Finance 101: February 2022

Last month the financial advisors at Ruedi Wealth Management wrote 4 more “Finance 101” columns for The New-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from February all four are below.

Avoiding Savings Burnout

Daniel Ruedi, CFP®, RICP®

Achieving financial goals takes time and effort. For long-term goals like saving for retirement, a person will need decades of unwavering, disciplined saving. But with so much time between setting a goal and achieving that goal, the possibility of simply getting tired of being so disciplined and “burning out” along the way is a serious possibility. A burnout can pause or completely derail your progress towards your goals, and is one of the key risks facing those preparing for retirement. But there are ways to avoid this burnout.

When financial goals are large and far away, it may be a good idea to break them down into smaller, short-term goals. This will provide a steadier stream of goals being achieved which can often provide the mental reward and motivation to continue moving forward. The key here is to strike a balance between having goals that are small and short-term, yet large enough to be meaningful.

For example, if a person wanted to save a million dollars starting from zero, if they set a singular goal of having $1 million dollars that goal may be far enough away to not feel anywhere within reach. A person could instead start small, and aim to save $10,000. Then perhaps the next goal would be to have $50,000 saved. The next steps could be to save $100,000, $250,000, $500,000, and then $750,000 before pushing on towards $1 million. Compared to just waiting to save $1 million, this person was rewarded by achieving meaningful goals six times along the way.

If achieving small goals isn’t enough for you, you may want to do the same thing you would do to avoid burnout in other areas of your life; take a break. A savings “vacation” can take many forms. A person could simply skip saving one month and spend the money on something they enjoy, or perhaps set aside a portion of their normal ongoing savings for a few months to fund a relaxing vacation in the near future. You don’t want to run to the extreme and miss out on entire years of savings, but often providing a little bit of leeway to take a break and reward yourself can keep you motivated to continue on your path.

Setting appropriate goals and treating yourself to savings breaks are things many people can do themselves. The important thing is to do whatever it takes to keep you constantly saving and working towards your goals. If you can’t do that yourself, you may want to talk to a financial advisor.

Discipline Equals Freedom

Paul R. Ruedi, CFP®

One of my favorite podcasters and Youtubers is a former Navy Seal named Jocko Willink. Jocko is an intense, gorilla of a man. If that didn’t make him intimidating enough, he is also a black belt in Brazilian jiu-jitsu. Naturally, this guy is right up my alley. One of the key lessons he constantly repeats is that “discipline equals freedom.” So much so he even wrote an entire book with the title. In life, if you do the things you need to do when you need to do them, you will be free to do the things you want to do when you want to do them. This certainly applies in finance as well, as disciplined spending, disciplined saving, and disciplined investing are the keys to financial freedom.

Disciplined spending is the first step on the path to financial freedom. Do you live well below your means? Or are you constantly trying to keep up with your spending by using credit cards or other forms of borrowed money? Disciplined spending provides you with the financial cushion you need, and those extra dollars can go towards saving and investing, allowing you to move towards financial freedom instead of being stuck in a cycle of keeping up with your debts.

Disciplined saving is also key to financial freedom. You must start early and be consistent. You can’t expect financial freedom to happen overnight. It may take decades of disciplined savings. Do your best not to interrupt that process and keep pushing forward even when you feel burnt out.

The final place you will need to practice discipline, is when you are investing. Commit to a sensible investment solution and then have the discipline to stick with it. Don’t go chasing investment fads and avoid unnecessarily tinkering with your investments. Keep your investment costs low, by owning funds with low expense ratios; ideally 0.50% or lower. It may sound boring, but boring gets results. You will also need to be disciplined during market declines, when most other people are not.

Discipline is important in all aspects of life. But as soon as you bring it up, it conjures up mental images of pushing through things that aren’t fun or rewarding in and of themselves. Finance is no different, as I’m sure being told about the importance of disciplined spending, saving, and investing feels like being lectured. But trust me, the financial freedom that discipline provides is worth it.

Why Own Bonds?

Paul A. Ruedi

I am known for being somewhat of an equity zealot. I firmly believe that investing in the great companies of America and the world through stocks is the best way to grow wealth over long periods of time. Bonds, on the other hand, provide little to no return once you account for inflation and taxes. So the question I often get is, why even own bonds at all?

Though stocks provide tremendous growth of wealth over long periods of time, their performance over short periods of time is inherently unpredictable. Large temporary declines and extended periods of little to no return are not just possible, they are to be expected. This may be okay for the saver who is not relying on their investment portfolio, but it can create real problems for someone who needs to withdraw from a portfolio to fund their lifestyle. From a financial planning standpoint, it is very helpful to balance the unpredictability of stocks with the more predictable returns of bonds.

For example, consider a person who is withdrawing 4% from a 100% stock portfolio. Withdrawing only 4% of a portfolio is likely sustainable over long periods of time if all goes well. But if a bear market comes along and cuts the stock market in half, that same withdrawal to fund your lifestyle is now depleting 8% of the portfolio. Moral of the story, a person who invested in 100% stocks could get unlucky with timing and have to deplete their portfolio at a rate that is detrimental to their financial plan.

Now consider if that same person had a balanced portfolio of 60% stocks and 40% bonds. Using the same 4% withdrawal means his or her investment portfolio has 25 years worth of withdrawals, and 10 years of those are in bonds. If that same bear market comes along, a balanced investor could rely on the bond portion of the portfolio for 10 years to allow the stock portion of the portfolio to recover.

The financial planning benefit of that is so great it is often worth trading off some of the return of stocks for the additional stability of bonds. But too much of the “safety” of bonds leaves investors exposed to the risk that inflation outruns their investment portfolio. Everything must be balanced. If you aren’t sure if you need to include bonds in your portfolio or are wondering how much is the right amount, you may want to talk to a financial professional

Will I Owe Taxes If I Sell My Home?

Paul R. Ruedi, CFP®

While it is always great to make money on an investment, the downside is that when you realize those gains it can count as taxable income and result in a hefty tax bill. With home prices rising rapidly, people who plan to sell their home this year may be wondering about the tax consequences of such a large transaction, as they will likely be selling at a material gain. The good news is, some or all of the gain on the sale of a primary residence may be excluded from your taxable income if certain qualifications are met.

Capital gains occur any time property is purchased and sold for a gain – that includes the sale of a personal residence. The tax treatment of capital gains depends on how long a person has held an investment. Gains on investments sold after being owned for less than one year, called "short-term capital gains," are taxed at your ordinary income tax rate. Gains on investments sold after being held for longer than one year, called "long-term capital gains," are taxed at more favorable rates.

For 2022, if your taxable income is less than $41,675 ($83,350 for couples filing jointly), you will not owe any taxes on qualified dividends or long-term capital gains. If you had between $41,675 ($83,350 for couples) and $459,750 ($517,200 for couples) of taxable income, then you will pay a tax rate of 15%. A person with more than $445,850 ($517,200 for couples) of taxable income would pay a tax rate of 20%.

Naturally, someone who plans to sell a home would be worried about bumping themselves into a higher tax bracket and owing 15% or 20% of their gain on the sale in taxes. Fortunately, a single person can exclude up to $250,000 on the sale of their primary residence provided certain conditions are met. That limit is double for couples, who can exclude up to $500,000. However, the key is that a person or couple must have lived in the home for two of the last five years to qualify for this treatment, and not necessarily in consecutive order.

If your gains extend beyond the exemption amount, any amount above the exemption will count as taxable income and you will owe taxes on that amount. This is something that will need to be accounted for when considering the sale of a property. Sellers should be aware of all the tax consequences of selling their homes. If necessary, they should seek out a financial professional to help them understand everything.

Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.