just got to get out of stocks.” Oftentimes, if you think that a stock fund manager or a stock ETF is going to go in and sell stocks just to raise cash in hopes of buying at a lower price in the future, that’s not going to happen. That’s delusional.

However, there are some that have the ability of having cash in the portfolio by design. Now, you need to be able to find those. Fortunately, we have an excellent team to utilize this with LSA Portfolio Analytics. They share their information with us. The reality is that we have been able to find some solution to that.

But in the meantime, I know people are nervous. They have every right to be nervous. You need to have a conversation with your advisor and make sure that things are moving in the direction that you want. We’re going to have these periods where it’s incredibly uncomfortable to stay in long stock positions, but in my 38 years of doing this, we’ve never seen anything didn’t come back in a meaningful way. But that’s only after time has passed and things have had the ability to re-regulate.

Logan DeGraeve: All right, Bud. To that point, what keeps up with inflation over long periods? The stock market.

What’s Going on with the Housing Market?

Bud Kasper: Absolutely. Another thing that is striking everybody right now is this crazy housing market that we have been in. We see things all the time that we can hardly believe when some people put a price up on their house. They get paid $100,000 or $200,000 more than what they asked. I thought we were supposed to be working these numbers down, not up.

Logan DeGraeve: You know, I’m thinking about selling my house and moving in with you, Bud. I’ll pay you rent.

Bud Kasper: I’ve got a downstairs that’ll be just right for you.

Logan DeGraeve: I think another reason why Shane’s article is so important is the section titled, “One Bad Home Prices Recipe.” There are a lot of charts that he references to make his point. What I want people to understand is the magnitude of how much information is in his article, What Is Going on with Interest Rates?

As Interest Rates Go Up, So Do Mortgage Rates

We’ve talked about interest rates from a Fed standpoint, inflation, and those type of things, but what I want to make a very simple example here. According to the article, the average home price is $330,000. If you were to go out and finance that on a 15-year mortgage at 2.8%, that payment principal and interest is about out $2,247 a month. In the same example, 30-year fixed is at 3.55% and you’re looking at about $1,491. This article highlights that as interest rates go up, so do mortgage rates.

Let’s look back to the 2007-2009 timeframe when interest rates, mortgage rates were about 6%. These same numbers that I just gave are shocking. That 15-year note at 2.8%, that’s $2,247 right now. At 6%, that number is $2,785 a month. The 30-year number increases by almost $500 a month. That means that someone that can afford that $330,000 house today may not be able to afford it as rates and mortgage rates continue to tick up.

Bud Kasper: You’re right, Logan. And it is a killer for the economy because housing is so important. The housing market that we’ve had over the last few years has been ridiculous. For example, let’s say a guy put up his home and sell it for $600,000. Typically, somebody might try to give him $700,000. We may not ever see that in our lifetime again, though.

Patience Is Pivotal in the Housing Market

The reason that can happen are because of low interest rates. Therefore, the amount of additional mortgage doesn’t offset what it would’ve been at a higher mortgage rate if they had waited a year or so. If people are patient in the housing market right now and interest rates end up going up, it means that housing prices are going to come down.

If you have a house that you’re selling and don’t have a whole lot of debt that you’ll take on, you might be helping yourself out considerably because you would have a little bit higher mortgage payment. That depends on how much principal that you applied to that, but you’re going to get a house at a much more reasonable price.

Debt and Leverage

Logan DeGraeve: This all goes back to a podcast that I did with Dean, The Difference Between Good Debt and Bad Debt. Bud and I see this all the time when we’re helping retirees and prospective clients live their one best financial life. Let’s say someone wants to get a second home in Florida or Arizona. Go use that money at 2.85% on that 15-year note. What we’re talking a lot about right now with clients is where rates going to go in the future and does it make sense to have that debt?

Bud Kasper: That’s true. When we do a full-fledged financial plan, we want to see where the impact on the net results for the retiree. Buying more house than you need when you’re really getting into that part of your life where you can go ahead and reduce could be the worst time to make a mistake. Instead of living in the McMansion, you can now do something a little bit less and still have a nice place to reside.

Is There a Possibility of Stagflation?

As we’ve mentioned, there are other issues that we’re dealing with outside of the housing market that are tied to higher inflation. One of the things that I think Dean would be talking about right now is whether there is a possibility of stagflation. It’s fair to have that discussion, but I don’t think it’s so paramount that we need to be overly concerned with.

At the same token, this is a world that I can hardly recognize with the supply chain issues that we have no control over. We have a lot of money on the sidelines that’s more than willing to come back into the market. That might be the saving grace by the time we get through the full year in terms of markets getting back to levels that are more appealing to retirees and people at large that invest in the stock market.

Having Discipline with Big Life Decisions

Logan DeGraeve: I agree with you, Bud. Patience is a virtue, and so is discipline. You need to make sure that you have both. More importantly, when you’re making these big life decisions and getting in and out of the market, talk to a CERTIFIED FINANCIAL PLANNER™ professional. Talk to someone that is a fiduciary and has your best interest at heart to run the numbers and make sure that you’re making wise decisions.

Bud Kasper: Yes. When Dean and I created America’s Wealth Management Show some 18 years ago, it was his vision to make it an educationally-based program. We have nothing to sell. Yes, we are in the business of advising people and are paid a fee for that, but you know what the fee is. When navigating our website, you’ll see the incredible amount of content that is on there. Any question you have is probably answered on our website.

We’re Here to Help You with Making Those Decisions

Logan DeGraeve: Absolutely. I encourage you to reach out to set up a 20-minute ask anything session or schedule a complimentary consultation CERTIFIED FINANCIAL PLANNER™ professional. There’s no reason not to get your questions answered. Let’s figure out what we need to do.

Bud Kasper: It’s incredible honor to talk to people about issues that are facing them right now. The 20-Minute ask anything sessions have been very popular.

Logan DeGraeve: I’ve done a few of them as well, Bud. We are here to help and we’re happy to help as we can.

Bud Kasper: Absolutely. Logan, thanks so much for joining me. Next week, Dean will be back in the captain’s chair. I’m sure he’ll have a lot to share with us at that time.

Thanks so much for joining us. It’s been our pleasure to once again, share a little bit of information. I hope it’s brought a little bright spot to your day. I’m Bud Kasper, along with Logan DeGraeve. Have a great weekend and thanks for joining us.

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.