a piece of the puzzle - a portfolio is not a plan

According to the U.S. Census Bureau, 4 million Americans are expected to turn 65 in 2024, more than in any other year in history. Whether it’s retirement, a gap year, or something else equally exciting, quite a few are approaching the next stage in their financial lives. Many of these folks have been contemplating their next steps for quite some time, and they’ve built up savings and investments in preparation for this next stage. However, a portfolio is not a plan, and having a portfolio is only part of the picture. Knowing how they’ll use that portfolio to fuel this next phase is critical.

A portfolio is not a plan

A portfolio is an ingredient – it is not the recipe. Your portfolio is the aggregation of all of your securities – in your retirement accounts and your regular taxable investment accounts. Sometimes, the portfolio may even include hard goods like art or collectibles. But, while you may have a sizable investment account, you can’t pay your property taxes or other bills with your Apple stock or your ’64 Mustang. This is where a plan becomes necessary.

As you know, a recipe is a set of step-by-step instructions for using listed ingredients in specific amounts. Your plan is like the recipe for successfully navigating a portion of your financial life. It is designed to answer questions like: When the bills come in, do you sell an investment in your taxable investment account? Do you take a distribution from your IRA or your 401k? Or is it time to take a distribution from your Roth IRA?

The plan also helps answer the question, “How much do I need?”. If you need to withdraw enough to pay your bills, you’ll probably also have to account for taxes, which means you’ll have to withdraw more than the bill amount. The amount of the taxes will depend on the type of account you’re withdrawing from and what other income you may have during the year. The more you need to withdraw to cover the bill and the taxes, the less you have left for future bills.

Considerations within your plan

A recipe helps prevent creating a mouth-puckeringly awful lemon cake by using too much of a particular ingredient. A plan can help prevent incurring unnecessary taxes and charges by avoiding too much reliance on a single source of income. If you take the full amount you need from your pre-tax retirement account, the tax associated with that amount must also be included in your plan. Each time you do this, you increase your taxable income for the year, which may increase other bills (like your Medicare premium or additional taxes like the Net Investment Income Tax). You can also take part of the amount as long-term capital gains from your investment account. The tax rate on that income is lower than the tax rate on the income from the pre-tax account. However, long-term capital gains will still increase your adjusted gross income and your taxable income and could still cause increases to other bills. Alternatively, you may take part of the amount from a Roth IRA, which won’t incur additional taxes and won’t affect your adjusted gross income or your taxable income. Just like a recipe tells you how long to beat the batter, the plan tells you at what point to switch to a different source of income.

With some planning, you might devise a strategy to keep your adjusted gross income below the thresholds for other taxes and surcharges and your tax bill low, leaving you more money for future cash needs. Like a page from a cookbook, your plan should tell you which components of your portfolio to use in which order and in what proportions to produce the desired outcome—progress towards your financial goals (or luscious lemon cupcakes).

ingredients without a recipe is like a portfolio without a plan

Ingredients without a recipe… like a portfolio without a plan

Your plan should be like a recipe. If you use all the same ingredients but treat them differently and in different amounts, you could end up with a cake, a cookie, something unidentifiable, or totally unsuitable for your needs. The recipe provides guidance on the ingredients, the order of the steps to take, and the methods to use to produce the desired result. Your plan should do the same.

Planning ahead

Planning for the next stage is at least as important as devising a strategy. It’s like gathering the ingredients for your baking project. You could have dozens and dozens of eggs, but if you only have a little or no flour, your cake recipe options will be limited. A similar situation occurs when all of your financial assets are of a similar nature with respect to taxable status or investment type. Your options for efficient income strategies will be limited.

Diversifying your assets, both in individual investment holdings and in the types of accounts, can allow you to choose from multiple strategies when you need to generate an income from your portfolio. As you’ve probably heard me say before, much of financial planning is about ensuring that you have options in the future.

The examples above are just a few of the things that you’ll want to consider when laying the groundwork for your future financial situation. Having long-term and short-term plans for your finances can help you efficiently pursue your financial goals. Operating without a plan may mean that you unnecessarily incur taxes and surcharges, which may hinder your ability to achieve your goals and may even exhaust your resources sooner than anticipated. Having a portfolio is a good start. Having a plan allows you to use that portfolio to its full potential.

This article is intended to be educational and thought-provoking rather than financial advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. We examine these factors and many others during our financial planning process to determine appropriate financial strategies for YOU.

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