What makes a successful investor? Hint: It’s not luck, nor is it timing. It’s a winning combination of traits, characteristics and habits — and John will reveal exactly which on this week’s episode. (48:00) Plus, don’t miss six surprising retirement expenses you might not be prepared for (24:13) and our deep dive into common tax misconceptions that could be costing you big bucks. (13:20)
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, The Attributes You Must Possess to be a Great Investor: The Biggest Tax Misconceptions with Creative Planning Director of Tax, Candace Varner, as well as how the rich live. Fancy cars, giant mansions, the answer may just surprise you. Now, join me as I help you rethink your money.
I want to begin though with a documentary I watched earlier this week on Johnny Manziel. It’s a really interesting story about someone with great talent. If you’re not familiar, he was the first Heisman Trophy winner ever in NCAA history as a freshman when he was at Texas A&M. And he ended up being drafted in the first round by the Cleveland Browns, and to make a long story short, just unraveled with all the fame and drugs and money. And at one point in the documentary, they highlighted this moment where the general manager of the Cleveland Browns contacted Manziel’s agent and said, “Your client watches no tape. None. We can’t get him to even put forth effort and he’s our starting quarterback.”
And the agent thought they were sort of speaking in generalities like, “Oh, he doesn’t watch a lot of tape, or he is maybe not putting forth a ton of effort.”
The GM said, “No, his tablet time, which we can track is zero. He doesn’t spend one second looking at film or studying.”
No surprise, he was out of the league quickly, total bust, but it was never a talent issue. It was his character. Discipline, selflessness, work ethic, you contrast Johnny Football with Tom Brady. Brady was taken in the sixth round. He was the 199th pick in the NFL draft. That year alone, there were six quarterbacks drafted higher than him. He was an okay player at Michigan. You watch his videos from the combine, he’s like a pudgy, slow quarterback with moderate arm strength. Well then why is he the go? Because he wasn’t even close to the most talented. He has less natural ability than hundreds of quarterbacks that have played in the NFL. No, it was his attributes. Zero alcohol during the season, sleep routines, complete dedication to fitness and flexibility.
The guy’s posting pictures eating avocado ice cream. Sounds disgusting. I like guacamole, but ice cream? I don’t know, it sounds gross. He adhered to this crazy diet. He was the first one in the building, last one to leave. And that’s what makes a great quarterback, which is why drafting them is such an imperfect science even with entire scouting departments because a lot of it’s immeasurable. They’re soft skills. And now I’m sharing this with you, not just because I’m a sports nut, which I am, my wife will attest, but because there are many parallels between what makes a great quarterback like Tom Brady and what will make you a great investor. And I’ll preface these five qualities with a warning. They’ll sound very simple. But like a lot of things in life, simple things aren’t always easy to execute. The first ingredient to being a great investor is humility.
See, a humble person is open to receiving advice, and the behavioral bias that applies here is called the overconfidence bias, which leads investors to making poor decisions, underestimating risks, and overestimating their personal abilities. Also, arrogant investors ignore diversification. And overconfidence also leads to overtrading. There’s a reason women average better returns than men. And all the studies show us that there’s one main reason why. Women possess more humility, they’re more interested in getting it right than being right, and in turn, trade less. There’s a direct correlation between the more you trade, the lower your expected returns are.
And the last major challenge for investors lacking humility is that they have a failure to learn from mistakes. See, overconfident individuals tend to attribute their success to their skills and to their intelligence while blaming external factors like bad luck for their failures. A lack of humility creates rigidity, which makes it tough to adapt. And that is my second attribute required to be a great investor, and that is you must be adaptable. Kodak, Blockbuster, Nokia, Sears, those names ring a bell? Yeah, you probably know where I’m going with this. These companies didn’t go broke because they lacked capital or intelligence or market share. No, it wasn’t that. They failed to adapt. And the behavioral bias that relates to this is called the sunk cost fallacy. We allow previous decisions to inform our future ones. There is a great exercise to check yourself that helps answer whether you may be holding certain investments that you shouldn’t be just simply because you already own them.
Now, I want you to imagine that every part of your liquid net worth. Bank accounts, 401Ks, brokerage accounts, IRAs, whatever it might be, all of that was piled up in a hundred dollars bills on your kitchen table. Now, I hope that’s a big pile for your sake. Maybe it’s a medium pile, maybe it’s a small one, that’s all right. We’re all on our own journey here, but as you looked at that money piled up and were determining where to invest it, how to invest it, would you buy the same things you currently own? Oftentimes, the answer’s no. Oh, gosh. Yeah, I probably wouldn’t have 30% of my portfolio and stock A, B, C just because I worked there. Yeah, I wouldn’t repurchase all of that. Well, that’s what you’re doing by not making the adjustment and not adapting. It can also lead to reduced portfolio diversification. And that may be due to an inability or unwillingness to rebalance, to maintain a well diversified portfolio. And here’s the biggest sunk cost that I see practically hurt investors every single day, and that is holding on to a suboptimal relationship with your advisor.
There are a lot of great financial advisors across the country. And there are a lot of great firms across the country. There are also a lot of really bad ones and many that I would consider average at best. But because it’s a relationship and you’ve shared important detailed, intimate information that you oftentimes don’t share with anyone else about your finances, it creates a bond and a sunk cost making it difficult for even intelligent, seemingly pragmatic, disciplined investors to fire their advisor.
Let’s do a bit of a self-assessment. I want you to think through these answers in your head. If you had a $100 million dropped in your lap tomorrow, would you continue working with your advisor? Would you interview other advisors? Would you certainly fire your advisor? Would you feel like they weren’t capable of handling that type of an account? If that’s the case, you’re probably going to be fine with a hundred million, but if you have 500,000, or a million five, or 4 million, isn’t it even more important that you have the absolute best financial advice?
And I’m not saying that all roads lead to Creative Planning, but I do want to ask you, is your advisor independent? Are they manufacturing and soliciting proprietary products or products that they’re receiving huge kickbacks on? Do you even know the answer to that? Because it creates a massive conflict of interest, and that’s still how the majority of the industry operates today. We at Creative Planning are not tethered to any investment company or strategy or funds at all. We work directly with our clients. Is your current advisor a fiduciary all the time? Are they legally required to act in your best interest just as an attorney and a CPA does for you? And if your answer is, “Well, I would assume so.” You may be surprised to know that the majority of financial advisors, and I’m using that term loosely, are brokers or put another way, salespeople. They just have to sell you things that are suitable.
They can’t put a 90-year-old in penny stocks, but they can certainly sell you a product that they make way more money on or get sent on a fancy vacation as a result of. And then lastly, does your advisor have the resources to help you with all of your needs? The most important question for you to answer is do you have a written, documented, dynamic, detailed financial plan right now that you can access and look at and review and update that takes into account your estate planning, your taxes, your retirement planning, your insurance needs, your income strategies? If you don’t like the answers to any of those questions, you probably should be interviewing other advisors. If you’re not sure where to turn by the way, you can visit us at creativeplanning.com/radio now to schedule your visit with a local advisor.
So far, we’ve talked about a great investor being humble, a great investor being adaptable, and this next one’s the hardest for me to pull off, and that is patience. A great investor is patient. Warren Buffett famously said, “Someone is sitting in the shade today because someone planted a tree a long time ago.”
Let me present you with a riddle. If you had a pond and that pond had started with a speck of algae and I told you that every single day for the next month, the algae was going to double in size until on the final day of the month, the entire pond would be completely consumed by algae. How much of that pond was covered in algae the day prior to it being fully covered? The answer is only 50%. It’s not 97%, it wasn’t 85% covered in algae because remember, it’s doubling every day, meaning half of it was still clear the day before it was engulfed. This is how exponential and compounding growth works.
See, being patient though is hard but absolutely necessary to being a great investor. The long-term returns of the market are phenomenal. Stock markets returned about 10% per year for a century. A diversified portfolio has never been down over a 20-year period. It’s up 98% of 10 year periods, 91% of five year periods. But five years and 10 years or 20 years, they feel like a really long time. A lot happens over our lives during those time periods.
The next characteristic, essential and being a great investor is having proper expectations. Frustration is the gap between expectations and reality. And so closing that gap is key to our contentment. But what if I told you that rather than focusing on the outcomes, which in many cases aren’t entirely within our control, how about ensuring that you set realistic expectations which are entirely within your control? From a globally diversified portfolio, you should expect your investments to correct over 10% on an average of about 14% in a given year.
You should also expect to have less money December 31st than you had January 1st about one out of every four years. You’re going to have a drop of 20% or more, a bear market, about every five years, and you’ll have a full on crash every decade or so. For bonds, almost all of your return will come from the yield from that interest that’s collected and you should expect to earn about inflation, maybe a little bit better. And if you’re mindful on credit quality and duration, so who you’re lending to and how long you’re lending for, you’ll typically create some stability for shorter term needs that will provide volatility dampening from your stocks and allow you a bucket to grab money from if you need it during times where the stock market is down. You should expect to go through many time periods, even long ones where you are wondering why your strategy doesn’t seem to be working.
Oh, and here’s the big one. You should expect to hear regularly about how awful everything is within the world, the economy, and the stock market. What bleeds leads. And you should have the expectation that you will be required to combat negative sentiment with regularity.
And the final attribute required to be a great investor is experience. Ever heard the saying, ‘This ain’t my first rodeo”? There’s value in experience. I think about myself as a parent. I’m far from perfect, but I’m way better than I was 10 years ago. But whether it’s parenting or in business or investing, experience matters. You can say while sitting on your sofa that you’re not afraid of snakes, but how will you respond to them? One is thrown in your lap? More than anything, experience provides perspective. And that’s the value of a great financial advisor.
And speaking of experience here at Creative Planning, we’re helping over 60,000 families in all 50 states and over 75 countries around the world. We’ve been providing perspective to the uncertain economy and markets for 40 years. It’s not our first rodeo. And so if you are looking for a second opinion to the plan that you already have or you don’t have a plan, you sort of have a plan, lean on our experience and meet with one of our 300 certified financial planners just like myself. To schedule a conversation with us, visit creativeplanning.com/radio now. Why not give your wealth a second look?
My special guest today is Candace Varner. Candace is Creative Planning’s Director of Tax managing the company’s tax practice as well as working directly with clients. She’s a certified public accountant. Candace graduated from the University of Kansas with her bachelor’s degree in business administration and accounting as well as her master’s degree in accounting. Candace Varner, thank you so much for joining me here again on Rethink Your Money.
Candace Varner: Thank you for having me back.
John: Well, I thought today you could set the record straight on some of the most common tax questions you receive, and in particular some of the misconceptions that you clarify every single tax season. And let’s begin with extensions. I’ve had plenty of clients say, “Extending, John? I don’t know. I don’t want to be on the IRS’s radar. If we extend, am I going to be more at risk of an audit?”
Candace, what are the real implications of extending?
Candace: Yeah, so I actually get clients that go both ways. Some think an extension is definitely an audit red flag and others insist on extending because if they file on time, that’s going to be an audit reg flag.
John: Interesting.
Candace: So that’s always interesting where people get that. In general, the idea that an extension is going to make or break an audit decision for the IRS is just sort of out in the general thought process, but I’ve never seen any actual evidence of that. We extend thousands of returns, we file thousands every deadline and no rhyme or reason related to that as to why they are being audited. So a lot of things with tax, it’s very psychological and people just want to feel like they’re doing everything they can to be protected and doing the right things. And so sometimes, I’ll file extension and file the return next week if you want me to just to make you feel better, but it’s not actually going to make any difference.
John: Outside of waiting on specific tax forms, which is obviously one of the common reasons some would extend, are there any other strategic reasons to extend versus filing on time if they were able to?
Candace: The biggest reason I see for delay, if we have everything, would be the additional time to make contributions to a retirement plan. So an IRA, they have to do by the April 15th deadline, but a SEP IRA and the match contribution to a solo 401K you can make to the extended deadline. So for cashflow planning, sometimes we’ll sit on it until they want to make that cash contribution to the plan. Otherwise, strategic-wise, unless there’s something in the tax law that’s in limbo or you think might change or something like that, there’s no reason to wait.
John: How about deductions? Sometimes people nearing the end of the tax season say, “I’m going to go spend a lot of money on X, Y, Z,” you name it. Something that’s totally unnecessary for the business, but they’re like, “Well, I’m going to get a deduction for this, John. Don’t you understand that?”
I do understand that, but it doesn’t make it free.
Candace: Right. Usually this is where I like to go into a bit about write-offs and people misunderstanding what that is and they just like to use the term, but think of a tax deduction as a discount. It’s not free. It’s like buying something on sale. If you weren’t going to buy it anyway, you are worse off. So if I-
John: Hold on. Candace, I’m going to get my wife, Brittany, on here for a second. Can you repeat that?
Candace: No, I’m not responsible for that. I’m sure she listens to all your shows, doesn’t she?
John: Oh yeah, of course.
Candace: If they said, “Okay, well I was going to buy this next year, but I’m going to buy it this year instead so that I get the deduction earlier,” great, makes perfect sense. I want to keep more of my tax dollars earlier. But if I’m going to buy a car for 20 grand and I otherwise wasn’t going to buy one at all, I’ve just spent 20 grand and got a tax deduction for part of it. Now the only exception or caveat to that would be if they’re paying themselves. So like the deduction for the SEP contribution. Okay, well, I’m not spending that money on a car, I’m moving it to another account that’s also in my name.
John: Sure.
Candace: So that is different and does net benefit you from taxes.
John: Certainly you don’t want to be missing out on deductible expenses that you weren’t claiming.
Candace: Right.
John: Obviously, those are great. I like to tell people when they say, “Well, I just need to spend the money.” It’s like, if you really like that, can you give me a dollar and I’ll give you 30 cents back and we can just keep making this exchange since it’s somehow saving you money?
Candace: I sometimes offer to increase my fees for their tax services because that increases the deduction too.
John: It’s deductible after all, right?
Candace: Right.
John: Yeah, no, that’s great. Well, so now credits are different than deductions and maybe that throws people off from time to time. Can you explain the differences?
Candace: Yeah, so this is one of those areas where accountants have their own language and we use words differently for things. So when you say, “Oh, I get credit for that,” that’s different than a tax credit. So a deduction is, we would call, above the line. So think I made 100 grand, I’m going to deduct 50 grand that I spent on something, that’s a deduction. The net amount is then multiplied by your tax rate.
Let’s say that ends up in a tax liability of $10,000. So you didn’t save the 50 grand you spent, you saved a percentage of that, that’s the deduction, but now my tax liability is 10 grand and I’m going to get a credit for something for $2,000. The credit is dollar for dollar, so a credit is worth much more to you. And these are usually done when Congress wants to incentivize specific things like renewable energy credits, things like that, as opposed to just spending money on deductions. So the credit is way more beneficial. A lot of people saw the increase in the child tax credit over the last couple of years and then took it away and threw everyone off. That was dollar for dollar cash in your pocket, and that’s better.
John: Deductions are more valuable when you’re at a higher income level because you’re saving more, right?
Candace: Correct.
John: So credits are also even sort of more valuable to someone who’s in a lower income state. I remember on one of our first adoptions, that was an enormous tax credit. We didn’t have a lot of money at the time, and it was huge. It made it affordable for us to actually go through with the adoption. So that was-
Candace: That’s perfect.
John: … an amazing credit. And I remember thinking at the time going, “Whoa, this is really valuable,” because it is dollar to dollar.
Candace: Yeah, which is an expensive process and did exactly what it wanted to do.
John: Yeah, which the deduction wouldn’t have helped me much. I didn’t have any money, so I wasn’t making much.
Candace: If your tax rate is 10%, the deduction is not that helpful.
John: Yeah, exactly. I’m speaking with Creative Planning Director of Tax Services, Candace Varner. Let’s talk about refunds and the amounts owed being unrelated to your tax liability because this trips people up as well.
Candace: Yep.
John: These are misconceptions.
Candace: And some people even who understand it still don’t follow what I would think is a logical way to go about this.
John: So walk us through this.
Candace: Okay, so example I was just using, we’re going to get to a tax liability of $10,000. That is the total tax you pay for let’s say 2022.
If you do not have withholding from your job and you have sent the government no money during 2022, then you have to write a check for $10,000. But if instead I have my regular day job and my day job withheld $12,000 for me during the year, I’m going to get a $2,000 refund. The tax I paid is the exact same, the $10,000, but whether or not I have to write a check or get a refund is purely based on how much money I already sent the government.
Now the thing here is that withholding feels very different. You don’t necessarily notice you’re withholding on a paycheck to paycheck basis. And you think of what you get is just the net amount, but your employer is sending money to the government all the time on your behalf. And so when you get to the end and someone says, “Oh, I didn’t pay taxes, I got a refund,” that’s not how that works. You paid taxes, but it feels really different. Now how it feels is important, so I can’t tell you how many times I’ve explained this to my mother and she maintains, “I’d still rather have the refund, just feels better.”
John: Well, and I think actually it’s worth noting too where right now you can make 5% on your money in treasuries.
Candace: Yep.
John: It might feel good to receive a refund, but you don’t want to massively over withhold because there is an opportunity cost to overpaying the IRS all of that money, but I agree with you. I think in some cases, someone owing $10,000 but receiving a $1,000 refund because they put 11 grand in during the year feels better than the person who only owes 6,000, but they have to write a check for 5,000 at the end of the year. They’re more upset with their CPA or their advisor like, “How did this happen?” You’re going, “Wait, you paid four grand less in taxes this year. It was a really good thing.”
You guys do such a great job on your team of this year at Creative Planning, and I hope that we coordinate this well between wealth managers and CPAs. That’s certainly the objective to have those conversations like you and I are having right now with the client so that they understand this because sometimes perception is reality and if they’re frustrated, the outcome’s still not good, even if it was, on paper, a good one. It reminds me of my father-in-law. He’s a pretty content guy, pretty laid back, and I remember asking him at one point, “You seem pretty pleased with most people. What’s your secret?”
He said, “I have no expectations for anyone. I set my expectations so low that anything that happens that’s good is a win.”
And I remember thinking for a moment, “I don’t know if you’re a genius or if that’s a really cynical way to look at life, but whatever. Okay, I’ll take it for what it is.”
Candace: If he’s happy, I got to go with Genius. I just don’t know how to do that. I don’t know how to lower my expectations in my head.
John: I know, I’m still working on it. But as we wrap up, Candace, what are some other items that people can be doing?
Candace: I think the biggest thing is, A, planning as we said, to know the expectations. And then I always encourage people to look at their tax return and think that that dictates how much tax they’re going to owe. It does, but it’s really important to zoom out and look at the items before they even get to your tax return. So what you guys are talking to clients about with the investing, there’s some income as taxed different rates than other incomes. So how do we get invested in this? Or are you in a year where you have a low tax liability and we should invest in something that’s higher growth, but the tax rate actually happens to be high. It is very personalized, but by the time you’re going to file your taxes, there’s not a lot left you can do.
And so when someone says, “Okay, well, my effective rate was 25%.” Yes, but you also had all this income that was tax-exempt and you had all of these things that were paid to your Roth IRA or your regular IRA. The things that happened before you even get to filling out the forms, that’s where the magic happens.
The stuff you don’t see is usually the most impactful.
John: I’ve heard you say paying yourself. Speak to that.
Candace: If you are working at a job where you get a W-2, there’s very little deductions you have wiggle room on when you go to file your tax return. And so the biggest thing is what can I do to lower the taxable wages? So if I make a million dollars and I end up paying tax on a million dollars, well that’s what the tax return shows is the one million. But if I first max out my 401K, max out my HSA, max out my dependent care accounts, all those things like we were talking about where the money is moving to another account in my name, now the taxable income only shows $950,000. Well, again, once I get to the tax forms it’s just the 950 and it doesn’t look like I saved anything. But it’s before we even got there, what amounts can I take advantage of that are deferred? And those kind of things I’m just naming are every year.
John: Yeah, those are really good points, Candace. Well, thank you so much for sharing your insights, helping the listeners out and joining me here on Rethink Your Money.
Candace: Thanks for having me.
John: Let me ask you a question. Has your advisor reviewed your tax return in the past year? If you don’t like the answer to that question, why not give your wealth a second look by visiting creativeplanning.com/radio to speak with a local advisor just like myself.
Now, I know I’m running the risk of completely bursting your bubble, but the Great Wall of China is not visible from space, Einstein never failed math, and the gum you swallowed seven years ago, it’s not still in your stomach. Now, these are wives’ tales. The things that our parents told us, we accept it as truth only to find out, no, that’s not true. Sorry, Kyrie Irving, the Earth isn’t flat, it’s round.
And yes, mom, if you’re listening, I do not tell my kids that they’re going to go blind by sitting too close to the television. Well, there are plenty of these accepted truths that aren’t actually truths all throughout personal finance, and one of those is that your expenses are going to go down once in retirement. In fact, many financial planners will use a baseline of expenses at 70 or 80% of your current expenses while working.
I love this from Dan Ariely who said, “The consensus that you’ll need 70 or 80% of your final income in retirement is way off. For many people, it’s around 130%.” And so let’s rethink this together.
Catherine Hoffman, fantastic attorney here at Creative Planning, wrote an article on the 6 Surprise Retirement Expenses and How to Prepare For Them. I don’t want you to be caught off guard by unexpected expenses. Because if you look right now at your credit card statement or your bank account as to which days of the week you spend the most money, you’ll find Friday, Saturdays, Sundays. Those are the weekends, of course we do. No, it’s because you’re not working on those days. And because of that, you have more time. And when you have more time, you go spend money. Try going to a movie theater for a one o’clock matinee on a Tuesday.
You will see that theater overtaken by people with white hair because they’re not working. But of course, they got to get delicious movie theater butter popcorn, the candy, the giant soda, it only cost about $25 for those three things, so no big deal. And off that retiree goes into the theater, munching on their Mike and Ikes. So the first of six surprise retirement expenses is healthcare and medical expenses. Healthcare is one of the most significant expenses faced by most retirees. And yes, Medicare covers some expenses, but it won’t pay for everything. Costs related to prescription medications, dental and vision care and long-term care can quickly add up. And I won’t leave you hanging. I’m not just going to provide you with the expenses without any tips. Here’s how you can help prepare for that estimate your healthcare needs.
Now, obviously this is a moving target, but consider your medical history, family health issues, and any lifestyle factors that may impact your future healthcare costs. Research your health insurance options. I know this is the Wild West, and if you want to be confused, start trying to look into health insurance and then establish an emergency healthcare fund. Maybe you have an HSA, that would be fantastic. But either way, within your financial plan, you need to have funds earmarked and set aside to cover unexpected medical expenses.
Another surprise expense for many retirees, home repairs and maintenance. This one’s pretty simple. Retirees spend more time at their home, which means it’s important to ensure that your house remains safe and comfortable. And let’s face it, during the pandemic this happened as well. We were all cooped up at home. No one was traveling anywhere and home repairs and renovations went through the roof, because you finally were like, “You know, this sliding door that doesn’t really slide very smoothly, it is kind of annoying. Let’s look at getting a new door. I’ve always wanted to blow out this wall and make a bigger master closet. All right, let’s go ahead and do it.” That’s what tends to happen in retirement. To prepare for home expenses in retirement, you can establish a home repair fund. You plan to renovate, you know that your home’s a little bit older, build that into your financial plan. And of course, this is a very personal decision with many additional factors, but you could consider downsizing.
Another expense I see surprise many retirees is supporting adult children or aging parents. And so the way you can hedge this with your children is encourage financial independence and try to teach them how to manage their money, stick to a budget, and become financially self-sufficient. Nothing more quickly submarines an otherwise great financial plan and derails retirement like a parent who has difficulty cutting their adult child off.
When it comes to aging parents, it’s important that you know whether or not they have a long-term care policy. If something were to happen to them, what’s the game plan? What are the details of that long-term care policy if they have one? How long will it pay? Is there an inflation adjustment? How much do they have in other assets that could support their needs in the event that they live a long time and need medical care?
Plan for travel and hobbies, because what you don’t want to do is retire and then realize, “Oh, well, I can’t afford to actually do anything.” What good is that? Not a lot of people want to rock in their family room with a little space heater on their feet watching Matlock reruns all day long. That’s not a great retirement. So research and plan ahead the types of vacations you intend to take, the expected costs for those vacations, and build those expenses into your plan.
Next, plan for grandchildren. I don’t think there is anything that brings the clients I directly work with more joy in retirement than having grandchildren and spending time with those grandchildren and being involved in their lives. But to financially prepare for grandchildren, make sure you budget in travel expenses. Unless all of your kids and subsequent grandchildren live locally, you’re going to need to travel to see them. And I can tell you as a parent to seven kids, we are not doing a lot of the traveling. We’re in the thick of it. So the grandparents, for holidays, for summer breaks, they’re coming to us.
And the sixth and final surprise expense, and this one’s a whole lot bigger than just money, is the loss of a spouse. While none of us want to consider the possibility of losing our spouse, it’s very rare that you and your spouse pass away at the exact same time. So in addition to final expenses, medical bills, funeral costs, all of that can add up quickly. But to add to the stress of the situation, you’re going to lose either yours or your spouse’s Social Security. If they had a pension, it may be reduced or go away entirely depending upon the specifics of that pension and what was elected. So how financially can you prepare for that? Plan out a bit of what your life would look like and what things would change if something were to happen to your spouse.
But so to recap, I don’t want you surprised in retirement by healthcare expenses, by needing to spend money on your home, the potential for supporting adult children and or aging parents, that you’ll want to travel and have some hobbies and those will cost money, your grandchildren won’t be an expense, and unfortunately at some point if you’re married, you or your spouse is going to be a widow navigating these financial waters of retirement on their own.
The answers to those specific questions and almost every other one that you can think of are found through a written, documented financial plan. If you’re looking for clarity around your life savings, that plan is the requirement. I encourage you to get one or have your current one reviewed by a fiduciary that’s not looking to sell you something if you have questions. And if you’re not sure where to turn and you think we might be a good fit here at Creative Planning, we are happy to help. Reach out to us at creativeplanning.com/radio now to schedule your visit.
Next piece of common financial wisdom that I’d like to rethink is that to benefit from the equity in my home, a home equity line of credit, or HELOC, is my only option. Well, this is a relevant one because just over 79% of Americans aged 65 and up are homeowners. Just over 75% of those between 55 and 64 own homes. And home equity accounts for about 48% of the median net worth of American homeowners over the age of 60. Let me summarize, about half of retirees’ net worth is found inside the Sheetrock of their homes. In fact, if you just look at the last 10 years, the US median price for existing single family homes, it’s been on a tear. It’s up 91% while the US consumer price index is up about 30. So I know from the data, with home prices appreciating 6% above inflation the last decade, a lot of people have a lot of equity in their homes.
So in that case, tapping your home equity can be a convenient low cost way to borrow large sums of money at normally favorable interest rates. And so whether it be for medical expenses, tuition bills, some of the expenses that I just mentioned end up being paid for by the equity in your home. There are four primary ways to access the equity in your home. One, you can sell your house. The title company is going to wire the proceeds right into your bank account. Now, of course, you need somewhere to live, so you’re probably going to need to use some of that to pay rent or for a down payment on another home, but that’s one way to access your home equity. The second is through a reverse mortgage. Now, reverse mortgage is sort of like the brother to annuities, very controversial, can be some high costs upfront, many people have buyer’s remorse.
It’s a complicated contract, but I will say that a reverse mortgage can work quite well for a very specific type of person who wants to remain in their home, has very limited cash flow, so can’t afford a mortgage payment. The vast majority of their net worth is inside of that home. So they need liquidity and they don’t care all that much about legacy. They don’t mind that it’s going to hinder what will pass on to the next generation. In some cases, maybe even someone who didn’t have children. I’ll talk in a future show more about reverse mortgages, but that’s not for today where I want to focus on the final two ways to tap into your home equity, and that is through a home equity loan or through a HELOC, that home equity line of credit. While they’re similar, they’re not the same thing. And there are a few key differences that are important to understand.
With a home equity loan, you’ll receive the funds in a lump sum, which you’ll pay back at a fixed rate with a term that can be as long as 30 years, be a 30-year fixed-rate mortgage. And could be as short as five years. Home equity lines of credit on the other hand, are a revolving line of credit. So you can take your money out as you need it, kind of like you would with a credit card, during an initial draw period, which depends upon the bank and the contracts, but it’s around 10 years, typically, and then you repay the funds you borrowed with interest. But here’s a key component that has had a major impact negatively on a lot of folks with balances on their HELOC. It’s a floating rate. So many of these HELOCs used to be charging 2%, 1.5%, 3% interest. Now many are in that eight to 12% range. And so while mortgage rates have hit the highest they’ve been in a long time, you’re going to need to be a bit more strategic when taking money out of your house.
My final piece of common wisdom today is to rethink the way that we perceive rich people living. Now, we think they live in big houses and drive expensive, exotic cars, have yachts, they wear the most expensive clothes and jewelry, and if you watch reality TV or you’re scrolling through the gram, that’s what you’re thinking. Sadly, a lot of those people don’t even have the money probably to pay for the things that they’re flaunting, which leads to a completely separate topic but an important one when it comes to personal finances of avoiding the comparison trap because you usually don’t know the whole story.
But the reality is that many rich people, they don’t live in mansions and they don’t have a fleet of Bentleys. There was a man who interviewed over 1,000 millionaires. And here are a couple of his interesting takeaways. 97% of millionaires own their home and have lived there for many years. Maybe not so surprising, they on average invest 20% of their income each year. You compare that to the 48% of Americans who save less than 10% of their income, including their investments. So millionaires tend to have a much higher savings rate. And lastly, 50% of millionaires never spent more than $29,000 on a motor vehicle in their entire lives. And so there are some of the spending habits according to the millionaire next door. Here are some other interesting millionaire spending habits according to budgetsaresexy.com. I’m not joking. I know it’s weird. I don’t even know if I’m allowed to say that, but that’s the name of the site.
88% of millionaires read 30 minutes or more every day. 67% watch less than one hour of TV daily, 86% like what they’re doing for a living, 76% of millionaires exercise at least four days a week, 67% consider themselves frugal with their money, 55% spend less than $6,000 on vacations per year, I don’t like that one, I’m throwing that one out. That’s what we do, right? Data that we don’t like, we just get rid of it. I’m not going to follow that one. “I like to travel too much,” 94% don’t buy lottery tickets, 81% use credit cards with reward options, and 65% of millionaires have three or more streams of income.
So let me summarize what you and I can learn from these millionaires. They have pretty healthy habits. A high savings rate, are content with their jobs and their lives, they stay active and physically fit, and they’re not blowing money on frivolous things like depreciating vehicles and lottery tickets. And that’s why you don’t judge a book by its cover because that person who parked next to you in a seven-year-old Honda Accord who lives in a very normal house, they may just be the richest person you know.
It’s time for listener questions, and one of my producers, Lauren, is joining us on the mic. Hey Lauren, who do we have up first?
Lauren Newman: Hi John. Our first question comes from Don in Tucson, Arizona, and he writes, “I have a variable annuity worth about $350,000. I sold it when I switched jobs in 2010 and rolled it into my 401K into an IRA. It has a guaranteed withdrawal benefit of just under $400,000. I just learned from my insurance agent that I cannot access the $400,000 in a lump sum only through monthly income. This seems like a bad deal as the withdrawal benefit is 4%. I also have $600,000 in my current 401K invested in index funds. That account has earned nearly twice the returns of the annuity. I have buyer’s remorse. What do you recommend?”
John: Well, Don, thank you for that question.
Full disclosure, I despise variable annuities with income riders, withdrawal benefits for a variety of reasons, but let’s unpack your specific question. Let’s start with what a variable annuity is. Let me just strip out all the convoluted, complicated components such as the guaranteed withdrawal benefit. You’re invested in the market, stocks and bonds, in mutual funds. They’re technically called sub-accounts. And those reprice every day just as your 401K or your brokerage account, that’s your account value at any time. Now, generally they will limit how aggressive you can be. So the insurance company will make you have a certain level of bond exposure within the portfolio because they want to limit the overall volatility of the account and your total fees for the M&E charge, the admin fees, the sub-account charges, the income benefit, any enhanced death benefits that may exist tend to be between three and four and a half percent per year.
That’s all coming off the top out of your account. So really high fees, which is one of the main reasons I do not like these. They’re all internal. Very few people have any idea what they’re actually paying. So that’s pretty straightforward. You’ve got a really expensive account that limits how growth oriented you can be, and you’ll be penalized if you want your money out before the contract term ends, which can be between three years, seven years, 10 years. Okay? So there’s what’s happening with your actual money in your account. In this case with you Don, you referenced your guaranteed withdrawal benefit. This is never your money. So that $400,000 is in a separate bucket that cannot be withdrawn in a lump sum, but the insurance company will allow you to draw an income stream that is calculated as a percentage of that amount. You mentioned it in yours, which is pretty typical right now, is at 4%.
So here’s what happens when you elect that. 4% of $400,000 is 16 grand a year. So this insurance company will start sending you $16,000 a year. And again, without reading the entire contract, generally speaking, that will be paid until the day you die. That is why people buy these variable annuities because they’re sold with essentially the explanation that you can participate in the stock market just like you would in any other account. But if the market tanks or you live a really long time, you’ll have essentially a pension for the rest of your life, the $16,000 a year. Okay, who wouldn’t want that in retirement? I get to be invested, plus my downside’s protected. But of course, that’s not the full story.
So what happens in that first year that you take income is that 16 grand will be withdrawn from your actual account value, the $350,000 that’s invested in stocks and bonds and going up and down in value on a daily basis just like your other investments. And here’s the key. If when you die, Don, that $350,000 account, your actual money, still has even a hundred bucks in it, then all you did was have limited investment options while spending three or 4% in annual expenses to have the right to take $16,000 a year out of your own money. You could have done that in any other account. Essentially, you just paid the insurance company a lot of money for nothing. So the first key component here is that none of the charade of the withdrawal benefit value, none of that matters unless your account runs to zero, you are still alive, and that will be the first moment where the insurance company is theoretically using their money to get you your $16,000 of annual income.
Now, if that happens, you’re going to say, “Well, John, so glad that I bought this thing because I’d be out of money.”
No, you wouldn’t. It was a self-fulfilling prophecy. Normally, the only reason that this runs out of money is because the fees are so high and the investment options so limited in many cases that yeah, who’s going to be able to withstand a 4% annual expense hurdle every year? The insurance company’s laughing, they’re essentially sending you $16,000 for your income out of the hundreds of thousands of dollars of fees that you just paid them over the previous 10 or 20 years. There are many other components to unpack with this, but in short, there’s almost always a better, more efficient way to drive income in retirement by having a great financial plan, rebalancing your account, making tax trades, having the right level of risk per your time horizons and income needs and risk tolerance and those sorts of factors. My suggestion, Don, because the difference between your withdrawal benefit value of $400,000 and your account value of $350 isn’t a ton.
You bought it in 2010, so you almost certainly have no penalties. It’s a rollover from a 401K so there’s no tax implications if you roll your $350 into an IRA. That’s probably just because of my negative bias toward these types of annuities is what you’ll want to do. But before making any changes, go speak with a fee-based fiduciary, find a certified financial planner who isn’t the one that sold you this and made a commission, and say, “Can I have some objective advice in terms of how this fits into my income plan and the rest of my assets and strategies in retirement?”
We have a lot of clients, they’re in Tucson, and we’ll be happy to meet with you in person. If you’d like that, you can visit the radio page of our website to request it.
All right, who’s next? Lauren?
Lauren: Next, we have Tom in Glendale, Arizona. He writes, “I plan to retire next year at 62, and while my retirement plan works, it doesn’t without my Social Security. How confident are you that Social Security will not run out of money with our huge debt?”
John: Thanks, Tom, for that question. While the future is unknown, the risk that you will not receive Social Security benefits is extraordinarily low. And if that were to occur, we would have much bigger problems than you not getting your Social Security. Politicians agree, this isn’t something that should be on the table, current entitlements are highly unlikely to be affected, the only change that I could see is plausible and potentially likely is some sort of additional tax or lowered benefit on the wealthiest Americans.
Now, I don’t love that because all of those Americans, although they have money paid into the system out of their paychecks, and you’re certainly not the only one that’s considered this or asked me about it. Because as of right now, our national debt is approaching $33 trillion, it represents over 120% of our gross domestic product, so I think it would be irresponsible for me to completely dismiss the concern of negative implications potentially due to high levels of national debt. But Social Security benefits is not something I would be worried about, especially for someone who’s 61 years old like you, Tom. My colleagues and I here at Creative Planning are very comfortable running financial plans because the ripple effect of turning off Social Security and that safety net that over half of American retirees rely on for over half of their retirement income would be catastrophic.
All right, Lauren, who do we have for our final question?
Lauren: Joel in Indianapolis, Indiana writes, “I’m currently in the process of saving up for a down payment and I’m trying to figure out the best approach. Should I go with a CD, a money market account, or invest in bonds?”
John: In short, totally depends on the timeframe. All of these are good options if you plan on spending the money within the next couple of years. Right now, short-term treasuries are the best vehicle. Because they provide the best yields, they have the opportunity to increase in value if interest rates drop, they’re fully liquid, they’re backed by the full faith of the United States government, and after the last question highlighting our nearly $33 trillion in national debt, you might say, “Oh, how safe is that?”
Well, we’ve never once missed a debt payment. So it’s pretty safe. And we have the ability to tax citizens to come up with that money. But frankly, all three of those vehicles would work. I’m not a proponent of hoping to catch one of the three out of four years where the stock market is up on monies that you need one or two years from now, even though your probability of having more money is higher, if the market turns against you, which is also very possible. Now you don’t have the money available when the right house comes up. And Joel, if you have any other questions, we have an office there in Indie and would be happy to speak with you.
If you have questions as Don, Tom, and Joel did, send those my way by emailing [email protected].
We’re here on Rethink Your Money, my goal is not for us to just learn to learn, but learn to live, because knowledge is only power if implemented. It’s not in the knowing, but in the doing where we see results. And it’s interesting to ponder how much of what you and I believe, it’s just simply a result of where we were born, what family we were born into, what did our parents believe, and in turn, what were the experiences that we had that were completely out of our control? Because while our perspective is mostly and almost entirely informed by our personal experiences, those personal experiences contribute to almost zero of the rest of the world. But they contribute to almost entirely to what we believe. And this is why we have terms like blind spots or you’ve got a narrow or limited perspective.
It’s not because you’re ignorant or that you don’t care. It’s that you’re you. And that’s what you know. My sons Beck and Shay who were born in rural Ethiopia to single moms, why I’m so proud to be their dad. They have just unfathomable resilience far beyond anything that I think I’d be capable of. Their desire to learn and grow and their loving attitude towards others, it inspires me. But they’d be the first to tell you their worldview and their circumstances and the way that they view things would be completely different if they had been born in America as our biological children, like our one-year-old Luna. Her life’s not going to look at all the same because she didn’t live in Eastern Africa for the first 11 years of her life. And so the reason I bring this up, and I love considering these types of topics is because while it’s impossible to answer, a great question is how would our outlooks be different simply if our experiences had been different?
How would your values be different if you had been born in a different country or in a different home to different parents or chose to go the other direction at one of those few key moments in life that we all experienced where there’s that fork in the road? Well, it certainly would’ve led you to a different place today and would’ve provided you a different view because we’re all result of our experiences, most of which are out of our control. So when you’re approaching your money or relationship, I want to remind you, others are mostly clueless to what your life experiences are. And therefore, they can’t relate. And along with that, neither can you for them because you didn’t live their life. And this, hopefully, will propel us forward toward a willingness to hear others’ perspectives rather than cramming our agenda down their throats. As the bestselling author Morgan Housel said, when it comes to investing, no one is crazy. We’re simply all making decisions that makes sense to us given our unique individual circumstances.
And when we approach others with this posture, it promotes empathy and a willingness to listen, both of which are key ingredients to fruitful relationships and personal growth. And when we extend this outlook to our money, it allows us to be receptive toward what we might be missing and what we can learn from others due to the beautiful reality that their life has likely looked very different than ours. And that ultimately is such a beautiful thing. And remember, we are the wealthiest society in history. 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 $210 billion in assets as of December 31st, 2022. 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.
John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Hagensen and ahead on today’s show, The Attributes You Must Possess to be a Great Investor: The Biggest Tax Misconceptions with Creative Planning Director of Tax, Candace Varner, as well as how the rich live. Fancy cars, giant mansions, the answer may just surprise you. Now, join me as I help you rethink your money.
I want to begin though with a documentary I watched earlier this week on Johnny Manziel. It’s a really interesting story about someone with great talent. If you’re not familiar, he was the first Heisman Trophy winner ever in NCAA history as a freshman when he was at Texas A&M. And he ended up being drafted in the first round by the Cleveland Browns, and to make a long story short, just unraveled with all the fame and drugs and money. And at one point in the documentary, they highlighted this moment where the general manager of the Cleveland Browns contacted Manziel’s agent and said, “Your client watches no tape. None. We can’t get him to even put forth effort and he’s our starting quarterback.”
And the agent thought they were sort of speaking in generalities like, “Oh, he doesn’t watch a lot of tape, or he is maybe not putting forth a ton of effort.”
The GM said, “No, his tablet time, which we can track is zero. He doesn’t spend one second looking at film or studying.”
No surprise, he was out of the league quickly, total bust, but it was never a talent issue. It was his character. Discipline, selflessness, work ethic, you contrast Johnny Football with Tom Brady. Brady was taken in the sixth round. He was the 199th pick in the NFL draft. That year alone, there were six quarterbacks drafted higher than him. He was an okay player at Michigan. You watch his videos from the combine, he’s like a pudgy, slow quarterback with moderate arm strength. Well then why is he the go? Because he wasn’t even close to the most talented. He has less natural ability than hundreds of quarterbacks that have played in the NFL. No, it was his attributes. Zero alcohol during the season, sleep routines, complete dedication to fitness and flexibility.
The guy’s posting pictures eating avocado ice cream. Sounds disgusting. I like guacamole, but ice cream? I don’t know, it sounds gross. He adhered to this crazy diet. He was the first one in the building, last one to leave. And that’s what makes a great quarterback, which is why drafting them is such an imperfect science even with entire scouting departments because a lot of it’s immeasurable. They’re soft skills. And now I’m sharing this with you, not just because I’m a sports nut, which I am, my wife will attest, but because there are many parallels between what makes a great quarterback like Tom Brady and what will make you a great investor. And I’ll preface these five qualities with a warning. They’ll sound very simple. But like a lot of things in life, simple things aren’t always easy to execute. The first ingredient to being a great investor is humility.
See, a humble person is open to receiving advice, and the behavioral bias that applies here is called the overconfidence bias, which leads investors to making poor decisions, underestimating risks, and overestimating their personal abilities. Also, arrogant investors ignore diversification. And overconfidence also leads to overtrading. There’s a reason women average better returns than men. And all the studies show us that there’s one main reason why. Women possess more humility, they’re more interested in getting it right than being right, and in turn, trade less. There’s a direct correlation between the more you trade, the lower your expected returns are.
And the last major challenge for investors lacking humility is that they have a failure to learn from mistakes. See, overconfident individuals tend to attribute their success to their skills and to their intelligence while blaming external factors like bad luck for their failures. A lack of humility creates rigidity, which makes it tough to adapt. And that is my second attribute required to be a great investor, and that is you must be adaptable. Kodak, Blockbuster, Nokia, Sears, those names ring a bell? Yeah, you probably know where I’m going with this. These companies didn’t go broke because they lacked capital or intelligence or market share. No, it wasn’t that. They failed to adapt. And the behavioral bias that relates to this is called the sunk cost fallacy. We allow previous decisions to inform our future ones. There is a great exercise to check yourself that helps answer whether you may be holding certain investments that you shouldn’t be just simply because you already own them.
Now, I want you to imagine that every part of your liquid net worth. Bank accounts, 401Ks, brokerage accounts, IRAs, whatever it might be, all of that was piled up in a hundred dollars bills on your kitchen table. Now, I hope that’s a big pile for your sake. Maybe it’s a medium pile, maybe it’s a small one, that’s all right. We’re all on our own journey here, but as you looked at that money piled up and were determining where to invest it, how to invest it, would you buy the same things you currently own? Oftentimes, the answer’s no. Oh, gosh. Yeah, I probably wouldn’t have 30% of my portfolio and stock A, B, C just because I worked there. Yeah, I wouldn’t repurchase all of that. Well, that’s what you’re doing by not making the adjustment and not adapting. It can also lead to reduced portfolio diversification. And that may be due to an inability or unwillingness to rebalance, to maintain a well diversified portfolio. And here’s the biggest sunk cost that I see practically hurt investors every single day, and that is holding on to a suboptimal relationship with your advisor.
There are a lot of great financial advisors across the country. And there are a lot of great firms across the country. There are also a lot of really bad ones and many that I would consider average at best. But because it’s a relationship and you’ve shared important detailed, intimate information that you oftentimes don’t share with anyone else about your finances, it creates a bond and a sunk cost making it difficult for even intelligent, seemingly pragmatic, disciplined investors to fire their advisor.
Let’s do a bit of a self-assessment. I want you to think through these answers in your head. If you had a $100 million dropped in your lap tomorrow, would you continue working with your advisor? Would you interview other advisors? Would you certainly fire your advisor? Would you feel like they weren’t capable of handling that type of an account? If that’s the case, you’re probably going to be fine with a hundred million, but if you have 500,000, or a million five, or 4 million, isn’t it even more important that you have the absolute best financial advice?
And I’m not saying that all roads lead to Creative Planning, but I do want to ask you, is your advisor independent? Are they manufacturing and soliciting proprietary products or products that they’re receiving huge kickbacks on? Do you even know the answer to that? Because it creates a massive conflict of interest, and that’s still how the majority of the industry operates today. We at Creative Planning are not tethered to any investment company or strategy or funds at all. We work directly with our clients. Is your current advisor a fiduciary all the time? Are they legally required to act in your best interest just as an attorney and a CPA does for you? And if your answer is, “Well, I would assume so.” You may be surprised to know that the majority of financial advisors, and I’m using that term loosely, are brokers or put another way, salespeople. They just have to sell you things that are suitable.
They can’t put a 90-year-old in penny stocks, but they can certainly sell you a product that they make way more money on or get sent on a fancy vacation as a result of. And then lastly, does your advisor have the resources to help you with all of your needs? The most important question for you to answer is do you have a written, documented, dynamic, detailed financial plan right now that you can access and look at and review and update that takes into account your estate planning, your taxes, your retirement planning, your insurance needs, your income strategies? If you don’t like the answers to any of those questions, you probably should be interviewing other advisors. If you’re not sure where to turn by the way, you can visit us at creativeplanning.com/radio now to schedule your visit with a local advisor.
So far, we’ve talked about a great investor being humble, a great investor being adaptable, and this next one’s the hardest for me to pull off, and that is patience. A great investor is patient. Warren Buffett famously said, “Someone is sitting in the shade today because someone planted a tree a long time ago.”
Let me present you with a riddle. If you had a pond and that pond had started with a speck of algae and I told you that every single day for the next month, the algae was going to double in size until on the final day of the month, the entire pond would be completely consumed by algae. How much of that pond was covered in algae the day prior to it being fully covered? The answer is only 50%. It’s not 97%, it wasn’t 85% covered in algae because remember, it’s doubling every day, meaning half of it was still clear the day before it was engulfed. This is how exponential and compounding growth works.
See, being patient though is hard but absolutely necessary to being a great investor. The long-term returns of the market are phenomenal. Stock markets returned about 10% per year for a century. A diversified portfolio has never been down over a 20-year period. It’s up 98% of 10 year periods, 91% of five year periods. But five years and 10 years or 20 years, they feel like a really long time. A lot happens over our lives during those time periods.
The next characteristic, essential and being a great investor is having proper expectations. Frustration is the gap between expectations and reality. And so closing that gap is key to our contentment. But what if I told you that rather than focusing on the outcomes, which in many cases aren’t entirely within our control, how about ensuring that you set realistic expectations which are entirely within your control? From a globally diversified portfolio, you should expect your investments to correct over 10% on an average of about 14% in a given year.
You should also expect to have less money December 31st than you had January 1st about one out of every four years. You’re going to have a drop of 20% or more, a bear market, about every five years, and you’ll have a full on crash every decade or so. For bonds, almost all of your return will come from the yield from that interest that’s collected and you should expect to earn about inflation, maybe a little bit better. And if you’re mindful on credit quality and duration, so who you’re lending to and how long you’re lending for, you’ll typically create some stability for shorter term needs that will provide volatility dampening from your stocks and allow you a bucket to grab money from if you need it during times where the stock market is down. You should expect to go through many time periods, even long ones where you are wondering why your strategy doesn’t seem to be working.
Oh, and here’s the big one. You should expect to hear regularly about how awful everything is within the world, the economy, and the stock market. What bleeds leads. And you should have the expectation that you will be required to combat negative sentiment with regularity.
And the final attribute required to be a great investor is experience. Ever heard the saying, ‘This ain’t my first rodeo”? There’s value in experience. I think about myself as a parent. I’m far from perfect, but I’m way better than I was 10 years ago. But whether it’s parenting or in business or investing, experience matters. You can say while sitting on your sofa that you’re not afraid of snakes, but how will you respond to them? One is thrown in your lap? More than anything, experience provides perspective. And that’s the value of a great financial advisor.
And speaking of experience here at Creative Planning, we’re helping over 60,000 families in all 50 states and over 75 countries around the world. We’ve been providing perspective to the uncertain economy and markets for 40 years. It’s not our first rodeo. And so if you are looking for a second opinion to the plan that you already have or you don’t have a plan, you sort of have a plan, lean on our experience and meet with one of our 300 certified financial planners just like myself. To schedule a conversation with us, visit creativeplanning.com/radio now. Why not give your wealth a second look?
My special guest today is Candace Varner. Candace is Creative Planning’s Director of Tax managing the company’s tax practice as well as working directly with clients. She’s a certified public accountant. Candace graduated from the University of Kansas with her bachelor’s degree in business administration and accounting as well as her master’s degree in accounting. Candace Varner, thank you so much for joining me here again on Rethink Your Money.
Candace Varner: Thank you for having me back.
John: Well, I thought today you could set the record straight on some of the most common tax questions you receive, and in particular some of the misconceptions that you clarify every single tax season. And let’s begin with extensions. I’ve had plenty of clients say, “Extending, John? I don’t know. I don’t want to be on the IRS’s radar. If we extend, am I going to be more at risk of an audit?”
Candace, what are the real implications of extending?
Candace: Yeah, so I actually get clients that go both ways. Some think an extension is definitely an audit red flag and others insist on extending because if they file on time, that’s going to be an audit reg flag.
John: Interesting.
Candace: So that’s always interesting where people get that. In general, the idea that an extension is going to make or break an audit decision for the IRS is just sort of out in the general thought process, but I’ve never seen any actual evidence of that. We extend thousands of returns, we file thousands every deadline and no rhyme or reason related to that as to why they are being audited. So a lot of things with tax, it’s very psychological and people just want to feel like they’re doing everything they can to be protected and doing the right things. And so sometimes, I’ll file extension and file the return next week if you want me to just to make you feel better, but it’s not actually going to make any difference.
John: Outside of waiting on specific tax forms, which is obviously one of the common reasons some would extend, are there any other strategic reasons to extend versus filing on time if they were able to?
Candace: The biggest reason I see for delay, if we have everything, would be the additional time to make contributions to a retirement plan. So an IRA, they have to do by the April 15th deadline, but a SEP IRA and the match contribution to a solo 401K you can make to the extended deadline. So for cashflow planning, sometimes we’ll sit on it until they want to make that cash contribution to the plan. Otherwise, strategic-wise, unless there’s something in the tax law that’s in limbo or you think might change or something like that, there’s no reason to wait.
John: How about deductions? Sometimes people nearing the end of the tax season say, “I’m going to go spend a lot of money on X, Y, Z,” you name it. Something that’s totally unnecessary for the business, but they’re like, “Well, I’m going to get a deduction for this, John. Don’t you understand that?”
I do understand that, but it doesn’t make it free.
Candace: Right. Usually this is where I like to go into a bit about write-offs and people misunderstanding what that is and they just like to use the term, but think of a tax deduction as a discount. It’s not free. It’s like buying something on sale. If you weren’t going to buy it anyway, you are worse off. So if I-
John: Hold on. Candace, I’m going to get my wife, Brittany, on here for a second. Can you repeat that?
Candace: No, I’m not responsible for that. I’m sure she listens to all your shows, doesn’t she?
John: Oh yeah, of course.
Candace: If they said, “Okay, well I was going to buy this next year, but I’m going to buy it this year instead so that I get the deduction earlier,” great, makes perfect sense. I want to keep more of my tax dollars earlier. But if I’m going to buy a car for 20 grand and I otherwise wasn’t going to buy one at all, I’ve just spent 20 grand and got a tax deduction for part of it. Now the only exception or caveat to that would be if they’re paying themselves. So like the deduction for the SEP contribution. Okay, well, I’m not spending that money on a car, I’m moving it to another account that’s also in my name.
John: Sure.
Candace: So that is different and does net benefit you from taxes.
John: Certainly you don’t want to be missing out on deductible expenses that you weren’t claiming.
Candace: Right.
John: Obviously, those are great. I like to tell people when they say, “Well, I just need to spend the money.” It’s like, if you really like that, can you give me a dollar and I’ll give you 30 cents back and we can just keep making this exchange since it’s somehow saving you money?
Candace: I sometimes offer to increase my fees for their tax services because that increases the deduction too.
John: It’s deductible after all, right?
Candace: Right.
John: Yeah, no, that’s great. Well, so now credits are different than deductions and maybe that throws people off from time to time. Can you explain the differences?
Candace: Yeah, so this is one of those areas where accountants have their own language and we use words differently for things. So when you say, “Oh, I get credit for that,” that’s different than a tax credit. So a deduction is, we would call, above the line. So think I made 100 grand, I’m going to deduct 50 grand that I spent on something, that’s a deduction. The net amount is then multiplied by your tax rate.
Let’s say that ends up in a tax liability of $10,000. So you didn’t save the 50 grand you spent, you saved a percentage of that, that’s the deduction, but now my tax liability is 10 grand and I’m going to get a credit for something for $2,000. The credit is dollar for dollar, so a credit is worth much more to you. And these are usually done when Congress wants to incentivize specific things like renewable energy credits, things like that, as opposed to just spending money on deductions. So the credit is way more beneficial. A lot of people saw the increase in the child tax credit over the last couple of years and then took it away and threw everyone off. That was dollar for dollar cash in your pocket, and that’s better.
John: Deductions are more valuable when you’re at a higher income level because you’re saving more, right?
Candace: Correct.
John: So credits are also even sort of more valuable to someone who’s in a lower income state. I remember on one of our first adoptions, that was an enormous tax credit. We didn’t have a lot of money at the time, and it was huge. It made it affordable for us to actually go through with the adoption. So that was-
Candace: That’s perfect.
John: … an amazing credit. And I remember thinking at the time going, “Whoa, this is really valuable,” because it is dollar to dollar.
Candace: Yeah, which is an expensive process and did exactly what it wanted to do.
John: Yeah, which the deduction wouldn’t have helped me much. I didn’t have any money, so I wasn’t making much.
Candace: If your tax rate is 10%, the deduction is not that helpful.
John: Yeah, exactly. I’m speaking with Creative Planning Director of Tax Services, Candace Varner. Let’s talk about refunds and the amounts owed being unrelated to your tax liability because this trips people up as well.
Candace: Yep.
John: These are misconceptions.
Candace: And some people even who understand it still don’t follow what I would think is a logical way to go about this.
John: So walk us through this.
Candace: Okay, so example I was just using, we’re going to get to a tax liability of $10,000. That is the total tax you pay for let’s say 2022.
If you do not have withholding from your job and you have sent the government no money during 2022, then you have to write a check for $10,000. But if instead I have my regular day job and my day job withheld $12,000 for me during the year, I’m going to get a $2,000 refund. The tax I paid is the exact same, the $10,000, but whether or not I have to write a check or get a refund is purely based on how much money I already sent the government.
Now the thing here is that withholding feels very different. You don’t necessarily notice you’re withholding on a paycheck to paycheck basis. And you think of what you get is just the net amount, but your employer is sending money to the government all the time on your behalf. And so when you get to the end and someone says, “Oh, I didn’t pay taxes, I got a refund,” that’s not how that works. You paid taxes, but it feels really different. Now how it feels is important, so I can’t tell you how many times I’ve explained this to my mother and she maintains, “I’d still rather have the refund, just feels better.”
John: Well, and I think actually it’s worth noting too where right now you can make 5% on your money in treasuries.
Candace: Yep.
John: It might feel good to receive a refund, but you don’t want to massively over withhold because there is an opportunity cost to overpaying the IRS all of that money, but I agree with you. I think in some cases, someone owing $10,000 but receiving a $1,000 refund because they put 11 grand in during the year feels better than the person who only owes 6,000, but they have to write a check for 5,000 at the end of the year. They’re more upset with their CPA or their advisor like, “How did this happen?” You’re going, “Wait, you paid four grand less in taxes this year. It was a really good thing.”
You guys do such a great job on your team of this year at Creative Planning, and I hope that we coordinate this well between wealth managers and CPAs. That’s certainly the objective to have those conversations like you and I are having right now with the client so that they understand this because sometimes perception is reality and if they’re frustrated, the outcome’s still not good, even if it was, on paper, a good one. It reminds me of my father-in-law. He’s a pretty content guy, pretty laid back, and I remember asking him at one point, “You seem pretty pleased with most people. What’s your secret?”
He said, “I have no expectations for anyone. I set my expectations so low that anything that happens that’s good is a win.”
And I remember thinking for a moment, “I don’t know if you’re a genius or if that’s a really cynical way to look at life, but whatever. Okay, I’ll take it for what it is.”
Candace: If he’s happy, I got to go with Genius. I just don’t know how to do that. I don’t know how to lower my expectations in my head.
John: I know, I’m still working on it. But as we wrap up, Candace, what are some other items that people can be doing?
Candace: I think the biggest thing is, A, planning as we said, to know the expectations. And then I always encourage people to look at their tax return and think that that dictates how much tax they’re going to owe. It does, but it’s really important to zoom out and look at the items before they even get to your tax return. So what you guys are talking to clients about with the investing, there’s some income as taxed different rates than other incomes. So how do we get invested in this? Or are you in a year where you have a low tax liability and we should invest in something that’s higher growth, but the tax rate actually happens to be high. It is very personalized, but by the time you’re going to file your taxes, there’s not a lot left you can do.
And so when someone says, “Okay, well, my effective rate was 25%.” Yes, but you also had all this income that was tax-exempt and you had all of these things that were paid to your Roth IRA or your regular IRA. The things that happened before you even get to filling out the forms, that’s where the magic happens.
The stuff you don’t see is usually the most impactful.
John: I’ve heard you say paying yourself. Speak to that.
Candace: If you are working at a job where you get a W-2, there’s very little deductions you have wiggle room on when you go to file your tax return. And so the biggest thing is what can I do to lower the taxable wages? So if I make a million dollars and I end up paying tax on a million dollars, well that’s what the tax return shows is the one million. But if I first max out my 401K, max out my HSA, max out my dependent care accounts, all those things like we were talking about where the money is moving to another account in my name, now the taxable income only shows $950,000. Well, again, once I get to the tax forms it’s just the 950 and it doesn’t look like I saved anything. But it’s before we even got there, what amounts can I take advantage of that are deferred? And those kind of things I’m just naming are every year.
John: Yeah, those are really good points, Candace. Well, thank you so much for sharing your insights, helping the listeners out and joining me here on Rethink Your Money.
Candace: Thanks for having me.
John: Let me ask you a question. Has your advisor reviewed your tax return in the past year? If you don’t like the answer to that question, why not give your wealth a second look by visiting creativeplanning.com/radio to speak with a local advisor just like myself.
Now, I know I’m running the risk of completely bursting your bubble, but the Great Wall of China is not visible from space, Einstein never failed math, and the gum you swallowed seven years ago, it’s not still in your stomach. Now, these are wives’ tales. The things that our parents told us, we accept it as truth only to find out, no, that’s not true. Sorry, Kyrie Irving, the Earth isn’t flat, it’s round.
And yes, mom, if you’re listening, I do not tell my kids that they’re going to go blind by sitting too close to the television. Well, there are plenty of these accepted truths that aren’t actually truths all throughout personal finance, and one of those is that your expenses are going to go down once in retirement. In fact, many financial planners will use a baseline of expenses at 70 or 80% of your current expenses while working.
I love this from Dan Ariely who said, “The consensus that you’ll need 70 or 80% of your final income in retirement is way off. For many people, it’s around 130%.” And so let’s rethink this together.
Catherine Hoffman, fantastic attorney here at Creative Planning, wrote an article on the 6 Surprise Retirement Expenses and How to Prepare For Them. I don’t want you to be caught off guard by unexpected expenses. Because if you look right now at your credit card statement or your bank account as to which days of the week you spend the most money, you’ll find Friday, Saturdays, Sundays. Those are the weekends, of course we do. No, it’s because you’re not working on those days. And because of that, you have more time. And when you have more time, you go spend money. Try going to a movie theater for a one o’clock matinee on a Tuesday.
You will see that theater overtaken by people with white hair because they’re not working. But of course, they got to get delicious movie theater butter popcorn, the candy, the giant soda, it only cost about $25 for those three things, so no big deal. And off that retiree goes into the theater, munching on their Mike and Ikes. So the first of six surprise retirement expenses is healthcare and medical expenses. Healthcare is one of the most significant expenses faced by most retirees. And yes, Medicare covers some expenses, but it won’t pay for everything. Costs related to prescription medications, dental and vision care and long-term care can quickly add up. And I won’t leave you hanging. I’m not just going to provide you with the expenses without any tips. Here’s how you can help prepare for that estimate your healthcare needs.
Now, obviously this is a moving target, but consider your medical history, family health issues, and any lifestyle factors that may impact your future healthcare costs. Research your health insurance options. I know this is the Wild West, and if you want to be confused, start trying to look into health insurance and then establish an emergency healthcare fund. Maybe you have an HSA, that would be fantastic. But either way, within your financial plan, you need to have funds earmarked and set aside to cover unexpected medical expenses.
Another surprise expense for many retirees, home repairs and maintenance. This one’s pretty simple. Retirees spend more time at their home, which means it’s important to ensure that your house remains safe and comfortable. And let’s face it, during the pandemic this happened as well. We were all cooped up at home. No one was traveling anywhere and home repairs and renovations went through the roof, because you finally were like, “You know, this sliding door that doesn’t really slide very smoothly, it is kind of annoying. Let’s look at getting a new door. I’ve always wanted to blow out this wall and make a bigger master closet. All right, let’s go ahead and do it.” That’s what tends to happen in retirement. To prepare for home expenses in retirement, you can establish a home repair fund. You plan to renovate, you know that your home’s a little bit older, build that into your financial plan. And of course, this is a very personal decision with many additional factors, but you could consider downsizing.
Another expense I see surprise many retirees is supporting adult children or aging parents. And so the way you can hedge this with your children is encourage financial independence and try to teach them how to manage their money, stick to a budget, and become financially self-sufficient. Nothing more quickly submarines an otherwise great financial plan and derails retirement like a parent who has difficulty cutting their adult child off.
When it comes to aging parents, it’s important that you know whether or not they have a long-term care policy. If something were to happen to them, what’s the game plan? What are the details of that long-term care policy if they have one? How long will it pay? Is there an inflation adjustment? How much do they have in other assets that could support their needs in the event that they live a long time and need medical care?
Plan for travel and hobbies, because what you don’t want to do is retire and then realize, “Oh, well, I can’t afford to actually do anything.” What good is that? Not a lot of people want to rock in their family room with a little space heater on their feet watching Matlock reruns all day long. That’s not a great retirement. So research and plan ahead the types of vacations you intend to take, the expected costs for those vacations, and build those expenses into your plan.
Next, plan for grandchildren. I don’t think there is anything that brings the clients I directly work with more joy in retirement than having grandchildren and spending time with those grandchildren and being involved in their lives. But to financially prepare for grandchildren, make sure you budget in travel expenses. Unless all of your kids and subsequent grandchildren live locally, you’re going to need to travel to see them. And I can tell you as a parent to seven kids, we are not doing a lot of the traveling. We’re in the thick of it. So the grandparents, for holidays, for summer breaks, they’re coming to us.
And the sixth and final surprise expense, and this one’s a whole lot bigger than just money, is the loss of a spouse. While none of us want to consider the possibility of losing our spouse, it’s very rare that you and your spouse pass away at the exact same time. So in addition to final expenses, medical bills, funeral costs, all of that can add up quickly. But to add to the stress of the situation, you’re going to lose either yours or your spouse’s Social Security. If they had a pension, it may be reduced or go away entirely depending upon the specifics of that pension and what was elected. So how financially can you prepare for that? Plan out a bit of what your life would look like and what things would change if something were to happen to your spouse.
But so to recap, I don’t want you surprised in retirement by healthcare expenses, by needing to spend money on your home, the potential for supporting adult children and or aging parents, that you’ll want to travel and have some hobbies and those will cost money, your grandchildren won’t be an expense, and unfortunately at some point if you’re married, you or your spouse is going to be a widow navigating these financial waters of retirement on their own.
The answers to those specific questions and almost every other one that you can think of are found through a written, documented financial plan. If you’re looking for clarity around your life savings, that plan is the requirement. I encourage you to get one or have your current one reviewed by a fiduciary that’s not looking to sell you something if you have questions. And if you’re not sure where to turn and you think we might be a good fit here at Creative Planning, we are happy to help. Reach out to us at creativeplanning.com/radio now to schedule your visit.
Next piece of common financial wisdom that I’d like to rethink is that to benefit from the equity in my home, a home equity line of credit, or HELOC, is my only option. Well, this is a relevant one because just over 79% of Americans aged 65 and up are homeowners. Just over 75% of those between 55 and 64 own homes. And home equity accounts for about 48% of the median net worth of American homeowners over the age of 60. Let me summarize, about half of retirees’ net worth is found inside the Sheetrock of their homes. In fact, if you just look at the last 10 years, the US median price for existing single family homes, it’s been on a tear. It’s up 91% while the US consumer price index is up about 30. So I know from the data, with home prices appreciating 6% above inflation the last decade, a lot of people have a lot of equity in their homes.
So in that case, tapping your home equity can be a convenient low cost way to borrow large sums of money at normally favorable interest rates. And so whether it be for medical expenses, tuition bills, some of the expenses that I just mentioned end up being paid for by the equity in your home. There are four primary ways to access the equity in your home. One, you can sell your house. The title company is going to wire the proceeds right into your bank account. Now, of course, you need somewhere to live, so you’re probably going to need to use some of that to pay rent or for a down payment on another home, but that’s one way to access your home equity. The second is through a reverse mortgage. Now, reverse mortgage is sort of like the brother to annuities, very controversial, can be some high costs upfront, many people have buyer’s remorse.
It’s a complicated contract, but I will say that a reverse mortgage can work quite well for a very specific type of person who wants to remain in their home, has very limited cash flow, so can’t afford a mortgage payment. The vast majority of their net worth is inside of that home. So they need liquidity and they don’t care all that much about legacy. They don’t mind that it’s going to hinder what will pass on to the next generation. In some cases, maybe even someone who didn’t have children. I’ll talk in a future show more about reverse mortgages, but that’s not for today where I want to focus on the final two ways to tap into your home equity, and that is through a home equity loan or through a HELOC, that home equity line of credit. While they’re similar, they’re not the same thing. And there are a few key differences that are important to understand.
With a home equity loan, you’ll receive the funds in a lump sum, which you’ll pay back at a fixed rate with a term that can be as long as 30 years, be a 30-year fixed-rate mortgage. And could be as short as five years. Home equity lines of credit on the other hand, are a revolving line of credit. So you can take your money out as you need it, kind of like you would with a credit card, during an initial draw period, which depends upon the bank and the contracts, but it’s around 10 years, typically, and then you repay the funds you borrowed with interest. But here’s a key component that has had a major impact negatively on a lot of folks with balances on their HELOC. It’s a floating rate. So many of these HELOCs used to be charging 2%, 1.5%, 3% interest. Now many are in that eight to 12% range. And so while mortgage rates have hit the highest they’ve been in a long time, you’re going to need to be a bit more strategic when taking money out of your house.
My final piece of common wisdom today is to rethink the way that we perceive rich people living. Now, we think they live in big houses and drive expensive, exotic cars, have yachts, they wear the most expensive clothes and jewelry, and if you watch reality TV or you’re scrolling through the gram, that’s what you’re thinking. Sadly, a lot of those people don’t even have the money probably to pay for the things that they’re flaunting, which leads to a completely separate topic but an important one when it comes to personal finances of avoiding the comparison trap because you usually don’t know the whole story.
But the reality is that many rich people, they don’t live in mansions and they don’t have a fleet of Bentleys. There was a man who interviewed over 1,000 millionaires. And here are a couple of his interesting takeaways. 97% of millionaires own their home and have lived there for many years. Maybe not so surprising, they on average invest 20% of their income each year. You compare that to the 48% of Americans who save less than 10% of their income, including their investments. So millionaires tend to have a much higher savings rate. And lastly, 50% of millionaires never spent more than $29,000 on a motor vehicle in their entire lives. And so there are some of the spending habits according to the millionaire next door. Here are some other interesting millionaire spending habits according to budgetsaresexy.com. I’m not joking. I know it’s weird. I don’t even know if I’m allowed to say that, but that’s the name of the site.
88% of millionaires read 30 minutes or more every day. 67% watch less than one hour of TV daily, 86% like what they’re doing for a living, 76% of millionaires exercise at least four days a week, 67% consider themselves frugal with their money, 55% spend less than $6,000 on vacations per year, I don’t like that one, I’m throwing that one out. That’s what we do, right? Data that we don’t like, we just get rid of it. I’m not going to follow that one. “I like to travel too much,” 94% don’t buy lottery tickets, 81% use credit cards with reward options, and 65% of millionaires have three or more streams of income.
So let me summarize what you and I can learn from these millionaires. They have pretty healthy habits. A high savings rate, are content with their jobs and their lives, they stay active and physically fit, and they’re not blowing money on frivolous things like depreciating vehicles and lottery tickets. And that’s why you don’t judge a book by its cover because that person who parked next to you in a seven-year-old Honda Accord who lives in a very normal house, they may just be the richest person you know.
It’s time for listener questions, and one of my producers, Lauren, is joining us on the mic. Hey Lauren, who do we have up first?
Lauren Newman: Hi John. Our first question comes from Don in Tucson, Arizona, and he writes, “I have a variable annuity worth about $350,000. I sold it when I switched jobs in 2010 and rolled it into my 401K into an IRA. It has a guaranteed withdrawal benefit of just under $400,000. I just learned from my insurance agent that I cannot access the $400,000 in a lump sum only through monthly income. This seems like a bad deal as the withdrawal benefit is 4%. I also have $600,000 in my current 401K invested in index funds. That account has earned nearly twice the returns of the annuity. I have buyer’s remorse. What do you recommend?”
John: Well, Don, thank you for that question.
Full disclosure, I despise variable annuities with income riders, withdrawal benefits for a variety of reasons, but let’s unpack your specific question. Let’s start with what a variable annuity is. Let me just strip out all the convoluted, complicated components such as the guaranteed withdrawal benefit. You’re invested in the market, stocks and bonds, in mutual funds. They’re technically called sub-accounts. And those reprice every day just as your 401K or your brokerage account, that’s your account value at any time. Now, generally they will limit how aggressive you can be. So the insurance company will make you have a certain level of bond exposure within the portfolio because they want to limit the overall volatility of the account and your total fees for the M&E charge, the admin fees, the sub-account charges, the income benefit, any enhanced death benefits that may exist tend to be between three and four and a half percent per year.
That’s all coming off the top out of your account. So really high fees, which is one of the main reasons I do not like these. They’re all internal. Very few people have any idea what they’re actually paying. So that’s pretty straightforward. You’ve got a really expensive account that limits how growth oriented you can be, and you’ll be penalized if you want your money out before the contract term ends, which can be between three years, seven years, 10 years. Okay? So there’s what’s happening with your actual money in your account. In this case with you Don, you referenced your guaranteed withdrawal benefit. This is never your money. So that $400,000 is in a separate bucket that cannot be withdrawn in a lump sum, but the insurance company will allow you to draw an income stream that is calculated as a percentage of that amount. You mentioned it in yours, which is pretty typical right now, is at 4%.
So here’s what happens when you elect that. 4% of $400,000 is 16 grand a year. So this insurance company will start sending you $16,000 a year. And again, without reading the entire contract, generally speaking, that will be paid until the day you die. That is why people buy these variable annuities because they’re sold with essentially the explanation that you can participate in the stock market just like you would in any other account. But if the market tanks or you live a really long time, you’ll have essentially a pension for the rest of your life, the $16,000 a year. Okay, who wouldn’t want that in retirement? I get to be invested, plus my downside’s protected. But of course, that’s not the full story.
So what happens in that first year that you take income is that 16 grand will be withdrawn from your actual account value, the $350,000 that’s invested in stocks and bonds and going up and down in value on a daily basis just like your other investments. And here’s the key. If when you die, Don, that $350,000 account, your actual money, still has even a hundred bucks in it, then all you did was have limited investment options while spending three or 4% in annual expenses to have the right to take $16,000 a year out of your own money. You could have done that in any other account. Essentially, you just paid the insurance company a lot of money for nothing. So the first key component here is that none of the charade of the withdrawal benefit value, none of that matters unless your account runs to zero, you are still alive, and that will be the first moment where the insurance company is theoretically using their money to get you your $16,000 of annual income.
Now, if that happens, you’re going to say, “Well, John, so glad that I bought this thing because I’d be out of money.”
No, you wouldn’t. It was a self-fulfilling prophecy. Normally, the only reason that this runs out of money is because the fees are so high and the investment options so limited in many cases that yeah, who’s going to be able to withstand a 4% annual expense hurdle every year? The insurance company’s laughing, they’re essentially sending you $16,000 for your income out of the hundreds of thousands of dollars of fees that you just paid them over the previous 10 or 20 years. There are many other components to unpack with this, but in short, there’s almost always a better, more efficient way to drive income in retirement by having a great financial plan, rebalancing your account, making tax trades, having the right level of risk per your time horizons and income needs and risk tolerance and those sorts of factors. My suggestion, Don, because the difference between your withdrawal benefit value of $400,000 and your account value of $350 isn’t a ton.
You bought it in 2010, so you almost certainly have no penalties. It’s a rollover from a 401K so there’s no tax implications if you roll your $350 into an IRA. That’s probably just because of my negative bias toward these types of annuities is what you’ll want to do. But before making any changes, go speak with a fee-based fiduciary, find a certified financial planner who isn’t the one that sold you this and made a commission, and say, “Can I have some objective advice in terms of how this fits into my income plan and the rest of my assets and strategies in retirement?”
We have a lot of clients, they’re in Tucson, and we’ll be happy to meet with you in person. If you’d like that, you can visit the radio page of our website to request it.
All right, who’s next? Lauren?
Lauren: Next, we have Tom in Glendale, Arizona. He writes, “I plan to retire next year at 62, and while my retirement plan works, it doesn’t without my Social Security. How confident are you that Social Security will not run out of money with our huge debt?”
John: Thanks, Tom, for that question. While the future is unknown, the risk that you will not receive Social Security benefits is extraordinarily low. And if that were to occur, we would have much bigger problems than you not getting your Social Security. Politicians agree, this isn’t something that should be on the table, current entitlements are highly unlikely to be affected, the only change that I could see is plausible and potentially likely is some sort of additional tax or lowered benefit on the wealthiest Americans.
Now, I don’t love that because all of those Americans, although they have money paid into the system out of their paychecks, and you’re certainly not the only one that’s considered this or asked me about it. Because as of right now, our national debt is approaching $33 trillion, it represents over 120% of our gross domestic product, so I think it would be irresponsible for me to completely dismiss the concern of negative implications potentially due to high levels of national debt. But Social Security benefits is not something I would be worried about, especially for someone who’s 61 years old like you, Tom. My colleagues and I here at Creative Planning are very comfortable running financial plans because the ripple effect of turning off Social Security and that safety net that over half of American retirees rely on for over half of their retirement income would be catastrophic.
All right, Lauren, who do we have for our final question?
Lauren: Joel in Indianapolis, Indiana writes, “I’m currently in the process of saving up for a down payment and I’m trying to figure out the best approach. Should I go with a CD, a money market account, or invest in bonds?”
John: In short, totally depends on the timeframe. All of these are good options if you plan on spending the money within the next couple of years. Right now, short-term treasuries are the best vehicle. Because they provide the best yields, they have the opportunity to increase in value if interest rates drop, they’re fully liquid, they’re backed by the full faith of the United States government, and after the last question highlighting our nearly $33 trillion in national debt, you might say, “Oh, how safe is that?”
Well, we’ve never once missed a debt payment. So it’s pretty safe. And we have the ability to tax citizens to come up with that money. But frankly, all three of those vehicles would work. I’m not a proponent of hoping to catch one of the three out of four years where the stock market is up on monies that you need one or two years from now, even though your probability of having more money is higher, if the market turns against you, which is also very possible. Now you don’t have the money available when the right house comes up. And Joel, if you have any other questions, we have an office there in Indie and would be happy to speak with you.
If you have questions as Don, Tom, and Joel did, send those my way by emailing [email protected].
We’re here on Rethink Your Money, my goal is not for us to just learn to learn, but learn to live, because knowledge is only power if implemented. It’s not in the knowing, but in the doing where we see results. And it’s interesting to ponder how much of what you and I believe, it’s just simply a result of where we were born, what family we were born into, what did our parents believe, and in turn, what were the experiences that we had that were completely out of our control? Because while our perspective is mostly and almost entirely informed by our personal experiences, those personal experiences contribute to almost zero of the rest of the world. But they contribute to almost entirely to what we believe. And this is why we have terms like blind spots or you’ve got a narrow or limited perspective.
It’s not because you’re ignorant or that you don’t care. It’s that you’re you. And that’s what you know. My sons Beck and Shay who were born in rural Ethiopia to single moms, why I’m so proud to be their dad. They have just unfathomable resilience far beyond anything that I think I’d be capable of. Their desire to learn and grow and their loving attitude towards others, it inspires me. But they’d be the first to tell you their worldview and their circumstances and the way that they view things would be completely different if they had been born in America as our biological children, like our one-year-old Luna. Her life’s not going to look at all the same because she didn’t live in Eastern Africa for the first 11 years of her life. And so the reason I bring this up, and I love considering these types of topics is because while it’s impossible to answer, a great question is how would our outlooks be different simply if our experiences had been different?
How would your values be different if you had been born in a different country or in a different home to different parents or chose to go the other direction at one of those few key moments in life that we all experienced where there’s that fork in the road? Well, it certainly would’ve led you to a different place today and would’ve provided you a different view because we’re all result of our experiences, most of which are out of our control. So when you’re approaching your money or relationship, I want to remind you, others are mostly clueless to what your life experiences are. And therefore, they can’t relate. And along with that, neither can you for them because you didn’t live their life. And this, hopefully, will propel us forward toward a willingness to hear others’ perspectives rather than cramming our agenda down their throats. As the bestselling author Morgan Housel said, when it comes to investing, no one is crazy. We’re simply all making decisions that makes sense to us given our unique individual circumstances.
And when we approach others with this posture, it promotes empathy and a willingness to listen, both of which are key ingredients to fruitful relationships and personal growth. And when we extend this outlook to our money, it allows us to be receptive toward what we might be missing and what we can learn from others due to the beautiful reality that their life has likely looked very different than ours. And that ultimately is such a beautiful thing. And remember, we are the wealthiest society in history. Let’s make our money matter.
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Disclaimer: The proceeding program is furnished by Creative Planning, an SEC-registered investment advisory firm that manages or advises on a combined $210 billion in assets as of December 31st, 2022. 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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