Be Careful What You Chase

Be Careful What You Chase

by Jason Watson, CPA - WCG, Inc.

This article will cover some overlooked retirement planning concepts. I’ll likely lose some financial advisor friends and perhaps get a phone call or two, but here are some counter-culture thoughts from your CPA down the street.

Full disclosure – my wife, Tina Watson, and I once owned a registered investment advisor firm to augment our business advisory and accounting firm. For no real reason other than workday time compression and the pains of life on life’s terms, we decided to let the investment advisory business go. So take this information for what it’s worth.

The first overlooked planning consideration is a budget. Sure, it is super easy to max out your 401k and call it a day. Is that enough? Is that too much? Dying with $2 million in the bank sounds like you didn’t party enough…and we can all imagine the yuck on the other side of that spectrum. Therefore, retirement nirvana is having the check to the mortician bounce, right? As such, get a financial plan and get a budget.

The next consideration is the title of this article: Be careful what you chase. Let me explain. Far too often I see people with significant funds in their 401k accounts and IRAs, but they are broke, or at least have very little discretionary cash. Why? They chased tax savings without a budget or a plan. I will say it again –

Your primary money focus is to build wealth. If we can save taxes along the way, great – but build wealth first.

I still haven’t fully answered the “why they are broke” question. Qualified retirement accounts are great since they have a tax advantage – either you defer taxes today and pay it later (an IRS IOU and eventual tax bomb), or you pay taxes now, but the growth is tax-free. Cool! But the yin to the yang is there are use restrictions and limits (shocker, I know). In other words, your money is tied up and largely inflexible.

To expand on this a bit, and to add another commonly overlooked consideration, we need to mention the intermediate investment horizon. Sure, you have an emergency fund, either in the form of cash savings or a nice HELOC on some real estate (now with decent interest rates on savings accounts, cash savings is becoming popular again). Next, you have your 401k and IRA which are long-term investment horizons.

What about that seven-year horizon? That is to say, do you have a plan to buy that rental property? Or maybe a second home? Or perhaps you want to start a new business? This is what I mean about being broke – you have a

bunch of money set aside, but it’s all tied up in qualified retirement accounts and as such you are willing, yet unable, to hit the “buy button” on any of these plans.

Another consideration is understanding risk. In a theoretical world, if you have unlimited time, you can absorb unlimited risk. Time is not unlimited, sure, but if you don’t need the money for at least 15 years, isn’t that almost unlimited?

Let’s look at some numbers. Since 1928, the stock market (and specifically the Standard & Poors Index) has provided an annualized rate of return of 9.82%. Also, if we deploy the Rule of 72* where we take 72 and divide it by 9.82, we get 7.3. This means that over time, your investment will double every 7.3 years given the historical rate of return of the stock market (and assuming your investments are based on this index).

Given what we know about emergency funds, longterm retirement planning, and intermediate investment strategies, each bucket has a different timeline and therefore a different risk profile. Emergency funds are usually cash savings or a HELOC, with virtually zero risk since time might not be available.

Long-term retirement accounts, such as 401k and IRA accounts, and as we’ve mentioned earlier, can have virtually unlimited risk given the historic averages of the stock market. Naturally, the intermediate or sevenyear horizon is much shorter and therefore requires managed risk.

Let’s take this one step further. As you approach age 65, understand that you likely have 15 to 20 years of living ahead of you, according to current mortality predictions. Let’s say you have $1 million saved in your retirement accounts. Do you need to put it all in a managed-risk investment? Perhaps, and that is something you and your financial advisor should review.

But given what we know about time and risk, there is a significant chunk, perhaps $400,000, that could be considered long-term with a completely different risk profile than the other $600,000. This is an oversimplification since income streams and spending habits will affect your plan. The real lesson is that becoming super-conservative at the age of 65 might not be the best course. Like Def Leppard sings, it is better to burn out than to fade away.

Jason Watson, CPA

Jason Watson, CPA, is a Senior Partner for WCG, Inc. a progressive boutique tax and accounting firm located in northern Colorado Springs.

Here is another way to look at this – if you missed the top 10 trading days from January 2002 to January 2022, your rate of return goes from 9.52% to 5.33%. This is crazy since over that same period of 20 years, there were 5,040 trading days. Miss 10 out of 5,040, and your rate is nearly halved?!

Painful as it might be, staying invested is important. Cycle your money down from long-term strategy/risk to intermediate strategy/risk as you move through your 60s and 70s, and yes, your 80s too. Refer above to Def Leppard.

I’ll leave you with one more thought. Who lost money in the financial crisis of 2008? Only those people who sold. Only those who had to pull money out of their investments in 2008, 2009, and some of 2010 lost money (or the ones who chose to sell which was and typically is a bad idea). How long did people have to wait for their investments to recover? Five years? Three years? Nope. It took about 22 months for an invested dollar in 2008 to return to being worth a dollar.

I will recap briefly. First, put together a budget of today’s spending and tomorrow’s spending. Next, embrace non-qualified retirement accounts and subsequent intermediate investments as another strategy to your 401k and IRA. Smartly invested cashequivalents give you options and will likely outpace inflation. Talk with your financial advisor about your different options to make the most of your resources.

* The Rule of 72 is a simple way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors obtain a rough estimate of how many years it will take for the initial investment to duplicate itself.

5 Overlooked Retirement Planning Tips:

1. Create a comprehensive budget to ensure sufficient retirement savings.

2. Prioritize building wealth over chasing tax savings.

3. Consider the limitations of qualified retirement accounts and plan for intermediate investments.

4. Understand different risk profiles for emergency funds, long-term retirement accounts, and intermediate investments.

5. Stay invested for long-term growth and gradually adjust your investment strategies as you age.

You may contact Jason at 719-428-3261 or jason@wcginc.com.

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