A client this week asked about a Roth versus a Traditional IRA. When I gave my answer he said, “You must write that in your next column.” My answer begins with this fable.
Farmer John looked at his freshly plowed field on a beautiful spring day. It was planting day and he could already taste the delicious corn that would one day be buttered on his plate. As he hefted his bag of seeds, a man in a black suit approached. Farmer John knew this man very well. He had seen him often and knew what he wanted.
Farmer Jane stood at the edge of her field as well. She was John’s neighbor and she too stood ready to plant her bag of seeds. Jane glanced over at John and noticed that familiar man in the black suit talking with him. Jane knew he would be visiting her next, same as he did every year. That man, was the taxman.
As always, the taxman had come to collect the tax, and the rate was 20%. Each year he made John the same offer. He could either pay the tax immediately, by giving taxman 20% of his corn seed, or he could wait until the end of the harvest season and pay 20% of the crop instead. The decision was John’s to make. Should he pay tax on the seed or on the crop? Soon Farmer Jane would be offered the same deal.
As it turned out Farmer John agreed to give taxman 20% of his seed and have his taxes over with. Farmer Jane, not wanting to give taxman any of her precious seed, decided on the second option. She would defer the tax and pay it on the crop at the end of her harvest. The question is, which farmer made the best decision?
John went ahead and planted his field. His seed didn’t go as far since he had given 20% of it to the taxman, but he was satisfied he had made the right decision, knowing that the large bounteous harvest would all be his.
Jane planted her field that day as well, filling up 20% more rows than John since she had the full bag of seed at her disposal. She was confident the harvest at the end of the year from her full bag of seed would more than make up for the tax she would then have to pay.
The two worked hard all season and since they were neighbors with identical soil and weather, their crops grew exactly the same. When harvest time came, John and Jane gathered up their beautiful corn and stacked it in their barns. Jane’s harvest was clearly more since she had planted more seeds. As they admired their beautiful crop, taxman arrived with his large truck and proceeded to load up 20% of Jane’s crop. As he waved goodbye, the two turned again to look at their storehouses of corn. The question is – who had made the best decision? (Answer Next Week)
We purchased an office building on Riverside Drive, looking to move to a more convenient and central location in our growing area. We also wanted to be on one level since many of our clients don’t do stairs as well as they used to.
The building was built in the late 90’s by a federal government agency and is in surprisingly good shape, but also lacks in some key areas. The property required compliance with current fire codes, updating equipment and systems for modern energy efficiency, and moving several walls to accommodate a new 100 seat conference room. Additionally, in the 90’s, digital communication did not exist. Today, we need modern media rooms where I can visit face to face with clients a thousand miles away.
Given the size of the project, there was some talk as to whether a full tear down and rebuild might be more cost effective. Ultimately, we decided a remodel would allow us to retain those parts of the building that were solid and still useful, while replacing or adding those features that our business would require going forward.
It’s definitely been an interesting project and, like most remodels, the design has changed a few times along the way. With remodels, there is always the potential for surprise with each wall you knock down. We decided these challenges were worth the cost savings over building new, including significant savings in fees and permits.
The other day while inspecting the property I thought about how similar this project was to what investors often face, especially if they decide to move their accounts to a new advisor. The new advisor usually makes the case that the portfolio needs some changes, sometimes significant ones. The decision has to be made, do you tear the whole portfolio down and start over? Or do you essentially plan to do a remodel? In each unique situation, proper time should be spent analyzing the options before you carelessly swing that wrecking ball against your portfolio.
For non-qualified accounts, unpleasant taxes could be incurred by a massive sell-off of assets, which cost must be weighed against the long term benefits of any change. Financial transactions often involve fees that should be calculated and taken into consideration. Sometimes, as with real estate, a full rebuild from scratch is the best option. Other times, there may be several positions in the existing account that could fit in well with the new plan, so you may decide to keep them. In this way, like any remodel, some existing structure may continue to offer the portfolio value.
If my completed building satisfies our company needs and does so at a reasonable cost, the remodel will have been the right decision. The same criteria is useful in deciding whether an investment portfolio needs a complete rebuild, or if a less dramatic remodel makes more sense. Regardless of which option you personally choose, think it through carefully. Once that wrecking ball strikes, it is difficult to turn back.
A recent newspaper story told of a college student who was visiting the Grand Canyon. When it came time to leave she was unhappy with the price of gas so decided to only buy enough to get her out of the canyon. Unfortunately, she took a wrong turn and got lost, resulting in her running out of fuel. She ended up spending five stressful days in her car before she was rescued, giving her plenty of time to regret the foolish decision made at that gas station.
Though running out of fuel in a car is a bad idea, running out in an airplane is often fatal. Surprising to many would be a recent story in AOPA magazine (Aircraft Owners and Pilots Association) that stated that on average there are three airplane accidents per week resulting from poor fuel management. Sadly, a large number of those accidents happen within sight of the destination airport. Fuel starvation accidents are uniquely tragic because they are almost always avoidable.
Like crashing short of the runway due to fuel starvation, there are many would-be retirees who make the same mistakes in managing their retirement assets. As if relying on luck to get them through, they continue pushing towards their retirement years without sufficient financial reserves in the tank.
There is an absolute in flying. If you run out of fuel the plane is coming down. There is also an absolute in retirement. If you run out of money, your plans will instantly change for the worse. What’s sad is that just as most fuel starvation accidents could have been prevented with only minimal adjustments to a flight plan, running out of money in retirement is also almost always avoidable by making minor adjustments along the way.
When I review financial plans I always look at least 20 years down the road, even if the person is 80. If a problem is detected 20 years out, it is usually easy to solve if you make adjustments today. However, if you allow your financial tank to approach empty, your options for a successful outcome disappear quickly.
I have listened to actual ATC tapes from hundreds of accidents. Sadly, I have heard the final words of many pilots. I imagined them thinking in those last moments how foolish they were to have not stopped and added some fuel when they had the chance. The saddest accidents are the avoidable ones.
I have reviewed financial plans with thousands of individuals and have found far too many who are content to only put aside in their tanks the minimum needed. They push towards retirement like a pilot with dangerously low fuel pressing towards his planned destination. The result of this attitude at worst is disaster, and at best is a life filled with unnecessary worry. Make a commitment to honestly assess what you will need in retirement, add a very generous reserve for those unplanned events, then track it carefully and always be willing to change course if the outcome is ever in doubt.
Hi, I'm Dan. I'm a CFP® Professional.
Securities and advisory services offered through Commonwealth Financial Network®.
Member www.finra.org / www.sipc.org , a Registered Investment Advisor. Wyson Financial, 375 E Riverside Dr, St. George, UT 84790
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