CPA/Attorney Jim Lange on Investment and Retirement Plan Landmines

Episode: 201
Originally Aired: September 6, 2017
Topic: CPA/Attorney Jim Lange on Common Investment and Retirement Plan Landmines

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:

Introduction of Jim Lange of Lange Financial Group LLC
Masterplan Coordinates Tax, Retirement and Estate Plans
Don’t Miss Out on Tax-Free Growth with Roth IRAs
Taking Social Security Too Soon Is a Costly Mistake
If You Have to Take Social Security at 62, You Shouldn’t Retire Yet
Spending Too Much in Retirement or Spending Too Little
Both Spouses Need to Be Involved in Planning
Diverse Portfolio Includes Small-Value Companies, Foreign Stocks
No One Stock Should Represent More Than 2% of Your Portfolio
Plan Appropriately for Your Biggest Asset, Your IRA
Strategic Decisions After First Death Are Crucial

Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.

1. Introduction of Jim Lange of Lange Financial Group LLC

Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and Attorney Jim Lange. Well, Jim has been helping people with their estate plans for more than 30 years, and in that time, he’s had the opportunity unfortunately to see people make all kinds of mistakes and miscalculations on their path to retirement, and this week, we’re going to talk about some of those common mistakes: that’s strategy mistakes, investing mistakes and estate planning mistakes and how to avoid them. Some of those common missteps include having outdated wills, failing to make Roth IRA contributions, strategy and investing mistakes like poor asset allocation and diversification, simply spending too much money, and another important one, taking Social Security too early, which can cost you tens, or even hundreds, of thousands of dollars. Jim will discuss ways to avoid these traps, and he’ll also outline specific strategies to help you prepare for the looming death of the stretch IRA, which could potentially cost your heirs hundreds of thousands of dollars. So, Jim, hello to you and let’s get right to this week’s topic.

2. Masterplan Coordinates Tax, Retirement and Estate Plans

Jim Lange: Well, thank you so much, Dan. So, what I think I’d like to do is talk about mistakes in three separate areas: One is what I’ll call strategy mistakes, which are very common; the other one is investment mistakes, which is probably equally common; and the last one is estate-planning mistakes. So, actually, all these are pretty common mistakes, but let me start with something that you would think that people would get this right, but very, very few people do. Most people, by the time they have come in to see me, they have already made a lot of decisions regarding their retirement and estate plan, and the way that they arrived at those decisions was not through one masterplan, but where they are is the result of many individual decisions. So, for example, maybe they saw the 401(k) plan administrator at work and he made a certain recommendation for asset allocation. Maybe they read an article and they started making Roth IRA contributions. Maybe they went to an attorney and the attorney drafted new wills and trusts. Maybe they went to a workshop and they learned about Roth IRA conversions, so they made a Roth IRA conversion. Maybe they read something about retirement plans, and specifically after-tax dollars in a retirement plan, and they tried to do something with the after-tax dollars in their retirement plan. Then maybe they had an additional child or a grandchild and they tried to make an adjustment at that point. But basically, the way most people are by the time they come to see me, it’s not like they haven’t thought about any of these issues, and sometimes they’ve thought about a particular issue quite a bit, but where they are is not the result of, “OK, let’s take a look at everything and come up with what I would call a masterplan.”

Where they are is the result of a bunch of individual decisions, again, that each one seemed to make sense at the time. To me, I think that that is a mistake to think like that, and I think it is much more beneficial to the family to come up with a masterplan, and this can be in the strategy area, things like Roth IRA conversions and when to take Social Security and how much money you can safely spend and what’s the best kind of estate plan for you and your family and how can you build flexibility into this and even well beyond that, without even touching investments or estate-planning mistakes. But the first problem that I often see, in fact, I’d say I see it far more often than I don’t, is not having a masterplan, and that is one of the things that we like to do in our office. Now, to me, the best way to do a masterplan is to come up with a whole bunch of different alternatives, and frankly, I think coming up with those alternatives is partly an art, partly a science and partly something learned from 30-plus years of experience, and then test different ideas, and it’s not nuclear science. We have more sophisticated software than Excel, but if you just think of it simplistically, putting all these different scenarios in an Excel spreadsheet and running them forward 20, 30, 40, 50 years and seeing what the result of different strategies would be, and then you typically then go back and you will tweak it, like, let’s say for example, example Number One is you just do the status quo. Example Number Two is you do the status quo, but you make a very large Roth IRA conversion. Example Number Three is you make a series of Roth IRA conversions. Example Number Four is you make a series of Roth IRA conversions and you hold off taking Social Security until age 70. Example Number Five is you do that and then you et cetera, et cetera. So, basically, you are testing a whole bunch of alternatives. We actually prefer if the client is in the room while we are doing this, what we call running the numbers, and that way, the client can actually see why we are recommending what we are recommending. So that would be, let’s say, the big mistake or failure, not having a masterplan.

3. Don’t Miss Out on Tax-Free Growth with Roth IRAs

The next area that I find people are not taking advantage of is tax-free growth. For whatever reason, the government is giving us a lot of opportunities to enjoy tax-free growth, and many of us are not taking them. The simplest way to do this, assuming that you are working and earning money, and assuming that you fall within the income limitations, is to make a Roth IRA contribution, and a lot of people don’t know that they can not only make a Roth IRA contribution for themselves, of, say, $6,500 if you’re 50 or older, but you could also make one for your spouse. So, for example, this year, I made … well, actually, I’ll get into non-deductible IRAs, but let’s say we often recommend that the husband make a $6,500 Roth IRA contribution for himself, that he make a $6,500 contribution for his spouse, and let’s say it’s February 2018. They can not only do it for 2017, but they could also do it for 2018. So, that’s $26,000 of money that can be put away that’s growing income-tax free, and many, many people don’t do that, when they could afford to do it, and it’s the smart thing to do. If you don’t make the income limitation, and I forget what it is, but it’s something like if you’re married filing jointly and you’re making more than, say, I think it’s like $180,000 — don’t quote me on that one — but you could also make non-deductible IRA contributions, and through a trick, assuming that you don’t have any other traditional IRA, you can actually convert that money to a Roth IRA shortly after you make the contribution. So the effect of that is as if you are, you’re basically getting around the income limitation on the Roth IRA contributions. So, that’s a very common mistake that I see missed.

One that is perhaps much more expensive than failing to make a Roth IRA contribution, and this would apply more to retirees, is the failure to make Roth IRA conversions. The numbers are pretty convincing and we have all kinds of peer-reviewed evidence showing the math on Roth IRA conversions, and very often, the benefits to the family are in the hundreds of thousands, or even more than a million, dollars. So, I see a lot of people miss the opportunity to do Roth conversions. Now, one of the advantages that we have is that we have some razor-sharp CPAs who love to run the numbers, and we determine not only if you should make a Roth IRA conversion, but when you should make a Roth IRA conversion and how much. So one example, in the ideal world, let’s say that you are 65 years old, you’re at the height of your earning power, you’re earning a lot of money through either self-employment or perhaps you have a job, and your plan is to retire at age 66. At age 66, you will no longer have the earnings or the wages from your job, you will not yet be 70, so you will not have a minimum required distribution of your IRA, and let’s say you’re going to take advantage of the next strategy that we’re going to talk about, which is holding off on Social Security. So you’re going to have this window between 66 and 70 where you’re going to have a really low income, and let’s say that you’re living on your savings during this period. Well, those are the ideal years to make a series of Roth IRA conversions, and it’s not uncommon to see families literally be hundreds of thousands of dollars better off because they were smart enough to make a series of Roth IRA conversions, typically while their income is lower. Now, sometimes, I don’t get that lucky, so I’ll meet people who are in their 70s and they might have missed the opportunity to do a Roth conversion, or they might have missed the opportunity to hold off on Social Security, and then we’re in, what we call, cleanup mode, meaning we didn’t get the strategies right right from the beginning. On the other hand, you do the best you can with what you have. So that is particularly a problem.

Then, sometimes, people that don’t even think about Roth IRA conversions because they’re not even paying taxes. So, let’s say, for discussion’s sake, that you have an elderly parent, and the parent is in an assisted-living facility, and the cost of staying in the facility is at least partially, if not completely, attributable to medical needs, and you have very, very high medical expenses, not a lot of income, and let’s say that the elderly parent has an IRA. Well, in that case, we might be able to make a Roth IRA conversion for free, or at a very, very low tax. You might say, “Well, gee, what’s the difference because the elderly parent doesn’t pay income taxes anyway?” Well, when that elderly parent dies, they will then pass an inherited Roth IRA to children or grandchildren, and the difference between that and leaving a traditional IRA again could be tens, hundreds of thousands of dollars, sometimes even more. So, we see that routinely overlooked, which is basically the failure to make a Roth IRA conversion when the income is very low.

The other failure that we see is, a lot of times, people have after-tax dollars or a non-deductible IRA, or after-tax dollars in their 401(k) or 403(b). If you jump through a couple hoops, you can actually make a Roth IRA conversion of some of those after-tax dollars. It doesn’t cost you a nickel, and the difference is, going forward, the amount of money that you converted to a Roth from a non-deductible IRA basically will grow income-tax free instead of growing taxable. And again, the difference can be hundreds of thousands of dollars.

4. Taking Social Security Too Soon Is a Costly Mistake

Let’s get to one that is very commonly done. In fact, I would say the vast majority of people get this wrong, and the people who get it wrong, let’s say the higher percentage of people who get this wrong is it will cost them more in terms of benefit to themselves than other people, and that’s taking Social Security too soon. So, so many people want to take Social Security at age 62, or even at age 66, when, just as an example, the difference between taking Social Security starting at age 66 and waiting until age 70 is that you get an 8 percent raise every year you wait between age 66 and 70. So, you might say, “Well, gee, Jim, the person who’s waiting until 70, they don’t collect anything until they’re 70,” and yes, when they’re 70, they collect a lot more, but the way it works, if you put this on a grid, if you will, yes, you’re starting at age 70, but you’re getting a much, much higher benefit. So, let’s say that you draw a line, assuming that you were reinvesting that money, that line would very quickly go to hundreds of thousands of dollars, where, let’s say, compare that to somebody who’s taking it at age 62, yes, they’re starting it much earlier, but because they’re making so much less, yes, for a while, they will be ahead, then they’ll get to what I call the breakeven point, which might be age 82. But if they live a long time, they’ll literally be hundreds of thousands of dollars better off.

A couple things there: first, all you need is one spouse to survive, let’s say, beyond age 82 because the spousal benefit, or the death spousal benefit, of Social Security is the higher of the two benefits. So let’s take a situation where maybe the husband was the primary worker and he has the higher Social Security benefit. If he waits until 70 and then dies, or dies somewhere along the way, but let’s say after 70, then his spouse will get all the 8 percent raises that he was receiving. If, on the other hand, he takes it at 62 and then he dies, then his spouse will forever have a much lower Social Security. So, Jane Bryant Quinn sees this as a women’s issue, that is, when the man takes Social Security too early and then dies and then leaves her with a lousy income, and compare that to somebody who did it right, waited until 70, and then maybe even the husband died but the surviving spouse lived into their 90s and would be much, much better taken care of. So one, people take it too early; two, they don’t take into consideration their spouse; and here’s the other thing: I sometimes have people say, “Oh, gee, Jim, if my husband and I die before age 82, that means that our children will inherit less money if we hold off on an IRA.” And that is true, but here’s the big picture: The big picture is if both you and your husband die early, you’re both dead. Dead people don’t have financial problems. You should not fear dying early for financial purposes. What you should fear is living a long time and outliving your money, and Social Security is probably … and holding off specifically on Social Security and getting the spousal benefits right is actually one of the most important things that you can do to protect yourself to have at least a minimal income.

5. If You Have to Take Social Security at 62, You Shouldn’t Retire Yet

Then, I sometimes get people who are 62 years old and they say, “Hey, Jim, I’d love to hold off on Social Security, but I’m 62 years old, I’m about to retire, and if I hold off on my Social Security, I won’t have enough money to live comfortably. So I have to take the money at age 62.” And they don’t like to hear this answer, but if that is the case, I will often say, “Gee, I’m sorry to hear that, but the truth is you don’t have enough money to retire. You have to keep working.” By the way, that’s a very unpleasant topic. I’ve just had that with a very, very bright college professor, and she thought that she was going to be able to retire early and take Social Security, and we did a couple numbers for her, and it turned out that she would literally be broke in her mid-70s. So she couldn’t afford to retire. She had to keep working. Not a pleasant conversation to have.

Earlier, I had said that the people who are impacted by getting Social Security wrong are typically more often the people who need it the most. So, let’s say you have $3 million, or even more than a million dollars, which, probably most of our clients have, and you get Social Security wrong. Well, it’s not a good thing to get it wrong, but it probably isn’t going to be a huge thing in the big scheme of things in your retirement and estate plan. Yes, it’ll be important, but it won’t be the difference between being comfortable and not having enough money. On the other hand, let’s say that you’re closer to the border, and you’re like, frankly, most Americans, where you either don’t have enough money to retire, or you barely have enough money to retire. Then, getting Social Security wrong is going to have a major impact on your lifestyle and your long-term financial security. So, sometimes, when I give these workshops at hotels, and I track people that have more than a million dollars, and I go on and I talk about Social Security, and a lot of times, they get it and they do the right thing, but frankly, what I really need to do — but there’s nothing in it for me — is talk to the employees of the hotel, who don’t have a million dollars, and, in fact, I actually have been giving out my Social Security book to anybody who will take it, even though they’re not likely to become clients of mine just because I want them to be in a much stronger position. So, that is another problem that I see very often is getting Social Security wrong.

Dan Weinberg: And this week, CPA and attorney Jim Lange is talking about common retirement planning mistakes. Now, Jim, we’ve talked so far about failing to have a masterplan, we’ve talked about mistakes related to IRAs, Roth IRAs, as well as Social Security mistakes, taking Social Security too early. Let’s move on now to spending.

6. Spending Too Much in Retirement or Spending Too Little

Jim Lange: Well, I see spending mistakes in two basic directions. One is, and this is probably more common for the people that we see, spending way under what they could afford to spend, and we’ll talk about why that can actually be a mistake, and then something that we don’t see as much, but it does happen, and by the way, the consequences are much more severe in that case, which is spending more than people can safely afford to spend.

So, let’s do the first one first. So, let’s say that somebody after we “run the numbers,” and we take a look at all the person’s financial resources, let’s just say, for discussion’s sake, that they could safely spend, say, $10,000 a month, and, in reality, they’re spending maybe $4,000 or $5,000 a month, and they’re maybe thinking, “Well, gee, yes, I’m living relatively frugally relative to all my assets and my income, but that way, I can build my estate, and that’s actually not a bad thing, right?” Well, maybe, but let’s just take the premise, and we’ve allowed for a drop in the market and we’ve allowed for health-care problems, and we have made certain provisions for, let’s call it, the “what ifs,” including the very predictable what ifs like roofs and furnaces and weddings and those types of things. Let’s assume all that is taken into account, and clearly, the person could spend $10,000 a month in today’s dollars, and they are spending $5,000 a month. Well, what is sometimes the impact of that? Number One, they might be depriving themselves of things that they might otherwise want to do, whether it’s travel, and I’d say it’s even more critical in the, what I’ll call, younger, healthy retiree years when people have the energy and the good health that they could go out to travel, and they sometimes don’t because of budgetary concerns that are, frankly, self-imposed. It’s kind of like putting yourself in a jail. So, sometimes, you might not be able to travel. You might not be able to do some of the things that I like to see clients do, which is to spend some money taking care of themselves, whether it’s the quality of the food you buy or maybe joining a gym. In our case, we have a private trainer come to our house three times a week, and for an hour, he trains me and then he trains my wife, and we love the discipline of having him show up, and we just go ahead and do that. Well, yes, of course that’s costing money and, frankly, it’s more money than if we joined a gym, but it’s a very good use of our money, in my opinion. The other thing sometimes families don’t do that they could because they could afford to, and this I’ve actually spoken about before and it’s a lesson that I learned from my father-in-law, is take the entire family on a vacation. So if you could afford, say, a vacation every year, or even every two or three years, where you’re actually taking the whole family, boy, what a great thing that is. To me, my grandfather will leave a much more important legacy than the money that he will leave, although he will do that, too, but he will also leave a history of about maybe, I don’t know how many years, but probably by the time he’s gone, maybe 30 years of family gatherings, and my daughter, who happens to be an only child, she has a sense of clan and she knows all her cousins and they Facebook back and forth, and she really feels like she is a part of a family, even though none of that family lives, at least on her mother’s side, in Pennsylvania, because Grandpa splurged, if you will, and got the family together and continues to do that every year.

The other possibility for somebody who could afford to spend $10,000 … by the way, I’m using $10,000. Sometimes, it’s $20,000 or $30,000 a month, is that they could help their kids out while their kids are younger. If you think about yourself, maybe, let’s say, you’re in your 60s or 70s and maybe your lifestyle is somewhat set, and inheriting some money or getting some additional income now might not be a huge deal in your life, but think about what it would have meant when you were in your 40s. You know, you could’ve used it to maybe buy a nicer house, you could’ve sent your kids to private schools, you could’ve had better cars, you could’ve gone on maybe more vacations yourself, maybe you could’ve had piano lessons for your own child, again, education for grandchildren, but a lot of times, it makes more sense to give some of the money to your children while they are young enough to really enjoy it, and also, by the way, you can actually have some great tax advantages.

Now, the thing that I fear is when people are spending too much money. There, let’s say, the downside of that is they run out of money or, more realistically, they might not run out completely down to zero, but they put themselves in a position where they are seriously compromised in their retirement, and I hate to see that, and let me tell you, a class of people who are often likely to do this, and at the risk of sounding sexist, it’s often women who get through a divorce. So they were used to a certain lifestyle when they had either two incomes or a significant income, and now they are divorced and maybe there’s a marital settlement and maybe there is some alimony or child support, but if particularly the dependent spouse, that is, the spouse that isn’t working, doesn’t really kind of take a step back and say, “Gee, how much money can I afford,” I often see spouses be inappropriate. So, the Pennsylvania Bar Institute one time asked me to teach a class to attorneys who represent women going through divorces, and they wanted me to teach all of this technical stuff about how to get into IRAs before you’re 59½ and all this other stuff, and I said, “No, no, no. If you have to go into an IRA before you’re 59½, you have major problems.” Here’s the issue: A lot of times, the women, and again, I hate to sound sexist about this, but it’s often the women, they are terribly concerned about the impact to the children, so they don’t want to move. They want to keep the house that they have, so they often give up their retirement plan and they keep the house, when really, it might be much more appropriate for them to have the retirement plan, or maybe live in the house for a little while, but to really come up with a long-term plan so that they won’t be broke at 70. So, by the way, this is a well-known phenomenon. In fact, when I was going through this, I was thinking, you know, gee, I really ought to get this message to more women and maybe represent some women who are going through divorces, and all the other planners are saying, “Oh, no, women going through a divorce, they are a nightmare for a financial planner because they all spend way, way too much money in the early years and then they run out of money,” and, very frankly, I have seen that. So that is another problem. That’s one particular set of people who tend to spend too much money.

7. Both Spouses Need to Be Involved in Planning

Speaking of marriages, another common mistake that I see is not getting both spouses involved in the investments and the retirement planning and in the estate planning. A lot of times, that typically goes to the spouse that tends to like it more, at least the majority of the time. So, certainly, not always, that happens to be the husband, and sometimes, I literally insist that the wife come to the meetings because I want them both to be onboard, because I can’t tell you how many times the husband has made really lousy decisions that have a much bigger impact on his wife, and particularly if he dies first, than he would if they were keeping both people in mind. So, I actually like to get both husband and wife onboard, and even if the husband has, let’s say, been the one who’s traditionally taken care of it, even if he, let’s say, knows a little bit more about taxes and investments. I will also tell you that I sometimes think women are more intuitive and sometimes can make a better choice on who their advisor should be. So, very frankly, I have a slight ulterior motive of having the spouse in the room is that I think a lot of women see that I’m trying to protect both husband and wife in a way that is beneficial for them, and then it doesn’t need to be said, but I’ll say it anyway, I am a fiduciary advisor, meaning I always put the needs of my clients ahead of myself.

The other thing that I see that’s related to that is that there is insufficient preparation of what to do in the event one of you dies. Again, let’s take the know-it-all husband who has been doing everything, and maybe he said some things to his wife but she didn’t really understand it, and then he dies, and then now what? It’s much better to have a plan, and that plan goes well beyond actually having wills and trusts, but actually some idea of what to do, or the ones that we tend to prefer in our practice, and we actually talked about this many times, the Cascading Beneficiary Plan, where we let the spouse help determine the plan, and that is done within nine months of the first death.

The other issue, and I don’t know if it’s a mistake or not, but a lot of times, there is insufficient communication between parent and child about what is in the parent’s estate and what will happen after both parents are gone. So, I had one pretty sophisticated family, and one of my clients became the executor, and he didn’t even know that he was named the executor on the estate, and it wasn’t really a happy surprise, and a lot of times, what happens is people are, let’s say, children, particularly adult children, who are maybe in their 40s or 50s, yes, you don’t want to tell your kids too early that they’re going to receive a significant inheritance, but at some point, it often does make sense to get the children involved, and I know that, by the way, that’s partly an ethnic issue. When I was a very young accountant, I was working for, well, a very good CPA firm called Arthur Anderson that is no longer there, but I did some tax returns on the side, and I did the returns for a husband and wife, and I did it for son Number One and son Number Two and daughter Number One. So it was basically four returns, and I drove to their house, and I gathered up all the information, and then I went back to my office and I did the four different tax returns, one for husband and wife and the three returns for the kids, and then, one day, I drove literally and delivered it and said, “Here you go, husband and wife. Here’s your return. Brother Number One, here’s your return. Brother Number Two, here’s your return. Daughter Number One, here’s your return.” And they looked at it for a minute, and then they said, “Let’s see yours,” and then they traded tax returns. Now, I was brought up in a Jewish home and we never talked about money. So I was literally shocked when I saw this, you know, that everybody was sharing all that information, and frankly, at that point, the kids were young enough that, if I were the parent, I wouldn’t want them to know that they were going to receive a significant inheritance because I never want to reduce the motivation for a child to move forward in his career. On the other hand, if the child has a great career and he’s in his 50s, it might help his planning to have some idea. So, that’s also another issue that I see, which I’ll call a behavioral mistake.

Dan Weinberg: Jim, we’ve now covered the first big category, which was strategy mistakes, and now, let’s move into investment mistakes.

Jim Lange: Well, the biggest mistake that I see in investing, now, we are big fans of low-cost index investing, but even forgetting that, I wouldn’t call it a mistake to be actively invested; I would just call that a choice that I now believe is not optimal. But the biggest mistake that I see is not taking everything into account. So, let’s say, for discussion’s sake, that you have a pension and Social Security that totals $70,000 per year, and let’s say that your total expenses are $70,000 a year. So, more or less, your expenses are covered by your pension and your Social Security, and let’s say that you have a million dollars on top of that. Well, a lot of people would say, “Well gee, it should be 50 percent stock and 50 percent bonds.” Well, what I would say is, since you’re not really using money from your portfolio for your day-to-day living, you’re really a long-term investor, maybe even for your kids, and you could have a much different allocation, much more towards growth and long-term growth, so for example, a higher percentage in the stock market than you would if you didn’t have pension or Social Security. If you had a million dollars and you didn’t have a pension and you didn’t have Social Security, then you have to be invested much more conservatively in what we call the “bucket analysis,” meaning you would have maybe five different portfolios. You’d have one that’s very conservative that would be cash and CDs and maturing bond ladders, and if the market went down, that money would be protected, and then, on the other extreme, you would have a long-term portion, and that money might be in small companies — we’ll get to that mistake of not having enough money in small companies and international companies and even emerging-market companies. And then you’d have several portfolios in between. So, even though two people might have a million dollars each, depending on their other sources of income, we would often recommend completely different types of portfolios, and a lot of times, people don’t take into account their entire situation when they are doing their investments.

8. Diverse Portfolio Includes Small-Value Companies, Foreign Stocks

The other thing I just mentioned, and this is almost universal, is that we find not only do people sometimes get the percentages of stocks and bonds, what I’ll call, wrong or inappropriate, they will also get the allocation within the stock market inappropriately invested. Now, I have nothing against American companies and I have nothing against the S&P 500 index. I have money invested in it myself and I have recommended virtually all my clients have money invested in that, or, for an active money manager, large U.S. companies. But there’s two categories that are often, in fact, I’d say way more often than not, underrepresented. One is value. These are companies that have a lower price/earnings ratio, and then the second category that is underrepresented is small companies, and I don’t mean mom-and-pop grocery stores, but I mean billion-dollar companies instead of hundred-billion-dollar companies. So, over the last, say, since 1928, if you compare small companies, and particularly small-value companies, which is the most underrepresented, they have done almost 4 percent better than, let’s say, the large U.S. companies, and if you think about it, 4 percent a year is enormous. You might say, “Well, gee, Jim, then why doesn’t everybody invest in small companies?” The reason is is because they are deemed a higher risk, but what does risk mean? To me, risk means losing money in the long run, but that’s not the way risk is defined by typical advisors. It’s defined as standard deviation, meaning how much money the stocks fluctuate. Well, you don’t want to have small companies in money that you need next year because if there’s a greater fluctuation in the small companies and it goes way down and you need that money to live, then you have a big sell-off at a low price. But if you take those small companies that typically aren’t even in the portfolio or are underrepresented, and you put that in the long-term bucket, you don’t care if it goes up and down a couple times before that money is needed, and you can get a much higher return. So, we often see those types of problems.

9. No One Stock Should Represent More Than 2% of Your Portfolio

The other very common mistake is retirees have too concentrated a portfolio in either an existing one stock, and they always have their story: “Oh no, gee, Jim, I know I have, you know, 40 percent or 30 percent of my money in PPG,” but then they tell me how wonderful PPG is. And by the way, I’ve had the same thing with Westinghouse, and, of course, you saw what happened to Westinghouse. It went bankrupt. So I don’t care how wonderful you think any particular stock is. The general rule of thumb is you don’t want more than 1 percent or 2 percent of your portfolio in any stock. Yes, we’ve seen and can live with sometimes 5 percent or 10 percent, but to have much more than that, you’re just really asking for it, and I see that very, very commonly, and people are so worried about paying a small amount of capital gains tax and the step-up in basis rules, but they really don’t do this right.

The other very common mistake that we see for investments, people are emotional animals, and we make mistakes because of our emotions. So, historically, what do we do when we put our hand near a fire and it’s hot, so we take it out. So, basically, what that means is when we fear when the market is going down, what do we do? We sell. On the other hand, let’s say we’re very cold and we want to get our hand near a fire, let’s say when the market is really good, so we buy even more, where if you think about it, if you’re doing that, you’re buying high and you’re selling low, and that’s the worst thing you should do. You should do the opposite. You should buy while it’s low and sell when it’s high. This is not market timing. This is rebalancing. And again, so I’ve actually been to workshops for advisors, and the speaker said, “See the guy next to you? You should have him invest your money, you should invest his money, and you’d both be better off because you’d both take the emotions out of it.” And frankly, I think that there is a lot to that.

People don’t tax-loss harvest, which is another area. People often underestimate the dangers of inflation, so they tend to be too heavily invested in bonds, thinking that they’re being safe, but what they’re actually doing is they’re setting themselves up for losing money and losing purchasing power to both taxes and inflation, and in fact, it’s not a conservative plan to have too much money in stocks and bonds. It’s actually risking the perils of inflation. And the timing, of course, you know, people say, “Well, I’ll get into the market after it comes to a reasonable level.” Well, what’s a reasonable level? Unfortunately, they don’t ring a bell at the top and they don’t ring a bell at the bottom. For market timing to work, you have to be right twice. You have to be right on the time coming in and the time going out. We actually think that you should have a well-diversified portfolio. If you’re all in cash and bonds, maybe get into some stocks gradually on a dollar-cost average basis, but come up with a plan, let’s say, using the stack analysis, and then adjust the plan every quarter, or, at least, every year. And by the way, I could go on and on, but I also wanted to cover the last category of mistakes, which is mistakes in estate planning with wills and trusts.

Dan Weinberg: OK. So, Jim, what are some of the big mistakes you’ve seen in this area of wills and trusts?

10. Plan Appropriately for Your Biggest Asset, Your IRA

Jim Lange: Well, probably the biggest issue that I have seen is people not taking into account their largest investment. So, I often see clients coming in, or prospects coming in, and they have these great big thick wills and it goes on and on and has trusts and trusts for the spouses, which, by the way, is often inappropriate, but you see maybe very significant wills, and I say, “Well, that’s nice. Where’s most of your money?” “Oh, gee, Jim, 90 percent of our money is in our IRA or retirement plan.” And I say, “Well, can I see the beneficiary of your retirement plan?” Which, by the way, most people don’t have, but if we do eventually get it, it’s typically spouse first, kids equally second. I say, “So, let me understand this. You have a 30-page will that doesn’t control very much wealth, but the vast majority of your wealth, which is in your IRA or your retirement plan, is covered by two lines in the IRA beneficiary designation.” And they go, “Yeah, that’s right.” So, the mistake is not doing the appropriate planning for the biggest asset, which is the IRA and the retirement plan, and the other mistake is people think that their will controls the IRA or their retirement plan, and it does not. Now, maybe in the IRA or the retirement-plan beneficiary designation, you reference a will or a revocable trust, but if you don’t, then you have to have a self-contained beneficiary, and it should be taking everything into account. We talked earlier in a different show about the Cascading Beneficiary Plan, which is our favorite for married couples who have traditional families, but this is routinely botched, and I’d say probably the biggest mistake and the costliest mistake is not getting the beneficiaries of the IRAs and retirement plans done.

11. Strategic Decisions After First Death Are Crucial

The other problem is that we find people not making the appropriate decision after a death. Now, in our firm, we’re very, very proactive in terms of tax savings, and again, we had a whole show on disclaimers, but I am very, very interested in making the appropriate strategic decisions after the first death. So in order to do this right, you have to not only have the documents in place before you die, preferably with, what I will call, Lange’s Cascading Beneficiary Plan, but then also you should have in place a good strategy or come to a good strategy after the first, and even after the second, death. So, a lot of times, people are just not doing this.

Another mistake we find is people are not avoiding probate when they probably should be. The other thing that we find is people are doing these fixed-in-stone types of estate plans, which take away flexibility and options for the surviving spouse. So, what I really like to do is I really like to do everything right. So, I like to, you know, earlier, I had talked about coming up with a masterplan, and I like to do that right, and that masterplan will often include things like what you should be doing about Roth IRA conversions, what you should be doing about Social Security, how much money should you be spending, should you be making a gifting program, should you be setting up 529 Plans for your grandchildren, what kind of wills or trusts should you have, what should the beneficiary of your IRA or your retirement plan be, should that be the same as your Roth IRA or should it be different? Then getting to investments, again, ideally, we are big fans of low-cost index portfolios, but a very, very well-diversified portfolio. So if you were to own a portfolio of the index funds that we like, called Dimensional Fund Advisors, you would literally have representation by 13,000 companies in, I think, 40 different countries, and you get your safety, not by putting everything in CDs that would be limited to what the upside is, but you get your safety by investing broadly.

So where should some people go from here? Let’s say you’ve heard about some of these mistakes, maybe you’ve recognized that you have made some of these mistakes, and let me give you two options. If all you are interested in is new wills and trusts and retirement plans, you might want to call our office and get a free second opinion or a free initial consultation with Matt Schwartz, and again, for people interested, they would call (412) 521-2732 to set up a consultation with Matt for wills and trusts. If you are interested in the bigger picture that included some of the other things I talked about, including Roth IRAs and Social Security and investments, and you are considering having at least a portion of your money, and we do have a $750,000 minimum, but you’re considering having at least a portion of your money invested using these low-cost index funds with well-diversified portfolios that includes running the numbers and coming up with a masterplan, et cetera, et cetera, then you probably want to have that consultation with me, and by the way, you do have to qualify for that. But in either case, the starting point would be to call our office at (412) 521-2732, ask for Alice, and if all you are interested in is wills, trusts, avoiding probate, Lange’s Cascading Beneficiary Plan, et cetera, then the person you’re going to want to see is Matt. If you’re interested in the whole picture, then you probably want to see me. Again, (412) 521-2732.

Dan Weinberg: And you can learn more as always at www.paytaxeslater.com. While you’re at the website, you can get a free digital copy of Jim’s latest book, The Ultimate Retirement and Estate Plan for Your Million-Dollar IRA, and you can check out the archives of this radio show, nearly 200 hours of some of the best advice out there with some of the biggest names in finance, and it’s all free. For now, I’m Dan Weinberg. For Jim Lange, thanks so much for listening, and we will see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.

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