Your home is likely the most valuable asset you own, but are you confident on the best way to incorporate it within your retirement plan? This week, John provides answers to the most common questions around home appreciation and downsizing so that you can make informed decisions now that won’t cost you later in life (2:29). Plus, John is joined by Chief Investment Officer Jim Williams to talk about the benefits of global allocation in your portfolio (13:25). And later, John plays a game of Rethink or Reaffirm on the topic of risk and volatility (36:04).
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 a head on today’s show. Is your home a solid investment or simply a place to live? The pros and cons of international investing as well as whether you should consider downsizing once in retirement. Now, join me as I help you rethink your money
And a good day to you. Happy Easter weekend. And if you grew up in a home like mine that meant fancy brunches, a big old Easter egg hunt with a bunch of cousins and trying to sneak a few extra Cadbury eggs, shove them in my mouth while my mom wasn’t looking. I always love this time of the year though, Easter weekend, growing up in the Pacific Northwest, I had a little hope that maybe it would stop raining. And if you’re listening to the Midwest, you’re relating saying, “Rain, John, we just got snow in April. You kidding me?” So I saw some schools were closed. It’s like I thought this was supposed to be springtime. I also recall my parents putting some restrictions on me regarding what I could wear to church. I mean, my church was pretty casual, but that’s not happening on Easter. Okay.
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On Easter I was wearing a clip on tie. I’d definitely be in dress pants and usually some awful pastel shirt or sweater to go along with it. And when I look back on those photos of my sister and I, her in some floral dress sitting next to me with my curly little mullet, I still remember not being real comfortable in those outfits. But these sorts of rules or restrictions that we often perceive in our lives as negatives, like, “Hey, little Johnny get dressed up for church.” Ultimately, in many cases they’re not. They’re for our benefit. And now being a parent is seven and raising children, I do the whole thing that you promise when you’re a kid, you’re never going to do things like, because I said so. My wife and I don’t permit sleepovers. Our kids don’t play violent video games and a lot of their friends have smartphones. They don’t.
But of course, we do this not because we don’t love our children, but because we believe that these guardrails will actually improve their outcomes. And I see this concept play out often in a few different areas of personal finance. The first is around retirement. I’m being restricted by work. I have a boss and schedule, and some of that’s true, but I’ve witnessed firsthand, many unfulfilled, unsatisfied, somewhat disappointed retirees because they lost the social interaction of work. They lost the value of feeling accomplished when using skills and talents to complete a project. You see, so often the restriction of work is accompanied by many valuable aspects as well. How about spending restrictions? You get married and now you’ve got some accountability on what you’re spending. And at first, that might feel like a big negative.
My wife and I do for the most part, a pretty good job being on the same page. But there are times where I want to spend money on something that’s dumb and my wife will point that out and say like, “Why? It’s not adding value to our family or to our life, or You don’t need a second driver, you got one 12 months ago, you’re not going to hit the ball straighter.” And she’s probably right. All right, I’ll just say it. She is right. And in the same way, we don’t need a new set of throw pillows on every piece of furniture in every bed in the entire house. I know. You’re wondering right now if you’ve listened to the show for any amount of time, you’re like, “John, I’ve heard you talk about throw pillows. What is your hangup?” I think it’s because I’ve now spent hours upon hours of my life removing throw pillows, stacking them up and then making the bed and we put them all back on and then we take them back off.
And I just don’t totally understand the point. Do they have to go until they’re almost falling off the foot of the bed? Because we have so many different layers of throw pillows, maybe we do. I don’t know, someone please explain this to me. I still haven’t figured it out. But the point is, it’s usually good for us to have someone close to us that loves us, that understands us for accountability on where we’re spending money because we all have blind spots. And in the end, you may even be in a better financial situation because of that give and take and that open dialogue about spending. And the last restriction that ultimately can be a positive in many cases are restrictions on liquidity when it comes to your investments.
Remember when Robinhood took all trading costs to zero? Well, everyone was going to have better returns now. Because they had the freedom to trade in and out of securities as often as they’d like, and with no friction, except of course the exact opposite occurred. Where we know from all the data that investors tend to do worse in correlation with the frequency of their trades, meaning the easier it is to trade, the more often we trade resulting in lower returns. Now, while we would never voluntarily ask for a restriction of $5,000 trades, most people would benefit assuming that their portfolio was well constructed in the context of their financial plan by having to at least pause and think about it due to the cost of making changes, oftentimes in the moment due to emotions. And where this often plays out is when it comes to selling a home, and we all know there are fees involved, you can’t snap your finger and sell your property like you can click a button and make a trade on your liquid investments in the market.
You’ve got to list the house, then you have to clean the house, you have to show the house. Generally you’ll hire a realtor. There will be fees involved with that. Then you have to move. Who likes moving? Absolutely no one. It’s awful. And then you have to find another home. And this is probably why you have never bought and sold and moved your family six different times in one calendar year. So you’re unable to make knee-jerk reactionary decisions on a whim with your house like you can with a portfolio. And this illiquidity restriction, I think mistakenly gives us the impression that real estate’s a much better investment than the stock market. So I want to investigate together how we should be thinking about home price appreciation.
And Charlie Bilello here at Creative Planning has a great article that I will post to the radio page of our website at creativeplanning.com slash radio that you can reference if you’d like to see the charts associated with it. Charlie is the king of charts, has over a half million followers on Twitter who are sticking around to see these varied charts, and they’ll certainly add some life to this discussion. If it’s of interest to you, I would recommend you checking those out. Again, that’s at creativeplanning.com/radio, and that is the very same place that you can go to schedule a complimentary second opinion with one of our local fiduciaries. As thousands of other radio listeners just like yourself have already done, why not give your wealth a second look?
There’s a great interest in conversations around real estate prices and primary residents appreciation because we all need shelter, we all need to live somewhere, and your home statistically will be the largest asset in the average Americans net worth. So we love to see it, appreciate and value over time what’s a reasonable expectation that you should have on your home? Well, if you look at the history of home prices, go back to 1981. Home prices have increased by 3.4% per year nominally. That equates to a half a percent above inflation since 1981.
Now does that surprise you? Well, and if you thought that it would be higher, you’re not alone. And I’ll share with you why your perception likely is what it is. But here’s what’s interesting. If you parse out the history of home appreciation, before the year 2000, we had never seen us home prices outpace inflation by more than 33%. And because of this, very rarely did people consider their home to be an investment similar to a stock. It was just really a place to live. But that mentality started shifting because in the mid two thousands during the housing bubble, we all remember that home prices exceeded the US inflation rate by a 99% margin in 2005.
So then many started thinking that a home was a much better investment than stocks because man, I don’t know, homes, they don’t ever go down. That was truly the mentality. And of course we know how this story ends. Go from 2007 to 2011, everything changed. Home prices fell every single year declining a total of 26% on a nominal basis, and a 35% decrease if you inflation adjusted. As a result to counteract this, the Fed tried to create a wealth effect and boost the value of housing and other assets. What did they do? Well, they held interest rates at zero for seven years. From 2008 through 2015, they purchased a ton of bonds to artificially suppress interest rates. The federal government created the first time home buyer tax credit, which was from 2008 through 2010, and the government borrowed money to send three rounds of stimulus checks to most Americans during the pandemic.
And as a result, we saw this second US housing boom take hold and home prices more than doubled from 2012 to 2021, 117% above inflation. And then in 2022, mortgage rates spiked, which meant the median home in the United States became even less affordable because most people are financing their home and demand for housing collapsed. 2022 as a result, was the first year since 2011 that home prices declined. Let me conclude this topic with two reasons why your home is likely not as good of an investment as you might think it is.
First, it’s that your home costs a lot of money in upkeep, and those costs are often massively underestimated because we don’t keep a ledger of every dollar going out as a result of our home ownership. I was just talking about the client this week. They split their time between North Dakota and Arizona, we’re running their financial planning projections, outlining expenses associated with their North Dakota home, which is on about two acres, most of which is manicured. Between mortgage, landscaping, snow removal, water, electric, propane, homeowner’s, insurance taxes, and general maintenance, the home is costing them $5,000 a month. Even if you extract out the mortgage, it’s about 40 grand a year in costs to own that home. Aggregate that over a decade, that’s $400,000 of costs to own the home.
So even if they bought it for 500 grand and sold it for 1,000,010 years later and they say, “Look at this, I just made a half million dollars.” No, you didn’t. You probably about broke even when it comes to your costs. And again, this doesn’t discount how much they potentially have loved that home. It just speaks to the reality that it’s not as good of an investment as most of us think. And number two is leverage. If you were to go buy $200,000 worth of stock index funds, you bought some ETFs, you were broadly diversified, and your financial advisor said, “Well, let’s just buy a half a million dollars of stocks.” You said, “Well, I’ve only deposited 200 grand.” Yeah, that’s okay. Let’s just borrow and buy another $300,000 worth of stocks because then if the market goes up, your cash on cash return is going to be through the roof and we’ll just have to pay a little interest on the 300 grand. Most would say that is way too risky.
We routinely put $200,000 down on a 500 or even an $800,000 house, and when it increases in value by 100 grand, we say, “Wow. We had $200,000, we just made 100 grand on our 200 grand. That’s a 50% return.” Well, that also came as a result of leverage. So to recap, over the last four decades, home prices have increased by 3.4%. While by comparison, the broad stock markets have earned approximately 10. If you have questions about real estate, your taxes, estate planning, your retirement plan, how to drive income in retirement from what you’ve worked so hard to save, how to manage risk as you near or enter retirement. We here at Creative Planning have been answering questions just like that since 1983. To speak with a local advisor who’s not looking to sell you something, but rather give you clarity around your life savings, visit creativeplanning.com/radio now.
My extra special guest today is Jim Williams. Jim is the co-chief Investment Officer here at Creative Planning as we combine to manage or advise on over 210 billion, it’s a huge responsibility and he is one of the smartest people you will ever meet. And I asked Jim to join me today to discuss the merits of investing beyond our borders. So without further delay, Jim Williams, thank you for joining me on Rethink Your Money.
Jim Williams: Glad to be here, John.
John: Jim, I’ve had clients drive up to the office in a Toyota. They’re wearing Adidas. The kid’s probably in the back on TikTok are listening to Spotify on a device that almost certainly has chips made in Taiwan. And then we start talking about the portfolio and they proceed to tell me that they feel like international investing is just simply too risky. So I want to start there. Let’s talk about risk. Simply put, is diversifying internationally riskier than only allocating within the US?
Jim: Well, I think there’s a good point to be made that adding international equities actually reduces volatility. Fidelity did a study where they looked at returns over the last 65 years, and what they found was if investors had a sleeve of US stocks or a sleeve of international stocks or a portfolio that combined the two, there’s actually less volatility by having the two combined then either with a standalone entity. And this makes sense because we work through cycles where historically US stocks have outperformed. What we’ve also had cycles where international stocks have outperformed. So long periods, what we find is actually the opposite is that including international stocks into a portfolio, we see reduced volatility within the combined portfolio. The problem investors are faced with is recency bias. We tend to focus on what’s happened so much more recent than what’s happened over a long period of time, but when we look at investing and we look at academic studies, we also know sample size matters. If we use too small of a sample size, we get misleading data. So when we start to expand that sample size, the results become more usable.
John: So can you talk about the cyclical nature of US versus international?
Jim: So the issue that we’re faced with is we’ve seen periods where both US and international have outperformed one another. It seems like the holy grail would be, well, this put me in whichever one is going to do better for the next time period.
John: That sounds great to me.
Jim: The problem is finding that person’s like finding Santa Claus. It sounds great, the idea of Santa Claus, but then you grow up and you realize that Santa Claus doesn’t exist. If it was possible to deliver that, we should be able to point to somebody who’s historically been able to execute that strategy in a consistent manner. But what you find when you start looking around for that person is they simply don’t exist. There’s a quote from Jane Bryant Quinn and she says, “The hall of fame of market timers is an empty hall. It’s because you can find somebody that can do it one time or two times, but then all of a sudden they get it so wrong that they cause permanent damage to their investors’ portfolios.”
What’s interesting is right now that the discussion might be, do I really want exposure to these international stocks they’ve gone through this period of underperformance? The funny thing is we had this conversation at the beginning of 2010. We actually wrote a newsletter that was titled The Bad 10 Years. It was the Lost Decade, but really only the lost decade for large Cap US stocks. In 2010, the conversation would’ve been, why do you want to keep putting me in these slow, stagnant US large cap stocks where it’s obvious that the growth is coming from all these other areas. Emerging markets has outperformed by almost a thousand basis points over the course of the last decade. Why don’t we go to these areas that there’s actually growth? So by focusing on 10 year cycles, it often again leads the investor down just the wrong path to create permanent damage to the portfolio. So the old scene of don’t put too many eggs in any one basket has a lot of validity when it comes to investing.
John: One of the ways we can fight against that recency bias is through strategic and systematic rebalancing like we do for our clients here at Creative Planning, which is a rules-based approach to ensuring that you are maintaining that diversified portfolio and not being subjected to the whims of what’s happened most recently and how we’re feeling. Because as you mentioned, those emotions almost always lead us astray. And while we can’t forecast the cycles as you mentioned it’s like finding Santa Claus, by the way, we’re going to need to make sure that any parents listening like that, we bleep that out like it’s a swear word or something. If they’ve got kids in the car, we don’t want to break that news to them. But while we can’t time the cycles, Jim, can you speak a bit to valuations currently? What are international stocks priced at relative to US at the moment?
Jim: Well, if we look at valuations and we define valuations of how much do you have to pay for a dollar of expected earnings. Today, we find that in the US it’s roughly 17.6 for every dollar of expected earnings. That’s how much one’s share of stock and aggregate would cost for a dollar of expected forward earnings.
John: And to put that in perspective, Jim, what has that been historically? And I know that that’s come way down in compressed with the bear market from where it was in 2021. What does that 17 compare to?
Jim: Historically, the rate that most people will cite is a rate closer to 15. It depends a little bit on the dates that you want to use, but fifteen’s the rate that’s accepted within the industry as the average.
John: And we were way above that in 2021, obviously.
Jim: Yeah. For the 2020 to 2022 time period, it was more in the mid ’22, ’23 type range. When we look at international, we definitely see a premium. The rest of the world is trading basically between 10 to 12 times future expected earnings. What’s interesting is we see this gap widen significantly starting in the mid 2015 type range to today. And any time you see some gap widen relatively unexpectedly, there’s a case to be made that that gap could close and it could close through two methods. One is US earnings could grow faster than the rest of the world or the rest of the world’s stocks could actually outperform US stocks to close that gap.
When we think of a company like Nestle, when I think of Nestle, I think of heath bars, but it’s an EU company. Is there a reason that Nestle should be trading in a lower valuation than a US stock? Same thing could be said for BP. When I think of BP, I think of an oil company should it traded a discount to its US counterparts just because it’s based in the EU will. We are seeing that there’s a premium being demanded for US equities versus their international counterparts.
John: It really is interesting how much cheaper international stocks are trading relative to the US. I’m speaking with creative planning co-chief investment officer, Jim Williams, and to me, Jim, the logical follow up question is what impact do these lower multiples have on forward returns?
Jim: There’s a variety of large financial institutions that put out capital market assumptions and they’re all very consistent. If we look at, as an example, BlackRock’s capital market assumptions, and we look at what they expect to occur over the next 10 years, BlackRock is the largest asset manager in the world, roughly 10 trillion of equities. They expect US stocks to return roughly 7.9% versus emerging markets and EU stocks between 10.4 and 11%. So we see this gap showing up within the expected returns over the course of the coming decade. If that proves to be correct, we’ll likely also see a corresponding closing of this gap from evaluation perspective.
John: All right, Jim. Well, that all make sense. We’ve talked about that US and international stocks perform in a cyclical fashion that current valuations are attractive for international investing that leads to future capital market assumptions that international is expected to perform at a little bit better rate than US stocks moving forward. But what if someone hears all of that, they understand the data, but they say, “I don’t want to own China in my portfolio.” There’s certain countries that we’re either at odds with from a political standpoint, or they have moral hazards that people just aren’t okay with. They don’t align with their ethical standards. So what would you say to that person who says, because of that, that’s why I only invest in the United States.
Jim: So when we think about at the heart of what we deliver to our clients, it’s a customized solution for the investments that we’re going to recommend. It’s very easy to exclude something like China from a portfolio. We can actually just use an investment that gives us emerging market exposure without any Chinese exposure. Or if we want to use an individual stock portfolio, we can actually drill down and define what we want to exclude from a portfolio on a number of different factors. Not only can we use exclusionary methods, but we can also use inclusionary and overweight certain sectors that we may decide that we want to have additional exposure to. So there’s multiple ways that we can address clients’ specific wants and goals within their portfolio to make sure that we deliver exactly what they’re looking for as we work through that together.
John: Yeah. And I think that’s fantastic because you still are able to receive most of the benefits by owning international stocks, but making it custom to your personal preferences. That’s fantastic. Well, thank you so much for joining me here today on Rethink Your Money, Jim, and for discussing a little bit about why international investing can be helpful over the long run.
Jim: Perfect. Thank you John.
John: That was Jim Williams, co-chief investment officer here at Creative Planning. And if you have questions about your investment allocation, are you maximizing your expected returns? Are you strategically rebalancing? Do you have confidence that you have the right mix of stocks and bonds? And then within those broad asset categories, the right allocation of international and us? Well, here at Creative Planning, we have been answering those very questions since 1983. We’ve got all the expertise, all the advice you need, all in-house. To speak now with a local advisor not looking to sell you something, but rather provide you with clarity around what you’ve worked a lifetime to save, visit creativeplanning.com/radio. Why not give your wealth a second look?
If you enjoy listening to Rethink Your Money, you will not want to miss out on an upcoming webinar that we’re providing here at Creative Planning entitled Invest Like A Pro. It’ll be held Tuesday, April 18th, 1:00 PM Eastern Time, 11:00 AM Pacific time. And if you are central or Mountain Time, I’m just going to make you do the math on that to figure it out. But you can register on the radio page of our website at creativeplanning.com/radio. And this webinar is fantastic. We’ll be talking about economic uncertainty and a potential recession, which I’ve talked about here on the show as well, because we know a lot of investors are wondering if ’23 looks more like 2022 and none of us can predict it, well then how can we plan for it?
Topics we’ll cover in this webinar are building a comprehensive financial plan designed to create long-term wealth, how to automate your savings and investing to help you reach your financial goals, avoiding the performance traps that truly wreck investors’ portfolios and ruin their returns. Tax efficient strategies that let you keep more of what you earn and help your money work harder as well as developing the right mindset to weather any economic or market conditions that may be out on the horizon. We here at Creative Planning have always been focused on providing value through education and information. We want you to be informed for your own money so that you can feel confident that you’re making solid decisions. This is just another way that we’re doing that. Again, it’s Tuesday, April 18th at 1:00 PM Eastern Time. Invest Like A Pro Webinar and sign up on the radio page of our website so that you can get the objective guidance you need to help you take charge of your finances.
Well, if you ever had an argument with someone, or we’ll call it a debate, sometimes for me, this might be with a friend discussing who’s the greatest basketball player of all time. And you’re going back and forth and then toward the end you realize we’re arguing different things here. Well, I think a lot of financial debates tend to be the same thing. Morgan Housel said, “A lot of financial debates are just people with different time horizons talking over each other and how true that is.” Two people with very different objectives and goals and time horizons and financial histories and money scripts talking over each other in an effort to be right or maybe to win the game. But in reality, they’re not even playing the same game. They just don’t even realize it. So what are the of the tips I have for you is to define the game itself that you are playing when it comes to your money and play it and play only that game.
There’s a story of a small kid playing a game with his grandfather. Whenever he’d enter his grandpa’s house, his grandfather would have a nickel and a dime, and he said, “All right, grandson. You pick. You can have either one. Which coin would you like today?” And the grandchild would always pick the nickel. And after a few months of this, the older brother came to his little brother, was like, “Hey, man, why would you grab a nickel when a dime is available?” And the younger grandson replied, “Because if I take the dime, grandpa will stop playing with me.” Encapsulates that sane when someone’s playing chess and we’re all playing checkers, it’s a sharp little kid. But when we are able to have intense clarity, not some vague idea of the game that we’re playing, but a definition of exactly what that game is, we are much more likely to not only win, but along the way, be able to clearly evaluate how we are progressing.
By contrast, if we don’t even know the game we’re playing, then we start taking cues from others who are playing entirely different games, by the way. And that can lead to risks that you didn’t intend and outcomes that you never imagined. And if you expand this analogy a bit further, when you go to play a game that you’ve never played before, you open up the rules and those rules make a lot of sense in the context of Monopoly or life or Sorry!, or Candy Land. If you’re like me, Sorry!’s actually pretty advanced. We’re in the candy land world with a lot of our kids right now. But if you tried to use the rules for Candy Land to play Monopoly, it wouldn’t work very well, would it? Neither will other blanket rules of finance if they are within a context that does not make sense for the game that you’re playing.
How about withdrawal rates? You should take about a 4% withdrawal rate. That’s a safe withdrawal rate. Well, what if the game you’re playing is I’m inheriting money at 80 and it’s more money than I could ever spend for the rest of my life and I’m 70 right now. Why would you take a 4% withdrawal rate? I mean, you might want to, but you certainly don’t need to. And where I see that more practically play out is someone that says, “I want the check to the morgue to bounce.” Well, that person can spend more money than a person who says, I need $1 million at a minimum to be there when I pass away, because that legacy for family members is incredibly important, maybe the most important aspect of my financial plan. Two people playing completely different games.
How about the idea that entering retirement with no mortgage, that’s the holy grail. You do not want to have a mortgage when you get into retirement. For some people that might make a lot of sense because they don’t have a lot of confidence investing. They don’t like taking risks with their investments. So even if their mortgage is at 4%, a lot of their money’s sitting in cash or CDs or money markets that are earning less than that. But yeah, why carry a mortgage and pay interest to a bank when the money in your other pocket’s earning less? Well, that doesn’t make a lot of sense for that person.
But how about for the person that has broadly diversified in the market and earned eight to 12% a year for the last 30 years on their money? Why would they want to pay off that 4% mortgage early when there’s no pre-payment penalty? And they’re getting tax benefits oftentimes for the interest when they can effectively use the bank’s money, receive the same exact depreciation on the property, whether there’s a mortgage or not, and earn money outside by properly investing two people playing totally different games.
Let’s take that a step further. What if we’ve got a third person who says, “My family lost our home in the depression. And the one financial principle that was pounded into my head from the time I was five years old was to never ever have a mortgage so that no bank could ever uproot your family. Well, then do the numbers even matter? Of course not. That person’s playing a completely different game. They most certainly shouldn’t have a mortgage regardless of how much more they could potentially have by creating leverage. And this leads me to my first piece of common wisdom as we play an all new game of rethink or reaffirm, where each week we will break down financial topics and decide together whether we should rethink it or reaffirm it.
Today’s piece of common wisdom that we will examine. You should downsize your home in retirement. Well, if we’re looking purely at the numbers, obviously you’re better off financially owning a cheaper home. You’re also going to have more money if you buy all your clothes at a thrift store versus Nordstrom. If you buy a $5,000 car instead of a $50,000 car, you have more money obviously. But what game are you playing? What are your financial goals? Are you going to be able to count on other people to help you care for your home? Do you have a big family? Do you like hosting? Are you someone who enjoys travel and isn’t home very often? These are just the tip of the iceberg on the questions that would be completely personalized and need to be answered in a customized way. But I will highlight some of the pros and cons that I’ve outlined for clients when we’ve had this very discussion.
Now, let me start by saying if your plan doesn’t work and you’re going to run out of money by staying in a large expensive home, then clearly that has to be taken into account. If you’re looking for financial freedom, you might not have a choice, but let’s suppose financially you do have some wiggle room, then downsizing can be positive for some of these types of scenarios. Number one, if you’re single, I’ve found that many single people don’t want to maintain a massive home. In fact, in many cases, a husband and wife choose not to downsize, and then one spouse passes away and the surviving spouse says, “This is too much now for me to take care of, I’m going to downsize.” Because it makes your life simpler and less expensive. There’s less moving parts.
Just like your investments oftentimes simpler, actually makes you happier than having a nicer asset or a more expensive asset. And if you have some flexibility, downsizing can allow you to get your money out of the house at an optimal time. Not that you can perfectly time the housing market, but you can pick your spots as to when it makes sense to potentially sell. I just mentioned it earlier, if you’re someone who loves to travel, you may want something that’s more lock and leave, townhouse, a condo, a small house with a minimal yard to take care of less to clean. And downsizing can be nice because many times you’re downsizing out of a house that you’ve lived in a long time and you may have some deferred maintenance that is going to accumulate and eventually cost even more money to maintain an older home.
Now, reasons you may not want to downsize is that you’re like me, you have seven kids. We’ll probably have 20 or 30 grandchildren. We may need a bigger house as grandparents. Britney and I already talk about how big of a priority it is for us to be involved with our grandchildren, with our adult children. We want to be a house where we congregate and host Sunday dinners, and so we will need the physical space to accommodate those sorts of memories. So to us, that’d be a very worthwhile investment to maintain a larger house, even if it’s more expensive in retirement.
It can be nice to maintain a consistent routine when you’re older. I mean, it may be a bigger house and a lot to take care of, but it’s your house, your neighbors and the knives are in the drawer in the kitchen that they’ve always been in, and that junk drawer where nobody can find anything in there. I mean you should see ours, it’s brutal. The one with post-it notes and a random stapler that’s out of staples and two broken pencils, some paperclips, couple batteries. I mean in my house, they may be old ones that the kids put back in there instead of the garbage you just never know. When it’s your house that you’ve lived in a long time, that’s your junk drawer. That’s nobody else’s. It’s yours.
From a financial perspective, here’s a consideration. If your house has gone up significantly in value, tax law allows for a certain type of exemption. As I talked about earlier on the show, there’s been a lot of appreciation on real estate over the last decade, and in some cases, the gain on your home might actually exceed some of those limits. So if you were to sell it while alive and downsize, you may owe taxes, but if you die with that house, your heirs will get a step up in bases. Now, you may say to yourself, “Well, who cares?” I mean that benefits my kids, doesn’t really help me, but in my experience, most people, even if your kid’s a knucklehead like their kids more than the IRS, so that may be a strategy for you. You can’t depreciate your house. There’s no benefit to that.
And lastly, if you’re well capitalized for retirement, you probably have a lot of liquid assets already. So you may like the diversification aspect of having some money in real estate. Again, if you’re already heavily invested in stocks and bonds, and so the verdict on you should downsize your home in retirement. If it’s purely financial, it’s a reaffirm. But as like most things in finance, that decision is far more personal than it is finance. And if you have questions about your financial plan, taxes, investments, estate planning, visit creativeplanning.com/radio now to speak with a local fiduciary advisor. It’s complimentary and our mission is simple, to help empower you with the information that you need to make informed decisions about your money. Why not give your wealth a second look by visiting creativeplanning.com/radio? Our next piece of common wisdom to examine risk and volatility are the same thing.
I meet with people all the time that use these words interchangeably. These are not synonymous words. Risk by definition is the probability that an investment will result in permanent or long-lasting loss of value. By contrast of volatility is defined as merely how rapidly or significantly an investment tends to change in price over a period of time. Let me give you an example. You own a total stock market fund. Well, of course there’s volatility in that fund because you’re diversified in hundreds or thousands of different stocks. And if you look historically, the stock market broadly could be up about 50%. In a calendar year, it could be down about 40. So you have a 90% range of volatility even if you’re broadly diversified in not only owning a few individual stocks. So that would be a representation of volatility.
But by contrast, if you were just buying one stock, well that stock’s going to have volatility. Again, it’s in the stock market, but it also has its own unique risk with a floor of absolute zero. And that’s a true risk because obviously that would result in a permanent loss that would never return. So the way that you can take advantage of this is you’re able to diversify away from risk, but you can’t diversify away from volatility because that volatility and price uncertainty is what in fact provides you return premiums. Here’s another way to look at this. Imagine I put three different bubbles in front of you with words in them. One said growth, one said liquidity, one said stability. All of us would love all three maximum growth, full liquidity, and having it staple along the way. We’d also all love a pot of gold at the end of the rainbow, doesn’t exist.
Generally, investments will offer you two of the three. So if you’re looking to maximize growth and you want liquidity, you’re not going to get stability. That would be investing in the market. Let’s say you want full stability and a lot of liquidity, well then you’re going to give up growth. You’re in treasuries or cash or a money market. If you want a bit more stability, maybe a little less volatility, but still some growth, you’re going to give up liquidity. So the verdict for risk and volatility are the same thing as a rethink. So the key is designing a plan, comprehensively and using these principles so that you’ve got enough growth to accomplish your goal. So that you have enough stability so that even in really bad economic times, you’re not only getting through those times, but you’re thriving and you’re sleeping well at night and you’re not stressed out, and that you’ve got enough liquidity built into the plan that when the unexpected arises, you have access to the money that you’ve worked so hard for.
How do you blend that plan together? Accounting for taxes and your estate planning desires, to minimize risk, to minimize fees? Will you do it by designing, implementing and monitoring a real financial plan, a written, a documented, a dynamic financial plan? And because here at Creative Planning, we are a law firm with 50 plus attorneys, a tax practice with over 100 CPAs and over 300 certified financial planners. There’s a reason Barons has called us a family office for all. We have been helping people just like you since 1983. We’ve got clients in all 50 states, in over 75 countries around the world. We have all the expertise, all the advice you need, all in-house. If you think having a customized financial plan would benefit you and your family, don’t wait any longer. Visit creativeplanning.com/radio now. Do it thousands of others just like you have already done. Go to creativeplanning.com/radio to speak with a local advisor.
Kevin in Iowa asked, “I’m 62 years old and planning to retire by 2028. What should I be doing or thinking about when it comes to social security? The talk about it disappearing has me thinking I should get at Walt’s still around. Is that what you recommend?” Great question, Kevin. If you’ve got questions like Kevin, you can ask those by emailing [email protected]. And one of the most common topics that I receive questions on is actually around social security because for most Americans, it’s their largest income source in retirement. Most understand that they’ve paid a lot of money into the system and there are a lot of different options as to how to take it, and you do it once and then it’s irrevocable 12 months later, so you don’t want to mess it up. So great question here, Kevin. Let’s unpack this.
There is a lot of talk about the future of social security. It is underfunded. Most of you have probably seen the headlines, but it’s projected to essentially run out of money in the year 2034. Now, by running out of money, it doesn’t mean you would receive zero, but benefits would be reduced by about 20 to 25% if nothing changed. So someone right now receiving $1,000 a month would drop to about $770 a month. Now again, that’s if nothing changes, which is highly unlikely. The way the system’s designed is to collect taxes from those currently working and use those to pay what’s due to current beneficiaries. So if you’re listing and you are a worker, the FICA taxes going out of your paycheck right now, now are not being set aside for you, but rather being used for your parents or your grandparents who are currently taking Social Security. To sidebar for a moment, if you’re wondering how social security is so underfunded, it’s that we have a huge generation of the boomers retiring and we’re living way longer than ever before.
So current retirees need benefits for far longer than what was ever projected, although the millennial generation is entering some of their higher income working years. For a long time, that large generation was in their parents’ basement playing Xbox or working lower paying jobs that simply weren’t bringing in enough revenue to support current retirees. Here’s a recap of how you qualify for Social security. You collect 40 quarterly credits, which are currently valued at $1,640 per credit. And because these are quarterly credits, you can collect up to four per year, and if you earn 1,640 in four quarters, it totals 6,560. If you do that over 10 such years, you’d fully qualify. So what that means is that most people will qualify after working for 10 years, assuming they’re making enough money and paying enough into the system, they’ll earn the adequate credits. So again, that’s the formula for obtaining enough credits.
The formula that determines the amount of benefit you’ll actually receive is your earnings. And I’m not going to go through that whole calculation, but obviously the more you earn, the more you’re paying into the system, the more you’ll receive back. And there is a cap on those earnings because eventually you phase out of needing to pay Social security tax. Where Medicare, it’s important to note, there is no cap. So if you make 10 million a year… By the way, congrats, you make 10 million a year, you are paying 1.45% on those millions and millions of dollars where you do not have to keep paying your 6.2% social security taxation on anything over $160,200. Full retirement age from most people is 66 or 67. If you’re born in 1960 or later, your full retirement age is 67. So by my napkin math, Kevin, I think you would’ve been born in ’61, so your full retirement age would be that 67.
If you’re listening and you were born before 1960, your full retirement age is 66 and 10 months or eight months or six months, something like that, we’re in the final few years of anyone having a full retirement age that is not 67, who hasn’t yet elected social security. The average social security benefit right now in America is about 20,000 a year, $1,677 per month. And now that the framework’s been laid back to Kevin’s question, the number one factor on when you should take social security comes down to how long you’re going to live. Now, while none of us have a crystal ball, if you are in poor health or have no longevity in your family, then you’d want to slant your benefit toward collecting early. But by contrast, if you have longevity in your family and you are in good health, otherwise you’d want to slant your plan toward taking it later with a couple of caveats. I don’t know anything else about Kevin’s financial situation.
Some folks need to take social security right when they retire because their financial plan does not work, and they will run out of money if they need withdrawals from their portfolio for several years without the supplement of social security income. Well, that makes the decision a lot easier, but if your financial plan is sustainable in the event that you wait, it can be fantastic Longevity protection. I also don’t know if Kevin is married. In the event that he’s married oftentimes, what makes the most census once you’re retired, the spouse with a smaller benefit will elect at full retirement age, and the spouse with the larger benefit will wait until 70 because that is also the survivor benefit in the event that either spouse passes away and when that occurs, the smaller of the two benefits will cease to exist. So to win by delay on both benefits requires both spouses to live a long time.
Social security is one of those incredibly tailored decisions based upon your uniqueness from a personal standpoint as well as a financial one. It should take into account the types of investments you own, the taxation of those investments, your current health, as I mentioned just a moment ago, your legacy desires, your current tax bracket, your marital status, even your past marital status because you may be able to collect as a widow or an ex-spouse in a divorce situation. So the best way to determine your tailored social security strategy is to meet with a credentialed fiduciary like us here at Creative Planning. If you’re not sure where to turn, it doesn’t need to be us, but someone like us who’s not looking to sell you something, who can legitimately build out a plan that’s constructed with your financial situation in mind to determine how this large income sleeve is going to best and most efficiently fit with every other element of your financial life.
We have offices there in Iowa. Kevin, if you’d like to speak with one of our advisors, you can go to creativeplanning.com/radio. If you’re listening from anywhere else across the country and you’d like a better understanding of your overall financial situation, maybe specifically when it comes to social security, you also can visit creativeplanning.com/radio to get your question answered. I’ve got time for one more.
Bill and Mission Beach, California says, “Should I withhold from my Roth conversions or pay the taxes from cash?” Easy answer, always pay the taxes from cash assuming that you have cash available. Roths are the golden goose. So when you convert money from a deferred retirement account into your Roth, you don’t want to pull out theoretically 20% of that conversion amount that could be in a Roth and use it to pay taxes, if again, you have the money outside to pay taxes.
Another consideration is that if you do the conversion and you’re not yet 59 and a half and you choose to withhold on the conversion for taxes, you’re also subjecting yourself to a 10% penalty on the amount you’ve segmented out to pay taxes from a withholding standpoint because technically it’s an early distribution from a retirement account. And always understand in advance where you’re going to pay the taxes from to ensure that you have the money available prior to processing a Roth IRA conversion. Great question, Bill. We have offices there in Southern California. If you’d like to speak to one of our advisors, you can of course visit creativeplanning.com/radio just as I mentioned to Kevin.
I want to conclude today’s show as I do each and every week discussing the meaning behind our money. Think about this. If you and I do a great job saving and investing and we reduce our taxes and we have a great financial plan built out, and as a result we have more money. But we never identify the deeper purpose of that money, the reason any of that money matters and how it can positively impact the most important parts of our lives and the most important people in our lives, then we’ve really missed the entire value of making those wise financial moves. Because money isn’t inherently valuable. It’s indirectly valuable as a tool to be used toward the things that are in fact inherently valuable in our lives.
And something I’ve wrestled with a lot as a financial advisor meeting over the years with thousands of perspective clients and current clients, all of which have unique aspects to their situations. Some grew up incredibly wealthy, some grew up in abject poverty, some are self-made, some have trust funds, some are blue collar workers with a side hustle who’ve just crushed it. Other people are entrepreneurial and have built businesses from the ground up and sold them. Others are physicians, engineers. Our clients come in all shapes and sizes. But one of the consistent challenges that I’ve seen with many clients across a multitude of backgrounds and circumstances is the difficulty of truly defining what is enough. The textbook definition of enough is having as much as is required to do or be or have something.
But that’s case specific, isn’t it? And it’s ever changing in our lives when it comes to our personal finances. And therein lies the problem, really. One of the hardest financial skills that I want to encourage you to be striving towards is to stop moving the goalposts. In the psychology of money, Housel has a quote that I absolutely love. It’s not that it’s wrong to strive for more. Meeting personal expectations is incredibly rewarding, isn’t it? It’s reaching beyond our own definition of enough. That can get us in trouble. So as you go throughout this upcoming week, I want you to ponder a bit on this idea what is truly enough? What does that mean for me? And when I get there, am I able to recognize that I’ve achieved what I set out to achieve and stop moving the goalposts? It’s one of the great challenges that we all are confronted with on our journey toward financial freedom and peace of mind, but it’s a worthwhile one because 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 podcast.
Disclaimer: The preceding program is furnished by Creative Planning, an SEC registered Investment advisory firm that manages or advises on a combined 210 billion in assets as of December 31st, 2022. 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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