Hello, everybody. It's Sam from Financial Samurai. And in this episode, I want to talk about two subjects, one, capital preservation, and two, the right contribution order between your investment accounts. Now, obviously, 2022 has started the year kind of shaky. S&P 500 was down two and a half, 3%, the Nasdaq corrected by 10.7%.

And individual tech stocks, some of them have just gotten slaughtered. I mean, they've completely round-tripped since starting in 2020. Based on my 2022 stock market predictions, 5,008 on the S&P 500, I'm going to still hold on to that. So right now, we've probably got 7% plus upside, which actually seems reasonable.

But now that I think about it, you know, at the beginning of the year, 5% upside, if that were to come true, and you're putting all that risk for 5% upside, it just doesn't seem that worth it, right? Because clearly, we could have corrected 5%, 10% easily. And for what, for 5% upside?

It's something that we should all think about when we're putting our hard-earned assets, our hard-earned savings to work. Now, on the flip side, you know, how much downside could there be? I was thinking 10%, right? And that's happened for the Nasdaq already in the first 20 days. Now, for the S&P 500, I still think probably 10%.

So in other words, I don't think there's going to be a massive bear market or crash. I just think, yeah, 10% sounds reasonable. Based on high valuations, based on slowing earnings growth, based on slowing margin expansion growth, the S&P 500 earnings for 2021 were up I think 50%. 50%.

And as a small business owner, I see that too. Because 2021, you know, you got a really big rebound in demand, consumption spending, ad spending, and so forth. But 2022, I think it's just totally going to moderate, partly thanks to the law of larger numbers, where the year-over-year growth rates tend to slow down.

So let's talk about capital preservation investments now that volatility is back and uncertainty is back. So we've got hard cash you put on your mattress, treasury bonds of all durations. Hope you guys got some $10,000 savings bonds, I bonds, Series EE bonds, you know, pay like 7.1%. So that's the other thing.

Okay, 7.1%, I would think 80% of investors would take that for the S&P 500 in 2022. 7.1% is pretty good. And this is the other thing, when you invest in capital preservation investments, you might not get a great return, you probably won't get a great return based on what these investments are low risk, low return investments.

However, the gains you actually do get are not investing in risk assets that could go down a lot, right. So instead of buying an I bond with a guaranteed 7.12% interest rate, for example, you bought some tech stock that went down 40% because it missed revenue estimates by 3%.

And I'm talking about, of course, DocuSign just got crushed. And so it is a defensive way to make a little bit of money, but it's also a defensive way not to lose a lot of money. Now, if we go further down the risk curve for capital preservation investments, we've got annuities, I don't have any of those AAA rated municipal bonds, I've got actually a ton of those.

This is after I sold my house in 2017. I reinvest a third of the proceeds in municipal bonds, they've done well, steady eddy, you know, very tax efficient, no state income, no state tax, no federal tax, triple rated corporate bonds, right. Corporates, they issue bonds like crazy, especially in a low interest rate environment.

And obviously, every single corporate quality is different. Apple, huge, massive cash balance sheet, you know, they're one of the top rated, you know, and they pay a dividend, not bad. And the stock has done phenomenally well. Gold and other precious metals, right, when things are hitting the fan, you want to own real assets like gold, maybe some silver, you know, if you are a fan of, let's say, watches, gold watches, rose gold, yellow gold, all that, they've done pretty well.

If you look at the prices over the past 10 years. Now we have fine art, wine and other rare collectibles. And then we have target date funds, real estate and hedge funds. Again, this is about capital preservation and going along from the least risky to the most risky capital preservation investments.

Hedge funds are interesting, because investing in a hedge fund in my 401k actually saved me a lot of grief back in 2000 when the Nasdaq burst, right, this is like the first time the dot com bubble, I invested like 40% of my 401k in the and or tech fund, and somehow they were able to short the market and actually was up in 2000.

But since then, obviously, the fees right 2% and 20 kind of tough. It's a drag on returns. And given it's been a bull market since 2009. Overall hedge fund returns have been poor, because at the end of the day, they're trying to hedge. But going forward, maybe maybe 2022 2023 will be the year of hedge funds, as investors look to preserve their capital and make moderate returns, given so many of us have done so well, even in the just past three years.

But fees, fees, fees, fees, tough, which is why I think most of us should invest 80 plus percent in index funds and ETFs, and just set it and forget it and follow a capital allocation model. Now, in terms of what percentage of your net worth you should have in capital preservation investments, it's hard to say because there are so many different types of capital preservation investments.

My steady state risk free allocation is 5% of net worth for the less risky capital preservation investments, right. So I know that if all goes to hell, I'm going to be okay, because I can live off 5% of my net worth, you know, risk free includes cash, Treasury bonds, certificate of deposit, money market accounts, US savings bonds, and triple A rated municipal bonds.

And the bond portion of my passive income investments accounts for about $3,000 a month. So I really encourage all of you to review your net worth now, this week, and see what percentage of your net worth is in capital preservation investments, then you should figure out what percentage of your net worth is in risk assets.

And if the risk assets go down 10, 20, 30%, how are you going to feel you're going to be okay, you're going to be able to survive, because investing is the long game. The other thing to think about is how will your investments affect your mental health, the more you have, the more you're going to think about your money often, because the more you could lose, yeah, you could gain more.

But when you lose, and you have a lot at stake, it is really a mental mind bender where you start questioning the reason why you're working so hard at work, if your investments are losing money, and you can't even make enough from your day job to get ahead. I mean, these are the things that we all thought about in 2000.

In 1997, in 2008, and nine and 10. When you are working your butt off, and you can't seem to get your net worth to grow, it is a really disconcerting feeling. So for 2022, I'm kind of reserved to lose 10% on my investments. It's just a mental state that I'm in.

So that when things go bad, I'm just like, ah, okay, I'm losing money. We've had a great run, but let's be appreciative of how far we've come. Things don't go up in a straight line forever. Let's just be okay, because a lot of money and financial independence and wealth creation is mental.

You need the mental fortitude to keep on going. And you need the mental fortitude to not panic. So by having a percentage of net worth in capital preservation investments, it'll help you not panic, it'll help you give the liquid courage to take more calculated risks. Now, since the S&P 500 and the Nasdaq, and a lot of single stocks have done so poorly to start 2022.

One of the main questions I keep on getting is, you know, what should I do with my money? Should I sit on it? Should I invest in single stocks? Should I invest in that cryptocurrency, whatever it is? My answer is pretty consistent. And that is to follow an asset allocation model over the long term.

Try not to deviate from it, continuously invest in good times and in bad time. Because over the long run, if you invest money during correction in bear markets, it generally pays off if you hold on to it long enough. In my 2021 review, I revealed that I have 14 different tax advantaged and taxable investment accounts.

And that's across four people, right? So we're talking Roth IRA, custodial Roth IRA, custodial investment accounts, solo 401k, 401k traditional, no, no traditional IRA, rollover IRA, Roth IRA for the kids, and then 529 plans and so forth. So it's really complicated. And I think this is what you're going to find if you have a family, if you get older, and you start investing in all these different tax advantaged vehicles.

And if you start opening up different accounts with different banks to get some better terms and better rewards. So let's say you have money coming in every single month, the right contribution order between your investment accounts is to contribute up to the maximum contribution amount in your tax advantaged retirement accounts.

So this means 20,500 for your 401k and 6000 for your traditional and Roth or Roth IRA. It's weird that it's only 6000 still in 2022. When the 401k maximum contribution went up 1000 bucks, you know, inflation is here. So what's up with that, guys, but that's what it is for 2022.

And the idea is you continue to contribute the maximum, whatever the maximum is, and over a 1020 year period, you're going to wake up and I think you're going to be astounded by how much you will accumulate in these tax advantaged accounts. Now, if you want to achieve financial freedom earlier, it's kind of an interesting scenario because you can't touch that money without penalty until 59 and a half.

So ideally, you make enough money where you max out your tax advantaged accounts and contribute at least 20% after tax after tax advantage retirement account contributions to taxable investments, because at the end of the day, it is your taxable investment portfolio, or various portfolios and other investments that are going to provide and generate the passive income for you to survive and have the courage to leave your job early.

And the reality is, the contribution is capped for tax advantaged accounts, but uncapped for your taxable investment accounts. And these include alternative assets, real estate and so forth. Therefore, your ultimate goal, I really believe this is to try to accumulate three times more in your taxable investments than in your tax advantaged accounts.

So you got $100,000 in your 401k shoot to gain $300,000 in your taxable investments. And by the time you're 5060 this ratio, this is really I think a very important ratio to think about instead of just thinking I'm just going to contribute to my 401k and IRA. No, no, no, you got to get out of that mindset.

And think about that as automatic, as if you're brushing your teeth once or twice or three times a day, it's just automated, you got to do it. And then if that money is there for you after 59 and a half, awesome, it's like a bonus, but you never counted on it.

And more than likely, more than likely, you're going to get to that age and you'll be like, well, let's just have that money compound further, because you've been able to build your taxable investment portfolio. Now, not everybody obviously has the cash flow the income to contribute the maximum to the tax advantaged accounts, and then also contribute another 20% plus to taxable investments and so forth.

So let's talk about different scenarios. One scenario is a correction or bear market scenario. And I think this is one of the reasons why people are emailing me asked me, I'm just going to play softball the other week. And people are like, Sam, what should I do with my money?

Because, you know, the markets are correcting. So during corrections or bear markets, it's easier to sit on your cash and do nothing. However, the risk of doing nothing is that you eventually miss out on a recovery. And in the history of the stock market, and real estate and other investments, generally, these risk assets have recovered, they have recovered.

Therefore, it is recommended to always be contributing something no matter the market conditions. So as the saying goes, time in the market is better than timing the market, right? So dollar cost averaging is great for when things are going poorly. So if your funds are limited, all else being equal, contribute the most to the tax advantaged account that is farthest away from being tapped.

For example, let's say you're 47 years old with 13 years left to be able to tap your 401k without penalty. You also have a one year old who is 17 years away from going to college. To overcome your fear of investing and doing nothing, perhaps the right investment contribution order is to contribute the maximum gift tax limit to your child's 529 plan first.

With such a long runway, your chances of having a positive return increases. And hopefully you can zoom out you right you zoom out, you look at the stock market, real estate market and so forth and realize that over the long run, things turn out fine. And then once you contribute, let's say $16,000, which is the gift tax limit for 2022, you then work throughout the rest of the year to contribute the maximum to your 401k, especially if you're above the 24% marginal income tax bracket.

If you're not just try that is we're talking about the orders here. Now, of course, the order in which you contribute to your investment accounts is also dependent on the various portfolio amounts you have. For example, if your 17 year old daughter has a $300,000 529 plan, well, she is set.

Now let's look at your 401k balance at age 50. It's only $200,000. Well, you're not set. So therefore, the right order is to concentrate all of your cash flow to maxing out your 401k and contributing to your taxable investment accounts. And the only way to know whether you're on track for your age is to make honest assessments about your future income needs and expenses.

Over the years, I've tried to provide guides, you know, a couple posts include 401k savings by age, recommended 529 plan amounts by age, they give you guides, they're not, you know, the end all be all, but they give you guides for how much you should save and have invested by age so that by the time that event comes, whether it's going to college, or retiring, you're good to go.

A final scenario I want to talk about regarding the proper order of contribution between taxable and tax advantaged accounts is the early retirement scenario. If you plan to retire early and have limited funds, then the most appropriate investment contribution order is to build your taxable investment portfolio. Also work on building your real estate portfolio and all other non tax advantaged investment accounts.

Given you can't tap your 401k and traditional IRA without a penalty before age 59 and a half, you need to build your taxable accounts in order to survive off the passive income. However, before you retire early, you should still contribute at least up to the maximum 401k match if you have one right it's free money, never turn down free money.

That's a sub optimal move. If you have enough funds to max out your tax advantage retirement accounts and contribute to your taxable investments, then you should do both and keep on going. Your 401k and IRA will act as your retirement insurance policy in your 60s and beyond. And if you get desperate and really need the money, you can always borrow from your tax advantaged funds without penalty, or you can withdraw from your funds early and pay a penalty.

Obviously not ideal, but the the money is there if you want it and you really need it. And if you have a reasonable amount of retirement income, but still plan to earn supplemental retirement income after achieving financial independence, then you should open up a solo 401k. Don't forget about the solo 401k.

I forgot about opening up one back in 2012. When I left work, you know, I was just so thrilled to be done. I just wanted to travel and relax. The last thing I wanted to do was, you know, make money and then contribute more to my retirement accounts because I thought I was retired.

But obviously, within a year later, I was like, this is just too boring. I wanted to do something and learn and be productive member of society. So if you're a freelancer, a solopreneur, whatever, open up a solo 401k, and you can contribute the employee maximum plus a percentage of your operating profits.

I'm going to conclude here because the episode is getting quite long. But check out the couple of posts I've written various other scenarios. And it's good to have a discussion. Remember, nothing is guaranteed when we're investing money. So we need to have the proper asset allocation. Further, our demands for our retirement funds will be different at different life stages.

So having that mix of taxable and tax advantage accounts is important. And I think you should really really focus on building that taxable investment portfolio as large as you can. Thanks so much, everyone. If you enjoyed this podcast, please share it, leave a positive review and I'll talk to you guys later.