We all dream of the day we can stop working and begin enjoying our retirement. But how do we know when that day will be? Join John as he shares six signs that indicate you’re prepared to retire (4:40). Plus, delve into the history of the 60/40 portfolio, how it’s evolved over the last six decades and what it means for you in 2024 (37:05).
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!
John Hagensen: Welcome to the Rethink Your Money Podcast presented by Creative Planning. I’m John Hagensen, and ahead on today’s show, managing the questions in life and finance that are simply unanswerable. How to ensure you are receiving every deduction and credit available surrounding health insurance premiums and medical costs, as well as a deep dive into the atrocious world of financial forecasting. Now, join me as I help you rethink your money. There are phases in life, we don’t know if we’re in fact ready for them until it actually happens. My wife and I got married young, especially for her. She still had one semester remaining at Arizona State before graduation. Common question from all of her college friends and even family members, are you guys ready to get married? Are you sure? If you’re asking, did we have it figured out? The answer is an emphatic no. Were we financially in a position to get married? Absolutely, not.
I took on a side job so that I could earn more money to support us. My wife, Brittany, in the midst of a full class load, worked part-time as well to earn money. We had faux wood floors in our apartment in black appliances. By the way, that option cost me an extra $80. I remember it well. I went back and forth, is it worth it? I don’t know, this is pretty cool for the fake wood floors. I don’t want white appliances. Let’s splurge for the $80 a month. We had a giant love sack, one of those huge bean bags in the tiny room that we had. It took up about half the room. The most uncomfortable futon of all time, a 37-inch television that weighed about a thousand pounds. We had an Ikea dining room table that was sized for second-graders. We had a Goodwill glider chair out on our patio with an ottoman that had a nice glide as well.
Now, this thing was so gross that we draped a blanket over it so you didn’t feel bad taking a seat. Again, the question of were we ready to get married? No, we weren’t. Of course, not. We were clueless, but we figured it out, and we figured it out together, and I’m grateful for those memories and for those moments early on in our relationship. They provide perspective for where we sit today and how far we’ve come. You can probably relate similarly if you’ve now been married for decades. We had the time of our life broke and in love, which is another reminder that money and contentment are not correlated. Life possesses many of these unanswerable questions. Are you ready for kids? Heck, no. Anyone who had no kids and then suddenly, finds themselves putting a two-day old into a car seat and walking out of the hospital. I remember looking back as we’re walking down the hallway trying to figure out why the nurses weren’t coming with us.
Hold on, so you’ve had this baby under 24-hour supervision, and now you’re trusting me to do everything for this baby? I don’t know what I’m doing. I’m supposed to put this little tiny plastic thing in the bath to give him a bath? Oh, okay. Never done that before. How about changing a diaper? Don’t worry, you’ll get good at it after changing thousands. If it’s a boy, you’re probably going to get peed on a couple of times before you figure out that’s not a good strategy. No one is ready for kids before they have kids. In the same vein, there are financial questions that are also unanswerable until you finally experience it. The most common of which is, am I ready for retirement? Just like getting married or having kids, the short answer is no, but hopefully you can figure it out along the way.
We tell ourselves things pertaining to retirement like, I’ll be ready when X, Y, Z happens. That’s almost never the case. When I hit $1 million of net worth, I’ll be ready. When my portfolio crests $2 million, then I’m going to retire. When my last kid is out of college, that’s when I’ll be ready. When my spouse retires, that’ll be the time that I have confidence that I can retire as well. When I finally have the right successor in place for my business, then I’ll be ready to retire. In my experience as a wealth manager, when those things happen, oftentimes, you realize I’m still not totally sure if I’m ready to retire. While it may be unanswerable with many variables, you can help yourself prepare by asking and hopefully, answering two primary questions. The first is, are you financially prepared for retirement? Answering this to the affirmative doesn’t ensure that you are fully ready to retire, but if you cannot answer this question, you certainly are not.
Given increasing lifespans, it’s not unusual to spend 20, 30 or even 40 years in retirement. Go to a certified financial planner who isn’t affiliated with a broker dealer. Find an independent advisor at a registered investment advisory firm who is a fiduciary acting in your best interests all of the time and get a detailed, written, documented financial plan. You cannot leave the blocking and tackling to chance. Like, okay, I think I’m probably going to be okay. No, dial that plan in and find someone you can trust who’s done this for thousands of other people just like you that has the experience and the credentialing so that you have accurate, solid information and projections relative to your situation. I cannot overstate this. The majority of people retire without ever having a true plan in place, which is wild.
Think about this. We’ll plan and prepare more in many cases for a one-week Hawaiian vacation than we will for what amounts to a 1,500-week vacation that we call retirement. This plan is central. If you don’t have this in place, whether you’re approaching retirement or you’re already in retirement, at Creative Planning, we built tens of thousands of financial plans over the past 40 years and we do so at no cost. To see exactly where you stand, visit creativeplanning.com/radio right now to schedule your visit with a local advisor just like myself. Again, that’s creativeplanning.com/radio or text the word plan, P-L-A-N to 1-888-914-PLAN. One of the first considerations within the planning process is identifying as accurately as possible how much you’re spending on a monthly basis. I subscribe to a strategy suggested previously on this show by my colleague, fellow Creative Planning Managing Director Scott Schuster, have a listen to this approach.
Scott Schuster: I always have our clients have what I call a comfortable cash zero. Let’s say your cash zero is 50 grand. If you have 49 grand in your checking account, you’re not going to go to Starbucks because you feel destitute. We’re going to trial run your retirement budget. You told me that you’re going to live on 12 grand a month. We’re going to have 12 grand a month flow from your paycheck into your checking account. On April 7th and on August 9th and on May 13th, I’m going to call you and say, “How much do you want to have in your checking account?”
You’re going to say one of three things. You’re going to say 49, 7, and I’m going to say, “Okay, all systems go.” Because you’re spending 12 grand a month, you’re going to say, “Oh, Scott, I got 33, but don’t worry about it.” You’re lying to yourself, so I’m going to say, “Okay, your spend rate is really higher than what you thought.” Or you’re going to say, “I have 63,005.” I’m saying, “Oh my gosh, your spend rate is lower.” We’re going to really dial in what your real spend rate is by test-driving it in the last year while you’re working.
John: Another consideration will be your social security distribution strategy. You have an eight-year window between 62 and 70. When do you start claiming? The longer you wait, the larger your monthly payment will be, but there are a lot of ins and outs when it comes to social security. If you claim before full retirement age, it reduces your payment by 8% each year. If you claim benefits after reaching full retirement age, it increases it by almost 8% per year until you turn 70. If you claim early and you make too much money, you can’t keep social security. If you claim early and you unfortunately pass away and you have the larger benefit, well, now your spouse has a decreased survivor benefit if they live to 100 years old. Could cost you hundreds of thousands of dollars. Also, what are the tax implications of when you take social security? Because now you voluntarily increased your income, which is why you want to integrate always your tax plan with your investment plan, in particular, during your retirement income years.
Have you eliminated or significantly reduced debt? Every dollar you have to spend paying down debt is a dollar you don’t have to meet your living expenses in retirement. Another financial consideration for retirement readiness is how will you cover healthcare expenses? Medicare doesn’t start until 65. If you’re retiring before, then how do you plan to pay for medical expenses? Even once you have Medicare, it doesn’t mean that it’ll be free. If you get a Medicare supplement drug coverage plan, those can be anywhere from 165 to $560 a month depending upon what type of plan you need and what prescriptions you need included. What’s your plan for paying for long-term care costs? Nearly 70% of Americans turning 65 today will need long-term care at some point in their lives. Now, let’s suppose you’ve checked that box. An experienced certified financial planner built you out a comprehensive financial plan.
Looking at your estate planning and your tax planning, your income needs, your expenses, your investments. You’ve considered things like social security planning, the debt on your balance sheet. How are you going to pay for healthcare expenses? You’re in really good shape. Most people stop there and say, “Yep.” People say, answering the question around whether I’m ready to retire is hard, not for me, I’m golden. Maybe. Maybe you’re ready, but you’ve only answered the first half of the equation. The second is, are you emotionally ready to retire? This can be equally as important or maybe even more important than the dollars and cents. Here are a few considerations when trying to answer this difficult question. Is your identity wrapped up in your work? Which by the way, isn’t a terrible thing. It doesn’t have to have a negative connotation, but many people derive a sense of identity and purpose from their careers.
You retire, you have a loss of that identity. I’ve seen this with many physician clients. They spend a lot of time in medical school and residency and they provide an incredibly valuable service to society. They’re highly skilled. Imagine you’re a surgeon saving people’s lives for 30 years and now you’re waking up in the morning wondering if you want to play a fourth round of golf that week. Maybe that’s great for you, but for many people, it’s not as appealing as they once thought. In addition to a loss of identity, there’s the fear of the unknown. People don’t like change. There is very few pivots in life more dramatic than working full-time and then headed straight into retirement. There’s a loss of routine and structure which can have emotional implications. Workplaces provide a sense of community. Many good friendships have developed likely at the workplace. Now you have to be proactive and ask if they want to go grab dinner or go play pickle-ball or whatever it might be, and that takes more work than bumping into them at the water cooler.
My last consideration on this list, which is certainly not comprehensive, are family dynamics. If your spouse has different retirement plans than you, either they want to retire early or later or just once you’re retired, you desire doing different things, can create friction and challenges sometimes within family relationships. If you want to boil the emotional readiness component down to one overarching question, here it is. How will you spend your time in retirement? Retirement can come as a shock. I have seen this time and time again with families that I work with. If you don’t have a plan for how you want to spend your time, you haven’t really thought this through. You could encounter negative effects, depression, and a sense that you made a mistake with your retirement decision. Remember, more time isn’t always better. It can be though if you use it in a way consistent with your values. In the end, show yourself some grace.
Because just as the case was with answering the question, are you ready to get married? Are you ready to have kids? Are you ready to retire? Is a question you’ll likely answer once you are already experiencing it. It’s time for this week’s one simple task where I help you make incremental improvements 52 weeks of the year for financial progress. Today’s tip, create a money mindfulness practice. Have a quarterly financial check-in. You don’t need to do this daily or weekly or even monthly, but once a quarter or whatever interval works best for you, set aside a few minutes to check in with your finances. Next, practice gratitude. Take a moment to appreciate where you are financially and what you’ve done successfully when it comes to your money. Whether it’s steady income, comfortable home that is safe for you and your family or supportive loved ones.
Cultivating gratitude can shift your focus away from what you lack and toward what you already have, which will promote a healthier relationship with your money. Be mindful of your spending. Before making a purchase, pause and ask yourself, does this align with my values and my financial goals? Practice non-judgment. Approach your financial situation with curiosity and openness rather than judgment and self-criticism. I can tell you the most successful people who have more money than they will ever need, even they point to things in their past with the benefit of hindsight being 20/20 and wish that they had done things differently. Finally, stay present. Yes, it’s great to plan for the future, but the truth is that life is what’s happening while you’re busy making plans. Creating healthy money habits like a money mindfulness practice will contribute more to your contentment and peace of mind than a higher net worth. Well, my special guest today is CPA and Creative Planning’s Director of Tax Services, Ben Hake. Ben, thank you for joining me on Rethink Your Money.
Ben Hake: Hey, John. Thanks for having me again.
John: Taxes can be confusing, and as a wealth manager, I receive a lot of questions, Ben, pertaining to the deductibility of health insurance and medical costs, as well as the most tax-effective way to pay for medical events, what credits are available. Let’s begin with the basics surrounding the deductibility of health insurance and medical costs.
Ben: The IRS breaks it down into two buckets. The first is going to be the actual premiums, which we’re all aware, kind of go up quite a bit over time, but those are what we pay on a monthly basis. Then there’s that second bucket, which is everything else. Basically, all your out-of-pocket costs. For the health insurance side, most people are familiar with it because they get it from their employer. That ends up being the most tax-efficient way. Your employer pays some portion of it, generally. That’s not taxable to you, you just get the benefit of it. Any part you’re responsible for paying reduces your taxable wages. You made 10 grand, paid a thousand dollars in premiums. You only get taxed on $9,000 of earnings. That’s a simple way, keeps it easy. That’s probably the best way to go about it.
The next would be if you’re self-employed, so these are going to be people who are doing some contract work, things of that nature. It gets a little more complicated here because your ability to deduct your premiums is either whatever your premium cost was or how much you made. If you’ve got a side job that’s only $10,000 in your premium or 12, you’re going to be capped at that $10,000 number. The least tax-efficient way to go about it, and what we see across early retirees as well as some people that work for really small companies where there’s no health plan is going to be the IRS says, “Hey, everything you pay out of pocket, you can deduct, but only the amount that exceeds 7.5% of your income.” For a lot of people, fortunately, you don’t have that much medical cost, so you’re not actually able to deduct it. That’s on the premium side.
The everything else side, all of that stuff falls under that same seven and a half percent bucket, but this is where you hear about all the weird stuff where people put in a pool or have all sorts of other things. It would seem maybe a little exotic or a little on the fringe of what would be deductible. The big thing, and I tell most of my clients, in order to be deductible, it’s got to be for a unique cause. We’ve got a specific illness or something we’re trying to fix, and then the doctor is prescribing it. We don’t just get to say, “Hey, I want to lose some weight. I think I look better 10 pounds less.” That doesn’t create a medical cost. If you’ve got something that resulted in you being obese or something of that nature, that’s where the IRS would say those costs are deductible.
John: Gotcha. You can’t say, well, I put in the pool to swim laps once every 365 days for my fitness because I’ve had a little shortness of breath, so I’m going to deduct the $150,000 pool that we just put in. You can’t do that, is that what you’re telling me, Ben?
Ben: That’s exactly correct. You could have some medical remedy where the only option is significant amount of time in the pool, either be it arthritis or something that makes doing physical exercise pretty difficult. That could, but again, that’s the sort of thing that it’s really a facts of circumstances.
John: Those folks coming in trying to deduct for water aerobics, I don’t know. That’s a little bit on the fringe, I would agree with you there. I’m speaking with Creative Planning Director of Tax Services, Ben Hake. Let’s talk about HSAs, FSAs, which ones I use it or lose it, can I invest the money? What are they used for? What are the limits? Briefly, what is an HSA? How does that differ from an FSA, and maybe the best uses for each?
Ben: I always like to start with the HSA. That’s the gold standard. It’s got all the benefits. For most people, what they need to know is they need to have a high-deductible plan. Generally speaking, your insurance company is pretty upfront about if it’ll qualify for the HSA. If you get to do that, then you get to get a tax-deductible contribution into the plan and they have different limits based if they’re on your single or covering a family. The upside is that as long as those distributions are used to pay for medical costs, so that same things that we were saying would fall under what the IRS would allow you to deduct, then those distributions are tax-free.
You save taxes when you put it in. You don’t pay any taxes when you take it out. If you have the ability to use outside funds to pay for your medical costs, inside the HSA, most of them will allow for some sort of investment option, and that growth in there occurs tax-free. You’re almost getting many Roth IRA that doesn’t have the age restrictions on it because you get to put it in, you get to take out the medical costs at any growth that occurs in there, assuming use for medical costs, comes out tax-free.
John: Can I pause there for a moment? One of the things that I think you hit on that I don’t want listeners to miss is in many cases, assuming you have the cashflow, not everyone has enough to fund the family max at whatever it is, over $7,000 I think, per year, and then pay for $7,000 of actual medical costs with outside dollars. Either way, it’s better to use the HSA. Even if you immediately spend it, you’re using deductible dollars, but it’s a home run with the triple tax treatment if you can let it accumulate off your tax return and then take it out tax-free down the road.
I’ve seen people do this all the way up until retirement and they have a half a million dollars available for medical expenses once they’re in retirement. Maybe you can speak a little bit to what would happen if that account still had a half a million dollars in it. Because people say, “Well, what if I die and I have a half a million dollars in it and I do that strategy? I mean, I just wasted this.” Can you set the record straight on what happens with the distribution of those dollars if something were to happen to you?
Ben: Unlike the FSA, which is use it or lose it, we’re really looking at that one specific year when you get to do the disbursement. The HSA can be reimbursed for any medical expense that ever happened that we didn’t deduct. If you have a significant surgery in 2020 and you retire in 2040, the IRS would say, “Hey, you can reimburse yourself for that expense 20 years later.”
John: I love it.
Ben: For a lot of our clients, we never get to the $500,000 because we go along and we’re like, “Hey, we’ve got 20 years’ worth of medical costs we just threw in a spreadsheet we wanted to track this through. Ultimately, we don’t have to have catastrophic events in our retirement to be able to access those funds.
John: I’m speaking with Creative Planning Director of Tax Services, Ben Hake, and to your point, the 82-year-old who says, “Oh, no, I have way too much in this account. How am I ever going to spend this?” You’re suggesting, what have you spent the last 20 years? Start paying yourself back for those medical costs.
Ben: An answer to your question, when you pass away, if you’ve got a spouse, those can transfer over to them. Otherwise, if you pass away and the beneficiary is your children or something like that, it gets distributed out to them, and that’s the growth on that’s taxable.
John: I think that’s the key there though, is that even in that scenario, which would be in many people’s thought process, that’s the worst case scenario. We didn’t use this. It basically turned into you passing on an IRA because you received the deduction on the way in, it grew tax deferred, you passed away with it, your kids still get the money, but it’s taxed at ordinary income just as if they were inheriting an IRA or a 401k from you. That’s the key takeaway for HSAs in my opinion, is just how flexible they are. You have so many options with these that for most people, assuming that they have enough cash flow to make it happen, it is a no-brainer to fund.
Ben: Exactly. The other benefit that is a distinction from the FSA is the HSA isn’t connected to your employer. You can have an HSA and have no employment related to health insurance. For the FSA, so that is a lot more restrictive. You still get a pre-tax contribution when you’re putting it in, so it’s reducing your taxable wages. It has to be an employer-sponsored event. If I’m a self-employed person, can’t set up an FSA. If I’m going to the marketplace, wouldn’t have that. The bigger issue we have is that it’s use it or lose it. At the beginning of the year you say, “Hey, I want to put in three grand.”
We get to December and you’ve had fantastic year, never got sick, never had to go to the doctor. You’re in this scenario, you’re like, “Oh, no. Now I got to find some costs to be able to do that.” A lot of the times your employees either going to say, “Hey, it needs to be done by the end of the year.” Or many of them have by March 15th of the following year, but it’s one of those where you definitely want to plan. Because if we don’t, it’s great to say the taxes on that $3,000 deferral, but you’d rather have the three grand if you didn’t spend it.
John: Basically, when I’m at Costco and I see a cart next to me with 16 years’ worth of contact lenses filling up an entire cart, that’s the person trying to get rid of all their FSA monies before they lose it, right?
Ben: We’ve stockpiled a couple of years of contacts ourselves, so we’ve been in that boat.
John: That one hit a little close to home. All right, let’s talk about ACA credits.
Ben: Under President Obama, they created the Affordable Care Act. A lot of the time they were trying to basically uniform what benefits you’d get out. One of the big things they created is this ACA or Affordable Care Act credit. What that does is they say, “Hey, healthcare is expensive, and if you hit these particular criteria based on income and your family size, we’re going to actually subsidize that.” Depending upon where your income falls, the lower it is, the more of that they’ll subsidize. To the point, it could actually be that you’ve got zero out-of-pocket cost. Up until right around COVID, the problem with that is it was very much a cliff system. You could be getting a credit every month along the way, and you go $1 over this threshold, which for a family of two might be $60,000 and you had to repay every dollar of that credit.
John: That’s crazy.
Ben: You can have these huge yo-yo swings, hey, we’ve got really affordable healthcare. At the tail end, we earned a little income. All of a sudden, we got to owe $15,000 back. As part of COVID, one of the things they did is they said, “Hey, now instead of having that hard cliff, they just say healthcare shouldn’t cost more than eight and a half percent of your income.” You make $100,000, healthcare premium should cost 8,500. They’ll subsidize the amount above and beyond that for what they call a silver plan. What we’ve really found is that for what I would call an early retiree, so somebody who isn’t Medicare eligible but no longer has that employer plan, we wind up in this real unique scenario where we can try and artificially keep their income low by maybe we realize gains in one year and then we live off that cash before, but we can have substantial credits for somebody in their late 50s.
It’s not uncommon for two taxpayers to have premium to two grand, even higher. That ACA credit can subsidize almost that entire amount. We’ve incurred a little extra tax in one of those years, but we’ve gotten a $20,000 credit and made our healthcare cost a fraction of what it would otherwise be. That’s really the point where we work with a lot of our clients is going to be those early retirees where taxes isn’t the only considerations. It’s like when we do that and balance it against what the healthcare savings could be, there could be some unique outcomes that wouldn’t be the top of mind when you think, how am I going to retire and going to live my life?
John: It’s just another example of why you want to coordinate your taxes with your financial planning. I can speak as a wealth manager and say, pre-COVID, I don’t know if there was anything more stressful as an advisor than trying to ensure someone didn’t go over one of those cliffs. Occasionally, there would be variables that were outside of the control of anybody involved and now all of a sudden, they go $1,000 over and it’s a $20,000 hit. You really want to be coordinating these things within your financial plan so that you ensure you’re not potentially missing out on any enormous credit like that.
I think another thing worth mentioning on the HSA is those do need to be tied to a high deductible medical plan. That’s one of their nuance to that is you do have some parameters in terms of what sort of health insurance plan you’re on to qualify for that. Well, Ben, I appreciate your time. These are things we all unfortunately have to deal with paying for medical expenses. It’s great to know that we have some options to reduce our taxes along the way. Thanks so much for joining me here on Rethink Your Money.
Ben: Thanks, John. Thanks for having me again.
John: Well, should you pay attention to forecasts? Is there any value in them at all? I recently heard Jamie Dimon, head of JP Morgan Chase, a bright guy, by all accounts. If you knew nothing else other than what you heard in his interview, you would assume that the economy is in chaos, that the stock market is in a huge drawdown, that unemployment is high. Of course, none of those things are true. It sure sounds smart to spot the obvious, and I’m putting up air quotes, risks that others simply can’t identify. Because if you’re the optimistic person and then the market goes down, you look really bad. The value of even the so-called experts’ predictions and forecasts have no value. I don’t mean that anecdotally like, oh, they’re a little bit valuable and I’m just saying no value. Literally, they have no value. Let me point out five times through history, and these are just a handful of examples out of the tens of thousands of terrible predictions and forecasts where investors, if they listen to the advice, were led astray, unfortunately.
Going all the way back to the Wall Street Crash, October 28, 1929, now known as Black Monday. The Dow Jones dropped 12.8%, the following day, it dropped another 12%. The world was plunged into what we now refer to as the Great Depression. Industrial production in the US fell by 47% and GDP dropped 30% during the Great Depression. The ripple effect even contributed to the start of the Second World War. Unfortunately, as you might expect, even the renowned experts of the day failed to predict it. Irving Fisher, a prominent economist who developed many theories that underpin our understanding of economics claimed, and I quote, “That stock prices have reached what looks like a permanently high plateau.” Well, three days later, the entire US economy collapsed. One of the biggest head-fakes in US economic history was the Y2K buildup along with the predictions that we would have an unprecedented disaster.
Remember, computers, they were only programmed with two digits? What’s going to happen when we reach the year 2000? I had an uncle who had filled up his hot tub with drinking water, not to mention all the other prepping components. He was convinced it was going to be Armageddon. I mean, there are banks that were worried interests would be calculated for a thousand years rather than a single day. Airplanes were going to fall out of the sky. When the millennium arrived, it was a whole lot of nothing. Then we had the dot com bubble bursting. We had the 2008 financial crisis where economic commentator, Ben Stein, said, “You can panic if you enjoy being panicky, but this will all blow over, and people who buy now in due time will be glad they did.” Well, we had the worst drop since the Great Depression. People certainly weren’t happy if they listened to that advice.
We understand that it would be impossible for a weather forecaster to tell us exactly what will happen a year and a half from now. Yet for some reason, we assume that these forecasters and in particular, the doom and gloom negative forecasters, which grab our attention, which scare us into submission know something that others just haven’t quite thought of yet. Well, I’ve seen more of this with the recent volatility in the S&P 500 where the largest peak to trough drop in 2024 is about five and a half percent. No one loves that. You have a million dollars, it’s fully in large cap US stocks, dropped $55,000. It’s painful. I’m not minimizing that, but it’s completely normal. The median entry year drawdown since 1928 is between 13 and 14%. If it surprises you, recalibrate your expectations. They’re probably unrealistic. I’ll post a chart to the radio page of our website provided by our Chief Market Strategist, Charlie Bilello, which shows the S&P 500 and its max entry year drawdown versus the end of year total return.
What was the worst drop throughout the calendar year, and then how did it do from January 1st to December 31st despite that? Here are a few highlights. In 1948, ’49 and ’50, there was a drawdown of 13.5%, 13.2%, and 14% during each of those years, yet the end of year total return, up 6%, up 18%, and up 31%, despite those drops. When you say, well, John, those are a long time ago. You’re going back to the late 40s and 1950. Give me something more current. All right, how about 1998? There was a drawdown of 19%. The market finished up 28.6. In 2003, there was a 14% drawdown, which is right around that average, market finished up 29% that year. In 2009, which is when the market bottomed, March 9 of ’09, we know was the bottom of the great financial crisis that I just referenced. Peak drawdown, a little over 27.5%, market finished up 26.5. The most extreme example of this was during COVID where the drawdown was 34% before you could blink an eye in about six weeks. Yet, despite that, the S&P 500 finished up nearly 20% on the year.
I remind you again, we’ve seen a 5.46% drawdown here in 2024. It’s barely halfway to a correction, which is a drop of 10% or more. Year to date, not surprisingly, if you look at this chart and understand market history, it’s not surprising that the S&P 500 is still positive since the beginning of the year. What wasn’t normal was how smooth the first three months of the year was with the market up over 10% and almost no volatility whatsoever. Here’s the takeaway for you. When it comes to these forecasters, these predictions, especially in the light of recent market volatility, that a broken clock tells the right time twice per day, and an average correction of 13 to 14% will occur in most years. If someone is shouting from the rooftop, be careful. Market is going to drop. You can respond, yes, you’re right, it will. Fortunately, for me, about three quarters of the time, the market will still end positive by December 31st.
If you have questions about your asset allocation, your investments, your broad financial plan, estate plan, taxes, whatever is on your mind, maybe your financial advisor hasn’t reviewed your tax return in the last year or doesn’t communicate with your CPA and you’re not receiving proactive tax guidance, maybe you paid a lot more in taxes these last few weeks than you were expecting, what might you be missing? We’ve been helping families for 40 years as we manage your advice on a combined $300 billion along with our affiliates. Why not give your wealth a second look at creativeplanning.com/radio to speak with one of my nearly 500 certified financial planning colleagues? One more time, that’s creativeplanning.com/radio to schedule your complimentary visit or you can text the word plan, P-L-A-N, to 1-888-914-PLAN.
The common wisdom that you’ll earn more on a bond with a higher interest rate is logical, and it’s sort of true, but it’s a notion that we need to rethink.
The humble dollar did a great piece on almost truths, and I’ll highlight a few of these. Suppose you’re choosing between two bonds, one that pays 3% and one that pays 5% interest. Which would you choose? The short answer is five, but of course, the reason I’m talking about it is that it’s not that simple because the answer depends on what that 3% and 5% represent. There are two different numbers that matter with a bond. It’s the coupon rate and its yield, and it’s really important that you know the difference. Let me share with you the example the humble dollar used. $1,000 bond with a 3% coupon rate and a one-year maturity. Let’s suppose that new bond rates are closer to 5%. Well, then you only need to purchase that 3% bond for $980. It has to be discounted, or you would select a bond with those higher prevailing rates.
Your interest payment is $30, that’s the coupon, and when the bond matures, you’re going to earn another $20 because the face amount of a thousand dollars minus what you paid, which was 980, you made a little extra money because you bought the bond at a discount. You put those two together, the coupon of $30 plus the $20 when it matures, and your total return would be $50. Since your purchase price was 980, your yield would be 5.1%. Now, I know I just gave you a lot of numbers. If you didn’t quite follow all of those, the broad concept is more important. You picking the 5% yielding bond may have seemed better, but you had to pay a thousand dollars for it. Assuming it was of equal credit quality, your yield to maturity was better buying the 3% bond at a discount. While I’m mentioning credit quality, that’s another factor that has a major impact on the interest rate, which may be a reason not to blindly select the higher rate.
A bond is a loan. You’re just lending money. A municipal bond, you’re lending to a municipality. A treasury, you’re lending to the federal government. A corporate bond, you’re lending money to a corporation, like Apple. A church bond, yes, they have those, you’re lending money to a church so they can build a new youth center or sanctuary. There are all different types of loans you can make. Think of it this way, if you lend money to your least responsible relative, you’d probably want them to pay you a higher interest rate than if you lent money to your most responsible friend who you knew was good for it. Credit rating is a reflection of how likely the borrower is to pay you back. The more likely they are, all things being equal, the lower the interest rate is that you’ll receive. On that note, don’t be deceived by the term high-yield bonds. It’s another name for junk bonds. Of course, no one’s going to lend junkie companies with low credit ratings that have a high likelihood of defaulting anything unless it’s high-yield.
Okay, you can call it high-yield bonds, and this is an example why simply looking on the surface for the highest interest rate misses much of the story. Our next piece of common wisdom to rethink is that when a company is doing well, its stock should go up. Benjamin Graham said, “In the short run, the market is a voting machine, but in the long run, it’s a weighing machine.” If you look at a long-term chart of the S&P 500, you’ll see stock prices over time increase more or less in line with corporate profits. Up into the right, dividends are a part of that growth. Inflation is a part of that growth, and future earnings are a part of that growth. If you look at that chart over a shorter period of time, it’s a totally different picture. Sometimes stock prices follow profits, but just as often, if prices seem like they’re really high or really low, it’s simply because of market sentiment, which is driven by the news of the day and often convolutes that relationship between company’s profits and their stock price.
The stock market in the short run is a lot like a popularity contest, as the humble dollar puts it. Look at Tesla for example. It didn’t suddenly become a terrible company after being an amazing company, but its valuation was through the roof, mostly due to a disconnect of sentiment and profits. The weighing machine finally caught up with the voting machine, and if you’re wondering, it’s still up over 800% over the last five years, but that’s with it being down over 50% the last two years. There is no straight-line correlation, certainly in the short run between a company doing well and their stock price mirroring it, and this is reason number 1,286 why individual stock picking is hard. Because in many cases, you research a company, you believe in the company, it’s a great company, its profitability is fantastic. You purchase it, you’re pumped up. You log into your Robinhood account six months later and you can’t believe that the stock price has fallen 50% because it’s such a great company.
Now, the takeaway is you should feel good about investing in the stock market for the long term. Stay broadly diversified, be disciplined, and never be discouraged by the short-term irrational behavior that it sometimes exhibits. A 60/40 stock bond portfolio is a classic investor strategy, and it has been for years, and it’s been really a staple for investors seeking a balanced approach for growing their wealth as well as managing volatility, preserving their wealth in down markets. After 2022, which was the single worst year for a 60/40 stock bond portfolio in the last eight decades, it gained a lot of attention in the media as strategists declared it dead. If we look at the nine worst years ever for a 60/40 portfolio all the way back to 1940, what we find is that only three times in 85 years has a 60/40 portfolio finished the year down double digits, 10% or more.
Well, when you compare and contrast that with a full 100% S&P 500 stock portfolio, it has created remarkable stability. Also, if you purchased individual bonds and held them until maturity rather than a bond fund, it negated all of that interest rate risk and you lost nothing at maturity assuming that they didn’t default. Another consideration is that not all 60/40 portfolios are created equal. There are different versions of the 60/40 portfolio. If you weren’t in 10-year treasuries, but instead were in short-term bonds that are impacted far less by rising interest rates, that portfolio was only down around 10%, not 18% in what is the worst of the last 85 years.
While bonds are not a perfect negative correlation with stocks, they still serve as a phenomenal diversifier to solve for your shorter term needs when stocks aren’t performing well. If you have questions about your asset allocation, how much you should have in stocks relative to bonds, you can speak with us here at Creative Planning. We help 75,000 clients in all 50 states and over 85 countries around the world at creativePlanning.com/radio. Why not give your wealth a second look? It’s time for listener questions and one of my producers, Lauren, is here today to read those. Hey, Lauren, how’s it going? Let’s go to our first question.
Lauren: Hi, John. First up, I’ve got Dan from South Dakota and he wrote in and said, “I’m looking to sell some of the highly appreciated portions of my stock portfolio. I’m in the highest tax bracket. Are there any strategies or investment vehicles you would recommend for someone in my situation to help mitigate the tax impact and potentially lower my overall tax liability?”
John: Well, congratulations on gains. This is a better question than you saying I’ve got a lot of losses and I’m in the lowest tax bracket. The easier from a tax planning standpoint, but not the situation that any of us want to be in. Because you’re in the top tax bracket, Dan, I would say make sure that these are long-term capital gains. They most likely are because you said you have a lot of gains, which generally accumulate over extended periods of compounding, but maybe you struck lightning in a bottle. Because even though you’ll be in the highest long-term capital gains rate, which is 23.8%, it’s the 20% long-term capital gains rate, plus the Obamacare component, which is 3.8%. That net investment income tax, which will take you to 23.8, that’s still significantly less than the top income bracket of 37%, and that’s what you would pay on any short-term capital gains.
Ensure that you’re isolating long-term capital gains. Once you do that, you can donate these appreciated securities or a portion of them if you’re charitably inclined rather than cash as that will wipe off the capital gains. You’re talking stocks, but if this were real estate, you could do a 10/31 exchange, like a light kind exchange of similar properties. If it’s insurance, you could do a 10/35 exchange. The IRS provides for options of exchanges with those types of assets. With stocks, it’s less well-known. You can utilize what’s called a swap fund or an exchange fund. These are not to be confused with an ETF, an exchange traded fund, which are extremely common. Exchange funds by contrast, are something entirely different, much more niche for specific situations. An exchange fund allows you to substitute or replace a concentrated stock position with a diversified basket of stocks of the same value, which will reduce your portfolio risk and it’ll put off your tax consequences until later.
Dan, if this growth has occurred across 48 different positions, the swap fund isn’t relevant. If you have one or two positions, and in many cases, this will be applicable for an executive who received a lot of stock options, which have grown a ton and they have a highly concentrated position that they’d like to, from a risk standpoint, get diversified. Then also from a tax standpoint, they’re worried about diversifying because they know it’s going to trigger significant taxation. That’s where a swap fund or an exchange fund, which they’re the same thing, can be helpful. Because what happens is you’ll take your concentrated position and add it to this fund alongside hundreds or thousands of other investors who had a concentrated position of a different stock that they’re now including in the fund. You swap that concentrated position for a partnership interest or share of the exchange fund. That’ll avoid the taxable event and provide you with tax-deferred growth.
They’re generally held for seven years and a taxable event will occur, but it’s once you redeem your partnership shares in the fund. I’m not certain that’s what you’re looking to accomplish, but I didn’t have quite enough information. The easiest way would be to offset these gains with losses. You may be thinking to yourself, well, I don’t want to have to lose money elsewhere just to wipe off my gains. That doesn’t seem like it’s helping me in the big picture, and you’d be right if that were the end of the equation. Utilizing what’s called direct indexing can be a very efficient approach to have your cake and eat it too. Direct indexing involves buying the individual stocks that make up an index in the same weights as the index. Instead of buying an S&P 500 index fund, you buy all 500 stocks in the ratios and their weighting of the current index.
This has grown significantly in popularity the last five or so years because in the past, buying 500 individual stocks to replicate an index like the S&P 500 would require dozens of hundreds of transactions, which would be really expensive due to commissions and trading fees. Now with the advent of zero commission stock trading and technology advancements, you can implement this strategy for in many cases a lower cost than buying the index itself. I realized that I haven’t yet answered how this would help you from a tax perspective. Here’s how it does. You now have 500 individual holdings and individual tax slots. There are many years where the index as a whole is up in value, but within that index, hundreds of the individual stocks are down. It’s not like all 500 stocks in the S&P 500 are all up 20% when the index is up 20%.
No, in many cases, 200 of the stocks are down in value. You sell off those losers to capture that loss on your tax return and offset the sales of some of these highly appreciated stocks that you’re looking to get rid of. If you don’t want to be out of the market those 30 days, buy something similar to those positions so that you’re still invested while capturing the capital loss to offset those capital gains. We utilize direct indexing portfolios for thousands of clients here at Creative Planning when appropriate. If you have questions, Dan, about how direct indexing may help reduce your taxes, you can request a visit with us there in the Dakotas at createdplanning.com/radio. All right, Lauren, who’s next?
Lauren: Next, I’ve got Becky from Evanston, Illinois, and she writes, “My husband got a new job in a school. Would you recommend the defined contribution plan or the defined benefit plan for him to invest?”
John: Becky, I appreciate the question and it’s not a very helpful answer, but it really depends upon not only your specific objectives and current situation, but also the specifics of the defined benefit plan that you’re being offered. Let me give you an example. If you were an extremely conservative investor, so even the money that you had in a lump sum or were investing on your own in a defined contribution plan would be extraordinarily conservative, maybe the defined benefit plan makes more sense. Also, what are your legacy objectives? If you don’t need the money and you have a very low cost of living and it’s a big priority to pass on lump sums to future generations or charities, then the defined contribution plan may work out better.
Now conversely, if you don’t like managing your own money and you’re more on the conservative side, as I just mentioned, then having stable income from a defined benefit plan may actually make sense. A good certified financial planner can sit down with your plan documents and options, look at that within the context of your priorities and offer significant more clarity. If you’d like to meet with us, we have a couple of offices in Illinois near you, and we’d be happy to do that for you. Again, we’d provide that at absolutely no cost. If you have questions just like these, email them to radio@creativeplanning.com.
This week, I was dropping my first-grader off so he could hustle onto the field for his final baseball game of the season. In that parking lot, we passed a Cybertruck, which is one of his teammate’s dad’s car, and then we parked right next to a brand new Corvette. One of his other teammate’s grandparents got out of that one. Well, Jude looked at me as he does whenever he sees cool cars, he’s really into cars right now. He said, “Dad, do you really want one of those two?” Now, for context, I drive a very boring vanilla F-150. I love my truck, but there’s absolutely nothing special about it at all. I was explaining to Jude when I answered his question of whether I wanted one or not, just the calculation with vehicles as a depreciating asset and that you’re really trying to factor in how much you like having a really nice car versus the financial alternatives.
Where else could I allocate those dollars? To be clear, this is not me being judge-y. Everyone spends money differently. My wife has a nice car, so more power to you if you have a nice car, but it’s obviously not in a vacuum a great financial move. The financial considerations are different when you’re allocating resources toward a depreciating asset like a car or an appreciating asset like your investment account. That is what I was trying to explain to Jude. “Yeah, buy the really nice car, but just know that’s money you won’t have growing somewhere else, so you better really enjoy the zero to 60 in that Corvette. You better really like the head turns you get in that Cybertruck, because your net worth’s going to be a lot lower 10 years from now than it would’ve been had you bought something cheaper.” An exercise that I like is to replace depreciating and appreciating with temporary and eternal when it comes to our money decisions.
Temporary purchases, that’s stuff. Even appreciating assets, they’re still temporary. Cars, houses, boats, clothes, toys, you name it. Where eternal purchases are on people and experiences. They’re when you allocate resources toward relationships. I think it’s important that we remind ourselves of this because it’s easy to get caught up in the moment, but spend money on people and experiences if you want to maximize joy. Things, stuff, items, they’re all fleeting. Even appreciating assets cannot be taken with you. The next time you’re oscillating on a purchase, pause and make a note that you never see a hearse pulling a U-Haul. Remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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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 it’s 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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