I want to share an investment system for retirees to hopefully assist you as you’re thinking about and planning for your retirement. We’re also going to look at how to prepare your retirement for the potential economic seasons that we may be headed into, and then the easy system that’s going to help lower taxes and lower risk as well.
If you need help defining the income plan, look at the DIY retirement course. Once you define your goals for retirement and the income needed to achieve those goals, creating the investment system becomes a lot easier. Within the investment plan we know that we can only control three things, and all three of the things we actually want to minimize through this investment system.
The first thing we can minimize or reduce is how much tax you pay when investing. We had a client who was not a client of Streamline Financial, but of a tax firm, coming to the CPA firm in March to pick up his tax return. He was completely surprised that he had $60,000 of extra income on his tax return that he had to pay tax on right away, before April 15th. It was due to the capital gains being recognized and other distributions within his investment account. He said, “But I didn’t sell anything and the account didn’t even go up that much last year, and I have to pay tax on it?” He was already in the highest tax bracket, paying close to 37% on short-term capital gains and dividends and interest, so that was an unpleasant surprise, and we see it happen more often than it should.
Here are two ways we can control tax so that we don’t have that happen. Number one is the kinds of investments that you own; funds, ETFs, individual equities or things like that. The funds and ETFs, they could pass on capital gains and distributions to you each year without you even selling or buying, but it happens within the fund a lot of times. We would use funds and ETFs that are considered tax efficient so that our clients can decide when to recognize gains rather than letting the fund company decide.
The second way is by using a strategy that’s called TLH. Each year, there’s many mini fluctuations or big fluctuations that happen in an investment account, and the strategy that we call TLH – tax loss harvesting. It allows them to sell an investment that may be down for part of the year and then move it into a very similar investment right away so that the investment strategy stays the same and they can actually take a write-off on that loss on their taxes that year.
The next thing that we can control in our investment plan is cost. This one’s easier, but many advisors don’t do it because it ends up paying them less. Since we’re certified financial planner professionals, we do follow the fiduciary standard and we’re obligated to do what’s best for our clients. So tell me this, if you had two investments, and they had the exact same strategy, the same returns, the same risk, and the same tax efficiency, would you rather want the one that costs 0.05% per year or the one that costs 12 times more, at 0.6%?
I know the answer is obvious, and we’d go with the lower cost funds. Low cost funds and ETFs, that’s how we can really help reduce the cost, or that’s how you can help reduce the cost in your investment plan. Every basis point or part of a percentage that’s saved in cost is added to your return each year, and this adds up to a lot over time.
The last thing that we want to minimize and control is risk. We believe there are four different seasons in investing, and depending on what season we’re in, some investments perform better than others. The four seasons are higher than expected inflation, lower than expected (deflation), higher than expected economic growth, or lower than expected economic growth. The goal is to reduce the risk in investing by making sure that we’re prepared for each and every one of those potential seasons.
There are individual asset classes that tend to do well during each one of those seasons and nobody knows what’s really going to happen. That’s why we want to make sure we have the asset classes in the right spots so that the income plan doesn’t get impacted. The investment system combined with the income system keeps you from having to worry about the movements in the market because you know you’ve got enough to weather any potential season.
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