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RETHINK YOUR MONEY

Your Portfolio’s Greatest Threat

Published on January 22, 2024

John Hagensen
MSFS, CFP®, CFS, CTS, CIS, CES

Investor overconfidence — and, sometimes, incompetence — can often go unnoticed, eroding your hard-earned savings. This week, John explores how irrational decisions and inflated self-assurance can wreak havoc on your financial success. (2:16) He’ll share pitfalls to watch out for (as well as how to successfully avoid them) and teach you how to navigate the unpredictable world of investing. Plus, find out what to watch out for with ETFs, including the new Bitcoin ETF. (24:26)

Episode Notes:

Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!

John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. I’m John Hagensen, and ahead on today’s show, Bitcoin ETFs have arrived, we’ll unpack what it means for you and your money, as well as the Magnificent Seven’s future prospects. And finally, the biggest mistake made by those who already have a financial plan. Now, join me as I help you rethink your money.

About 10 years ago, I was precariously laying on top of the roof on our three-story home, a good 20 feet above the ground, with my feet on the gutter, with a slope toward my potential fall and death, most likely, or at least breaking every bone in my body, all to hang Christmas lights. I thought about it at the time and I’m like, “Man, with all of our kids, this is crazy. What am I thinking? I probably have about a 1% chance of actually dying right now. Why am I taking this chance?” Well, because I want our kids to have a festive Christmas. There’s a lot of logic in that, but it all started with me thinking, “I can easily do this on my own. This isn’t a big deal. I don’t need to rent a lift. I don’t need someone’s help. I’ll just lean out over the edge and install these Christmas lights.”

Now, fast forward, I learned my lesson. I was way too overconfident, and I have those permanent EverLights, the LEDs that you can control from your phone, and so I never have to get on a roof again risking my life to properly celebrate the holidays with my family. Overconfidence impacts us all in different ways. How about them Cowboys? Since their last Super Bowl, the Cowboys are five and 13 in the playoffs, yet their owner Jerry Jones won’t relinquish control to an outsider. It’s the Albert Einstein insanity quote of doing the same thing over and over expecting different results. No, the key decision-makers are all family members. Well, that’s not working. You just got boat-raced by the youngest team in the NFL. Those darn cheeseheads. And I contend that one of the most valuable skills you can learn is to be self-aware enough to recognize what you don’t know.

It’s easy to spot our talents. It’s easy to spot where we excel. But it takes a lot of humility, and I struggle with this as well, to concede areas that we’re not experts in. There’s a cognitive bias dubbed the Dunning-Kruger effect, in which people with limited competence in a particular domain overestimate their abilities. This manifests itself occasionally while dangling your feet off the top of a roof or being a billionaire running an NFL franchise. But how I see this play out every day with our money is that we think we can outsmart or master returns on our own. We think we can beat the market, and we really want to beat our peers.

In fact, I had a physician, really bright, she went to one of the best medical schools she’s at one of the best hospitals, wildly respected, but that didn’t translate to her being an expert when it came to managing her money. That didn’t mean that she was an investment guru. But it can be very difficult to resign to that fact when pretty much every other aspect of her life she’s excelled. So why wouldn’t she be way above average when it came to trading and investing? I’m not just picking on docs, this applies to my colleagues and myself here as financial advisors as well. We may be the most susceptible to the Dunning-Kruger effect and the overconfidence bias, which is why with my own money I use a colleague here at Creative Planning to run point as our wealth manager. It may seem counterintuitive, I’m a certified financial planner, I use all the same software, the same philosophy, the same team, why would I have someone else help me? Because I need to protect myself from myself.

I have my own biases, overconfidence being one of them, that are blind spots that can lead to suboptimal results. I want a third party. I want another perspective. And generally, the risks of overconfidence bias, when it comes to trading, is that you’ll have excessive trading because it leads investors to trade more frequently than necessary thinking we’re going to achieve better returns. It results in higher transaction costs and potentially lower investment returns. Every study out there shows that there is a direct correlation the more you trade, the lower your returns. It also can lead to under diversification because if you have overconfidence, you’re thinking, “Why do I want to spread my bets when I can select the best bets, when I can find the perfect position, when I can find the over-performance? Diversifying is for those average people.”

Overconfidence bias also leads to underestimating risk. And here’s the big one, it leads to ignoring contradictory evidence. Overconfident traders and investors generally downplay or even dismiss altogether evidence that contradicts their thesis. And while we’re spending some time exposing the challenges of being human beings, let me hit you with two others that I see impact investors: loyalty bias. I’m referencing the tendency of individuals to favor certain investments, certain companies, or certain brands that they feel a strong emotional attachment or loyalty to. Why do we all think that our kids are the cutest kids on the planet? Objectively, it’s not possible. There’s eight billion people. But we firmly believe that they are, don’t we? Loyalty bias rears its ugly head when it comes to investments as well as with financial advisors.

I remember as a broker, early on in my career, one of my very first clients was very high up with Bank of America. And even after retirement had a lot of friends still working there, they were a customer of the bank, they had a ton of belief in the bank, they had spent their entire career at that bank. And so they over-concentrated due to this loyalty bias and ended up losing about 85% of their entire life savings. A good way to check yourself against loyalty bias is to perform an exercise. It’s a little bit weird. But pretend that you’re not you. You’re just a random person on the street, you don’t have any loyalty to any of your current investments. Would that person, who we are assuming is a savvy, good, prudent investor, would they put their money in the same investments that you do? Like in my previous example, would they own 85% of their portfolio in one stock? Of course not. If they didn’t work at Bank of America and didn’t have that loyalty, no way. Check yourself with that exercise.

When it comes to financial advisors and loyalty bias, it’s usually a friendship, there’s a history together. We fish together. We go golfing together. It creates this loyalty, and so even if they suck at their job or even a little nicer, they’re just not the best, but they’re okay, it’s hard to separate. So for that, I want you to pretend that you don’t have an advisor. Take that loyalty out of there, no attachment to your current advisor, and you had your pick of the 300,000-plus financial advisors in America, would you rehire your current advisor? Put slightly differently, if you had 10 times as much money, would you rehire your current advisor? And if the answer is no to either of those, loyalty bias is most likely guiding that relationship.

We’ve talked about overconfidence bias, we’ve talked about loyalty bias, and my last behavioral bias is the sunk cost bias. You’ll also hear this referred to as the sunk cost fallacy, and it’s a cognitive bias where you let past costs or investments influence your current and your future decisions. Practically, this will play out where an investor makes suboptimal choices on the emotional attachment to past investments. What did I pay for that investment? I see it all the time, “I’ll sell that stock, I don’t like it, but I’m going to wait until I’m back even.” A newsflash: that company and the future movement of that stock price does not care or have any knowledge or any correlation to what you, random individual, bought the stock for six years ago. It’s completely irrelevant.

I had a conversation with a prospective client last month in December about this very topic. One position, in fact, they had loyalty bias attributed to that position, they had some overconfidence related to that security, but more than anything, they had sunk cost bias. They wanted to get back even and didn’t want to sell it because once they sold it, it wasn’t a paper loss, that was the admission, “Wish I hadn’t purchased that stock.”

Here’s the exercise to perform for a little self-check on how this may be impacting you. Pretend you liquidated every dollar of your net worth and it was piled in stacks of $100 bills atop your dining room table and you had to start from scratch building your investment portfolio, would you build the portfolio as it is presently constituted? And if the answer is no, well, that is, in essence, exactly what you are doing because every day you are choosing, deliberately, to invest how you are invested. If you’re feeling stuck or that you’re settling, it’s a bad feeling, let me offer you some encouragement. All that matters is your next decision. Previous ones are in the rearview mirror and you can’t change those.

Ben said, “The cost of a mistake is not what you paid for it, but what you failed to learn from it.” My broad advice for how you can combat these behavioral biases and the countless others that impact us and our emotions, certainly when it comes to our money, is to seek diverse opinions, set realistic expectations, and have a rules-based approach when it comes to your money and your decision-making process.

Well, my special guest today is Chartered Financial Analyst and Creative Planning investment manager Kenny Gatliff. Kenny, welcome back to Rethink Your Money.

Kenny Gatliff: Hey, thanks, John. A lot’s happened since we last talked, so looking forward to it.

John:     It really has and most of what has happened fortunately for investors has been really good. What do you feel like we learned here in 2023 as we reflect back on what ended up being a fantastic end of the year?

Kenny:  Most of the year stocks just existed. They went up, they went back down, there wasn’t a lot of movement. And then all of a sudden in the last couple of months, that’s when we saw this big move forward. That really came from what was happening with the Fed. The whole year, investors were really wary about what might happen, whether we’re going to enter a recession or whether rates were going to stay high. And then all of a sudden, in the early November, we got the message from Jerome Powell and the Fed saying, “It looks like we’ve hit that soft landing. Next year it looks like we’ll be able to not only stop raising rates but actually lower rates.”

John: It’s easy to criticize the Fed, and certainly they, in hindsight, kept rates too high for too long, and we can argue some of those things, but they may have actually pulled this off when you consider how uncertain times were during the middle of COVID. It’s easy to forget about that, but go back and remember, there was so many things going on in the economy in the world and businesses shut down. How do you grade or judge really how the Fed did throughout the process?

Kenny:  It’s really easy to be critical of the Fed and have difference of opinions, but when we look at the end result, we did have high inflation for a short period of time, but we avoided a recession, at least so far it’s looking like that’s going to be the case. And inflation stayed high for a year or two, but it’s come back down relatively quickly. I think you’d have to give them a solid grade on where we stand now relative to what possible outcomes could have happened from 2020 forward.

John: There’s people saying that rates may be interest rate movement, that blunt force that the Fed works with, maybe that’s not as effective as it once was because we’re not as sensitive as an economy to interest rate movement. Would you say that rates still matter?

Kenny:  Yeah, they absolutely still matter. This is just a matter of how much they matter relative to maybe the past or maybe some other countries even. You’re right. The market’s not exactly coupled to interest rates. We have a pretty robust monetary system at this point, but they still matter a lot. And we definitely saw that in the last year or two. We saw inflation go up pretty considerably. We saw them move the rates, and we saw it come back down, and once rates were up, we saw the market drop 20% pretty quickly. And once rates stabilized, we saw a lot of that 20% come right back in the stock market.

John: Yeah. I think it’s worth mentioning that sometimes the impact of Fed policy can be on a big lag. So sometimes people say, “Well, look, it didn’t have this effect.” Well, maybe you just haven’t given it quite enough time for it to matriculate all the way through the economy. What do you think we learned about bonds in 2023, Kenny?

Kenny:  Well, you’re going to see a lot of that same movement between bonds and interest rates. And bonds are very sensitive to interest rates. When we look at the beginning of 2023, we saw bonds, especially long-term bonds, having one of the worst periods in history. However, as interest rates plateaued and then came back down a little bit at the end of the year, we actually saw bonds recover a little bit. And so for those that just held onto their allocations and kept their maturities and durations at a sustainable level, we saw them not experience too big of a downturn. And then we saw them pop back up a little bit.

So as we always talk about, bonds are there to mute the volatility of the equity side of their portfolios. Over the long period of time, we’re going to see equities go up most of the time, but have these time periods where they’re down. And then those are the times where we want to have bonds in the portfolio that aren’t too volatile that we can use as dry powder to rebalance or just as income when we don’t want to sell stocks while they’re down.

And now we’re at a place where bonds are yielding a little bit higher. We’re through that muddy volatility that we’ve experienced last year. So we are in a much better position now for those classic 50/50, 60/40 investors that have a lot of bonds that are a place where they’re paying a reasonable yield at this point. So I think we’re better off now than we were a year ago certainly.

John: I’m speaking with Creative Planning investment manager, Kenny Gatliff, Chartered Financial Analyst. Let’s talk about risk, that’s another thing investors became acutely aware of in 2023, if they weren’t thinking about it previously. What stands out to you from last year?

Kenny: The rate cuts at the end of the year and this great stock market run from November through the first of the year is really a double-edged sword. On one hand, we got this great economic news that we’re going to see this soft landing and the economy looks better than some people anticipated. But at this point now a lot of that good news is priced in. And so now we’re kind of the spot where the good news is expected. So if the Fed does cut rates and if the recession is avoided, that is the expectation at this point. So any amount of bad news then could really drive that narrative the wrong way.

John: Yeah, it’s not, is the news good or bad? Is it better or worse? I try to explain that to clients. They say this great thing is happening, why isn’t the market doing better? Well, that was already priced in four months ago because the market is forward-looking and that can throw us off, but all the information and expectations are baked into the price to your point. That’s why some analysts, and by the way, I don’t think analysts are pundits have been proven to be right very often, but a lot are saying, hey, maybe 5% year up 7%, just kind of a decent year in the markets because that’s their basic premise. And again, they’ll probably be wrong or lucky if they’re right. But the argument is a lot of this good news that we do anticipate things are looking good, is priced in, which is why we saw the phenomenal run to close out 2023.

Let’s switch over to the rebirth of the 60/40. There were hundreds, probably thousands of articles, written on why it was dead. You can’t invest in a 60/40, basically you have 40% of your portfolio earning nothing. That was the argument. So it’s just too much and you’re not getting the diversification in 2022 because people were in long bonds as we mentioned earlier, or low credit quality bonds and those didn’t do well, so you weren’t able to actually dampen your volatility. Does this even work anymore? Should we rethink the entire allocation? And then 2023 happened and everyone said, “Oh, maybe it does still work.” Can you speak a little bit to exactly what happened with the 60/40 last year?

Kenny: Yeah, so at the beginning of the year here, it’s really a good time to reassess your portfolio, reassess that allocation, and I think a lot of people had gone away from the 60/40 or at least gotten weary about it. And when we look at what has happened in the last couple of years, you’re absolutely right, it was a very difficult time to be in the 60/40 with stocks and bonds going down together through most of 2022 and early 2023. But then if we look at it as a whole, if we include these last couple months of 2023, we actually see a very different story than what the prognosticators had talked about and what a lot of the expectations were that, look, this portfolio is going to have another really bad year.

And that’s kind of how the stock market works, or investing in general works, is that these short runs come very unexpectedly, these short bull markets where we see stocks go up, we see interest rates come down and yields go up, those things happen unexpectedly and in a very quick time period. If we’re not in the right portfolio, if we get squeamish as investors and say, you know what, this might not be the right portfolio for me anymore. We miss out on those times where it does have good performance.

John: I like to say that the recoveries happen often just as quick or quicker than the drops, and that will surprise people certainly if they’re not rebalancing, which is really a good case for why you’d want to rebalance when things are out of favor, you buy more the Warren Buffet, be greedy when others are fearful and fearful when others are greedy. Everyone loves that quote until they actually have to put it in practice when something’s been underperforming for a year or two years or three years, or if we’re talking about international investing or value or small cap, maybe it’s been underperforming for a decade, but you and I both know that when it decides to give you those return premiums, it often does so without notice and in a very short amount of time. You’ve got a three-month period where all of a sudden you see emerging markets or small value or something up 60% in three or four months and there’s your entire over performance for a 10-year period and you have to be ready and positioned to take advantage of that when it comes.

And I think 60/40 showed that people that bailed on that strategy or cheated out on the yield curve and went long or just went a hundred percent equities, they really changed the entire construct and risk profile of their portfolio due to two years of underperformance or three years of underperformance, which in our life seems like a long time, but it’s just not worth making a material change to your long-term financial situation. But I do think that can be tricky. And Kenny, do you have any suggestions for maybe how often to rebalance? When you think you should be rebalancing? Because I get that question a lot. Is it a drift on deviation of the asset allocation? Is it on the calendar? How much is too often? What’s that sweet spot, in your opinion, for when people should look to rebalance their portfolios?

Kenny: Rebalancing is one of the most important things we do as long-term investors, and there are a couple of different ways that people look at it. One is just temporal saying once a quarter, once a year, I’m going to relook at my goal allocation and trade to get back to targets.

John: And I personally hate that by the way.

Kenny:  And that was going to be my next point is that’s better than not rebalancing over the long term. You’re not going to have your portfolio deviate from your initial risk that you assigned yourself, but there’s a better way of doing it and what we call opportunistic rebalancing is really the better way to get your portfolio back in intolerance and actually get some advantages out of it. And so when we look at years like 2020 or 2008 or really any year where there’s a lot of volatility, what we often see is that volatility happens entirely intra year. So 2020 is a great example where stocks were down 20 or 30% in March, but then back up, not only recovering some of that, but they made up all of those losses and then finished the year up by December of 2020. And if you were just waiting for January, well, you probably look at your portfolio and say, I didn’t even need to rebalance in 2020.

Whereas, if in March you say, Hey, look, stocks are down considerably, I’m going to use this opportunity to take some for my bonds, buy into those stocks while they’re down. Not only did you put yourself back at your risk profile, which is the purpose of rebalancing, but you were able to take advantage of that extreme growth we saw April forward and have the ideas buy low, sell high, and we did exactly that. You sell high on bonds at that time, you buy low on stocks, and you get yourself a little bit of a premium. We are able to take advantage of the rest of the year. And we see that in a lot of different years. The market’s very volatile intra year and if you can take those opportunities, you just give yourself a slight advantage in long-term returns relative to whatever risk that you’re comfortable with.

John: So maybe set some drift parameters in advance, more volatile asset classes. Let drift a little bit more so you’re not rebalancing every four days and more stable ones that like short-term bonds maybe have the drift a little bit less and when those deviate, certainly in an IRA or an account that has no tax implications to rebalance, you can be fairly aggressive on rebalances and then you do want to be mindful. What would be your suggestion in taxable accounts, how those would differ from a rebalancing strategy, any other considerations that you would advise investors think about?

Kenny: Yeah, you definitely want to be cognizant of the taxes within those accounts. And so really the best way to do this is not rebalance at the account level, but rebalance out what we would call a household or a client level. And so this gets into the conversation of asset location as well. So if you are 60/40 investor and you’ve got some non-qualified accounts and some qualified accounts. Well that’s really good to have that bond allocation in those qualified accounts. Let your non-qualified accounts grow with those equities so you’re not having to trade those. You’re not having to sell off those equities if they’re high and do all of that rebalancing within the qualified account.

Now of course, this doesn’t work out perfectly. We always say allocation is more important than taxes. We want to make sure, to some degree, you’re still making the trades that are needed, but if you’re smart about it and you’re looking at those accounts as a whole and making the trades based on those deviations that you mentioned, John, you’re going to see a much better result, both from a rebalancing perspective but also from a tax efficiency perspective.

John: Absolutely. A little bonus, check your statements and one really good indication of whether you’re mindful of asset location, do you have bonds inside of a Roth IRA? Nothing drives me more crazy than seeing a Roth IRA for a 42-year-old, but because they’re 70/30, everything’s exactly 70/30 in all six of their accounts, including their Roth, where obviously the growth is tax-exempt, withdrawals are tax-free, it passes to the next generation tax-free. There’s no RMDs. You want growth in that account. That’s the value of that. You’d rather be a little more conservative in a traditional IRA or in a non-qualified and have a hundred percent growth in the Roth. So that’s one way to easily check to say, am I thinking about this? Or if somebody’s not working with creative planning, is my advisor even considering this, or does every one of my accounts basically hold the same things? Because you do want to be more strategic than that.

Kenny:  Right. And that’s why we always talk about the beginning of the year being the perfect time for that. It’s always easy just to let your accounts run for a year, two years, five years without really looking into them, really reassessing your financial plan, your allocation, your asset location. And if you’re not doing that at least once a year, it is easy to miss things like that. That’s not something a normal investor is keen to checking all the time. If that once a year in January is a great time for that, you reassess your goals, you reassess what your financial plan is trying to do and then make sure that it’s set up perfectly to execute that plan. There’s a number of things that I would recommend doing every single year just to make sure that you’re not deviating from your long-term goals.

John: Yeah. And to your point, Kenny, we’re here in January. You’ve got a lot of tax flexibility if you make moves today to offset any gains that might be triggered over the next 11 months. Really good tips. If you’re listening, you’d like to sit down with a local wealth manager just like myself here at Creative Planning, visit creativeplanning.com/radio or you can call 1-800-CREATIVE. Kenny Gatliff. Thanks for joining me again here on Rethink Your Money.

Kenny:  Yeah, thanks for having me, John.

John: On January 10th, the SEC approved the first ever spot Bitcoin exchange traded fund, including those from Fidelity, BlackRock, and Invesco. In total, the SEC approved 11 spot Bitcoin ETFs and they started trading on the next day, Thursday, January 11th. The impact of the approval on the crypto markets started to manifest days before the actual approval announcement itself. Another recognition that the market is forward-looking and anticipatory of future news.

Now if you’re wondering, hold on a second, weren’t there already Bitcoin ETFs on the market? The answer is yes and no. There were crypto related ETFs and trusts out there, but there had never been a spot Bitcoin ETF on the market until this recent approval. Whether you own Bitcoin, whether you’re interested in cryptocurrency, I want you to listen because this technology is real. Now, the use cases are unknown, the opportunity as an investor very much up in the air, but blockchain technology is in place and will continue to be a big part and a growing part, in my belief, of our economy as a whole.

So a spot Bitcoin ETF is a highly liquid fund that changes price throughout the day, so it trades just like a stock and directly tracks the price of Bitcoin primarily by holding a large amount of the cryptocurrency itself. So very similar to a spot gold ETF, which holds physical gold bullion on behalf of its shareholders. Previously, companies like ProShares had a ticker trading net bidow that invested in Bitcoin futures, not Bitcoin itself. And its returns diverged quite substantially from the actual price of Bitcoin as a result.

The why behind this is that it will provide much more access for investors to invest in Bitcoin, much easier, much lower cost. Many of these ETFs are already down at 20 basis points or a quarter of a percent in management fees, and I believe it’s worth backing up briefly and looking at the blockchain itself, which is simply a decentralized and distributed digital ledger that records transactions across multiple computers in a secure and transparent manner, and it consists of a chain of blocks literally each containing a list of these transactions.

And once a block is filled with transactions, it’s linked to the previous block, forming a chain. This technology is used by many of the biggest companies around the world for aspects of the business like inventory. So the key features are that it’s decentralized. There’s no single entity that has control over the entire blockchain network transparency. All participants in the network can view the entire transaction history immutability once the blocks added to the chain. It’s nearly impossible to alter ensuring the integrity of the data and security. Cryptographic techniques, secure transactions and control access to the blockchain. So the blockchain is here to stay regardless of what you think of cryptocurrency, that is a real thing. It would be like saying, I don’t know about America online. Okay, that’s fine, but the internet is a real thing. The technology is here. So a cryptocurrency is a digital currency that operates on this decentralized network utilizing blockchain technology.

And unlike traditional currencies that are issued by governments, fiat currencies, cryptocurrencies are not controlled by any central authority. The largest of these cryptocurrencies and the most well-known is Bitcoin. It was created in 2009 by an unknown person or group that used the pseudonym Satoshi Nakamoto, and it was developed as a peer-to-peer electronic cash system allowing for decentralized transactions without the need for intermediaries. When I look at the bull case for Bitcoin specifically, or maybe a bit more broadly, cryptocurrencies, it’s that they haven’t crashed. They’re like the villain in a bad horror movie. They just keep coming back with the massive pullbacks, huge volatility, even in the midst of bad actors and fraudulent behavior like the FTX scandal, it’s still chugging along.

And beyond that, the current system is pretty archaic and it’s littered with unnecessary fees, unnecessary middlemen, and now with spot ETFs being approved, the assets going to see a lot more investment with mainstream access. The biggest bear case is that it’s been almost 15 years and it has limited adoption. The practical deployment and use case for crypto is still uncertain.

We’re not rolling up to Starbucks and using our Bitcoin to buy a Frappuccino. And as a store of value it’s dicey because it’s incredibly volatile. And lastly, even if crypto takes off and is more widely adopted in 25 years from now, we’re looking back thinking, how do we ever not see this coming? It was so obvious. Look at how huge this has become. The likelihood that it’s Bitcoin itself that emerges as the victorious cryptocurrency is really difficult to say.

Back to my internet example, there’s a big difference between the bleeding edge and the cutting edge, and it’s often not the first or the biggest initially that becomes the long-term dominant player. Think palm Blackberry, and now of course the iPhone. You will continue to see huge spikes because like most commodities, Bitcoin is a speculative asset that experiences large swings, mostly based on consumer sentiment and herd mentality.

So how should you as an investor be thinking about the blockchain and crypto and Bitcoin specifically as an investment? Now looking at these ETFs, I would make very clear that you do not need to allocate any part of your portfolio to be properly diversified by owning Bitcoin. If you do choose to own Bitcoin, position size it correctly. This is a speculative play that should it go to zero, should you lose 100% of your money, it better not have an impact on your overall financial wellbeing. But if despite all that you believe you’d like 1%, 2%, a small amount of your liquid net worth, in a speculative investment, then that’s certainly your prerogative. But it’s not something here at Creative Planning that we are recommending our clients be invested in. It’s far too risky and uncertain as to the risk and return expectations of these brand new Bitcoin ETFs.

If you have questions about your asset allocation or your investments, your investment costs, your taxes, your estate planning, whatever is on your mind, we are here to help. If you’re not sure where to turn, we’ve been helping families since 1983. In all 50 states in over 75 countries around the world,. We have over 60,000 clients and believe that your money works harder when it works together for a complimentary second opinion on your life savings from a credentialed fiduciary not looking to sell you something, visit creativeplanning.com/radio or call 1-800-CREATIVE.

2023 was a phenomenal year for the biggest companies in the biggest stocks in the S&P 500. In fact, they even got themselves a nickname. It used to be the fangs. Now we got rid of that. Now it’s the magnificent seven. And I think the common wisdom after a year like that is that they’re so big, they’ve got such a big moat, like these guys are going to be around forever. These companies aren’t going anywhere. Why wouldn’t we pour the vast majority of our investment dollars into these seven companies?

Well, if you look at the stock market, it does seem logical and kind of obvious. Look at these certain companies. I can spot who’s going to be around forever, Microsoft and Apple, and Google, Tesla, Nvidia. But no matter how strong a company seems, capitalism has a real powerful way of humbling it, then replacing it with something else. Peyton Manning, Tom Brady, Drew Brees, NFL’s done. Oh, here’s Patrick Mahomes. Looks like we’ve got a superstar in Jordan Love. There’s Joe Burrow. How about CJ Stroud. Retired NFL players say all the time, it was kind of weird. I injured myself and I was out of the league and the next year the NFL just kept on going. The stadiums were filled with fans who were still showing up to the games. You turn on the TV and the league didn’t stop for me.

Well, the American economy and the global economy for that matter, it doesn’t stop. In fact, it’s just looking to grow. Whoever’s on top now there’s plenty of companies looking to upseed them, and so even while looking at the Magnificent seven, feeling like it’s hard to even imagine something happening with these companies, history tells us if we look forward 20 years from now, maybe one is still going to be in the top five maybe. And I’ll post a chart to the radio page of our website if you would like to view this for yourself. It shows the top five companies by market cap of the S&P 500 in each decade from the sixties, the seventies, the eighties, the nineties, 2000, 2010, and now in the 2020’s.

Just a few of the highlights. General Motors was the second largest company in 1960 and the largest in 1970 and hasn’t made the list since then. IB M1 of the top five in the seventies, number one in the eighties, number one in the nineties, goodbye. One of the best runs we’ve ever seen was General Electric. Number five in the sixties, number four in the seventies, dropped out in the eighties, then back number three in the nineties, number one in the year 2000, number five in 2010, and then a drop of over 70%, when you could argue, has there ever been a company that seemed more consistent, more primed for success than GE?

And this is why even though that Magnificent seven seem like they’re always going to be on top, diversifying to ensure that you own the next Amazon, the next Microsoft, the next Tesla is critical in sustaining consistent returns, what I call durable returns over the coming decades. So the next time someone tells you the magnificent seven oh they are, it’s easy. That’s the investment strategy they’re going to be around forever. Tell them, have you ever heard of the Standard Oil Company in New Jersey? Yeah, might want to rethink that.

Our next piece of common wisdom pertains to once you have a financial plan built, you’re all set. No, the value is not in building a financial plan. It is in changing your financial plan. My iPhone is only about two or three years old. My teenagers act like it is a blackberry. Like what is that thing? It’s horrible. The megapixels on your camera, I mean, how do you even use that thing, dad, it’s atrocious. Same is true with your financial plan. As you’re starting this new year with fresh goals, consider the impact of various parts of your plan and make updates to accommodate them.

And here are a few to consider. Account for life events. Have you experienced a major life change. Marriage, divorce, new baby, seventh baby? If you’re like me, unfortunately, maybe the death of a loved one, a new job, promotion, or you lost your job, did you move maybe to a new state? Next, update your goals. They’re likely not the same as they were a year ago. They’re almost certainly not the same as they were five years ago. Minimizing taxes is a great update and review when it comes to your financial plan because proactive tax planning is, in my opinion, the most overlooked and the least emphasized part of the typical American’s financial plan.

And it’s because most financial planners are not CPAs. They’re not like us here at Creative Planning where the firm is also a tax practice. And so it just gets neglected because your advisor’s not looking at it and your CPA is basically filing whatever you already did in the previous year, just putting the right numbers in the right box and being a great historian, Hey, you have to do it. You don’t want to be penalized, but that’s not going to reduce your taxes.

Another part of a dynamic financial plan, check your investments. Does your asset allocation still mesh with your current situation and your current goals? Did you rebalance some of your winnings? Did you harvest losses? How about planning for retirement? That’s an important goal to focus on at any age. Sometimes it becomes the central focus of the entire financial plan, which I think can be a mistake. Retirement’s not always this pinnacle that you’re shooting to achieve. You may not even want to retire or you just want to work part-time, but as you review your financial plan, don’t forget to review progress toward that retirement goal. You are also preparing for emergencies.

And lastly, protecting your loved ones. No one likes talking about insurance. No one likes talking about estate planning, but they’re vital components to a comprehensive financial plan because after all, it’s not enough to simply build your wealth. You do also have to protect it. So even if you’re one of the few Americans that actually has a documented written financial plan, let’s not fall victim to the common wisdom that once you’ve done that, you’re good to go. No. You’re not all set. That plan needs to be as dynamic as your life.

Well, it’s time for this week’s one simple task where I provide you an easy to execute checkup of your financial plan so that when we enter the year 2025, you will have made 52 small incremental adjustments to hopefully improve your plan throughout this year. Today’s simple task, check your asset allocation. The research tells us that over 90% of the risk and return, like the broad characteristics of what will happen with your investments, is driven not at the security level, assuming that you’re even moderately diversified, but rather at the layer of that pie chart asset allocation. Most notably, how much do you have in stocks versus bonds and cash.

From there, what percentage is allocated to large US growth, small growth, micro cap, small value, large value, emerging markets, developed markets, short-term bonds, intermediate term bonds, municipal bonds, corporate bonds, treasuries. And I want to encourage you, if you don’t have a way to confidently evaluate your asset allocation, is it aligned with your time horizons when you want to retire, when you want to spend the money, if it’s a shorter term goal for your risk tolerance and your capacity for risk within the plan, and you’d like us here at Creative Planning to review your asset allocation where we have over 300 certified financial planners just like myself, who would be happy to offer wisdom and experience so that you can have even that much more confidence in what you’ve worked a lifetime to save. Visit creativeplanning.com/radio now to speak with a local wealth manager. Why not give your wealth a second look?

Well, as always, one of my producers, Lauren, is here for listener questions. Lauren, who do we have up first?

Lauren Newman: Lynn in Boise, Idaho says, I’m exploring investment options and I’ve heard a lot about mutual funds and ETFs. Can you help me understand the key differences between these two types of funds? What factors should I consider when choosing between them, and are there specific market conditions or investment goals where one might be more advantageous than the other?

John: Well, in mutual funds and ETFs, exchange traded funds, are both vehicles that pool money from multiple investors who invest in a diversified portfolio, whether it be stocks or bonds, or some other asset. But there are some real key distinctions, and it’s worth noting, there have been significant outflows over the last several years from mutual funds and significant inflows into ETFs. They have become increasingly more popular, and in my opinion, for good reason.

Here are a few of the key differences between mutual funds and ETFs. The first is the trading method. So a mutual fund is bought and sold through the fund company at what’s called the net asset value price, and that’s just calculated at the end of each day. It does not move in price intraday while the market is open. Where ETFs trade on stock exchanges just like individual stocks throughout the trading day at market prices, which may differ, and this is a key distinction, from the fund’s net asset value, meaning you could be buying something that’s at a discount or a premium to what it’s actually worth. when looking at an ETF, A mutual fund will not.

Pricing is the next difference. Mutual funds transact at the end of the day at net asset value, so all investors of a mutual fund receive the exact same price regardless of when they buy or sell during the day. ETFs, if you buy something 10 minutes before your friend, you may get a completely different price. When it comes to minimum investments, mutual funds often have a minimum investment requirement. Where ETFs are purchased in increments of one share, making them a lot more accessible to investors with smaller amounts of capital. The management style is different as well. Mutual funds can be actively managed or passively managed like index funds and so can ETFs, but many ETFs are passively managed and track specific indices similar to an index mutual fund. When it comes to fees and expenses, a lot of mutual funds still have sales loads.

If they’re A share funds, you’re paying a commission upfront. If they’re C shares, you’re paying an expensive trail to the broker. And in addition to those sales loads, you may have management fees and operating expenses, and these fees are disclosed in the fund’s prospectus. ETFs tend on average to have lower expense ratios compared to many mutual funds, and if you’re not working with a registered representative, you should have little to no upfront costs when buying the ETF. When it comes to tax efficiency, this is probably the biggest difference when looking at non-qualified investment accounts. So not talking 401Ks or IRAs or Roth accounts, but your taxable brokerage accounts, mutual funds come with a lot of surprises. You’re sharing the cost basis with all of your neighbors, and so very typical where you’ll have a scenario where you purchase a mutual fund, the mutual fund’s down in value, you haven’t sold it, you still get a 1099 that you owe capital gains tax, and you’re asking, what in the world, I’m down in value? I sold nothing. Why do I owe taxes?

Well, if that mutual fund manager had purchased Apple inside of that fund seven years earlier, it doesn’t matter that you’ve only owned the mutual fund for two months. When they sold Apple, you shared along with everyone else in the capital gains distribution, regardless of whether you benefited one bit from the appreciation of that security. ETFs are generally much more tax efficient due to their in-kind creation and redemption process.

In summary, Lynn, if you’re looking at a Roth or an IRA or a 401K account index mutual funds and an index oriented ETF are going to look very similar, but when utilizing after-tax dollars, ETFs are significantly more efficient than mutual funds, and I won’t get into it today, but for larger account balances, what we call direct indexing is even far superior from a tax efficiency standpoint than ETFs, and that is when you unwrap the S&P 500 index fund, for example, and buy all 500 securities individually. So you end up with 500 different tax lots that you can harvest gains and losses against one another to optimize your tax savings.

All right, Lauren, let’s jump to David’s question on buy-sell agreements.

Lauren: Yeah. So next is David. And he asks, when should business owners get buy-sell agreements and how much life insurance do they need for it?

John: Well, buy-sell agreement is a legally binding contract that outlines what happens to a business in the event that an owner or a partner wants to leave or is forced to leave the business. They’re commonly used in closely held businesses, partnerships, LLCs, corporations, and the agreement’s purpose is to provide a plan so that there’s a smooth transition of ownership which protects the business, it’s owners, it’s customers, all the employees from a major disruption.

So the question for you, David, would be if something were to happen to you or one of your other partners, assuming that there are other owners involved, maybe there aren’t. Maybe it’s just your business, but you want to make sure someone else can continue running it. Maybe it isn’t even an owner right now? Maybe it’s a key employee or a competing business in your same industry that you’re friends with that lives a couple states over.

I’ve seen these agreements set up with children, colleagues, frenemies, everybody, but they’re initiated once a triggering event occurs. Basically the activation is death, disability, retirement, a voluntary or involuntary departure of one of the owners. And again, this buy-sell agreement will define what events trigger that buyout. You’ll have a valuation of the business as well. And the buy-sell agreement should specify, are you going to use a predetermined formula, an independent appraisal, some sort of multiple on earnings or revenue? Those are all typical ways. In reference to your life insurance question. You may or may not need life insurance, but if the business is valued at $10 million, let’s say, and there are two partners and they each own 50%, and one partner dies, they’re surviving spouse or their estate, their children are entitled to $5 million. The other partner who’s still alive that now presumably will own 100% of the business has to come up with 5 million bucks.

This is where life insurance can play a key role to immediately make the beneficiaries whole and keep the business on track without needing to pull significant amounts of money out of the business, which may hurt its ability to operate. But in some cases, the owners or an owner may not be insurable. Life insurance is based upon a medical assessment or maybe the premiums seem too high. In this case, you may use installment payments, sinking funds, bank loans, but you are going to have to come up with some way to fund it. And in answer to how much life insurance, maybe none, but that would be determined based upon a lot of factors like the value of the business and how much money is readily available within the business to complete the buy sell agreement. If you have similar questions, you can email those to radio@creativeplanning.com.

James Clear, author of Atomic Habits, which is one of my favorite books, said it’s more fun to be a fan than a critic. I’m not looking to spend my life tearing things down when it can also be so satisfying to build things up. Looking on the bright side has many positive benefits, including building healthier financial habits. The problem is we’re fighting against science and research and the media that reveals that our brains are wired to gravitate toward negative thinking. That’s why so much marketing is like, I’m going to throw you in a hole, make you hopeless, and then offer you the solution like here’s the rope to pull you out of the hole and I happen to have the solution and this is going to take what you are terrified about and it’s going to make it all better. That’s essentially insurance sales.

Now, I’m not saying you shouldn’t have risk management and you shouldn’t be properly protected, but the big annuity pitches are like, hey, the world’s ending, the stock market is terrifying. You’re going to lose everything you worked for and your family’s going to be in a van down by the river unless you buy this really safe thing that pays me a giant commission. Oh, thankfully for you, you showed up in my steak dinner workshop. I’ve got just the answer. That unfortunately is a lot of the sales that are out there, they’re not aspirational. They’re let me scare you, often unjustifiably so into buying my product.

And optimism may not come naturally for you. I think certain people are more naturally positive, but like any habit, practice can shift your mindset and ultimately your outcome. Three tips. Practice gratitude. If you need to start a gratitude journal, start your day, write down two or three things that you’re grateful for, don’t repeat them. I’ve done this exercise and what I found is that there are thousands and thousands of blessings that I completely take for granted that are under the surface of the most obvious blessings. And when you have to come up with new ones each day, it reveals how many incredible gifts are right in front of our face.

Seek progress, not perfection. We’re not going to achieve perfection. It’d be great if we could, but it’s not going to happen. We’re imperfect human beings, but how can you make a little progress tomorrow? How can you be a little further along next week than you are this week and expect success instead of worrying about failure? When you look at the most successful individuals, whether it be business, financially, in sports, all have suffered great failures because the only way to achieve great success means you’re taking chances that others aren’t willing to endure. And some of those won’t end up exactly as you had planned, and that’s okay because you’re either winning or you’re learning. Failure is simply an opportunity to grow. I want you to think about your life. Are you more of a fan or a critic? And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.

Announcer: Thank you for listening to Rethink Your Money, presented by creative planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode, you can subscribe to Rethink Your Money wherever you get your podcasts.

Disclaimer: The proceeding program is furnished by Creative Planning, an SEC-registered Investment advisory firm that manages or advises on a combined $245 billion in assets as of July 1st, 2023. 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 or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning Tax and Legal are separate entities that must be engaged independently.

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