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Securing Your Portfolio From Global Conflict

Published on November 6, 2023

John Hagensen

In a world that can often feel chaotic, war has a way of injecting even more uncertainty into the mix. So, how should we navigate the financial landscape during ongoing events in the Middle East? Join John as he delves into historical market patterns during times of conflict and provides valuable strategies to help you chart a course through these turbulent times. (1:30) Also, how to bridge the income gap when you decide to retire early (6:01).

Episode Notes:

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

John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Hagensen, and ahead on today’s show, How to Invest During Times of War. The best approach to discussing estate planning with those that you love and why downsizing your home in retirement may not be quite as helpful financially as you once thought. Now, join me as I help you rethink your money. It’s difficult right now in many ways to think about our portfolio, our investments, just our money in general. In fact, it sometimes feels insensitive relative to the tragic events taking place right now in the Middle East, and for that matter, the devastating events over in Ukraine that have been going on now for well over a year. And our thoughts and our prayers are with those who are experiencing the loss of loved ones and the uncertainty of their future and fear.

But this is a show on personal finances, and I’ve received more questions in the last few weeks regarding how this war impacts your money, your portfolio, what does it mean for your strategies? I want to start today by unpacking that together. It may sound counterintuitive, but during times of war, historically speaking, the stock market has performed surprisingly well. World War II started September of 1939, the forward five-year return to the stock market 56%, so a little over 11% per year. The five years following D-Day in June of 1944, market was up 49%. The Korean War in June of 1950, the five-year market returns, 172%. The Vietnam War in November of 55, market followed with five years averaging 52%. The US and Vietnam in March of 1965, five-year returns only up 20%, so not great, but still up 4% per year. The five years following September 11th, those tragic events in New York, market was up 26% over the next five years. And the US and Iraq, March of 2003 following five-year return up 73%.

Now, of course, none of this is promissory. Certainly doesn’t mean you should expect 10% per year or 13% per year or 6% per year. But did you notice the one commonality regarding the five-year returns following the start of all of those wars? Yeah, they were positive. Your investments still continued to grow in the midst of conflicts, in the midst of tragic events across the world, in the midst of geopolitical unrest and uncertainty. And so when you invest during times of war, here are a couple of highlights that I think are important for you to remember. Number one, wars and their impact fortunately are declining. I know a lot of people are fearful right now that this could escalate. Is Iran going to enter the picture? Would that draw China in? What does this mean for us and our role? But generally speaking, if you look back throughout history, we are in a time of increasing peace.

Number two, stocks do fine during times of war. I just outlined that for you. Number three, wars can lead to higher inflation. There’s historical data that shows during war times inflation tends to increase. And so to go a layer deeper related to high inflation, well, it negatively impacts bonds, specifically longer term bonds as we’ve recently seen with the blowout inflation coming out of COVID and the massive amount of fiscal stimulus that we basically poured gasoline on the fire and continue to do so in hindsight, at far too high levels for far too long. But generally your investments in real estate and stocks do well in high inflationary environments. It’s also worth noting that concentrated positions can be even more risky than they already are by being under diversified during times of war. Think oil shocks, supply chain shocks, during times of war, you’ll generally see very big winners and very big losers.

And so if you are under diversified, that variance in your returns between different sectors or asset classes can have a massive impact on your personal returns if you have big concentrated bets. It’s just basically reason 1,122 of why you want to be diversified. Also, regional positions can be more risky. Foreign economies can be more greatly impacted. This is why I’m an advocate of international investing. It’s why I’m an advocate of broadly diversifying and having no big bets in any single spot. And yes, this applies also to investing entirely in the United States. And so what’s the takeaway for you as you look to invest your savings during this time of war? Ensure that you’re broadly diversified both domestically and globally and avoid major changes assuming that you already have a great financial plan.

This war is not a reason in and of itself for you to be adjusting key pieces of your financial plan and strategies because you suspect it’ll have a negative impact on your investment returns. It’s simply not the case. It’s not what history has shown us. But if you don’t have a financial plan, I could see where this would be really unnerving. Or if you don’t have conviction about the plan that you do have and it hasn’t maybe been reviewed recently or it’s somewhat incomplete, your advisor’s not a CPA, they don’t look at your taxes. They haven’t reviewed your tax return in the last year. Your estate attorney couldn’t pick your financial advisor out of a lineup. They don’t communicate. Well, yeah, then it’s probably time to have that reviewed.

And if you’re not sure where to turn, at Creative Planning, we help over 60,000 clients in all 50 states in over 75 countries around the world. To speak with a local advisor just like myself, visit creativeplanning.com/radio. Why not give your wealth a second look? I had a couple of conversations this last week with clients I made a note of after the fact and thought, you know what, I’m going to talk about that on Rethink Your Money. The first was someone who’s 51 years old and wants to retire in the next two years or so. The challenge with that for them is that all the money that they have saved and intend to use for retirement, which by the way is a lot, their retirement accounts are over $3 million, are in fact retirement accounts that they’re worried about being penalized on if they take distributions prior to 59 and a half.

So this is someone who saved really well, wants to reap the benefits of that hard work and hang it up early and enjoy what they’ve saved, but they’re not interested in paying a 10% penalty plus income taxes on those distributions. He said, what are my options here, John? What can I do? And so I discussed with him what’s called a 72(t) distribution. It’s also known as a substantially equal periodic payment plan. I know, it’s a mouthful. But a 72(t) is essentially a method that allows you to access your retirement accounts such as traditional IRA or a 401(k) before that age 59 and a half without incurring the 10% penalty. Now you’re thinking, well, that sounds like a unicorn. I get to take it out early and not pay the early withdrawal penalty. Yes and no. It’s certainly not a unicorn. It does allow you to do that, but with many provisions.

Let me outline some of the pros and cons if you are someone falls into this situation. The pros are pretty simple. You gain early access to your funds. You can retire early and enjoy those distributions. There’s flexibility. You can choose three different methods for calculating that amount. There’s an RMD method that required minimum distribution method, a fixed amortization method, and a fixed annuitization method. Don’t worry, I’m not going to bore you with breaking down each of those. Just know that there’s three different methods. And by the way, do not even think about doing a 72(t) by yourself. Go see a financial advisor like us here at Creative Planning that have done hundreds or thousands of these for clients and ensure that you understand all the ramifications. Because, yes, there are some pros, but I’m going to get to the cons here in a moment. And if you mess this up, there are huge penalties.

But the third and final pro is that you receive regular income to live on, even though you’re not 59 and a half, you get some stable cashflow. Those are the obvious pros as to why you would do it. The cons are, number one, exactly what I referred to. It’s a rigid schedule. Once you select one of those three options and then you accidentally mess something up, all of the penalties are retroactive. So you can get hammered for penalties, not just for right now, but for the previous three, four, five years because you made a mistake in year four or year five, let’s say. You’ve got limited withdrawals, you can’t make additional withdrawals after the distribution schedule is put in place. So yeah, I only need 50 grand a year, let’s set it up where I’m going to get 50K every year. All of a sudden you go, whoa, whoa, no, I need 80 grand. Sorry. Nope, you’ll be facing penalties. You need to only take the 50.

And there are still tax implications. Yes, you’ll avoid the 10% early withdrawal penalty, but distribution is still subject to regular income tax. I don’t know how much of a con that is as much as just pointing out, you don’t eliminate that. There’s a long-term impact. Depending upon the method that you choose, it may not align with your actual financial needs. The one thing that I’ve seen sitting down with thousands of clients is that every plan we build is wrong because people’s lives are constantly changing. A 72(t) doesn’t allow for your life to change essentially, you’re locked in. You’ve also got a risk of running out of money because if your 72(t) is the primary source of income and market conditions are unfavorable, you do run the risk of depleting your retirement savings prematurely, leaving you with inadequate funds for later years.

So the investment allocation really needs to be aligned with this 72(t) and the amount of income that you are taking out, to ensure that if you get bad market returns and poor performance early on in this 72 schedule, that you’re not selling off significantly more shares than you’d like, which potentially then even if the market recovers, you’ve cannibalized the portfolio and you may run out of money. But by far the biggest con is the complexity. They’re hard to follow. This isn’t something you just sort of, yeah, I’ll just do a 72(t). And I explain this to our client, we can help do this, but you need to understand the ins and outs fully. And I would advise that you exhaust basically every other option prior to utilizing a 72(t). When interest rates were lower, that might mean taking a home equity line of credit, selling a rental property, pulling from non-qualified funds, whatever it might be, a 72(t) should be used in limited circumstances where you really feel like it’s your only option.

The other question I received was from a new client who said, hey, what do you guys do here at Creative Planning with the extra cash that flows into my accounts from interest and dividends? Do I need to tell you guys to reinvest that? Does it just sit in cash? How does that work? And the answer is, a good financial advisor is going to set in your account whatever amount of cash you’d like to have remain in there. And my belief, certainly in this environment where inflation’s higher and you can earn a lot of money even on basic money markets or short-term treasuries, you want as little pure cash as absolutely possible in the portfolio. It’s an unnecessary headwind where you’re earning no money when you could be earning right now, even in money markets around 5%.

So we systematically and automatically invest cash consistently with your tax strategy, with the asset allocation, with the type of account that it’s in, to ensure that you don’t have a performance drag by extra money sitting in cash. It’s interesting, probably the most annoyed I ever see prospective clients when they’re thinking about making a change, they’re going to fire their advisor, they’re going going to hire us at Creative Planning. One of the fastest ways for an advisor to get fired is when a client deposits money, they’ve got a rollover check or there’s a lot of dividends and distributions going into an account, and it initially sits in cash. Two or three months later, the client looks at their statements and says, wait a second, that $50,000 is still sitting in cash? It was never invested? Wow. Well, it’s pretty obvious you’re not looking all that closely at our account or you’re not organized either of which concerns me. I’m finding a new advisor because I’m paying you guys to ensure that that doesn’t happen.

And so that is how we handle dividends or cash that comes into an account here at Creative Planning. But I think the broader takeaway for you is to just consider what cash you in fact have right now potentially on the sidelines, and is it earning the amount of interest that’s available to you in the marketplace right now? If you’re earning less than say 4%, I would be looking for alternative places to allocate those dollars because even short-term liquid accounts are paying healthy interest rates right now. And really for the first time in decades. And I know how hard you’ve worked for your money, I want your money to be working just as hard for you.

My special guest today is Creative Planning attorney, Lenny Best. Thank you for joining me, Lenny here on Rethink Your Money.

Lenny Best: You’re welcome, John. Thanks for inviting me.

John: How do you recommend going about discussing your estate plan with family members? How should that be communicated?

Lenny: That’s a great question. And there’s really no black and white correct answer, it really depends on the family dynamics. The best practice there is don’t surprise those who are going to be in charge of the plan and who are going to be benefiting from the plan, especially if you think there might be surprises to the family or to the members involved. If you bring that into the light, that allows you while you’re alive to clear up any problems that could arise post death. So that’s the real benefit of communicating and sharing the plan. But it’s also sensitive information. And so I understand where sharing the plan either is not going to be very easy or maybe unwise. There are circumstances where there might be estranged family members or family members that aren’t estranged that you’re not including in your plan.

John: You want to use common sense for sure, but I’ve seen probably the biggest disagreements or feuds, I would put it, with existing clients or beneficiaries of clients I should say when they’re surprised by, let’s use the example of mom and dad, by what they put within their estate plan that they never communicated and then they passed away and it was almost like was this an omission? Did they actually mean to do this? When you’re in a disagreement with someone, it’s never best to text them or email. It’s better to call or get together in-person, because you can contextualize.

I hear what you’re saying. Sometimes it doesn’t make sense too, depending upon the dynamic of the family, which every family is very unique, but my experience, if there’s a way to communicate, you don’t need to say you’re getting this exact dollar amount, but to share the broad plan with people that will be involved at a high level of what your intentions are thinking this was by mistake.

Lenny:  That’s right. And sometimes when parents share the plan with adult children or other members, they bring up questions that the clients never thought of, bringing them back to the attorney to clarify things for themselves. And there’s also some technical things to keep in mind. There is attorney-client confidentiality and attorney-client privilege. And so whenever a client might be sharing their legal information with another person, they’re potentially waiving that privilege. And that can be something that needs to be considered, especially if it’s dealing with a situation where maybe they’re excluding or disinheriting someone from the family in the estate plan and they want that to remain protected under attorney-client privilege. So that makes things a little bit more difficult too when it comes to sharing.

John: Lenny, what would you suggest for people asking their parents proactively about their estate plan? Because I know that can be a little bit sensitive. Oftentimes the adult child doesn’t want to make mom and dad feel like they’re waiting for them to kick the bucket and how much money am I going to get? It can come off a little bit insensitive, but I think when you have a healthy family dynamic and a close relationship, there are many clients that are trying to build out their retirement plans that are in their 50s, maybe even their 60s. They don’t know if they’re inheriting a half a million dollars, if they’re inheriting $3 million, if they’re going to inherit one penny or nothing at all, and it has a huge impact on their planning for retirement, how do you suggest that they best approach that conversation?

Lenny: That can be a delicate thing. And I often get that question from clients where they are wondering what do they need to do in their plan with respect to what might happen in the inheritance they receive and they don’t know what that might be. And they’re also often concerned about whether or not parents have granted authority to them or any siblings in the event of incapacity as their parents are getting older. So that’s a sensitive topic, and I answer that by saying, depends on the motive that you’re bringing to your parents and whether or not they’re sensing that you’re asking these questions out of care and concern for their wellbeing or if you’re asking these questions because you’re just curious about your inheritance. And so one way that they can approach that is if they’re doing their own estate plan, the client, then you could share with the parents, hey, listen, I’m creating the estate plan for me and my spouse and our children and our attorney has shared with us a lot of things that really enlightened us about what we need to be thinking about and being prepared for. And it made me wonder what you have in place too, because honestly, we don’t want to be surprised by things that we didn’t know weren’t in place. If you were to become incapacitated and not grant healthcare powers, we’ve learned that we have to go to court and become your guardian and get guardianship and conservatorship before we have any authority to act on your behalf. Most folks are going to say, yeah, I would never want that to happen or for my kids to have to go through that. So that can help sort of break the ice, if you will, to address that topic.

John: That’s a fantastic approach. Even sharing with your parents at that time saying, look, I’m not trying to pry. I’m not looking for information you are not comfortable sharing. I just want to open this dialogue, to your point, because we just worked on this or because something happened with a friend and now they’re going through probate. And it just got me thinking, we’ve never talked about this mom and dad. I remember an example of a client ended up inheriting money from parents that passed away. They lived in the Silicon Valley area and the parents had a huge Apple position like a lot of people do in that area. Well, the kids did as well. So it was interesting because had they known that they were going to be inheriting mom and dad’s portfolio, they wouldn’t have been as over concentrated. They were overlapping a ton of their positions in tech.

And by the way, it ended up working out really well because Apple’s been overall a great company. But they probably for all intents and purposes, were much more overweighted in a specific holding than they would’ve wanted to be had they known that was essentially part of their portfolio because mom and dad were never going to spend it down. It had a ton of unrealized gains and they planned on just getting the step-up in basis and passing it on to the kids. So it can really help from a financial planning standpoint. Do you think that’s a good approach, Lenny? Also, you can say the estate planning conversation, but you can also say, I’ve just worked on my entire financial plan and I’m trying to prepare for retirement and understand how to invest properly and have the right risk tolerance. It got me thinking about my future and how maybe your situation may impact mine, again and approaching that delicately.

Lenny: Yeah, it can be. I think the important thing in that situation to keep in mind is their parents plan is still revocable, they’re still alive and they’re not incapacitated.

John: Good point.

Lenny: They can change their plan. But I’ll tell you, the more that a family can be and have solidarity throughout the generations and be truly intergenerational in the family wealth while at the same time have their own individual realities with regards to their family and their household and their personal wealth, the better off the overall plan’s going to be. Because the more you can really plan out throughout the generations, the more likelihood it’s going to succeed throughout those generations.

John: I’m speaking with Creative Planning attorney Lenny Best. Ultimately we want to avoid a family feud here, not the game show, not the fun one, the actual family feud where you see money unfortunately just rip apart relationships. How do you suggest people best avoid through a good estate plan, some of these conflicts that we unfortunately see?

Lenny: There is no legal plan or legal document that can really guarantee prohibiting or preventing family feuding, but having no plan is probably a good way to instigate family feuding where it should have never happened or existed in the first place. And so simply putting a good plan together and making sure that that plan makes sense for you and your family is going to go a long way in making it possible for that family to really deal with the death of their parents, the loss of loved ones, and not be as distracted as they might be if there’s no estate plan in place. And that distraction and that stress and that grief is often what underpins the feuding, the emotional response that comes with that lack of planning.

So simply having a plan in place is so important for that, but then making sure it’s the right plan to not create situations where you’re probably triggering family feuds. And that can come about through disinheritance or unequal distributions among children. One of the most difficult sometimes challenging cases is we’ve got mixed families. So children from different marriages, those children might expect one thing from parents, whereas the other children would expect something different from that married couple.

John: We just had a client here in Arizona where this exact thing happened. Second marriage, their parent was the first to pass away unfortunately. And all of a sudden within six months there were houses being gifted and new cars in driveways to the surviving spouse’s children. The child of the spouse who passed away is sitting there going, whoa, I haven’t seen a penny and it doesn’t look like I’m going to because this estate is getting spent down really quickly. And it was one of those scenarios where verbally it had been said, oh, this is going to get split evenly. It doesn’t matter which one of us passes away, everybody trusts their spouse. And after one spouse passes away and the other spouse legally has full control to do whatever they want, it is not uncommon, and I would challenge anyone listening if you’re in a second marriage, to make sure you put this in place, it’s not uncommon to have the surviving spouse slant the assets or all of the assets toward their children.

Lenny: It’s easily something that can be overcome with proper trust planning. Well, I shouldn’t say easily, there’s often nothing easily done when we’re dealing with-

John: But can be overcome is your point. You can put mechanisms in place to make it happen.

Lenny: And it’s not wrong for folks to think and they should say, I want to trust my spouse and I trust my spouse. And I’ve had cases where in those family dynamics and those mixed families, really that married couple started out with that family, those children, all of them from both sides were young, and so they all grew up together and there’s really no, it would be very bizarre for one spouse to choose to disinherit the other spouse’s children because they’re like family.

John: So as we wrap this up, Lenny, what would you say is the most important estate planning conversation, if you had to pick one that people should have with family members?

Lenny: I think the most important conversation is really revolving around what happens upon incapacity. And none of us want to think about a parent, an elderly parent becoming incapacitated. What do we do next? What’s the plan?

John: An often-forgotten part of the estate plan. People are thinking death, people are thinking only death, right? Not incapacity.

Lenny: And then when it comes to healthcare decision-making authority, there’s really no great perfect way to handle that. You’re either trying to predict and tell the physician what you may or may not want, and you have no idea what your circumstances are going to be. So that’s virtually an impossible task, and by trying to do it that way through a directive or living well or something like that, you’re essentially becoming a ward of your healthcare professional. They get to determine your condition and they get to interpret that document. So they’re always better off appointing somebody that they trust, who will advocate for them to make those healthcare decisions for them, and that’s usually a child or a sibling, somebody they trust their life to.

John: This is great advice, Lenny. I’ve been speaking with Creative Planning attorney, Lenny Best. Thank you for sharing this information with us and I look forward to having you back on Rethink Your Money.

Lenny: You’re very welcome. Thanks for having me today.

John: Well, it’s pretty common when reaching retirement age or maybe just the empty nest season of life, that you downsize. People say to themselves, I don’t need all this house, it’s just the two of us. And I can attest even with all of our children, my wife and I occasionally think to ourselves, man, maybe we should downsize, but it’s for different reasons. It’s because cleaning a house where our kids are intent on making a mess in every square inch of it, it can be problematic. I don’t live in some mansion or anything like that, but it’s a good size house and it has a basement and it’s a basement that I try to avoid at all costs. It’s just negative energy. You start walking down there and I’m seeing costumes laying on the ground and I’m stepping on Legos. Don’t ever walk in my basement. This is a warning.

If you ever happen to be in my house, do not walk in the basement with your shoes off. You will step on Legos. It will be like the unintentional home alone, Kevin McCallister, you’re breaking Christmas ornaments on your bare feet. And because of this, sometimes when we’re on vacation and we’re staying in a small place, maybe an Airbnb, it’s like, wow, this is kind of nice. It’s easy to pick up things. And if you’re approaching a season in life where downsizing may make sense, I want you to consider a couple of things that are more relevant today within that decision than maybe they have been in the past. The Wall Street Journal as well as Business Insider had a couple of great articles on this. The number one reason typically is to simplify and then to save some money.

But it’s no longer a surefire financial move to accomplish that. And I’ll give you a few reasons why. The supply of smaller homes in the real estate market, which is by definition homes that are 750 square feet to 1,750 square feet, so a little under 2000 square foot homes, that inventory has decreased by 41% since 2019. We just don’t have enough of those homes. And what’s happened, because of that low supply, basic economics, is that it’s driven up prices by over 50% on those smaller homes, making it a challenge for older Americans to even find affordable options at that size. Of course now with rising mortgage rates peaking up over 8%, the cost of smaller homes can strain the budget of retirees, particularly those with fixed incomes who are looking to purchase using a mortgage.

And in many cases, that two and three-quarter percent fixed rate mortgage, even on a higher dollar amount of a larger home can be less expensive on a monthly basis than taking on a mortgage in this much higher interest rate environment. Those looking to downsize are also competing with younger generations for these homes because of this tight housing market. And my final consideration for why you may want to rethink the idea of downsizing in retirement, is because it may help you avoid triggering significant capital gains taxes on that appreciating home. Now you have a $250,000 capital gain exemption on your home sale if you’re single or 500,000 if you are married, filing jointly, but with the massive boom in the real estate market in particular over the last decade plus and one that we saw accelerate significantly during COVID, there are many homes and not the most expensive that have seen appreciation. Certainly if you’ve lived there for a long period of time, well in excess of that exemption amount.

So to recap, there’s a limited supply of smaller homes, which has driven up the prices. Mortgage rates are through the roof. You’re competing with a lot of younger buyers due to the tight housing market, and you may trigger unwanted taxes. So of course, this is a decision that needs to be made within the context of your financial plan, your tax plan, your estate plan, and it’s no longer the obvious and savvy financial move to make once in retirement. And if you have questions about your financial plan, a real estate transaction, or anything else in your life that starts with a dollar sign, speak with one of our local advisors just like myself here at Creative Planning by visiting creativeplanning.com/radio now. Why not give your wealth a second look?

My next piece of common wisdom that I’d like to rethink together is that real estate is more tangible than a stock ticker sitting in a brokerage account. I get asked often, should I invest in real estate or the stock market? Well, my answer isn’t typically one or the other. It’s why not invest in both? Because it’s not that one is necessarily better than the other, they’re different. Let’s start with real estate pros. Easy to understand. If you’re an adult and you’ve lived a while, you’ve probably bought and sold a home or two, and that provides a comfort level when investing in real estate. You purchase a property, you manage the upkeep or tenants. If you have additional properties beyond your primary residence and you’re renting those properties out and you attempt to resell the house at a higher value than you bought it for.

You can invest with debt. Most homes are purchased using a mortgage, and there are fantastic terms related to that mortgage. Relative to all other debt, there’s no interest rate you’re going to achieve that’s lower, and that’s because there’s a margin of safety for the bank. They require you to put a down payment down so you’ve got some skin in the game. Go back to the great financial crisis, we know what happens when that requirement is ignored. We have all sorts of problems because then people just walk away from the house and don’t lose any of their own money. But let’s assume there’s a 20% down payment and the collateral of the house, the bank says this is relatively safe, plus you need somewhere to live if it’s a primary residence. We’re pretty comfortable offering you a 30-year fixed rate mortgage at whatever the prevailing rates are.

Right now they’re extremely high, but at the lowest rates possible within the current environment. Real estate investments have historically served as a great hedge against inflation, because both home values and rents typically increase along with inflation. You get tax advantages to property ownership. You may qualify for a tax deduction for the mortgage interest paid on up to the first 750,000 in mortgage debt. And there are also tax breaks when you sell a principal residence such as that 250 or $500,000 exclusion depending upon your marital status on your net proceeds.

Now, what are the cons of real estate? They are a lot more work than stock. You’ve got to maintain a property. If you have renters, you either have to hire a property manager and pay them, and even then there’s still some work or you’re handling the call it midnight from your renters telling you that the dishwashers leaking all over the hardwood floor in the kitchen. Real estate generally has an expensive entry point. You could open a basic brokerage account with $200 and purchase an S&P 500 index fund. You need a lot more money to purchase your first property, even if you’re looking to only put 5% down or 20% down, there’s a big upfront investment that you have to save for.

It’s also illiquid. Getting money out of your real estate through resale is a lot more difficult than clicking a button like you’re able to do with stocks. Real estate has high transaction costs. 6% is the traditional amount that’s going to buyers and sellers agents. Even if you negotiate that down to 4% or 5%, you also then have a other closing costs that can total up to close to 10% right off the top of the sales price. It’s also difficult to diversify your investments. If you’re buying individual properties, unless you own a lot of them. And I have some friends that have 30, 40, 50, 60 rental properties, but even those, they’re all located in the same area, significant geographical risk. And that’s people with a massive rental property portfolio. Most have one or two rentals, so not a lot of diversification when it comes to real estate. And location absolutely matters.

And the last con on real estate is that your return certainly isn’t an assured thing. While property prices tend to rise over time, there’s always a risk you could sell at a loss. And during the pandemic, if you were a landlord, I know in certain parts of the country I personally have clients whose renters refuse to pay rent for over 12 months, and per the laws, there was absolutely nothing they could do about it. And by the way, that mortgage bill that was still coming every month for them as the property owner to have to pay. Let’s shift over to some of the pros of stocks. They’re highly liquid. You get ownership in some of the best companies in the world. It can be done in a moment’s notice. It’s really easy to diversify your investment. You can own very small amounts of thousands of the best companies spread out all over the country, all over the world, different industries, sectors and sizes.

There’s fewer, if any transaction fees. In many cases, you’re paying 0% for trades at many of the custodians, and you can grow your investment in tax advantage to retirement accounts, like a Roth where you’re able to see tax-exempt growth and distributions assuming you follow a few basic rules or a traditional retirement account where you’re receiving a tax benefit on the way in and tax deferred growth while it’s accumulating. Now, it’s not all gravy with stocks though. What are some of the cons? The stock market is volatile. Even as much of a believer as I am over the long-term prospects of investing in a diversified mix of stocks, I have no idea what their value will be 12 months from now. Keep in mind, over a one-year period, you have about a 75% chance of making money. Over a five-year period, about a 90% chance, and over a 10-year period, 98% chance of having more money than you started with.

So the odds become progressively more in your favor the longer you invest, but the negative is 18 months from now, no clue, no idea. In fact, from a historical perspective, you could be up about 50% or down 40. You have a 90% range, and that should not be underestimated. Monies that you invest in the stock market, and by the way, this is true of real estate as well, need to be earmarked for longer term goals, not money you want to use for a down payment on a house or to start a business or send a kid to college in 18 months. Normally you’ll have more money, but you may not and you may have a lot less depending upon what’s going on in the current moment. When you sell stocks and brokerage accounts, you might have to pay capital gains. By the way, that’s kind of a good thing just like with your real estate because it means it’s increased, but it’s not without the requirement to pay taxes.

And frankly, that liquidity that I mentioned as one of the pros, is in my opinion, one of the greatest disadvantages. I know this is counterintuitive, but disadvantages to investing in the stock market. People make very emotional, imprudent, I’ll just say it, stupid moves with their money because of the fact that it’s almost entirely frictionless to sell even $5 million of your investments with the click of a button. So should you invest in real estate? The answer is maybe. For me, I own real estate, but I prefer to find who I believe to be the best managers in the world, invest my capital with them, and then collect income and price appreciation without ever needing to lift a finger. Alternative investments are less liquid, they’re less transparent, they’re higher in costs. They can be more complicated at tax time.

A lot of alternative investments, they’re a big pain, they’re inconvenient, but they do offer returns outside of traditional liquid markets. And for many clients, especially those with higher portfolio values, having 10 or 20 or 25% of the portfolio mix allocated to non-traded investments may be helpful at lowering expected risk and simultaneously increasing potential returns.

Let’s examine how to most effectively rebalance your portfolio to maximize returns and minimize risk. Now, there isn’t a lot of debate as to whether you in fact should rebalance, that is a given. And if you’re not sure what I’m referring to, it’s simply the process of selling the excess of your higher performing investments and using those proceeds systematically to purchase your underweighted positions within the portfolio. So for example, at the most simplistic level, if you wanted 50% of your portfolio in stocks and 50% in bonds, and you did that 40 years ago and you never rebalanced, your account right now would be over 94% stocks and less than 6% bonds. Well, how could that be? Well, because for four decades, your stocks have progressively outperformed and compounded that outperformance and your bonds just haven’t grown as much.

And that’s the most important aspect of rebalancing. It reduces risk by ensuring that you are not overweighted in any one type of investment. The second benefit, it systematically allows you to sell high and buy low, which is the name of the game in investing. If you have 15 or 20 different asset categories, the only reason that one of those would be significantly overweighted, is the result that it performed far better than its peers in the portfolio. And because most investors, I hate to say it, are kind of suckers and they chase the hottest investment and they’re a product of their emotions. When you look to rebalance and sell the surplus of that investment, you have your friends lined up down your driveway looking to buy it from you at a premium. And as they’re traipsing back down your driveway, you stop them. You go, hey, hey, almost forgot. Hold on, hold on, Jim, you don’t happen to have any of that investment that’s doing really, really bad right now that you want to sell me at a huge discount, big sales price, do you?

And Jim looks at you and says, well, you want that? That thing’s doing terrible. And you go, yeah, yeah, no, no, I understand. That’s how I make money in the markets. I buy low and I sell high. First the buy and hold strategy starting on January 1st, 2020, so you haven’t probably heard much or anything about this pandemic, about COVID. You’re 75% stocks, you’re 25% bonds, you have a $5 million portfolio in this example. The S&P 500 fell 31% from January 1st to March 23rd. Less than three months, it was down 31%, fastest bear market we’ve seen. At that point, your $5 million, that was 75, 25 is now worth 3.8 million. Remember how I was talking about the cons of the stock market? This is it. You can go from five million to 3.8 before you blink an eye. Now, again, that’s a historical outlier, but it’s possible. If a global pandemic comes through, that can happen.

And at that point, you’re 67% stocks, 33% fixed income, because again, your stocks fell 31%, your bonds were probably pretty much flat or up a little bit depending upon what type of bonds you owned during that period. Well then from March 23rd to August 17th, the S&P 500 went up just under 50%, 48.29%. At which point on August 17th, you would’ve had 74% stocks and 26% fixed income. So you’d be right about back to your 75, 25 and your $5 million that went all the way down to 3.8 million is back up to $5.2 million. What a ride for that eight month period, not even factoring in all of the real world ramifications of online school for your kids and family members sick or potentially even passing away in some tragic cases. Maybe you’re working remote completely for your job. You’re not even sure if you’re going to have a job.

If you’re a business owner, you’re wondering how the heck you’re going to make payroll. That was a wild time period. But if you were in a coma from January 1st to August 17th, you would’ve woke up eight and a half months later and gone, I don’t know, I’m still 75, 25, my five million is at about 5.2. Nothing’s really happened the last eight months. Your friends would look at you and chuckle and go, you’ve missed a lot. We’ll explain it to you later. Now, let’s use that exact same $5 million portfolio, same time period, but someone who opportunistically rebalanced. And that is what we advise here at Creative Planning. It’s not once a year, it’s not once on a calendar quarter because those are arbitrary, manmade, insignificant intervals. If your portfolio drifts within certain asset categories beyond what we deem acceptable, we are going to rebalance.

So again, March 23rd, 2020, the market’s down 31%, you’re 67% stocks and 33% fixed income. That’s not what we want. You go ahead and rebalance. You sell about $298,000 of your bonds because you have too much of those, because they haven’t lost any money and your stocks are down and you use those strong dollars, those proceeds from your bonds to purchase more stocks while they’re at one of the deepest sale prices we’ve seen in decades. As mentioned previously, the S&P then jumps over 48% from March 23rd to August 17th, resulting now in an 80% stock, 20% fixed income portfolio, and you’d be ready for a rebalance again. But instead of having $5.2 million as you would’ve had had you not rebalanced, your portfolio now is at 5.325, you had $118,000 more simply by seizing the opportunity of buying while stocks were temporarily on sale.

And here’s the best part, you don’t have to be a fortune-teller, you didn’t need to have any idea of what would happen next, where the market would go. You simply said, I want to be a 75% stock, 25% bond investor, and I’m not that right now. I’m 67% stocks and 33% fixed income, and that’s not going to get me where I need to go. And that means that bonds have done better than stocks. So I’m going to opportunistically rebalance and sell 300 grand on my bonds and buy more stocks. And at the end of that, we’re talking in an eight-month period, 118 grand more in your portfolio by keeping the portfolio constituted in a way that, here’s the best part, is consistent with your long-term financial goals. And so my question for you is a simple one. Did you do that in 2020? Did you opportunistically rebalance your account?

If you’re not sure where to turn and you’d like to speak with a wealth manager here at Creative Planning just like myself, visit creativeplanning.com/radio, because we believe your money works harder when it works together. But we’ve got time for one question. And as always, one of my producers, Lauren is here to read those. Lauren, hey, how’s it going? I think we had a question on Medicare. Let’s go to that one.

Lauren Newman: Hi, John. First question I have here is from Diane in Cave Creek, Arizona. She says, this is the first year Medicare is available to me, and I’m hoping you can help me with a question. How often can I change my Medicare Part D prescription drug plan and is there a specific time of year when I can switch to a plan that covers my pharmacy’s discount card?

John: Diane, this is a great question. Anyone on Medicare can review their drug coverage options annually during the Medicare annual enrollment period, which is October 15th through December 7th. So we’re smack in the middle of it right now. And during that period, you’re allowed to change your drug coverage for the upcoming calendar year if needed. Now for you it’s your first year, so it’s a little bit different, but I’ll speak to subsequent years because it will encompass your situation as well. I recommend you identify which plan covers your medication needs the best at the lowest total annual cost. So then what you’re going to do is review the drug coverage options and that’ll result in one of two potential outcomes. Number one, it’s going to confirm that the current plan you’re on is the best option for the upcoming year. And by the way, if in future years that happens to be the case, no action is required on your part. You just keep the same plan.

But because these government programs are kind of the wild West, outcome number two is you go through the process and you realize a different drug plan is actually better for your medications for the upcoming year. And maybe even in some cases you’ve switched your medications, that typically prompts people to look into this, although I think you should do it every year, but that is a really good trigger to remind yourself, I need to look into this to see if I can save some money. And if that’s the case, you do need to complete the enrollment process via the Medicare website. And of course, we have a big Medicare team here at Creative Planning that it’s all they do. They help people just like you navigate this complex and what can sometimes be confusing world of Medicare, certainly when it comes to supplements and advantage plans and Part D with drug coverages. So don’t feel like you need to go about this alone. If you’d like our help, we are happy to do so.

If you have questions, do what Diane did and email those over to radio@creativeplanning.com. Well, this past weekend, our pastor at church was talking about money and giving. And it was interesting, somewhat humorous, because he even qualified the series by saying, look, I know when people are in church they get very uncomfortable with the thought of talking about money, but I’m still going to do so. And the reason is because where we spend our money is a great indication of what we prioritize and value. And if we believe the way we allocate our time is also of great importance, well then I think it’s worth asking ourselves, which is more important? If we had to choose. And they’re both a great indication of our priorities, is time or money more important? It’s clearly time. Every day that we have is a gift. Money’s just a tool to potentially buy us more time or to help enhance the things that we care about.

But if I gave you a million dollars in cash right now, how would you feel? You’d feel pretty good, right? Be like, man, nobody’s putting me in a bad mood today. I just got a million bucks from John. This is great. Now what if I gave you $10 million? Sounds pretty good too, right? But it came with a qualifier. I said, here’s the 10 mil, but you can’t wake up tomorrow. Today’s your last day on earth. Do you want my $10 million? Well, of course not. Waking up tomorrow is worth more than $10 million, yet it’s easy, and I do this too, to forget that. Instead we wake up and we worry about making money, losing weight. I got to get to work on time. I want a new car, I don’t like my car, it’s not cool. Man, my friend, their house is way better than mine. My sibling’s going on a lot better vacays than I am, and that gets me down.

No, you woke up and simply because you woke up, it’s going to be a good day. It’s already a great day. The only question is really, how great is it going to get? So the takeaway is time equals your money plus your values. And so recognizing when you can retire early because you have enough saved, is important. You don’t have to retire early if you find a lot of joy in your job, but if it’s getting you down or taking up all of your time to accumulate more money, what’s the point? Delegate activities and responsibilities to others that are professionals, and that’s what they do, to free up more of your time. Here’s a big one that I’ve learned as we continue to have more and more kids, and as I had more and more responsibilities, learn to say no.

For me, if it’s not a heck yes, it’s the heck no. Because remember, when you say no to one thing, you’re simultaneously saying yes to something more important. So keep in mind, there is no better use of your money than when you use it to buy yourself more time, because time is far more valuable than our money. 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 Hagensen works for Creative Planning and all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance.

The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you 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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