There is a lot we can’t control when it comes to our finances, but that doesn’t mean we should be consumed with worry. Join John this week as he examines the best ways to deal with fear and uncertainty surrounding our wealth. Plus, Creative Planning estate planning attorney Megan Kelly drops in to discuss how the newly passed SECURE 2.0 Act could affect your estate plan.
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, are big tech layoffs a precursor for the Broader Economy? How might your job be impacted? As well as practical estate planning tips that you can apply right now within your plan… If you have assets that you’d like to see go to those who you care about, you are not going to want to miss that. And finally, ways that you can reduce your taxes, even if you’re already in retirement… I’m John Hagensen, and this is Rethink Your Money.
I want to begin with a story regarding one of my childhood friends, who came to visit me this past month. Well, we’re both big football fans, and so we recorded one of the evening games to watch together once I had gone through the two and a half hour chaos of putting all of my kids to bed. So after a real life game of Whack-a-Mole, multiple kids getting up, because they need water, and now this kid forgot to have a permission slip signed, and then another kid doesn’t have the right stuffed animal in their bed, we finally were ready to watch the game. And I asked him, “You haven’t seen the score, right?” And he sort of sheepishly said, “Well, I did check it out at halftime.” I’m like, “Wait, what? I’ve had my phone away from me for the last two and a half hours to ensure I didn’t see anything.”
I mean, I felt betrayed. Well, he went on to tell me that he hates the uncertainty so much. When he knows that a game’s being played and he’s not following it, it just creates angst in him. In fact, when his beloved Seattle Seahawks are playing a game, he told me that he’ll pause the game on the TV, go to the Gamecast on his phone on the ESPN app, watch what happens with the play on his phone, then unpause the game so he can watch the play already having knowledge of what occurred, so he’s not as nervous about what’s happening. Now I know what you’re thinking, “John, do you have friends that are all serial killers? What’s going on?” Yeah, I know. It’s weird. I told him that. In fact, I recommended the guy got some therapy.
But while we all might not take things to that extreme, isn’t it human nature that we feel anxiety regarding the uncertainty of our future? It can be difficult when we are confronted with the fact that we don’t know what the next 30 years is going to look like, in many cases not even the next 30 hours. So let’s unpack the implications of our human nature with your money. So we just wrapped up January, and it was the best January in four years for the S&P 500, which closed up 6.2% on the month. The NASDAQ, which got absolutely clobbered in 2022, was up more than 10%. Tesla alone up 55% in January, now it’s still down over 40% over the past 12 months even with that run-up. Peloton jumped 20% on Wednesday alone at market open. And that must have occurred because they had a lot of earnings, right? Wrong, they just didn’t lose as much money as was expected. Remember, it’s not what actually happened, but what happened relative to expectations that move the market. And it’s still down from over $160 a share at its peak to under $20 a share today.
Interestingly though, there have been five previous times where the S&P 500 gained more than 5% in the month of January following a negative year, as we just saw. And the average return of that year, which would of course be 2023, the year we’re in, has been 30% in those five scenarios. And this is getting some attention. And let me tell you, it shouldn’t be. I’m acknowledging it, because you may have read it and I want to make sure you understand this is an example of worthless information. It’s a tiny sample size. And not only are forecasters likely wrong, based upon today’s information, but additionally there will be a plethora of new information that’s completely unknown throughout the year, that even the smartest, most intelligent people cannot forecast.
And if you don’t believe me, consider this. In 2022, 9 of the 10 largest investment houses predicted gains for the market, and we had the worst stock market year since 2008. Bonds had their worst year in four decades. And was that broadly predicted? Of course not. We don’t like to acknowledge that things are unknowable. It makes us feel vulnerable. And in this case, it’s not just that the markets are unknowable, they are unknown. But we search for indicators that don’t exist. We look to exploit patterns that are false. And so the big question for today is how do you feel secure? How do you achieve peace, when it comes to your money, when there are so many aspects completely out of your control? As it’s so often said, the first step in recovery is acknowledgement. You come to terms with this reality, you stop deceiving yourself. You stop having your financial advisor or an economist or a blogger or some newsletter you’re subscribed to or an investment manager deceiving you. They don’t know either. The smartest, most educated people in the entire world are wrong constantly.
Exhibit A Jamie Dimon. He runs JPMorgan Chase. He’s got a Harvard MBA. He’s a billionaire. I’m sure he’s mostly correct, since he manages one of the largest banks in the world, right? I mean that would seem logical. Well, let’s examine this. In 2020, his shareholder letter warned of a bad recession combined with some kind of financial stress similar to the global financial crisis. By the way, that probably seemed logical in the middle of the pandemic, didn’t it? Market finished up nearly 20%. Then in 2021, he was really optimistic, said we had a Goldilocks moment with strong growth alongside, hear this, slow climbing inflation in interest rates and that it could last into 2023. Well, 2021 was a really good year, but it certainly didn’t last through 2022 did it? And then in January of 2022, he said, “We’re going to have the best growth year we’ve ever had this year, I think since maybe sometime after the Great Depression.”
This is just the last couple of years. It’s just painfully wrong. It’s terrible, yet I still often see him and others in similar positions quoted, as if what they say is predictive in any way. Now, I’m not saying I could do any better. I’m not saying he’s not smart. I’m just saying even the Fed with 400 PhD economists were even wrong about the persistent level of inflation that we’ve seen. And so I say again, the first way to reduce stress in uncertain times is to fully resign to the reality that you’re never going to figure this out in advance.
Here are just a few of the things that we cannot control. How about market performance? It’s down about 30% of the time in calendar years. Corrections on average during a calendar year drop about 14% peak to trough. And they occur about, by the way, once a year. You’ll see a bear market about every five years and an atrocious down market approximately every 15 years. You can’t control changes in tax laws. You can’t control changes to the retirement system or future entitlement programs, like social security. You can’t control inflation, cost of healthcare, job security, regulations or innovations impacting certain industries, maybe your profession. But this also doesn’t mean that you throw your hands up in the air, you give up and you put everything in cash and CDs. So let’s talk about how you can win amid an uncertain future and probably even more importantly, that you can have confidence along the way.
First and foremost, have a plan that focuses all of your energy and all of your attention on the things you, in fact, can control, which I’ll list for you here in a moment. I cannot tell you how many clients have come in over the years and spoken to me for 45 minutes about how much they dislike the president or the direction of the country or how volatile certain asset classes have been. And while I want to be empathetic and I listen, but I’m mostly thinking, “This exercise is futile, because we’re focusing on things we can’t do anything about.” Perfect example in the Hagensen household, just had this conversation with one of our kids. He’s struggling in math, and he’s telling me, “This current section, it’s difficult for me to grasp. The concepts are hard.” And I pull up his progress report, and he has two incomplete assignments. I found out from the teacher he’s been out on the playground playing football, instead of being in tutoring, when he gets to school early. Clearly, he can’t control the subject matter, so why focus on it? But he can get his butt off the playground and make sure he is turning in his assignments.
And the same is true when it comes to controlling your financial wellbeing. Here are five areas in your plan to gain control of. Number one, buy the broad markets. You’re not beating the indexes over a long period of time. Your financial advisor isn’t either. You can’t rotate sectors and asset classes to time the market. There’s an overwhelming amount of data that supports this. So go low-cost, and make sure the only way your investments are going to zero is if the world ends. If thousands of the largest companies around the world simultaneously stop producing goods and services and go bankrupt, the last thing you care about is your investment portfolio. Grab guns and a six-pack and get to your bunker. And so always remember to invest broadly based upon your plan. Creative Planning president, Peter Mallouk, spoke about this very topic.
Peter Mallouk: Investors should always be investing based on their needs, because the market is unpredictable. Instead of looking at investments and saying, “Which investments are going to do well this year or next year? Should be stocks or bonds, US or overseas,” you should be saying, “What do I need and when do I need it? What is the plan telling me, ‘When do I need this capital?’ How do markets tend to play out over these periods of time?,” and match up your allocation to your personal needs rather than to what anyone is predicting, what any strategist is saying, or how you think the world is going to play out over the next one to two years.
John: Second area within your plan to gain control is regarding taxes: optimize for tax efficiency. Just ask yourself right now maybe a hard question. When’s the last time that you proactively plan for your taxes with your financial advisor? When is the last time that they reviewed your tax return? When’s the last time, if they’re not a CPA, that they sat down with you and your CPA to go through your tax strategies? That is what we offer to our clients here at Creative Planning with nearly a hundred CPAs, along with our 300-plus certified financial planners. If you don’t like the answer to the question I just asked, go to reativeplanning.com/radio and sit down with a local advisor, just like me, to review your tax strategies.
Number three, don’t live entirely in the future. Now, financial planning insinuates inherently that we’re talking about something that hasn’t happened yet, that we’re planning for. But if your life and your happiness is always out in the future, the goalposts are always moving, it’s what is next, then the uncertainty of the future can create a lot of anxiety. Instead, live today, because it’s really the only thing that is certain, where you’re at right now. And this might mean practically spending money on some things that you want right now or some experiences. It might mean giving money away to a cause that you really care about, rather than waiting. And that can bring a lot of peace and a lot of joy.
Number four, avoid sunk cost bias. Be willing to pivot. Fail fast, and quit things that aren’t working for you. You’re not a wave of the sea blown and tossed in the wind, as James 1:6 says in the New Testament. You’re not a bystander to your life just voyeuristically observing each day. You have power to change your circumstances, but it requires you to make changes, and not insanely do the same thing over and over expecting different results. Think about your closet right now. How many items in there are things that you would not purchase again if you had the choice? Are you like me where you have 15, 20 T-shirts? You’re never going to actually wear them the next decade, but they’re just sitting there. Why? It doesn’t save us any money to keep them in there. But you know what? I paid money for those. And so in some weird convoluted way, I feel like if I donate them, I’m losing that money. No, I already lost it. I hate the shirt. It doesn’t fit me well. And I see sunk cost bias play out in two prevalent ways. People won’t fire their advisor, even though they know there’s a better one out there. And people won’t switch jobs for a better one, because there’s uncertainty around the future.
And my fifth area within your plan to gain control: provide yourself with plenty of margin. We all know someone who’s late everywhere. My grandma used to show up to church halfway through the sermon. I mean, if she walked in before the singing was over, we were all shocked, “Whoa, grandma, you’re on the ball right now. Good job.” But I just love the chronically late person, who always has a reason, “Oh, there was construction. I had to go the long way, couldn’t find my keys. I was running on empty; I had to grab gas.” And you’re like, “Wait, you have a Tesla? What are you talking about?” You want to tell the person, “Control what you can control. Maybe leave a little bit earlier.” And from a financial perspective, creating margin reduces stress, because it means increasing your savings rate. It means not consistently and constantly creeping your lifestyle and expenses right up against your income. It means not going into debt. It means having an emergency fund of six months of your expenses. And it also means ensuring that you have enough bonds, or safer, more stable assets, to sustain a five to seven-year period of down stock market performance.
And so to recap those five areas within your plan to gain control is… Don’t go hunting for individual stocks or try to time the market; just buy the broad markets. Have a great tax strategy. Don’t forget that life is happening right now, while you’re busy making plans. Be willing to pivot, and avoid sunk cost bias. And provide yourself with a margin of safety and a buffer, when things inevitably don’t go as planned. And of course, my assumption, when talking about five specifics within your plan, is that you do in fact have a measurable, written, documented financial plan. If you haven’t sat down with a credentialed fiduciary recently to review your situation, and you’re not sure where to turn, we’re happy to help here at Creative Planning, as we have been since 1983. Why not give your wealth a second look? Go to creativeplanning.com/radio today to speak with a local advisor. There’s no cost or obligation to become a client, but rather we will provide you with a clear and understandable breakdown of exactly where you stand with your money, taxes, estate planning, investments, whatever is on your mind. Gain clarity around what you’ve worked a lifetime for in the midst of an uncertain future. One last time, visit creativeplanning.com/radio.
Well, my special guest today is Megan Kelly. She is an attorney with Creative Planning Legal, who practices specifically in the area of estate and transfer tax planning through the preparation of estate planning and business succession documents. Her mission is to help clients protect and pass on their legacies to loved ones, in a way that makes sense for each family’s particular situation, while simultaneously, and this is important, being tax efficient. Megan received her bachelor’s degree from Kansas University and her JD from Duke Law School. And so not only great academic schools, but March Madness must be pretty exciting in the Kelly household with those two alma maters. And so without further delay, thank you for joining me today here on Rethink Your Money, Megan.
Megan Kelly: Happy to be here. Thanks for having me.
John: I wanted to invite you on for a discussion on the estate planning side of things, regarding the recently passed Secure 2.0, and maybe a bit on the original Secure Act as well, for those that aren’t familiar. And from your perspective as an attorney, does this new change mean we need to be updating our estate plan?
Megan: So I think that’s a good question. And very standard lawyerly answer: yes and no.
John: Oh, great. You’re giving us the yes or no?
Megan: Yeah, I am. You’re ready for it. The Secure Act 2.0 is going to build on the original Secure Act that was passed in 2019. So for estate planning purposes here, we’re focusing on the passing of assets to our loved ones at death. Many of the biggest changes we saw occurred with that original legislation. So if you revisited your plan since 2020, you may be okay. But if not, and if you have retirement assets you’d like to pass to your loved ones, now’s the time to give your plan another look.
John: Well, Megan, what were some of the changes from the original act? And do those still apply?
Megan: Many of the biggest changes we saw is what happens to the non-spousal beneficiary, if they inherit a qualified retirement plan. So that qualified retirement plan is an IRA or a 401k. So background on those changes. So if a non-spousal beneficiary is inheriting a qualified retirement plan, we first probably need to know what happens if a spouse is inheriting. So then and now, if a spouse inherits a qualified retirement plan, they have the ability to roll over that IRA from their deceased spouse and treat it as if it was their own IRA. So the account basically exists like it was always the living spouse’s account. That rollover treatment hasn’t changed with either the original Secure Act or Secure 2.0.
So turning to the non-spouse is where we really saw the big changes. Prior to the original Secure Act, if we have a non-spouse who inherited, that’s commonly a child or a grandchild, that beneficiary was required to take a distribution from their retirement account each year following their relative’s death. So rather than waiting until they themselves reach their ’70s, they immediately have to start taking distributions. And this required minimum distribution, or RMD, was calculated based on that beneficiary’s own life expectancy. So basically, we look to the IRS life expectancy tables, and then we divide the account balance by the corresponding life expectancy factor, and that yields the required RMD each year.
John: And that was a huge benefit, right?
John: I mean you’ll hear that referred to as an inherited IRA beneficiary, stretch IRA.
Megan: That’s exactly what I was going to say, mm-hmm.
John: And it provided these… The younger the beneficiary and the larger the account balance, I always tell my clients, the more beneficial that was to not have to pay the taxes all upfront. If somebody’s 50, and they can stretch it out over 40 or 50 years, that can be really beneficial. Obviously, as you’re about to get into, I’m sure the Secure Act changed that. So let’s continue on with how that was changed and adjusted. They took that away from us. Darn it.
Megan: Yep, exactly like you said, John. So the stretch IRA is no more. So since the original Secure Act went into effect 2019, 2020, the game has changed. And now we are stuck with the 10-year rule. So with a few exceptions, inherited retirement benefits now must be distributed to a non-spousal beneficiary within 10 years of their loved one’s death. So while the RMDs are no longer required, the beneficiary can work with a tax advisor to decide when, during those 10 years, they want to receive a distribution and how large or small it should be. Ultimately, at the end of the 10 years, anything that’s left in the account needs to be out of the account.
John: And I’d like to say if you’re inheriting a $200,000 IRA, and you’re going to take it over 10 years, you may only need to take, with some assumed rate of return, maybe 20 to 30 thousand dollars per year. And that doesn’t usually move the needle too much, in terms of accelerating someone’s tax bracket. It’s not that much additional income. But if the IRA is, for example, $3 million, let’s say. And now you’re needing to withdraw 300, 400 thousand dollars per year all at ordinary income rates, to get it all out over a single decade, rather than being able to stretch it over 30 or 40 years, it’s a big change regarding the tax rate paid on those inherited dollars.
Megan: Yeah, we’re much more compressed now.
John: And as an estate planner, how are you accounting for that change? What have you been doing since 2019, with our clients here at Creative Planning, to account for this adjustment in the new 10-year rule?
Megan: As you mentioned, this impacts some people more directly than it impacts others. And there’s a technical answer to it, and there’s a non-technical answer. So the non-technical answer is that it really comes down to how you see your kids, or any other beneficiary, inheriting your assets. Do you give them the reins from day one, say, “Take what you want, no questions asked,” leave it up to them? Or do you try to put some precautions in place to say, “Let’s hold on to this for a bit. Let’s let a trusted family member or an advisor manage your money, until you’ve reached a certain age and then give you control, but only after you’ve matured”? That kind of ladder approach, the holding assets and trust for someone, is what we see a lot of our clients want to do. If you have these kind of inherited trusts built into your estate plan, they have to be structured correctly, so that we can pass the retirement assets outside their qualified accounts within 10 years, but we’re still holding them in trust for your kids’ benefit until whatever age you pick.
John: Hey, this is very important. I’ve got seven kids. And I tell you what, there’s a reason why, when they go to the movies, you choose to give one of the kids the money and not the other one. Right?
Megan: For sure.
John: So it’s important that you have this structure to accommodate your family and where they’re at in life, so that, hopefully, you’re not providing them with a burden of inheriting a bunch of money, but rather doing it in a way that enhances their life and, hopefully, continues to make them good kids or grandkids. Right?
Megan: Yeah, for sure. Yep, mm-hmm.
John: So let’s finish up with this. When are other times that you might want to update your estate plan, Megan?
Megan: Most frequently, we see estate planners talking about the federal estate tax exclusion amount. And the federal estate tax exclusion amount is the amount that a US citizen or resident can pass at their death without paying that 40% federal estate tax. So in 2018, that exclusion amount doubled from about 5.5 million to 11 million. And it currently, in 2023, sits at just over 12.9 million per person. So that amount is set to drop back down at the end of 2025. So of course, any change in that number, higher, lower, big, small, that’s going to drive an estate planning change for some clients.
John: Well, my assumption is the vast majority of people aren’t worried about paying 40% on monies over 12.9 million, because there’s just not all that many Americans that have a net worth that high. But their lives are obviously still changing. And those life changes can necessitate estate plan adjustments as well. Can you maybe share with us a couple of examples, where you’ve seen life changes impact their estate plan?
Megan: Yeah, absolutely. Changes in laws, those don’t impact people nearly as readily as a change that we have in our lives. So before the show, I was trying to come up with some great example to share with everyone, racking my brains for the golden ticket, the Mega Millions lottery winner. And really all I was coming up with were kind of the sad stories that aren’t worth talking about on the radio: the family members who had lost a loved one, who they were dealing with a terminal diagnosis, going through a divorce, the estrangement of a child or a relative, stuff we don’t want to talk about on the radio.
John: Yeah, thanks. We’re all depressed now.
Megan: Yeah. So I’ll bring it back up. So I kind of reframed the issue. I started thinking about all the clients who come to me. And they have maybe just started a business, and that business is just really taking off. Maybe they’re expecting a child. Maybe they are moving to a different state for some sort of great opportunity or a dream job. They’re starting a charitable venture or funding a scholarship, doing something that’s really meaningful to them. I just started thinking about those. And then I started laughing to myself, because I sound like the voiceover from Love Actually. I don’t know if you’ve seen that. But thinking about the arrivals gate at the Heathrow airport, and love is actually all around us. So yeah, I mean it’s true. Life changes. And for better or worse, you have to make adjustments. So that’s one of the great things about my job and one of the things that estate planning can help us do.
John: Great reminders, Megan, thanks for shedding more light on the Secure Act, what changed with the Secure Act 2.0, and things that we can be thinking about each year as it pertains to our estate plans? I enjoyed our discussion, and I appreciate you joining me on Rethink Your Money.
Megan: It was great to be here. Thanks, John.
John: Again, that was Megan Kelly, estate planning attorney here at Creative Planning Legal. If you have questions regarding your estate plan… Does it need to be updated? Is it current? Maybe you don’t have an estate plan. Whatever else may be on your mind, visit us now at creativeplanning.com/radio to speak with a local fiduciary. One more time, that’s creativeplanning.com/radio.
I want to share with you a situation that came up this last week, where one of our clients, who works in tech, really wanted to kind of revisit their plan in the event that possibly they were laid off. Now, this contingency plan probably wasn’t that realistic, because this person’s super marketable, has no indication they’re going to be laid off, very well educated, their financial plan has a lot of margin, and probably would get a big severance even if he were to be laid off. But said, “Let’s look ahead, reevaluate what the plan would look like if tomorrow I had no income.” And so we did. And again, the plan was airtight and looked great, because this person has been disciplined and done a fantastic job saving. But maybe even if you’re not in tech, you’ve been seeing the headlines and wondering, “Is this sort of big tech recession that I’m hearing about, as it’s been dubbed, all these layoffs, will there be a trickle down to other industries within our economy?”
And so let’s examine this together. And I think it’s worth noting that the script has been flipped to some extent, because, throughout the 21st century, our norm has been that tech is doing well. It’s leading the way. It’s providing some of the highest paying jobs. Some of the most wealth creation in the world is coming out of tech. And so hearing about these layoffs, and seeing the plummeting stock prices for some of these household names, can create maybe a bit of nervousness for you. And a nice buoy to begin with is that overall unemployment is around 3.5%, which is near the lowest of the 21st century. But we have seen over 130,000 people lose their jobs with these big tech companies.
But my opinion is that this is nothing more than a reset to normal. Big tech basically expected the disruptions of the pandemic to permanently reset our way of life, the way we did things. And it turns out people still like going to restaurants. They go to Top Golf. They go see a movie occasionally at the theater. And so as The Atlantic’s Derek Thompson referenced when talking about the pandemic, those changes were less representative of a new set of norms and much closer to a mirage. Let’s look at the employment growth of four tech giants since 2019. Meta had 45,000 employees in 2019, by 2022 87,000 employees. They had a 94% growth rate. It was nearly a doubling of their entire workforce. NVIDIA went from 13,000 employees to 22,000, a 70% increase. Alphabet went from 119,000 employees in 2019 to 187,000 in 2022, nearly a 60% growth rate. And Microsoft already had 144,000 employees and still managed to hire nearly 80,000 more employees, taking their workforce to over 220,000 employees, or put another way of 53% growth rate of their workforce. And again, they did so thinking, “We’re going to need this, because everything’s changed permanently now because of this pandemic.”
The other aspect leading to these layoffs is that we saw unsustainable valuation growth. At one point, five tech stocks represented nearly one quarter of the entire S&P 500. Think about that. 500 companies in the index, and the largest five represent a quarter of what happens with that index. So what if these companies aren’t crashing, but rather just coming back to some sense of reality? In fact, I’ll post a chart to creativeplanning.com/radio that you can view that shows the one-year growth during 2020 of some of the highest flying tech stocks. Tesla was up 743% in a year. I mean, really think about that for a moment, up 743% in 12 months. NVIDIA was up 122%, Apple was up 81%, Amazon was up 76%, Netflix was up 67%. Meta was up 33%, and Google was up 31%, all in one year.
And it wasn’t that their current or long-term profitability was rising at those rates, but rather an expansion of the multiples of those earnings that they trade based upon. And this valuation expansion is somewhat intuitive when you look at two key drivers of that growth. The first was that money was being dumped from the sky during the pandemic, like manna from heaven to the Israelites in the desert, and then the fact that interest rates were suppressed to near zero, because investors, who have a lot of cash, are willing to plow money into companies that have great stories about the future, when the cost of capital is really low. Tesla, Peloton, Robinhood, Teladoc, Carvana, the list goes on and on. But when rates start rising, as we’ve seen now, people look for more stable companies, who have strong current cash flow. That really hurts these high flying growth stocks, that ran up similar to the late ’90s before the dot-com bubble burst.
And so while I’m not an economist, and there are far too many variables for me to make an accurate forecast of any kind, I don’t necessarily think that, if you’re in healthcare or if you’re in construction or if you’re in medicine, that you should be taking much away from what is happening in big tech with your industry, regarding the future prospects of your employment. But I do believe there’s a takeaway and a practical reminder for you as an investor, when we look at these tech layoffs. And that is that trees don’t grow to the sky. No strategy can outperform always and forever. Think about this logically. If any strategy could, so much money would pile into that strategy that it would stop working. Every bit of capital in the world would all flood to that one strategy that always outperformed. Size becomes the enemy of outperformance over time.
And so even when FOMO is at its peak during a run, like 2020, the key and challenge, and it is a big challenge, is to remain disciplined and diversified. And let’s continue on with that theme of diversification as we play a game of Rethink or Reaffirm, where each week I break down common wisdom or a hot take from the financial headlines. And together, we’ll decide if we should rethink it or reaffirm it. Common wisdom is that diversification means owning many different investments. What do you think? You think that’s right? Well, on the surface, sure. If you own five stocks, you are more diversified than if you own one stock. If you own 10 stocks, you’re more diversified than if you own five stocks. But so often, I see fake diversification. I see people mistaking that owning a lot of different investments means that they are properly diversified.
And let’s be clear, proper diversification is a central building block to growing your wealth and managing the inevitable ups and downs of the financial markets. One of the best ways to ensure against financial ruin is to not have all your eggs in one basket, so to speak. But while most agree with that core concept, it can be one of the least understood, in terms of how to properly execute it. Let me provide you with five telltale signs for you to self-examine about your plan so that your portfolio doesn’t let you down, when you need it most. Is your portfolio nothing more than a collection of funds that you have accumulated over time? Do you have the perception that the more funds and strategies you have then the more diversified your portfolio is? Do you have a portfolio that contains a lot of investments with the same theme or maybe the same asset class or the same sector? And also the last time that you went through a tough market environment, did you see significant dissimilar price movement within your portfolio?
You see, diversification doesn’t just mean having a lot of holdings. It means strategically and intentionally owning various percentages of investments that move dissimilarly to one another. And without going too far into the weeds, that’s an academic process. In fact, you can look at a correlation matrix and see over the past 40 years how often one asset category moves in tandem or dissimilarly with another asset class. And through that, you can build a portfolio that sits right along what’s called the efficient frontier curve. Now, can an under-diversified portfolio overperform a properly diversified portfolio? Of course, it can, because if you’re overweighted in one asset category, and that happens to be the best performing, you’ll overperform. But to optimize your expected returns with the lowest amount of risk, there is a process when building a portfolio.
And so as we evaluate the common wisdom that diversification means owning many different investments, the verdict is rethink, because that’s simply not good enough. And if that’s piquing your interest, and you’re wondering like, “Am I properly diversified, John? Do I have too much of one thing or not enough? Could I be maybe getting a bit more dissimilar price movement?”, maybe you have overlap where you have multiple investment funds that own a lot of the same stocks. Have you ever had an overlap report run on your investment portfolio? All of those are great questions. And if you’re not sure where to turn, we are happy to help here at Creative Planning, as we are for clients in all 50 states and 85 countries around the world, managing or advising on $225 billion. We’ve been helping families since 1983 and are not brokers, but rather fiduciaries acting in your best interests at all times. If you’d like a complimentary second opinion, as so many other radio listeners have done, go to creativeplanning.com/radio to speak with one of our local advisors.
Our next piece of common wisdom, “Pay off all debt before you retire.” Well, this is a good one and similar to our diversification topic in that there is a lot of truth that could be reaffirmed with this statement. But the word all, “pay off all your debt before you retire”, is what I’d like to examine. Should you go into retirement with large car payments? No, probably not. Should you go into retirement with credit card debt? Absolutely not. But should you go into retirement with a mortgage? Maybe. That would be the one aspect regarding debt that, in many cases, especially if you have a 30-year fixed rate mortgage that you locked in over the last couple of years at maybe 3-3.5%, that you may want to hold onto. In a high inflationary environment, where your mortgage rate is fixed at far below inflation rates, and far below what you can earn in a one or a two-year treasury, then keeping that flexibility and liquidity and having that positive arbitrage may actually strengthen your retirement situation. So that’s a rethink in terms of paying off all your debt before you retire.
And our final piece of common wisdom to examine and rethink or reaffirm is that it’s wise to divide your money evenly between your kids. This reminds me of a book that I enjoyed reading from Ron Blue titled Splitting Heirs, and of course it’s a play on splitting hairs, spelled H-E-I-R-S. And its topic centers around the division of assets and considerations within an estate plan. And a line that really resonated with me, as the father of seven children, was that you love your children equally by treating them uniquely. And so if you have five kids, and one went through a difficult divorce and is a single parent, who you see making overall good decisions, being responsible, but unable to get ahead, maybe you help that child out, if you have the resources a little bit more than another child, who’s doing very well financially on their own.
But in my experience, what I would encourage you, regardless of how you decide to split up your assets or build out your estate plan, to communicate that with your family. Talk to your kids about your thinking. They may or may not agree with you, but where problems and jealousy and resentment tends to build is when they are surprised, almost blindsided, by not getting as much as one of their siblings and never having had a discussion for you to contextualize that. And so while in many cases, it does make sense to divide your money evenly between your kids, it doesn’t make sense in all situations. So I would rethink that piece of common wisdom.
And this leads me to my four estate planning tips for today. The first continues on with this theme of multiple kids. Strategically plan which kids you have as beneficiaries on which accounts, based upon their situation. Even if you decide you do want all of your children to receive the same amount. At a macro level, think twice before listing, let’s say, all four of your kids as 25% beneficiaries on each account. Instead, the child who’s backpacking around Europe and is a musician trying to break through, making $1,000 a month, would be better off receiving the IRA assets than your other child who’s a radiologist in San Francisco, because that kid, between state and federal taxes, would have to share about 50% of the assets with the IRS. And so it’s important that you’re strategic with which types of accounts from a taxation standpoint go to each kid, so that you disinherit the IRS to whatever extent is legally possible.
Tip number two will help secure your children’s retirement. Create an irrevocable trust while they’re still a minor and put provisions in place that they can’t touch it until their 60s. If you do this for your child when they’re five years old, you don’t have to put a whole lot in there for the compounded amount at their retirement to be enormous.
Number three, create asset protection for your beneficiaries. Nothing is more disappointing that I have witnessed firsthand than a client passing away, a large chunk of their estate goes to one of their children, who is currently going through a divorce or in the middle of a lawsuit, and then all of those inherited monies get pulled in, because there weren’t proper asset protection mechanisms in place.
And my fourth and final tip is to receive trust funds through an independent trustee. But it’s worth noting that trustee will have discretion on distributions. We’ve worked with clients and done several of these, and the benefit is lower taxation, trust rates versus individual tax rates on IRAs, for example. It provides max asset protection from divorce, creditors, just the dumb-kid protection. And my kids are like, “Which one of us are you talking about, Dad?” “Well, you don’t need to know.” But it helps with that. And you’re also able to sprinkle a small percentage to tickle them with income and motivate them to earn in their own careers. Most importantly, if you don’t have an estate plan, or your estate plan hasn’t been reviewed or updated recently, if the tips I just shared are new to you, you’ve never discussed those, and maybe you’d like to, visit us at creativeplanning.com/radio to get your questions answered.
My first question comes from Lindsey in Tampa, Florida, “Should I take Social Security as soon as I turn 62 years old?” This is a common question, and if you are in your 50s or 60s and have not yet made this decision, it’ll be one of the most important impactful retirement decisions you assess. 70% of all Americans take their social security before 64 years old. And so let me start by saying, “Lindsey, if you’re someone who is forced to retire, and don’t have enough in retirement savings to sustain your income, then you don’t really have a choice.” So a lot of times taking Social Security at 62, or early, is more out of necessity. And if you are someone who needs it, you’re probably in a low tax bracket. And taxation of those Social Security benefits probably isn’t a huge factor either. Now remember, if you take Social Security at 62, your benefit will be reduced assuming your full retirement age is 67 by 30%.
Remember, also one of the drawbacks of taking it at 62 is if you go back to work, and make about $20,000 or more, you’ll have to pay it back. Now, one of the things I don’t know here is if Lindsey is married or not. But if you’re married, one of the reasons you may want to take it at 62 is that, if Lindsey’s the lower earning spouse, that benefit ceases to exist the moment the first spouse passes away. So you need longevity for both spouses to benefit from waiting on the lower of the two social security benefits. Whereby contrast, often your financial plan looks better by waiting on the larger benefit, because that will be the benefit that continues on with whichever spouse lives the longest. The smaller benefit drops off, when the first spouse passes away.
One of the benefits to not taking Social Security at 62 is that you’re getting a growth rate of nearly 8% every year that you wait. You’re also able to take out money from IRAs, in probably lower brackets if you’re retired and haven’t yet turned on Social Security. Obviously, everyone’s situation is different. And I don’t know all the details of Lindsey’s situation, so it’s difficult to answer this question. But here are some of the pros and cons. By taking money out of your IRA, you also are reducing future RMD obligations, those required minimum distributions. And so in short, I would say, if you don’t have a choice, and you need to take it at 62, okay. If you’re married, and your benefit is a lot smaller than your spouse’s, maybe. But in most cases, you will benefit from letting Social Security continue to compound and grow, while using other resources to support those early retirement years.
Now, if you hear that and you’re thinking to yourself, “Yeah, but John, I paid into this. And if I wait on it until 70, and I die at 71, I’m going to be mad, because I never opted in my Social Security.” And to that, I would say, “No, you won’t, because you’ll be dead.” And I know that sounds harsh, but think about it. You’re not probably going to run out of money if you wait on Social Security, and that doesn’t end up being a good decision, because you passed away younger than expected. When is the solvency of a financial plan most stressed, most at risk for not working? When you live into your 90s or past 100, which is why if you wait on social security and let your income floor increase substantially, you’re essentially providing yourself longevity insurance in the scenario that you’re playing bingo on your 100th birthday.
Jules in Wichita, Kansas asks, “How much of my overall budget should be committed to housing or rent?” Interestingly, I was just going through this with one of our adult children, who’s completely getting priced out of the rental market, basically needs multiple roommates to even be able to afford an apartment where we live, let alone good luck buying a house, not even close. He asked me the same question. So here’s the general rule. And obviously, the stability of your income, the future prospects of your income, how long you plan on living where you are… Do you have kids? Do you see value in the flexibility of renting or maybe more value in the stability of owning? And that’s why personal finance is so much more personal than finance often. But painting with a broad brush, the most common rule of thumb is that no more than 30% of your gross monthly income, total income before taxes or other deductions are taken out, should be allocated to housing. If you’re a renter, that 30% includes rent and utility costs like heat, water, and electricity. If you own a home, you should include interest, your homeowner’s insurance, your property taxes and utilities, in addition to your mortgage. To put some numbers around this, that means if you earn 75 grand a year before taxes, you should spend no more than $1,875 a month on your housing.
And if you’re looking to buy a home, many financial pundits also recommend using the 28/36 rule, meaning your housing expenses shouldn’t exceed 28% of your gross monthly income, and your total debt shouldn’t exceed 36% of your gross monthly income. And Jules, if you’re married or you have a partner, keep in mind that the calculation includes the entire household, so you’ll need to include their salary and debts into that equation as well.
My third and final question for today’s show comes from William in Des Moines, Iowa, who asked, “I’m retired, and I don’t itemize. Are there any other ways I can optimize my taxes?” Great question. Yes, there are. And the first thing that I speak about often is to ensure that you have a tax plan, that you’re looking forward with your CPA in advance to review your tax situation, not just reporting what you already did, because there’s so much less you can do after the fact. But a few common ways, even if you’re taking that increased standard deduction from the Trump tax reform, consider donation bunching.
So if you give five grand a year, let’s say, to your church, and that along with your other deductions doesn’t get you above the standard limit, it’s great that you’re giving money to an organization that you believe in, but you’re not receiving a tax break on that, as if you were itemizing. A simple solution to this is set 5 or 10 years worth of your annual giving into an account like a donor advised fund. Get the deduction all at once by itemizing a 25- or a 50-thousand-dollar donation, and then you can invest that money and grow it and distribute it to the charity of your choice in $5,000 annual increments as you plan to do anyhow. And that’s one thing you can do that’s simple. And here at Creative Planning, we set up thousands of those donor advised funds for clients all over the country.
And the second would be to consider QCD’s qualified charitable distributions. And so while I don’t have William’s age, if he’s over 72, he can direct what would’ve been his RMD straight from the custodian to the charity of his choice. Code it as a QCD, it will satisfy that required minimum distribution without needing to claim it as income and pay tax on it, while simultaneously still getting that standard deduction. So donation bunching, using a donor-advised fund, and qualified charitable distributions are great ways that most retirees, who are focused on giving, want to investigate taking advantage of to minimize taxes, even while they’re not itemizing. If you’ve got questions like Lindsey, Jules, and William, send them our way by emailing firstname.lastname@example.org.
And I want to conclude today’s show with a thought that I had around how much our behavior impacts our success. I think we know this, but our lives are more or less the result of thousands of choices, both good and bad, that we’ve made along the way to get us to where we are. And if you back up even more, our behavior and our choices are mostly a result of our habits. And if you’re like me, sometimes it’s difficult to establish healthy habits, even ones that are really important to us. It can be hard. And so I want to share with you this idea, which will help you financially, and I think in other areas of your life as well. And that’s the concept of habit stacking.
Habit stacking essentially creates an on-ramp for the new habit that you want to establish. By the way, habit stacking can be both good and bad, like when I grill, I sometimes have a beer. There’s something about I’m outside, and I’m flipping my steak and a cold beer, I mean, it sounds good. But we’re in the winter and I haven’t been grilling hardly at all, so I actually don’t think I’ve had a beer in the last couple of months, not a single beer. Why? Not as much because of the beer, but because I haven’t been grilling, which is where I habit stack a bad habit with cracking a Michelob ULTRA. Don’t judge me. I still like trying to be healthy, even when I’m having a beer. Some of you are like, “I only drink IPAs craft beer. John, what’s wrong with you? I used to like you.” But I digress.
But positive habit stacking can have a huge impact on your results. James Clear, who wrote Atomic Habits has an exercise for this. And it’s basically your right two columns, so there’s a left-hand column and a right-hand column. And on the left side, just write down things you do every single day without fail: I get dressed, I brush my teeth, I drink my coffee. Right? And you’ll probably have some things segmented for what you do every day while you’re at work and in the evening and your bedtime. And then on the right-hand column, list things that happen every single day: the sun rises, the sun sets, you see traffic lights turn red, you see traffic lights turn green, a song plays, whatever it might be. You now have a comprehensive list of triggers that can be used to stack with whatever new behavior you’re looking to achieve. Maybe it’s every time I drink my coffee in the morning, I meditate quietly for five minutes. Every time a traffic light turns green while I’m driving, I pray for somebody that I care about. Keep your eyes open if you’re driving, but you pray. It reminds you to do that.
And of course, you can do this when it comes to your money as well. If you want to save more each month, you might add $100 into your brokerage account every time you pay the credit card bill. Whatever it is that you’re looking to achieve, the results will only occur if we can adjust our habits in a way that aligns with our most important goals and desires. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter. If you enjoy the podcast, please subscribe, share, and leave us a rating.
Disclaimer: The preceding program is furnished by Creative Planning an SEC-registered investment advisory firm that manages or advises on $225 billion in assets. 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. This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk. And there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels. Clients of Creative Planning may maintain positions in the securities discussed on this show. For individual guidance, please speak with an attorney, CPA or financial planner directly for customized legal tax or financial advice, that accounts for your personal risk tolerance objectives and suitability. 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.
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!
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