How Can I Prepare for a Recession?

00:00:00.000 | Welcome back Portfolio Rescue, as always I am joined by producer extraordinaire Duncan

00:00:20.320 | Hill.

00:00:21.320 | Duncan, last week the show was a little downer, I think, we had a lot of recession talk, and

00:00:27.440 | basically the idea was history has shown that the only way to get inflation down from current

00:00:32.040 | levels of like 8%, really high inflation, is to see a recession to pull that back.

00:00:36.000 | So let's play one of my favorite Austin Powers clips before we get into what I'm going to

00:00:39.080 | say here.

00:00:40.080 | "Allow myself to introduce myself."

00:00:44.960 | Alright, so allow myself to contradict my self.

00:00:51.000 | So I don't know if we're going to go into a recession, I was laying out the historical

00:00:54.520 | precedent for it, but let me contradict my self on this one.

00:00:57.880 | So consumers could cut back in the face of higher inflation, right?

00:01:00.560 | Higher costs mean I'm going to spend less on certain items, they could pull it back,

00:01:04.640 | or they could lever up and borrow or spend down their savings.

00:01:08.600 | If you think about it, inflation has really only been above trend, and I call trend 3%

00:01:12.520 | or so, which is what it's been for the last 100 years, since last April.

00:01:15.680 | So we're talking about a year with high inflation, higher than average inflation.

00:01:19.040 | Let me share some anecdotes from this week, see if this sounds inflationary to you.

00:01:23.800 | Delta's CEO this week said that they had the busiest two days of history for sales

00:01:27.800 | for the airline, ever.

00:01:29.640 | Ever.

00:01:30.640 | Busiest two days ever for sales.

00:01:32.400 | My Disney trip a few weeks ago just slammed with people.

00:01:35.400 | Ever since I started talking about that trip, I've been getting some tips and stuff from

00:01:38.600 | my DMs and email from Disney insiders.

00:01:41.180 | They said in March they think the park could have its biggest week ever.

00:01:44.920 | Ever.

00:01:45.920 | Places are packed.

00:01:48.560 | And let me tell you, inflation at Disney, if you think inflation is bad everywhere else,

00:01:51.760 | it's in the stratosphere there.

00:01:52.760 | Here's what people do not care.

00:01:55.040 | When we got back from Disney, we were kind of on the fence about doing something for

00:01:59.840 | spring break in April, and right when we got back from Disney, we said, "All right, let's

00:02:03.000 | book a trip."

00:02:04.000 | Basically, the entire state of Florida was sold out.

00:02:06.000 | Obviously, we waited a little too long, but there was nothing.

00:02:08.580 | No hotels, no resorts, no Airbnbs.

00:02:11.680 | Those are just kind of minor anecdotes.

00:02:13.160 | The housing market is still on fire.

00:02:14.280 | Two-thirds of Americans own a home, right?

00:02:17.200 | And rates are going up, right?

00:02:18.480 | Mortgage rates.

00:02:19.480 | If you bought a home before the last year or so, you've built up a ton of wealth in

00:02:25.840 | your house.

00:02:26.840 | My point is, there's a ton of pent-up demand from the pandemic.

00:02:30.620 | Consumers have spent the last two years repairing their balance sheets, paying down debt, building

00:02:33.280 | up savings.

00:02:35.200 | What if inflation is just this thing that was caused by exogenous shocks like the pandemic

00:02:39.760 | and a war?

00:02:40.880 | What if those things kind of improve in a couple months?

00:02:42.520 | I still believe the probability of a recession is higher today than it was a month ago, but

00:02:46.160 | I'm not 100% certain about that.

00:02:49.120 | I know we'll see one at some point, but I don't know.

00:02:52.000 | When will it be?

00:02:53.000 | I don't know.

00:02:54.000 | Jerome Powell yesterday, my colleague at the Fed, said the probability of a recession in

00:02:56.380 | the next year is not particularly elevated.

00:02:58.440 | So I don't know.

00:02:59.440 | Is it this year, next year, four years from now?

00:03:00.440 | I honestly have no idea.

00:03:01.960 | I do know that this is the craziest macro environment I've ever seen.

00:03:05.040 | So if anyone tells you who knows how this is going to play out and a recession is going

00:03:08.240 | to start here or not going to start here, they're either delusional or lying because

00:03:10.880 | no one really knows, especially with the setup we're going through.

00:03:13.360 | So that's where I am, and I know we're going to talk about recession talk today on the

00:03:16.720 | show again because we had some questions to follow up from this.

00:03:20.160 | I saw someone in the comments on Animal Spirits telling you guys that Kiyosaki turned out

00:03:24.680 | to be right.

00:03:25.680 | I think they were being serious.

00:03:30.020 | All right, so that's where I am on recession talk.

00:03:34.360 | So let's get into the first one because I know some people in the comments last week

00:03:36.520 | were asking after I kind of gave a little doom and gloom.

00:03:39.000 | So where are we at?

00:03:40.000 | Yeah, I love the first one here.

00:03:41.920 | We're starting off with a super, super brief one.

00:03:45.360 | So first up we have what are some of the moves you're making to prepare for the recession?

00:03:50.240 | And they're saying it like it's a foregone conclusion, right?

00:03:52.520 | The recession.

00:03:53.520 | I think this was a comment actually last week on last week's show from YouTube, so we're

00:03:56.000 | getting some good questions in there.

00:03:57.520 | Let's do a little recession history lesson.

00:03:58.840 | So John, give me a chart on of the dates for recessions here.

00:04:01.680 | So this is since World War II, so we're talking about the last, call it 80 years.

00:04:05.320 | We've had 13 recessions.

00:04:07.280 | That means you have one every five and a half or six years.

00:04:09.960 | Now, of course, that's on average.

00:04:11.640 | That's not, it doesn't come on a schedule like the train, although Duncan, it sounds

00:04:14.600 | like your train.

00:04:15.600 | The schedule doesn't really matter.

00:04:18.500 | So again, every five and a half or six years now, even though we just had one in 2020,

00:04:22.920 | you think, okay, it's going to be a while, but there have been recessions that happened

00:04:25.800 | pretty quickly, you know, back to back.

00:04:27.320 | So there was one that happened in the late 1950s and it happened again in 1916.

00:04:32.160 | There was a recession started in 1980, and it was six months long.

00:04:35.120 | Then in 1981, we had another one again, that was actually caused by the Fed to get rid

00:04:38.600 | of recession or to get rid of inflation, ironically.

00:04:42.040 | So it's not out of the question to have them relatively quickly in succession with one

00:04:45.120 | another, but even if we don't go into recession this year or next year, eventually it's going

00:04:49.760 | to happen.

00:04:51.400 | But I think preparing for recession is not what people think.

00:04:53.640 | Duncan, remember last week you asked me, when you got hit in a football game, was it better

00:04:57.480 | to know it was coming or be blindsided so you could tense up, right?

00:05:01.080 | I think that idea of tensing up is actually worse when you're thinking about a recession.

00:05:04.720 | So Peter Lynch had his quote where he said that far more money has been lost by investors

00:05:08.600 | preparing for corrections, trying to anticipate them, than lost in the corrections themselves,

00:05:12.960 | right?

00:05:13.960 | And I think the same is true of recessions.

00:05:14.960 | How do you prepare for one?

00:05:16.160 | The same way you prepare your finances for anything else.

00:05:18.880 | I don't think you change your portfolio because you think a recession is coming.

00:05:22.120 | You create a portfolio that's durable enough to handle a recession because you know it's

00:05:24.760 | going to happen at some point.

00:05:26.400 | And the other thing is, if you had the headline, "Recession is going to start in June of 2023,"

00:05:32.640 | even knowing that date, the idea of when to time your portfolio to get out of the market

00:05:37.320 | and then get back in, the timing on this stuff is really difficult because guess what the

00:05:41.800 | stock market is for looking?

00:05:43.360 | It could go into a bear market before a recession happens.

00:05:46.400 | It could not even go into a bear market because the government's going to step in.

00:05:48.560 | Who knows?

00:05:49.560 | How else do you prepare?

00:05:51.080 | A high savings rate is always a good cushion.

00:05:52.880 | But do you do that because of a recession or because having a high savings rate is good

00:05:55.720 | for you regardless?

00:05:56.720 | You do it because it's good regardless.

00:05:58.320 | You have an emergency savings fund.

00:05:59.680 | God forbid you lose your job, right?

00:06:01.420 | And the other thing is, we're talking about recessions like a contraction in GDP.

00:06:06.440 | You could always have a personal recession that has nothing to do with the economy having

00:06:10.400 | a contraction.

00:06:11.400 | You could lose your job.

00:06:12.400 | You could incur a huge expense because you have a big medical expense.

00:06:14.200 | You have something wrong with your house.

00:06:16.400 | You have a tree fall off your house, whatever.

00:06:18.220 | Your car breaks down.

00:06:19.320 | You could lose money on a bad investment.

00:06:21.320 | Plenty of people have lost 60 or 70% of their money investing in tech stocks in the last

00:06:25.240 | few years.

00:06:26.240 | And guess what?

00:06:27.240 | There hasn't been a recession.

00:06:28.240 | They just lost that money.

00:06:29.240 | So what am I personally doing to prepare for a recession?

00:06:31.000 | The same thing I'm doing outside of a recession.

00:06:32.840 | I'm saving money.

00:06:33.840 | I'm automating my investments.

00:06:34.840 | I'm spending on things that matter to me.

00:06:36.840 | I'm keeping my credit score up by paying down my bills.

00:06:39.600 | I'm only carrying intelligent debt, like mortgage and my home equity line of credit.

00:06:43.880 | And I'm making sure my credit score is up to snuff if I want to borrow some more money.

00:06:47.320 | Here's what I'm not doing.

00:06:48.320 | I'm not changing my portfolio because I think a recession is coming.

00:06:50.920 | I'm not burying gold bars in the backyard.

00:06:53.400 | I think the idea of trying to time this stuff, it sounds intelligent and it's like, I should

00:06:57.400 | prepare.

00:06:58.400 | I should get ready.

00:06:59.400 | But you should always have your finances prepared for a recession, whether it's the economy

00:07:03.320 | itself going into a tailspin, or your local economy, or your personal circumstances, right?

00:07:08.880 | So I think you just build that into your plan that something is going to go wrong eventually.

00:07:12.400 | You just don't know when.

00:07:13.720 | If not your backyard, where are you burying your gold?

00:07:16.120 | No, just kidding.

00:07:18.040 | I keep my gold on the blockchain these days, actually.

00:07:20.280 | That's safer.

00:07:21.280 | All right.

00:07:22.280 | Let's do another one.

00:07:23.280 | Okay.

00:07:24.280 | So up next we have a question from Jeff, who writes, "You guys often say that down markets

00:07:28.560 | are good for young investors with long time horizons, but can't they be good for early

00:07:32.360 | and regular retirees too?

00:07:34.480 | If I have a 60/40 portfolio with comfortably on a 3% withdrawal and have two years in cash

00:07:39.040 | to ride out a down market, can't my yearly rebalance help me buy low?

00:07:43.440 | I'm hoping to have a 40-year retirement and I'm 15 years away from max social security.

00:07:47.920 | Ben wrote a great post, as usual, on sequence risk, and by withdrawing from either my stocks

00:07:53.100 | or bonds for expenses and rebalancing, depending on what's up or down, a retiree can do fine.

00:07:58.040 | It seems like a down market could be my friend too."

00:08:02.200 | Duncan, we have some very astute viewers here.

00:08:04.800 | This is a great question and brought up some very good points, right?

00:08:08.680 | So I think that a lot of people say, "Why in the world would I own bonds right now?"

00:08:13.840 | If bonds are paying 2% for 10-year coverage.

00:08:15.480 | We've had a lot of those questions over the last months.

00:08:17.520 | Right.

00:08:18.520 | So bonds are paying 2%, inflation is at 8%.

00:08:19.900 | Why in the world would I ever own bonds?

00:08:21.240 | I think there's four reasons to own bonds.

00:08:23.060 | The first one is that bonds hedge against market volatility, and then for some people

00:08:26.340 | that means they hedge emotional volatility.

00:08:28.080 | So put this chart up here of when bonds outperform stocks, when the stocks fall.

00:08:31.600 | So this is every year going back to the late 1920s when the stock market fell, and the

00:08:36.640 | average down year in the stock market when it's down is about a 13% loss.

00:08:40.600 | Obviously the range is all over the place.

00:08:42.400 | But in those years when stocks fall an average of 13%, the bond market is up 5%.

00:08:46.680 | So this is the S&P 500 in 10-year treasuries.

00:08:49.060 | So bonds are a great hedge against a falling stock market.

00:08:52.480 | And guess what you don't want to do when they're falling?

00:08:54.560 | Sell your stocks.

00:08:55.560 | And that's as a retiree, if you don't have savings coming in anymore, you don't have

00:08:58.880 | that human capital anymore, you're gonna have to spend your portfolio down.

00:09:01.760 | So you don't want to sell your stocks when they're down and have a double whammy of stock

00:09:04.680 | losses and selling.

00:09:05.880 | You have those bonds for that stabilizer.

00:09:08.240 | And actually I looked at this, the only time that both were down in the same year, it's

00:09:11.760 | happened four times previously, 1931, 1941, 1969, and 2018.

00:09:16.080 | Right now, bonds and stocks are both down this year.

00:09:19.240 | So 2022 could be the next one.

00:09:21.280 | It's possible.

00:09:22.280 | Number two, bonds are a hedge against deflation.

00:09:23.960 | Deflation sounds like the furthest thing in the world from us right now since inflation

00:09:27.160 | is so high.

00:09:28.640 | Inflation is bad for bonds as a risk over the longterm.

00:09:31.680 | Deflation is actually, that's why you hold bonds.

00:09:32.920 | It's actually a good thing because your money's going up that you're being paid back.

00:09:35.560 | So no one thought inflation was going to happen until the pandemic hit.

00:09:41.080 | No one right now thinks deflation is going to happen.

00:09:42.760 | I tell you what, it's going to happen at some point, we don't know when.

00:09:45.640 | As our listener pointed out here, bonds can be used to rebalance, right?

00:09:49.760 | So you can either, when stocks fall, you can either spend your money from bonds and leave

00:09:53.520 | those stocks alone so they have time to come back.

00:09:56.000 | Or you can take those bonds, if you're not selling at all, and use it as dry powder.

00:10:00.200 | The whole point of buying low comes from having some dry powder.

00:10:03.080 | If you don't have savings anymore and you're a retiree, then bonds are your dry powder.

00:10:06.920 | And it makes a lot of sense.

00:10:07.920 | And of course, you're not going to spend all that 40% down.

00:10:11.140 | And now let's look at the, so of course, bonds as the spending, let's look why that's going

00:10:16.760 | to be the case.

00:10:17.760 | So let's put up this chart about how long it takes a stock market to break even.

00:10:20.320 | So this is historical bear markets, again, going back to the 1920s and it goes back to

00:10:25.080 | the Great Depression.

00:10:26.080 | And I looked, how long from the peak of the market to the trough and then break even,

00:10:30.120 | right?

00:10:31.120 | How long does it take?

00:10:32.120 | And the longest one ever is the Great Depression.

00:10:33.620 | It took 13 years.

00:10:34.720 | That's with dividends reinvested.

00:10:37.380 | But the average, even including that really long period, was two years, roughly, 2.2 years.

00:10:42.360 | Take the Great Depression out of there, that long one, that's your worst case scenario.

00:10:44.960 | It's more like 1.7 years to break even.

00:10:47.440 | Since 1950, call it more modern times, it's about 1.3 years on average from the time the

00:10:52.800 | bear market begins until you make your money back in the stock market.

00:10:56.080 | And so if you have bonds, that year-long period can seem like it takes forever.

00:11:01.620 | You don't want to be selling your stocks while they're down, while they're underwater.

00:11:05.520 | So that's the whole point of bonds, right?

00:11:07.240 | And the idea here, this reader said that they have a 3% withdrawal rate, right?

00:11:11.600 | I think one way to think about bonds for people in terms of, well, how do I set my asset allocation,

00:11:15.720 | especially retirement?

00:11:16.720 | I don't know what's the mix between safe assets and these assets I want to grow, because guess

00:11:21.240 | what, you have two, three, four decades left once you retire to still grow your assets.

00:11:26.200 | So this person has 40% in bonds, they're spending 3% a year.

00:11:28.960 | Taking out the whole inflationary thing of your spending, that's roughly 13 years of

00:11:33.420 | current spending in bonds.

00:11:35.200 | So that's how much of a buffer that this person has built in to allow stocks to come back.

00:11:39.440 | And I think that's the idea here, is that bonds can help you offset and not have to

00:11:42.400 | sell stocks.

00:11:43.400 | That's the biggest thing, is you don't want to make a bad situation worse when stocks

00:11:46.240 | are down by selling them.

00:11:47.580 | And that's what bonds can do.

00:11:49.060 | And so I think this person, great points, makes a lot of sense.

00:11:52.700 | That's kind of how you can think about bonds, though, in the current environment.

00:11:55.360 | Yeah.

00:11:56.360 | Yeah, good take.

00:11:58.860 | And so up next we have a question that is another long one.

00:12:06.180 | So this one is, "I've been a long proponent of directing my own investments.

00:12:10.000 | I do quite a bit of research and use a basic strategy primarily built on utilizing index

00:12:14.200 | funds with a splash of diversification into more fun and alternative investments as well.

00:12:19.440 | As my nest egg gets larger, I'm starting to worry that I'm leaving value on the table

00:12:23.480 | by largely ignoring tax strategy beyond funding my 401(k) and trying not to sell assets within

00:12:28.600 | the first year.

00:12:29.880 | I feel really confident in the allocation of my portfolio, but tax strategy seems like

00:12:34.120 | a mysterious thing that rich people use to get richer.

00:12:36.880 | At what point is there enough value to be gained through tax planning to make the cost

00:12:40.400 | of an advisor worthwhile?"

00:12:42.140 | I have my own little bit of follow-up question, like a noob whale question.

00:12:47.840 | What exactly do they mean by the cost of an advisor?

00:12:51.160 | Could you maybe just go over that?

00:12:52.560 | I think they're trying to determine when does it make sense to hire an advisor and then

00:12:56.460 | bring in some sort of tax planner to help?

00:12:58.840 | When is your situation?

00:12:59.840 | And so I think we're going to talk about that in the answer here.

00:13:02.060 | So we've talked about this before, Duncan.

00:13:04.160 | Taxes are one of the biggest question categories we get, by far.

00:13:08.000 | People hate paying taxes.

00:13:10.500 | So we needed to grow our tax team in the last couple of years, and we put out something

00:13:16.400 | on LinkedIn and we said, "Hey, we need someone named Bill, because our other guy, Bill Sweet,

00:13:20.120 | we need to keep it the same."

00:13:21.120 | So we got another guy named Bill.

00:13:23.120 | We were so lucky.

00:13:24.120 | Let's bring him in.

00:13:25.120 | Bill Artzaronian.

00:13:26.120 | Hey, Bill.

00:13:27.120 | Hey, guys.

00:13:28.120 | Thanks for having me.

00:13:29.120 | A tax professional at Ritholtz Wealth Management.

00:13:31.120 | Bill, how do you quantify the idea of tax planning when meeting the clients?

00:13:35.240 | What is a reason someone can reach out?

00:13:36.480 | Because obviously this person is thinking, "My life is getting a little more complicated.

00:13:39.940 | When does it make sense to talk to a professional and figure out if it makes sense for me?"

00:13:43.440 | Right.

00:13:44.440 | And it is really hard to quantify.

00:13:46.360 | We can quantify a portfolio through returns, but with tax planning, it's like, "Did I pay

00:13:51.040 | less tax?"

00:13:52.040 | And that's not always the best answer.

00:13:53.040 | Sometimes, and I'll give you an example of this later, sometimes paying more tax in a

00:13:56.360 | given year might be the right decision.

00:13:57.920 | But I've identified three tax events that make tax planning worth it.

00:14:03.880 | Number one is market events.

00:14:05.600 | We may be living through one right now, but let's take you back two years, February, March

00:14:10.380 | 2020.

00:14:11.380 | Aside from having an advisor to help walk you through a 35% drop in the market in 30

00:14:18.060 | days, there were tax savings opportunities in that window through tax-loss harvesting,

00:14:23.180 | through some other strategies that we can discuss.

00:14:26.100 | And so these market events come up every couple years.

00:14:29.100 | If you have a tax plan in place, you're there to take advantage of those.

00:14:32.260 | Number two is life events.

00:14:33.540 | So this is marriage, having a child, maybe a career change with equity compensation that

00:14:40.100 | you don't quite understand.

00:14:42.060 | Having an advisor or a team around you of professionals makes you more prepared for

00:14:46.180 | those types of events.

00:14:47.180 | And number three is policy changes.

00:14:48.940 | And these happen every, maybe twice every decade.

00:14:52.020 | But if you have a team around you to prepare and know your specific situation, these policy

00:14:57.820 | events, you can be prepared for them without having to read the legislation.

00:15:01.380 | Nobody wants to sit through tax documents and read what's new.

00:15:04.020 | You want to rely on a team of professionals to have you prepared for those moments.

00:15:07.380 | And maybe you could talk about the difference of hiring a CPA to do a tax return for you

00:15:11.860 | versus having an advisor who has a tax element to their firm, right?

00:15:16.260 | Because that's two different things as well.

00:15:17.820 | Yeah.

00:15:18.820 | Historically, these two functions have been totally separate.

00:15:21.380 | You've had an advisor, you've had a CPA, and they don't really communicate.

00:15:24.780 | They don't talk to each other.

00:15:26.740 | And I've noticed a lot of CPAs and tax professionals out there, they focus on tax and that's it.

00:15:31.360 | They bang out hundreds of tax returns each year.

00:15:34.100 | They talk to you once a year, they get you your tax return, they say, "Okay, call me

00:15:37.380 | in 10 months, we'll talk again."

00:15:39.500 | But what we do at RWM and some of our tax offering involves the portfolio, it involves

00:15:45.480 | a financial plan and we're now offering tax prep to some of our clients.

00:15:50.100 | And when you have those two things hand in hand, it makes your financial plan part of

00:15:54.780 | the tax planning process and you're able to achieve a lot more.

00:15:58.580 | And I want to give you a few examples of that.

00:16:00.780 | We started working with a small business owner in last year, 2021, and maybe I shouldn't

00:16:06.820 | say small business owner.

00:16:07.820 | This is a family that their small business net's $3 million in profit each year.

00:16:11.980 | And I took a look at their tax return and they were missing out on a huge deduction

00:16:15.780 | for small business income.

00:16:17.460 | It's a qualified business income, QBI, it's basically a 20% deduction on the net profit.

00:16:23.500 | But there are limitations to it.

00:16:24.940 | So this client, their CPA was not planning for these limitations and the CPA would get

00:16:31.220 | their information every January, give them a tax return and say, "Cool, that's it."

00:16:35.280 | But I looked at the tax return, I said, "All we have to do is make a few very minor changes

00:16:39.820 | and we can get you a much, much larger deduction."

00:16:42.620 | And the total tax savings for this family in 2021 alone was $150,000.

00:16:48.360 | So that's example one.

00:16:50.300 | Example two, and this is more common, 150 grand, that's an outlier.

00:16:54.060 | But more common, you know, we had a family that we were working with that was charitably

00:16:58.500 | inclined.

00:16:59.500 | They were giving away $10,000 to $15,000 a year, but they weren't receiving any tax benefit

00:17:03.220 | because they were still under the line between standard deduction and itemized deduction

00:17:07.540 | because they didn't have a mortgage, so they weren't itemizing their deductions.

00:17:11.100 | So they were taking the standard deduction each year while giving away $10,000 to $15,000.

00:17:14.940 | So what we used is, we used a donor advised fund, which is basically just a middleman

00:17:20.180 | in the form of an investment account where you put charitable contributions and then

00:17:24.180 | the donor advised fund sends out cash to the charities of your choice.

00:17:27.380 | And we bunched five years of their charitable contributions into a single year so they could

00:17:31.940 | itemize with a large itemized deduction in that first year.

00:17:35.460 | And then years two, three, four, and five, they were going to take the standard deduction

00:17:38.540 | anyway.

00:17:39.540 | So the total tax savings on this strategy was about $35,000 over that five-year period.

00:17:44.860 | And these things will not happen unless you have a team around you that knows what they're

00:17:49.660 | looking for.

00:17:50.660 | And these decisions are not made in a vacuum.

00:17:53.700 | So working with an advisor, working with an advisor with some type of tax background or

00:17:58.780 | a professional team who understands your very specific situation, it puts you in a position

00:18:03.700 | where you can take advantage of tax planning that you otherwise probably couldn't.

00:18:06.540 | So yeah, I think your point is like, if you do go to an advisor who does tax planning,

00:18:10.840 | the idea is not just they're going to find a bunch of mistakes you've been making.

00:18:13.500 | It's probably possible that you could find a bunch of stuff you're not even thinking

00:18:15.820 | about yet.

00:18:16.820 | And you haven't even thought to build into the plan and how it works together with the

00:18:19.500 | rest of your investments in your portfolio and all those other things, right?

00:18:22.100 | It's like this holistic thing where you can look at everything.

00:18:24.220 | That's right.

00:18:25.220 | And it may be once every five years that you find something.

00:18:28.420 | It's not going to, it probably is not going to be an annual thing where you're saving

00:18:31.580 | a bunch on taxes because you're working with an advisor, but working with an advisor puts

00:18:35.260 | you in a position where when the opportunity comes, you're there to strike on it.

00:18:39.740 | Yeah.

00:18:40.740 | So I think for this person wanting to know it doesn't make sense, I think it makes sense

00:18:43.820 | to reach out to someone and understand what are you going to be able to do for me tax

00:18:47.260 | wise?

00:18:48.260 | So here's my situation.

00:18:49.260 | What are you going to do for me?

00:18:50.260 | I think so.

00:18:51.260 | Having that conversation probably makes a lot of sense.

00:18:52.260 | All right, Duncan.

00:18:53.260 | Let's do the next one.

00:18:55.140 | Okay.

00:18:56.140 | I just learned something new.

00:18:57.140 | Donor Advised Fund.

00:18:58.140 | That's a new thing I can drop when I'm around finance people so they know I know what I'm

00:19:01.580 | talking about.

00:19:02.580 | DAF.

00:19:03.580 | Add it to your acronyms.

00:19:04.580 | Yeah.

00:19:05.580 | Okay.

00:19:06.580 | So up next we have a question from Gregory who writes, I like this one.

00:19:09.020 | I got on the ARC train at exactly the wrong time earlier this year.

00:19:12.540 | I don't believe in it and I'm tired of looking at my portfolio.

00:19:15.300 | So I'm interested in tax loss harvesting.

00:19:17.460 | Can you explain tax loss harvesting and how it works?

00:19:20.380 | I vaguely get the idea, but I want to make sure I'm selling my losses in the most efficient

00:19:24.260 | manner.

00:19:25.260 | Only in years when I want to offset short term capital gains, does it have to be short

00:19:29.420 | against short or long against long?

00:19:31.860 | Okay.

00:19:32.860 | Now this is probably something that a decent amount of people are going through right now

00:19:36.380 | if they got into this late.

00:19:37.380 | So as of right now, the ARC Innovation Fund is down 53% from all time highs and that probably

00:19:43.380 | is a little more than a year ago.

00:19:44.940 | So I'm sure a ton of money poured into this one.

00:19:46.780 | So there's a lot of people thinking right now if I, and I think I like the way that

00:19:50.100 | this viewer is thinking about this because they're saying, all right, I don't want to

00:19:53.580 | stick with it.

00:19:54.580 | I timed it wrong.

00:19:56.060 | Geez, I got to get out, but can I do it in an intelligent manner?

00:19:58.980 | So Bill, start off, what are the considerations here?

00:20:01.620 | What is tax loss harvesting in the first place that people don't know?

00:20:03.740 | And then what are some of the things that you can think about when trying to pull this

00:20:06.500 | off?

00:20:07.500 | Yeah.

00:20:08.500 | So first, honestly, if you're sick of looking at this position, whether it's ARC or whatever

00:20:13.060 | else, you're probably better off without it in your portfolio rather than looking at it

00:20:16.660 | every day.

00:20:17.660 | The psychological benefit of dumping it is probably going to be greater than any tax

00:20:21.100 | benefit you could see.

00:20:22.100 | Yes.

00:20:23.100 | The whole, "I'm going to wait until it breaks even," could just have you just pulling your

00:20:26.140 | hair out until it happens or maybe never happens.

00:20:28.300 | Right.

00:20:29.300 | Exactly.

00:20:30.300 | So tax loss harvesting, very simply, is selling an asset for less than you paid for it.

00:20:35.580 | When you capture a gain like that, when you realize, I'm sorry, when you realize a loss

00:20:38.380 | like that, they can offset your capital gains.

00:20:41.380 | Now if you have net losses, up to $3,000 of net losses each year can be used to offset

00:20:47.220 | your ordinary income, your wages, your other income on your federal tax filing.

00:20:51.940 | Excess losses carry forward into future taxes.

00:20:53.340 | By the way, can the government increase that amount because inflation?

00:20:57.060 | Let's put it up to $4,000.

00:20:58.060 | $4,000.

00:20:59.060 | I mean, this $3,000 limit has been in place since 1978.

00:21:03.320 | So we're talking probably close to-

00:21:04.820 | Is it really?

00:21:05.820 | Holy cow.

00:21:06.820 | Jeez.

00:21:07.820 | I don't know.

00:21:08.820 | I can't do that compounding in my brain.

00:21:09.820 | It's been 35 years.

00:21:11.700 | So yeah, it may be time for a change.

00:21:13.780 | So with tax loss harvesting, let's play with your ARC position.

00:21:17.180 | Say you have a $10,000 loss on the ARC position.

00:21:20.020 | You have no other activity for the tax year.

00:21:23.020 | $3,000 of that loss is going to be deductible on your tax filings, and then $7,000 is going

00:21:28.420 | to carry forward into the next year.

00:21:30.780 | Now let's say you have the $10,000 ARC loss, but you also have an Amazon gain of $15,000

00:21:35.420 | that you realize.

00:21:36.660 | So your net gain is $5,000.

00:21:38.920 | So the ARC losses are there to offset the gains from the Amazon position.

00:21:43.820 | In terms of ordering, now we haven't gone into short-term long-term, so let's do some

00:21:47.340 | ordering.

00:21:48.340 | First, your short-term losses offset your short-term gains.

00:21:51.900 | Next, your long-term losses offset your long-term gains, and long-term is a holding period of

00:21:56.820 | 365 days or more.

00:21:59.580 | If there are excess losses of one type, they can offset the net gains of the other type.

00:22:04.840 | So back to our example, $10,000 ARC loss, $15,000 Amazon gain.

00:22:10.140 | The ARC loss, let's call it a short-term loss.

00:22:12.540 | The Amazon gain is a long-term gain.

00:22:14.940 | You still have a net $5,000 gain.

00:22:16.960 | That's going to be a net $5,000 long-term gain because you had $15,000 of long-term

00:22:21.980 | gains versus $10,000 of short-term losses.

00:22:25.900 | Where this is most effective is probably in a portfolio that's mixed between passive and

00:22:31.780 | active.

00:22:32.780 | We do this through direct indexing through our Canvas platform.

00:22:35.900 | That's our passive investing platform.

00:22:39.000 | Other robo-advisors like Betterment do a nice job of this.

00:22:41.960 | But you find losses in your passive portfolio to offset gains in your active portfolio.

00:22:47.720 | So if you're able to do that, if you're able to have passive losses, you're less likely

00:22:52.200 | to worry about the tax on the gains in your active portfolio because you're trading in

00:22:56.400 | the active portfolio, but you have losses to soak up any gains.

00:22:59.220 | So that's where it's most effective is if you have kind of a mix and you're able to

00:23:02.220 | realize the losses in the passive side of the portfolio.

00:23:05.600 | Let's talk about one tax thing I know about.

00:23:07.300 | Let's say the wash sale rule.

00:23:08.300 | Let's say this person was a believer in ARK and they said, "I've got this huge loss, but

00:23:11.980 | I want to do something where I can sell these stocks, but I want to stay in the innovation

00:23:15.160 | game."

00:23:16.160 | So there's a bunch of ARK imitators now, right?

00:23:17.980 | I found another fund.

00:23:19.020 | So I sell ARK.

00:23:20.020 | I lock in this gain.

00:23:21.480 | I buy another ARK imitator from someone else that's these innovation stocks.

00:23:26.220 | How long do I have to hold that fund until I can then sell it and buy back into ARK

00:23:29.860 | without having some weird taxable thing that messes with my taxes?

00:23:33.400 | If you want to buy back ARK, and it sounds like our listener here does not, but if you

00:23:37.860 | want to buy back ARK, it's a 30-day waiting period.

00:23:41.220 | So you can't just sell for a loss and then immediately pick it back up.

00:23:44.620 | Right now you can do that in crypto, and that's kind of a little bit of a crypto loophole,

00:23:48.580 | but for an ARK position on a stock, you can't just sell it for the loss and pick it back

00:23:52.380 | up and reset your cost basis.

00:23:53.380 | There has to be a 30-day waiting period.

00:23:54.380 | And you have to be careful because if you sell ARK and you buy a substantially identical

00:24:01.260 | security, that would be a wash sale as well.

00:24:05.780 | Now that substantially identical ruling, that has not been challenged very much in tax breaks,

00:24:12.060 | so there's not a long history.

00:24:14.500 | But the IRS does have language to say you can't buy the substantially identical security.

00:24:18.700 | Duncan, are you ready to tax loss harvest some of those Robinhood holdings?

00:24:21.480 | I think I am.

00:24:23.140 | I think I've been doing it.

00:24:24.140 | All right.

00:24:25.140 | Bill, that was great.

00:24:26.140 | By the way, it's St. Patrick's Day and the first day of March Madness, and my one question

00:24:27.140 | is, why is this not a half-day holiday?

00:24:28.140 | Everyone's done working at noon.

00:24:29.140 | We need some time.

00:24:30.140 | I mean, there's probably 10 basketball games today.

00:24:31.140 | Duncan said he wanted to drink Guinness for the show.

00:24:32.140 | It was a little before noon, so we're not quite drinking yet.

00:24:33.140 | Bill, is that a signed basketball behind you?

00:24:34.140 | It's signed by Bill Hertz-Rooney, and so I play basketball with him.

00:24:35.140 | You know, I don't play with him.

00:24:36.140 | It's up for sale, if anyone wants to buy, it's up for sale.

00:25:01.380 | On that note, I've actually seen a video of Bill dunking a basketball on a regulation

00:25:05.260 | board.

00:25:06.260 | Oh, that's right.

00:25:07.260 | Yes.

00:25:08.260 | Bill, how tall are you?

00:25:09.260 | I'm 5'8".

00:25:10.260 | A CPA at 5'8" and can dunk.

00:25:12.300 | Wow.

00:25:13.300 | Wow.

00:25:14.300 | That's impressive.

00:25:15.300 | Not bad.

00:25:16.300 | All right.

00:25:17.300 | Thanks for all your tax help.

00:25:18.300 | We'll have to have Bill back on the show again because, again, we get so many tax questions.

00:25:21.740 | Keep those questions and comments coming.

00:25:23.340 | Remember, askthecompoundshow@gmail.com.

00:25:24.340 | If you want to go to idontshop.com, we have a new compound hat in there, I believe.

00:25:31.540 | We do.

00:25:32.540 | It's a flat brim, so Michael can't wear it.

00:25:35.660 | Tomorrow, Compound and Friends.

00:25:38.580 | Who's on, Duncan?

00:25:39.580 | Yes.

00:25:40.580 | So today we have Leanna Hawkins and Dan McMurtry.

00:25:43.620 | Awesome.

00:25:44.620 | Animal Spirits will be back on Monday and Wednesday.

00:25:48.060 | Everyone enjoy all the games, enjoy your weekend, and we'll see you next time.

00:25:50.820 | See you, everyone.

00:25:51.460 | Bye.

00:25:52.460 | Bye.

00:25:53.460 | Bye.

00:25:54.460 | Bye.

00:25:55.460 | Bye.

00:25:56.460 | Bye.

00:25:57.460 | Bye.

00:25:58.460 | Bye.

00:25:59.460 | Bye.

00:26:00.460 | Bye.

00:26:01.460 | Bye.

00:26:01.460 | (upbeat music)

00:26:04.040 | (upbeat music)

How Can I Prepare for a Recession? | Portfolio Rescue

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