What happens when your financial intentions are good but lead to unintended consequences? John walks us through six of the costliest blind spots we have in our financial lives and shares how to avoid veering off-track. (1:30) Plus, Creative Planning President & CEO Peter Mallouk joins the show to discuss the most critical mistakes investors make and how these errors can put their portfolios into jeopardy. (8:00)
Episode Description
Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!
John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Higginson and ahead on today’s show, why good intentions can still lead to unwanted results. My conversation with Creative Planning President, Peter Mallouk, and the difference between being rich and wealthy. Now, join me as I help you rethink your money.
Will Rogers famously said, and I quote, “It isn’t what we don’t know that gives us trouble, it’s what we know, that ain’t so.” Sometimes our intentions are in the right place, but unfortunately, the outcomes don’t align. One famous example of good intentions going horribly wrong is the case of the new Coke, which was a reformulation of Coca-Cola and it was introduced in 1985, that by offering a sweeter and a smoother taste, they could attract more customers, and regain market share that they were losing. If you remember anything about this story, it turned into a major marketing and public relations disaster. This is why you see Coca-Cola Classic because that’s what they ended up rebranding the original formula back to. So it bombed. It was terrible, but it wasn’t because they had bad intentions. They just had a blind spot. And if you’re like me, you do the same thing in life, and certainly with your money because you’re a human.
I’ve unfortunately seen many portfolios and plans wrecked, not normally because they invested in Enron or Washington Mutual, but because they misplaced good intentions, and I have a few common examples of this. The first is minimizing mortgage debt. I met with someone recently, who had a seven-year arm at 2%, so they had an adjustable rate mortgage, when rates were very low. Didn’t want to get rid of the 2%, for even a three and a half or 4% mortgage that was available, because they thought, “Well, why don’t I want to make a higher payment? I mean, rates don’t seem to be going anywhere, anytime soon.” Now, we have the benefit of hindsight. We know that we saw some of the fastest rate increases in the history of our country. Now this person’s intentions were to pay the least amount in interest. It was a good intention, but by being unwilling to pay a little more interest, in the short term, to create long-term predictability, now they’re at a floating rate of nearly 8%. Good intentions, bad outcomes.
Another good intention that can have bad results is when you’re being proactive, trying to find the best returns. You might want to think about this as trend chasing. A couple of weeks ago on the PGA Tour, Tom Kim, one of the golfers, wore these short cuffed pants, that hit him kind of mid-calf. And while those are kind of coming into style now, he had long white socks with it, and it was just a bad look. But as investors, sometimes we want to look cool and have the short pants, and unfortunately, we don’t look like a GQ model, as we saw it going in our head. Think about the 2020 biggest winners, the pandemic darlings. How much they have gotten crushed, after the hype, and this is why trying to find the best returns, can often have very negative consequences.
Peloton, down over 90%. Zoom down over 85%. Etsy down over 70%. ARK Innovation ETF, down about 70%. The Grayscale Bitcoin Trust, down over 60%. How about the intention of staying flexible and having plenty of cash on hand? Well, that’s unfortunately, had terrible consequences. In fact, someone sitting in cash, since pre-COVID, has lost over 25% of their purchasing power, by “protecting themselves.” Can you imagine walking into your bank? You had a hundred grand there. You ask for the balance and they say, “Oh, you have $75,000.” You’d lose your mind. “How am I down $25,000?” That is practically what has happened. In the early 1970s, the average price of a loaf of bread, in the United States, was 25 cents. Now, about $3. If you’re in my home, and my wife refuses to get anything that’s enriched, it’s got to be the seeded Dave’s Killer Bread, whatever it is, it’s way more.
Many investors have the intention of finding safety in bonds. Well, certainly bonds are less likely to be down in value, in any given year, than the broad stock market. Bonds have a lower standard deviation meaning there’s less volatility day-to-day, month-to-month, year-to-year. So that part’s true, but bonds have default risk. They have purchasing power risk and they have interest rate risk. Default or credit risk is pretty self-explanatory. As a bond holder, you’re lending money. If who you lend money to, can’t pay you back, then it isn’t all that safe, is it?
Purchasing power risk alludes to exactly what I just spoke of. If you lend a hundred thousand dollars over 30 years, and at the end of the 30 years, they don’t default, and they give you your principle back, it buys less than half, than when you originally lent the money. That’s why bonds are terrible in high inflationary environments. And you have interest rate risk, which we have felt, for most investors, for the first time in their life. I mean, rising interest rates and the risk of bond prices going down, when rates rise, was mostly hypothetical, for anyone that’s invested in bonds, over the last three decades. But as of now, long-term bonds have lost 50%. Remember, the intention was to find safety in bonds. Long-term treasuries are down 40 to 50%, depending upon coupons, in the last three years. Inflation’s up 28%, during that same time.
So think about this, if a retiree said, “I don’t want to be in the stock market. I want to be safe so I’m going to be in the bonds,” and they took all $1 million of their life savings, they put it in government treasuries. “I don’t have to worry about default risk, theoretically with that. I’ve eliminated that risk because the US government is backing this.” Their principle could be down 50%, plus inflation is up 28%, during that time.
So let me summarize, their million dollars is now worth 500 grand, and not only that, but to make matters worse, now they need $1.28 million, just to have the same purchasing power, so this is a 61% loss of purchasing power. And lastly, the good intention of sticking with a plan. Prior to becoming a financial advisor, I was an airline pilot. I never once pushed off the gate at LAX, and by the way, you should be thankful for this, if you were ever a passenger in the back, without a flight plan. We didn’t push off like, “We’re headed to O’Hare. What are we doing?” “Oh, well, we’ll fly east.” “We’ll get out over the ocean on departure, we’ll just kind of whip a right turn, and let’s get out there. Illinois, here we come.” And along the same lines, you shouldn’t be pushing off the gate, so to speak, headed toward retirement, without a written, documented dynamic financial plan.
And that word dynamic is the important one. Once I had that flight plan, I’m assuming you would expect me to adjust, while in midair, to avoid a thunderstorm, that we’re now aware of. Or to change our arrival procedures or the landing runway, if winds have shifted. Of course you would, you don’t want your cocktail spilling all over your lap. You see, as new information is available, you want your pilot to use that, for the safety of the flight. And when it comes to your money, we are in a completely different environment. Rising bond yields, mortgage rates over 7% and inverted yield curve. And while it’s great to maintain discipline to a plan, it must be reviewed and adjusted. This is your life savings, so why not give your wealth, a second look @creativeplanning.com/radio.
Well, my special guest today is Peter Mallouk, and if you are a financial advisor, you are very familiar with that name. And I’m not just saying that because he is the President here at Creative Planning, but because he’s been a trendsetting visionary, for this entire profession. He was providing advice, as a fiduciary, long before that gained momentum, when the standard practice at the time was slinging a bunch of commissionable products. Through Creative Planning, he was the first, at any scale, to build a comprehensive offering like a true comprehensive offering. A hundred CPAs, 75 attorneys. He’s a New York Times bestselling author. He’s been named three times, consecutively, in 2013, ’14, and ’15, by Barron’s, as the number one financial advisor in America, and is the architect responsible also for Creative Planning’s success, being named the number one firm in America by CNBC, Barron’s and RIA channel, which is published by Forbes, in 2014, ’15, ’17 and 2020, respectively.
Peter’s on a number of boards. He’s received so many awards that it’d take five minutes for me to read them all. We wouldn’t even get to the interview. And by the way, I’m not joking, but I would be leaving out a huge part of who he is, if I didn’t mention the time and resources that he and his wife Veronica have dedicated to serving those in need. He inspires me to be better and that extends far beyond just the workplace. Peter graduated from the University of Kansas in 1993 with four majors. You heard that correctly, four majors, including degrees in business administration and economics. He went on to earn a law degree and also receive his MBA, both at the University of Kansas. He’s also a certified financial planner, and is the recipient of the University of Kansas School of Business Distinguished Alumni Award becoming the second-youngest recipient, ever to receive that award. And fun fact, his wife, Veronica, holds the spot of the youngest. Without further delay, Peter Mallouk, thank you for joining me on Rethink Your Money.
Peter Mallouk: Awesome to be with you finally, John. I was waiting for the invite.
John: Peter, you wrote a book, the Five Mistakes Every Investor Makes and How to Avoid them. So often, investors are looking for that big win, but in many cases, it’s less about knocking the ball out of the park and more about avoiding the strikeout. One of those unforced errors pertains to timing the market. Why do you think, Peter, it’s so hard to beat the market?
Peter: It’s interesting because when we start with the bias, like if you’re talking to somebody who’s got 500,000, one million, five million, this is a small part of the population. It’s not a big part of the population. They tend to be more successful. Sure, some of them are lucky, but most of them worked really hard. They saved a lot. They’re really diligent. They’re good at repeating the behaviors that create wealth. And so their whole lives, their brains have been trained to believe, which is accurate, in almost every field, “The more effort I put in, the smarter I get, I will get an edge over other people.” This works in professional sports. It works with architecture, engineering, medicine, law. It works in construction, and so you expect, “Well, I’m going to enter this area where there’s millions of people investing. And of course, if I try harder, or get smarter or some combination, I will beat them.”
So it’s a natural feeling to have. And what’s different about the markets is there’s so many people in them, that you have so much smart money on both sides of every trade, that it’s very hard to beat it enough to win. Winning meaning after fees and taxes that you’ve beaten, just buying and holding a basket of securities, and rebalancing, and tax harvesting and things like that. So there’s just enormous bias comes into play, that makes us want to believe that we can beat the market, and that’s the starting point of all of the big mistakes that happen along the way. And I think the biggest mistake is the one you pointed out, which is market timing. And the reason market timing is so dangerous is there’s a perception of, “If I’m in the market, things can go really bad.” Well, let’s look, historically things have gone really bad over 150 times now, being a 10% drop or more, and almost 40 times, we’ve seen a drop of 20, 30, 40, 50% or more.
That’s pretty bad to watch your net worth go down 10 to 50, 60%, but in every single instance, the market recovered. So it’s sort of like, yeah, you might go get a Diet Coke over time. We expect it to go up in price, but every now and then it goes on sale, but we never expect it to be permanent. But with the stock market when it’s down, people expect it to be permanent, but we know the worst case scenario, for a diversified investor, has been a temporary pullback in the stock price. Now, if you’re out of the market, which perception wise is safer, “Hey, Obama became president, I’m going to the sideline.” “Trump became president, I’m going to the sideline.” Whatever’s happening in Ukraine, the dollar is losing its reserve status. The banks are failing. COVID, 911, tech bubble, I’m going to go to cash because it’s safer.
Well, with all of these instances, the market went on to new high, and may never go back to where it was before so that loss is permanent. If you exit the market at 30,000, and the Dow goes up to 40, it may never go back to 30, and that’s why market timing is so devastating. The risk of being out is so much more significant than the risk of being in. And you couple it with that human bias that, “Maybe I can do it because I’m probably smarter than average.” You can’t do it enough. Even one market timing move, you have to be right twice, when to get out, and when to get back in.
Just the odds are stacked against you. I could do our whole episode on this, and like you said, I wrote a whole chapter on a book about it, but it is the biggest mistake I see people make. It causes just total devastation, especially when you see in a big event like COVID or tech bubble, where you see somebody at the bottom exit, which is where most people exit, it causes maximum damage. You can wipe out 15, 20 years of your work life with one trade.
John: And I think the best example of this, Peter, that I hope discouraged people from trying to market time was COVID. If somebody in 2019 had a crystal ball, most rational people, certainly market timers, would’ve said, “I’m shorting the market or I’m going to cash. The entire world is shutting down.” The market finished up almost 20% in 2020. So the challenge with market timing also is that you don’t know the info, and even if you did, how seven or 8 billion people are going to respond to that, makes it very difficult, no matter how smart you are.
Peter: Great point, and I think a lot of people look at things as, “Oh, this happened so therefore because of this, then that,” but the market’s dynamic. The market doesn’t care about anything but future earnings and there’s a lot that goes into future earnings besides say a pandemic or a terrorist event, and that’s how’s Congress going to react? If Congress is going to hand everybody money, well they’re probably going to spend it, and that’ll impact future earnings. How’s the Federal Reserve going to act? Well, if they’re going to lower interest rates to zero, people will probably borrow money and buy cars, and maybe that’ll turn the market around. There’s just all these things. If all market conditions are absolutely perfect, you have a perfect analyst, and says, “Okay, everything’s perfect. The market’s going to go up, let’s buy.” Well, you can still have that cyber attack, that 911, it’s dynamic, and if you can accept that it’s dynamic and unpredictable, then you stop to do it.
There are a few warning signs that you’re talking to somebody, and I’m just going to use the word because I truly believe it, that’s incompetent. They tell you that they can predict the market. If they’re telling you, “I have a downside solution. I’ve got a downside exit strategy. I’ve got a tactical allocation strategy. I know when to move from one thing to another.” If they’re telling you that, they’re usually going to fall into one of two camps, one is they don’t know enough to know what they don’t know, and they’re gambling with your money. Or they know exactly that that’s not possible, but they’re trying to persuade you, that they know how to do it. Either way, that’s not the advisor or money manager to be with. You have to accept these basic facts because when you can accept those basic facts, you can then implement a strategy that works within the market, right?
John: You don’t need to look further than the fact that the Fed has 400 PhD economists, and have the ability to manipulate the money supply, and they couldn’t get it right because there’s so many dynamic factors. Which leads me to my next mistake, that you wrote about, which is active trading. Nobody wants to be average, although investing is one of the weird things where if you are averaged by owning indexes, you beat 85% of the active fund managers from all of history. But how do you think about that when a client says, “Well, gosh, just boring, diversify. Isn’t there some manager that knows to buy Nvidia before it goes up 200%?” What do you say to that person?
Peter: I think you have to start with just the understanding of why security selection is so hard. So if you’ve got somebody who says, “You know what? I’m going to be in the market. I’m not going to market time, but what I’m going to do is I’m going to buy and sell stocks regularly. Make these moves, in and out of different securities.” Now let’s just pick a random stock. Let’s pick McDonald’s. So McDonald’s, on an average day, has millions of people sell, which means millions of people are buying. There’s always a seller, there’s always a buyer, for every seller. They have to match up. So the question is, do you know more than these millions of people? And I think it’s easier for people to understand how hard it is to beat, if you talk about real estate. So just wherever you’re listening, whatever city you’re in, there’s probably a condo for sale nearby.
Let’s say there’s a condo in a building, there’s a hundred units in there, and a couple of people put their condo up for sale, and then the average in the building is 700,000. You probably know if somebody lists it for 900,000, no one will buy, and that no one would be stupid enough to list theirs for 600,000, if the last 10 transactions were higher. We can accept that, that the real estate market is fairly efficient. Well, the real estate market is 99% less efficient than the stock market because the difference is in the stock market, by law, all the information has to be public. You have millions of people on both sides, not a couple of people looking at that condo, or maybe even a hundred people looking at the condo.
You have millions of people, that have very sophisticated teams. They’re spending millions of dollars, on trying to beat the other side. That’s the kind of marketplace you’re walking into. So if you walked into a tower, with thousands of units, in your downtown area, you expect if someone wants to sell it, the real estate agent’s going to say, “Look, you’ve got to sell in this tiny band because if you put it higher than that, you’re not going to sell it, and lower than that, you’re crazy.” That’s kind of efficient. Multiply that by a hundred, you get the stock market, and so it becomes very hard.
I mean, give me a break. The guy down the street from you, knows when to buy and sell McDonald’s, and if you look at the top a hundred mutual funds, over 90% of them won’t get that right, over a decade. To your point, John, if you just owned those a hundred stocks, you would’ve done better. And so once you accept that premise, it all becomes about what are your goals? What asset classes should you be in, in the first place? Should you have money overseas or just in the US? Should you also have bonds in real estate or not? How do I get a better after tax outcome? Should my IRA own this account or not?
You start to make smart decisions that we know add value, and they cannot subtract value, and so it’s another big premise to investing. Now, the issue with active trading is people that have done really well, it’s like winning at a blackjack table, right? You’re not leaving the table, you’re winning. It feels good, and people that are doing really poorly, they go, “Oh, I just got to get back to even. Once Facebook gets back to where it was, then I’ll exit.” Of course, when it gets back, you’ve got those good feelings again. It’s a very hard thing to do because it feeds on a lot of that innate human behavior, that makes us want to do it.
John: Yeah, that’s a good point. I’m speaking with Creative Planning President, three time Barron’s Financial Advisor of the Year, Peter Mallouk. Let’s shift our focus over to someone who says, “I do think I need some help on this. I’d like to find advice. I’d like to have somebody help shepherd my life savings. It’s become too complex. Either I don’t have the expertise or the time or the desire to do this.” Well, then the most important decision isn’t figuring out whether to be active or passive, or how much international to have in the portfolio, it’s, “Who do I hire to help me make all of these decisions?” And so that ends up being the most important financial decision that people make, and it’s one that I’ve seen firsthand. You certainly have, as well. People don’t necessarily always have a great premise with which to make that decision, “Hey, I golf with this person,” or, “They go to my church,” and, “I don’t know. They seem like they have a decent office. I guess I’ll work with them.” I mean, that’s sort of what people are doing.
Peter: It’s crazy, right?
John: Yeah.
Peter: If you were going to go get, if you had a problem with your liver, you wouldn’t just do it with whichever of your buddies helps you with that, right? If you need a knee surgery, you wouldn’t go, “My buddy is a surgeon.” You’re going to go on Google, and whatever you need to do, you’re going to ask around. You’re going to look for a top advisor, that meets some certain criteria. You’re going to seek that person out, but there’s something about you can work hundreds of thousands of hours, and then hand everything you’ve ever worked for, to somebody who just happens to go to your church, or lived down the street. It’s crazy. There needs to be some due diligence that goes into it.
And the first thing I tell people to look for is alignment. You should never have an advisor that owns their own products because guess what? They’re going to go, “Thank you for paying me. I now recommend my own product.” It’s like going to a Ford dealership, paying them a fee to ask them what car to buy, they’re going to go, “Thank you for the fee. Here are several Fords for you.”
John: You don’t think they’re going to recommend a Silverado?
Peter: Yeah, so you definitely want alignment. That’s the first thing you want. You don’t want anybody that owns their own products, or gets paid revenue sharing or commissions, for selling you an investment. There’s plenty of investments that don’t have commissions. The second is you want a fiduciary, so someone who has a legal obligation to act in your best interest. That requirement alone, eliminates 90% of advisors, that work in brokerage houses, that have revenue sharing, commissions on their investments, all those conflicts. But I think you also want experience. You want a firm that’s got a lot of expertise, and a lot of things that they can deliver to their clients, and that whatever it is that you’re going to go through, they’ve seen it before, and whatever bear market’s coming, they’ve been through something like that before. That they have access to the best investments, and the best technology, and the best cybersecurity.
So you want some scale. The sweet spot is if you can get an independent advisor, that’s got a lot of experience. If you go to the problems in the marketplace, 90% of advisors are in these brokerage houses, right? The Merrills, the Morgans, the Goldmans of the world, and where they have their own products, and all these conflicts of interests. So you go to the independent world, and there are a lot of wonderful people there, that are aligned with their clients. They don’t have their own products and so on. The issue is they might only have a few hundred clients. They might only manage a few billion dollars. They just don’t have the scale, to really provide the client the optimal probability of a good chance of success. And so it’s a very interesting field.
It’s hard for people to understand because with an architect or a doctor or a lawyer, they always have to act in your best interest. That’s just how that works. Same with the CPA. So you expect that that’s just how it is with financial advice. But listen, the difference between doctor, lawyer, CPA and financial advisor is you have to have some education, to be a CPA, or a lawyer, or doctor. Anyone can call themselves a financial advisor, so you really have to look for experience, and alignment, and credibility, and so on, before you put your life’s work with somebody. And it will translate into probably a better portfolio, that will probably have a better chance of getting you where you want to be, over time.
John: Very good points, Peter. Thank you for sharing your perspective with us, here on Rethink Your Money.
Peter: Thanks for having me, John.
John: Important things in life aren’t always jumping up and down, in front of us, but they still very well may be important, especially over the long haul. Another example of this, we know that there’s great need, locally, and abroad. That poverty exists around us. People are hurting, but it’s easy to go about our lives, disregarding that reality, if we’re not in positions to regularly be exposed to it or see it. One of the most meaningful things that we can do for our children, as parents, is seek opportunities to put them in environments, for their eyes to be opened, where we’re not just telling them about the need, theoretically, it’s out there. No, they see it, for themselves. Their eyes are opened. Their perspectives are changed.
And I have a confession, like I’ve fallen short of this, as a parent. I need to do better. It’s a huge priority of mine, over the next decade, to proactively seek out those sorts of opportunities with my kids because no one wants to raise entitled minions, who lack empathy. And if that’s the case, the best way to help them gain that, isn’t by telling them, it’s by having them see it for themselves. The most impactful experience of my entire life was working in the orphanages of Bucharest, Romania, as a high schooler because when I saw the need, for myself, I knew in that moment, “Now that I’ve seen this, I’m responsible. I want to adopt when I have a family.” Without that trip, my life looks completely different, and it’s very unlikely that we would have adopted four of our seven children.
And to transition this over to finance, and by the way, I understand the risk of sounding insensitive. We did the same thing with our money. It’s not even in the same galaxy, in terms of the lasting importance of the example that I just used, but hear me out because if you are not aware, regarding the negative consequences for things that you may not see, you’ll have suboptimal outcomes.
A current example of this, I read recently that Toyota SUVs went from $67,000 on average, sales price, to 80,000, between 2022 and 2023, yet sales were still at a peak, demand had basically just shrugged off, this major increase in price, over a one-year period. And the article didn’t really talk much about why that was, but I have a pet theory. It’s that very few people write a check for the entire price of that car, like a higher sales price by $13,000, if financed over a five, six, seven year period, isn’t that much. You don’t really feel it, in the moment. You’re signing a bunch of paperwork, in the finance director’s office, one of the 14,000 pages you sign, and one of them says, “The payment’s going to be a little bit higher.” You’re still paying 13 grand more, for that car, but that’s out of sight, out of mind.
Another spot of personal finance, where we see this play out is with student loans. Now, there are all sorts of inherent issues, with the way college is priced, and the way that we pay for it. That’s a discussion for another show. But when a 17-year old is looking at colleges, and a lot of it’s going to be financed, if one school costs 40,000, and the other costs 30, is that high school junior or senior really considering that? Not really because they’re not going to write a check for $10,000 more, every single year, and have to part with that money. So instead they’re like, “I don’t know, kind of similar in price. Man, look at Greek row. Man, the dining hall. Look at this campus, incredible,” because it’s out of sight, out of mind. And how this pertains more broadly to investing, a lot of people would rather lose 3% of their portfolio, every single year, due to inflation, then take a 10% loss, one time, even if they know that over the next 10 years, they’ll earn that back, plus a lot more because it’s out of sight, out of mind.
And the cognitive bias, the term for this, is hyperbolic discounting. I know it sounds fancy, but the concept’s pretty basic in one that, if you’re like me, you struggle with. It’s where people choose smaller immediate rewards, rather than larger later rewards. For example, if you had to choose between $50 right now, or $100 in two years, the behavioral finance studies show us that most people would take the 50 now, even though clearly, the better long-term option is waiting. So here’s the takeaway, and where we need to have self-awareness, and understand that we are more likely to procrastinate, when decisions and the impact of those decisions, are far away. Remember, just because we can’t see it, doesn’t mean that it’s not important.
Our first piece of common wisdom, that I’d like to rethink, together, is that a high salary means you’re wealthy. Just because you make a lot of money, actually doesn’t mean you’re wealthy. It may mean that you’re rich, if we want to use that term, but while rich and wealthy are often words that are used interchangeably, they carry different connotations. Rich typically refers to a level of financial comfort, that allows someone to afford luxuries and cover their expenses, without significant concerns about money. And being rich can also be relative, as it often depends upon how your situation compares to others. Rich is much more focused on immediate financial well-being and liquidity. The term wealthy, that goes well beyond having high income, or a lot of money at a given time. It implies a more enduring and substantial accumulation of assets, investments, and resources, that can sustain a person, and a family, over a long period of time.
I think oftentimes we admire, in the short term, on social media, or the new car that they bought, those who make a lot of money, those who are rich, but you want to be seeking the freedom that comes along with wealth. And I love the definition that Morgan Housel uses, regarding wealth, and that is that wealth is achieved by closing the gap between what you have and what you desire. And by that definition, many people with a $500,000 net worth, are far wealthier, than many billionaires are ever going to be. So let’s rethink that, a high salary equals a wealthy person because it doesn’t. Another piece of common financial wisdom that I’d like to rethink is that financial scams are obvious, if you’re looking for them. It may surprise you how frequently I receive emails, or have conversations with people, who have lost significant money, due to Ponzi schemes, sometimes simple, or very sophisticated scams.
So I’m going to post an article to the radio page of our website, that highlights some of the most common financial scams, if you’d like to read that for yourself. I think we’re mostly aware that we don’t have a distant cousin who is prince of an obscure country, in Africa. They just need us to Western Union, a few thousand dollars over, so that they can unlock their millions, that will get sent back to us like we mostly understand that’s probably not real, but here are a few of the most common scams, I do see. Debt collection scams. So fraudsters will pose as debt collectors, who are trying to get you to pay debts, that you actually don’t owe. Phishing scams, and I’m not talking about phishing with an F, I’m talking about a Ph, sending emails purporting to be from a reputable company, in order to coerce you into providing confidential information, that they then use for identity theft or other illegal activities.
Ransomware is a type of software that holds your computer, or another device, hostage by restricting your ability to access your own computer, until you pay a certain amount of money. There are mortgage closing scams. Some fraudsters will pose as real estate agents, mortgage loan officers, or title agents, in order to steal a home buyer’s closing expenses or a down payment. A scam that’s growing in popularity is a relationship scam, where someone pretends to fall in love with someone, to earn his or her trust. I know this is messed up on all sorts of levels, and then they scam that individual out of money. And my second to last common scam pertains to prize and lottery scams. So here’s what happens. A scammer will call you, and inform you that you just won a large sweepstakes like a free vacation or some other prize. And in exchange, all you have to do is pay some upfront fees, or provide some banking information, so that we can quickly and efficiently wire the money into your account. Because you want to get your winnings.
And one that can be kind of sneaky is the overpayment scam. It’s a little bit more complex, but very common. A scammer sends you a counterfeit check, and asks you to refund the money to him or her, or sometimes, they’ll purchase an item from you online, and then accidentally pay too much. They then ask you to provide a reimbursement for the overpayment, while a short while later, the entire payment’s voided, or the check will bounce, and any money that was reimbursed is likely gone. Understanding what these scams are and how to avoid them, is critical to your financial success because your ability to avoid the big mistake, will likely be the determinant in whether you maximize your financial potential. Well, it’s time for listener questions. One of my producers, Lauren, as always, is here to read those. Hey Lauren, who do we have first?
Lauren Newman: Hi John. This question is from Marjorie, in San Diego, California. She writes, “Hello, I’m 74-years-old, and thought my RMDs were taken out automatically, from my accounts. Turns out they’re not and I have missed one. What can I do about that?”
John: So let’s start first, by describing what an RMD is. That required minimum distribution is a mandatory withdrawal, that you have to take from certain types of retirement accounts, such as traditional IRAs and 401Ks, and with the Secure Act 2.0 just passing, you need to do so in the year that you turn 73. It’s worth noting that there is a provision, that in the first year, you have until April 1st, of the following year, to take that RMD. Essentially, the IRS is saying, “We’ll give you a little cushion, in case you forget how old you are,” like I do all the time now. If you forgot that you turned 73 last year, you get until April 1st, of that next year. But you better take two that year, because moving forward, the deadline is December 31st of each year. Now, the purpose of RMDs is to ensure that you don’t indefinitely defer paying taxes, on retirement account savings.
The amount you’re required to pay is based upon your age, so your remaining life expectancy, and a calculation that takes the closing value of your retirement accounts on December 31st, of the previous year. And if like in this case, you fail to take all or a portion of your RMD, the amount not taken, is subject to a 50% penalty, in addition to income taxes. You didn’t mishear that, not 15, 50, 5-0. Now, here’s the key, Marjorie. The IRS can waive that 50% penalty, for a reasonable cause. There’s no guarantee that they will, but there is a way to request a penalty waiver for a missed RMD, and here’s the steps. Take your RMD, first and foremost, right away. Take it as soon as possible. It’s better to take the missed payment, as its own distribution, rather than combining it with your current year’s RMD.
So separate them and take that required minimum distribution, even though you already missed the year that you should have done it in. Then you’re going to complete and file IRS Form 5329, which your advisor should be able to help you with, if you have an advisor, or your CPA, for the year in which the RMD was missed. Lastly, I’d write a letter to the IRS, outlining your case for why the penalty should be waived. And so that’s what I would recommend doing. If you have additional questions specific to your situation, we have an office there, in beautiful San Diego, and we’d be happy to walk you through this. You can request that @creativeplanning.com/radio. All right, Lauren, who’s next?
Lauren: James from Charleston, North Carolina, writes, “If you transfer ownership of a 1031 exchange property, from an individual to an entity, do you have to pay the capital gains on the property?”
John: So for those listening, who are unaware of a 1031 exchange, it’s also known as a like kind exchange or a tax deferred exchange. It’s a provision, within the internal revenue code, that allows individuals and businesses to defer capital gains taxes, on the sale of certain types of investment or business properties, if they reinvest those proceeds into a similar property. So to answer your question, James, the ownership has to be identical. You can’t switch from an individual to an entity. The taxpayer must remain the same. And in addition to that provision, the property type has to be similar in nature or character. There are strict timelines. You have to identify a replacement property, within 45 days of selling the original, and complete the entire exchange, by acquiring and closing on that replacement property, within 180 days. You have to use a qualified intermediary, which I’m not going to get into right now, and to completely defer taxes, the replacement property must be of equal or greater value, than the property being sold, and all of the net proceeds from the sale must be reinvested. All right, Lauren, let’s go to the next question.
Lauren: Next, I’ve got Stella A. from Franklin, Wisconsin. “I just inherited 150,000, and I don’t know what I should do with it, but I know I don’t want to take on any risk. Is a CD my best option?”
John: Well, Stella, a CD has, theoretically, zero principal risk. It’s FDIC insured on $150,000, but the most important thing here is having an actual plan. I’m not discounting your priority of minimizing risk. The best way to minimize risk, and understand how to properly deploy those assets, will be based upon your objectives. Your potential use for the money, and most importantly, when does that occur? Because if you don’t need this money for 25 years, then a CD is a really bad option, even if you find yourself as a very risk averse person. Now, I’m certainly not saying you place all 150 on the roulette wheel, and say, “All right, let’s go with red.” Or you buy an individual stock, or a few individual stocks, but possibly a mix of stocks and bonds, and a well diversified portfolio, would make more sense, but conversely, if you told me that you’re going to need this money in six months, I wouldn’t buy a CD because money markets or treasuries would be a better option.
And this is why it all starts with a written, documented, detailed financial plan. I know if you’re someone who listens each week, you’re rolling your eyes saying, “Oh no, not the financial plan thing. Again, here John goes.” But it’s true because almost all questions, pertaining to how and where to invest money, are informed by that financial plan. And there are so many great certified financial planners across the country, who aren’t charging commissions, who can listen to your objectives, and put together a great plan. So you don’t have to wonder if you’re investing in the right places, or if you’re managing risk appropriately, or if you’re going to be able to retire. That’s the peace of mind and clarity you can receive, with a great financial plan. Not everybody needs a financial planner, but everybody does need a financial plan. Stella, I would encourage you, whether it’s us, or someone else, speak to a fiduciary, who can look at your entire situation, to ensure that that CD is in fact the most appropriate option, relative to your risk tolerance, your objectives, your time horizons, and your broad plan. All right, Lauren, who’s next?
Lauren: Our last question comes from Carrie in Minnesota. She writes, “I’m getting married for the second time and my partner and I are in our ’50s. We both have our own money and kids from previous marriages, which has me thinking about finances. Do you think I should consider separate bank accounts?”
John: Well, congratulations on your upcoming wedding, Carrie, and I want to commend you. You’re thinking about things, that according to a recent survey, 49% of others, are not talking about, which is how they’re going to handle their money before they tie the knot. Only 41% of couples even tell their salaries to each other, and just 36% are willing to confess to how much debt they have, and it really matters. You’re asking the right questions because how couples manage their money isn’t just about making sure the water bill gets paid on time. Discussions about money can cause much bigger issues in the relationship, like in some cases like who wields more power? Whose career is more important? Who’s going to be responsible for more of the domestic labor? And unfortunately, a lot of people aren’t on the same page with that. And while money doesn’t define who we are, it can reveal us, and it says a lot along with how we spend our time, about what we prioritize.
It is absolutely an expression of our values and sometimes a sobering one. I don’t sometimes like looking at how I’m spending money because I hope that’s not actually a reflection of what I care about, but it is some true serum, that’s for sure. So my verdict, share the wealth, use a joint account, and the number one reason for that is because all the studies show that it appears to lead to a happier marriage. In fact, in a recent one, looking at 230 newlywed couples for two years, the couples who kept separate accounts, saw the typical decline in relationship satisfaction, where they were happiest at the start of their marriage, and satisfaction dropped after the honeymoon phase. The couples who had joint accounts stayed at the initial level of happiness and if anything, their relationship satisfaction and I quote, “The study seemed to increase a tiny bit over time.”
Plus some of the practical benefits of keeping all your money at one bank can help you avoid minimum account balance fees make you eligible for a higher tier of customer rewards. Ultimately, it provides greater ease of managing your bills, planning for the future and for emergencies. Appreciate all the questions today. Those were fantastic. Again, if you have questions, email those to [email protected].
I want to conclude today’s show with a piece of advice. Outline your plans. By the way this goes for your life and for your financial plan, in pencil, not pen. Consider the randomness of life. If I think about just my situation, with how our family came to be. My parents were divorced my senior year of high school. I was the youngest in my family. At the time, difficult. I was confused. Why is this happening? Why is my family breaking apart? Well, to make a long story short, it was through that divorce and my mom’s subsequent move, to a different state, where she was next door neighbors with my now in-laws. Fast-forward several years later, it is through that friendship of my mom and my mother-in-law, that I was encouraged to send Brittany an email. My mother-in-law said, “Well, don’t you fly occasionally to Phoenix from Los Angeles?” My daughter Brittany, she goes to Arizona State. I think you guys would get along really well.”
There’s another fluke. We’re both in the same area. She lives in a major city, where I fly to often, couldn’t have planned that. I then don’t email her, and my mom follows up and says, “Did you email her?” “No.” “Well, why not? Jan gave you her number. You need to email her.” “All right, mom. Well, I mean, I don’t know. I don’t really know her. I don’t know when I’m going to be in Phoenix next, but I will.” There was another fluke, almost never happened. Eventually after we meet and fall in love, and we’re getting serious, I get to know her father. Well, what do you know? He’s been a financial advisor for 30 years. Before that, when he was in his ’20s, he was a corporate pilot, another fluky thing that we had in common. And I could spend 20 minutes going through every single specific thing that had to go just right, for our lives to have merged, as they did.
Now, I look at my seven kids, the life that we have together, and I don’t even want to try to imagine any of those little things going differently, which would ultimately have led to our lives not being together, and our family not being what it is. And my suspicion is that your story has just as much randomness, fluffiness, whatever you want to call it, that ultimately led to some of the greatest blessings. But many of those things will only occur if we are willing to be open-minded, if we’re willing to pivot off of what we currently think. If our eyes are open to new opportunities because many of the biggest blessings in our lives are the ones that we least expected, and in some cases, seemed insignificant, in the moment. And that’s why you should outline your plans in pencil and not pen. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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Disclaimer: The proceeding program is furnished by Creative Planning, an SEC registered Investment advisory firm, that manages or advises on a combined 210 billion in assets, as of December 31st, 2022. John Higginson works for Creative Planning and all opinions expressed by John, or his guests, are solely their own and do not represent the opinion of Creative Planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice, and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help, request to speak to an advisor, by going to creative planning.com. Creative Planning tax and legal are separate entities that must be engaged independently.
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