Should You Use Cash, Debt, or Investments for a Big Purchase?

When Cash Feels Safer Than the Market: Funding Big Projects, Managing Risk, and Avoiding Tax Traps

Hunter Kelly discusses a client case (names changed) involving Mark and Lauren, who earn just over $300,000, have nearly $1 million in retirement savings, and $100,000 cash while considering a $175,000–$180,000 pool project. They explored HELOC/pool loans but were uncomfortable with added debt, so they chose to delay until Mark’s July bonus and retention payment arrive, including temporarily reducing his 403(b) contributions to increase short-term liquidity. The episode also covers Mark moving about $700,000 of his 403(b) into a money market due to market fears, the risks of staying in cash, and using a rules-based reentry plan and more fitting allocation. Kelly explains capital loss limits ($3,000 against ordinary income with carryforwards) and a backdoor Roth IRA reporting error on Form 8606 that, once corrected, saved about $1,000, emphasizing sequencing and broader advisor value beyond investments.

00:00 Welcome and Setup
00:46 Meet Mark and Lauren
02:23 Pool Project Costs
04:31 Debt vs Peace of Mind
05:42 Waiting for Bonus Cash
07:33 Pause 403b for Liquidity
09:10 Moved Retirement to Cash
11:56 Rules Based Reentry Plan
14:08 Breakeven Bias and Purpose
17:00 Capital Losses Explained
19:54 Backdoor Roth Reporting
23:03 Sequencing and Takeaways
26:02 Wrap Up and Disclaimer

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Transcript

0:00

And welcome back to The Retire Early Retire Now podcast. I'm your host, hunter Kelly, certified financial planner and founder of Palm Valley Wealth Management, where we help high income families build wealth with intention, reduce financial stress, and create more freedom, not just someday in retirement, but along the way. today's based on a recent client conversation, but as always, names and identifying details have been changed to protect their privacy. But I've been enjoying, and it seems like you guys have been enjoying these real life stories about how I. And Palm Valley Wealth Management help clients along the way through their journey. So if you're continuing to like this, shoot me a text in the link of the show notes and would love to maybe answer your questions or hear more about what you want to hear about. So today we're going to talk about family, and I'll call them Mark and Lauren. Mark and Lauren are doing very well financially. Mark earns a strong income. Just north of$300,000 per year, and they have meaningful retirement savings, so just under a million dollars with their IRAs and the 4 0 3 B that Mark has. And they have a significant amount of cash on hand, about a hundred thousand dollars, and they're thinking through a big lifestyle purchase, adding a pool with outdoor kitchen and all the fancy gadgets, to their home. But underneath that decision, there were several deeper planning questions. How much cash is actually enough to keep on hand for their particular situation? When does using debt make sense? And what happens when you move a large portion of your retirement account, to cash because you feel that the market is too risky, uh, in the moment. Right? another question and topic that we talked about was how do capital. Gain loss or capital losses actually work on your tax return. And most importantly, what should a financial advisor actually be helping with, beyond just investment accounts, right? And so today's episode, we'll call this when cash feels safer than the market, how to balance. Big expenses, liquidity, and long-term growth. And so again, let's, add on to the picture that we've already talked about here in the opening. Mark and Lauren, have been talking about getting a pool for some time. They had some issues with permitting and an easement and all these things. So it's been quite a while, since they've been wanting to get this pool. So again, they've been going through the permitting and have gotten. updated quotes, really because the permitting took so long that the quotes changed quite a bit, as they were working through, all the things that needed to work through with the county. And so they've, they've talked to, the designer got updated prices and most home projects today. The number, well, it's not small, right? Everything's just more expensive than it was six, seven years ago. No surprise there. So the pool screen enclosure, outdoor kitchen decking and everything, would cost right around$162,000. Then you add in electric gas yard repair, side sprinklers, all the things that come after getting the pool installed. That kind of bumped up the all in cost around 175 to$180,000 is what they're projecting. So now. They do have cash. They have roughly a hundred thousand dollars set aside for this purchase. but they do not have the full amount sitting in cash without touching emergency, reserves. So naturally, they've already explored a heloc, they've explored, pool loans, things of that nature. So on paper it seems like a reasonable option. Use some cash, use home equity, but keep. The project, project moving. Right. But there was a catch. the lenders they spoke with were offering around$60,000 of available credit. One of the structures required them to draw the full amount right away. Mark did not love this idea. he's not a fan of taking on more debt than he really needs to. They already have about a$500,000 loan on their house. And, the idea of adding more debt, drawing cash, didn't necessarily excite him. he wants to find a way to maybe avoid that. And so we were talking through those options that we'll talk about here in just a second. And I think this is where a lot of families find themselves, right? most families don't necessarily want. To take on more debt, right? They, they can technically afford it. They can afford the debt, their income is strong enough to do so. They don't have any other debt than their mortgage. And their mortgage is reasonably, their debt to income is, is very reasonable, right? They can add on and be fine and still reach their retirement goals. But the real question is not can we afford it? The better question is, can we afford it in a way that still allows us to sleep at night? And so this distinction really matters from emotional standpoint because financial planning is not just math. It's math plus behavior, plus emotions, plus timing, plus the trade offs that we talk about a lot in this podcast, right? So what is the trade off? If I get this loan, what am, what am I giving up, to pay this extra interest or have this monthly payment? Right? liquidity is not just about having cash. It's about. Maintaining flexibility and flexibility is one of the main pillars of what we talk about in this podcast. this is, a big reason why I'm in financial planning to help families so that they have that financial flexibility, right? And so in Mark and Lauren's case. This decision they landed on was to wait. Mark has a large annual bonus, expected to come in July. He, also has a second retention payment expected, I guess. what had happened is that he, had some health issues late in the year last year. and his company realized how important he was, while he was gone and basically gave him a bonus to stay. if he makes it. To through June, he'll receive the second half of that bonus, which is, Obviously good to know that you're valued, but also like, why weren't you paying me that in the first place? but in any case, so rather than force the pool project now, drain most of their cash and take on more debt than they're really comfortable with, they're deciding to delay the project until those payments hit, which I think is a super smart idea, right? If you don't want to take on that debt, like, let's not. Force this thing through. So this may sound simple, but it actually is a great planning move. So sometimes the best financial decision is not yes or no. Sometimes the best decision is just not yet, right? So why don't we just wait a few more months. or maybe a year or whatever the case may be in your particular situation. So by waiting a few months, they give themself more optionality. He can keep that cash on hand and give him more flexibility. He'll receive that bonus and then they can purchase the pool and not have to dip into their savings, right? or their emergency fund. They can reassess the pool quote. They can decide how much cash they want to preserve. They can decide whether the HELOC actually makes sense for them. They can avoid making a six figure lifestyle decision, from a place of pressure. Really, they can, they have all the leverage of the world there, right? So one tactical item that we discuss as a temporary. mechanism is to turn off Mark's four, three B contribution just for a paycheck cycle when that bonus comes in, so that he would actually have a little bit more cash on hand. He's ahead of the game on saving. So, putting that extra couple thousand dollars into. His, 4 0 3 B in June just wouldn't be worth the juice, wouldn't be worth the squeeze there, for what he would actually get in return. So the flexibility in this particular moment, of having that little bit of extra cash on hand makes more sense than putting it into his 4 0 3 B. So, so again, because he contributes a percentage of his paycheck to his retirement. That bonus will get applied to that percentage. And again, we're gonna lower that percentage basically to zero. and, allow him to take that full, net paycheck out of their, minus taxes and all those things, right? So this is a good example how, how planning is not always about maxing everything, right? So in this case, we're going to lower mark's, 4 0 3 B contribution to give him a little bit more flexibility in the short term because we know he's already ahead and saving on that. 4 0 3 B, it's more. and we're more saving for the tax benefits, mostly versus, for TA saving for his retirement. So it's not always about maxing the retirement account no matter what. sometimes the right move is to temp, temporarily, prioritize liquidity or whatever other expense because you have, you want that flexibility. Versus just saving for retirement. So the second major part of our conversation, mark, has been very, weary of the market, given the circumstances of the New War and so on and so forth. And he moved all of his retirement account into a cash-like holding, So the money market inside of his four three B. So he moved roughly$700,000 of his 4 0 3 B to cash or a cash like holding. his reasoning was straightforward. He's concerned about the market, right? He's worried about market downturn, and he said in effect, I would rather miss some of the upside than watch my account fall dramatically. And this feeling is real. Like we've had this conversation, I've talked him out of it a couple of times, and this past time he, I guess he didn't reach out to me, he just get, went ahead and did it. and so we, we had a long conversation about that. And so if you've ever had a amenable amount of money invested. During a volatile market, you probably understand, hey, that$70,000 I used to have in that account that went down 10%, uh, or$7,000 feels a little bit different than the$700,000 that went down 10%. Now they lost$70,000 in about a two day period or, or whatever it may be, right? And so it's one thing, again, to be aggressive when you have$25,000, it's another thing. Or you have several hundred thousand dollars invested and you start thinking, what if it becomes$600,000 or$500,000? Right? And so we really need to, reassess his risk tolerance. His risk capacity and start to work in a new portfolio for Mark, so he can feel better about being invested. But, that is a conversation that we're gonna continue to have a along the way this year. So Mark moved to safety, right? He moved to cash. And here's the thing. You may reduce one type of risk. And it reduces that short term volatility, but it introduces other risk. It introduces missing, some of the recovery, introduces inflation risk. It introduces risk of sitting and cash too long, and so maybe. Most importantly, it introduces the risk of needing to make, two very hard decisions correctly. The first decision is, Hey, when do I get out? And to me, the harder decision is when do I get back in, right? yeah, you can get out, but. When do we get back in? There's usually never a clear path to getting back in, right? they say, I'm just going to move cash until things calm down. But the problem is markets rarely send an all clear signal. It's, it's rarely clear, Hey, we need to get back in. by the time things feel safe again, prices may have already gone much higher. One of the things we discussed was not necessarily jumping all the way back in at once, but creating rules based reentry plan, right? And so if you are one of those people that may have went to cash because you were scared of the war or whatever, X, y, Z thing that you saw in the news, or, read online, whatever that may be, that scared you to go to cash, having a rules-based reentry plan over an emotional plan. Will help you get back into the market, and reap the benefits of, what the market can provide. Right? And so for example, what if we put a fixed amount back into the market every month, right? So dollar cost average back into the market, and then reinvest that,$700,000 over the next six, 12, or 18 months. What if we choose an allocation that fills more intentional? Then, the default allocation of the 4 0 3 B, right? he was in a target date fund. Maybe we can pick some more, some more selective funds, add in more, fixed income, things of that nature. And so that way the decision isn't based entirely on emotion or headlines or news or anything, that would sway you. But it becomes a process, right? And this is where I think investors need to be careful. There is nothing wrong with saying my risk tolerance has changed. There is nothing wrong with saying, I do not, want to be invested as aggressively as I was before. Especially as you start reaching age 50, which is where Mark is headed, right? And, Both, but there is a big difference between changing your allocation and abandoning your plan, right? a change in allocation might sound like, Hey, I was 90% stock and now I'm 70% stock. Abandoning the plan. Is, saying, Hey, I'm gonna sit in all cash until I feel better. Right? Uh, you're, you're taking all, all growth off the table at that point, right? And so that second one can be dangerous because feelings are not a reliable investment strategy. And, you can see that throughout. The history of the market, right? Being emotional about your investments generally does not work out. And so Mark had, mark also had cash outside of retirement accounts. He had money sitting in a taxable brokerage accounts, some individual stock positions that he was watching, and some crypto holdings as well, that were down from their original value. His plan with some of those investments was to wait for the rebound. Pull out of the original principle and then let the rest ride. this is a common strategy for a lot of, day traders and individual investors. and Honestly, I understand the appeal. It feels like you're saying once I get my money back, I'll reduce risk. But the challenge in this is the market does not care about your breakeven point, doesn't care about your feelings, doesn't care about your plan. The fact, that you paid a certain amount for an investment doesn't necessarily mean that that investment is likely going to return to that value. Sometimes it will. sometimes it won't. Right? And so the better question is not. When can I get back to even the better question is if I had the same amount of cash as I do in the investments right now, would I purchase this investment today? And if the question, this question does a couple different things, but the main thing is that this question removes the emotional anchor, right? Because once we own something, we tend to make a decision based off what we paid for it. But planning requires us to ask, what role does this investment play now? Does this still fit my plan? Does it still fit my risk tolerance? All those things, and is the risk worth it? the other question it may ask is, and if this money is still needed for something else, like a pool, emergency fund, car, family expenses, should it really be exposed to the market volatility that, that I haven't invested in? that does not mean every speculative investment should be sold, but it does mean that every dollar needs a job. So it needs a purpose. And if it's serving that purpose, then great charge on. But if it's not, maybe we need to reallocate it. So some dollars are long term growth. Some of it's near term growth, some of it's funds, some it's emergency. Some of it's is your speculative money, right? if you're able to be able to do those certain things. the danger comes when these categories get mixed together, right? Everything needs a purpose. And if it doesn't have a purpose, then what are we doing here? How is this serving, my overall goal?'cause again. I've said this before, if you're able to outperform the s and p or whatever, x, y, Z benchmark, 10, 15, 20%, let's say over your lifetime, but you still can't retire, you can't still do the things that you want to do, then what's the point? we're not here to just make money, to make money. We're here to make money to do the things that we love to do with the people that we love. Right? And so another big part of this meeting was taxes, mainly because we met, right before tax season was over. So Mark and Lauren had filled out their tax return using a tax software and realized that they had somewhere between 30 to$35,000 of capital losses from their investments in crypto. And understandably they expect it to create a bigger tax benefit, but their federal return was, around$5,800, which was actually a bit lower than the prior year, right? So, they had, a return. A refund of$5,800, which again was lower than last year. So they were confused. How did we realize such a large loss and not see a bigger re refund? And this is a common misunderstanding. Capital losses are valuable, but they do not offset your income the way that people think that they do. Right? And general capital losses, first offset capital gains, which they didn't have very many of. And then if you have losses left over, you can. use up to$3,000, of those losses to offset ordinary income in a given year. The rest of those losses will be carried forward. So if someone realizes$35,000 worth of losses, capital losses, and they don't have gains to, to offset those losses, they usually, they do not usually get to deduct$35,000 off of their W2 income that year. They may. Get$3,000 this year and the remaining of those losses. So the$32,000 we carry forward and can still be useful'cause they can carry forward indefinitely, right? And so this will offset future capital gains. So we'll wanna make sure that we keep track of those losses moving forward on those tax returns and it may continue to offset. Up to$3,000 until those losses are used, via capital gains or, the ordinary income deduction. So this is one reason tax planning, tax preparation are not the same, right? Tax preparation looks backwards and says what happened last year and how do we report it? Tax planning is always forward looking right and ask, what should we do before December 31st to improve the outcome for W2 employees tax planning levers. Feel limited, right? So you generally have your pre-tax retirement accounts, HSA contributions, maybe a dependent care FSA contribution charitable giving. Tax loss, harvesting, asset allocation, timing of income or deductions in certain cases. Right. But you usually do not have the same deductions as maybe like a business owner. So the key is not to chase deductions for the sake of. Chasing those deductions. the key is to understand which levers that are actually available, and then use them intentionally. Another tax related issue that came around, was IRA contributions. Lauren had noticed something in their tax software that made it feel like their IRAs were being, quote unquote double counted or double taxed, right? Or creating some confusion. when we first started working together, I think they were using a CPA. I suggested that we do backdoor Roth contributions because at that time they really had no Roth money, to speak of. So I wanted to start creating that Roth bucket to give them some tax diversity, right? So give them some asset location diversity. Start building those different tax buckets. And so this is where the backdoor Roth IRA contribution can get tricky, for high income earners. Direct Roth contributions are often not available because of income limits. No surprise for most of you that are probably listening, right? So many use a backdoor Roth strategy and You make a non-deductible contribution to your traditional IRA. Then you convert that Roth IRA money over generally immediately. So there's no gains and things of that nature, but you still have to report it, right? And oftentimes. Form 86 0 6 is either forgotten or not filled out correctly, and that's what happened in this case. So the original contribution is generally reported as non-deductible, and the conversion is reported separately, and if you have other pre-tax money, which they do not, in this case, the pro, pro-rata rule can complicate. Things further. In Mark's case, they, the key point was that the IRA contribution should not be treated as a deductible, uh, as a deductible contribution. If the plan is to convert the Roth, That would be the wrong framing. The goal is not to get the deduction today. This is basically what we had the conversation about. The goal is to get the money into Roth through the backdoor process and build tax free growth over that time. I'm not sure what happened in translation here. Lauren was working on the tax return and ended up, filling out the 86 0 6 incorrectly and adding another$4,500 worth of income to their tax return. So I was able to review their tax return and show them and give them resources to be able to fix that, to show them their basis, how much they had contributed on a non-deductible contribution basis. do that conversion and put all the numbers in correctly, which ended up saving them another thousand dollars on their taxes. Right. And so with this strategy, like a backdoor Roth tax loss, carry forwards, non-deductible contributions to their IRA, a simple mistake can create confusion and even tax issues later. So we wanna be careful, and this is something that. That it good advisors should be looking over and watching out for. Right? a lot of advisors don't prep taxes, but they should be very, fluent and understand how the tax code works, especially for backdoor Roth contributions, things that maybe they do on a regular basis so that clients can avoid these simple mistakes yet, can get really annoying, when doing their taxes and things of that nature, right? So when I step back from this conversation, the big thing, the big, so when I step back from this conversation, the big theme. Is all about sequencing. Mark and Laura did not decide whether the pool was good or bad. This they were deciding when to do it and how to fund it. Mark was not deciding whether investing matters. He was deciding on when and how to take that risk. Again, they were not deciding on whether taxes matter they were trying to determine or trying to understand. Which tax benefits apply now and which ones carry forward and how all those things work, right? Uh, and having this sequencing or proper sequencing really matters, and having a professional on your side matters. The order of the decisions can dramatically change how you feel about your financial. how easy it can make your financial life, or how difficult it can make your financial life. so sequencing matters. So what can we take away from Mark and Laura's situation first? Before making lifestyle purchase, before making a large lifestyle purchase, ask whether the decision still leaves you with enough liquidity to feel secure. Second, debt is not automatically bad. Debt that makes you feel trapped or exposed should be evaluated carefully. They're moving Your investments to cash may reduce short-term volatility, but it creates the challenge of deciding when to get back in Fourth, if you're sitting in a, oh my gosh, fourth, if you're sitting in cash because the market feels uncertain, consider making a rules-based re reentry plan, not an emotional reentry plan instead of waiting. Uh, for that perfect moment, create a rule and get back into the market because the history says the longer you're in the market, the better the outcomes will be. Fifth, capital losses are useful, but they may not reduce your taxes as much as you expect in the current year. sixth, the backdoor Roth IRA Contributions need to be reported correctly, especially when dealing with non-deductible. IRA contributions and Roth conversions. Make sure you get that 86 0 6 correct. And then seventh, your financial advisor should be helping you with making better life decisions, not just reviewing investment performance. the big idea from today is Financial planning is not about always choosing the mathematically correct, perfect answer, right? It is about choosing the answer that gives you the best combination of progress, flexibility, and peace of mind. For Mark and Lauren, that meant waiting on the pool until the summer. And not making a RAs decision, preserving their liquidity, being thoughtful about the bonus and timing of all that. and then reviewing the tax return and creating more intentional plan for cash versus investments and things of that nature. So if you found this episode helpful, I'd really appreciate it if you share this with someone that is trying to find balance with big financial decisions, whether it's a home project, a career change, a major purchase, simply just trying to figure out what they're doing with their life You can always go to my website, Palm Valley wm.com, go look at the Palm Valley pathway. it's the process that I've created to help high income earners create that flexibility, optionality, and help them retire early. So we will see you in the next one. this podcast is not meant to be financial or investment advice. Please do not make decisions solely based on this podcast alone. Please seek professional help when making those big financial decisions.