It’s an election year, and, like many, you might be wondering whether your investments are prepared for the potential impact. But should current events truly affect your investment approach? This week, we’re answering this question and sharing four common mistakes you should avoid in an election year. Plus, we welcome Director of Tax Services Candace Varner back to the show. She’ll share five key questions to help assess your portfolio’s tax efficiency.
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, it is an election year and it is fast approaching. What should you be aware of when it comes to your investments? One of the simplest ways to reduce your taxes. And finally, a common belief that works well in life and horribly when applied to your finances. Now, join me as I help you rethink your money.
We know that election years come with a lot of uncertainty. In a polarized political climate, it can be easy to get bogged down by fear, certainly of the unknown. That’s magnified on social media, there’s no question about that. And you would be typical if you find yourself worrying about how the outcome of this year’s presidential election may impact your portfolio. You may wonder will the markets tank if a certain candidate is elected? What asset classes will be most impacted? What types of investments will respond positively or negatively as a result of the election?
Will there be market chaos following the results? The question I’m asked often and people seem to love is which side is better?
“Hey, John, I’m a Republican. Republicans are better though, right, for the markets.”
“Let’s just be honest. I’m a Democrat… Man, those Republicans…”
“Supply side economics, I mean obviously when the Democrat gets in, things have been a lot better, right John?” Very common question. I’m prepared to answer each for you.
And fortunately, past experience shows us that presidential elections tend to have a minimal impact on your long-term returns. In fact, election years often even offer investment opportunities for savvy investors who remain true to their plan, true to their long-term objectives, and make proactive moves. Here’s the overarching theme. If you know what you’re doing, elections are not something you need to worry about.
However, I’ve seen firsthand, people do crazy things. Many people are not well-prepared. They don’t have confidence in their plan, usually prompted by a lot of emotion, namely fear, that essentially lit their portfolio on fire. There are four particular mistakes that I see often, and I want you to not only be aware of them but also understand how to avoid them.
Mistake number one is worrying about the potential market volatility. Without boring you on the standard deviation numbers, like those measurements of volatility in the markets, both the 100 days leading up to an election and the 100 days following an election have slightly less volatility than the annualized volatility over the complete timeframe.
Think of it this way, are the markets volatile during election years? Yes. Are the markets also volatile during normal, and I’m up air quotes, times? Yes. The stock market is volatile, period. Not more so during elections, but it reminds me of the saying, you will see what you look at. Probably just more aware of volatility when we are near an election due to a heightened awareness and sort of alert level to the risks that may be presented in the midst of political uncertainty.
Mistake number two is missing out on investment opportunities. If you look at average net fund flows by year of presidential terms over the last 30 years, where is money moving? During election years, 37 billion into equity funds on average, nearly 200 billion into money market funds, over five times as much money into cash versus stocks. How does that compare to the year after an election? Over 200 billion of flows, not into money markets, into equity funds, while only 85 billion flow into money markets. It’s virtually flip-flopped. So those investors who implemented a more conservative allocation likely missed significant opportunities.
The one thing that we know to be true is that Democrats earn less when a Republican is elected, and Republican investors earn less when a Democrat president is elected. Why? Because they’re more likely to move money into conservative investments, and the stock market has always moved up into the right over long periods of time. If three out of every four years the stock market is up in value, anyone for any reason who gets more conservative has a lower probability of achieving optimized returns.
Mistake number three is believing capital markets care about politics. The markets do not see red or blue, they see green. The markets care about future earnings, period. And here’s why which candidate is elected is statistically irrelevant for future market returns. Because even if your preferred candidate loses, the next week you still get on Amazon and do one-click ordering. You still take the grandkids on a Disney cruise. You hop on an airplane to see family. You buy a pair of Nikes. You get a new iPhone. You buy a Chipotle burrito bowl. You head to your place of worship. You put gas in your tank or charge your car. You see, while you might expend energy around the election, it won’t impact the way you spend your money as much as you might think.
To put some substance around just how little it matters which political party is in control, and I’m looking at 48 month periods, four year terms, Republican president, 49% increase. Democratic president, 46%. And every combination of president and Congress falls right around those percentages as well. And if you look at all elections, 47%. So 49, 46, all elections are 47. There is no statistical evidence that you’ll get worse returns if the candidate you desire loses. The only way you assure yourself of a lower probability of success is by moving more defensive with your strategies as a result of fear.
Worst returns for a president were Hoover during the Great Depression. Best returns were Roosevelt coming out of the Great Depression. The Reagan years were great. The Clinton years were great. The George W. years were terrible because of the dot com bubble bursting, 9/11, and the great financial crisis. And then we had pretty good returns with President Obama, President Trump, and now President Biden. Very different people, very different presidents, very different policies, but again, the capital markets care little for their differences.
To recap, mistake number one, worrying too much about potential market volatility. Mistake number two, missing out on investment opportunities. Mistake number three, believing capital markets care about politics. And finally, our fourth mistake, sacrificing long-term returns over worries about short-term volatility. Worst case scenario, you make emotional changes. The next best action you could take is nothing. But there’s one better. And that is to develop or reaffirm your current long-term strategy, ensure that your portfolio is well-diversified and built in a manner that will see you having success regardless of which candidate wins.
If you don’t consider the IRS to be your buddy, as most of us don’t, you don’t like donating money to the IRS, then Creative Planning Senior Tax Director, she’s a certified public accountant, master’s degree in accounting, Candace Varner is your white knight. Candace, thank you for joining me on Rethink Your Money.
Candace Varner:
Thanks for having me back.
John:
Today we’re talking about the upcoming election and how to best prepare your financial plan for election years. Taxes in particular, Candace, are always a hot button in these debates. And I suspect this will be no different this time around either when these two candidates shuffle out onto the stage and start screaming at one another. The reality is we have $33 trillion in national debt. We have a seven plus trillion dollar annual budget, nearly doubling what we used to spend not even all that long ago. We got to pay for it somehow. And tax increases are likely in our future, most agree. And this is why I have you on today, Candace, because no one likes paying more in taxes than legally required. One simple way to lower your tax bill is by tax loss harvesting. What is it and how does it work?
Candace:
Tax loss harvesting is the idea that you can take a position that has an unrealized loss. We’re going to go ahead and realize it, essentially creating an asset for ourselves, saying we have this capital loss that we get to use to offset some other gain. We’re going to use this in taxable accounts. Let’s say we’ll buy five different positions today, and next month one of them is in a sector where the price has gone down or maybe the entire market has gone down. At that point we’re going to say, “I’m going to sell Walmart and I’m going to buy Target.” Very similar, but it’s not the same in that it won’t trigger a wash sale, which is something you have to look out for.
But now that I’ve sold it for tax purposes, I have realized that loss, which means I’ve locked it in. So if I bought it at 10, now it’s six, I have a capital loss of four. Then I get to keep that loss. And five months from now the market’s way up and I want to move stuff around, I can sell something else and realize a gain of $4 and not pay any tax on it because those are going to offset. And it doesn’t have to even be in the same year because if I realize a bunch of losses this year and don’t have gains that I want to realize and offset, that capital loss is going to carry forward indefinitely and I can use it to realize some gains later.
John:
That’s well said. A recent example of this we saw was during Covid where the market drops 35% about in six weeks. You sell, and I think the important distinction which you hit on, but I don’t want to be missed, is that you’re not actually in cash. Because a lot of people will say, “Well, isn’t that the opposite of rebalancing? Isn’t that the opposite of buying low? Why would I want to cash out at the bottom?”
You’re not cashing out and sitting in cash, you’re selling and repurchasing something similar to still achieve the recovery. And we saw during Covid the rest of the year was up about 70%, but you booked losses. This is also important for investors to understand because I’ve had clients that work with outside CPAs.
Candace:
Right.
John:
And we tax loss harvest, and the CPA goes to the client and says, “What is your advisor doing? The market was up 20% this year and you have a hundred thousand dollars of losses. You might want to move your accounts. I don’t know what they’re doing.”
The client comes back to me and I go, “We actually were really good. You have a hundred thousand dollars of losses on your tax return. Your million dollar account is worth 1.3 right now. You’re up 300 grand with a hundred grand of losses on your account that you can now use to offset future gains.” And like, “Oh, okay, that makes sense.”
Candace:
I totally agree. I was thinking that when you were making that description, it’s kind of the best of both worlds. On paper, I have a loss, but in reality I have a gain. So it’s, yeah, best of both worlds.
And I have several clients who we’ve done this where you actually, they’ve realized losses for years, and they think, oh, I have this million dollar capital loss out there for something. And then last year I had a client sell a house in Florida for a $2 million gain. It makes a huge difference when you finally get to use it.
John:
Yeah, it’s a beautiful strategy when it works well, there’s no doubt about that. In the scenario where, let’s use 2023 as an example, the market’s up over 20%, maybe own four index funds, and that person says, “Well, I’d love to tax loss harvest, but everything that I own is up in value. There are no losses.” Again, it’s a good problem to have from an investment standpoint, but from a tax perspective, there’s not a whole lot you can do. From a CPA’s point of view, Candice, what are the limitations of mutual funds?
Candace:
So mutual funds are something I dislike as a CPA, specifically because it’s really hard, almost impossible to plan around them.
John:
You don’t have any control.
Candace:
Right, you have no control, and you find out at the last minute. We’re going to find out that there are capital gains that are being allocated to us because of our mutual funds that we own. We don’t know how much and we don’t know almost until it’s too late to do anything about it.
So I’ll see a lot when somebody has legacy positions or something that is a large position in a mutual fund. We’ll do all this planning, and then we get to December and it turns out that they’re actually going to distribute large capital gains. Because like I said, the market was up all year. The mutual fund didn’t have any tax loss harvesting they could do either. And we don’t have any control over that coming out.
And so it’s another way that having those harvested losses can help protect you against that, because then when those mutual funds distribute the capital gains we can offset with those losses. Or it might be better to just not own as much in mutual funds and instead own the indexes in ETFs or something else so that you are in more control of what’s happening and you’re only realizing gains when you trigger it.
John:
Well, and this is why there are massive flows into ETFs and out of mutual funds.
I’m speaking with Creative Planning Senior Tax Director and CPA Candice Varner. Are you subjecting yourself to extra taxes and a lack of control? Now you know there are other ways to achieve diversification that in my opinion also offer a lot more control and flexibility.
Well Candice, this has continued to evolve. So it went mutual funds into ETFs, and now there’s direct indexing, which is effectively taking an S&P 500, mutual fund or ETF, unwrapping that, holding all 500 positions in the same proportions that the index fund would. And in a scenario like 2023, yes, in the aggregate they’re up over 20%, but it doesn’t mean all 500 individual stocks were all up in value. In fact, well over 100 lost money in 2023. And now we have 500 individual tax lots that we can identify some of those losses, sell those, buy something similar, and then get back into them in their entirety 31 days later. That’s really the new wave of tax efficiency even beyond ETFs.
I’ve had clients ask me, Candice, “Why haven’t I heard of this.” Or “Why haven’t I been doing this the last 20 years?” And it’s pretty simple. Well, this was available to people with 30 or 40 or 50 or $150 million, because it made sense to have all these individual positions and you could offset the fixed costs. Now trading’s free. So before, to hold 500 positions and make all those trades was thousands of dollars. So if you had a $500,000 account, you’re not going to do that. It wipes away all the tax efficiency and then some. But now the trading costs are so low, and technology has advanced so far that you can effectively deploy this type of strategy on a half a million dollar account. And with non-qualified monies, it gives you significant tax flexibility.
That’s the next iteration. I personally, I could be wrong on this, but I think 10, 15 years from now, Candace, this is what anybody with 500,000 or a million dollar non-qualified account, I think you’re going to see almost entirely direct indexing portfolios just because the tax efficiencies are so great.
Let’s talk a little bit about taking full advantage of tax-efficient accounts and investments, Candace.
Candace:
So hopefully everybody knows tax-efficient accounts, I think what were tax-deferred, so we’re talking about qualified accounts, IRAs, Roth, IRAs, 401ks, HSAs, all of that. So first, maximizing what you can contribute to every account and working with an advisor to know, do I want to contribute to an IRA and deduct something now, or do I want to contribute to a Roth IRA, same with 401k and that kind of thing, to decide based on your personal situation, what’s the tax benefit now versus what do we think the tax outcome is going to be when you eventually withdraw from that. And then looking at all of the different types of accounts that you have and picking different investments for different ones. So yes, we want a certain amount of bonds, we want a certain amount of ETFs or direct indexing or any of these things, but which accounts do we want to hold them in?
And that’s where it becomes important to look at if something’s going to grow a ton but it produces no income while it’s growing, we want to own that in a taxable account. Because, like we were just talking about, I get to pick when I sell it and realize that gain. Whereas if I want to hold something that’s producing ordinary income, which is the least tax efficient type, just interest income or other ordinary income, we want to hold that particular asset in a tax deferred account like your IRA or 401k. Because then every year when it spends off income, we’re not paying tax every year as we go.
And so in total, two people might have the exact same ownership of different positions, but we want to hold them in different accounts depending on how much we have in each account, what the withdrawal strategy is, how much longer are you going to work, all those kind of things come into play.
John:
Yeah, it’s not just what you own, it’s where you own it, and then marrying those two things together in a way that makes sense for your overall strategy. All right, Candace, let’s talk withdrawal strategies because this trips people up too. I think a lot of people, they’re saving for retirement. They feel like they’ve got a pretty decent handle. They’ve got an index one portfolio and their 401k. And they’re like, “I’ve run all the retirement calculators and I think I have enough money.”
And then they get to this transition point. “Oh, I’m not only not saving anymore, I’m actually going to start using it.” Which by the way is kind of funny because it’s the whole reason that they saved it in the first place.
Candace:
Yeah, but it’s scary.
John:
But how many people have so much trouble going, “Wait a second, I like watching my accounts get larger as I have for the last… Now you want me to start spending this?”
“Well, yeah, and Mr. and Mrs. Smith, that’s why you saved it.”
“Well, I guess that’s true, but this is kind of a little bit difficult. I don’t want to run out of money. And beyond that, which accounts do I sell first with which types of investments?” Because that can make a significant difference over a 20 or 30 year period and how much you have. So can you speak a little bit to a tax efficient withdrawal strategy?
Candace:
You have to look at it holistically. So whenever someone asks, “Should I own this? Or what should I do here?” I’m like, well, it depends. And that’s why we always say it depends because everyone’s situation is different.
For a withdrawal strategy, the traditional approach would be we’re going to look at your taxable accounts first. I want that money I put in those accounts that are growing tax deferred, I want it to stay tax deferred as long as possible. So I’m going to use my taxable accounts first and then eventually take money out of my 401k, IRA.
John:
And how about conversions on top of that possibly, right? Taking the brokerage accounts and then having some room, especially during the Trump tax reform, to maybe use up some of those lower brackets with conversions. Because you’re basically transitioning at that point, right, Candace? You’re transitioning non-qualified money to Roth effectively.
Candace:
Right. And that’s what the other way people would describe it is using a proportional approach, being I’m going to take some money out of each type of account. But a Roth conversion essentially gets you that anyway, gets you both, it ends up being proportional. Because whatever I’m not taking out of my taxable accounts, I want to make sure I use those lower brackets. So let’s say I retire, and for five years I could live off just my taxable accounts. That puts me in the lowest possible tax bracket and I’m giving up the opportunity to use those lower rates every year I don’t do something.
John:
It drives me crazy when people go, “Well, I don’t have a tax problem. My taxes were nothing last year.” Because they’re doing exactly what you just said. They’re just drawing non-brokerage accounts.
Candace:
Yes.
John:
And I look at their accounts and they go, “You have 2.9 million in deferred accounts. Let me run an RMD projection for you in your eighties. You’re going to be in a very high tax bracket.”
Candace:
Yeah, but that’s future me’s problem, John. This year I paid no taxes.
John:
What you’re talking about is really income smoothing, right?
Candace:
Right, yes.
John:
Trying to fill up brackets rather than accepting, oh, this is great. I paid no taxes this year, but I’m going to pay way more 10 years from now.
Candace:
But it’s just like the tax loss harvesting where I always tell people, tax is an alternate universe. Sometimes things that just don’t feel correct are actually extremely helpful. Because at the face of it, no one’s going to say, “Yeah, I want to pay tax earlier. Let’s pull some income in. I want to pay tax 10 years before I need to.
John:
I’m voluntarily going to make my taxes higher, Candace. Doesn’t that sound great?
Candace:
Yes, but when we look at the full picture, it is a better option. But again, that’s why sometimes if you’re looking, like you said, with an outside CPA or someone who’s looking at just the tax return, it’s a very different story than when you’re looking at the full financial picture.
John:
You’re absolutely right. We could spend another 30 minutes talking about these strategies because there is so much to unpack here. But I sure appreciate you sharing your insight, as I’m confident it will help us all improve the tax efficiency within our investment plan.
Candace:
Thanks for having me.
John:
A saying that you are likely very familiar with is, go with your gut. You probably said it before too. “I’m just going with my gut here.” And in some cases that intuition is helpful. Malcolm Gladwell wrote the book Blink, where he outlines why often our first impression is in fact more accurate than once we spend countless hours analyzing something or someone. And so I don’t disagree with this premise in general. However, when it comes to investing, this could not be further from the truth.
If we back up and look at the human race and our ability to survive for thousands of years, it is due to a couple of factors, one of which is that we stay together in groups for safety. Also, something not helpful when it comes to your money is following the herd. But I’ll save that for another show. Secondly, it’s because we’re defensive and paranoid when we sense danger. If our ancestors heard a rustle in the weeds, they would protect themselves because it just might be a saber tooth tiger. It wasn’t helpful for them to assume it was wind, even though that was most likely all it was. Because if it was that tiger, they’re dead. And we still do this.
But since fortunately we’re not often confronted with life and death situations, we apply the principle to areas of life like our retirement savings. And our investments in the midst of times like this upcoming election, or when there’s geopolitical uncertainty, or wars breaking out in other parts of the world, or a global pandemic, or a financial crisis, or a terrorist attack, whatever it might be, we feel that fear around our money. It’s generally because of recent performance that hasn’t been good, and the current narrative is negative. Of course, when we step back and remove our emotions, when we remove that gut instinct, a successful disciplined investor understands that’s actually when I need to be more aggressive, not less.
Think of one of Warren Buffett’s most famous sayings. “Be greedy when others are fearful, and fearful when others are greedy.” I’ve heard people allude to the fact that he removes his emotions. That’s why he’s so successful. No, he isn’t unemotional. Warren Buffett is inversely emotional. That’s way better. He takes other people’s feelings, turns them inside out, and makes the resulting emotions his own. So when it comes to your money, I’m not suggesting you deny, I’m suggesting you take note of that emotion, flip it on its head and do the exact opposite.
Another piece of common wisdom that I find to be misunderstood is that risk and return are a trade-off in an investment principle that indicates that the higher the risk, the higher the reward. Creative Planning Chief Market Strategist, Charlie Bilello and Creative Planning President Peter Mallouk recently spoke of this on Signal or Noise. Have a listen.
Charlie Bilello [Sound Bite]:
Not all risk is rewarded. This is a concept you and I have talked about with a number of different areas. Today I want to focus on long-term bonds. This is from your book, a quote here. “In an environment like we have today, long-term bonds are very, very dangerous.” And you just point out some simple math here. Obviously when interest rates rise, if you have a high duration in terms of your bond, you’re going to get hit. And if we look at the longest duration, zero coupon bond ETF the zeros. That’s a duration around 25 years, Peter, which I know a lot of people, what does that mean? Well, if interest rates go up 1%, that means you’re losing 25% in that instrument. And not only did they go up 1%, they went up a few percent.
So this is comparing that investment to an investment in a treasury bill, ETF. You could see the difference in volatility. Much higher volatility in long duration bonds over the last four years, actually higher than the stock market. Treasury bill ETF obviously almost no volatility. So what the efficient market people would say, well, this is higher volatility, this is higher risk, you should be rewarded for that. Hasn’t been the case, been the exact opposite. Obviously if you’re sitting in treasury bills, not a huge gain, you’re up 8%. But if you’re in that long duration bond ETF, 56 plus percent decline over the last four years.
Peter Mallouk [Sound Bite]:
Yeah, I guarantee you that there are people that did not know they could lose that much money in bonds. And even if you hold the bonds to maturity and you go, “I didn’t lose any money,” you hold these for the 25 years, you got crushed in terms of purchasing power. Before you buy any long duration bond, make sure you understand the risks. They’re very real. In my opinion, much more severe than the risks of investing in the stock market, where you have more volatility but the risk of losing your purchasing power, much, much, much less significant.
John:
So long bonds are just one example as outlined by Peter and Charlie, something I’ve spoken about multiple times. And in particular in the year 2022 when rates were climbing at warp speeds, and investors were feeling firsthand the risk that once seemed hypothetical.
How about if you went to Vegas? You put all your money on the roulette wheel and someone asked you, “Why are you taking your life savings that you worked 40 years to accumulate and placing it on a spinning wheel?”
“Well, don’t you know, risk and return are correlated, and this is really risky.” Yes it is, and this is why risk and return are not always aligned.
Another piece of common wisdom is that I can’t possibly save for a home and retirement. Now in fairness, first time home buyers are in a world of hurt across many markets in the United States. Mortgage rates are through the roof and home prices simply haven’t compressed due to a lack of supply, making it one of the most difficult situations for those looking to buy who don’t have any current equity in a home they’re selling.
But a big mistake I see people make is having an all or nothing attitude with money. I get it. Putting things in boxes and having a black and white approach can be helpful for our sanity. Having less nuance, less gray can make things easier. But the idea of either being completely debt-free or I invest money, or the example I just used, like a home or investing for my retirement, either save for college for my children or help an aging parent, either give money to my kids today or to charities in my estate plan once I’m gone.
It’s important you remember that financial priorities are not often sequential. They are simultaneous. You are going to have conflicting money priorities that overlap. And at the end of the day, the only reason you are in fact investing money, it’s for some future objective. And oftentimes, unless you just have an unlimited amount of money to fund everything, you’ll have to make trade-offs. And that doesn’t need to result in 100% toward one thing and zero toward another.
If you look at this even more broadly, forget the specific examples I just used, how about saving or spending? I found in meeting with thousands of families, very few people have this figured out and have a healthy balance between the two. I remember reading the story of a gentleman who was a janitor, made close to minimum wage. He died with nearly $10 million in his nineties, which was a complete shock to everyone who knew him. He had invested everything, essentially spent nothing. And what I found strange, not to be a judgmental guy, but it was like the article was written commending him, like, look at how much money you can amass regardless of what you make if you just save.
But to me the story was a tragedy. His family probably could have benefited from some of that while they were in their family building years. He didn’t travel, he had a house that was not in good shape. I get it. If that’s his thing, great. But a number on a page in my opinion, I mean, getting larger, it’s completely meaningless. It’s also a tragedy when a high income earner is in debt up to their eyeballs and as little saved for retirement and meanwhile owns a motor home and a boat and has car payments and ends up with not enough money to be generous with others and depends on their kids because of their irresponsibility. Yeah, that’s a tragedy as well. And it’s because money is not inherently valuable. It’s indirectly valuable. Having a higher net worth that isn’t put to use, is worthless.
What are your priorities? What are your objectives? What are your goals? What are the things that you’re passionate about? You probably have more than one, which means you’re going to have to simultaneously address those within the context of your financial plan. And this is the key. A financial plan, written, documented, delivered by a certified financial planner who’s not looking to sell you commissionable products, but rather provide you advice, should marry these priorities together, quantify the impact, so that you can make progress toward the many objectives that you have, and so that you can have peace of mind and confidence and clarity along the way.
A lot has been written about regarding being on the same page with your spouse, needing to be completely aligned around money. In fact, one of the leading causes of divorce relates to disagreements around money and a lack of communication around the differences of beliefs of money.
An example of this occurred with my wife, Brittany and I. We ran some projections on our financial plan for a purchase that we were batting around. In the end, I looked at how much less we would have at retirement and thought, it is not worth it. That’s not a sacrifice that seems reasonable to me. My wife, looking at the exact same numbers, saw that we didn’t run out of money if we made this purchase, our retirement would still be fine. And therefore she came to a completely different conclusion, which was why would we not do this? It’s going to enhance family experiences and memories and this is a worthwhile purchase. Why do we want to die with more money? And I’m looking at it as a financial planner saying, why do I not want to have more security and more money later in life?
But we talked it through. In doing so, discovered that my wife felt much more strongly about pursuing this than I felt about not pursuing it, which has always been a great process for she and I when we’re approaching things from different perspectives. Does one of us feel way stronger about this than the other? Well, all right. In the event that either decision is okay, there’s not a right and a wrong, there’s not a better or worse, just different, let’s go with who’s more passionate about their position.
We’ve helped thousands of families here at Creative Planning over the last 40 years find common ground in their marriage with their money, and it starts with a written documented financial plan. Because once you can come together on quantifiable numbers and actually evaluate the impact of decisions, you have a foundation to build from.
It’s time for this week’s one simple task where I help you incrementally improve your situation 52 times throughout 2024. Today’s tip is to pick a book. Find a beach read for personal finance. You don’t need that long-haired guy with an eight-pack romance novel. You don’t need to read Harry Potter or Lord of the Rings for the 28th time. You don’t need those little boxy John Grisham books that are six inches wide, the paperbacks on the airplane. No, no, no. I’m suggesting in this simple task to find a read on personal finance.
Now rather than promoting my two books, I won’t do that, I’m not going to literally talk my book, instead, let me give you a few of my favorites. Morgan Housel’s, the Psychology of Money is one of the easiest reads and one of my favorite books that is broken down into small chapters, and I’ve yet to meet someone who said that they didn’t like the book.
Another great option is Creative planning President Peter Mallouk’s most recent book titled, Money Simplified. If you’d like to reference all the simple tasks from 2024, they are available on the radio page of our website at creativeplanning.com/radio.
Well, it’s time for listener questions. And to read those for us today, one of my producers, Britt is here. Hey, Britt, how’s it going? Who do we have up first?
Britt Von Roden:
Hey John, it’s going great. Thank you. Up first today we have Melissa out of Kansas City. And she mentions that you talk a lot about investing on your show. So she’s curious, what is your take on micro investing? Is this something that Melissa should be considering?
John:
Yeah, absolutely you should be considering it, Melissa. I think it’s a great question. The idea of micro investing, for listeners who aren’t aware, is to round up purchases often to the nearest dollar. And then you’re essentially using that spare change to slowly build up savings into a diversified portfolio. Maybe it’s a total stock market ETF. And investment apps like Acorns and Stash have made this easier.
You’re essentially employing dollar cost averaging, which is a universally accepted strategy for accumulating wealth, which is you’re systematically and regularly contributing to your accounts. It’s also automated, which I like because the more friction you can remove, the more likely you are to continue to save.
Now the problem is it’s probably just not enough on its own. For example, if a 25-year old wanted to micro invest, and maybe all those roundups save $1.50 a day, so $45 a month, and they invested that $45 a month for 40 years until around retirement age of 65 years old. Assuming an 8% rate of return, they’d have $157,000, which is why I said, yeah, like micro investing. Anything you can be doing to systematically save money is fantastic, but not many people, especially 40 years from now, will be able to retire with $157,000.
Thanks for that question, Melissa. All right, Britt, let’s go to Justin in Arizona.
Britt:
So, Justin has an insurance agent that’s a friend of his who presented the idea of banking on yourself. He says he’s heard you mention whole life before and that you’re not a big fan. His question today is why do you not like this strategy?
John:
Thanks, Justin, for that question. Why do I not like this strategy? For about 1700 different reasons. And I say that tongue in cheek, not to attack you here. But it doesn’t surprise me that this was pitched to you from a friend. Affinity bias is a huge component of insurance sales. It’s my buddy from college, it’s my neighbor, we go to the same church. There’s usually a foot in the door because permanent life insurance is virtually always sold and almost never bought.
Let’s say it’s a pretty large life insurance policy and you’re putting in 3000 a month, 36K for the year. When that’s sold, the agent’s getting a check in some cases for around $36,000. So let’s not kid ourselves. We’re all humans. That’s a massive incentive.
To not go too far into the weeds on the concept of banking on yourself, it relates to having a bucket of money with this life insurance policy that you then borrow against from yourself, tax advantaged, and essentially you get to be the bank. You’re earning interest rather than utilizing a bank.
But here’s what I find strange. You can borrow against a lot of your other assets as well. And let’s not have the tax tail wagging the financial planning dog. Just to scratch the surface and name a few of the cons. The investment returns are poor. It doesn’t keep up well with inflation. It’s illiquid and inflexible if life changes. The cost of insurance is remarkably high because it’s permanent. And you have a lack of investment control.
In short, insurance is not an investment, it’s insurance. There are very good reasons for being properly insured and for having adequate coverages of insurance. In fact, in our financial planning process with clients, we run an insurance needs analysis to ensure that we close any gaps in your plan, require insurance. But oftentimes those insurable needs change. You may have minor children that will be out of the house and on their own in 15 years.
Well, then buy a 15-year term life policy to protect your spouse and your children, if you prematurely pass away and your income is lost, that they’re able to continue to live their life and stay in the home and not have financial hardship. That’s really responsible.
But because a 35-year-old is unlikely to pass away before the age of 50, especially once health underwriting is done and they determine that you’re healthy, the cost is very low. You take all the difference that you would’ve had to pay in premiums to whole life insurance to cover a permanent death benefit, and you invest them properly and efficiently, and you have flexibility and you’re not paying crazy commissions, and you’re getting historically far higher returns. And that’s why you’ve heard the expression buy term and invest the rest.
There’s one common scenario where permanent life insurance can make sense, and that is for someone with a very high net worth, much of which is illiquid, farmland, real estate, businesses. And there will be a need for beneficiaries to pay estate taxes at the time of their death, and they don’t want to have to sell an illiquid asset to do so. That’s where you might need permanent life insurance. But we are talking about a fractional percentage of the population. This is not a foundational piece to a well-built financial plan, Justin. So in general, when pitched permanent life insurance, just say nothing. Just stand up. Like if you’re in the office, just stand up and just briskly walk out of the office without saying anything. If you’re on Zoom, have connection problems and just immediately leave the meeting.
Thank you for those questions Melissa and Justin. And if you have questions, just as they did email those to radio@creativeplanning.com.
T. Harv. Eker said, “Your income can grow only to the extent that you do.” You earn money in proportion to the value you create for others. You don’t earn it by chasing after the money itself.
I was reminded of this a couple of weeks ago. My third grade daughter was giving a career presentation in school. Of course, she wanted to be a marine biologist as every elementary student does at some point in their childhood. So my wife and I get to the classroom and we watch other kids giving their presentations prior to our daughter. And the best part of all these presentations are the questions asked at the end.
My daughter had a standard question that she asked multiple kids after their presentation, and that was, “How much money do you make in that career? Oh, you’re an author. How much money do you make?” I was chuckling thinking, well, if you’re J.K. Rowling, you make a little more than a self-published person down the road. It’s like on career day, I’m going to be a YouTube video gamer and record myself. Okay, how much does that make? That sounds pretty cool.
According to my 22 and 21 year old, there is a guy named Ninja who records himself playing Fortnite and makes millions. So now that’s actually a real career thing. But I think if you ask most boomers, the millennials living in their basement, even if they’re recording themselves, aren’t making a whole lot. Probably not a great career path.
But I found it interesting that my daughter was already thinking, what does this earn? Not that that’s bad or good, but you certainly don’t want to pick a career solely because you think it will earn you a lot of money. The idea of chasing wealth on the surface might seem logical, but I’ve rarely seen it work out the way the person had hoped. You accumulate money as a result of adding value for your customer, for your client, for your employer.
The path to financial abundance isn’t achieved by fixating on money day and night. It’s by laser focusing on your growth. Maybe that means you’re going back to school to collect more knowledge. Maybe it’s seeking out a mentorship of someone who’s further along in the career than you are, who you really respect. Maybe it’s just simply outworking others on in earlier out later. It could be diligence and the speed at which you’re responding to others. Maybe it’s a desire to help pick up the slack on something that wasn’t your issue or wasn’t your responsibility.
So if you want to be rich, figure out how to become more useful to others. The more valuable you become, the more you will earn. It’s simple arithmetic. Your growth is directly proportional to your income, and money is a reward for your contribution to others. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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