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welcome to the best interest podcast
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where we believe Benjamin Franklin's
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advice that an investment in knowledge
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pays the best interest both in finances
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and in your life every episode teaches
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you personal finance and investing in
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simple terms now here's your host Jesse
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Kramer hello and welcome to episode 95
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of the best interest podcast my name is
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Jesse Kramer and today we are bringing
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you another AMA episode uh if you want
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to you can go listen to the Past AMA
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episodes which I believe were all very
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well received uh which were episodes 90
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86 and 81 and before we get into
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question one today we are going to start
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with our customary review of the week
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this one comes from nirak
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111 and nirak wrote in and said
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straightforward clear concise language I
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stumbled upon this podcast after hearing
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about it on another podcast I've
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listened to more than five episodes
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already I really like Jesse's
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presentation style and I will be
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listening more well NRA thank you very
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much for those kind words if you're
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listening to this right now you can
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email me Jesse bestter interest. blog
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and we will get you hooked up with a
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super soft bestest t-shirt okay let's
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dive into the AMA first question one
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Kate wrote in and Kate's got a a semi
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long question but it's pretty good
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pretty detailed so we're going to take
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our time and work our way through it
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Kate's question is about portfolio
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rebalancing Kate's in her early 40s she
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plans to work another 25 years years she
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has
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$650,000 in Ira 250,000 is in a S&T 500
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ETF the remaining 400,000 is in
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individual stocks with a very heavy
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concentration in tech stocks like Amazon
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Apple and Google and when Kate was
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younger she followed the maxim of buying
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what she knew which is something if
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you're familiar with Peter Lynch
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listeners he's a famous proponent of buy
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what you know and Kate says that those
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stocks the stocks that she knew they've
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done incredibly well for her over the
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last 15 years years but now she's
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getting nervous about having that much
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money in individual stocks especially
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all in the same industry the tech
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industry it's hard to sell those stocks
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in Kate's words when they've done so
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well for her over the past years but I
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know that I need to rebalance or risk
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tremendous loss so Jesse can you tell me
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how you would look at this which is a
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very good but ultimately still a problem
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a good problem to have how much of these
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tech stocks would you recommend selling
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and should Kate just keep pouring that
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money into an S&P 500 fund or diversify
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into another category how often would
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you consider rebalancing so Apple Google
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and Amazon they initially started out at
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only about 20% of Kate's portfolio but
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they've grown significantly over the
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last decade do you consider rebalancing
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on a regular schedule is there a point
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in time when the more conservative
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portion of your investment account is
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high enough that you just let the
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individual stocks ride Kate also
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included that she's a government
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employee and she's on track to retire
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with a pension that will be north of
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$75,000 a year here so she can afford to
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be a little bit more risky in her IRAs
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fantastic question Kate so first
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rebalancing inside of Ira accounts and
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other qualified accounts like a 401k or
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an HSA or something like that has no tax
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consequence and that's wonderful that's
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a great thing for you you don't have to
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fret about capital gains taxes in this
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case even though the stocks that you've
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picked have increased so much yes there
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are capital gains there but you don't
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have to pay capital gains taxes on any
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inside of a qualified account uh so that
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would be different if the Investments
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were in a taxable brokerage account I
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know later in today's episode we have a
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question about taxable brokerage
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accounts I I'll address that idea in a
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minute quite simply Kate the easiest
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diversification method would be to sell
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those individual stocks completely and
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then buy a total market index ETF that's
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the simple answer but okay you mentioned
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Apple Amazon and Google so I'll think
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about those I'll use those three
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companies in this example let's look at
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vti that's vanguard's total stock market
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index ETF that fund uh is composed of
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obviously many many many different
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companies but 6% of it is Apple 3.3% of
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it is Google 3.4% of it is Amazon in
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other words you'll still have plenty of
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exposure to those same exact tech
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companies inside of vti you won't
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necessarily feel the daily ups and downs
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of those individual names I would say
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many of us listening right now my own an
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index fun or just some sort of sort of
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Diversified mutual fund and we're
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blissfully unaware of the fact that on
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any given day some of the stocks that we
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have ownership of inside that fund
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they're losing money they're down on the
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day we don't know it because maybe the
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fund on the whole is up but anyway so
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that's just part and parcel of investing
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in a diversified fund or divers
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investing in a mutual fund like vti now
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Kate if you feel a particular emotional
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connection to those companies to Amazon
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and Apple and Google and you don't want
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to abandon them completely I get it
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that's very very common and in that case
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I would recommend you carve out a small
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portion of your investable dollars and
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make that small portion your sandbox
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that you get to play in how big is that
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portion it might be 3% it might be 5%
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maybe it can get all the way up to 10%
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of your investing dollars that's
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probably where I would cap it is at 10%
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of your investing dollars that can be
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your sandbox and within that sandbox if
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you want to own just Apple Amazon and
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Google so be it that's fine that's fine
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so 90% of your investing dollars will
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end up in a diversified lowcost
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portfolio the other 10% that can be your
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sandbox where you maybe you take more
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risks you hold single stocks you have a
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little bit of fun you own individual
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companies that you know companies that
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maybe you don't understand their balance
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sheets maybe you don't understand the
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true uh intricacies of their business
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but you're familiar with the brands and
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there's something interesting fun about
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owning brands that you're familiar with
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okay let's go to the other part of your
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question I recommend you create a
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rebalancing rule that works for you that
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you can stick with through thick and
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thin and there are a couple ways to
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approach the rebalancing rule one of
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them is very much time based where
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someone says I rebalance every 3 months
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or every 6 months or every 12 months no
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matter what there's a reminder on my
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calendar and it's time based it's
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date-based that on certain times of the
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year whether the Market's gone up or
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gone down I am going to rebalance or
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there's another type of rule where
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someone might say it's not time based
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but it's allocation based they might say
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if my allocation gets more than 5% out
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of whack then I rebalance so let's say
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you start at a 8020 allocation well in
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that case you're going to rebalance if
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you get to 7525 because you're 5% out of
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whack or if you get up to 8515 then
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you're going to rebalance and that
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Target 8020 right is like this
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gravitational pull or like this bungee
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cord that's going to pull you back in as
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soon as you get too far out of whack you
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go back to your target allocation so the
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first type requires you to bake in
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rebalancing into your calendar the
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second type requ Ires you to keep tabs
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on the portfolio itself so is one of
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those two rebalancing strategies better
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than the other not necessarily I mean I
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I suppose when it actually comes down to
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brass taxs and numbers yes I'm sure
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someone out there has done research and
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there are differences between the two in
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fact I I do remember reading something
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that the allocation based rebalancing
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tends to be better than the time-based
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rebalancing although in my opinion I
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think just from the human behavior point
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of view I would think that the
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time-based rebalancing is just easy
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easier right it's easy to say yeah on
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June 31st and December 31st every 6
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months I rebalance my portfolio and for
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what it's worth I think the differences
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between the two rebalancing strategies
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are slim and small enough you know very
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small differences and small benefits
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that either one you choose is going to
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be helpful and is going to be better
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than doing nothing at all so that
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listeners and K I I would leave that one
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up to you yourself best what works for
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you best but Kate had another part of
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her question is there a point in time
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time when the more conservative portion
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of your investment account is high
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enough that you just let your stocks
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ride and and yes there is I'm going to
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link an article in the show notes that I
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called the title of the article is when
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not to rebalance and in short it goes
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back to a couple fundamental ways to
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construct a portfolio one way to
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construct a portfolio is to measure
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strictly in percentages based on your
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ability to take on risk based on your
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willingness to take risk and your need
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for the returns that come from risk
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let's say you settle on a 60/40
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portfolio great that's your target
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you're measuring in percentages and
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whenever the portfolio Strays too far
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from those percentages you're going to
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rebalance right or whenever their six
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months or 12 months date comes up you're
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going to rebalance back to in that
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example 6040 but the second way to
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construct a portfolio is more about
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timelines and goals and building a
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certain amount of buffer into your
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portfolio that kind of investor might
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think to themselves you know what I I
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always want to have 10 years worth of
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spending sitting in lowrisk US bonds
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inside my portfolio I'm not thinking
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about 40% of my portfolio I'm thinking
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about 10 years worth of spending in
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bonds right it's not a percentage it's a
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dollar amount and so for that investor
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they will probably reach a point in
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their investing career where the bonds
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in their portfolio continue to cover
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their 10year need and their stocks are
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continuing to grow far beyond their
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original investment so what might have
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started as 6040 just because 40%
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happened to be 10 years worth of
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spending for them maybe it now becomes
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7030 because well their portfolio has
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grown and now only 30% of it is needed
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in bonds to cover 10 years worth of
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spending it's not that the bonds have
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shrunk in fact it'd probably be that the
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bonds are just the same exact size that
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they were when they started it's just
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that the stock growth is far outpacing
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the bond growth now I'd argue that as
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long as that investor is still
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comfortable in their financial plan with
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the idea of holding 10 years of bonds
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then yeah I I don't think they need to
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rebalance in that case so it's important
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for each of us to understand the reasons
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the rationale behind our chosen asset
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allocation your need to rebalance to
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that allocation will depend on the
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reasons that you chose it in the first
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place and the current state of your
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portfolio and in some cases it means a
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change in your portfolio will lead to
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rebalancing right the natural forces of
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the market will lead you to rebalance
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your portfolio but in other cases maybe
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your portfolio can be changing beneath
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your feet and that's perfectly fine
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because it's still doing the thing that
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you need it to do in this case you know
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you might still have the right amount of
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bonds that you need to reach your
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long-term goals and in that case you can
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let your portfolio ride at least you
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don't always have to rebalance it so
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thank you for the great question Kate
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question two Dan C wrote in and asked
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Jesse I'm hoping to get some
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clear-headed Jesse thinking here you and
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another financial planner encouraged me
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to buy bonds I'm involved with Vanguard
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and Fidelity so I looked at vanguard's
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vbtlx total Bond Market indexed Admiral
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shares it states that the average return
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after taxes on distributions was low
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single digits or even negative
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performance over 135 and 10year
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timelines since October 2001 that fund
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the Vanguard Total Bond market index
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fund has returned an average of
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1.8% per year I also looked at
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vanguard's long-term corporate bond
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Index Fund recommended by Morning Star
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and after taxes on distributions that
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one's returns are even worse over the
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past 135 and 10 years and since
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Inception it has returned 2.8% per year
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I'd like to see that performance laid
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out against inflation and as a hedge
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against falling markets I don't see how
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choosing bonds or a bond fund can help
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it looks like there would be a large
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loss so I haven't moved forward with
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bonds until I can figure out why the
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experts are recommending them in the
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first place what am I missing what am I
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not understanding am I reading the wrong
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chart or in the wrong way Dan what a
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phenomenal question another great
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question and there are two big big
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issues that I want to address here in
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the answer the first one is part of your
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question why the negative performance in
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bonds or just why the bad performance in
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bonds especially compared to stocks and
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then the second part of your question
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are bonds good against inflation or how
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should we think about bonds and and
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compare them to inflation so as far as
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the negative performance goes so
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listeners you you might be familiar with
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this already that bonds are quite
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sensitive to interest rates and the
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longer the bond you know a 30-year Bond
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versus a one-year Bond generally the
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more sensitive that bond is to interest
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rates that goes into uh this term called
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duration if you hear the word duration
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with bonds it doesn't quite mean what's
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the length of the bond you know 30 year
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versus one year so it is a bit confusing
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but it's related in a way duration
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really is a synonym for interest rate
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sensitivity now okay but why does this
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matter why are longer bonds more
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sensitive to interest rates or or simply
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why are bonds sensitive to interest
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rates in the first place so let's say
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you own a 30-year Bond or any year bond
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we we'll just use 30-year Bond and it's
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yielding 2% per year well right now you
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can go to the US Treasury and buy a bond
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at probably four four and a half%
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something like that I'm not sure what
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the 30-year yield is off the top of my
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head but the idea is if you own a 2%
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Bond and you're trying to sell it on the
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open market but I can go to the treasury
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and buy a bond at 4% why the heck would
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I want your 2% right so the only way you
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could entice me to buy your 2% bond is
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if you lower the price so much
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that rather than buying spending $1,000
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at the US Treasury to buy a 4% Bond I'm
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going to pay you much much less to buy
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your 2% Bond so much so that the
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effective rate of return in the long run
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would be the same for me right because
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at the end of the day when you when a
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bond expires at the end of the day you
00:13:46
you get all the money back that was
00:13:48
originally used to purchase the bond so
00:13:50
in that way it is a little confusing I I
00:13:54
do admit that but bond prices are very
00:13:56
mathematical right cuz your 30-year 2%
00:13:59
Bond and my 30-year call it 4% Bond we
00:14:02
each spent $1,000 upfront but if I'm
00:14:05
getting all this extra return 4% versus
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2% well I'm certainly not going to pay
00:14:10
you $1,000 for yours when I can go buy a
00:14:13
new one for $1,000 at at the treasury so
00:14:15
I I hope that makes sense and the
00:14:17
interest rate hikes that we saw in 2022
00:14:20
and 2023 essentially what that did was
00:14:23
it took all these people out there who
00:14:25
owned bonds that they maybe bought in
00:14:27
the 2010s or the early 2020s that were
00:14:30
paying 1 or 2% and now all of a sudden
00:14:33
the treasury is selling bonds at 4 and
00:14:35
5% and what did we just go over well the
00:14:38
price of your existing bonds would have
00:14:40
dropped quite suddenly and that's why
00:14:43
Dan when you see those bond funds that
00:14:45
you're looking at on Vanguard or Morning
00:14:46
Star wherever you're looking that
00:14:48
explains the negative performance if we
00:14:50
zoom out further we do see that the 2022
00:14:53
and 2023 interest rate hikes and the
00:14:55
bond performance in those years is
00:14:56
fairly anomalous and that generally
00:14:59
bonds do provide a slow and steady
00:15:01
long-term return and there's another
00:15:03
note here another very important note
00:15:05
for what it's worth cuz this is a
00:15:06
mistake that I see all the time I see it
00:15:09
you know sometimes I'll see it when a
00:15:11
client asks me a question but way more
00:15:12
often than that I see it online right I
00:15:15
see it in the Facebook groups the Reddit
00:15:17
groups the places where DIY investors
00:15:19
and DIY financial planners talk with one
00:15:21
another and the mistake is that we need
00:15:23
to be very careful with bonds and bond
00:15:25
funds about looking at their prices
00:15:27
versus looking at their total returns we
00:15:30
need to be very careful here because a
00:15:31
bond by its very design is supposed to
00:15:33
be relatively stable in price while
00:15:36
providing a a coupon or an interest
00:15:38
payment to the bond owner so for example
00:15:41
if you pull up the chart for one of the
00:15:43
funds that Dan mentioned the Vanguard
00:15:45
Total Bond market index fund or
00:15:47
vltx you can see that the price was $10
00:15:50
per share in 2001 and it's about $9.60
00:15:54
per share today that's 23 years and the
00:15:57
price has actually gone down right it's
00:15:59
basically flat but it's even a little
00:16:01
bit negative over 23 years and to those
00:16:04
of us who understand say what the stock
00:16:05
market has done over the last 23 years
00:16:07
we think what a travesty and well the
00:16:10
thing is price alone simply doesn't
00:16:12
suffice here that's the fundamental
00:16:14
error and as fundamental an error as can
00:16:17
occur for someone who's looking into
00:16:18
their own Investments so make sure you
00:16:19
don't do this and the reason why is
00:16:21
because that price data it doesn't show
00:16:24
the coupons or the interest payments
00:16:26
that vbtx has been providing to it
00:16:29
owners over the last 23 years and that's
00:16:31
where all the return on bonds come from
00:16:34
so I went and pulled data on a couple
00:16:36
total Market bond funds for what it's
00:16:38
worth couldn't find the data on vbtx as
00:16:40
it's a mutual fund and the site I was
00:16:42
looking at had very very detailed data
00:16:44
on ETFs not on mutual funds so that's
00:16:46
what I'm using here but essentially the
00:16:48
two ETFs I'm looking at are proxies for
00:16:52
vbl TX one of them is called BND as in
00:16:55
bond without the O and that's vanguard's
00:16:57
Total Bond ET F and the other one is
00:17:00
called a ag which is the ey shares
00:17:03
version of the Bloomberg aggregate index
00:17:06
uh so they're both Index Fund ETFs with
00:17:09
mission statements of tracking the
00:17:11
Bloomberg a which you can kind of think
00:17:12
of as the total bond market so if I look
00:17:14
at Price alone right I'm only looking at
00:17:17
Price not Total return I'm making the
00:17:19
mistake here I would see that the a is
00:17:21
down 4.8% over the last 21 years 4.8% in
00:17:25
total over the last 21 years but if I
00:17:28
include interest payments from a which
00:17:30
again that's the whole point of owning a
00:17:31
bond in the first place we see that the
00:17:33
a is actually up 2.9% per year or 83% in
00:17:37
total over the past 21 years a very
00:17:39
similar story for BN B andd was created
00:17:42
in 2008 it's also down about 4% on price
00:17:46
over the last 16 years but if we look at
00:17:48
Total return it's up 57% or about 2.7%
00:17:52
per year over those 16 years granted if
00:17:55
we held those Bonds in a taxable account
00:17:57
then the interest we receive is is
00:17:59
taxable and those taxes do eat away at
00:18:01
our long-term returns so I think that's
00:18:03
probably where Dan is getting some of
00:18:05
the after tax numbers that he quoted in
00:18:07
his question they they sound quite
00:18:08
accurate I did some back of the napkin
00:18:10
math assuming a 25% marginal tax rate
00:18:12
blah blah blah and yeah it drops the
00:18:14
annualized returns from roughly 2.7% per
00:18:17
year down to about 1.8% per year that's
00:18:19
a big difference and for what it's worth
00:18:22
that gets into a a nuanced topic called
00:18:24
asset location some of you might be
00:18:26
familiar with that it's another way of
00:18:27
saying not only what are you investing
00:18:30
in you know stocks bonds blah blah blah
00:18:32
but which accounts are housing those
00:18:35
assets your IRA your 401k your taxable
00:18:38
account now personally I'm not a huge
00:18:41
proponent of allowing the tax tail to
00:18:44
wag the investment dog because sometimes
00:18:46
paying taxes on positive returns it's
00:18:48
simply part of this investing process
00:18:51
and it's a sign that your Investments
00:18:52
are performing pretty well for you but
00:18:54
all else being equal Why Pay More tax
00:18:56
than you have to so asset Loc a is a
00:18:59
good concept to know there but getting
00:19:01
back to the main point of this little
00:19:03
diet tribe price when it comes to bonds
00:19:06
price is not the metric of Merit and
00:19:08
even when it comes to stocks price is
00:19:10
not the metric of Merit right because
00:19:13
stock prices don't include dividends the
00:19:15
dividend is gone the price has gone down
00:19:17
well it's still part of Total return and
00:19:19
that's why Total return is the metric of
00:19:22
Merit which by the way it includes both
00:19:25
the price return and it includes the
00:19:27
interest or the dividends that are being
00:19:29
paid as a side note longtime listeners
00:19:31
will have heard me rail against the
00:19:33
baloney reasons why some people cling to
00:19:36
the idea of dividend investing yes
00:19:38
Dividends are a great thing and they are
00:19:40
part of the reason why we invest in
00:19:42
stocks in the first place but some
00:19:44
people would rather own say a 7%
00:19:47
dividend paying company whose price
00:19:48
never changes instead of owning perhaps
00:19:51
a non-dividend payer that grows by 10%
00:19:53
per year it's just terrible logic
00:19:55
there's nothing magic about dividend
00:19:57
payments any one who tries to claim or
00:19:59
or sell you otherwise they have a
00:20:01
fundamental misunderstanding of the math
00:20:03
or they simply don't understand how
00:20:04
businesses are run they don't understand
00:20:06
how the stock market works it might be
00:20:08
all three if you're listening right now
00:20:11
and you've been sold this idea that
00:20:13
dividend investing is Magic or some sort
00:20:15
of superior way of investing in stocks I
00:20:18
highly recommend you you dig into some
00:20:21
research or just dig into some just some
00:20:23
common articles that have been written
00:20:24
I'm happy to link mine in the show notes
00:20:27
I think you need to Avail yourself of
00:20:28
that misconception all right now for the
00:20:30
second part of Dan's question which is
00:20:32
about inflation and specifically Dan had
00:20:34
a question about whether bonds can or
00:20:35
should be acting as some sort of
00:20:37
inflation hedge where Dan was asking you
00:20:39
know why would I hold long-term bonds if
00:20:42
bonds lose value to inflation over time
00:20:44
and and the answer quite simply Dan is
00:20:46
that bonds are not a hedge against
00:20:48
inflation in fact quite the opposite
00:20:50
bonds are heavily affected uh heavily
00:20:53
subject to the forces of inflation with
00:20:56
a bond you are lending money to someone
00:20:58
today
00:20:59
in exchange for a fixed amount of money
00:21:01
in the future and what does inflation do
00:21:03
well it reduces the value of fixed
00:21:05
amounts of money in the future yikes so
00:21:07
it can be very risky to say okay here's
00:21:10
$1,000 today please give me $1,000 back
00:21:13
in 2034 that's a risky proposition
00:21:16
because who knows how much $1,000 will
00:21:18
be worth in 2034 so yes it is nice to
00:21:22
receive the coupon interest payments
00:21:24
along the way right that's the whole
00:21:25
point or that's the whole value
00:21:27
proposition of a bond in the first place
00:21:29
is that we get this Dependable interest
00:21:31
stream as long as we hold the bond but
00:21:33
who knows if those interest payments
00:21:35
will be worthwhile as we wait for our
00:21:38
principal payment to come back to us so
00:21:40
again inflation is the enemy of bonds
00:21:43
and that's why for most individuals and
00:21:45
families planning for their investment
00:21:47
lifetimes we don't want to give
00:21:49
inflation the opportunity to eat away at
00:21:51
our bond returns and that means bonds
00:21:53
should be thought of as a shorter term
00:21:55
asset than for example stocks so what
00:21:58
are bonds good for instead well bonds
00:22:00
provide a much higher guarantee over
00:22:02
short periods of time as compared to
00:22:05
stocks and they provide a slightly
00:22:07
higher return than straight up cash so
00:22:09
if you need money in the next two or
00:22:11
four or 6 years bonds likely make more
00:22:14
sense than stocks or cash in that
00:22:16
scenario once maybe you get out to eight
00:22:18
or 10 years down the line and we can
00:22:20
look at historical back tests and we can
00:22:22
see that the probability of stocks
00:22:25
exceeding Bond performance over that
00:22:26
kind of a time period really starts to
00:22:28
slant in our favor then those are the
00:22:30
time periods where stocks really start
00:22:32
to make more sense than bonds what else
00:22:34
are bonds good for well bonds provide
00:22:35
ballast which can be important and
00:22:37
appropriate for more risk averse
00:22:39
investors from experience it can be
00:22:41
scary for people when 90% of their
00:22:43
assets are in a 30% draw down if you
00:22:46
have like a 9010 portfolio and that 90
00:22:48
represents your stock allocation if the
00:22:50
stock market drops 30% well that that's
00:22:52
pretty scary that means your portfolio
00:22:54
is really feeling it if instead only 60%
00:22:57
of your assets are in draw down and the
00:22:59
other 40% which are in bonds are
00:23:01
actually up well that can lead to a much
00:23:03
better investing feeling and even if the
00:23:07
long-term numbers would push you toward
00:23:09
more and more stocks a big risk possibly
00:23:12
one of the biggest risks that any
00:23:14
investor faces and I'm glad I I don't
00:23:16
think I'm alone in saying this it's the
00:23:18
risk that along your long-term investing
00:23:21
Journey something is going to Buck you
00:23:23
off the horse something is going to make
00:23:24
you feel so upset frustrated scared
00:23:27
stressed that you are going to abandon
00:23:29
your investment plan that's one of the
00:23:31
biggest risks that we all face and one
00:23:34
of the ways we fight against that risk
00:23:36
is by making sure there's enough
00:23:37
conservatism in our plan and enough
00:23:39
conservatism in our portfolio that we
00:23:42
don't subject ourselves to those kind of
00:23:44
negative feelings that that would Buck
00:23:46
us off that horse so the idea there is
00:23:49
designing a portfolio that you can stick
00:23:50
with through thick and through thin
00:23:52
that's of ultimate importance and we
00:23:54
need to ask ourselves on on a personal
00:23:55
level what is that portfolio what is
00:23:57
that asset alloc that we can stick with
00:23:59
through thick and thin bonds often play
00:24:01
an important role in that conversation
00:24:03
another way uh of thinking about the
00:24:05
point that I just made is I can go to
00:24:07
some of my clients who who like to think
00:24:08
of things this way and I can say hey
00:24:10
Bobby you have eight years of future
00:24:13
spending safely allocated in bonds and
00:24:15
yes it stinks that here in the current
00:24:17
moment let's say the stock market
00:24:18
happens to be down and your stock
00:24:20
portfolio lost $100,000 from where it
00:24:23
just was a month ago that stinks but we
00:24:26
got to zoom out you still have eight
00:24:28
years worth of spending in bonds which
00:24:30
which means you have eight years before
00:24:32
you have to worry one little bit about
00:24:34
selling your stocks so do you believe
00:24:36
that 8 years is enough time for the
00:24:37
market to rebound from this current uh
00:24:40
draw down that that it's in some worried
00:24:42
investors they need that kind of cushion
00:24:44
in their portfolio to stick it out and
00:24:46
for some investors it just really helps
00:24:47
them to think about the amount of time
00:24:49
that their bonds are buying them where
00:24:52
they can stick it out they can wait for
00:24:54
the stock portion of their portfolio to
00:24:55
recover Dan thank you for the great
00:24:57
question again the topic of bond returns
00:25:00
to making sure we're looking at Total
00:25:01
return which includes interest payments
00:25:03
and possibly includes taxes that you've
00:25:04
paid not just looking at the price of
00:25:07
the bond or the bond funds alone and
00:25:09
yeah bonds should not be thought of as a
00:25:11
hedge for inflation in fact probably the
00:25:13
biggest risk to owning bonds is the
00:25:14
inflation risk so if anything I mean
00:25:16
it's just a reminder of why bonds are
00:25:19
generally a shorter term stable asset a
00:25:21
ballast of the portfolio you aren't
00:25:23
looking for long-term growth from bonds
00:25:26
from Bond ownership so thank you thank
00:25:28
you Dan here's a quick ad and then we'll
00:25:30
get back to the show did you know my
00:25:32
written Blog the best interest was
00:25:35
nominated for 2022 personal finance blog
00:25:38
of the year and it's been highlighted in
00:25:39
the Wall Street Journal Yahoo finance
00:25:41
and on CNBC I love writing especially
00:25:44
when that writing is to share financial
00:25:46
education and I usually write one or two
00:25:48
articles per week you can read them all
00:25:51
at bestter interest. blog again the web
00:25:54
address is bestter interest. blog check
00:25:58
out question number three comes from
00:26:01
Peter G Peter says I hope all is well I
00:26:03
appreciate all the great content you
00:26:04
provide I know the conventional wisdom
00:26:06
on Social Security is to wait for the
00:26:08
maximum lifetime benefit however doing
00:26:11
the calculations on online calculators
00:26:13
when I enter my information I get much
00:26:15
better long-term outcomes by taking
00:26:17
social security earlier and reducing my
00:26:19
portfolio withdrawal percentage using
00:26:22
the open Social Security app I come out
00:26:24
$60,000 ahead on the social security
00:26:27
access by waiting until age 70 rather
00:26:29
than taking it early but if I claim
00:26:32
Social Security earlier then my
00:26:33
Investment Portfolio would end up $1
00:26:35
million higher than if I claim at age 70
00:26:38
in other words would I rather receive
00:26:40
$60,000 extra in Social Security or have
00:26:43
one million extra in my portfolio it's a
00:26:46
no-brainer for this analysis I was using
00:26:48
a 40% stock 40% Bond 20% cash portfolio
00:26:52
with various withdrawal rates and
00:26:54
different amounts saved early claiming
00:26:56
of Social Security one each and every
00:26:58
time time I'd like to know your thoughts
00:26:59
on this Jesse and if I'm missing
00:27:01
something thank you so very cool
00:27:02
question Peter that's an awesome
00:27:04
question and here's the first thing
00:27:05
Peter's question inspired me to put some
00:27:07
of this down in writing because
00:27:09
sometimes it's just easier to show the
00:27:10
numbers in writing right than it is to
00:27:12
talk through a microphone so I think you
00:27:14
listeners should go read an article I
00:27:15
wrote we'll link it in the show notes
00:27:17
it's called why can't I take Social
00:27:19
Security early and invest it so again
00:27:21
the link will be in the show notes the
00:27:23
heart of the question is that an
00:27:24
Investment Portfolio might be able to
00:27:27
return seven or eight or 9 or 10% plus
00:27:30
per year who knows right it it can vary
00:27:31
over time but uh an Investment Portfolio
00:27:34
might be able to provide a really strong
00:27:36
return over a long period of time and
00:27:38
meanwhile the benefits of waiting on
00:27:39
Social Security especially in the early
00:27:41
years only increase in individuals
00:27:43
monthly payments by five or six or 7% or
00:27:46
if we look at the internal rate of
00:27:48
return on waiting for to claim our
00:27:50
social security that irr might only be
00:27:53
you know four 5 6% something like that
00:27:55
and so just from that kind of zoomed out
00:27:57
point of view the math does scream at us
00:28:00
and it says well duh you know if you can
00:28:03
get a 9% return on a 60/40 portfolio
00:28:06
over a sufficiently long period of Time
00:28:08
Versus a 5 or 6% irr from the Social
00:28:11
Security Administration by waiting well
00:28:13
then you'd be a fool to choose 6% just
00:28:15
take your Social Security as early as
00:28:17
possible invest it in your portfolio and
00:28:20
get the higher return and if we zoom out
00:28:22
on Peter's question today and the
00:28:24
question that inspired the the article I
00:28:25
just mentioned well of course that Math
00:28:27
Makes sense with sufficiently high
00:28:29
investment returns you should always
00:28:31
invest as early as possible even if the
00:28:34
benefit of delaying Social Security was
00:28:35
20% per year but I had an investment
00:28:38
that was paying me 40% per year well I'd
00:28:40
rather start collecting as soon as
00:28:41
possible and get the money invested in
00:28:43
the higher yielding investment so given
00:28:45
sufficiently High returns you always
00:28:47
want to start compound growth as soon as
00:28:49
possible but there is an all important
00:28:52
flaw in this line of thinking and it's
00:28:55
not subject only to Peter because this
00:28:57
is a flaw I think every time this
00:28:58
question comes up because I see this
00:29:00
question I saw this question come up
00:29:01
last week on Reddit and I chimed in with
00:29:03
an answer every time this question comes
00:29:05
up it's coming up because of this flaw
00:29:09
the flaw is that we need to return to
00:29:11
the foundational pillar of investing and
00:29:13
something we repeat pretty often here on
00:29:15
the best interest that risk and return
00:29:18
are intrinsically connected that returns
00:29:21
are not free but instead that returns
00:29:23
are compensation for taking on
00:29:25
investment risk so whenever an investor
00:29:28
Compares returns alone without also
00:29:30
comparing the risks involved they've
00:29:33
conducted an incomplete and an incorrect
00:29:35
and a flawed analysis Peter's question
00:29:37
today it's a great question but it only
00:29:40
looks at returns it doesn't consider
00:29:43
risk this is the reason for this concept
00:29:45
in the investing world of risk adjusted
00:29:47
returns because comparing only the
00:29:49
returns of two Investments without
00:29:52
dividing in some way by the risk that
00:29:53
we've taken it's not an Apples to Apples
00:29:55
comparison you know we just spent we
00:29:57
just answered Dan's question question
00:29:58
about bonds we talked about bonds and
00:29:59
stocks well if you look at the long-term
00:30:01
returns of stocks and you look at the
00:30:03
long-term returns of bonds why would you
00:30:05
ever ever own bonds stocks always
00:30:09
outperform Bonds in the long run well
00:30:11
the the reason why bonds make sense is
00:30:13
when we think about it through a risk
00:30:14
adjusted lens and we think about
00:30:16
especially over short periods of time
00:30:18
the probability the odds that stocks
00:30:20
actually lose US money versus the odds
00:30:23
that bonds lose US money and if we're
00:30:24
planning for some short-term goal can we
00:30:27
afford to take on that kind of risk so
00:30:29
anyway that gets us back to that idea of
00:30:30
risk adjusted returns so in order to
00:30:32
make a sensible comparison here in
00:30:34
Peter's question about social security
00:30:37
we need to level the playing field in
00:30:38
terms of risk the benefits of delaying
00:30:41
Social Security they are guaranteed by
00:30:43
the US government that's a very low risk
00:30:46
you we can get into a debate if you want
00:30:47
about how low of a risk it is with the
00:30:49
state of the US government fiscally and
00:30:51
all that but we need to ask ourselves
00:30:53
what kind of investment risk do we
00:30:54
compare uh the risk of the US government
00:30:56
to I see two VI options the first one
00:31:00
why does Warren Buffett invest all of
00:31:01
Burkshire Hathway's extra cash into US
00:31:04
Treasury short-term us treasury notes
00:31:06
instead of into say an S&P 500 Index
00:31:09
Fund doesn't he know that the S&P has a
00:31:11
much better long-term return blah blah
00:31:12
blah well the answer is US treasuries
00:31:15
are as risk-free as anything in the
00:31:17
investing Universe backed by the full
00:31:19
faith and credit of the US government so
00:31:21
as long as Uncle Sam pays his debts us
00:31:24
treasuries are risk-free the S&P is far
00:31:26
from risk-free and and Warren Buffett
00:31:28
knows that he wants his cash to be safe
00:31:30
and ready for deployment at a moment's
00:31:32
notice the S&P 500 cannot fulfill that
00:31:35
need so the first logical comparison
00:31:37
today then is to use a true risk-free
00:31:39
rate as our investment return something
00:31:42
like a high yield bank account or a
00:31:44
short-term us treasury note is
00:31:45
appropriate for that conveniently we did
00:31:47
that analysis in the linked article in
00:31:49
the show notes where a conclusion ends
00:31:51
up being no different than traditional
00:31:53
social security advice uh which is to
00:31:56
say that the break even point
00:31:58
which is the point at which uh
00:32:00
collecting late makes more sense than
00:32:02
collecting early or the point at which
00:32:03
the different ages that you can collect
00:32:05
Social Security they kind of converge at
00:32:07
a single age that occurs in the late 70s
00:32:10
and and what I mean by that is uh if
00:32:12
someone lives beyond their late 70s they
00:32:16
will have wished they collected later in
00:32:18
life if someone passes away before their
00:32:21
late '70s they would have wished that
00:32:23
they started collecting Social Security
00:32:24
as early as possible that's the break
00:32:26
even point and even when throw this
00:32:28
investing question into the analysis
00:32:30
like we're doing today if our investment
00:32:32
return is the risk-free rate of return
00:32:35
that you can get from a high yield
00:32:36
savings account or from a US Treasury
00:32:38
well then the break even Point still
00:32:40
occurs in the late '70s which is the
00:32:42
same as all traditional social security
00:32:45
advice that tends to be given now the
00:32:47
second option the second way to approach
00:32:48
Peter's question is to show the
00:32:50
potential downsides of Peter's analysis
00:32:53
so that is it's to show how higher
00:32:55
returns from a stock portfolio yeah if
00:32:57
they work in your favor I'm sure and and
00:32:59
the math shows it clearly that if stock
00:33:02
market returns work in your favor you
00:33:04
will have wished that you started
00:33:05
collecting Social Security as early as
00:33:07
possible so you could either put that
00:33:09
money to work in your portfolio or you
00:33:11
could reduce your withdrawals and
00:33:13
therefore keep more money in your
00:33:15
portfolio right the math is exactly the
00:33:17
same if we think of it that way the
00:33:18
point being if you start withdrawals
00:33:20
earlier more of your money is at work in
00:33:22
your portfolio compounding at a higher
00:33:24
rate of return and that ends up being
00:33:26
better but the the second thing we're
00:33:28
going to do right now is to show the
00:33:29
downside of that type of analysis which
00:33:31
is to show how higher returns from a
00:33:33
stock-based portfolio they're far from a
00:33:35
guarantee more specifically we can show
00:33:37
how the downside risk of a portfolio
00:33:39
could actually turn this result on its
00:33:41
head what happens if we suffer a bad
00:33:43
Market if we have bad Market timing if
00:33:45
we have a bad sequence of returns during
00:33:48
our early Social Security period so in
00:33:51
the linked article we looked at a
00:33:52
traditional 6040 portfolio looked at all
00:33:55
the historical returns of that 60/40
00:33:57
port pfolio as in you know the actual
00:34:00
returns that portfolio would have given
00:34:01
an investor since 1950 it had multiple
00:34:04
10-year periods with returns below 2%
00:34:07
per year what if we started our social
00:34:10
security timeline with that kind of low
00:34:11
return and then even if we said let's be
00:34:14
holistic here let's make up for that
00:34:15
return at the end of the analysis so
00:34:17
let's start with a pretty bad return and
00:34:19
then later on in life let's assume we
00:34:21
had pretty good Returns what does that
00:34:22
do to the idea of collecting Social
00:34:24
Security earlier the results are that
00:34:26
the 6040 solution if you will or just
00:34:28
the idea of collecting early and
00:34:30
investing it that solution comes with
00:34:33
very large risks our early Social
00:34:35
Security hack only worked in this
00:34:37
particular case if our retiree died
00:34:39
before age 75 that's not a good outcome
00:34:43
doubly so if Social Security ends up
00:34:45
being a safety net or a back stop in
00:34:46
your financial plan if something like
00:34:48
this were to work we would want to see
00:34:50
data that shows that yeah we can start
00:34:52
collecting Social Security at 62 and
00:34:55
even if we live till 85 90 95 that still
00:34:59
ends up being the smarter Choice than
00:35:01
waiting until age 70 to start collecting
00:35:03
that's how Social Security analysis
00:35:05
that's kind of the metric of Merit here
00:35:07
is what age would you have died at for
00:35:09
this particular choice to have made
00:35:11
sense so maybe I didn't explain that
00:35:13
perfectly clearly before but that's the
00:35:14
helpful way to think of it and all
00:35:16
traditional social security advice shows
00:35:18
the break even points occurring you know
00:35:20
in the late '70s what Peter's proposing
00:35:22
here are just the idea of collecting
00:35:24
Social Security early to invest it if
00:35:26
markets go through
00:35:28
a very realistic somewhat negative
00:35:30
sequence of returns that we've seen
00:35:32
before here in this world that we live
00:35:34
in what we see is that the break even
00:35:36
Point drops down to age 75 and that's a
00:35:38
bad thing that's a negative that's a
00:35:40
very much a negative uh result so if
00:35:43
Social Security is play money if it's
00:35:46
just for fun money in your financial
00:35:48
plan and you're okay with risking a loss
00:35:51
I can see the Merit and the appeal of
00:35:53
Peter's question today you can apply for
00:35:55
Social Security early you can invest it
00:35:56
reasonably and as long as markets
00:35:58
cooperate which to be fair they tend to
00:36:01
do that's the whole reason why we invest
00:36:03
in the first place as long as markets
00:36:05
cooperate you will be better off for it
00:36:07
but it's no guarantee and that's the
00:36:09
entire point of the Social Security
00:36:11
System it's to provide a guaranteed
00:36:13
benefit to retirees so if Social
00:36:16
Security and the guarantee that it
00:36:17
provides is playing even a minor role in
00:36:20
your financial plan I would strongly
00:36:22
discourage putting that money at
00:36:24
investment risk simply to eek out extra
00:36:26
investment returns ears when we make a
00:36:29
Level Playing Field comparison by using
00:36:31
a risk-free rate like we did today
00:36:33
whether it was the short-term treasury
00:36:35
note or the high yield savings account
00:36:38
kind of returns we see that there is no
00:36:40
net benefit to taking social security
00:36:42
early and investing it the only possible
00:36:44
benefit comes when we put our social
00:36:46
security dollars at risk and of course
00:36:48
if we're going to take on such a risk we
00:36:50
better have better looking numbers at
00:36:52
the end of the day right that's the only
00:36:54
logical result that would make us feel
00:36:56
good about taking net investment risk in
00:36:58
the first place so Peter for your
00:37:01
specific scenario I would ask yourself
00:37:03
how vital are social security dollars to
00:37:06
your long-term financial plan if it's
00:37:08
the kind of thing where you know you're
00:37:10
going to be okay without it even if
00:37:12
Social Security disappeared you'd be
00:37:13
fine without it then I could understand
00:37:15
your desire to take it early and
00:37:17
therefore decrease your withdrawal rate
00:37:19
from your portfolio but if you're
00:37:21
listening right now and you know Social
00:37:22
Security is going to be important for
00:37:23
your financial future I would highly
00:37:26
recommend hesitating double-checking
00:37:28
your numbers looking really deeply at
00:37:30
your plan asking your financial planner
00:37:32
whatever it may be before you make a
00:37:34
decision like collecting early just to
00:37:37
make extra Investments question number
00:37:39
four today comes from Lucas hey Jesse I
00:37:41
hope you're well I just recently found
00:37:43
you after you a guest on stacking
00:37:44
Benjamin's podcast and I've been
00:37:46
listening to your AMA episodes which I
00:37:47
find enjoyable and helpful I've got a
00:37:49
question I was hoping you could answer
00:37:51
here on your show my wife and I are in
00:37:53
our early 30s and we're shifting our
00:37:54
Focus to filling out our taxable
00:37:56
brokerage with all our extra funds
00:37:57
because we have our house paid off we
00:37:59
maximize our 401ks and backdoor Roth IRA
00:38:02
contributions throughout the year and we
00:38:03
usually have anywhere between 4, 6,000
00:38:06
left over each month to put into a
00:38:08
taxable brokerage which we just started
00:38:09
this year what are some things I should
00:38:11
be on the lookout for or take into
00:38:13
consideration we do reinvest dividends
00:38:15
and I know we'll need to pay taxes on
00:38:17
those and any distributions but is there
00:38:19
anything else I need to account for
00:38:20
thanks and keep up the good work Lucas
00:38:23
Lucas thank you for tuning in and
00:38:25
congratulations on what sounds like a
00:38:26
fantastic situ ation you find yourself
00:38:28
in you've got a paid off house you're
00:38:30
maxing out your retirement accounts and
00:38:32
you still have another 4 or $6,000 per
00:38:35
month to save and invest I believe
00:38:37
that's what they call a not to brag
00:38:38
moment but seriously kudos to you okay
00:38:41
here's some food for thought for you on
00:38:43
those taxable accounts to answer your
00:38:45
direct questions yes you'll want to have
00:38:47
a plan for reinvesting dividend payments
00:38:49
good for you it sounds like you have
00:38:51
that which is true for just about any
00:38:52
other account you own usually that means
00:38:55
a simple dividend reinvestment plan or
00:38:57
or drip it's usually like a toggle or an
00:38:59
option for those of you listening who
00:39:00
are unsure what I'm talking about it's a
00:39:02
a toggle or an option on the account
00:39:04
itself so when you log into Fidelity or
00:39:06
Vanguard or wherever and you can just
00:39:08
toggle this on to automatically reinvest
00:39:11
any dividends that are paid for you that
00:39:12
is almost always a good idea and yes
00:39:14
Lucas you'll need to pay annual taxes on
00:39:17
any interest or dividends you receive in
00:39:19
this account so that might be the first
00:39:21
thing to be aware of Lucas as your
00:39:23
taxable account grows in size and as
00:39:25
your interest and dividends also grow in
00:39:27
size there might come a point actually
00:39:29
where you're earning so much interest in
00:39:31
dividend income that it's actually going
00:39:32
to be a reasonably sizable portion of
00:39:35
your overall income pi and you're going
00:39:37
to have to do one of two things you'll
00:39:39
either have to increase the amount of
00:39:40
tax withholding at your day job or
00:39:43
you'll have to make quarterly estimated
00:39:44
tax payments so let's spend a couple
00:39:46
minutes on that quick aside what are
00:39:48
quarterly estimated tax payments and why
00:39:50
do we need to pay them first it's
00:39:51
important to uh establish that the US
00:39:53
tax code expects us the taxpayers to pay
00:39:56
in throughout the year it's a pay as you
00:39:59
go system it's not a pay the whole bill
00:40:02
next April system and for most of us
00:40:04
that means we pay into the tax system
00:40:07
every single time we receive a paycheck
00:40:09
that's called your withholding you can
00:40:10
see it right there on your pay stub uh
00:40:12
we've all seen it or felt it in our own
00:40:14
lives but now we need to ask ourselves
00:40:17
what happens when we receive income that
00:40:19
does not have that kind of withholding
00:40:22
set up that's exactly what Lucas or any
00:40:24
of us with a taxable brokerage account
00:40:26
that's what ends up happening to us
00:40:27
we're receiving dividend or interest
00:40:29
income we don't necessarily have tax
00:40:31
withholdings set up in those uh taxable
00:40:33
brokerage accounts well the answer is
00:40:35
that the IRS still expects us to pay as
00:40:38
we go and we can't get away with waiting
00:40:41
until next April to pay that tax bill so
00:40:43
for situations like that the IRS has
00:40:46
four quarterly deadlines where they
00:40:49
establish that deadline to receive an
00:40:51
estimated tax payment from us the
00:40:53
taxpayer typically you would work with
00:40:55
your accountant to calculate and admit
00:40:57
your estimated tax payment now the IRS
00:41:00
understands that nobody is perfect and
00:41:02
some taxpayers will end up owing a
00:41:04
little bit of money when they file taxes
00:41:06
in April and that's not because you
00:41:08
avoided the pay as you go system it's
00:41:10
just that you didn't quite pay enough as
00:41:12
you went as it were however so that's
00:41:14
why the the IRS does have a a 90%
00:41:17
Threshold at which they draw the line as
00:41:19
long as you paid as you went a total of
00:41:22
90% or more of the taxes you owed you
00:41:25
are safe or the alternate is as long as
00:41:29
you paid as you went the full amount of
00:41:32
taxes you owed in the previous year then
00:41:34
you're safe and and a quick example just
00:41:37
to make sure we're on the same side here
00:41:38
because taxes are confusing and this
00:41:40
logic is confusing here we are recording
00:41:42
in November of 20124 so let's say last
00:41:45
year 2023 let's say I my total federal
00:41:48
tax bill ended up being
00:41:50
$20,000 and this year 2024 well I don't
00:41:54
know what my tax bill is going to be
00:41:56
maybe my total tax bill is going to be
00:41:58
$30,000 for whatever reason so I I kind
00:42:01
of have two choices there either way I
00:42:03
need to pay as I go throughout the year
00:42:05
I need to make sure I'm paying into the
00:42:06
system and the IRS really has two
00:42:09
different benchmarks that they're going
00:42:10
to compare me against the first one is I
00:42:13
either need to make sure that I pay as I
00:42:14
go the full amount of whatever I I owed
00:42:17
them last year which was $20,000 so
00:42:19
that's the first barrier that I I can
00:42:21
try to get over or I can think about the
00:42:25
year as it goes along I can try to
00:42:26
estimate what my total tax bill will be
00:42:28
by the end of the year and I need to
00:42:29
make sure I pay in at least 90% of that
00:42:32
now in this hypothetical I just set up I
00:42:34
was saying that my tax bill this year is
00:42:37
$30,000 90% of that is 27 Grand it's
00:42:40
going to be easier for me in this case
00:42:42
just to make sure that I put in the full
00:42:44
amount that I owed last year so the IRS
00:42:47
will expect me come the end of 2024 that
00:42:50
I paid as I went $20,000 throughout this
00:42:54
2024 year that's how that system works
00:42:57
if you pay less than one of those two uh
00:43:00
thresholds that we just described you
00:43:02
will be subject to a small fine for lack
00:43:04
of timely payment it's an annoying thing
00:43:06
that you don't want to have to deal with
00:43:07
so Lucas as you're just starting out
00:43:09
this is probably going to be a non-issue
00:43:11
for you because your income your
00:43:13
interest income your dividend income is
00:43:15
going to be so small compared to uh your
00:43:18
W2 income and and the amount of
00:43:20
withholding that you're already taking
00:43:21
but if you eventually reach a point
00:43:23
where your taxable account is shutting
00:43:24
off lots of interest in dividends enough
00:43:27
so that it's a good percentage of your
00:43:28
total take-home income then you'll
00:43:29
definitely want to ensure that you're
00:43:31
either making estimated tax payments or
00:43:34
what might be easier is adjusting your
00:43:36
workplace withholding from your normal
00:43:38
paycheck adjusting that higher so that
00:43:41
you pay as you go more throughout the
00:43:43
year let's talk about your investment
00:43:44
strategy Lucas first I'd ask if you have
00:43:46
any specific goals for your money are
00:43:48
you saving for a boat for a lake house
00:43:50
are you investing just because you know
00:43:52
you just want to put that money to work
00:43:54
as always if you have specific goals
00:43:56
with specific timelines you can and
00:43:57
should construct your portfolio based on
00:43:59
the dollar amounts of those goals and
00:44:01
the asset classes that make sense for
00:44:03
your timelines but what if you don't
00:44:05
really have any specific goals what then
00:44:08
well I'd maintain that your tax bill
00:44:09
account should be slightly more
00:44:11
conservative than your retirement
00:44:12
accounts and again it comes down to
00:44:14
timelines because even though you might
00:44:16
not have a goal set for your tax
00:44:18
Investments right now and you might be
00:44:20
thinking in your head well there's an
00:44:21
infinite indefinite timeline there it's
00:44:23
a super long timeline I'm going to go
00:44:25
high risk there's always a chance that
00:44:27
that changes in the future I can say
00:44:29
from experience of working with clients
00:44:31
who on day one said yep we're just
00:44:33
investing for the long run just put it
00:44:34
to work long-term assets then a couple
00:44:36
years later they came back to me and
00:44:37
said well actually we're going to give
00:44:39
$30,000 to our kid for a home down
00:44:41
payment with a taxable account you can
00:44:43
pull the money out at any time for 90%
00:44:45
of people including me perhaps including
00:44:47
you I think it helps to look yourself in
00:44:49
the mirror and say you know what life
00:44:51
changes curveballs happen my goals for
00:44:53
this money today might change in the
00:44:55
future and I might have a sudden
00:44:57
timeline shift that I wasn't quite
00:44:58
expecting allocating this taxable
00:45:01
account in a slightly more conservative
00:45:03
manner as compared to retirement
00:45:04
accounts is acknowledging that very
00:45:06
human truth about ourselves so I would
00:45:08
consider that Lucas the next topic
00:45:10
capital gains if and when you eventually
00:45:13
sell Assets in this account Lucas you
00:45:14
will be subject to capital gains and
00:45:16
capital losses well hopefully more gains
00:45:18
and the subsequent taxes that come with
00:45:20
that capital gains tax planning it's a
00:45:22
very fun financial planning topic timing
00:45:25
is everything here if you end up
00:45:26
realizing capital gains while you're
00:45:28
still earning lots of income like from
00:45:30
your normal W2 job well you're
00:45:32
definitely going to pay taxes on those
00:45:33
gains if you can wait until low earning
00:45:36
years such as Retirement or just
00:45:38
something else that happens in life when
00:45:39
you have a low earning year I don't know
00:45:41
maybe you'll have a sabatical something
00:45:42
like that you can probably avoid quite a
00:45:45
bit of capital gains tax if you're
00:45:47
charitably inclined you can avoid quite
00:45:49
a bit of capital gains tax you can also
00:45:51
look into tax loss harvesting which
00:45:53
coincidentally is a common endof year
00:45:55
topic here we are in November 2024 even
00:45:58
though it shouldn't really be an endof
00:45:59
year topic it shouldn't be based on the
00:46:01
time of year at all tax loss harvesting
00:46:03
should only be based on market
00:46:05
performance that's an aside for another
00:46:06
day anyway there might not be uh many
00:46:09
tax losses for you to harvest here in
00:46:11
2024 Lucas or anyone listening uh in
00:46:14
general assets have performed very well
00:46:16
this year but on that topic tax loss
00:46:18
harvesting it's an okay but certainly
00:46:21
not an outstanding tool in the toolbx
00:46:24
I'll share my thoughts via an article I
00:46:26
wrote the link is in the show notes is
00:46:28
tax loss harvesting worthwhile for those
00:46:30
curious the short answer is the way most
00:46:33
people use tax loss harvesting results
00:46:35
in zero net change in their portfolio
00:46:38
construction right they're they're
00:46:39
selling one stock or One Fund to buy a
00:46:43
very similar stock or a very similar
00:46:44
fund so it's not like they're achieving
00:46:46
a better asset allocation or better
00:46:49
diversification there's no change there
00:46:51
but also the way people at least the way
00:46:53
most people use tax loss harvesting also
00:46:55
results in no net change in the cost
00:46:58
basis of their portfolio they realized
00:47:00
some losses today and they reinvest the
00:47:03
money which that that lowers your cost
00:47:05
basis right you're selling an asset that
00:47:07
had a higher cost basis you're selling
00:47:09
it for a loss you're buying back in a
00:47:11
different asset which presumably has a
00:47:13
lower cost basis so on that side of the
00:47:15
equation you're lowering the cost basis
00:47:17
of your portfolio and then you're
00:47:18
offsetting that by realizing some gains
00:47:21
and reinvesting that money too which
00:47:23
raises the cost basis on on that side of
00:47:25
your portfolio the losses offset the
00:47:27
gains resulting in no net tax this year
00:47:30
great that's fine that's kind of the
00:47:32
idea of tax loss harvesting but what did
00:47:34
we actually accomplish the cost basis of
00:47:36
your portfolio is exactly the same as it
00:47:38
was before you lowered it on one side
00:47:41
you raised it on the other side all we
00:47:43
did in this case was kick the capital
00:47:45
gains taxes down the road which has a
00:47:47
small minor benefit of doing that but
00:47:50
it's not nearly as good as as most
00:47:52
people think now there are some
00:47:53
interesting cases where tax loss
00:47:55
harvesting uh is extremely worth while
00:47:57
but usually it has to do with offsetting
00:47:58
the tax gains from some other type of
00:48:01
investment usually it might have to do
00:48:03
with a real diversification play that
00:48:05
also provides tax benefits so here's an
00:48:09
example let's say a retiree is
00:48:11
downsizing their house and the home sale
00:48:13
results in a large amount of taxable
00:48:15
gains now many of those gains are
00:48:17
actually going to be tax exempt as it
00:48:18
was their primary home but let's say
00:48:20
there's still another $100,000 in gains
00:48:23
resulting in about $24,000 in federal
00:48:25
taxes for them well if that individual
00:48:28
has a taxable account with any sort of
00:48:29
losses in it I would definitely
00:48:31
recommend running the math on if those
00:48:33
losses can be realized to offset some or
00:48:36
all of the gains from their home sale
00:48:38
that's a great use of tax loss
00:48:40
harvesting because the gains from the
00:48:41
home sale are there they didn't sell
00:48:43
their home to to adjust their asset
00:48:45
allocation they sold their home because
00:48:46
of just life in general and yeah those
00:48:50
gains all occurring in one year might
00:48:51
not be a very good thing for them and if
00:48:54
they can offset those gains with some
00:48:55
losses then might be a great net benefit
00:48:58
in the long run so anyway that's my
00:49:00
quick little aside and rant on tax loss
00:49:03
harvesting and just taxes and general
00:49:05
capital gains in in a taxable account
00:49:07
Lucas uh lastly I would think from an
00:49:09
estate planning point of view Lucas you
00:49:11
should understand what would happen with
00:49:13
your taxable account in the event of
00:49:15
your untimely death if for example you
00:49:17
know the assets would pass to your
00:49:19
spouse it might make sense to put a to
00:49:21
transfer on death designation on that
00:49:24
account if it's already a joint account
00:49:26
between you you and your spouse you
00:49:27
might want to put a uh with rights of
00:49:29
survivorship wos designation on the
00:49:32
account or if you'd want to pass those
00:49:35
assets onto another family member or a
00:49:38
friend you might want to detail that in
00:49:40
your will so thank you for the good
00:49:42
question Lucas and happy investing to
00:49:44
you here's a quick ad and then we'll get
00:49:47
back to the show serious question why do
00:49:50
podcasters constantly ask for ratings
00:49:52
and reviews yes they do help highlight
00:49:55
our shows to new listeners they help
00:49:56
strangers find us on Apple podcast and
00:49:59
Spotify it's totally true and a good
00:50:01
reason to ask for ratings and reviews
00:50:03
but I have something more important at
00:50:05
least more important to me I want to
00:50:07
know if you like this stuff I want to
00:50:09
know if you like my podcast episodes my
00:50:11
monologues my guests the information I
00:50:13
share with you and the stories I tell I
00:50:15
want to improve and make your listening
00:50:17
more enjoyable in the process so yeah I
00:50:20
would love to read your reviews and sure
00:50:22
if you throw a rating in there too
00:50:24
that's great if you like what I'm doing
00:50:26
please share it with me it's such a
00:50:28
great feeling to read your feedback I'd
00:50:30
love to read your review or see a rating
00:50:33
on Apple podcasts or Spotify thank you
00:50:36
and here's the last question today
00:50:37
listeners question number five comes
00:50:39
from Chris Jesse thanks for the work you
00:50:41
do there are a few local financial
00:50:42
planning firms who I know and trust and
00:50:44
I'm interested in working with them I've
00:50:46
asked them many questions thank you for
00:50:48
guiding Us in what questions to ask your
00:50:50
article was very helpful side note
00:50:52
listeners the article that Chris is
00:50:53
referring to we will link it into the
00:50:54
show notes it's the questions that I
00:50:56
would recommend that any of you go and
00:50:57
ask a financial adviser when you're
00:50:59
interviewing them now back to Chris but
00:51:02
my question Jesse is this I want to
00:51:03
potentially give a third of my portfolio
00:51:05
to each of the three advisers I know and
00:51:07
trust and get financial planning advice
00:51:09
from each and then depending on
00:51:11
performance and the quality of the
00:51:12
advice and just how I feel about the
00:51:14
relationship I'll Whittle two of the
00:51:16
three of them away over time what are
00:51:18
your thoughts on that Chris that's a
00:51:21
cool question and you're certainly not
00:51:22
the first person who's had that thought
00:51:24
or thought that question to themselves
00:51:26
and I get it you want to test drive a
00:51:28
little bit before you commit this is a a
00:51:30
very hopefully a long-term relationship
00:51:32
that you're entering into and there is
00:51:35
that question of do I know enough as an
00:51:37
outsider do I know enough between these
00:51:39
three different financial planners to
00:51:41
really make the decision on which one I
00:51:43
should go forward with or does it just
00:51:45
make more sense to spend a few years
00:51:47
getting to know each of the three better
00:51:49
and better and better before then
00:51:51
committing to to the long-term aspect of
00:51:53
the relationship I totally understand
00:51:55
that but I do think think what you
00:51:57
propose has way more negative downside
00:52:01
than positive upside way more cons than
00:52:03
pros and I I would caution you against
00:52:05
it and to be honest if I was one of
00:52:07
those three advisers and I knew that's
00:52:09
what you were doing I wouldn't agree to
00:52:11
sign up for it in the first place I
00:52:12
wouldn't partake in your experiment cuz
00:52:14
Not only would it be probably a bit of a
00:52:16
conflict of interest for me to
00:52:18
participate for myself but I I also know
00:52:21
for a fact that it would be bad for you
00:52:23
you're setting up a situation that's
00:52:25
going to be bad for you and there a few
00:52:26
reasons why that's what we'll get into
00:52:28
here with the meat of the question you
00:52:29
know the King Solomon baby story right
00:52:31
the Judgment of Solomon from the Hebrew
00:52:33
Bible in which Solomon ruled between two
00:52:35
women who' both claimed to be the mother
00:52:37
of a child Solomon orders the baby to be
00:52:39
cut in half pretty barbaric and each
00:52:42
woman receives one half the first woman
00:52:44
accepts the compromise as fair but then
00:52:46
the second woman begs Solomon to give
00:52:48
the baby to her rival preferring the
00:52:50
baby to live even without her and of
00:52:52
course that was a sign that the second
00:52:53
woman is the true mother blah blah blah
00:52:55
Solomon ch es it decree and gives the
00:52:57
baby to her that that's kind of what's
00:52:59
going on here is I I think the dividing
00:53:02
your portfolio and dividing your
00:53:03
financial plan into three different
00:53:05
parts it's a bit of a judgment test as
00:53:07
to to whether the folks who you're
00:53:09
planning to work with are are thinking
00:53:11
it through and thinking your best
00:53:12
interests getting back to Chris's
00:53:14
question let's just say I was one of
00:53:16
Chris's three advisers first it's going
00:53:18
to be challenging to invest Chris's
00:53:21
third of the the pie when there's a lack
00:53:24
of knowledge about what's going on in
00:53:25
the other 2/3
00:53:26
we've talked here on the podcast before
00:53:28
about the puzzle piece metaphor building
00:53:30
a plan building a financial plan is like
00:53:32
putting together a puzzle it comprises a
00:53:34
lot of different puzzle pieces from all
00:53:36
different aspects of your financial life
00:53:38
and it really does help having all the
00:53:39
puzzle pieces in order to successfully
00:53:41
and efficiently solve the puzzle I mean
00:53:43
just imagine solving a puzzle without
00:53:44
all the pieces it just doesn't work if
00:53:47
2third of Chris's assets are being
00:53:48
invested elsewhere and I don't really
00:53:50
know what's going on there I don't know
00:53:52
how they're approaching the investment
00:53:54
problem I don't know what kind of
00:53:55
decisions they're making what kind of
00:53:56
asset allocation is going on I'm not
00:53:58
sure I can do as good a job for Chris as
00:54:01
otherwise I could so that that's a
00:54:03
negative that's a pretty big negative
00:54:04
downside second for Chris I'm a little
00:54:07
curious what You' end up doing with the
00:54:10
three parallel sets of financial
00:54:11
planning advice three different
00:54:14
retirement dates three different Roth
00:54:16
conversion plans three different
00:54:17
everything and the question is are you
00:54:20
Chris going to be the knowledgeable
00:54:22
Arbiter who determines which of those
00:54:24
three sets of plans is best because it
00:54:27
does kind of beg a question if you're
00:54:29
smart enough to rank order those three
00:54:31
Financial plans I wonder why in your
00:54:34
interview process you haven't already
00:54:36
been able to separate the wheat from the
00:54:37
chaff of these three advisers why can't
00:54:40
you already tell which adviser or
00:54:42
planner is smartest order the question
00:54:44
is if you're smart enough to tell which
00:54:46
of those three is good why aren't you
00:54:48
just doing more of it yourself why are
00:54:50
you offloading it to them in the first
00:54:52
place and I think I might know the
00:54:54
answer to my own question there and the
00:54:56
answer there is the stuff can be pretty
00:54:57
complex and you might not be able to
00:54:59
tell which planner or plan is truly the
00:55:02
best you'll probably sit there for a few
00:55:04
years during this experiment you'll
00:55:06
stress out over a question that you're
00:55:09
probably unable to truly answer that's a
00:55:11
big challenge instead and and so what
00:55:13
I've done there is I presented you with
00:55:14
a problem that you don't really have an
00:55:15
answer to and that's harsh of me to do
00:55:18
but here's the answer here's my
00:55:20
recommendation I would ask yourself do
00:55:22
you believe that this person is an
00:55:24
expert and their value will be in excess
00:55:27
of the fees that you pay so that's a yes
00:55:29
or no question that you can answer for
00:55:31
all three advisers you're not
00:55:33
necessarily ranking them one two and
00:55:35
three it's just a yes or no black or
00:55:37
white question are they an expert and
00:55:39
will their value be in excess of their
00:55:41
fees so it sounds like maybe you said
00:55:44
you you know them you trust them maybe
00:55:46
the answer is yes for all three of them
00:55:48
you know they'd be a good adviser for
00:55:49
you you just don't know which one's
00:55:51
going to be the best okay well take all
00:55:53
the ones that you answered yes to that
00:55:55
they're an expert their value will be in
00:55:57
excess of their fees and then you can
00:55:59
ask some softer questions as tiebreakers
00:56:01
such as yeah which one do I trust the
00:56:03
most which one do I want to see the most
00:56:06
right which one do I want to see once or
00:56:07
twice or three times a year for the next
00:56:09
few decades um which one has the
00:56:11
smartest contingency plan in place if
00:56:13
they get hit by a bus uh which one's
00:56:16
investment philosophy just makes the
00:56:18
most sense to me and my understanding of
00:56:20
the investment World etc etc etc these
00:56:22
are some of the questions Chris that we
00:56:24
talked about in the article that you
00:56:25
mentioned in your question that I've
00:56:27
Linked In the show notes the 16
00:56:28
questions that you should be asking a
00:56:30
financial adviser so here's another
00:56:32
thought for you though Chris and a
00:56:33
thought that I think should give you
00:56:34
some hesitation if I'm one of these
00:56:37
three advisers and I know I'm being
00:56:39
judged on investment performance
00:56:41
especially over a short period of time
00:56:44
which in the investing world might mean
00:56:45
a year or two or three or five then I'm
00:56:48
going to think okay I've got a one in
00:56:50
three chance of winning the odds are not
00:56:52
really in my favor if I invest in a
00:56:55
simple or boring or mostly index or
00:56:58
highly Diversified way then I'm going to
00:57:00
expect my performance to be pretty
00:57:02
average right I mean that's the whole
00:57:03
idea of simple boring index Diversified
00:57:06
investing we get average Market type
00:57:08
performance but in a competition with
00:57:11
many different players average is never
00:57:13
going to win so doing the right thing
00:57:15
from a certified financial planner
00:57:17
fiduciary point of view doing the right
00:57:19
thing for you Chris is actually going to
00:57:22
lose in this competition that you've set
00:57:24
up so from a game theory point point of
00:57:26
view it's your competition is going to
00:57:28
incentivize me to do what exactly well
00:57:31
to take extra risk with your money Chris
00:57:33
in order to achieve extra returns that's
00:57:35
the only way I can expect to outperform
00:57:38
my competitors I I have to take more
00:57:40
risks than them and if they're smart
00:57:42
they're thinking the exact same thing
00:57:45
and then if I'm smart I know they're
00:57:47
thinking the exact same thing so now it
00:57:49
really becomes an arms race as to who's
00:57:51
going to take the most risk that's the
00:57:53
nature of the competition that you've
00:57:55
set up and it's clearly something that
00:57:57
is not in your best interest so one of
00:57:59
my friends listener of the show Craig he
00:58:01
likes to say imagine you did the keto
00:58:03
diet for breakfast a vegan diet for
00:58:06
lunch and the Mediterranean diet for
00:58:07
dinner would you expect good results
00:58:09
from that assuming you even achieved
00:58:11
some of your health or weight goals
00:58:14
you'd have no way of knowing which of
00:58:16
those three diets was actually
00:58:17
beneficial for you or which one was the
00:58:19
most beneficial for you in conclusion
00:58:22
Chris I would recommend you not pursue
00:58:24
that idea I understand the reasoning
00:58:26
behind it it's just a a fantastic and
00:58:28
beneficial question for everyone
00:58:29
listening to hear the thought process
00:58:31
there cuz I know for a fact you're not
00:58:32
the only person who's thought that but I
00:58:35
would caution you Chris against going
00:58:36
down that path and with that thank you
00:58:38
all for listening if you enjoyed this
00:58:40
AMA go back and listen to past amas
00:58:42
which were episodes 90 86 and 81 as
00:58:46
always thank you for all those who leave
00:58:47
ratings and reviews on Apple podcast and
00:58:49
Spotify I really appreciate it if you
00:58:51
haven't yet please go leave a rating and
00:58:53
review so that others can find this
00:58:55
helpful content and as always thank you
00:58:57
for listening to the best interest
00:58:59
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00:59:07
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00:59:33
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00:59:35
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00:59:37
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00:59:40
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00:59:42
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