Don’t let the lazy days of summer influence your investing! When you’re smack dab in the middle of what’s historically the best-performing stretch of the year for the S&P 500, there’s no time to relax. Join me on this week’s episode, where I remind you how to stay engaged with your plan throughout the summer and also welcome back Creative Planning Chief Investment Officer Jamie Battmer for a second quarter market update.
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 your host, John Hagensen, and my mission is to help you make smarter money moves. On this week’s episode, I’m reminding you to stay engaged with your plan amidst chaos and noise that inevitably ensues in the marketplace. Neglecting to do so could prove detrimental. And welcome back Creative Planning’s Chief Investment Officer, Jamie Battmer for a quarter two market update. Now join me as I help you rethink your money.
About 10 years ago I made a big move in my life, I bought my first tailored suit. Now, no, this wasn’t $3,000, it wasn’t even $500 but it looked a whole lot better than the off the rack suits that I had been wearing where I looked like I was wearing my dad suits, a little baggy in the midsection. It certainly didn’t fit my build well. And if you’ve ever had a tailored shirt or maybe a dress for a wedding or a suit, like in my case, and you look in that 360 mirror you think to yourself, I clean up nice. This does look a whole lot better than what I was wearing before. Financial planning is similar in that it is not one size fits all, we’re all different. Different backgrounds, different goals, different social aspirations, and family dynamics, different health conditions, lifestyles. Yet most financial advice offered is broad, it’s generalized.
By nature, even this show, Rethink Your Money, I offer generalized ideas because I don’t know all the thousands of different specific situations for each listener, I don’t know everything about you. But you should take the information that you hear on this show or listen to elsewhere or read and run it through the filter of your customized, personalized financial plan. For example, general advice may be to never put something on a credit card, or avoid borrowing from your 401(k). Those are general rules that are good. But if you have a child with a life-threatening illness who needs treatment, that’s not covered by insurance and it’s more than your emergency fund, you’re going to eat into 100% of your retirement funds, you don’t care that there’s a 10% penalty. You’re going to take on as much credit as you can possibly obtain. I mean, shoot, if this were me I’d be panhandling on the street doing whatever it took to pay for as many treatments as needed. But you’re not going to hear that advice on a radio show or in a financial article.
You hear, when you’re young, you shouldn’t own bonds, but maybe you need distributions from your portfolio because you just lost your job unexpectedly and you don’t plan to get another job for two years, you need to draw down the portfolio. Well, you should probably have some bonds in there. Maybe you’re in the top tax bracket. Theoretically you should be deferring in your 401(k). But you know your situation and that your pay is actually going to go up significantly in the coming years from even your current high wages. And so maybe you eat the 37% and direct it to the Roth side of your 401(k) because you believe taxes are going to go up with over $33 trillion of national debt in the future and you know your income’s going up.
How should you spend your money? How should you save your money? How should you invest your money and give away your money? That’ll be different for you than for me. Financial author Morgan Housel stated that the majority of financial debates are not actually people debating with each other, they are individuals with different perspectives and situations talking over each other. It can be uncomfortable to allow for the space of nuance. It’s easier to put things in little boxes and create black and white rules but that’s not life and that’s not personal finance.
Housel asked five questions that I want to ask you now. Number one, who are you trying to emulate that you shouldn’t be? Are you playing your own game when it comes to your money or someone else’s? Dave Ramsey famously said, “We buy things we don’t need with money we don’t have to impress people we don’t like.” How much would your personal finances change if you stopped considering social comparison or others’ opinions? Remember, what other people think of you is none of your business. Maybe you grew up with a car that broke down constantly and you were late for practice. And when you made it there on time you were embarrassed to pull up because you were in such a beater. Well, then it would be understandable if you wanted to buy a really nice car, once you could afford it, in adulthood.
Maybe your childhood was the opposite. You were embarrassed for different reasons because your parents dropped you off in a flashy car that they were leasing and couldn’t even afford. And then you heard them discuss how tight money was and argue about money, or tell you you couldn’t go to summer camp because they couldn’t afford it behind closed doors. While your friends told you, “Man, it must be so nice to be rich. Dang, your parents are loaded.” So now even though you’re making a million dollars a year and could afford two AMG Mercedes tomorrow and not have it dent your finances, you’re driving a 13-year-old Toyota Camry with 200,000 miles and you plan to drive it another five years. Remember, your view of others is likely only a small sliver of the total picture and also a pretty inaccurate view of their life.
Have you ever met someone in real life that you followed on social media? You had a couple of thoughts. One, they don’t look anything like their airbrushed filtered pictures. That’s pretty interesting. Two, I thought they were happy. Wow, this persona that myself and anyone else who follows them in the fake world of social media sees is nothing like their reality. Be careful trying to emulate someone else’s highlight reel. Number two, who has the right answers but you’re not listening because they’re not compelling or articulate? The counter to that is, who do you listen to simply because of good marketing and a dynamic personality?
As a certified financial planner and partner at Creative Planning, as well as a national radio host, I’m confronted with this quandary often. I’m trying to be interesting and provide valuable information that is helpful for your personal finances but the right advice is usually pretty boring. Sometimes it’s a challenge for me with this show because it’d be a lot easier for me to spout things that I don’t believe to be true. But man, they are sure interesting, and they catch your attention, and they scare you, and they worry you. And man, I better contact Creative Planning because I’m going to be in trouble if I don’t.
But I will not do that. They’re the hardcore scams like Ponzi, the whole scheme is named after, as well as Bernie Madoff’s notorious $65 billion fraud. But there are many other subtle deceits that come from very compelling messages. These sorts of backroom deals are commonplace. Are they giving you a full breakdown and understanding of that when you go to meet with them for a second opinion on your life savings? Almost certainly not. Yet it likely distorts the objectivity of their advice dramatically. So again, I ask question number two, who has the right answers but you’re not listening because they’re not articulate?
Number three, what haven’t you experienced firsthand and therefore are naive to? How much less judgy would you be of the President of the United States, or maybe even just smaller scale your boss if you had to do that job for a year? You’d certainly gain an appreciation and probably a better understanding of the challenges that are faced within that job that maybe you just didn’t understand prior, didn’t have perspective on. In the same vein, which of your current views would you disagree with if you were born in a different country or a different generation? And every generation thinks that the younger ones are nuts but they’re experiencing a different time in society, a different economy, different politics, different technological advancements. But this is why the saying exists, “Oh, kids these days.”
Have you ever shifted your views after experiencing something firsthand? I know I have. Homebuilders in America are a perfect example. Why have we had so few houses built the last 15 years? Because home builders experienced the great financial crisis where home prices fell 40 or 50% in certain markets and they don’t want to get out over their skis because it was painful. But those who hadn’t experienced in the early 2000s were “Let’s build away, overextend” because they hadn’t experienced it firsthand.
Number four, what do you so desperately want to be true so much so that you think it’s true when it’s clearly not? And this can, in some cases, be driven by incentives. Which of your current views would change if your incentives were different? My pet theory is that sales on high commission annuities and permanent life insurance would drop by 95% if the commissions went away and instead the advisor just charged, let’s say, 1% per year exactly as they would on a stock or an ETF or a mutual fund. Meaning they got paid no differently if they were doing insurance or managed money. They wouldn’t be slinging these high-commission insurance products. So what are you potentially ignoring when it comes to your money, or maybe your life more broadly, that you want to be true because it’s too painful to accept it not being? What do you believe today that will be obvious a year or 20 years from now as being so obviously wrong? This is why I advocate you meet with an advisor, you have guidance because a good advisor will expose some of those biases and hopefully help you overcome them.
The fifth and final question to ask is what has been true for a long period of time but will eventually run its course? Think brick-and-mortar retail dominance. It was the case until it wasn’t. Economic supremacy of the United States seems to be here, never going to change until it will. Look at Japan. 30 years of their market going absolutely nowhere. Look at the Soviet Union. Once a power, gone. Of course, we assume that couldn’t happen to us but it absolutely can. These five questions either come with no answer, but they’re still worth considering, or an answer that is really difficult to find. I encourage you though to ponder them with humility, reflect on them because there are plenty of lessons to be learned and they’re unique to you. Personal finance simply isn’t a one-size-fits-all.
It’s a real privilege to talk markets, the economy with the chief investment officer of a firm managing or advising on a combined $300 billion. Jamie Battmer leads investment research and strategy efforts for both private and institutional clients. Here at Creative Planning he has more than two decades of experience analyzing investments, constructing portfolios, and providing economic and market commentary. Jamie received his bachelor’s degree from the University of Montana and his master’s from the London School of Economics. Thank you for joining me on Rethink Your Money, Jamie.
Jamie Battmer: Hey, John, thanks a lot.
John: We’ve had large-cap dominance now for going on almost 15 years. I think a lot of folks are waiting for a rotation wondering if small caps are dead, if value’s dead. How do you think about diversification, Jamie, when talking with investors when one asset category, and frankly the most noteworthy asset category that everyone pays attention to, continues to outperform?
Jamie: Yeah, that number works out really well, 15-year outperformance. It’s actually outperforming by about 15% year-to-date as well-
John: Wow.
Jamie: And that makes it even that much more difficult emotionally to hold the line. Over the long run, there will be a reversion to the mean. We don’t know if it’s going to start tomorrow or be another 15 years from now. It makes it challenging when one asset class is just so dominant. Now, it’s beneficial that is probably the largest individual exposure people have, how we manage portfolios. Yes, you have large-cap stocks or the largest constituent, the overall market. And so people say, “Do I own Nvidia?” Yes, you do it’s a part of this. Before Nvidia, it was Cisco. That was the last time we had this type of relative outperformance for large cap versus small caps. And then when that reversed itself, really just over the next seven years, small caps outperformed by essentially 100%. You have to stay diversified. It’s just that much more challenging when there’s such one hot dot out there.
John: Not only has it been now a very long run of overperformance but it’s in the one asset category that people think to themselves well, I could just buy the QQQs or the S&P and look at my performance the last 15 years.
Jamie: That fear of missing out, FOMO dynamic, that you see, it’s domestic. That behavioral dynamic we all have, that angers us just a little bit more.
John: It almost feels more like an unforced air, right, than when some obscure, in their mind, asset categories outperforming. It’s well, I wasn’t going to have 40% in emerging markets that just went up 400% in a decade. I don’t feel like I missed out because, of course, I’m not going to invest that way. But when it’s the S&P, oh, well, I could have just owned this the last 15 years, look at how well I would’ve done.
Jamie: That’s a real common mistake people need to try and avoid, greed-driven decision-making, trying to chase that hot dot.
John: So is now the time, Jamie, to tilt more toward large US growth? Because that’s what investors are doing if you look at flows.
Jamie: Sorry, I keep using the term but they’re chasing the hot dot. Should it continue to be, if you’re broadly continuing to invest, yes, but your allocation, your funding should still be broadly diversified as well not just chasing that. As you mentioned the lost decade, that full 10-year period where we didn’t earn anything for the S&P 500. And emerging markets, as the example, we’re up 400%. Everyone was saying, “Oh, put all your money in emerging markets, that’s the future.” They were just chasing the recent returns. And yet you should still be allocating some of it to that. But think about it, John, everyone is pitching the bricks. Imagine walking into a client meeting right now and say, “Brazil, Russia, India, China.” You can’t even invest in Russia anymore, just how much it’s changed. And so that was just such a sales narrative that sounded good, that people listened to that siren song the decade before. You have to tune it out just like now and not be chasing.
John: Could run another five years, it could run another 10 years, it could rotate tomorrow, and that’s the key to diversification. There have been plenty of periods that you and I know of, especially that last decade, where you can have 10 years where you make nothing. And it seems like that’s such a implausible scenario but we’ve seen it multiple times.
Jamie: The key was let the empirical data in academic research drive decision-making. To your point, John, it feels safe. Actually, the data would say, after something hits its crescendo, after it goes to the top, you’re actually going to underperform the broad markets over the long run. Nvidia just blasted to the top of the charts, the largest company in S&P 500. There have been 12 different market leaders, the number one dog in the S&P 500 over the years. Several names you wouldn’t even recognize. Cisco was that example when they blew to the top of the charts in the last tech mania. But the data says you typically underperform after you hit there. It’s like the Sports Illustrated jinx. It’s not that you’re doing that terrible, it’s just you did so great to get on the cover that now when there’s that inevitable reversion of the meme, oh, you underperformed. Well, no, it just happens.
John: Expectations get so out of whack there’s no question about that. Let’s transition over to interest rates. How did everyone get this so wrong, Jamie?
Jamie: Well, another core tenet of how we look at the investment world is we don’t try and pretend like we can foretell the short-term future. The Federal Reserve came into 2024 saying, “We’re going to lower interest rates three times.” Well, they were wrong it hasn’t happened yet. But then all the experts, the Wall Street top economists they said, “No, no, no, they have it wrong they’re actually going to have to do it six or seven times.” So essentially the Federal Reserve said, “We have a crystal ball.” And then these Wall Street starters says, “Oh, no, we spend a lot of time analyzing crystal balls so we know it even better.” No, the future forever remains unwritten. The economies remains stronger than people anticipated.
That in turns read to inflation staying a little bit elevated. But it didn’t have to lower rates because no one knows what’s going to happen in the short run. Over the long run, the data works out. Diversification, the rebalancing, the tax harvesting, that works out over the decades. We measure success in decades, not days, not quarters. And everyone getting it so wrong is an example of that with interest rates.
John: I remember speaking with Creative Planning President Peter Mallouk on this a while back on the show. When I asked him, “What’s the number one mistake? You’ve written a book on the five mistakes.” And he said, “People being creatures of the moment, not zooming out enough in the midst.” Because investing is over a lifetime theoretically. What happens in our lives over six months or a year, that doesn’t feel like a short amount of time in our lives a lot can happen. You can get pregnant and have a baby and all of a sudden have a newborn and it’s a year later. In the investment world that’s nothing but in life a lot can happen. And so reminding ourselves we have to take a long-term approach and not be creatures of the moment. Jamie, let’s transition over to inflation. It’s still a little high. Can you give us a lay of the land?
Jamie: The economy has continued to surprise to the upside. And so that in turn means people have still been able to spend more money and so inflation has remained a little bit elevated. Focusing on the long term, the trend is still very, very positive.
John: It is.
Jamie: The overall inflation rate has come down dramatically. This actually reversed itself about a year ago. Wage growth, wage inflation is outpacing overall inflation. For a while, the early innings of inflation, inflation was going up faster than wage growth. Wage inflation is still net positive. And so even though yes, the cost of bacon is going up, your ability to buy bacon is going up more. That’s a positive dynamic. But more importantly, yes, a little bit elevated. But the trend line has been moving down and we see that. People that freak out month over month, it’s that short-term thinking we try to avoid. So the trend is still positive.
John: Prices are right in front of us every single time we go to the grocery store but yet we seem to underestimate and underemphasize the fact that our wages have gone up. Maybe because it’s a direct deposit and some of it’s withheld for taxes and some of it’s heading out to our 401(k), and we’ve absorb that and take it for granted. And then look at prices and say, “Prices are still so high.” “Well, yeah, you’re up 20% on your wages.” “Oh, I guess that’s true.” Is that just human nature? And why do you think that is?
Jamie: The sign for gas is right in front of us, we drive past that 10 times a day. You’re going to the grocery store on a regular basis. Like you said, it’s always right in front of us. A well diversified investment portfolio, it’s going up, it’s inflating at about a 10% annualized rate but you don’t see that in front of you all the time and so it’s a specter. When you have these dynamics, when you make more money, that’s when you have to pay yourself first. We’re all creatures of habit. And so let’s say you get a raise, that’s the time to increase your 401(k) contributions or your Roth IRA contributions or whatever’s right for you because then it’ll just go somewhere else and because life happens. It’s just the fact that that’s in front of us versus the long-term benefits of prudent investing that are compounding vastly, vastly, vastly higher than the overall inflation rate.
John: An effective way to continue to increase your savings and crush your long-term goals is every time you receive a raise I encourage clients to take half of it, enjoy it, include it in their lifestyle, take the other half and add it to all of their savings. So now you’re feeling the benefit and the effects of the raise and enjoying it in the short term, not pushing everything off for 30 years down the road. But if you do that, all of a sudden you look down 15 years later and your savings rates 25% plus you’re living a better life. Because we all know once you have that raise and it gets absorbed into your everyday lifestyle you take it for granted and you don’t really think of it much anymore. It’s like the garage, right, you just fill it. You go from a two-car garage to a three-car garage. You look up a year later and you’re like how do I have all this stuff in here? Why can I not park all my cars in the garage now?
Jamie: The key is when your pay changes that’s when you look at things. When you have a child that’s when you look at things. When you get married that’s the time to really say, “Okay, am I right?” Not looking at okay, what’s going on with interest rates? What’s going on in the Ukraine? What’s going on with the elections? Those are those decision points. And yet if you can make the prudent decisions now, the compounding benefit over the years is extraordinary.
John: What do you see as the state of the consumer right now, four years past the height of the pandemic, the stimulus, inflation? Now it’s come down as we just spoke of. How are consumers doing?
Jamie: Surprisingly strong. And that’s what really caught the Federal Reserve off guard, caught all these Wall Street strategists off guard is that the consumer is the engine of the overall economy, it’s about 70-plus percent. You and I as consumers have continued to spend.
John: Nobody lost their job. Not employment, right?
Jamie: The jobs market’s still very strong. It’s oftentimes too focused on one side. Yes, interest rates are higher but there’s a lot of people that don’t carry any debt so they’re actually benefiting from the higher interest rates. Total invested income is at the highest level ever year-to-date because people are making 5% on investments that they were making about half a percent before. They always talk about housing’s unaffordable, mortgage rates are high. Well, 43% of houses have no mortgage attached to them so that doesn’t impact them.
John: And many of the others are locked in at 3.5% or lower.
Jamie: The average effective rate on mortgages right now is about 3.5%. So yeah, someone waiting to buy a home that’s a challenge. Oftentimes they only focus on the negative side of the ledger. Where there’s actually this element that’s actually benefiting from higher interest rates that doesn’t have a lot of debt and they’re using that to advantage. And so that’s helping to continue to spur the consumer forward. All-time high airport traffic. The consumer is still being the engine of the overall economy. We take that as a very, very positive thing.
John: My family just came to visit me and they all almost missed their flight going out of Sea-Tac because the security line almost took two hours. And my dad told me he’s never seen Sea-Tac busier in his entire life. And, obviously, that’s a small sample size and anecdotal. When you look at the data, that’s happening across the board. If you have no debt, to your point, or the only debt you have is a fixed-rate mortgage at 30 years, high inflation is eating away at that payment making it easier. To your point, you’re making a lot more money on fixed income, and money market investments, and CDs. The difficult part I think for inflation is everyone’s personal inflation rate’s different. High inflation, like we’ve seen, tends to hurt those that really require a lot of credit. The lower quintile of the population is who’s hurt the most. To your point, if you’re wealthy you don’t mind high inflation. You already own assets you don’t require debt.
Jamie: Exactly. It really depends on your unique situation. And that’s why we’re a planning-led organization. If you’re listening and you have a lot of credit card debt you’re paying a high interest rate on, you should really be looking at that. Maybe you don’t contribute to your 401(k) momentarily to help pay that down. Everyone’s circumstance is different. It’s a shame that it’s hurting people that typically don’t have as much assets. But that’s why you have to look at everything customized to where you particularly need the help. And so those paying minimums on credit cards should maybe focus that for the time being. Get that squared away and then start redeploying that towards investments. So it really depends on everyone’s unique circumstances.
John: Jamie, thank you so much for joining me on Rethink Your Money.
Jamie: Hey, John, thanks a lot.
John: An apple a day, that’s right, keeps the doctor away. We’re all familiar with this term. It’s a common wisdom because it’s true. Now, it’s not entirely true in the sense that if you eat a Granny Smith seven days per week but get four hours of sleep, drink a six-pack every night, have high stress you’re probably not keeping the doctor away. This same conventional wisdom exists within personal finance as well. Truths that are mostly correct but worth exploring a bit deeper because there are nuances that we should rethink. The conventional wisdom that the best place for you to save money for retirement is in your retirement plan, it’s clearly in your 401(k). That’s one of these that’s mostly true like the apple a day.
I’ve recently met with two prospective clients who came from this very radio show. They contacted us by going to Creative Planning.com/radio just like you hear me mention each week, and their similarities were striking. One in their early 50s, the other in their late 40s, both wanting to retire in their mid-50s with an early retirement. Both had done a fantastic job saving a little over $2 million of portfolio assets so in a really good place. Considering that they didn’t spend a whole lot of money they were well-funded for retirement.
But both of these couples had the same hole in their plan. Almost all of their money was saved in deferred retirement accounts. In both cases inside of 401(k) plans. They had done a really good job over the last 20-plus years reducing their taxable income. Not eliminating it though just deferring it, asking the IRS if they could claim that income later. In fact, one had all but $40,000 in deferred retirement accounts, the other had about $90,000 in outside accounts beyond what they had saved in their company retirement plan. So on paper they had enough money to drive income but a lot of complications getting to it which is why you should rethink the idea that your company retirement plan is the best place to save money.
Now, you can contribute $23,000 per year into your 401(k). If you’re 50 or older and you have that catch-up provision, save $30,500 per year. So I met with a lot of people like these folks who, unless they were saving more than 23,000 or the 30,500 all of it was going into their retirement plans. And if you’re married it was 46 grand or 61,000 before they ever started saving in other types of accounts. And this put them unnecessarily in a difficult situation from a liquidity standpoint, from an access standpoint. So once you’ve determined how much to save for your needs and your goals, meaning you have an actual written, documented detailed financial plan in place. But then most people’s next consideration is what to invest in. So they’ve got a good plan, they’ve determined they need to save X amount per year. Should it be stocks, bonds, real estate, large-cap, small-cap, growth, value? What should that asset allocation be?
That’s actually not the correct next question. No, the next question after building out your financial plan and determining how much to save is not what to invest in but rather where to invest. And for most that’s not entirely into tax-deferred 401(k) accounts. Now, there are some pros to investing in your company retirement plan that is a guaranteed 100% return on your money which no other investment certainly can offer. Day one you put a dollar in and day two it’s worth two. Absolutely take advantage of that company match. But that may only be on the first 3% of your salary. So if you’re making 100 grand, the first 3K into your 401(k) yeah, it goes to six.
But the real question is, should the next 20,000 of your contributions also go into that deferred side? You also receive tax-advantaged growth. If you’re a high-income earner, deducting those contributions and potentially getting you underneath high brackets can also be a big advantage to retirement plans. As a result of the Trump tax reform, being lower than they’ve been in decades. If you’re married filing jointly, you have to be making over $370,000 a year before you jump out of even the 24% bracket. So even relatively high-income earners today are not in a high tax bracket. So it might make a whole lot of sense to yes, fund that company retirement plan but the Roth side of the plan rather than deferring the income to a later date.
The cons are that you often have limited investment options. Now, certain big companies are offering a more open architecture 401(k) plan which also allows you to potentially reduce fees. The old-school plans were limited with high-cost investments. Deferring money into a 401(k) subjects you to required minimum distributions. So post ’73, you’re required whether you need them or not to take distributions and pay tax which speaks to that lack of tax flexibility. And as I mentioned, of those two prospective clients, your liquidity can also be very limited. If you need distributions prior to a normal retirement age you’ll be subjected to 10% penalties on top of the income taxes.
And there’s one more cherry on top of the sundae and I’ll frame it as a question. Do you expect taxes to be higher or lower 20 years from now? If you think they’ll be higher it’s just one more reason to rethink the notion that the best place for you to invest and save for retirement is clearly in your tax-deferred 401(k). If you’re wondering if you’re saving in the correct places … Forget what you’re invested in or how much you’re investing, I’m talking about where you are investing.
My last piece of common wisdom, we’ll rethink today, is that paying your mortgage off fast or paying cash for your home is a smart financial move. I already know that Dave Ramsey and Suze Orman disciples, or those of you that hate debt of all kinds at all costs are ready to turn me off or at least tune me out. But you don’t need to because I get it. There are reasons to pay cash for your home or pay it off early in certain situations.
I’ll give you a few examples. If you are a bad investor, I say that lovingly, or aren’t an investor at all, you just keep all your money in cash and CDs or almost entirely in bonds, then paying off your home quicker or paying cash might make sense. If you’re paying four or 5% interest on your mortgage and you’re only earning one or 2% with your liquid investments, yeah, you’re crazy not to pay it off. You’re certainly paying more in interest than you’re earning on those dollars. Maybe your mortgage is at a high interest rate. You bought recently and your mortgage is 7.5%. I think paying that down quicker may be justified or making a larger down payment or not financing it might make sense. That’s a whole lot different than paying cash or double paying on your mortgage when rates were at 3%.
Another reason to pay it off is maybe that your number one priority isn’t maximizing your money but rather simplifying to the extreme. If you told me, “John, I know that I’ll have less money 20 years from now but I just really don’t want to have a mortgage.” Great. As long as you’re aware that you’ll likely have less money and you’re okay with that. Maybe you grew up in a home that was buried in debt and it created a lot of stress. Or you were evicted from your home and it was foreclosed on when you were a kid. Well, I get it you don’t want to have a mortgage because there are a lot of emotional components to that that might even stress you out to the point where it’s negatively impacting your health or your peace of mind. Then yeah, by all means, you probably shouldn’t have a mortgage. And if you want to pay cash for your house or pay off your mortgage quicker for those reasons, it’s your money, it’s fine. We have plenty of clients at Creative Planning who have their houses paid off.
However, there are many disadvantages to paying off your mortgage early such as you have less money for higher-interest debt. I’ve seen people with credit card debt or student loan debt at higher interest rates double paying on their home. Clearly, that doesn’t make sense. How about less money for savings? Putting all of your money toward your mortgage cuts into what you can set aside for savings. So if you’re going to focus on paying off your loan early, it’s certainly a good idea to make sure you have an adequate emergency fund first because those three to six months of expenses, not very liquid which is my next point.
Paying off your mortgage early or paying cash for your house reduces your liquidity. You can’t sell off your master bathroom for money. Yeah, you can try to go get a HELOC. But a lot of times when you need to take money from your home or refinance it’s because you’ve hit tough times either economically or in your own personal situation. Now you’re going to a bank hoping that they’ll provide you money or you have to sell your home. Most people don’t want to uproot their life and their family because they need money. So be careful of the reduced liquidity. Just as I spoke of regarding 401(k)s, you need adequate access for whatever life brings.
Along those lines of being house-poor, if your house is paid off and you pass away your kids are going to call a realtor quickly after you die. They’ll effectively take a sledgehammer to the walls, your million dollars in home equity will spill out that you never had the opportunity to use in retirement, and they’ll go buy a 7 Series BMW with those proceeds, in some cases, before the dirt’s even settled on your coffin. You also lose many of the tax benefits by paying off your mortgage early. You lose the best inflation hedge you likely have. Inflation spiked, and the big hot topic of personal finance was how do you hedge inflation? Well, how about with a 30-year-long fixed-rate mortgage that inflation is making easier and easier every single month? About every 23 years your money has to double just to keep up with inflation. Put it another way regarding your home mortgage. 20 to 25 years from now, even in normal inflationary environments, not even the high ones that we recently saw, your mortgage payment is effectively half what it was when you took out the loan.
And the big one is that you could miss out on higher returns from investing. If your mortgage is 3.5% and you earn six or 7% or 8% or 10% with money that you’re not paying extra onto your home, it’s simple math, you end up with way more money. Which is why at the beginning I said, if you’re a bad investor or you don’t invest maybe this isn’t a good idea. But if you’re someone who believes you can earn more than what your mortgage rate currently is by investing the money … Oh, and by the way, you have no prepayment penalty so if at any point you change your mind, you pay off the mortgage, you keep full flexibility and liquidity, you will come out ahead.
And if you hear all that and you mostly agree but your final argument is, well, John, I’m near retirement or I’m in retirement and I don’t want the payment. Just for cash flow I’m in retirement. You are missing an important point. Your balance sheet is the exact same. If you have a $2,000 a month payment but you have 500,000 in your investment account, make your mortgage payment from the investment account if it makes you feel better. Just have that self-fund so that you don’t see it coming out of your bank account and feeling like your cash flow is pinched. A good portion of your net worth is sitting inside the walls of your home. That may be something you should rethink.
It’s time for this week’s one simple task which is to compare your credit card interest rates. Now, if you never pay interest on a credit card because you either don’t have them or you pay off the balances each month, congratulations, you get the applause of the day. But if you’re working to get yourself out of debt, or maybe one of your grandchildren or children is going through this, encourage them. It’s important to review the credit card accounts and note the current interest rates because they may have increased since you first applied for the card. And if you can find a better deal elsewhere, or even consolidate them down to a 12-month 0% card, it may be a good time to switch. Now, be mindful of transfer and membership fees when you select a new card.
Changes to your line of credit certainly need to be made with caution, especially when closing an account you want to be conscientious of your credit score. Because sometimes leaving accounts open despite not using them can help boost your score. But absolutely avoid using accounts with higher interest rates if you’re unable to pay off the balance each month. Again, your task is to review current rates and compare those with your other options. I posted an article related to this at creativeplanning.com/radio if you’d like to reference that, as well as all simple tasks from 2024. Well, it’s time for listener questions. And one of my producers Britt is here. Hey Britt, thanks for joining us. Let’s kick it off with Shane in Virginia.
Britt: Thanks, John. Glad to be here as always. All right. So Shane shared that he has opened a brand new IRA for backdoor conversions. He said that he funded 7K into it, did a backdoor Roth conversion immediately, and now his CPA said it was taxable because he had other IRA dollars. He wants to know if his CPA is correct.
John: All right, Shane, well, you’re ahead of the game even knowing what a backdoor Roth conversion is. For listeners who aren’t aware, you make an after-tax contribution to a non-deductible IRA and then you immediately turn around and convert that to a Roth. The idea being that since you’ve already paid taxes on it the conversion costs you nothing more. You’re able to basically take money that would be in a brokerage account, like in an after-tax account where you’d be forced to pay capital gains on the growth, and you put it into the golden goose, a Roth.
But, unfortunately, Shane, your CPA is correct because there’s what’s called a Pro-Rata rule on backdoor Roth conversions. Imagine you have the following: a traditional IRA with $10,000 in pre-tax contributions and earnings so you just got a regular IRA out there. And then you make a non-deductible like this after-tax contribution that you intend to convert to a Roth using this backdoor strategy of $5,000. I know you said seven but I’m just using round numbers to make the math easier. When you convert the $5,000 to the Roth, you cannot isolate that away from the other $10,000 that you have in IRAs they’re all aggregated together. The IRS views all of your traditional IRAs as a single combined retirement account. This means the conversion must be a proportionate mix of pre-tax and after-tax money.
So back to my example. You have a $10,000 traditional IRA, you put five grand into this non-deductible that you intend to immediately convert to a Roth, you’re only going to get 1/3 of it converted without paying tax. Because the after-tax portion, that 5,000, was 1/3 of the total 15,000 you had in IRAs. To help conceptualize this further, I’ve had clients with $2 million in IRAs come to me with this very question because they just did a $5,000 backdoor Roth. And I have to be the bearer of bad news and say, “Basically, 99%-plus of that conversion is taxable. You can’t isolate this five grand from the other $2 million.” And they’re shocked. Because they Googled somewhere that they do a backdoor Roth, they did what they thought they could do, and it didn’t work out the same. So I apologize, Shane, that you maybe were caught off guard with this but your CPA is absolutely correct. Britt, we had a question on the housing market, let’s go to that one next.
Britt: Yes, the infamous housing market. Emma out of New Orleans just learned of the mortgage buydown concept as something she may consider. She shares that all she knows is that she wants to avoid being house-poor. And she’s asking you if you happen to have an easy button.
John: Emma, I wish I had an easy button. US home affordability right now is the lowest it’s been since 2007, right before that huge housing crisis. The cost of a typical home including mortgage payments, property insurance, and taxes consume just over 35% of the average wage in the second quarter here of 2024. And it’s not always easy right now in today’s market with rates where they are and home prices not really compressing due to a lack of supply. You are not alone. In fact, Zillow did an analysis on home buyers making the median income in the United States. They need to spend about $127,000 on a down payment just for their total monthly costs on a $360,000 home to not exceed the offsided rule of 30%. That’s a 35% down payment just to get monthly costs within range. You’re talking about being house-poor, that’s a typical rule is to not spend more than 30% of your income on housing.
Now, real estate’s very regional, I’m not an expert on New Orleans real estate. If someone’s listening in the Bay Area or Southern California I mean, they’re laughing at the Zillow analysis of a $360,000 home. They’re like “I can’t put an Airstream on a piece of dirt in Southern California for 360 grand.” If you’re in rural Ohio you might be feeling pretty good about that. You can get something nice within that price range. Real estate varies so much depending on specific location. But I would suggest, Emma, sitting down with a certified financial planner, going through your objective of buying a home, really looking at the whole picture, your income, your future earnings, what’s saved where, how much do you have set aside for a down payment, to assess exactly what you could, and maybe even more importantly should, spend on a home or whether it makes sense to continue renting. Don’t do what the typical American does which is go to their lender, ask for the absolute max they can qualify for, and then go look for homes right up to that limit. All right, Britt, I’ve got time for one more question.
Britt: You got it, John. Chad from Maryland is saying that all he hears about is that he needs to find a new fiduciary but it seems like the last few that he’s interviewed are what’s known as dually registered. He’s asking today what he needs to know about with this type of advisor.
John: Well, dually registered advisors are … I feel bad saying this, but potentially the absolute wolf in sheep’s clothing. Because if you ask them, “Are you a fiduciary?” They say, “Absolutely.” But then they can turn around and sell you a brokerage product as a representative of their broker-dealer two minutes later. You literally have to be asking them, “Are you now giving me advice as a fiduciary or is your broker hat on right now?” In fact, Creative Planning President Peter Mallouk has spoken extensively about this. He even co-authored a book with Tony Robbins titled Unshakeable where they address this very topic in saying … It turns out the fiduciaries can moonlight as a broker when it suits their pocketbook. You heard me right. Somehow regulators will allow advisors to be both a fiduciary and a broker through a process called dual registration. One foot in both camps. That’s like sitting in your doctor’s office, and after they diagnose you they prescribe you a medication that he mixes up in the back room and sells at a profit. I mean, we would never accept that conflict.
And I get it, finding the right financial advisor can often feel like you’re picking through a line of thunderstorms among a sea of options. Here’s what I believe you should be looking for, a registered investment advisory firm. If your advisor, on their business card, has something that says, “Securities offered through X, Y, Z or registered representative of X, Y, Z” they are dually registered. Thank you so much for those questions. If you have questions just like these send them my way by emailing [email protected].
It’s never going to happen to me. I think we’ve all thought that at times, haven’t we? Something happens to someone else, terrible for them but I don’t really ever see that happening to me. And maybe you’ve experienced one of those unexpected moments that you never thought was going to happen to you but it did. I mean, those can rock us to the core, can’t they? Well, if you’re one to follow financial headlines and appreciate a vulnerable but what I consider a heroic approach to the discussion, then you may be seen the news about my colleague Jonathan Clements. Jonathan was the longtime columnist at the Wall Street Journal, he is our Director of Financial Education at Creative Planning. Hosts a monthly podcast, Down the Middle, each month with Creative Planning President Peter Mallouk. A true pioneer in our industry. Jonathan was recently diagnosed with lung cancer totally out of nowhere, and he sat down with Peter just recently on their podcast to discuss … And I’m gleaning a lot out of this short interview and I think you can as well. Have a listen to what he had to say.
Johnathan Clements: One of the biggest surprises of discovering that you’re dying is how busy it is. I never thought that dying was going to be busy but it is. I thought everything was pretty well organized but I’ve taken countless steps in recent weeks to try to make things easier for the kids and for Elaine after I die. So, for instance, I’ve been closing credit card accounts, taken my checking accounts and I’ve made them joint accounts with Elaine so they pass directly to her. One of my checking accounts all the bills are paid out of so if she has control of that account she will see all the bills getting paid. So I’ve been taking steps like that. I also had some small accounts. I had a inherited IRA from my father that had $6,000 in it and I was like “They don’t want to be closing this account after my death and sending a death certificate” and so I just went ahead and liquidated it. Why leave this problem to them?
Peter Mallouk: Make sure that the people that you love, and admire, and respect know that. Jonathan, I will tell you that early in my career, and I shared with you very early in my career, I read everything that you did. You were just such common sense, you were so ahead of your time. You were spotting trends and investing around low-cost, and passive, and so on way before other people. And when I look at the people that influenced my investment in planning thinking it’s you and John Bogle.
John: I echo Peter’s sentiment. Jonathan has been an incredible pioneer and helped so many people within the world of finance. Even in this difficult, unexpected situation his vulnerability, his willingness to share his perspective is what he’s done throughout his entire career. Be prepared for the unexpected and live a life that’s worth living now so that you can also have no regrets just as Jonathan has expressed. He’s thankful for the time that he’s had and the memories he’s made. Isn’t scrambling as a result of this news but instead continuing to pursue the passions and the relationships that he has thoughtfully and intentionally built along the way. 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. Creative Planning, along with its affiliate United Capital Financial Advisors currently manages or advises on a combined $300 billion in assets as of December 31, 2023. John Hagensen works for Creative Planning, and all opinions expressed by John or his guests are solely their own and do not necessarily represent the opinion of Creative Planning. This show is designed to be informational in nature and does not constitute investment, tax, or legal advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help request to speak to an advisor by going to CreativePlanning.com. Creative Planning tax and legal are separate entities that must be engaged independently.
Important Legal Disclosure:
creativeplanning.com/important-disclosure-information/
Have questions or topic suggestions?
Email us @ [email protected]
