On this week’s show, John discusses what to expect from the current bear market. Plus, Creative Planning’s Tax Director stops by to share year-end tax planning tips.
Read more on planning around rising interest rates:
Read about Roth conversions:
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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John Hagensen: Welcome to the Rethink Your Money Podcast, presented by Creative Planning. I’m John Hagensen, and ahead on the show, How to be offensive in a rising interest rate environment, the ins and outs of Roth conversions and other year-end tax planning tips, as well as a highlight on one of the riskiest assets in existence that masquerades as if it were a safe one. Now join me as I help you rethink your money.
I’d like to start with an event that happened this week with one of our teenagers. I looked down on my phone and I had a missed call and then I also had a text that said, “Please call me.” And then I had another text that said, “Dad, call me when you get this.” Well, of course, I instantly suspected Shane must have crashed his car. I better give him a call back. And it was one of those interesting times that, yes, in fact he was in a car accident, but while it was bad news, it could have been so much worse. In fact, when I was on the phone with him and found out that he just glanced a car while pulling into a parking spot to get a breakfast burrito, yes, I’m not joking, the other car wasn’t moving, that no one was injured and it was minor damage. And this is why we have insurance. It’s part of having seven kids. Stuff like this seems to always be happening and it’s not ideal, but life will go on. It’s not the end of the world.
Well, on Wednesday, the Federal Reserve essentially text us all again for the fourth time this year that they were in a car accident raising interest rates by 75 points. And prior to June of this year, the Central Bank hadn’t raised rates by 75 basis points or three quarters of a percent at a policy meeting since 1994. But it was a lot like that conversation with Shay where the news could have been a lot worse, because they also hinted that they’ll likely be much less rapid in raising rates moving forward. Fed Chairman Powell said that the continued rate rises were needed and I quote, “to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% overtime.”
Well, of course the market responded as it seems to always do when the Fed speaks by jumping 300 points and then falling almost 800 points in afternoon trading on Wednesday. But despite that daily volatility and response to the Fed, the Dow Jones Industrial Average just finished its best October since 1976. Did you know that the Dow was up 14% last month? Did you even notice? Maybe not. We didn’t hear much about it, did we? I don’t know if we’re too busy looking into the sky at the SpaceX shuttle launch, which by the way, we spotted and it was pretty cool. Maybe in October we were too busy with the best sports month of the year. NHL, NBA, World Series, College Football, NFL, it’s the sports fans coup de gras, that’s for sure. Or I don’t know, maybe you missed it because you were just living life, working, hanging with friends and family, taking care of all the normal aspects of life.
But I point this out because recoveries are weird in that you can blink and they’ve happened. The Dow Jones is now only down about 10% for the year. The S&P is down about 20%. The NASDAQ down around 30%, which is up substantially from their bottoms at the end of September. And I found myself having many conversations with our clients over the last few weeks regarding this October pop and the clients’ questioning, “Is this the bottom? Do you think we’re through the worst of it, John?” I wish I knew, of course, because that would be really convenient for our clients’ wealth and my personal wealth if I could tell the future. But Creative Planning President Peter Mallouk recently spoke about what generally does end bear markets when you look historically with our Director of Financial Education, Jonathan Clements, on their podcast Down the Middle, have a listen to their thoughts.
Peter Mallouk: A lot of bear markets end with capitulation, which is when the last reasonable person you’re following says, “You know what, I’m throwing in the towel and I’m going to cash when the retail investor has finally given up and gone to cash.” We saw that in ’08, ’09, March 9th of ’09, the market just massive, massive drop and you could just feel the blood in the streets. The last person who had hung on that was going to sell had sold. And what capitulation does is that all the sellers are gone. All that’s left is the buyers and it allows the psychology to shift. We see that in some markets. Sometimes you just need the situation to be resolved. Like with COVID, the Federal Reserve came in and said, “Okay, you’re worried about these markets collapsing, we’re going to back them up.” And then you saw a vaccine and the combination of those things, the markets said, “Okay, we can go about our business.”
So capitulation is not a requirement to get out of the bear market. We need the cloud lifted. The cloud here is the market sees reduced earnings and higher unemployment and less people buying homes and big purchases because interest rates are going up. And I think once the market feels like the Fed is done with that, and the Fed has said they’ll be done with that around the first quarter of 2023, I think we’ll see the market start to look to the future further and begin to recover. The issue with that, that means all things being equal and all things are never equal, right? Russia could pull out of Ukraine, in the next couple weeks peace could break out and the market would soar. Things in Ukraine could get worse and the market could tank. There could be a cyber attack, a terror attack, something we’re not thinking about.
There’s always that added variability and so it’s kind of a fools game to even say, “Well, if the Fed does this then that.” Because there was a time where the Fed wasn’t doing anything and you always had to worry about anyway the thing coming out of nowhere. So I think an investor should just step back, look at their portfolio and say, “If I need money in the next few years, it should be in conservative investments. If I need money five years out, I can look at stocks. 10 years out, I can even do some illiquid things.” And they should really bring the portfolio back to their needs. The market is going to work itself out whether it’s due to capitulation or the Fed gets done or earnings wind up stronger or peace breaks out in Ukraine or whatever is going to happen in the short run.
John: And the point he made is a noteworthy one. Markets are forward looking and recoveries are often as fast or faster than the crash. I mean I can close my eyes and I can picture Cruz, our 11 year old, as a newborn. Poor kid had terrible acid reflux and would just spit up everywhere. And that cute little newborn has only seven years left in our home. It’s actually really sad to think about. And then after that, the entire rest of his life, he’ll be doing his own thing. And if you’re a parent you can relate, the days are long but the years are short. And as children leave our homes as we’ve had now with our oldest two boys, I mean you think to yourself as a parent, did I do enough? Was I intentional enough? Did I invest enough in them? Did I do a good job? Did I make all the moments that went by so quickly really count?
And you want to consider, although a whole lot less important, the same thing with your money. You’ll seemingly blink and this bear market will have graduated into a bull market. You’ll be helping your index funds move into their college dorm room. Taxes are going to be higher, the market will be making all-time highs. And in the same way you did as a parent, you’ll be looking at your financial plan pondering, did I do enough? Was I intentional? Did I make those moments count? Because it sure feels like all I did was blink and that opportunity has passed me by. I don’t want that for you. We are in unprecedented, unique times right now, lowest tax environment we’ve seen in the last 40 or 50 years and likely one of the lowest we will ever see for the rest of our lives.
And so what should you be doing right now? And I hope you’ve already done this. If you’re a client of Creative Plannings, you certainly have. Rebalance, meaning taking some of your securities that are doing well or up in value and purchasing equities while they’re on sale. And while executing that, you may also find the opportunity to tax-loss harvest by selling certain investments, capturing those capital losses, repurchasing a similar security to maintain the constitution of your investment allocation and your financial plan. And the third one that I want to focus more specifically on for a few moments is the opportunity for Roth conversions. And here’s a practical example of where there can be confusion around Roth conversions.
A prospective client came in from the radio show looking for a second opinion, was very interested in converting some of their traditional IRAs to a Roth, but had been told by a previous advisor that if they were to do this they would lose the compound interest benefits by making their account balances smaller earlier. But unfortunately they were missing the elephant in the room, which was you’re also exponentially compounding the taxes owed on that larger account.
And so to help us conceptualize this today, which I know can be difficult sometimes without any visuals, so I apologize if this is a bit confusing, but here’s the key. Let’s suppose the two accounts, the $78,000 Roth that had already been taxed and the $100,000 IRA that was yet to be taxed were invested exactly the same and down the road your tax bracket was exactly the same, it was still 22%. Once you distributed the IRA, which had grown to be a much larger dollar amount and had to pay 22% on that much higher value, you end up down to the penny with the exact same balance after tax as you had in your Roth IRA.
And so to simplify whether a Roth conversion might make sense or not comes down to one primary question along with many smaller questions. But that paramount question is simply do I think the taxes I’ll pay today are lower or higher than down the road? And so as I circle back to what I emphasized earlier, we don’t know what’ll happen the next 25 years with taxes, but what we do know is, historically speaking, we’re in one of the lowest environments we’ve seen in the last 100 years. It’s reasonable if you have saved the majority of your money in a traditional IRA or a 401(k) that is yet to be taxed. One of the greatest opportunities that you might have right now before December 31st, while taxes are low, while the market’s down in value, is to consider whether a Roth IRA conversion makes sense for your situation.
It’s worth noting that these conversions are irrevocable, they cannot be reversed. And so you want to do this within the context of your financial plan and with the help of a CPA who is engaged in your overall financial planning situation. If you’re not sure where to turn and you would like help on that, here at Creative Planning, we are doing this for families in all 50 states and 65 countries around the world and we can help you as well. Do not let another year pass with your tax strategies where you’re blinking and your portfolio’s gone from a newborn to helping them get their driver’s license. Let’s not wait. Let’s not miss this. The time is right now.
Contact us at creativeplanning.com to request to sit down with a local fiduciary who is not looking to sell you something, but rather give you a clear and an understandable breakdown of exactly where you stand, whether it be your taxes, your estate planning, your financial planning. It’s complimentary and there’s no pressure to become a client. Do what thousands and thousands of other radio listeners just like you have done over the years. Again, that’s creativeplanning.com. Don’t wait any longer. Time is running out. December 31st is the deadline for many of these opportunistic tax moves I don’t want you to miss out on. One last time, that’s creativeplanning.com.
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: Well, whether you believe it or not, the year is coming to a close here in about eight weeks. I know this because my children’s favorite holiday Halloween just came and went and in our neighborhood they shut down certain streets to traffic and there are literally kids bust into our neighborhood. In fact, I was talking to one of our friends on one of the busier streets and they estimated over 3000 kids came to their door for candy. But to continue on with a theme that time moves quickly and we seemingly blink and years have passed, the same is true with the end of the year holidays. It’ll be Thanksgiving before we know it. We’ll be watching the Lions get crushed by, I don’t know, whoever they play. We’ll be having our food coma, and then it’ll be Christmas, and then it’ll be New Year’s and we’ll be setting resolutions that we probably won’t stick to for longer than a couple of weeks, because that’s how we do it.
But this is the time of year from a tax standpoint where we got to get moving. It’s time to get busy. This isn’t the time to stand pat. Well, we’ve got plenty of time. We’ll figure this out in a couple of months. No, a couple of months, it’ll be January. And so this is why I asked our Senior Managing Tax Director Candace Varner, to join me as we discuss end of the year tax planning to ensure that you have the information you need to pay the least amount possible. And so with that said, Candace, how can people get started with their year-end tax planning? Where do they even begin?
Candace Varner: That’s a good question. Where to even start? So what I like to do with all of my clients is to start, we want a baseline where we’re at right now. So my first step is I’m basically going to recap what happened last year for 2021. Say, this is all my income, these are all my deductions, and then I’ll start looking at each individual thing. Is that going to be the same for 2022? Why or why not? What do I know? What do I not know? And those things that might not be the same, how many of those things do I have control over? Can I even make any difference as to what that’s going to happen? If it’s your regular wage, no, that’s just going to happen between now and the end of the year, but you can control the withholding. And so maybe we want to make some adjustments there. And if you’re charitably inclined, maybe we want to do more donations in this year than another year.
So start with the baseline and then see where am I at for 2022 year to date. What’s everything I know? And then we can see, okay, what’s different and what moves could I possibly affect?
John: That makes sense. What are some common moves, Candace, that taxpayers make at the end of the year?
Candace: I would still rather know everything that you have done this year, now, even December 15th, I would rather know than find out in March, because then there really is almost nothing you can do. We’re totally locked in.
John: Good point.
Candace: Obviously I’d like to talk to clients throughout the year and have them keep me involved as we’re selling things or doing things. But still now would be a great time to reach out to your CPAs. So one of the things that we’re going to look at is what are those things that we can affect? Common things that come up are making sure that everyone’s maximizing their deferrals, 401(k)s, IRAs, HSAs, all those things. Has the maximum been put in? And if not, can we still do that before the end of the year? I want to look at what estimated payments they’ve made so far and what might be due for fourth quarter. Again, that might be the withholding for people.
A key thing to look at on the withholding is if you have variable pay, if you’re getting bonuses or stock compensation, the withholding is basically never correct on those. So keep an eye out for what the withholding is on that to avoid a surprise bill, come next April. If you’re someone who pays estimated tax payments in addition to withholding or in lieu of, how much do we have to pay now to avoid any penalties? You don’t want to pay them early, but I want to make sure I pay in enough that I’m not going to owe the IRS or any states some interest. And with these projections I can say, “Okay, well, here’s how much we need to pay in, but also get an idea of what’s going to be due next April.” Because again, no surprises. That’s the whole goal.
For our business owners that are cash basis, we’re looking at what expenses can we accelerate into this year? Again, what are those things that we have control over? Don’t go buy stuff you don’t need, but if you were going to buy it in January anyway, let’s buy it now so we can get that expense into this year and accelerate that deduction. Loss harvesting for capital gains or capital losses are a big thing we look at, but we’re looking at that all throughout the year and although most people probably don’t love the wild ride of the stock market this year, as a tax accountant, it’s beautiful. Loss is for everyone that we can use to offset any gains that they might have. You can use that. Think of it as an asset in your hands as this loss. So we can use, maybe you have an appreciated position you’ve been holding onto and didn’t want to. You can realize some of those gains and pay no tax, all those kind of things. Any more losses we can take during the year would be helpful.
And then the biggest one that most people take advantage of and usually at the end of the year is donations. So a lot of stock donations, which we prefer over the cash donations between now and the end of the year. And then QCs. If you have required minimum distributions from your IRAs, you can give away the first 100,000 directly to a charity. So IRA to charity, the cash never comes into your account and that income is just never taxed to you at all. So if you’re someone who has an RMD and you don’t need the money, we’re going to donate it anyway. That’s a better way to get rid of it.
John: Well, I couldn’t agree more, Candace. And that’s why so much of this comes down to ensuring that you’re doing tax planning ongoing and looking at this on a regular basis. Don’t show up to your CPA’s office and, Candace, you know exactly what I’m talking about, with a shoebox and all your statements and receipts and probably like utility bills and a bunch of other random miscellaneous things that have no relevance for your tax return on April 14th and say, “Can we still take care of a lot of these tax savings strategies without extending my return?” And so I think the key to this whole conversation is have a trusted CPA that’s helping you navigate the ever-changing environment and so that you are taking advantage of these opportunities, especially as we approach the end of the year. Well, great advice as always, Candace, and thanks so much for joining us here on Rethink Your Money.
Candace: Sure, thank you.
John: Let’s continue on with the broad theme of important tax moves that must be made before the end of the year. Kim Riewerts, a Certified Financial Planner here at Creative Planning, wrote an article this week that I will post to the radio page of our website at creativeplanning.com/radio if you’d like to read that in detail regarding Roth conversions and why the time just might be right now. And while there are certainly many factors to consider when determining the exact timing of a Roth conversion, including, as I mentioned earlier, your current and future income as well as tax rates, your legacy and estate planning goals, your plans for retirement and much more.
But assuming that some of these other factors are favorable, there are two primary reasons you may want to consider initiating a conversion before the end of this year on December 31st. Number one timely factor is that we are in a down market. It often makes sense to initiate a Roth conversion while we sit in a bear market as we do right now because if you sell assets from a traditional IRA, when the account value is down as it is right now, you’re theoretically paying taxes on fewer assets. Hopefully you reinvest those assets inside of the Roth IRA and then the market recovers and the value of your assets will rise again, and you’ll be able to take advantage of that tax exempt appreciation for the recovery.
And so while the first reason of a down market makes right now opportunistic for a Roth conversion, the second is what I touched on briefly earlier, we’re in a really ridiculously low tax rate environment that is scheduled to revert back January 1st of 2026, meaning the standard deduction that doubled will get cut back in half. The estate planning exemption will be cut in half and all of your individual income tax rates will be compressed. The 25% bracket married finally and jointly in the Bush tax cut years started at $83,000. In our current Tax Cuts and Jobs Act brackets, the 24% bracket ends at $340,000, meaning at 340 grand you’re paying 24%, where previously the 25% bracket was applied to all of your income above $83,000.
And there are a few other factors that I’d like to share with you in addition to the bear market environment and low tax rates for you to determine at least at a high level, whether now might be the right time to complete a Roth conversion. And remember, December 31st is the deadline. Here’s where it might make sense. You experience a year in which your income’s lower than normal, you lost a job, your business didn’t do as well, market fluctuation, maybe a reduction in a bonus or total income. Another circumstance where it might make sense, you believe that you’ll fall into a higher tax bracket in the future. Well, we know rates are likely to go up. So for many people, unless your income’s also going to dramatically increase, that’s probably the case. Maybe you recently made a large charitable donation that reduced your taxable income. Maybe you wish to reduce the amount of your RMDs in retirement. If you’re unfamiliar, those are the taxable distributions that are required starting at age 72 from retirement accounts.
Another circumstance where a Roth conversion might make sense is that you wish to leave a tax-free inheritance to your loved ones. Where I see this as a wealth manager often played out is you’re in a much lower bracket than your children. Maybe you have one kid who’s a physician in Manhattan Beach, California and another kid who’s in tech in Silicon Valley, and they’re not only in the top federal bracket, but they’re also in the state of California paying their highest state income tax, over 14%, and you’re in retirement in a place like North Dakota with very low state income tax or Florida or Texas with no state income tax. It may make sense for you to be converting and paying less tax on those assets today than what your beneficiaries in those scenarios are going to have to pay.
Now here’s a few circumstances where converting would not make sense. The market’s not down and the conversion’s going to push you into a much higher tax bracket for the present year. You have high taxable investment gains. You expect to be in a lower tax bracket in future years. You don’t have enough savings to pay the tax on the conversion, which is something to really consider because if you’re under 59 and a half, it may make sense for you to convert, but you’re going to have to pay the tax bill for that converted income with after tax dollars, meaning you can’t withhold on the conversion if you’re under 59 and a half or you’ll be hit with a 10% early withdrawal penalty. And with me risking going a bit into the weeds, even if you’re over 59 and a half, you don’t need to pay the penalty and can certainly withhold the taxes due at the time of the conversion, you’d prefer not to, because the Roth IRA is the golden goose. You’d like to get the entire amount converted into the Roth and use other monies that are in a taxable environment like your brokerage account to pay the taxes due.
Another circumstance where it might not make sense to convert is you plan to leave your IRA to charity after you die. 501(c)(3)s don’t have to pay taxes on that inherited money, so it can be passed along tax free. Why would you pay tax today, deplete the asset value when it’s essentially for all intents and purposes, sitting in a “Roth” right now in terms of how it will be taxed when received by the charity? Maybe you’re going to need a lot of this money in five years or less and there’s a five-year waiting period to withdraw converted assets without a penalty. Now there’s a lot of nuance around that and some specifics, feel free to contact us here at Creative Planning and we’ll walk you through that five-year waiting period and what you need to know about that.
Maybe you recently sold an investment or had higher than normal standard compensation, maybe you received a large bonus or deferred compensation payout. Any large income events have the potential to push you into a higher bracket, which likely means it’s unwise to add more income on top of that by completing the Roth conversion once you’re already in that higher bracket. Or maybe you just reached the age of 65, you’re collecting Medicare, and this is a big one, the Roth conversion might push you over Irma cliffs, meaning you’d get hit with higher monthly premiums on part B and D. Make sure you work with your wealth manager and your CPA to weigh in on the present and future impacts along with your RMDs of a Roth conversion. I can’t overstate this. A Roth conversion is an incredibly enormous opportunity for many people out there, but it must be done with intentionality and strategy and planning. This cannot be, let’s just sort of guess.
But fortunately for you, our team here at Creative Planning specializes in helping people just like you take into account a wide range of both investment and tax factors when proactively planning out how to minimize taxes over your lifetime, not just this year, but over the next 5, 10, 15, 20 years of your life. If you haven’t had your tax return reviewed by your financial advisor in the last year, what are you waiting for? Go to creativeplanning.com. Speak with a local advisor. Double-check that you’re not missing anything where the opportunity will be lost, like Roth conversions on December 31st. The time for you is right now to ensure that you get the information that you need. Again, visit us at creativeplanning.com and take us up on our complimentary second opinion. We’ve been helping folks since 1983 in all 50 states and 65 countries around the world. Why not give your wealth a second look?
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Now back to Rethink Your Money, presented by Creative Planning, with your host John Hagensen.
John: We’re now in the final eight weeks of 2022 and the clock is ticking on some of our most pressing and timely personal finance moves. Here is your public service announcement. Not making a decision is in fact making a decision. If you can’t decide whether to get on a subway and the doors close and it takes off down the tracks, well, you, in fact, made a decision. You’re not on the subway. It’s gone. You were left behind. I’ve had a few friends over the years that just could not make a decision on whether or not they should propose to their girlfriend. Well, once they had been dating 3, 4, 5, 6, 7 years, she’s likely going to say that indecision is a decision as she’s singing Beyoncés “if you like it, then you should have put a ring on it.”
And in the thousands of meetings that I personally have had with families all across the country, I see this challenge with indecision so often hamstringing people’s ability to make positive change. Let me share with you an example that I just had with a couple that I met with in Arizona. Here is their situation, and by the way, they’ve done a fantastic job setting themselves up well for retirement. They’re about five to 10 years away from wanting to retire, have just under $1 million saved for retirement, have a business that’s producing income that they have no need to retire from, even when one of the spouses retires from his day job. When he retires, he has two different pensions and they both have extremely strong social security benefits. Their house is paid off and they have no other debt of any kind. Oh, and by the way, they spend about $50,000 a year and are saving about $10,000 per month right now. Their income needs in retirement, they expect to be in today’s dollars about $50,000 per year.
So the first thing that I told these clients from a big picture standpoint is that they’re in a great position, they’ve done the heavy lifting, they’ve put in the hard work and should have a lot of optionality in retirement. However, the disappointing part of their situation is that very little of this, if any, was because of the financial advisor that they’re paying. Instead, it was unfortunately despite their advisor. And here’s why I mention that. They have no estate planning documents of any kind. Their advisor hasn’t reviewed their tax return in the entire 10 years since 2012 that they began working together. Oh, and their investments, their investments directly off of their statement since inception in 2012 have earned 4% per year while the S&P 500 has made nearly 15% per year.
And of the variety of reasons why they’ve suffered that underperformance is due to over 2% per year in total costs between their advisory fee and unnecessarily expensive mutual funds, combined with an active management approach where they are shifting investments and the managers that they are selecting are actively trading within their funds to try to achieve superior results to that which the broad markets has provided. To put this in perspective, if you had $500,000 and it earned 15% a year for a decade, it will have grown to approximately $2.2 million. That same $500,000 earning 4% per year over a 10-year period has only grown from 500,000 to 750 grand. 2.2 million verse $750,000. So together, let’s unpack the practical moves this couple could make to improve their progress.
The first thing they can do is lower costs. How do they do that? Sell the unnecessarily expensive active mutual funds with poor performance in favor of low-cost index funds and ETFs. This shift immediately would put $6,000 back in their pocket. And although past performance is no guarantee of future results, they’re likely to get significantly better returns by saving the money. Second adjustment they should make is to get an estate plan done. With the savings that they would realize from lowering the cost of their investments, the cost to get the estate plan done would be offset in less than half a year. And the third big directional change that should be made is to build out a detailed tax plan.
You see, they’re in a situation because of the pensions, strong social security, and the business that will continue on once he retires means that their income isn’t going to drop dramatically, if at all, once they’re in retirement. Yet the vast majority of their current savings is being allocated to deferred retirement accounts. Remember, when you put money in 401(k)s or IRAs, you’re not eliminating taxes, you’re simply asking to pay them later with the assumption that later will be at a lower rate. Well, if their income’s not dropping, then at 72 it certainly won’t be dropping, because they’ll be forced to take required minimum distributions from these retirement accounts on top of everything else. Combined with that we expect taxes to likely rise from the current Trump tax reform, it’s a fairly high probability that their tax rate will be higher in retirement.
And it’s situations like these where I have mixed emotions because on one hand these folks have done a fantastic job saving and should have an incredibly optimistic and positive outlook on their future, but on the other hand, I’m disappointed because they’ve accomplished the running of this marathon with a parachute strapped to them. And while I don’t presume to suggest that this person has to hire Creative Planning to help improve their situation and get these things done, obviously I’m biased and we’ve been doing this since 1983, and we do have 85 CPAs and 45 attorneys and 300 plus Certified Financial Planners, and we’re not dually licensed in selling products on behalf of our broker dealer and being a fiduciary some of the time. And so yes, I believe we would knock it out of the park for this client and help them accomplish all of these different things of lowering costs, tax plan, state planning, but I sure hope they don’t have indecision.
And that indecision leads to a lack of progress by staying with their current advisor. And this is why sometimes as a wealth manager, I feel like Jerry Maguire when he’s there with Rod Tidwell saying, “Rod, help me help you.” And maybe there are pieces of that example that you can relate with. And if there are, remember, not making a decision is in fact making a decision. And I want to offer you a simple first step at a second opinion that will likely be the most valuable time you’ve ever spent with a financial advisor. Contact us today at creativeplanning.com to speak with a local fiduciary for your second opinion. Again, that’s creativeplanning.com. Why not give your wealth a second look?
I want to transition over to a client that came into our Bismarck, North Dakota office and their situation was they were ready to buy a new home. They wanted a bit more square footage, a larger lot, a newer home. They’re making considerably more money than they previously were. Their family formation looked a little bit different and it was time. But not unlike many others, they’re looking around at current mortgage rates and asking themselves, “Does this make sense?” And by the way, that’s a logical question when mortgage rates have risen from three to three and a half percent all the way up to as high as seven in less than a year.
But it’s not just mortgages that we need to be thinking about in this rising interest rate environment. Jeff Stolper, our Director of Financial Planning, who’s a CPA and also a Certified Financial Planner, wrote an article that I’ll post to the radio page here at creativeplanning.com/radio if you’d like to check it out specifically on a guide to rising interest rates. And while you might not be a financial planner by profession, you’re listening to this show, which gives me hope that you have a commitment to wanting to do a great job with your money. And so let me share with you from the perspective of a planner what you should be thinking about when the Fed announces its fourth three quarters of a percent rate hike just in this year alone.
The first thing is fairly intuitive that almost all planners go to when interest rates are rising like this is anything and everything tied to those rates, the first of which is the aforementioned mortgages. And if you don’t have a strong need to move like this couple did, hopefully you were able to refinance your previous loan into that three, three and a half, 4% range, or you purchased a new home with a fixed rate mortgage at those rates to begin with. But if you really need to make a move and you can afford that payment, you should still do so with a fixed rate mortgage. And while I don’t want you reaching for more house than you can afford with the assumption that rates will drop, remember you’re not married to that mortgage or that interest rate, you’re just dating it. And what I mean is with rates where they are today, it’s highly likely that at some point down the road rates will drop and drop significantly, at which point you can refinance that loan to a lower interest rate.
Second tip, in a rising interest rate environment, look at your credit cards. I mean rates on credit cards are through the roof anyhow, but remember they’re also variable. So as high as they were previously, they can even go higher. And if you’ve been carrying a balance on a credit card, which I highly advise you do not do, it’s time to pay it off. If you have a certificate of deposit at a bank, it may make sense to redeem that CD early, take the penalty and invest that money at a higher rate given how quickly rates have been going up. And remember, as I spoke about on a recent past show, CD penalties are linked to the remaining interest to be paid. And if there’s not a lot of interest because your CD was at a very low interest rate, the penalties might be far lower than you first expected.
And the last financial instrument tied to rates are bonds. When rates go up, bond prices decrease due to it being less attractive to another buyer. If you hold a longterm bond, you’re likely down anywhere from 15 to 30%. It’s why in our portfolios here at Creative Planning, we use short to intermediate-term bonds to protect against price fluctuations. The entire bond market is down year to date, but to a much lesser degree in shorter duration bonds than in those longer-term counterparts I just mentioned.
Now the examples I just outlined are more defensive and reactive moves, but I want you as a great planner and a listener to the show to also know how you can go on the offensive to capitalize on rising rates. And the first of those specific opportunities relates to cash. If you’ve been waiting for an opportunity to enter the market, I can’t yell it loud enough. The opportunity is now. Remember, not making a decision is making a decision. Get the money invested. I don’t know where the market’s going from here in the short run, but in the long term, it’s extremely likely it goes on to make new highs. In fact, when the market’s dropped 25% or more, historically speaking, it’s up 95% of the time two years later. And obviously if you go out much further, five years, 10 years, 15 years, the probability of positive returns increases to almost and eventually 100% from a historical perspective. Past performance, of course, no guarantee of future results.
And really that idea of deploying cash is relevant at any point in any market cycle, but it’s particularly relevant right now as we sit in a bear market. Rising rates are also one factor currently impacting extreme market volatility. And with volatility, the opportunity to engage in tax-loss harvesting increases. And I have spoken at length about tax-loss harvesting on many previous shows, and you can find those by going to the radio page of our website at creativeplanning.com/radio or by searching Rethink Your Money anywhere you listen to podcasts.
The next defensive move you can make is to be diligent in your planning. If you built a plan for the long term, now is the time to stick to it. Yes, you’re constantly hearing about how bad things are today, but almost never is that followed up with how great things will be tomorrow. And that’s why having a written plan can make it easier to get through a down market because it helps us keep perspective. As a former airline pilot, I wasn’t pushing off the gated LAX without a flight plan and you as a disciplined investor shouldn’t invest without a plan either. And if you don’t currently have a financial plan, the time is now to put one together, because a comprehensive plan considers the appropriate portfolio mix: your savings goals, insurance, estate planning, taxes, and so much more. And this is a great opportunity to take action and put a plan in place.
You might be feeling a bit overwhelmed. Maybe you’re thinking, “John, I don’t know how to maintain a dynamic plan through rising interest rates.” That’s okay because we here at Creative Planning are here to support you throughout this journey. There’s a reason Barron’s dubbed us a “family office for all.” What might you be missing? Contact us today at creativeplanning.com for your second opinion. Up next, how the midterm elections may impact your money.
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Now back to Rethink Your Money, presented by Creative Planning, with your host John Hagensen.
John: Well, the midterms are now upon us and I can feel the anxiety in the office, and I’m sure some of it’s related to uncertainty around the economy or this current sustained bear market that’s running 10 months long or 40-year high inflation, just overall negative sentiment. But as I mentioned earlier on the show, the Dow just had its best month of October since the early 1970s, and it doesn’t really feel like it. The vibe I’m receiving from prospective clients is not one of optimism. And I think a lot of that it’s the political landscape and discourse and uncertainty around the outcome of the November 8 elections. And it’s important if you’re feeling that to remind yourself that in the history of the markets, a 60-40 stock-to-bond portfolio, when there is a Republican in the White House, 8.2%. When it’s been a Democrat, 8.4%. Creative Planning President Peter Mallouk recently addressed the very question of should we allow our political views to guide our investment decisions? I’ll let you have a listen.
Peter: I like to tell people the market’s not blue or red, it’s green, right? All it cares about is money and profits. That’s it. I remember a call with somebody, a client when President Obama was elected that couldn’t talk about going into cash. The person made a huge irrecoverable mistake. Same thing after Trump won, had a call with a client, couldn’t stop them from going to cash. Huge irrevocable mistake. We’re talking about the midterms here, the midterm elections. If you look, the market does do very well after the midterms. On average, it averages at 16% the six months after the midterms, averages almost 19% over the next year, and averages about 33, 34% over the next two years. And that’s usually because the midterms result in a swing and power that creates paralyzation and nothing gets done and the markets like knowing what’s going to happen, which is nothing.
Also, if you go all the way back to World War II, there has never been a time following the midterms where the market has not been up. Now, I would never say that’s the case here, especially with what’s going on with the Fed and everything else, but certainly the election’s not a reason to be exiting the market or going to cash or really having it influence any kind of decision around your portfolio.
John: And I bring this up because you may be someone who, when you sense uncertainty, your safety response is to move money to cash because we often think of all the risky asset classes, commodities, real estate, stocks, maybe even certain bonds, definitely junk bonds or longterm bonds in a rising rate environment, as we just spoke about. But cash tends to be last on the list. Here’s the irony. Cash has many inherent risks as well. They’re just more subtle. They’re not as obvious. First and foremost, cash is the worst-performing asset class in history. You didn’t mishear me. Over long periods of time, cash has underperformed all other major asset classes. So basically the more time you spend with a significant portion of your holdings in cash, the higher the probability that your portfolio is going to underperform just about everything.
Second, holding cash for long periods of time practically guarantees that you’re not going to keep up with inflation. Forget 40-year high inflation, even in normal environments, try keeping up with inflation sitting in cash. I’ve seen plenty of people with 100 grand in the bank and it’s earning 1% and 10 years later they say, “Look, this feels great. I didn’t lose anything.” Yes, you lost a lot, because your growth didn’t even come close to keeping up with the cost of a stamp, a suit, a candy bar, certainly not healthcare or education. So you think you made money, but no, you lost purchasing power. And one of the many reasons I see investors holding cash is because they’d like to try to time the market. And, of course, we do this without any sort of historical evidence whatsoever that you could actually do this effectively, as virtually every real-world study out there shows that moving from the market to cash and back into the market doesn’t work, even for professionals trying to do it.
There are just far too many variables. You have to be right on the way out and then right on the way back in and then right on the way out and right on the way back in, over and over and over without making any large mistakes that which would erode the majority of your returns. And I don’t know the data that went into this, but the director of research at Morningstar, which is a company that evaluates portfolio performance, stated that there is not a single example ever of a mutual fund beating the market over time through market timing.
And so the alternative to sitting in cash, even in times that feel uncertain, is to stay invested in the broad market rather than trying to time it. Because if you stayed in the market over the long haul, how many times have you permanently lost money? The answer is zero. Unfortunately, though, the investor graveyard’s full of people who fled to cash for, and I’m putting up air quotes, safety. You think great investors like JP Morgan and Templeton and Buffet are trying to hop from cash and into the market? No, in those legends, you find longterm investors who buy more when there is, as Templeton said, blood in the streets.
And the last terrible reason to hold cash is in the event of financial Armageddon. You know that situation where the stock market goes to zero or near zero and it never recovers, so I’m going to hoard a bunch of cash that I can use. But the reality is, if the world that we live in where Walmart and Amazon and Apple and McDonald’s and Google and the rest of all the world’s dominant companies go down and never recover like Johnson & Johnson and Proctor & Gamble and Toyota, it will likely accompany a default by the US government on treasury bonds. Because how can the US government make its debt payments on its bonds if major US companies have all collapsed? Who in the world’s working and paying taxes to cover those debt payments? In this event, cash is worthless because the FDIC guarantee would essentially mean nothing.
And so if you don’t believe that thousands of the largest companies in America and across the world will survive, then the natural conclusion is that the entire US economic system itself couldn’t survive. And in that event, cash may be the absolute worst asset to own. And despite all of this, Americans are sitting on near record levels of cash. And so in offering you some truth, just remember that cash gives us comfort because it doesn’t move around much. It’s not volatile. It’s easy to understand and it just doesn’t go down. But there’s so much more to the story of cash than that. And while it might bring us comfort, it doesn’t keep up with inflation, it constantly loses purchasing power. It drags down longterm investment returns, and is of no value if a true economic collapse were to occur.
And so, of course, keep short-term cash reserves on hand, that is a great idea. Have that emergency fund and that buffer set aside, but hoarding cash as a longterm investment, do not do it. If you have cash and you’ve been sitting on the sidelines because probably in part you don’t have confidence in your financial plan, you don’t have conviction about where that cash would be invested or a comfort level that that would be in line with your risk tolerance and your time horizons and your goals and your needs, then I want to invite you to come talk with us here at Creative Planning and speak with a local fiduciary financial advisor who isn’t looking to sell you something.
In fact, one of the unique things that we do here at Creative Planning is that we will build your financial plan right in front of you. We quarterback it, but we are doing it together and we think this is incredibly important. And in the thousands and thousands of plans that we’ve done, we’ve found this to be incredibly valuable for you, because we can provide confidence and clarity that you’ll have enough money to last for retirement. You won’t have to guess what that number is. And we’ll show you an estimate based on the assumptions of how much you’ll have when you pass away. If you don’t have a written documented financial plan that outlines all of these measurements while also outlining and accounting for your tax plan and your estate plan, there is a reason Barron’s has called us “a family office for all.” We’re a tax practice, we’re a law firm, and we are a wealth management firm managing or advising on $225 billion. Your time is now to get clarity around what you’ve worked so hard for.
And what I hear often from radio listeners just like you who take us up on this offer while they’re finding clarity around this plan that’s been built out in front of them that they can see and interact with, and I can tell that a weight’s been lifted and their anxiety’s been lowered, and I ask, “Well, you already have an advisor and you already have a plan that they’ve put together for you.” And they say, “Not like this. Not at this level. And most importantly, while I had a plan, this is the first time I’ve ever understood this plan, where it really makes sense for me.” And I want that for you. And you can request this by visiting creativeplanning.com right now for your complimentary second opinion where a local credentialed fiduciary will build out your financial plan right alongside you. Again, request this by going to creativeplanning.com.
One of the great takeaways that I found that emerges from having clarity around your financial plan is that it often provides a comfort level that then allows you to look around and not be so worried about, “Will I have enough? But I have clarity around that I absolutely will have enough. Now, how can I bless others?” And so as we come down the home stretch of this year, if you are in a situation of abundance where you are able to help others who are less fortunate, I encourage you to speak with your financial advisor and have them review your tax return to ensure that you’re giving the right assets, whether it be highly appreciated stocks, whether it be shares of a closely held business, and not only that you’re using the right assets, but also the most efficient tax conduits for your specific situation.
If you’d like guidance around how to minimize taxes regarding your end of year giving strategies, don’t hesitate to contact us. We love doing everything that we do here, but there isn’t a whole lot of what we do that’s more meaningful than when you are making the world a better place through the generosity of your resources. If you have any more questions about what was discussed today, visit us at creativeplanning.com/radio to sit down with a local financial advisor. 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 Hagensen 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. 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.