If you find yourself weary from the roller coaster ride of the stock market over the past 18 months, you’re far from alone. Join John as he shares invaluable insights into the five most effective wealth-building strategies you can implement, regardless of the market’s unpredictability. (2:20) Plus, discover essential advice for a seamless international relocation (10:40) and explore how childhood classic The Game of Life may surprisingly illuminate what truly matters in adulthood. (34:38)
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!
John Hagensen: Welcome to the Rethink Your Money Podcast presented by Creative Planning. I’m John Hagensen. And ahead on today’s show, the money moves you can make regardless of what’s going on with the markets, the most popular countries Americans are moving to in retirement, as well as the single most important factor when determining whether to use a Roth instead of a traditional deferred retirement account. Now, join me as I help you rethink your money.
Well, Malcolm Gladwell wrote a great book back in 2008, still one of my favorites, titled Outliers, and its purpose was to examine the factors that contribute to high levels of success. A really interesting read. But while it might be useful to look at these outliers, replicating what made them successful likely won’t produce, unfortunately, similar results for you and I. Because of this, it can be dangerous to use outliers as proxies.
Let me give you an example, Russell Wilson. If you’re a Broncos fan, you’re rolling your eyes, not a good start to the season. When he was drafted out of Wisconsin by the Seattle Seahawks, he was very undersized, but then he went to two Super Bowls in his first three seasons. He was the only quarterback in NFL history to win 10 plus games in each of his first five seasons and just hushed down all my colleagues out of our headquarters in Overland Park, Kansas. Patrick Mahomes had to sit behind Alex Smith his first season, technically did not accomplish this.
But what took place on the heels of Russell Wilson’s early success is that you saw other teams draft players like Johnny Manziel, Kyler Murray, just this last year, the number one overall pick, Bryce Young. All massively undersized, not the prototype for a good NFL quarterback. And Russell Wilson’s success in a way got them drafted because general managers said, “He’s really short compared to typical quarterbacks, but look at how much success he’s had. Clearly that’ll translate to these other draft picks.”
How has that worked out? And the lesson for you and I, don’t use exceptions to the rule as your guide when it comes to quarterbacks. Or if you never end up as an NFL GM, don’t do it with your investment moves either. See the bigger picture and broaden your perspective rather than fixating on the outlier.
Now, what outlier am I referencing the last two years? The recent performance of the stock and bond markets are just that, a complete outlier. Are you frustrated when you look at your statements? Are you fatigued at feeling like you’re essentially rowing in a boat into a strong current with a headwind? You’re looking at the shore and realizing you’re not going anywhere. For a while, that’s all right. I’ve got an energy drink. I’ve got some good company. My lats are going to get yoked. Then after two years, it starts getting discouraging.
Our chief market strategist here at Creative Planning, Charlie Bilello, had a recent tweet that was accompanied by a chart that I’ll post to the Radio page of our website showing US bonds are down 15% over the last three years. That’s the largest three year decline in history. Since 2022, so a little less than two years, a three to seven year treasury bond is down 12%. You’ve gone almost two years where your stocks are down 10% and bonds are down 12%. That is unprecedented. It’s an outlier.
But let’s zoom out and look a little further back. I’ll start in 2018. You may not remember, but it’s a bad year in the market. We had three rate hikes, a trade war, and the market finished down almost 5%. But then 2019 happened a year that was all about market performance, S&P up 30%. Nearly every investment was up. Treasuries also soared in 2019. Then we had 2020. That’s a little more fresh in our mind with the pandemic. Fastest bear market, down 30% before you could blink. Then it came screaming back, ended the year up 18%.
One of the interesting parts about 2020 is even prior to having any knowledge about the pandemic, strategists back in 2019 forecasted that it would only increase by about 5% and it had a much better year than its historical average of about 10%, and that’s despite that 34% drop from its February peak. Then we had 2021, S&P up 25%. And then … we hit 2022, market down 18%. And while the S&P is positive year to date here in 2023, I just shared, when you look at a stock and bond portfolio, it’s dismal. But again, that period is an outlier.
If we just aggregate all of that and look over the last five years, the S&P’s up nearly 50%, the Nasdaq up 75%, the Dow, not quite as good, still up 25%, three to seven year treasuries are down about 1% per year, but with interest still made about 2% or so annually. Nothing to write home about, but you certainly haven’t lost all of your money. And if we back up 10 years, all the numbers look way better.
So do you just give up during this period of time that, let’s face it, it stinks to be an investor the last two years? No, you don’t give up. Just had a client this last week tell me they wanted to move everything into money markets because they’re paying 5%.
They already have 50% of their portfolio out of the stock market yielding 5%. Now they want to sell the other 50% while we’re in this period that’s an outlier and the markets are already down with monies that they have no need for within their plan for over 10 years? In fact, they’ll likely never need to sell anything within that part of their portfolio. It’s just dumb.
I get it. It sounds good. It makes us feel better. We’re tired of this bad performance, but it’s not what wise investors do. It’s what immature, emotional investors do. Here’s a great reminder for you, know your time horizons because the stock market isn’t a one or a two-year investment, it’s a longer term investment and the longer term performance is still really good, much better than bonds or cash or CDs.
And also remember to control what you can control. You can’t control the next 21 months. I can’t either. I don’t have a crystal ball. We don’t know if we’re looking at 2018 or 2019, but here are five wealth building strategies for you to implement now, and here’s what should encourage you most. They work in every market environment, bull, bear, sideways, they’re evergreen.
Number one, save as much money as possible as early as possible. The number one thing you can control is your savings rate. And returns, they certainly matter, but not as much as you think, especially at the start. You can heal a lot of bad performance by saving a lot of money.
Vanguard had a study on this. For every dollar you save at age 20, you have nearly $6 at age 65. If you save that dollar at 55, it’s about a buck 50. And of course, none of that is surprising if you understand compound interest. Put it another way, if you saved 150 grand over a 15-year period, so 10K a year from age 25 to age 40, then you got busy, you had a bunch of kids, life was expensive, you didn’t save another dollar, you ended up with over 1 million at retirement.
Now your friend is out living the high life not saving any money early on, and then at age 35 said, “You know what? I got to get serious about this.” So they saved from 35 all the way until 65. So instead of saving for 15 years, they saved for 30 years. They saved 300 grand instead of 150,000. With the exact same performance, instead of over a million dollars they had just north of 800,000.
You see that illustrates how important saving earlier is. If you’re already 35 or you’re already 55 and you feel like you’re behind, when should I start saving, John? Today, immediately, because the sooner the money is invested, the sooner it starts compounding.
What I find to be true is the people who fixate most on performance are often those who didn’t save enough and didn’t save early enough and now are scrambling, maybe taking on more risk than their plan has capacity for because their savings rate wasn’t as high or consistent or done as early as it should have been.
Second financial move that you can control and works in any market environment is to rebalance your portfolio. Assuming you build a great financial plan and have your investments aligned with that plan, you want to rebalance only when necessary, but always when necessary as your portfolio moves out of your predetermined alignment.
And this leads me to number three, which is to diversify your investments. Part of the reason you need to rebalance is because hopefully you have investments that move dissimilarly to one another. For example, if 40 years ago you were a balanced investor and you built a financial plan and you determined that you wanted 50% of your money in stocks and 50% of your money in bonds.
Well, stocks have massively outperformed bonds over the last four decades and you’d be sitting today with a portfolio consisting of well over 90% stocks and less than 10% bonds. That’s an extreme example to illustrate the importance of rebalancing to ensure that your risk doesn’t get out of alignment and you don’t become massively overweighted in certain stocks or sectors or asset classes.
Number four, harvest your investment losses. When there are periods of time like we are going through right now, one no-brainer move is to book losses, purchase a similar security immediately after and use those losses to offset future gains.
And the fifth and final area you can control in any market environment is to ensure that you have a written, documented dynamic financial plan. Nothing else matters if you do not have a financial plan.
So to recap, what you can be doing in this frustrating stock and bond market environment is to control your savings rate, rebalance your portfolio, diversify your investments, harvest your investment losses, and finally to create or review, if you have one, your financial plan.
When you imagine retirement, you probably aren’t hoping to sit around and watch Matlock reruns. For most retirees today, people have big dreams. It’s an exciting season of life. You’ve got more time. Maybe it’s sipping wine in the South of France or relaxing on a Portuguese beach. I don’t know, that sounds pretty good, right?
Well, there’s a growing trend of Americans living abroad. They’re doing just that, whether it be due to the geographic freedom of retirement or an increasingly virtual work environment. We’ve got FaceTime now, so we can stay better connected with family. And living outside the US offers simplification in many regards, but when it comes to your finances, it can add a lot of complexity.
To discuss these implications with me today is Creative Planning’s director of international wealth management, David Kuenzi. David, welcome back to Rethink Your Money.
David Kuenzi: Great to be here, John. Thanks for having me again.
John: What trends are you seeing in recent years among Americans moving abroad?
David: I would say that if you go back to our business working with Americans abroad 15 years ago when we started, most of the clients we worked with were people who have been living abroad permanently for family reasons or because they’re executives traveling globally constantly. They have US citizenship because they lived here for a little while, but they really weren’t Americans. And they came to us for the tax and the investing planning that we do for them.
But in the last several years, say the last four or five years, a huge part of our business has become working with Americans at retirement age, considering moving abroad.
John: I want to highlight, you’re hosting a webinar on October 18th at noon Central, and it’s titled Retiring Abroad: Four Financial Tips Before Moving Overseas. There will be a link on the Radio page of our website to sign up for that webinar. Where are people moving? Where are the hotspots right now for Americans that they’re saying that’s where I want to go retire?
David: We work with clients in over 75 countries, so we’re dealing with a lot of people in a lot of different scenarios.
John: Can you list all 75 for us right now, David?
David: No, I cannot. I cannot. But I can list perhaps the five or six most common retirement destinations for Americans who are, as I just described, choosing to retire after a career in the United States. The most common countries are Portugal, France, Italy, Spain. I would also throw in there Australia and New Zealand. And I would say, not quite so common, but interestingly prevalent, Japan as well.
David: And we could talk about that, but the big countries are the Southern European countries for a variety of reasons. They’re attractive from the point of view of the lifestyle.
John: Yeah, a little slower pace maybe.
David: Yep. Cost of living now in an environment where the US dollar has been very strong for a long time. They have excellent healthcare. The food and the lifestyle is very attractive to many people. And in today’s environment people are saying, “Hey, let’s take advantage of this. Why do we have to settle for Florida or Arizona? Let’s go to Europe.”
John: Sangria at noon and siestas and a little slower pace, that’s for sure, along with maybe some tax benefits and other things that your team is able to help them out with.
John: Can Americans retiring abroad keep US financial accounts, collect social security? Do they have to move all their money when someone moves abroad?
David: As an American abroad, where you’ve accumulated all of your wealth inside the United States, and as an American citizen, critically, you remain taxable in the United States, even if you leave the United States and never return because the US practices citizenship-based taxation. And by the way, that’s completely unique. The United States is the only country in the world that does that.
When Germans retire in Spain or in Portugal or in Greece or in Italy, they don’t continue filing and paying taxes in Germany. When Canadians do it, they don’t pay taxes in Canada anymore. But as an American, if you retire outside the United States or you move outside the United States, even if you never return, you will have to continue filing and paying taxes in the US.
But, in most of these countries, and it depends country to country, you’re going to have to pay taxes there as well. So that sets up a lot of complexity with respect to your US tax obligations and your local country of residence tax obligations and how those systems interact.
But in general, despite that complexity, the best advice and almost universally correct is you should leave all of your assets, your financial assets in the United States. You will need a local bank account where you’ll want to accumulate some cash on hand for current expenses held in euros typically if you’re in the eurozone, or if you’re in Australia, in Australian dollars for your local needs. But your investment accounts and other financial assets you will want to keep in the US.
John: I’m speaking with director of international wealth management and partner here at Creative Planning, David Kuenzi. To be clear, even though you need to file a US tax return, in most of these countries, there is a treaty where they’re not paying twice as much tax, like paying in both countries. You’re needing to file in the United States, but you’re getting a credit in many cases for what you’re paying overseas or vice versa, correct?
David: Yes, that’s correct. So in all of the countries that I’ve mentioned so far, the US does have a double tax treaty with them. The main way that Americans retiring abroad will avoid taxation though, it does not have anything to do with the tax treaty. It’s simply part of the US tax code, which allows a US citizen who is paying income taxes in a foreign tax jurisdiction to get a credit for having paid those taxes to a foreign jurisdiction and use that to offset the corresponding tax in the United States.
I chose my words very carefully there because the US allows credits only for income taxes. It does not allow credits for other types of taxes that you may encounter when you’re living abroad. So in Europe there’s VAT taxes. Some countries they have a wealth tax, which the US does not consider an income tax. And you cannot take a credit for those kinds of taxes to offset what you owe in the US.
Furthermore, I would add that some of these countries have provisions locally that are designed to attract foreigners to come, retire, and spend money in their country. So most famously, Portugal has something called the non-habitual residency tax regime, which allows you to live there essentially in retirement for 10 years and not pay local Portuguese taxes. So you won’t pay any Portuguese taxes.
Now, are not relieved of paying US taxes, but you will therefore default to US federal rates generally. And if you can live in Europe and only pay US federal tax rates, that is about a good of a deal, taxwise, as you’re going to find anywhere.
John: Well, it makes sense why you started the conversation saying a lot of Americans are going to Portugal. It’s an interesting approach that they’ve taken. Anyone listening right now, David, who’s considering retiring abroad, my guess is, is thinking to themselves, “This seems complex.” We work with clients in 75 countries around the world. Is that common? Are most people going to be able to stay with their existing advisor or are they going to need to find a team like yours that specializes with international clients?
David: Well, Creative Planning has over 25 wealth managers and financial planners who are dedicated to working with our international clients.
David: So we have been doing this for a long time. We’re very committed to it. We have thousands of clients residing outside the United States. Most other independent wealth managers in the United States do not have any expertise in international. There’s only a handful that do. So that’s one side of the equation.
The other side of the equation is dealing with the financial institutions, what we might call the custodians of the brokers, where you’re actually going to have your money in custody, which typically for our clients will be Charles Schwab or Fidelity, but people have them at other firms such as J.P. Morgan or Morgan Stanley or Merrill Lynch.
And what you’ll find is large US financial institutions, especially in recent years, heavily restricted if not eliminated services for Americans abroad. So we talk to people all the time who come to us having thrown up their hands saying, “Every time I call my bank or I call my broker, they tell me if I move abroad, they’re not going to be able to work with me.”
So this is a huge problem, but there are solutions. We have arrangements with the custodians that we work with, Schwab and Fidelity and some others, so that we can continue to work with our clients, maintain their accounts at these institutions, but it is a very big problem.
John: Yeah, I could see where that would be. So I’d see why your team is so busy and have so many people dedicated to this space. What are some of the big investing and financial planning issues that you see for Americans who are considering retiring abroad?
David: The biggest one is understanding how taxes work. And we’ve touched on that briefly, but you really have to understand the local country’s tax rules. And they’re very distinct. I gave the example of Portugal earlier, but that’s only an example. We could also talk about France or Spain or Italy or Greece. These are all popular places and I can tell you every single one of them is a different story. It has to do with tax treaties, it has to do with the way they tax their own residents and so on and so forth.
So you have to get a handle on the local tax situation you’re going to face once you move to these countries and understand how that local tax regime, as I might call it, then interacts with your US tax obligations. And we work on that very closely with our clients and it gets quite complex, but it is manageable if you understand it.
The other big area that we work on with our clients where we have to be very careful because mistakes made here can be very consequential, is estate planning. We assume-
John: I was wondering if you needed a whole new estate plan, if you’re going to move abroad.
David: You generally will. A lot of Americans imagine the world is bowing down before the US and if it’s good in the US, it’s good there, but that will not be the case. Your country of residence will make the same claim that any country will, including the US, for anybody that lives in its shores, which is that all of your assets, your worldwide assets are going to be subject to their inheritance tax, to their probate process, to their laws of succession.
John: That could be significant-
David: Yes, it’s huge.
John: … and a big consideration, right? I mean, that’s significant and a big consideration if somebody’s in their 70s and they want to live abroad or even in their 60s. You hope you’ve got 30 years left, but you’d want to figure out if you’re going to lose half of your assets to a foreign country if you end up passing away there.
David: Yeah, it’s absolutely true. It can be manageable, but if you do not anticipate it, and if you do not plan for it, then it will blow up on your heirs.
John: Or even the surviving spouse, right?
David: Or your surviving spouse. Yes, absolutely.
John: David, I’d assume sometimes it’s like one spouse passes away and now the other spouse is trying to make sense of everything in a foreign country where they may not feel like they have the resources.
David: That’s exactly right.
David: So if I’ve got time, I’ll just give you a little example.
David: I often tell people that France is not well-recognized as being one of the most attractive places for Americans to retire from an income tax perspective because of a very unique provision in the US-French double taxation treaty that essentially allows an exemption from French taxation of all US-sourced income, and most Americans in retirement have all of their income sourced in the US. Wow, that’s a great deal. I don’t have to pay French taxes. That’s a big generalization, but it generally works out that way.
John: But …
David: But that’s French income taxes. We’re not talking about French inheritance taxes. French inheritance taxes will be imposed on your estate, your worldwide estate, if you die a domicile in France. And so how do you plan around that? Well, you raised the issue of just the spousal benefits or how is it taxed between spouses?
And France is one of the countries in Europe, and not all the countries in Europe have this, but France like the United States allows what we would call an unlimited spousal exemption. So any assets you leave to your spouse will not be subject to French inheritance tax.
So generally what I tell people is if you retire to France, presuming that you are not both going to die simultaneously, one spouse can die leaving the assets to the other spouse, and then the other spouse can make a decision about whether or not they want to stay in France and have their worldwide assets subject to what amounts to basically a 40% inheritance tax.
John: Wow. Yeah, 40%, I mean that’s significant. Certainly if you have a higher net worth-
David: With very small exemptions.
John: … that can be some serious dollars. Yeah, and that’s what I was going to ask, the exemptions are pretty low then too? It doesn’t even-
John: It’s not 40% over, like in our case in America, 12 plus million dollars per person. It’s probably a lot lower than that.
David: Yes, less than half a million dollars.
John: Wow. Less than a half a million. Well, we’re just scratching the surface here, David. I appreciate your expertise and your insights.
Again, if you’re listening and you’re interested in this topic, David’s hosting a webinar on October 18th at noon Central Time, entitled Retiring Abroad: The Four Financial Tips Before Moving Overseas. There will be a link on the Radio page of our website at creativeplanning.com/radio if you would like to register. And of course, if you’d like to speak with any of our certified financial planners or David and his international team, you can do so at that same spot on the Radio page of our website at creativeplanning.com/radio.
Well, David, thanks so much for joining me again, look forward to having you back on real soon.
David: Thanks, John. Great to be here.
John: I remember the first time I was watching golf, it was during Tiger-mania and they were showing Tiger warming up prior to his round out on the driving range, and his coach at the time, Butch Harmon was talking with him and giving him instruction. I remember thinking to myself, “This is Tiger stinking Woods, the most dominant golfer in history. What can he learn from a coach who’s clearly way worse than him at golf?”
Then he had Hank Haney and Sean Foley and Chris Como, not to be confused with Cuomo. No, he wasn’t his golf coach. Chris Como. So not only did Tiger have a swing coach, but he had multiple swing coaches. Why? Because he wanted a different perspective. You see, you don’t hire a coach, whether to help you with your money or business or creativity or sports, like the example I just used, because you’re stupid. You hire a coach because they’re not you.
And perspective is so important not just with our money, but in life. Think back to a time where you’ve traveled internationally. Isn’t it interesting? You come back to your same house driving your same vehicle, eating your same food, working the same job, yet, so often things feel different, not because our circumstances have changed, but rather our perspective has. The lens with which we’re viewing the world is different.
I came back from a high school trip to Romania as a 16-year-old and my life was changed forever. And the irony is nothing in my circumstances changed, it was my perspective. I had a blind spot as to the poverty that existed around me. I had a blind spot to all of these orphans in Bucharest who had no parents and I knew at that moment I wanted to adopt. And I’m so thankful that I gained that perspective that that veil was lifted for me.
And when you look at your personal finances, and in particular as an investor, market perspective is essential in you avoiding mistakes, removing those blind spots. And that can be hard with CNBC airing markets in turmoil every time the market dips. It’s no wonder that investor sentiment is now the lowest we’ve seen since the financial crisis.
Think about that for a moment. I know it’s been bad. I spoke about it earlier in the show, but investors are trained by the financial media to anchor to a fixed point in the market. We all do this, I’m guilty of it. We measure market performance from the first trading day of each year. Why? It has no bearing on our personal circumstances, it’s just a random day on a calendar. Or from the peak of an advance.
For example, I could tell you the market’s up about 120% from the March 2020 lows. That sounds amazing. I love the stock market. Or I could say the market’s down 10% from the 2022 peak. That’s been a while, John, that doesn’t sound very good. That’s why I hate investing in the stock market. But the problem is that almost all investors didn’t buy the 2020 bottom or sell the 2022 peak. So these anchor points provide very little perspective for you regarding where you’re actually at relative to your goals.
Thestreet.com had a great piece on this and it said, “To reduce your emotional action button, step back and change your anchor point.” I love that. We see what we look at, don’t we? And this is where you feel the value of a financial advisor. Yes, I’m a financial advisor. Yes, I’m talking my book, I’m biased, but we all tend to misjudge facts and alter information to make it fit neatly into our preconceived notions of how the world works.
I mean, there was tulip-mania back in the 1600s, and before we get too judgy of those folks, 400 years back, we just had NFTs and meme stocks. Remember even Tiger Woods had four different coaches. An experienced financial advisor that’s independent, that’s credentialed, they know what they’re talking about, they’re acting in your best interest as a fiduciary, can help you filter out irrelevant or incorrect data and help you make decisions that are actually in your best interests that may, not because you’re stupid but because you’re human, be a blind spot.
If you haven’t had your financial plan or your tax return or your estate plan reviewed within the last year or maybe you don’t have one or all of those, visit creativeplanning.com/radio now to speak with a local advisor.
Well, it’s time for us to rethink some common financial wisdom and I’m going to kick it off with the idea, the more information we have, the easier it will be to outperform. The blog, awealthofcommonsense.com had a great piece on this where it said, “There are fewer and fewer informational advantages today because information is so readily available to every investor.”
You see, it becomes harder to outperform in a world with more information to everyone, and you’ve seen this even amongst the smartest, most experienced money managers. Overperformance in the hedge fund space has basically vanished. And you could make the claim that the past couple of decades have become increasingly more and more difficult to overperform and in some ways, have been the hardest environments ever to outperform.
I mean, I love to quote Warren Buffett as much as anyone, but he’s had a very difficult time consistently outperforming broad markets in recent years. I mean back in the ’60s and ’70s he was digging through financial statements, gaining access to information that others simply didn’t have, but that’s a big competitive advantage.
Now the kid in his parents’ garage in Malaysia has access to the exact same information as top financial analysts on Wall Street. This is absolutely something you need to rethink, and you don’t need to take my word for it. Here are the percentage of large cap mutual fund managers who have underperformed the S&P 500, their comparable index.
Year to date, 60% have underperformed. Over the last three years, 79% have underperformed. Over the last 10 years, 85% have underperformed. 15 years, 92% of all fund managers have underperformed. And you go out 20 years, nearly 94% of all active managers of large cap United States stocks have gotten their doors blown off by you just buying a basic index for a lot less money, a lot lower turnover, meaning more tax efficient in most cases and better performance.
Now, there are a few spots where you can outperform, but it’s not in the public markets. If you’re really smart and you build a business, you’re probably going to beat your competition in that field. You can also look for outperformance in the alternative non-publicly traded investment space where manager experience and track record has shown to be correlated with future results.
Now of course, disclaimer, past performance, no guarantee of future results, all investments involve risk. You get the idea. But those are places where you can look for overperformance because as mentioned, if you’re looking for it in the public markets, well, over the next 20 years you have less than a 10% chance, even enlisting professionals, of outperforming.
All right, let’s transition over to my next piece of common wisdom, inflation is a key component driving long-term stock market returns. Creative Planning president, Peter Mallouk’s most recent book titled Money Simplified spoke of this. And to quote Peter, “We don’t freak out when the price of a Hershey bar hits an all-time high, but for some reason we think the stock market’s different. If you think a hamburger or a Chipotle burrito will cost more 10 years from now, the stock market will probably be okay as well.”
Now, there is some nuance to this. In the long run, companies can make real inflation adjusted profits and therefore to Peter’s point, real expected returns don’t really differ whether or not inflation’s high, but the nominal returns will. And for example, a company might make a 12% profit instead of a 9% profit, but if inflation’s at 4% instead of 1, they’re not making more money in real terms.
And it’s also true that in the short run, the uncertainty of inflation can cause market volatility. Companies don’t like not knowing what they’re going to earn and this can have a short-term impact. We’ve seen some of that here the last 18 months or so.
But if you break out stock market appreciation into three parts, expected future earnings is one, dividends is two, and the third, inflation. To Peter’s point, if everything’s going to cost more in your life 25 years from now, then you should fully expect the market to also be priced higher.
And the last piece of common wisdom we’re going to rethink together is that tax planning and tax preparation are the same things. Tax preparation is when you report accurately what you already did the previous year. All your CPA or you, if you file your own tax return, are doing is putting the right numbers in the right boxes. That’s not going to reduce your taxes. You do have to file to avoid penalties and it does of course need to be accurate. So it’s not that that’s unimportant, but it’s not going to save you any money.
Tax planning means reviewing in advance not just this year, but the next two years or four years or six years, and aligning that with the rest of your financial plan to ensure you’re saving money in the right places, not just in the right investments, but first and foremost saving it in the right spots from a tax standpoint.
If your financial advisor is not a CPA or they don’t work closely with your CPA, what might you be missing? Maybe just consider when the last time was that your financial advisor reviewed your tax return and then offered suggestions not just for this year, but big picture many years down the road, what you could be doing today to minimize your lifetime tax bill.
If you haven’t had your tax return reviewed in the last 12 months, why not give your wealth a second look? We have over 100 CPAs here at Creative Planning and we are committed to helping our clients pay the least amount in taxes legally required. If you think you may benefit from sitting down with us here at Creative Planning, don’t wait, visit creativeplanning.com/radio now.
Well, this past week I had a prospective client ask me about whether they should max out contributions to their Roth 401(k) and they were aware of the advice that they’ve heard me talk about on this show that it might make sense because they’re not into the 32% bracket, they’re below that. It’s oftentimes the threshold.
And they were younger, 28 years old, and they don’t plan to retire for 35 or 40 years. Their basic question was, “How does my long time horizon affect this decision?” Since they’re so young and they’re so far out from retirement, does it even make more sense for a Roth? I think that’s conventional wisdom because you’re getting tax-free growth along the way, but I got to set the record straight. People just don’t seem to understand this.
Quick recap, a traditional deferred retirement account, whether we’re talking about a 401(k), or an IRA, or a 403(b), or a 457, or a thrift savings plan, those accounts are being funded with pre-tax money. So if you make $100,000 and you put $10,000 into your 401(k), you only pay tax on 90 grand. You get to deduct that contribution. The money in that account then grows tax deferred.
So as it’s growing, maybe you sell one fund, buy another one, it had appreciation. It doesn’t matter, you only pay tax on those monies when you withdraw them from the account. And when you do that, you’re subject to ordinary income rates. So that distribution will stack on top of all the rest of your income once you’re in retirement.
Now, a Roth by contrast is essentially the opposite. You make $100,000, you put 10,000 into your Roth, you still have to pay tax on $100,000. There’s no immediate tax benefit, but that money then grows assuming you follow a few basic rules, tax-exempt, and when you withdraw the money, you don’t pay tax on it. If you pass away with that account, it’s inherited by your beneficiaries and they don’t have to pay tax on what you contributed as well as all the growth.
So I can’t stress this enough, the only thing that matters when debating between a Roth and a traditional is do you think you’re going to pay more in taxes now, in my example, on that $10,000 than you’re going to down the road?
Conventional wisdom always has been while I’m working, I have wages, I make more money, so I should defer income in traditional retirement accounts and then pay tax at theoretically a lower rate in retirement when I pull the money out because I won’t have earned income. I’m in retirement.
And while that’s not incorrect, it’s logical thinking, much of that traditional finance strategy has been put in question since 2018 with the implementation of the Trump tax reform. You could make a lot of money now and still be in a 22 or a 24% tax bracket, which isn’t necessarily going to be higher than when you’re in retirement.
This is why you’ve likely heard a lot about Roths. There’s been a lot of momentum. A lot of companies have been adding a Roth option, as this prospective client was talking with me about at his company, so that you can contribute to your retirement account right out of your paycheck every two weeks, still get your company match, but say, “I want to pay tax on it today so that I can have it tax-exempt moving forward.”
But again, and I cannot stress this enough, all that matters is your current tax rate and your future tax rate. When you put $10,000 into your traditional 401(k) and you’re in a 22% tax bracket and your CPA says you just saved yourself $2,200 this year on your taxes, great job … wrong. You didn’t save $2,200 on your taxes, you simply asked to pay them later. You’re deferring that $10,000 of income.
The only money you in fact will save is if down the road in retirement you withdraw that $10,000 and you only need to pay 12% tax because your income’s lower and tax rates haven’t gone up, which by the way is a totally separate conversation. But yeah, in that case, you would’ve saved 10% in taxes. You would’ve had to pay 22% 30 years earlier and you only ended up paying 12. Yep, perfect, you saved $1,000 on your taxes by doing that, and it was a smart move.
But with $32 trillion in national debt and current tax rates at the lowest levels they’ve been in decades, and what’s the likelihood taxes are going to be lower 20 or 30 years from now? If you are deferring into traditional accounts, that’s the bet you’re making.
Now, again, it may be prudent because your income’s going to drop significantly, and even if tax rates increase, you’ll still pay at a lower rate. Okay, that might make sense. Let me give you some hard numbers to communicate exactly why the only thing that matters is current and future tax rates.
If you were in a hypothetical 25% tax bracket, it doesn’t exist, it will when the Trump tax reform sunsets and in 2026, we’re back to the Bush tax cut years. So just go with me on this. The math is easier. You have $10,000 to put in your 401(k). You say, “I don’t want to pay the 25% taxes on this money. I’m going to defer and take my chances later.” Over the next 30 years, it makes 10% per year, good investment returns. At the end of the 30 years, you’ve got $198,374, but of course you haven’t paid tax on it yet because you’ve been deferring taxes.
Now, let’s suppose your tax bracket never changed. Somehow 30 years later, you’re still in a 25% tax bracket. You pay 25% tax on your $198,000, you end up with $148,780 and 50 cents. Oh, and I promise there’s a reason why I didn’t estimate that, because now let’s say you warp back 30 years earlier, you’re in that 25% tax bracket, you’ve got $10,000 to invest. You decide, “You know what? I’m going to do the Roth, I’m just going to pay 25%. I’m going to pay $2,500 in taxes today, then I don’t have to pay taxes down the road.”
So you don’t get $10,000 to invest, you only have 7,500 because you had to pay your 25% tax upfront. Well, you might be thinking this is going to affect compound interest because you’re starting with a lot less money. Yeah, you’re right, it does. 30 years later, at the same 10% rate of return, you end up with a lot less than the 198,000. You have $148,780 and 50 cents. And if you didn’t notice, that is down to the penny, the exact same amount as what you had once you paid your 25% taxes on the deferred account.
You see, the decision of whether to contribute to a deferred account or a Roth account has zero, not minimal, no impact if your tax rates never change. And that’s why I will say again, the consideration you must make is fully dependent upon current and future tax rates. If you think your taxes will be higher down the road, Roth, if you think your tax rate’s going to be lower down the road when you take withdrawals, defer.
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My wife Brittany bought some new games for us to play as a family. We’ve got a cabin up in the mountains. We get a lot of family time, slower pace of life, and we’ve got this game table, and it was time for a refresh. And one of the games she bought was The Game of Life. Remember that game? I had to read the rules to remember exactly how to play, and then I was teaching my kids how to play it.
And by the way, if you’re wondering, spoiler alert, I did win. I’m not a parent who lets my children win. Got to teach them the hard way. That’s what my dad did for me. I’m sure they’re going to need a bunch of therapy down the road. Dad was blocking all my jumpers out on the sport court. Sorry guys, you’re going to have to learn to get that floater up over the hand.
But anyhow, our first-grader, Jude, it’s hilarious, he’s going through the game, all right, you have to stop. Do you want to buy a house? He’s like, “Ah, nah. I don’t want to spend money on a house.” All right, Jude, it’s time to start growing your family, do you want to have any kids? “Nope. No kids.”
He’s got his car with only one peg and he’s going around the game and I mean the guy is just spinning like nines and eights and he’s just cruising around the board. He did really want a pet. He was very disappointed he never landed on the pet thing. He wanted to be the single bachelor, never married, transient and rents, but he did want himself a dog. Sorry. Nope, he couldn’t even get a pet.
But here’s the thing, he retired first by a long shot, and had a huge wad of cash and he was pumped. He was like, “Look at all my money. All of you guys are still way back there on the board.” And meanwhile, my wife is laughing because it was like real life. My entire car was full. I even had twins. It was hilarious. I didn’t have enough space in my car for all the pegs.
This is hitting really close to home, but the way you win this Game of Life is at the very end, everyone’s retired, you sell off everything. It’s kind of weird, even your kids, you get money for them. I don’t know, creepy. And then he or she who has the most money wins.
Now, ironically, The Game of Life didn’t start off this way. The game board initially resembled a modified checkerboard. This game’s been around well over a hundred years, and the object was to land on the good spaces and you’d collect points, you’d get points for virtues. Those were the good spaces, like happiness, success, bravery, and you lost points for what The Game of Life called vices, disgrace, crime, idleness.
You could gain 50 points by reaching the happy old age of 50. Seriously, that was in the upper right corner. It was like a miracle you made it to 50. No money was involved, you didn’t retire, and the winner wasn’t the richest person. Then in the 1960s, the modernized version of The Game of Life was introduced and became closer to what we know today.
All right, so I told you the story just to brag that I won. I wanted you to respect me for beating a bunch of little kids in The Game of Life. But I’m also sharing this with you because while it’s a bit silly, there are some relevant takeaways. And here was what jumped into my mind as I was playing this game.
Dying with the most money or attempting to win in the actual game of life that we’re all living by accumulating as many assets as possible is futile. It’s an empty way to live life. As I say, often money is not inherently valuable, it is a tool to be used for valuable things.
I joked with Jude when he retired early and had to sit and watch us play the rest of the time. This is the problem with retiring early. None of your friends are retired early. You don’t even have a pet. You’ve got no kids. You don’t even have a friend in your car, you don’t have nobody. And I got a little philosophical with them. I said, “Jude, meaningful relationships, all the studies say that’s what makes us happy, not money.”
Second takeaway is that kids are way more expensive in real life than what you have to pay for kids in this board game.
Next, helping a lot of clients who are nearing and then enter and move into retirement, unlike the board game, the game of life doesn’t end the day you retire, especially now that we’re living in many cases, 20, 30, 40 years after we retire. Some of your best years are in retirement. Some of the opportunities to make the biggest impact are in retirement, thankfully.
Next, I’m going to be writing Milton Bradley. I know you created the game in 1860, but there’s only six spots for pets, parents, and children. Let’s go. I need a 12 passenger van to fit everybody.
And lastly, and probably the most important takeaway is that the fun we had as a family playing The Game of Life, it wasn’t found in reaching the last square. It was over the 45 minutes of joking and laughing and trying to beat one another, and the kids getting hopped up on too much sugar and forgetting when it was their turn. The fun was the journey, it was in playing the game.
And the same is true in the real game of life. It’s not about fixating on a destination, it’s about all the twists and turns that occur along the way. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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Disclaimer: The proceeding program is furnished by Creative Planning, an SEC-registered investment advisory firm that manages or advises on a combined $245 billion in assets as of July 1st, 2023. 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 this station.
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