This week, John shares five steps to finding contentment with your money, regardless of your current circumstances. Plus, Creative Planning’s Director of Tax, Candace Varner, CPA, joins John to talk about health savings accounts (HSAs), one of the most underutilized tax benefits available.
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!
Have questions or topic suggestions?
Email us @ email@example.com
John Hagensen: Welcome to the Rethink Your Money Podcast presented by Creative Planning. I’m John Hagensen, and on today’s podcast, the five steps to defining contentment with your money regardless of your current circumstances. We’ll also examine how to establish proper investing expectations as well as a plethora of client questions, situations, and mistakes for you to learn from. So, now, join me as I help you rethink your money. What if I told you that the origin of your financial success would not be rooted in your income, your degree, or your lack thereof, your job history, your marital status, your race, your gender?
No. Instead, what if the most important building block for you, finding that abstract word of success, that that would be shepherded more by your perspective than anything else? Why I think this should actually be quite encouraging for you is that your perspective is something completely within your control. Here’s what got me actually thinking about this. I was reading the story of Tom from Myspace. If you need a refresher, you’re probably not between about 35 and 45 years old, but Myspace was out there before Facebook and it was a similar concept. Your first friend when you would sign up for Myspace was this random dude named Tom, who by the way, happened to be the founder.
Well, in 2005, he sold the Rupert Murdoch’s News Corp for $580 million. Now, not all of it went to him. He’s worth and estimated about $60 million right now. He’s 51 years old. The point of this article was how great of a life Tom Anderson now has. He travels the world, he’s into surfing and photography, and by all accounts is really enjoying the fruits of his labor. So, often people look at Mark Zuckerberg who’s worth a thousand times more than Tom. Oh, by the way, if you’re wondering, Zuckerberg’s net worth is down $71 billion this year alone with the Facebook stock plummet, but they feel almost a sadness for Tom Anderson.
They think you left tens of billions of dollars on the table by selling Myspace for such a small amount. But from my perspective, his life appears to be way better than Mark Zuckerberg’s. I mean that guy’s being hauled in front of congressional committees to discuss his role in misinformation and disinformation and censorship and elections. So, I can pretty much assure you that Mark Zuckerberg’s life isn’t a thousand times better than Tom Anderson’s. I mean, it might be a thousand times worse. I don’t really know, but you may be listening and thinking, “Well, John, yeah, whatever. I mean, they’re both crazy rich. They’re both ridiculously wealthy.” So it’s easy to say, “Who cares? What’s the difference?”
But I think there’s far more overlap to our situation, normal people like us than you might realize. Daniel Kahneman, one of the great behavioral economists of the last century, he’s won the Nobel Prize. I think he’s in his late 80s now. But he wrote a book titled Thinking Fast and Slow, which is a heavy read, but one of the most thought provoking books I’ve ever read. In his extensive research during this book, he found that $75,000 was really the baseline for happiness.
What I mean is from a clinical standpoint, if you were below $75,000 of income, you did have meaningful amounts of lower happiness. But once you were above $75,000, there was no direct correlation or proportional increase in a person’s happiness as their income increased. So, put differently, if someone made $25,000 a year, they did have less happiness. For them to get to 75,000 meant they could have more meaningful interactions with family and friends, maybe travel a bit more, pursue hobbies, not have as much financial stress around paying medical bills. Those were really meaningful and that person’s ability to feel confident and comfortable that their wellbeing would be taken care of.
However, the person making $180,000 was not twice as happy or even more happy statistically than their neighbor making $90,000. There were some specific examples related to this topic in the book, The How of Happiness by Sonja Lyubomirsky. Her findings showed that most people, regardless of what they make, would like to make about double. In fact, the gap widened with the more income. Meaning the person that made 40,000 wanted to make about 70,000. The person making 250,000 wanted to make about 600,000. So, not only did the person making more money also want more money, they wanted even a higher proportional increase percentage wise than the person making less money.
It reminds me of the famous quote, “Nothing is enough to the man for whom enough is too little.” So I bring this up to start the show because I find so often that the primary driver of most of your decisions in life will revolve around finances or improving your financial situation, increasing your income, which by the way, in and of itself isn’t a bad thing. I mean, I’m a certified financial planner. I’m a wealth manager. I’m hosting a personal finance radio show. So, it’d be a little weird if I wasn’t hoping for you to make wise intentional moves to improve your financial situation. But if what you’re chasing in terms of more income or a higher net worth is nothing more than a mirage of happiness, then it’s a meaningless endeavor.
I don’t want you seeking something that can never be found. Along this same line, Will Smith launched a book in late 2021, a few months, by the way, before he launched his right hand into Chris Rock’s face at the Oscars, but it was a memoir entitled Will. For what it’s worth, Oprah called it the best memoir she’s ever read. I don’t know. I feel a little bit like Oprah right now with my book recommendations. That’s the third one already in the first segment of the show. So, you get a book recommendation and you get a book recommendation and you get a book recommendation. All right. I’ll stop.
But one of the things that Will Smith said in this book that parallels this thought of chasing happiness with more wealth was that early in his career, he would be lonely and depressed and struggling and he would cite these external factors, the circumstances, and say things, “Well, I haven’t made it big yet. I’m not super rich. I’m not as famous as I want to be. I’m not dating the women that I want to date.” Fill in the blank. That’s the reason I’m not happy. For him, the height of confusion and depression came when he looked up one day and realized he now had those things. He had accomplished everything he thought wasn’t possible. Weirdly, it didn’t solve his problems. He wasn’t significantly happier.
Here’s how practically this awareness around not always wanting more can assist in your financial success. Well, when you’re not chasing an ever changing imaginary number or the next thing you want to purchase that’s likely not to make you happier, you become willing to live within your means, because you’re content with where you are. When you live within your means, you’re able to save money. The more you save, the more secure you feel, the more peace of mind you have regarding your situation. When you have more peace of mind around your situation, you’re less likely to take unnecessary risks and your entire financial life starts compounding and snowballing in the right direction.
So, if you’re with me on this, you’re thinking, “All right, cool, John. More money, more problems. I got it,” or at least more money, not less problems. Contentment’s the key. Let me share with you five tips to finding contentment in the here and now. The first is give, save, and live in that order. You see, for most people, the personal finance equation goes like this. Income minus expenses equals money left over to save and give. However, this is not the way that the wealthy of contentment live. The reason is because it subjects your financial future and of course your contentment to the whim of what your expenses are.
So, again, if it’s financial contentment you seek, you need to reverse the equation to look like this. Income minus giving minus saving equals remaining living expenses. Number two, stop comparing yourself to others. The Jones aren’t as happy or as rich as you think they are, especially what they’re showing you on the Gram. Spend half as much time on social media as you currently do. Boost your contentment because you’ll stop seeing everyone else’s unrealistic highlight reel. Number three, change your environment. Your environment plays a major role in your contentment, and there are two areas in particular that deserve your constant attention.
Number one, your community. Number two, how you choose to fill your time. Spend your time and your energy around people who themselves are content, who are positive, who are encouraging. The fourth tip to finding contentment in the here and now, say goodbye to debt. If you want to find fulfillment in your finances, you need to make every effort to get out of debt. I’m talking about everything outside of your mortgage. It might not be easy. I’m not minimizing the sacrifice, but it will be fulfilling and it will be worth it. The fifth and final tip, learn about personal finance. Would you trust somebody that barely understands finance to handle your money? I hope not. But by that logic, can you honestly trust yourself?
The very fact that you are listening right now to the show tells me that you want to learn about personal finances, and that’s great, because the more you know, the better decisions you’ll make in your financial life. So, to quickly recap those five tips, give, save, live, stop comparing yourself to others, change your environment, say goodbye to debt, and learn about personal finance. Speaking of contentment, if you listen to the financial pundits, there is a lot of negativity with the state of the markets and the economy right now. All we’re hearing is that the economy’s slowing, inflation’s high, the Feds raising rates. We’re in a bear market with people worried about lower corporate earnings moving forward. But let’s take a moment to look at the other side of the coin.
The Fed is aggressively raising rates. Why? Because we can’t cool off the economy, because it’s too good, unemployment’s too low. So, this isn’t 2008 or 2020 where we had systemic issues, a global pandemic, a financial crisis. This again is that things are too good. Currently, stocks are trading at under 20 times earnings. Meaning from a historical perspective, the valuations are back in line with how they typically trade. They’re not overpriced. While we all know that we should be greedy when others are fearful and fearful when others are greedy, the reality is it’s a whole lot easier to say, “You’re not afraid of snakes until the snake’s thrown in your lap.”
Then how do we react? And I thought our president, Peter Mallouk, did a great job of explaining some of the optimism that should surround this current environment on his podcast with our Director of Financial Education, Jonathan Clements entitled Down the Middle. Take a listen.
Peter Mallouk: I think what people are worried about and people who have seen us talk would say, “Well, employment’s very low. What’s the problem? Why is there a bear market?” It is so low and demand is so high and there are still disruptions to the supply chain that you take the combination that the Fed lowered rates, Congress, and the president’s handed out a ton of money, and we have supply chain issues and immigration issues and everything else. You have unemployment so low and demand so high that prices are carrying to higher levels too quickly. As they’re raising rates, what’s different about this market isn’t just that there’s a lot more outs here.
So, people are worried with the stock market because they’re saying, “Look, the Federal Reserve, oftentimes when they raise rates, they accidentally raise them too fast or too much and then you go into a recession.” The home builder goes, “I’m not going to build as many homes.” The employer says, “I’m not going to hire as many people because I’m not confident that down the road the economy will be strong.” So that’s why the stock market’s reacting negatively, that there won’t be a soft landing, that the Federal Reserve will screw it up. But what is different is that when you raise rates, you are making it easier to get out of a jam later. So, with 9/11, the tech bubble pandemic, 2008, 2009, you have rates near zero.
If another problem happens, well, what’s the Federal Reserve going to do? I mean, it can’t take rates any lower. It can keep printing money, but it can’t take rates lower. Here, if they overdo it, if they mess it up, what are they going to do? They’re going to lower rates until they go back and right size this thing. So, what we’re going through now is a short term disruption. The Federal Reserve, are they going to land the plane perfectly on their runway? I’m pretty certain won’t.
Hopefully, it’s just a little bumpy. We don’t go sliding off the edge of the cliff, but they have outs here. They did not have outs, they did not have off-ramps with the last four significant bear markets. That’s another very big difference here. The other thing I’ll say is we have never in the entire history of the United States had a severe recession with low unemployment.
John: So there you have it. It’s not all doom and gloom. There are certainly reasons to be optimistic about the future.
Announcer: At Creative Planning, our wealth managers work with in-house CPAs and attorneys to ensure your money is working as hard as it can for you every day. Give your wealth a second look at creativeplanning.com and connect with a local advisor. Now back to Rethink Your Money, presented by Creative Planning with your host, John Hagensen.
John: I’d like to share with you one of the simplest yet most underutilized tax benefits available to the masses and that’s around health savings accounts. You’ll hear them referred to as HSAs. Drew Blessman, a certified financial planner here at Creative Planning, posted an article on the four overlooked benefits of health savings accounts. I’ll have that article in its entirety at creativeplanning.com/radio. If you would like to go back and view this, you can do so there. To discuss HSAs a bit more, I have back by popular demand, Creative Planning’s Director of Tax and Rethink Your Money’s go-to tax expert, Candace Varner. Candace, thank you so much for spending a couple of minutes with us.
Candace Varner: Thanks for having me back, John.
John: We’re talking HSAs today because I see a miss often. So, can you kick us off maybe by explaining the basics? What’s an HSA and who can contribute?
Candace: HSA stands for a health savings account. This is a qualified account that you contribute to. Think of it like an IRA, but it’s specific for medical costs. So, you can contribute every year that you are covered by a qualified high deductible plan. What makes a qualified high deductible health insurance plan are some specific limitations on the minimum deductible and the max out of pocket and things like that, but what you need to know is that it’s not Medicare that’s going to automatically exclude you and otherwise your health insurance plan should specify.
So, some of them will just have it in the name, HSA qualified, high deductible plan, or other things, but when you enroll, it will specify if you can contribute. As long as you’re on one of those plans, you can contribute up to $3,650 if you’re single and $7,300 for a family every year.
John: Well, I’ve seen people get thrown off by HSA or an FSA. How do those differ from one another, Candace?
Candace: That is a common confusion point. An FSA is similar in that it’s for medical costs and you defer out of your paycheck into it, but the FSA has to be used by the end of the year. So, if I put in $5,000, I have to know I’m going to have $5,000 of medical expenses to reimburse myself by the end of the year or usually a grace period after the end of the year. if I don’t use it for those qualified purposes, I just lose that money, which no one likes.
The HSA can go on forever. So, it’s one of the reasons that we like it. You can contribute those maximum amounts and then you don’t need to use any of it. You can let it grow your whole life if you really want to, but until sometime down the road, you might have medical expenses, which is more likely because most people’s medical expenses are towards the end of their life.
John: HSAs have triple tax benefits, which is a unicorn from a tax perspective. What, Candace, is that trifecta referring to?
Candace: This is one of those fun things for tax. I know there’s not a lot, but usually when I’m talking to people, everything else I’m talking about is a deferral. So, you put money in now pre-tax like an IRA, but you’ve got to take it out later and pay tax. This one is different, it’s special. So, we get to put that money in pre-tax, meaning I get a tax reduction now. It’s going to grow tax free as long as I have it in there with no requirements as to what I take it out. And then as long as I take it out for qualified medical expenses, I don’t pay tax then either. So, I get to escape tax the entire time, which makes it tax beneficial on the way in while you hold it and as it comes out of the account.
John: Well, you heard it here from our Director of Tax, Candace Varner. If you’re looking for a simple tweak to immediately improve your tax situation, you may want to start with an HSA. Candace, I know you’re busy. Thanks so much as always for your time.
Candace: Thanks for having me.
John: So just as a lot of things are within our life and within our finances, while we’re looking for the next best thing, we might want to pause and just say, “Are we even maximizing what’s available to us right now?” I find as a wealth manager that that HSA is one of the most underutilized tax advantages in personal finance. If you’ve got questions about this and would like to talk with a local advisor, visit us at createaplanning.com to request a second opinion. Well, as promised, I’ve got three tax saving strategies for those of you working as well as three additional tax saving strategies if you’re retired. Let’s start with a three if you’re still working. The first is considering a defined benefit plan. Now here’s what a defined benefit plan is.
It’s a pension plan, and this is most effective the older you are as the owner. If you have very few employees or the employees you have are much younger than you and also not nearly as highly compensated, that is where this type of plan can work incredibly well, because unlike a defined contribution plan like a 401k where the plan rules limit how much you can contribute every year, a defined benefit plan is just exactly like it sounds. You’re able to save an amount for a future defined benefit. So, if you are a business owner in your 60s and you want a really big pension benefit when you retire at 65, you’re able to contribute in some cases seven figures in a year if you’re making that money or at least several hundred thousand a year, all of which is tax deductible.
Now like with any type of retirement plan, there are pros and cons. I don’t have the time to get into each of those today, but if you’ve got questions about defined benefit plans and you’re within maybe 10 years of retirement and have a small business, make it high income that you’d like to defer, this may be a great option for you, but definitely talk with a fiduciary who’s experienced with helping business owners navigate these types of plans. The second strategy for current workers is a backdoor Roth IRA. Here’s how a backdoor Roth IRA works.
It’s a type of retirement savings vehicle that allows you as a high income individual to access a Roth IRA, which if you make too much money, you’re not normally allowed to contribute to a Roth IRA because of the income limits that are set by the IRS. If you’re wondering what those are, if you’re single and make over $144,000, you don’t qualify. If you’re married and make over $214,000, you don’t qualify. So, what a backdoor Roth IRA allows you to do is to contribute $6,000 per year or $7,000 if you’re over 50 due to that extra $1,000 catch contribution and then you immediately convert that non-deductible IRA to a Roth IRA, you’re allowed to do a conversion.
Now be very careful that the rest of your money is in qualified 401K plans and not other IRAs because that conversion will be pro-rata across the board with all of your IRAs. Again, this is important to speak with your CPA or a firm like us here at Creative Planning that can help you navigate this to ensure that you do it correctly. Third tax saving strategy for current workers is harvesting losses. I’ve spoken at length about this in past episodes. The opportunity during times of market volatility is to harvest losses, buy something that is not identical to what you just sold. So, if it’s an individual stock, you cannot sell that stock and then repurchase the exact same stock within 30 days or the wash sale rule applies and you do not get to claim those losses.
But if we’re talking about mutual funds or ETFs, buy something similar and harvest those losses to offset either current gains that you have. Maybe if you’re rebalancing off of all the previous gains of the market the past eight, nine years, maybe you sold a business, maybe you just want to carry forward everything but the 3,000 you can claim for a future year where you have more gains or you sell a business. So, again, those three tips. If you’re currently working, defined benefit plans, backdoor Roth’s, and harvesting losses. Now if you’re retired, you say, “Cool, John. That’s great. None of that applies to me, talking about defined benefit plans. I’m already 70. I’m in retirement. What can I do?”
Well, the first would be you can wait on Social Security and Roth convert. You have a window when you first retire often where you’re not yet forced to take those required minimum distributions. Tizzy Blackburn, a managing tax director here at Creative Planning, spoke about this very thing on a previous Creative Planning Podcast and I’ll let you hear it directly from one of our CPAs.
Tizzy Blackburn:Another option are going to be the individuals who retire prior to 72. So, maybe you’re 62, 65, 66, even 70, and you’re not required to take that minimum distribution yet until you’re 72. You have no earned income coming in anymore. At the end of the day, you’re able to live off of after tax dollars. So, your trust account, your taxable investment account, your savings account. If you’re able to live off of those, your taxable income is going to be pretty low for those years before you’re required to start triggering that ordinary income. So, those Roth conversions are going to be a great option for us to once again maximize the 12%, 22% brackets and be able to get some money working for us tax free growth wise in the Roth in the long run.
Another piece on that would be the more you convert to a Roth, the lower your IRA balances, your traditional IRA, and the lower tax you’re going to have later on because those RMDs are going to be less when you turn 72 as well.
John: So to piggyback on Tizzy’s astute recommendation, when we see big pullbacks in the market like we have right now during this bear market, a conversion’s even more attractive just as it was in March of 2020 during the pandemic stock market crash. Because if you believe the market’s going to recover, it’s ideal that it recovers tax free within your Roth. Second tax savings tip, if you’re in retirement, donate highly appreciated positions. So, often when we give money to organizations, we just write checks. But if you have highly appreciated securities inside of your accounts, you may want to consider donating those securities to that organization, let them divest those and avoid paying capital gains tax.
Keep the cash in hand and then if you want to reinvest it back into those securities at a higher cost basis. The third and final tax reduction strategy if you are in retirement applies to taking distributions with tax bracket maximization in mind. So, what I’m referencing is that determining which accounts to take distributions from, it’s a little bit like solving a puzzle in retirement, but I’ve seen an extra $10,000 of income be taken from an IRA instead of a non-qualified account. That one decision then caused their social security income to be taxed.
They could have taken that from a different location. I’ve seen other retirees sell highly appreciated securities, which then pushed them over the Irma Cliffs, because now with their income too high, Medicare Part B and D, which is means tested, had higher premiums. Their social security benefit went down because more was being siphoned off to pay for the exact same benefit they’ve always had than now unfortunately, they have to pay more for because they’re high income earners. So, understanding how much to take from which types of accounts and the tax treatment of those can be vital to you having a sustainable retirement.
Announcer: At Creative Planning, we provide custom tailored solutions for all your money management needs. Why not give your wealth a second look and learn how the team at Creative Planning covers all areas of your financial life. Visit creativeplanning.com. Now back to Rethink Your Money presented by Creative Planning with your host, John Hagensen.
John: As I was sitting and watching the Bills completely dismantle the Tennessee Titans on Monday Night Football, they went to a commercial break. Although I do not remember the specifics, it was probably right after Josh Allen threw another touchdown pass to Stefon Digs and who popped up on my screen none other than one of our longest standing wealth managers here at Creative Planning.
Tim Sutton was on my screen on ESPN speaking in this commercial all about why customizing your portfolio, looking beyond just your agent risk tolerance is what you should be expecting when having a tailored, unique financial plan as I spoke about last week on this radio program. So, congrats to Tim Sutton. He’s not only a fantastic wealth manager. Now he is a TV star. Maybe days of our lives will be up next for him, I’m not sure, but the sky is definitely the limit. Good job, Tim. Kudos to the marketing team here at Creative Planning for a fantastic ad campaign. Look forward to seeing more of those this football season. Keeping with this Monday Night Football theme, the Bills were the pre-season odds on favorites to win the Super Bowl.
So, you’ve got Bills Mafia pounding PBRs in the parking lot outside the stadium, jumping onto folding tables with this expectation that they are going to destroy every one of their opponents similarly to exactly what happened this last Monday night. Meanwhile, the opposite side of this, as you’ve got fans of Dubbers, Dubbers, Dubbers fully expecting to win like four or five games. If the Bears went nine and eight and somehow snuck into the playoffs, it’d be a dream season. Fans would be ecstatic. If the Bills ended up going nine and eight and maybe snuck into the playoffs with a seven seed, their fans would be wildly disappointed. Why is that? I mean, both teams had the exact same record. It’s because of the gap between expectations and reality.
The wider that gap, the more disappointment we feel, which leads me to my rule for money today. Your expectations, not your account balance, will dictate your financial peace of mind. Just as it’s true with sports, the same is true with the stock market. Let’s talk about proper expectations. The stock market’s down one in every four years. An average correction’s about 14% in any calendar year peak to trough. A drop of 20% or more, what we refer to as a bear market like we’re in right now occurs about every five years. As Barron’s two time financial advisor of the year and our president Peter Mallouk recently tweeted, by the way, you can follow him @PeterMallouk when he said and I quote, “Successful investors know this. If you can’t accept it, the stock market isn’t for you.”
Put another way, if you move to North Dakota and then complain in January that it’s cold, that is a you problem. If you walk outside in Phoenix and it’s July and you complain that it feels like you’re living in an inferno, right? Like you’re Shadrach, Meschach, and Abednego going in the fiery furnace, then your expectations were clearly off. What were you expecting? It’s the desert. Same is true with the stock market. As we’re sitting right now, the NASDAQ’s down about 25% year to date. S&P 500 is down about 20%. Long bonds are down about 25%, which is by the way, totally unsurprising in a rising interest rate environment. Why do we diversify? Other asset categories aren’t doing quite as bad. Small value, down about 8%.
Large value, down about 12. Emerging markets, down 15%. John, give me something that’s up. Well, all right. Well, one to three-month treasuries are up about a half a percent. The Bloomberg gas oil index is up about 70% year to date. The energy sector as a whole is up 45%. Utilities are up 6%. By the way, gold, that great… By the way, I’m saying this sarcastically. … diversifier, down about 9% year to date. I know you gold bugs don’t like me talking about this, but there’s more to come on gold later in the show. I’ll get to that.
So, if what’s occurring right now has you flustered or has you concerned or worried or wondering if you should deviate from your plan, that is not a byproduct of what’s happening in the markets because everything that’s happening should have been within your range of expectations, but rather your expectations need to be adjusted. So, establish a financial plan. Here at Creative Planning, it’s in our name. We are a planning-led firm. Everything begins with the financial plan. That plan needs to account for how it’s going to navigate these sorts of events because you’re not going to avoid them.
So, if you’re thinking, “Well, John, all of those indexes are down and that’s why I just keep my money in CDs and cash. I don’t want to deal with that,” if that’s the expectations that I have to have, that I need to be okay with to accomplish my goals and be in the stock market, then I’m sitting in cash bond and CDs. The problem with that is go put your money somewhere, especially in this inflationary environment that’s guaranteed to lose money from a real return standpoint. So, that’s not a viable strategy either. So, let me share with you five realistic expectations that we are sharing with our clients on a regular basis.
Number one, expect to see your net worth decline and decline often. You will have extended periods of time, such as even several years where the broad stock market loses money. Almost always, if you give it 7 to 10 years, you come out ahead. But about 10% of the time, even over five-year periods, you still have less money. Imagine that, starting with $100,000, doing everything right, shredding your statement for five years, being so excited to come see your account balances, open it up five years later and you’ve got $90,000. That wouldn’t feel very good, would it? You’d probably think something was broken. Well, since the Great Depression, that’s happened a little less than 10% of the time, but it’s possible.
You should expect to have extended periods where you lose money. But that same volatility is also why the stock market has earned about 10% a year for 100 years, which is why you receive massive premiums above treasury rates or CDs or cash. The second expectation you should have is to expect to have no enormous return years. That’s right. If you’re doing things right and you’re well diversified, it means you’re never going to hit a Barry Bonds rioted out home run into McCovey Cove. You’re going to be hitting a lot of singles and doubles. You’re going to take the Tony Gwen approach, maybe the Pete Rose approach, minus the betting on games and getting kicked out of the sport.
Number three, expect to pay taxes. If you are making money, you’ll be paying some taxes. The goal obviously is to strategize in a way where you’ll pay the least amount legally required, but you’re going to pay some taxes. So, don’t be upset when tax time comes and oh wow, I owe taxes on capital gains, because my investments have grown. Just make sure you’ve got a plan to minimize the unnecessary taxes. Number four, expect to be bored. Get your thrills downhill skiing, bungee jumping skydiving, trying to hit the national parks over your lifetime. Whatever gets you going. But as George Soros famously said if investing’s entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.
My fifth and final proper expectation you should have is to expect the unexpected. Throughout the rest of your life, many things are going to happen that you didn’t see coming, that your advisor didn’t see coming, that the best economist in the world didn’t see coming. Because things occur often that are different than before. You’re going to be required to have discipline and fortitude, especially in times where your convictions are tested. What will make you a successful investor is that when those moments come, you were already expecting to encounter them. You didn’t know what they’d look like. You didn’t know how long they’d last. You didn’t know how painful they’d be, but you were expecting to overcome them within your plan. It accounted for these unknowns.
One of the things that you can do to give yourself the highest probability of withstanding those moments, those times where things are really scary and it’s difficult to stay the course, have great accountability. Have somebody help remind you what it is that you know to be true. So, to recap those five expectations for you to have a successful investing experience, number one, expect to see your net worth decline often. Number two, expect to have no enormous return years. Number three, expect to pay taxes. Number four, expect to be bored. Number five, expect the unexpected. It’s time for me to share with you a few of the biggest mistakes that I’ve seen investors make recently because I want you to learn from these and avoid them for yourself.
Number one, we had a client come in who had missed out on taking advantage of net unrealized appreciation. Now if you’re listening and you’re wondering, “What in the heck is net unrealized appreciation?”, you’re thinking the same thing as about 98% of the other radio listeners. The 2% that know what I’m talking about are probably financial advisors. So, this NUA election is only available when you have a stock that is placed in a tax deferred account. So, you own company stock, let’s say, for your current or now a past employer inside your 401k and is only applicable to the stock of the company for which you were employed. It can’t be any other random stock that you own in let’s say a brokerage linked 401k where you can pick individual stocks.
So, here’s an example. You’re getting ready to retire. Generally speaking, which is what this person did, they just direct transferred everything from their 401k into an IRA, including their company stock. Now everything was deferred. That wasn’t a taxable event. But when this person starts taking withdrawals from that IRA in retirement, it’s all taxed ordinary income. Instead, what this person should have done, because the company stock was highly appreciated, they could have elected an NUA strategy.
Basically, what happens is this person would’ve received the stock and paid ordinary income tax on the average cost basis, which again, in this example was low. Then they can defer the remaining tax and that accrues over time until the stock is eventually sold and they pay capital gains rates on the growth between the basis and what their sales price is. A massive opportunity. In this person’s case, it was hundreds of thousands of dollars lost by simply doing what they thought they were supposed to do and transferring their 401k directly into an IRA. So, if you have company stock inside of an employer plan, make sure you talk to someone that knows what they’re doing, like us here at Creative Planning and get advice prior to initiating the rollover.
Another big mistake that I recently saw just reminded me that so often, we’re better off not knowing anything than knowing just enough to be dangerous. Like I know I can’t build a swimming pool in my backyard, I don’t know how to excavate the pool in a perfect shape, and then I have a shot truck shooting in concrete, making it look perfect. I can’t do that, but you know what I can do, unfortunately, build random dressers from IKEA. I remember lamenting to my wife when we were newlyweds, “All I want in life is to make enough money so that we can buy furniture that’s already built. I do not ever want to have to build one of these 22,000-piece dressers ever again where I’m inevitably cursing under my breath halfway through and then it’s missing pieces.”
Then I’m calling some random 800 number because it says, “Don’t take this back to the store. If it’s missing parts, call this number.” You know what I’m talking about. I know you feel sorry for me right now and you should, but sometimes it’s just better if you say, “I am not even going to attempt this for myself.” This was the case with a do it yourself investor who recently came in wondering what they could do to correct this problem that was on their hands. You see, they had four different old 401ks from previous employers and they had read that it would be smart to consolidate those into one IRA. While I don’t know the specifics of each employer plan that they were in, in theory, they were probably correct in that. It would’ve made things easier.
So, they requested a transfer out from all four of these different plans. What they had read is they had 60 days to get that money put back into an IRA so that it wasn’t taxable and there were no penalties because this person wasn’t 59 and a half yet. Well, what they didn’t know was this small little detail that made all the difference in the world. You’re only allowed to do one of those rollovers in any one-year period. They did four. The final three were all taxed at ordinary income with a 10% penalty because they weren’t yet 59 and a half. This is a perfect example of why it can be way more expensive trying to save money by not hiring a professional.
I’ve got one extra bonus mistake for you as well, a client that put everything into long term bonds because why? They were worried about the volatility of the stock market, but when they looked at short and intermediate term bonds, the yield was not generating enough income for them to live on. So, they cheated out on the duration to get a little bit higher income. But as I’ve talked about in previous shows, massively increased risk, especially when you’re sitting in a low interest rate environment with an expectation that rates might rise. So, here’s where they sit now. They’ve got 20 years left to the average maturity on all the bonds. If this individual unloads them now, he’ll lose about $250,000 of his million dollar portfolio.
The problem is, if he chooses not to take that loss, he sits there with now relatively low income compared to what he could receive in current bonds with this flattening yield curve. Assuming none of these bonds default and he receives his principal back in 20 years, it’ll likely be worth far less than half of the million dollars from a purchasing power standpoint. Oh, he’ll get his million dollars back. It’ll be worth about $500 grand, maybe even less because inflation will have eaten away at it like little termites. I mean, this is an abject disaster. The lesson for you is be careful what you wish for. I want to move out of that risky volatile stock market into this seemingly safe long term bond portfolio jumping from the frying pan into the fire.
So, stay disciplined and stay diversified. Those mistakes aren’t shared to make anyone feel bad about their decisions. We’ve all made plenty of mistakes, but hopefully, they’re lessons for you so that you can avoid the pain from similar mistakes.
Announcer: At Creative Planning, we provide custom tailored solutions for all your money management needs. If you have any questions about what you’ve been hearing, visit creativeplanning.com and connect with a local advisor. Why not give your wealth a second look? Now, back to Rethink Your Money, presented by Creative Planning with your host, John Hagensen.
John: One of the many things I appreciate about being a wealth manager here at Creative Planning is that I have the opportunity to interact with some of the top talent within our industry all across the country. Throughout the week, I provide a platform for them to share with me things that have occurred with families that they help, so that I can curate those and share the experiences that I believe to be valuable pieces of information and examples for you to learn from. So, for the next several minutes, I want to essentially invite you into the room, pull back the curtain, and allow you to hear others’ experiences. I’m convinced this will make you a more knowledgeable investor. I said earlier, for all the gold bugs, I’m going to come back to gold.
The reason for this is because anytime the market gets volatile, when we go into a bear market, people start asking me and our other wealth managers about gold. Is it viable? And sure, you can grab a five-year period from 2002, 2007. Gold was up 18% a year and the S&P was only up 13%. But overall, it’s an abysmal long term investment. I mean, just dreadful. It’s why I mentioned in my first book, you should wear gold but not invest in it, because from a risk and return standpoint, it’s lagged behind virtually every other asset category. Consider this. Gold’s price per ounce right now, about $1,600 to $1,700. If you’re curious, you know what it was 10 years ago in 2012? About $1,600 to $1,700 an ounce. It’s gone nowhere in a decade.
Here’s the thing. This is with inflation at 40-year highs. I thought gold was supposed to be such a great inflation hedge. It’s down about 9% this year. Yeah, but gold probably did really well during the pandemic when the world almost ended. That’s why I want to hold gold as well. During one of the greatest economic crisis of the past century, no, it hasn’t moved the last 10 years. Well, but at least gold’s paying really good dividends. So, if the share is sideways, at least I’m getting some nice dividends, some income off of it. No, unless your gold bars in your safe somehow figure out how to procreate, you’re not going to open it and see a bunch of extra baby gold bars running around in the safe.
During this time, even with us sitting in a bear market right now and the rapid correction during the pandemic, S&P is up 170% over that 10-year period while paying dividends. Oh, but at least gold’s really stable. I buy it for its stability. Nope, sorry. No, it’s not. Gold has about twice the volatility as the broad stock market. In fact, the Motley Fool did a piece on gold that showed over the past 200 years, the growth of a dollar, gold would’ve lost you indexed for inflation about 2 cents on every dollar and that was ending in 2016. During that same time, a dollar in stocks was at $599,000. Here’s another crazy thing. Not to rip on bonds, bonds were just under $1,000. Think about the impact of long term compounding. There is nothing like the stock market historically speaking.
So, again, wear gold, buy it for your spouse on Valentine’s Day, but do not invest in it. Second question I received this week, how do I select the best performing mutual funds? So when it comes to private investments, I talked recently about this with our Chief Investment Officer, Jim Williams. Manager selection is critical. The dispersion of returns from the best and worst managers is wide. The predictability for a top manager in the private space is far more likely to repeat than on the public side.
When looking at public securities like a mutual fund or an ETF, your asset allocation is by far the biggest determinant in your risk and returns, not which manager you select, which is why here at Creative Planning, we recommend you go low cost, synthesize the allocation with your financial plan because it’s highly unlikely to find the best mutual fund manager, I’m putting that up in quotes, that will predictably outperform the broad markets. Another example is from some wealthy clients who work with our ultra-affluent group with more than $25 million or more invested and their concerns, which are often not around maximizing returns, but far more around, “How do I not lose what I already have?”
In fact, last month our president, Peter Mallouk was interviewed by Barron’s regarding this very topic and he shared two specific threats to family wealth that lie outside of the capital markets. The first risk that Peter mentioned was not having proper asset protection plans in place, not protecting the assets from creditors and litigation and divorce. We think of these things especially around insurance as, “Ugh, boring insurance, life insurance, disability. It’s just an agent trying to sell me things.” For ultra-affluent families, by the way, and this applies to millionaire next door type scenarios too, oftentimes, the biggest threat to your plan working is not stock market volatility. It’s not having proper asset protection in place.
The second risk that Peter cited with Barron’s is a lack of generational education. One’s control to money passes to errors, it really attracts deal making. So, if you’re a wealthy family, your heirs will constantly be approached with the next great investment opportunity and they’re going to want to make their own decisions, blaze their own trail, but without proper education, they can be far too aggressive and make costly mistakes. So, again, if you’re someone with 25 million or more, we’ve got a specific group and it’s actually the fastest growing segment at creative planning to help you navigate the unique and specific challenges faced when having a higher net worth.
You can go to creativeplanning.com to request a visit with one of our wealth managers who specializes in working with ultra-affluent clients. Another question I received, are there mechanisms to defer more money beyond a 401k? I would say reference what I spoke of in the first half of the show on defined benefit plans. That’s a great place to start. Go to create a planning.com/radio to find the digital version of this show. Another question is, what are some major red flags? My answer to this is simply, if it seems too good to be true, it probably is. There’s no market downside in these equity index annuities, but look at the returns over this cherry picked 10-year period.
In most of those, which by the way, the products vary widely and there’s thousands of them, you should be shooting to outperform CDs or short term bonds by locking up the money and receiving for that lockup an illiquidity premium. Continuing on with that theme, I get asked a lot about annuities. So, I’ll share with you one of the types of annuities that I really like for the right scenario, a fee-based deferred annuity. So, here’s what that is. There’s no commission. There’s no surrender penalty. It’s not locking up your money. It is simply a vehicle where you can have low cost index funds inside of it, but wrap it in this deferred annuity to avoid any flow through to your tax return so it becomes a tax deferred vehicle.
Here’s practically where it can be used. Do you have a really junky, antiquated annuity? Maybe it has some growth in it, but you don’t want to surrender the policy because all the growth that’s been deferred inside of that annuity would come out at ordinary income rates. So, you’re stuck between a rock and a hard place. The same thing can happen with cash value life insurance. In fact, we had a client this week who had a 20-year-old cash value life insurance policy with about a half a million dollars of cash value. So, we were able to utilize what’s called a 1035 exchange for this client, allowing them to transfer the money through this exchange while continuing to defer taxes. So, it’s not a taxable event. That can be a great tool.
Again, there’s no upfront commission, there’s no lockup or surrender period, but it allows you to, in many cases, get to a significantly lower cost, more efficient vehicle than whatever you were sold by an insurance agent in the years past. My final tip is around how to not outlive your money. By far, the biggest concern of those looking to retire or those that are already in retirement and it’s not close is, “How do I make sure I’m never living in my kids’ basement? How do I make sure that I’m not a burden to those around me and I’ve got enough to be financially independent for the rest of my life?”
Andrew Ferrette, a certified financial planner here at Creative Planning, had a piece for our clients that I will post to creativeplanning.com/radio if you’d like to read it around properly planning for longevity. He provides five different tips that I think are fantastic to ensure that you don’t outlive your money. Things like position your portfolio for enough growth and planning for healthcare expenses are just a couple of the suggestions that he has in that article. Again, you can find that at creativeplanning.com/radio, because if you’re like most folks, everything else is details. You first and foremost need to ensure that you do not outlive your money.
I want to end today’s show with a thought that I was pondering while reading a biography on Tiger Woods. Obviously, an immense talent, probably the greatest golfer of all time, but how often, as was the case with Tiger, our greatest strengths can simultaneously be our biggest liabilities? By all accounts, Warren Buffet maybe the greatest investor of all time, but that was his focus was being the greatest investor of all time. There aren’t a lot of things written about him being a really involved parent, because he was laser focused on being the best investor ever. From what I’ve read, other things in his life suffered as a result. I mean, Tiger Woods didn’t just blow up his marriage and his family.
He actually ruined the very thing that he was the best in the world at as a result of his addiction. The same principle is true with our money. Where I practically see this play out is the most successful savers often die with a bunch of money that they never spend. You say, “Well, John, of course, because they saved so much money.” No, it’s not just because of that. It’s because they can’t ever spend it. The traits that made them phenomenal savers are the very same ones that make it incredibly painful to then relinquish that money when they’ve watched it go up for 40 years. You see, the skill of accumulating money is different than the skill to decumulate, whether it’s spending it or giving it away.
So, being good at the first not only doesn’t correlate to being good at the second, it often has a negatie correlation. So, if you’re someone who really prides himself on frugality and discipline and saving, just understand that you’re going to have a hard time and you’re going to need to be very intentional in retirement to begin enjoying hopefully with those that you really love and care about, make memories with to start using some of that money. In closing, here are two tips that I have for you. Number one, have a great financial plan so that you can feel completely confident that you’re not going to run out of money even if you begin spending some.
Number two, have a great estate plan, because when you start understanding that all this money is going to go to these people that I care about anyways, maybe I should do some things today with those people so that we can enjoy it together. Remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
Disclaimer: The preceding program is furnished by Creative Planning, an SEC registered investment advisory firm that manages or advises on $225 billion in assets. 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. This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
Clients of Creative Planning may maintain positions in the securities discussed on this show. For individual guidance, please speak with an attorney, CPA, or financial planner directly for customized legal tax or financial advice that accounts for your personal risk tolerance, objectives, and suitability. 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.