The sentiment “the smaller the gap between your expectations and reality, the happier your life will be” is true of investing. This week, John examines how to manage money-related expectations and find greater satisfaction with your wealth (1:26). Plus, learn how the definition of retirement is changing (24:35) and why the best returns you’ll get may come from the times you invest in yourself (46:10).
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: Welcome to the Rethink Your Money Podcast, presented by Creative Planning. I’m John Hagensen and a head on today’s show. I’ll share one of the most common misconceptions and the impact that it has on your money, whether or not retirement should be the ultimate financial goal, as well as my answers to listener questions. Now, join me as I help you rethink your money.
When my wife plans a date night and she asks, do you want me to surprise you or do you want to know where I made reservations? I’m the guy who 100% of the time says, “Where are we going?” Now, I may have some sort of control issues that may be part of it, probably is. I just don’t really like surprises. My kids think it’s hilarious to hide at the bottom of the basement stairs and when it’s pitched dark down there and I’m walking down, they jump out around the corner and yell and scare me. But when it comes to surprises, you could really categorize them into two different groups. Those with which you could have prepared and those that were completely unknown. For instance, if you show up in Arizona for the 4th of July and you exclaim that you are surprised at how hot it is, that’s a you problem.
Why are you surprised by that? And so, the key with our money is to not get caught flatfooted and surprised by things that shouldn’t surprise you. Because whether you’re someone like me who hates surprises or my wife who loves them, no one wants to be surprised when it comes to their life savings. What’s the simplest way to reduce the agony of these surprises? It’s through expectation setting and it’s important to note that we all have expectations. Some are conscious, some are unconscious, some are reasonable, some are unreasonable. We may state those expectations, we may not, but expectations can certainly cause problems when they’re not met or they conflict with someone else’s expectations. But when expectations are conscious and they’re reasonable and they’re stated, they can be powerful motivators and can provide you with peace of mind and a lot of comfort. Remember the smaller the gap is between your expectations and your reality, the happier you will be.
There was a study at Berkeley a while back where they had students imagine getting their grade back on an exam. And those who predicted they’d get an A and then received a C were unsurprisingly very disappointed, especially compared to those who also received a C, but were expecting to get a C. They weren’t upset even though the outcomes were exactly the same. As a parent, I can tell you firsthand that the most practical way I can keep my kids in good spirits and the house from imploding is by controlling their expectations. It’s far more important than circumstances under promise to your kids and over-delivered. “Hey dad, do you think we can go to Topgolf this weekend?” “Ah, probably not Jude.” But then when it’s Saturday and I realize that we have two hours available, I say, “Hey, you want to head over to Topgolf?”
He’s incredibly excited, way more so than if I had told him at the beginning that we were going to, in fact, go to Topgolf. And then I say, “Hey, but we’re only going to be able to go for an hour. We don’t have a lot of time.” “All right, that’s fine.” Maybe then we get there and I realize we have an hour and a half. I say, “Let’s play for 90 minutes.” “Wow, this is amazing.” Just as Bobb Rutledge, a neuroscientist and senior research associate at University College of London concluded when he said, “Your happiness increases only if you do better than expected.” And in light of this acknowledgement, I want to help reinforce for you proper expectations regarding six different categories of personal finance. I’m going to cover the stock market, bonds, the economy, taxes, social security, as well as longevity.
Regarding the stock market, here’s what you should expect. It has averaged around a 10% rate of return not considering inflation for about the last century. However, this doesn’t mean that each year you’re going to match that 10% or frankly even be close to it. In fact, between 1926 and 2022, returns were in that average 8% to 12% band. Only seven times in nearly a hundred years. The rest of the time they were much lower or usually and thankfully much higher. Volatility is just the table stakes when it comes to the stock market. An average correction, peak to trough, it’s about 14% and you’ll experience a bear market about every five or so years. That is the price required, your toll fee, so to speak, of achieving that 10% historical rate of return. More data on the stock market, it’s up about seven out of every 10 calendar years. So, if you shredded your statement throughout the year and every December 31st, you checked your accounts first, January 1st, seven out of 10 times you should expect to have more money.
Of course, that also means 3 out of 10 years you’ll have less even if you are well diversified, you’re staying disciplined. Doesn’t mean the plan’s broken, it just means that’s normal market movement. This is why of course the stock market is geared toward long-term investments. The longer you remain invested, the more reliable those returns become. And so, to summarize your expectation of the stock market in the short run, it is extremely volatile, but given enough time, this has been the absolute best growth vehicle that you can invest in. So, we talked about stocks, what can you expect from bonds? The average rate on a 10-year treasury since 1900 is 4.62%. Now, that’s not the return, that’s the yield. Bonds are not a growth vehicle. They’re designed to try to keep up and hopefully slightly outpace inflation. Now, the obvious downside is that when inflation is where it is, even if your bond is paying 4% but inflation’s at six, your real returns are negative.
So, your expectation on bonds should be that they’re less volatile than stocks. They can cover short-term needs while stocks are down, but your best cases to slightly outpace inflation. With regard to the economy, what are realistic expectations? While there have been 11 recessions since 1948, averaging out to about one recession every six years, we’ve had 49 periods of economic expansion and they have varied lasting as little as one year or as long as a decade. The average length of a recession is about one year. And so, while the economy is cyclical, it’ll expand. It’ll contract. Remember that the stock market is always forward looking. And so, historically by the time the recession is over or near over and you are feeling more optimistic, the market is often already way off of its lows and in some cases it’s already making new highs. You’ve missed the recovery. So, the expectation when it comes to the economy, never try to manage your investments based upon economic forecasts or sentiment.
Let’s proceed to our expectations when it comes to taxes. While none of us want to pay one penny more than legally required when it comes to our taxes, you should expect to have to pay some taxes if you are financially successful. But one of the big misconceptions I see when it comes to taxes is that you will benefit most by attempting to reduce your taxes this year as low as possible. Keep in mind that today’s favorable tax code is set to expire in 2025 unless Congress acts. So, if there may be an opportunity to take advantage of the lower rates, consider this. We have over $30 trillion of national debt and we are in one of the lowest historical tax rate environments of the last half century.
Your expectation when it comes to taxes is not only that you’re going to have to pay some, but that they will potentially be significantly higher over the next 20 or 30 years than they are today, and your strategy should be informed in light of that. This is why here at Creative Planning, we’re not only a law firm with 50 attorneys but also a tax practice. We have over 100 CPAs on the team because we believe your money works harder when it works together. Tax strategies are a central foundational part to your financial plan and to comprehensive wealth management. If you are not getting tax advice, if you’re advisor’s not reviewing your tax return, if they’re not meeting regularly with your CPA, what might you be missing? Do what thousands of others just like you have done who have wondered what might be able to be improved if someone were reviewing my tax situation proactively.
Go to creativeplanning.com/radio right now to speak with a local financial advisor who is not looking to sell you something but rather give you clarity around your situation. We’ve hit on the financial expectations for the stock market bonds, economy, taxes, which leads us to our second to last topic, which is social security. The Social Security trust fund is projected to be exhausted in 2033. And if that were the case, benefits would be reduced by about 25% to 30% across the board. Now, because of the financial hardship that would put many American retirees in, there are likely to be substantial changes, whether it be a higher tax rate for current workers. Removing the wage cap on social security taxation means testing the benefit or pushing back full retirement age even further than 67.
Think about this logically. When Social Security was enacted back in the 1930s, full retirement age for the benefit was 65 years old. Life expectancy was 62.5. Now we’ve pushed it only two years back to full retirement age being 67, and we are living far longer than ever before. This was never designed to be a benefit to fully support a retirees lifestyle for 30 years. It was initially considered to be old age poverty insurance. So, here’s what you need to expect. Benefits are likely not going to be enough to live on. Secondly, the buying power of benefits is declining. Yes, there is a cost of living adjustment. It is important to note you will receive inflation bumps on your social security, but very rarely do those calculations accurately depict the inflation you are feeling as a retiree in particular when it comes to the exceedingly high inflation levels of healthcare.
Our final category, which is longevity, it’s often the most overlooked with the biggest ramifications in a retirees financial plan. In fact, I will post an article to the radio page of our website at creativeplanning.com/radio that takes a more in-depth look on how to properly plan for longevity. But here’s the key. The number of us living beyond age 90 has nearly tripled since 1980. Today there are nearly 2 million Americans over the age of 90, and that number’s expected to increase by, get this, nearly 8 million people over the next 40 years. One in every four 65 year olds can expect now to live past age 90. So, the misconception of, well, I’m in retirement or I’m in my ’60s, so John I’m not a long-term investor anymore, I’m a short-term investor. No, you are still a long-term investor because you’ll likely live another 20 or 30 or 35 years. And so, here’s what I want you to expect when it comes to retirement and longevity. You need to reframe your retirement.
You may be in retirement nearly as many years as you were working. You need to position your portfolio for more growth because if you’re 65 and you are still alive at 75, hopefully you will have not spent all of your money, meaning there will be dollars at the beginning of your retirement that will still be inside of your accounts 10 years later at 75 or 20 years later at 85. And why would you want those dollars in bonds or cash or CDs, which are at best keeping up with inflation, but likely if it’s cash, not even rather than subjecting that to a longer term strategy with a bit more volatility to earn historical growth rates of return. I want you to expect a plan for healthcare expenses. Quarter of a million dollars per spouse is around the average. I’ve seen some studies as high as $400,000 in retirement out of pocket per spouse.
So, don’t be surprised by that. You also want to establish a tax efficient drawdown strategy. How much money can I pull from the accounts? How am I going to be taxed in light of the fact that I might need to live on this money for 30 years, not just 5 or 10 like my grandparents? And then lastly, have a detailed written, documented dynamic financial plan in place. Financial planning was really easy when you retired at 65, you had a pension and social security and you lived on that income and a little bit of interest from your bonds or CDs and five years later you passed away. That is not the reality for today’s retirees, which puts even far more emphasis in your success on having an actual plan. Do you, right now, have a comprehensive financial plan? If you don’t have that and you’re not sure where to turn, here at creative planning, we are helping families in all 50 states and over 75 countries around the world.
Why not give your wealth a second look and request a complimentary visit by going to creativeplanning.com/radio. There’s no pressure to become a client and there is no cost. Our mission is simple, to help you feel empowered with what you’ve worked a lifetime to save. And so to recap, don’t be surprised with the following. Volatile stock markets, stable and low performing bonds, an inability for you to invest based upon economic cycles, massive tax increases potentially down the road, social security to be insufficient to keep up with your retirement expenses, and when you’re blowing out candles on your 100th birthday, don’t be surprised. And remember, these are important because it’s our expectations often far more than our circumstances that dictate our contentment
And my special guest today is Creative Planning Partner and Managing Director, John Baker. John is a wealth manager who has spent his entire career in the financial services industry and prior to joining Creative Planning, he was a vice president at one of the nation’s largest investment advisory firms working directly with high net worth families. John is a former United States Marine and received his bachelor’s degree from the University of Nebraska at Omaha. John Baker, welcome to Rethink Your Money.
John Baker: Thanks, John. Happy to be here.
John:
As I just shared in your intro, you have a unique background. You served in the Marines prior to becoming a financial advisor. Tell me a little bit about your journey and transition from the military into helping people with their money.
John Baker: If I look at some family history, I do think there’s some service component to both myself and a lot of folks that came before me. My mom, for example, she was a nurse for 40 years before she retired.
John: Wow.
John Baker: Both my grandparents were in the military during World War II. My dad, he also served in the military during Vietnam. And then as you pointed out, I was in the military from 2003 to 2008. So, deep down somewhere inside of us, I guess in my DNA, there’s this motivation to be of service to others that ultimately what was most attractive to me about being a wealth manager and financial advisor were those relationships that I could foster.
John: And again, thank you so much for your service and for your family service over the years. My son’s active duty army, so I understand the sacrifice that was for you as well as your entire family. Let’s transition over to volatile markets. What do you think is the best thing people can do during these times of uncertainty, which let’s face it, tend to be kind of all the time? If you’re in the public markets, especially in equities, what do you think people can be doing?
John Baker: It’s a short answer. Nothing. Seriously. I’m not saying that someone should just bury their head in the sand and assume that everything’s okay, but what I’m recommending that investors make a conscious decision to sit tight. We all have this fight or flight instinct. So, our natural tendency when we’re going through these volatile markets is to do something which I think is inherently true when we parallel that to a survival situation. But when it comes to investing, I think about the best trades or the ones that you don’t make.
John: We mistake activity for control so often, but how about rebalancing?
John Baker: The reason that we feel so strongly about rebalancing is because if we just think about stocks or investments in general over longer periods of time, they tend to move higher. Now it’s never in a straight line as we’ve certainly experienced over the last 12 to 18 months, but rebalancing is really just the important process of placing trades across your portfolio to bring your investments back to target. So, for example, after a very strong year in the stock market, rebalancing is capturing profits with those investments in the portfolio that have done the best and you’re moving the proceeds from those investments to other parts of the portfolio that maybe haven’t done as well. So, the simple mechanism of rebalancing really forces us into that sell high and buy low mindset.
John: I’m speaking with Partner and Managing Director here at Creative Planning, John Baker. It’s great wisdom. I want to piggyback on a couple of things that you just said. Volatility, which so often people will say I don’t like. I hate volatility and I have to remind clients, well, volatility is not just down, it’s also up volatility. And when the market comes screaming up over the back half of 2020 and into 2021, no clients are complaining that they don’t like volatility. And if you look at the data, the volatility works to your advantage as an investor far more frequently than it does to your disadvantage. So, I think that’s one important distinction is that volatility does cut both ways.
And then the second thing that you said is that while the markets averaged, let’s say 10% a year for the last a hundred years, it almost never makes 10% in a year. In fact, if you look at history, most of the returns come in very short bursts. Let’s transition, John, over to some tax strategies that we can do during volatile markets because there are opportunities especially during these times of down markets that aren’t available to us when the markets are doing better. Can you speak to some of those things?
John Baker: Sure. I think the two most common and easily executed upon strategies, one is tax loss harvesting, and the second is Roth conversions. So, the first, tax loss harvesting, this is important to just make a distinction that tax loss harvesting is really only something that can be executed in a non-retirement account. So, as much as I wish that we could do tax loss harvesting and IRAs and 401(k)s and Roth IRAs, we can’t. If we think about 2020 where at the low point in the market the S&P 500 was down 35% in the middle of March of 2020, and then again it ended the year plus 18%. So, if we think about this not in the context of rebalancing, but maybe now in the context of tax loss harvesting, what would we do in that situation?
Well, to use maybe a simple example, if let’s just say we had absolutely horrible timing and we invested $100,000 into an S&P 500 index fund and we did it right in the middle of February of 2020, right before really things started to get bad. Well a few short weeks later, that $100,000 is now worth roughly $70,000. So, what we’re doing when we’re tax loss harvesting is we’re intentionally selling that investment. We’re taking that $30,000 capital loss and we’re moving that to the client’s tax return. But then simultaneously we’re reinvesting the $70,000 that we originally sold from an S&P 500 index fund, and we’re reinvesting that into a very similar investment. Now, it’s important to note, we can’t reinvest into the exact same investment. The IRS does not allow that. It’s called the wash sale, but we can reinvest that $70,000 into a very similar investment. Maybe we reinvest into the S&P 750.
And so, if we fast forward to the end of 2020, we’ve got a similar return with that particular investment then had we done nothing at all, but we’ve got this $30,000 capital loss that’s now sitting on the tax return. And what we appreciate about those capital losses is that if you happen to have any capital gains that occurred in that same calendar year, there’s a dollar for dollar offset. And if you don’t, those capital losses will roll forward on your tax return until they’re used up. So, tax loss harvesting on paper is a performance neutral trade. But as you can see with that simple example, it can have a very positive impact on improving the after tax return for a portfolio.
That’s one of the very first assessment pieces that we look at. If someone’s coming to talk to Creative Planning and they’re maybe just wanting a second opinion or they’re curious how their current advisor’s doing, we’ll look at the 1099. We’ll look at some of the trading activity that occurred in 2020 or 2022. And if we see that there wasn’t rebalancing that was done during those periods of time or there wasn’t tax loss harvesting that wasn’t but could have been done during those periods of time, those are great differentiating points that we can have valuable conversations with clients just so they understand what they’re doing or maybe what they could have otherwise been doing.
John: So, let’s transition over to Roth conversions. How do those impact us positively during times of unwanted volatility possibly, but we can benefit from?
John Baker: Sure. So, Roth conversions are loved by some clients and probably equally hated by others because really what we’re doing is we’re paying taxes now at a known tax rate with the thought, an educated thought, that taxes are going to be higher in the future. So, for example, we actually started working with a client last year up in Fort Collins in Colorado, and he forever and ever as many clients had contributed to a traditional 401(k) and almost all of his investible assets were in a traditional pre-tax 401(k), but he was retired, didn’t have any income and wasn’t yet collecting social security. So, his tax bracket was temporarily going to be very low before he was collecting social security and before he was required to start taking minimum distributions from his IRAs. And so, we actually worked with him last year and helped him come up with a Roth conversion analysis by taking some money intentionally out of his IRA and moving it into a Roth IRA.
Paying taxes on it at a known low rate now will ultimately save him pretty meaningfully in his case relative to if you were to just wait and take those distributions down the road when he was required to or when he otherwise needed to. Doing a Roth conversion analysis is something that we’re also very much so happy to help with. And I think the X variable there is the likelihood that tax rates are going up in the future. There’s not a lot of people that I talk to, John, I’m sure you agree with this, that think that tax rates are going to be the same or even go lower in the future. Almost everybody is of the belief that tax rates are going to be higher in the future. So, I do think it’s important to work with an advisor or partner with someone who’s able to help you think through this Roth conversion analysis because really it can ultimately just translate to paying less than taxes over someone’s lifetime.
John: That’s all fantastic advice. Thank you so much for joining me here today and sharing some of your wisdom on Rethink Your Money.
John Baker: Thanks, John. Happy to be here.
John: I’ve been speaking with Creative Planning and Wealth Manager, John Baker. If you’re not sure where to turn and you have questions about your money and you’d like to speak with one of our local financial advisors like John and myself, visit creativeplanning.com/radio now to schedule your complimentary visit. Why not give your wealth a second look.
Every season of life comes with pros and cons. We tend to, as humans, focus on the cons while in that season. But then once we’re beyond that season and we’re reflecting back, we romanticize the past with fondness. If you have kids, I’m sure you can relate to this, my wife, Brittany and I, before we had children, I mean we were really anticipating the excitement of having kids and growing our family, and then we started having children. And of course it was a huge blessing and we absolutely love having a big family with seven kids and all the beautiful chaos that comes along with that. But it’s interesting because when we had Cruz, our first child, I remembered then thinking, “Oh man, this is great, but I’m exhausted.” The little guy just won’t sleep through the night. And I remember thinking, if this is normal, how do people have more than one kid?
How do they even function? We were like walking zombies with our sleep deprivation, but then he started sleeping through the night and you’re like, “All right, well, once he’s potty trained, that’ll be kind of nice,” and “Oh, it’d be great once they’re a little older and they can travel, a little easier without screaming on the airplane.” Yes, I apologize. That was me ind 22B with the screaming children. And now, Cruz is 12 and we look back on all of his baby pictures and we’re smiling and go, “Man, you were so stinking cute. I wish we could go back and do that all over again. That was such a fun season.” That rosy retrospection is a cognitive bias that causes us to remember past events as being more positive than they were in reality. And so while we romanticize the past and were critical of the present, we often also are anticipatory of the future and how much better things will be than our current circumstances.
I just use the example of sort of the next milestone for your kid that will make life a little easier. But often it’s once I get that promotion, once I have that raise, once we buy that next house or I get the new car or we’re able to get out of debt or whatever it is, and by the way, it’s not bad to be aspirational, it’s not bad to have goals. Those are fantastic. But often once you climb that mountain and you’re standing on the summit, that satisfaction loop doesn’t immediately stop and the irony is you’ll often then begin reflecting back on those stressful times that you weren’t that happy. And during the present, with Rosy Retrospection, my wife Brittany reminds me often, the days are long, but the years are short. So, I would encourage us all, myself absolutely included, to appreciate where you are right now in life.
And where I see this play out in personal finance in particular is when it comes to retirement. If I can get to that retirement goal, the storm clouds will roll away. It’s going to be rainbows and unicorns and man, that is the pinnacle. But I’ve seen a lot of retirees after their sixth round of golf in the last week, sipping there Arnold Palmer, seemingly without a care in the world, reflecting back on how much they actually miss about their younger days. And of course, I’m generalizing here, but what I’ve found to be true is that retirees don’t miss working. They miss the people. 1938, Harvard researchers gathered health records from 724 people around the world and asked detailed questions about their lives at two-year intervals. As participants entered retirement, they found the number one challenge. People faced was not being able to replace the social connections that they had sustained from their work.
In fact, CNBC wrote a follow up to the Harvard study and they titled it, the No. 1 retirement challenge that ‘no one talks about’. And that is a sense of loneliness in many retirees, which leads me to an all new rethink or reaffirm where we will break down together common wisdom from the financial headlines and decide whether we should rethink it or reaffirm it. Our first piece of common wisdom is that retirement is the ultimate end game. I think it’s worth noting the idea of retirement, even that word is evolving because for many decades you would work at the same company for 20, 30, 40 years. You’d get a gold watch and a retirement party. You’d take your pension and your social security and you’d enjoy 5, 10, 15 years of retirement. But now, as technology has changed for many occupations the way that we work, there are far more jobs that offer flexibility while working. A little more work-life balance, as we call it, especially after the pandemic.
And this is why you’re seeing a higher percentage of the working class rather than retiring, dropping down to part-time. Working two or three days a week from home instead of commuting. What that’s doing is delaying for many people their official retirement. But as humans, our self worth is defined by the things that we do and the impact that those things have on others. Del Webb was a one-time co-owner of the New York Yankees, and he later made his fortune in real estate development, including Sun City, the country’s first 55+ active adult community. Webb’s been credited with creating the terms golden years and the golden age and the idea that retirees had earned their day in the sun and should leave work behind. But that is a marketing idea and doesn’t necessarily mean the leisure picture of retirement is for everyone. Again, I’m painting with a broad brush.
Some of you worked for 30 years long hours and you’re like, “John, this is not registering with me. I just rode off into the sunset and have never been happier.” But for many people, retirement is not the ultimate end game. In fact, I engage weekly with clients in retirement who say, “I really miss working. I miss my coworkers, my customers and clients, even my bosses in some cases. I really miss that camaraderie, the teamwork, the utilizing God-given traits that I have and the skills that I had developed and worked hard for toward a bigger purpose.” And so, I think it’s important if you’re someone who is not yet retired and is eagerly awaiting and working toward that, pay attention to what it is you enjoy right now about your work life.
Is there a way to continue to incorporate those things into your later years? Because you’re not likely going to work until 90, and it may make sense for you to retire so that you can have more flexibility. But if you can continue to pull through some of the things that you really appreciate about this season in life, it can be a big assist toward a content retirement. The verdict to whether retirement’s the ultimate end game is rethink. But speaking of retirement, one of the most important services we provide here at Creative Planning is in-depth retirement planning and an analysis of exactly where you stand. Whether you retired 10 years ago, you’ve recently retired, or you’re someone who may retire in the future. Are you on track? And what would your retirement look like from an income standpoint? If you are not sure where to turn in, you’d like those questions answered by a fiduciary that’s not looking to sell you something, visit creativeplanning.com/radio now to request your complimentary visit.
Next piece of common wisdom, if you are responsible for someone financially, you need life insurance. I’ll post an article to the radio page of our website on specifically the questions to ask when choosing a life insurance policy. But while in some cases we detest the idea of needing to pay for insurance or that we’re going to be sold insurance, risk management is one of the most important aspects of a well constructed financial plan. I mean, you can do everything right from a tax and an investment and an estate planning standpoint, and then you have some tail risk event occur that derails the entire otherwise well-built plan. And life insurance in particular is something that none of us want to think about, but if you want to protect your family, you need to have the appropriate policy in place so that they’ll be okay if something were to happen to you.
I would start by asking four questions. Number one, how much life insurance do I need? It’ll depend on exactly what you’re trying to accomplish. Three of the top reasons for purchasing life insurance would be to pay off debt, mortgage, student loans, those are both common, to support minor children and then potentially even get them all the way through college, and to replace lost income for loved ones who are depending upon your income, that would obviously cease if you were to pass away. So, after you’ve answered the question, how much life insurance do I need? The second one would be, how long will I need the insurance funds to last? And again, this answer depends on what you ultimately hope to accomplish with the funds. Because for debt, you’d simply match the term of the life insurance policy with the year you expect to pay off your debt. And for income replacement, it may just be exactly the amount of years before you plan to retire.
Question number three, how much should I be willing to pay in premiums? As a general rule, you can expect to pay 5% or less of your household income. However, the actual premium for coverage varies greatly based on your health and your age. The younger and healthier you are, the lower the premium will be. Fourth and final question, should I consider buying permanent life insurance? At Creative Planning, we typically do not recommend permanent life insurance. We believe insurance should be used for insurance, and investments should be used for investing. A rare exception to this rule may apply to high net worth families with mostly illiquid assets. And so, the verdict on the common wisdom, if you are responsible for someone financially, you need life insurance. That is absolutely a reaffirm.
And our third and final piece of common wisdom, the uncertainty around the banking sector has made crypto an important piece of your portfolio. Now, while there is some anecdotal evidence, crypto received an adrenaline boost from the SVB and banking crisis. You can’t ignore the extraordinary volatility this has shown over the last two years. Creative Planning President, Peter Mallouk recently spoke about this on his podcast, Down the Middle.
Peter Mallouk: Here, there seems to be a domino effect of one bank happening over the other, but we really have to segment this out into four different categories. So one, we have an issue with crypto banks. Well, that’s because most crypto, as we’ve been saying from the beginning, is totally worthless. Somewhere between 99% and 100% of all cryptocurrencies are going to zero. And as we started to see that unfold, we’ve seen so many of them go to zero or even the top 10, many of them go down 90%. Some of those banks are failing, some of them committed fraud, some just have been trading in crypto themselves and suffered.
John: And I couldn’t agree with Peter’s assessment more. Just look at the level of volatility in particular with Bitcoin over the last five years. November of ’21 through November of ’22, Bitcoin lost 77%. April ’21 through July of ’21, Bitcoin lost 53%. June, 2019 through March of 2020, Bitcoin lost 62%. May of ’18 through December of ’18, Bitcoin lost 67%. Now, if you want to put 1% or 2% of your portfolio an amount that you are fully willing to lose and can afford to lose as a speculative flyer, go for it. But the verdict to whether the banking uncertainty has made crypto an important piece of your portfolio, that is a resounding rethink.
It’s time for listener questions. If you’d like to submit a question for me, email those to [email protected]. Steven in Peoria, Illinois, asked, “My daughter is graduating college this June, but has never taken an economic or finance class. She really doesn’t know anything about personal money management, investing or budgeting. What advice do you have for educating adult children who are about to enter the workforce?” Well, this is a great question, and I have personally gone through this with our 21 and our 19 year old. One of the things that was interesting in that process for me, when we adopted them from Ethiopia at ages 11 and 9, we had to shift our expectations quickly in terms of where they were at academically because, believe it or not, school costs money in rural Africa. And since they couldn’t afford it, they had not been to school.
And so, why would we expect them to know any English or how to read and write even in Amharic, their native tongue, if they’d never learned it? And the same is true sadly in America when it comes to personal finance. Most even smart, well-educated teenagers in America have very little, if any, education, around personal finances. So, that’s the first thing worth noting, Steven. This is common. AIG Retirement Services conducted a research study where they surveyed 30,000 college students and 35% of respondents reported never having taken a personal finance course, 47% felt unprepared to manage their money. The key is starting simple, so you don’t want to overwhelm them. But here are the six kind of general items I think are important. Number one, help them understand and make a budget. A super simple and useful tool. If they’re tech savvy, like almost all college students are today, there are plenty of apps that will track either their credit card or their bank account and sort where they’re spending money.
Secondly, build a safety net. Have them open up savings account at their bank to be used as an emergency fund. Having a safety net will let your child potentially leave a dead end job that they’re not happy with or an unsafe living environment without having to worry how am I going to pay bills? Ideally, this would be six months of their expenses. Number three, help them understand taxes. Teach your child about deductions, credits, withholdings, social security taxes, filing dates. It might even mean once during the year you’re discussing some of their tax situation with them. Then help them file if they’re going to use TurboTax or if their situation’s a little more complicated. Steven, if your daughter gets a good job and is receiving stock options and things like that, which isn’t common for a young 20-year old, but if she is and she needs to go to a CPA, I would go with her the first couple of times assuming that she wants you to and help ask and answer some of the questions that are pertinent.
Number four, maximizing employee benefits. For someone graduating college, understanding their employer benefits may be a factor in which job offer they ultimately select and then maximizing those benefits is also incredibly important. Number five, talk about how to manage her debt. One in six students have already taken out loans to cover their tuition bills, and only 65% of borrowers think they can pay them on time. One in three students with credit cards have already amassed more than a thousand dollars in debt. There is nothing more oppressive that will derail the potential for greatness financially than carrying debt.
And number six, invest wisely. Help your daughter understand the basic principles of investing, not only where to invest, but how to invest, how much to invest, and how to do that within the context of a broad overall strategy and plan. Sometimes for a college graduate, the idea of how much they’ll have at 65, I mean, my two boys go, “Dad, I’m 65.” I mean, that’s a forever from now. That’s not very motivating for them. But building a plan that balances some of their short term goals like buying a home, getting a new vehicle, taking a vacation with friends, in addition to broader long-term retirement goals can be very helpful.
So again, the six steps. Make a budget, build a safety net, understand taxes, maximize employee benefits, manage debt, and invest wisely. And if this seems like a lot, Steven, we will gladly sit down with your child and build them a financial plan, and we will help answer all of these questions for them. And we’ll be a resource and a contact for your child even if they are just getting started in life. We have an office right there in your area. Steven, if you have more questions or would like us to meet with your daughter, you can request that by going to creativeplanning.com/radio.
Gary B in Indie asked, “I’ve gotten into dividend investing recently, but don’t fully understand the difference between ordinary and qualified dividends. I want qualified dividends because of the preferential tax treatment. How do I assure that I’m getting qualified dividends?” Ordinary dividends are taxed at ordinary income rates, where qualified dividends are taxed at the same rate that applies to net long-term capital gains, which is no more than 20%. And a qualified dividend can be reported to the IRS as a capital gain rather than as income. A qualified dividend needs to be a US company or a foreign corporation in a country where the US has a favorable tax treaty, and you must hold the stock for a 61-day period or at least 60 days prior to the dividend. The pros of qualified dividends are obvious, they’re taxed at a lower rate. You can receive qualified dividend tax treatment for stocks held inside of mutual funds or ETFs and dividend payments provide cash flow without having to sell the stock.
So, those are some of the benefits. Some of the cons, you must meet the holding period criteria. If you’re earning this dividend inside of a retirement account, those dividends are going to be subject to ordinary income tax rates when you take a distribution from the account. So, you’re not benefiting in any way there. And if you’re a high income earner, you will need to pay the 3.8% net investment income tax just as you do on top of other long-term capital gains. But the more broad con of investing entirely into a dividend heavy strategy is that oftentimes, unless you’re using all the dividends for income, it’s less tax efficient than a total return strategy because even if they’re taxed at qualified rates, you’re paying tax and then reinvesting the net difference versus leaving it all inside of the portfolio. And the other broad con is that you are limited to only dividend oriented stocks, which often removes big slots of some of the best stocks that are more growth oriented from your portfolio. So, you tend to not be as well diversified when focused primarily on dividends.
Kristen in Houston, Texas, asked, “I’ve recently been trying to clean up my finances, especially for identity theft when it comes to all my open credit card accounts. I’d like to close out some of the ones I do not use, but it got me thinking, is this a good or bad thing to do?” I think I butchered reading that question, Kristen. Really what you’re asking is how do making these decisions impact my credit? So, let’s unpack this. Your credit utilization ratio makes up 30% of your entire FICO score. So, it’s a calculation of how much you owe compared to your total credit limit. The ideal cure number is 30. Another factor on your FICO score is the length of your credit history, and that accounts for 15% of the total score.
And so, generally speaking, when does it make sense to keep a credit card? I’ll just throw out some of the examples that come to mind. Your credit score’s right on the edge of a good credit range and you don’t want to risk dropping it. Your score’s already pretty good. You can obtain credit when you need it, and you don’t want to disrupt that. Maybe you plan on applying for a mortgage and you don’t want to risk having your credit score drop. Maybe it’s at your account’s, one of the oldest ones, and it will shorten the length of your credit history. Now, here’s when I think you would want to close a card. You’re having trouble using credit cards responsibly, you’re missing payments, you’re going into debt, you’re worried that you’re not going to be able to pay them all off. Maybe you have a retail card from a specific store, you don’t use it anymore, you don’t shop there.
So, getting a 5% discount or a 10% discount is irrelevant. Maybe you have a premium credit card that charges a high annual fee and that card no longer makes sense for your lifestyle, or you found lower interest rates elsewhere and the card that you currently have retire. Our last question comes from Marianne. Not sure where this is coming from, but she asks, “I have a friend who just recently lost her husband. She has a supportive family around her, but is still struggling with both the emotional steps and practical steps she needs to take financially. I would like to help her. In your opinion, what’s the first step you should take when your spouse dies?” Well, first off, Marianne, I’m very sorry for your friend’s loss. And the first step is to not do anything. The number one recommendation that I have for widows is to not make any large decisions.
Certainly don’t make any financial decisions that lock up money. I will post to the radio page of our website an article that I wrote middle of last month, specifically on this topic. Financial considerations for surviving spouses. In that article, I outline who your friend needs to notify, what sort of access she needs to various financial accounts and insurance policies, how she can evaluate her current financial situation now that it’s a different, and what are the less urgent tasks that long-term she’ll want to take care of, but that don’t need to cloud her decision making and cause her more stress in the short term because they’re not as mission critical and time sensitive.
More than anything though, Marianne, your friend, needs to find a trusted financial advisor that’s, again, not looking to sell her expensive products or lock up her money, but actually do planning for her. Now, of course, I’m biased. It’s like this is not an all roads lead to Creative Planning, but an advisor or a firm like us here at Creative Planning who can help walk her through all of these things. But I appreciate the question and it’s fantastic that you’re looking out for your friend wanting to help in any way you can.
And if you have questions like Steven, Gary, Kristen or Marianne, email those to [email protected] to get answers. And of course, you can visit creativeplanning.com/radio to schedule a complimentary visit with a local advisor just like myself here at Creative Planning. This past week, I heard Jonathan Clements, our director of financial education on an interview that he was doing for Morningstar, and he mentioned something around return on investment and how often we’re only focused on the monetary side of things rather than the more compound impact of other life decisions we choose to make with our money and are reflected on my own life. And I can honestly say that the best returns, so to speak, that I’ve ever received on my money were the decisions that I made investing in life.
I started thinking about our four adoptions, our decision to buy a cabin as a family where we’ve made so many incredible memories, our decision to buy a 12 passenger van so that we can take road trips. Choosing to have another three kids. I mean, any parent knows kids are expensive by most measurements, over a quarter of a million dollars just to get them to 18, per kid. All of those decisions from a financial perspective were terrible. I mean, it could have so much more money at retirement, but of course I would choose a hundred times out of a hundred to repeat all of those things again. But I don’t look at those decisions as poor investments. Sure, I’ll enter retirement and die with a lot less money, but how else could I have allocated those resources to a more meaningful part of my life than investing in family?
And for you that might be similar, it’s children, but it may be in friendships or in relationships with siblings. But I think it’s worth considering compound interest. And I don’t mean compound interest in the traditional sense when it comes to our accounts. If I tell you to add five plus five plus five plus five, nine times, you fairly quickly figure out the answer is 45. If I tell you to multiply five times, five times five, nine times, it’s just under $2 million.
You see the ripple effect of compound interest is difficult to quantify. And I want encourage you, you’re not failing to invest money when you choose to direct your resources toward relationships because you’re actually investing it for compound growth with a far longer time horizon than the 30 or 40 years that your 401(k) will have. It multi-generational. And the ripple effect is far broader and wider than anything you’ll ever see and possibly even ever dare dream. And so, when you reflect on finding financial freedom just to understand that it is a winding path to finding that. And along the way, some of the detours that you take will provide you with bigger returns than you could have ever imagined. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode you can subscribe to Rethink Your Money wherever you get your podcasts.
Disclaimer: The proceeding program is furnished by Creative Planning, an SEC registered investment advisory firm that manages or advises on a combined $210 billion in assets as of December 31st, 2022. John Hagensen works for Creative Planning and all opinions expressed by John or his guest 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. It 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 for 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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