Ep5: Economic Outlook for 2019

About This Episode

Is America headed for a recession or is this economic expansion part of the typical business cycle? Patti explains what is really happening and what to look for in 2019. Her Chief Investment Officer, Brad Everett, joins her and explains what YOU, the investor should be doing with your portfolio as they both navigate the world markets and how it will be affecting our investment decisions this year.


Patti Brennan: Hi, everybody. Welcome back. This is the “Patti Brennan” show. Whether you have $20 or $20 million, this show is for those of you who want to protect, grow, and use your assets to live your very best life.

With me today, I have Brad Everett. Brad is our Chief Investment Officer. We’re going to break down what’s going on in the economy. Just to give all of you listening today a sense of what stage are we in in terms of this economic expansion and even more importantly, are we headed for recession?

Patti: Brad, welcome to the show. Thanks for joining me.

Brad Everett:: Hi, Patti. Thank you.

Patti:Let’s talk about this thing. We’re hearing it. There’s headlines, recession right around the corner, Fed reserve is tightening, lots of different signs of a late stage economic expansion. Can you elaborate on that a little bit for us and for our listeners? Talk about the four things that we look at when we’re trying to determine what stage we’re actually in.

Brad: I think any analysis like this is relatively crude. I think there’s an infinite spectrum in between the early growth phase and a recession, but I think if you can try to put it into quadrants you can have a little bit of success in trying to figure out what things have worked in the past during similar types of times.

When we talk about late expansion, there’s a few things that we consider that seem relatively obvious signs. The first one would be labor markets tightening. There seems like a real shortage of workers, which can begin to constrain activity. If you can’t find somebody to hire, then you can’t invest, you can’t build your business, and that can tend to slow an expansion down.

Patti: It’s interesting because I’m working and gave a keynote to the Economic Development Council. This is a very big issue for small business owners. They can’t find qualified people to hire. They want to hire people. They can’t seem to attract people either moving into their business or what have you, because there’s just a lack of qualified workers out there.

We certainly are feeling that here in this county and on a national basis.

Brad: Sure.

Patti: What else?

Brad: I think another sign is probably tightening credit. Mortgage credits begin to rise. It’s harder to get a loan. Even parts of the loan process other than just the interest rates seem a little tougher to get a loan. Order rates begin to creep up.

Patti: You know what it is? Banks are getting stingier.

Brad: Sure.

Patti: We’re seeing that as well. Our clients are applying for mortgages. It’s taking longer. They want more information. They’re getting stingier, whether it be for mortgages, for their business, etc. That again is classic late business cycle activity.

Brad: Also, so then in addition to that, the Fed typically will begin to contract, that they’re very forthright with what they are trying to do, what they’re trying to stop, and Fed minutes are 75 pages long. You can figure out what they’re projecting in the economy.

Patti: Exactly what we want to do late at night is read this 75 paper from the Federal Reserve. Yet, it is interesting that in December when they raised rates, the commentary was very, “Look, you’re not going to like it, but we’re going to stay on this path of increasing interest rates whether you like it or not. That’s our job.”

The market reacted so negatively to that, losing in December 13 to 15 percent just on large cap US alone. The markets are very sensitive to what Jerome Powell actually says. Fast forward, what did he say in January?

Recognizing the impact of his words, he came out and said, “You know, I know what I said, but here’s what that really means. Yes, we are looking to continue the interest rate increases and the tightening cycle, but we are still going to be data dependent. We’re taking a flexible approach.”

The market went nuts. It’s exactly what the market wanted to hear. “Hey, listen, don’t push us in this box. Don’t put us into a recession.” The Federal Reserve doesn’t want to put us into a recession. What their mandate is, two things, number one, their mandate is full employment. Well, we certainly have that with an unemployment rate of 3.7 percent.

Control inflation. Inflation is below two percent. That’s their two mandates. Guess where we are? We are also at a period of still historically low interest rates. Since they seem to have the buffer of they’ve solved the problem, we’re where they want us to be. They’re increasing interest rates.

I think that people felt much more comfortable that he was going to take a flexible approach to that whole thing.

Brad: I think as a sleep aid, too, it is nice in the sense that if you can get through one or two pages a night before you fall asleep, by the time you get through one version, the next one will be out shortly after you finish that.

Patti: Absolutely. We’re waiting with bated breath, that’s for sure.

Brad: It’s exciting stuff.

Patti: Then last but not least…

Brad: You finally start to see pressure on earnings growth. That is not yet, but I think when you see the fourth quarter numbers come out, and it’s certainly most analysts do expect that in the next three to nine months to start seeing not declines in earnings, just slower growth, not the same high growth rates that we’ve seen over the last few years.

Patti: I think it’s important for our listeners to understand that the growth is measured year over year. Embedded into 2018 was this wonderful tax cut for corporations that actually helped their earnings. It helped those comparisons. Compared to 2017, wow, that was terrific earnings growth!

Once we get that 2017 out and now we’re comparing 2019 to 2018, we may not see that double digit earnings growth. It still doesn’t mean that those companies are not good companies to invest in because there’s still some growth. It’s just might not be as fast as it was before.

I think that that’s important to keep in mind, that there was that fiscal stimulus in all of this that helped things along. The goal there was to extend the economic expansion that we’ve been enjoying for the last 10 years.

Brad, as a chief investment officer, we take all of these things in. If we believe that we are in the later stages of this business cycle, what do you recommend for the people that are listening today?

Brad: I think it’s never the same for everybody, I guess, first of all. We look at it on an asset class basis. Some things aren’t going to matter to you because that’s not something that’s in your portfolio, and it’s not an appropriate investment.

We look at it on a broad asset class basis. What does this mean for bonds? What’s it mean for US equities? What’s it mean for alternatives? What’s it mean for international investments and go that way. To think about what it means for bonds, a rising interest rate environment does not mean that you should avoid bonds.

If I remember correctly, the Barclay’s Egg has actually only been negative four times since 1980. A bond is a total return investment, so as long as you’re receiving income and coupons.

Faster than the value of the bond itself is declining, you can still have a positive rate of return. Bonds are not something you need to avoid. I think for us, this is a time to be shorter duration, higher quality.

The effect of a change in rates is far more drastic to a longer term bond, so we want to stay short. Especially for people that have the money set aside for spending, we want to go much higher quality. If there is a lot more volatility in the stock market, high yield bonds often can almost act more like an equity investment than a bond investment.

I don’t know that the extra yield that you can get from a high yield poor quality bond can give you enough to offset the downside. If the S&P goes down 20 percent, I don’t think high yield bonds, they’re not going to save you from that and they’re not going to be a safe haven during that time.

Patti: Let’s go back to something earlier you said about duration. For our listeners today, let’s define that so that they can wrap their brains around this. It’s a neat kind of simple and easy way to determine how much risk are you actually taking with that bond or bond fund? Let’s define it for them.

Brad: I think duration, there’s a few different ways to measure it. We think of it as a weighted average of when you’re going to receive the money. To use an extreme example, if we had a bond that matures in a week from now for $100, I don’t particularly care what the interest rates are in the economy because I’m going to get my money in a week.

If the bond doesn’t mature for 100 years and interest rates go up, there are going to be a flood of new investments that will look very appealing compared to this old one I have at the old interest rate. I’ve got to sit with that one for the next 100 years.

The value of that could drop significantly, so there’s going to be pressure to sell that and to buy the new one at the new higher interest rate. You would tend to think that longer duration bonds would preferred stock to it can affect preferred stock in similar ways would be much more volatile in times of changing rates.

Patti: Basically, duration, to narrow it down, it’s a way to determine the sensitivity of that bond or bond fund to rising interest rates. By definition, give or take a little bit, but basically for every one percent rise in interest rates, a bond will fall by its duration.

Let’s go through a real example. Let’s say that you’ve got a bond that’s paying three percent. Let’s say the duration is five. The price loses five percent but remember during that year, you got three percent interest. Your total return on that bond is 2, not 5. By shortening the duration, if you got duration of two, and you’re still getting your three, you’re actually getting a positive return.

Brad: You’ll still capture that same three every year for the next five, as long as you continue to hold it.

Patti: That’s the other thing. That is the other part of duration. Just because it goes down one year, you’re still getting that interest every year that you continue to hold that bond or bond fund.

It gets a little bit trickier when you’re talking about ETFs and bond funds. The goal or the hope there is if you choose to have professional management that you’re having those professionals manage duration, manage the risk of that bond portfolio so that you won’t be subject to as much volatility.

Or conversely as we’re going to learn in a minute, sometimes you want that higher duration. Especially after we go through that tightening cycle, you think it’s close to done or you’re done, that’s often a good time to extend that duration, right?

Brad: Yeah. Lock in to a higher coupon for as long as you can.

Patti: Exactly. That’s terrific. We’ve talked about the bonds. We can scale back on the riskier asset classes, go shorter duration, higher quality, etc. That’s especially true for people who are receiving distributions retirements, etc.

One thing I don’t want anybody to interpret or hear in this. We are not changing the asset allocation of the total portfolio. If your goal or if your financial plan suggests that you should have 10 percent in cash, 30 percent in bonds, and 60 percent in various types of equities, that ratio stays exactly the same.

What we’re trying to do is within each of these asset classes, reduce the risk during the later stages of economic expansion. Again, I’m saying that as if it’s a fact. It is not a fact that we are in a last stage of this business cycle. We just want to frame it within that context of, gee, we’ve just gone for a terrible bear market of a loss of 20 percent.

The market is a leading indicator trying to anticipate what’s going to happen in the economy in the next 9 to 18 months. Keep in mind, everybody listening, the market is not always right. Just keep that in mind.

Let’s talk a little bit about, gee, if we’re in the later stages, 10 years into this thing, what are we doing on equities? What should be people begin to think about as it relates to their stock funds.

Brad: There’s arguments to be made on both sides for stocks and they’re valid. That’s how the market has gotten where it is because there’s 50 percent of the money on the one side of the price, and 50 percent on the other side. You can see a lot of the negatives. Volatility has begun to return to the market. Again, like we talked about before, there’s expectations for fading earnings growth.

There has been, despite the lack of workers, surprising lack of inflationary pressure on wages. But if that does arrive, companies would again…It almost feeds itself. If you can’t find employees, then you have to pay them more. As you’re going into this late stage recessionary cycle, now your profit margins are lowering because you’re having to pay employees more and things like that. That can feed on itself.

The other thing that works against the stock market now is for so long, there’s not really been a compelling alternative to stocks anyway. Would you consider cashing out something that had a three percent dividend in order to put it at the bank and earn a tenth of a percent? I think stocks had a staying power there just because there was very little appeal to investing in anything else.

That’s not true anymore. If you can find a short term bond fund that pays three percent, then maybe you consider just taking the yield and taking the volatility out of your portfolio. There are compelling alternatives that begin to arise as interest rates begin to go up again.

Patti: It’s really interesting because we saw that through 2018. That came through in terms of the trading volumes on a day to day basis and the volatility. In 2018, for example, the stock market rose or fell by one percent 84 times last year. Just to give you a feel for how much that is, in 2017, it did that only six times.

Volatility, up or down, has definitely increased because people are trying to figure out, gee, where should I be? They’re restructuring portfolios. Again, understand that this is a lot of traders, not necessarily investors. You don’t want to necessarily make your portfolio decisions based on what traders are doing, because they’re being paid to trade.

You’re an investor. The most important thing is let the financial plan guide you in terms of how your allocation should be and some of the decisions that you might make, if we are in fact in this later stage cycle.

Brad: I think there’s a difference in incentives there too. The traders probably got a time horizon of 30 seconds to 10 minutes in a lot of cases. That’s just not the case for most people. They have certainly a different trading pattern and incentive to act.

Patti: There are certain sectors within that 60 percent again, just using that as an example that are a little bit more resilient during this period of time, aren’t there?

Brad: Yeah. On a whole sale basis, we have definitely made shifts from more volatile growth oriented stocks to value…

Patti: Folks, if you were watching us today, I’m knocking on my head because we got really lucky there. Did that earlier in the year only to see that large growth stock like Apple. I don’t know if you hold Apple. If you have Apple, you watched your stock, your holding, fall by 40 percent. That’s a lot more than the overall stock market lost during this period of time.

The GOGO stocks, they go, go, go, but boy when they fall, they fall like a rock. By shifting a little bit less…Again, we’re not talking all in or all out. We are talking tweaking and reallocating. Taking those gains. Yes, you have to pay your taxes, but I think that’s what you’re supposed to do, right? Sell high?

Brad: That’s the goal, yeah.

Patti: What do you think?

Brad: The goal to investing is to make money, right?

Patti: You got it. OK. That’s good. Defensive sector. Let’s define for people who are listening. How do we translate that?

Brad: It’s interesting. There’s a couple of ways to think about it in what are the things that are still necessary? Not necessary consumer staples. I think that’s almost even more necessary than what we’re thinking. But when times get tough, you find that discretionary spending would drop. What are the things you still need? You need energy. You need to buy toothpaste still.

Patti: Utilities.

Brad: You can’t give up brushing your teeth just because the stock market’s down five percent.
Patti: Don’t tell Lily that, right? [laughs]

Brad: I know. No kidding. We want to drift into those staple sectors that have shown a lot of resilience. I think valuation matters too. Some things will arise as just being cheaper relative to what they had been in the past. That makes it more attractive too, and a valuation comes into the sweet spot where you’re ready to invest again. Energy is one of those things for sure.

Patti: Certainly. If you just take a look at the broader bases after the 20 percent loss, P/E ratio on the S&P 500 went down to 14.1. Anybody who is an expert in this area would say, “Hey, that’s pretty low.” It’s probably undervalued if average is about 15. It’s not dirt cheap, but it’s certainly not overvalued by that measure.

Other areas that got especially hit before that were underperforming significantly were small cap stocks, especially value, small cap value. They got hit especially hard prior to this. While they certainly took it on the chin as well, it does present some interesting opportunities. Again, if you buy low and it goes lower, it’s OK because you didn’t buy high and watch it go lower. Does that make sense?

Brad: Yeah, absolutely.

Patti: That’s the key here in managing and taking a fresh look at the portfolio. What about international?

Brad: Sure. The case for international has actually been relatively strong for a while. We just haven’t seen it, as US investors we just haven’t seen the returns. I guess there’s two components to your return if you’re investing in international stock. One is the return in the local currency. What did someone who lives in Japan earn on their Japanese investment.

The second component is bringing the money back in the United States. For you to actually sell your investment, you have to get your investment back in dollars. You have to sell yen and buy dollars. That currency return can be a pretty significant portion of the change in the value of your investment.

At the beginning you sell dollars to buy yen. Let’s for a year, you invest in a Japanese company. At the end of that year, you have to sell your yen and buy dollars again for you to spend it. That currency change can be a pretty significant one.

Patti: It’s interesting because when you look on a worldwide basis, the US has been the one economy that has been growing. The other economies, they’ve also been growing but not at the same rate. That can have a significant influence on the value of the dollar because people want to invest in the area that is actually growing. That’s definitely a factor.

What’s really fascinating is to look at the different periods of time when international has outperformed versus the US and the amount of the outperformance that is attributable to the currency. It’s fascinating.

Brad: Yeah, can be a lot.

Patti: If we take a look at the seven cycles since 1970, it’s pretty interesting to see. First of all, in each one of these silos, the outperformance they’ve changed hands. One period of time it’s the international, then the S&P outperforms, then the international, then the S&P. Literally, they trade places in each particular period of time.

What I think is also fascinating is the amount of the outperformance that’s primarily attributed to currency. It can be, for example in the ‘70s, the outperformance on international was 48 percent of the result. If we go back to…Let’s look at the S&P 500 during the ‘80s. That was 90 percent of the outperformance just had to do with the dollar strengthening.

We have got to keep that in mind as we’re looking at the international investments. For those of you who are listening at home, does that mean that we want you to study the dollar, to study the currency and pick only those areas where the US currency is going to start falling relative to that particular local market? The answer’s no.

We don’t want you to be doing that. It’s just bringing up that to the surface. Letting that bubble up and understanding that it is a factor in how these investments perform. Just because the international hasn’t performed as well in the last 10 years…

By the way, the underperformance is significant over this time period. As of the end of 2018, the international markets as measured by the world index was up 90 percent. Not bad for 10 years, right? But the US was up 271 percent. That’s a significant outperformance.

Here we talk about diversify, diversify, diversify. We add that into our portfolios, and yet we’re doing it and it’s just pulling away, reducing the returns. We all know that eventually these things will trade hands, and you want to have something in there to add a little bit of a turbo charge to your portfolio.
Brad: The tough thing is that I guess this is another form of market timing it’d be tough to figure out, especially with currency, when will the cycle change? We’d expect at some point, there will be some significant amount of time where international stocks outperform the US, but when that begins and when it ends is pretty tough to figure out.

Again, we always want to have access to both and have investments in both. Again, like you said, you were just tweaking back and forth in minor amounts to try to take advantage of where we think everything falls.

Patti: Excellent. Let’s talk about the trade deficit, because that does have an impact on the international, etc. We’re talking about trade, and the tariffs, and all of this. Our president is really concerned about the imbalances that have occurred over the years, especially with China. How does that impact all that? What creates the trade deficit? How concerned are we? What should we be doing about it?

Brad: That’s just one of the other things that can affect the value of the dollar. We just have to think through this equation, for some reason very unnatural to me. If we’re exporting more than we’re importing, then the dollar is going to rise in value because people need to buy dollars in order to buy our goods. The opposite would be true if we’re net exporting.

The tariffs. This is probably the thing that would cause the direction of US and international stocks to go one way or the other. We don’t know how it’s going to turn out, but that could be the dominating factor of the next relatively major market move. That’s the thing that’s on the horizon that’s so unclear. It affects a lot of things. Like long term business investments, things like that.

Politically, it matters. Jimmy Carter, probably the last person to try to get reelected during a recession, and it did not go well for him. You get reelected based on economic strength, other than a few other things, like wartime or something like that. But for the most part, you need a strong economy as you’re going into reelection.

China needs it too. They’re further along this process than we are. Probably more in a recessional period than we. There’s certainly incentive on both sides to get it done. It’s easier to start a war than to finish one.

Patti: Boy, is that the truth. We have got to be really careful, because as this thing takes on and continues, etc., it is those tensions between those two countries. It’s pretty scary. The one thing that is classic and textbook is that tariffs can definitely cause recessions. It can cause slowdowns, and it’s bad for the entire world economy. One way or the other, they have got to get it solved.

For those people who are concerned about some of this stuff that China has been doing, there are legitimate concerns about the fact that China has been cheating a bit. It’s hard to do business in China. You run the risk that the government is going to take over your company whether you like it or not. You’ve invested billions and billions of dollars.

I just had a pharmaceutical executive in. They were looking at starting operations over there. They decided not to for that fear. Sure enough, a competitor did. Opened operations in China with a particular division. Within a few years once it was up and running billions of dollars later, the Chinese government took over, and they were SOL.

It is a concern. Something does need to be done. Hopefully, the two sides can come together and figure it out.

Brad: Even the greater effect that I’ve heard than the actual price of the level one cost of the tariffs, it was one of Fidelity call. They use the example of the iPhone 15. The tariffs change very little the phones that are for sale now and what’s in the pipeline.

But when you’re looking that far away, how do they make the plans for their development not knowing what all the components are going to cost? They can’t lock in the long term contracts to do things like that. The real cost is in the business development that was never undertaken.

Patti: That’s the thing that is very difficult to measure. What would Apple have been able to launch if this wasn’t going on at this point in time? It’s like all decisions, it’s a wait and see. You do that for six months, a year, two years, etc. You’re not going to get your iPhone 15. It really undermines innovation and undermines progress if it lasts too long. It is a fine balance.

When we take a look at the overall… We often talk about the impact of a president. Typically, a president does not have really that much of an impact on either the economy or the markets. This is an unusual period of time where we’ve got someone who is very visible and is tweeting, and things of that nature. It does seem to be affecting sentiment.

That level of uncertainty that is typical in the contraction of the economy. People just not knowing what we’re really dealing with and deciding, “I’m just not going to make any decision. Let’s just wait and see how this thing plays out.” That will definitely undermine confidence and what people do. Therefore, it affects the stock market. It affects the bond market as well. Everything.

Brad: In a lot of ways, the president is like the chief public relations officer for the country. That’s his influence on, like you said, sentiment, the feelings, consumer confidence, things like that. But the business cycle will last three or four presidents.

Patti: That is a really good point. Just because this thing lasted 10 years doesn’t mean that it has to be over. We look at Australia. Australia has had 26 years of growth. They have not had a recession at all. Just because it’s lasted for 10 years doesn’t mean that it has to be over, which is I think the most important takeaway.

We can talk about all of these things, but the most important takeaway is nobody really knows where we are. For those of you who are uncomfortable, we got our bear market. It happened. Hopefully, we run that excess out of the system and we can look forward to better times ahead.

I think that for those of you who are listening, let’s wrap this up for everybody, Brad.

I think there’s three takeaways three key takeaways. Number one, don’t panic. Just because we could be closer to the end, it’s not the time to be changing your overall investment policy, your asset allocation.

We were talking earlier, and you mentioned David Kelley’s comment. Why don’t you tell listeners what his comment was about the light switch?

Brad: [laughs] We try not to think of investing as a light switch that you turn on and off. You don’t just decide that you’re all in on equities or all out on equities. It’s a series of dimmer switches where you fade one way, fade another way.

You fade a little bit between geographical regions. You fade a little bit between market caps. You fade a little bit between different sectors and things like that. You need to participate. The money that you need in three months probably shouldn’t be in the stock market anyway.

This is all for things that with a much longer investment in mind than any single piece of news that you’re going to hear tonight on the news or any headline. These are all things that are for way down the road. We’ve had terrible times before, and there’s always a disaster on the horizon.

The stock market has steadily ticked up over the decades. I think that’s what we want to keep our eye on. If you need the money shorter than that, then let’s think of something else to put it in.

Patti: OK, everybody, so the three key takeaways, first of all, Brad Everett, thank you so much for joining us today. I think it was a great, important, timely conversation. Three takeaways, number one, don’t panic.

Number two, remember the light switch and the dimmer. It’s not on and off. You want to fade one way or the other. Last but not least, just because we’ve been doing this for 10 years, we’ve had this wonderful expansion, doesn’t mean that it has to be over any time soon. Remember Australia.

That’s it for today’s show. Again, thank you so much, Brad, for joining me.

Brad: Thank you, Patti.

Patti: Thank you all. Thank you all for listening to us today. It means a lot that you tune in, spend 20 or 30 minutes with us hearing about these different subjects because we do this for you.

Number one, I do think it makes us better. It helps us to zero in on the things that we believe are important. More importantly, we want to make sure that it’s helping you. If there’s anything else that you’d like to hear about, definitely go on our website, send us a message, say, “Hey, Patti and Brad, can you talk about A, B, or C?”

Sometimes we can, sometimes we can’t. We’re going to talk about the things that we believe we’re experts at, where I believe that we do real financial planning, which might include portfolio management, risk management, how to put your kids through college, making sure that you never run out of money for the rest of your life.

That, to me, is real financial planning. The things that we’ve talked about today are things that give us the tools and the intellectual capital to help make decisions that are right for you. Again, thank you so much. I’m Patti Brennan, and we’ll see you in the next podcast.

Ep4: Headlines and Havoc

About This Episode

In this episode, Patti and Michael Brennan discuss how to differentiate the “noise” from the “substance” in today’s headlines. We are living in an era of information overload and newspaper headlines are designed to inspire reaction. Patti and Michael share some alarming headlines that are aimed at inspiring action, while explaining why reacting to them, is the last thing a listener or a reader should be doing!


Patti Brennan:  Hi there. Welcome to the “Patti Brennan show.” Hey whether you have $20 or $20 million. This show is for those who want to protect, grow and use your assets to live your very best life. Joining me today is Michael Brennan. Michael, thanks so much for coming on the podcast this afternoon.

Michael Brennan:  Thanks for having me.

Patti:  We’ve got an interesting topic, don’t we? It is called “Headline Havoc.” Let’s talk about that a little bit. The amount of financial news that’s published these days is staggering. Even if it were to go down by 90 percent, it would still be overwhelming for most people. How do we distinguish the signals from the noise?

What’s useful versus what’s just distraction? What’s just mediocre? That’s the real question.

Michael:  Right. It is almost never a look in the part, filtering it all takes a lot of time and effort. This is especially true with an always on real‑time news cycle. There’s extreme competition for eyeballs and attention from all over the place. We have journalists, we have blogs, we have massive information overload.

Patti:  They’re in business. They’re in business to get eyeballs. Right?

Michael:  That’s right. Today, just looking at the Yahoo finance earlier today, there’s quarterly reports. There’s economic reports. There’s upgrades, downgrades, fed minutes on and on and on.

Patti:  You know what? It goes according to the formula. If it bleeds, it leads. It’s like the tabloids. Simplify then exaggerate. We know that fear sells. If it’s uncomfortable, if it’s a topic that people think, “Oh my goodness, I better listen to this otherwise, I’m going to lose…” fill in the blank. Pay more money taxes, lose money.

Whatever the case might be, they’re going to really pay attention to that particular article or show.

Michael:  To their own detriment, they pay attention to that. These headlines often stir emotions and make people want to change their investment strategy. That is no bueno. These different headlines as you said if they bleed they lead, they do have the potential to cause these knee‑jerk reactions, which negatively can affect their investment returns over the long run.

Patti:  Exactly. Think of them, for the most part, they’re going to be distractions. We call it Headline Havoc. Let’s take that to another level.

Michael:  All of these discussions got me thinking. If even I have a difficult time sorting through the noise of the financial news, can you imagine how confusing it must be for regular investors? Plus, today I feel like people don’t really read the news. It’s really all consume through headlines.

With that, I have created a little exercise here I want to do with you and have aptly titled it “Headline Havoc.” How it is going to work is I’m going to read a headline and I want to know how Patti Brennan, the financial advisor interprets that headline. I want to know what goes on in between the ears of a financial advisor like yourself.

For example, I’m just going to do this one real quick by myself. For example, headline “Stock Markets Enters Painful Correction.” My interpretation of that headline, “Hurray, stocks on sale. Retirement savers rejoice as stock prices fall. [laughs] Those with time to save and money to invest should hope it continues.”

Patti:  That’s exactly the way you would want people to interpret that headline or to respond but that’s really not the way most people. It’s human nature to say, “Oh my goodness, what’s going on? What do I need to stop?”

Michael:  With that, let’s give us a shot here.

Patti:  OK.

Michael:  Headline, “Popular Economist Expects Market Volatility to Pick Up Later This Year.”

Patti:  My response to that would be saying you expect volatility to pick up at some point in the future is saying you expect it to rain at some point in the future. By the way, it works both ways. Volatility is to the upside and the downside. Basically, what we’re saying here in this headline is markets are going to fluctuate. OK, what else is new?

Michael:  Right. [laughs] I like that analogy. Today, it seems like everyone’s a market weatherman. Relying on these experts could result in either being caught outside in the rain or maybe even worse, caught inside during a beautiful, sunny day.

Patti:  Remember, even rain is important.

Michael:  Of course. Here we go. Headline, “George Soros Lost $1 Billion.”

Patti:  OK, guys, George Soros is worth about $25 billion. What he does with his money really shouldn’t concern you and I.

Michael:  Headline, “Markets Got Slaughtered Today ‑‑ A Sign of Worse Things to Come.”

Patti:  Here’s the deal. Nobody really knows why stocks go up or down in a single day. Everybody’s going to give their opinion after the fact. Really, ultimately, nobody knows why it does one thing or another. Stocks go up half the time, stocks go down half the time. Just keep that in mind as you’re listening to these people or reading these headlines.

Michael:  Headline, “Investors are Dealing with More Uncertainty.”

Patti:  Again, here is where I go. OK, the future is always uncertain. The past just feels more certain because we already know what happened.

Michael:  God point. Like Sir John Templeton says, “I don’t know the direction of the next 1,000 points. But I do know the direction of the next 5,000 points.”

Patti:  Exactly. We’re going to go through these ups and down, etc., just stay focus on the long term and you’ll do just fine.

Michael:  Here’s a layup here for the Patti.

Patti:  All right. [laughs]

Michael:  Headline, “Are Markets Overbought Here.”

Patti:  I have no idea. Ask us again in a few months.

Michael:  Next. Headline, “The President Cause 15 Percent of Stock Market Growth This Year.”

Patti:  Here’s the deal. News alert, everybody, presidents and political parties don’t really control economies or stock markets. We have an adaptive system called the US economy. Things don’t just come with levers that you can pull like you do with the polling booth. There’s a lot that goes into what makes up the economy and how markets are responding.

Michael:  Headline, “Inflation Could Cause Gold to Rise More Than $1,500 an Ounce.”

Patti:  That’s a total guess. No one really has a clue.

Michael:  [laughs] Headline, “Is This the Stock‑Picker’s Market We’ve Been Waiting For?”

Patti:  Here’s the deal. It is and always will be a stock picker’s market because it all depends on the ability of the stock picker not the market. Stock pickers theoretically are going to make money in all kind of market environments. That’s the definition.

Michael:  Headline, “Goldman Sachs Expects Stock to Rally for the Next Three Months.”

Patti:  These big firms have lots of strategists and experts. Boy, one week they’re saying one thing and the other week, they’re saying something else. You can’t even believe how often these bigger firms and it’s not just the bigger firms. It’s the contradictory pieces that come out even from the same entity.

Michael:  Headline, “When Will the Fed Raise Rates?”

Patti:  Has the Federal Reserve, do you happen to know who Jerome Powell is? Is he ultimately going to help you make better investment decisions? No offense but he doesn’t know who you are. Why are you making investment decisions based on what the Fed does?

I understand we have all been programmed to think that the Federal Reserve ultimately determines whether we are in an expansionary period or we’re going into a recession. But really, nobody really knows. In fact, they don’t even know.

In December, in January, they basically went from “We are raising rates three times in 2019” to “Hey, you know what? That’s not cast in stone. We’re going to take a thoughtful approach. It’s data dependent. We’re going to be flexible and really do what we believe is best.” They don’t even know what they’re going to do.

Would you actually change your investment policy based on something that they don’t even know?

Michael:  Right. Even if we did exactly know what they were going to do in the future, we still have no idea how the other investors are going to react. It’s all really a crapshoot.

Patti, there’s just a couple more so then we can take off the hot seat. Just a couple more to get through here.

Patti:  I’ll tell you what. This is an easy. Thanks a lot for putting me on that hot seat but it’s what we do every day, right, Michael? It’s just we have to respond to what’s out there to help people understand that just because you read it in the newspaper doesn’t mean that they need to do anything about it.

Michael:  That’s exactly right. Headline, “Investors Panic as Stocks Enter a Bear Market.”

Patti:  Investors aren’t always right. Stuff happens in the markets and we’ve got to be careful not to react to something that might be happening a day or two.

Michael:  Headline, “A Perfect Storm Caused Markets to Fall.”

Patti:  It sounds really important. That sounds really important narrative. A hundred years’ storm now seem to come around every once a month or so. Again, it’s a headline. They’re grabbing eyeballs.

Michael:  Got you. Headline, “Expert Who Predicted the Tech Bubble Predicts a Market Crash Worse than 1987.”

Patti:  There are some people who make a living out of predicting. These terrible perils in these times of huge losses. Literally they’re called permabears. Eventually, they’re going to be right. They just keep on doing it until they’re right. Just be really careful, understand who is the person that’s actually saying that, what did they say five years ago in the midst of a secular ball market.

Michael:  I love this next one especially because I see it at least twice a day. Headline, “The Top 10 Best Stocks to Own Right Now.”

Patti:  My initial response to that, Michael, is here’s 10 random stocks. We think they could go up for reasons we have absolutely no idea. It’s catchy.

Michael:  Right. It reminds me of the “Cosmopolitan,” or the men’s health journals that we read. “Six Tips to Rock Hard Abs in Six Minutes.” It doesn’t work like that. It’s not going to happen.

Patti:  Exactly.

Michael:  Headline, “Investors are Cautiously Optimistic.”

Patti:  The way I look at that is that’s the journalist who’s basically saying, “I got nothing to write about so I’m just going to write this and add a little bit of fluff.”

Michael:  Got you. Two more then we’re done. Headline, “Earnings Growth is a Second‑Half Story.”

Patti:  It’s interesting. Nobody really checks on these predictions to see whether or not the second half of the year really did turn out that way. It’s easy to predict stuff when you’re not being held accountable.

Michael:  Final headline is “Fill in the Blank Hot Stock Du Jour a Buy Here.”

Patti:  I’ll never forget I was at a meeting one time. There was a money manager on the stage and I’ll never forget what he said. He said, “You know, I just want you to understand that when I get a phone call from a journalist and they’re asking me what stocks I’m buying or what do I think is a really great investment right now.”

He said, “This happen to me a couple of years ago and I gave him that one stock that I would buy right now. By the time they did their checking and their writing, etc., and they actually published it in the magazine, it was nine months later.” He said, “The thing about that was nobody called me nine months later to say, ‘Is that still the one company that I would invest in now?'”

“They just published the article.” Be really careful when you’re acting upon headlines like that. You don’t know when that person might have said it.

Michael:  That’s it for Headline Havoc. Thank you so much for participating in that with me, Patti. With all of that being said, I have one final question for you. If what we’re saying is a lot of these headlines are really nothing more than noise, what type of headline really gets your attention.

Patti:  There is a lot of good stuff out there. Again, we’re just talking about some random headlines that are out there. There are great periodicals, great magazines, great newspapers that really provide good content that has been fact‑checked, etc. I read four to five newspapers every morning before I even come into the office.

Papers like “The Wall Street Journal,” “The New York Times,” “The Philadelphia Inquirer.” There are really gifted writers who are trying to give real information. By all means there is good content. I would say that I would really pay attention to headlines that say congress is eliminating state taxes. That’s one that I’m going to put aside, highlight, underline, and want to dig a little bit deeper.

Things of that nature that are actually relevant and also actionable. That’s something that I need to pay attention to because it does impact our clients. We can be proactive when it comes to things like that.

Michael:  In conclusion, maybe we can just go over a few quick tips that readers could keep in mind when going through the morning papers. For starters, I would say avoid reading things that confirm what you already have theories on. It’s what we call confirmation bias.

Patti:  It’s a good one, Michael.

Michael:  It’s what occurs when you start with a theory or an answer and then you dig for information that backs it up. It’s really dangerous because once your find someone else who agrees with you, you become more convinced that you’re right.

Patti:  Actually, you might want to think about doing the opposite. It’s a Charles Darwin approach who basically went out there and tried to disprove his own theories. At worse, you can continue to disagree with it but at least that way, you’ve gotten some perspective in terms of what you’re thinking about and why you have that particular opinion.

Michael:  You know what else will give you that perspective? Reading old news. I know it sounds a little crazy but if you read enough old news and headlines, you quickly realize two things. The majority of predictions never come close to being true. Most of what we think is important news is really trivial in the long run.

Once you become convince of this, you react differently to today’s newspaper. One more headline, I know I’ve said we were done but I have one more. Take this headline from August 2011. “Dow falls 502 Points and Steepest Declines Since ’08 Crisis.”

Patti:  You know what, Michael? That’s really a good example. Guess what? That wasn’t a bad prediction. It actually did happen and it felt like such a big deal at that time. I remember it like it was yesterday. Fast forward, the Dow Johnsons regained all of its loses and then some. What seems so monumental at that time is irrelevant now.

You only get that perspective in hindsight. I love your idea of looking at past predictions and see how we’re feeling about those things today.

Let’s pull this together. In conclusion, we want to be wary of these scary financial headlines.

As always we want to focus on the long term. You’ll hear that time and time again. You don’t want to change your asset allocation or react to something just because something got published in the paper today. You don’t want to have any impulsive changes. If you have a goal that changed, yeah then. Absolutely. That might be when you make adjustments.

Don’t do it based on someone’s article or an opinion piece.

Michael:  Bottom line, know your goals, know your time horizons, and don’t trade too much. Don’t think every news story is actionable. There are thousands of news articles published every day. Very few of them, if any, should ever compel you in action.

Patti:  Michael, I can’t think of a better way to conclude today’s podcast. Thank you so much for joining me today. I think that was a unique look at the newspapers, the news, etc. Again, thanks for being here today and that’s it for today’s show.

Michael:  Thanks for having me. I really appreciate it and also huge thanks and shout‑out to Ben Carlson and his blog, his books, “A Wealth of Common Sense.” If you guys, if you listeners want some great sources to get your headlines from, Ben Carlson has some really great stuff.

Patti:  I’ll tell you what I get his stuff every day. He is such a thought leader in the industry, well worth it. Michael, thank you so much for joining me for today’s show. We wanted to have a little bit of fun with the headlines and the Headlines Havoc, and what that tends to do to people and their emotions. Again, as always don’t necessarily act on that.

Thanks again so much for tuning in to this podcast. Be sure to hit the subscribe button if you like today’s show. Feel free to visit the website if you have any questions, want additional insights. That’s what we’re here for. Also, again, as always if you have ideas of things that you’d like to learn about, let us know. That’s what we’re here for.

Until next time, I’m Patti Brennan. Thank you so much for joining us today.

Ep3: Man vs. Machine

About This Episode

In this episode, Patti Brennan and Brad Everett discuss the pros and cons of robo-advising and using online financial calculators. There are many pros and cons to using these online tools – so why and maybe more importantly, when, is it the right time to seek out a professional? Patti and Brad use their years of experience, combined with real life examples, to help answer these questions.


Patti Brennan: In this episode, we’re talking robo‑advisors versus human advisors. What are the pros and cons of each one? Let’s just really look at it down the line. With me today, I have Brad Everett. He’s our chief investment officer.

Brad, what do you think about this subject, robo‑advisors versus human advisors?

Brad Everett: There’s certainly a valid case for each. Maybe, I wouldn’t think of a robo‑advisor as a full advisor. They can be great for single‑goal projects, things like that. If you were 22 years old and you want to retire in 40 years, I don’t doubt that a robo‑advisor can give you a great allocation.

Your job at that point, at that point in your life, is to save as much money as you can and be aggressive. I don’t think that a robo‑advisor would have trouble guiding you to that goal. From there as you get older and you start to have competing goals, goals that, maybe, you should go in one order or another, accomplish this before you do this.

If you do this, you might not be able to do this anymore. That would probably require a human advisor that can help you prioritize those things, help you see which ones might conflict with the others.

Patti: It’s like to your point, when people are first starting out, the most important thing is just start doing something.

Brad: Just participate.

Patti: Just participate. Get in there. You don’t necessarily have to over‑complicate things. I think that sometimes can negatively affect people, where it gets so overwhelming. Just start with something. We often use the Starbucks example when we’re talking with young people.

The old, if you avoid going into Starbucks every day, saving that $5.48 a day, that adds up to about $2,000 a year. If you invest that money at about eight percent, that person who just decided to make coffee at home that morning will have $675,000 more money than the person who stopped at Starbucks.

Those little things can add up to a lot, and it can make a big difference. To your point, you don’t necessarily need a human being there all the time watching and making sure that you’re not stopping and that you’re actually saving that money.

Once you get the discipline, and you get started, and you get in the habit of putting that money away every month, you just get used to it. You want to do it. It feels uncomfortable when you’re not seeing that account growing.

Brad: You’re not going to want to stop. I guess the other side of that too is that you will probably find that your life is getting complicated far sooner than you thought. Your life is really only simple for how many years out of college before you have a kid and a marriage.

You’re trying to then debate whether you fund a 529 Plan, or pay off your own college debt, or save for your own retirement, or buy your own car, or finally get off your parent’s cellphone plan. Those complicating goals show up relatively early.

Patti: It’s amazing to me. That’s a really good point. I have four kids. It’s amazing to me, even with my 30‑year old. He’s looking at buying a house. He’s looking at all of these things and trying to figure out how am I going to do this?

Fortunately, he’s a financial planner so he’s been able to do that. He grew up with this thought process. Again, for those people who don’t have a mom who’s a financial planner, you can start out with a robo.

The advantage to the robo is that it’s cheap, it’s inexpensive, and it just gets you started. There’s value in that. Do you absolutely have to have a robo? Not necessarily, you could actually go and invest in a no‑load mutual fund, stick it in one of the target date funds.

Again, long‑term be as aggressive as you can. Understand that markets are going to go up and down. I think that that’s the most important differentiation is what happens when things go wrong?

Brad: You would definitely understand about yourself. You have enough discipline to stick it out at times like that. A very valuable service that an advisor can offer is to smooth out those emotional highs and lows.

They can explain, and educate, and talk about why this is happening and why it’s happened a hundred times before. A robo can give you an optimal asset allocation theoretically, but it can’t force you to keep it. You could save for 10 years and leave the market at the wrong time.

The robo has no ability to stop you or to protect you from yourself.

Patti: Exactly. I use that phrase all the time. Most of the time, or a lot of the time I should say, what we end up doing for people is just really saving them from themselves because, again, it’s human nature to be fearful.

It’s human nature to say, “Oh my goodness, the markets are going down. I’m going to pull it out, or I’m going to stop contributing.” That’s exactly the opposite of what they should be doing. I think your statistic, the Fidelity statistic, was fascinating.

Brad: About how it seems like clients always seem to add money to the asset class that’s the exact wrong thing to be adding to at the time like chasing returns or investing in an asset class that has recently done well or avoiding one that’s recently done poorly.

You’re doing the exact opposite of…You’re buying high and selling low.

Patti: It’s the rear‑view mirror thing. I’ve been doing this for 32 years. One thing that hasn’t changed is, again, that human nature. You want to be investing in the thing that you think is going to continue to do what it’s been doing the last year or two years, etc.

Usually, that’s exactly the opposite of what you should be doing. That’s where a good advisor can point those things out. Just as those questions become apparent and someone’s asking that, we can show the data to say, “The reason that we’re doing this is A, B, and C.”

Again, nobody really knows, that’s the most important thing to recognize. That we’re all making educated guesses, but it’s the underlying experience, having been through it time and time again that can really make a difference.

Again, starting out robos can be a perfect way to start out, get you in the habit of just saving money, investing in aggressive. Go through a couple of rough spots, but an algorithm isn’t going to necessarily get you to do the thing that’s probably going to be the right thing for you.

When we think about this whole thing and the idea of automation and the online stuff, I think also the other thing about it is is that people’s financial situations are far more diverse. They’re much more all‑encompassing.

An advisor, whether it be a certified financial planner, hopefully, or just another advisor, a financial advisor of any kind, they can take a look at your tax return. They can remind you to update your will, get the power of attorney updated, things of that nature.

You might have questions about parents. They can help you with those things. Healthcare, it’s a holistic approach to your financial situation. You’re not a pie chart. When you start out, really what you need is what you’ve said.

Save as much as you possibly can, especially before your life becomes complicated. You got the life, the wife, the kids, the cars, that’s the complicating factors. That’s when sometimes it’s important to be able to bounce ideas off of somebody who already knows you.

We may have clients who come in who are in the exact, similar situations. They may be the same ages. They may have the same level of income, kids, etc. Yet the advice that we give them is different because they’re different.

They have different priorities. Some people want to pay for a full college education. Some people want their kids to have skin in the game. Some people, cars are important to them, the other family. They drive them until they drop.

Everybody’s different and then to take all of that, including the human emotion, and to create strategies that are actually going to be workable for those people.

Brad: Also, there’s a real benefit to the ability to coordinate with other professionals. As your life does become more complicated, you have somebody that can coordinate with your accountant, coordinate with your estate planning lawyer, and things like that.

Which an advisor can quarterback that from the financial planning side and either work with them or even bring things to their attention that they never would have thought to ask their accountant in the first place.

Patti: It’s amazing some of the insights that just reading someone’s documents that we’ve been able to bring to their attention that they didn’t realize was in there and the implications. Because we’ve worked with so many people over the years, we see the before, the during, and the after.

When I’m able to point out to a couple that based on what their will says, this is what’s going to happen. Is that what they really wanted to do? I’ve got to tell you, Brad, I can’t tell you the number of times people come back and say, “Is that really what we said?”

I said, “Well, it’s what this says. Tell me what you want.” It’s a wonderful, wonderful way to bring this full circle. To make sure that what they really want is actually going to occur.

Brad: In the end, it is a tool that you can use for a very specific purpose. It’s programmed to do exactly what you want it to do. It’s great for an individual with simple cases.

We use several different, call them software programs, or robo‑advisors that we use internally to make a lot of decisions and to monitor across a broad spectrum of points of data, clients, and all kinds of things that we rely on.

Whatever the word for it you want to use, it’s a robo. It’s a robot. It’s a computer that’s giving a decision based on information we ask it to give us. We need them every day.

Patti: It’s so interesting that you bring that up because I think that the longer that I do this, the more I realize the less I know. The advantage of those programs, it allows us to recognize our own humanity, go into this with humility, and understand that for most of the families, this is a stewardship.

This is pretty much everything that they’ve got. We can’t let our emotions…We’ve got to have the discipline that a lot of people who, maybe, are working for pharmaceutical companies, or they may own a business, etc. It’s not what they do.

They don’t realize that the discipline is actually really important. The experience is also very key with this. To combine the two, to use as much of the artificial intelligence and the software and to program it customly for each client so that we get alerts and alarms when something needs to be attended to.

That’s what that’s there. That’s a beautiful way to use systems like that.

Brad: Absolutely. We have the same emotions that clients have. We’re just an added level of experience and discipline that…

Patti: And we have each other to bounce things off of. That’s the real key. To check‑in and just make sure that we’re always doing the right thing or what we believe is the right thing at the time. Let me play devil’s advocate here for a second for our listeners.

We look at the cost factors of these things. You get a young person and young person might say, “Gee, a financial planner is not going to want to meet with me. I don’t have any money.” That’s the one, one thing.

A second would be, “I’ve got kids in college. I’m planning for retirement. I can’t afford a financial planner.” The robo is an alternative that may, and I caution everybody listening, it’s not always lower cost.

You got to be careful with that as well, but it may provide a solution for people that is easy to use and gets people started. Again, it’s not to say that they’re bad, they’re great if the option is doing nothing. If it’s a way of someone getting motivated and beginning the steps of, “Let me just pull this together and make sure that, at least, I’m tracking towards those one or two things.”

That’s where I think the application is. I encourage everybody to do that. Maybe, when someone does that, you can run the numbers or take a look at it and then bring it to a financial planner or an advisor. Again, I’m biased here, a CFP, to get an extra set of trained eyes on what you’re doing, etc.

To me, planning is a verb. It’s not something that you do once and have it sit on the shelf. It’s something that you’re going back to time and time again to make sure that what you’re hoping for is actually occurring.

Now, as lives get so busy, you may or may not have time to do those things. The key here is to know thyself, be honest with yourself, and understand that that may or may not be something that you’re interested in doing.

If it is, fantastic, all power to you. Do those things. Use the robo approach, and then you’re going to know when, maybe, it’s not enough anymore. That’s the key with all this. There’s no perfect answer for everybody, but to be honest and to recognize this is where I am and to take the step of running numbers and deciding this isn’t working.

Do the things that are necessary to get you on track to the things that are most important to you. If you’re not sure how to prioritize, if you’ve got those competing goals as we all do, that’s when, maybe, having an extra set of trained eyes, someone with experience to sit down with and then to meet with from time to time to say, “What’s new in your life? What’s different?”

Then adjust the recommendations accordingly. Let’s talk about the cost of these things. What was your quote?

Brad: I quoted this morning and said actually, “A price is only a major factor in the absence of value.” I think the point being you don’t want to just compare a financial advisor to a robo‑advisor based on cost. They’re very different products. They’re very different offerings.

You just want to know what you’re paying for with either.

Patti: It’s so interesting. We’ve talked about this. Vanguard has a white paper that they’ve got on their website. The reason that this came about, as I understand it, is apparently Vanguard has three silos, their 401(k)s, the do‑it‑yourselfers, and then the advisor‑led portfolios.

They have been monitoring each one of those silos. They’ve noticed significant differences in, frankly, performance. They did this white paper. They went back and tried to figure out what was the difference and tried to measure the difference between the three, in terms of not only the return according to the Vanguard paper.

A good advisor can add about 2.3 percent per year. It’s not always going to come in performance. It may come in tax benefits and things of that nature. They went into a lot of depth in terms of the things that were done in that third silo that they felt made the difference.

I am reminded of a quote that was on the back of my grandfather’s card. It really is something that meant a lot to me. I’m going to read it to you, and you’ve probably heard this. It’s from John Ruskin. He’s a philosopher.

“It is unwise to pay too much, but it is worse to pay too little. When you pay too much, you lose a little money. That is all. When you pay too little, you sometimes lose everything because the thing that you bought was incapable of doing the thing it was bought to do. The common law of business balance prohibits paying a little and getting a lot.

“It can’t be done. If you deal with the lowest bidder, it is well to add something for the risk that you run, and if you do that you will have enough to pay for something better.”

That is so interesting. As people listen to this and start to look at that, keep that in mind. There are certain things where you definitely want low cost. You want low cost investments, etc. Is that always going to be the case with the advisor‑led piece? Maybe, maybe not.

As you go through this, let’s pull this together and think about how you might want to approach this decision. Number one, be honest, figure out where you are. Is what you’re doing going to help you to accomplish all the things that you want to do?

Whether you do it yourself, again, be careful with some of the online programs. They will create a fairytale. They’re not very accurate but, at least, do something. The next step is, do some research.

Look at the different programs out there, pros and cons for each. Figure out how much each one would cost and then, maybe, interview two or three financial planners to get a sense of what that relationship might look like.

Get a sense of what feels better to you and then act. Make the decision and move forward with something because doing something is going to be far better than doing nothing.

Thank you, Brad, for joining me. I appreciate your time. All of you who are listening, thank you for your time and listening to the Patti Brennan podcast.

Ep2: Investing with Emotion

About This Episode

In this episode Patti Brennan and Eric Fuhrman discuss what it means to Invest with Emotion. Great real world examples of why you shouldn’t let emotion get in the way of good decision making. Plus a head to head battle between Patti and Eric to help you, the investor to truly understand what it means to invest with emotion.


Patti Brennan:  Welcome to “The Patti Brennan Show.” Hey, whether you have $20 or $20 million, this episode is for those of you who want to protect, grow, and use your assets to live your very best life.

Joining me today is Eric Fuhrman. We’re going to be talking about behavioral investing. Now, I know that sounds odd, right? Of course, we all want to think about, “Oh, that middle thing. I want to grow my assets. To do that, I’m going read the ‘Wall Street Journal’ every day, look at the business section, and watch CNBC. That’s how I’m going to make more money.” Right?

Well, Eric and I are going to talk today about, really, what is the big driver of investment investor returns? Not just investment, investor returns. Eric, thank you so much for being here today.

Eric Fuhrman:  Patti, I wouldn’t spend my time any other way.

Patti:  All right, good deal. Good deal. Let’s talk about, really, the three things. There are three major things that contribute to how well a person does in their 401(k), or their portfolio. Why don’t you tell our listeners today what are those three things?

Eric:  I think when you look at it, obviously one of the important things that drives long‑term returns, and again, the focus here is long‑term returns, but number one is going to be your asset allocation, your overall mixture between stock and bonds.

That’s really going to dictate the volatility, but also the long‑term returns in your account, investment selection and…

Patti:  Hold off, can I just stop you there? Because a lot of people listening today, they hear this thing called asset allocation, and all of a sudden, I can just imagine that your eyes are beginning to glaze over, and think, “Oh, God. This is so boring.”

What exactly is asset allocation? What is it in English, Eric?

Eric:  Asset allocation is just really the mix of different investments that you own in your portfolio. For example, that would be the different type of stocks that you might own, it could be bonds, it could be cash, it could be this new emerging area called alternative investments, but the idea is they’re really just investments that react to a set of economic conditions in a different kind of way.

Essentially, everything is not moving in the same direction at the same time in the same order of magnitude.

Patti:  One of the things that we tell people is that asset allocation really isn’t the same thing as diversification. You could be well diversified by going to 12 different banks and getting a CD from these 12 different banks. That’s diversification, but that’s not really asset allocation because it’s all the same kind of investment.

Asset allocation takes it to another level, to make your returns more, I hate to use the word predictable, but more resilient in various economic scenarios because nobody really knows what’s going to happen in the near term, or frankly, even the long term. We want you to be able to participate in it, but not get killed, you know?

It’s using that same metaphor with baseball. Just hit a whole bunch of singles. Don’t worry about the home run. In baseball or many games in life, the people who hit a whole bunch of singles end up winning the game.

Asset allocation number one. What’s number two?

Eric:  Investment selection and diversification. Again, a lot of people think if they own a bunch of different investments, they’re diversified. That might not be necessarily true. You have to think again about the different types of investments that you’re going to own in your portfolio.

The third thing, which is really the focus of this podcast, is behavior. I think that’s often the most overlooked and missing element. Ultimately, the behavior of the investor is going to be the long‑term determinant of whether or not you realize successful long‑term returns in the market.

Patti:  When we think about behavior, I think back to my four children. I think about behavior when they were toddlers. That’s not really what we’re talking about. It’s really, what do people do? What is the natural instinct that you want to do when things are going really well, or not so hot?

What I think is interesting and really brings this home for people are the DALBAR and Lipper studies. They’ve been doing these studies year after year after year. What is amazing to me is how consistent the results are. Eric, why don’t you share with us what they are?

Eric:  Again, this is going back from 1998 to 2017. We’re basically covering roughly a 20‑year period. DALBAR’s been doing these studies for a really long time.

The essence here is to show that when you look at the returns of different areas of the market that are quoted, let’s say the S&P 500 or even a diversified portfolio, 60/40 portfolio and so forth, oftentimes the average investor not only underperforms the market, but more importantly, they actually underperform the very investments that they own.

Again, the result of that is from behavior. If you look, for example, over the past 20 years in this study ‑‑ this is a very general categorization ‑‑ bonds on average generated a 5 percent annualized average return. A 60/40 portfolio between bonds and stocks earned about 6.4 percent. The S&P 500, an all‑equity portfolio, did 7.2 percent.

The average investor generated a 2.6 percent rate of return. Again, even if you just think about a blended portfolio, they underperformed by almost 400 basis points or 4 percent per year, on average, which is huge. A lot of that can potentially stem from the behavior of that individual.

Patti:  Basically, what I think is interesting about the DALBAR studies is, they’ve been doing these studies for the last 20 years. They take rolling periods of time. This happened to be the last 20 years. The year before, it was from the 20 years prior.

It’s also interesting, even in shorter time periods, that people tend to confuse investment returns with investor returns. It’s a very big deal and it’s a very big difference. What causes that difference?

Eric:  Again, I think you have to look, really, at the sources. I think part of it, no fault of their own, is the investment community. I think there’s a hyperfocus. Whether it’s somebody who watches the business news or a lot of commercials that come on TV, the focus is on what investments to be in and when to be in them. What and when are the key things that are coming across.

Ultimately, poor investor behavior arises from this emphasis, this hyperfocus on timing and selection as the primary drivers of return. If I can go back to when we just started out this podcast, that asset allocation and behavior are really the critical determinants that people have to think.

I’m reminded by a great quote from Bobby Jones. Some of you in the audience who may not be golfers, he was the Tiger Woods of his day back in the ’20s or ’30s. He has a quote that I think really parallels this theme, this narrative of behavior. He basically said, “Competitive golf is played mainly on a 5.5‑inch course, the space between your ears.”

Ultimately, to me, behavioral investing is all about the space between your ears and how you react that determines on making the difference between the average investor and realizing the returns that the market can offer.

Patti:  You know, it’s a really good point. I think that, as well‑intentioned as the media is…and they are, they generally want to give people information…the problem is that there’s almost too much information. We also have to keep in mind, let’s face it. It reminds me of the story about the guy who was a fisherman.

He’s a fisherman, right? He goes into the bait‑and‑tackle shop, gets all of his stuff, puts it in his basket, comes up to the counter, drops it all off on the counter, and says, “Do fish really like these lures?” The guy behind the counter says, “Well, I don’t know. I don’t sell to fish.”

Eric:  [laughs]

Patti:  The point here is that TV, newspapers, they’re not really selling education. They’re selling to their advertisers. People will watch. They will read. They will pay attention when things are being hyped up. That’s often the antithesis of making good decisions.

When people get emotional, get all ramped up, that’s when you want to take a step back and say, “OK, what does this really mean for me?”

Eric:  Right, and Patti, I couldn’t agree more. By the way, in your joke, I would be the guy that’s buying all the lures, and probably not asking the questions. I’d be buying the shiny objects.

I think your point is well‑taken. When you think about the messaging that’s being put out there today to today’s people that are investors or even retirees, it’s this narrative of take control, about empowerment to make decisions. I think, as Americans, that speaks to our cultural heritage. We love that idea.

The reality is, this process has been occurring since the 1970s. We have moved from a defined benefit retirement system to defined contribution through the 401(k). The reality is that those critical decisions about funding, about investing, have been placed squarely in the palms of every individual investor’s hand.

I think the issue that we have when it comes to the messaging is that the focus is on more data and news. It’s about being able to make lightning‑fast decisions, to be able to be quick. There’s a premium on speed.

My feeling on this is that it cultivates a transactional and reactive person. It’s really highlighting, as you said, behaviors that are antithetical to realizing the long‑term returns that the market can offer. Could you tell us, maybe, about some of the solutions that you would think that are important for them to look at?

Patti:  It’s really interesting. I think a really interesting statistic…I wish I could cite it to the wonderful people who have published this. It’s consistent, and for you and I, it’s common sense. There is an inverse relationship to a person’s results with how many times they make changes.

The more someone makes a change in their portfolio, the lower their return. This doesn’t mean that you set it, and forget it, and never look at it again. It does need to be monitored, but this rapid‑fire change based on what’s happening, what the latest guy or woman said, it really works against you.

The thing about it is, and I understand because we watch it too, it’s important to get the data and understand what people are listening to. The thing is, it sounds really good. It sounds really smart.

You don’t want to make long‑term decisions based on what your life is going to look like, or how to create the life that you want, based on what some guy said at six o’clock last night.

Eric:  Yeah, totally. I’ll tell you what, what I think is a great segue into this next part is really to crystallize this in the minds of our listeners for both them to really distinguish and say, “What does this performance mindset truly look like versus somebody who has an outcome or goal‑oriented mindset?”

Our premise on this is really that really investment decisions need to be tethered to a goal‑based framework that is ultimately anchored by a long‑term financial plan. Really, that plan is going to then dictate the asset allocation. The plan itself and the asset allocation are going to be the things that drive really the long‑term returns for the result.

Patti:  It’s interesting because I often tell people I think, and frankly, again, even people in our own industry do this completely backwards. They look at the different choices that they have in their 401(k), and they say, “Well, this one looks good and this one did really well. And I’ll do a little bit of that,” etc.

That’s the last thing that you want to do. The best way you approach this stuff is to say, “OK, what do I want in my life? What’s the outcome that I’m looking for? What do I want this money to do? When do I need it? What’s realistic, given our resources?”

You start with the big picture. Once you have that laid out, you figure out, “OK, how much do I need to save per month to put my kids through college, be able to retire in comfort and maybe get a house, a second home, if we accomplish those things.”

This is the fun stuff that comes along with real financial planning. You start with the big picture, then you get down to, “OK, what’s the combination of cash, bonds, and stocks that will give us the highest probability of earning the rate of return that we need to do all those wonderful things in our life?”

Then you say, “Hey, should I pick investment A or investment B?” That’s the last thing you do, and by the way, you do want to monitor it because things are not going to continue exactly in a straight line, and you make adjustments from time to time.

Eric:  Absolutely. I couldn’t have said it better.

Patti:  We’re outcome‑oriented. It’s a very subtle difference that we hear and we see on a day‑to‑day basis. Let’s give our listeners and viewers a feel for the nuances between the two different mindsets.

Eric:  Sounds good. Do I get to be the performance guy and you can be the outcome‑oriented person?

Patti:  I’ll be outcome.

Eric:  Perfect. If I’m a performance mindset, I might think my mindset might be under maybe the following. Let’s start with number one. Patti, here’s the deal. I want a return that beats the market because that’s what I need to retire.

Patti:  That is very different than someone who’s outcome‑oriented. Someone who’s outcome‑oriented wants an income they could never outlive.

Eric:  Oh, there you go. That’s good. How about this? Patti, I only buy four and five‑star funds to ensure that I’m going to get good returns in my portfolio.

Patti:  An outcome‑oriented person understands that those stars have to do with past history, and are completely irrelevant as it relates to how is it going to do in the future. An outcome‑oriented person is looking for a portfolio that provides the highest likely of earning the lifetime returns that they need to accomplish their goals.

Eric:  How about this one? Patti, I think I should invest more in pharmaceutical stocks because their returns have been incredible. They are going through the roof.

Patti:  An outcome‑oriented person says, “OK, that sounds great, but again, they’re already going through the roof. It’s already happened. I want enough exposure to participate in attractive industries, but not so much to undermine my chance of success.”

Eric:  Last point here, Patti. I hear what you’re saying, but this market has been going crazy. It has got to go down at some point. I think it’s time to get out of all my stocks.

Patti:  An outcome‑oriented person says, “Well, gee, I know the market. It is volatile right now, but I still want to put my kids through college. I still want to retire. I still would love to have that second home, so I’m not going to change my investment policy for something that happens to be happening right now.”

Eric:  Wait a minute. If I hear right what you’re saying, basically, if my financial plan hasn’t changed, then I shouldn’t be changing my investments?

Patti:  That’s exactly right. Remember, a financial plan, let’s kind of talk about that because it tends to be this kind of nuanced thing. What’s a financial plan? All a financial plan is are the steps that you need to take to accomplish the things that you want to accomplish in a cohesive package.

Understanding what your resources are, understanding what your desires are, it’s a set of progressive strategies to get what you want.

Eric:  Beautiful. Absolutely. How about next, why don’t we transition a little bit here, and let’s go back and talk about the experts? You can’t help it in this day and age, in the age of communication, we are constantly bombarded with what the market is doing through the little tickers and little informational windows they have on all the business news channels.

People are always talking about what you should be buying or selling, why the market’s going up, why is it going down? It really creates this mindset, at least when we talk to a lot of investors, where they always feel like they should be doing something.

I think maybe we could reference the Survey of Professional Forecasters. This is actually produced by the Philadelphia Fed, which is actually not too far from where we’re located. This is one of the oldest quarterly surveys of macroeconomic forecast in the United States dating all the way back to 1968, I believe.

It’s distributed every quarter, but it’s meant to provide forecast for GDP and inflation. They usually have a number of panelists, 30 or more panelists from some of the top investment industries, academic research industries across the country.

It’s really the consensus of all these people about what GDP and inflation might be like.

Patti:  We should be listening to the Philly Fed because, after all, these are really smart people. Don’t they know more than we do?

Eric:  Exactly right. You would think of anybody, forget about the nightly businesses that you might see. These are very credible people in the industry that you would think have a good history of success.

When you look at the forecast that come out, what you find are, number one, the range depending on whether you go out a year or two years out, the range is very wide. It’s a little bit difficult to say the market could have a massively different reaction to say one percent GDP versus three.

The forecasts are very wide in terms of their accuracy, but then they also tend to miss crucial turning points.

Case in point, if you look back into the report that was filed in the fourth quarter of 2007, there was a prediction that GDP in 2008 was going to be a positive 2.5 percent. The actual result was a negative 2.5.

Now, we’re probably picking them on a little bit because that was an extreme event, but it just goes to show that, again, there was a forecast, and then there was reality.

Their assessment of negative GDP in 2008 was a negative five percent…I’m sorry, was about five percent that we’d have negative GDP, so it’s about 1 in 20, if you work that out. Again, missed a crucial turning point, and we’re using the Professional Forecaster Survey.

Patti:  It just goes to show you that statistics really don’t tell you much, especially when you’re averaging things out. I think it’s really important that our listeners and our viewers understand, that nobody really knows what’s going to happen in the future.

This is one of those areas that the more…I often talk about this, we don’t get to queue. We don’t pretend to know what’s going to happen. The more somebody has this strong position, the firmer they believe it, the less I respect that person, because nobody can be that confident and that sure.

Eric:  The ability to be flexible. You remember the old joke, that economists have predicted nine out of the last six recessions correctly, so it just goes to show.

Patti:  I think for those of us who do this on a day‑to‑day basis, it’s interesting to get a sense of the cycles, and understand what’s happening on a real‑time basis. I think that’s valuable.

What I don’t think is valuable, is trying to anticipate and predict what it’s going to be three months or a year from now. I think that could sabotage people, and it could make them do things that are really not in their best interests.

Eric:  That actually brings us to the next point, which is short‑term volatility. This is actually highly relevant if you look at the month of October and into November here.

We’ve had some really extreme moves in the market, a lot of short‑term volatility. Folks at home that may be opening their October, and even November statements, might see a rather large departure in that account value from a month‑to‑month basis.

Talk a little bit about short‑term volatility, and how that can influence somebody to make, potentially, a bad decision, just by reacting on what’s happened over, say, the last month.

Patti:  It’s really interesting. We had a meeting early this morning, and the clients came in and they brought their October statements. Their October statements showed that they were down a lot of money, it was about a 10 percent loss.

Theirs was an unusual situation, most clients’ weren’t. It was fascinating, because what they didn’t realize, is on a year‑to‑day basis, they were flat. They were so focused on this one month that they didn’t realize, “Oh, I didn’t lose any money this year. It was just in the last month.”

In other words, they basically gave back what they had earned earlier in the year, but that’s not what they were focusing. They were focusing on the most recent loss. The key here is to understand that over short‑term periods, whether it be a month, three months, etc., markets are going to do their thing. Let’s talk about the probability of success in your investments over different periods of time.

There’s a chart that we’re going to put up that talks about the last 20 years. In the last 20 years, if you look at what’s happened on a daily basis, markets were up 53 percent and down 47 percent.

On a week‑by‑week basis, it was a little better. 56 percent of the weeks, it was up, 44 percent of the weeks, it was down. Monthly, 61 percent, 39 percent. If you just hung in there for a full year and didn’t do anything, 80 percent of the time, your portfolio would’ve been up. Again, if it was 100 percent in the S&P 500, versus 20 percent it was down.

Again, we talk a lot about, “Think long‑term, think long‑term,” and you’re probably out there thinking, “Yada, yada, yada, I hear that all the time, it’s so trite.”

Eric:  [laughs]

Patti:  There’s a reason why we do that, because it really does make a difference. If you can just understand, again, be outcome‑oriented and ignore the noise, markets lose 14 percent on average, once a year. Understand, if you have any of your money invested in markets, you’re going to have periods where it is down. Ignore it. Go into a coma if you have to.

Eric:  [laughs]

Patti:  Don’t open your statements. The key here is, don’t do anything about it.

Eric:  I think there’s also a quality of life issue here. If you’re somebody that watches, just remember, just being exposed to the market by, say, watching TV, looking at your statements day‑in and day‑out, that doesn’t necessarily lead to higher quality decisions.

What some of these numbers lead to, that Patti just highlighted, is that shorter time‑frames leads to worse odds of success. Just think about in terms of your emotional state, the time that you’re spending. If you’re looking at daily returns every day, you’re checking the market, over the course of 10 years, several thousand times.

Think about the time you save, and the emotional mindset of somebody who looks at it once a year, 10 times. They’re probably feeling a lot better about things, than somebody that’s checking it each and every day, and experiencing that roller coaster of being up and down, over and over again.

The other important part is, just think about it too is, if you’re looking at it every day and it causes you to be transactional, you have to be right not once, but twice. If you’re going to sell, that means you have to buy, and what you have to buy is, hopefully, going to end up better than the thing that you had just previously sold.

Long‑term, again, I think the numbers are there to show that frequent decision‑making is usually at odds with your long‑term success.

Patti:  Eric, it reminds me of the story of what we did during the tech bubble. During the tech bubble, markets were really volatile. It was an unusually long bear market.

Typically, we’ll have people who come in calling, concerned, worried. The first year, I was able to keep them comfortable, confident, they didn’t do anything. Second year, kept them comfortable, they were really getting a little bit more scared. It was the third year, that’s when it all happened.

We kept track of the clients. Let’s say that we, at the time, had 400 clients. I was able to keep everybody confident, comfortable, etc., except for seven people. We did this thing, we tracked what the Dow and the S&P 500 were. The day that they called, nobody sold out completely, but we moved a portion of their portfolio out.

We logged what the S&P was on that particular day, and then we just waited. Not once, not twice, but in every single, solitary time, those same people…so they sold when the market was down. The market, in many cases, continued to go down.

Initially, those clients felt really good, “I made the right decision, we moved out. That was really smart.” What happened was, as the markets started to recover, and it recovered and it recovered, not one or two, all seven clients called and came in, and said, “Hurry up, we gotta get back in.” In every single case, they got back in when the market was much higher than what it was when they pulled out.

Eric:  When they sold out.

Patti:  It’s human nature, I understand that. Again, I often say it to people in this podcast, part of what we’re here to do is to, first of all, create a portfolio that that person can live with, so that they don’t panic. That they’re not in that situation, and they understand the process and the thought that went in to putting those investments together.

Eric:  I think another way of saying this is, focus on what you can control. What do you think are the elements for an investment’s success, if we think about, what are the things that we can control?

Patti:  Exactly. We can’t control markets, we can’t control what they do or when they do, but we can control what we do about it when these events do occur. Eric, let’s talk about, what are the most common mistakes people make when it comes to what they do.

Eric:  The first one I’d say is, maybe overdiversification. It seems like you can’t possibly have overdiversification, but the reality is, it can take several different forms. I think one of the common things that we see on a regular basis when we look at people’s portfolios, is that they end up having a lot of overlap.

For example, they may own 5 or 10 large cap stock funds. Really, even if these are some of the best managers that you could ever buy, in terms of a large cap stock fund, the reality is, you just own a more expensive version of an index fund by just owning multiple funds in the same category.

Patti:  It just goes to show, it’s much easier to buy an investment, it is much harder to sell it.

Eric:  [laughs] So true. I think another area is probably panic. I’m sure you’ve heard the saying all the time, “This time, it’s different.”

Patti:  Absolutely, we hear it all the…

Eric:  It’s never different. Who was it, Samuel Clemens, or Mark Twain, once said that, “History never repeats itself, but it does rhyme”? I think that’s true to the market.

Patti:  What’s interesting is, if we go back to earlier, what makes people feel like it’s different, is what they hear in the media. The media is pushing that, and saying, “This is really different, it is different.” The catalyst is often different, what causes it could be different, but the mechanism, the result, it’s usually the same.

Eric:  I think it really stems from this irrational fear, that basically, that the client is never going to end, that there’s a loss in faith in the future, that this long‑term upward slope in the equity markets is somehow forever broken, that it will never be repaired.

Patti:  Here’s one that we often get, and that is, “Well, wait a minute, if I sell this investment, I’m gonna have to pay all of these taxes,” or the other side of that is, “Wait a minute, I’ve lost this money. I wanna wait until it recovers.”

Eric:  Yes, oh my gosh. This is such a good one, too, because this is one that is really hard when you talk to people, to get them over and around this emotional bias…

Patti:  Hurdle.

Eric:  …or hurdle, if you will, is that somehow the basis, what you paid for the investment, somehow has anything to do with the fundamentals of that investment, and whether or not it should be held or sold, or if it’s a significant risk in the portfolio.

Patti:  In other words, that stock or that large cap fund has no clue what you paid for it, nor does it care. If the CEO of the company doesn’t know how his company is going to do next quarter, why should you be making investment decisions based on what you pay for it?

Eric:  In a lot of situations, you could have a highly appreciated stock, and people don’t want to pay the tax. The reality is, folks, if you look back to whenever the capital gains tax was initiated, it has never been lower than where it is today.

The cost to get out of a highly‑appreciated stock is lower than it’s ever been. For some people, a part of that could be at zero percent, depending on your tax bracket.

Patti:  We both know people who have investments in companies like GE, and CISCO, etc. They never wanted to sell…

Eric:  …because of the tax.

Patti:  …because of the tax. Boy, when looking back, they would be very happy to have kept 85 percent of what they earned.

Eric:  Remember, too, that any stock, a single stock, could easily move 20 to 30 percent, up or down, in a single year. A 15 percent tax on the gain is a small price to pay to protect and remove the rest out of harm’s way. Even, what about people with stock at a loss, where they say, “I have to earn back my investment. I can’t sell, because I’m at a loss”?

Patti:  You know what I always say on this one, and Eric, you’ve heard it a million times, my question is, if you paid $10,000 for something and now it’s worth $8,000, the question to ask yourself is, “If I had $8,000 of cash today, would I be buying that stock?”

If the answer is, “Yes,” you want to hold it. If the answer is, “No, there’s no way I would ever buy that stock again. Are you kiddin’ me, Patti? I lost money,” then the answer is, you need to sell it, because that’s the reality. You have $8,000. What are you going to do with it?

Eric:  By the way, that’s not an exaggeration, I actually have heard it 10,000 times. [laughs]

Patti:  I’m sure you have. It’s a common thing, it’s just human nature.

Eric:  It is, very common.

Patti:  We have to understand human nature, and then frame it in a way that people say, “Oh yeah, that’s right. You probably make sense.”

Eric:  What about, we hear this in a certain population of the client as well, is that they believe when they go into retirement, that they want to invest for yield? They don’t invest for total return, they expect that they’re going to be able to live just on the interest or the dividends that their portfolio throws off.

Is it that realistic, and does it make sense?

Patti:  Wow. My first response that came to my head when you said that is good luck. Good luck with that one because when you look at yield, if you’re lucky, the yield that you get on your investments is just keeping pace with inflation. Most of the time, it doesn’t. Then you have to pay taxes, etc.

The key here is giving yields today. Is that realistic? Is that going to replace your salary because that’s what you need to do when you retire? Total return, I believe, is a much better framework to look at your investments because the key here is let’s ignore that word, income, from your investments.

What you need is cash flow. What’s the best way to create the cash flow that you need to live the very best life that you want to lead? How are we also going to make sure that that cash flow is growing with inflation?

By the way, it’s really important, especially for retired people because people who are retired feel inflation more than people who are younger.

Eric:  Absolutely. To give you an example, the St. Louis Fed publishes numbers on this. The 10‑year AAA corporate bond, as of the end of September, was paying just a hair over four percent.

If you’re somebody that, say, needed $6,000 a month to live on, $72,000 a year, if you were just going to live on the interest, you’d need nearly $1.8 million just so you’re extracting the interest. If you’ve a more diversified portfolio, the dividend yield on stocks is even lower than that.

You would need a significant amount of capital if your goal was just to live on the income alone.

Patti:  What we’re not even paying attention to is that $72,000 and using those numbers, that $72,000 isn’t growing. You’re just using all of the interest. Well, 10 years from now, you’re going to need a lot more than $72,000 to buy what it buys today, especially with healthcare. Healthcare’s rising at six percent per year.

It is astounding how much people have to spend. Even with Medicare and good supplemental plans, it’s not a couple thousand dollars a year. We’re talking 10, 20, 30 thousand dollars a year just for healthcare. It’s growing much faster than average inflation.

Eric:  That’s an excellent point because, again, as you said, people feel inflation differently when you’re older and you consume a different basket of goods. What do you say, before we wrap up this podcast, that we play a little game between you and I?

Patti:  I love games.

Eric:  Who doesn’t like a game? I have two kids at home. We play games all the time. Let’s play a little game called, “Are you a speculator or an investor?” How about this?

Patti:  Sounds good.

Eric:  You want to start us off on this little one?

Patti:  Sure, I’ll start off.

Eric:  Sounds great. Go on.

Patti:  Eric, I know the stock is down, but all the analysts say the company’s going to turn things around the second quarter. Am I an investor, or am I a speculator? If so, why?

Eric:  Man, you gave me the softball pitch here. This is definitely a speculator when you look at it. Number one, they’re talking about an individual stock. That tells me that, maybe, they’re not properly diversified to begin with.

Again, if we’re just focusing on a single investment and what the analysts say, the fact that the stock is down, you are speculating on that investment. You’re hoping for it to go up. The more important thing is to look at the fundamentals.

Is the risk of that investment appropriate for your portfolio in your long‑term financial plan? This is definitely in speculator territory for sure.

Patti:  Perfect. Sounds good. All right, your turn.

Eric:  Gotcha. Here it comes. Patti, everybody knows we are going to have a correction at some point. Look how much the market has gone up. I think it’s time to sell and go to cash.

Patti:  You’re a speculator. By the way, I agree with you. The market is going to go down at some point in time. You know what, we don’t care. We’re not going to pay attention to that.

We’re going to assume that it is going to go down, but we also understand that you’ve got a beautifully crafted, well diversified portfolio that is far more resilient than you might even realize.

Eric:  Perfect.

Patti:  My turn.

Eric:  You got it.

Patti:  Let me see. Going back to you. I’m comfortable holding an investment for 10 years or so. I’d like to purchase some growth stocks. Am I an investor or a speculator?

Eric:  I’ll tell you what, that’s music to my ears. You sound like an investor to me. Now, let’s keep in mind here, again, the big defining characteristics here is that you’re comfortable holding an investment for 10 years.

You have a long time horizon that suggests to me that you’re willing to stay invested through the ups and downs, even though you said that you wanted to invest in growth stocks. Again, this is one area of the market. You’re looking for a long‑term time horizon.

As long as that growth stock allocation fit in with your long‑term financial goals, then it could definitely be appropriate. Again, time horizon here and your comfort level of staying in something for a long period of time. You’re an investor.

Patti:  Also, the key here is to make sure that you’ve got something to balance that thing out, so you’ve got complementary assets.

Eric:  Absolutely.

Patti:  Excellent. Go ahead.

Eric:  My turn. I know this stock is most of my portfolio, but I can’t sell it. My mother worked for the company 30 years before passing it on to me. Are you an investor or a speculator?

Patti:  You’re a speculator, but you also have a sentimental attachment to that stock, don’t you? That’s important to recognize. I think that your mom would have wanted you to enjoy whatever that company did for her. She worked there for 30 years. They were good to her.

She gave you that stock because the company was good to her. Let’s acknowledge that. Now think forward and say, “What would your mom want for you today? Would she want all of your eggs to be in that one particular company?”

Maybe, it might make sense for you to take a portion of it and keep it if that sentimental attachment is important to you. Then take the balance because your mom would have wanted you to be diversified.

When you were little, she didn’t feed you eggs every morning, noon, and night. You had a diversified meal plan. She gave you lots of different things. It’s the same thing with your portfolio. She’d want your portfolio to be as well balanced as your meals were.

Eric:  Well‑balanced diet.

Patti:  I’ve never used that metaphor before. It’s a weird one.

Eric:  [laughs] First time ever, right?

Patti:  These things pop into my brain, Eric. I have no idea where they come from.

Eric:  I gotcha. I didn’t hear dessert in there anywhere.

Patti:  Mm. OK.

Eric:  I guess it’s your turn.

Patti:  Let me see. The market’s fallen about 10 percent since the beginning of the year. I feel like now is a good time to get in. I’m comfortable making this investment as part of my long‑term investment plan. Am I a speculator or an investor?

Eric:  I would say, in this case, that you would be an investor. Again, because of the context of how this is framed is that, yes, the market has fallen 10 percent, but you’re comfortable getting in. You’re comfortable with the risk, acknowledging that the market has gone down, but with the idea that this is going to be part of your long‑term financial plan.

You were not transactional, that you have a very long‑term view on things. You’re willing to be patient and wait. I would say you would definitely be an investor.

Warren Buffett had a great quote. He said, “The market is a very efficient mechanism for transferring money from the inpatient to the patient.” Again, patience is key.

Patti:  Terrific. Let’s pull all of this together. Let’s bring this together. We’ve got three points that we want to make. Number one, don’t let your emotions get in the way to good decision‑making. Number two, do not, please, please, please don’t let short‑termism impact your decision to what you do. Short‑termism is a disease that is usually fatal.

Number three, focus on your outcomes. Remember, it’s all about your outcomes not your performance. It’s about your financial plan. The plan is just a series of steps that you’re going to take to accomplish the things that you said you wanted to accomplish in a cohesive plan that is based on your resources and what’s realistic over time.

Focus on your outcomes, forget performance. That’s short‑termism. That’s the disease and understand that you’re a human being. When in doubt, talk to your advisor. Talk to a professional. Make sure that before you do something that could be fatal, that you’ve gotten a second opinion.

That’s it for today’s show. Thank you so much, Eric, for joining me today. This was an important topic.

For those of you who might be interested in learning more, feel free to go onto our website, keyfinancialinc.com. I know you’re probably driving in your car, or you might be watching it on TV. We are open to any questions you might have. We’re happy to help you any way we can.

Most of all, don’t forget, hit “Subscribe.” These podcasts are going to continue, and we want to hear from you. Let us know whether or not this resonated with you. Would you like to hear more about this subject, or is there something else that you’d like to learn about?

That’s what this is all about. We want to improve the outcomes for all Americans, not just you but your friends and anybody that you care about.

Thank you so much for listening to us today, watching the podcast. Thank you, Eric, for a great game session. I didn’t realize we were playing games.

Eric:  I enjoyed it.

Patti:  Again, don’t forget to hit “Subscribe.” Share it with your friends and join us next week. Take care. Have a good one.

Ep1: Year End Tax Planning Tips

About This Episode

In this episode Patti Brennan and Eric Fuhrman discuss Year End Tax Strategies, Roth IRA’s, Tax Loss Harvesting, QCD’s, 529 Contributions, Roth Conversions and much more.


Patti Brennan: Welcome again to the Patti Brennan Podcast. Today, joining me is Eric Fuhrman. He’s our Chief Planning Officer. Thank you so much for being with us today, Eric.

Eric Fuhrman: Patti, it is my pleasure. I couldn’t think of anywhere I’d want to be right now. Not only do I get to spend the afternoon here with you today, but also we get to talk about taxes, which are terribly exciting to us.

Most of our listeners here don’t realize that at this time, but I think by the time we get to the end of this podcast, they’re going to get some really insightful and new and exciting tips that they’re going to get out of this.

Patti: You know, Eric, it’s something I say all the time. When we get to this subject, I always warn clients, “I’m about to nerd out on you.”

Eric: [laughs]

Patti: It’s a very nerdy kind of subject. I’ve got to tell you. Isn’t it fun when you know certain things are going to make the difference? It could be $1,000. It could be $5,000. If people don’t know these things that we’re going to be talking about today, they’re not going to do them. If they don’t do them, then guess what?They’re paying more taxes than they have to.

Eric: Absolutely right. They get a lot out of it, but the best part is it gives us a lot of excitement and something to talk about to have a lot of deep and important conversations with our clients.

Patti: Let’s talk about what are the things that people should be thinking about today. Here it is, beginning of November, and markets are in a turmoil. They were doing really well. Now, they’re doing terribly.

What’s the first thing? What are we doing for our clients, and what should clients be doing for themselves?

Eric: As the year draws to a close here, there’s a lot of really important things that clients need to think about. That applies to a lot of different situations.

Now that we’re here towards the end of October, we have about two months left, but there’s some really critical things that they can do here in the next 60 days or so that can really make the difference for their taxes and going forward.

One of the things they have to be thinking about, especially when we have a really volatile market, is something that we talk about all the time internally, which is tax loss harvesting.

Patti: Eric, it doesn’t sound great. Why would I want to harvest a loss? Don’t we want to make money in our investments?

Eric: That is the goal, is for appreciation over time. Nobody invests with the expectation of a loss, otherwise, it wouldn’t be a very good investment.

You’re absolutely right, investments are something where when we set them up, these are things that we’re thinking about over many years, whether it be 5 years, 10 years, or possibly a lifetime, but within any given period of time, not all investments are always going to be producing gains.

You’re going to have certain investments that may have a loss at different point in time. That is not, relatively, a permanent thing. It might be a temporary thing, but it’s an opportunity that we can harvest and take advantage of in each tax year that can certainly deliver long‑term benefits for our clients.

Patti: For the folks that are listening and watching us today, let’s talk about the difference between the amount a person invested and what their cost basis is. Even though, for example, they may have a tax loss, it doesn’t necessarily mean that they lost money. How does that work? Can you explain it to our listeners?

Eric: If you think, if originally you put $10,000 into an investment, over time, that investment paid out dividends and capital gains, and if you’re someone that has opted to reinvest those capital gains and dividends, like many investors do, that will increase your basis over time.

While you may have originally invested $10,000, you may look five years down the road from now, and you might have a basis of, say, $14,000, because you’ve been reinvesting all that income that has been distributed.

It might so happen that you run into a period, like we’ve experienced over the last couple weeks, where all of a sudden your investment, the actual value of it, has now dropped below your basis. If you originally put in $10,000, your reinvestments have taken you up to a basis of $14,000. Basically, now, you might have a loss if the investment’s now at $13,000.

Remember, you still put in $10,000, you still have a gain in the investment, but you have a tax loss that is available to take advantage of.

Patti: That is powerful. That is so very important. We talk about these things, cost basis and the amount invested. These are things that we talk about all the time, but it’s important for people who are listening to understand the difference.

By the way, to clarify this further, what we’re really talking about are your non‑retirement plan accounts.

Eric: Good point.

Patti: This doesn’t apply to your 401(k) or your IRAs. It’s really your non‑retirement plan accounts.

Let’s say that you’ve got one account and another account. Let’s say that those losses add up to $10,000. Why don’t you explain to our listeners what is the process of harvesting a loss? What does that really mean in English?

Eric: Tax loss harvesting, like you said, it only works with, obviously, non‑retirement assets.

It really works well for portfolios that are really well diversified, where you have a lot of assets that are going to be doing different things. If you have, basically, a portfolio that’s full of large company stocks, you’re not going to get a lot of tax harvesting opportunities.

What we would do is look through your portfolio and try and find investments that have current losses before year‑end, with the idea that we’re going to actually sell those investments to capture the loss before year‑end.

Then what we’re going to do with those gains is basically reinvest it. You can’t invest it back into the exact same security, but reinvest it into something that’s of similar quality to keep you invested, but harvest the loss.

Patti: What you just said raises a red flag in my mind, because it sounds like you’re market timing. It sounds like you’re selling these investments, but, wait a minute, don’t we usually tell our clients and tell people you want to buy and hold?

You don’t want a lot of buying, selling, and transactions, because that generates cost, so what’s the value of this?

Eric: Basically, the idea is we’re not market timing, because ideally when you sell to capture the loss, we’re going to be reinvesting those proceeds back into the market.

Patti: To clarify, it’s really important, you go from literally blue chip investment A to blue chip investment B. It could be the exact same asset class.

To Eric’s point, it can’t be the same investment, but it can be the exact same asset class. It can be a same day.

We’re not market timing. All we’re doing is capturing a tax deduction that you otherwise wouldn’t have had. Sounds like a win‑win. It’s a heads you win, tails you break even, because you’re going to save money on your tax return.

Eric: Ultimately, it’s really about managing your tax exposure and the timing of it. There’s different ways where tax loss harvesting can make sense, such as if you have an investment that happens to pay out a really large taxable gain, then you want to look through the portfolio for losses where you can offset that gain and minimize your taxes in a given year.

Tax loss harvesting can also really work well when we go into different market cycles, like, say, a bear market where probably your equities, your stocks are going to be down. In this way, you can actually capture the losses, but we’re going to be reinvesting the proceeds so you stay invested.

Then, when the business cycle picks back up again, the economy starts doing well, a lot of those losses may turn into gains, but now, we have a bank of losses that we can use to offset those capital gains in the future. It’s a better way to manage your tax picture all around to follow this strategy.

Patti: I love the way you described it as the bank. Now, you’ve captured these losses. It literally is like a bank account that is sitting there waiting to be used. You carry forward your losses indefinitely until they’re used up.

One thing that we know about investments and portfolios is markets don’t go straight up and they don’t go straight down. In those periods of time that we all really don’t like, let’s make lemons out of lemonade.

Grab a tax benefit today. That way, when the market does recover, you can rebalance your portfolio and not have to worry about the taxes you’re going to have to pay on those gains, because guess what? You’ve got this great bank account, and it’s got this wonderful $30,000 loss, you have no out of pocket cost. Fundamentally, everything’s beautiful.

Eric: Couldn’t have said it better.

Patti: [laughs] You know what? You’re the one that gave me the idea. You’re the chief planning officer, and I’m so grateful for planning these ideas.

Let’s talk about what else? We’ve got tax loss harvesting. What do you think is the next best thing that people should be considering today?

Eric: We’re trying to think about year‑end tips or strategies that people can put in place. Another one would actually be purposefully creating capital gains.

This is the opposite of tax loss harvesting, where we’re purposely trying to create losses. Here, we’re actually trying to create gains on purpose.

That sounds counterintuitive. Why would you want to do that? The reason is because under the existing tax law, and this existed before the new tax law that was passed in December 17th of 2017, is to the extent that your income remains what it is now under the 12 percent bracket, used to be the 15 percent, any kind of qualified dividends or capital gains are actually taxed at zero percent.

The question is who does this apply to or who would it make sense for? Really, it’s these people that are newly retired, probably in your 60s, have a fair amount of non‑retirement assets that have been saved up in investment accounts.

You also probably haven’t elected social security benefits or have a really robust pension at this point. The rationale is that somebody in this situation, at some point in the future, their income is probably likely going to go up significantly when they elect for social security benefits, or maybe they have a pension that doesn’t start until 65, 67, or 70.

Also, there’s this thing called required minimum distributions that is going to start at age 70 and a half, whether you like it or not. The confluence of all these different factors can push somebody into a much higher tax bracket later on in life.

The strategy is when you’re in this window, this golden zone, is to actually create capital gains at zero percent to effectively reset the basis of that taxable account higher, so that once you get into this high tax phase, now, you’re going to minimize the capital gains that would otherwise flow through to your tax returns.

We’re taking much greater control. We’re being much more proactive about managing the life cycle of their investments, not just now, but in the future.

Patti: Isn’t it true that by doing that proactively we have literally taken somebody’s investment, and instead of paying what could be 23.8 percent on the gain, to zero. Sounds like a good idea to me, Eric.

Eric: There’s not many wonderful opportunities in the tax code, but a zero percent tax rate is a pretty good one.

Patti: Let’s do a deep dive and nail this down. For people who are married, who’s in the 12 percent tax bracket? Up to what amount of taxable income?

By the way, guys, taxable income, to clarify, is not what you see on the front page. Taxable income is line 37 on your 1040, after you’ve taken your tax deductions.

When you’re trying to figure out whether this applies, you want to look at your 1040. Don’t look at the first page. You want to go to the top of the second page to find out what is the taxable married filing jointly income after you’ve taken all your deductions, including the new standard deduction, which for married people is $24,000.

A lot more people may find themselves in this 12 percent bracket. That’s why you want to really, really pay attention to this.

Eric: People that are the top of the 12 percent bracket is $77.400. If you’re someone who’s single it’s $38,700.

An important distinction is that it’s not all or nothing. Let’s say you do this. It doesn’t require surgical precision, because even when we do this, we have to make estimates, because ultimately, we’re not going to know exactly where you’re going to be on December 31st. We do our best.

Realize if you realize capital gains and go a little bit over that $77,000 number, and it spills over into the next bracket, you only pay capital gains on the excess above that bracket. Everything else is still protected at the zero percent rate.

Patti: That’s a great point. Sometimes when we talk about things, people say, “Well, I don’t think that that’s going to apply to me.” You know what? If it’s an investment that you kind of want to sell, you feel like you need to sell, why not?

Worse comes to worst, in this situation, you’re paying a 15 percent capital gains tax, but you could be avoiding a tax altogether on, pick a number, $10,000, $20,000, $50,000.

Eric: It can be huge, especially depending on the size of your gains. We’re in the eight or ninth year of a bull market, up until about a month or so ago, at least it seemed. A lot of people have really, really significant gains that have accrued in that run‑up, this is a great strategy for them.

There’s two important caveats that people really need to consider. Is, number one, we’re taking about the federal tax. If you’re a resident of PA or some of these other states, you may not pay federal tax, but you may be creating an additional state income tax by doing that, because a lot of states will tax capital gains.

PA, for example, they don’t allow you to write off losses, but you have to report your gains. Sorry, it’s very one sided.

The other important point to remember is that if you are somebody on social security and you can do this, remember that you’re increase your income by realizing capital gains, which means more of your social security benefit might actually become taxable because of that.

You have to be very careful and you have to be strategic. It is has to be very customized to the individual. You can’t use general rues of thumb, because that will get you into trouble.

Patti: Exactly. It’s one of those unintended consequences. You think you’re doing the right thing, and there’s this consequence on the other side.

Eric: Domino effect, right?

Patti: That’s why you really want to understand, holistically, the impact on your personal situation.

To highlight the people and understand, especially for those of you who are listening, if you are retired, you’re newly in retirement, you really want to think about this, because typically, what we find is that people go from a really high tax bracket, and then all of a sudden, you go into a really low tax bracket.

Let’s say you retire at 62. For the next seven or eight years, you’re probably going to be a really low tax bracket, much lower than you probably even realize. Then, as Eric said, when you hit 70 and half, you get hit with those required minimum distributions and you’re right back up there again.

What we’re talking about here is to be aware of where you are from a tax perspective. Think about where you’re headed, and optimize these years when you’re in the lowest tax bracket you’re probably ever going to be for the rest of your life.

Eric, this is so much fun. What else are we going to be talking about for year‑end? We’ve talked about tax loss harvesting, and then, on the other hand, accelerating gains. What else can our listeners do, our viewers do before the year‑end?

Eric: I’ll tell you what, I feel like we are hitting on all the high notes here, so why don’t we talk about something called Roth conversions? Have you hear about this concept before?

Patti: Yes.

Eric: I bet.

Patti: It’s one we preach.

Eric: [laughs] All the time. As you know, Roth conversions are something that, again, this is situationally dependent. It really depends on the situation and whether it makes sense. It also really takes somebody that can do a good forecast to where you’re going to be in the future.

In terms of Roth conversions for our clients, who do you feel is the typical client where this really makes sense for? What do they look like?

Patti: You go back to those people who are recently retired. If they don’t have a lot of non‑retirement assets where there’s lots of gains, this is a great plan B.

Plan B is, “Gee, should we take some of that 401(k), and take some of it out, convert it into a Roth, and take you up to the tippy top of that 12 percent tax bracket?” Because chances are you’re never going to be back here again, so let’s take full advantage of it. That’s a perfect situation.

Younger people who might have 401(k)s. They may have left their position and they’ve got this 401(k) hanging out there. Chances are, depending on their situation, it might be a good idea for those people also to consider converting that into a Roth IRA.

They’re, again, hopefully, in one of the lowest tax brackets they’ll ever be, because the goal, of course, is to always earn more income. If that’s the case, your bracket’s going to go up. Why don’t you convert that 401(k) into a Roth IRA while your tax bracket is still low?

Eric: That’s really key for our listeners, is that ultimately you have to be in this golden zone where the expectation is that your tax rates are temporarily low, but could be significantly higher in the future.

Under the new tax law the reality is that it’s going to sunset, anyway, in 2025. We’ll see whether there’s the political will to actually let that occur, but tax rates are scheduled to go up right now unless Congress acts.

Patti: That’s a great point. This is another example of being proactive. Let’s be proactive.

Here, for the people who’re listening, why the Roth? What’s the big deal with the Roth?

Were talking about converting into a Roth. What’s the big deal? Where’s the value coming into play?

Eric: The big thing with a Roth, number one, is that requirement distributions do not occur, where they do with a traditional IRA. There’s nothing that will ever compel you over your lifetime to force distributions from this account.

If you do have to take distributions, those distributions are never taxable. The earnings, anything that accrues in the account isn’t taxable, whether it be as part of a broader income retirement plan as you age, or maybe this could be an excellent vehicle for legacy intentions, where you can leave money to an heir that will never, ever be taxed during their lifetime.

Patti: It is absolutely the best thing that you can leave to the next generation. You look at your house. You look at your retirement plans. You look at your after‑tax, your bank accounts. Then you have this Roth. The Roth is a home run for those kids or the people that you care about most.

Also, to just frame it and understand, what is the value? You have two accounts. One is growing tax‑deferred. The other one is growing tax‑free. Same investment, same starting point, same rate of return.

Eric: The reality is, Patti ‑‑ that’s a great point ‑‑ is whether you have a traditional IRA or a Roth, the reality is the tax has to be paid somewhere. You’re going to have to pay taxes.

Whether you elect to pay them now with a Roth IRA or you elect to pay them some point in the future with a traditional IRA, the tax is going to have to be paid. It’s unavoidable. The real critical question is “What is the best rate to pay those taxes at?”

If you’re in this golden opportunity zone that we’ve talked about, depending on your situation, where your tax rate is really low, a Roth conversion is a great way to basically pay taxes now at a really low rate and avoid them in the future, when they could be a lot higher when other things come into play.

Patti: Isn’t it even better, Eric? If you have time, which is why I always bring up the point of younger people, if you have time, that ‑‑ pick a number ‑‑ $50,000 that grew to $100,000 that grew to $200,000 and maybe $400,000 over that lifetime, you can pay taxes on the $400,000 if you’d like, or you can have this $400,000 account.

You already paid taxes on the $50,000. You did pay taxes on that when you did the conversion. Guess what? You never have to pay taxes on $350,000. That’s about as good as it gets. The key here is time.

Eric: That’s a great point, too. A lot of people don’t realize when they retire that their traditional IRA or 401k has an unfunded tax bill that’s due to Uncle Sam at some point in time. Whatever that balance is, there’s still an amount that hasn’t been paid. Roth is a great way, or a Roth conversion is a great way to try and take advantage of a better tax rate.

Patti: We’re not going to get into it today, but maybe an idea for a future episode would be, Eric, is for…

Eric: I love ideas.


Patti: I know you do.

Eric: [laughs]

Patti: I know you do. Here’s the thing. What we should talk about ‑‑ let’s make a note of this ‑‑ is for those people who are in that zone, those people are really worried about or thinking about retirement income.

How am I going to create cash flow to replace the salary that I’m no longer getting? How do you choose one account over another account? Furthermore, how do you invest for that period of time? Again, we’re not going to talk about it today. We’re talking about year end tax planning ideas. Just know we’re going to be talking about that in the future.

Eric: Another reason to tune in to the next podcast.

Patti: You got it. We did Roth conversions. We’re talking about retirement plans. I’ll just throw this out there. For those of you who may be working, may have a spouse who is a stay‑at‑home parent, keep in mind that you can do IRA contributions for that non‑working spouse.

The income limitations have risen. You really want to take a look at that. The good news is you have until April 15th to fund it. It’s not a year end…You’re not up against the wall at this point in time.

Eric: That’s a good point. It’s something you have until April 15th, when you file your taxes, to do. It doesn’t have to be done by December 31st. You can still make a deductible IRA contribution or a spousal IRA contribution, as you’re alluding to, Patti, at any point in 2019 up until the tax filing deadline.

Patti: The one thing that I think does get overlooked, Eric, is this thing called the backdoor Roth, which does have to be funded before year end. Why don’t you walk people through what a backdoor Roth is? Just real quick and simple.

Eric: Basically, a backdoor Roth is normally most people that make over a certain income ‑‑ I believe it’s 189,000, is where the phaseout begins ‑‑ you have a limited ability, or, if anything, you’re precluded from making a direct contribution to a Roth. You can’t do it, but there’s a backdoor way that allows you to do it.

Ideally, this would be, again, for someone that doesn’t have substantial pre‑tax IRA assets. If you don’t have an IRA, anybody can open an IRA and contribute, regardless of your income. Ideally, you’re going to make what’s called a non‑deductible contribution.

Then you can immediately convert that over to a Roth IRA after you make that contribution. You’re not going to get a tax deduction for it, but the big part is that after‑tax contribution in that IRA moves right into a Roth. There’s no tax that’s due on it.

Again, it doesn’t really work too well for people that have pre‑tax money that’s out there, but it is a really, really powerful strategy. It’s a great way, as you point out, to get money in a Roth when most people thought they couldn’t because they make too much money.

Patti: Here is another example of just know the rules, know whether or not it applies to you, and make sure that you are avoiding any of the landmines. In this case, this landmine’s called the pro rata rule. Just understand it. Know whether or not it applies. Boy, if you can do these backdoor Roths, again, another…

We talk about home runs. These are singles. You’re hitting singles all along the way. You do this every year. I’ve got to tell you these are things that really can really leverage your retirement income later down the line.

Next topic. Again, year end, we’ve got people who are retired, who are 70 and a half. We’ve got a new tax law. One of the most powerful tools we have available in this arena is something called a qualified charitable contribution. A QCD is what we refer to it. Why don’t you walk people through that.

Eric: The QCD is a really powerful tool and is actually more and more relevant now, with the new tax law, than it ever was. It doesn’t matter if you’re somebody that has a very large IRA account or somebody that has a more modest balance. This is applicable to you.

The reality is with the new tax law, they raised the standard deduction. A lot of people, where they would itemize, that’s how you get credit for the charitable deductions you might give to your church or local charity when you make cash contributions.

You don’t really get the benefit from that now if you have to standardize. Most taxpayers will have to standardize. There is a way to leverage your gift through what’s called a qualified charitable distribution, basically, through your IRA.

The way it works is basically as long as you’re over 70 and a half when you make the contribution, you have to make the check directly payable to the charity, say, to your local church, local food bank, whatever it is, the organization that you’re supporting.

You have to make the check directly payable to them. It counts towards your required minimum distribution, to the extent that you haven’t taken it for that year, but it is a non‑taxable distribution from your IRA.

Patti: Basically, just to use an example, let’s say that your required minimum distribution is $20,000. Let’s say that you typically donate $5,000 a year to charities of your choice.

If you take that $5,000 out of the $20,000 that the IRS is forcing you to take out, guess what? You’re only paying taxes on $15,000. You’ve got the $24,000 standard deduction, and you’ve got another $5,000 that you otherwise wouldn’t have gotten if you didn’t do this.

Again, another tip, tool, thing that you can do before year end to really get some leverage and get some benefit next April.

Eric: With the new tax law, you might not be able to take that deduction otherwise. One important point too is just remember that your year‑end tax document is not going to reflect the QCD. This is something you have to remember to tell your tax preparer to put on your return.

They won’t know otherwise, unless you have, basically, the proof from the charity. You also have to tell your tax preparer to put it on there. Your 1099 will not show it. It comes up a normal distribution.

Patti: That is a really, really important point. How often do we find people don’t take the deductions that we set up for them just because they didn’t tell their CPA? Great point there, Eric.

Eric: You bet.

Patti: Taking on to the next subject. Since we’re on charitable contributions, given the fact that most people are not going to be able to get the benefit that they used to get from charitable contributions, what are we telling people today?

Eric: I guess there’s a couple concepts or strategies that are out there for people. Again, you’re absolutely right.

With the new standard deduction that is going to minimize the ability to take a charitable deduction, what a lot of people are suggesting now is rather than giving each and every year, as you might, it’s this concept of bunching or taking five, maybe six years of charitable contributions and putting them all together in one.

That way, you’re going to be able to itemize that charitable deduction, rather than taking the standard deduction. That’s a concept that people can do and they might want to think about.

Another is, a really great way to leverage a gift is if you have appreciated securities, an appreciated stock maybe that you owned for many, many years or in a company that you used to work for, so forth. A great way to do this is that you can actually donate that appreciated stock to what’s called a donor‑advised fund.

This is a bit of an advanced concept here. Obviously, we encourage you to talk to a qualified professional and have them help you out with this. It’s a great way where you can make a gift, get a charitable deduction, and you can avoid the capital gains tax on an appreciated security.

Patti: Again, it’s lots of things wrapped up in one to give you many benefits just with this one tool. That’s excellent. I guess the other thing that I’m thinking of is for the families in our audience. We’ve got lots of families who are putting kids through college, etc.

There are 529 plans. We live in Pennsylvania. Pennsylvania actually is one of the states that gives you a Pennsylvania income tax deduction on your contribution to a 529. You can gift up to $15,000 per person per year. Husband and wife can do $30,000. You write it right off of your Pennsylvania income tax.

It saves about $900. It’s $900 that you wouldn’t have had otherwise. That money also grows tax‑free for that important objective of putting your kids through college and now, under the new tax law, even high school. Again, it’s just one of those things out there.

Eric: There are very few things out there that really help you to leverage the tax benefit. A 529 is definitely one of those. As you just alluded to, you’re getting a PA state tax deduction. The money’s growing tax‑free. As long as you’re using it for a qualified education expense, there’s no taxes due on any of the earnings.

It’s really a great vehicle and far superior to some of these things that I had when I was a kid. My parents used things like UTMA or UGMA accounts. A lot of times, these were set up for educational purposes. The 529, in terms of tax benefits, is far superior to what these older vehicles used to have. Definitely a great way to go and a great thing to do before year end.

Patti: Again, remember, there is full reciprocity for any state, whether your child wants to go to college. That is not a restriction. Pennsylvania’s one of the only states that does give you the tax deduction even if you wanted to invest in another state’s 529. Eric, like I said, I’m really jazzed up about this subject. We’ve talked about a lot of things.

Eric: How could you not be?


Eric: It’s taxes, for goodness sake.

Patti: I know. How about it? How about it? You know what? It’s one of those things where if we can save somebody $5,000, $10,000 that they otherwise wouldn’t have had, that’s a good day. I think that’s a really good thing.

Eric: You know what, Patti? It’s such an important thing. I think it’s why we both love what we do. It’s these little things that add up with each person. Every situation is different.

Again, like you said, you had this great concept that I love, of hitting singles. I’m going to have to put that in the memory bank and remember to use it again. It’s this whole concept of hitting singles.

Lot of people are always looking for that home run. What’s that big thing we can do? That’s not really how it works. It’s about finding these little things that we can do each and every year, that will add up to a big difference over the long haul.

Patti: Let’s wrap this up and talk about action items. Number one, we talked about tax loss harvesting. Look at your non‑retirement accounts. See if there’s any losses to harvest.

Eric: You got it.

Patti: Number two, we talk about accelerating capital gains. If you’re in a 12‑percent tax bracket, go ahead and take those capital gains. You pay no tax when you realize that gain. Again, that’s a really, really big win for you. We also talked about…Go ahead.

Eric: I was going to say rarely is zero a good thing in life, but in this case, it is.

Patti: Boy, you’re not kidding.

Eric: [laughs]

Patti: You’re not kidding. We also talked about QCDs. For those people who are 70 and a half or older, take your charitable contributions from your required minimum distribution.

Instead of writing out the check, just take it out of the required minimum distribution. That way, you get your standard deduction and you get the charitable deduction, as well. What else?

Eric: Just again, with IRA contributions, just remember they don’t have to be done by year‑end. Don’t panic. If we are in between Christmas and New Year’s and you’ve forgotten about doing it, you have until April 15th.

Patti: Roth conversions.

Eric: Yup, Roth.

Patti: Remember Roth conversions. If that situation applies to you, if your tax bracket is low, it’s usually a temporary situation. Certainly with the way the tax code is currently working, think about Roth conversions. Also, 529 plan contributions. By the way, not just for parents. Also for grandparents. Hey, everybody gets the benefit, especially the kids.

Eric: Yup, absolutely. You’ve brought up a lot of great points. I think the big thing underlying all this is just remember that all of it is so much based on the individual situation. It is truly customized. This is not something where just rules of thumb or conventional wisdom always work out so well.

Patti: Because our listeners have listened today, at least they’ve got some new tools, new nuggets that they can ask somebody about. If you don’t know what your situation is, whether or not they apply to you, go to your advisor.

Again, it doesn’t have to be Patti Brennan and Eric Fuhrman or Key Financial. There are a lot of good advisors out there. Talk to your tax professional. Just do these things. Do these things. These singles lead to runs and lead to World Series championships. With that, thank you so much for tuning in. We will see you next week for the Patti Brennan Podcast.