What's the Market Going to Do in 2023?

00:00:00.000 | Welcome back to Portfolio Rest, where we take your questions and answer them, provide some

00:00:21.340 | context, a little analysis. Remember, our email is askthecompoundshow@gmail.com. Today's

00:00:25.720 | sponsor is Craneshares. Craneshares is an investment company that allows you to invest

00:00:29.900 | in China, but they also have funds focused on the transition to renewable energies. Duncan,

00:00:33.800 | you can get behind this one. We actually had Luke Oliver from Craneshares on Animal Spirits

00:00:37.920 | I think just about a year ago, talking about investing in carbon allowances. Luke actually

00:00:42.320 | has a new piece up outlining how they work, how they tie into climate change, along with

00:00:45.940 | the investing implications. Worth a read. If you want to read this piece and learn more,

00:00:49.480 | go to craneshares.com. Duncan, we emptied our inbox for the last show of the year. I

00:00:55.480 | have a few questions on the stock market that we brought in Bill to answer all of your year-end

00:00:58.640 | tax questions. I just want to let you know, my Christmas present to you is that I let

00:01:04.320 | go of the idea of doing a 12 days of finance. I thought about it. I had it in a hopper.

00:01:09.280 | Some good musical opportunities. As long as you would have been able to sing them, that

00:01:12.840 | would have been good. I would have had to. My gift to you is not embarrassing myself

00:01:16.280 | by going through with it. So Merry Christmas. Thank you. All right. Let's talk about the

00:01:22.720 | live show at the end. Let's get into the first question.

00:01:26.720 | Wathen: OK. Up first, we have a question from Brian, who writes, "Big fan of the show and

00:01:32.560 | all the compound content. I know no one can predict the future, yada yada yada, but just

00:01:37.040 | between us, what's going to happen with the stock market next year? I'm not sure I can

00:01:40.500 | handle another year like 2022." Same, honestly. It's pretty rough.

00:01:45.540 | Lewis: The good news is, big, huge, back-to-back losses are pretty rare. Life would be a lot

00:01:50.140 | easier if I could just give you the answer to the question. I guess the good news is,

00:01:53.400 | there's not much connective tissue from one year to the next in terms of gains and losses.

00:01:56.760 | John, do a chart on here. I did a simple analysis of the average annual stock market returns

00:02:01.900 | following an up year or a down year, going back to 1928. The average return following

00:02:05.680 | an up year is 9.8%. The average return following a down year in the prior year is 9.2%. Really

00:02:11.280 | doesn't tell you much, so not much help here. But I know what you're thinking. A lot of

00:02:14.760 | people would come back and say, "Well, Ben, how many times has the stock market been up

00:02:18.340 | following a year where the Fed is in a tightening cycle, or when inflation remains above average,

00:02:22.780 | or when there's such a high probability of a recession, or when interest rates have risen

00:02:26.980 | so precipitously, or when there's going to be another fast and furious installment released

00:02:32.140 | in the following year?" Can you believe they're on No. 10 already?

00:02:35.700 | Lewis: I can't remember the last one I saw, if I'm being honest.

00:02:38.600 | Did they teach you about sequels in film school? Because that's obviously all you need to know

00:02:42.660 | to make hit movies.

00:02:43.780 | Lewis: That and horror films, easy money.

00:02:46.060 | I guess so. Here's my one big takeaway that's not really groundbreaking. The stock market

00:02:50.500 | is inherently unpredictable. Sure, we all understand the current environment and what

00:02:55.860 | it looks like, but that doesn't help you figure out how things are going to shake out. Just

00:02:58.460 | think about how many people at the end of 2019, coming into the year, forecast a pandemic

00:03:02.740 | that would cause lockdowns, quarantines, millions of people working from home, schools being

00:03:07.200 | shut down, the worst quarterly GDP print in modern history, and then the biggest government

00:03:10.840 | spending package since World War II. How many people had that on their bingo card? Of course,

00:03:14.560 | no one. Coming into this year, how many people predicted that a crazy person in Russia would

00:03:18.300 | invade an innocent country that would cause an upheaval in food and energy prices, and

00:03:21.580 | then we'd have the highest inflation in four decades, and the Federal Reserve would be

00:03:24.740 | actively rooting for the stock market to come down? No one predicted that, right?

00:03:27.880 | No.

00:03:28.880 | Let's do a tweet on here. This is Bloomberg's Jonathan Farrell. He posted this weekend the

00:03:33.020 | year-end 2022 stock market forecast from all the big banks and Wall Street firms. This

00:03:37.220 | was done at the beginning of the year, of course. You can see the range is anywhere

00:03:40.340 | in the S&P from $4,400 to $5,400. Right now, the S&P is trading around $3,800. Now, the

00:03:48.060 | point here is not to dunk on these Wall Street people who make forecasts. That's part of

00:03:51.220 | their job, but it's just to show how ludicrous it is to think you have the ability to predict

00:03:54.700 | what's going to happen over any year-long period. Sure, someone's bound to get lucky

00:03:58.680 | and nail it once just because of the sheer number of people making predictions these

00:04:03.060 | days, but I have no idea what's going to happen.

00:04:05.620 | Well, you've got to shoot your shot, right? I mean, that's...

00:04:07.260 | Sure. It's kind of fun to put stuff out there, but you have to think more in terms of probabilities

00:04:11.060 | and then tail events that could upend any of those probabilities. So, I have no idea

00:04:15.460 | what's going to happen in 2023, neither does anyone else. And I guess this is the reason

00:04:18.640 | you have a plan in the first place. If you knew it was going to happen, there would be

00:04:20.900 | no need for an investment plan. That's the whole point of a plan is because you have

00:04:24.980 | to kind of think in terms of probabilities and ranges of outcomes, and that's where I

00:04:28.820 | stand. So, not much help. I don't know if stocks will be up or down next year.

00:04:32.260 | All that being said, what is your S&P target for 2023?

00:04:35.300 | Well, what did you say yesterday? If stocks go up, you have a target, and if stocks go

00:04:39.060 | down, you have a target? That's not a bad way to put it.

00:04:40.820 | Yeah, I said, if stocks go up $45, $50, and if they go down $3,600.

00:04:45.260 | Okay. That's not a bad way to look at it. Because it gives you a range of returns, right?

00:04:48.860 | Yeah.

00:04:49.060 | I don't know. All right, let's do another one.

00:04:52.420 | Okay. Question two today is from Swayze. Cool name. "Higher inflation should be good for

00:04:58.820 | stocks. Not bad, right? If prices are rising in the U.S. economy, it means some group -- corporations,

00:05:03.900 | the government, or individual taxpayers -- is generating more income. If rent is up, my landlord

00:05:08.500 | is making more money. If gas is up, energy companies are making more money. If wages

00:05:12.300 | are up, individuals are making more money. The data shows that wage increases haven't

00:05:17.740 | kept up with inflation and taxes haven't gone up, which means that corporations, not individuals

00:05:22.580 | or the government, have to be the ones benefiting, right? So, corporate earnings in aggregate

00:05:27.100 | are only getting better in this inflationary environment. Is the stock market getting this

00:05:31.180 | wrong?"

00:05:33.420 | Obviously the stock market is right. I'll say that. This does make sense in theory,

00:05:36.420 | especially since you look at corporations. They have pricing power. They can raise their

00:05:40.100 | prices and pass along to consumers, which is kind of what a lot of them have done. Obviously,

00:05:45.020 | corporations have higher costs, too, so you have to think about commodity inputs and that

00:05:47.580 | sort of thing. But considering margins remain near or at all-time highs, this is kind of

00:05:53.420 | what's happened. But even if that's the case, high inflation is generally bad for the stock

00:05:57.140 | market. Why? Warren Buffett wrote a piece in 1977 for Fortune magazine called "How Inflation

00:06:02.580 | Swindles the Equity Investor." Inflation was scalding hot at the time. It had been running

00:06:07.540 | hot for a very long time, almost a decade. His main takeaway was that stocks are more

00:06:11.860 | similar to bonds than most people think, especially when it comes to a highly inflationary environment.

00:06:16.100 | For bonds, it's not necessarily the rates rising that hurts as much as the inflation.

00:06:20.660 | It's the real returns over the long term that can eat into bonds. So, he talked about how

00:06:24.020 | it might not seem to make sense since bonds have a fixed yield and stocks kind of have

00:06:28.300 | this return on equity, or earnings, which can vary. But his point was that, if you look

00:06:32.660 | back at history, the ROE, the return on equity for U.S. corporations, is relatively sticky

00:06:37.420 | and stable over the decades. He said it's like 12%. I think it's actually maybe gone

00:06:41.460 | up a little bit since then. The problem is, obviously, the price people are willing to

00:06:45.260 | pay for that ROE can vary, but here's a quote from Buffett. "Your future results will be

00:06:49.700 | governed by three variables. The relationship between book value and market value, the tax

00:06:53.520 | rate and the inflation rate." So, there we are. 12%, which is the ROE, before taxes and

00:06:58.140 | inflation, 7% after taxes and before inflation, and maybe 0% after taxes and inflation. It

00:07:03.500 | hardly sounds like a formula that will keep all those cattle stampeding on TV. As a common

00:07:06.700 | stockholder, you will have more dollars, but you may not have as much purchasing power.

00:07:12.180 | So the whole thing is, is that inflation is going to eat into your ROE, regardless of

00:07:16.180 | what happens to your earnings. Because if you look at it, the 1970s had really strong

00:07:20.580 | profit growth, right? It was up like 9.9% per year. If you look back at the last nine

00:07:25.780 | decades of earnings growth, the 1970s was the second largest earnings growth we've seen,

00:07:29.900 | on a nominal basis. Duncan, do you know what the first one was? Care to make a guess?

00:07:35.780 | No.

00:07:36.420 | The 2010s has the largest profit growth of any decade, going back to the 1930s. Mainly

00:07:41.580 | because banks got decimated in 2008, but still. So, the '70s was the second. That's great.

00:07:48.300 | It looks good on a nominal basis, but on a real basis, it really doesn't matter. Unfortunately,

00:07:51.580 | what this means is that high inflation tends to be bad for both stocks and bonds. Thanks

00:07:54.620 | a lot, Ben. You could have brought that to our attention. What's that M Sandler one?

00:07:58.580 | Yesterday? Things that could have been brought to my attention yesterday? P.S., if you're

00:08:02.180 | following along on my blog, I wrote about this exact relationship in February, why the

00:08:06.940 | stock market doesn't like high inflation. I wish I would have taken my own advice back

00:08:10.100 | then. At the time, I think the S&P was only down 3%. I guess I didn't think inflation

00:08:15.500 | was going to get as bad as it was. This is not a true not to brag, though, because I

00:08:20.420 | certainly underestimated how much damage high inflation could cause in rising interest rates.

00:08:24.940 | But that's a thing. I think that inflation just eats into your returns as an investor,

00:08:29.700 | whether you know it or not.

00:08:31.260 | Right. And you couldn't predict what your pals at the Fed were going to do.

00:08:35.060 | Yeah, those jerks. See, this is the problem. People were excortiating the Fed for years,

00:08:40.060 | saying all they do is care about the stock market. The Fed never once said, "We want

00:08:42.740 | the stock market to go up." This year, they said, "We want it to go down." Right?

00:08:46.140 | I just have to point out that you were giving Mike a hard time about granular, and you just

00:08:49.300 | said "excortiating" on a podcast.

00:08:52.020 | Pull that straight out of my rear end. Come on.

00:08:54.460 | One follow-up I do have about that question, though, is, like a wise man wrote in a book

00:09:02.020 | that I've been reading, "Saving for Retirement" --

00:09:05.780 | Took you long enough. Geez.

00:09:09.100 | But in there, it's the best thing you can do, right? The stock market is basically the

00:09:13.460 | best thing you can do for inflation.

00:09:16.420 | Over the short term, the stock market is going to be impacted by inflation. But over the

00:09:19.660 | long term, the stock market remains your best hedge against inflation. That's the problem.

00:09:23.220 | So, yeah, the takeaway is not, "So, that's why you shouldn't invest in the stock market."

00:09:26.820 | Yeah. It's just, over the short term, you're going to see some compression in valuations,

00:09:31.340 | and it's not very good over the short run for stocks. Over the long run, the stock market

00:09:35.180 | remains, because dividends grow above the inflation rate, earnings grow above the inflation

00:09:39.300 | rate, and that's why stocks do better than inflation over the long term.

00:09:42.980 | Yes, it still remains your best bet.

00:09:45.220 | That's an important lesson to make sure our younger and new investors are taking away

00:09:49.740 | from this.

00:09:50.740 | Great point. Yes. All right. Let's do another one.

00:09:52.980 | Okay. Question three. This one's from Nate. "Earlier this year, I sold some Palladium

00:09:57.500 | bars I originally purchased in 2005. From my internet research, precious metals are

00:10:01.820 | categorized as collectibles and are taxed at a maximum rate of 28%. Can I tax-loss harvest

00:10:09.320 | stocks to offset the capital gains from my Palladium sale? Are there restrictions on

00:10:13.740 | what can be offset by tax-loss harvesting, other than the $3,000 of income per year?"

00:10:17.740 | All right. Let's bring in the taxman himself, Bill Sweet, to answer this one. Bill, I'm

00:10:22.380 | not going to lie. I have no idea what Palladium is. I would have thought that was something

00:10:26.820 | that Bond villain tries to steal.

00:10:28.580 | Yeah. It sounds like it belongs in a nuclear reactor. Yeah.

00:10:31.580 | I did not know you could buy it and borrow from it. I guess it's some sort of precious

00:10:34.620 | metal. It is something people can... Duncan told us you can invest in it in ETF form,

00:10:39.420 | I guess.

00:10:40.420 | Yeah.

00:10:41.420 | Can you tell us a little bit about how the collectible stuff works? Because I have heard

00:10:43.700 | this before that commodities have a similar tax treatment to collectibles, how that works

00:10:47.260 | and how that interacts with your stock losses, potentially.

00:10:50.020 | Yeah. I'm fresh off my kid's Christmas concert, and we were not discussing Shea Stadium, Palladium,

00:10:55.180 | or EMC Squared, any of that. But yeah, this is a collectible. Ben, I know you're a big

00:11:00.580 | collectibles guy. Some of our sponsors, for example, do great work there. Anything that's

00:11:05.260 | an art, or let's say rug, I know Duncan's a big rug guy, antiques, metals, including

00:11:10.540 | ETFs backed by metals, gems, stamps, comic books, coins, alcoholic beverages that you

00:11:16.020 | don't consume, guys, that's the key, musical instruments, and historical objects, such

00:11:20.700 | as the copy of the Constitution I keep in my basement. Those are all subject to a maximum,

00:11:25.900 | maximum tax rate of 28%. So if your ordinary income rate is, let's say, 12%, 22%, or 24%,

00:11:32.500 | which is where it is up to about $195,000 if you're filing single, that would be actually

00:11:37.380 | just the lower ordinary income rate. So really, the 28% thing really only applies for people

00:11:42.500 | making, let's say, $200,000 a year or more. But that said, not sure how many Palladium

00:11:46.860 | bars we were talking about for our guy here. Ultimately, that can add up. Ben, the key

00:11:52.460 | question here is that can I net this out against my other capital assets? And the answer, fortunately,

00:11:57.860 | is yes, is that like other gains from property or losses, and boy, have there been a lot

00:12:02.260 | of losses this year, you can net out your capital gains from your Palladium bars.

00:12:05.540 | It all goes into the same bucket, right? All the losses and gains, net them out.

00:12:09.660 | Yeah. The technical answer is there's actually three buckets, right? So there's short-term,

00:12:13.460 | long-term, and then short-term, long-term from a partnership. But yes, the concept is

00:12:19.740 | the short losses net out the short gains. The long losses net out the long losses. And

00:12:23.020 | it all goes into one big blender. And at the end of that, whatever's left, depending on

00:12:26.620 | the nature of it, that can be taxed at a maximum of 28%.

00:12:29.060 | For most people this year, it's going to have to be long-term capital gains because there's

00:12:31.860 | not many short-term capital gains.

00:12:33.100 | Not a whole lot. No baking around. I mean, it is possible, right, if you got really lucky

00:12:36.560 | in the end of September. But ultimately, that's the case. So yeah, I think you've still got

00:12:41.500 | time. You have about, what, six trading days left, maybe four or five trading days left

00:12:45.220 | in the year to go ahead and realize some losses, right? Cryptocurrency generally is down 80%,

00:12:50.380 | 90% this year. So realize those losses, bake it off against your gains, and hopefully that'll

00:12:54.920 | make a dent in that tax that you're due in April.

00:12:58.060 | This might be a stupid question. First of all, I can't even imagine how you go about

00:13:00.580 | selling physical bars of a metal. Like, I guess it's a pawn shop.

00:13:04.340 | Pawn shop.

00:13:05.340 | Yeah, you don't have an exchange. You just put it in a mailbox with a sticker and somebody

00:13:08.180 | comes and takes it.

00:13:09.180 | But so how is the price set? So I can't just go somewhere and sell it for 50 bucks a bar

00:13:13.100 | and take a huge loss, right?

00:13:14.100 | Well, have you ever seen those stores that say, like, we buy gold here? It's got to be

00:13:17.340 | something like that.

00:13:18.340 | Yeah. They're everywhere in New Jersey. Yeah. Yeah. So I mean, you can walk in there with

00:13:22.180 | some metal and see what they'll do for you.

00:13:23.500 | Market price minus a broker fee.

00:13:24.500 | It seems like someone could intentionally take a big tax loss that way, right?

00:13:26.820 | I've personally never sold a palladium bar before, so I don't know. I feel like you'd

00:13:31.140 | need a nuclear reactor. It sounds like something like that to me.

00:13:34.100 | Do you have to smelt it?

00:13:35.100 | As opposed to the metal.

00:13:36.100 | Is there smelting involved? Yeah, I'm not sure either. But no, but congratulations. I mean,

00:13:39.420 | ultimately, if you've held that long, I mean, just about anything, you hold it for 20 years,

00:13:42.980 | generally you get some price appreciation, even good beer.

00:13:45.820 | Except for my old Beanie Babies and Pogs.

00:13:48.820 | Yeah, but at the high there in $1.99.

00:13:52.340 | Okay. Question four is from John. I'm about to rebalance my retirement accounts in January.

00:13:58.220 | I'm thinking of switching all of my index holdings from mutual funds to ETFs. Do you

00:14:02.300 | see any reason not to do this?

00:14:04.020 | All right. Here's the ETF pros. Lower cost, typically in a mutual fund. More tax efficient.

00:14:10.120 | Same exact strategy. The only thing I can think of that's easier with a mutual fund

00:14:13.860 | that you can automate purchases and sales easier in rebalancing, right? A little easier.

00:14:17.700 | You can do that with a lot of some places with ETFs now. What do you think? Is there

00:14:20.620 | any reason not to do this?

00:14:22.460 | Yeah. No, I can't think of anything significant. Probably the only advantage that you would

00:14:27.300 | have from a five ticker mutual fund, Ben, is exactly what you just discussed. That ultimately

00:14:31.580 | the systematic purchases tend to be a little bit easier because you're just doing that

00:14:35.220 | through the fund, right? You don't have to go through an exchange. Most exchanges will

00:14:38.740 | offer you commissionless trades, but not all, right? So ultimately you might pay some ticker

00:14:43.020 | charges. The other factor, Ben, I might just throw out, it's technical, but there's a bit

00:14:46.620 | of spread, right? With an ETF that you don't have to mess around with if a five ticker

00:14:49.380 | mutual fund. Every night those things rebalance at net asset value. And basically you're buying

00:14:53.660 | it net of any commission costs you might pay at net asset value versus an ETF where there

00:14:58.500 | might be a bit of a bid-ask spread or premium or discount on the trade. So that's really

00:15:04.260 | the only factor.

00:15:05.500 | But I think this is a great year to make this switch. It's been a very difficult year for

00:15:09.820 | just about everybody in just about every asset class. And so if your capital gains have been

00:15:13.580 | cut by 20%, let's say, on where you were this year, taxes are the primary reason why

00:15:19.220 | most of our investors, Ben, end up holding onto these legacy five ticker mutual funds.

00:15:24.180 | And the key difference though, you get this, the big benefit I would focus on is right

00:15:28.260 | now, like this week, probably right now, you're getting capital gains distributions from your

00:15:32.380 | mutual funds. So let's say a hypothetical, a US mutual fund, a five ticker mutual fund,

00:15:37.340 | they need to distribute by year end 90% of what they realize in capital gains throughout

00:15:41.380 | the year. A year like this, it's not just that prices are down, but typically there's

00:15:44.840 | more redemptions, right? Investors tend to get spooked when their investments decline.

00:15:49.020 | And so even if you hold onto those shares for a five ticker mutual fund, what tends

00:15:51.980 | to happen at the end of the year is you get whacked with a capital gains distribution.

00:15:55.820 | It just gets reinvested in the fund, but you have to pay tax basically on the actions of

00:15:59.300 | other investors.

00:16:00.300 | And as people make this shift, it's going to keep happening.

00:16:03.420 | I think so. I think so. So I think there's a long tail, right? Probably 20, 30, 40 years.

00:16:08.500 | But yeah, ultimately if you get ahead of it and some really awesome funds, some of the

00:16:12.540 | Vanguard mutual funds, some of the iShares, some of the other funds that are out there

00:16:15.420 | have had like 10%, 15% net asset value capital gains this year.

00:16:19.700 | So ultimately it's this process of do you bite the bullet? Do you rip the Band-Aid off

00:16:24.580 | and just realize the gains and move on into the ETF and then not have to worry about this

00:16:27.860 | again? Because the neat thing about an ETF is it can trade those low basis securities,

00:16:32.780 | those stocks with the market. And so ETFs throughout the year, if you have a good fund

00:16:35.980 | manager, they're stepping up their basis probably every day of the market, whereas a five ticker

00:16:40.320 | mutual fund cannot. That's the key difference.

00:16:42.060 | It almost doesn't feel fair to mutual funds. Yeah, no, it doesn't. But like dinosaurs,

00:16:47.980 | they might be getting obsolete, right? So they still have a place I think in investing.

00:16:51.460 | But I think the ETF in the late '90s, that was a strategically forward, sort of like

00:16:55.780 | the money market mutual fund was in the 1970s, 1980s. It just opened up the door to a new

00:17:00.700 | wave of investing and probably the thing that's going to replace ETFs, which we have been

00:17:04.660 | doing for our clients for almost three years now, the direct indexing approach, right?

00:17:07.940 | So the market's constantly evolving, in my opinion, constantly getting better ETF over

00:17:12.320 | mutual fund, I think now's the time.

00:17:16.500 | But they'll always have that extra character in the ticker.

00:17:19.380 | Yep. Yep. It's very cool. Yeah, no, but yeah, I think that's it. And now's the time, generally.

00:17:24.860 | Next question.

00:17:25.860 | Do it.

00:17:26.860 | Okay, this question's from John spelled with an H. The previous one was like Jonathan John.

00:17:31.340 | On episode 51, you addressed changing asset allocation as net worth increases. I have

00:17:36.900 | a follow up question. Looking forward to 2026, when the federal federal estate tax exclusion

00:17:42.780 | reverts to 2017 levels, maybe between six and seven million. Does it make sense to reduce

00:17:48.220 | risk as your net worth approaches this level? It seems like you have a partner on the upside

00:17:52.900 | 40% estate tax, while the downside risk is all yours. Am I thinking about this correctly?

00:17:58.700 | This is a subtle not to brag here.

00:18:00.340 | I have no idea.

00:18:01.340 | Yeah, these portfolio rescue questions constantly impress me, the listeners with their $7 million

00:18:06.460 | portfolios.

00:18:07.460 | Phil, I have no idea how estate taxes work. Explain it to me and what this change is potentially

00:18:11.220 | coming down the line.

00:18:12.220 | Yeah, so-

00:18:13.220 | Should this person die before 2026 to save on taxes?

00:18:16.220 | No, I would not recommend dying in order to save on taxes. That generally-

00:18:20.300 | Just checking.

00:18:21.300 | Yeah, we'd be putting literally the tax-

00:18:22.620 | Over all our bases here.

00:18:24.300 | Yeah, or whatever we want to say. But no, but it's an interesting question. So what

00:18:29.020 | the listener's getting at is, unfortunately, father time is undefeated, Ben. I hate to

00:18:33.660 | break this to you, the both of you, but there will come a time when we have to settle our

00:18:37.000 | affairs or for our spouses or loved ones. And yeah, if you happen to pass away and your

00:18:40.220 | net worth is above whatever the estate tax exemption today, it's 12.9, so effectively

00:18:45.580 | $13 million per person. If you're above that limit, there is a phase in the estate tax

00:18:52.020 | that applies. It starts at 12% and rolls all the way up to 40% of assets. And so what the

00:18:57.820 | listener is getting at here is that, ultimately, like you said, there's a partner, potentially,

00:19:02.740 | to realize some of the gains upon his passing or her passing. So ultimately, again, I wouldn't

00:19:07.580 | wish death on anybody, but thinking about how to plan for this, I think the solution

00:19:11.260 | is very easy. You just do your best to stay below the limit. What the listener is getting

00:19:15.180 | at to explain it, so right now, today, this very- or excuse me, next year, the estate

00:19:20.380 | tax limit is close to $13 million. However, the Tax Cuts and Jobs Act, the Trump-era tax

00:19:26.500 | code change of 2017, that is set to expire. It is set to sunset in Congress beginning

00:19:31.540 | in tax year 2026. And so at that time, we do expect the limit to revert. However, it

00:19:37.060 | depends on what Congress does between now and then. And as we're seeing this week, they're

00:19:41.260 | rushing through. I'm not sure if this is made news, but like a $1.2, $1.3 trillion spending

00:19:45.940 | bill. And so Congress tends to do things at the last minute. And I think my advice would

00:19:49.900 | be for somebody that's in between that range, let's say $7 and $13 million of assets, first

00:19:54.740 | of all, you won the game. So reducing your risk, I think, would be a great thing to play.

00:19:57.500 | But isn't this kind of like your thing? You always say, like, why would you not make more

00:20:01.020 | money just because you're paying taxes on that money? Is that not the same thing here?

00:20:03.740 | Yeah. Yeah. And then my point is that there's time. So if this tax law is going to change

00:20:08.220 | potentially in January 2026, and we know what the limit is now, you can start gifting out

00:20:12.860 | assets to your heirs in between now and then. Many states do not have a gift tax, New York

00:20:18.100 | among them. Many states do not have an estate tax at all. So you do have to pay attention

00:20:21.700 | to the--

00:20:22.700 | So this could be the kind of thing where you could do charitable contributions too, right?

00:20:24.740 | Front load those, potentially?

00:20:25.740 | That's where I'm going. Yeah. You don't just have to gift assets to charity, although that's

00:20:28.140 | a great thing to do, right? And leave a bequest at your passing to get below that estate limit.

00:20:32.180 | Sit down with an estate planner and attorney, write your will a little bit differently to

00:20:35.140 | take advantage of this. Or more so, make that choice. Do I want my money to go to the federal

00:20:39.060 | government or do I want it to go to my library down the street?

00:20:42.660 | Can you give your favorite charity bars of palladium?

00:20:45.220 | That is definitely something you could do and is subject to the property rules and would

00:20:48.900 | be a great way to avoid the 28% tax.

00:20:50.780 | The point here is, like, talk to an estate planner about this.

00:20:54.540 | This is very complex, but you have time to do it. I think generally, if your net worth

00:20:59.180 | is this high, absolutely. I think it's a great concept to think about lowering your risk

00:21:03.380 | if that's applicable. Sit down with a financial planner or CFP and think about it. But I also

00:21:06.820 | would sit down and talk to an estate planner. What do you actually want your money to do?

00:21:10.220 | If you don't care where it goes and you want to help finance the federal government, leave

00:21:13.480 | it alone. Let it compound.

00:21:14.480 | So here's someone who 2022 was a good year for. It had to decrease their net worth.

00:21:19.340 | If they're still looking at it, yeah.

00:21:20.340 | It's helping out with estate taxes.

00:21:21.340 | I think so. But the last thing, Ben, you know what the back tattoo is. I don't want to take

00:21:24.980 | my jacket off right now, but it reads Roth IRA conversion. And so if the government is

00:21:29.380 | going to get 40% of your assets, a great way to lower your estate tax is to voluntarily

00:21:33.580 | pay some income tax. And then that's less because, again, whether it's a traditional

00:21:37.100 | IRA or a Roth IRA, the 40% tax applies. So why not just fork that money over earlier?

00:21:41.900 | And then your heirs will get a Roth IRA and just distribute that over 10 years, completely

00:21:45.460 | income tax-free.

00:21:46.460 | Nice. Okay. All right. Speaking of Roth, we had a Roth question. We couldn't leave without

00:21:51.300 | asking one more of those.

00:21:52.300 | Oh, I'm in the right place.

00:21:53.300 | Yeah.

00:21:54.300 | Merry Christmas to me.

00:21:55.300 | Derek coming in with the Roth question.

00:21:56.780 | Let's do it.

00:21:57.780 | With time, the percentage of our portfolio that is Roth is less than 10% and getting

00:22:01.720 | smaller every year. At what dollar amount saved would it be beneficial for us to diversify

00:22:06.220 | and contribute retirement money into Roth or after-tax contributions? Should I shift

00:22:12.020 | and make after-tax retirement contributions now, despite being in a high tax bracket,

00:22:16.220 | which will largely eliminate the largest tax deduction I take every year? We don't itemize

00:22:20.980 | deductions.

00:22:21.980 | All right. He wants more Roth dollars working for him, which I'm sure you can get behind,

00:22:27.140 | Mr. Roth. What does he need to do to make this happen?

00:22:30.500 | So answer one is, this is a complex question and we cannot give people direct advice here

00:22:36.860 | on this show. Shout out to our Chief Compliance Officer, Patricia Hetzfeld. But in general,

00:22:41.980 | what I would advise somebody to think about is, what is my current tax rate? And they

00:22:47.500 | indicate high versus what is my future tax rate going to be? And that, to me, drives

00:22:51.620 | the traditional versus Roth conversation.

00:22:54.100 | Let me give you the Michael Kitsis answer, which I think in this scenario would be the

00:22:56.620 | right one, in that when you're contributing, I think it does make sense, especially if

00:23:00.620 | you're in a high tax bracket, which I would define as 32%, 35%, 37%. So we're talking

00:23:04.720 | people making $300,000 a year or more. Ultimately, I think it would make sense in that tax bracket

00:23:09.460 | to do the traditional first, right? Because ultimately, you can make a decision towards

00:23:13.260 | the end of the year, depending on your capital gains, depending on how many bars of Palladium

00:23:16.620 | you put in the mailbox and stuck a sticker on. Depending on your big picture scenario,

00:23:20.900 | you can make a choice to do a Roth area conversion late in the year. But ultimately, you cannot

00:23:24.980 | go back, right? So it's a one-way street. Once you make that Roth conversion, thou shalt

00:23:28.460 | not undo it anymore.

00:23:29.860 | So I think it would make sense in this scenario, generally, to do a traditional contribution

00:23:34.920 | throughout the year and then make a decision on whether Roth convert when you have a low

00:23:38.100 | tax year, when you have a tax break, when there's something else.

00:23:40.220 | So you're saying for most people making that Roth decision, you can wait till December

00:23:43.580 | and see how your year looks and kind of get a good idea and then decide whether you want

00:23:46.740 | to do it or not?

00:23:47.740 | Yeah, I think so. For somebody that's in a high tax bracket, Ben, that's exactly it.

00:23:50.100 | Because if you're paying 32, if you're paying 37%, you probably don't want to add to that.

00:23:54.020 | And the listener's question framework was, this is probably my largest tax deduction,

00:23:58.820 | my traditional 401(k). I'm putting $20,000 a year away and I'm able to deduct that. Do

00:24:02.900 | I want to flip the switch? And I would say, again, no, you probably don't. But you can

00:24:06.700 | make that decision on a year-to-year basis and do it via Roth conversion. But I probably

00:24:10.460 | in this scenario would contribute to the 401(k) on a traditional basis.

00:24:13.340 | We want to mention, we talked about this yesterday, 401(k) limit is going from $20,500 to $22,500

00:24:20.020 | next year.

00:24:21.020 | Yeah. Thanks, President Biden, right? Inflation cuts both ways. And yeah, for savers, that's

00:24:26.380 | a really, really good thing, right? So obviously, if we could choose, we would say no inflation.

00:24:29.740 | But the good news is anything that's inflation adjusted, including your tax brackets, including

00:24:33.420 | your standard deduction, that's going up along with inflation too, to the tune of 7, 8, 9%.

00:24:37.980 | So yes, that's a good thing for savers.

00:24:40.660 | Awesome. All right. The only other thing this person needs to do is ask their employer to

00:24:45.620 | start having a Roth 401(k), right?

00:24:47.420 | Yeah. And it's interesting too, the omnibus bill, it looks like there might be a provision

00:24:51.260 | that might come out starting early next year for the employer match to be happening in

00:24:54.940 | Roth contributions. So that's interesting because right now-

00:24:56.900 | Hand up, hand up. Omnibus.

00:24:57.900 | Yeah.

00:24:58.900 | No idea. I got nothing.

00:24:59.900 | Latin. I took Latin.

00:25:00.900 | Yeah, it's 6,000 pages of potential tax law. And it's not even real tax law yet, right?

00:25:07.620 | Because it hasn't been passed. So if you really want some bedtime reading, I think that's

00:25:11.180 | it for Christmas Eve.

00:25:13.220 | Speaking of reading, in this book again, another plug.

00:25:17.340 | Duncan, a company man.

00:25:20.060 | I learned how recent 401(k)s became a thing. I didn't know, like in the late '70s, right?

00:25:26.720 | I just, in my head, thought that they'd been around since at least like the '50s or something.

00:25:30.060 | That's why a lot of people need to give themselves a little bit of slack if you're not very well

00:25:33.680 | prepared for retirement. It's a concept that hasn't been around very long. It really hasn't.

00:25:37.780 | Yeah, most of the time you worked and then you died. That's my plan today, hopefully

00:25:41.500 | in my '90s. But no, the Roth hasn't been around since I think '95 it was signed into law.

00:25:45.940 | I don't think that you could do a Roth area until 1997. So yeah, we're only looking at

00:25:49.140 | 25 years. And that's not enough compounding for me, guys. I need some more.

00:25:52.980 | All right, we got one more.

00:25:53.980 | I'll always take more.

00:25:54.980 | Give it all to your kids, Bill.

00:25:55.980 | Always more compounding, right? More compound?

00:25:57.660 | Yeah, compound gains.

00:25:59.100 | Okay, so last but not least, when looking for a CPA or tax preparer, what are the smart

00:26:04.220 | questions to ask? How do I know if the fee is fair? Is there any correlation between

00:26:09.220 | net worth and the complexity of a tax return? Is there an advantage to seeking a CPA whose

00:26:13.980 | practice is within one's own state? So that's kind of a cheat because that's multiple questions

00:26:18.420 | in one, but they're good.

00:26:19.860 | This is a good, I'm actually surprised a lot of tax questions we get that we haven't gotten

00:26:23.700 | this one sooner. I mean, obviously, I think maybe everyone just assumed Bill would do

00:26:27.740 | pro bono tax work for everyone emailing into the show.

00:26:31.860 | I did have somebody send me a Chipotle gift card, which was very kind. Thank you, Bill.

00:26:34.980 | So beyond asking friends and family, where do you even begin trying to find some answers

00:26:39.140 | to these questions?

00:26:40.140 | Yeah, so like any other professional, ultimately, this is more art than science, right? So you

00:26:44.900 | can read reviews, you can do X, Y, Z. But the question was, what smart questions can

00:26:48.420 | I ask? So this would be my take on it. I think the big software providers, the turbo taxes

00:26:53.980 | of the world, the Intuits, the tax slayers, I think they do a very, very good job for

00:26:58.460 | the purpose of commoditized tax returns.

00:27:00.740 | So I would separate in my mind the work that is actually a tax filing, which in my opinion

00:27:05.500 | can be done mostly by software. Who knows, ChatGPT might come out with a tax filing service.

00:27:10.100 | We'll do it all through AI next year. And I think the cost for that is somewhere around

00:27:13.420 | $50 or $100, and maybe more if you're filing multiple states. But that to me is table stakes.

00:27:19.420 | So what questions should you ask a tax professional that you might want to be working with?

00:27:23.740 | My opinion, the cardinal sin, in my opinion, of most of the tax professional community

00:27:28.100 | is they are driving while looking at the rearview mirror. They do not care about what happens

00:27:32.020 | this year. They don't care what happens next year. They care about what happened last year,

00:27:35.780 | because ultimately, that's the business model. Can I crank out a tax return and charge $300,

00:27:39.340 | $400, $500, $1,000?

00:27:40.340 | We should also, full disclosure here, you used to run a CPA tax practice, right?

00:27:45.100 | I did. I did.

00:27:46.100 | Now you run a tax practice for us, but it was an actual tax preparation, tax filing,

00:27:50.700 | all that stuff.

00:27:51.700 | We have tried through our two years, and Bill Archeroni, big shout outs, because he's done

00:27:56.140 | amazing work here in the space and is taking a well-deserved week off. So I hope he's not

00:27:59.540 | watching today. But ultimately, he's spending time with his child. But ultimately, we have

00:28:04.220 | tried to solve for this. And the way we've tried to solve for this is by setting up a

00:28:07.460 | series of meetings throughout the year that's in concert with our work as advisors and start

00:28:12.900 | to look ahead. We build a tax return during the year, and then we sort of lay it all up

00:28:18.380 | with this fourth quarter meeting. So I think that back to the question, I would engage

00:28:22.780 | with the CPA and find out how much forward tax planning can I expect to receive from

00:28:26.220 | this relationship? Are we going to be able to meet in October, November, December? Are

00:28:30.020 | you going to be on vacation? Or is this something we can do? Because on 12/31, in about a week,

00:28:34.860 | Ben, it's too late. It's too late to make a charitable contribution. To make a charitable

00:28:38.140 | contribution on January 2nd, that counts in 2023. And so I would be looking, if you're

00:28:42.500 | going to work with somebody and work with a human being, I would be trying to engage

00:28:46.020 | their skills and get some forward tax advice. What can I be doing during tax season?

00:28:49.340 | So talking to someone in January or February might help out, because you're getting ahead

00:28:53.120 | of things a little bit.

00:28:54.120 | I think so. But ultimately, that's tax season, right? So I would probably just go with whatever

00:28:58.780 | you're doing this year and be looking for the next tax preparer, maybe in July, June/July.

00:29:04.060 | After they've been able to take a vacation, they're coming back, they're sort of thinking

00:29:06.580 | about, OK, how many people do I have in extension? That, in my opinion, is a time to engage.

00:29:10.340 | Last point I want to make, there are certain states that are very complex-- California,

00:29:13.460 | New York, Oregon among them, for example-- or states can be very simple. So there's no

00:29:17.500 | blanket answer here. Texas, Tennessee, Washington, they don't have a state tax, right? So you

00:29:21.020 | don't have to worry about it at all. Pennsylvania has a flat tax, not very complicated.

00:29:24.920 | So I think it really all depends on your specific situation, unfortunately, which is a terrible

00:29:28.140 | answer for an interview show. If you have a lot of palladium bars, probably something

00:29:32.060 | you want to talk about in advance. But I think the general gist is, how much forward tax

00:29:35.420 | planning am I going to get? Because that, I think, is the big advantage you get working

00:29:38.540 | with a professional versus software.

00:29:40.880 | My biggest thing, talk to more than one person, or more than one firm. You can compare and

00:29:44.680 | contrast a little bit, just to know what they're going to give you, what you can expect, what

00:29:48.440 | the fees are, all that stuff. Talk to more than one person.

00:29:50.400 | It looks like you've got a pretty nice TAM here, Bill. I'm seeing in the poll in the

00:29:54.880 | chat right now, 65% of people do not use a CPA right now. So there's pretty good--

00:30:00.280 | Yeah, the software is very good, Duncan. It's great. It's great. But like anything else,

00:30:04.560 | are you getting what you're paying for, right?

00:30:05.680 | I started out with TurboTax, and it worked until things got complex for me. Then I had

00:30:09.040 | to move on to Bill Suite.

00:30:10.040 | I used to do my own, and I would always upgrade for the audit protection, because I was like,

00:30:14.680 | of course, I have no idea what I just did.

00:30:16.800 | Right. Well, I'm sure it's worked out. I mean, the audit rate is hysterically low.

00:30:20.360 | That sounds like the warranty at Best Buy. That can't be worth it, right? There's no

00:30:23.920 | way TurboTax is going to bat for me if the US government comes after me, right?

00:30:27.080 | Yeah, I don't think so. I'm not going to render an opinion, but yeah, I can't imagine this

00:30:32.800 | working.

00:30:33.800 | SPF, FTX, they were using TurboTax, right?

00:30:35.000 | Isn't it like--

00:30:36.000 | For real? No, I'm not. That's not a joke.

00:30:38.840 | They were using QuickBooks, which I'm very familiar with. But yes, I find it great for

00:30:43.400 | a small business. But yeah, we weren't running anything near that line.

00:30:47.680 | Okay, I got you.

00:30:48.680 | But no, but isn't it like the insurance policies you get for if you go buy a toaster or microwave?

00:30:52.960 | That's all pure profit for the company, right? Because they very, very rarely end up replacing

00:30:57.080 | that. So yeah, I would agree. But I think it's like anything else. Are you getting what

00:31:00.520 | you pay for, and are you valuing the relationship? That, to me, is it. And some people do a great

00:31:04.680 | job, but most people don't.

00:31:06.160 | All right, we are off until the new year. Everyone's taking a break. Duncan, you met

00:31:09.480 | a bunch of our viewers at the live show last week, right?

00:31:12.400 | Yeah, no, it was great. At NASDAQ, and then at Perfect Pine afterwards. Met Dave from

00:31:18.520 | Michigan. He was awesome. Met George, a chef in Colorado Springs. He was very nice. Talked

00:31:24.660 | with a PhD academic researcher from California. We had all kinds of really cool people there.

00:31:29.960 | It was very intelligent amount of viewers here, don't we?

00:31:33.080 | The vibes are good.

00:31:34.080 | Definitely.

00:31:35.080 | Yeah, definitely.

00:31:36.080 | All right, thanks always for the people who show up live in the chat. Thanks, everyone,

00:31:38.920 | for listening and watching on YouTube. We appreciate all your feedback. Merry Christmas.

00:31:42.520 | Happy Holidays. Remember, if you have a question for us, askthecompoundshow@gmail.com. We will

00:31:46.940 | be back in the new year with plenty of new questions for you. See you then.

00:31:52.440 | Happy birthday, Sean.

00:31:53.440 | Big Sean.

00:31:54.440 | Yeah.

00:31:55.440 | That's right.

00:31:56.440 | Happy birthday.

00:31:57.440 | Thanks. That's tough.

00:32:16.760 | Happy birthday, Sean.

00:32:24.760 | you

What's the Market Going to Do in 2023? | Portfolio Rescue 57

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