Everyone has in their mind the concept of designing an ideal retirement savings portfolio, but should you be blindly following the same methods that people have always used? Large institutions have been telling people for decades to pump money into their tax-deferred retirement accounts, keep cash in the bank, and get your mortgage paid off. But will these status quo methods help you achieve the financial security you dream about?
The Redefining Wealth Process℠ is all about taking a comprehensive approach to building your portfolio through an income blueprint. Laura and Michael will dispel many of the common planning strategies that are always promoted and break down the process we use to identify the proper financial framework through out proprietary Redefining Wealth Process℠.
The status quo will have you believe there’s nothing more to learn and tries to convince you that trusting others is you best path to success. But just because you haven’t heard of an investment, or a product, doesn’t mean you should close your mind to it. You also need to incorporate a process.
There are ways to design an ideal portfolio to include certain features you desire while maintaining the balance you need. The biggest challenge is remaining open-minded and consider the fact that there might be a better way.
Join us for episode 104 of the Retirement Talk Podcast as we help you understand how to create the ideal retirement savings through our Redefining Wealth Process℠.
If you’d like to read the Kiplinger article discussed on this episode, click here.
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Timestamps (show notes)
1:12 – Background on the article
1:58 – What is the perfect investment?
3:30 – Ways to design an ideal portfolio
5:15 – Story about a recent meeting
8:29 – Examples of mistakes
10:50 – Accumulation tools
14:33 – Relying heavily on tax-deferred contributions
17:40 – Storing too much money in the banks
21:55 – Pay off the mortgage or not?
24:13 – Understanding your investment vehicles
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Welcome to Retirement Talk, the redefining wealth show. Your source for financial information specifically for pre-retirees and retirees. We are here each and every week to help you better navigate during these economic times. We’re here to discuss thoughts and ideas in the field of finance and retirement, as well as discuss trending topics that can impact your bottom line. We will break it all down. These discussions can help you make better informed decisions so you can make better financial choices and live the lifestyle you imagine for retirement. Laura Stover is a [inaudible 00:00:47] financial consultant and CEO of LS Wealth Management, as well as founder and owner of LS Tax, a consulting firm. She’s been featured in Forbes, CNBC, and the Wall Street Journal. I’m Ron [inaudible 00:00:58]. Our topic of discussion for today is from Kiplinger, titled For Real Financial Security, Do Not Do What Everyone Else Is Doing.
Hello. Hello. Hello. Welcome to Retirement Talk, the redefining wealth show. We are here to discuss today from Kiplinger magazine, a fantastic article that I thought looked like a lot of fun for us to dive into, and especially for our listeners. Because everyone has in their mind the concept of designing an ideal retirement savings portfolio. And you’ve got to buck at the status quo. I mean, why rely on the same owed financial advice, right? Including blindly just pumping money into a 401k plan. That could be a huge mistake. You have to think outside the box. That’s what the article’s about. We’re going to do as Michael says, unpack this article. So how would you characterize the perfect investment? How would you describe its features? You most likely are describing something that doesn’t exist, maybe a financial unicorn. What say you Michael, my certified financial planner?
Yeah, that would be the crystal ball. And unfortunately we do not live life in reverse. And so investing is always going to take on risk, but every time we talk to clients and we ask them that question, what is your experience in investing? What have you used in the past? What have you had a great experience with? We never have that, “Oh, I had a great experience with this.” It’s always been, “Well, it was good up for a period of time, but what I’m looking for is that product that will yield me unlimited gains with no downside losses. I never have to think about it. All it does is really just sends me income into my bank account so that I could live that life that I’ve always dreamed of.”
Well, I think everyone, they all want guarantees and the highest investment return and full access to their money if someone could just wind up describing something. So it’s about having a plan more than a product. If you don’t have a plan, a product’s eventually going to cause you, I think, a trip up. Because you didn’t plan and there’s always a pro and a con to every type of investment. So without a plan, at some point, it may not work out too well. So even though that concept of the perfect investment or a single product that just doesn’t exist, there’s ways to design an ideal portfolio to encapsulate certain features that you may desire. And you just have to know what you’re looking for. A business coach that I have a lot of respect for, I read a lot and have studied and have been in some sessions with Dan Sullivan.
And he has a saying, “Our eyes only see and our ears only hear what our brain is looking for.” So in other words to find what you’re looking for, it is essential to know what you’re looking for. So it’s a simple concept, right? And I see people making mistakes with their money on a daily basis in my practice by overlooking many options that aren’t the status quo. They just default. It’s our human nature. We default to things that don’t always align with what they want to achieve. And we’re going to talk about a few examples, but just because you haven’t heard of it, just because you haven’t had experience in that, you’ve got to open your mind up and be a little more comprehensive. That’s my word of the week. Because I think this year I have seen a few examples of people that maybe need to be open with a little more comprehensive approach so that they can take a timeout. When little kids act up, sometimes Michael, you need a timeout, right? I know you have a couple of kids. Timeout.
Yes. Sometimes I need a timeout, but what you’re saying there Laura is let’s have realistic expectations. Yesterday, this is a perfect timing of this episode, yesterday, I get a call from a client or it’s a prospect, not a client. Individual has owned a small business for a period of time, has done a great job. They’re going to be selling the company for a million dollars. They have some other saved assets, but at the end of the day, it’s going to be about $1.2 million. And I was instructed that they would like to have a plan and they would like to have about $72,000 of income adjusted cash flow every year. So as the inflation rates go up that we’re going to see this $72,000 just kind of increase up, but we’re going to try to draw this out of $1.2 million. Now, if this client was 75 years old, you may say, “Well, Mike, that’s probably not too hard for us to overcome.”
The issue is the client is 60 years old and their spouse is 50 years old. So we’ve got a very long time horizon that money’s going to need to come out of this. It was very unrealistic expectations. Now the problem is they’ve sold their business and did not consider capital gains on the selling of that business. So what started out at the million dollars came back down to about $850,000. We haven’t got the final total on that, but we don’t even have what we were originally going to start with, but they sold their business before they actually had a plan. And it’s not going to be sustainable and it’s not going to be realistic for what their dreams and goals and aspirations are.
See, my comment about comprehension is valid and I mean that in all due respect. We spoke about on episode 103 about the importance of the redefining wealth process. There’s six risks that we’ll all face, and making sure that you have a financial blueprint and a framework to work around these various risks. Income tax, healthcare cost, investment management, estate planning, all of this is interrelated and you need the right balance. So no perfect investment is going to fix the differentiation of each type of category and the problem. So it has to be a comprehensive plan, and it starts with an income plan regardless of wealth that you’ve accumulated. We see some mistakes that people make like that. They sell the business. They’ve like, oh, in my head they probably think we have more than enough money. They’re probably estimating what the sale proceeds are going to be, but they missed a lot of critical information.
And I’m sure if they’ve accrued that much money, they’re fairly successful people. And they terribly miscalculated tax being one of the key pillars, and income. They’re going to live hopefully, they’ll probably live 50 plus years as young as they are. Anywhere from 30 to 50 and there’s no income plan. So it’s not sustainable. No product can solve all those problems. In the article, it was talking about a 45 year old business owner and another mistake we see often. Storing cash in a bank account earning nothing, while borrowing money from a bank and paying interest to finance equipment purchases. Another example, an investor who’s close to retirement investing in mutual funds, which it’s a non IRA account, creating tax inefficiency. We’re seeing this quite a bit. Last year was a good year. So what’s going to happen this year now? And the thing when you own a mutual fund, Michael, is you don’t own those shares. So that can be a big problem with capital gains or ever getting out of that without a plan.
Yeah, those mutual funds are like having a membership over to Sam’s Club. You have access to it, but you don’t own it. And unfortunately there’s a money manager inside of it with discretion that is making traits because there is an objective for them to generate returns. They’re looking and seeking alpha inside of those models. They have a benchmark, they have to outperform them if they want to keep their job. So sometimes they will sell positions and then there will be what’s called Phantom income that is triggered. Oftentimes when it’s tax season, an individual will come along and they’re sitting in a mutual fund in a non-qualified account and they get a 1099 from that custodian. And they’re like, wait a second. I haven’t traded anything. I’ve not made any transactions on this or inside of this mutual fund. Why am I getting capital gains?
Sometimes it’s short term, most of the time it’s long term. But it’s because you’re participating with a pool of other investors. And there is a money manager that is seeking to make you the money. They are not looking at tax harvesting. They’re not looking at what is the most tax efficient. They’re looking at accumulation. And I tell all clients that if we’re looking in a non-qualified account, our number one objective is to give you accumulation. When we see opportunities, we make trades to increase that accumulation. Sometimes that’s going to spend off long-term or short-term capital gains that someone may not have really been expecting to have for that year.
Well, mutual funds could be a good accumulation tool when you’re starting out. They don’t require a large balance. They don’t require a large commitment for the saver, the accumulator, but it can be not efficient if we’ve accumulated some wealth. And a mutual fund can be very tax inefficient. When someone buys a share of a publicly traded mutual fund, he or she’s buying a share of an existing company that owns many individual investments, each with its own preexisting tax liability. So whether or not that person ever sells those shares, he or she’s responsible for a proportional share of the existing tax liability. And the way the mutual fund accounting works, a fund has to pay out at least 90% of any investment income earned and 98% of any realized capital gain. So the inflows and the outflows affect all shareholders, even though they may have personally performed no trading during the year. And we’ve kind of seen some clients that had run into that situation this year.
And I think that’s where individuals are looking at their overall strategy, really needs to look at a tactical approach versus a strategic approach. And then how those assets are allocated is very important. It’s why it’s very important to have a plan, and that you have a reason behind why you’re investing the way that you’re investing. You have a plan of putting or contributing dollars into your accounts, but you also have a strategy of how you’re going to take distributions out of your accounts. And I find that to be one of the biggest reasons that individuals are not able to sustain their wealth throughout the years is because they don’t understand where they’re invested, how it works fully. And then they make arbitrary decisions that is not in their best interest.
We’re going to take a real quick break. You’re listening to Retirement Talk. When we come back, we’re going to discuss deferring taxes in a 401k. Should you pay off your mortgage? And what about storing money in the bank, and last but not least investing in the wrong type of investment vehicles. All here on Retirement Talk, the redefining wealth show.
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In each scenario, we’re looking at a variety of people really looking for financial security and unfortunately settling for a typically accepted path out there, but they really desire to do something, but most often it’s not what they’re looking for. And this disconnect is a result of a continuous drumbeat of doing the status quo. So we’re always told, Michael. There’s four key things here let’s hit. Deferring taxes in a 401k. We’re always told to invest in our 401k. Yes, if you’re employed, if your employer is doing a match, you want to equal the match. But what about the tax deferral aspect of that? That could be great now, but if you don’t do an analysis, it’s like the devil goes down to Georgia. You know that song, where you’ve got to pay the piper later on down the road if you, again, don’t have a good plan. And that’s one of our six pillars, a tax plan.
I would love to pull a survey to our 65,000 plus listeners to our episodes here. And I would ask them, tell me about that day you went into your work site retirement plan meeting, and all of your colleagues are there. And the company that’s supporting or managing that company’s 401k or 403B and they hand out all of their booklets and they say, “Okay, here, you can now enroll as a participant in this plan. And here’s the options of how we can invest.” And they go in and they mark into a 401k. And the difference is I could do a deferral or in a lot of plans today, which hopefully you work for an employer if you’re listening, that offers a Roth 401k. So you have a different option there. Deferral, or go ahead and pay the taxes and let that money grow tax free inside of that Roth 401k option.
I would be very interested to see the numbers of individuals that would say, “Wait a second, I can’t complete this paperwork yet because I need to take a look at my tax return. I need to understand how much room I have in this progressive tax rate to determine, do I want to defer money or should I go ahead and pay my taxes? How much more room do I have in my existing tax bracket?” Because for many people, if they’re starting out and they’re putting money over into this retirement account, they may have been in a 10% or a 15% tax bracket, maybe in 18. When you’re looking at that rate, but what’s going to happen is they work over another 40 years and they never change their strategy. And then when they’re taking money out in retirement, they’re taking money out at 25%. That does not make sense. You got to have a plan.
And when you fund a tax deferred account, you’re really allowing the government to dictate when you can access your money. And they’ll have to let you know later what tax rate you’re going to pay them since obviously you don’t know what taxes are going to be in the future. Another big mistake, people tend to just do the status quo, storing money in the bank. So here again, you are giving up control of a portion of your cash flow to repay a loan while the bank, I mean the interest from the bank these days, even though the fed chair is raising the monetary rate with inflation, at eight and a half percent, you’re slowly dying with your money there. It’s an erosion of purchase power. It makes no sense other than what you need for an emergency fund, there’s better choices for your money. And I think a lot of people just put excess amounts of money in the bank, Michael. I see it over and over and over because they’re fearful and they don’t know what else to do.
Last night, we were at the local park, my six year old. She says, “Daddy, let’s get on the teeter totter over here.” So we go over and she hops up on the teeter totter. And then I get on the teeter totter. How much fun was it for her? Because she is not of equal balance. She is not equal weighted with me. So when you’re looking at an investment opportunity and you look at what is the bank willing to give me? And over the last decade, it’s been sub 1%. I mean, in some of our software, the fractional share of 1% is so small that the system cannot even register it as a return. So if you’re thinking about a money market accountant for the last decade, we’ve been looking at those at like 15 basis point. That’s 15% of 1%. Now that’s one side of the teeter totter.
Let’s think about the other side of it. Let’s say you wanted to go borrow money. If it’s a 30 year note on a home, yeah, you may have been in that three and a half, four and a half percent rate. So 15 basis points versus what they’re giving you the money back at their interest rate. Or let’s say you wanted a small business loan and they say, “Well, you know what? We got a great rate for you today. We’ll give you 15 basis points on the money you give to us. And we’ll give you a loan at 14%.” And that is a great rate. Now think about the difference between who’s making the money there.
And there is no fair equity when you’re storing money in the bank. If you’re looking for liquidity, you can get that liquidity in other ways. You can use an FDIC insured or backed money market account with an investment company through the broker dealer that your investment advisor is clearing from. There is ways of having liquidity without giving all of your money up and make a much better return. Even if it’s making a hundred basis points versus 15 basis points you’re making, what is that? A six times greater return.
So again, it comes down to having a purpose and a plan with what’s the money earmarked for. If it is funds that you know you are spending, you’re building a house and it may take six to 12 months even before you need to utilize it all, well, no, I can see people maybe short term putting excess funds in a bank. But if it’s partially earmarked for retirement funds, it’s for your future, then you really need to walk through a process. Our life art planning system provides that process where you can get a budget and a cash flow analysis, where you can have an income blueprint and really have a design and a purpose for all of the money within your portfolio. Without a plan, how can you invest it? It’s like going to the doctor. If I say I have a pain in my chest and they just start giving me pills or they want to operate and they haven’t run any tests, they haven’t done any analysis.
They haven’t looked at any family history. You’d be running for your life to get out of that doctor’s office. So I don’t know why people think differently with their money and go by oh, this sounds good. And I’m just going to do this. Again, not just going with the status quote. Now, when it comes to a mortgage payoff, everyone with the status quo, paying off that mortgage is a good thing. Sure. No mortgage is probably a good thing. A race to zero with no wealth creation and no access to cash, is paying off a mortgage always the first priority if you haven’t saved anything for your retirement? This is a big one.
Paying off a mortgage is a very personal decision. But I would say that oftentimes it becomes an emotional decision. And as we all know, sometimes on our emotional decisions, we could use a little Pepto-Bismol because we do not make the best decisions there. If you’ve got a rate on your mortgage of say two and a half or 3%, because you refied when rates had plummeted, do you really want to take money out of an investment account that let’s say over the 2021 year you were yielding double digit returns? Does it make sense that you would take out those assets and pay off a note that’s only costing you two and a half percent? And I would say, no, I have a client. And I know she’s listening to the show. And so I won’t say any names. She knows I love her dearly.
We’ve had conversations with our CPAs over this exact topic. Because emotionally she likes the idea of having her home paid off. It gives her this sense of security. However, mathematically, financially, it is not in her best interest. Having that compounding ability on those accounts is going to give her sustainable investing strength and buying power throughout her retirement. If she pays this loan off with a very low interest rate, it’s not going to make a positive impact. It’s actually going to have a detrimental effect on her in the future. So I would always say have an investment account that is equal to your mortgage, let it gain. And in the future, if it makes sense to pay it off at that time, just leverage it over at that moment. But when the market’s going in your favor and interest rates are low and it’s locked in contractually, don’t pay it off.
And lastly, I think this one here is very important. People that maybe have invested in the wrong type of investment vehicle, but you don’t know it until it’s too late, until it trips you up somewhere. Sounds good at the time when you go into it. And unfortunately a circumstance comes up and now you found out maybe I put too much money in this. Oh, I lost too much money, or I don’t have access to all of my money like I thought. I thought it was a Swiss army knife and it was going to be able to do this, that, and everything. Breaking this down a little bit. Let’s start with maybe the investment security side of this. I think we want to maybe divide this between safe money and securities. Anything that doesn’t have a contractual guarantee is money that’s at risk essentially. And there’s different ways to manage those risk assets.
Again, that’s why you have to go through the process. Having a blueprint, having the income plan, setting aside what you need for income so that’s never at risk, but having growth buckets then, and [inaudible 00:25:24] as you’ve talked about many times, Michael. I’ve seen instances where in ’08, especially years ago, or people had a negative market downturn, they were too correlated to the benchmark in static types of accounts or concentrated stock positions. It did good for a while, but you have too much of your portfolio in one sector. We know how the outcome can happen when there’s risk factors, when all your eggs are in your company stock or your employer stock. Let’s unpack this a little bit on the security side first, because we’ve seen, or they’ve got a big tax liability now to try to untangle some of these monies. We’ve seen it all.
Looking at the wrong type, yes, we have seen this many times.
We’ve seen it all.
When you’re looking at the wrong type of investment vehicles and I think the first step of prevention is stop working with a salesperson. You need to be working with somebody that actually has a plan and builds a plan for you. And that brings up… We’re talking about quotes earlier. Steven Covey is one of my favorite authors and there’s two quotes that he has. Begin with the end in mind. First of all, you have to know what kind of results that you’re going to expect in the future. And then back into what type of investment solution, whether it’s a safe money or at risk approach, which one’s going to yield me the highest probability of achieving that destination? Steven Covey also has a quote that says, “If you lean your ladder against the wrong wall, every step you take will take you farther away in the wrong direction.”
So you’ve just got to be really careful of first of all, building a goal and a dream and an aspiration, building that into your plan of what you want it to be in the future. And then back into where you are today, and then look at the universe of opportunities. Don’t be one dimensional. The investment world is not the solution for everything. The insurance world is not the solution for everything. There is a blend, and then make sure you’re using the products the way they were actually designed to give you the highest probability of success.
Well said. And the status quo will have you believe there’s nothing more to learn, and that trusting banks and the government, maybe your neighbor, your best friend at work, maybe that’s in your best interest. But as ridiculous as it may sound, the biggest challenge that most people face is to remain open-minded and consider the fact that there is a better way. You have to have a process. The process is the key. We work with the [inaudible 00:28:17] planning system. This runs through the redefining wealth process that covers those six key areas that we’re all going to face. And there’s a saying that goes, “Your brain is like a parachute. It only works when it’s open.” Thank you for listening to Retirement Talk, the redefining wealth show.
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