Is cash affecting your investment returns? In this week’s episode, we’re discussing the journeys of two renowned investors, leveraging their experiences to explore the concepts of compound interest and exponential growth. Additionally, we take a closer look into how the utilization of private markets can mitigate volatility and chat more about the current trends in financial influencers (Finfluencers) and the gold frenzy.
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 Hagenson:
Welcome to the Rethink Your Money Podcast presented by Creative Planning. I’m John Hagenson and ahead. On today’s show, I compare and contrast the paths of two of the most successful American investors and what you can learn from each of them. The vast world of private investments and their potential benefits, as well as whether you need a will and a trust or just one or the other. Now, join me as I help you rethink your money. Theodore Arntzen said, “There are just a few individuals who have truly changed how we view the markets.” John Maynard Keynes is one of the few. Warren Buffett is one of the few. So is Jim Simons. But Jim Simons died earlier this month. He was the billionaire hedge fund manager and founder of Renaissance Technologies. Simons pioneered a revolution in financial trading. He embraced a computer oriented quantitative style in the 1980s, well ahead of the rest of Wall Street.
Now, Simons isn’t nearly as famous as Warren Buffett, but he was a way more successful investor. His returns aren’t even close, and I think there are a few lessons that you and I can learn when comparing and contrasting the history of each of these great investors. As a summary of their paths, Buffett’s 10 years older, so in 1950 when he was 20 years old, Simons was only 10. That’s when Buffett turned $20,000 into 140 grand by the age of 26. By the age of 30, Simons was still in undergrad and Buffett had a net worth of $1.8 million. At age 43, Buffett turned $34 million into a hundred million. By the age of 48, during that five year period, Simons was just starting Renaissance Technologies at that time in 1978. Fast-forward to when Buffett was 70 years old, he had a $62 billion net worth, so a lot happened over that 20 to 25 year period.
At this point, Simons is 60 years old and has an $8.5 billion net worth. So he’s doing quite well in his own right, but of course, big difference between 62 billion and eight and a half. A decade late, Buffett is in his 80s. He’s the third-richest person in the world behind Gates and Bezos and Jim Simons has a net worth of nearly 22 billion and retires. As of just about a month ago, Buffett’s net worth at $135 billion in his mid ’90s and Simons passed away with a net worth of 31.4 billion. Now I understand, that I’m comparing someone worth 135 billion to someone worth 31 billion. Neither one is going to be worried about how to pay for their Big Mac next time they’re in the drive-through. But Buffett and Simons teach us regular people three very important lessons. The first is the power of compound interest. Buffett earned far less than Simons whose estimated annual returns were 66% per year.
You did not mishear me. The guy made 66% per year and still ended up with a net worth a hundred billion dollars less than Buffett. Exponential growth in compound interest is hard to fathom. Buffett started as a teenager. He’s still investing in his mid ’90s, while Simon’s money compounded decades less. He started way later, he retired sooner, and he passed away over a decade earlier. If I told you there was a pond out in a field and it had just a spec of algae and every day for the next month that algae was going to double, and at the end of the 30th day, the entire pond would be covered in algae. How much of the pond is covered in algae at the end of day 29? I know I’m giving you a riddle here. I’m making you think. The answer is only half the pond. Meaning in the final day, as much of the pond increases in algae as what took place in the aggregate of the first 29 days combined.
The first thought, if you don’t think about it that carefully is that almost all of the pond is covered the day before the final day, but that’s not how exponential growth and compounding works. Buffett has earned well over 99% of his net worth after age 60, and this is why we never want to interrupt compound interest unnecessarily. This is why we want to start saving as early as possible. So Simons had a much smaller net worth despite significantly higher annual returns because of compound interest. But in addition, there are a couple of other smaller issues. You see, Simons figured out a way to solve the markets, but it was limited in size. Meaning when he tried to make the fund larger and more available to the general population, his arbitrage dried up. So put it another way, his strategy only worked up to a certain amount of money.
It wasn’t scalable to an unlimited amount. Another interesting side note to Warren Buffett is that he’s not only under performed Jim Simons, but he’s underperformed the broad markets over the last couple of decades. And part of the reason for that is his cash drag. That’s lesson number two. Do not think of cash as an investment ever. Cash is really dead money. Every dollar bill is working for someone. That’s how you should think about it. If you put money in the bank, they then loan that money out to someone else to buy a house or build a business and they charge them 7 or 8% interest.
They’re making money off of you. Your money is going to work for the bank, but you want your money to throw a shovel over his shoulder and go to work for you, not for someone else. And while cash is working for someone else, I’m not suggesting that you have no cash. Because you’ll need some in the case of an emergency. Things happen in life that we’re not expecting and carrying three to six months of cash on hand for unexpected events makes a lot of sense within a well-built financial plan.
However, that’s very different than what Warren, Buffett and other active managers and stock pickers do within their investment strategies. I get it. Warren Buffett’s a value investor and he’s looking for opportunities to be greedy when others are fearful, and so he wants some dry powder on hand to buy discounted stocks at the right times, but that has hurt his performance even against the broad markets over the last 20 years. In fact, Creative Planning President Peter Mallouk and Chief Market Strategist, Charlie Bilello spoke of this on their podcast Signal or Noise. Have a listen.
Peter Mallouk:
If you’ve got a bunch of money sitting in cash and the stock market’s going up, well, don’t be surprised when you underperform the stock market. My guess is if Warren Buffett took his same portfolio but had not set on cash so much, he probably would at least have matched the S&P 500 over the last decade or two. And I think this is a big part of why he struggled against it recently.
John:
I don’t want to gloss over the negative impact of cash. Imagine this 20 years ago, Warren Buffett, the Oracle of Omaha knocks on your door. You think it’s a solar salesperson? No, it’s not. Buffett’s standing in front of you and he says, “It’s your lucky day. I am offering to personally invest your life savings.” You would think to yourself, I just hit the lottery. I am going to be so stinking, filthy rich. Buffett is investing for me. Here’s what would happen in the next 20 years. The S&P 500 up 593%, Berkshire up 572%, that’s right. Warren Buffett has lost slightly to a simple low-cost strategy that virtually anyone could execute. He’s lost, he’s under-performed and if you take the Nasdaq-100, that’s up over 1000% the last 20 years, which is probably why Buffett decided since he couldn’t beat them, join them and started buying a bunch of Apple stock.
So lesson number one, the power of compound interest. You can get worse returns, but if they’re for a much longer period of time, you still win. Number two, cash drags down returns even for the great Warren Buffett, it has cost him dearly even against just the broad markets. And the third and final lesson is that professional managers have a very hard time winning. And so if that’s the case, buy low-cost investments broadly diversify, make smart tax trades strategically rebalance. Locate your investments in the right types of accounts, save adequate amounts per your goals and invest aligned with your objectives. Take the entire variable out of the equation of you needing to find the right manager or the right investments. Simply don’t make that a hurdle that you need to clear. Because one of the only people in the history of the markets that found a way to predictably and consistently produce phenomenal returns didn’t do so because of their ability to time the market or research undervalued companies.
No, he figured out an algorithmic way to exploit tiny inefficiencies thousands and thousands of times. And to do so at the highest volume possible. Simons had his PhD in mathematics. He was a code breaker during the Vietnam War and he chaired the math department at Stony Brook University in the 60s and 70s. He wasn’t a fundamental investor. He didn’t comb through financial statements. He didn’t listen to what the Fed chairman was saying about where interest rates are headed. He didn’t hire a bunch of economists to determine whether there was strength or weakness in the domestic and foreign economies. No, he found a cheat code. And so unless you’re able to find that cheat code and write it to billionaire status, I suggest you build a great financial plan and stay disciplined to that long-term strategy and let the first lesson of compound interest do the heavy lifting. My special guest today is Creative Planning Chief Investment Officer, Jamie Battmer. Jamie, there’s a lot of confusion around the term private markets. Let’s start there. What are private investments?
Jamie Battmer:
Yeah, it’s extraordinarily misconstrued and Wall Street did it almost by design to create less transparency and charge more for it. But really it’s very straightforward, there’s public markets and there’s private markets just like there’s public schools, there’s private schools, public planes, private planes. And when you think about it, there are equities in fixed income in the public markets and there’s also equities and fixed income in the private markets. So it’s really just a more effective way to broadly own the overall economy because there are elements of it that operate in both the public market space and the private market space. It’s as straightforward as that. It’s been unnecessarily complicated by design for not the right reasons.
John:
No, I think it might surprise people. The public markets are smaller than they once were. And there are more private companies than most people realize.
Jamie:
It’s dramatically smaller than it was, but you’re right, it’s what do we want to do for our clients? We want to broadly own the markets, broadly own elements of the economy. So the public market sphere that we’ve always invested in, that’s what people think about traditional stocks and bonds in the public market space. Apple stock, government, treasury bonds. What’s interesting since the mid 1990s, around 1996, ’97 there were over 8,000 publicly traded stocks out there. You can open up the Wall Street Journal, look at the back 8,000 names you could pick from, throw a dart at say, “I want to go with this. I want to go with that.” Fast-forward to today, 8,000 publicly traded stocks has contracted to only 4,000. So literally the number of publicly traded stocks we can pick from has been cut in half while interestingly, over the same time for the economy as a whole, there’s 72 million more of us. There’s 20 plus trillion more dollars in the economy, but the public market sandbox has contracted by half.
John:
I find it interesting, maybe ironic’s the better word, that you have tens of thousands of fun companies all trading four to 5,000 individual holdings.
Jamie:
Yeah, there’s more indexes than stocks to pick from. But that 4,000, even 8,000, let’s get in the time machine, go back to the mid ’90s, check out the hairstyles and check out how many stocks we had. But regardless of that number, it’s 4,000 a day, but that is just dwarfed in comparison to the 7 million plus private market companies in the economy, all shapes and sizes, everything. Any element of the economy, there’s a private company involved with it, but the most important thing for investors to keep in mind that yes, the vast, vast, vast majority of those 7 million private market companies are something we would never want to invest in.
But the really important thing is that we want to be owners of and lenders to the rocket ship companies, right? The companies are doing great, taking off, earning a lot of money, providing goods and services that people really like and are willing to pay for. Well, what’s interesting, 87% of these rocket ship companies that make more than a hundred million dollars per year are in the private space. If you’re only investing in the public market arena, you’re only investing in 13% of these rocket ship companies. So that’s why if you want to broadly own the economy, you’re not doing that if you do not have a blend of public and private markets within the portfolio.
John:
You’re not quite getting the true diversification and non-correlated movement. Even if you own a total stock market fund and you theoretically own, and I’m putting up air quotes, “everything you own,” everything of 13%, that in some cases have a lot more correlation than some of those private companies. I think that’s really fascinating. Let’s talk about the ideal person. Someone’s listening and they go, “Well, I don’t have any private investments in my account, and that’s interesting. Maybe I should.” What type of investor do you think should be considering adding private investments to their plan?
Jamie:
It’s all driven by the historical empirical data in academic research. There’s a lot of great data going back for a long, long time. I mean, going back to the mid 1980s, the great thing it shows is that regardless of risk profile, my parents’ accounts, my parents are in their 80s or my accounts or my kids’ accounts a lot longer time horizon. What the data shows is that by adding high quality private market investments to a portfolio, you are simultaneously increasing annualized returns and reducing annualized volatility. It can be beneficial and it’s absolutely something that should be considered.
John:
What misconceptions do you find that investors have about private markets?
Jamie:
It’s how you are really accessing the broad economy. It’s just you’re able to own more of the economy. You’re able to diversify the particular type of risk that can impact your portfolio. But some of the real hangups, you went and Googled the pros and cons of investing in private markets. That’s what we’ve solved for and really trying to make it not only more accessible, but more transparent. We’ve been investing in these things for decades for our ultra-high net worth clients. Because they had tons of money and fleets of CPAs to deal with all the complications. But the great thing is now these industry-leading partners make them more transparent to not complicate your taxes. They don’t have to create K-1s anymore, and the albatrosses that come along with that, it’s just regular like stocks 1099s.
John:
Well, liquidity has certainly been considered by many to be the biggest drawback. I’m speaking with Creative Planning Chief Investment Officer, Jamie Battmer. So you’re saying, Jamie, that has changed now and there is more flexibility today within the private markets?
Jamie:
Absolutely. Because that was a real concern. Because that was the traditional way of accessing private markets. Your money is locked up for years and years, so don’t get me wrong, we want to invest in these things for years and years and years and years, but we’re not beholden to it. That’s what these industry-leading partners to create accessibility so we can unlock new elements of the economy to broaden and diversify the risk. Add those strong risk-adjusted returns without a lot of the traditional complications that come along with it. So yeah, that’s a real misconception there. It’s great that the evolutionary process of this has made it less complicated, made it more transparent and can be more effectively utilized.
John:
The public markets, people understand that saying they’re risky or not risky would depend upon whether you’re in a government treasury or a small cap value stock or emerging markets. They’re all public investments, but those have very different risk profiles, and the same is true when it comes to private markets. Just as an example, to put some color around this, for someone listening who’s never invested in private markets, what does private debt look like?
Jamie:
I’ll focus on private debt, but stepping back an element again, it’s just a difference between public and private. There’s public equity, there’s private equity, there’s public debt, there’s private debt. Public debt misconception we saw big time here not too long ago in 2022, oh, my bonds are safe. Well, more aggressive bonds were down 20, 30%. No, you can’t together certain-
John:
Sure, certainly long-term ones.
Jamie:
And so accessing bonds in the private space, it’s just a diversified way of doing it, and it happened to actually hold up really well during this challenging period because it had some inflationary protective benefits to it that traditional public market, fixed income doesn’t. You’re just spreading out the risk, and so again, there’s public bonds and there’s private bonds. There’s four elements that can serve a purpose within a well diversified portfolio that you can access in the private market space. There’s private equity like public equity, that’s people oftentimes think about private markets, right? The acquiring of companies, trying to make them more profitable, selling them again, but that’s just a component of private markets and that’s the private equity side. Like you just mentioned, private debt, it’s just like public debt, but it has a different risk profile to it.
John:
Sure. Well, a lot of it was floating rate, right? That we had clients in on the private side, and that was really helpful with rising interest rates.
Jamie:
Oh, absolutely.
John:
Just as an example of something that was different than maybe a lot of their intermediate term bonds that they had in the bond fund, for example.
Jamie:
Absolutely. In 2022 when good bonds, good public bonds were down 9, 10, 11, 12% bonds issued by apple bonds issued by the government because they were fixed rate. A lot of private market debt is floating rate, so it can move more quickly as interest rates adjust like they did higher. So instead being down 9, 10, 11, 12% private market debt was often up 6, 7, 8, 9%. Did it do anything special? Absolutely not. It just did exactly what it was supposed to do, and that’s how you really need to think of private markets is that you’re owning more of the economy and further diversifying the risk profiles that will be coming at your portfolio.
John:
It’s not that private debt or public debt is better or worse, but they’re different and we all understand the importance of diversification and that was a perfect example of I have different profiles of debt between public and private and they moved differently in one of the fastest interest rate increasing environments we’ve ever seen. While that was nice to have a little bit more of a hedge against rising interest rates. Lastly, before I let you get out of here, Jamie, I think private real estate is a good one to also touch on because the correlation between public real estate and the overall broad stock market is very high. Can you speak a little bit to maybe the value in potentially considering private real estate?
Jamie:
Absolutely. Just exactly what you said, it’s just a diversified way of looking at it that’s not as highly correlated. And so there’s public real estate and there’s private real estate. What we love in the private real estate space is that you can be a lot more tactical. What’s a concern in the marketplace right now, commercial office space, we’re still figuring out a post COVID world. Only about 60% of us are going back to the office. The rest of the people are staying home, right?
In the private real estate space, you can be much more tactical to say, “Hey, let’s avoid that right now, or let’s avoid investments that predated 2022 when interest rates were a lot lower.” So the thesis worked at 2.5% interest rates, but doesn’t work so well at 7.5%. So you can be a lot more tactical in the private real estate space. Well, if you’re accessing that in the public market space, yes, it’s highly correlated to the stock market, but you’re also beholden to a certain percent in commercial office space, beholden to what’s in the underlying index. So it’s not that it’s better or worse, it’s just a different way of accessing real estate markets that serves a purpose in both the public and private sectors.
John:
I lied. I said it was going to be our last question, but I thought of one other that I want to give you before we take off please. I think it’s really important. In terms of manager selection and the importance of the due diligence process, which I believe we do a very good job of at Creative Planning, vetting these companies to ensure that hopefully we’re giving our clients the access to some of the best managers in the world that are in these spaces. But can you speak a little bit just to the importance of really understanding what you’re owning in the private markets.
Jamie:
From our mandate and what the historical empirical data and academic research supports that in the private market space, you really want to make sure you’re working with firms that have decades of track record. Huge scaled resources, the efficiencies because in the dynamics, the rules and regulations in the private markets are different than the public markets. There is scale advantages. There are information advantages. You want to work with people that have the large teams, have the information, have done successful deals in the past. Again, working with the largest players, working with them from an optimized pricing standpoint, an optimized access standpoint. The data supports. You don’t want to invest with anything that is a fly by night. Maybe they got lucky recently. They have a long-term institutional track record of successfully executing upon is even of more paramount importance in the private market space. And that’s how we focus on that. Because it’s extraordinary what these large private market partners have, the scale they have.
John:
It’s definitely a fat head, long tail industry. A lot of companies that you wouldn’t want to invest in and some of the best have a great tremendous track record of overperformance course past performance, no guarantee of future results. We’ll put that disclaimer in there. I’ve been speaking with Creative Planning Chief Investment Officer, Jamie Battmer. If you do not own any private investments, this conversation has prompted you to think, am I as diversified as I maybe I think I am, and you’d like to speak with one of our wealth managers just like myself. You can visit creativeplanning.com/radionow to schedule your free consultation to discuss these private market investments and anything else that’s on your mind related to taxes, investments, or your estate planning. Jamie, thank you for joining me here on Rethink Your Money.
Jamie:
Thanks a lot for having me.
John:
The world is getting older. It’s getting older fast. If you look at the world broadly, about 9.7% of the entire population is age 65 or older today. In about 25 years, by the year 2050, that’ll jump to 16.4%. Put another way, the United Nations predicts that one in six people will be 65 or older by the year 2050. Getting investments right for that world is a particular concern to pension funds. If you look at a massive cohort managing about 50 trillion globally, they’re already thinking about how do they align investment strategies to ensure that they meet liabilities for future retirees. And many of those principles apply to you as an individual investor looking to drive income that you won’t outlive as well over the course of your retirement. Eric Wiseman, a portfolio manager at $607 billion MFS Investment management out of Boston said, “We think of demographics as a slow moving train and it’s not. It’s a train that’s barreling toward us and if you don’t get off the tracks, you’re going to get run over.”
Wiseman is among those coming around to the view that its birth rates continue to fall in populations age. Companies are going to have to fight for workers, which will boost wages and hold inflation potentially stickier than desirable. If we head back to 1971, so about 50 years ago, we were at 2.27 kids per woman in America. Now today we’re at 1.66. China, I mean this was wild, went from 5.52 kids per woman 50 years ago to 1.16. Bloomberg had an article recently that spoke of this saying that the US is running very high debt levels and we’re just about to hit a lot of these age-related challenges that are unfunded. Yields on longer dated treasuries are not really compensating investors for the longer term risks that they present.
Learn from a common mistake that I see in many retirees, and that is they get far too conservative, far too early in their life. It’s easy at 65 or 70 years old to say, “Well, I should have 65 or 70% of my portfolio in bonds because I’ve heard that’s what you’re supposed to do. And I’m not a spring chicken anymore. Hey John, I’m in retirement. I’m not going back to work. I need this money to last me for the rest of my life. I need to downshift my risk.” Sounds logical, right? Except for having your age in bonds, which is one of the dumbest, least logical shortcuts that has ever gained traction. Within personal finance, it makes no sense. You might be 75 years old but have very little need for money because of a pension or an inheritance or strong social security, maybe no debt of any kind, low cost of living.
Well, then why would you want the vast majority of your portfolio in stable investments that are unlikely to grow much beyond inflation? Instead, your plan should be built on your time horizons. The expectation is that stocks will produce about twice the growth of bonds over a long period of time. But intro year, you’ll see corrections of 10 to 14% regularly within the stock market. One out of every three or four calendar years, you will lose money. You’ll have less money in your account December 31st than you had January 1st when it comes to your stocks. About every five years, you’ll have a bear market. Once every 10, 15 years you’ll have a full on terrible crash or bear market. Think dot.com bubble bursting, 2008, COVID where the market dropped 35% in six weeks, and that is the purpose of bonds. They provide stability and a buffer so that your stocks have time to work back to their averages.
A great rule of thumb when looking at your asset allocation, how much should you have in stocks and growth oriented investments relative to bonds and more stable investments? Calculate how much you need from your portfolio over the next five to seven years. That’s a very good starting place for what should not be in stocks. With demographic shifts of us living longer and birth rates declining, this is more important today than maybe ever before. Having 22 and 21 year old sons, I learned a lot about the world of TikTok and Snapchat. I’m not on any of these social media channels. I have a LinkedIn account that I check about every three or four months and that’s it. No Facebook, no Instagram, I don’t do any of it and I’m certainly clueless on these new ones, but there is an entire world on TikTok of what is referred to as finfluencers.
Now you’ve heard of influencers, but I think there’s this common belief that if someone has a lot of followers, that must equate to knowledge. You must know what you’re talking about because thousands or millions of people follow you. But here are just a few of the ridiculous, stupid, completely wrong pieces of advice that I’ve been shown on TikTok. 401 case, that’s a dumb idea. Want to earn more money, sick of your job day? Trade at home. Want to turn a hundred dollars into a million? Follow my strategy for earning 2% per day on your money. Pay taxes, not if you spend tax season on a boat. Barry Ritholtz said, “It’s a massive Dunning-Kruger exercise of inexperienced but overly confident finfluencers reducing complex issues about money to slick but misleading sales pitches, no audited returns, mathematically improbable claims and zero accountability.” But none of these TikTok influencers sell securities to clients.
So here’s the thing, they don’t fall under the regulatory oversight of the SEC. There are so many things on this radio show and podcast that I’m not allowed to say. There is consumer protections in place. Just as one example, I’m not allowed to share client testimonials on the show. But if I’m a finfluencer on TikTok making fun videos, I essentially can say whatever I want because I’m not regulated. While I’m one of the first people to rip on the mainstream media who are looking for clicks and are looking for ratings and sensationalize information and certainly aren’t acting as fiduciaries to you, but rather to their shareholders. Which means create as much value in advertising as possible, which means get as many eyeballs as possible, which means say in many cases crazy things. But social media is so much worse. They make the mainstream media look like a certified financial planner.
No editors or gatekeepers, just a total wild west without landish claims, and they don’t have to worry about any repercussions. So if you are someone in your life is being influenced by these finfluencers, please tell them to either unfollow or just laugh. My next piece of common wisdom is that gold is a good diversifier for your portfolio. I know I talk a lot about gold. I’ve written a chapter in each of my two books on gold, but with Costco selling out a gold, it’s in the public consciousness. And certainly with our level of national debt and a real concern of long-term solvency, gold might feel like a safe investment. In fact, Creative Planning President Peter Mallouk was recently on the Money Rehab podcast with Nicole Lapin and she asked him about gold. Here’s what he had to say.
Peter Mallouk (Sound Bite):
Separating out just gold, you often hear a lot of bears like you mentioned, Nicole, they really recommend gold. The world’s going to end. I’m going to buy gold. And I really view gold as money, right? So gold was money 4,000 years ago. Gold was money a thousand years ago, and gold is money today. So if you told me Nicole, “Hey Peter, I’m going to give you $100 000 and we’re going to get in a time machine and it’s 4,000 years from now and we can only use one currency. What are you going to take?” I’m not going to take dollars.
I’m going to take gold because every other currency in the history of the world has eventually gone away. Romans, Greeks, Egyptians, whatever, but gold has always been there. It’s a currency because it’s basically stable. And so if you look at gold over the very, very long run, it barely matches inflation. It buys you a good suit today, buys you a good suit a thousand years ago, buys you a good suit a hundred years ago. So you get all this volatility, all this up and down for a historical rate of return that’s worse than bonds. No, thank you. Right? So I’m not a big fan. It doesn’t mean I don’t think gold is worth something. It is. It’s just not a great investment.
John:
Thank you, Peter. I could not agree more. Our final piece of common wisdom to rethink is that every deal is a good deal. That means you are saving money. So there’s a difference between saving and spaving. What are you talking about, John? What is spaving? Well, it’s not a real word, but it’s basically when you are spending money to save money. I have joked many times with my wife that we can’t afford for her to save us any more money. She loves the clearance rack. We’re humans, buy one, get one free, spend more to get free shipping. I love that one. The other day I was buying hangers, just plastic vanilla hangers on Amazon and it had the little bar up there for the $25 that was almost filled up and it said, “Just spend seven more dollars and you can get this today, this afternoon for free instead of tomorrow.”
I already had my shirts hanging up on the railing. It didn’t matter if they came tomorrow or that day, but you know what I did? I’ll just buy two sets of 50 hangers. I didn’t need that. Why? I’m an idiot. I don’t know. Because Amazon’s really smart and messes with my mind. Now we’ll have extra hangers in every closet in our house so that I could receive them 12 hours earlier. How about the save 10% with this special discount code? They’re the kind of sales pitches we find impossible to resist yet spaving rarely benefits us as consumers. To be clear, there’s nothing illegal or even especially underhanded about such offers. Merchants are in the business of making money. That’s their job and they want to incentivize us to buy their products. And so as consumers, we need to have self-awareness and bear some of the responsibility for determining is this deal actually worth it?
I think part of it comes down to FOMO. We definitely have the fear of missing out on a limited time sale or some other purported bargain. It might be loss aversion. Feel like you’re losing money by paying for shipping or waiting longer. So how in the world do we avoid spaving? Here are a few tips. Stick to your list. Go into a store with intention around what you’re buying. So then even when you see something on sale, you can remind yourself, I don’t need that. I wasn’t here for that. By the way, this is actually one of the benefits of Instacart. I know everything’s more expensive, but you’re able to reorder things that you ordered the previous time and you’re not walking up and down the aisles. So while things are marked up because it’s being delivered, I think in some cases it saves money because you’re able to stick exactly to your list.
You can de-link your credit card from retail websites. When you store your payment information online, it makes it really easy to spend money. Amazon’s figured this out. Click one button for easy ordering. They’ve removed all friction. So might sound counterintuitive, but if you create a bit more friction for your purchases, it may help you curb your spending. Unsubscribe from promotional emails. Don’t see the Black Friday deal in your inbox. And lastly, sleep on it. Wait 24 hours before making an unplanned purchase. Not on everything obviously, that’s not practical. But if it’s something that was unplanned and now you’re thinking, I might want to buy that because it’s on sale, just wait. It’s crazy how often 24 hours later you’re like, oh, why would I have done that? I don’t need that. And you have a lot more clarity by not being a creature of the moment. I hope these tips help you. I’m certainly going to attempt to remind myself of these very same things and my quest to avoid spaving as well.
It’s time for this week’s one simple task. This week’s is to review your 401(k), but I’m not referencing your investment options or your performance. But rather where your contributions are being directed. Should you be funneling money to the deferred side of your account like the traditional 401(k) or the Roth side? Because before determining how to invest or what to invest, you want to answer the question where you should invest. I recently met with a physician, married kids making really good money, about $350,000 per year. Naturally, her belief was to defer as much income as possible because she’s making a third of a million dollars plus per year. But because of the Trump tax reform that went into effect in 2018 and sunsets at the end of 2025, they’re only in a 24% tax bracket. The 25% bracket by contrast during the Bush years began at a little over $75,000.
So yes, she’s making a lot of money, but she’s not in a high tax bracket. For her strategy, it made a lot more sense to still max out the 401k plan, but do so with after tax dollars into a tax-exempt account that Roth, which will be a ghost and off of her tax return for the rest of her life. Because the income limits within each bracket have expanded dramatically. This is also true from many other investors.
If you have any questions about whether you should be directing savings into a Roth or a deferred account, speak with a certified financial planner, have them review your tax return, and if you’re not sure where to turn, we are happy to help here at Creative Planning, you can request that visit at creativeplanning.com/radio. A great question to ask yourself as to whether you should seek out a second opinion. When is the last time that your financial advisor reviewed your tax return? If it hasn’t been recently, what might you be missing? Speak with a fiduciary. And again, you can request that from us here at Creative Planning as we help 75,000 families in all 50 states and abroad at creativeplanning.com/radio.
It’s time for listener questions and to read those today, one of my producers, Britt is here. How’s it going? Britt, who do we have up first?
Britt Von Roden:
Hi, it’s going great, John. Thanks for asking. So first up today we have Peter out of Minneapolis and he shared that his portfolio has been very volatile over the last few years. And a buddy of his says he owns some rental investments as those don’t have the same issues. So John, what he’s wondering is what you think of this as a strategy to reduce volatility?
John:
Real estate is a viable investment, but I think the first question you want to answer is, do you want to be a landlord? I met with a lot of clients who cannot wait to sell off their rental properties because they are so sick of being called at one in the morning because the dishwasher is not working. So think about some of the broader implications of owning rental real estate beyond just the dollars and cents. If you’re okay with that, then start evaluating the financial implications. I do think it’s interesting though because real estate values do go up and down even though the perception is, oh, there’s so much less volatility. But you’re not asking to have your home appraised once a week. So the change in price isn’t front and center. You’re not logging in like some people do 16 times a day to their brokerage account.
Look at the price change of their stocks from 16 minutes earlier. Real estate historically has appreciated it at only about half the stock market. Why do we all seem to know a lot of people who have created significant wealth in real estate? It’s because there’s almost always leverage. People with $100 000 don’t often say, “Buy me $500,000 of stock.” In fact, custodians won’t even let you have that much margin, generally speaking, it’s too risky. But with real estate, we have no problem doing that. 20% down payment’s pretty healthy. Yeah, I put 200 grand down, I bought a million dollar asset. That leverage component is what amplifies potential cash on cash returns. In addition, you might have positive cashflow from the rental income if it’s more than your mortgage, but current interest rates, Peter right now are making it less attractive to borrow for a rental and if you have no leverage, again, that appreciation on its own hasn’t competed well with the stock market.
The other thing to keep in mind is that there are ongoing costs associated with owning rental properties. I found that they’re often wildly underestimated. So let’s just play this out for a moment. Let’s say you buy a $300,000 house in Minneapolis and you’re able to rent it for 1500 a month. I don’t know if that’s what you can rent it for. Maybe a little more, maybe a little less. So at first thought you might say, “Well, I’m collecting $18,000 a year of rental income.” That sounds pretty good. It’s pretty stable, but even if you put $60,000 down, you had a 20% down payment and you finance the other 240,000. Your mortgage payment at today’s rates is going to be around $2,000 a month. So just your mortgage is 6,000 more than the hypothetical rental income. Additionally are those costs to maintain the property, which easily can be five to $10,000 a year, but would vary wildly depending upon how new or old the home was and what condition it was in when you purchased it. Which would certainly have an impact on how much you could collect and rent as well.
I’m just generalizing here because I don’t have all the specifics of the investment properties you’d be considering, but at that point between mortgage and upkeep, not even factoring in property taxes, you’re at 30 to $35,000 a year of costs. You need to hope that the real estate appreciation and rent offsets those costs. And right now for a lot of people, it doesn’t. Now, I’m not trying to say that real estate’s a bad investment or the specific property you’re looking at won’t pencil out, might be worth it.
But in general, if you pay cash for rentals, you can almost always do better in other investments. And if you leverage the property in this interest rate environment, the mortgage cost itself can be too punitive for it to really make sense. If you like the idea though of having more stability and more diversification, maybe a rental property is worth considering. But maybe the other option is to simply allocate part of your portfolio that’s in publicly traded stocks and bonds into private investments. Professionally managed, for example, real estate, but they don’t require any time or extra effort on your end. All right, Britt, we have time for one more question.
Britt:
That works great, John, because we just received a question from Diane who was wondering if she has a living trust, is a will still necessary.
John:
The short answer is yes, but not the type of will probably that you are thinking of. A typical last will and testament won’t have any authority over your trust in the assets inside of your trust. However, typically you’ll have what is called a pour over will included with your trust as one of the documents that your estate attorney will draft. A pour over will is a specific type of will that’s used in conjunction with a living trust to manage your assets after you’re gone. And while it’s not right for everyone, it can be helpful when used appropriately. In a nutshell, a pour over will is a type of will that allows assets to, as the name suggests, pour over into a trust when you pass away. So it’s different from that traditional will, which will specify how you want your assets to be distributed among your legal heirs when you die.
By contrast, a pour over will is only used in situations where you have the trust as part of your estate plan. Let me give you an example. Elderly couple has three children. They have seven grandchildren. They have a substantial amount of assets. Let’s suppose their net worth is $5 million. So in order to avoid a legal mess and probate after death, they establish a revocable living trust. In addition, both members of this couple execute pour over wills and those will direct the remaining assets they own into that trust once they die. So let’s say the husband dies, he has a boat and it was titled in his name and not the name of his spouse. His wife’s the trustee of the trust where the ownership of the boat now resides. Since she’s the trustee, she gets to use the boat if she wishes. When she dies, then the boat will remain in the trust and be passed down to the next trustees who are their children.
So there are advantages, there are disadvantages, but the goal is that it helps get remaining assets over into the trust if something were to happen to you. I’m just scratching the surface. There are all sorts of specific estate planning strategies that you can utilize. I don’t know whether a trust is even right for you, whether you just need a will, but fantastic estate planning attorney can walk you through that in coordination with your certified financial planner, which is what we do here at Creative Planning. With nearly 500 certified financial planners and over 50 attorneys, we work together to find the right estate plan for you that fits your needs and your broad financial strategies. And if you have questions just as Peter and Diane did, you can email those to [email protected].
Wisdom Before Wealth. King Solomon in the Bible is an iconic example of this tried and trued finance principle that money is attracted, not pursued. So aim for wisdom rather than wealth. Wisdom is really of no benefit if not applied or shared. Now, you’ve probably learned some of your wisdom through making mistakes. I know I have. And we often allow our children to make some of these mistakes for themselves because you understand as a parent, that’s how they’ll learn. However, it’s universally accepted that if you continue making the same mistakes over and over and over, and we all know people that do this, you’re a fool. So we learn and we apply our past experiences to increase our wisdom and hopefully we share, pass that wisdom onto others in our lives. And sometimes I try to pass wisdom onto my children and I’ve got a few children who seem to prefer making their own mistakes.
They want to learn for themselves. And you know what? As I just mentioned, that can be a really effective way to learn. There’s no question about it, but sometimes it’s nice to learn the easy way through someone else’s experience so that you can avoid those for yourself. And I found that one of the best ways to pass on wisdom is through captivating stories. Did you know that the human mind is 22 times more likely to remember facts if they are part of a story than if they’re isolated on their own?
So sharing wisdom with others about what you’ve learned from challenging times in your life that you’ve experienced or what life was like growing up and how that shaped who you are today, those are incredibly valuable to share with those that you love. Remember, you want to pass on your values, not just your valuables. Share your wisdom with your children and your grandchildren, not just your wealth. Share stories that have shaped you into the person that you are. Maybe they’re around your money or relationships. Life in general, faith, that wisdom is what they will hold onto and benefit from long after you’re gone. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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Disclaimer:
The preceding program is furnished by Creative Planning an SEC registered investment advisory firm. Creative Planning, along with its affiliate, United Capital Financial Advisors currently manages or advises on a combined $300 billion in assets as of December 31st, 2023. John Higginson works for Creative Planning and all opinions expressed by John or his guests are solely their own and do not necessarily represent the opinion of Creative Planning. This show is designed to be informational in nature and does not constitute investment, tax or legal advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on the show, will be profitable or equal any historical performance levels. 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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