On this week’s show, John explores when quitting may be better than having perseverance, discusses how recent events affect our financial decision-making and shares option strategies that may boost income. Plus, Creative Planning Tax Director Ben Hake joins the show to share the most important aspects of the upcoming expiration of the Tax Cuts and Jobs Act.
Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!
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Transcript:
John Hagensen: Welcome to the Rethink Your Money Podcast, presented by Creative Planning, I’m John Hagensen, and ahead on today’s show, why quitting may just be better than having perseverance. The sun setting Tax Cuts and Jobs Act, as well as option strategies that may boost your income. Now, join me as I help you rethink your money.
When we were in high school, we learned trigonometry, we learned calculus, and the thinking, which by the way has been totally debunked, was that if students learned complex math problems, it would correlate to success elsewhere in our lives. What we now know is that helping students build a lifelong matrix for assessing risk, reward, skill, luck, that’s far more relevant. The reality is, even if we had all the information, there would remain scenarios where we made quality decisions that tilted the odds in our favor and we still wound up losing. Let me give you an example of this. If I were playing blackjack and I was showing a 17, the dealer’s exposed card is showing a six, but I hit on three consecutive hands where this scenario occurred and I happened to win all three, did it make it a smart decision? Well, of course not. But sometimes just as good decisions can have negative outcomes, poor decisions can still lead to positive results.
Annie Duke, a professional poker player, world renowned, has wrote extensively about these types of decisions in her books. And so the first takeaway for us as investors is to understand that outcomes do depend upon two factors, skill and luck. And remember, investing is a lot more like poker than chess. Consider this. In chess, while the number of possible moves is enormous, there isn’t an element of chance or uncertainty involved. Theoretically, you could retrace any of your moves in any game and find out exactly where you went wrong. Furthermore, all the information required for you to make a quality decision in the game of chess is available on the board the entire game.
But by contrast, when you think about poker, your opponent’s cards are hidden. So you’re forced to learn to make decisions without having a complete picture of the situation. And then in addition, there is always this element of luck in the cards that are flipped over from the deck. And so due to this element of chance, you can calculate the probability of outcomes in each hand, but it’s impossible to know with certainty how each hand will play out. And here’s how I see this element of skill and luck playing out in the real world with our money.
Imagine that you assessed everything perfectly on this Japanese stock that you wish to purchase, and the company had major promise and you had done significant research, and your odds of that stock making money were, let’s just say 85%. But then an earthquake hits Tokyo and that company’s headquarters happened to be at the epicenter. And as a result, the stock dropped 75% in the six months following your purchase. Did that outcome mean that you purchasing it was a bad decision or was it a good decision where luck, which you couldn’t control, worked against you?
The reverse of that, and I see it from time to time, someone makes a terrible decision. Let’s say they shorted that stock, they were completely wrong in their assessment, but then that same earthquake causes the stock to drop to 75% and they make a fortune, and they’re walking around saying, “I’m a genius. I know how to pick stocks.” No, you got really lucky. You hit on a 17 with the dealer showing a six. It was dumb, but it worked out.
Let me add here. This is why I discuss on this show, and we put such an emphasis here at Creative Planning on tax and estate planning. It’s why we have 85 CPAs and 45 attorneys working in coordination on your wealth management plan because those two elements of your financial plan are a whole lot closer to chess than poker. Which is why I often tell you to ensure that those two components are dialed in and efficient because your outcomes are far less attributable to luck.
My second takeaway is to understand how relevant events impact your decision making and can cause tilt. If you’re not familiar, let me define what tilt is in the game of poker. It’s a state of mental or emotional confusion or frustration in which a player adopts a less than optimal strategy. Basically, you get emotional, you get angry. Oftentimes, by the way, this happens when you play the game correctly, you assess the odds and you still lose due to bad luck. That can be incredibly frustrating, can’t it? Where you do everything right and it still doesn’t work out. Well, we see this every year in the quantitative analysis of investor behavior from DALBAR, which is an annual study that essentially breaks down whether invest stores capture investment returns. And their studies now have shown for decades that investors are lucky to capture half of the investment returns available due to emotional investing.
It’s really difficult to not go on tilt when you look up nine months into 2022, and we’re having the worst stock bond performance in over 50 years. And this, by the way, is where a great financial advisor can help you control those emotions and stick to the rules that you have in place with a defined financial plan so that you avoid reactionary moves by being on tilt.
And the third parallel is to use mental time travel to improve the quality of our decisions. I’ve discussed this very concept with Dr. Dan Pallesen, a psychologist and wealth manager here at Creative Planning, and you can find that in past episodes by going to creativeplanning.com/radio or by searching Rethink Your Money anywhere you listen to podcasts. And Dr. Dan’s advice is to consider your future self when making decisions in the here and now. Because when we make in the moment decisions and we don’t ponder the past, we don’t ponder the future, we are far more likely to be irrational and impulsive.
I’ve seen investors take lump sum distributions to get paid immediately, even though the deferred reward could potentially be much larger. Or maybe have you ever been asked to do something several months out by a friend only to regret having agreed to it when the time finally comes? “Oh man, why did I say I’d do that? I wasn’t really thinking that far in the future.” Maybe you had an extra drink while you’re out with friends, yeah, and then you regret it the next morning. Well, these are all examples of temporal discounting, which is when you value your present self at the expense of your future self.
And so to recap these three highlights with our money. Number one, understand that outcomes depend on two factors, skill and luck. Number two, understand how recent events impact your decision making and can cause tilt. Number three, use mental time travel to improve the quality of your decisions on behalf of your future self. If you have questions about any of this, visit us at creativeplanning.com to speak with a local fiduciary who isn’t looking to sell you something but rather give you a clear breakdown of exactly where you stand with your money. Again, that’s creativeplanning.com.
And while all of those lessons are fantastic when it comes to us making quality decisions, I want to highlight something Annie Duke talked about in her most recent book, Quit. And that is while we associate grit positively, we often by contrast, associate quitting with being really negative. I mean, think when great athletes retire, Serena Williams most recently. She was very clear to say, “I am not quitting, I’m just beginning a new chapter.” That’s how concerned she is about the association with being a quitter. But what if I told you quitting is totally fine? You likely should quit a lot of things in your life right now.
I mean, what if I told you, “I want my kids to be great quitters.” You’d be like, “What is wrong with you, man? You’d probably be appalled. But there are many instances in life where quitting is positive. A couple of weeks ago Tua Tagovailoa, who is the Miami Dolphins quarterback was clearly concussed in the game. He wanted to go back in and then in the next game got his bell rung again and it was an ugly sight watching him taken off in a stretcher. He should have quit in the game against the Bills when he was clearly concussed.
So let me share with you three biases around quitting and why it actually might be positive for most of us as investors. Number one is endowment bias. Endowment bias just means that we value things that we currently own more than we probably should. And a one way to overcome this is flip the bias on its head by considering opportunity cost. Meaning that when you quit one thing, you’re starting something potentially better, what you want to ask yourself is today moving forward, “Which path provides me the highest likelihood of success?”
Example of this is a client came in actually to our Chicago office and had an insurance agent masquerading as an advisor that had sold them annuities for 100% of their portfolio. They did in 2009, and the most they could make in any year was 5% as that was the annual cap. Well, the market’s of about 350% since that decision, and this person was up about 35%. It would’ve been really easy for that person to say, “Well, I’m just going to stick with this. I already did it. Let’s just hold onto it.” But instead, they did the right thing. They quit those annuities. It’s like, “Hey, I’m in my late 60s, I’ve got 20 plus more years to invest this money, Lord willing.” And obviously while they don’t know what the future holds, they understand that the market’s earned about 10% a year for almost a hundred years.
Bonds are yielding north of 4% right now. They had held them long enough to avoid any surrender penalties, and they have enough safety buffered and set aside within the plan to bridge any volatility in the next five to seven years. So quitting that annuity strategy was the right call. Great job being a quitter to that client out in Chicago. And by the way, if you don’t believe me on the endowment bias, walk out to your garage and look around. If you were to buy a new home with an empty garage, half the stuff that’s sitting in your current garage would not be repurchased for your new garage. Well then why don’t we get rid of it? Because it’s ours. We already own it. But just like endowment bias, this next bias makes it very hard for us to quit. And that’s the sunk cost fallacy, which also applies to the garage item example.
You don’t get rid of those items in part because I paid $200 for that blower, and yes, I’m never going to use it again, but I don’t want to donate it because I already paid $200 for this. And I saw this manifested recently with a prospective client who had a highly concentrated growth stock portfolio that of course had shot up through the roof during the pandemic and then came crashing back to earth like a meteor the last 12 months, they were able to quit and sell out of it. That’s hard to do because a lot of people would say, “Well, I’m sticking with this until I get back to even because I paid a hundred grand for that stock and it’s only worth 40,000 right now and at one point it was worth 180,000. So I think it can get back there.” This is the sunk cost fallacy that trips us up and stops us from properly quitting a strategy that is likely suboptimal from this point moving forward.
And the third reason that it’s hard for us to quit is the sure loss bias. Nobel Laureate Daniel Kahneman wrote extensively around the concept of sure losses and how we generally will avoid those at all cost. Let me give you an example. If I offered you $100 and then I said, “Or I’ll flip a coin and if you win, I’ll give you $220, but if I win, you don’t get the hundred dollars that I’m willing to give you right now.” The vast majority of us would take the $100 that was the sure thing. Which is interesting because I’m willing to offer you $220, which is certainly better from a probability standpoint on a 50/50 coin flip. But we like making the choice that ensures we won’t have a sure loss. Oh, and interestingly, if we reverse that, and now let’s say you owe me $100 and I suggest that we flip a coin and if you win, you owe me nothing, but if I win, you’re going to owe me $220. You will want to flip the coin because it’s your only shot of not booking a sure loss and needing to pay me the $100. Even though again, the odds don’t speak to that.
And you can probably think of countless practical examples of where this plays out with our money. But I had an investor who flipped a lot of houses and with the market softening and the juice ratcheting up on hard money loans, he had to unload them at about a $250,000 loss. Now, that same leverage made him a lot of money the last 10 years so he is still certainly in the positive, but the sure loss of selling those homes at a price that you’ll lose money on is really difficult for us to essentially quit in those moments. And so to summarize some tips for successful quitting, don’t double down on bad decisions. Remember that not quitting is a decision every single day and it’s likely stopping you from starting something that might be better. And remember this, that generally healthy quitting should be done prior to it being obvious to those around you.
Announcer: At Creative Planning, we provide custom tailored solutions for all your money management needs as our team is structured to cover all areas of your financial life. Why not give your wealth a second look? Visit creativeplanning.com. Now back to Rethink Your Money, presented by Creative Planning, with your host John Hagensen.
John: Well, I am joined again by an extra special guest that we’ve had on before. His name is Ben Hake, he is a Tax Director here at Creative Planning and I asked him to be on today to share with us the most important aspects of the upcoming expiration of the Tax Cuts and Jobs Act. So Ben, let’s just jump right in with tax rates, what is the 2025 sunset going to do with those?
Ben Hake: Just to kind of take a step back. So 2018, the tax reform comes out, a lot of times people focus on that top line number, so hey, they dropped tax rates. But unfortunately not every one of my clients make $600,000 or $700,000 and they’re still being impacted by this. So the big change is going to be from 17 backwards, all the rates basically dropped by 2% or 3% per band. So historically, you were in the 15% bracket, this reform made it so that you were in the 12% bracket. So the impact of that is come 2025, everyone’s tax rates are going to go up incrementally. So each band kind of increases by 2% to 4% depending upon how it all falls out. And if you’re at the very top of that, then your rate’s gone from 37% to 39.7% going forward.
John: I found that many people are focused heavily on that 2% to 3% tax rate drop within the bands as you put it, but fail to either recognize or maybe properly emphasize, I should say, the impact of the income expansion that has taken place within each bracket.
Ben: Exactly. And with the sunset coming up here in the next couple of years, the one thing we’re looking at, and it’s definitely not the most intuitive thing when I go to reach out to a client and be like, “We should look at ways to generate income and pay a little extra tax this year.” And so the big one we’re focusing on right now is Roth conversions. And for some of our clients who are still working is doesn’t make sense to contribute to a Roth 401k versus your traditional.
And the thought is that, especially for our retirees, it’s like, “Hey, if we look at a Roth conversion today, what are we going to pay?” With everything else maybe we’re in that 22% bracket, which is pretty wide, it’s like $80,000 to $160,000. The thought is, generally speaking, we don’t want to pay tax before we need to. But if we look at the horizon and say, “Hey, when the sunsets we’re going to be in 25% or 28%, well that’s a 6% discount for doing it early.” So that’s really the conversation we’re having with a lot of our clients, which is, “I don’t get any cut from when we tell you to pay extra taxes, but it’s in this case maybe in their best interest.”
John: Wait, you mean you don’t get a commission every time they pay more in taxes?
Ben: No. Flip side too, and someone owes a lot, I tell them I don’t get commission.
John: Yeah, right. Yeah, I guess that’s not quite in line with the fiduciary standard being a CPA.
Ben: Yeah, exactly.
John: You’re absolutely correct though Ben. I’ve seen with clients that are relatively high income earners. I mean maybe it’s a family physician making 330,000 a year and they’re used to maxing out deferred accounts to whatever’s allowable, whether it be a step IRA or a qualified retirement account. And I tell them, “Scrap that idea and stuff as much as possible into a Roth 401k.” And they look at me like I’ve lost my marbles. They’re like, “John, I’m a high income earner. I’m a doctor. Of course I’m going to defer income to when I expect to be making less money in retirement and pay taxes at those rates.” But the reality is, if they’re married filing jointly even at $340,000 of income, they’re not out of the 24% bracket.
So I think that component is surprising to people who haven’t looked closely at this that might be making 200, 300 grand a year and aren’t above, as I just mentioned, that 24% bracket. And if you look back at the Bush tax cuts, that 25% bracket, if I remember correctly, started at about $80,000. And so while I think it is very counterintuitive to spend more on taxes today, obviously voluntarily, but wouldn’t you agree Ben, that we’re shooting for the lowest lifetime tax bill?
Ben: Exactly. And that’s really the part that is also trying, and it also helps get you a little tax diversification too, which is that you now have a pot that’s growing tax free if you need to access it’s tax free. And especially again, we get a lot of retirees who wind up, they got really large IRA 401k balances, 2, 3 million bucks. Well, if you need to start taking out big chunks for big purchases, you’re going on a trip, you’re doing something like that, all of a sudden that can be really costly on the tax bill for that. And so these times now we’re paying tax on it, but it’s at a relatively low rate. We get to enjoy the fruits of that when we’re retired later on in life, when you get that access to be able to have something that you don’t have to incur huge tax bill to touch.
John: And right now we’re talking about the sun setting rates at the end of 2025, and I know we’ll continue to unpack that further. But the other component to this that I think’s worth mentioning is that the United States has over $30 trillion of national debt. And so while none of us have a crystal ball, I think it’s more than reasonable to suggest rates may jump higher than even the Bush rates that are set to be reinstated in 2026 when looking out certainly over the next 10, 20, 30 years. And if that ends up being the case, then this opportunity in 2022 becomes even more attractive as we sit here in the Trump tax rates. But regarding this sunset, what should we be aware of regarding standard deduction changes?
Ben: So the other big thing is obviously the rates dropped a little bit and the one thing that’s really been advantageous for almost every taxpayer is that the standard deduction effectively doubled. So historically been about 6K a person, so you’re married it’s 12. Well, it’s jump up to $24,000, $25,000 right now. And so we get into a scenario because you’re limited on your salt deduction, so your state local income, real estate and property taxes is at 10 grand. So if you want to get over that, you got to have 14 grand in mortgage interest, which is rates were low, was difficult or you had to be very charitably inclined and give quite a bit away to charity. So we had quite a number of clients who that hit the 10K, it got some mortgage interest, they gave away five grand of charity, but they were still taking that standard deduction.
So as we get closer to that sunset, it’s kind of counterintuitive just going the other direction, which is that we may want to punt on making some of our deductions. So if we’re in 25, we may look to hold off a little bit to make your charitable contributions into early 26. We haven’t really had to look at it for a while, but if you’ve got a state where you’ve got December or January to make your real estate payments, you may want to pump those into that next year. And similarly, if you’re making estimated payments right now, it hasn’t mattered if you pay the state of Arizona or wherever you lived, doesn’t matter if you paid in December or January, you’re likely capped out on that. And so starting in 26, you’ll be able to get in that benefit. Again, overarching pictures, we want accelerate income and defer deductions, which is a hundred years of tax planning. That’s not generally the recommendation.
John: We’re speaking with Creative Planning tax director Ben Hake, and this is certainly counterintuitive, but it also makes perfect sense to not trigger deductions that you cannot even benefit from if you’re not itemizing. Ben, let’s expand this a bit though. What would you say if someone said, “Well, I get that, but I’d like to give now.” Would you suggest that they maybe bunch deductions now into something like a donor advice fund to allow them to continue to give annually, but get a large deduction well above that standard limit right now and then maybe take the standard deduction the next couple of years? What are your thoughts on that concept of bunching deductions?
Ben: That’s something we recommend to a lot of clients, especially those $5,000 givers are the classic one. That’s a pretty significant amount of money to give over time. But if you keep doing that every year, you’re really not getting any tax benefit whatsoever because you’re hardly ever going over the standard deduction. So bunching is definitely something between now and the end of 25 where if we want to give five grand a year, well maybe we do 15K one year into a donor advised fund, which gets the benefit of you still get to give it to the charity on that same five year clip that you would be used to, but you get the deduction all at once. That would be one. And then for our retirees, we generally talk about again, using RMDs or the qualified charitable distributions to be able to get the exclusion versus the deduction.
John: Let’s change gears to estate taxes. What should we know about regarding those and the 2025 sunset?
Ben: So right now, the big thing is that they’ve effectively doubled the lifetime exemption. So it had historically been five and a half or 6 million dollars that you could give away or if you pass away you could give your heirs estate tax free. And as part of the reform, they doubled that. And so one thing that the IRS said is that, “Hey, if you give during this expanded exemption, they’re not going to claw back when this sun sets.” And so for a lot of our very wealthy clients, they’re looking at tax efficient ways to be able to use that exemption now while it’s available and not let it just go away.
We kind of talked about it on the Roth where you’ve got these buckets of income you can fill up and once it’s gone, you can’t go back and use it. Similar with this exemption, once it drops back down, that opportunity’s gone. So again, we’re looking at ways, and this is something that we’re working with our attorneys and the estate planning team to work with clients to figure out ways to use that and still meet their goals kind of lifetime, what they want to give to charity, their children and their beneficiaries.
John: It wasn’t that long ago that it was at $600,000, which is pretty eye opening when you consider how large it is right now. I think it’s an incredible opportunity, and this is one of those financial planning topics where those that are not proactive are potentially going to be kicking themselves in 2026 or even 2036 and subsequently firing their CPAs and advisors who didn’t discuss this with them when they finally realize what they didn’t do today back in 2022. And of course for you listeners, that’s not going to be you because you’re listening to Rethink Your Money and Ben is making sure that you have the information that you need.
And if you’d like to discuss this further with one of our fiduciaries to evaluate your specific situation, go to creativeplanning.com to speak with a local advisor. And Ben, can we assume that with the political unity that we have out there, Republicans and Democrats singing kumbaya with each other, that this is set in stone and guaranteed not to change. Or by contrast, and I think you hear the tongue in cheek, what do you see possibly changing that would make basically everything that we’re talking about either less relevant or completely erroneous between now and the end of 2025?
Ben: So I’ll always throw out there that this has the benefit of requiring no action. So if Congress is in a stalemate that doesn’t do anything, this will automatically revert back. Which does increase the likelihood a little bit, but I always preface this, it’s 100% dependent upon who’s going to be in office at the time that we get close to this sunset. And the reason for that is tax bills over the last 10 years, we’ve seen tons of them and it’s one of the few things that the Congress with the Senate and 50 votes can pass without having kind of the other side’s participation in it.
And so I would argue that there is a chance that depending upon who’s in office, we might even see lower rates. I think that’s highly unlikely and don’t quote me on that, but it’s just as likely that we could see no action whatsoever, they extend it, they let it sunset, I think there’s a variety of options. And that’s why this is something that we’re going to kind of plan as we go versus just assuming it’s going to happen and going forth with a plan for the next three years.
John: Well, lot’s changing Ben, but what isn’t changing when this sunsets in 2025?
Ben: The big ones, and I think it’s relevant for a lot of investors, are going to be that right now there’s no change to the long term capital gains rates and qualified dividends. So it’s that 15%, 20% bracket. And then the taxes that were implemented well before the Trump tax reform, so you make over 250 in salary or self-employed income, you got to pay Medicare surtax, or if you make over 250, you got to pay that net investment income tax at 3.8%. All those are still in play. So if you’ve got a large brokerage account generating a lot of dividends, the tax on that should be pretty consistent under both of these regimes or tax rules.
John: Well, I just spoke about this very topic earlier on the program that we are operating within a world of unknowns trying to make quality decisions. And so with that reality in mind, the goal is you’ve got to give yourself the highest probability of success based on the information available while accepting that some of that information is going to change along the way.
Ben: Exactly.
John: Fantastic advice has always Ben, this is going to affect all of us here at the end of 2025 and it’s important that we take action between now and then to be proactive. Thanks so much for joining us again here on Rethink Your Money.
Ben: Thank You, John.
Announcer: At creativeplanning.com, you’ll learn how your investments, taxes, and estate plan can work harder together. Go to creativeplanning.com. Creative Planning, a richer way to wealth. Now back to Rethink Your Money, presented by Creative Planning, with your host John Hagensen.
John: I want to start with this quote from the great Hans Rosling, where he said, “When things are getting better, we often don’t hear about them. This gives us a systematically two negative impression of the world around us, which is very stressful.” And he’s not wrong. I’m having a health competition right now with my sister. And my wife Brittany decided to jump in late, which isn’t fair because my sister says she has better genetics than us. She’s in way too good a shape. So my sister and I bought these Bluetooth scales that not only provide our weight, but body fat percentage and BMI and water weight and a couple of other measurements. Now side note, I don’t think this thing is all that accurate. I’m not trusting these Amazon reviews that were five stars because I’m getting in a little bit better shape, but my body fat isn’t going down.
But here’s what I found in doing this competition. Weighing myself every day is incredibly disheartening. Because if you’ve ever tried to get in better shape, you realize not a lot changes from day to day. You need to let a little more time pass by so that the progress can be more measurable. And the same thing is true when it comes to life or our money or the markets. We don’t care about small incremental improvements as much as we do rare big sensationalized, in many cases, negative events. For one, they’re more interesting to us. And secondly, the small incremental moves are often very difficult to identify. Consider this, the split of up and down trading days in the US stock market over the last 50 years is 53% positive, 47% negative. Now in spite of the near every other day volatility up and down the S&P 500 has still earned an 11.1% per year return according to BTN Research and MFS.
So the key here is focusing on the long game and staying disciplined, and we know that intuitively as investors. I mean if you have $10,000 right now and you’re 30 years old and all you do is save $200 a month, this is less than $2,500 a year, you have $1.8 million at retirement. Again, small incremental changes do have huge long-term impacts, but it can be difficult to see those in the moment. What if you up that a little bit, you’re 30 years old, you’ve got 10 grand, and you say, “You know what? I can save a thousand dollars a month” That’s just 12 grand a year. You are at $7 million at the age of 67, assuming that 11.1% rate of return that we’ve received the last 50 years in the S&P 500. But that’s methodical and that’s boring, isn’t it? It’s why news shows throw up the most recent Powerball winner, not the millionaire next store driving a 10 year old Honda Accord with 3 million bucks in their retirement accounts that took 30 or 40 years to build up. That’s not sexy, that’s not fun, and it’s certainly not interesting for us to watch on TV, but it’s powerful.
Hans Rosling, who I referenced earlier in the quote, wrote one of the greatest books I’ve ever read entitled, Factfulness: The 10 Reasons Were Wrong About The World and Why Things Are Better than You Think. And if you haven’t read it, I highly recommend you do. In those 10 bullet points, he includes topics like the media’s negative bias and how that skews our perspective on progress. What I just alluded to, this idea that much of the world’s changes are slow and progressive and so they’re not newsworthy. But when you actually look at the percentage of the world that’s still living in true poverty today, versus 30 or 40 years ago, the medical advancements in not only our country but around the world, the improvements are enormous and they’re encouraging.
That’s why I want to share with you the 10 reasons that I’ve come up with, they’re not as good as Hans Rosling’s, but I’ve got 10 reasons why things are better than you think when it comes to your financial life. And we need to be reminded of this during a bear market where we’ve had the worst nine months stretch for a stock and bond portfolio in five decades and inflation’s at a 40 or high and negative sentiment is all around us.
The first is that investing has never been more affordable. If your pain front loaded commissions when you buy mutual funds, or maybe even worse, you’re in C share mutual funds paying one and a half to two and a half percent in ongoing internal fees, just stop right now. And as a side note, do you know what you’re paying in fees? If not, go talk to a credentialed fiduciary who isn’t trying to sell you some other loaded product to get a breakdown of your fees both those that are visible and those that are unseen, which impact you just as much. Every dollar that does not leave your account for fees stays in and compounds exponentially. This is something that you can control.
I personally have clients today that came in for a second opinion, thought they were paying a couple grand a year, were paying 15 or 20,000 a year when we added up their internal fees and they had been doing so for decades just completely unaware of this. Make sure you know what your costs are. Again, we can help you with that. If you’re not sure where to turn by going to creativeplanning.com to request a second opinion. Again, that’s creativeplanning.com.
And the second reason why things are better than you think they are, certainly better than the way the media presents them, you have access to the right coach slash advisor for whatever your needs are, regardless of where you live. For decades, the number one reason we knew this from all the industry benchmarking studies that you chose your advisor was geography. You would look at whose office is near my house and that is the way you would choose the person or company to manage your entire life savings. Now, regardless of your unique needs, you can find the perfect fit for you and work with them efficiently regardless of how close your home is to their office.
Third reason why things are better than you think, more tools and visibility thanks to technology that allows you to access your plan. In fact, we’ve just launched here at Creative Planning a financial calculators section to the website that will help you make more informed decisions on how, when and where to save, there’s all sorts of different calculators available. You can find those by going to creative planning.com/calculators.
Number four, expected returns out of bear markets are much higher than prior to a bear market. I spoke about this last week as did our President here at Creative Planning, Peter Mallouk on his podcast entitled Down the Middle. Have a listen to his thoughts.
Peter Mallouk: So what’s easy about bonds is bonds is really math, right? We know that you buy a bond, you’re going to get the interest and then the meantime it fluctuates based on whether rates went up or down. Stocks can fluctuate for all kinds of reasons. I mean sentiment or earnings contractions and all kinds of things. But in general, we do know that this is not the first bear market in the history of the United States, this is the 30th bear market. And we know the previous 29 gave way to a bull market. So we know if you own quality stocks, the odds are pretty darn good you’re going to be okay. Now, what’s the expected return? When you see a bear market, so it’s a drop a 20% or more, which is where we are now, the expected return over the next three years is over 50%. Very, very high so you can expect you look forward three years from now, your average return will be in the low teens per year.
Now is it start today? No. Is it perfectly spaced out? No. Are there any guarantees? Definitely no. But we know that when the market recovers, there’s this every now and then a client says, “Well Peter, it’s going to take me five years to get back where I was with the market going up six, 7% a year. That’s not how it works.” Almost always when the cloud is lifted, whatever the cloud was, when it’s lifted, the market rockets and recoups most if not all of its losses, and goes on to new highs. And so at some point we’re going to see that probably happen, we’ll probably see double digit returns over the next couple years. People thinking about going to cash now, I mean, you’re not an experienced investor if you’re thinking about that now. We’re not even an average bear market, the average bear market’s a 34% drop. We got a long way to go to get there, maybe we will. But the expected return, even from these levels is very, very strong based on history.
John: Again, that was Creative Planning CEO and President Peter Mallouk on his podcast Down The Middle that you can find anywhere you listen to podcasts. Fifth reason why things are probably better than you think, you have more of an opportunity to start a business or a side hustle than ever before in history. Consider this, 5.4 million businesses were started in 2021, that blew away the previous record that was set in 2020, just a year earlier, at 4.4 million businesses started. So circling back to my quitting theme that I spoke about earlier on the show, if you want to start a business and you want to quit your current job, there has never been more of an opportunity for you to get away from a situation that you’re not happy in and have more control over your career.
Number six, standard of living in America has increased so dramatically from even 20 or 30 years ago. I mean, think about this. We’re all living in mansions. Like, “No John, I’m in a two bedroom apartment.” Well, compared to the rest of the world, it’s still a mansion. And if you live in a single family home compared to 1950 where the average size was 983 square feet, it is a castle because the average single family home right now in America is over 2,500 square feet. So even though we’re sitting here in a bear market and no one likes it, keep in mind that our standard of living here in America is unbelievable.
Number seven, mobility is at record levels. If you don’t like where you live, you move. My wife and I live in an area of the country where we are not from. That’s not that difficult to do nowadays. I actually still think it’s interesting that about 50% of all Americans will never move more than 25 miles from where they grew up.
Number eight, access to information has never been more free flowing. Now that’s a double edged sword as I talk about on the show quite often, it’s never been easier to find information and never been harder to find truth. More information isn’t always better. But I tell you what, we purchased a house and they left in the home office a dictionary and an encyclopedia collection. But I’m thinking to myself, why do I need a hard copy dictionary that’s heavier and thicker than the Bible collecting dust in my office? Essentially, if you need to know a fact about virtually anything, it’s not too hard to find.
The ninth reason why things are better than you think, you could work a lot later in life and positions that fit that are much more broadly available than ever before. I mean, for most of human history, your job required significant physical exertion and when you reached a certain age, you simply couldn’t do it any longer. So if you’re behind a bit financially and you’re feeling discouraged, there are a lot of jobs and some of which you might really enjoy that you can continue to do well into your 70s and maybe even 80s.
And the 10th reason I’d like to highlight why things are better than you might think, life expectancy is lengthening every single decade. And I’ll tell you why this is important because time is far more valuable than money. Imagine if I told you that you could change places right now with someone worth $10 billion. All I would need to say to stop you in your tracks is, “Oh by the way, that person’s 95 years old. Now do you want to switch places with them?” You’d go, “Well no. I mean they’ve got $10 billion that’s pretty cool, but they’re 95.” You’re not going to make that trade because time is more valuable than money. And money without time doesn’t do anything for us.
And so while it’s fantastic that we’re living longer, I would be remiss if I didn’t emphasize the fact that this creates major financial planning challenges and implications because no longer do you work until 65, get your pension and a gold watch in a retirement party, collect your social security, live off 7% interest in your CDs, sit on the front porch with some ice tea rocking for five years and die at 70. Today, that 65 year old’s often retiring with no pension. And although rates have ticked up, they’re still not historically as high as they’ve been in the past for savers looking to earn interest on things like CDs. And most importantly, that person’s living 25 to 35 more years that their money needs to last. So living longer is certainly a great thing, but it requires you to even have a better financial plan.
Let me recap the 10 reasons why things are better than you think when it comes to your financial life. Investing has never been more affordable. You’ve got access to the right coach wherever you live. More tools and visibility than ever before thanks to technology. Expected returns coming out of a bear market like this are higher than average. You have more opportunity to start a business or a side hustle. Standard of living in America has increased dramatically. Mobility is at record levels. Access to information has never been more free flowing. Jobs later in life are more broadly available. And you are living longer than ever before.
And of course, if anything that you’ve heard so far in the program has brought about a question in your mind, I want those answered for you. I know how hard you’ve worked for your money and we think here at Creative Planning that your money works harder when it works together. So I want to invite you to do what so many others have done before you and request a second opinion by going to creativeplanning.com to speak with a local fiduciary advisor who is not looking to sell you something, but rather give you a clear, understandable breakdown of exactly where you stand with your money. We’re managing or advising on $225 billion for clients in all 50 states and 65 countries around the world. We’ve been helping families just like you since 1983. Why not give your wealth a second look? Again, that’s creativeplanning.com to request a second opinion with a local advisor here at Creative Planning.
Announcer: At Creative Planning, our wealth managers work with in-house CPAs and attorneys to ensure your money is working as hard as it can for you. Give your wealth a second look at creativeplanning.com, and connect with your local advisor. Now back to Rethink Your Money, presented by Creative Planning, with your host, John Hagensen.
John: USA Today posted an article, it was regarding the increase in cost for both crop farmers and livestock farmers. And many of our clients here at Creative Planning, certainly in those rural areas, have made a lot of their wealth working their tails off, oftentimes in multi-generational family farms that their parents and grandparents and great-grandparents have farmed. And in this article, they interviewed certain farmers that said, “We’ve gone through a lot over the last 50, 60 years as a family and this is right up there at the top.” One corn and soybean farmer said that he used to grow corn at 350 an acre not that long ago and now it’s $600 an acre. Most farmers quoted estimated that their costs have increased 40 to 50% in the last two farming seasons alone.
And again, I’ve had this conversation with many of our clients that are farmers or ranchers and it’s been uniquely challenging for them just as it has for an urban American then going to the grocery store, seeing higher prices on food and wondering why is this so expensive? Well, there’s the reason. And certainly things like buying stocks and real estate and hard assets versus bonds or cash is one way to protect yourself against 40 year high inflation.
But I’d like to expand that topic a bit and discuss what I have for you on today’s technical topic where I help you gain in your knowledge of investing one show at a time. And that is how you can use option strategies to both hedge price movements as well as increase income. Now obviously I must disclose options are very risky, they’re a complex strategy, this is not personalized advice for your situation, do not do this on your own. Clearly inexperienced option buyers on a platform such as Robinhood, probably others as well, have been completely obliterated by not understanding how to trade options and the underlying risks.
But options do exist for a reason. Remember when Southwest Airlines was making a ton of money while other airlines were hemorrhaging money because they had hedged fuel costs and purchased jet fuel and locked in those current prices before they jumped significantly. That’s a real world practical example where you see hedging strategies played out.
But here are two option strategies that I want you to be aware of. Number one is selling covered calls. Now this is used as a hedge and there are all sorts of examples of this similar to what I just shared, whether it be with farming or airlines. But for you, it might just mean that you have a highly appreciated stock or you work at a company where you’re fortunate enough to get a lot of company stock and you look at your plan and say, “Well, as long as this stock does well, I’m golden.”
But maybe you’re not comfortable with a concentrated risk that if things go poorly for that stock, it could have a sizable negative impact on your financial success or ability to retire. But the reason I say selling covered calls in this example is because obviously you own the stock long. And where this can be incredibly risky and where people that I just mentioned have lost crazy amounts of money because they didn’t understand this is that if it’s a naked call and you’re uncovered, your losses are infinite. Meaning that you don’t also own the stock and it could theoretically go up 50000% and you’d be obligated to purchase it at that new market price. Well, if you already own the stock and you’re just using this as a covered call hedging strategy, you’re going to benefit from the massive price increases on all this company stock that you own.
So the reason you do this is that you can earn some income by selling call options and you also benefit if the stock drops because you then keep the shares and the premium, which will partially offset the losses associated with that declining value of the stock. And I don’t want to go too far into the weeds, but again, this can be a nice play to hedge of position you already own and collect some income in the meantime.
Option strategy number two is selling cash secured puts. This was extremely attractive, especially when bonds were yielding 1%. And you might have been looking around saying, “Well, I don’t want everything in the stock market, but I also want to earn some income. I don’t like the idea of sitting in something guaranteed to lose to inflation from an income standpoint.” So if you buy a put, you’re bearish. But what I’m talking about is selling a put, that means you’re bullish and on the surface that can be really risky.
Again, you want to be very careful how you do this because if a stock goes down a lot, you have downside risk. But here’s the key when you sell cash secured puts. You can define your risk based upon the probability of where you sell that put, which is called the strike price, and how far out you’d like to go in terms of the time period, how many months. So for example, if you sell a 15% put, the market has to drop more than 15% for it to potentially be exercised. But you’d have risk if the market went down 40%, you’d still be down 25% because you only had that 15% protection. And if you’re wondering how much income do I earn off of this? Well, it depends on a variety of factors. But essentially the higher the risk of downward movement of the market and volatility, the more highly compensated you will be by selling that put.
But if you don’t mind owning, let’s say the S&P 500 once it drops more than 15%, you just want a little bit of a buffer, this can be a really nice way to collect income. And again, if the market moves sideways or up, you can collect the premiums. Now, as part of our offering here at Creative Planning, we have an options team. And I would advise before you engage in any of these strategies to speak with someone like us at Creative Planning to first off, make sure that the strategy is even appropriate and optimal for your situation. But then even if it is, you want to make sure that they are executed properly which takes a high level of experience and expertise. As always, you can contact us at creativeplanning.com if you’d like to discuss with a local advisor how some of these strategies may benefit you. Again, that’s createplanning.com.
Let’s transition over to a very common mistake that I see and that is borrowing from your 401k. Sara Krause, who is an attorney and also a certified financial planner here at Creative Planning, wrote an article for our clients that I will post to creativeplanning.com/radio. If you’d like to check it out on the four reasons not to borrow from your 401k. You may or may not know that many 401k plans allow participants to borrow up to 50% of their vested account balance up to 50 grand for five years and pay it back at a low interest rate that goes right back into the account, which is why a lot of people think, “Well, that sounds like a really good deal, doesn’t it? Why wouldn’t I want to do that? Why would that be a mistake?”
Well, there’s several important reasons why taking a loan from your 401k is a bad idea, and here are four of them. Taking a loan from your 401K comes with significant tax consequences. That’s right. You might be thinking, “Well, I thought 401K loans were tax free.” They are at the time they’re taken, but they end up costing you in the long run. Because remember that 401k deferrals are made with pre-tax dollars while your loan repayments are made with after-tax dollars.
Number two, you’ll be missing out on growth opportunities. And Sara has a fantastic chart outlining how missing the best days can be costly to your compound interest. This is intuitive. If the money’s not in there growing at theoretically 10% a year as it has for a hundred years, you’re not just missing out on what you borrowed, you’re missing out on the entire opportunity cost of not having that invested.
Number three, you may need to pay back the loan at the most inopportune times. I’ve seen participants take this loan, their financial situation changes, and now it puts them in a huge bind. And remember, if you don’t pay it off on time, you have a 10% early withdrawal penalty.
And the fourth reason why it is not a good idea to borrow from your 401k is that you may miss out on the benefits of pre-tax deferrals and employer matching funds. Some 401k plans don’t allow participants with an outstanding loan balance to make additional contributions until it’s paid off. And that’s obviously a triple edged sword because you’re not only missing out on the benefit of regular contributions, you’re also potentially missing out on the company match and your taxable income’s going to increase without the benefit of those pre-tax deferrals. So again, that article written by Sara Krause will be posted to the radio page of our website at creativeplanning.com/radio.
And as we come down the home stretch of today’s show, I’d like to shift the focus to our kids and our grandchildren. Did you know that an estimated $68 trillion will be changing hands within the next 25 years? That’s right. The youngest baby boomers right now are 58 years old, the oldest are 76. There are roughly 75 million boomers according to the US Census Bureau and right now alone have about $40 trillion in assets. And so the question I have for you today isn’t whether your plan is dialed in. I hope it is. Whether your tax strategies are in place and your estate plan is efficiently constructed, and all of those things are being coordinated as I talk about each and every week as we do for our clients here at Creative Planning. If they’re not go to creative planning.com and speak with a local advisor, we’ll help you get on track. But let’s assume that your plan looks great. Can you say the same thing about your children and your grandchildren’s financial situations?
Are they financially literate and knowledgeable at the same level you are? Are they receiving great advice from a firm like us at Creative Planning? Are they talking with an attorney and a CPA and a financial advisor and coordinating that advice? Or if you’re being honest with yourself, are you a little bit concerned about their lack of progress or knowledge? Do you think it’d be beneficial for them to inherit a million dollars or $5 million or $250,000, whatever your situation is? Are they ready for that? Because the reality is oftentimes we don’t want to think about it but we’re all going to die at some point. And you’ve worked hard for what you have and I assume that you’d like to know that the money will be stewarded well and maximized and not squandered. And oftentimes by squandering, I don’t mean because your children mean to. Oftentimes they’re just not experienced handling that amount of money or aren’t getting the advice from the right places when they do inherit that money.
And this really is why we’ve had such a commitment here at Creative Planning to being one of the larger estate planning law firms in the country, having a large tax practice, having over 85 CPAs on our team in addition to tax attorneys and real estate attorneys in a trust company to help administer trust if something were to happen to you and you need that service in addition to our over 300 certified financial planners.
And that’s because we want you to feel confident that even if something happens to you, your children will be receiving the same great advice. And again, that doesn’t mean that all roads lead to Creative Planning and you have to work with us, but you want your heirs prepared financially for this great transition. And one real practical easy first step that you can take with your children is to invite them to a short webinar that we are hosting on Tuesday, October 25th, one in the afternoon and one in the evening on taxes and your wealth, how to keep more of what’s yours.
One of our managing directors in the Atlanta area is who will be hosting that webinar. I’ve seen it, it’s fantastic and it’s filled with all sorts of practical applications that you and or your kids, regardless of whether you ever worked with Creative Planning, can use to take advantage of this historically low tax environment as we sit here in the Trump tax reform before it sunsets, as I spoke about, and you can register for this by going to creative planning.com/radio and you will see a popup right there on the radio page to sign up. Again, that’s creativeplanning.com/radio. Of course, it’s complimentary and comes with no obligation to become a client.
Let’s all ensure that our future generations who will inevitably be inheriting some of the wealth that we’ve worked so hard for are informed and educated long before they’re making critical decisions with those assets. Again, you can visit creativeplanning.com/radio to register for that webinar.
Well, that brings me to the conclusion of today’s show, and if you’ve been listening the whole time, you’ll understand what I’m talking about when I say it is time for me to quit. That’s right. I’m stopping while I’m ahead and I’m quitting well. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
Disclaimer: The preceding program is furnished by creative planning, an SCC registered investment advisory firm that manages or advises on 225 billion in assets. John Higginson works for Creative Planning and all opinions expressed by John and his guests are solely their own and do not represent the opinion of Creative Planning. This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
Clients of Creative Planning may maintain positions in the securities discussed on this show. For individual guidance, please speak with an attorney, CPA or financial planner directly for customized legal tax or financial advice that accounts for your personal risk tolerance objectives and suitability. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning Tax and Legal are separate entities that must be engaged independently.
