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5 Mistakes Investors Make

Published on May 13, 2024

John Hagensen

Join John as he details five mistakes every investor makes. From market timing to misunderstanding performance data, find out how to recognize and avoid these mistakes and put yourself in a better position to achieve long-term financial success. (2:07) Plus, learn why understanding the future of taxes may make you rethink your current tax strategy. (24:10)

Episode Notes:

Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!

This show is designed to be informational in nature and does not constitute investment, tax or legal advice. Different types of investments involve varying degrees of risk, and there can be no assurance that future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.”

John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Hagensen and ahead on today’s show, the five mistakes every investor makes and how to avoid them. Also, how to assess your asset allocation. And finally, when you hear reference to the market or the markets, what is it? Now, join me as I help you Rethink Your Money.

I was recently at the DFW Airport and that is one enormous airport. I had my mother and our four-year-old traveling with me, and so I’m looking after them and wheeling our suitcases around after baggage claim. And I’m trying to find my Turo. Turo is the rental car version of an Airbnb. And generally, in my opinion, this is a lot more convenient. The standing in the rental car lines and all the issues that go along with that. But after you hear my story, you’re going to think to yourself, that sounds a lot more complicated.

And in this case it was. Because they had dropped off my Turo on level five of the parking garage, to which I went looking for the vehicle, only to realize they left it at the wrong terminal. I was in Terminal D and they said, “Oh, earlier this afternoon it looked like you were flying into Terminal A. Sorry about that. You’re going to need to catch a bus and ride for about 15 minutes to get over to this other terminal with all of your checked luggage and a mother who needs help and a four-year-old who seems to be dead set on running into oncoming traffic because there was a butterfly flapping around.” But we got there. But it reminded me that even if I know where the car is, I’m only going to get there if I have clarity where I, in fact, currently am.

Now, if you’re trying to get to Kansas City, Missouri, it’s helpful to know whether you’re starting in Nashville or Denver. And the same is true when it comes to our personal finances. Before you do anything, you must first establish where you sit today. You have to know what your purpose is with the money. Because if it’s to help a grandchild pay for college in two years, you’d want to invest that differently than if it’s likely not going to be touched for 15 or 20. Creative Planning President Peter Mallouk wrote a book on these mistakes. Mistake number one is market timing. All right, I’m glad you’re listening because I have an amazing investment opportunity for you. Okay, are you ready for it? I want you to close your eyes and hold out your hands just like my little toddler Luna does this. Amazing investments made 10% per year for a century. It’s called, drum roll please, the stock market.

Now picture a yo-yo going up and down. Yeah, that’s the stock market. But don’t forget the stock market is akin to a kid, yes, playing with a yo-yo, but while walking up a flight of stairs. Now going from floor one to floor 10 is far more meaningful than the temporary up and down of the yo-yo. Creative Planning Director of Financial Education and longtime Wall Street Journal financial columnist, Jonathan Clements said, “What, do we do when the market goes down? We read the opinions of the investment gurus who are quoted in the Wall Street Journal. And as you read, laugh.” Author of A Random Walk Down Wall Street, Burton Malkiel, said, “There are three kinds of people who make market predictions. Those who don’t know. Those who don’t know what they don’t know. And those who know darn well they don’t know, but get big bucks for pretending to know.”

See, it’s very difficult to beat the markets, to outsmart the markets by getting in and out. Because the markets are relatively efficient. Meaning the actual price of a security is a pretty good estimate of its intrinsic value because it represents what thousands of participants in a free market on both sides of the trade are willing to buy and sell a security for. And the real challenge is that you can’t just be a little better than the overall market to outperform. It’s logical to think, oh, I just need to be right a little more than 50% of the time and my returns will be phenomenal. When in fact, an exhaustive study by Nobel Laureate William Sharpe definitively concluded that you as an investor must be right 69% to 91% of the time, depending upon the market moves, actually outperform in the end.

Good luck with that. The masses get it wrong over and over. The media gets it wrong over and over. Economists. Yeah, even them, they get it wrong over and over. I love the quote, “If you’re going to predict, predict often.” By John Kenneth Galbraith. Put another way, a broken clock tells the right time twice a day. Newsletters. It’s only $19.99 a month to subscribe to learn the right stocks to buy and sell and when to get in and out. I think they would just trade for themselves if they actually had a solution. They wouldn’t be trying to hustle $20 a month. And your buddy’s not right most of the time either. Now, there are other strategies that they don’t sound overtly like market timing, but they are. And by the way, they don’t work either. Like asset class rotation, tactical asset allocation, style rotation, sector rotation. So remember, the market is volatile. Get used to it. And you can’t wait until you feel good because by the time that occurs, where sentiment has shifted to the positive, the market’s long moved off of its bottom.

Avoid market timing by reminding yourself corrections will occur. On average they’re about 14% from peak to trough. Down markets will happen every three or four years. Bear markets and crashes will come once or twice a decade. But no matter how nervous you get or how bad things appear, the bear will give way to the bull. And since you can’t predict them, you’re going to do more harm than good by trying to navigate your way through them by trading. And if an advisor tells you that they utilize market timing strategies, any of these, even the more subtle ones, I want you to say, “See you later.” Put up the deuces, walk out of their office and continue to search for another advisor. If you have questions about how you can succeed without the need for market timing or you feel like you may be missing something within your financial planning, we help over 75,000 families, and have been doing so for 40 years. Why not give your wealth a second look and speak with a local advisor just like myself at creativeplanning.com/radio?

Next of our five common mistakes every investor makes and how to avoid it for yourself is active trading. Do you realize there are nearly 8,000 mutual funds and 3,400 hedge funds, most of which are trading US stocks? Well, that’d probably lead you to believe that there are approximately 100,000 exchange listed stocks. Nope. 25,000 listed stocks? No. Get this. There are approximately 4,500 companies listed on the public exchanges. Yeah, that’s right. Tens of thousands, if not hundreds of thousands of professionals, plus tens of millions of other people are trading these 4,500 stocks. And it sounds silly because it is. It’s ridiculous. According to Morningstar, if you look at the fate of 1,540 actively managed United States equity funds between 1998 and 2012, only 55% survived. So there’s already a survivorship bias because almost half of all the traded funds are so bad they’re gone.

Then the data you’re looking at is just the 55% that have survived. And of those 18% outperformed the broad markets. That’s why the late great John Bogle said, “Don’t look for the needle in the haystack, just buy the haystack.” A passive strategy wins more frequently due to lower transaction costs, lower expense ratios, less taxes. And generally active managers sit on more cash than index funds. And that cash drag also leads to worse performance. And finally, active managers fall prey to the same behavioral biases and mistakes that we all do. So while we know that active trading doesn’t win, remind yourself that if you hand your money to an active manager, someone’s getting gamed and that someone is you.

Mistake number three is misunderstanding performance and financial information. We so often judge performance within a vacuum. If I filled up Yankee Stadium and I told everyone to stand up and hand it out a penny to each person in the stands and then I said, “All right, let’s flip the coin and if you land on heads, stay standing. If you get tails, sit down.” We could repeat the exercise 15 times and there would be someone, most likely, or even multiple people, maybe a handful who would still be standing. Remarkably, they flipped heads every single time. It doesn’t mean they’re a genius, it doesn’t mean they could repeat it. It’s simply the law of large numbers.

If one person at the Wynn Casino in Vegas has made a bunch of money on the roulette wheel, we don’t all rush and give them our money to invest and say, “Well, you’re obviously the best in this casino.” No, there are thousands of gamblers in here, most of which will lose, all of which will lose given enough time, but you happen to be the outlier right now who’s gotten lucky. The same is true when looking at market performance and financial information. We misunderstand and believe that the market cares about today. No, we’re focused on today, but what matters when it comes to the market are future earnings.

I see people mistake the information that an all-time high signals a market pullback is coming. No, my children get taller when I mark off their ages in the pantry with a Sharpie because they’re getting older. It doesn’t surprise me and it shouldn’t surprise you that the stock market is reaching all-time highs. You know what else will be an all-time high? The price of a candy bar 10 years from now. It’ll be the highest it’s ever been. Your Chipotle burrito bowl, it’s going to cost more 15 years from now. And that won’t surprise us. Neither should the market continuing to forge on toward new highs. Don’t believe that correlation equals causation. A black cat went in front of my car and it was raining, so therefore, whenever a black cat goes in front of my car, stormy weather is on the horizon. No. Remember that a large part of the financial information that you are consuming and that you’re encountering is worthless, damaging and misleading. View all financial news with skepticism and more importantly, develop a skill for filtering out all the noise.

Our final two mistakes are letting yourself get in the way. And working with the wrong advisor. I’ll quickly unpack each. Regarding our emotions. If 30 years ago all you did was buy the 500 largest US stocks and then control your fear and greed, you would’ve doubled your money about every seven years, while the average American has only earned approximately half of those returns over the same 30-year period according to a recent DALBAR study. Not because the market didn’t behave, not because it was the president’s problem or an economic catastrophe, it was that we are humans and it’s very difficult to control our emotions, especially when it comes to something as important as our entire life savings.

Warren Buffett said, “The fact that most people will be full of greed, fear or folly is predictable. The sequence is not predictable.” We tend to have overconfidence and we have confirmation bias and we have anchoring and loss aversion and mental accounting and recency bias and negativity bias. We fall prey to the gambler’s fallacy. So avoid the mistake of letting yourself get in the way. Be aware that what your instincts are telling you, which might be fantastic in other areas of your life, are almost certainly the opposite of how to be a successful investor.

And as I mentioned, the final mistake is working with the wrong financial advisor. Avoid choosing the wrong advisor by asking these seven questions. Where will my money be held? The right answer is somewhere else. Number two. Are you a broker? I don’t care if they’re a fiduciary some of the time, they’re occasionally a financial advisor. Are you a broker ever? And the correct answer you’re looking for is no, never. Number three. Are you a duly registered advisor? Which is what I just referenced. The correct answer again is no.

Number four. Do you or an affiliate sell proprietary investments of any kind? The right answer, no. Because if they do, what will they be recommending you put your life savings into? Yeah, their investments. Number five. How are you compensated? The right answer is total disclosure in writing and never make commissions on any investment product. Number six. What are the credentials of you and your team? The right answer, if planning is involved, a certified financial planner is ideal to have on the team. If it’s taxes, a CPA. If it’s legal work, an attorney. Here at Creative Planning, we have nearly 500 CFPs, over 200 CPAs and over 50 attorneys.

And the seventh and final question, what is your planning and investment management approach? The right answer you’re looking for is that the firm should follow a coherent philosophy rather than a bunch of different strategies that are unprincipled. And they should follow an approach that does not involve market timing or active trading in any way. Abraham Lincoln said, “Be sure you put your feet in the right place, then stand firm.” If you can avoid market timing and active trading and misunderstanding performance data and financial information. If you can avoid letting yourself get in the way or working with the wrong advisor, you will put yourself in a great position to make progress and have success.

My special guest today is certified financial planner and doctor of psychology, Dan Pallesen. Dan, thank you for joining me on Rethink Your Money.

Dr. Dan Pallesen: Thanks for having me back, John.

John: The S&P 500 has delivered 10% per year, while the average American has made about half that the past 30 years. For three decades, we’ve underperformed to that extreme. Dan, I need you to get in our heads and use your psychology skills to tell me why are we so bad at this historically speaking? How do we get better? Or put another way, are we crazy? Are we hopeless? Is that it? We’re just crazy?

Dan: Yeah, these are good questions, John. I’m going to come on today-

John: You said, “Yeah,” and I thought you were going to say, “Yeah, you are crazy.” Put me in a padded room. Okay.

Dan: All of us are a little crazy. Sure, absolutely. But I’m actually here to defend the average person or the average investor and make the argument that it’s not that we are crazy or we are just bad at making decisions, but it’s the system itself that’s a little crazy. And I have to give credit where credit’s due. Daniel Crosby has a great book out there, The Laws of Wealth, so check it out. He’s an author, he’s a financial psychologist, and some of these principles I’m going to get into, he addresses in The Laws of Wealth. So here’s the first principle. The certainty that we have with the stock market is completely backwards.

So John, I know what I’m doing the rest of the day. I’ve got my schedule laid out. I know who I’m going to see. I have a pretty good idea what I’ll be doing a week from now. I even have a decent idea of what I might be doing a year from now. But the further out I go into the future, the less certainty I have with what I’ll be doing or with what’s going on. I have no idea what I’m going to be doing 50 years from now. The stock market’s the opposite. We have less certainty with the shorter time horizon we have. I have no idea what the market’s going to do tomorrow. A month from now, I have a general idea based on what rolling monthly periods have done in the stock market, but there’s still a lot of unknown.

But when I go out further and further, five years, 10 years, 15, beyond, I have more certainty, and not just certainty, but certainty of positive growth in the stock market. And so it’s like the further out we go or the longer that we delay our feedback, the more likely we are to have positive results. So human beings aren’t necessarily wired to make decisions like that. We need immediate feedback to determine if we’re making the right decision or wrong decision. But when it comes to investing, you have to wait a really long time to see some of that feedback and have some of that certainty.

John: Yeah, it’s a really interesting way of putting it actually. I’ve never heard that take exactly that way. And it makes a lot of sense because people will say, “Well, how am I doing?” And as a financial advisor, you say, “Well, just wait longer. You’ll be good. Well, stuff hasn’t been great for the last year. It’s okay. You’ve got to give it 10 years.” And there’s truth to that. It’s not a cop-out, it’s reality. But it’s also reasonable for a human with their life savings to go, “All right, we’ve been at this for 24 months, should we be making some big course corrections? This asset category has done better than this one. Why are we not more in growth, that’s clearly doing better?” Or whatever it might be. Because that’s basically how we operate in every other aspect of our lives to be successful. What’s another way the market’s crazy?

Dan: So another way the market’s crazy is effort does not equal results. So when I think, again, in about every other area of my life, my physical health, my relationship with my wife, my relationship with my kids, my career, my education, the more effort that I put in, I tend to get better and more positive results. When it comes to investing, the more effort that people put in terms of researching the hottest stocks or even just trading more frequently, trying to time the market or beat the market or keep pace with the market, results in less favorable financial results.

John: Yeah. It reminds me of the, I think it’s Forgetting Sarah Marshall, I think it is, and Paul Rudd’s on the beach and he’s trying to surf. The surf instructor is, “Do less. Do less.” And he keeps getting up and he was like, “Nope, you’re trying too hard. Do less.” And so at the end, he’s just laying on the board and he’s like, “Pop up.” And he just lays there. He is like, “Okay, well, you’ve got to do something. You’ve got to do a little more than that.”

Dan: That’s so good. That’s very true.

John: But yeah, it really is counter, isn’t it? There’s not a lot of things in life where you are better off doing absolutely nothing. I mean, if someone 30 years ago lost their login, they just bought an S&P index fund at Vanguard, let’s say. And they just lost their login and forgot they even had the account, they’ve essentially earned 10% per year compounding for three decades. And they’ve doubled the typical American. It’s one of those scenarios where their friend would be like, “Oh, what did you do? I mean, you have $5 million. How did you do this? Did you buy Nvidia before it popped? Did you get into Apple early? Were you able to get out of tech stocks before the dot-com bubble burst? What’s your secret?”

And the person goes, “I forgot I had this account. I literally didn’t know that I had it. I received a statement that finally got forwarded to me three addresses later and I had made 10% a year.” I’m speaking with Creative Planning wealth manager, doctor of psychology, financial therapist and certified financial planner, Dr. Dan Pallesen. This is an interesting discussion. What else makes the market crazy? This is fun. I like passing the buck. It’s not you, it’s me. Hey, this isn’t our issue. This is the market’s thing, right?

Dan: That’s right.

John: So what other ways is the market crazy?

Dan: So another way that the market is crazy is around the idea of general consensus. So think about this, John. When you’re buying something on Amazon, we’re looking at reviews and the more positive reviews tend to result in some better products. And a lot of us base our purchases off of reviews. When I’m looking at what restaurant to eat at if I’m traveling, I’m in a city, I have one shot to have a nice dinner, I’m usually going to Yelp or some kind of a platform that has reviews on it. When I’m traveling… I think of my wife, when we travel, she immediately is jumping on TripAdvisor, looking at what are the best hotels, what are the best restaurants, what are the best experiences based on the general consensus of those that have experienced it. So there are certain things in our lives that we can rely on the general consensus to help improve our own decisions.

When it comes to investing, the general consensus is usually wrong. And we see this over and over again when we see peaks in the market, and that’s when money is flowing in. We’re wired to buy high because we’re excited. When the market drops, money is flowing out. The general consensus or the herd mentality of investors is to put money in when they’re confident, when prices are up and pull money out when they’re panicked and prices are down. And we have to reverse that. We have to be willing to systematically buy low and sell high, but that’s not what the herd does. That’s not the general consensus. And so that’s another way where in any other area of our life, if we do what everyone else around us is doing, we’ll probably be okay. But when it comes to investing, it can really get us in trouble.

John: Yep. Doing the opposite of what basically the herd is doing can be difficult. But if there’s one thing that summarizes Warren Buffett’s strategy, I mean he said often, “When everyone’s going in one direction, at least just pick up your head and look the other way.” And if investors did that more frequently, they’d be better off. I think that’s why rebalancing and systematically rebalancing is so important because it creates a rules-based approach to doing the opposite.

Because you’re selling things that are up and you’re buying things that are down, and it’s exactly the opposite of what the herd is doing. And it’s exactly the opposite, frankly, of what we want to do as human beings that are investing. But it forces you to do it because you have that in place and you’re never sitting there wondering, well, do I think this asset category is going to do better or worse the next 12 months once I buy it? Nope, I’m overweighted because it’s done better than other things. My risk tolerance is off, my allocation’s off, my diversification’s not efficient. I need to rebalance. And so that can be one practical way to mitigate some of our own pitfalls as investors.

Dan: Yeah. And John, I want to bring up one more thing. And you hit on it earlier. When we’re in a relationship and we feel crazy and we’re doing some of the soul-searching or we might go to therapy and we realize it might not be me, it might be that other person, they’re crazy or they’re toxic or they have poor boundaries or whatever it is, and we can identify the other person. In a lot of areas, we can try and separate ourselves from that person. If you’re in a bad relationship, you can get out. If you have a bad, toxic boss, you might look at changing companies. The unfortunate thing about investing is we really need it. We really do need it.

Think about it, John. If someone’s working starting at age 20 and they retire at 65, they have 45 years of a career. And let’s say on average they’re earning about $100,000 a year. The median income right now is about $70,000. So they’re above average, early years working earning less, maybe later years earning more, but on average $100,000. And let’s say on average they saved about 10% of their salary per year, but it was just going into cash. They weren’t investing at all. They’re going to retire after 45 years with $450,000. If they’re living from 65 to 95, they have almost a third of their life in retirement that that money has to last. And so $450,000 might sound like a big number, but spread out over the course of 35 years, whatever the retirement is, it can start to get pretty tight. And so my point being-

John: Yeah. And you’re only pulling maybe a couple of thousand a month from that?

Dan: Yeah. And my point being with this, we really do need to invest. We need our money to be working for us while we’re working as well to have a well-funded retirement. Just identifying that the market is crazy, the solution is not, “Hey, let’s not invest. Let’s get away from the market.”

John: That’s a really good point.

Dan: We need to understand that the market is just set up a little differently than how we are wired as a human. And then what do we do with that? How do we engage well with that? So I just want to, again, encourage the listener, the takeaway of this is not, don’t invest, but it’s just recognize we’re not naturally set up to be good investors, but it’s still really important to be investing.

John: Well, and I think the takeaway, to extend that one further, is your money’s your shadow or your Siamese twin. It’s not something that you can get away from. It’s going to be a part of your life whether you want it to be or not. And so you better learn to understand these things as best you can to have a positive interaction. So I think that’s fantastic. Thanks for joining me on Rethink Your Money, Dr. Dan.

Dan: Thanks, John.

John: Pre-tax or Roth? Which is the better strategy? It’s a very common question for those saving toward retirement or into retirement with large lump sum balances of deferred accounts like 401(k)s and IRAs. And CNBC recently had an article that was titled Trying to Choose Pre-Tax versus Roth 401(k). Why It’s Trickier Than You Think, Experts Say. Now, it’s really not trickier than you might think if you focus on the most important question. Do you think your current tax bracket is higher or lower than it will be in the future? That’s the most pivotal question in the entire decision.

Now, there are sub questions that are meaningful but not ultimately anywhere near as important as the question I just stated. And those may be a bit more nuanced. So let’s look at this from another angle. If you had a crystal ball and you knew your tax bracket was going to be exactly the same 20 years from now as it is today, both options will have identical after-tax balances. This decision is pointless. Does it matter? It’s meaningless. And once you realize that, it reaffirms what I just said, which is will my bracket be higher or lower in the future than it is right now? Because while the tax deferred option continues to grow larger and larger and separate further and further from the Roth, that started with less money because you had to pay taxes on it due to that exponential compounding. What people miss is that you’re also continuing to compound your tax obligation larger and larger simultaneously.

So let’s look at this if you’re working currently and contributing to retirement accounts. And you’re trying to decide whether to deposit a portion of your paycheck into a traditional IRA or the deferred side of your 401(k) or whether to choose the Roth IRA or the Roth option within your 401(k). In this example, let’s suppose you’re married and you have a combined income of $150,000. You’d be in the 22% bracket. So if you contribute $10,000 to your 401(k), it feels as if you’ve just saved $2,200. Because you didn’t have to claim that $10,000 of income on your taxes and pay 22%. But if that eventually grows over many years to $100,000 and you take it out in retirement, and of course none of that’s been taxed because it’s been tax deferred, and now you’re in a 32% bracket, remember when you were contributing, you were in a 22% bracket, you actually just cost yourself an extra 10% on your taxes.

And so that’s an example where it clearly would’ve been advantageous to just pay the 22% tax, take your $7,800 and have all the future growth tax-exempt and eventually down the road avoid that 32% bracket during the withdrawal phase. So that’s someone who’s working where the Roth would’ve made more sense. The other scenario where this decision of whether to defer your contributions or whether to take your medicine today for future benefits is once you’re in retirement. Maybe you have a $1 million balance in your retirement accounts that have never been taxed. So you made the decision that you were going to defer. Which is what most current retirees did because Roths have only been around about 25 years. And they weren’t all that popular at first. And the ability to contribute has been expanded.

So this is a scenario that’s quite typical. This retiree’s assessing whether it would make sense now to convert some of the traditional IRA money. Which is where you make a direct transfer from your IRA to a Roth IRA and you pay tax at whatever stated amount you choose, and then that conversion amount is added to your income and you pay tax on it at whatever rate you’re in. When would that strategy be viable? Well, for many people, right now. Because in 2018 through the end of 2025, when the Trump Tax Reform sunsets, we’re in the lowest tax rate environment we’ve seen in decades. And we have $33 trillion of national debt. And most people, when they assess whether or not they believe taxes will be higher or lower in the future, they expect they’ll be higher.

Now, if you parlay that with a retirement where your wages have now decreased or ceased to exist, you may have the optionality around taking Social Security or not if you are in your 60s. So you have a lot of control over how much income you’re willing to drop onto your tax return. And so rather than saying, as a 65-year-old, “Wow, I’m in a 10% bracket, I don’t have to pay any taxes.” Well, that may not be the right decision. It might be for this year, but not the right decision to reduce your lifetime tax bill if you’re sitting on a large lump sum balance in retirement accounts that between now and the day you die will be taxed at ordinary income rates unless you give them away to charities.

What often makes sense in this scenario, consider filling up the 22% bracket by doing a Roth IRA conversion with a strategic amount that brings you right to the top of a bracket that through planning is determined to be an attractive rate that you will probably never have the opportunity to pay at that amount or lower in the future. You always want to make Roth conversion decisions within the context of a written, documented, detailed financial plan. These decisions are irrevocable, you cannot undo them. That was another change with the Trump Tax Reform. You used to be able to, now you cannot.

So I advise that you also include a CPA who understands your tax situation, working with your certified financial planner in coordination to ensure that you don’t mess this up. But again, all of that is still an evaluation as to whether or not you think your current tax rate is higher or lower than your future tax rate. Some other minor considerations that are not centralized to the strategy but can certainly tilt the scale one way or another. If your answer to my first question is, “Hey John, it’s really close. I’m not sure, right in the middle, I don’t know if my bracket based upon projections is going to be higher or lower.” Well then you may want to look at things like what are my liquidity needs? You have limited liquidity for five years following Roth conversions. So that may be a factor. What are your legacy concerns? I mean, who’s going to inherit the balances of these accounts once you pass away?

I’ve had scenarios where my retiree client is in a 22% tax bracket and they’re deferring and they’re deferring and they’re just taking out the required minimum distributions and letting the entire rest of the balance sit in their accounts and grow. And I ask them, “Who will be inheriting this?” “Well, I’ve got a son in Newport Beach, California, that’s a radiologist.” “Okay, so they’re making a million dollars a year. They’re in the top tax bracket and paying well over 10% state taxes in California. Meaning over half the inheritance of IRA dollars is going to be gone. Half’s going to your son and half’s going to the IRS?” And they say, “Well yeah, but I have another child too.” “Okay, tell me about that child.” “Oh, well, she’s in tech in Silicon Valley, entrepreneur, top tax bracket.” Wait, and we’re deferring right now at 22% bracket, even though you have no need for this money and aren’t using it for your income strategies, it’s just an inheritance play?

That’s the scenario where systematic Roth conversions can potentially disinherit the IRS out of 20% or 25% of the money. How about your own inheritance? That’s a consideration. Do you intend to receive money down the road? How will that impact your tax situation? Will you be inheriting IRA dollars from your 95-year-old mother? Will they be stepped up in basis because they’re all rental properties? These are really important questions to answer. How about longevity? RMD considerations? And how long will you potentially have the benefit of tax-free compounding inside of that Roth account? And also, what is your investment strategy? If it’s consistent with your goals, you generally want to have a growth bias in Roth accounts because all the growth is off your tax return.

So how aggressive are you as an investor? How conservative are you? And in light of that, will you maximize that tax-free growth potential of the Roth? Lastly, your marital status is a huge factor. One of the things that I find catches people off guard, that they haven’t thought through. And by the way, probably for good reason. Because generally you’re not thinking about, well, if I lose my spouse, how is that going to affect my taxes? If you have thought about that, maybe you’re a sociopath. I’m just saying. Or maybe you’re an engineer, I don’t know.

Again, don’t hold that against me engineer clients. I know you want to know how the watch was made. You don’t want to know what time it is. I get it. You’ve thought these things through. I appreciate that about you. But your marital status, in all seriousness, is important. Because assuming that you are not the couple from the notebook who dies at the nursing home holding hands on a twin size bed at the exact same time, when one spouse passes away, you go from married filing jointly as a taxpayer to a single filer. Meaning all of your brackets get cut in half, but in most cases, your financial situation doesn’t get cut in half.

The surviving spouse inherits all the accounts often. Maybe they lose the smaller of the two Social Security benefits, but most everything else is the same and they have much less space within each tax bracket. So practically speaking, your bracket usually goes up. And if that’s at the same time you need to take required distributions out of your IRAs, fully taxed at ordinary income rates. A lot of retirees are very surprised how much tax they’re paying on these IRA assets that 40 years earlier they had deferred into their 401(k) thinking they were saving money on their taxes. No, you were deferring your taxes. You were simply asking the IRS if you could claim that income later.

Well, it’s time for this week’s one simple task where I help you improve your financial situation 52 times throughout 2024. And if you’d like to reference all of my previous tips, they’re available on the radio page of our website at creativeplanning.com/radio. Which is, of course, also where you can schedule to meet with myself or one of our colleagues for a second opinion on your life savings. Today’s one simple task, audit your portfolio holdings. An investment portfolio audit helps you develop and understand your current portfolio strengths and their weaknesses.

You can use this information to identify areas that potentially were great when you initially made the investment, but your life has changed, your income needs have changed, your kids are older or out of the house or your grandkids are starting college and you want to help them. Whatever’s going on in your life, what I do know is that it’s dynamic. So it’s important that you consistently reevaluate the way that you’re invested, what to keep, what to get rid of, what to add, what to discard, to fully optimize your investment portfolio and to ensure that you’re not beholden to something we all are as humans, which is the sunk cost bias. Think of it this way, if your entire net worth was piled up on your dining room table, just all $100 bills. Hopefully it’s falling all over the floor because the stack is so big. It’s like the World Series of Poker final table when it gets down to the final two and they’re playing heads up and they pile all these $100 bills in the middle just to show how big the stakes are.

Let’s imagine that’s your dining room table. Would you invest that money in the exact same places and in the exact same investments as you are currently positioned? Or if you’re like most people, a lot of the things you’re invested in, you’re just invested in them because that’s where it’s been, not because it’s where you’d put it today with a fresh look. So again, the simple task is to audit your portfolio holdings for expected return, standard deviation, that range of volatility that you can expect, fees and expenses, dividends, taxation. And if that feels overwhelming, sit down with a certified financial planner and say, “What do you see? Share your perspective.” To ensure that you’re maximizing what you’ve worked a lifetime to save.

Well, it’s time for listener questions, and as always, one of my producers, Lauren is here to read those. Hey, Lauren, how’s it going? Who do we have up first?

Lauren:  Hi, John. First up we have a question from Shawna in Chandler, Arizona. And she asks, what’s the difference between the markets? What is the S&P 500 versus Dow Jones? And when we hear the market is up, what are they referring to?

John: I think this is a really good point because on the news or talking with a friend, you’ll hear them refer to the phrase, “The markets.” Cool. What are the markets? Mostly the markets are these big US indexes that you referenced. Most diversified portfolios have small cap and small cap value and emerging markets and international large companies and bonds and maybe private investments like private equity and private real estate. Maybe 20% of someone’s portfolio is in the markets, but that’s the only performance you are hearing about on your commute into work in the morning times. So let’s first look at the Dow Jones. It was started in 1896 by Charles Dow and Edward Jones. And it followed the 12 largest companies in each sector of the US stock market. The index was a way for Dow and Jones to report the overall health of the stock market to investors.

Here’s a fun fact, 12 of the companies were American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding. This one you’ll recognize, General Electric. Laclede Gas, National Lead, North American, Tennessee Coal & Iron, US leather, and United States Rubber. The S&P 500 came about in 1923, moved from those 12 to 233 of the largest US stocks. Now, it’s 500 and that’s been the case since 1957. It’s limited because it only represents the largest 500. Large stocks can certainly move different than small. Which is the biggest companies. And it is somewhat of a reflection of the overall markets. But you have a decade like the last decade, as it’s referred to, from 2000 to 2010 where US large stocks made nothing for 10 years, while emerging markets were up 430 plus percent.

A diversified portfolio that had international and small cap value and the aforementioned emerging markets was up 6%, 7% per year. But by year 10, the media was saying the markets have lost you about a half a percent per year now for 10 years. And Shawna, I’d caution you when you’re calculating performance, you need to be aware of what you are comparing. What do you actually own in your portfolio? What is your risk tolerance? How much do you have in equities? How much is in large cap of those equities? How much is in United States versus international? So that you’re evaluating apples to apples. All right, Lauren, who’s next?

Lauren: Next I have Josh in Virginia. Should I fund my retirement with an annuity?

John: Well, short answer, Josh, is no. Annuities certainly have pros and cons. They’re almost always sold, not bought. They come with high lockups, huge commissions, a lot of complexity. Often the income is not inflation adjusted. So while you have it for the rest of your life in the event that you annuitize your money into lifetime income payments, they’re slowly being eaten away like little termites as a result of inflation. If you told me I’m terrified of investing, I’m hyper conservative, all of my money is going to be buried in the backyard or I can buy an annuity. The annuity would probably have better outcomes for you if the decision was that binary. But there’s almost always a better, more efficient way to engineer the portfolio, in my opinion, than locking up your money in a high cost insurance vehicle.

And most importantly, never purchase an annuity unless a comprehensive, detailed financial plan has been built out for you by a credentialed fiduciary because that plan will usually answer this question. All right, Lauren, last question. Who do we have?

Lauren: Ryan in Mesa, Arizona wrote in. Do you think it is reasonable I am paying my advisor a 1% fee a year? This amounts to roughly $10,000 and seems overpriced.

John: Well, Ryan, congratulations. Based upon my napkin math, you have about $1 million saved. So great job living within your means and consistently saving. In short 1% is around the going rate for a comprehensive wealth management firm. The question always becomes, what value are you receiving for the 1%? If everything else was equal, you could do all of what they’re doing for you on your own, and let’s say it only took you two hours per year and your outcomes were no better working with this firm, then you’d be crazy to pay more than $500 a year, let alone $10,000.

But if that firm is doing things like, “Oh, they tax lost harvested for me and they Roth converted and they run my tax projections and they do my tax returns and they get me into private investments that I don’t have access to and they’re providing financial planning and looking at my estate plan and building gifting strategies.” They’re doing all of those sorts of things and maybe finding you lower cost investments than you had on your own. But then you might look at it and say, “I pay them 1%, but I think I’m benefiting by 3% or 4% a year.”

Well then obviously it’d be worth it. I mean, in the event that some advisor out there said, “You’ve got to pay me 1%, but the value is going to be 20% per year.” Well then you’d say, “You’re really cheap. That’s the best deal in town. Can I pay you 20 grand a year because I’m still going to be making way more than I would on my own?” I mean, that’s an extreme example, I’m not suggesting that that’s realistic. But you get the idea. The fee is never in a vacuum. It’s what value am I receiving for that fee? And a good advisor should more than pay for themselves.

If you are paying an advisor quarter after quarter after quarter for a short phone conversation once a year, and maybe occasionally they rebalance your account, call you back within a couple of days if you call them, and that’s all they’re doing for you, they’re not a tax practice, they’re not a law firm, they’re not a certified financial planner, they’re not credentialed. They probably aren’t worth it. So I apologize for not really giving you much of an answer, but 1%’s around the average and I think it’s worth it if you have a great advisor and it’s probably not at all worth it if you have a mediocre or bad advisor. I appreciate those questions. If you have similar questions, submit those to radio@creativeplanning.com and I will do my best to answer it as quickly as possible here on the show.

Want to conclude today with one of the biggest secrets in personal finance. You may have heard of it, but it’s not about buying something that will triple your money overnight. It’s not about some penny-pinching hack. It’s about your habits. Those are even way more important than your money manager or your financial advisor. With the caveat that sometimes a great financial advisor can actually help you spot habits that are destructive, build up habits that are healthy when it comes to your money. Those habits are ultimately what’s going to matter. F.M. Alexander said, “People do not decide their futures. They decide their habits and their habits decide their futures.” Let me give you a few ideas, some takeaways that I have observed in people I admire who are disciplined, who have the ability to repeat with consistency the behaviors of success.

Start day on purpose. Identify your most important tasks the night before and start ticking them off first thing in the morning. How do you start your day? Do you immediately go to your emails? Because if you do, now you’re reacting. You’re unable to be intentional and proactive around what you are going to prioritize early on in your day because you’re beholden to what those emails are. Number two. Whatever you do, find time to move every day. It doesn’t matter how long, it improves blood circulation and helps you think better. I like working out, being physically fit, jogging. It’s actually less for me about my physical health and it’s far more about my emotional wellbeing and my mental stability. When I don’t work out, I am short with my kids, not as patient of a spouse. But if I get out and move, I find that holistically I’m in a much better space to show up for those that I love. Also, sit with yourself for a few minutes a day and declutter your brain. It can reduce stress.

One of my friends was telling me about how they went to the Masters, just an incredible golf tournament, a bucket list experience. Said, “You know what was really interesting? They don’t let you take your phone in.” So no one at the Masters has a cell phone, which in today’s world you feel naked. But he said it was cool because you’re interacting with people and you’re present on what you’re watching. For most of us in everyday life, we have to be intentional to not do something other than think even for five minutes, but it’s important.

And lastly, start a hobby or a passion project outside of work that makes you come alive. And here’s the key to healthy habits. You’re going to miss a day. Of course, you can’t have a streak of your morning routine that for 40 years you don’t miss a single day. But here’s the key, don’t make it two days. Because then that starts becoming a habit the other direction. If you miss a day, show yourself some grace, make sure on day two you’re back at it. Ask yourself this question, when did you last set a new habit and stick to it? What worked? What didn’t work? And how can you build upon that for future positive habits? And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.

Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode, you can subscribe to Rethink Your Money wherever you get your podcasts.

Disclaimer: The preceding program is furnished by Creative Planning, an SEC registered Investment advisory Firm. Creative Planning, along with its affiliates, currently manages or advises on a combined $300 billion in assets as of December 31st 2023. United Capital Financial Advisors is an affiliate of Creative Planning. John Hagensen works for Creative Planning and all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or the station. This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning Tax and Legal are separate entities that must be engaged independently.

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