Are you fixated on your investments’ past performance rather than exploring their potential future impact? Ignoring this crucial aspect of your portfolio could lead to unexpected consequences for your future returns. Join John as he demystifies the concept of opportunity costs and their significance in wealth management. (1:44) Plus, Charlie Bilello joins the show to discuss the latest financial news and strategies you need to stay clear of. (13:33)
Episode Notes
Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!
John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Higginson and ahead on today’s show, How Opportunity Costs Impact our Success, a conversation with chief market strategist, Charlie Bilello, and a recent scam that cost a well-known company nearly $10 million per day. Now, join me as I help you rethink your money. I remember my first bad breakup. Do you remember yours? Maybe in high school, college. Maybe it was middle school if you were dating younger than me. But that first real heartbreak, and it’s tangible and it hurts and it feels like at the time your world’s ending. But then I reflect on the possibility of me having never crossed paths with my wife. In fact, we were set up by our mothers, and I remember on our first date things were going really well and we were getting along and I said, “Well, Brittany, the downside to this is if this works out, our moms are going to be way too happy and they’re going to take far too much credit for this.”
And after 15 years and seven kids, and the most incredible memories I could ever fathom had I not met my wife, the loss would’ve been infinitely worse to my life, and I met the greatest woman I could ever even imagine. But what’s really interesting is it wouldn’t have been more painful because it wouldn’t have been quantifiable. I wouldn’t have known what I was missing out on. And this very same idea, this concept of opportunity cost applies to our money as well. We often evaluate investment opportunities as a simple trade-off between risk and return. It’s that basic tenant that to become an optimal investor, you’ll define an acceptable level of risk and then you’ll attempt to maximize your return without exceeding that predetermined risk. And let me be clear, it’s correct, that is an optimal portfolio, but it’s incomplete because that’s just referring to simply principle risk, which can be defined as the likelihood of you losing your money. If you invest a dollar, what are the chances that at some point in the future it’s worth less than a dollar?
There’s a concept regarding risk in wealth management that precedes that basic risk, and that is the idea of opportunity cost, which can be defined as the loss of potential gain from other alternatives. That’s the key. When one alternative is chosen over another. Any decision you are making or money that you’re using is sacrificing something else you could be doing. Maybe it’s time, maybe it’s money. And with most choices where you’re losing something on an opportunity cost, it’s easy to fail to apply that risk to both options equally. Now, if I’ve lost you, let me go back to my incredible wife and use her as an example. If I had married someone else, it isn’t just the risk of having a good or a bad marriage or having that marriage end in divorce or whatever it might be, that wasn’t my only risk. It was that by marrying this hypothetical person, I would’ve also lost the opportunity to marry my wife.
And again, that’s more nuanced and almost impossible to quantify. And so here’s the overarching idea to opportunity costs. The biggest misses are the things you didn’t do, the less obvious opportunities that you never got to see play out. There are three big areas where I see investors misunderstand opportunity costs with regularity. The first of those is keeping money on the sideline. This is the most destructive, yet subtle and probably destructive because it’s so subtle that derail otherwise good potential financial plans. I’m going to post an article on opportunity costs to the radio page of our website at creativeplanning.com/radio. I’ve got a couple fancy charts that I think will bring the point home if you are a visual learner, but the most obvious cost to keeping money on the sideline is that you’re missing out on potential gains.
If for the last 10 years you had your money on the sidelines, it would be reasonable to say, I’ve lost nothing. I’ve made two point a half percent per year of interest for the last 10 years. So just using simple interest, I’m up 25%. A diversified portfolio in the stock market is up about 125%. The entire story isn’t that you’re up 25%. It’s that your opportunity cost by not investing for the last decade was 100%. If they have a million dollars, they should have two million. They’ve cost themselves $1 million, yet because it’s not tangible or quantifiable, it’s just an opportunity cost. It’s often disregarded. Another opportunity cost of keeping money on the sideline is losing purchasing power. Since the beginning of 2021, $1 on the sideline is now worth 82 cents from a purchasing power standpoint. So that’s the first opportunity cost that I see overlooked often, that’s keeping money on the sideline.
Number two, are the opportunity costs associated with real estate investing. It just seems like passive income. Let’s say you own a property for $500,000 and you collect $2,000 a month in rent, most people would say, you know what? 24 grand a year, $500,000 property, I’m making about 5% on my money. That’s pretty good. I’ll get some appreciation probably on the underlying price. I’m getting 5% in the cashflow. This is gravy. I love real estate investing. And they’ll probably add that cashflow, what they earned, back into the total return when they sell the property, hopefully for more than they originally bought it for. And by the way, real estate investing can be a great diversifier in a portfolio. When you use leverage and low interest rate environments, you can accumulate a lot of properties and build your net worth. I’m not poo-pooing real estate investing as a viable way to grow your wealth, but the opportunity costs are almost always overlooked.
You see, the person that owns the $500,000 rental property, they’re not making 5%. There’s oftentimes HOA fees. There are repairs and maintenance costs. If a tenant signs a 12-month lease, statistically about half won’t renew their lease. You may have a month or two with vacancy where you don’t have any money coming in, because you don’t have a new tenant or you have to drop the price to entice a new tenant. You might have to market it to rent it. In some rentals you as the owner pay the utilities. If you don’t want to manage it yourself because you want it to be passive, you’ll have property management costs. You may have to screen tenants, insurance, property taxes, which in many states are significant. And if your rental’s out of state, you may even have to travel.
In a recent article titled The Cost of Owning a Rental Property: What Homeowners Need To Know. The expenses I just shared total up to, on average between 37 and 46% of that monthly rental amount, meaning if you’re grossing 2000 a month in rent, you’re probably netting maybe 1100 to 1300 a month after all of those expenses. But because many of those are not a check you are writing every single month, you don’t truly quantify the opportunity cost. And the third common area that I see investors misunderstand opportunity costs along with keeping money on the sideline and real estate investing is regarding longevity risk versus the fear of missing out. So many people are unwilling to spend their money in retirement or even before retirement if they’re overfunded because they’re nervous, they might run out of money. And as a result they miss out potentially on making memories and enjoying life. I’ve referenced Bill Perkin’s book, Die With Zero, several times on the show.
It’s not a perfect book, but it really got me thinking. And every client that I’ve ever given a copy to has said the exact same thing. And to summarize some of his ideas, for you to feel a 100% confident that you’ll never run out of money, you’re going to have to overfund to such an extreme that you will have sacrificed working far longer than you needed to or saved way more, and thus spent a lot less on potentially experiences that would’ve brought you joy. And so I think the question to ask yourself when it comes to opportunity costs is what’s the value of the quality of life? Is there value in living to 90? But you didn’t get to enjoy anything. Like I had enough money, I didn’t run out. I’m 95 years old, but you didn’t do anything, and then that person dies with a bunch of money.
See, when I hear those “success stories,” this person lived so frugal and they saved so much money that they died with $7 million even though they only made 60,000 a year for their entire life. I actually think it’s sad. Not because I want them to spend frivolously and needlessly, but even if they didn’t have reasons to spend money and they didn’t want to spend money, what could they have given while they were alive, who needed their help? So keep in mind, as you are diligently saving, which I, of course, as a financial planner advise you do, create freedom and a sustainability and flexibility and margin in your life for the unexpected so that you can have peace of mind and less stress, but while you’re saving it enough to ensure that you’ll be okay if you live to a 100, don’t dismiss the opportunity costs. And I believe that’s one of the greatest values you find when you meet with a fantastic financial advisor.
Not only will they reaffirm some of those areas of your plan that are on track that look good, which will give you additional confidence, but they’ll uncover and make you aware to some of the less obvious aspects of your plan that could be improved. And sometimes those are very subtle opportunity costs that you’ve never considered. What might you be missing that my colleagues and I here at Creative Planning may be able to help with? To sit down with a local advisor just like myself, visit creativeplanning.com/radio now to schedule your meeting. Why not give your wealth a second look?
Well, it has been tragic to see what is taking place in the Middle East. It is heartbreaking and in no way by me talking about the portfolio and investment implications of this devastating crisis, am I failing to acknowledge how little of importance the financial aspects are compared to human life and peace, obviously, but there always seems to be this instinct, maybe it’s just human nature, to take risk off the table and to flee for safety, or if you’re listening to half the news channels or podcasts, into gold, the safe haven of gold. This happens whenever a geopolitical crisis pops up, especially when it involves the Middle East. As we assess the possibility of an oil spike or a wave of terrorism that comes through, it’s a natural reaction and it makes sense. But while history doesn’t repeat itself, it often rhymes. And what disciplined, mature investors have learned is this is not a time to throw away your portfolio of investments and dig a big hole in the backyard and dump a bunch of money in it and then cover it back up with dirt.
Josh Brown had a great piece on this where he posted a couple of charts to his blog, and I think they’re really relevant and great reminders for what we’re seeing today. In July of 2014, Israel began a major offensive push into Gaza after three Israeli teenage boys were kidnapped and murdered by Palestinian terrorists. That war went on for a few weeks and thousands were killed as a result. The S&P 500 did fall as the war intensified, but eventually investors got acclimated to the fighting as just unfortunately part of the reality. And the effect of that conflict, like so many others, did not hamper United States stocks. In fact, over the next five years, the S&P 500 increased 51%.
Now it’s certainly a small sample size, and there are countless other examples of conflicts that broke out or horrific wars that were experienced, and the only investors that were hurt were those who rushed to the sidelines due to the unrest. So I just want to encourage you, if you’re selling US stocks today because you’re waiting for someone to shoot flares up in the air and tell you that the coast is clear and the entire world is at peace, you’re going to be on the sidelines a long time. And are likely never going to find that perfect time to reenter. You’ll be waiting the rest of your life. And so while this is one of the most tragic events that we’ve ever seen, it is unfortunately, as Brown puts it, part of the status quo.
Put your money concerns, your investment concerns, your portfolio concerns aside, and instead, focus on your loved ones. Wrap your arms around them, tell them that you love them, be patient and kind because that’s going to be a far better use of your time. Well, my special guest today is Creative Planning’s chief market strategist, Charlie Bilello. Charlie is an award-winning author with a background that spans the global investing landscape. He has a JD, an MBA in finance and accounting from Fordham University and a bachelor’s in economics from Binghamton University. He holds the chartered market technician designation and a certified public accountant certificate. Charlie has been named by Business Insider and MarketWatch as one of the top people to follow on X. He has over a half million followers there where he posts fantastic charts that I also regularly share on the radio page of our website. Charlie’s often featured as well in Barron’s Bloomberg and the Wall Street Journal. Charlie Bilello, thank you for joining me here on Rethink Your Money.
Charlie Bilello: Good to be with you, John.
John: Well, if you’ve owned a home since prior 2020, you probably have a sub 4% interest rate and have seen great home appreciation. The flip side of that is if you’re a renter or you are a first time home buyer in the market right now, you’re probably frustrated by this unaffordability. Charlie, you posted some great charts on this very topic. What’s your take? Are we in a bubble that hasn’t yet popped or is there such a lack of supply that steady prices may hang around for longer? How do you see this playing out over the short and long term?
Charlie: Yeah. Let me first give you a backdrop in terms of the housing market and affordability or lack thereof. So we now have the situation where to afford the average home that’s for sale today, you need a median household income of $115,000.
John: Wow.
Charlie: Okay. And that number, it should seem high to you, but let me tell you what it is compared to three years ago, it’s over 50% higher than it was three years ago.
John: Wow.
Charlie: Yeah, that’s an incredible stat by itself. But here’s the troubling part of this. The median American household income is only 75,000, so we’re short $40,000 for the median household in terms of what they can afford.
John: Well, so what do you think gives here, Charlie?
Charlie: It’s an absolute standstill. It’s a frozen housing market. And the Fed is trying their best to unwind what they did, but they’re finding that it’s not so easy to bring things down as it was to prop things up. The big mistake the Federal Reserve made in 2020 and 2021 is we already had a home price bubble before that point, and then they decide to throw a trillion dollars into mortgage bonds, into buying these bonds, putting them on their balance sheet. So creative money driving mortgage rates down below 3% in addition to increasing the money supply by over 40% in a short period of time. And that led to this explosion higher in terms of home prices. And you would think that doing the opposite. So they’re letting some of those mortgage bonds roll off and they’ve hiked interest rates now to over 5%. You would think that would bring down home prices, but here’s what they didn’t count on. The fact that all of these people who are locked into low rate mortgages, A, don’t want to give them up, and B, they couldn’t afford to if they had to.
So it’s really a tangled web that they’re in to say the least.
John: Those who already own a home don’t probably want a big correction that breaks the housing market, while many first time home buyers are wondering if they’ll ever be able to afford a home in their city, in many cases.
Charlie: Nobody wants to see their value of their home go down. But if you’re in it for the long run, the fact that your home price has gone up isn’t actually a great thing unless you’re selling it in that moment, because as you know, your taxes go up. They come in and say, well, your house is worth more. We want more. Your insurance costs, and we’ve seen that unbelievable rise in insurance costs over the last few years. If you look at Florida, they had a massive home price boom, but insurance costs have skyrocketed higher there. Now your home was 500,000, now it’s worth a million. Well, guess what? That insurance on that is going to double.
So there’s a lot of different solutions here, John. None of them are going to be easy. The simplest thing, and it’s not happening yet, would be for home prices to come down quickly and be more affordable. Obviously mortgage rates coming down would be helpful as well, but I think there’s a third scenario that could happen. It’s not ideal as well, which is the situation that Japan faced after their huge housing bubble during the 1980s, which is a period of stagnation for a decade or more.
John: To your point, nobody is rooting for a drop in home prices, but that may actually be less painful over the long haul than watching your home go nowhere for over a decade. To piggyback on that, Charlie, what are we seeing with rent? So we know housing’s unaffordable, people have to live somewhere and they’re choosing to rent. What’s affordability look like right now from a rental standpoint?
Charlie: It’s certainly much better than buying a home. So a new study just came out showing that the average monthly mortgage payment is now 53% higher than the average monthly rent for a home in the US.
John: That’s pretty wild.
Charlie: That’s the widest spread by far on record. Back in 2006, at the peak of the last housing bubble, it was 33% more expensive to buy a home than to rent. Today it’s 53%, so just an enormous gap. So certainly if you’re young and you have to stretch and spend 40 to 50% of your income to buy a home, not advisable for anyone, you have a better option for now renting. That doesn’t mean that rents haven’t gone up significantly over the last few years. They have, but they didn’t go up as much as the combination of rising home prices, which went up over 40% in three year period, and rising mortgage rates going from under 3% to 8%.
John: It’ll be fascinating to see how it all plays out. I’m speaking with Creative Planning chief market strategist, Charlie Bilello. Let’s shift gears here for a moment. Let’s talk bonds. We’re in the longest bond bear market in history. I don’t know if a lot of people realize that because bonds are mostly boring and nobody thinks about them until really the last year or so, year and a half. Now people started thinking about them because-
Charlie: You never even heard that word.
John: Yeah. They’re like, wait a second, my bonds are down? I had some clients say to me, I didn’t think bonds could go down. They’ve been in a 30 year decreasing interest rate environment and they’ve never experienced it firsthand. Let’s talk durations. Obviously we’re in a different environment than we’ve seen in the past when it comes to bonds, what’s happened first of all, and then how investors can take advantage of the current market.
Charlie: So how did we get here? How did we get to the longest bear market in history and now it’s over three years. The bear market started in the summer of 2020, and there’s a good reason why it started back then. It’s because interest rates were at historic lows. We had a 10 year yield below 1%. The 30 year yield actually briefly dipped below 1% as well. Historic lows, we hadn’t seen anything like that. And when you have a bond, everyone knows if you buy a bond, you hold it to maturity, you’re going to get your money back plus the coupon. What happens in between though is the prices can fluctuate and the longer duration, the longer term the bond is, if it’s a 10 year versus a one year, that price is going to fluctuate much more.
John: Well, I want to interject for just a second, Charlie, I don’t think this can be overstated. To lend money to the federal government for 30 years, to give them your capital they said, thank you so much. We will pay you less than 1% interest per year for the next 30 years. You really stop and think about that for a moment. That’s unbelievable.
Charlie: It’s insanity. But if you go back to that time, people are actually saying buy those things because we’re going to have negative interest rates. We’re going to join places like Switzerland, which actually had a negative 50 year-
John: I remember that sentiment. Hey, it’s still a pretty good deal. You’ll probably… May even be a capital appreciation play because when rates go negative, you’ll see some pretty good price appreciation.
Charlie: It was crazy. And the crazier thing as we talked about the last time I joined you is that the US government didn’t use that to their advantage and say, we should issue 30, 40, 50 year debt at these low rates. We’re borrowing so much money and people are willingly buying that at these low interest rates. Let’s use that to our advantage. Unfortunately, they didn’t do that whatsoever.
John: Well, and that’s a big part of the conversation right now with a lot of debt being renewed now at higher. People say, well-
Charlie: Correct.
John: … how is our national debt going to affect us? Well, a lot more when they have to pay a lot more interest on it than they were previously.
Charlie: We’re finding it very difficult to all of a sudden issue $2 trillion. In the last four months the national debt’s increased by $2 trillion and it’s not so easy to sell that, A, when the Fed is no longer buying that debt as they were back in 2020, B, international. We’re seeing less buying out of places like China and just yields are higher elsewhere as well, and it’s just too much to flood the markets.
John: It really is. Yeah. So sorry, I derailed you. Let’s get back to bonds.
Charlie: So bonds started, if we look at three years ago, 30 basis points in terms of the 10 year yield, so 0.3% for 10 years, and now today you can get 5% for that same 10 year bond. Now, the math of that has translated into if you owned a 10 year treasury bond, you bought it a few years ago, you’d be down around 25% on that bond. Now, if you held it until 2030, yes you’ll get your money back, but for now you’re down around 25% and this would be the third consecutive down year for the bond market as a whole, which has never happened before in history. So I think the question though, for investors today, if you’re coming into the bond market today, very different situation. So a lot of people are saying, well, given that, why should I ever buy a bond? And also why should I take risk in longer term bonds when I can get 5.5 and a half percent on treasury bills? I don’t have to take any of that risk. Those are the big questions people are asking today.
And there’s a lot of different ways to answer that. But the most important thing is for an investor to understand that that short-term interest rate you’re getting on treasury bills isn’t permanent. Back in 2020 you had to do risk management saying interest rates could rise here. So I don’t want to have too much duration risk in my portfolio. Today you have to think about perhaps interest rates could be lower a few years from now, and if they are, I’m going to be happy that I locked in some of these longer term yields. But people had to learn the hard way, John, that there is indeed risk in bonds as well.
John: It all starts with a financial plan, understanding what each dollar’s need and uses and when you’re going to need it. This isn’t exclusive to bonds, it’s true of your stock portfolio, your tax strategies, because it allows you to then match up your investments with the appropriate time horizon and goal for that portion of your plan. Right, Charlie?
Charlie: Customization is so important here, John, and it can’t be overstated that you have to align that portfolio with the risk that you can take. If you’re the type of person that can’t take any risk in bonds and you’re saying, I can’t sleep at night because my bonds are down a few percent, then maybe you should only be in treasury bills, even if that means a lower long-term return.
John: Oh, yeah.
Charlie: But if you’re someone who can stomach that, include some duration in there because if there’s economic weakness next year because of these Fed hikes or because of anything else, well the Fed will likely respond to that by cutting interest rates and the fact that we have all this national debt going higher, believe me, there’s going to be pressure for them to start moving interest rates lower again.
John: Well, that’s why answering questions like is a long-term bond at 5% better than a short-term one at 6% or 5.8? Two smart people could arrive at different answers based upon their needs and their risk tolerance and their time horizons and the rest of their financial plan, tax situation, everything else.
Charlie: That’s right. So back in October 2007, you had short term treasury bond yields similar situation, above 5%. Longer term yields were a little bit less and people were saying the same thing, why should I take any duration risk? Well, they learned over the next year when the fed cut interest rates to zero by December 2008. Well, that’s why you do it because there’s not permanence to that. And if we look at Fed rate cutting cycles, John historically having bond exposure does very well. It’s the opposite of what we’ve experienced over the last few years. So not only do you have locking in that higher coupon, but you’ll actually get some of that price appreciation in the short run because interest rates are falling.
John: Recency bias is a powerful thing. All of us have to remind ourselves, this has been extremely unique what we’ve seen in bonds. And Charlie, I have one other topic that I want to cover with you. We’ve seen small cap and international underperform, really brutally underperformed since 2010. If someone bought an S&P 500 index fund and forgot about it, they’ve done much better the last 13 years than someone investing in broadly diversified portfolios. So my question for you is this the time now to finally diversify? I talk with certain investors who tell me they don’t want small cap, they don’t want value, they don’t want international. Large US growth for the win. I don’t need anything else, John. And to that person who says, I think I’m going to achieve better returns by simply owning the S&P, that’s my strategy the next decade, what’s your response?
Charlie: I would say first it’s understandable that they feel more comfortable and safer regardless of the performance buying US investments. There’s an old saying in investing, buy what you know. And a lot of people take that to heart. And when you look at the S&P 500 index and you say Apple’s the number one holding, Microsoft number two, Google number three, and Amazon number four, I know these companies, I use their products, I feel good about it and it’s therefore easier for me to buy a portfolio that includes these stocks, much easier than some international brand that you’ve never heard of even forgetting about the returns. Now, adding on top of that, the fact that we’ve had this pretty much record differential over the last decade, US stocks, as you said, S&P 500 has done about 11% per year. So trouncing international. International’s about 2% per year over the last decade, and we have small caps a little bit in between at 6%.
And if we zero in even further than that, if we look at the NASDAQ-100 which is dominated by those big tech names, that’s up 17% a year over the last decade. Now here’s the reason why you should consider not only investing in the US and not only large cap but other things as well. And that reason is there’s this cycle to everything. And it might seem like today that there won’t ever be a cycle where the US and large cap and TechOps are outperforming again, but people thought something similar back in early 2000 and they then had to learn the hard way the next 10 years when all of that stuff did the worst and international and small caps outperformed. So people will then ask, well, is today the same as 2000? No, it’s not the same. Every time is different, but there’s that possibility of something like that happening again. And if it does, you have to protect yourself in advance. You can’t wait until after it occurs, which is another way of saying the best time to diversify is when it’s most painful to do so.
And it’s extremely painful to think about doing it today because small caps have been underperforming for over a decade, international over a decade, and you can’t envision that ever changing because it’s been so long. But that’s precisely the best time to do it because now you have a valuation tailwind in your favor. There’s two real big reasons why you should invest outside just one particular area, and number one is humility. So having the humility to say, I don’t know what’s going to happen in the next decade. And therefore I can’t concentrate in just one area. I have to spread my betts. And number two is simply risk management. We know concentration’s the fastest way to build wealth, but it’s also the fastest way to destroy it, and if you’ve worked hard to amass savings and portfolio, you want to put the highest probability outcome in your favor. So it’s humility first and then risk management is the reasons why you would think about investing in something other than just the S&P 500.
John: I love that. The eighties, international won, the decade of the nineties, the US won. You had the lost decade of the 2000s. That is named the lost decade because large US slightly lost money over a 10 year period. International and a diversified portfolio performed fantastic. And then as we’ve been discussing since 2010, US is back on top, but I think the pain of diversification as you put it, is you are never going to have all of your money in the absolute best thing. It’s the very nature of diversification. You have dissimilar price movement. And Charlie, if it’s like anything, when I review my kids’ report cards when they bring them home, A, A, A, C in science, what do you think I focus on? I’m looking at that C saying, what is going on in that class? Are you sitting in the back? Are you not paying attention? It’s human nature, and we tend to do the same thing with our portfolios.
We look at the underperformance and we think, man, I wish we didn’t have any of that in the portfolio. I would’ve achieved much better returns. The reality is I tell my clients all the time, I am going to have you broadly and globally diversified, which means I am never, ever going to have to say that I’m sorry. And yet I’m always going to have to say that I’m sorry. Of course, I’m referring to the fact that we’ll always have some things doing great and there will inevitably be portions of the portfolio that just aren’t doing that well, but that’s just part of being a disciplined, mature investor and not getting caught up in the moment as it’s so easy to do. Well, thank you for sharing your wisdom and insight. These are great tips. I’ve been joined by chief market strategist here at Creative Planning, Charlie Bilello. Thank you for joining me on Rethink Your Money.
Charlie: Thanks, John. Great to be with you.
John: Well, this past week we were in San Diego as a family, and my wife and I went for a walk on the boardwalk. She suggested, well, let’s go down onto the beach. Let’s just walk in the sand, because we’re romantic like that. Long walks on the beach holding hands. I know. So I took off my shoes. I had these brand new shoes on and had planned to walk on concrete. Well, now I’m walking on the sand, so I take them off and I put my socks inside of my shoes and I set them down next to my wife’s cheap slippers for my Maui Ohana flip-flops for all of us mainlanders, and we take our walk. About 15, 20 minutes later, we come back. Her cheapo flip-flops are still sitting there. My brand new shoes are gonzo. My wife, she looks at me, says, you seriously left your shoes right there. We’re at the beach. You know they’re going to get taken.
And it was a rookie move by me, it was dumb, and I did actually really like those shoes, so I was frustrated. Didn’t help that she was pouring a little salt on the wound, but when something’s stolen from you or you get scammed, it’s just a terrible feeling, isn’t it? You feel vulnerable like, oh man, my wife said yes. Somebody was definitely watching you take off those shoes and then jumped on it once we took off. It’s like, that’s creepy somebody’s looking that closely. But before I let her get away with telling me that, I said, well, remember when we were newlyweds and our net worth was zero, and you got scammed into buying some fantastic sound system. That was, in hindsight, a complete scam. It was one of those where almost immediately after buying it, she knew something was off.
She got home and was like, I think I got scammed. But my guess is you’ve probably had an encounter similar to my shoes being stolen or my wife being scammed out of a few hundred bucks for a speaker system at some point in your life. But we can always find solace in the fact that we weren’t scammed as bad as the MGM. And I found this MGM ransomware attack both troubling and also applicable for you and I. What happened was Caesars paid a $15 million “ransom” due to an attack that was launched on their hotel. The attack on the MGM caused issues with slot machine payouts, guest check-in and payments, digital key malfunctions and guest account logins, VZ underground hints, voice phishing was the attack method and Moody’s warning of potential credit impacts on MGM. MGM was thought to be losing somewhere in the neighborhood of eight to $9 million per day during the attack. And eventually paid up to get their system back. So while you likely don’t own a giant casino, you may own a business or if nothing else, you have your own individual personal accounts.
Well, Adam Jones, the director of technology here at Creative Planning, provided me with a summary of how you can protect yourself and, or your business, should you be targeted in a similar manner, use the strongest available security methods and multi-factor authentication. Use strong and unique passwords and ideally a password manager. Back up all your data in more than one place. And have a plan of how you’ll respond in the event that something like this happens. Be skeptical of everything. I know it’s a terrible way to approach life, but when it comes to these things, just assume that the intentions are wrong. To protect yourself, be paranoid and remember, pressure is a flashing warning sign. If whoever you’re talking with is telling you it’s now or never. Make a decision right now or this opportunity will be gone, that should trigger major suspicion.
Remember, you can minimize taxes. Have a great financial plan. Invest your money wisely, work your tail off for 40 years, build your net worth and unfortunately have all or part of it completely destroyed due to fraud or a scam. It’s important that you understand how to protect yourself, act with caution and diligence when it comes to your life savings.
It is time for listener questions, and one of my producers, Lauren, is here to read those. Hey, Lauren, who do we have up first?
Lauren Newman: Hi John. So first off, I have Chris from Flagstaff, Arizona and he says, my wife and I bought a cabin home for 700,000. It’s now worth 1.2 million. Do we sell now to avoid capital gains?
John: To lay the groundwork for my answer, existing legislation allows for single tax filers to exclude 250,000 in capital gains and that doubles to 500,000 for joint filers such as you and your wife, and obviously you’re aware of that saying, we’re up 500K, should I be selling the house? Now, long-term, federal capital gains for a house that you’ve owned for over a year are taxed at zero, 15 or 20% depending upon what income tax bracket you belong to. I think the question you want to be asking yourself though, Chris, is do you see this as a forever home? Is this a long-term house that you love, that you don’t want to move from, or is it very replaceable in your mind and there’s not a lot of attachment to the location or past memories there? Because if it’s a long-term home, I would think of it another way.
You bought a $1.2 million home for 700K, it’s a win-win. You got a great deal. Now, if you were to say, John, my primary focus is on avoiding capital gains taxes, I couldn’t care less about this house relative to another one I could buy down the road, then I guess there’s an argument from a financial perspective to selling, but you’ll probably be paying more in property taxes on whatever you buy next and moving costs and what you lose in comfort, security and memories. Yeah, you’ll save in capital gains taxes over the long run, but are you planning on spending your life buying and selling homes? Because keep in mind, if you pass away, the capital gains will be stepped up for your beneficiaries. That’s another consideration if you hold it all the way until death. One way you could buy yourself a little more time is you could make some capital improvements that are deductible. If you spend 50 grand renovating your home, constructing an addition, for instance, you could deduct that expense at the time of sale.
Of course, it’s worth noting that not all renovations and repairs are eligible, so speak with a tax professional if you’re not sure where to turn. You can speak with us here at Creative Planning at creativeplanning.com/radio. Generally speaking, I don’t want the tax tail wagging the financial planning dog or in this case, the life dog. I know it’s confusing, it doesn’t really make sense. Just go with me on the analogy. I would always prefer that you’re using wisdom and not overpaying on your taxes, and frankly, you’re on top of things, Chris, to even be thinking about that at this point. It’s not even on most people’s radar, but keep in mind, if your property goes up in value to 1.5 million or in 10 years, it’s at 1.8 million, you’ll only be paying capital gains on, in that case, 300K or maybe 500,000, not including the sales fees, and after adding back into your basis some of the potential renovations and improvements that are deductible. All that appreciation’s just free money after taxes anyway. And remember, if you have questions like Chris, send those my way by emailing [email protected].
All right, Lauren, who do we have next?
Lauren: Okay, so our next question comes from Sam from St. Petersburg, Florida. I’ve been exploring ways to guarantee a stable income during retirement. I’ve heard a lot about annuities, but I’m not sure if they’re the best option for me. Can you explain the pros and cons of using an annuity to secure income in retirement, and are there alternative strategies I should consider? I’m 70 years old and have the bulk of my two million retirement savings in an old 401K.
John: Well, Sam, thank you for the question. The pro to an annuity is quite simple. It provides you predictable retirement income that can last the rest of your life. Now, there are two basic types, immediate and deferred. And immediate annuity is exactly like it sounds. You provide a lump sum payment to the insurance company and in exchange they provide you with either a fixed or variable income payment beginning on a specific date, and it’ll either last for a fixed number of years or you can just elect over the rest of your entire life. Obviously, it’ll be a lower payout if you want it over the rest of your life versus if you say 20 year period certain. These types of annuities aren’t all that common because the rates of return that you receive on those have been pretty undesirable for more than a decade. I don’t personally like this strategy because I think there are more efficient ways to go about it, which I’ll share with you here in a moment.
The person purchasing an immediate annuity is really solving for longevity. If you think you’re going to live to a 105 and you’re taking payments over the rest of your lifetime, it’s going to be a better deal than if you die at 75. Essentially what you’re doing in this type of contract is you’re pooling your money with thousands of other annuity holders. And those who live a really long time get some of your money, and if you’re the one that lives a really long time, you benefit from the pool of money that was provided by certain people that died three years after they bought the annuity. So think of an immediate annuity as longevity insurance for your income. And these aren’t the worst thing ever as long as you are aware that in most cases the actual rate of return that you’ll receive on your lump sum through those income streams is unbelievably low. The insurance company is going to make a lot of money off of you purchasing that annuity.
As long as you’re okay with that, they can be a viable solution. The more common type though, are deferred annuities, and this simply means that the income phase of the annuity is going to start at a later date. You’re going to still give the insurance company a lump sum, but you’ll say, have this invested either at a set interest rate in a fixed annuity or indexing to how the S&P 500 does. I won’t get all of it, but give me part of the growth of it for my interest rate, or invest me in a variable annuity where you are essentially in mutual funds called sub-accounts, stocks, bonds that go up and down in value and are invested while you’re deferring and waiting to start that guaranteed income stream. Generally speaking, I’m not a fan of annuities because if you know what you’re doing, you almost always can do better by having a great financial plan, properly diversifying by having shorter term needs and safer investments and longer term needs in growth oriented investments, and not giving up the lump sum to an insurance company.
If you’re someone who can’t get their head around investing in the stock market, you’re going to keep everything in cash and CDs. And you don’t really care much about estate planning or having anything left over for beneficiaries, then maybe an annuity would be the best solution. But I would encourage you, Sam, speak with us here at Creative Planning or a company like us, an independent fiduciary who’s not pushing high commission insurance products. If you’re not sure where to turn, we can help you. We’ve got an office there in your area and put together a financial plan. This shows exactly how you could create that desirable income stream that you’re looking for without all the negative implications of buying an illiquid, expensive, poor performing annuity product.
One of my favorite financial writers of all time is Morgan Housel. He actually has a new book coming out that I’m looking forward to reading, I think it releases here in the next couple of weeks. But in his first book, The Psychology of Money, he wrote about the laws of getting rich. And I think there’s a lot that you and I can learn from his insight. Most of what makes you happy in life has absolutely nothing to do with money. Consider this, would you rather make a hundred thousand dollars a year but have a spouse who loves you, a family supporting you, or would you rather make a million dollars a year but have none of the above? You see, when we believe in our heads that we’ll be happy when we have money or when we have more money and then we obtain that and nothing changes, that’s depressing.
That’s a really empty feeling. Chasing something, aspiring towards something, working so hard for something, telling ourselves that we’ll be happy when we finally possess it, only to reach that mountaintop. Look around and think to yourself, wow, not a whole lot’s changed in my life other than a little bigger number on my net worth statement, little bigger balance in my investment account. Rick Rubin said it best when he said, “It’s hard to get really depressed until your dreams come true.” Once your dreams come true and you realize you feel the same way you did before, you get a feeling of hopelessness. Most worldly things like money tend to not be so satisfying. Sarah Landrum wrote a great article for the crosswalk.com highlighting key reminders that happiness has nothing to do with money. Instead, there are many doors to happiness and many doors that happiness opens, and I want to share seven with you today.
Number one, being with friends and family. Spending time with those you love reminds you of where you came from and gives you a sense of belonging and interconnection. Number two, play more. Even as adults, we are allowed to play. Having seven kids I’m reminded of this. Kids are always playing. They’re imagining, they’re dreaming, they’re laughing, they’re running through the house, screaming at insane volume levels, but they’re having a good time. Number three, being alone but not lonely. If you’re like me, you don’t give yourself near enough space for solitude, quietness to reflect. Maybe it’s taking a nap, reading a book, working on a hobby, taking a walk, and as my wife Brittany tells me often, without your AirPods in, you don’t need to be on the phone doing something for work. You don’t need to be listening to an audiobook or a podcast. Just go for a jog or a walk. Whenever she tells me that, I look at her like, what are you talking about? Why would I do that? That’s so unproductive, but there’s value in being alone but not lonely.
Number four, the gift of small kindnesses. We all know the golden rule. You want to find peace, you want to find happiness, do kind things for others as you will be inevitably blessed and fulfilled through it. Number five, laugh more. Humor is such an amazing gift that we’ve been given. Did you know that when you hear the sound of laughter, your brain responds and triggers the muscles in your face to interact? Sometimes it’s hard, even if it’s dumb, I say a lot of dumb stuff my wife starts laughing and she goes, Ah, it’s so stupid. You’re so dumb. And I go, no, you think I’m funny or you wouldn’t be laughing. Number six, motion boosts positive emotion. You may think of exercise as routine maintenance, but it’s actually proven to improve your wellbeing and help with depression and mood shifts.
And finally, number eight, appreciate the little things in life. For a while, I was starting my morning with a gratitude journal, just three simple things every morning to start my day that I was grateful for. Like a lot of things in life, I’ve gotten away from it, but I should get back to it because there are hundreds, probably thousands of specific aspects of your life from huge things to very small, subtle ones that we just forget to remind ourselves how blessed we are. And so while it may seem counterintuitive for the host of a personal finance show to tell you money probably isn’t going to make you as happy as you think, but I tell you that because it’s true, we’d all be better off with a little less money if that meant having quality relationships and being active and grateful and laughing and spreading more kindness to those around us. And it’s important because we are the wealthiest society in the history of planet Earth. 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 $245 billion in assets as of July 1st, 2023. John Higginson works for Creative Planning. And all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice, and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help request to speak to an advisor by going to creativeplanning.com. Creative Planning tax and legal are separate entities that must be engaged independently.
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