The Power of the Plan in an Uncertain Market

Episode 119 of the Investopedia Express with Caleb Silver (January 9, 2023)

Stocks closed out last week in rally mode as the December payrolls report showed continued jobs growth, but a slight cooling in wages. Some investors took that as a sign that the Fed's plan to cool down the labor market is finally starting to work, and maybe—just maybe—the Fed will cool the pace and size of future interest rate hikes. Treasury yields, the dollar, and gold all fell on the news, while the Dow and the S&P 500 had their best day on Friday since late November. Both of those indexes closed the week 1.5% higher, while the Nasdaq added 1%.

In case you're keeping score, the last time the S&P 500 closed at an all-time high was just over a year ago on January 3, 2022. Since then, according to our pals at YCharts, the benchmark index is down 18.8%. The Dow is down 8% and the Nasdaq is down more than 33%. Big tech is still deep in a bear market. Back to the labor market, which has been an enigma for the past year, given all the worries about inflation and the pending recession—it's still pretty strong in some sectors.

Leisure and hospitality, health care, social assistance, and government-related jobs are where the hiring is strong and where wages keep rising. Information technology, manufacturing, and professional services are where job growth and wages are stalling out. Still, for all of 2022, U.S. employers added 4.5 million jobs. That was the second-best year for job creation on record going all the way back to 1940. 2021—when the labor market rebounded from those pandemic-induced shutdowns—saw gains of 6.7 million jobs. And there are still 10.7 million jobs available, or 1.7 for every available worker, according to the latest JOLTS report.

Remember—the Fed wants to slow job growth and wage growth. Job growth did slow from November to December, but the unemployment rate fell to 3.5% as less people were looking for work. The Fed's latest projections for unemployment pin it at 4.6% in 2023, and staying there through 2024.

What does this all mean for what the Fed might do next? More rate hikes—most likely—but probably smaller than before. According to the CME's FedWatch Tool, there's a 75% probability that the Fed will hike rates by only a quarter of a point at its next meeting on Feb. 1, and there's only a 25% probability that it will hike rates another quarter of a percent when it meets in late March. That would put the terminal rate between 4.75% and 5%, which is lower than what was projected back in December. These small basis point (bp) increments matter when it comes to the federal funds rate, because that is one of the key components of what makes up the equity risk premium.

Meet Taylor Schulte

Taylor Schulte

2015FoundCreativeStudio / Taylor Schulte, CFP

Taylor Schulte, CFP, is the founder of Define Financial and host of the "Stay Wealthy Retirement Show" podcast. Since launching Define Financial in 2014, Taylor has been recognized as a multi-year, award-winning wealth manager. He’s been a top 10 financial advisor on the the Investopedia 100 list since 2019.

Taylor is a columnist for Kiplinger and is frequently quoted in the media as a financial expert. He’s a graduate of the Eller College of Business at the University of Arizona and the Executive Financial Planner program at San Diego State University.

Taylor also holds the Certified Financial Planner (CFP) designation and is a member of the CFP Board, Financial Planning Association, Retirement Podcast Network, National Association of Personal Financial Advisors (NAPFA), Fee-Only Network, and the San Diego Financial Advisors Network.

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What do we do when "keeping it real" goes wrong? We had a plan. We had a strategy. We tried not to let our emotions get the best of us. Still, the losses of 2022 and the bleak forecast for this year are enough to rattle individual investors like us, making us question the soundness of our strategy and our tolerance for investing. This is exactly the kind of problem that great financial planners and advisors are here to help us with, fix, and contextualize.

Taylor Schulte is one of the best in the business at this. He's the founder of Define Financial—a fee-only financial planning firm in San Diego—but you'll find him all over the financial planning ecosystem. He's a regular contributor to Kiplinger, the host of several podcasts, including the Stay Wealthy Retirement Show, and one of the top ten of the Investopedia 100—our list of the most influential advisors in the U.S.—several years running now. He's also our very special guest on the Express this week. Welcome, Taylor. So good to see you.

Taylor: "Caleb, thank you very, very much for having me, and thank you for the kind introduction."

Caleb: "You're welcome. Well, the biggest question your clients are asking you right now—I have a feeling I know what it is, just given the year that we've had and what we're facing right now—but what does everyone seem to be coming to you with right now?"

Taylor: "Yeah, I mean, it's been such an interesting environment. I say interesting because I feel like, I don't know, since '08 and '09, things have been relatively calm. At least it seems that way—you could pretty much throw a dart and make money over the last decade, and all of a sudden here in 2021, 2022, two things have really shaken up. And we've got this likelihood of a recession and higher interest rates and inflation for the first time in a really long time, not to mention geopolitical uncertainty."

"With all these things going on, the biggest question that I get from clients is just "How does all of this affect me? How does this impact me? How does this impact my financial plan?" And then, second to that, "Are there opportunities?" We have the Secure Act 2.0 that just rolled out, so there are tax laws that are changing. So there's just a lot of things going on, and the biggest question we get is "How do I make sense of all this? How does it impact me? How does it affect my financial plan?" And, "Are there any opportunities that I can take advantage of to put myself in a better position?""

Caleb: "Yeah, I'm asking that same question myself. I know a lot of our listeners are asking that question as well. And—it's personal, right? I mean, what works for me may not work for you, may not work for other people. And that's why we call it personal finance, which is why planning is so important, which I know is something you're so passionate about—the power of the plan. You know, my portfolio had a terrible 2022 like a lot of other people, but when I looked at my financial plan with my advisor at the end of the year, the plan was still relatively intact. How important is that as a core to really getting your arms around your finances?"

Taylor: "So critical. My analogy is that your retirement plan or your financial plan is like a diagnosis, and your investments, or your investment allocation, is the prescription. And far too often what I hear from people is they're so focused on the prescription, and they're wondering if they're taking the right prescription—if it's the right investment portfolio, if they're holding the right positions—but they don't have that diagnosis first. It would be strange if I was at a party and I met a random doctor and I said, "Hey, doc, should I be taking this prescription? Should I be adding another one? Should I be swapping it for something else?" To which they would say, "Well, I don't know. Come into my office and let's do a diagnosis and let me do some blood work, and then I'll tell you what you should be taking."

"So that diagnosis—that financial plan—is so important in driving not just your investing decisions, but how much insurance you should have, what sort of estate planning you should be doing, what changes you should be making to your financial life, if you can afford that home. All these different prescriptions really rely on that diagnosis. And I find that most people skip that diagnosis because it's not fun—it's not fun to sit there and be vulnerable, and look at your financial plan and do the hard work. Even if you have a financial planner, it still requires, as you know, for you to be involved in it. I just find so many people skip that step and they just want to talk about the next hot stock, or what they should be investing in or what changes they should make. But that diagnosis is so, so important for long-term success."

Caleb: "Yeah, it's that inventory as well. We say to do it every quarter if you can, but if you're not going to do it every quarter, do it twice a year. Do it definitely at the end of the beginning of the year, because you have to know what's coming in, what's going out, and where you are in terms of your plan and strategy for whatever it is you're trying to do."

"So a lot of people are asking themselves at a time like this—potential recession coming up and the stock market has been no friend to investors lately—is it a better time to be saving or investing? And I know that's personal, depending on where you are in your life, but are you counseling folks to have a little more cushion going into 2023 than they normally would? Stocks are pretty depressed right now—we're still in the midst of this bear market—and you want to have powder for that as well."

Taylor: "So at my firm, we specialize in working with people over the age of 50. They're either close to retirement or they're in retirement, and they generally have tax problems in retirement—we do a lot of tax planning for our clients. I'd say that a lot of our clients are not saving money anymore—they're retired and they're no longer generating income. And so it really is focusing on those withdrawal strategies and getting money out of the portfolio, or reducing their tax bill. So investing becomes really important—making sure that they're not going to outlive their money."

"Second to that, in retirement, cash management becomes really important. You mentioned dry powder, and in the accumulation phase of life, of course, you want to have that emergency fund in place, but you have income, so you don't need to hold as much cash in retirement when you're taking money from your portfolio. And we go through crazy, wild events like we did last year, where bonds and stocks are down for multiple quarters in a row, and you have to have a smart cash management plan."

"So we're really focused on those things that we can control, especially holding enough cash. But for those that are in the accumulation phase of life, of course, it's an opportune time to be saving and investing more money. And we don't know if the market will go lower—we don't have a crystal ball—but when the market is down, we have higher future expected returns. And we absolutely want to invest more money if possible. We also want to make sure that we have a proper savings plan in place."

Caleb: "For those spending it down, we used to have this rule—it's still out there—the 4% Rule, spending down your retirement funds or your 401(k) or your IRA. But lots of things have become a lot more expensive, and we're living a lot longer than we used to as well. Do you still abide by that rule, or do you still counsel that rule? How do you talk to folks about "It's okay to spend—in fact, you need to spend down." But how do you do that right now, especially in this environment?"

Taylor: "The 4% Rule is a great starting point for determining how much money you can take from your nest egg while mitigating the chances of running out of money. So some quick back-of-the-napkin math—take 4%, multiply by your nest egg, and you can get a general idea. The 4% Rule is what I would call a 'static withdrawal strategy'. What we prefer to use is something called a 'dynamic withdrawal strategy,' and the strategy that we use is based on academic research done by Jonathan Guyton, or the guardrails approach. And, as you mentioned, we don't know how long we're going to live, and that's one of the two things that we don't know, when it comes to taking money from our portfolio."

"One—we don't know how long we're going to live, and two—we don't know what the markets are going to do tomorrow. At least that's our philosophy—we can't predict the markets and we don't have a crystal ball. So, because we don't know what the markets are going to do tomorrow, and what our portfolio balance will be tomorrow, we prefer this dynamic approach. When the market does well, we will take a little bit more money from our portfolio, but when we go through tough rocky times—like what we're going through right now—we have to be nimble enough and willing to take a little bit of a pay cut from our portfolio."

"So we kind-of bounce around through these guardrails, we take some pay raises during the good times, and we take some pay cuts during the bad times. This allows us to take a higher percentage from our portfolio out of the gates, something closer to five or 6%, as long as we're willing to be dynamic and adjust those distributions as we go through different market environments. And again, this allows us to solve for not knowing how long we're going to live, and making sure we enjoy life and maximize our income, and not knowing what the market's going to do tomorrow."

"And the last thing is want to mention here is that one of the hardest things that we see, and that we coach clients on regularly, is actually spending their money. As you might know, the type of person it takes to build a nice multimillion-dollar nest egg is not the type of person that's really good at spending money and enjoying money. So a lot of what we're coaching clients on is giving them the confidence that they can go out and enjoy retirement, that they can go out and spend money, even though we are going through a difficult period. It's just that weird psychological thing that's like, being afraid to start seeing your portfolio balance go in the other direction when you've been watching it go up and to the right for the past 30 years."

Caleb: "What are the biggest mistakes, Taylor, that investors and even planners make at times like this, in these times of uncertainty?"

Taylor: "I think one of the biggest mistakes that planners make—and I can certainly fall into this trap as well—as we're going through difficult times, clients are asking really good questions or they're venting to you, and we want to solve their problem right away, we want to answer their question, we want to maybe predict the future. In these situations, when we're going through a difficult time, I think a lot of what clients really want is for us just to listen. They just want an ear. They want somebody to say, "You're going to be okay." They don't need us to predict what the S&P 500 is going to do this year, or what the 10-year Treasury yield is going to be on 12/31. A lot the time they just want us to say, "You're okay. We have a financial plan, we've modeled this out, and you are going to be okay.""

"So I think that's one of the traps we fall into, as professionals, where we want to answer questions and we want to prove that we're smart. But trying to answer that question or predict the future can be a slippery slope. So I think that's one of the biggest mistakes that planners can make."

"I think one of the big mistakes clients can make is that when things get rocky like this, they want to make a change. For most things in life, if we want to accomplish something, we have to make a change. If we're going to lose weight, we have to make a change. If we want to get stronger, we have to go to the gym. So in most things in life, we have to take action in order to achieve something. But in investing, in retirement planning, a lot of the time it's to do nothing."

"And that's really counterintuitive to a lot of other things in life. Markets are rocky, bonds are down, stocks are down—we need to do something. But in most situations it's like, "No, we actually need to stay put and stay committed to the plan that we worked so, so hard to put together." And again, it's just really counterintuitive and really challenging."

Caleb: "Doing nothing is also a decision—you have made the decision to stay the course, you've made, the decision not to make a rash move in your portfolio, or in your plan, ultimately. You came to this industry, to the financial planning industry, out of the wire houses, out of the big shops—Wall Street, as a lot of us call it. It's not only Wall Street, but you came out of that industry because you saw an opportunity to make a change and really touch people's lives. What do you think is the future of your industry, and financial planning and advice in general? There's a lot of technology out there that can do a lot of the things that advisors and planners used to do, but there's something holistic about the way you guys do it that will never be replaced. What do you see as the future in your industry?"

Taylor: "I do think there's a lot of technological advances, and the world of fintech is amazing, and I'm sure you've talked about it a lot. I know Investopedia.com has written a lot about the fiduciary standard and working with the fiduciary and fee-only financial planners, and I think those are all really important things to take into consideration."

"I think one of the bigger changes—one of the bigger movements we have seen and will see over the next several decades—is financial advisors and financial planners becoming more specialized. So, unlike other professions like doctors and attorneys, most financial planners are generalists—they're out there to help everyone. They serve business owners and individuals and married couples and young professionals, and retirees, but there are a growing number of specialists that have a very specific expertise. For instance, we only work with people over age 50 who have a sizable nest egg and have tax problems in retirement. We help them solve their very specific problems."

"So, just like you wouldn't go to a heart surgeon if you needed brain surgery, I think going forward—and something to take into consideration to know if you are going to make a change—thinking about working with a specialist—somebody who has expertise and works with people just like you, and you only. So I think that's a trend that we're seeing right now. It's becoming more and more popular, and I think that will continue for decades to come."

Caleb: "You play such a big part in helping younger advisors establish their businesses, establish their planning practices. You're a founder of the AGC. What is it that a lot of young advisors are recognizing as they come into this industry? They want to help people, just like you wanted to help people when you came into the industry on your own. What is it that you're seeing in terms of trends for these younger folks?"

Taylor: "Yeah. So in addition to getting specialized and working with one single demographic, I think one of the things that younger financial planners are recognizing is exactly what we're doing right now, which is that education, and educating the public, is so important. And it feels counterintuitive."

"I remember when I started my retirement podcast, my mom was like, "What are you doing? Why are you giving away your secret sauce. Why are you giving away all this information to people for free? Don't you want people to pay you for that information?" It's so backwards, but it does work, and educating people and giving that knowledge, and then letting them determine if they need help and when they need help."

"So I see a lot of young financial planners not only getting specialized, but going out into the public, going on Twitter, going on LinkedIn, starting podcasts, and educating people. Not only is it helping people better understand the world of personal finance, but it's also helping people get connected with the right financial advisors as well. So I think public education—we've seen it directly—Investopedia is a leader in this, but public education and educating people, and not holding this stuff in."

"I remember when I worked at the wire house, one of the older guys that was there, an advisor, was talking about sitting on a chairlift with somebody, and the person on the chairlift asked them for a stock tip. And he said something like, "Open up an account and I'll tell you." That's how it was back then. It was like, "I'm not going to give you any information. Give me your money, open up an account, and then I'll give you advice." And that's just not really the way things go anymore. And I think that's a trend that the younger generation is adopting."

Caleb: "Yeah. You're so good about extending your voice and extending your financial education in people, which is why you're one of the top ten on the Investopedia 100. This is about generosity and helping people. And you know what? It's a great marketing tool for your business as well, so the more you share, the more it comes back to you. Let's talk a little bit more about 2023. Lots of uncertainty out there. Everybody is guessing on what's going to happen. But what's your hottest take? What are people not talking about, Taylor, that you think deserves a little bit more attention, as we go into this year?"

Taylor: "I don't know if people are not talking about this, but for the last couple of years, inflation has been the big headline—it's one of the major concerns for investors. And I was reading up, Caleb, on your most recent investor survey, and it said that 70% of the Investopedia audience is still concerned about inflation impacting their investments this year, in 2023."

"However, I personally wouldn't be surprised to see if, instead of inflation, we begin to see disinflation. And I did an entire podcast on this on the Stay Wealthy Retirement Show last year. In short, disinflation is when the rate of inflation slows down. So if the rate of inflation goes from 7% to 5%, prices are still increasing year-over-year, but just at a slower rate."

"So, disinflation could be something that we see, and it is a positive thing. The rate of inflation is slowing down, which is different than deflation, right? Deflation is when prices decrease, and that can be really negative for the economy. So, again, I don't know if it's a really hot take or not, but inflation is just still stealing all the headlines. It's still a major concern for your readers. And so, I would say, you know what? It wouldn't be surprising if we saw disinflation hit here in 2023."

Caleb: "Yeah, I think you're on to something there and I don't think a lot of folks expect that, but we did see that term popping up a lot towards the end of the year—people starting to look that up, people starting to look up 'stagflation'. So inflation, in its many manifestations, is definitely front and center in people's minds. Well given that, you know we're a site that is built on our financial terms and our definitions. I'm sure you have your own favorite financial term. I would love to know what that is, Taylor."

Taylor: "I'm going to be really boring with this one today, and I'm going to say that 'diversification' is my favorite term. It is wildly important not just in investing, but also in life. We've gone through some really rocky times recently, and diversification has proven to do its job. Even in a year where most asset classes are down, you can look at your portfolio—if you have a properly diversified portfolio—and you can conclude that diversification did its job. So if you don't do anything else, if you need to take action and do something, I would say diversify your portfolio, and make sure it's properly allocated."

Caleb: "Yeah, you can't go wrong with that definition, and there's nothing wrong with being boring either—there's a reason that that is such a popular and well-respected term, and I'm not surprised that that is one of your favorites. Taylor Schulte, again, thank you so much for joining us, the founder of Define Financial and also the host of several podcasts, including the Stay Wealthy Retirement Show—we're going to link to that as well. And Taylor, so good to have you on The Express. Thanks so much for being on the show and for being such a good friend to Investopedia."

Taylor: "Absolutely, Caleb. Thank you so much."

Terms of the Week: Ponzi Scheme and Inflation Swap

It's terminology time—time for us to get smart with the investing term we need to know this week. And this week, we're doing a two-for—that's right—two for the price of one. We got so many great suggestions from our listeners on Instagram and via email that we said "What the hey!" Give the passengers what they want on this train, and that's how we roll.

The first comes to us from Josh McKendry Dow, who suggests 'Ponzi scheme' this week, given the new documentary about Bernie Madoff that just came out on Netflix. The monster of Wall Street, as it's called, is pretty good, I must say. Some new info in that one. And James Campbell, who was on this podcast a couple of years ago, is in the dock. He had a lot of correspondence with Madoff when Bernie was in prison before he died.

According to my favorite website, a 'Ponzi scheme' is a fraudulent investing scam, promising high rates of return, while promoting little risk to investors. The scheme generates returns for earlier investors with money taken from later investors, but it eventually bottoms out when the flood of new investors dries up, and there isn't enough money to go around.

The term Ponzi scheme was coined after a swindler named Charles Ponzi back in 1920. However, the first recorded instances of this sort of investment scam can be traced back to the mid-to-late 1800s, and they were orchestrated by Adele Spitzeder in Germany, and Sarah Howe in the United States. Madoff's Ponzi scheme was notable both for its size and for how he was able to evade regulators and scrutiny for so many years. In the end, Bernie Madoff's Ponzi scheme topped $64.8 billion. Good suggestion, Josh. Socks for you, my friend.

And Rijo Varghese hit us up on Instagram with his suggestion, and he'd like to learn more about inflation swaps. According to the world's greatest investing and financial education site, an 'inflation swap' is a contract used to transfer inflation risk from one party to another through an exchange of fixed cash flows.

In an inflation swap, one party pays a fixed-rate cash flow on a notional principal amount, while the other pays a floating rate linked to an inflation index, such as the Consumer Price Index (CPI). The party paying the floating rate pays the inflation-adjusted rate multiplied by the notional principal amount. Usually, the principal doesn't change hands. Each cash flow compromises one leg of the swap. Inflation swaps are used by financial professionals to mitigate or hedge the risk of inflation, and to use the price fluctuations to their advantage. You see companies like utilities using inflation swaps frequently because their income is linked to inflation, and swaps can help them stabilize their cash flows. Good suggestion, Rijo. Socks for you too, my friend.

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