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Inside Look: A Wealth Planning Case Study (Part 1 of 3)

Published on February 12, 2024

John Hagensen

Is your financial plan truly complete, or could it be missing something? Over the next three weeks, join John as he uses a common client situation to walk you through what a complete wealth plan should include and how having one can dramatically impact your retirement outlook. (8:54) Plus, Creative Planning Attorney Annie Rogers joins the show to clear up some common misconceptions about estate planning and show you how to ensure your needs are met. (13:47)

Episode Notes:

Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!

John Hagensen: Welcome to the Rethink Your Money podcast presented by creative planning. I’m John Higginson, and ahead on today’s show, three lessons that you can learn from market declines, the giant great area of personal finance, as well as a simple task that may be great for your financial future but should not be combined with Valentine’s Day. Now, join me as I help you rethink your money.

Every generation faces its share of challenges and I think there are three important lessons that we can learn from past market declines. Creative Planning President Peter Mallouk wrote an article on this very topic a couple of weeks ago. On October 28th, 1929, the Dow Jones Industrial Average began a nose dive that lasted until 1932 where it closed at, this number will blow your mind if you know anything about the Dow today, at 41.22, it was an 89% decrease from its pre-crash high. This period of falling markets of course kicked off the Great Depression and the market didn’t recover fully until November of 1954, but it did recover. So investors who remained invested in the market throughout the Great Depression were poised to experience a 168% return over the three subsequent years after the market bottomed down. And that scenario has repeated itself throughout history. Markets tend to recover even in the face of seemingly insurmountable declines.

And of course in the moment, everyone’s running for the hills and thinks this time is completely different. And by the way, usually the specific event that is causing the market crash or the prolonged bear market, it is different. But I’ll post a chart to the radio page of our website @creativeplanning.com/radio, which is also where you can go if you’d like a second opinion from a credentialed fiduciary like myself. This chart illustrates though how remaining invested throughout periods of market volatility has the potential to pay off over time. Shows events like the Great Depression that I just referenced, Black Monday, the Gulf War, tech crisis, financial crisis, trade war, COVID, I’ll just share a few of these with you. The financial crisis was down 55.3% followed by a one-year return of 79% and a three-year subsequent return of 122.5%. Remember, the trade war, market dropped 18%, one year forward return 37.9%, and the three year was up 111%, and even COVID, down 35% before you could blink an eye, the one-year forward return following was up 85.6%.

And wise investors understand this, that there’s a benefit of maintaining a long-term investment outlook and not getting spooked when volatility rears its angry head. And it’s important to not only intellectually know this, but really think it through emotionally because the market never drops in a vacuum. When you’re sitting there comfortable and someone says, well, if the market dropped 40%, what would you do? Oh, I’d rebalance and I’d Roth convert and I’d make tax trades and that’d be a great opportunity. Buffett says, “Greedy when fearful and fearful when greedy”. I’ve got this all figured out, but those market drops don’t occur in a vacuum. The economic news is terrible. Things in your life that are impacting your day-to-day suddenly look bleak. But it’s that idea that you can say you’re not scared of a snake, but how are you going to react when one is thrown in your lap?

And there are three great lessons that span generations that we’ve learned through market declines, one after another, and the first of those lessons is trying to time the market often does more harm than good. Don’t mistake activity for control. Now of course, if it were possible to time the market, we would all be billionaires. It’s important to keep in mind that the best days in the market are often concentrated around the worst days in the market. So selling out to avoid a potential drop means you may miss out on the full benefit of a recovery. Let’s look at the value of $10,000 invested in the S&P 500 January of 2003. Let’s just run it forward 20 years to the end of 2022. You did nothing. You just shredded your statement and lived your life, kept it in the S&P. You would’ve gone through the great financial crisis, which was the worst drop since the Great Depression.

You would’ve gone through COVID obviously, a trade war, our debt being downgraded, like some stuff happened during the 20 years. It wasn’t all unicorns and rainbows, but if you just stayed invested and forgot about it, your 10 grand grew to $65,000. This is going to blow your mind though, if you just missed the 10 best days, not over a month or a year. If you missed the 10 best days over the 20-year period, meaning you were invested essentially the entire time other than 10 days out of 20 years, your 10 grand didn’t grow to 65,000, it grew to 30,000. You lost more than half of your returns by being out of the market on only 10 days, but they were the wrong 10 days to be out of the market. That’s how dangerous it is. If you missed the 60 best days, your 10 grand not only wasn’t it 65 grand, you lost money, your 10 grand was at $4,200 after 20 years because you missed the 60 best days.

So lesson number one, don’t try to time the market. Lesson number two, it’s important to remain invested, but it’s also important to ensure that you have cash or safer investments on hand during times of volatility. What if something happens in your life? The most common, retirement, you don’t have a paycheck anymore, but sometimes you may lose your job and now unexpectedly, I don’t have a way to pay for my daily living expenses during this period of time before I can find a new job. Well, that’s why it’s important to keep some cash on hand in an emergency fund, and that’s why it’s important to have safer investments like bonds to buffer a period of time that allows your stocks to get back to their averages, because there will be down markets about one out of every four years and there will be bear markets and crashes once or twice every decade.

So three to six months of living expenses for an emergency fund is fantastic and somewhere between five and 10 years of a buffer of bonds for what may be needed from the portfolio is also prudent to avoid the need to sell your investments anytime you don’t want to. And the third generational lesson of stock market declines is that volatility can enhance long-term returns. You shouldn’t just say, well, I deal with volatility. You should wrap your arms around volatility. You should give it a big hug. This is why I get the return premiums I get. If you are a saver, if you have yet to retire, if you are not at a point in life where you are taking money out of your investments, you should be rooting for down markets. I know it feels completely counterintuitive, but you should be hoping that the market drops 25% and stays down like we just saw this last bear market, stays down for an extended period of time so you can continue to buy shares at a lower price.

Think about this in any other context of life. If you’re a real estate investor and you’re buying rentals, you’re not selling your rentals, you’re buying them. Do you want prices high or low? You see, when it comes to the market, the only time you want the market high is when you in fact are selling positions. So to recap those three lessons from past market declines, trying to time the market does more harm than good. It’s important to remain invested, but to do so, it’s going to require that you have a buffer to weather the storm. And lesson number three, volatility is actually your friend when it comes to long-term returns. But the biggest key to not only surviving a down market but thriving and coming out of it on the other end better off is by having an actual strategy in place so that you’re not acting impulsively or are surprised and caught off guard by the next bear market.

If you’d like help evaluating your financial plan, maybe you don’t have a written documented detailed financial plan and you’d like one from a financial advisor that’s not pushing product and looking to sell you something but rather offering you a clear breakdown of exactly where you stand. That’s what we’ve been doing here at Creative Planning for over 40 years. We help clients in all 50 states and over 75 countries around the world. Why not give your wealth a second look by visiting creativeplanning.com/radio now? Well, I think it’s helpful to learn from the experiences of others so that hopefully you can glean wisdom and also avoid potentially some of the mistakes that others before you have made so you don’t have to painfully suffer the consequences for yourself and it’s because of that that over the next three weeks, we’ll together walk through an example of a couple who came in and saw us at Creative Planning.

We’ll refer to them as John and Jane Smith so that you can learn from some of the recommendations that we provided. Maybe those apply to you but also so that you can see what in my opinion, financial planning should look like. The first visit is all about John and Jane Smith. What is going on in your life? What brought you in today to speak with us? Why’d you reach out? Because let’s face it, we don’t sit around and think to ourselves, this would be great to go see a financial advisor. I can’t wait to go do wealth management and tax planning and have an attorney look at my estate plan. That sounds like a great way to spend a Thursday. No, we reach out because there is a problem that we want solved. There’s a situation that we are unsure of, that we want confirmation, that we want an answer to, and that’s the primary focus of this first visit, figuring out what’s going on.

Why are you here? So John and Jane Smith are 63 and 61 years old. They’re in their prime earning years right now. They want to retire in the next five years, and they came in with three primary questions that they wanted answered. Number one, where are we sitting from a financial independent standpoint? If we want to retire in the next five years, what does that look like? My question is, well, what do you like to spend? What’s your lifestyle require? They’ve grown accustomed to a real comfortable lifestyle that requires them to spend about $200,000 of income per year. One of the things we’ll need to solve for in the planning process is are they on track to actually maintain that lifestyle throughout retirement even if they live to a hundred years old? Or one of them passes away at 70 and the other lives to a hundred, are they financially independent?

Can they pull the plug on their jobs between now and five years from now and do the numbers work and do they work index for inflation because that’s the key, right? Their money will have to double over the next 20 to 25 years just to keep up with inflation, meaning 25 years from now that 200 grand is going to be 400,000. Will they be able to make that happen? The second thing they shared with me is legacy is really important to them. They want to have enough savings in retirement to create memories with their family while they’re alive, and then also they want to have something left over for the next generation. So does their current financial plan allow for plenty of short-term expenditures while still building generational wealth? Is that didn’t play for them? And their third priority was funding education. They currently have two grandkids and they want to set aside funds in retirement to contribute to their future education.

They want to know what the best option is for setting aside about 150 grand for each kid, so 300,000 total for their future education and ensuring the funds are passed down as intended. John and Jane brought copies of all their statements, which I will scan into their client file and use for our next visit together. But for the sake of this first conversation, I just want to have a feel for their bigger picture situation and that is that they have about $3 million invested, a house worth a little less than a million with a mortgage balance a little over 300 grand, giving them a total net worth of around $3.5 million.

In a nutshell, they’ve done a fantastic job saving. They’re family oriented, but they’ve never had a documented financial plan put together. They each have their retirement accounts through their employer. They’ve done a good job saving in after tax accounts, they have great equity in their home, they’re looking to retire in a few years, and really the purpose of them wanting to go through the planning process is how does all of this fit together from an investment standpoint, from an income standpoint, legacy, taxes, how about our estate plan?

Which by the way, they did a will about 15 years ago, so they’re interested in evaluating that and they’ve never had their CPA talk to their financial advisor. Their advisors never reviewed their tax return. They’re wondering from a tax standpoint, what might they be missing and are their investments aligned with their current income, with their expected future income in retirement to ensure they’re not paying the IRS one penny more than legally required and they kind of suspect they are because they haven’t had any centralized strategy that takes into account their taxes and their investments.

Next week, I’ll share with you exactly how I walk John and Jane through the initial planning process, not to provide all the detailed recommendations, but for them to feel confidence in exactly where they currently sit as it is today relative to their retirement goals, relative to their legacy goals and relative to this future education for their grandchildren goals. Where do they currently stand? Are they on track or not?

My special guest today has helped families all across the country establish estate plans that fit their unique needs. Creative planning partner and attorney Annie Rogers. Thank you for joining me on Rethink Your Money.

Annie Rogers: Hi, thanks for having me.

John: Well, before we jump into our discussion, I want to point out another great opportunity for listeners to expand their knowledge if they’re interested. You are hosting a webinar with Seattle managing director and certified financial planner, Carlos Lopez, titled Why Estate Planning is Essential to Your Financial Success. That is on February 27th at noon central time. So for those interested, you can register on the radio page of our website, that same spot where you can request a visit with us, that’s creativeplanning.com/radio to register for Annie’s upcoming estate planning webinar again, the 27th of February at noon Central.

Well, Annie, in a perfect world, every American would have an estate plan, their documents would be in place, they’d be updated regularly, but we know we live busy lives. That’s not the case for so many and that’s why these conversations are important and your webinar is important. Annie, estate planning is not entirely about what happens after death, even though I think that’s how oftentimes we think of it. It also includes directives regarding incapacity as well. So what happens if you don’t have these documents in place and you become incapacitated? What does that process look like for people?

Annie: Unfortunately, somebody has to go through a court proceeding on your behalf to be named a guardian of your person, so who can determine medical decisions or your care. And then also a conservator for financial decisions, so who is paying your bills and managing your assets and you have to hire an attorney and you have to be evaluated by a doctor. Often the person, if they’re incapacitated, has their own attorney that’s a guardian ad litem, somebody who’s evaluating what’s in your best interest, and it can take a while. It’s costly and it may not be the person you want doing that for you.

John: So, Annie, what’s the general timeline? What’s the cost process? What does that look like if a plan’s not in place?

Annie: I work with lots of clients in California and fees can be statutory. The statute sets the cost, which is what it’s like in California where there’s a graduated rate that graduates down based on the size of the estate. Sometimes it’s reasonable hourly rate and the court approves it, but in California it’s statutory and I calculated that if someone had a $2 million estate that went through probate, the attorney’s fees themselves are like $30,000.

John: And people say, oh, if I get a full estate plan done, it might cost two to $3,000. Do you know how much this will cost if you do not get an estate plan done?

Annie: Well, and it also ties it up for a long time. In every state there’s a statutory period, and this only happens once you file the petition with the will or if you don’t have a will. It’s pursuant to what the statute says on who gets your stuff, but you have to leave it open for creditors to make claims usually for six months where they can say, oh, you have outstanding credit card bill or you owe this debt or whatnot. So it’s kind of a hurry-up and wait situation. You’re saying these are the assets, you have to publish notice to creditors so they have an opportunity to make claims. All those debts have to be paid before anything gets distributed out to your loved ones. Probate is public so people can look up in the probate record who’s opened up a probate.

Here at Creative Planning we have attorneys that handle that side of things and I handle more of the drafting of the estate planning documents, but I used to get letters at my old firm all the time from people who are flipping houses and things like that saying, oh, we want to buy your house from the estate. Do your clients want to sell this house? So they can look all that up. People know what your kids are getting and when they’re getting it can make them targets. There’s no privacy. It always takes longer than you think it’s going to and if there are multiple beneficiaries, even if you’re going to waive hearing, there’s always one beneficiary who’s not signing the waiver to send it back so you could move on to the next step.

John: Well, that was the other aspect that I was just thinking about too. Nothing you mentioned even hits on contested probate. We’re not even talking about a scenario which is very common when there is no plan in place and there are no documents, you have a lot of different mouths to feed. Every family’s unique and have different dynamics and oftentimes not all agree on exactly what should happen if there was no plan in place, which can complicate the time that it takes to actually receive any of the assets and the cost for attorney fees. But the more important stuff-

Annie: Family stress.

John: Like family relationships, can be just hemorrhaged because of that. Okay, so we know we don’t want to go through probate. It’s terrible. We need those documents updated. What are the best ways to avoid this horrible situation that we call probate?

Annie: Some people have simpler situations. You can avoid an asset going through probate if you have a checking account and you have a beneficiary on it.

John: POD, TOD?

Annie: POD, TOD, or you have a joint account that goes to the surviving spouse or surviving account holder. But beyond that, if there’s not an owner or a beneficiary, then it goes through probate so that solution doesn’t work for everybody.

John: Let’s talk about the most practical ways people avoid probate.

Annie: So, the primary way is creating a revocable trust, which is a document we create that establishes this entity that holds assets. So either they hold the asset now or the trust is the beneficiary upon your death, and it depends on the type of asset.

John: Talk to an attorney about that. It depends upon the taxation and other components.

Annie: So that’s the funding of the trust, but you can dictate who manages this for you if you become incapacitated or if you pass away. Who is your successor trustee? Who gets the assets? How they get it if they are minors. My daughter’s 13, so I’m always using her as an example, but I used to joke, she’d blow all her money on Legos and now it’s Starbucks and Sephora now that she’s 13. But you update how mature you think your kids are and how they get access to the fund. So maybe you want them to be 30 before they can take it and manage it themselves, but until then you designate someone who can pay for college or pay for their healthcare needs or if they need a car, make sure it’s a Honda and not a Lamborghini. Based on what’s in there, they’re helping make sure the money is invested in growing.

John: The follow-up to that is that minor children cannot inherit money directly.

Annie: Correct. So they’re going to have to get a conservator named if they are named as a direct beneficiary on an account. So then if that happens, there’s court oversight until they’re 18 and they get the money, which is probably too young in most cases, but the conservator has to give an annual accounting to the court to make sure that money is being used wisely on that child’s behalf. So it’s not a great plan.

John: I’m speaking with Creative Planning partner and estate planning attorney Annie Rogers. What kind of decisions Annie, do people need to make in order to establish that plan?

Annie: On a regular basis I’m telling clients that it’s better to have a plan in place and be 90% right and you can tweak it over time than to not have a plan in place at all.

John: That’s a good point.

Annie: And it does make for a much smoother transition and you can create this trust and then amend it over time because there are law changes, the people in your life may change that you think are the best suited to serve in these different roles.

John: It’s going to change. You should expect it to change, right?

Annie: Yeah, and we would draft this in a way that it’s going to grow with you and have some flexibility, but you can’t forecast 50 years from now who the right person’s going to be to make your healthcare decisions.

John: Who are some of those people that you need to be thinking about when you’re drafting your estate plan?

Annie: Who would be the best suited to make your healthcare decisions? Who would be the best person to handle financial matters for you? Who’s going to pay your bills and file your taxes if you’re incapacitated? Who is going to be the trustee for your kids when you pass away if they’re not getting access to the funds right away? Who do you want to name as guardians for your children? If something happened to you and you have minor kids, who’s the best one to continue raising them until they’re 18? Also, who are your beneficiaries? If you have kids, usually it’s those.

Some of the decisions you have to make or how you feel comfortable with them getting access to the funds. If you don’t have kids, it’s always harder. Do you want to leave assets to charity? Do you have loved ones you want to receive a portion of your assets? And it’s a whole lot easier to do that through a trust versus trying to put different people as beneficiary designations because you can tweak it and you can say, I want this charity to get $10,000 upon my death. You can’t really do that on your IRA unless you put a percentage.

John: Yeah, I think those are really good points. It doesn’t need to be this over weighted huge decision that feels ominous because it’s irrevocable. If we’re talking about a basic estate plan, it could be changed whenever you’d like it to be changed, it should be reviewed and updated I think you would agree on a regular basis and certainly as life is changing. I know the guardianship resonated with me because when we had one or two kids, we had my wife’s parents and then we had more kids and more kids and more kids, and we ended up with seven kids and they were getting older and older and older, and we were looking at it going, they’re really tired after being with our kids for two days.

They cannot have seven kids in their seventies. So it’s a perfect example that life is going to change around you and your plan not only can be updated but should be updated along the way. But the first step is get the basic documents in place, have a plan for what you do know for today and then be willing to recognize that it’s probably not going to be perfect.

Annie: I feel like I’ve done this enough where I’m asking pointed questions that kind of help narrow it down.

John: A great attorney can help prompt the things that you’ve already heard asked a thousand times so you can see around corners that the person isn’t thinking of because it’s their first time doing this, and that’s where great advice can be helpful.

Annie: So, if we’re asking the right questions, we can at least get you in the right direction to help you make those decisions.

John: Yeah, absolutely, and I can attest our team here. Annie’s not scary. She’s easy to talk to, and it also doesn’t mean that you’re going to die immediately following doing this. Like the whole thing of I don’t want to get life insurance because then I’m going to die. No, you’ll be fine. It doesn’t change your outcomes if you get your estate plan done.

Annie: It really is about peace of mind. At Creative Planning you have your binder with all the stuff, all the financial information, all the estate planning documents, and creating a roadmap for your loved ones on what happens if you can’t do it yourself.

John: Annie, thank you so much for joining me here again on Rethink Your Money.

Annie: Always a pleasure. Thank you.

John: Well, Morgan Housel, the great financial writer, said it best when he said, “A lot of financial debates are just people with different time horizons and different opinions and different life experiences talking over each other. There’s a common wisdom that there’s one correct strategy. Like financial planning and investing, it’s black and white. There’s right and there’s wrong”. Personal finance is so much more personal than it is finance. Here’s a perfect example. Let’s say you had two 60 year olds. They both want to retire in seven years. Both have $1 million saved. Both have $4,000 a month coming in from social security between them and their spouse. They both want to spend about $75,000 per year in today’s dollars. Well, isn’t there a correct strategy for them? Shouldn’t they both do the exact same thing? Well, of course not. What if I told you that one of them has longevity in their family and the other one has already been battling cancer, totally different life expectancies.

What if one’s going to inherit money and one’s caring for an aging parent who has no money and they’ll likely have to support, maybe one has kids and passing money onto their kids and grandchildren is a high priority while the other is hoping the check to the morgue bounces. One’s charitably inclined the other isn’t. What if one filed for bankruptcy during the great financial crisis of 2008 and the other’s had a very smooth ride, a lot of stability in their childhood with their money and as well as their experience throughout their adult life? One wants to buy a second place in a warm location and Airbnb it. The other wants to downsize and buy an RV and travel the country. You see, even when you find people who are identical on paper regarding assets and income and expenses and even their age, their plans will and should be customized to them and should look completely different and unique because the qualitative aspects of their plan are nothing alike.

Everything is situational, whether it be your financial plan, whether it be in life and certainly in sports. It’s actually why I’m going to rant here for a moment. I hated Detroit Lions head coach Dan Campbell’s assertion that we’re aggressive and that’s what we do and that’s why we go for it every time on fourth and less than a couple of yards on the short side of the field. It’s why the little analytics graphic that pops up during NFL games on the broadcast, it says, here’s the situation and then it spits off whether they should kick a field goal or whether they should go for it is incomplete because that doesn’t factor in things like do I have a play call that I’m confident in if we go for it? Did my best offensive lineman just limp off the field before the play and now we have a backup tackle trying to block one of the best pass rushers in the league?

Did my kicker feel pretty good in warmups kicking into the wind this direction? Oh, it just started raining. See, these are things that would have to be considered and aren’t when purely looking at the analytics, when purely going with the approach of saying, well, this is what we do. This is what we always do. Yeah, you can be the backward hat guy, that’s fine, that’s who you are. But if you’re at your sister’s wedding, that may be a situation where you throw some gel in your hair and put some dress pants and a button up on. It’s situational. And this is why you have to rethink this notion that there’s one right strategy to financial planning and there’s one way to invest your money. No, there isn’t one correct strategy. It must be customized to your unique needs and it must be dynamic because situations dictate change.

Well, it’s an election year and there’ll be a lot of talk about that moving the market, but you could really insert any hot topic of the month into that blank and say, well, that’s going to move the market. But in reality, it might a little bit in the short run if you’re a day trader, but in the long run it’s future expected earnings that dictate market prices. You’ve got millions upon millions of market participants deciding together exactly what they’re willing to buy and sell a stock for or a bond for or a piece of real estate for. Warren Buffett said, “In the short run, the market is a voting machine, but in the long run, the market is a weighing machine”. Short-term movement of the market is all about supply and demand, which can be dictated a bit by sentiment. If more people want to sell a security than want to buy it, the price is going to drop.

If more people are looking to buy, then sell, the price will increase to find that equilibrium. But in the long run, sentiment tends to align with what those fundamentals actually are. So we need to rethink the common wisdom that the hot topic of the hour is going to move the market because over the long run, and that is what you should be as a stock market investor, a long-term investor, it has little to no impact on where the market will be 5, 10, 15 years down the road. I had a client the other day that was confused and thought that percentage of gains and percentage of losses were equivalent. And this is an important concept to understand, but actually losses are more impactful than gains. Let’s suppose you were down 20% last year and now you’re up 20% this year. So you started with $100,000, you go down to 80 grand when you lose 20% and then the next year you’re up 20%.

No, you’re not back to $100,000. You’re at 96,000. Wait a second, how can that be? Well, again, $100,000 loses 20% takes it to $80,000, then you gain 20%, but 20% not on a hundred grand. Remember, you’re only at 80,000, which is a $16,000 gain, which brings you to $96,000. In fact, you would’ve needed a 25% gain after that 20% loss to get back to your hundred grand. Now annuity and life insurance salespeople, they use this principle as one of their main pitches for why you should never ever want your accounts to go down in value. However, you fail to mention, if you only make two, three, 4% a year, yeah, it’s great that it never goes down. You’re still far worse off than being up 75% of all calendar years and when you’re up being up at a lot higher percentage than the quarter of all years that you’re down in value.

But it is important to understand the concept that if the market were to close down about half of all calendar years and the down years were similar to the up years, you would be losing money in your account. You wouldn’t be treading water and staying even because again, there is a greater negative impact on losses than the positive one to equal gains. Ideally, your dollar cost averaging and buying automatically when things are down in value to offset some of that volatility and you’re rebalancing as well. And if you’re retired, you may be not contributing anymore, saving more money, but you should still be rebalancing and buying more while things are on sale. But the key is you need a strategy for those losses in down years or they can submarine your financial future. And it’s also important for us to admit our minds can easily play tricks on us.

This is just one example of something that is kind of confusing and not as it seems on the surface. So make sure you have good advice, objective advice from a fiduciary who’s not looking to sell you something to ensure that you’re not getting fooled. And of course, if you need any help, you can visit us @creativeplanning.com/radio to request a second opinion.

Well, I heard the other day that all debt is bad and should be avoided. That’s not uncommon. You’ll hear that from time to time. There are several nationally known pundits that are not just against bad debt but anti debt in its entirety. And frankly, that just doesn’t make a ton of sense, especially considering that I just mentioned that personal finance is a lot more gray than it is black and white. The Motley Fool had an article a couple of years ago that listed the 19 companies inside the S&P 500 that had no debt.

Think about that for a moment. The biggest, most successful companies in the United States, 481 of the 500 carry debt. Why would Amazon or Apple or Microsoft, why would they carry any debt? Don’t they have enough money to get themselves out of debt? Well, they carry debt and I would refer to it as leverage because it’s simple math. If they believe that they’ll use money that they borrow to earn 20% and it’s going to cost them 4% in interest, why would they not do that? Why would they not supercharge their growth? Why would they not be efficient and good stewards of their resources? This idea that having any debt or leverage of any kind is just irresponsible, from a number standpoint is just plain wrong if you are looking to maximize returns. Let me give you a few examples of what I would consider bad debt versus good debt.

I think you intuitively know what some of these are. Car loans, bad debt. One of the biggest hindrances to most people achieving the retirement that they want and the financial security that they desire is the $80,000 luxury SUV that has a $1,100 a month payment and currently at seven or 8% interest. I’m not spend shaming, I’m not car shaming. I don’t care if you drive a nice car, but you shouldn’t be making payments and paying interest at the expense of saving for your future. Credit cards are the worst kind of bad debt. They get as high as 25 to 30% in some cases. That’s the easiest way to implode your financial future. Store credit, cash advances, payday loans, buy now, pay later. Those are clearly not good uses of capital, but a 30-year fixed rate mortgage at three and a half percent, that’s one of the best financial tools you could have.

Consider when inflation was at seven or 8%, you were literally making money by having a mortgage. Now, if it really bothers you and you want no debt of any kind and you don’t care that it’s probably not the best on paper financial move and you’d like to pay off your home, and that’s been a big goal and your plan works regardless, by all means, go for it because everyone’s plan should be unique to their desires. But there are plenty of people with high net worths who have mortgages on their real estate because they understand that a low interest rate mortgage that’s fixed for decades is an incredible financial tool and great leverage, especially when you have the expectation to earn more wherever that money is invested. How about education? You should be mindful of the cost of student loans. Shouldn’t just be willy-nilly taking them out and I’ll pay for that later.

But if you have no choice and you want to be a radiologist making $1 million a year at some point down the road, but you’re going to have to take out some loans to go through medical school, that’s probably a good decision and good debt. What if you have a fantastic business idea but you don’t have $250,000 to pay out of pocket to get the business up and running, but your bank offers you a line of credit and eventually that grows into a multimillion-dollar business? Probably a good decision. That’s probably good debt. So I think this idea that you need to steer clear of any and all debt is a financial principle that you should rethink.

Well, it’s time for this week’s one simple task. Each of the 52 weeks here in 2024, I’ll be offering you an easy to execute tip so that you can start next year in a significantly better financial situation than you’re in today. Well, continuing with the theme of Valentine’s Day, your simple task is to go on a money date. A money date is a way for you and your spouse if you’re married, to come together and talk about money and the things that matter most and in a way that you’re comfortable with. It’s a scheduled conversation, it’s a date but to talk about your money and more importantly, how your money fits into your shared goals and your individual goals and the values you have and your priorities and what you’re hoping to accomplish in life. And it’s important that you schedule the time in advance so that you have some time prior to the conversation to be really thinking about how each of you feel about the answers to those questions.

Now, I’m also going to warn you, not as a financial advisor, but as a husband, do not do this for your Valentine’s Day. That’s a great way to say how is a divorce going to affect our financial future? Because husbands, if instead of flowers and chocolates and a romantic dinner, you say, I’ve got an idea this year. Let’s talk about our financial goals. Your spouse is probably going to look at you and think to themselves, where did I go wrong? How did this happen? What is wrong with you? So do the money date, just don’t do it on February 14th.

It’s time for listener questions? And one of my producers, Lauren, is here to read those for us. Hey Lauren, how’s it going? Who do we have up first?

Lauren Newman: Hi John. So first off, we’ve got Danny who wrote us and said, I made the New Year’s resolution this year to pay off debt and save more money. Specifically, I want to pay off my HELOC, about $15,000 with a 10% interest rate, while building an emergency savings. I currently have about 2,000 in my savings account. What are some things I can do to stick with my resolution and make it impactful?

John: Well, Danny, I think these are great resolutions, fantastic things to shoot for. I think I could be doing better at both of those things as well. I think SMART goals can be very effective, and that’s an acronym, and I think yours fits this description, specific, goals that have a desired outcome that’s clearly understood, which yours do, they’re measurable, that’s the M in SMART. Goals that have numbers used with this specific goal, you did that. You want to pay off the entire balance of that 15K on your HELOC as well as save more money. Now, that’s not as specific as I’d like, but you’re on the right track there. You want them to be achievable. And while I don’t know your exact income or expenses, it feels reasonable that you’re trying to pay off 15,000 over the course of 2024. It needs to be a relevant goal, which this certainly is for your financial success and the T in SMART is time-bound.

You need to have a deadline. You don’t want to just say, well, at some point during my lifetime, maybe I’ll solve for this. No, that doesn’t work. So I believe you’ve already set up a SMART goal and then related to your question on how do you stick with it, remove as much friction as possible. It’s the same way we give ourselves the highest probability of success in all matters of our life that we’re trying to make progress. You need to use automation. And even though the 10% interest rate is there, I would build the emergency fund, that idea of saving a little bit more money before aggressively going and paying off the HELOC. Because if you do that without the emergency fund built up and an unexpected event comes up and now money’s going back on the HELOC or back on a credit card because your emergency fund wasn’t adequate to pay for that new expense, and then you just get on that debt, merry-go-round.

So build up the emergency fund. The other thing that I would remind you of is even though the stock market earns eight to 12% historically, around 10% per year, and that’s far from guaranteed, certainly especially over the short run, if you’re receiving a match from an employer, I would be taking advantage of that even before aggressively paying off the HELOC. I’d pay off the HELOC a little bit slower to ensure that you’re receiving a 100% return on your investment through that employer match. Well, thank you for that question, Danny, and I’ll be rooting for you here in 2024. Hope you’re able to make significant progress on those goals. All right, Lauren, who do we have next?

Lauren: Next, I have Richard in Des Moines, Iowa. I’ve heard about the benefits of Roth conversions, but I’m not clear on the age restrictions. Can I initiate a Roth conversion before reaching age 59 and a half? And if so, what are the considerations and potential implications? Are there penalties or limitations I should be aware of when converting to a Roth IRA before this age?

John: Well, Richard, great question. Yes, you can initiate a Roth conversion before reaching age 59 and a half, but there are some important considerations and potential implications that you should be aware of. I’ll also say there are no limitations in terms of how much you can convert, its self-policing because remember, anything you convert gets stacked on top of all the rest of your income. So practically speaking, if someone converted 1 million of their IRA balance in one swoop and they had made $100,000 at their job, their taxable income that year, no other factors withstanding would be $1.1 million and they would go if they’re married, filing jointly from a 22% tax bracket all the way up through 37. And that’s the first consideration really are those tax implications. And that’s why converting to a Roth can be particularly advantageous if you expect your tax rate to be higher in retirement than it is right now.

And this is a hot button and has been widely talked about because with the Trump tax reform that began in 2018 and is set to expire at the end of 2025, tax rates are the lowest they’ve been in decades, making Roths in general more viable for more people. The next consideration though of doing this prior to reaching age 59 and a half are the early withdrawal penalties. So normally if you withdraw earnings from a Roth IRA before age 59 and a half, you’ll be subject to a 10% early withdrawal penalty. However, when you convert a traditional IRA into a Roth, there is a special rule that applies, the converted amount, so excluding any earnings on that amount can be withdrawn penalty free at any time. So that’s a little bit unique. There are still some considerations, one of which being you’re going to have to come up with a tax owed for that conversion with outside monies.

If you’re over 59 and a half, you could choose to withhold tax from the conversion itself. Now, that’s not ideal because you’d like to get all of the money into the Roth because that’s the golden goose and has the best tax treatment moving forward. But if you’re under 59 and a half, that’s not even an option because you’d pay a 10% penalty on the amount you withheld for taxes because it would be considered an early withdrawal. But there’s one consideration that I’ve seen really confuse people. So let’s walk through the basics here together, and that is the five-year rule. The five-year rule for Roth IRAs means that at least five years must elapse before the beginning of the tax year of your first contribution to a Roth account and withdrawal of your earnings. So if fewer than five years have past before you make a withdrawal of earnings, that withdrawal is considered a non-qualified distribution and may be subject to either taxes or penalties or both.

Richard, once that five-year rule has been met, and let’s say at this point you’re over 59 and a half, then you can make what’s known as a qualified distribution of your earnings and those are exempt from both taxes and penalties. But specific to Roth conversions in the five-year rule, it’s a little bit different. And that’s why these things can be really confusing. The IRS requires a waiting period of five years before withdrawing balances that are converted from a traditional IRA to a Roth IRA, or you may pay a 10% early withdrawal penalty on the conversion amount in addition to those income taxes that you’re going to pay in the tax year of your conversion.

So I know that may be more than you bargain for, but there are considerations that you need to factor in over the first five years of the conversion. Talk with your CPA, talk with a good advisor, speak with us if you need help on this @creativeplanning.com/radio, we’ll walk you through it. But in short, you can initiate the Roth conversion. Just be mindful of all of the various implications, tax-wise, penalty wise, and how it fits in ultimately with the big picture of your financial plan.

Thank you for those questions today. If you have a question similar to these and you’d like me to answer it on the air, email your question to radio@creativeplanning.com.

There are things in life that aren’t important and we can’t control. Those should be pretty easy to ignore. They’re not a big deal. We don’t have any control over it. I’m not going to burn a bunch of energy or mental space worrying about this. Then there are those things in life that are really important. They mean a lot to us, but unfortunately we also cannot control them. And these are often circumstances that create a ton of frustration. You have a child who’s sick and it’s really important, but there’s nothing you can do. You are doing a fantastic job at your workplace, but due to outside factors, the company lays you off. Someone sideswiping your car changing lanes because they don’t check their blind spot. A president gets elected that you didn’t vote for and you don’t like. There’s a global pandemic, the economy slowing. These are just a few examples off the top of my head of things that are important to you. They affect your life but you just can’t control it.

But then there’s a third category, and these are the things in life that are both important and you can control, and that’s where the magic happens. That’s where your energy should be devoted. So that leaves you with taking care of your health, spending time exercising, making those who you care about a priority, your intention around your spiritual wellbeing, if that’s a priority to you. With your money this would be something like your savings rate. Maybe it’s your work ethic and your commitment to your career to try to earn more money. Now, I don’t know about you, but I find in my life that some of the most difficult times come when I’m focused on things that I can’t control or things that aren’t important or even worse sometimes the things that fall into both of those categories.

My sports team not winning, I can’t control it. And in the scheme of things, it’s not that important. My wife likes to point that out to me when I’m overreacting. She’s like, Hey, you got a family who loves you. We’ve got a roof over our head. We live in America. Stuff’s pretty good. You can’t control what happens out there. You sports fans out there, you get it. It’s irrational. And I’m sure you lead a busy life. You’ve got a lot of moving parts, and sometimes it might even seem like you’re just go, go, going from sun up to sundown and week after week and month after month. And so it’s important for you to give yourself a little self-evaluation to check yourself, am I focused on the things that matter and that I can control? And when it comes to those things, how am I doing? How would I grade myself? Because I want you to be able to focus on not only the positive, but also the negative to make progress.

So here’s the exercise. Once a month, at the beginning of every month, I want you to reflect back on the previous one. We’re a little bit into February here, but look back on January and ask yourself three questions, what went right and what went wrong? Number two, what can I do differently? These are things that I can control. What can I do differently in February to change the outcomes? And then number three, what are my top three priorities for the coming month? And make a point to ensure that those are important things. They should be right, they’re your top priorities, but also things that are within your control that you can affect the outcome to the positive because you are on a journey that has plenty of mountaintops and valleys. It’s a winding road. And along the way, it is important to pause and reflect so that you can continue striving toward being the best version of yourself. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.

Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio and to make sure you never miss an episode you can subscribe to Rethink Your Money wherever you get your podcasts.

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 Higginson 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 would like our help, request to speak to an advisor by going to creativeplanning.com, creative planning tax and legal are separate entities that must be engaged independently.

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