When is it smart to follow the crowd, and when can it get you burned? Join John as he delves into the powerful influence of groupthink and how it can lead to unexpected pitfalls for even the savviest investors. (3:30)
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, why The wisdom of crowds isn’t always helpful when it comes to your investment decisions. The differences of revocable and irrevocable trusts, as well as with higher rates is cash now a good investment? Now join me as I help you rethink your money.
I used to love watching the television show Who Wants to Be a Millionaire? Regis, loved that guy. It’s a great show. If you don’t recall, this was a game show where the contestant needed to answer a series of multiple choice questions and each question was for more money, and if they answered 15 consecutive questions correctly, they won $1 million. But what made it interesting was along the way, they had the choice to just stop and take whatever money they had earned up to that point or risk that money and attempt to answer the next question.
The contestant had three what were called lifelines in the show. They could phone a friend, they could ask the audience, and then there was a 50 50 which eliminated two of the three incorrect answers, leaving just two remaining options, one of which of course was the correct answer, and I have two memories that stand out from this game. The first was a guy who was so stinking smart that he won the $1 million. He never used a single lifeline except on the 15th and final question. He said, I’m going to phone a friend. So re just says, all right, let’s call him up. Who are we doing? I’m going to call my dad. His dad gets on the line and he says, Hey, I’m here on who wants to be a Millionaire? I don’t actually need your help. I’m just calling to let you know I’m about to win $1 million.
It was the biggest flex I think I’ve ever seen on TV. It was fantastic. Of course, he got the question right and the guy went down as a legend. The other memory I have was the person who had someone cheating in the audience, like a family member, and they would cough a certain amount of times to give away the correct answer. Now, in the end, they were caught, didn’t get the money, but those two memories along with Regis wearing the same color tie with his shirt, it was kind of a cool style for a while. I remember that, real trendsetter, but typically the most helpful lifeline was to ask the audience where every member in the studio would individually key in the answer that they believed was correct, and then those answers would be aggregated into a graph that would be shown to the contestant.
The reason that was helpful is because there’s wisdom in crowds. The idea is that conclusions of large groups can, in a sense, be better than even one expert simply because such groups can combine a large amount of dispersed wisdom and life experiences. But there’s one key detail. It only works if the group isn’t influenced. You see, in my example, the Ask the Audience works because they don’t all get together for 10 minutes and discuss what they think might be the right answer before each votes, they go purely off of their own thinking. It reminds me, I recently took my kids to SeaWorld in San Diego and one of the entrance lines was four times shorter than the other seven. This is where group thinking can be influenced. Everyone assumed, oh, that line must be for VIPs or something’s going on. I mean, it’s way shorter than the others, and so everybody sits like idiots in their car waiting in longer lines.
This is an example where social influence can actually lead us astray. It’s easy to become anxious as an investor. It’s particularly easy to become anxious when there’s a war in Europe, a war in the Middle East. Markets are gyrating and stocks and bonds are both down over the last two years, inflation spiking, the Fed’s raising interest rates. And so what do you and all of us as human beings do in times like these? What our human nature leads us to do, which is we reflexively look around to see what everyone else is doing. The herd must be right. Group thinking is better than my own, and then we tend to just follow the herd. Here’s the problem when it comes to our money, historically speaking, when you follow the herd, you get slaughtered when it comes to investing. The wisdom of a crowd is better than one, but not when the whole crowd is doing the same thing, being influenced by one another and the media.
Let me give you five examples from history, and by the way, I will share a chart on these historic bubbles to the radio page of our website at creativeplanning.com/radio where you can also request to meet with a local wealth manager just like myself here at Creative Planning. Tulip Mania. Yep, none of us were alive. This was back in the 16 hundreds, but it was the first recorded bubble in history and it was so ridiculous. That’s why you hear about it and it’s used in examples. It was a period during the Dutch golden age when contract prices for some bulbs of the recently introduced and fashionable tulip reached extraordinarily high levels. The major acceleration started in 1634 and then dramatically collapsed in February of 1637. 10 grand would’ve gone up to about $190,000, and then within three months, all the way back down.
Next we had railway mania in the UK. This was an instance of a stock market bubble in the United Kingdom of Great Britain and Ireland in the 1840s, and it followed common patterns. As the price of railway shares increased, speculators came in and invested more and more money, which further increased the price until the share price eventually collapsed.
Three more recent examples, the dot-com bubble. The Nasdaq was down over 80% during the dot-com bubble bursting. Then we had the great financial crisis or the housing bubble back in 2008 and 2009, where real estate prices rose steadily for decades, which were supported of course by low interest rates and anyone who could fog a mirror qualifying for a mortgage. And my fifth and final example is the Bitcoin bubble. Bitcoin’s value soared by 5000%, but as of now, Bitcoin is still down about 50% from its all time highs. A classic bubble where the influence of others and the excitement of others and the fear of missing out drove prices higher without really any application or use case at the moment.
And rather than blindly accepting my advice that you’ll likely get slaughtered if you follow the crowd, I have some fund flow numbers that will bring the point. Home investor flows show us how much money is entering a stock or an asset category or broadly just the stock market as a whole or into cash or how much is leaving, like where’s the momentum? And I’m going to post this chart to the radio page of our website as well showing equity fund flows. And if you look during the pandemic, the third week of March when the market was down 30% plus, and of course no one knew what was going to happen next. We were in the middle of a global health and economic crisis. People were bailing out of the market. The stock market is truly the only place on earth where when things go on sale, everyone runs out of the store.
If we look at historic returns, 8 to 12% a year in the stock market, and we assume there will be mean reversion, meaning if the market’s up 40% a year, it’s probably not going to continue. It’s going to work back to its averages. If it’s down 40% in a year, it’s thankfully not going to persist and continue to lose 40% year after year, when looking broadly at history. Well then if the market is down in value and it’s going to work back to its averages, it certainly wouldn’t be a time to sell. But we follow the herd and as people start selling and the price drops, more and more people continue to sell. United States stock funds had net outflows of over $50 billion the last two weeks of March, which we now know was the bottom during the pandemic, we had more people selling at one of the best possible times to buy.
This wasn’t unique to the pandemic though. In October of 2008, over $60 billion flowed out of stock funds as the market was tanking that we know bottomed out in March of 2009 and was the single best time to purchase stocks since the Great Depression. But the influenced thinking of the group accelerated outflows. And so to summarize this, what can you learn? The first is that you’re not going to be successful if you just follow the crowd. In fact, when it comes to investing, you’d be far better off being fearful when others are greedy and greedy when others are fearful as Warren Buffett so perfectly put it, basically just doing the opposite of what the group is doing because the average American makes less than half of what the market returns, you’d be way better off. Oh, everyone’s selling in 2008, I’m going to buy. Secondly, when you are feeling emotional, remind yourself that it may be due to the fact that timelines with investing and life are incongruent.
Luna, our youngest of seven just turned two years old. She won’t even be in kindergarten for three or four more years. A lot’s going to happen the next three or four years. I mean, think back on your life over the last four years, we went through the pandemic, that happened over the last four years. You may have changed jobs, moved, had another kid retired, lost someone in your family that you love. Four years is a long time in our life, but it’s a blink. It’s a short time horizon when it comes to your money. And so when we’ve gone through a period like we’ve seen the last couple of years where stocks and bonds are both not performing well, we become fatigued because it feels like a really long time within every other context of our life. But if you’re investing in things like stocks or private equity, real estate, those are long term investments.
Seven years, 10 years, 15, 20 years, shoot, Luna will be out of the house. That’s the type of time horizon you want when it comes to your stocks and reminding yourself of that long time horizon can help you not to be a victim of the moment. So I want you to ask yourself the next time you’re looking to make an investment decision, what’s driving this decision? How influenced is your choice by what others are doing? Instead, contact a firm like us at Creative Planning. It doesn’t need to be creative planning, but contact someone who is credentialed and experienced. We are helping over 60,000 clients and have been working with families for 40 years. A firm that’s acting in your best interest, it’s a fiduciary. They’re not selling you commissionable products and get a second opinion. Where might my blind spots be? What might I be missing?
And if you haven’t had your plan reviewed recently or you don’t have a written documented dynamic financial plan, have that done. If you’re not sure where to turn, visit creative planning.com/radio now to speak with a local wealth manager to have your plan built or reviewed. Why not give your wealth a second look?
Few topics are as personalized and as nuanced as estate planning. To give to charity, to give more to your children, maybe attempt to spend it all. If you choose to give, do you do so while you’re alive? Do you wait until after death to ensure that you have enough for your own retirement? If you’ve got living wills, pour over wills, financial powers of attorney, medical powers of attorney, acronyms like GRATs, CRUTs, ILITs, and a hundred others just to confuse you. One of the most common questions I receive as a wealth manager pertains to trusts. Specifically, John, do I need one? If so, would it be a revocable trust or an irrevocable trust, which would be more appropriate? And to help me unpack this today, I have an extra special guest who lives in this world every day. Annie Rogers is an estate planning attorney here at Creative Planning with a mountain of experience on this topic. Annie, thank you for joining me again here on Rethink Your Money.
Annie Rogers: Hi, thanks. It’s always a pleasure.
John: Revocable and irrevocable trusts are very different from one another, but because they’re both named trusts, one is regularly mistaken for the other. I’ve had clients say, I don’t need one of those. When the conversation of a trust comes up and they’re referencing an irrevocable trust that their wealthy aunt put in place who has a $30 million net worth, others who need a revocable trust come in saying, I need one of those trusts that my family member has. It’s called I think, an irrevocable trust. I need one of those. And of course, it’s by mistake. It’s confusing. They sound similar. It’s just an extra IR at the beginning of the word. So today I want you to help us sort through both revocable and irrevocable trusts, and let’s begin maybe with what are the primary differences, Annie, between the two?
Annie: In the simplest of terms, a revocable trust can be amended or changed or revoked, and an irrevocable trust except for a few kind of limited circumstances is irrevocable. It can’t be changed, so it’s permanent, so it’s a bigger deal because you’re creating and funding this irrevocable trust, and so you want to make sure it’s right because you can’t go back and change it later if you change your mind.
John: That lack of flexibility pertaining to irrevocable trusts certainly give clients pause in general with the word trust. When they associate all trusts with irrevocable, that’s what they’re envisioning. Expensive to put together, additional complexity, lack of control and flexibility. So let’s focus though on the far more common revocable trust. What are the primary uses?
Annie: Revocable trust is more than 90% of the time what people need. You can amend it. It provides flexibility. It is kind of a basic estate planning option to avoid probate and pass assets onto your kids or family members or loved ones without having to go through that whole court proceeding to do that. It gives you more flexibility with distribution provisions. The nice thing about it is the person who creates the trust, the grantor still owns and controls all the assets. They don’t have to use a new tax return. Once they’ve created this trust, everything’s still reported on their individual or joint return. Depending on how the trust is structured, the social security number is the tax ID, it can plan for incapacity. So you have people that are managing the assets if you can’t, whether you’re incapacitated or pass away.
We can also add some estate tax planning in there, especially if you’re married and you have a joint trust, there’s some language we can put in there to make sure we’re utilizing both of your exemptions if we need to try to eliminate a state tax for your beneficiaries. There’s a lot of flexibility and these are things you can change over time. And my daughter’s 13, she’d probably love this, but I always joke that the jury’s still out. I don’t know how responsible she’s going to be with money, so I have this today, but in 10 years I’m going to have a much better idea of where she’s going in live and how I think when she’s an adult, what makes sense.
John: Don’t hold her as a 13 year old, don’t hold it against her. I’ve got teenagers too. Don’t hold it against them, at least I don’t want to be judged for what I did as a teenager. Right? Yeah, that’s great. One because it’s flexible, because it’s in the social security number of the grantor. It doesn’t provide asset or creditor protection, which is sometimes what people are looking for with that trust. So that’ll lead us over to irrevocable trust. That’s one of the reasons why someone might want an irrevocable trust because they’re actually getting it out of their estate. It lacks flexibility, it’s more cumbersome, but it achieves creditor protection in most cases. What are some of the other components of an irrevocable trust?
Annie: Except for a few exceptions, and if there’s the right provisions in there, they can’t be modified. Usually there’s some provision for designated a new trustee if there isn’t one that can serve, or if the beneficiary of the trust is not meshing with that trustee, maybe they can be removed and a new one named. Irrevocable trust, oftentimes the grantor cannot be the trustee. So that is a downside of this because people want to create these trusts and get assets out of their estate, but they still want to control the assets in there and they want to be the beneficiary of it.
John: They’re like, Hey, can I get this out of my estate, get all the asset protection, remove it from my estate for potential estate tax purposes, but I still actually want to have full control of everything and still be able to use all the money.
Annie: Right. And that’s not how it works.
John: Yeah, exactly. I know. Dang it. That would be so nice if we could do that.
Annie: Yeah, totally. So if you create one for asset protection for yourself, you can be the beneficiary of it, but you can’t be the trustee, but it also doesn’t provide any estate tax planning because it’s still part of your estate, and you can’t do that if you have a pending claim or think there might be something coming your way with a creditor, you can’t do that because that’s fraud. So I get that question every so often. I’m like, yeah, it’s too late.
John: I’m about to lose everything. Can we get it out of my state and into an irrevocable trust? Nope, sorry.
Annie: Yeah, no, not yet. You have to pre-think that and you don’t want to do it with all of your estate because then you’re giving somebody else control over everything. Probably the most common irrevocable trust we do is called an intentionally defective grantor trust. People will do some lifetime giving and that reduces what they can leave at death that won’t be subject to estate tax. So right now the estate tax exemption is 12.92 million. If you give a million dollars to your kids, now you have 11.92 you can leave when you pass because you have to file a gift tax return and report to the IRS that you made the gift.
The beauty of this is, I mean you don’t really want to give any money that you still need. So if you can afford to do it, you put it in this trust for your children. Somebody else has to be the trustee, the kids are the beneficiaries, but generally don’t take the money while you’re still alive so that $1 million is growing while you’re still living, even if they don’t get it till you pass away. So really, if you put 1 million in there and you live another 25 years, you may get five or 6 million out of your estate that won’t be subject to estate tax. So it can be a really powerful tool.
John: That’s the biggest thing that I found people miss is they say, well, if I’m going to reduce my estate exemption, that almost $13 million by a million, what’s the advantage? And what they’re missing is all the future growth of that account is outside the estate. So instead of you eating up $5 million 20 years from now of your 13 or what we expect to be a lot lower with its sunsetting and wealth inequality, and who knows, this is the highest it’s been in a long time at that 13 million, you’re using up some of it, like a million of it, of an already high exemption to potentially down the road have five or 10 million that would’ve been in the estate. And I think that’s what people miss is the growth happens outside of your estate once the gift is there. I’m speaking with creative planning, estate planning attorney Annie Rogers about revocable and irrevocable trusts. What other types of irrevocable trusts are there outside of that defective grantor trust?
Annie: So another one that’s pretty common, especially when the exemption goes down is an ILIT, which is an irrevocable life insurance trust. And so basically you create this irrevocable trust that will own an insurance like a whole life insurance policy, and people use their annual gift exclusion amount to pay the premium, so they gift that into the trust and the trustee pays the premium. And so when that insurance is paid out upon your death, that whole amount is not considered part of your estate like it would be otherwise. And then that can often provide liquidity that may not otherwise be there to pay estate tax. This is a really powerful tool for people that own a lot of real estate or people that farm and things like that.
John: Privately held businesses.
Annie: Like land rich, cash poor, and so this can provide some cash there to pay estate tax if that may be due at the end of the day.
John: Absolutely. A lot of our larger ranchers, farmers in the Midwest, I’m thinking of where their desire is for the next five generations to hold on this entire farm and their kids are working the land with them currently, and that’s a huge part of the ethos of who they are as a family. But if that farm’s worth $50 million or a hundred million dollars, they’re going to have a huge tax bill come due when the parents pass away and if there isn’t money elsewhere, the only way they’re coming up with that is by selling off part of the land that they have no interest in selling. That’s the perfect scenario for those listening saying, well, when would you want to utilize that? John, I’ve heard whole life insurance isn’t a great investment vehicle. Why would we do permanent insurance? This is one of the rare scenarios for a wealthy family with illiquid assets, right? Maybe the family has a $200 million business, they can’t sell off part of the business, they need to keep it, they don’t want to. This is a perfect case for that ILIT. How about a CRT Annie?
Annie: So a charitable remainder trust, I do a lot of these and they provide a lot of benefits. People like it because they still get something back from it. So on this one, you can be the trustee and the beneficiary over the course of your life or for a term of years. And the way this works and the most beneficial way to use this is if you have some highly appreciated assets that you’re using to fund the CRT.
John: Because you eliminate the capital gains.
Annie: Because you eliminate the capital gain. I have clients in California that have worked for companies where they have a lot of stock, they have concentrated stock, and so they’re wanting to diversify, and so they will fund some of those shares into the CRT and then also sell some of the shares for themselves. But when it goes into the CRT, you have to take at least 5% annually during the term of the CRT. Usually it’s between 5 and 10%. The less you take, the more charitable deduction you get at that same time because you’re anticipating what the charity is going to get at the end of the term. And so a lot of times I have clients who create a donor-advised fund to name because then you can update the charities all the time and have a lot of flexibility there.
John: And it doesn’t complicate it yet.
Annie: So you get 5% of what’s ever there. If it’s drafted as a crutch, which is a unitrust, say you put a million dollars in there, you get 5% of whatever’s in there on January one, and you can pay it out monthly or quarterly or annually or however you want to structure it over the term of that period. And then at the end, the remainder goes to charity, but you get the charitable deduction today. So that can help offset the capital gain for any of the shares that maybe you’re selling just individually that aren’t in the CRT, and it can really help people diversify and eliminate some of the capital gain tax that may be due.
John: Yeah, so if you’re a business owner, this is where I see this often, business owners sells a company, has a massive capital gain event, is charitably inclined. That’s a key component to this. If you’re not charitably inclined, it doesn’t make any sense. But if you’re already wanting to give money to charities and you’re having an abnormally large year from a capital gain standpoint, this is a great way to say, well, this is going to get to charity anyways. Help me get it today. And we’re talking about CRTs. There’s CRATs. If you’re listening and you’re confused and you’re going, wait, what are all these acronyms? Speak with a really good attorney who does this all the time, like Annie and our team here at Creative Planning, if you’re not sure where to turn, you can visit us at creativeplanning.com/radio. Definitely don’t go about this alone. You’re going to want some professional guidance.
It needs to be set up right. There’s a lot of options in terms of how much you want to give to the charity, which will affect the deductible amount and all of those sorts of things, but it can be personalized. And I think the other lesson here is for most people, it’ll be a revocable trust which is less expensive and has all the flexibility. If you’re a higher net worth individual or someone looking for asset protection, an irrevocable trust may be the right option, but only with the portion of your portfolio that you’re willing to essentially part with.
Annie: Even doing it simultaneously. You need the revocable trust first because that is just the basic estate planning.
That’s the foundation.
Annie: That’s the foundation. So we do that first. It’s a lot when you’re talking about these things, it can be overwhelming, just probably us talking about it right now. This sounds complicated, so we kind of take it one bite at a time. Let’s get this basic stuff done first and then let’s look at what your assets are and what the exemption is. And this is something we’re constantly evaluating. I was just talking to another attorney and the exemption may reduce by half in 2026. So in 2025, there may be a lot of people that are needing to take advantage of some of these irrevocable trust options.
John: Back in the day when the exemption was at a million dollars, a lot of people needed irrevocable trusts, and I think some people still are thinking, well, my parents had an irrevocable trust and they did this AB trust thing that I don’t really get how it worked, but there was an AB trust. Do we need that? Well, now your net worth is 2 million. You’re married, you’re not at the 25 million. We expect that to come down. We know it’s sunsetting. So this sort of planning will become increasingly important in the upcoming years. So thank you so much for helping us make sense of the differences of irrevocable and revocable trusts, Annie.
Annie: Yeah, you’re welcome. Good to be here
John: Probably at least once per month when meeting with a prospective client and discussing their financial priorities and their goals and their concerns, especially if they’re in retirement, they’ll say, I just don’t like gambling, John, with my money in the stock market. Usually they’ll follow that up with something to the effect of that’s why I buy CDs or I just own rental properties, or I put everything in annuities. But the important piece of this is establishing what it means to be a stock market investor. Because I find that that definition varies widely. Someone might say, well, I don’t like living in Arizona because it’s way too hot. Well, not if you’re in Flagstaff, half the state is in the mountains. Parts of it are over 7,000 feet elevation and have weather more similar to Denver certainly than Phoenix, but both places are in Arizona. Same is true with the stock market.
If you’re on Robinhood or a similar trading app during the pandemic trading individual stocks all day long, yeah, you’re gambling. I would understand a retiree or frankly anyone saying, I’m not comfortable doing that with my life savings. And the reason that’s wise is because the odds are that you’ll likely underperform the broad markets potentially by a lot, and if you do it long enough, you’ll likely end up going broke because it’s statistically probable that you’ll eventually own Washington Mutual during the great financial crisis or AOL in the early two thousands. You’ll make one mistake over 30 years of essentially gambling with your money that is so costly that it destroys your financial plan. So no one is disputing that, just like no one’s saying Phoenix isn’t hot. When I talk about investing in the stock market, I’m assuming you’re broadly diversified across multiple asset classes.
You’re low cost and you’re in it for the longterm. And in that case, is the market really gambling? Is it like a casino? Well, let’s look at the odds of winning in various casino games. Keno 23%, terrible game. Who is playing keno? 23% odds. Slots are about 40%, roulette 45%, let it ride 47%, blackjack 48%, craps 48%, and baccarat 49%. We all understand that the longer we play in a casino, the more likely we are to lose. The odds are in the casino’s favor. That’s why they have these giant casinos and offer you free cocktails the whole time you’re playing. They want to keep you in there. There’s no clocks. There are no windows. Keep you gambling because the longer you do, the more the house is going to win. It’s easy to leave Vegas after one day and be up because with craps you had just under a 50% chance of winning.
But when applied over long periods of time to the law of large numbers, the house always comes out ahead and you will always lose given enough time and assuming you’re not the MIT card counters where you’re doing something to increase your odds, but on the flip side, the longer you’re in what we would call the stock market game, the more likely you are to win. If you put your money in the stock market today, the odds of your return being positive next year are about three out of four. Imagine you walk into the Bellagio. That beautiful music’s playing. The fountains are going with the light. There’s blackjack and poker and slots, and this new game called the stock market game. What is this? Somebody tells you, oh, well this game is kind of amazing because over a one-year period, you’re up 73% of the time, you beat the house, five year periods, 92%, 10 year periods, 97% and 15 year periods, 99.9% of the time you win.
If that were the case, you would play that game for the rest of your life as quickly as you possibly could, but the biggest challenge for all of us is not walking away from the table at the wrong time. Gosh, the Bellagio Buffet crab legs, they’re calling my name. I’m going to go away from the table. I’m not winning a lot right now anyways, I’ve lost three straight hands, and by the way, I get it. At the Bellagio, they pre-cut those crab legs. You don’t even have to work to get the meat out. Then they have the little bowls for the melted butter. It’s delicious. I mean, I haven’t had it in five years, but just talking about it, my mouth is watering and yeah, this isn’t a show about health, okay? So don’t judge me. You can feel yourself gaining weight while you’re sitting there eating these crab legs that have butter dripping off of them.
By the way, side note, is there a better example of sunk cost bias than delicious buffets, right? Because once you pay, it’s all you can eat. And I mean, if I’m not sick walking out of there because I’ve overeaten, I don’t feel like I got my money’s worth. Every single bite I take, no matter how full I am, I’m just saving a little more money in my mind. This is how irrational we are as humans. I go to the most expensive items that will be the least filling, and I fully admit to judging the person sitting next to me with a giant bowl of pasta. I’m like, this person doesn’t get it. They just don’t get it. I’m off track and now I’m hungry. But in summary, your odds long-term investing in the stock market are phenomenal. I find it unintelligent when people say, I don’t want to gamble in the stock market.
What are you talking about? And if you’re in agreement with me, but you’re kind of thinking to yourself, well, I’m in retirement, ask yourself how much of your money will not be spent over the next five to 10 years? So if you’re 70 years old, are you going to be broke at 75 or 80? No, of course not because if you’re still alive, now you’re in your kid’s basement. Any of the money that’s in your portfolio that are still going to be unspent when you’re 75 or 80 in this example, should be in the stock market if you are pragmatically playing the odds, because again, 93% of the time over a five year period, you make money in a diversified stock portfolio. If you have any questions about your investments or your financial plan, taxes, estate plan, visit creative planning.com/radio now to speak with a local wealth manager just like myself. Why not give your wealth a second look?
Well, our first piece of common wisdom to rethink together is that cash is the most basic investment. No, it’s not an investment because cash isn’t working for you. Think of cash as something working for the bank. If we go back to the last full decade starting in 2010, and you look at the estimated $20.4 trillion of cash and the annual income that it has generated, let’s assume it’s a hundred grand in a one year cd. After inflation, you have been negative all but one year. Here’s how cash should be used, unforeseen medical expenses, home repairs, car fixes, unemployment. Yes, you should have an emergency fund with three to six months depending upon the predictability of your income, whether it’s sourced from two different spouses or one in cash for emergencies, and that right now can be in a high interest savings account earning some decent yield, but referencing the odds that I just talked about related to the stock market, the longer you sit in cash, the more likely you are to underperform.
In fact, Morningstar did a study on this going all the way back to 1928, so the last 95 years, you had a 31% chance of overperforming the stock market in cash on a one year period over a 10 year period that dropped to 16% likelihood that you’ll overperform in cash versus a diversified stock portfolio, and over every rolling 25 year period, your odds of cash outperforming stocks was 0%. Now this data isn’t particularly profound. The stock market goes up more often than it goes down, so more often than not, stocks are going to outperform cash, but here’s the less obvious piece of this. How much do you lose with this opportunity cost? It’s not just that 70% of the time over a one year period, the market’s going to outperform cash. It’s how much does it overperform on average over a one year period? It over performs by 8% over a 10 year period, 158% over a 25 year period going back to 1928, cash will underperform stocks by 1281% when compounded.
The lesson here is clear. The opportunity cost of sitting in cash is enormous and it grows exponentially over time. Cash is not an investment. It’s to be held for short-term needs, knowing the bank is making money off of you, you’re the mark. The bank is making the money. If you have excess cash sitting on the sidelines possibly because you’re just not certain where to invest it, it all starts with a financial plan to identify your objectives, your income needs, your risk tolerance, your time horizons, and countless other factors. It’s important that you get your questions answered because after all, this is your life savings. Our last piece of common wisdom comes from legendary hedge fund manager over at Bridgewater and Associates, Ray Dalio, who said that right now is not a good time to own debt.
Now it’s helpful I think if we set the stage with the fact that here’s someone worth tens of billions of dollars who is judged in a hedge fund, very much on short-term performance. And so what are the advantages you have as a main street investor is that you don’t have to worry about what happens the next two months or four months or even year with your portfolio. You should be focused on your long-term goals and putting together a strategy that provides you the best opportunity and probability for achieving those goals. Dalio was quoted as saying, I don’t want to own debt, bonds and those things. Here’s what he was actually saying. He’s only holding short-term debt, and his point was because we have an inverted yield curve. What effectively that means is that shorter term bonds are paying you a higher interest rate than longer term bonds, and that is atypical. Normally, if you are willing to lend money, they’ll pay you a higher interest rate if you let them have the money for a longer period of time before they have to pay you back your principal.
Well, the opposite’s true right now. Practically, what does any of this mean for Mr and Mrs Retiree? Well, my take is there’s likely never been a better time to be a bond investor. You’re earning interest rates that are higher than at any point in the last 20 years and whether or not you should own a one year bond or a five-year bond or a 10 year bond depends primarily on your broad financial plan, but I think it’s important that we pause for a moment to identify why we even own bonds in the first place within a portfolio. I mean, why do we own an investment that we fully expect to drastically lag in performance behind our stocks? I mean, our bonds are probably only going to earn half of what our stocks earn, maybe less than half. Why do we even want them then?
We own bonds to create stability and a buffer for our stocks to be volatile and have enough time to work back to their phenomenal averages. That’s the only reason we own bonds is to minimize portfolio volatility. And they accomplish this a few different ways. Number one, they have far fewer down years than stocks. Number two, the years that are down are on average down a whole lot less than the stock market can be down in a negative year. And third, they almost always zig when stocks sag.
Well, it’s time for listener questions and as always one of my producers, Lauren is here to read those. Hey, Lauren, how you doing? Who do we have up first?
Lauren Newman: Hi John. Our first question comes from Jeff in Coolidge, Arizona. He writes, hello, I’m writing on behalf of my son. He’s in his late thirties and has been making small student loan payments since graduating college in the two thousands. Now that the pause and payments has ended and forgiveness seems to be off the table, are there any good options for him? Is there a way for him to repay his student loans and still hit other financial goals like retirement savings?
John: Well, Jeff, your son is not alone. There are about 45 million borrowers that collectively owe $1.7 trillion in student loans. The first step is for him to look into the new save repayment plan that President Biden’s administration just announced. It’s an income driven repayment plan, so the less money he makes, the more beneficial the plan, and it’s worth noting that it’s not driven by total balances. So if he has a very high balance and is a reasonably high income earner, the save program may not be best for him. The save plan reduces the percentage of discretionary income that can be used toward loan repayment down to 5% from what used to be 10% for undergraduate loans. Now for graduate loan payments, they’re still capped at 10%. In addition, the plan increases the definition of what discretionary income is from income above 175% to now 225% of the federal poverty level.
So essentially you can make more money and still qualify. That alone will cut payments significantly for millions of borrowers and many middle income borrowers could even see their required payments fall all the way to zero. Now, Jeff, your son and you may have heard of the on-Ramp program, but I’d only suggest he uses that if he actually cannot make the payments. On-ramp allows for a 12 month period before any payments are needed without affecting your credit score or piling up any penalties. Now, the downside and why I said I’d only use this in the event of an emergency is that interest still accrues during those 12 months. Another aspect of that save plan, which is by the way, replacing the old repay plan, I know it’s confusing all these acronyms, is that any remaining loan balance is forgiven after 20 years for undergraduate loans or 25 years if you have graduate loans.
If your original balances were $12,000 or less, forgiveness will now happen after only 10 years of repayment. Your son can apply for the save plan at studentaid.gov. And so more broadly, from a financial planning perspective, once your son identifies exactly how much those payments are going to be and which programs he qualifies for, I recommend he recalibrates his budget looking at this new expense, then put all savings and all payments, and I recommend giving as well, on autopay. This isn’t advice specifically for someone with student loans. This is advice for all of us. What gets automated gets done. And then of course, additional evergreen advice would be does he have a financial plan? If he’d like a written documented dynamic financial plan and isn’t sure where to turn, our 60,000 clients are in all 50 states and over 75 countries around the world, he can visit creativeplanning.com/radio to meet with a local advisor. All right, Lauren, who’s next?
Lauren: Okay, so our next question comes from Dolly. She’s in Charleston, South Carolina and she writes, my husband and I have 31 million saved for retirement, which puts us over the federal state exemption amount. We would like to know about strategies for mitigating taxes for future planning. I’m 58 years old and my husband is 60.
John: Well, first off, congrats. You are in a fantastic spot and it’s very typical that high net worth individuals are concerned about taxes. The more money you make and the more money you have, the bigger the potential dollar amounts are that you’re losing to the IRS. And estate taxes, also known as a death tax is one of the most punitive for those individuals over the exemption amounts as you are, Dolly. And I actually reached out earlier in the week to one of Creative Planning’s barons, top 100 independent financial advisors here in 2023, Jessica Culpeper, who works with many of the wealthiest families that we serve here at creative Planning to see if I was thinking about this answer the same way she was and we agreed that at this level of wealth in particular, it’s very important Dolly for you to understand first and foremost what your goals are in terms of funding your own accounts as well as what you’re considering for generational wealth transfer.
And that’s to family, kids, grandkids, and or charities. And in fact, how much you plan to give to each does matter significantly from a tax standpoint. We still want somewhere in that three to seven year range of fixed income to cover any spending needs that you have. And while maybe those of you listening are thinking to yourself, well, they have $31 million, like, why do you still need to buffer your volatility of stocks? Well, we still don’t want to have to sell stocks in a down environment like we’ve seen the last 18 months. We want pieces of the portfolio available, and I’ve interacted with clients who have this type of wealth that spend $75,000 a year and others that spend a million a year or 2 million a year. So spending patterns differ widely amongst the affluent.
So Dolly, once you’ve determined how much you personally need and then how much you want to give to charity and how much you want to give to other generations, then I want to better understand how you feel about risk. Because many affluent clients feel they’ve hit their asset and portfolio size goals and they have more than they need for the rest of their lives. And so they choose to be more conservative because frankly, they can. And you can, assuming you’re not spending at a 10% withdrawal rate, but others know they have plenty so they can withstand big market swings and they want little to no bonds because they want to grow their assets as much as possible for the next generation.
This is why I advise whether it’s us here at creative planning or another firm, it’s important that you lead with that type of financial planning because the financial plan itself will answer these questions and then direct us toward the tax and investment strategies most appropriate for you. Obviously, total performance is important, but what you keep after taxes and fees is more important. Do you own the right investments in the right buckets to maximize that after tax return? Bonds, real estate, private lending, private real estate, put that in IRAs, large cap developed markets, private equity generally in taxable accounts, emerging markets, small cap and Roth IRAs?
And then even further, if you’re dealing with trust for the benefit of kids or different generations, owning equities and alternatives there generally make sense as well. Tax loss harvesting also becomes incredibly important to add real after-tax returns for someone in your situation. Are you working with an advisor who truly understands this and is implementing it or are they maybe only looking at your accounts in December and trying to potentially harvest losses? Because in many cases the opportunity’s gone. You want to be rebalancing strategically throughout the year, not just at the end of a quarter or the end of a calendar. And finally, while minimizing income taxes during your life is certainly important, minimizing estate taxes is even more important since the estate tax rate is 40%, you are married and your net worth is over that combined exemption amount of 24.84 million. So I imagine something motivating this question is that you don’t want the government to take 40% of every dollar over that amount.
I mean, it’s a huge amount of money even without future growth. You’re still relatively young at 58 and 60, and it may be worth considering some advanced estate planning strategies utilizing irrevocable trusts in an effort to use up some of your exemption at today’s dollars and then receive the subsequent growth outside of your estate. So I know this was a long-winded answer, but you have a complicated situation. We have an office there in your area and be happy to sit down, visit with you in much more detail. If you have questions, do as these listeners did, and email email@example.com.
Regina Brett is a New York Times bestselling author, a Pulitzer Prize finalist, and an inspirational speaker. And the night before Regina’s 45th birthday, she wrote an article titled 45 Lessons Life Taught Me and they instantly became very popular. The article was shared by thousands of people from all over the world, but it wasn’t until one final version included a picture of a vibrant gray-haired lady that the 45 lessons became a viral hit and the name of the article changed to 45 lessons from a 90 year old. Now, while you’ll hear people say, oh, it’s a young person’s world and so much innovation and new ideas come from younger generations, there is so much wisdom that can be found only in life experience. Think about what your perspective was 20 years ago versus today, and then imagine what it will likely be 10 or 20 or 30 years from now when you’ve lived and experienced so much more.
I believe having mentors in our lives that are older than us can help us fast track what we otherwise may have only painfully learned through our own mistakes along the way. And while I’m not going to share all 45 life lessons, here are 10 that jumped out to me and I hope you find insightful as well. Number one, life isn’t fair, but it’s still good. Number two, when in doubt, just take the small step. Isn’t that true about so many things in life? Every great journey started with one step. When you look at compound interest and long-term wealth, it has to start somewhere and often it’s not a lump sum of a million dollars. It’s small incremental steps consistently over long periods of time in the same direction. Number three, pay off your credit cards every month. Probably the most valuable advice in all of personal finance, you will not meet someone who is successful with their money and carries credit card balances with over 25% interest.
Number four, make peace with your past so it won’t screw up your present. Buddha said, do not learn how to react. Learn how to respond. I remember playing baseball with a good buddy of mine, and if he struck out early in the game or he made an error at shortstop, you knew it was unlikely anything good would come out of the next six innings from him. His past mistakes impacted his future performance, and if we’re not careful, this can happen with relationships, it can happen with our careers, and it can happen with our money. Number five, don’t compare your life to others. You have no idea what their journey is all about. There’s never value in comparison. Either it causes pride and arrogance because you’re doing better than whoever you’re comparing yourself to or greed and envy because you don’t stack up. But to Regina’s point, you may be comparing yourself to someone who is playing a completely different game.
Number six, get rid of anything that isn’t useful, beautiful or joyful. The addition by subtraction. Number seven, whatever doesn’t kill you really does make you stronger. One of my favorite Bible verses in James says, consider it pure joy, my brothers, whenever you face trials of many kinds, because the testing of your faith develops perseverance and perseverance must finish its work so that you may become mature and complete, not lacking anything. Another great quote from Winston Churchill says, if you’re going through hell, keep going. You will not live a life without pain and difficulty, but there may be no other circumstance where we grow in our character and we learn more about ourselves and are better off in the long run because we experienced it. Number eight, no one is in charge of your happiness but you. And I’d add to that, happiness is much more rooted in your perspective than in your circumstances.
Number nine, frame every so-called disaster with these words, in five years, will this still matter? I’ve been doing this personally over the last couple of years since creative planning President Peter Maluk mentioned this very exercise to me, and it really works because most circumstances in your life when run through that filter, you realize not only is this not going to matter, I’m going to have forgotten about this in way less than five years. And the 10th and final lesson from a 90 year old, however good or bad a situation is, it will change. You can fear change, but it won’t stop it. Change is inevitable. I hope these 10 lessons were as thought provoking for you as they were for me, and that you reflect on these over the coming week. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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Disclaimer: The proceeding program is furnished by Creative Planning an SEC registered Investment advisory firm that manages or advises on a combined 245 billion in assets as of July 1st, 2023. John Hagensen works for creative planning and all opinions expressed by John or his guests are solely their own and do not represent the opinion of creative planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you’d like our help request to speak to an advisor by going to creativeplanning.com, creative planning tax and legal are separate entities that must be engaged independently.
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