Are You Really as Wealthy as Your Net Worth Says?
On this episode of Simply Money presented by Allworth Financial, Bob and Brian explain why your net worth may not tell the full story of your financial health, how to identify your most valuable asset at every stage of life, and why forgotten 401(k)s deserve a closer look. Plus, they tackle retirement spending, helping your kids financially, concentrated stock positions, and when it’s time to rethink an old life insurance policy.
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Bob: Tonight, are you richer than your financial plan says you are? And what if the opposite is true? You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James.
Let's ask a question tonight. How wealthy are you really? And I'm not asking you to pull up your investment accounts and add everything together because your net worth and your actual financial resources are not necessarily the same thing. Right, Brian?
Brian: Yep, that's right, Bob. Well, let's start with the number that everybody knows, right? We all kind of start with our net worth, right? It's still useful. It's a rough idea. And most people have just a rough idea of what it is. So, that's adding up what you own, all your investments, retirement accounts, cash, house, other real estate, business interests. Maybe there's artwork. Maybe there's, you know, I don't really think too much about cars, but if you have something of value, maybe you count that. But off of that, that's your pile of assets. Then knock off what you owe, your mortgage, your business debt, whatever other liabilities, credit cards, store cards, furniture bill, or whatever you just bought last week that you're thinking maybe you shouldn't have. We've all done that. That's your basic net worth, stuff minus debt.
And there's nothing wrong with that number, but it creates a little bit of a false sense of precision. People will say, "Well, we're worth $5 million." Okay, that's great. Tell me what's inside that $5 million. That has everything to do with liquidity because that's where financial planning actually starts. Two families can each have a paper $5 million net worth and be in really completely different financial positions.
So, let's say family number one, they've got $4 million in diversified investments, $500,000 in cash, and $500,000 worth of equity in their house. Another family, again, with that same $5 million bottom line, they've got $3 million in business, a $1.5 million house, and $500,000 invested. Exact same net worth, but completely different financial lives. That first family has some more flexibility because their investments are more passive in nature. They're not having to deal with them. They're not dealing with employees and running the business day-to-day. That second family, again, has a good, solid business with a good net worth to it, but that's a business that they own. And whatever happens to it also happens to their net worth. And so, that's almost effectively like having too much money tied up in one stock. Two solid financial situations, but two very different outcomes and very, very different planning techniques.
Bob: Yeah, Brian, what I think you're talking about here is liquidity really does change everything. In other words, how much of your wealth can you actually use or spend, and how much are you going to need to spend? You know, Brian, I feel like we talk about this almost every night on this show. The people that tend to have a lot of money also tend to be the people that really don't think about or quantify how much money they actually spend every year and where they spend it. Because let's face it, those are the people that tend to have high income coming in, a lot of assets, a lot of options, and they just don't think about it because scarcity is not a thing while you're working and earning a high income.
But when you start to think about retiring, yep, this is where liquidity really does change everything. Because you can't buy groceries with the kitchen of your house, you know, unless you start selling kitchen cabinets off one at a time. But seriously, this is where people can sometimes be asset rich and cash flow poor if they really have not thought about where that paycheck is going to come when they retire. Again, you might have $6 million in net worth, sounds great, but if $2 million is in your house and another $2 million is tied up in commercial real estate and another $1.5 million is tied up in a family business, now you've got only $0.5 million in liquid investments. It doesn't mean you're not wealthy, it doesn't mean you don't have enough to convert this into a retirement paycheck, but there's quite a bit more work that needs to be done and thought that needs to happen in order to get us there.
Brian: That's right. So, let's flip this around. That's not the only situation out there. There are also people who could be financially stronger than what their investment statement suggests. So, for example, let's take Social Security. Lots of people don't put Social Security on a personal balance sheet because it's not really an asset, it's a stream of income. But economically, there's a value to it. We can assign a value to Social Security. Just think back to your most basic finance classes if you took any back in the day, it's the present value of a future income stream. Well, that has a dollar amount.
So, let's say, if you and your spouse are eventually receiving several thousand dollars a month and adjusted over time, we know Social Security currently has inflation built into it. That is income that doesn't have to be generated by your portfolio. It's what I like to call OPM, other people's money. It's money that comes from outside my household and I'm allowed to use to pay my bills. It's really no different than that paycheck. And lot of people are comforted by the fact that, "Yes, I have a portfolio, but it's awful nice that money comes from somewhere other than my portfolio so I don't have to feel like I'm actually spending my own dollars." At the end of the day, a dollar is a dollar. It doesn't matter where it comes from. But psychologically, we really like it when other people give us money and we can go spend it. It's a monthly gift card kind of thing.
So, think of this situation. Somebody retires with $2 million invested, right? That's $3 million less than the first 2 we were talking about, and a pension that covers a meaningful portion of that household's basic expenses. Now, let's compare with somebody who's got $3 million, but no pension. Which one is richer? What I can tell you the spreadsheet would look like is that that $2 million person is probably going to wind up with more later in life because they haven't had to tap into the $2 million nearly as much as the person with the $3 million. That extra stream of income, right? Married couples at least have two Social Security checks. Some people also have a pension from some former job. Some people have two pensions from a former job. So, those paychecks, those monthly cash flow paychecks that come in sort of predictably and are not exposed to the ups and downs of the market, that really can smooth out the ups and downs of what that investment portfolio does.
Bob: No, for sure. And then another forgotten asset out there, Brian, your paycheck, your potential future paycheck. I think this is something a lot of people don't think about, their future earning power. For example, let's say you're 52 years old, you make $250,000 a year and you expect to work another 10 or 12 years. Yeah, your brokerage account might be worth $2 million today, but you've got potentially millions of dollars of gross earnings still ahead of you. Assuming you continue to work and you stay healthy, this is where a disability income protection conversation might need to happen. Because whether you realize it or not, your future earning power is, in fact, your most valuable asset. I mean, that's your real human capital out there. Now, compare that with somebody who's 70 years old with maybe $1.5 million saved and no earned income, they're retired. That 70 year old has twice as much invested than a 40 year old, but they're not working anymore. They're depending...
Brian: Yeah. No...
Bob: No, go ahead.
Brian: I like that analogy. What that makes me think of is somebody who's in their 20s and 30s, of course, they are their own most valuable asset because of what you just said, their ability to earn. But the flip side of that is somebody who's retired is completely worthless because they don't have that or don't want to have that anymore. And that's the goal, right? I want to make myself completely worthless. That's my goal lifelong. I want to be a useless lump on the couch. That's sort of what retirement is. Not quite, yeah, but I get your point.
Bob: No, and nobody's worthless and I know you're just joking around. But I think the whole point...
Brian: Depends on the day, Bob. It depends on the day.
Bob: No, I know. The whole point of this is the importance of building a financial plan sooner rather than later and building different scenarios and assumptions and putting a proper value on all the things both of us just mentioned, whether it's Social Security, a pension, future earnings, future contributions to retirement plans, and current portfolio assets that have already been accumulated. That's where you want to take a look at your financial plan, look at various retirement dates, look at various spending scenarios and just see if we've got a plan in place that's going to allow you and your family to do what you want and need to do when you need to do it. That's what we're talking about.
Another thing that gets overlooked here, and I've run into this, Brian, from time to time, business owners can sometimes make the mistake of treating an estimated business value like it's already cash sitting in a brokerage account. They think the business is worth $4 million so they say, "Well, we're fine." Have you had a professional valuation of the business? Has anyone actually offered you $4 million for the business? Have you factored in capital gains taxes that you will have to pay even if it is worth $4 million? There's a lot of things to consider there, one of which, depending on how much cash flow and income you take out of the business, you might think it's worth $4 million. A potential buyer will value it less than that because you're pulling all the cash out of it to live off of. Those are things that come up from time to time among business owners, Brian.
Brian: That last point, I've seen clients run into this, that very last point you just made, I think it's a great point. First of all, it takes two people to recognize that it's worth $4 million for it to actually be worth $4 million. You've got to have a buyer on the other end of this. But people tend to think, business owners sometimes think, "I'm taking this big owner's compensation chunk out of it, and that's therefore income. And therefore, I can count that as income that the business produces." A buyer may not be thinking the same way and they're thinking, "Hey, you're coming off the payroll. We don't have to account for you, and I'm not going to pay for that." So, that will come into the discussion of a price from an educated buyer. But I think a lot of people lose sight of that a little bit. Now, another...
Bob: Brian, let's talk about inheritance. How many times do you have people come in, and you build a financial plan for them and we factor in all the income, the investments, the assets, all of that, and then they want to already count a future inheritance of X amount of dollars and just assume that that's just going to happen. You know, bake that into the cake and that's going to absolutely happen. How many times do you run into a situation like that?
Brian: Oh, pretty frequently, right? So, it's just assumed that something's going to happen, right? Your parents, though, they may live another 25 years. They could spend a lot more than you expect. Healthcare, long-term care, that can become expensive. Heaven forbid, they may have different ideas about their money than you do. Shocker of all shockers. Maybe they want to give more to charity. They might be looking at their kids going, "Hey, these kids are pretty successful. They're doing okay." Or, "you know what? I want them to earn their own keep and build their own just like I did. They may have thoughts they have not shared with you. So, it behooves everyone to make sure that your own plan can support your situation, not relying on something out there. And that, of course, will keep those conversations on a more positive level versus some nasty surprises down the road, too.
Another thing that tends to sneak into the conversation is future liabilities, money I don't owe today, but I could owe in the future. So, we do spend a lot of time finding hidden assets out there, right? A lot of people want to, "Where's that old retirement plan?" Or, "Hey, I found this old 401(k) statement that's great." Let's find all the hidden liabilities too, because those matter just as much. That can make a $6 million net worth look a lot stronger than it actually is because you've got a big bill to pay down the road.
Maybe you've promised to pay for three grandchildren's college educations. That's not debt today because they're not old enough, but that's a commitment you made and you want to keep it. Well, we need to take that into account for budgeting. Same with helping adult children. This may not already be in place, but it's a possibility that a bill you may have down the road, supporting aging parents, or if you know that house, if you're going to stay in it, you're going to have to put $200,000 into it to make it comfortable to age in, those kinds of things. These are all the kinds of things that sneak up. It's not only about hidden future assets, right? It's also about future liabilities that we're not currently thinking of as a current bill.
Bob: Here's the Allworth advice, don't judge your financial security by net worth alone. Understand your liquidity, future income, taxes, any obligations that are out there, and of course, how much you actually plan to spend someday when you retire. All of that working together in an actual financial plan will determine how much financial freedom you really have. Well, what's the most valuable asset on your financial statement? We'll discuss that next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" live every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your favorite podcast. Well, how do you adjust when your monthly budget and actual spending don't quite match up? We'll help two local couples try to figure all this out straight ahead at 6:43. If I asked you to name the most valuable asset you own, what would you say? Your investment portfolio, your house, maybe you own a business. If you're retired, maybe it's your pension. But here's what's interesting. The answer can completely change depending on what stage of life you are in. Brian, let's get into that because this comes up all the time with folks that we talk to.
Brian: Yeah, sure. And so, in a case where I'm talking to somebody who's on the younger end, 20s, 30s, even 40s, I'm going to say that for those folks, it's their future earning power. It's their ability to go out and use their body and their brains to go earn a paycheck. So, let's take somebody who's 45 years old, maybe making $200,000 a year. They look at that 401(k) and they've got $700,000, $800,000 built in there and they're thinking, "That must be my biggest financial asset. That's a big number and it's starting to sneak up on seven digits and two commas. That's huge." But this person has another 20 years of paychecks coming, presumably, at that income level. So, even without assuming raises, that's literally millions of dollars of future gross income.
And we don't necessarily think about that paycheck as an asset because it arrives every two weeks, right? That's not an asset. That's something that lives on your income statement. It's not a pile of money. So, we don't really think about it as something that's on the balance sheet. But we can do math. We can figure out that the 20 years of $200,000, that's $4 million. And so, let's make sure that we understand what the impact of that is, knowing that that income stream is going to keep coming. You can calculate a present value of that pile of money. But going forward, if this person is living kind of a typical average life, the bills are going to go up, too. We will have mortgages coming up, possibly college, 401(k) contributions, Roth contributions, all of that. That's the job of that paycheck to cover all of those things, and that eventually, you'll be retiring off of that pile of money.
So, again, as we've said a few times on this show, that somebody who is younger, your best asset is your ability to earn a paycheck. Make sure you're handling it well. This is the time you're going to have extra dollars to put away. And the sooner you start, the better. And the more you get in there earlier... I'd rather see somebody put a huge amount of money in a huge percentage of their net worth in early in their career and then back off later because they got college bills and mortgage and all that other stuff. That's somebody who's going to wind up a lot better off than somebody who waits until they're 40 to start saving for retirement.
Bob: Yeah. And it's also somebody, the sooner you get started and the younger you are and the more paychecks you have ahead of you, you know, the more aggressive or growth oriented you can get with that portfolio because time is on your side. You can handle even prolonged market volatility or market declines because you got time for all that money to recover in value. And I think that's why people inherently know when they're still working and contributing, they really don't look at the market every day, because they know over the long term, it's going to go up and the returns are going to be there.
Things definitely change. There's a definite mental paradigm shift that happens when we get closer to retirement, Brian. Now, let's say, we've got somebody that's 62 years old and maybe has $4 million invested. They know or they want those paychecks to come to an end because they want to retire. And that portfolio isn't just a number anymore, it's their future paycheck. And that's where that portfolio composition may need to change because after all, during your working years, you're putting more into it, and you don't worry so much about it. But now, we got to turn that paycheck on immediately.
And that whole sequence of returns conversation needs to come up and be discussed because volatility is a thing. It always has and always will happen. And that portfolio needs to be structured appropriately to handle some market volatility. Sometimes Brian, people just aren't aware that that stuff goes on. Also, people can tend to get a little over fearful in their early 60s, 65, 66 and move too much money out of the stock market for fear that that pile of money, as you like to call it, might decline by even a little bit. And we got to have that conversation with folks as well.
Brian: Yeah. And I think one other thing that can derail people from figuring out exactly how strong of a position that they're in is the house. So, for a lot of people, the house is one of their biggest assets. That doesn't make it their most valuable. Important? Yes, certainly. Got to have somewhere to keep the rain off your stuff. And if it's paid off, that's great. That can dramatically lower the amount of income you need in retirement because you're not paying a mortgage. Now, that does not mean you don't have housing expenses. Raise your hand if you've ever lived in a house that never needed work where the hot water heater never died and the air conditioner never quit.
So, houses themselves, basically, they're kind of always a liability because you're never looking at a glorious future where nothing bad ever happens to the house again. Things tend to atrophy if left alone. And that is definitely the case for a house. So, we got to take into account, it might be a big, solid asset, larger than some of your investment accounts out there, but at the same time, it has more expenses built into it than any of your investments do. So, make sure you're thinking about that the right way.
Bob: Here's the Allworth advice, your most valuable asset changes throughout your life. Know what it is today, protect it appropriately, and make sure your financial plan is not overlooking the things that really do matter most. Next, we launch a rescue mission on one of the most overlooked parts of high net worth portfolios, those neglected old 401(k) accounts. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Let's be honest, when you hear the words 401(k), you probably think about your very first job out of college. You said it, you forget about it, and you move on. But if you're now worth, let's say, a few million bucks, maybe even more, that first 401(k) or first two or three 401(k)s could be the weakest link in your whole financial plan if you've completely thrown them in the proverbial drawer and forgotten about them. And so, tonight, we're going to go on a little rescue mission. We're going to tell the story of someone who built some real wealth over the course of their career but never circled back to fix that major blind spot, those old 401(k)s, Brian.
Brian: Well, we're going to talk about Laura. Laura is a fake person. Now, I would say, all of our stories we share here are real stories that come from real clients, but obviously, names are changed to protect the innocent. And today, the innocent's fake name is Laura. Laura is 58, married, with two grown kids, and she owns a marketing firm in Cincinnati that did really well in her 40s. And today, she and her husband have a net worth of about $3.2 million, including some real estate brokerage accounts, growing cash reserve, typical assets for somebody in that kind of a position, and life is good.
But she came out to me with a financial advisor, and during that whole review, what stuck out was a 401(k) that was a $480,000 account. That's a significant chunk of her net worth, still 100% in a 2035 target date fund. Really no customization and no real... It looked like there hadn't been any discussion of this account really at all because she was busy building her business, and that's where their net worth was. So, now, that wound up being $0.5 million that could have been handled a lot differently. For example, she's in a position where she's got a decent amount of assets sitting there outside the 401(k). That's what they're going to rely on to live off of in the earlier years of retirement.
That means that these accounts, the tax advantage ones, a couple of things. Nobody had had a conversation with her about should this stay in the traditional side, should we be thinking about Roth conversions here after you retire, and more importantly, should it really be in a 2035 target date fund? That is not that far out. And if these assets are going to sit there for maybe 20 years or longer or possibly just be inherited by your kids, then that is a very, very different strategy. That's really where we're talking about Roth conversions.
But again, it sat there in the same fund that she had decided when she first set the thing up when the business was barely off the ground and hadn't thought about it ever since because she worked so hard. The end result, it underperformed the market by about 2% every year over the past seven years because it was targeted for a risk tolerance portfolio that really didn't match what she needed. Now, is this going to bankrupt her? Of course not. But it's a question of efficiency. When you look at it in the context of her wealth, that's a big hole in the boat, Bob, because she left a lot of money on the table over those years for an asset that most likely is going to sit there for several decades until it gets inherited.
Bob: Yeah, I think the important thing here is just to make sure when you sit down with your advisor, you are talking about all of your assets and you actually know what you have and where it's sitting. I mean, sitting in a 2035 target date fund isn't the worst thing in the world. I mean, the thing got probably a pretty nice return over the period that this person was ignoring it. I came across a situation late last year which was a bit more dramatic than that. These folks had sold a business for quite a bit of money and they were very and are very risk averse people. They want to be almost 100% in bonds, maybe a 10% to 20% slice in the stock market just for some inflation protection.
And I asked them about these couple old 401(k) accounts that they had. They hadn't looked at them in 15 years. And I said, "Well, why don't you send the statements and we'll look at it." Well, they sent the statements, Brian, and they were 100% invested in the stock market and they were in a variable annuity. So, not only was the risk profile completely different from where these people wanted to be today as they progress through their retirement years, but when you ran a fee analysis on the whole thing, I mean, they were paying very, very high fees, upwards of about 3% all in on these annuities. So, again, in some cases, it makes sense to leave the money at the 401(k) if it matches what you're trying to do and you can get the investments for low cost. But in a lot of cases, it's not the case. This was one example where it was just a no brainer for multiple reasons that I've already covered to just consolidate this over the assets that we were handling for them. And they were glad we had the conversation.
Brian: Well, that's good to hear. And that's the whole point of that entire type of a discussion. So, just to make sure that you understand what you own. And one of the interesting phenomenons we see every now, is we take people through this risk discussion. They'll say that they're super conservative people. And then like you just said, we look at the portfolio and it's invested really, really aggressively. And oftentimes, they'll show us this, and they won't have reacted to 2022, which was, as I always say, one of the five worst market years we've ever had. And it's like, "Are you really risk averse? Because it didn't appear to have bothered you that 2022 came out the way it did." So, it's almost like sometimes those risk questionnaires are more of a, "Here's where I think we should probably be, but we're really okay not being there." So, that's why risk is a discussion, not just a questionnaire. But that's still an important thing for you to talk about with your advisor to make sure everybody's on the same page.
Bob: Here's the Allworth advice, if you've built some real wealth, you can't afford to just let those old 401(k) plans lay around and coast. It deserves the same level of scrutiny and customization as everything else in your plan. All right, can you afford to give your kids, let's say, $25,000 each for a house down payment and still retire comfortably. We'll dig into that question from Loveland next, plus whether an $8,000 a month retirement budget really holds up over the long haul. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening on the iHeart app. Simply record your question and it will come straight to us. All right, Brian, Greg in Madeira says, "I'm worried that one bad year early in retirement could change everything for us. What practical steps can you take to protect against that without parking everything in cash?" Great question.
Brian: Well, Greg, you're talking about something called sequence of returns risk. And the reason this is so dangerous, it's timing, not the long term averages. So, a poor market year, like you said, in the first few years of retirement can permanently shrink that capital base you're drawing off of, even if markets recover later as they always have in the past. The solution is not to walk away from growth because this can happen. It's to separate the income I need now from the money that can grow over time. So, really what that looks like, maybe somewhere between a giant cash pile and no cash pile at all. Build that retirement paycheck buffer.
I always suggest, look at the things you're going to need to spend money on. You know the bills that are coming due over the next 12 to 24 months. The good idea would be to make sure that that particular pile of cash is sitting somewhere safe, generating a little bit of interest, but its job is to be spent to pay those bills. That means that if the market does go the wrong direction early in retirement, it doesn't hurt you because you weren't going to spend those particular dollars anyway.
And you can also take this a little further by looking at and segmenting your dollars into buckets. Maybe the first bucket is money you're going to need between now and three years. That's really liquid. Again, you're looking for money markets, high yield savings accounts, those kinds of things, maybe a CD. Second bucket for four to 10 years, which would be a little maybe like a balanced fund, inflation-protected assets, those kinds of things. Then of course your 10 years and out bucket, that's the long-term growth money that's going to be pretty heavily invested toward the stock market side. So, just be thoughtful about when these dollars are due. And you don't have to invest every single dollar the exact same way if these are concerned. So, I hope that helps. Ron in Marymount. Ron says they need about $110,000 to live comfortably. And he's wondering, how much of that should come from dividends, interest versus selling investments, especially in a down market?
Bob: Well, Ron, I would first say, you know, don't let the proverbial tax tail wag the dog, meaning that you should build a financial plan based on your personal goals and your investment risk tolerance, and then set your asset allocation accordingly. Once that's done, you know, like you said, if you've got money coming in from dividends and interest, from bonds or some dividend-paying stocks, you know, those are going to be pretty consistent. The other thing to look at, you know, if we're talking about selling investments or using capital gains, you want to try to get as much control over those capital gains as possible, meaning have some type of tax loss harvesting or tax smart investing going on, you know, in your non-IRA accounts so you have some control over capital gains and when those are generated versus just waking up in the fourth quarter of the year and being surprised when you get a capital gain distribution.
Obviously from your question, I don't know how much of your assets are in IRAs versus, you know, taxable accounts. That's a big part of this whole discussion, too. So, I think, you know, sit down, build your plan from an allocation standpoint. And a good fiduciary advisor can take your plan and then also apply some tax smart strategies to it as well to make sure that we're pulling money from the right places without triggering unnecessary taxation. Hope that helps. All right. Alan in Loveland says, "We want to give our kids $25,000 each toward home down payments. How do I evaluate," Brian, "making those gifts against our long term plan instead of just going with our gut and giving the kids the money?"
Brian: Yeah, this is a common... You know, this is really the core of financial planning, right? "So, I know I've got money now and I can do whatever I want to do with it. But my question is, what's that impact in the future? Can I get away with this now or is this going to hurt me 10, 15 years down the line?" So, think of it in terms of retirement income. A permanent $25,000 gift is probably about 1,000 to 1,200 bucks a year of lifetime spending you're giving up. And if you got two kids going on now, you're thinking $2,000 to $2,500 per year for the rest of your life. So, now you're thinking, this is different from, "Can we spare the cash?" To now you're thinking, "Are we comfortable trading this much future spending for this outcome?"
And then you're also gonna look at what dollars that you're using for. If this is coming from your own excess taxable assets, then that risk is usually pretty manageable, not too painful. But if you're going to be taking this out of tax sheltered accounts, you know, Roth IRAs, traditional IRAs, that's going to be income taxable or you're sacrificing that tax free growth, that'll have a bigger impact on it. And then I would also stress test the timing of it, "What if markets fall 20% right after we make the gift?" Well, hopefully, you've already got a financial plan in place where you can easily do this, model this out, and then pretend the market takes a hit. But on the other hand, we don't know when you're talking about doing this. You didn't give us the age of your kids. You know, they might be 10 years old. We're talking 15 years from now. You're thinking way ahead of time. It could be this Christmas, you're going to do it. Who knows?
But in any case, what I would look at is, what have your investments done recently? Because very often, if the market has had a positive run, you might be able to do these gifts with money you didn't have a few months ago. If that's the case, oftentimes I say, you know, as long as the plan floats, take the windfall that you found from that recent market performance and do the things that you want to do for your family. So, it's not about affordability. It's about intentional trade-offs. If you'd still be comfortable with that decision after a bad market year, it fits the plan, if you wouldn't change the size, the timing, or maybe the source of that gift. We got one more for Tony in Newport. And Tony's asking about a single stock. He's got one worth over $0.5 million, and it's about 25% of their portfolio. He said he's concerned that if he sells it all, he's going to owe about $90,000 in capital gains. And he's wondering if it's smarter to spread that out over the years or just tear the band-aid off and write the check and smile.
Bob: Well, Tony, if you can help it, we don't want to just rip the band-aid off and write a $90,000 check. Usually, there's some better ways to go about this. But 25% of your overall net worth is a bit high, and we want to try to get that down under 10% if we can, but do it responsibly. So, we got to take a look at your overall tax situation, what your income goals are. Just as a reminder, up to $96,000 and change of taxable income, you don't pay any capital gains taxes. So, you might be able to, you know, to use your words, rip some of the band-aid off this year, spread it over a couple years, and maybe, you know, gradually move down out of that position without paying any taxes at all.
But the other option is you can literally use options. Meaning you can buy some put protection to protect your downside. If you want to help pay for some of that downside protection, sell an out of the money call option on your stock to help pay for some of that. There's varying ways to go about it. But, yeah, I would not rip the band-aid off at once. Sit down with a good fiduciary advisor, and come up with a good strategy. All right, coming up next, I've got my two cents on a few things to consider when you go over a periodic review of your life insurance. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Let's spend a few minutes talking about what everybody should do as part of their comprehensive financial plan, I'd say, at least every two to three years, and that's just a life insurance review. Brian, let's get into some of the things we should be reviewing. What does a life insurance review actually mean?
I think I'd start with step one, as part of your financial plan, determine how much life insurance you even still need given your current goals and your current stage of life, not what was in place 15, 20, 30 years ago. So, a lot of people never do that. They have these old policies they've had for years or decades. They don't touch them. They don't look at them. And they don't even take a look at, do I even still need them? And a lot of times, Brian, there's a lot of hidden cash value in these policies that could be put to better use elsewhere. So, that's step one. Take a look at whether it's insurance that you actually still need or want.
The other thing, if you're talking about cash value type of policies, and, Brian, I find fewer and fewer, I'll call them advisors, even do this anymore, is do what's called an in-force illustration of the policy. Go back to the insurance company and say, "Hey, run an illustration as of today based on the current amount of cash value. And assuming I want to keep this coverage for the next 15, 20 years, what am I going to need to pay out-of-pocket to keep this thing in force with the current interest rate structure?" And then run it a couple of different ways.
What if interest rates go up, interest rates go down? If you're in a variable policy where your cash value is tied to the stock and bond market, you want to look at some variable average rates of return there, too. What we don't want to have happen is someone who really wants to keep life insurance into their 80s or 90s wake up at age 77, 78 and realize their cash value is about to go to 0, which means unless they start writing humongous checks, their coverage is going to lapse. So, those are a couple of things to factor in as you're doing insurance reviews.
I guess the third one would be, you know, if we decide that the life insurance is really not something that's suitable for your current financial plan, there's some things that you can do with that coverage. You can try to convert that into some long-term care type of coverage, maybe a hybrid approach, or just avoid the taxes, put it into an annuity, turn it into an income stream. There's a lot of options there. The important thing is to sit down with a good fiduciary advisor, someone that's not just trying to sell you the next insurance product, but actually customize what you have into your current financial plan based on your current needs. I know you run into this all the time too, Brian.
Brian: Yeah, my absolute favorite thing to do is when we find a policy like this... And most times these things were purchased for good reason, "We've got babies now, we've got a mortgage, and we're going to buy a whole life policy because that's what is recommended to be a good idea." Now, 30 years have gone by, mortgages paid, the kids have their own mortgages, we just don't need this anymore. So, my absolute favorite thing is to redeploy that into something that doesn't cost a nickel in taxes, but now will provide long-term care benefits. That's like trading in your old 13-inch black and white TV for a 60-inch LED screen and not paying in anything at all. You're just redeploying those assets for a need you have now and getting rid of that need you don't have anymore.
Bob: Yeah, so just, again, make sure you sit down with your advisor and talk about this stuff because there might be some better, more efficient uses for that capital that you've worked so hard to build over the years. Thanks for listening tonight. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
Let's ask a question tonight. How wealthy are you really? And I'm not asking you to pull up your investment accounts and add everything together because your net worth and your actual financial resources are not necessarily the same thing. Right, Brian?
Brian: Yep, that's right, Bob. Well, let's start with the number that everybody knows, right? We all kind of start with our net worth, right? It's still useful. It's a rough idea. And most people have just a rough idea of what it is. So, that's adding up what you own, all your investments, retirement accounts, cash, house, other real estate, business interests. Maybe there's artwork. Maybe there's, you know, I don't really think too much about cars, but if you have something of value, maybe you count that. But off of that, that's your pile of assets. Then knock off what you owe, your mortgage, your business debt, whatever other liabilities, credit cards, store cards, furniture bill, or whatever you just bought last week that you're thinking maybe you shouldn't have. We've all done that. That's your basic net worth, stuff minus debt.
And there's nothing wrong with that number, but it creates a little bit of a false sense of precision. People will say, "Well, we're worth $5 million." Okay, that's great. Tell me what's inside that $5 million. That has everything to do with liquidity because that's where financial planning actually starts. Two families can each have a paper $5 million net worth and be in really completely different financial positions.
So, let's say family number one, they've got $4 million in diversified investments, $500,000 in cash, and $500,000 worth of equity in their house. Another family, again, with that same $5 million bottom line, they've got $3 million in business, a $1.5 million house, and $500,000 invested. Exact same net worth, but completely different financial lives. That first family has some more flexibility because their investments are more passive in nature. They're not having to deal with them. They're not dealing with employees and running the business day-to-day. That second family, again, has a good, solid business with a good net worth to it, but that's a business that they own. And whatever happens to it also happens to their net worth. And so, that's almost effectively like having too much money tied up in one stock. Two solid financial situations, but two very different outcomes and very, very different planning techniques.
Bob: Yeah, Brian, what I think you're talking about here is liquidity really does change everything. In other words, how much of your wealth can you actually use or spend, and how much are you going to need to spend? You know, Brian, I feel like we talk about this almost every night on this show. The people that tend to have a lot of money also tend to be the people that really don't think about or quantify how much money they actually spend every year and where they spend it. Because let's face it, those are the people that tend to have high income coming in, a lot of assets, a lot of options, and they just don't think about it because scarcity is not a thing while you're working and earning a high income.
But when you start to think about retiring, yep, this is where liquidity really does change everything. Because you can't buy groceries with the kitchen of your house, you know, unless you start selling kitchen cabinets off one at a time. But seriously, this is where people can sometimes be asset rich and cash flow poor if they really have not thought about where that paycheck is going to come when they retire. Again, you might have $6 million in net worth, sounds great, but if $2 million is in your house and another $2 million is tied up in commercial real estate and another $1.5 million is tied up in a family business, now you've got only $0.5 million in liquid investments. It doesn't mean you're not wealthy, it doesn't mean you don't have enough to convert this into a retirement paycheck, but there's quite a bit more work that needs to be done and thought that needs to happen in order to get us there.
Brian: That's right. So, let's flip this around. That's not the only situation out there. There are also people who could be financially stronger than what their investment statement suggests. So, for example, let's take Social Security. Lots of people don't put Social Security on a personal balance sheet because it's not really an asset, it's a stream of income. But economically, there's a value to it. We can assign a value to Social Security. Just think back to your most basic finance classes if you took any back in the day, it's the present value of a future income stream. Well, that has a dollar amount.
So, let's say, if you and your spouse are eventually receiving several thousand dollars a month and adjusted over time, we know Social Security currently has inflation built into it. That is income that doesn't have to be generated by your portfolio. It's what I like to call OPM, other people's money. It's money that comes from outside my household and I'm allowed to use to pay my bills. It's really no different than that paycheck. And lot of people are comforted by the fact that, "Yes, I have a portfolio, but it's awful nice that money comes from somewhere other than my portfolio so I don't have to feel like I'm actually spending my own dollars." At the end of the day, a dollar is a dollar. It doesn't matter where it comes from. But psychologically, we really like it when other people give us money and we can go spend it. It's a monthly gift card kind of thing.
So, think of this situation. Somebody retires with $2 million invested, right? That's $3 million less than the first 2 we were talking about, and a pension that covers a meaningful portion of that household's basic expenses. Now, let's compare with somebody who's got $3 million, but no pension. Which one is richer? What I can tell you the spreadsheet would look like is that that $2 million person is probably going to wind up with more later in life because they haven't had to tap into the $2 million nearly as much as the person with the $3 million. That extra stream of income, right? Married couples at least have two Social Security checks. Some people also have a pension from some former job. Some people have two pensions from a former job. So, those paychecks, those monthly cash flow paychecks that come in sort of predictably and are not exposed to the ups and downs of the market, that really can smooth out the ups and downs of what that investment portfolio does.
Bob: No, for sure. And then another forgotten asset out there, Brian, your paycheck, your potential future paycheck. I think this is something a lot of people don't think about, their future earning power. For example, let's say you're 52 years old, you make $250,000 a year and you expect to work another 10 or 12 years. Yeah, your brokerage account might be worth $2 million today, but you've got potentially millions of dollars of gross earnings still ahead of you. Assuming you continue to work and you stay healthy, this is where a disability income protection conversation might need to happen. Because whether you realize it or not, your future earning power is, in fact, your most valuable asset. I mean, that's your real human capital out there. Now, compare that with somebody who's 70 years old with maybe $1.5 million saved and no earned income, they're retired. That 70 year old has twice as much invested than a 40 year old, but they're not working anymore. They're depending...
Brian: Yeah. No...
Bob: No, go ahead.
Brian: I like that analogy. What that makes me think of is somebody who's in their 20s and 30s, of course, they are their own most valuable asset because of what you just said, their ability to earn. But the flip side of that is somebody who's retired is completely worthless because they don't have that or don't want to have that anymore. And that's the goal, right? I want to make myself completely worthless. That's my goal lifelong. I want to be a useless lump on the couch. That's sort of what retirement is. Not quite, yeah, but I get your point.
Bob: No, and nobody's worthless and I know you're just joking around. But I think the whole point...
Brian: Depends on the day, Bob. It depends on the day.
Bob: No, I know. The whole point of this is the importance of building a financial plan sooner rather than later and building different scenarios and assumptions and putting a proper value on all the things both of us just mentioned, whether it's Social Security, a pension, future earnings, future contributions to retirement plans, and current portfolio assets that have already been accumulated. That's where you want to take a look at your financial plan, look at various retirement dates, look at various spending scenarios and just see if we've got a plan in place that's going to allow you and your family to do what you want and need to do when you need to do it. That's what we're talking about.
Another thing that gets overlooked here, and I've run into this, Brian, from time to time, business owners can sometimes make the mistake of treating an estimated business value like it's already cash sitting in a brokerage account. They think the business is worth $4 million so they say, "Well, we're fine." Have you had a professional valuation of the business? Has anyone actually offered you $4 million for the business? Have you factored in capital gains taxes that you will have to pay even if it is worth $4 million? There's a lot of things to consider there, one of which, depending on how much cash flow and income you take out of the business, you might think it's worth $4 million. A potential buyer will value it less than that because you're pulling all the cash out of it to live off of. Those are things that come up from time to time among business owners, Brian.
Brian: That last point, I've seen clients run into this, that very last point you just made, I think it's a great point. First of all, it takes two people to recognize that it's worth $4 million for it to actually be worth $4 million. You've got to have a buyer on the other end of this. But people tend to think, business owners sometimes think, "I'm taking this big owner's compensation chunk out of it, and that's therefore income. And therefore, I can count that as income that the business produces." A buyer may not be thinking the same way and they're thinking, "Hey, you're coming off the payroll. We don't have to account for you, and I'm not going to pay for that." So, that will come into the discussion of a price from an educated buyer. But I think a lot of people lose sight of that a little bit. Now, another...
Bob: Brian, let's talk about inheritance. How many times do you have people come in, and you build a financial plan for them and we factor in all the income, the investments, the assets, all of that, and then they want to already count a future inheritance of X amount of dollars and just assume that that's just going to happen. You know, bake that into the cake and that's going to absolutely happen. How many times do you run into a situation like that?
Brian: Oh, pretty frequently, right? So, it's just assumed that something's going to happen, right? Your parents, though, they may live another 25 years. They could spend a lot more than you expect. Healthcare, long-term care, that can become expensive. Heaven forbid, they may have different ideas about their money than you do. Shocker of all shockers. Maybe they want to give more to charity. They might be looking at their kids going, "Hey, these kids are pretty successful. They're doing okay." Or, "you know what? I want them to earn their own keep and build their own just like I did. They may have thoughts they have not shared with you. So, it behooves everyone to make sure that your own plan can support your situation, not relying on something out there. And that, of course, will keep those conversations on a more positive level versus some nasty surprises down the road, too.
Another thing that tends to sneak into the conversation is future liabilities, money I don't owe today, but I could owe in the future. So, we do spend a lot of time finding hidden assets out there, right? A lot of people want to, "Where's that old retirement plan?" Or, "Hey, I found this old 401(k) statement that's great." Let's find all the hidden liabilities too, because those matter just as much. That can make a $6 million net worth look a lot stronger than it actually is because you've got a big bill to pay down the road.
Maybe you've promised to pay for three grandchildren's college educations. That's not debt today because they're not old enough, but that's a commitment you made and you want to keep it. Well, we need to take that into account for budgeting. Same with helping adult children. This may not already be in place, but it's a possibility that a bill you may have down the road, supporting aging parents, or if you know that house, if you're going to stay in it, you're going to have to put $200,000 into it to make it comfortable to age in, those kinds of things. These are all the kinds of things that sneak up. It's not only about hidden future assets, right? It's also about future liabilities that we're not currently thinking of as a current bill.
Bob: Here's the Allworth advice, don't judge your financial security by net worth alone. Understand your liquidity, future income, taxes, any obligations that are out there, and of course, how much you actually plan to spend someday when you retire. All of that working together in an actual financial plan will determine how much financial freedom you really have. Well, what's the most valuable asset on your financial statement? We'll discuss that next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" live every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your favorite podcast. Well, how do you adjust when your monthly budget and actual spending don't quite match up? We'll help two local couples try to figure all this out straight ahead at 6:43. If I asked you to name the most valuable asset you own, what would you say? Your investment portfolio, your house, maybe you own a business. If you're retired, maybe it's your pension. But here's what's interesting. The answer can completely change depending on what stage of life you are in. Brian, let's get into that because this comes up all the time with folks that we talk to.
Brian: Yeah, sure. And so, in a case where I'm talking to somebody who's on the younger end, 20s, 30s, even 40s, I'm going to say that for those folks, it's their future earning power. It's their ability to go out and use their body and their brains to go earn a paycheck. So, let's take somebody who's 45 years old, maybe making $200,000 a year. They look at that 401(k) and they've got $700,000, $800,000 built in there and they're thinking, "That must be my biggest financial asset. That's a big number and it's starting to sneak up on seven digits and two commas. That's huge." But this person has another 20 years of paychecks coming, presumably, at that income level. So, even without assuming raises, that's literally millions of dollars of future gross income.
And we don't necessarily think about that paycheck as an asset because it arrives every two weeks, right? That's not an asset. That's something that lives on your income statement. It's not a pile of money. So, we don't really think about it as something that's on the balance sheet. But we can do math. We can figure out that the 20 years of $200,000, that's $4 million. And so, let's make sure that we understand what the impact of that is, knowing that that income stream is going to keep coming. You can calculate a present value of that pile of money. But going forward, if this person is living kind of a typical average life, the bills are going to go up, too. We will have mortgages coming up, possibly college, 401(k) contributions, Roth contributions, all of that. That's the job of that paycheck to cover all of those things, and that eventually, you'll be retiring off of that pile of money.
So, again, as we've said a few times on this show, that somebody who is younger, your best asset is your ability to earn a paycheck. Make sure you're handling it well. This is the time you're going to have extra dollars to put away. And the sooner you start, the better. And the more you get in there earlier... I'd rather see somebody put a huge amount of money in a huge percentage of their net worth in early in their career and then back off later because they got college bills and mortgage and all that other stuff. That's somebody who's going to wind up a lot better off than somebody who waits until they're 40 to start saving for retirement.
Bob: Yeah. And it's also somebody, the sooner you get started and the younger you are and the more paychecks you have ahead of you, you know, the more aggressive or growth oriented you can get with that portfolio because time is on your side. You can handle even prolonged market volatility or market declines because you got time for all that money to recover in value. And I think that's why people inherently know when they're still working and contributing, they really don't look at the market every day, because they know over the long term, it's going to go up and the returns are going to be there.
Things definitely change. There's a definite mental paradigm shift that happens when we get closer to retirement, Brian. Now, let's say, we've got somebody that's 62 years old and maybe has $4 million invested. They know or they want those paychecks to come to an end because they want to retire. And that portfolio isn't just a number anymore, it's their future paycheck. And that's where that portfolio composition may need to change because after all, during your working years, you're putting more into it, and you don't worry so much about it. But now, we got to turn that paycheck on immediately.
And that whole sequence of returns conversation needs to come up and be discussed because volatility is a thing. It always has and always will happen. And that portfolio needs to be structured appropriately to handle some market volatility. Sometimes Brian, people just aren't aware that that stuff goes on. Also, people can tend to get a little over fearful in their early 60s, 65, 66 and move too much money out of the stock market for fear that that pile of money, as you like to call it, might decline by even a little bit. And we got to have that conversation with folks as well.
Brian: Yeah. And I think one other thing that can derail people from figuring out exactly how strong of a position that they're in is the house. So, for a lot of people, the house is one of their biggest assets. That doesn't make it their most valuable. Important? Yes, certainly. Got to have somewhere to keep the rain off your stuff. And if it's paid off, that's great. That can dramatically lower the amount of income you need in retirement because you're not paying a mortgage. Now, that does not mean you don't have housing expenses. Raise your hand if you've ever lived in a house that never needed work where the hot water heater never died and the air conditioner never quit.
So, houses themselves, basically, they're kind of always a liability because you're never looking at a glorious future where nothing bad ever happens to the house again. Things tend to atrophy if left alone. And that is definitely the case for a house. So, we got to take into account, it might be a big, solid asset, larger than some of your investment accounts out there, but at the same time, it has more expenses built into it than any of your investments do. So, make sure you're thinking about that the right way.
Bob: Here's the Allworth advice, your most valuable asset changes throughout your life. Know what it is today, protect it appropriately, and make sure your financial plan is not overlooking the things that really do matter most. Next, we launch a rescue mission on one of the most overlooked parts of high net worth portfolios, those neglected old 401(k) accounts. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Let's be honest, when you hear the words 401(k), you probably think about your very first job out of college. You said it, you forget about it, and you move on. But if you're now worth, let's say, a few million bucks, maybe even more, that first 401(k) or first two or three 401(k)s could be the weakest link in your whole financial plan if you've completely thrown them in the proverbial drawer and forgotten about them. And so, tonight, we're going to go on a little rescue mission. We're going to tell the story of someone who built some real wealth over the course of their career but never circled back to fix that major blind spot, those old 401(k)s, Brian.
Brian: Well, we're going to talk about Laura. Laura is a fake person. Now, I would say, all of our stories we share here are real stories that come from real clients, but obviously, names are changed to protect the innocent. And today, the innocent's fake name is Laura. Laura is 58, married, with two grown kids, and she owns a marketing firm in Cincinnati that did really well in her 40s. And today, she and her husband have a net worth of about $3.2 million, including some real estate brokerage accounts, growing cash reserve, typical assets for somebody in that kind of a position, and life is good.
But she came out to me with a financial advisor, and during that whole review, what stuck out was a 401(k) that was a $480,000 account. That's a significant chunk of her net worth, still 100% in a 2035 target date fund. Really no customization and no real... It looked like there hadn't been any discussion of this account really at all because she was busy building her business, and that's where their net worth was. So, now, that wound up being $0.5 million that could have been handled a lot differently. For example, she's in a position where she's got a decent amount of assets sitting there outside the 401(k). That's what they're going to rely on to live off of in the earlier years of retirement.
That means that these accounts, the tax advantage ones, a couple of things. Nobody had had a conversation with her about should this stay in the traditional side, should we be thinking about Roth conversions here after you retire, and more importantly, should it really be in a 2035 target date fund? That is not that far out. And if these assets are going to sit there for maybe 20 years or longer or possibly just be inherited by your kids, then that is a very, very different strategy. That's really where we're talking about Roth conversions.
But again, it sat there in the same fund that she had decided when she first set the thing up when the business was barely off the ground and hadn't thought about it ever since because she worked so hard. The end result, it underperformed the market by about 2% every year over the past seven years because it was targeted for a risk tolerance portfolio that really didn't match what she needed. Now, is this going to bankrupt her? Of course not. But it's a question of efficiency. When you look at it in the context of her wealth, that's a big hole in the boat, Bob, because she left a lot of money on the table over those years for an asset that most likely is going to sit there for several decades until it gets inherited.
Bob: Yeah, I think the important thing here is just to make sure when you sit down with your advisor, you are talking about all of your assets and you actually know what you have and where it's sitting. I mean, sitting in a 2035 target date fund isn't the worst thing in the world. I mean, the thing got probably a pretty nice return over the period that this person was ignoring it. I came across a situation late last year which was a bit more dramatic than that. These folks had sold a business for quite a bit of money and they were very and are very risk averse people. They want to be almost 100% in bonds, maybe a 10% to 20% slice in the stock market just for some inflation protection.
And I asked them about these couple old 401(k) accounts that they had. They hadn't looked at them in 15 years. And I said, "Well, why don't you send the statements and we'll look at it." Well, they sent the statements, Brian, and they were 100% invested in the stock market and they were in a variable annuity. So, not only was the risk profile completely different from where these people wanted to be today as they progress through their retirement years, but when you ran a fee analysis on the whole thing, I mean, they were paying very, very high fees, upwards of about 3% all in on these annuities. So, again, in some cases, it makes sense to leave the money at the 401(k) if it matches what you're trying to do and you can get the investments for low cost. But in a lot of cases, it's not the case. This was one example where it was just a no brainer for multiple reasons that I've already covered to just consolidate this over the assets that we were handling for them. And they were glad we had the conversation.
Brian: Well, that's good to hear. And that's the whole point of that entire type of a discussion. So, just to make sure that you understand what you own. And one of the interesting phenomenons we see every now, is we take people through this risk discussion. They'll say that they're super conservative people. And then like you just said, we look at the portfolio and it's invested really, really aggressively. And oftentimes, they'll show us this, and they won't have reacted to 2022, which was, as I always say, one of the five worst market years we've ever had. And it's like, "Are you really risk averse? Because it didn't appear to have bothered you that 2022 came out the way it did." So, it's almost like sometimes those risk questionnaires are more of a, "Here's where I think we should probably be, but we're really okay not being there." So, that's why risk is a discussion, not just a questionnaire. But that's still an important thing for you to talk about with your advisor to make sure everybody's on the same page.
Bob: Here's the Allworth advice, if you've built some real wealth, you can't afford to just let those old 401(k) plans lay around and coast. It deserves the same level of scrutiny and customization as everything else in your plan. All right, can you afford to give your kids, let's say, $25,000 each for a house down payment and still retire comfortably. We'll dig into that question from Loveland next, plus whether an $8,000 a month retirement budget really holds up over the long haul. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening on the iHeart app. Simply record your question and it will come straight to us. All right, Brian, Greg in Madeira says, "I'm worried that one bad year early in retirement could change everything for us. What practical steps can you take to protect against that without parking everything in cash?" Great question.
Brian: Well, Greg, you're talking about something called sequence of returns risk. And the reason this is so dangerous, it's timing, not the long term averages. So, a poor market year, like you said, in the first few years of retirement can permanently shrink that capital base you're drawing off of, even if markets recover later as they always have in the past. The solution is not to walk away from growth because this can happen. It's to separate the income I need now from the money that can grow over time. So, really what that looks like, maybe somewhere between a giant cash pile and no cash pile at all. Build that retirement paycheck buffer.
I always suggest, look at the things you're going to need to spend money on. You know the bills that are coming due over the next 12 to 24 months. The good idea would be to make sure that that particular pile of cash is sitting somewhere safe, generating a little bit of interest, but its job is to be spent to pay those bills. That means that if the market does go the wrong direction early in retirement, it doesn't hurt you because you weren't going to spend those particular dollars anyway.
And you can also take this a little further by looking at and segmenting your dollars into buckets. Maybe the first bucket is money you're going to need between now and three years. That's really liquid. Again, you're looking for money markets, high yield savings accounts, those kinds of things, maybe a CD. Second bucket for four to 10 years, which would be a little maybe like a balanced fund, inflation-protected assets, those kinds of things. Then of course your 10 years and out bucket, that's the long-term growth money that's going to be pretty heavily invested toward the stock market side. So, just be thoughtful about when these dollars are due. And you don't have to invest every single dollar the exact same way if these are concerned. So, I hope that helps. Ron in Marymount. Ron says they need about $110,000 to live comfortably. And he's wondering, how much of that should come from dividends, interest versus selling investments, especially in a down market?
Bob: Well, Ron, I would first say, you know, don't let the proverbial tax tail wag the dog, meaning that you should build a financial plan based on your personal goals and your investment risk tolerance, and then set your asset allocation accordingly. Once that's done, you know, like you said, if you've got money coming in from dividends and interest, from bonds or some dividend-paying stocks, you know, those are going to be pretty consistent. The other thing to look at, you know, if we're talking about selling investments or using capital gains, you want to try to get as much control over those capital gains as possible, meaning have some type of tax loss harvesting or tax smart investing going on, you know, in your non-IRA accounts so you have some control over capital gains and when those are generated versus just waking up in the fourth quarter of the year and being surprised when you get a capital gain distribution.
Obviously from your question, I don't know how much of your assets are in IRAs versus, you know, taxable accounts. That's a big part of this whole discussion, too. So, I think, you know, sit down, build your plan from an allocation standpoint. And a good fiduciary advisor can take your plan and then also apply some tax smart strategies to it as well to make sure that we're pulling money from the right places without triggering unnecessary taxation. Hope that helps. All right. Alan in Loveland says, "We want to give our kids $25,000 each toward home down payments. How do I evaluate," Brian, "making those gifts against our long term plan instead of just going with our gut and giving the kids the money?"
Brian: Yeah, this is a common... You know, this is really the core of financial planning, right? "So, I know I've got money now and I can do whatever I want to do with it. But my question is, what's that impact in the future? Can I get away with this now or is this going to hurt me 10, 15 years down the line?" So, think of it in terms of retirement income. A permanent $25,000 gift is probably about 1,000 to 1,200 bucks a year of lifetime spending you're giving up. And if you got two kids going on now, you're thinking $2,000 to $2,500 per year for the rest of your life. So, now you're thinking, this is different from, "Can we spare the cash?" To now you're thinking, "Are we comfortable trading this much future spending for this outcome?"
And then you're also gonna look at what dollars that you're using for. If this is coming from your own excess taxable assets, then that risk is usually pretty manageable, not too painful. But if you're going to be taking this out of tax sheltered accounts, you know, Roth IRAs, traditional IRAs, that's going to be income taxable or you're sacrificing that tax free growth, that'll have a bigger impact on it. And then I would also stress test the timing of it, "What if markets fall 20% right after we make the gift?" Well, hopefully, you've already got a financial plan in place where you can easily do this, model this out, and then pretend the market takes a hit. But on the other hand, we don't know when you're talking about doing this. You didn't give us the age of your kids. You know, they might be 10 years old. We're talking 15 years from now. You're thinking way ahead of time. It could be this Christmas, you're going to do it. Who knows?
But in any case, what I would look at is, what have your investments done recently? Because very often, if the market has had a positive run, you might be able to do these gifts with money you didn't have a few months ago. If that's the case, oftentimes I say, you know, as long as the plan floats, take the windfall that you found from that recent market performance and do the things that you want to do for your family. So, it's not about affordability. It's about intentional trade-offs. If you'd still be comfortable with that decision after a bad market year, it fits the plan, if you wouldn't change the size, the timing, or maybe the source of that gift. We got one more for Tony in Newport. And Tony's asking about a single stock. He's got one worth over $0.5 million, and it's about 25% of their portfolio. He said he's concerned that if he sells it all, he's going to owe about $90,000 in capital gains. And he's wondering if it's smarter to spread that out over the years or just tear the band-aid off and write the check and smile.
Bob: Well, Tony, if you can help it, we don't want to just rip the band-aid off and write a $90,000 check. Usually, there's some better ways to go about this. But 25% of your overall net worth is a bit high, and we want to try to get that down under 10% if we can, but do it responsibly. So, we got to take a look at your overall tax situation, what your income goals are. Just as a reminder, up to $96,000 and change of taxable income, you don't pay any capital gains taxes. So, you might be able to, you know, to use your words, rip some of the band-aid off this year, spread it over a couple years, and maybe, you know, gradually move down out of that position without paying any taxes at all.
But the other option is you can literally use options. Meaning you can buy some put protection to protect your downside. If you want to help pay for some of that downside protection, sell an out of the money call option on your stock to help pay for some of that. There's varying ways to go about it. But, yeah, I would not rip the band-aid off at once. Sit down with a good fiduciary advisor, and come up with a good strategy. All right, coming up next, I've got my two cents on a few things to consider when you go over a periodic review of your life insurance. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Let's spend a few minutes talking about what everybody should do as part of their comprehensive financial plan, I'd say, at least every two to three years, and that's just a life insurance review. Brian, let's get into some of the things we should be reviewing. What does a life insurance review actually mean?
I think I'd start with step one, as part of your financial plan, determine how much life insurance you even still need given your current goals and your current stage of life, not what was in place 15, 20, 30 years ago. So, a lot of people never do that. They have these old policies they've had for years or decades. They don't touch them. They don't look at them. And they don't even take a look at, do I even still need them? And a lot of times, Brian, there's a lot of hidden cash value in these policies that could be put to better use elsewhere. So, that's step one. Take a look at whether it's insurance that you actually still need or want.
The other thing, if you're talking about cash value type of policies, and, Brian, I find fewer and fewer, I'll call them advisors, even do this anymore, is do what's called an in-force illustration of the policy. Go back to the insurance company and say, "Hey, run an illustration as of today based on the current amount of cash value. And assuming I want to keep this coverage for the next 15, 20 years, what am I going to need to pay out-of-pocket to keep this thing in force with the current interest rate structure?" And then run it a couple of different ways.
What if interest rates go up, interest rates go down? If you're in a variable policy where your cash value is tied to the stock and bond market, you want to look at some variable average rates of return there, too. What we don't want to have happen is someone who really wants to keep life insurance into their 80s or 90s wake up at age 77, 78 and realize their cash value is about to go to 0, which means unless they start writing humongous checks, their coverage is going to lapse. So, those are a couple of things to factor in as you're doing insurance reviews.
I guess the third one would be, you know, if we decide that the life insurance is really not something that's suitable for your current financial plan, there's some things that you can do with that coverage. You can try to convert that into some long-term care type of coverage, maybe a hybrid approach, or just avoid the taxes, put it into an annuity, turn it into an income stream. There's a lot of options there. The important thing is to sit down with a good fiduciary advisor, someone that's not just trying to sell you the next insurance product, but actually customize what you have into your current financial plan based on your current needs. I know you run into this all the time too, Brian.
Brian: Yeah, my absolute favorite thing to do is when we find a policy like this... And most times these things were purchased for good reason, "We've got babies now, we've got a mortgage, and we're going to buy a whole life policy because that's what is recommended to be a good idea." Now, 30 years have gone by, mortgages paid, the kids have their own mortgages, we just don't need this anymore. So, my absolute favorite thing is to redeploy that into something that doesn't cost a nickel in taxes, but now will provide long-term care benefits. That's like trading in your old 13-inch black and white TV for a 60-inch LED screen and not paying in anything at all. You're just redeploying those assets for a need you have now and getting rid of that need you don't have anymore.
Bob: Yeah, so just, again, make sure you sit down with your advisor and talk about this stuff because there might be some better, more efficient uses for that capital that you've worked so hard to build over the years. Thanks for listening tonight. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
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