Brian Perry

In addition to overseeing Pure’s investment offering and platform, Brian works closely with Pure’s financial advisors, helping provide them with the tools and resources necessary to serve their clients and continue the firm’s mission of providing the highest quality financial education and planning to as many people as possible. He has been actively involved in [...]

We’re halfway through 2021. Where do the financial markets stand? Pure’s Executive Vice President and Director of Research, Brian Perry, CFP®, CFA® provides an update and analysis of what rising inflation means for your investments, what’s next for markets as the Coronavirus recedes, and financial strategies for the rest of 2021.

Free Financial Assessment


How to Look at Stocks and Bonds

I want to start by talking about how to think about stocks and bonds. And, you know, when you build a portfolio, you want to think about a couple things. And one of the most important ones is that you want to be able to sleep at night. Right. And so it comes down to what kind of risk are you taking? What kind of risk should you be taking? And then should you worry about what your stocks are doing? And let me do a little bit of a drawing here.

How Do You Sleep at Night?

  • Where are you taking risk?
  • What’s the right asset mix for you?
  • Do you need to worry about what stocks are doing?

True story, I actually flunked second-grade handwriting and art and now I’m drawing on a whiteboard with my finger. So bear with me, but you’ll get the concepts. And what I want to do is walk you through an exercise that if you’re at home and you’re like what most people do, they go out, they buy some mutual funds or some stocks and bonds and they get a mix and there’s really no logic to it. So I want to walk you through an exercise for how to think about building that portfolio, not going to tell you what stock you should buy or anything like that. But how to think about how many stocks should you buy, how many bonds, how much cash, things like that.

And it all begins with what’s your required rate of return? What number do you need to meet your financial goals? And I’m going to make up a number here and call it 6. I’m not going to draw the percentages, but you get it, 6%. There’s no magic to that number. I’m only using it for an example. And because the math gets clean. And then let’s say you have two choices for investing. You can buy some large-company stocks and you can buy some small company stocks. And at the end of the day, the large company stocks are going to get you some returns, they’re going to get you 8%. And the small company stocks are going to get you some returns, too. They’re going to get you 10%. But now, in exchange for 10%, that basket of small-company stocks is going to bounce around a lot more. It’s going to go up more. It’s going to go down more. But it’ll get you higher returns over time. Again, these are hypothetical numbers, but the order of magnitude in the real world is about the same. Your choices then become, do you buy the large companies or small companies? Your other choice is, how much money do you put under the mattress? That’s your other investment choice. And so hypothetically, let’s say that your two choices, you decide you’re gonna buy large-company stocks. Some of your money is going to go in there. Some is going to go under the mattress. You need to get to the 6% number to meet your goal. So what are you going to do is you’re going to put about 75% of your money into large company stocks. 75% of 8 is 6. You meet your goal. The other 25% goes under the mattress. Right. Good news under the mattress, you’re not going to lose anything. It’s not going anywhere. Bad news is it doesn’t grow and it could be lumpy as all get out. Right? If instead you buy the small company stocks, though, again, more volatile, more risk. But if you follow the same exercise, you would need to put about 60% of your wealth in the small companies, 60% of 10 is 6. Again, you’re going to get your required rate of return. You’re going to reach your destination. But now 40% of your wealth is going under the mattress where it’s not going to fluctuate. Right. So the idea becomes that even though these large company stocks may be a little bit less volatile than the small company stocks, the idea that you could have more money under the mattress might make sense. Right. And here’s why.

Let’s say for round numbers, you had $1,000,000, I’ll write it as 1MM. And you had a 60/40 mix. You have $600,000, 600K in this example in small company stocks, and you’d have $400,000, or $400,000 under the mattress. Now, let’s say you’re taking $40,000 a year in distributions from your portfolio. Every year, you need to pull $40,000 from your wealth. Well, if you’re pulling $40,000 a year. And you have $400,000 in the mattress and you do some division, you get 10. And 10 is the number of years, it’s the number of years before you need to take any money out of your stocks. So think about it like this, folks, the next time somebody comes to you and says, hey, what do you think about the possibility of inflation? What if the economy slows down again? What if this market that’s been doing so well falls? What about the next election, et cetera, et cetera? You can say, I don’t care. You can say I don’t enjoy watching the market fall and it might well fall. But I know that I’ve got 10 years of spending underneath the mattress before I need to touch these dollars. And that’s how you think about building a portfolio, is you look for what rate of return you need to meet your goal? And then what’s the least amount of risk you can take in order to get to that goal? Again, nobody ever got on a plane and signed up for turbulence, but everybody wants to reach their destination. If you’re flying from here to New York, you want to make sure you get there. That’s the 6%. Focusing on having as much as possible underneath the mattress, that’s signing up for less turbulence along the way.

Reversion to the Mean is Still a Thing: Market Returns Before and After November 6, 2020

This chart, there’s a lot of numbers going on, but if you focus on a couple things, the gray is the performance last year. So that’s basically from the start of Covid. Right. The run up to start of Covid, through November through the election. Right. And you see that some things did badly, right. Not a big surprise as the world was falling apart and people couldn’t leave their houses, energy stocks didn’t do well. Neither did airlines. If you can’t fly. Why would airlines do well? Banks, hotels and resorts. Right. How many people went on a cruise in 2020? Probably not a lot. Right. And then you look at what did well, down here in gray, online retail. Well, if I can’t leave my house, I’m going to do a heck of a lot of shopping on Amazon. I’m almost positive I do because- I think it’s more my wife, to be honest with you, but every single day there’s packages and boxes packing up from Amazon, really single-handedly supporting that stock price. Maybe some of you can relate. Home improvement, if you’re stuck at home, you might as well fix up the house. Right. You’re there a lot. So you look at the stocks that did well, not a surprise. Groceries, you still need to eat.

But now let’s flash forward to from the time of the election to present. Right. Look at what’s done well. All these energy stocks have started doing really well. The airlines and cruises and stuff like that that were suffering during the pandemic have done really well as we started to look towards the end of the pandemic and move past the election. By the same token, those online retail and home improvement stocks and grocery stocks that were doing so well, they’re not doing terribly, but they have small losses, small gains, not nearly as well as the pandemic’s losers. And the point of bringing this up is to remember the age old adage that markets move in cycles. What did best last time may not do best this time. There’s going to be ups and downs, and it’s really, really important not to get sucked into what’s done the best lately, because reversion of the mean is very much a thing in financial markets.

Why Diversify? Asset Class Performance by Year, 2006-2020

And if you want more proof of that, I’m going to show you this kaleidoscope. Looks like if anybody remembers high school chemistry class, the periodic table. Right. So we’ve got across the top years from 2006 to 2020. Then we got annual returns for different asset classes, stock stacked from highest to lowest. REITs you could see had some good years. They also had some not so good years. You can see commodities here didn’t do very well for a while. Here’s large company stock, small company stocks. But if you’re at home and you’re looking at this, you might be squinting your eyes right now to try and find the pattern in this chart. And the pattern is simply that there is no pattern. It’s random. What did best in one year may not be the best the next. I mean, we had a pretty good run here for real estate investment trusts in some of these years. But it turns out that they didn’t do the best over time. There are kind of in the middle, right. So the idea here is look at the line. The line is an asset allocation portfolio. It’s a mix of all of these asset classes. And what you see is that never did the best, but it also never did the worst. It kind of went through the middle. And folks, that’s what diversification is. When you diversify, you are lowering the ceiling on your possible returns, but you’re raising the floor. Think about it like this. The Del Mar Fair is, I believe, still going on at a very low level this year, right, over by my house. And so you go to the carnival and there’s a game, there’s balloons on a wall. And the idea is you walk up, you pay $1, you throw a dart, you hit the balloon and you win a crummy plastic whistle. But behind a couple of those balloons is a gigantic stuffed panda. And that’s what you want to win for your kids or your grandkids. So if you walk up and you just get one dart and you throw it and you get that panda, you’re a hero. But what are the odds of getting that? If instead you walk up and you pay $20, you get 20 darts, you start throwing it, well, you’ve drastically increased your odds of getting the panda that you want. Now, the best possible outcome is you pay $1 for one dart and win the panda. If you diversify, if you buy 20, you’ve lowered the ceiling, you removed the possibility of getting the single best asset class, just like if you’re trying to pick what does best year to year, what’s going to do best next year. If you stop trying to do that, you’re going to lower your potential returns. But with the panda throwing 20 darts, you raise the floor, you increase the odds, you get the outcome you want. That’s diversification in a nutshell. It’s lowering the ceiling. It’s raising the floor and increasing the odds. You get what you want out of your finances. That’s the goal for most people trying to save for, enter into, any final financial goal and then particularly into retirement is, you need to be getting 20% a year is great, picking the best stock, the best asset class, but avoiding those devastating years or periods when all your money’s in one or two asset classes. Imagine if you had concentrated in commodities. They did really well for a period in the mid 2000s. But look at this run. Second worst performing asset class in 2011, worst in 2013, ‘14, ‘15 and ‘16. Second worst in ‘17. Imagine if you’ve moved all your money when commodities were doing great in the mid 2000s into commodities just when they suffered. Right. So again, that concept of diversification is really powerful. Depending on what your goals are.

Premiums Compound Over Time

Even more so is think about it like this. What if when you went to that carnival with the balloons, the person working there said, hey, the boss doesn’t tell me where the big panda is, but I’ve been working here for a decade and I can tell you that it seems like the big yellow balloons on the corner seem to have more of the pandas? Well, you might not throw all 20 darts at those yellow balloons, but you might throw a few more. Makes sense, right? You’re increasing your odds of success. Something similar happens in the financial markets. Over time, there are different kinds of stocks, large companies and small. A large company might be McDonald’s, a small company might be Dennys. And then there are what are known as value stocks and growth stocks. Value stocks are a little more beaten down. They’re less expensive. Their business model may not be exciting. They may not be growing, but you pay less. Growth stocks are rapidly expanding companies. Maybe it’s your Tesla or something like that. Whatever. A company is really growing quickly, but you pay a lot for that growth, right? Over time, academics have dissected the data and said, well, what does better? Do large companies or small companies do better? What about value or growth? And what they found is that different kinds of stocks do better.

So if you look at the data, the data goes back to 1929 right before the Great Depression. And if at that time you’d put $100 into all the large companies, basically the equivalent of the S&P500, you bought all of these, it turns out that today you’d have about $600,000, right? So $100 into $600,000 by buying all the big companies over the last century. That’s the power of capitalism right there. Your timing wasn’t very good, investing right before the Great Depression and World War II. But it turns out if you just like good companies grow, some faltered, some went out of business, some expanded, some new entrants came in. But you just kept buying them all and the performance was pretty fantastic. But what the academics have found is that instead of buying all of these, let’s see if we can find an eraser here, instead of buying all of this. If instead you just bought here, you just focused on the large value stocks, instead of $600,000, you’d have about $1,300,000. So about twice as much money by buying the large value instead of all the large. A little bit counterintuitive. Right. You might think that that growth stocks do better than value because they’re expanding more quickly, but they don’t. Turns out value stocks do better. Right. Well, the way I think about that is that- see if my eraser works here- the way I think about that is if you’re in real estate, think about this. If you were looking at a couple of condos to rent and they were both, they were both pretty similar, similar block, one was going to pay $1000 a month in rent. One was going to pay $1500 and the price on one was a little bit lower than the other- you know price matters. If you can buy a similar set of cash flows for less money in real estate, you’re usually going to do better off. The same concept holds true in the stock market. Now, I mentioned small companies before had higher returns. How much higher? Well, it turns out that if instead of buying all the large companies 100 years ago you bought all the small companies, instead of $600,000, you’d have about $2,700,000. So about 4X times more money for buying all the small companies over all the large companies. Now, it would have been a bumpy ride. There would have been more turbulence, but I’ll take $2,700,000 over $600,000 any day.

All right, so if we know now that small companies have done better than large companies and value companies have done better than growth companies, we’re dialing it in here. What if we bought all the small value companies? Well, instead of $600,000, instead of $1,300,000, instead of $2,700,000, if you bought all the small value companies, it turns out you’d have about $7,800,000. So about 13X more money buying the small value over all the large companies in the last 90 years. It’s a pretty dramatic difference, right, $7,800,000 over $600,000. I live in San Diego, and even today with home prices, I think you can find something for $7,800,000 in San Diego if you try hard enough. You might have to cut your standards or kind of look for a little bit smaller house, but there might be something out there. So the suggestion isn’t that you put all your money in small value. It’s just that you look at what sort of stocks you own, because what happens is that a lot of people wind up heavily clustered in just the large companies and particularly the large growth companies. These concepts, the small versus large, this value versus growth, this doesn’t work all the time, but it works over time. So there’s no guarantee that you’re going to get the returns that you want each and every year.

The Value Premium

These concepts, the small versus large, this value versus growth, this doesn’t work all the time, but it works over time. So there’s no guarantee that you’re going to get the returns that you want each and every year. So here’s the value premium, right, and what you see here is that value stocks versus growth stocks going back to 1932 for rolling 5-year periods. And any time you see blue, that’s years in which that the value stocks were doing better than the growth stocks. Any time you see red, the growth stocks were doing better than the value stocks. So I would point out a couple of things. One, is that there’s a heck of a lot more blue than red. And that makes sense. If value stocks are going to outperform growth stocks, they should do better more often. And they are. But the other thing I’ll point out is that it’s not always blue. There are periods in which growth stocks outperform value stocks. In fact, some of those periods have been quite recently. Since the great financial crisis of 2008, 2009, growth stocks have mostly outperformed value stocks. It’s changed a little bit here in the last 6, 9 months. Value stocks have started to pick up and do better, but there is a long stretch where growth stocks outperform. So, again, two things. One is that you’re not putting all of your money in value or growth. You want some of both so that when you’re getting the blue periods, you’re doing OK and when you get the red periods, you’re doing OK. That’s diversification concept.

The Size Premium

The other thing is that the size premium- so this looks at years in which big companies have done better than small or small has done better and anything in the aquamarine color- and I’m not sure where we get these colors from, this is very like 1970 shark shag carpet in color, but we’ve got the green aqua marine here- and any time you see that, that’s years in which the small companies did better than the large. And then by how much, more than 0% to 5% better, 5% to 10% better, et cetera. And then any time you see the light gray, those are years in which small companies didn’t do as well. Large companies did better. And so, again, the same story is with value versus growth, is that over time you expect tilting portfolios towards small and value to help you, but not every time. And that’s- that’s the way that it is.

But again, those are some ideas, some concepts on how to get a little bit more return from a portfolio by clustering it into value stocks and into small stocks. Doesn’t work every time, but it works over time. The idea being that you’re going to focus your portfolio on where you have the best odds for success. You’re also going to build that portfolio where you acknowledge that you might be lowering the ceiling. And this may not be right for everybody, guys. The best way to build significant wealth is to put all your eggs in one basket and have it be the right basket. The richest people in the world have had a concentrated position in either real estate or a company that grew phenomenally or something like that. They started a company, that’s the best way to build significant wealth. But it’s also not a great way to keep wealth. The best way to keep wealth is to diversify, build a combination of different kinds of investments. Figure out what your required rate of return is, make sure your portfolio is going to get there, and then tilt the scales in your favor by taking advantage of what the research tells you to do with your portfolio.

But again, concentrated positions can be fantastic. They can also result in disaster. And I’ll tell you a quick story before moving on to a more topical look- is I knew of somebody that worked at Charles Schwab back in the 1990s and this person back in the 1990s, companies handed out stock options to employees like it was candy at Halloween. It was like, hey, you’re working, here are some stock options. And that was great if your company did well. And if you remember, there was the dot com boom back then and Schwab was offering online trading. Stocks were going up, their stock was soaring. And there was this woman who worked at- she wasn’t a senior level person by any stretch. I don’t know that she ever made more than $50,000 in a year, but she had these stock options. And so she retired in her early 30s in the year 2000 with $3,000,000 and moved to Maui. That’s the power of a concentrated position, is that you buy something, it’s soars and you get to retire in your early 30s to Maui. Here’s the power of diversification or why you might want to diversify, because the second part of that story is that several years later, this woman went back to work at Schwab, where she still is today. And why? Because she never sold any of that stock. And after the dotcom boom went bust, the stock fell and her $3,000,000 went to whatever, $200,000, $500,000, whatever it was, she could no longer stay retired and now she’s back at work.


So Andi, we’re going to shift into the more topical portion, but are there any questions on what we’ve covered so far?

Andi: So first one comes from our dear friend Batman. He would like to know, “Do you like crowdfunding, for example, Fundrise or Ashcroft? And then what do you think of real estate for diversification?”

So those are two really broad questions and Hi Batman, by the way. Yeah, I mean, you know, crowdfunding can be OK, I guess it’s what are you investing in, right? And how much research have you done? There aren’t any bad asset classes. It’s gets down to the specific investment and how much research you’re doing. So I’m not an expert on crowdfunding. I know that just with any kind of investment, there are good projects and bad. I will say you probably want to do an extra level of due diligence because usually I think most people, if they could just get funded from a bank or a stock offering or a venture capital company or something would probably go that route. And so what you’re getting access to on some of those platforms are deals that want to get underwritten other places. And sometimes that just means that there’s more opportunity because it’s slipping through the cracks. Other times there’s a reason the deal wouldn’t get underwritten. And so you definitely want to do your due diligence. Yeah, I like real estate. I mean, I own rentals. I think that it can be good. You just need to be honest with yourself what you’re buying real estate for. We hear a lot of people like, hey, I’m going to buy real estate for cash flow in retirement. And then you look at what the projected cash flow is going to be and its break even, or they’re making $200 a month for the next 20 years. So you buy real estate in San Diego. It goes up over time, historically. It doesn’t necessarily cash flow that well. Right. You buy real estate in Memphis or Dallas. Maybe the appreciation is not there, but maybe the cash flow’s better. So it’s figuring out what is your financial goal? What is your financial plan for getting there? And then what role does real estate play? And if it plays a role, then yeah, real estate can be great.

Andi: All right, and then the next question, actually, we’ve got another one from Batman, he says, “A little off subject, but I would like your opinion on a 1031 exchange into a DST. And also I’d like to know your opinion of LIRPs as a tax-free retirement savings vehicle.”

Yeah, so I’ll punt on the second one, because I’m not familiar with- I’ve come across them, but it’s been a while, so I’m not going to claim to be an expert. The 1031 exchange, Yeah, I mean, so what- what that question refers to is that if you own appreciated real estate and you sell it, sometimes you’ll be subject to taxes. If you 1031, it’s a tax loophole that allows you to move into a similar type of property, basically roll your cost basis and you don’t pay taxes on the transaction. So it’s been a really popular strategy for a lot of people, has helped them build significant wealth over time. 1031-ing into instead of a property, a DST, that means Delaware Statutory Trusts, those are basically where professional investment management company or real estate management company is pooling various investments or investors to invest in maybe a larger project than somebody could afford on their own. And maybe it’s an apartment building or something like that. So I would say that my- my- from a tax perspective, 1031s can be great to save you money. If you don’t have a specific property identified, I think a DST could- could make sense. And even in some cases, if you don’t want the headache of owning the actual property, a DST could make sense. Same caveat as with crowdfunding. I mean, there are good deals and bad deals and you just need to do your research, right? It’s- it’s like saying, hey, are stocks good or bad? Well, it depends on what stock you buy. I would say it’s the same thing with the concept of 1031-ing and 1031-ing it to a DST could be sound. But then it comes down to the specifics of the deal.

Andi: This is from Brent. “Can you help define what makes a value, large, growth or small stock?”

Brian: Yeah, so that’s a good question. The short answer is that people have different definitions. And that’s one of the things that makes it confusing, is that either a fund manager or somebody that creates an index like S&P or Dow Jones will define how they’re going to characterize small versus large. Generally large companies are the 10% biggest in the universe. So think your Googles, your JP Morgan’s, your Wells Fargo’s, companies like that, Intel. And then your small companies tend to be the 90% of the smallest companies that would again be like a Denny’s or a Foot Locker or something like that. So these aren’t fly-By-night companies, but they’re much smaller than- than the other ones. As it happens, if you look at how much weighting they have in the universe, the- the I don’t know, the 100 largest, the 500 largest companies out of, let’s call it 3000, make up about 90% of the weight of the overall stock market. The other 90% of names of stocks only make up about 10% of the actual weight in the market. So it’s definitely the old rule of the market is dominated by the largest companies, small versus- or excuse me, value versus growth, similar where there are different metrics to look at. Some people will look at the price earnings ratio. Some people will look at book to price. We- we should look at book to price, as well as PE ratio and some other ones. And really what you’re just doing is you’re just carving out and you’re saying stocks that based on these accepted valuation metrics fall in let’s say the upper third of the most expensive, those would be growth stocks. And then stocks that are on the bottom third of the valuation spectrum fall into value stocks. That’s the most common way to do it.

Andi: All right, that’s all the questions, shall we go back to the slides?

The Outlook for Markets in a Post-COVID World

The National Debt

Brian: Yes, let’s please go back to the slides. So outlook for markets in a post-Covid world. And lo and behold, what’s the first slide? It’s the national debt. Some of you may have heard some rumors that we spent some money lately. Some of you may have even benefited from that. The deficit is at levels- or the accumulated debt- excuse me, is at levels not seen since World War II. Government’s been spending money quite aggressively for a number of reasons. Even in the years leading into the pandemic, they were spending money certainly to get us out of the great financial crisis. But then they continued to spend in the years after that. Everybody’s got opinions politically and stuff, so I won’t touch on that. But I will say that from an economic perspective, if you have kind of revisionist history in a perfect world, when the economy is reasonably good like it was in the mid-2010s, you’d want to be paying down debt, not accumulating debt. I mean. Right, everybody at home has a personal balance sheet that when times are tough, maybe you put something on the credit card, but then when you get a bonus, you pay it off. The government theoretically should work the same way. And then certainly in response to Covid, there have been some massive payments. These forecasts for what the debt will look like, I think are pretty conservative. I’ve seen other ones where the debt is more like 150% of gross domestic product out here in 10 years or something like that. So we’ve accumulated a lot of debt. And one of the concerns that we get is, is two things. One is how are we going to pay this back and how? There’s four ways to reconcile a large debt. You can default. I do not think the US government is going to default on Treasury bonds. There may- now the caveat is at some point you may see a technical default because of some government impasse where they choose not to pay interest for a few months or something like that. But that’s different. I don’t think that they’re truly not going to be good and paying back the debt. You can grow your way out. So if the economy takes off, the idea is that for a given tax level, if you get more economic growth, you collect more taxes, you pay back the debt. I haven’t seen any signs that either a) the economy is going to grow at that rate or b) that those excess dollars, if they did come in, would be used to pay down the debt. But who knows? I think the two most common ways and the two most likely ways are you can tax your way out of it with higher taxes. And we’ll talk about that in a bit. Or you can inflate your way out of it, right. You can pay back the debt with dollars that aren’t worth as- as you can print more dollars. And so let’s talk about a little bit.

Inflation: Cost of Living Increase Since WWII

This is the cost of living since World War II. And I think that there are a couple of things to note. One is that the cost of living is increased about 13 X over the last- what is that 90 years. A movie ticket might have been $1 back in 1940, today it’s $13, or something like that. Right. So those get more expensive over time. But you can say it’s been a pretty gradual rise for inflation. It’s not like- it soared, it’s just kind of gradually creeps up. And the reality is that you do want some level of inflation.

Inflation Has Been Muted

So every economist’s worst fear isn’t inflation. If you’re a central banker, what you worry about is deflation, prices dropping. Because inflation is something that economists feel like they know how to cure. Deflation is really hard. And if you want proof, look at Japan. They’ve been trying to get out of deflation since the early 1990s and haven’t been able to do it. So the reason that they target- so the Federal Reserve targets 2% inflation. The reason they do that is, is that they recognize that their tracking of inflation is imprecise. So if they’re targeting 2% and if it says 2%, it could really be 1.25%. It could really be 2.5%. It’s a blunt instrument that they’re measuring. And what they don’t want to do is have it drop too close to zero, again with that deflation. So you feel like 2% is a level at which it won’t get too excessive, inflation won’t take off. But you’re also not going to be flirting with falling into deflation. And what you see here is that inflation has been pretty muted for most of the last 30 years. You had the large inflationary period in the 1970s into the 1980s, but since then it’s almost never been above 4%. I mean, to be honest, and in a lot of cases and I’ve talked about this in the past, is that inflation is a little bit like the boogeyman. It’s often feared but rarely seen. So I think some of the fears of inflation are set by people out of experience, high inflation, back with the 1970s and stuff and what that can do to an economy. Now, that being said, I think two things. One is that we certainly have seen inflation tick up here recently. It’s still relatively low. And I think the argument at this point is, is inflation transitory in the sense of, is it just a function of people that were trapped in their house and that now can go out and spend money again? Or is inflation more permanent? And is it here to stay with these higher prices and this elevated economic activity? My personal opinion is that I do not believe that the slightly higher inflation is transitory. I think that there are- certainly there are supply chain constraints in places and stuff like that. But I actually think inflation is higher now than it was several years ago. And I think it will continue to go higher for a multitude of reasons.

But then it becomes two things. One is, is it going to get out of control? And two is, what do you do about it? The answer to the first question is, I don’t think inflation is going to get out of control. I think it will run higher than it has in the past decade or two. But I don’t think we’re going back to the 1970s. I could see us being, if we’ve been running more in the call it 1% to 3% range, I can see us running more in the 2% to 4% or 5% range over the years to come. So, which would be higher inflation, but not excessively so. That’s just in my opinion. But here’s the important part is markets can adjust to higher inflation, markets can adjust to almost anything. And that’s an important lesson. Right. Here’s what markets have trouble with: markets have trouble with sudden movements that were unanticipated. So if inflation runs at 3% or 4% for the next 10 years, markets are already talking about that. It’s not going to upset the apple cart. What upsets the apple cart is if markets expect inflation to creep towards 3% or 4%, call it 3%, and all of a sudden next year, it’s running at 5.5% or 6%. Right. It’s unanticipated and it’s a sudden increase. It’s not- remember, look at the long-term chart of how inflation has changed. It’s been gradual. If all of a sudden you get a spike and it’s not an anticipated spike, that’s when you see markets fall sharply. I don’t quote Donald Rumsfeld a whole lot, but Rumsfeld had a quote where he said ‘there are the things we know, the things we know that we don’t know, and then there are things we don’t know that we don’t know.’ And I think that it’s that last it’s the unknown unknowns, as people call them, that upset markets. So I don’t think higher inflation is going to blow up the markets here in the future. Unanticipated spikes could temporarily upset it, but you would need a really significant, unanticipated move up to really destroy the stock market and the bond market.

Market Returns and Inflation

But still, the question becomes, how do you protect yourself against it? I think that’s an important question. And the first is simply to look at how markets have done over time. Right. And here you’ve got some different periods. And I’ve gotten the question before, why does this data only go back to 1988? And the reason isn’t to exclude the high inflation of the ’70s. The reason is because some of these asset classes only have data available since then. But what you see is different periods. You see on the left-hand side, high and rising inflation in the left-hand top. Then in the top right you see high and falling inflation. The bottom is low and rising and the- on the bottom left- and then the bottom right is low and falling. And then you see how asset classes have done in these periods. And so there have been 10 times when inflation was high and rising. And you can see that assets actually did pretty good. Look at the returns there across the board, pretty strong. You have times when you had high and falling inflation, which has occurred 6 times. You can see that there are pretty strong returns there as well. You have low and rising inflation. I would characterize this is the period that we’re in right now, actually, 4 times since 1988. You can see returns for most things other than cash were pretty good. And then low and falling inflation 13 times. You can see returns were OK. You saw some losses for commodities and stuff. That’s usually an economy that’s falling into recession. So the bottom line is that most asset classes have done OK during times of falling inflation- or during times of various inflation periods.

What I think is important to remember, is when you look at a portfolio and it gets back to that diversification concept, there are things you’re buying for different scenarios. Right? So you’re buying investments that will do well if you have higher inflation, if you have lower inflation, if you have a strong economy, a weak economy. Right. That implicitly means that you’re buying something that, you know in certain environments won’t do well. You get much higher inflation, bonds aren’t going to do great. You know that going in. It’s what you’re signing up for. People come to me. I mean, somebody will call me and still complain, hey, inflation went up and my bond didn’t do good. And I’m like, yeah, I told you it wouldn’t. But your stocks and your real estate did well. The bonds are there in case the inflation falls, in case the economy is weak. Right. What if there’s a resurgence of Covid? What if markets have just gotten ahead of themselves or the economy and as we come out of this, the economy falls. Well, that’s when you want your bonds, right? What if there’s high inflation, higher than expected? Well, real estate, maybe you can reprice some of the rents. What about natural resources? They tend to do good with inflation. Foreign stocks, the definition of inflation is that the dollar is worth less. As a US based investor, the weaker the dollar is, the more your foreign stocks are worth. So you want a weaker dollar if you’re a US investor buying international stocks. So as you look at these different asset classes, you’re putting together a recipe, right? If you’re building a recipe for something and you put salt in there, it has a function. If you put sugar in there, it has a function. Those functions aren’t the same. The sugar – oil and vinegar in a salad, right. They do different things. You put them together and it’s a good combination. But if you- you don’t, you know that you want to just want to use one or the other. Right. And so the idea is that you’re building this recipe in order to do well or do OK across various time periods. Again, you’re raising the floor, lowering the ceiling. What you’re not trying to do is pick what asset class does best. Right. And here’s another reason why.

Investors Are Their Own Worst Enemy

Look at this chart. Right. This is 20-year returns for different asset classes. Real estate on the left, high yield bonds, small companies, emerging markets. You can see the S&P, you can see a couple mixes of 60/40 portfolio of stocks and bonds and vice versa. Bonds, cash, commodities. Look at where the average investor falls. The only thing that did worse was commodities. And that’s just a timing issue. If I ran it for a different time period, commodities would have been better. The idea is that for all the time people spend trying to buy the best asset class, the average investor does worse than almost anything else. The average person at home would do better regardless of what they bought, despite the time is spent thinking about it. Why? Because they’re getting in and out of each of these asset classes at the wrong time. They’re worried about inflation. So they sell all their bonds and they buy all natural resources at just the wrong time. They’re worried about the level of stock markets. They sell all their stocks and they buy bonds at just the wrong time. And they get in and out again and again at the wrong time. Not accepting that when you build a portfolio, you are signing up for some things that are going to do well in environments and some things that aren’t going to do well. So unless you have perfect clairvoyance, which not too many people do, you have to be honest with yourself. What kind of changes should you be making in a portfolio? And the reality is you should be making small changes. Maybe you buy a little bit more or something, maybe buy a little bit less of something based on your outlook. But you don’t go all in or all out. You make small, incremental changes. I used to manage portfolios for large institutions. That’s what we would do. If the target for something was 10% we’re worried about inflation, and it’s going to do good. If there’s inflation, we might bump it up to 11% or 12%. It’s not as exciting as selling everything else and going all in, but it’s a way better recipe for success over the long run.

Market Performance

Market performance, this is the last thing I want to touch on, and there’s a lot of numbers on here and I I want to answer any question and talk about taxes. I’d ignore the level and the one-week return, but if you look at the columns towards the right-hand side, year-to-date, one-year, and especially look at the one-year returns and the 3-year cumulative, those are pretty good, right? S&P 35 Russell 2000. So this is your small stock premium in the last few years, your small companies in the last year are up 58%. Right. Emerging markets here up 40%. And then you look at 3-year cumulative returns. Look at the Nasdaq in the last 3 years, up 86, you know, so these have all done pretty good. And even bonds, some of them have done OK.

The reason I’m bringing this up is, think about what kind of returns you’re targeting for retirement across time. Maybe you’re targeting 6%, maybe 7%, maybe 10%, whatever you’re looking for. Then do the math, take these 3-year cumulative numbers and divide it by 3. Just simple math, right? So the Russell 2000 is up about 12% or 13% a year in the last 3 years. The S&P, which is the broadest number, is up about 19%. The Nasdaq up about, what, almost 30%. Right. So if you do the math and you think you’re going to get 10% on your stocks over time just to pick a number and maybe 3% or 4% on your bonds, it’s pretty clear that going forward you would expect returns to be a little bit lower. And you just need to sign up for that. You know that they’re going to be good periods and bad periods. We’ve gone through a good period. But what you don’t want to do is get out now because returns have been really good. You just want to be cautious that you’re not too invested. You want to rebalance and make sure that if your stocks have gotten overweight, maybe you bring them back into alignment.

Where Do You Think Taxes Are Heading? US Debt Clock

Let’s go back to the whiteboard and do some more drawing here and talk a little bit about taxes. Over here you can see the US national debt at $28,436,000,000,000. That’s a pretty big number. What I like to focus on is this. Here’s your debt per citizen, $85,307. Here’s your debt per taxpayer, $226,000. So those of you that are taxpayers, if you’ve calculated your net worth recently, you forgot to account for the fact that you also owe the Feds $226,000. Then we look at revenue per citizen over here, $10,000. Now, if we were running a business, right? If you’re bringing in $10,000 per citizen, but you owe $85,000 per citizen, that’s not great math, right? At some point you need to rectify that. I talked about the other ways, the growing the defaulting, higher inflation. Well, the easiest way to get out of it is to generate more tax revenue from each citizen, right?

Taxes Stairstep: Long Term Capital Gains Rates

You guys, many of you may have seen the tax triangle in the past. Right? At the top, you got your tax-free pool; the bottom, you got taxable; and you got tax-deferred. Tax-free is usually Roth. And the thing here is you put money in without any tax advantage. There are rules and regulations about putting money in. But when it comes out, it comes out at zero, which is a pretty good tax rate. You get the after-tax here, there are no rules or regulations, it’s really flexible, you put money in, it grows at a special rate. When you put it in, it establishes a basis. So that’s your cost basis. Anything on top of that you owe taxes on. If done right, you can get special rates of anywhere from 0% to 20%. Then your tax-deferred account, those are your IRAs, your 401(k)s, you put money in there pre-tax, it grows tax-deferred. But then when it comes out, it’s ordinary income of anywhere from 10% to 37%. Right. Three different pools of money, 3 different, very different tax treatment. What you want heading into retirement is diversification and some sort of flexibility. And here’s the issue. These are the tax brackets right now. You’ve got a 10%, a 12%, a 22%, a 24%, 32%, 35%, 37%. These are the lowest in history. They were really low 5 years ago and they got lowered further. There’s talk about raising these, especially up in here.

I also mentioned the long-term capital gains rates, if you’re down here and you do it right in that taxable pool, your long-term capital gains rate is 0%. If you do it right in here, your long-term capital gains rate is 15%. If you’re up in here, you do it right, your long-term capital gains rate is 20%. One of the proposals is to do away with this. And if you’re up here all the way at the top, make this 39.6%. So almost double.

Tax Diversification Strategies

So what do you do? What you do is you make sure you have some flexibility. May you dedicate some Roth IRA contributions, right. You can put $6000 a year if you’re 50 or under, you can put $7000 if you’re over age 50. Maybe you switch your 401(k) contributions from here over to the Roth account. You can put up to $26,000 if you’re over age 50, $19,500 if you’re under age 50 in there. Maybe make some contributions here. Right. I’d rather have money come out at 0% or 20% then at long-term capital gains rates that we just talked about. But you want to be really sensitive, particularly given all the talk about potential changes.

Maybe there are some things to do this year, right? Maybe you should consider if you’ve got gains in here. Right. We talked about how well markets have done in the last few years. You might have some gains here in this taxable brokerage account. Well, people talk about tax loss harvesting, and that’s something that’s important to focus on. Maybe this is a year to look at tax gain harvesting. If capital gains rates may go higher next year, maybe you want to realize some gains this year, maybe, or maybe you just want to be strategic about it, depending on your tax bracket. If you have the ability to realize long-term capital gains in these tax brackets at zero, you want to do that every single year. If you think at some point cap gains rates are going higher and you can realize that in the 15% rate, you might want to do it. There’s also with long-term capital gains rates, a 3.8% Affordable Care Act surcharge over a certain income limits to 250 single, 250 married. If you can realize capital gains below there, it might make sense. So, again, I think it’s worth, for most of you, taking a look at your taxable pool of money and seeing if it makes sense to realize any capital gains in this year.

You might also want to start thinking about Roth conversions. That’s where you take some of the dollars you’ve accumulated here and you move them up here. When you do that, it’s no fun because you do pay taxes. However, in paying taxes, you’re paying at what might be the lowest rates of our lifetime, right. All of these are likely going higher over time. Your choice if you have money in this pool is not whether or not to pay taxes. With RMDs, this is coming out at some point, depending on the law, it might be 72, if it goes through, it might be 75. But you are paying taxes. Your only choice is when, at what rate. You pay it at today’s all time low rates, oh, and by the way, then all future growth is tax-free. There are no required minimum distributions. It comes out at zero. Or do you pay it in the future at some unknown, but potentially higher rate. Right. So I think that those are things that make sense to consider.

I’ve talked a lot, so I’ll take some questions, take a break. I also want to throw out that there’s a lot going on here. So if you want, our firm does financial planning. We’re fee-only financial planners, fiduciaries legally obligated to act in people’s best interest. We usually charge $250 an hour to meet with people. But for people that have gone through one of these webinars, we’ll do it for free. We will meet with somebody for a couple hours, do a free financial assessment. We’ll take a look at your investment portfolio, where your assets lie. Are you over-concentrated in small companies or large companies? Do you have any kind of diversification among your assets? Are you on track for whatever your required rate of return is to actually get there? And then with your taxes, where do your assets lie? Which pool of money is it in? What tax bracket are you likely to be in in the future? Should you be considering trying to get money into the tax-free pool? Should you be considering tax gain or tax loss harvesting? Should you be – I don’t know. Maybe you should be moving into this pool to lower your taxes now because you’re going be higher in the future or excuse me, vice versa- you’re higher now than you will be in the future. We’ll take a look at all that, we’ll go through your tax return. We’ll go through your investment statements, give you some thoughts on your cash flow, Social Security, et cetera. Like I said, we usually charge $250 an hour. We waive the fee. We’ll spend a couple hours with you with one of the CERTIFIED FINANCIAL PLANNERs here to review all of that, give you our thoughts. No cost, no obligation. If you’re interested in that, Andi will put up the offer. Again, we’re not- we do it all the time. We do it for a lot of people. Might be helpful just to kick start. You can go then kind of put some of those concepts into work on your own, if that’s what you’re interested in. With that, let me pause and let me take any questions that might have come up along the way.


Andi: So our first one is from Doug. “How does real estate relate to your bond and stock ratio?”

Brian: Well, real estate usually- so when I consider real estate, I would generally throw it in, I usually think of things at the high level, like growth and safety and high-quality bonds and there’s a continuum, obviously, but cash, high-quality bonds are your safety. And then things like stocks, real estate, natural resources are more for growth. So I would throw it in that pool. And then I would look at- I mean, the ratio is going to be different for everybody. There is no- if it was as simple as a magic bullet, I would have put it in my last book and I would have sold it, added some zeros to my sales column. All of you need to go buy the book, but I’d have more zeros on it because it would be a magic solution. There is no magic solution. It depends on what you’re comfortable with. Some people love real estate. They love the idea of looking at their investment, knowing they can drive by it. Other people get a call from about the plumber and the toilet and they’re like, I never want to deal with this again. This is God awful. You get a bad tenant that makes you reassess your life. So it really depends. But I would definitely throw it into that growth bucket along with your stocks or natural resources as the assets that are going to keep pace with and hopefully exceed inflation while you also have those safe assets to pull on in the near term.

Andi: All right, the next question comes from Richard. “Do you suggest cryptocurrencies for a retirement investment?”

Brian: Not necessarily at this point. For one thing, they’re incredibly volatile, right? I mean, we saw cryptos soar and go up and down. You’d need to figure out which crypto, bitcoin is the most well-known one. It doesn’t mean it’ll be the winner. The bigger issue is, is a couple-fold. I think that it’s still early in the game. So it’s uncertain how that space will play out. You’re seeing more potential regulation, whether it’s with the Chinese government, the US has talked about issuing potentially digital currency. What does that mean for this? So it’s tough to evaluate what they’re actually worth. I’m not dismissing the space. I think that it’s exciting to watch and has lots of possibilities. But I’m not sure. I’m not sure that in the long run, we’re going to have 50 or 500 or whatever digital currencies. We’ll probably have potentially a couple. Which are going to be the winners? I don’t know. I mean, same stage of development. You probably would have wanted to put your money into MySpace and Netscape as opposed to, let’s say, Google and Facebook. Right. And those when it turned out that well. So you don’t really know what the winners are going to be. It’s also incredibly volatile. If you do use it, what I would say is you probably want to use it like salt on your food, right? Like a little sprinkle, a couple percent not go all in.

Andi: All right, Laurie would like to know, “What do you think about gold for an investment?”

Brian: I would throw gold in there in the crypto space in the sense that, well, in this case, the long-run return of gold is effectively zero. The issue with gold and I would say the same thing with crypto, is there’s no cash flow. So when you value real estate, when you value a bond, when you value a stock, you’re looking at what kind of cash return can you get? If I put $1000 in, what kind of cash will kick off today, tomorrow in the future? And then you’re assigning some sort of value to that. So it’s math. When you look at gold, it’s never kicked off any cash flow. When you look at crypto, it doesn’t kick off cash flow. So now you’re looking at sentiment. You’re saying not what kind of cash flow will I get, but what will other people say it’s worth in the future? That doesn’t make it a bad exercise, but it is fundamentally different. It’s more psychology and less math. And so it just becomes a little bit different.

Andi: All right. And then Peggy says, “Where should international stocks fall in a portfolio?”

Brian: Yeah, it depends on your- on what you’re trying to accomplish. But we believe international and global investing makes sense for almost everybody. There are times when international stocks do better, times when US stocks. We tend to focus depending on the portfolio on anywhere from 20% of the stocks being international to 40%. You can make an argument for almost all your stocks being international, depending on how you want to measure it or on very few. There’s different ways, but I think having a significant exposure to international stocks. Again, 15%, 20%, 30%, 40%, 50%, but still having more of a weighting towards the US because that’s where you live. That’s where you spend your dollars and stuff. I think that’s probably the right approach.

Andi: All right, and then Brent asks his question in another way, he says, “What industries go up with inflation increasing?”

Brian: It depends. Usually industries that have pretty good pricing power. So, again, it’s all relative. If inflation spikes, nothing is going to go up, right? If we wake up tomorrow and inflation’s at 8%, everything will go down. I’m generalizing, but if inflation gradually goes higher over time, industries that have really good pricing power. So I’m not singling out, let’s say, Apple, because I have no opinion at all on the stock. But if Apple’s music raise their price $1 a month, you probably want to just cancel the subscription if it’s something you use. Right. Apple has a name brand recognition. So you’re looking at companies like Coke, right? You’re not going to stop drinking Coke or Budweiser or whatever it is, based on a small increase so companies with pretty good name recognition and pricing power. Companies that usually in an inflationary environment, raw materials do well. So those sectors could do pretty well. What you usually want to avoid are industries that don’t have pricing power. Right, because now they’re just getting crunched right. Their input costs might be going up and their export costs aren’t- or their sales pricing doesn’t go up.

Andi: And then- right now, this is our final question, so literally now last chance, if you have any more questions, enter into the chat right now, Sam says, “Isn’t it true that the current tax rates will revert to the prior administration’s rates in 2025? And what is the impact on tax planning then?”

Brian: Yeah, here’s the rates right now, the old rates, this 10% was the same, 12% was 15%, 22% was 25%. 24% was 28%. 32% was 33%. 35% stayed the same. 37% was 39.6%. Yeah. And after 2025, we are scheduled- these were never permanent tax cuts we got, they were temporary. They’re scheduled to expire after 2025, we’re scheduled to go back to these old rates. The amount of dollars- taxes are marginal so the amount of dollars that get taxed at these higher rates will also be greater after 2025. So for instance and I’m rounding but the top of the 24% bracket for married couple is about $320,000, at the top of the old 25% bracket was about $150,000 for married couples. So you get more dollars falling in higher tax brackets as well. The impact is that everything that I talked about with this is I mean, it’s more important, you know, that in 2025 or after that, taxes are going higher, you want to start positioning for that. I think the only thing that’s changed is that those higher taxes may be coming sooner. Even if they don’t come, they’re coming. It’s just a matter of how fast is the locomotive moving towards you. If it’s moving faster there’s even more urgency. But either way, the sooner you begin to take action to build tax flexibility in your retirement, the better off you are. Because what you don’t want to do is have to try and do a huge conversion or realize all your capital gains in a single year because you blow yourself up. You want to come up with a roadmap for where you want to get and then gradually be able to do it. And whether it’s 2025 or this year, taxes likely going higher at some point in the future. You want to take steps to protect yourself. And again, that’s something that if you want to come in and have a chat, that’s basically what we’ll talk about with you for an hour is, hey, here are some possibilities you have to position yourself to avoid this locomotive that’s heading down the tracks, whether now, next year, 3 or 4 years from now or a decade from now, either way, taxes are going higher. It’s going to be your biggest expense in retirement. How does that fit in with your cash flow? How does that fit in for your investments and what do you do? That’s what we go over in that assessment. If that’s something that you want to take advantage of.

Andi: Brian, thank you so much for the great presentation today.

Brian: Thanks. Yeah, appreciate it. Wish everybody the best. And I look forward to seeing you next time. Take care.

Andi: All right. Thank you, everybody. Have a great day.

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