When investing, consider the how over the what – Twin Cities

These are portraits of Bruce Helmer and Peg Webb, financial advisers at Wealth Enhancement Group and Pioneer Press business columnists
Bruce Helmer and Peg Webb

People always seem more concerned with where they invest than with how to invest.

They get hung up on what stock, what bond, or what mutual fund to own, and worry about whether they need to be in or out of the market. Instead, in the long run, strategies are far more important than specific tools or tactics. Here are five key areas where it can be beneficial to be more strategic rather than investment-focused, and why.

Roth IRA and Roth conversions

Although more Americans own far more traditional individual retirement accounts (IRAs) than Roth IRAs, the tax benefits of a Roth IRA are likely to be a far greater influence on wealth accumulation than the investments you choose. That’s because, with a traditional IRA, you can lose almost a third of your withdrawals to federal taxes. With a Roth IRA, you make contributions after paying taxes but enjoy tax-free growth and tax-free qualified withdrawals. Plus, traditional IRAs have required minimum distributions (RMDs) beginning at age 73, depending on your birth date. Roth IRAs don’t, meaning that you can benefit from a longer period of tax-free growth.

Converting all or some of your traditional IRA to a Roth now could be a good move. One reason is that there are no limits on conversion amounts. If your current income is too high to qualify for opening a Roth IRA, you can use a “back door” Roth IRA conversion. With a back-door Roth, you first put your contribution into a traditional IRA (where there are no income limits), then move money into a Roth IRA using a trustee-to-trustee Roth conversion.

Another reason to consider a Roth conversion sooner than later is that you will pay taxes on the amount converted at today’s lower marginal tax rates. This means that conversions are “on-sale” until the Tax Cuts and Jobs Act sunsets in December 2025, when today’s lower tax brackets return to their 2018 levels (unless Congress acts). Take care that the 10% federal penalty on withdrawals from IRAs made before age 59½ doesn’t erase the benefit of the conversion.

Time, not timing

Market timing is not easily achievable, even for professional investors. But that has not stopped legions of day traders who think they have a surefire way to beat the market. When you try to time the market, you need to make two correct calls — when to get out and when to get back in. Over time, almost all investors do better by simply investing immediately and letting the miracle of compounding do the heavy lifting.

A long-term strategy of staying in the market is a more sensible approach since you participate in market recoveries in real-time. Often, the largest returns are realized in short, fleeting windows when markets recover. In addition, there is an available strategy to soften the potentially negative effect of buying when markets are volatile or overvalued. By dollar-cost averaging (DCA), you buy more of what you own at lower prices when markets are down, thereby lowering the average cost of your investment and allowing for more potential returns when markets get healthier. (Remember, though, that DCA never guarantees a profit nor protects against loss.)

Spend the smartest money first

Spending smart money first means seeking to balance tax consequences with investment performance. For example, decisions to take withdrawals from a tax-advantaged account or sell appreciated securities from a taxable account aren’t always as straightforward as they may seem. If you are in a low tax bracket, taking withdrawals from an IRA or 401(k) now, before your required minimum distributions kick in (or tax rates increase, as they could after 2025), could be a good strategy. Similarly, if you have long-term embedded gains in a taxable account, it may make sense to sell some and pay the taxes at today’s lower long-term capital gains rate rather than waiting until 2026, when long-term capital gains rates could potentially be higher.

Sometimes figuring out this balance between tax considerations and investment results is more art than science, and it’s quite likely that the most effective strategy could change year to year. It’s a good idea to work with an experienced and knowledgeable financial adviser to optimize your income decisions.

Reducing taxes is one of the best ways to lower your return on investment (ROI)

So much of the financial industry tries to encourage people to put most of their wealth into qualified plans, including IRAs and 401(k)s. That’s because some of the largest banks and financial services companies have strong incentives in place to “lock up” your money in qualified plans for years or even decades, earning fees on assets you’re actively encouraged not to spend due to early (that is, pre-age 59½) withdrawal penalties. You may also have seen lots of ads touting the benefits of rolling money from your company pension into IRA accounts managed by those same organizations.

Pretax retirement plans are generally inefficient when it comes to taking distributions or passing wealth to your heirs. In fact, given the high percentage of household wealth that resides in retirement plans, paying the taxes due on traditional IRA or 401(k) withdrawals at ordinary income rates could be the biggest investment expense you’ll face during your lifetime — as well as the biggest drag on ROI.

Tax diversification

All this leads us to an evergreen topic at Wealth Enhancement Group — encouraging clients to diversify their tax liability into three buckets: taxable, tax-deferred, and tax-free. Planning for taxes in this way can give you peace of mind by providing for yourself and your family no matter where taxes are headed in the future.

By working with an experienced and knowledgeable adviser who can help construct a comprehensive financial plan built to withstand market volatility while offering the opportunity for growth, you can avoid the common trap of emphasizing short-term investments at the expense of strategies designed to help achieve your long-term goals.

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