You’re doing everything right — living below your means, have a sufficient cash reserve, and are taking advantage of your tax-deferred retirement accounts to the full extent. So what’s next when you still have discretionary cash flow left over?
First of all, this is a good problem to have and you should congratulate yourself for not falling victim to lifestyle creep!
When deciding on how to allocate additional cash flow towards a worthwhile goal, consider the following:
Is there a shorter-term goal you have outside of investing for financial freedom (retirement)?
Do you have a business idea you’d like to pursue? Investing in yourself is often the best return on investment.
Real Estate – consider adding a rental property to your portfolio for income generation.
Enjoy life in the present more — travel more, go out to dinner more and invest in experiences!
From an investment standpoint, continuing to do more of the same is often a great option! Sometimes, as our net worth and incomes rise, we believe adding complexity to our investments is a natural form of progression.
This is not the case!
If you’re looking to use your money to enjoy life more in the present, consider what your money dials are.
Think about the things in your life that you can outsource, because you:
Don’t enjoy doing them.
Want to free up your time for things you do enjoy.
Want increased convenience.
Time is our most valuable commodity, freeing it up is a form of wealth on its own!
Even if you’re not dependent on your investment portfolio, losing money (even if only temporary) is never fun. Fortunately, there are strategies you can take advantage of to lessen the impact of a bear market and *hopefully* set yourself up for success when markets rebound.
Although no one knows when markets will rebound, now is the time to fight panic and be proactive with planning.
Here are three strategies you can take advantage of during a bear market:
When investments in a taxable account drop in value, “harvesting the losses” is a great strategy for lessening the impact of these losses.
Any losses harvested can be used to offset gains that have been realized (in that tax year), effectively reducing taxes owed. If you have no capital gains to offset, you can use up to $3,000 of loss to reduce your taxable income, or $1,500 each if married filing separately. However, the additional tax loss may be carried forward for use on future tax returns.
One of the key things to be aware of with tax-loss harvesting is to make sure you avoid the “wash-sale rule”. The IRS won’t let you buy an asset and sell it solely for the purpose of paying less taxes. The loss will be disallowed if the same or a substantially identical asset is purchased within 30 days.
It’s important that you get back invested right away after taking advantage of tax-loss harvesting (so that you don’t miss out on potential rallies).
You want to make sure you avoid the wash-sale rule when buying a stock, mutual fund, ETF, etc. to replace the security you’ve sold to take advantage of the loss.
Luckily, there are plenty of options that are considered “substantially different” but still allow you to maintain your risk profile.
This only works if you have a defined investment strategy ahead of time. If you’ve done a financial planning analysis and determined how much risk you can afford (and/or is needed) in your portfolio to achieve your financial goals, now is the time to remain disciplined to that risk profile.
Even for the investor with a long time horizon (20 + years), it’s unlikely you would have 100% of your investment portfolio in stocks. If you had built in some kind of diversification into your portfolio, by owning other assets such as bonds, treasuries, and commodities, there should be room to rebalance back to your original risk profile.
The best way to rebalance is to have rules built in ahead of time. By having rules in place for when a rebalancing event is triggered, it removes the emotion from the decision making progress when you’re trying to determine “the right time to buy stocks”.
The time when it feels the most painful to rebalance back into owning more stocks is *usually” the best time to do so. While there is always the risk of increases in short-term decline, your future self should be rewarded for remaining disciplined to the risk profile that is appropriate based on your current financial situation.
It’s important to avoid “all-in” or “all-out” strategies. We don’t know the sequence of returns and we definitely don’t know when markets will bottom and rebound. The most important thing is to remain disciplined to your pre-determined risk profile to benefit once markets inevitably rally.
Planning for tax diversification is essential to any financial plan. Regardless of market environments, you should want to plan for flexibility in retirement to be able to pull from pre-tax and after-tax accounts depending on where tax brackets are at that time. That way, you’re not *totally* beholden to the unknown fiscal policy that awaits us.
If you’ve been looking to take advantage of Roth conversions to shift pre-tax money to after-tax accounts, now would a great time to consider converting securities that have declined in value.
By doing so, you’re putting yourself in a position to potentially benefit from substantial growth once markets rally. As a reminder, any money (or securities) converted to a Roth IRA will never be taxed again (after the conversion amount has been paid).
Dave is a big advocate for prioritizing paying off debt and ultimately living a debt-free life. Which, I would agree is a worthwhile goal.
BUT, just like anything in life, debt is a tool that, if used responsibly, can be beneficial.
If I have a mortgage, should I not step inside a restaurant until I’ve paid it off? I think it’s fair to give Dave the benefit of the doubt and say he’s referring to high-interest rate debt (like credit cards).
What if I graduated with student loan debt? Am I not allowed to ever go out to dinner and enjoy myself?
What if I work hard, live below my means, and are making progress towards my financial goals? Should I still not be allowed to treat myself to an occasional night out because I have student loan debt?
This is one of the differences between being a “personal finance guru” and being a financial planning professional that provides one on one advice. Personal finance is PERSONAL. Rarely are there situations where there isn’t nuance or it doesn’t “depend”.
Unfortunately, “it depends” doesn’t drive engagement like, “If you’re working on paying off debt, the only time you should see the inside of a restaurant is if you’re working there”.
If you want to live an all-or-nothing lifestyle, I respect it. I just don’t think it’s sustainable for the vast majority of us. I’d rather focus on creating a plan, and recognizing that you’re going to make “mistakes” (enjoy) yourself along the way.
The most important thing is that you are continuously making progress towards your goals even if you treat yourself to the occasional night out.
Incentive Stock Options (ISOs) are one of the most complicated forms of employer stock compensation.
In this podcast episode, I discuss the basics of ISOs, how they function from a tax perspective and some major pitfalls to be aware of. One of the most common pitfalls people neglect is looking into potential alternative minimum tax (AMT) exposure when they exercise lucrative ISOs.
This happens when you are attempting to hold two years from the grant date and one year from the exercise date to benefit from long term capital gains. This can be a good strategy if you believe the share price will continue to rise and you want to reduce your tax liability.
However, the difference between the strike price and the fair market value of the stock on the day the option is exercised (known as the bargain element) is a tax preference item for calculating AMT.
Depending on how large your ‘bargain element’ is, you could be opening yourself up to a large AMT liability. You must be aware of this so that you’re not stuck with a massive tax bill come tax filing time (and have to find the cash on hand to pay it).
There’s a balancing act when it comes to divesting from concentrated stock positions via an ISO while being mindful of the tax implications.
In this episode, I also discuss the fear of missing out (FOMO) as it relates to owning employer stock (or any concentrated position for that matter), and why I’m a fan of regret minimization.
Anytime you’re selling off a concentrated position, there is an opportunity cost (which I like to refer to as investing FOMO). There’s always the chance that your stock (in this case employer stock) takes off and vastly outperforms the broader market.
However, you have to consider the downside as well, and that the individual security can massively UNDERPERFORM the overall market. You must have a long term financial plan that factors in your complete financial picture to determine whether you should (or need) to be taking on concentration risk.
ISO compensation is one of the most common windfalls I see. Especially, when you’re compensated from a private company that goes public, there’s the potential to become an ‘overnight millionaire’.
If you’ve experienced that ‘pop’, I discuss different ways to approach diversifying depending on your short and long term goals.
At what point in your business’s lifecycle are you? Are you at the point where reinvesting in your business (increasing employees, equipment, etc.) provides diminishing profit returns? If so, consider creating a financial fortress outside of your business so that you are NOT dependent on your business to supplement your lifestyle.
When you create a business, it’s your baby (I get it). It’s easy to get sucked into your business and reinvest 100% of every dollar you generate to grow your business. And if you’re creating a scalable product or service, maybe that’s the right decision (personal finance rules don’t apply to entrepreneurs). However, if you hit a wall (cannot scale further) or are at a point where you are paying yourself an amount that you’re happy with, consider fortifying your personal finances.
In this podcast episode, I discuss some of the pitfalls of becoming overly dependent on your primary business. Especially businesses where there may be little (or no) market value if you were to sell the business, why it’s important to fortify your personal finances sooner rather than later.
How susceptible is your business to changes in the health of the economy? What would happen if your business suddenly came to a halt? These will vary depending on your type of business but are important questions to ask yourself.
One of the first steps in creating a fortress around your business is creating a separate business entity that protects your personal assets from any potential financial and liability claims. The type of business entity you select (such as an LLC, S-Corp, or Partnership) will depend on the number of owners (and employees) you have, and how you want your business to be taxed (flow-through, dividend, etc.).
Once you’ve fully separated your personal assets from your business assets, you must pay yourself an appropriate amount from the business. You want to make sure that you’re keeping the cash flow of the business separate so that you can accurately keep track of tax liability and not compromise your liability benefits of having a separate entity.
As a business owner, you should be paying yourself for the risk you take on and the hard work you put in. Even if the business is self-sufficient, you should be reviewing the amount you are paid so that you can build financial independence outside of your business.
While it’s not uncommon for successful business owners to be dependent on their business to supplement their lifestyle, there may come a time when they’d rather not carry that burden. Depending on the revenues of your business and how transactional they are, you may or may not have as much equity in your business as you believe (if you were to sell). This is another reason why fortifying your personal finances sooner rather than later is a smart move.