Wealth Decision #5- Don't Just Invest in Your 401k

Wealth Decisions Podcast Transcript for Wealth Decision #5- Don't Just Invest in Your 401k

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You know, one of my favorite Jim Rohn quotes from all time that has stuck with me all these years was when he talked about discipline.

He said, we all must suffer one of two things.

The pain of discipline or the pain of regret.

The difference is, is the pain of discipline weighs ounces, but the pain of regret weighs tons.

And isn't that so true?

Regrets can really weigh us down if we hold on to them.

And that's really the goal of the Wealth Decisions Podcast, is to make sure I help you make better wealth decisions so that you don't have regrets down the road.

And wherever you are right now, whether you feel like you haven't saved enough or you'd like to save more, just know one thing, the past does not define you.

What defines you is what you do right now.

What we talked about in last week's episode was the importance of trying to funnel as much money into Roth IRAs as possible, using Roth 401Ks, backdoor Roth strategies, as well as after-tax options that are available in some 401K plans.

The whole goal is to have a balance of different types of accounts.

Just like you have diversification when it comes to your investments, you want to have account diversification.

So you want to have some money in tax-deferred accounts.

You want to have some money in Roth IRAs, and you want to have some money in a taxable account.

So you have different pools of money to draw from down the road when you need to create a tax-efficient income in retirement.

So in today's episode, we're going to talk about Wealth Decision number five.

Don't just invest in your 401k.

If all of your money is in a traditional IRA or 401k, every dime you take out when you retire will be taxable.

And we don't know where tax rates are going to be 10, 15, 20 years from now.

But if you ask anybody, if they think tax rates are going to be higher or lower 20 years from now, not very many people will say lower.

So having money in Roth IRAs, like we talked about last week, is super crucial, but also having money in a taxable investment account.

You get favorable tax treatment with long-term capital gains.

Usually taxed at 15% or lower, depending on your tax bracket.

And if you have a long-term time horizon, it's a very efficient way to invest some money towards retirement other than investing in your 401k.

Your goal, I often say this should be to put away at least 15 to 20% of your income.

And some of that in a Roth 401k, some in a Roth IRA, and some in a taxable account.

If you want to retire early, in other words, early would be anything earlier than age 60 or 65.

Let's say you want to retire at age 55.

You're going to need some money in a taxable account.

Because IRA accounts or 401ks, you can't touch until you're 59 and a half.

If you want to retire at age 55, you should aim to have at least five times your yearly expenses saved in a taxable account.

If your expenses are $70,000 per year, your goal should be to have somewhere between 300 and 400,000 saved in a taxable account by the time you're 55.

Here are some rules to follow when investing in a taxable account, just to make sure that you do the right thing with your money.

Number one, just like your 401k where you're investing a set amount each month, usually a percentage of your income, do the same in your taxable account.

Set it up to have money go out of your savings or checking account, right into your taxable investment account on a monthly basis.

This would be called dollar cost averaging.

With dollar cost averaging, you benefit from stock market volatility.

You can buy quality stocks sometimes for 20 to 40% less during corrections or bear markets.

The idea is that let's say you're buying a large cap growth ETF that is $10 per share, and you're investing $1,000 per month.

That means that you could buy 100 shares at $10 per share with your $1,000 per month.

But if in month two, that ETF is now worth $12 per share, you can only buy 83.33 shares, which means you're buying fewer shares at a high.

And if in month four, the ETF is now worth $8 per share, you can buy 125 shares with your $1,000, which means you're buying more shares at a lower price.

So you're taking advantage of market volatility.

Since the 1950s, the stock market has had 10% corrections about every 1.6 years and 20% or more corrections or sometimes they're called bear markets on average every four years.

So taking advantage of volatility by investing a set amount each month can set you up for better success over time.

Rule number two in a taxable investment account is avoid mutual funds with high turnover.

Every mutual fund that actively trades stocks throughout the year will buy and sell stocks and they'll have distributions at the end of the year that are taxable to you as an investor.

And you may get long-term capital gains, but you also may get short-term capital gains.

But you have no control over what distributions will be.

That portfolio manager could sell half his portfolio, and you're going to get the brunt of that.

And especially don't buy an active mutual fund with high turnover near the end of the year.

If the market did really well throughout the year, and you buy that mutual fund at the end of the year, you're going to get all the capital gains from that particular year.

You could actually be down on your investment and still get a capital gain.

So avoid mutual funds in taxable accounts with high turnover.

Rule number three.

If you're investing in ETFs or stocks in a taxable account, which would be the two most tax efficient things to invest in, you need to be able to use tax loss harvesting strategies to minimize gains and maximize any losses you may have.

Tax loss harvesting is just taking a look at throughout the year.

If you have big gains in some investments, but you have some temporary losses in others, you can use those losses to offset gains.

Let's take, for example, you have a consumer staple stock that you have a loss in.

You can sell that consumer staple stock to offset some gains in some, maybe some technology stocks.

And if you still want exposure to consumer staples, you can buy a consumer staples ETF and hold that ETF for 30 days or longer and then invest back in that same stock if you still think it's a good quality company.

The reason why you do that is to keep exposure to the market or a particular sector.

But there's a rule called the wash sale rule.

So you can't sell a stock and take a loss and immediately buy it back.

You have to wait 30 days to be able to still use that loss if you want to buy back that particular stock.

Rule number four, invest with a three to five year time horizon when you're buying investments in a taxable investment account.

You're going to have ups and downs in the markets, in the economy and investing with a short time horizon usually is not a very good idea.

You always need to keep a long term perspective.

Peter Lynch often said, you get recessions, you have stock market declines and if you don't understand that's going to happen, then you're not ready.

You won't do well in the markets.

So you want to keep a long term perspective.

We're going to go through all kinds of difficult periods over time, but making sure you buy quality investments and hanging on to them for the long term will set you up for long term success and a really, really comfortable retirement down the road.

When you buy a good stock at a fair price, eventually the market is going to agree with you.

It may not be next week or next month, but a good company with great fundamentals will reward you over time.

And even just investing in a good quality diversified ETF will reward you over time.

In the three to five year range, you have time to ride out any market fluctuations without stressing about having to constantly monitor your portfolio.

So rule number five, be aware of short term capital gains.

If you buy a stock and it goes up very quickly, you're going to be tempted to sell that particular stock.

Don't always look at the tax liability as your reason to sell a company or not sell a company.

But you always want to keep in mind that if you're getting close to that 12 month timeframe, which is the long term capital gains rate, anything held over 12 months is taxed at 15% or lower depending on your tax situation.

But if you sell a stock or an ETF in the short term, 12 months or less, you're going to pay the tax rate on the gains based upon your particular tax rate.

So if you're in the highest tax bracket, you're going to pay up to 40% of your gain in the form of taxes.

Rule number six when investing in a taxable account, especially when you're investing in individual stocks, cut losses short.

I typically use a 15% rule.

That means if I buy a stock and it's down 15%, I try to cut my losses short so I don't ride a company all the way down, especially if their fundamentals have deteriorated.

George Soros often said, it's not whether you're right or wrong that's important, but how much money you make when you're right and how much money you lose when you're wrong.

Investing in stocks is a journey.

It's filled with ups and downs and it's crucial to have a sell discipline to cut your losses short.

Having this type of discipline will make sure that you don't follow a company all the way down 50, 60, 70%, which takes a lot to recover from.

There's a quick equation called the arithmetic of loss.

If you're down 40% on a stock, you have to make about 66% to get back to even.

If you're down even further, you may have to make 100% on that stock to get back to even.

You don't want to ever be in that position because now you have to find a company if you get out of that company that has quite a bit of upside to recover your losses.

So in summary, when you're investing in a taxable account, invest systematically by dollar cost averaging, use tax loss harvesting strategies, avoid mutual funds with high turnover, invest with a three to five-year time horizon, be aware of short-term capital gains, and cut your losses short by using the 15% rule.

That's it for today's episode.

Don't just invest in your 401k.

If you like to schedule a discovery call with me, you can go to my website at momentouswealthadvisors.com and I'll spend some time to get to know you a little bit and find out if I might be able to steer you in the right direction or help you with your financial future.

Listen to this episode on Apple Podcasts or Spotify


-Brian D. Muller, AAMS® Founder, Wealth Advisor

Momentous Wealth Advisors in a fee-only fiduciary advisory firm

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